** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D. C. 20549**

 

**FORM 10-K**

 

| ý                                                  |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**      |
|---------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
|                                                    |   |                                                                                                |
| **For the  Fiscal Year Ended: September 30, 2003** |
|                                                    |   |                                                                                                |
| **OR**                                                  |
|                                                    |   |                                                                                                |
| o                                                       |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number: 0- 20330**

 

**GARDENBURGER, INC.**

(Exact name of registrant as specified in itscharter)

 

| **OREGON**                                                                  |   | **93-0886359**                        |
|-----------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization)            |   | (I.R.S. Employer  Identification No.) |
|                                                                        |   |                                  |
| **15615 Alton Parkway, Suite 350, Irvine, California 92618**                |
| (Address of principal  executive offices)                                   |
|                                                                        |   |                                  |
| Registrant’s telephone  number, including area code:**(949) 255-2000** |
|                                                                        |   |                                  |
| Securities  registered pursuant to Section 12(b) of the Act: **None**  |
|                                                                        |
| Securities  registered pursuant to Section 12(g) of the Act:           |
|                                                                        |
| **Common Stock, no par value**                                              |
| (Title of Class)                                                            |

 

----

 

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days:         Yesý     Noo

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K, or any amendment tothis Form 10-K.   o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Act). Yes o     No ý

 

The aggregate market value of the voting and non-voting common equityheld by non-affiliates of the Registrant was $1,755,695 computed by referenceto the last sales price as reported by the NASD’s OTC Bulletin Board ($0.31) asof the last business day of the Registrant’s most recently completed secondfiscal quarter, March 31, 2003.

 

Thenumber of shares outstanding of the Registrant’s Common Stock as ofDecember 22, 2003 was 9,002,101 shares.

 

----

 

**Documents Incorporated by Reference**

 

TheRegistrant has incorporated into Part III of Form 10-K by reference portions ofits Proxy Statement for its 2004 Annual Meeting of Shareholders.

 

 

----

 

**GARDENBURGER, INC.2003 FORM 10-K ANNUAL REPORTTABLE OF CONTENTS**

 
| **PART I**    |                                                                                            |
|---------------|-------------------------------------------------------------------------------------------------|
|          |                                                                                            |   |
| Item 1.       | Business                                                                                        |   |
|          |                                                                                            |   |
| Item 2.       | Properties                                                                                      |   |
|          |                                                                                            |   |
| Item 3.       | Legal Proceedings                                                                               |   |
|          |                                                                                            |   |
| Item 4.       | Submission of Matters to a Vote of Security  Holders                                            |   |
|          |                                                                                            |   |
| **PART II**   |                                                                                            |
|          |                                                                                            |   |
| Item 5.       | Market for Registrant’s Common Equity and  Related Stockholder Matters                     |   |
|          |                                                                                            |   |
| Item 6.       | Selected Financial Data                                                                         |   |
|          |                                                                                            |   |
| Item 7.       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations     |   |
|          |                                                                                            |   |
| Item 7A.      | Quantitative and Qualitative Disclosures  About Market Risk                                     |   |
|          |                                                                                            |   |
| Item 8.       | Financial Statements and Supplementary Data                                                     |   |
|          |                                                                                            |   |
| Item 9.       | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure           |   |
|          |                                                                                            |   |
| Item 9A.      | Controls and Procedures                                                                         |   |
|          |                                                                                            |   |
| **PART  III** |                                                                                            |
|          |                                                                                            |   |
| Item 10.      | Directors and Executive Officers of the  Registrant                                             |   |
|          |                                                                                            |   |
| Item 11.      | Executive Compensation                                                                          |   |
|          |                                                                                            |   |
| Item 12.      | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters |   |
|          |                                                                                            |   |
| Item 13.      | Certain Relationships and Related  Transactions                                                 |   |
|          |                                                                                            |   |
| Item 14.      | Principal Accountant Fees and Services                                                          |   |
|          |                                                                                            |   |
| **PART IV**   |                                                                                            |
|          |                                                                                            |   |
| Item 15.      | Exhibits, Financial Statement Schedules and  Reports on Form 8-K                                |   |
|          |                                                                                            |   |
| Signatures    |                                                                                            |

 

1

----

 

**PART I**

 

**Item 1.  Business**

 

**WhereYou Can Find More Information**

 

We file annual, quarterly and special reports, proxy statements andother information with the Securities and Exchange Commission (“SEC”) under theSecurities Exchange Act of 1934 as amended (“Exchange Act”). You can inspectand copy our reports, proxy statements, and other information filed with theSEC at the offices of the SEC’s Public Reference Room in Washington, D.C.Please call the SEC at 1-800-SEC-0330 for further information on the Public ReferenceRoom. The SEC maintains an Internet site at http://www.sec.gov/ where you canobtain most of our SEC filings. We also make available, free of charge on ourwebsite at www.gardenburger.com, our annual reports on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K, and amendments to thosereports filed or furnished pursuant to Section 13(a) or 15(d) of theExchange Act as soon as reasonably practicable after they are filedelectronically with the SEC.  The information found on our website is notpart of this Form 10-K. You can also obtain copies of these reports bycontacting Investor Relations at (949) 255-2000.

 

**General**

 

Gardenburger, Inc. was organized in 1985 as an Oregoncorporation under the name Wholesome & Hearty Foods, Inc. and completed itsinitial public offering in 1992.  InOctober 1997 we changed our name to Gardenburger, Inc; and, as our productline expanded to include meat alternative offerings beyond veggie burgers, begandoing business in 2002 as Gardenburger Authentic Foods Company.  Our common stock trades on theover-the-counter market and is quoted on the NASD’s OTC Bulletin Board.

 

**Overview**

 

We believe we are one of the leading producers and marketers of meatalternative products and branded veggie burgers. The Gardenburger® product lineis a national brand in the retail grocery, food service, club store and naturalfoods channels of distribution and features core burger offerings such as theOriginal Gardenburger® veggie burger, analog soy burgers such as GardenburgerFlame Grilled, and innovative non-burger items such as Gardenburger RibletsTMmeat analog rib with sauce and Meatless Meatloaf meat analog in browngravy.

 

Several factors beyond healthy eating have contributed to the growth ofmeat substitutes.  Consumer reaction tobad publicity related to meat recalls and the heightened publicity surroundingmeat farming practices and their effect on human health and the environment hasfueled the growth of imitation meat sales in the United States and Canada.  According to AC Nielsen data, annual grocerysales of imitation meat in the United States grew at an annual growth rate of6% between 2002 and 2003.  Gardenburgerwas a pioneer in the meatless burger segment of the category and, in tandemwith recent consumer trends favoring low-carbohydrate foods, has expanded itsproduct offerings to include center-of-the-plate, soy-based meatless optionssuch as a chicken fillet, pork ribs and meatballs.  In fiscal 2002, we launched three new products, our Herb CrustedCutletTM, Crispy NuggetsTM and Breakfast Sausage, and in fiscal 2003, we launchedfive new products, our BBQ Chik’n, Meatless Meatloaf, Meatless Sweet & SourPork, Buffalo Chik’n Wings, and Country Fried Chik’n with Creamy Pepper Gravy.

 

While we believe Gardenburger enjoys solid brand awareness, ourindustry is highly competitive and includes both large food companies andsmaller independent manufacturers.  Inthe first quarter of fiscal 2004, we began shipping reformulated grain burgersand using redesigned packaging consistent with our efforts to position ourproducts as supporting a 100% natural and healthy lifestyle.  Fat gram, protein gram and net carbohydrategram information will be added to the front of the packaging to help consumersbetter understand the nutritional value of our products.

 

We intend to continue as an innovative force in the meat alternativecategory with the objective of being a leading provider of meatless mealalternatives in the four primary distribution channels in which we distributeour products: retail grocery stores; food service, including restaurants,universities

 

2

----

 

and other commercial outlets; club stores; and natural foods outlets.We currently distribute our products through more than 24,000 retail outlets,30,000 food service outlets, 325 club store locations and 3,500 natural foodsstores.

 

Within the retail grocery channel, our largest channelof distribution, we have approximately 154,000 retail grocery placements of ourproducts, representing an all commodity volume (“ACV”)(1) penetration ofapproximately 77% as of September 30, 2003, with an average of 5 productvariations available in each retail outlet. Each product is commonly referred to as a stock keeping unit (“SKU”).

 

**BusinessStrategy**

 

In recent years, we have seen increased competition inthe meat alternative category, including the veggie burger segment, and haveseen our market penetration of meat alternative burgers decline due to heavyspending by competitors and changes in consumers’ eating habits.  Our business strategy consists of thefollowing key elements:

 

***Focus on AchievingProfitability. ***Weare focused on achieving near-term profitability.  In furtherance of this goal, fixed overhead is closely monitoredand, in November 2003, our Portland, Oregon administrative office wasclosed with four positions eliminated, certain positions relocated to our Utahmanufacturing facility and the remainder relocated to a new, smaller office inIrvine, California. Trade and marketing spending is focused on new productsupport and incentives to customers and end consumers as we believe thisapproach has the quickest and most direct impact on sales. There is noassurance that we will be able to successfully achieve near-term profitabilityor maintain our market share in the veggie burger segment, particularly giventhe current highly competitive retail market.

 

***Introduce NewProducts Beyond Veggie Burgers.****** ***In fiscal 2003, as infiscal 2002, we continued to move beyond the veggie burger segment of the meatalternative category.  Consumers areadding new items to their menu with increasing frequency and the meatalternative category growth is primarily in the non-burger segment.  According to AC Nielsen data, grocery unitsales in the veggie burger segment decreased approximately 6% in fiscal 2003;however, unit sales in the non-burger meat alternative segment increasedapproximately 6%.  To take advantage ofthis trend, we launched Riblets, a meatless barbequed rib alternative, andMeatless Meatballs in the fourth quarter of fiscal 2001; and we launchedBreakfast Sausage, a meatless sausage patty alternative, Herb Crusted Cutlet, abreaded cutlet alternative, and Crispy Pizza Nuggets, a spicy veggie nugget, infiscal 2002.  We followed those effortswith the launch of five products in fiscal 2003, including BBQ Chik’n, MeatlessMeatloaf with brown gravy, Meatless Sweet & Sour Pork, Buffalo Chik’n Wingsand Country Fried Chik’n with creamy pepper gravy.  We believe that new product introductions in other segments ofthe meat alternative category will support our efforts to maintain a strongposition in all channels and reinforce our brand equity.

 

***Increase Key ChannelPenetration.**** *We**believethat we are one of the leading producers and marketers of meatless products inthe retail grocery, food service, club store and natural foods distributionchannels.  Our goal is to manage astrong brand position in these channels with profitability in allchannels.  We recognize that increasedcompetition in the grocery channel may result in a loss of grocery marketshare.  We are pursuing profitablegrowth in the food service channel where we have a strong market positionacross key business segments.  We wereselected as a vendor of choice in the Sysco Corporation launch of its MoonroseVegetarian line, a private label brand of premium products targeted at theemergent food service natural foods segment.  In addition, we believe that other distribution channels, such as fastfood chains, K-12 schools and colleges and universities, present growthopportunities, and we continue to actively pursue these opportunities throughsales calls to potential customers and research into product types that bestsuit the particular markets.

 

----

(1)  ACV calculates the percentage of U.S. stores that carryat least one Gardenburger product.

 

3

----

 

**Products**

 

Gardenburger is committed to offering great tasting,better for you, convenient meatless food choices to consumers.  All of our products are frozen and include:grain-based and soy-based veggie burgers, which are offered in seven varieties,and include specialized burger products in certain channels, including GardenburgerSub® for food service and GardenVegan® for natural food stores.  We also offer a variety of meat analogproducts including Chik’n Grill, Meatless Riblets, Meatless Meatloaf, and HerbCrusted Cutlet, all of which imitate the taste and texture of meat, chicken orpork products.

 

The recipes for our products are proprietary, althoughthey contain commonly known ingredients. Veggie-grain based burgers contain fresh mushrooms, brown rice or otherwhole grains, onions, rolled oats, cheeses, bulgur wheat, natural seasoningsand spices.  Soy-based products areseasoned to taste like chicken, pork or beef. All of our meat alternative products are considerably lower in fat andcalories than respective meat products of comparable weight, are good sourcesof protein and are 100% natural.

 

Our products are as follows:

 

**RetailGrocery Veggie Grain Products**

 
| **Product**                                                                          |   | **Description**            |   | **Characterizing Ingredients**                                                             |   | **Fat** |   | **Calories** |   |
|--------------------------------------------------------------------------------------|--------|----------------------------|--------|--------------------------------------------------------------------------------------------|--------|---------|--------|--------------|--------|
| The Original  Gardenburger® sold in boxes of 4/2.5 oz. servings                 |   | Veggie-grain style burger  |   | Mushrooms, kashi blend, soy, onions, rolled  oats and low-fat cheese                       |   | 3       | g      | 90           |   |
|                                                                                 |   |                       |   |                                                                                       |   |    |   |         |   |
| Gardenburger  Black BeanTM  sold in boxes of 4/2.5 oz. servings                  |   | Spicy burger               |   | Black beans, soy, Anaheim chilies, red and  yellow bell peppers, cilantro                  |   | 2       | g      | 80           |   |
|                                                                                 |   |                       |   |                                                                                       |   |    |   |         |   |
| Gardenburger  Veggie Medley® sold in boxes of 4/2.5 oz. servings                |   | Veggie-grain style burger  |   | Soy, mushrooms, kashi blend, broccoli,  carrots, red and yellow bell peppers               |   | 2       | g      | 90           |   |
|                                                                                 |   |                       |   |                                                                                       |   |    |   |         |   |
| Gardenburger  Savory PortabellaTM  sold in boxes of 4/2.5 oz. servings           |   | Gourmet burger             |   | Portabella mushrooms, wild rice, soy, blue  cheese, kashi blend                            |   | 2.5     | g      | 100          |   |
|                                                                                 |   |                       |   |                                                                                       |   |    |   |         |   |
| Gardenburger  Sun-Dried Tomato BasilTM sold in boxes of 4/2.5 oz. servings       |   | Gourmet burger             |   | Roasted garlic, sun-dried tomatoes, soy,  mushrooms, kashi blend, mozzarella cheese, basil |   | 3       | g      | 100          |   |
|                                                                                 |   |                       |   |                                                                                       |   |    |   |         |   |
| Gardenburger  GardenVegan® sold in boxes of 4/2.5 oz. servings                  |   | Veggie-grain style burger  |   | Bulger wheat, brown rice, mushrooms, onions                                                |   | 1       | g      | 100          |   |
|                                                                                 |   |                       |   |                                                                                       |   |    |   |         |   |
| Gardenburger  Pizza NuggetsTM sold in 8 oz. packages of approximately 18 nuggets |   | Pizza-Spiced Veggie Nugget |   | Mozzarella cheese, brown rice, tomato paste                                                |   | 9       | g      | 180          |   |

 

4

----

 

**RetailGrocery Meat-Like Products**

 
| **Product**                                                                           |   | **Description**                               |   | **Characterizing  Ingredients**                                             |   | **Fat** |   | **Calories** |   |
|---------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|-----------------------------------------------------------------------------|--------|---------|--------|--------------|--------|
| Gardenburger  Homestyle ClassicTM sold in boxes of 4/2.5 oz. servings             |   | Hamburger analog                              |   | Soy                                                                         |   | 5       | g      | 110          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Flame Grilled® Hamburger Style sold in boxes of 4/2.5 oz. servings |   | Flame grilled hamburger analog                |   | Soy                                                                         |   | 4       | g      | 120          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Flame Grilled Chik’nTM sold in boxes of 4/2.5 oz. servings     |   | Flame grilled analog chicken                  |   | Soy, wheat gluten                                                           |   | 2.5     | g      | 100          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  BBQ Chik’nTM sold in 10 oz. packages                           |   | Analog chicken  with sauce               |   | Soy, wheat gluten, barbecue sauce                                           |   | 8       | g      | 250          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Buffalo Chik’n WingsTM sold in 10 oz. packages                 |   | Analog chicken wings in hot sauce             |   | Soy, wheat gluten, pepper sauce                                             |   | 12      | g      | 180          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Country Fried Chik’n with Creamy Pepper GravyTM                |   | Analog chicken cutlet                         |   | Breading, soy, wheat gluten, cream gravy                                    |   | 9       | g      | 190          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Meatless RibletsTM sold in boxes of 2/5 oz. servings                |   | Analog pork rib with sauce                    |   | Soy, wheat gluten, barbecue sauce                                           |   | 5       | g      | 210          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Sweet & Sour PorkTM sold in 10 oz. packages                     |   | Analog pork pieces in sweet & sour  sauce |   | Soy, wheat gluten, sweet & sour sauce,  green peppers, onion, pineapple |   | 2       | g      | 170          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Herb Crusted CutletTM sold in boxes of 4/2.5 oz. servings           |   | Analog pork or veal cutlet                    |   | Breading, soy, wheat gluten                                                 |   | 9       | g      | 170          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Breakfast SausageTM sold in boxes of 6/1.5 oz. patties              |   | Analog breakfast sausage                      |   | Soy                                                                         |   | 3.5     | g      | 50           |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Meatless MeatballsTM sold in 10 oz. packages                        |   | Analog meatball                               |   | Soy, bread crumbs                                                           |   | 4.5     | g      | 110          |   |
|                                                                                  |   |                                          |   |                                                                        |   |    |   |         |   |
| Gardenburger  Meatless MeatloafTM sold in 10 oz.   packages                  |   | Analog meatloaf                               |   | Soy, brown gravy                                                            |   | 3.5     | g      | 130          |   |

 

**ClubChannel Products**

 
| **Product**                                                               |   | **Description**            |   | **Characterizing  Ingredients**     |   | **Fat** |   | **Calories** |   |
|---------------------------------------------------------------------------|--------|----------------------------|--------|-------------------------------------|--------|---------|--------|--------------|--------|
| Original  Gardenburger sold in packages of 17/3.5 oz. servings            |   | Veggie-grain style burger  |   | Kashi blend, soy, mushrooms, cheese |   | 4       | g      | 130          |   |
|                                                                      |   |                       |   |                                |   |    |   |         |   |
| Gardenburger  Herb Crusted Cutlet sold in packages of 12/3.0 oz. servings |   | Analog pork or veal cutlet |   | Breading, soy, wheat gluten         |   | 11      | g      | 210          |   |
|                                                                      |   |                       |   |                                |   |    |   |         |   |
| Gardenburger  Meatless Riblets sold in packages of 8/5.0 oz. servings     |   | Analog pork rib with sauce |   | Soy, wheat gluten, barbecue sauce   |   | 5       | g      | 210          |   |

 

5

----

 

**FoodService Products**

 
| **Product**                                           |   | **Description**                        |   | **Characterizing Ingredients**                                                         |
|-------------------------------------------------------|--------|----------------------------------------|--------|----------------------------------------------------------------------------------------|
| 48/3.4 oz.  Original Gardenburger                     |   | Veggie-grain  style burger             |   | Mushrooms, brown  rice, onions, rolled oats and low-fat cheese                         |
|                                                  |   |                                   |   |                                                                                   |
| 60/2.5 oz.  Original Gardenburger                     |   | Veggie-grain  style burger             |   | Mushrooms, brown  rice, onions, rolled oats and low-fat cheese                         |
|                                                  |   |                                   |   |                                                                                   |
| 48/2.75 oz.  Gardenburger SubTM                   |   | Veggie-grain style burger              |   | Mushrooms, brown  rice, onions, rolled oats, red bell pepper and feta cheese           |
|                                                  |   |                                   |   |                                                                                   |
| 48/3.4 oz.  Gardenburger Veggie Vegan®           |   | Veggie-grain style burger              |   | Bulger wheat, brown rice, rolled oats,  broccoli, carrots, red and yellow bell peppers |
|                                                  |   |                                   |   |                                                                                   |
| 48/3.4 oz.  Gardenburger Santa Fe®               |   | Spicy, Mexican  flavor burger          |   | Red and black  beans, Anaheim chilies, red and yellow bell peppers, cilantro           |
|                                                  |   |                                   |   |                                                                                   |
| 48/3.4 oz.  Flame Grilled SoyTM                   |   | Flame grilled  hamburger analog burger |   | Soy                                                                                    |
|                                                  |   |                                   |   |                                                                                   |
| 36/5 oz. Garden  SteakTM                          |   | Veggie-grain  style burger             |   | Mushrooms, brown  rice, onions, rolled oats and low-fat cheese                         |
|                                                  |   |                                   |   |                                                                                   |
| 48/3.4 oz.  Gardenburger Fire Roasted Vegetable® |   | Gourmet burger                         |   | Roasted garlic, sun-dried tomatoes                                                     |
|                                                  |   |                                   |   |                                                                                   |
| 106/1.5 oz.  GardenSausage®                      |   | Sausage patty analog                   |   | Soy                                                                                    |
|                                                  |   |                                   |   |                                                                                   |
| 4/2.5#  Meatless CrumblesTM                       |   | Ground hamburger analog                |   | Soy                                                                                    |
|                                                  |   |                                   |   |                                                                                   |
| 53/3.0 oz.  Chik’n GrillTM                   |   | Flame grilled  analog chicken          |   | Soy, wheat  gluten                                                                     |
|                                                  |   |                                   |   |                                                                                   |
| 1/10# (220  Nuggets) Chik’n NuggetsTM        |   | Breaded nuggets  of analog chicken     |   | Breading, soy,  wheat gluten                                                           |
|                                                  |   |                                   |   |                                                                                   |
| 48/3.4 oz.  Diner Deluxe BurgerTM                 |   | Fried hamburger  analog burger         |   | Soy protein                                                                            |
|                                                  |   |                                   |   |                                                                                   |
| 48/3.4 oz.  Gardenburger Black Bean                   |   | Soy-grain veggie  hybrid burger        |   | Soy, black  beans, brown rice                                                          |
|                                                  |   |                                   |   |                                                                                   |
| 48/2.75 oz.  Flame Grilled Sub PattyTM            |   | Flame grilled hamburger  analog burger |   | Soy                                                                                    |

 

**Distribution**

 

We primarily distribute our products into fourchannels: retail grocery, food service, club stores and natural foods stores.

 

***Retail Grocery****.*Gardenburger veggie burgers can now be found in more than 24,000 grocery storeswith over 154,000 placements.  Our ACVpenetration in the U.S. retail grocery channel was approximately 77% as ofSeptember 30, 2003, with an average of 5 SKUs.  Our products are currently carried in the majority of the majorU.S. retail grocery chains.

 

***Food Service****.*We distribute our products to more than 30,000 food service outlets throughoutthe U.S. and Canada, including restaurant chains such as Applebee’s,Fuddruckers, Marie Callenders, Red Robin, Subway and T.G.I. Friday’s.  In many of these restaurants, theGardenburger brand name appears on the menu. Additional points of food service distribution include academicinstitutions, hotels and other outlets, including amusement parks and sportsstadiums.  In the United States, thereare approximately 800,000 outlets in the food service channel.  We rely primarily on distributors such asSysco for distribution to this channel.

 

6

----

 

***Club Stores.***Ourproducts are distributed to club stores with over 325 locations, includingCostco.  Currently, these stores carrythe Original Gardenburger and the Gardenburger Herb Crusted Cutlet.  Costco has decided to remove the Kirkland Signatureco-branding from our original packaging, effective in early 2004.  Accordingly, the Costco club stores willcease to require system-wide distribution of our Original Gardenburger product,which may have a significant adverse impact on our club store sales for theremainder of fiscal 2004 and beyond. Gardenburger Meatless Riblets have been accepted for test in both Sam’sClub and Costco in early 2004.

 

***Natural Foods.***Ourproducts are distributed to more than 3,500 natural food stores, includingWhole Foods and Wild Oats.  We utilizefood brokers that specialize in natural foods stores.

 

Our ability to expand distribution in each of the described channelswill depend in part on consumer preferences, and to a certain extent oncontinuation of the current trends of health awareness.  There is always a risk that furtherdevelopment of low fat red or white meat products or technological advancesthat limit food-borne disease risks may lead to a change in consumerpreferences and reduce demand for meat replacement products.  Demand for our products may be adverselyaffected by external factors, including dietary concerns about carbohydratesand ingredient preferences, which may occur rapidly and without warning.Because of our current dependence on meatless burgers and meat analogs, anychanges in consumer preferences or increase in competition in the meatalternative market segment would adversely affect our business to a greaterdegree than if we had multiple product lines.

 

We sell our products in North America, primarilythrough more than 100 independent, commissioned food brokers and 1,000 activedistributors. The retail food brokers are independent sales organizations,which have close working relationships with the leading grocery chains, clubstores and natural food stores. The food brokers arrange for sales ofGardenburger products, which we then ship and bill directly to theretailers.  Products sold into the foodservice channel are purchased directly by distributors, which arrange forshipment by temperature-controlled truck to their frozen storage warehouses inprincipal cities throughout the U.S. for distribution to U.S. food serviceoutlets and some Canadian grocery and food service outlets. Sales todistributors and retailers are final sales and, historically, we have notexperienced significant levels of return product requests.

 

We have no non-cancelable long-term contracts with our food brokers ordistributors and occasionally change brokers or distributors in an effort toincrease coverage in a geographic region. We could experience a substantial temporary or permanent decline in netsales if one or more of our major food brokers or distributors were todiscontinue handling our products, go out of business, or decide to emphasizedistributing products of our competitors.

 

Contract Management Companies, which manage cafeterias and otherinstitutional eating establishments, also purchase our products.  Examples of the additional points of foodservice distribution reached through the Contract Management Companies includeacademic institutions, hotels, amusement parks and sports stadiums. ContractManagement Companies typically purchase our products through distributors andprovide us with an additional means to distribute our products.

 

7

----

 

The following table lists selected retailers,distributors and food service outlets that offer our products for sale toconsumers:  

 

**Retail**

 

**Grocery**

A&P

AWG

Albertsons

Burris Foods Wholesale

C&S Wholesale

Cub Stores

Demoulas

Dillon’s Stores

Dominick’s

Fleming Wholesale

Fred Meyer

Giant Eagle

Giant Food

Hannaford

Jewel

King/Cullen

King Supers

Kroger

Marsh

Meijers

Publix Super Markets

QFC

Rainbow Foods

Raley’s

Ralph’s

Randall’s

Safeway

Shaw’s

Smith’s

Shoprite

Stop and Shop

Supervalu Wholesale

Thriftway

Tops

Von’s

Wakefern

Wal-Mart

Wegmans

White Rose Wholesale

Winn-Dixie

 

**Natural Foods**

Wild Oats

Whole Foods

 

**Club Stores**

Costco

Sam’s Club

 

**Food Service**

**Distributors**

Food Services of America

Dot Foods

Sysco

Gordon Food Service

Reinhart Food Service

U. S. Food Service

 

**Restaurants**

Applebee’s

Arctic Circle

A&W

Burgerville

Friendly’s

Dairy Queen

Damon’s

Flamers

Foster Freeze

Fuddruckers

IHOP

Lyons

Marie Callenders

Red Robin

Subway

T.G.I. Friday’s

 

**Hotels**

Marriott

Sheraton

## ** **

**Universities**

Colorado University

DePaul

Harvard

Indiana University

Johns Hopkins University

MIT

Princeton

Purdue

Stanford

University of California, Berkeley

UCLA

University of Chicago

USC

 

**Sports/Entertainment**

Dodger Stadium

Yankee Stadium

Rose Garden Arena

Six Flags

Universal Studios

 

**Contract Management Companies**

ARAMARK

Avendra

Foodbuy

Gukenheimer

Sodexho

 

8

----

 

Our sales by region are as follows: 

 
|       |   | **% of Gross Sales** |   |
|------------|--------|----------------------|--------|
| **Region** |   | **FY 2003**          |   | **FY 2002** |   | **FY 2001** |   |
| Northeast  |   | 24                   | %      | 31 | % | 27 | % |
| Southwest  |   | 12                   |   | 5 |   | 6 |   |
| Midwest    |   | 18                   |   | 16 |   | 16 |   |
| Northwest  |   | 26                   |   | 36 |   | 34 |   |
| Southeast  |   | 16                   |   | 8 |   | 13 |   |
| Canada     |   | 4                    |   | 4 |   | 4 |   |
|       |   | 100                  | %      | 100 | % | 100 | % |

 

To date, we have focused our sales efforts primarily in North America,and international sales have not been material.

 

**Sales and Marketing**

 

***Sales*.**  Our sales objective is to manage a strongmarket position with our veggie burgers and other meat alternative products inthe retail grocery, food service, club store and natural foods store channelsand to continue our expansion beyond veggie burgers in the meat alternativecategory.  Our use of regional foodbrokers as our representatives allows us to maintain contact with the nation’smajor retail grocery chains and food service outlets without a large internalsales force.  Brokers are paid salescommissions on all products sold.

 

Our regional sales force is located strategically in our primarygeographic sales regions and in proximity to our brokers and is divided into afood service division, a retail division and a club division.  The regional sales directors have substantialsales and industry experience. These regional sales directors coordinate theefforts of the food brokers and distributors.

 

***Marketing*.**  Our marketing efforts take advantage of keyseasonal periods for burgers.  Factorssuch as the aging population, obesity concerns and consumer interest in healthyliving continue to stimulate positive consumer acceptance.  We utilize free standing inserts and in-packcoupons, website communication and in-store advertising to market our products.

 

**Researchand Development**

 

Our research and development activities are focused onthe development of new meat alternative products outside the veggie burgersub-category of the meat alternative market, as well as improvement andincreased efficiency in the manufacturing process.  We continue to develop non-burger items such as breakfastsausage, cutlets and nuggets to meet the needs of the variety-seeking consumer.We conduct our research and development activities at our facilities in Clearfield,Utah.

 

In fiscal 2003, 2002 and 2001, we spent approximately $235,000,$222,000 and $188,000, respectively, on research and development activities,which are included in sales and marketing expense.

 

**Manufacturing**

 

Our 120,000 square-foot Clearfield facility handles multiple manufacturinglines for our products.  We believe theClearfield facility will be able to support our growth plans for theforeseeable future.

 

The manufacturing process involves cleaning, choppingand mixing the ingredients; then forming, baking and quick-freezing theproducts and finally packaging them. The manufacturing process at our Clearfield facility is highlyautomated, mixing and baking products in assembly-line fashion with minimalhuman interaction.  The Clearfieldfacility also utilizes newly-developed, proprietary ovens that quickly cook theproducts.  Products are shipped, fullycooked, frozen and packaged, via temperature controlled trucks to distributorsthroughout North America.

 

9

----

 

We consider food safety a high priority and haveprepared, in conjunction with government agencies, a Hazard Analysis andCritical Control Point (“HACCP”) system and other programs directed at ensuringthe safety of our products.  HACCP is acomprehensive system that food companies use to monitor specific steps in foodproduction to identify safety issues. Using this type of system, we can focus on the areas in which greatestrisks exist and implement preventive measures.

 

A significant disruption in our Clearfield facility’s productioncapacity as a result of, for instance, fire, severe weather, regulatoryactions, work stoppages or other factors, could disable our capacity tomanufacture our products.  If our meatalternative products become less available, consumers may switch to anotherbrand of products and grocery stores may reduce shelf space allocated to ourproducts.  Any significant disruption inmanufacturing would likely have a material adverse effect on our results ofoperations and financial condition.

 

**Seasonality**

 

The third and fourth quarters of our fiscal year typically havestronger sales due to the summer grilling season.  We typically build inventories during the first and secondquarters of each fiscal year in anticipation of increased sales in the third andfourth fiscal quarters.

 

**Competition**

 

The market for veggie burgers and other meat alternative products ishighly competitive. Our products compete primarily on the basis of brandpreference, taste, innovation, quality of natural ingredients, ease of preparation,availability, price and consumer awareness. We believe that our productscompare favorably to those offered by our competitors in all of theseareas.  We price our productscompetitively to our primary competitors. The calorie and fat content ofGardenburger® products is generally equivalent to that of competitors’products. According to AC Nielsen, sales of our veggie burger productsrepresented 19.7% and 22.3% of the total veggie burger sales during fiscal 2003and fiscal 2002, respectively.

 

We believe that our principal competitors are The Kellogg Company,which distributes its products under the “Morningstar Farms” and “HarvestBurger” brand names to the food service and retail grocery channels; and PhilipMorris/Kraft Food Products, which distributes soy-based meat analog productsprimarily in the food service, retail grocery, club and natural food channelsunder the “Boca Burger” label.   Thesecompanies have substantially greater financial and marketing resources thanus.  In addition, other major nationalfood products companies could decide to produce meat alternative products atany time in the future.

 

Our products also compete indirectly with low fat meatproducts, such as ConAgra’s Healthy Choice 96% Extra Lean Ground Beef burger,and chicken or turkey based low fat products distributed by several largecompanies such as Tyson Foods, and with frozen, mass-produced low calorie/lowfat entrees, including national brands such as Healthy Choice, Lean Cuisine andWeight Watchers.  Large companies withsubstantially greater financial resources, name recognition and marketingresources than us produce these products.

 

**SignificantCustomers**

 

Costco Wholesale, Sysco Foods and Dot Foods, Inc., accounted forapproximately 13%, 12% and 9%, respectively, of our fiscal 2003 gross revenuebefore trade discounts.  AtSeptember 30, 2003, Costco Wholesale, Sysco Foods and Dot Foods, Inc.accounted for approximately 18%, 5% and 11% of the outstanding accounts receivablebalance, respectively.  Costco has decidedto remove the Kirkland Signature co-branding from our product packagingeffective in early 2004, which may result in a significant decline in revenuesattributable to Costco because our products will no longer be required to bedistributed throughout the Costco system.

 

Sysco is a food service distributor and sells our products torestaurants, hotels, and other food service customers. Dot is a redistributor;they sell our products to other, smaller distributors. The loss of thesecustomers could have a material adverse effect on our business; however, thereare competing food service distributors through which our products could bepurchased by the end users.

 

10

----

 

**Sources of Supply**

 

Gardenburger uses natural ingredients such as mushrooms, oats, rice,onions and soy protein.  These arecommon agricultural items typically available in most parts of the UnitedStates.  In addition, we use packagingand other materials that are common in the food industry.  As a result, we believe, but cannotguarantee, that our sources of supply are reasonably reliable and that we areat no greater risk regarding supply issues than other similar food processorsand producers.

 

**Employees**

 

As of November 15, 2003, following the move ofour corporate headquarters to Irvine, California, we had approximately 188full-time equivalent employees, with approximately 153 of them employed at ourClearfield facility.  None of ouremployees are subject to a collective bargaining agreement, and we believe ourrelations with our employees to be good.

 

**IntellectualProperty**

 

We have approximately 25 U.S. registered trademarks, including“Gardenburger,” “Gardenburger Hamburger Style,” and “GardenSausage.”  We have registered certain trademarks inAustralia, Canada, France, Germany, Japan, Mexico and the United Kingdom, alongwith other smaller countries.

 

We actively monitor use of our trademarks by foodservice customers and others and take action we believe appropriate to haltinfringement or improper usage.  Wedefend our intellectual property aggressively and, from time to time, have beenengaged in infringement protection activities. Nonetheless, in the event third parties infringe or misappropriate ourtrademarks, we may have to incur substantial costs to protect our intellectualproperty or risk losing our rights.  Anylarge expenditure or loss of rights could have a material adverse effect on ourresults of operations, cash flows and financial position.

 

We generally do not seek patents for our recipes orproduction methods and, therefore, can protect them only as trade secrets.  Some or all of these trade secrets could beobtained by others or could enter the public domain, which could place us at acompetitive disadvantage.

 

##### **In an effort to protect our tradesecrets, all of our employees sign an “Employees Proprietary Rights andConfidentiality Agreement,” which states that they will not disclose ourmanufacturing processes, recipes, customer lists or other confidential materialvital to our business.  In addition,senior sales, marketing and administrative personnel sign non-competeagreements, which prohibit them from working for a competitor for specifiedperiods of time upon the termination of their employment with Gardenburger.**

 

**Management Information Systems**

 

We utilize a single Baan enterprise resource planning system, which isexpected to meet our information system needs for the foreseeable future.  In addition to integrating manufacturing,sales and accounting functions, the Baan system provides real-time informationfor management analysis and use in operations. The Baan system aids management with production planning (planning ofraw material purchases) and demand forecasting (matching supply to distributioncenters with order volume) capabilities. The Baan system also includes pallet tagging, bar coding and scanningapplications that facilitate tracking of raw materials and finished goodsthrough our manufacturing operation. The Baan system enables us to use electronic data interchange (“EDI”) ifdesired by customers and suppliers, which we believe expedites order entry,payment and cash collection processes.

 

**Government Regulation**

 

The manufacturing, packaging, storage, distribution and labeling offood products are subject to extensive federal and state laws andregulations.  The FDA has issuedregulations governing the ingredients that may be used in food products, thecontent of labels on food products and the labeling claims that may be made forfoods.  Foods may only includeadditives, colors and ingredients that are either approved by the FDA orgenerally recognized as safe.  Ourproducts must be manufactured in compliance with the FDA’s current GoodManufacturing Practice regulations applicable to food.

 

11

----

 

Regulators have broad powers to protect public health,including the power to inspect our products and facilities, to order theshutdown of a facility or to seize or stop shipment of our products and order arecall of previously shipped products, as well as the power to imposesubstantial fines and seek criminal sanctions against us or our officers.  While we currently carry $1 million ofinsurance against the cost of a product recall, a significant recall could havean adverse effect on our results of operations, cash flows and financialcondition. In addition, negative publicity may result if regulators take any ofthe foregoing actions against us or if we were to voluntarily recall productsto avoid regulatory enforcement.

 

**Insurance**

 

We maintain insurance against various risks related to ourbusiness.  This includes property andcasualty, business interruption, director and officer liability, food spoilage,product liability, product recalls and workers’ compensation insurance.  We currently maintain $1 million of productrecall insurance coverage, $2 million of product liability insurance coverageand $20 million of general umbrella coverage. We consider our policies adequate to cover the major risks in ourbusiness, but there can be no assurance that this coverage will be sufficientto cover the cost of defense or damages in the event of a significant productliability claim.

 

**Item 2.  Properties**

 

In November 2003, we moved our administrative office space fromPortland, Oregon to Irvine, California, where we lease approximately 5,200square feet of administrative office space pursuant to an operating lease withan initial term of three years. Current monthly rent is approximately $10,300.  This lease expires October 31, 2006 andhas one renewal option for 24 months.

 

Our Portland, Oregon facility lease expires December 31,2003.  Monthly rent is approximately$19,000.  We vacated this facility inNovember 2003.

 

We lease 120,000 square feet of production space atFreeport Center, Building A-16, in Clearfield, Utah, pursuant to a lease thatwill terminate on December 31, 2007. We have the option to renew the lease for one additional five-year termcommencing January 1, 2008.  Themonthly rent on this facility is currently $33,500.  Our Clearfield, Utah production facility can support sales levelsof approximately $220 million at current pricing levels.  Given our current level of sales, we areoperating the facility at approximately 35% of overall capacity.

 

We also lease 22,000 square feet of storage space at the FreeportCenter in Clearfield on a month-to-month basis.  The monthly rent for the storage space is $6,600.

 

**Item 3.  Legal Proceedings**

 

There are currently no material, pending legal proceedings to which weare a party.  From time to time, webecome involved in ordinary, routine or regulatory legal proceedings incidentalto our business.

 

**Item 4.  Submission of Matters to a Vote ofSecurity Holders**

 

During the fourth quarterof fiscal 2003, the holders of our Series C and Series D ConvertiblePreferred Stock approved an amendment to our Amended and Restated RightsAgreement dated July 15, 1999. Under the amendment, no person would be deemed an acquiring person as aresult of participation in negotiations with certain members of our management,our preferred shareholders, and the holder of our convertible seniorsubordinated debt regarding a going-private transaction.  Those negotiations were abandoned asannounced in our report on Form 8-K filed August 19, 2003.  The amendment was approved at a specialmeeting of preferred shareholders held on August 18, 2003 by the followingvote:

 
| **Votes For** |   | **Votes Against** |   | **Abstentions** |   | **Broker Non-Votes** |   |
|---------------|--------|-------------------|--------|-----------------|--------|----------------------|--------|
| 2,400,000     |   | —            |   | —          |   | —               |   |

 

12

----

 

**PARTII**

 

**Item 5.  Market for Registrant’s Common Equity andRelated Stockholder Matters**

 

Our common stock trades on the over-the-counter marketand is quoted on the NASD’s OTC Bulletin Board.  Over-the-counter market quotations reflect inter-dealer prices,without retail mark-up, mark-down or commission and may not necessarilyrepresent actual transactions. The high and low bid quotations for the last twofiscal years were as follows:

 
| **Fiscal  2002** |   | **High** |   | **Low** |   |
|------------------|--------|----------|--------|---------|--------|
| Quarter 1        |   | $        | 0.68   |    | $      | 0.19 |   |
| Quarter 2        |   | 1.45     |   | 0.22    |   |
| Quarter 3        |   | 2.25     |   | 0.63    |   |
| Quarter 4        |   | 0.96     |   | 0.41    |   |
|                  |        |          |        |         |        |  |  |

 
| **Fiscal  2003** |   | **High** | ** ** | **Low** | ** ** |
|------------------|--------|----------|------------|---------|------------|
| Quarter 1        |   | $        | 0.85       |    | $          | 0.25 |   |
| Quarter 2        |   | 0.51     |       | 0.25    |       |
| Quarter 3        |   | 0.55     |       | 0.26    |       |
| Quarter 4        |   | 0.53     |       | 0.24    |       |
|                  |        |          |            |         |            |  |  |

 

The number of shareholders of record and approximatenumber of beneficial owners of our common stock at December 12, 2003 were624 and 5,500, respectively.

 

There were no cash dividends declared or paid infiscal 2003 or 2002 on our common stock and we do not anticipate declaring cashdividends on our common stock in the foreseeable future.  Under the terms of our loan agreement withCapitalSource Finance LLC, we may not pay any cash dividends or otherdistributions with respect to, or redeem any of, our capital stock.  We also may not, without the consent of DresdnerKleinwort Benson Private Equity Partners, LP (“Dresdner”), declare or pay anycash dividends or make any distributions with respect to our capital stock orother equity securities to the extent that at least $5 million in principalamount remains outstanding under our convertible senior subordinated notes andDresdner owns a majority of the then outstanding principal amount of suchnotes.

 

In addition, no cash dividends may be paid on ourcommon stock unless dividends have been paid on all outstanding shares of ourSeries C and Series D Convertible Preferred Stock in an amount equal to 12%cumulative dividends accrued on such preferred shares through the record datefor the common stock dividend (or, if greater, the amount of the common stockdividend payable on the preferred shares on an as-converted basis). Thequarterly dividend accruing on the preferred shares is $975,000.

 

Information regarding securities authorized for issuance under equitycompensation plans is included in Item 12.

 

13

----

 

**Item 6.**  **Selected Financial Data**

 
| **IN  THOUSANDS,**                                        |   | **Year  Ended September 30,** |    | **Nine  Months  Ended  September 30,** |   |
|-----------------------------------------------------------|--------|------------------------------------|---------|---------------------------------------------|--------|
| **EXCEPT PER SHARE AMOUNTS**                              |   | **2003**                           |    | **2002**                                    |   | **2001** |   | **2000** |   | **1999** |   |
| ***Statement of Operations Data*****(1)**                 |   |                               |    |                                        |   |   |   |   |   |   |   |
| Net sales(2)                                              |   | $                                  | 49,447  |                                        | $      | 54,596 |   | $ | 50,751 |   | $ | 61,113 |   | $ | 60,106 |   |
| Gross margin                                              |   | 18,738                             |    | 22,907                                      |   | 18,193 |   | 24,976 |   | 25,772 |   |
| Sales and marketing  expense(2)                           |   | 14,208                             |    | 13,711                                      |   | 13,586 |   | 18,358 |   | 48,021 |   |
| General and administrative  expense                       |   | 5,218                              |    | 4,210                                       |   | 4,997 |   | 7,304 |   | 5,064 |   |
| Other operating expense,  net                             |   | 105                                |    | 184                                         |   | 57 |   | 303 |   | 2,677 |   |
| Operating income (loss)                                   |   | (793                               | )       | 4,802                                       |   | (447 | ) | (989 | ) | (29,990 | ) |
| Cumulative effect of a  change in accounting for goodwill |   | 411                                |    | —                                      |   | — |   | — |   | — |   |
| Preferred dividends                                       |   | 5,177                              |    | 4,955                                       |   | 4,367 |   | 12,492 |   | 1,980 |   |
| Net loss available for  common shareholders               |   | $                                  | (10,790 | )                                           | $      | (3,874 | ) | $ | (7,156 | ) | $ | (32,653 | ) | $ | (22,146 | ) |
| Basic and diluted net loss  per share                     |   | $                                  | (1.20   | )                                           | $      | (0.43 | ) | $ | (0.80 | ) | $ | (3.67 | ) | $ | (2.51 | ) |
|                                                      |   |                               |    |                                        |   |   |   |   |   |   |   |
| ***Balance Sheet Data***                                  |   |                               |    |                                        |   |   |   |   |   |   |   |
| Working capital                                           |   | $                                  | 5,937   |                                        | $      | 10,245 |   | $ | 9,857 |   | $ | 8,058 |   | $ | 11,741 |   |
| Total assets                                              |   | 28,228                             |    | 31,062                                      |   | 22,061 |   | 25,160 |   | 52,702 |   |
| Long-term debt, less  current portion                     |   | 4,979                              |    | 6,540                                       |   | — |   | — |   | — |   |
| Long-term convertible notes  payable                      |   | 18,672                             |    | 17,596                                      |   | 17,364 |   | 15,000 |   | 15,000 |   |
| Convertible redeemable  preferred stock                   |   | 51,012                             |    | 45,835                                      |   | 40,880 |   | 36,513 |   | 32,147 |   |
| Shareholders’ deficit                                |   | (56,000                            | )       | (45,210                                     | )      | (41,431 | ) | (34,311 | ) | (10,319 | ) |

 

----

(1)          Statement of operations data for 1999 includes only nine months ofactivity due to the change in our fiscal year during 1999 from a calendar yearto a fiscal year ended September 30.

(2)          Revenues and sales and marketing expenses each decreased by $8,806 and$9,930, respectively, in fiscal 2001 and 2000 upon adoption of EITF 00-14 andEITF 00-25.  Fiscal 1999 was notadjusted as to do so would be impracticable due to the way data was collectedin the system at that time.

 

**Item 7.**           **Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Forward-Looking Statements**

 

This report contains certain forward-looking statements that involveknown and unknown risks and uncertainties. Our actual results, performance, or achievements could differ materiallyfrom historical results or from any future results anticipated by theforward-looking statements.  In additionto statements that explicitly describe such risks and uncertainties, readersshould consider statements containing words like “believes,” “expects,”“intends,” “anticipates” or “plans” to be uncertain and forward-looking.  Important risks that could cause actualresults, performance or achievements to differ from those expressed or impliedby the forward-looking statements are described below and elsewhere in thisForm 10-K.  Investors are cautioned notto place undue reliance on the forward-looking statements.

 

**General**

 

Approximately 75% of ourgross sales are attributable to the Gardenburger® veggie burger and soy burgerproducts, with the remaining 25% of our gross sales attributable to our newermeat alternative products.  Consumersare quickly moving to the wider range of meat alternative products rapidlybecoming available in the marketplace. In response to this development in consumer tastes, we expanded ourproduct line in fiscal 2002 to include a breakfast sausage alternative, ourHerb Crusted CutletTM and Crispy NuggetsTM.  In addition, in fiscal 2003 we added five new products, including BBQChik’n and Meatless Meatloaf. These additions join our meat alternative productsreleased in fiscal 2000 and 2001, Riblets, Meatless Meatballs, and Chik’nGrill.

 

14

----

 

Our fiscal 2003 results were adversely affected byconsumer trends favoring a low-carbohydrate diet.  This shift in consumer demand led to an 11% decrease in sales ofour veggie burger products in fiscal 2003 compared to fiscal 2002.  Demand for veggie burgers may continue todecrease in fiscal 2004 and beyond.  Inaddition, effective the second quarter of fiscal 2004, the Costco club storeswill cease to require system-wide distribution of our Original Gardenburgerproduct, which may have a significant adverse impact on our club store salesfor the remainder of fiscal 2004 and beyond. Beginning in fiscal 2002, we launched a variety of new soy-based productofferings, which accounted for a revenue increase of approximately $4.0 millionin fiscal 2003.  We expect sales of oursoy-based products, including reformulated meatless burgers to be introducedover the next few months, to continue to increase for fiscal 2004.

 

In connection with theamendment of our senior and subordinated debt instruments inDecember 2003, as discussed in more detail below, our interest expensewill be approximately $125,000 higher in each fiscal quarter until the interestpayments on our subordinated debt are brought current, which is not expected tooccur until at least fiscal 2005.

 

**Results of Operations**

 

The following table is derived from our Statements of Operations forthe periods indicated and presents the results of operations as a percentage ofnet sales (amounts may not add due to rounding).

 
| **Year Ended  September 30,**                                                                |   | **2003** |   | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                                                                   |   |     |   |     |   |     |   |
| Net sales                                                                                              |   | 100.0    | %      | 100.0    | %      | 100.0    | %      |
| Cost of goods sold                                                                                     |   | 62.1     |   | 58.0     |   | 64.2     |   |
| Gross margin                                                                                           |   | 37.9     |   | 42.0     |   | 35.8     |   |
| Sales and marketing expense                                                                            |   | 28.7     |   | 25.1     |   | 26.8     |   |
| General and administrative expense                                                                     |   | 10.6     |   | 7.7      |   | 9.8      |   |
| Other                                                                                                  |   | 0.2      |   | 0.3      |   | 0.1      |   |
| Operating income (loss)                                                                                |   | (1.6     | )      | 8.8      |   | (0.9     | )      |
| Other expense                                                                                          |   | (8.9     | )      | (6.8     | )      | (4.6     | )      |
| Income (loss) before cumulative effect of a change in  accounting for goodwill and preferred dividends |   | (10.5    | )      | 2.0      |   | (5.5     | )      |
| Cumulative effect of a change in accounting for goodwill                                               |   | (0.8     | )      | —   |   | —   |   |
| Income (loss) before preferred dividends                                                               |   | (11.3    | )      | 2.0      |   | (5.5     | )      |
| Preferred dividends                                                                                    |   | (10.5    | )      | (9.1     | )      | (8.6     | )      |
| Net loss                                                                                               |   | (21.8    | )%     | (7.1     | )%     | (14.1    | )%     |

 

**2003 Compared to 2002**

 

***Net sales.***  Net sales for fiscal 2003 decreased $5.1million to $49.4 million from $54.6 million for fiscal 2002.  The decrease in fiscal 2003 compared tofiscal 2002 was due to an 11% decrease in sales of veggie burger products, primarily due to lower unit sales, andincreased trade spending, offset in part by increased unit sales of newproducts. Sales of our new Herb Crusted CutletTM and Crispy NuggetsTM products,which began selling during the fourth quarter of fiscal 2002, accounted for$2.4 million of our sales during fiscal 2003 compared to $219,000 in fiscal2002.  We launched two additionalproducts in the second quarter of fiscal 2003, our BBQ Chik’n and MeatlessMeatloaf, which had sales of $1.8 million in fiscal 2003.

 

Trade spending totaled$11.8 million in fiscal 2003 compared to $9.5 million in fiscal 2002, andincludes promotions, discounts, contract origination fees and slottingexpenses. Pursuant to EITF No. 01-9 “Accounting for Consideration Given by aVendor to a Customer or a Reseller of the Vendor’s Products,” such expenses arenetted against sales when incurred.

 

15

----

 

***Grossmargin. ***Gross margin decreased to $18.7 million(37.9% of net sales) for fiscal 2003 from $22.9 million (42.0% of net sales)for fiscal 2002.  The decrease ingross margin is due primarily to lower unit sales as discussed above and lowergross margin percentages in fiscal 2003 compared to fiscal 2002.

 

The lower gross margin percentages resulted from:

 

•                  anincrease in non-burger sales in the product sales mix, which have higherproduction costs than our veggie burgers;

•                  increasedtrade spending in 2003;

•                  newproduct production start-up costs; and

•                  increaseddepreciation in fiscal 2003, due primarily to the purchase of thepreviously-leased Clearfield manufacturing equipment in earlyJanuary 2002.

 

These factors were offset in part by reduced lease expense in fiscal2003 due to the termination of the Clearfield equipment operating leases.

 

***Sales and marketingexpense.***  Sales and marketing expense increased to$14.2 million (28.7% of net sales) for fiscal 2003 compared to $13.7 million(25.1% of net sales) for fiscal 2002. Increases in sales and marketing expenditures are primarily due to thefollowing:

 

•                  a $225,000 increase in inventory storagecosts due to higher inventory levels;

•                  a $220,000 increase in in-store productdemonstration and sampling expense in the club channel;

•                  a $600,000 increase in other tradepromotions; and

•                  $150,000 of costs, primarily severance,related to the relocation of our corporate offices from Portland, Oregon toIrvine, California.

 

These increases were partially offset by thefollowing:

 

•                  a $240,000 decrease in sales commissions dueto lower sales; and

•                  a $775,000 decrease in media spending as wemoved away from this type of advertising and increased our trade spending.

 

We anticipate incurring approximately $40,000to $45,000 of additional sales and marketing expenses in fiscal 2004 related tothe relocation of our corporate offices.

 

***Generaland administrative expense.***** **General and administrative expense (“G&A”) increased to $5.2 million(10.6% of net sales) for fiscal 2003 from $4.2 million (7.7% of net sales) forfiscal 2002.  The increase in fiscal2003 compared to fiscal 2002 is due primarily to a $650,000 increase in costsincurred in development of a long-term business strategy, which primarily includedcosts related to our failed attempt to sell the Company, and $300,000 of costsrelated to the relocation of our corporate offices from Portland, Oregon toIrvine, California.  We did not have anyrelocation expenses in fiscal 2002. We anticipate incurring approximately$360,000 to $400,000 of additional general and administrative expenses infiscal 2004 related to the relocation of our corporate offices.

 

***Legal settlement. ***Legal settlement of $108,000 in fiscal 2002relates to a settlement received from a raw material supplier due to an August 2001recall of our Chik’n Grill product due to the omission of sulfites, which areknown allergens, from the ingredient label. The raw material supplier reimbursed us for lost operating profitsassociated with the recall. This is a final settlement and no further amountswill be received from this supplier related to this recall.

 

***Debtrestructuring costs. ***Debt restructuring costs of $716,000 infiscal 2002 include an early termination fee of $175,000 for our previous lineof credit facility, the write-off of $279,000 of unamortized financing fees,$95,000 for the value of common stock warrants issued in connection with therestructuring of our Convertible Notes and preferred stock and $167,000 oflegal fees.

 

16

----

 

***Otheroperating (income) expense, net.*** Other expense of $105,000 in fiscal 2003 represents losses on thedisposal of fixed assets.******Other general income in fiscal 2002 includes $303,000related to the reversal of restructuring reserves, which were established infiscal 1999 and, in the first quarter of fiscal 2002, were determined to nolonger be required, as well as $117,000 related to the recognition of adeferred gain on our Clearfield operating lease upon its early termination inconjunction with our purchase of the related equipment.

 

***Operatingincome (loss).***  Loss from operations was $0.8million in fiscal 2003 compared to income from operations of $4.8 million infiscal 2002.  The loss from operationsin fiscal 2003 compared to income from operations in fiscal 2002 resulted fromlower revenue, lower gross margin percentages and increased operating expensesas discussed above.  Fiscal 2002includes a gain on the reversal of previously expensed restructuring expenses,the recognition of a previously deferred gain and a legal settlement.

 

***Interest expense. ***Interest expense was $4.4 million for fiscal2003 compared to $3.8 million for fiscal 2002. The increase is due to an increase in outstanding debt as a result ofthe purchase of manufacturing equipment in January 2002 utilizing an $8.0million term loan, as well as an increase in the outstanding balance on ourline of credit.

 

***Income taxes.***  A valuation allowance has been recorded for the full amount of deferred tax assets due to the uncertainty regarding the realization of the net deferred tax assets consisting primarily of net operating loss and credit carryforwards.  Accordingly, no benefit has been recorded related to our losses in fiscal 2003 or 2002.

 

***Cumulative effect ofchange in accounting for goodwill. ***Inaccordance with the adoption of the provisions of SFAS No. 142 in the firstquarter of fiscal 2003, we tested the carrying value of our goodwill utilizinga discounted cash flow analysis and determined that the remaining balance of$411,000 should be written off.

 

***Preferreddividends.***  Preferred dividends were $5.2 million duringfiscal 2003 compared to $5.0 million in fiscal 2002.  Due to the addition of a 10% exit premium in conjunction with thechanges made to the outstanding preferred stock during the second quarter offiscal 2002, the quarterly dividend charge increased from $1.1 million to $1.3million.

 

***Net loss available for common shareholders.***  Netloss available for common shareholders was $10.8 million in fiscal 2003 comparedto $3.9 million in fiscal 2002 due to the line item changes discussed above.

 

We believe that the impact of inflation wasnot material for fiscal years 2003 and 2002.

 

**2002 Compared to 2001**

 

***Net sales.***  Net sales for fiscal 2002 increased $3.8million to $54.6 million from $50.8 million for fiscal 2001.  Fiscal 2002 sales included approximately$7.1 million attributable to gross sales of products introduced during latefiscal 2001 or in fiscal 2002.  Theincreased sales from new products were partially offset by the loss ofapproximately $1.9 million of revenue from Sam’s Club due to the cessation ofsales of our products in 215 Sam’s Club stores during fiscal 2002.

 

Additionally, weexperienced a disruption of our Canadian distribution in the first quarter offiscal 2001 due to the financial difficulties of our distributor in thatcountry, which decreased sales in fiscal 2001 by approximately $340,000.

 

***Grossmargin. ***Gross margin increased to $22.9 million(42.0% of net sales) for fiscal 2002 from $18.2 million (35.8% of net sales)for fiscal 2001.  The increase in grossmargin was due to an increase in sales and an increase in the gross marginpercentage.  The improved gross marginpercentage was attributable to reduced selling discounts, reduced lease expensedue to the

 

17

----

 

elimination of the equipment operating leases in earlyJanuary 2002 and increased operating efficiencies at our Clearfield, Utahmanufacturing facility, offset in part by increased depreciation due to theacquisition of the Clearfield manufacturing equipment.

 

***Salesand marketing expense.***  Sales and marketing expenseremained relatively flat at $13.7 million (25.1% of net sales) for fiscal 2002compared to $13.6 million (26.8% of net sales) for fiscal 2001. The decrease asa percentage of sales is due to increased sales in fiscal 2002 compared tofiscal 2001.

 

***General and administrative expense.***** **G&A decreased to $4.2 million (7.7% ofnet sales) for fiscal 2002 from $5.0 million (9.8% of net sales) for fiscal2001.  The decrease was primarily due to$700,000 of savings due to cost reduction initiatives at the Portland, Oregoncorporate offices.

 

***Legal settlement. ***Legal settlement of $108,000 in fiscal 2002related to a settlement received from a raw material supplier as a result of anAugust 2001 recall of our Chik’n Grill product.

 

***Debtrestructuring costs. ***Debt restructuring costs of $716,000 infiscal 2002 included an early termination fee of $175,000 for our previous lineof credit facility, the write-off of $279,000 of unamortized financing fees,$95,000 for the value of common stock warrants issued in connection with therestructuring of our Convertible Notes and preferred stock and $167,000 oflegal fees.

 

***Other operating (income) expense, net. ***Othergeneral income in fiscal 2002 included $303,000 related to the reversal ofrestructuring reserves, which were established in fiscal 1999 and, in the firstquarter of fiscal 2002, were determined to no longer be required, and $117,000related to the recognition of the remaining deferred gain on the disposal offixed assets.  Other general expense infiscal 2001 represented losses on the disposal of fixed assets.

 

***Operatingincome (loss).***  Income from operations was $4.8million in fiscal 2002 compared to a loss from operations of $447,000 forfiscal 2001. The improvement in operating results in fiscal 2002 compared tofiscal 2001 was primarily a result of the increased revenue, increased grossmargin percentage and decreased expenses discussed above.

 

***Interest expense. ***Interest expense was $3.8 million for fiscal2002, compared to $2.4 million for fiscal 2001. The increase was primarily aresult of increased outstanding debt balances and increases in the effectiveinterest rates of previously outstanding debt.

 

***Incometaxes.***  A valuation allowance has been recorded forthe full amount of deferred tax assets due to the uncertainty regarding therealization of the net deferred tax assets consisting primarily of netoperating loss and credit carryforwards.

 

***Preferreddividends.***  Preferred dividends were $5.0 million duringfiscal 2002 compared to $4.4 million in fiscal 2001.  Due to the addition of a 10% exit premium in conjunction with thechanges made to the outstanding preferred stock during the second quarter offiscal 2002, the quarterly dividend charge increased from $1.1 million to $1.3million.

 

***Net loss available for common shareholders.***  Netloss available for common shareholders was $3.9 million in fiscal 2002 comparedto $7.2 million in fiscal 2001 due to the line item changes discussed above.

 

We believe that the impact of inflation wasnot material for fiscal years 2002 and 2001.

 

**Liquidityand Capital Resources**

 

At September 30, 2003, working capital was $5.9 million, including$1.3 million of cash and cash equivalents. In fiscal 2003, working capital decreased by $4.3 million compared toSeptember 30, 2002 and the current ratio decreased to 1.6:1 from 2.6:1.

 

18

----

 

Cash and cash equivalents decreased $1.5 million fromSeptember 30, 2002, primarily due to $2.0 million used for the purchase ofequipment and $1.9 million used for payments on long-term debt, offset by $1.3million provided by operations and $1.1 million of net proceeds from our lineof credit.

 

Accounts receivable decreased $167,000 to $3.0 million atSeptember 30, 2003 from $3.1 million at September 30, 2002.  Days sales outstanding were approximately 20days at September 30, 2003 compared to approximately 19 days at September 30,2002.  The decrease in accountsreceivable is primarily due to lower sales in the fourth quarter of fiscal 2003compared to the fourth quarter of fiscal 2002.

 

Inventories were relatively flat, totaling $9.2 million atSeptember 30, 2003 compared to $9.1 million at September 30, 2002,but decreased from $11.0 million at June 30, 2003.  Inventory turned approximately 3.4 times onan annualized basis in the fourth quarter of fiscal 2003 compared to 4.0 timesin the corresponding period of fiscal 2002. We do not believe that we have any inventory obsolescence issues aboveour currently established reserve.

 

Prepaid expenses increased $523,000 to $2.1 million atSeptember 30, 2003 from $1.6 million at September 30, 2002 dueprimarily to a $216,000 increase in prepaid slotting, which is being amortizedover a 12 month period, and a $310,000 increase in prepaid contract originationcosts, which are also being amortized over a 12 month period.

 

Other current liabilities increased $2.1 million to $2.3 million atSeptember 30, 2003 from $222,000 at September 30, 2002 due primarilyto an increase in accrued coupon liabilities of $874,000 and an $845,000increase in accrued interest.  Theincrease in the coupon liability is due to increased circulation and timing ofcoupons and related redemption.  Theaccrued interest relates to interest due to Dresdner, payment of which wasoriginally deferred beyond its due date of September 30, 2003 toDecember 31, 2003, and was further deferred in connection with the December 2003amendments to our senior and subordinated debt instruments discussed in moredetail below.

 

Capital expenditures were $2.0 million during fiscal 2003 primarily formanufacturing equipment relating to our new product lines.  In February 2003, our loan agreementswere amended to exclude certain capital expenditures from our debt covenantcalculations to enable us to purchase additional equipment beneficial to ourproduction process. Capital expenditures are currently estimated to total asmuch as approximately $1.2 million in fiscal 2004, primarily for manufacturingequipment.

 

Other assets decreased $726,000 to $757,000 at September 30, 2003from $1.5 million at September 30, 2002 as a result of the write-off of$411,000 of goodwill during the first quarter of fiscal 2003 and continuedamortization of the existing intangible balance.

 

Our Revolving Credit and Term Loan Agreement (the “Loan Agreement”)with CapitalSource Finance LLC (“CapitalSource”) provides for an $8.0 millionterm loan and a $7.0million line of credit (together, “the Loans”).  The Loan Agreement permits us to request advances under the $7.0million line of credit up to the sum of 85% of eligible receivables and 60% ofeligible inventory.  AtSeptember 30, 2003, there was $4.8 million remaining available onthe CapitalSource line of credit, which will be used as needed for workingcapital.  The balance outstanding of$6.8 million on the term loan includes $0.5 million of accrued exit fees at September 30,2003.

 

We also have approximately $16.9 million of principal and $1.8 millionof accrued exit fees due to Dresdner under an Amended and Restated ConvertibleSenior Subordinated Note (the “Convertible Note”).  The Convertible Note requires payment of a 20% premium on theprincipal plus accrued but unpaid interest at repayment or maturity. TheConvertible Note is convertible into common stock at the election of theholder; the conversion price at September 30, 2003 was $9.78 per share.

 

In September 2003, Dresdner agreed to permit the deferral of ourSeptember 30, 2003 interest payment, which totaled $845,000, toDecember 31, 2003.  Accordingly, weincluded the $845,000 on

 

19

----

 

our balance sheet as of September 30, 2003 in other current liabilities.  As discussed below, this interest paymenthas been further deferred.

 

In accordance with excess cash flow provisions in the Loan Agreementand the Convertible Note, approximately $184,000 of principal and $550,000 ofprincipal and exit premium, respectively, were due in fiscal 2003, rather thanas previously scheduled, the sum of which was reflected on theSeptember 30, 2002 balance sheet in the current portion of long-term debtbalance.  Such amounts were paid inJanuary 2003. The $550,000 paid on the Convertible Note was allocated 80%to principal and 20% to exit premium.

 

We do not have any payment obligations under the excess cash flowprovisions in fiscal 2004 based on fiscal 2003 financial results.

 

During the quarter ended March 31, 2003, our debt agreements withour lenders, CapitalSource and Dresdner, were amended to exclude certainequipment purchases during fiscal 2003 for purposes of the financial covenantsrelating to capital expenditure limits and fixed charge coverage ratio requirementscontained in the debt instruments.  Inaddition, the minimum fixed charge coverage ratio in the CapitalSource LoanAgreement was amended for the quarterly period ended March 31, 2003 to be1.125:1.0, instead of 1.25:1.0.

 

Principal payments under our term loan, our Convertible Note and ouroperating leases are significant.  Aschedule of payments remaining due at September 30, 2003 on all ofthese obligations, including exit fees of $750,000 for the term loan andapproximately $3.4 million for the Convertible Note, in the next five fiscalyears is as follows:

 
| **Year Ending September 30,** |   | **Term  Loan** |      | **Convertible  Note** |   | **Operating  Leases** |   | **Total**  |      |
|------------------------------------|--------|----------------|-----------|-----------------------|--------|-----------------------|--------|------------|-----------|
| 2004                               |   | $              | 1,833,336 |                  | $      | —                |   | $          | 701,538   |   | $ | 2,534,874 |   |
| 2005                               |   | 5,233,176      |      | 20,286,750            |   | 664,881               |   | 26,184,807 |      |
| 2006                               |   | —         |      | —                |   | 678,154               |   | 678,154    |      |
| 2007                               |   | —         |      | —                |   | 547,927               |   | 547,927    |      |
| 2008                               |   | —         |      | —                |   | 134,143               |   | 134,143    |      |
| Thereafter                         |   | —         |      | —                |   | —                |   | —     |      |
| Total                              |   | $              | 7,066,512 |                  | $      | 20,286,750            |   | $          | 2,726,643 |   | $ | 30,079,905 |   |

 

We anticipate funding our 2004 commitments out of operating cash flowsand line of credit borrowings.  Cash required to meetour interest and principal payments (prior to the extension of the maturitydates discussed below) on our debt outstanding at September 30, 2003totals approximately $5.4 million in fiscal 2004 as follows (in thousands): 

 
| Interest  deferred on convertible notes at September 30, 2003      |   | $     | 845    |   |
|-------------------------------------------------------------------------|--------|-------|--------|--------|
| Additional  interest on interest deferred at September 30, 2003    |   | 21    |   |
| Fiscal  2004 interest on convertible notes                              |   | 1,691 |   |
| Principal  payment due on long-term debt                                |   | 1,833 |   |
| Interest  on long-term debt                                             |   | 561   |   |
| Estimated  interest on short-term note payable                          |   | 351   |   |
| Estimated  unused line of credit fee related to short term note payable |   | 48    |   |
| Total                                                                   |   | $     | 5,350  |   |

 

Pursuant to the CapitalSource Loan Agreement and Convertible Note, werecord quarterly interest expense of $75,000 and $269,000, respectively,related to exit fees.  These amounts areadded to the long-term debt and convertible note balances, respectively.

 

20

----

 

At September 30, 2003, we were out ofcompliance with the following debt covenants:

 
| **Covenant**                         |   | **Requirement** |   | **As calculated  September 30,  2003** |   | **Required by**             |   |
|--------------------------------------|--------|-----------------|--------|---------------------------------------------|--------|-----------------------------|--------|
| Minimum  adjusted EBITDA             |   | $6.0 million    |   | $2.1 million                                |   | CapitalSource  and Dresdner |   |
| Maximum  leverage ratio              |   | 2.50:1.00       |   | 3.97:1.00                                   |   | CapitalSource  and Dresdner |   |
| Minimum  fixed charge coverage ratio |   | 1.25:1.00       |   | 0.34:1.00                                   |   | CapitalSource  and Dresdner |   |

 

In order to address issuesrelating to our ability to meet our financial obligations and to addressnon-compliance with certain of our financial covenants, we entered intoamendments to our Loan Agreement with CapitalSource and our Convertible Notesheld by Dresdner in late December 2003, following fiscal year-end.  See Note 9 of Notes to Financial Statementsfor a discussion of the terms of the Loan Agreement and Convertible Notes as ofSeptember 30, 2003.

 

The amendments extend thematurity of the Loan Agreement from December 15, 2004 to January 31, 2007 andof the Convertible Notes from March 31, 2005 to June 15, 2007, subject to (i)shareholder approval of an amendment to our Restated Articles of Incorporation(“Articles”) or (ii) the exchange of all of our preferred stock for newpreferred stock, in each case giving us the right to extend the earliest datethat the holders of our preferred stock can demand redemption to June 30,2008.  If the required shareholderapproval of the Articles amendment is not received and we are not able toeffect an exchange of at least two-thirds of our outstanding shares ofpreferred stock for new preferred stock with the later redemption date, thematurity dates will revert to their original dates of December 15, 2004 for theLoan Agreement and March 31, 2005 for the Convertible Notes.  If the required shareholder approval is notobtained, but we are able to exchange at least two-thirds of our outstandingshares of preferred stock for new preferred stock with an earliest redemptiondate of June 30, 2008, the maturity date on our Loan Agreement will becomeDecember 10, 2005, while the maturity date on the Convertible Notes will becomeMarch 25, 2006. To be approved by shareholders, the Articles amendment must beapproved by the holders of our preferred stock voting as a separate votinggroup and by the holders of our preferred stock and common stock voting as asingle voting group.  We have receivednon-binding indications from holders of approximately 90% of our Series C andSeries D Stock that they intend to vote for the amendment of our Articles.

 

We also negotiated amendmentsto our financial covenants in the Loan Agreement and the Convertible Notes tolevels that we believe we will be able to achieve.  Beginning December 31, 2003, we are required under the LoanAgreement to maintain compliance with the following financial covenants,measured quarterly unless otherwise noted:

 

•                  amaximum ratio of long-termindebtedness to earnings (as defined below) ranging from a high of 3.60:1.00for the quarter ended March 31, 2004, to a low of 2.50:1.00 for each quarterending after June 30, 2004;

•                  minimumearnings for a rolling 12-monthperiod, as adjusted to exclude certain expenses and non-cash charges, rangingfrom a low of $3,000,000 for the quarter ended June 30, 2004, to a high of$6,000,000 for the quarter ended September 30, 2005, and thereafter (“minimumadjusted EBITDA”);

•                  aminimum senior fixed charge coverage ratio (which excludes from fixed chargesinterest expense and accrued premium on the Convertible Notes) ranging from alow of 0.90:1.00 for the quarter ended June 30, 2004, to a high of 1.57:1.00for the quarter ended June 30, 2005;

•                  aminimum fixed charge coverageratio of 1.10:1.00 for the quarter ended September 30, 2005 and 1.25:1.00thereafter; and

**•****                 **capitalexpenditures in an amount perfiscal year not exceeding $1,200,000 for the fiscal year ending September 30,2004, and $1,100,000 for fiscal years ending thereafter.

 

The financial covenantsapplicable to the Convertible Notes are similar, but in each case slightly lessrestrictive.

 

We also received waivers ofnon-compliance with our financial covenants as of September 30, 2003 fromCapitalSource and Dresdner and an agreement by Dresdner that future failures topay interest on the Convertible Notes when due will not be deemed, underspecified conditions, to be an event of default under the Convertible Notes.

 

In consideration of thematurity date extensions, the financial covenant amendments, and the waivers,we agreed to pay a loan amendment fee to CapitalSource of approximately$130,000 and to pay interest on the unpaid principal and accrued interest onthe Convertible Notes at the annual rate of 13% rather than 10%, which is thedefault interest rate provided in the notes beginning October 1, 2003, andcontinuing until our interest payments to Dresdner are brought current. TheLoan Agreement as amended prohibits us from paying interest to Dresdner priorto September 30, 2004, and permits us to pay interest to Dresdner on or afterSeptember 30, 2004, only if and to the extent that we comply with specified financialcovenants and levels of capital availability.

 

We have 552,500 shares of Series C Convertible Preferred Stock and97,500 shares of Series D Convertible Preferred Stock outstanding. The Series Cpreferred shares are convertible into common stock at a price of $10 per shareand the Series D preferred shares are convertible at $3.75 per share (subjectto antidilution adjustments), in each case based on a base price of $50.00 pershare, at any time at the discretion of the holder.  Both series of preferred stock are entitled to a 12% cumulativeannual dividend payable upon redemption of the stock or in the event of a saleor liquidation of Gardenburger.  Theterms of the Series C and Series D Stock provide for a 10% premium on anyliquidation or redemption and for an earliest date on which holders may requireredemption of their shares of March 31, 2006, at which point they may beredeemed at the election of the holders or, under certain conditions, at ourdiscretion.  The 10% redemption premium,which totals $4.3 million, is being accreted over the redemption period.  At September 30, 2003, $1.8 million ofthe redemption premium has been accreted and is included in the preferred stockbalance on the balance sheet.  Theliquidation preference of the Series C and Series D Stock was $54.2 million atSeptember 30, 2003.

 

**Seasonality**

 

The third and fourth quarters of our fiscal year typically havestronger sales due to the summer grilling season.  We typically build inventories during the first and second quartersof each fiscal year in anticipation of increased sales in the third and fourthfiscal quarters.

 

**New Accounting Pronouncements**

 

See Note 2 of Notes to Financial Statements included in Part II, Item 8of this report on Form 10-K for a discussion of the adoption of new accountingpronouncements.

 

**Critical Accounting Policies and Estimates**

 

The discussion and analysis of our financialcondition and results of operations are based upon our financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets, liabilities,revenues and expenses.  On an ongoingbasis, we evaluate our estimates, including those related to inventory reservesand allowance for doubtful accounts. We base our estimates on historicalexperience and on various other assumptions. Actual results may differ fromthese estimates if conditions turn out differently from our assumptions.  We believe the following critical accountingpolicies and the related judgments and estimates affect the preparation of ourfinancial statements.

 

21

----

 

***RevenueRecognition***

 

Revenue from the sale of products isgenerally recognized at time of shipment to the customer.  Our revenue arrangements with our customersoften include sales incentives and other promotional costs such as coupons,volume based discounts and off invoice discounts.  These costs are typically referred to collectively as “tradespending.”  Pursuant to EITF 00-14, EITF00-25 and EITF 01-09, these costs are recorded at the later of when revenue isrecognized or when the sales incentive is offered and are generally classifiedas a reduction of revenue.

 

***InventoryReserves***

 

We regularly evaluate the realizability ofour inventory based on a combination of factors including the following:historical usage rates, forecasted sales or usage, historical spoilage ratesand other factors.  Raw materials arereviewed periodically by our operating personnel for spoilage.  Finished goods are reviewed periodically byoperating personnel to determine if inventory carrying costs exceed marketselling prices.  If circumstancesrelated to our inventories change, our estimates of the realizability ofinventory could materially change. Our inventory reserve totaled $138,000 and$113,000 at September 30, 2003 and 2002, respectively.  We have not experienced material lossesrelated to our inventories in the past and believe that the current level ofreserves is adequate.

 

***Allowancefor Doubtful Accounts***

 

Credit limits are established through aprocess of reviewing the financial history and stability of each customer.  We regularly evaluate the collectibility ofour trade receivable balances by monitoring past due balances.  If it is determined that a customer will beunable to meet its financial obligation, we record a specific reserve for baddebts to reduce the related receivable to the amount we expect to recover.  Bad debts have not historically had amaterial effect on us.  If circumstancesrelated to specific customers deteriorate, our estimates of the recoverabilityof receivables associated with those customers could materially change. Our baddebt reserve totaled $193,000 and $200,000 at September 30, 2003 and 2002,respectively. We did not record any bad debt expense during fiscal 2003.

 

***TradeSpending***

 

Certain trade spending items are subject toestimation (i.e. volume discounts). Estimated trade spending is reviewed andrecorded on a monthly basis based on information provided by our regional salesmanagers as to the types of arrangements that have been made with our customersand are recorded on the balance sheet as an offset to trade receivables.  Actual dollar amounts associated with tradespending can vary with sales volumes achieved and other factors. Accordingly,the ultimate liabilities associated with trade spending may differ from thoserecorded due to changes in estimates and actual results achieved.

 

***SlottingFees***

 

Slotting agreements refer to oralarrangements pursuant to which the retail grocer allows our products to beplaced on the store’s shelves in exchange for a slotting fee. Slotting feesassociated with a new product or a new territory are initially recorded as aprepaid asset and the related expense is recognized ratably over the 12-monthperiod beginning with the initial introduction of the product as an offset tosales.  We believe that 12 months is theminimum period during which a retailer agrees to allocate shelf space.  If a slotting fee agreement were breached,we would pursue available legal remedies to enforce the agreement asappropriate. Total slotting fees included in prepaid assets at September 30,2003 and 2002 were $1.1 million and $934,000, respectively.

 

**Off-BalanceSheet Arrangements**

 

We do not have any off-balance sheet arrangements that have or arereasonably likely to have a material current or future effect on our financialcondition, changes in financial condition, revenues or expenses, results ofoperations, liquidity, capital expenditures or capital resources.

 

22

----

 

**Item 7A.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Amounts outstanding under our Loan Agreement with CapitalSource bearinterest at rates tied to the prime rate. At September 30, 2003, we had $6.3 million outstanding at aninterest rate of 10% and $2.2 million outstanding at an interest rate of 8%.  A hypothetical 10% increase in the primerate would not have any effect on the interest rates currently being charged onthese notes.

 

We do not currently utilize, nor do we anticipate utilizing, derivativesecurities.

 

**Item 8.**           **Financial Statements and Supplementary Data**

 

The financial statements and notes thereto required by this item beginon page F-1 as listed in Item 15 of Part IV of this document.   Unaudited quarterly financial data**foreach of the eight quarters in the period ended September 30, 2003 is asfollows:

 
| **In  thousands, except per share data**       |   | **1st Quarter** |   | **2nd Quarter** |   | **3rd Quarter** |   | **4th Quarter** |   |
|------------------------------------------------|--------|-----------------|--------|-----------------|--------|-----------------|--------|-----------------|--------|
| **2003**                                       |   |            |   |            |   |            |   |            |   |
| Net sales                                      |   | $               | 8,989  |            | $      | 12,408          |   | $               | 15,040 |   | $ | 13,010 |   |
| Gross margin                                   |   | 3,364           |   | 4,367           |   | 6,551           |   | 4,456           |   |
| Net loss                                       |   | (3,626          | )      | (2,476          | )      | (856            | )      | (3,832          | )      |
| Basic and diluted net loss  per share          |   | (0.40           | )      | (0.28           | )      | (0.10           | )      | (0.43           | )      |
|                                           |   |            |   |            |   |            |   |            |   |
| **2002**                                       |   |            |   |            |   |            |   |            |   |
| Net sales (1)                                  |   | $               | 10,847 |            | $      | 11,603          |   | $               | 17,083 |   | $ | 15,063 |   |
| Gross margin (1)                               |   | 4,183           |   | 4,633           |   | 7,614           |   | 6,477           |   |
| Net income (loss)                              |   | (1,150          | )      | (2,788          | )      | 221             |   | (157            | )      |
| Basic and diluted net  income (loss) per share |   | (0.13           | )      | (0.31           | )      | 0.02            |   | (0.02           | )      |

 

----

(1)          Net sales and gross margin differ from amounts originally reported forthe first quarter of fiscal 2002 due to the reclassification of costs incurredfor certain sales incentive programs and promotional costs as a reduction ofrevenue rather than as sales and marketing expense.

 

**Risk Relating To Arthur Andersen LLP’S LackOf Consent**

 

Arthur Andersen LLP were the independentaccountants for Gardenburger, Inc. until May 16, 2002.  Representatives of Arthur Andersen LLP arenot available to provide the consent required for the incorporation byreference of their report on the financial statements of Gardenburger, Inc.appearing in this Annual Report on Form 10-K into registration statements filedby Gardenburger, Inc. with the Securities and Exchange Commission and currentlyeffective under the Securities Act of 1933. Because Arthur Andersen LLP havenot consented to the incorporation by reference of their report, investors willnot be able to recover against Arthur Andersen LLP under Section 11 of theSecurities Act of 1933 for any untrue statements of a material fact containedin the financial statements audited by Arthur Andersen LLP that are included inthis report or any omissions to state a material fact required to be statedtherein.

 

**Item 9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

On May 16, 2002, based on a recommendation of the Audit Committee,our Board of Directors approved the dismissal of our independent publicaccountants, Arthur Andersen LLP. Arthur Andersen LLP’s reports on our financial statements for the yearended September 30, 2001 did not contain an adverse opinion or disclaimerof opinion and were not qualified or modified as to uncertainty, audit scope oraccounting principles.  During the yearended September 30, 2001 and during the subsequent interim period throughthe date of dismissal, May 16, 2002, there were not any disagreementsbetween us and Arthur Andersen LLP on any matters of accounting principles orpractices, financial statement disclosure or auditing scope or procedure, orany reportable events as defined under Item 304(a)(1)(v) of Regulation S-Kpromulgated by the Securities and Exchange Commission.

 

23

----

 

A copy of a letter addressed to the Securities and Exchange Commissionfrom Arthur Andersen LLP stating that it agrees with the above statements isincorporated by reference into this Form 10-K as exhibit 16.

 

Also on May 16, 2002, based upon a recommendation of the AuditCommittee and approval of the Board of Directors, we engaged the firm of KPMGLLP to be our independent public accountants. We did not consult KPMG LLP prior to May 16, 2002 with respect tothe application of accounting principles to a specified transaction, eithercompleted or proposed, or the type of audit opinion that might be rendered onour financial statements, or concerning any disagreement or reportable eventwith Arthur Andersen LLP.

 

**Item 9A.  Controls and Procedures**

 

***Disclosure Controls and Procedures***

 

Our management has evaluated, under the supervision and with theparticipation of our President and Chief Executive Officer and Senior Vice Presidentand Chief Financial Officer, the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this report pursuant to Rule13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Basedon that evaluation, our President and Chief Executive Officer and Senior VicePresident and Chief Financial Officer have concluded that, as of the end of theperiod covered by this report, our disclosure controls and procedures areeffective in ensuring that information required to be disclosed in our ExchangeAct reports is (1) recorded, processed, summarized and reported in a timelymanner, and (2) accumulated and communicated to our management, including ourPresident and Chief Executive Officer and Senior Vice President and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

***Internal ControlOver Financial Reporting***

 

There has been no change in our internal control over financialreporting that occurred during our last fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART III**

 

**Item 10.  Directors and Executive Officers of theRegistrant**

 

Information required by this item is included under the captions *Election of Directors, Meetings and Committees of theBoard of Directors, Audit Committee Financial Expert, Code of Ethics, ExecutiveOfficers*, and *Section 16(a)Beneficial Ownership Reporting Compliance* in the Proxy Statement forour 2004 Annual Meeting of Shareholders and is incorporated herein byreference.

 

**Item 11.  Executive Compensation**

 

Information required by this item is included under the captions *ExecutiveCompensation, Director Compensation, Employment Contracts and Severance andChange-in-Control Arrangements*and*Compensation Committee Interlocks and Insider Participation inCompensation Decisions* in the Proxy Statement for our 2004 AnnualMeeting of Shareholders and is incorporated herein by reference.

 

24

----

 

**Item 12.  Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters**

 

The following table sets forth information, as of September 30,2003, about shares of our common stock that may be issued upon the exercise ofoptions granted under our equity compensation plans and arrangements, dividedbetween plans approved by our shareholders and plans or arrangements notsubmitted to our shareholders for approval.

 
| **Plan Category**                                      |   | **Number ofsecurities to beissued uponexercise ofoutstandingoptions, warrantsand rights** |   | **Weighted averageexercise price ofoutstandingoptions, warrantsand rights** |   | **Number of securitiesremaining available forfuture issuance underequity compensationplans (excludingsecurities reflected infirst column)** |    |
|--------------------------------------------------------|--------|-------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|---------|
|                                                   |   |                                                                                      |   |                                                                        |   |                                                                                                                                        |    |
| Equity compensation plans approved by shareholders     |   | 2,635,623                                                                                 |   | $                                                                           | 3.32   |                                                                                                                                        | 715,400 |   |
|                                                   |   |                                                                                      |   |                                                                        |   |                                                                                                                                        |    |
| Equity compensation plans not approved by shareholders |   | 2,409,462                                                                                 | (1)    | 1.78                                                                        |   | —                                                                                                                                      |    |
| Total                                                  |   | 5,045,085                                                                                 |   | $                                                                           | 2.58   |                                                                                                                                        | 715,400 |   |

 

----

(1) Includes 1,115,962 warrants exercisable for ourcommon stock at $0.28 per share plus options granted pursuant to plans notapproved by our shareholders.  See Note12 of Notes to Financial Statements under the heading “Non-Plan Options” for adescription of the material terms of options granted without shareholderapproval and not requiring shareholder approval, which information isincorporated herein by reference.

 

Additional information required by this item is included under thecaption *SecurityOwnership of Certain Beneficial Owners and Management* in the ProxyStatement for our 2004 Annual Meeting of Shareholders and is incorporatedherein by reference.

 

**Item 13.     Certain Relationships and RelatedTransactions**

 

Information required by this item is included under the caption *CompensationCommittee Interlocks and Insider Participation in Compensation Decisions andManagement Transactions* in the Proxy Statement for our 2004 AnnualMeeting of Shareholders and is incorporated herein by reference.

 

**Item 14.  Principal Accountant Fees and Services**

 

Information required by this item is included under the caption *IndependentAuditors* in the Proxy Statement for our 2004 Annual Meeting ofShareholders and is incorporated herein by reference.

 

25

----

 

**PART IV**

 

**Item 15.  Exhibits, Financial Statement Schedulesand Reports on Form 8-K**

 

**(a)****FinancialStatements and Schedules**

 
| Report of KPMG LLP                                                                                  |                              |
|-----------------------------------------------------------------------------------------------------|-----------------------------------|
|                                                                                                |                              |
| Report of  Arthur Andersen LLP                                                                      |                              |
|                                                                                                |                              |
| Balance Sheets – September 30, 2003  and 2002                                             |                              |
|                                                                                                |                              |
| Statements  of Operations – Years ended September 30, 2003, 2002 and 2001                 |                              |
|                                                                                                |                              |
| Statements  of Shareholders’ Deficit – Years ended September 30, 2003, 2002 and 2001 |                              |
|                                                                                                |                              |
| Statements  of Cash Flows - Years ended September 30, 2003, 2002 and 2001                      |                              |
|                                                                                                |                              |
| Notes to Financial Statements                                                                       |                              |
|                                                                                                |                              |
| Report of Independent Public  Accountants on Financial Statement Schedule                           |                              |
|                                                                                                |                              |
| Schedule II                                                                                    | Valuation and Qualifying Accounts |   |
|                                                                                                     |                                   |  |

 

**(b)  Reports on Form 8-K**

 

The following reports on Form 8-K were filed duringthe quarter ended September 30, 2003:

 

•                  DatedAugust 18, 2003 and filed August 19, 2003 pursuant to Item 5. “OtherEvents,” regarding the receipt of an offer to purchase all of the outstandingcommon stock of Gardenburger in a going-private transaction; and

•                  DatedSeptember 17, 2003 and filed September 18, 2003 pursuant to Item 5.“Other Events,” regarding the withdrawal of the previously disclosed offer topurchase all of the outstanding common stock of Gardenburger in a going-privatetransaction.

 

**(c)****            Exhibits**

 

The exhibits filed as a part of this report are listed below and thislist is intended to comprise the exhibit index:

 
| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                                                     |
|------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |   | Restated Articles of Incorporation, as amended January 9, 2002  (15)                                                                                                                                                                           |
|             |   |                                                                                                                                                                                                                                                |
| 3.2              |   | 1995 Restated Bylaws, as amended  July 13, 1999 (11)                                                                                                                                                                                           |
|             |   |                                                                                                                                                                                                                                                |
| 10.1             |   | Amended and Restated Rights Agreement  between the Company and First Chicago Trust Company of New York, dated July 15,  1999 (11)                                                                                                              |
|             |   |                                                                                                                                                                                                                                                |
| 10.2             |   | Amendment No. 1 dated as of January 2,  2002 to Rights Agreement dated as of July 15, 1999 between First Chicago  Trust Company of New York and the Company, dated effective as of  January 2, 2002 (16)                             |
|             |   |                                                                                                                                                                                                                                                |
| 10.3             |   | Amendment No. 2 dated as of  January 10, 2002 to the Amended and Restated Rights Agreement dated as  of July 15, 1999, between the Company and EquiServe Trust Company, N.A.  (successor to First Chicago Trust company of New York) (16) |
|             |   |                                                                                                                                                                                                                                                |
| 10.4             |   | Amendment No. 3 dated as of April 29,  2002 to the Amended and Restated Rights Agreement dated as of July 15,  1999, between the Company and EquiServe Trust Company, N.A. (20)                                                           |

 

26

----

 
| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                           |
|------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5             |   | Amendment No. 4 dated as of August 18,  2003 to the Amended and Restated Rights Agreement dated as of July 15,  1999, between the Company and EquiServe Trust Company, N.A. (23)                                |
|             |   |                                                                                                                                                                                                                      |
| 10.6             |   | Purchase and Sale Agreement and Receipt for  Earnest Money between the Company and John M. Hopkins, dated October 5,  2000 (13)                                                                                      |
|             |   |                                                                                                                                                                                                                      |
| 10.7             |   | Office Space Lease by and between The  Irvine Company and Gardenburger, Inc. dated August 21, 2003.                                                                                                                  |
|             |   |                                                                                                                                                                                                                      |
| 10.8             |   | Facility Lease  by and between Freeport Center Associates, a Utah general partnership and the  Company, dated May 28, 1997  (3)                                                                                 |
|             |   |                                                                                                                                                                                                                      |
| 10.9             |   | Addendum, dated August 1, 1997, to  Facility Lease by and between Freeport Center Associates and the Company (4)                                                                                                     |
|             |   |                                                                                                                                                                                                                      |
| 10.10            |   | Lease Extension, dated October 17,  2002, to Facility Lease dated May 28, 1997 by and between Freeport Center  Associates and the Company (20)                                                                  |
|             |   |                                                                                                                                                                                                                      |
| 10.11            |   | Warehouse Lease between Freeport Center  Associates and the Company, dated January 25, 1999 (8)                                                                                                                      |
|             |   |                                                                                                                                                                                                                      |
| 10.12            |   | Note Purchase Agreement, dated as of  March 27, 1998, between the Company and Dresdner Kleinwort Benson  Private Equity Partners L.P. (5)                                                                            |
|             |   |                                                                                                                                                                                                                      |
| 10.13            |   | First  Amendment to Note Purchase Agreement, dated December 30, 1999, between  the Company and Dresdner Kleinwort Benson Private Equity Partners L.P. (12)                                                           |
|             |   |                                                                                                                                                                                                                      |
| 10.14            |   | Second  Amendment, dated as of January 10, 2002, to the Note Purchase Agreement,  dated as of March 27, 1998, between Dresdner Kleinwort Benson Private  Equity Partners L.P. and the Company (18)              |
|             |   |                                                                                                                                                                                                                      |
| 10.15            |   | Third  Amendment, dated as of September 30, 2002, to the Note Purchase  Agreement, dated as of March 27, 1998, between Dresdner Kleinwort Benson  Private Equity Partners L.P. and the Company (20)             |
|             |   |                                                                                                                                                                                                                      |
| 10.16            |   | Fourth  Amendment, dated as of December 31, 2002, to the Note Purchase  Agreement, dated as of March 27, 1998, by and among Dresdner Kleinwort  Benson Private Equity Partners L.P. and Gardenburger, Inc. (21) |
|             |   |                                                                                                                                                                                                                      |
| 10.17            |   | Amended and  Restated Convertible Senior Subordinated Note dated January 10, 2002,  issued by the Company to Dresdner Kleinwort Benson Private Equity Partners  L.P. (18)                                            |
|             |   |                                                                                                                                                                                                                      |
| 10.18            |   | Warrant  Agreement, dated as of January 10, 2002, between Dresdner Kleinwort  Benson Private Equity Partners L.P. and the Company (18)                                                                               |
|             |   |                                                                                                                                                                                                                      |
| 10.19            |   | Form of  Warrant issued to Dresdner Kleinwort Benson Private Equity Partners L.P. and  holders of the Company’s preferred stock (18)                                                                                 |
|             |   |                                                                                                                                                                                                                      |
| 10.20            |   | Registration  Rights Agreement, dated as of March 27, 1998, between the Company and  Dresdner Kleinwort Benson Private Equity Partners L.P. (5)                                                                      |
|             |   |                                                                                                                                                                                                                      |
| 10.21            |   | First  Amendment, dated as of January 10, 2002, to Registration Rights Agreement,  dated as of March 27, 1998, between Dresdner Kleinwort Benson Private  Equity Partners L.P. and the Company (18)             |
| 10.22            |   | Revolving  Credit and Term Loan Agreement dated as of January 10, 2002, between  Gardenburger, Inc., CapitalSource Finance LLC, as administrative agent and  collateral agent for Lenders, and the Lenders (18)      |

 

27

----

 
| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                                                                                       |
|------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.23            |   | First  Amendment, dated as of September 30, 2002, to Revolving Credit and Term  Loan Agreement, dated as of January 10, 2002, between CapitalSource  Finance LLC and the Company (20)                                                                                       |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.24            |   | Second Amendment, dated  December 31, 2002, to Revolving Credit and Term Loan Agreement, dated  January 10, 2002, between CapitalSource Finance LLC and Gardenburger,  Inc. (21)                                                                                            |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.25            |   | Third Amendment, dated  March 31, 2003, to Revolving Credit and Term Loan Agreement, dated  January 10, 2002, between CapitalSource Finance LLC and Gardenburger,  Inc. (22)                                                                                                |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.26            |   | Stock  Purchase Agreement, dated March 29, 1999, by and between Gardenburger,  Inc. and Rosewood Capital III, L.P., Farallon Capital Management LLC, Gruber  & McBaine Capital Management, LLC, BT Capital Investors LP and certain  other purchasers identified therein (7) |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.27            |   | Amendment  and Waiver of Stock Purchase Agreement, dated April 14, 1999, by and  between Gardenburger, Inc., and the Purchasers identified on Exhibit A  thereto (9)                                                                                                             |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.28            |   | Investor  Rights Agreement, dated April 14, 1999, by and between Gardenburger,  Inc., and the investors identified on Exhibit A thereto (9)                                                                                                                                 |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.29            |   | Preferred  Stock Exchange Agreement, dated as of January 10, 2002, by and among the  Company and the holders of its preferred stock (18)                                                                                                                                         |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.30            |   | Registration  Rights Agreement, dated as of January 10, 2002, by and among the Company  and the holders of its preferred stock (18)                                                                                                                                              |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.31            |   | Paul F.  Wenner Stock Option Agreement dated January 20, 1992 (2) (6)                                                                                                                                                                                                            |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.32            |   | Amendment  effective May 8, 2001 to Stock Option Agreement dated January 20,  1992 between Gardenburger, Inc. and Paul F. Wenner (6) (15)                                                                                                                                   |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.33            |   | 1992 First  Amended and Restated Combination Stock Option Plan, as amended (“1992 Plan”)  (6) (10)                                                                                                                                                                          |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.34            |   | Form of  Incentive Stock Option Agreement for Option grants to executive officers  under 1992 Plan after May 24, 1995 (6) (8)                                                                                                                                                    |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.35            |   | Form of  Non-Statutory Stock Option Agreement for Option grants to executive officers  under 1992 Plan after May 24, 1995 (6) (8)                                                                                                                                                |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.36            |   | Incentive  Stock Option Agreement with Scott C. Wallace dated January 15, 2001 (6)  (19)                                                                                                                                                                                         |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.37            |   | 2001 Stock  Incentive Plan as Amended and Restated Effective June 1, 2001 (“2001  Plan”) (6) (15)                                                                                                                                                                      |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.38            |   | Form  of Award Agreement under the Gardenburger, Inc. 2001 Stock Incentive Plan (6)  (22)                                                                                                                                                                                             |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.39            |   | Form of  Director Nonqualified Stock Option Agreement under 2001 Plan (6) (19)                                                                                                                                                                                                        |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.40            |   | Paul F.  Wenner Employment Agreement and Amendment thereto (1) (6)                                                                                                                                                                                                                    |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.41            |   | Employment  Agreement dated January 15, 2001 between Gardenburger, Inc. and Scott C.  Wallace (6) (14)                                                                                                                                                                           |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.42            |   | Supplement,  dated April 30, 2003, to Employment Agreement, dated January 15,  2001, between Gardenburger, Inc. and Scott C. Wallace (6) (22)                                                                                                                               |
|             |   |                                                                                                                                                                                                                                                                                  |
| 10.43            |   | Change  in Control Agreement dated April 30, 2003 between Gardenburger, Inc. and  Scott C. Wallace (6) (22)                                                                                                                                                                      |

 

28

----

 
| **Exhibit  No.** |   | **Description**                                                                                                                                             |
|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.44            |   | Employment  Agreement dated March 25, 1997 between Gardenburger, Inc. and James W.  Linford, with addenda (6) (15)                                     |
|             |   |                                                                                                                                                        |
| 10.45            |   | Change  in Control Agreement, dated October 30, 2001, between Gardenburger Inc.  and James W. Linford (6) (15)                                         |
|             |   |                                                                                                                                                        |
| 10.46            |   | Form of  Indemnification Agreement between the Company and its Officers and Directors  (6) (8)                                                              |
|             |   |                                                                                                                                                        |
| 10.47            |   | Form of sale  bonus agreement entered into by Gardenburger, Inc. with Lorraine Crawford and  five members of non-executive management (6) (21)              |
|             |   |                                                                                                                                                        |
| 10.48            |   | Agreement  and Release of All Claims dated October 1, 2003 by and between  Gardenburger, Inc. and Lorraine Crawford (6)                                |
|             |   |                                                                                                                                                        |
| 10.49            |   | Employment  Agreement dated November 12, 2003 by and between Gardenburger, Inc. and  Robert T. Trebing, Jr. (6)                                        |
|             |   |                                                                                                                                                        |
| 10.50            |   | Option  Agreement dated April 14, 1996 between Gardenburger, Inc. and Lyle G.  Hubbard relating to 300,000 shares of common stock (6) (20)             |
|             |   |                                                                                                                                                        |
| 14               |   | Code of  Ethics                                                                                                                                             |
|             |   |                                                                                                                                                        |
| 16               |   | Letter re:  Change in Certifying Public Accountant (17)                                                                                                     |
|             |   |                                                                                                                                                        |
| 23               |   | Consent of  KPMG LLP                                                                                                                                        |
|             |   |                                                                                                                                                        |
| 31.1             |   | Certification of Scott C.  Wallace Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                           |
|             |   |                                                                                                                                                        |
| 31.2             |   | Certification of Robert T.  Trebing, Jr. Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                     |
|             |   |                                                                                                                                                        |
| 32.1             |   | Certification of Scott C.  Wallace Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002       |
|             |   |                                                                                                                                                        |
| 32.2             |   | Certification of Robert T.  Trebing, Jr. Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
|             |   |                                                                                                                                                        |
| 99               |   | Description  of Common Stock of Gardenburger, Inc.   (20)                                                                                              |

 

29

----

 

----

(1)          Incorporated by reference to the Company’s Form S-1 RegistrationStatement (Commission File No. 33-46623) filed May 6, 1992.

(2)          Incorporated by reference to the Company’s 1992 Form 10-K Annual Report,filed March 23, 1993 (Commission File No. 0-20330).

(3)          Incorporated by reference to the Company’s Form 10-Q Quarterly Reportfor the quarter ended June 30, 1997, filed August 14, 1997.

(4)          Incorporated by reference to the Company’s 1997 Form 10-K Annual Report,filed March 31, 1998.

(5)          Incorporated by reference to the Company’s Form 10-Q for the quarter endedMarch 31, 1998, filed May 15, 1998.

(6)          Management contract or compensatory plan or arrangement.

(7)          Incorporated by reference to the Company’s Form 8-K Current Report,filed April 1, 1999.

(8)          Incorporated by reference to the Company’s Form 10-K for the year endedDecember 31, 1998, filed March 31, 1999.

(9)          Incorporated by reference to the Company’s Form 10-Q for the quarterended March 31, 1999, filed May 17, 1999.

(10)    Incorporated by reference to the Company’s Form 10-Q for the quarterended June 30, 1999, filed August 13, 1999.

(11)    Incorporated by reference to the Company’s Registration Statement onForm S-8 (No. 333-92665), filed December 13, 1999.

(12)    Incorporated by reference to the Company’s Form 10-Q for the quarterended December 31, 1999, filed February 9, 2000.

(13)    Incorporated by reference to the Company’s 2000 Form 10-K Annual Report,filed December 26, 2000.

(14)    Incorporated by reference to the Company’s Form 10-Q for the quarterended December 31, 2000, filed February 14, 2001.

(15)    Incorporated by reference to the Company’s Form 10-Q for the quarterended December 31, 2001, filed February 13, 2002.

(16)    Incorporated by reference to the Company’s Form 10-Q for the quarterended June 30, 2002, filed August 9, 2002.

(17)    Incorporated by reference to the Company’s Form 8-K/A dated May 16,2002 and filed May 30, 2002.

(18)    Incorporated by reference to the Company’s Form 8-K datedJanuary 10, 2002 and filed January 17, 2002.

(19)    Incorporated by reference to the Company’s 2001 Form 10-K Annual Report,filed December 10, 2001.

(20)    Incorporated by reference to the Company’s 2002 Form 10-K Annual Report,filed December 19, 2002.

(21)    Incorporated by reference to the Company’s Quarterly Report on Form 10-Qfor the quarter ended December 31, 2002, filed February 13, 2003.

(22)    Incorporated by reference to the Company’s Quarterly Report on Form 10-Qfor the quarter ended March 31, 2003, filed May 14, 2003.

(23)    Incorporated by reference to the Company’s Form 8-K datedAugust 18, 2003 and filed August 19, 2003.

 

30

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: December 29, 2003

 
|   | **GARDENBURGER, INC.** |                                               |
|--------|------------------------|----------------------------------------------------|
|   |                   |                                               |
|   | By:                    | /s/ ROBERT T. TREBING, JR.                         |   |
|   |                   | Robert T. Trebing, Jr.                             |
|   |                   | Senior Vice President  and Chief Financial Officer |
|        |                        |                                                    |  |  |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities indicated on December 29, 2003.

 
| **Signature**              |   | **Title** |
|----------------------------|--------|-----------|
|                       |   |      |
| /s/ SCOTT C. WALLACE       |   |      | Director, Chairman, President |
| Scott C. Wallace           |   |      | and Chief Executive Officer |
|                       |   |      | (Principal Executive Officer) |
|                       |   |      |   |
|                       |   |      |   |
| /s/ ROBERT T. TREBING, JR. |   |      | Senior Vice President and Chief Financial  Officer |
| Robert T. Trebing, Jr.     |   |      | (Principal Financial and Accounting  Officer) |
|                       |   |      |   |
|                       |   |      |   |
| /s/ KYLE A. ANDERSON       |   |      | Director |
| Kyle A. Anderson           |   |      |   |
|                       |   |      |   |
|                       |   |      |   |
| /s/ CHARLES E. BERGERON    |   |      | Director |
| Charles E. Bergeron        |   |      |   |
|                       |   |      |   |
|                       |   |      |   |
| /s/ ALEXANDER P. COLEMAN   |   |      | Director |
| Alexander P. Coleman       |   |      |   |
|                       |   |      |   |
|                       |   |      |   |
| /s/ RICHARD L. MAZER       |   |      | Director |
| Richard L. Mazer           |   |      |   |
|                       |   |      |   |
|                       |   |      |   |
| /s/ KEVIN M. REILLY        |   |      | Director |
| Kevin M. Reilly            |   |      |   |
|                       |   |      |   |
|                       |   |      |   |
| /s/ PAUL F. WENNER         |   |      | Founder and Director |
| Paul F. Wenner             |   |      |   |
|                            |        |           |  |  |

 

31

----

 

Independent Auditors’ Report

 

The Board of DirectorsGardenburger, Inc.:

 

We have audited the accompanyingbalance sheets of Gardenburger, Inc. (an Oregon corporation) as of September30, 2003 and 2002, and the related statements of operations, shareholders’deficit and cash flows for each of the years in the two-year period endedSeptember 30, 2003.  These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits. The financial statements of Gardenburger, Inc. for the year endedSeptember 30, 2001 were audited by other auditors who have ceasedoperations.  Those auditors expressed anunqualified opinion on those financial statements, before the restatementdescribed in Note 1 to the financial statements, in their report dated November2, 2001.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica. Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, the financialstatements referred to above present fairly, in all material respects, thefinancial position of Gardenburger, Inc. as of September 30, 2003 and 2002, andthe results of its operations and its cash flows for each of the years in thetwo-year period ended September 30, 2003 in conformity with accountingprinciples generally accepted in the United States of America.

 

As described in Note 2, thefinancial statements for each of the years ended September 30, 2002 and 2001have been revised to include the transitional disclosures required by Statementof Financial Accounting Standards No. 142, Goodwill and Other IntangibleAssets, which was adopted by the Company as of October 1, 2002.  As discussed above, the financial statementsof Gardenburger, Inc. for the year ended September 30, 2001 were audited byother auditors who have ceased operations.

 

As described in Note 1, thefinancial statements for the year ended September 30, 2001 have been restatedas a result of the adoption of EITF No. 01-09, Accounting for ConsiderationGiven by a Vendor to a Customer or a Reseller of the Vendor’s Products.  We audited the adjustments described in Note1 to the financial statements that were applied to restate the 2001 financialstatements and the transitional disclosures required by Statement of FinancialAccounting Standards No. 142, included in Note 2.  In our opinion, such disclosures and adjustments are appropriateand have been properly applied. However, we were not engaged to audit, reviewor apply any procedures to the 2001 financial statements of Gardenburger, Inc.other than with respect to such disclosures and adjustments and, accordingly,we do not express an opinion or any other form of assurance on the 2001financial statements taken as a whole.

 
| /s/ KPMG LLP                                                                                           |   |
|--------------------------------------------------------------------------------------------------------|--------|
| Portland, Oregon                                                                                       |
| November 7, 2003, except as to Note 16 to  the financial statements, which is as of December 29, 2003. |

 

F-1

----

 

***THISREPORT IS A CONFORMED COPYOF THE REPORT PREVIOUSLY ISSUED BYARTHUR ANDERSEN LLP AND HAS NOT BEEN REISSUED BY THAT FIRM.***

 

**Reportof Independent Public Accountants**

 

To the Board of Directors and Shareholders ofGardenburger, Inc.:

 

We have audited the accompanying balance sheets ofGardenburger, Inc. (an Oregon corporation) as of September 30, 2001and 2000 and the related statements of operations, shareholders’ equity(deficit) and cash flows for the years ended September 30, 2001 and 2000and the nine months ended September 30, 1999. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position ofGardenburger, Inc. as of September 30, 2001 and 2000, and the resultsof its operations and its cash flows for the years ended September 30,2001 and 2000 and the nine months ended September 30, 1999, in conformitywith accounting principles generally accepted in the United States.

 
| /s/Arthur Andersen LLP |   |
|------------------------|--------|
|                   |
| Portland, Oregon,      |
| November 2, 2001  |

 

ARTHUR ANDERSEN LLP WERE THE INDEPENDENTACCOUNTANTS FOR GARDENBURGER, INC. UNTIL MAY 16, 2002. REPRESENTATIVES OF ARTHURANDERSEN LLP ARE NOT AVAILABLE TO PROVIDE THE CONSENT REQUIRED FOR THEINCORPORATION BY REFERENCE OF THEIR REPORT ON THE FINANCIAL STATEMENTS OFGARDENBURGER, INC. APPEARING IN THIS ANNUAL REPORT INTO REGISTRATION STATEMENTSFILED BY GARDENBURGER, INC. WITH THE SECURITIES AND EXCHANGE COMMISSION ANDCURRENTLY EFFECTIVE UNDER THE SECURITIES ACT OF 1933. BECAUSE ARTHUR ANDERSENLLP HAVE NOT CONSENTED TO THE INCORPORATION BY REFERENCE OF THEIR REPORT, THEINVESTOR WILL NOT BE ABLE TO RECOVER AGAINST ARTHUR ANDERSEN LLP UNDERSECTION 11 OF THE SECURITIES ACT OF 1933 FOR ANY UNTRUE STATEMENTS OF AMATERIAL FACT CONTAINED IN THE FINANCIAL STATEMENTS AUDITED BY ARTHUR ANDERSENLLP THAT ARE CONTAINED IN THIS REPORT OR ANY OMISSIONS TO STATE A MATERIAL FACTREQUIRED TO BE STATED THEREIN.

 

F-2

----

 

GARDENBURGER, INC.

BALANCE SHEETS

(In thousands, except shareamounts)

 
|                                                                                                                   |   | **September 30,** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                                                                   |   | **2003**               |   | **2002** |   |
|                                                                                                                   |   |                   |   |   |   |
| **Assets**                                                                                                             |   |                   |   |   |   |
| Current Assets:                                                                                                        |   |                   |   |   |   |
| Cash and cash equivalents                                                                                              |   | $                      | 1,262  |   | $ | 2,760 |   |
| Accounts receivable,  net of allowances of $193 and $200                                                               |   | 2,960                  |   | 3,127 |   |
| Inventories, net                                                                                                       |   | 9,191                  |   | 9,093 |   |
| Prepaid expenses                                                                                                       |   | 2,089                  |   | 1,566 |   |
| Total Current Assets                                                                                                   |   | 15,502                 |   | 16,546 |   |
|                                                                                                                   |   |                   |   |   |   |
| Property, Plant and  Equipment, net of accumulated depreciation of $10,588 and $8,311                                  |   | 11,969                 |   | 13,033 |   |
| Other Assets, net of  accumulated amortization of $1,397 and $1,902                                                    |   | 757                    |   | 1,483 |   |
| Total Assets                                                                                                           |   | $                      | 28,228 |   | $ | 31,062 |   |
|                                                                                                                   |   |                   |   |   |   |
| **Liabilities  and Shareholders’ Equity (Deficit)**                                                               |   |                   |   |   |   |
| Current Liabilities:                                                                                                   |   |                   |   |   |   |
| Short-term note payable                                                                                                |   | $                      | 2,183  |   | $ | 1,116 |   |
| Current portion of  long-term debt                                                                                     |   | 1,833                  |   | 1,901 |   |
| Accounts payable                                                                                                       |   | 2,546                  |   | 2,340 |   |
| Payroll and related  liabilities payable                                                                               |   | 704                    |   | 722 |   |
| Other current  liabilities                                                                                             |   | 2,299                  |   | 222 |   |
| Total Current  Liabilities                                                                                             |   | 9,565                  |   | 6,301 |   |
|                                                                                                                   |   |                   |   |   |   |
| Long-Term Debt, less  current maturities                                                                               |   | 4,979                  |   | 6,540 |   |
| Convertible Notes  Payable                                                                                             |   | 18,672                 |   | 17,596 |   |
|                                                                                                                   |   |                   |   |   |   |
| Convertible Redeemable  Preferred Stock, liquidation preference of $54,204 and $50,304 and 650,000  shares outstanding |   | 51,012                 |   | 45,835 |   |
|                                                                                                                   |   |                   |   |   |   |
| Shareholders’ Equity  (Deficit):                                                                                  |   |                   |   |   |   |
| Preferred Stock, no par  value, 5,000,000 shares authorized                                                            |   | —                 |   | — |   |
| Common Stock, no par  value, 25,000,000 shares authorized; shares issued and outstanding: 9,002,101  and 9,002,101     |   | 11,189                 |   | 11,189 |   |
| Additional paid-in  capital                                                                                            |   | 12,500                 |   | 12,500 |   |
| Retained deficit                                                                                                       |   | (79,689                | )      | (68,899 | ) |
| Total Shareholders’  Deficit                                                                                      |   | (56,000                | )      | (45,210 | ) |
| Total Liabilities and  Shareholders’ Deficit                                                                      |   | $                      | 28,228 |   | $ | 31,062 |   |

 

The accompanying notes are an integral partof these balance sheets.

 

F-3

----

 

GARDENBURGER, INC.

STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

 
|                                                                                                                             |   | **For the Year Ended  September 30,** |    |
|----------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|---------|
|                                                                                                                             |   | **2003**                                   |    | **2002** |   | **2001** |   |
|                                                                                                                             |   |                                       |    |   |   |   |   |
| Net sales                                                                                                                        |   | $                                          | 49,447  |   | $ | 54,596 |   | $ | 50,751 |   |
| Cost of goods sold                                                                                                               |   | 30,709                                     |    | 31,689 |   | 32,558 |   |
| Gross margin                                                                                                                     |   | 18,738                                     |    | 22,907 |   | 18,193 |   |
|                                                                                                                             |   |                                       |    |   |   |   |   |
| Operating expenses:                                                                                                              |   |                                       |    |   |   |   |   |
| Sales and marketing                                                                                                              |   | 14,208                                     |    | 13,711 |   | 13,586 |   |
| General and  administrative                                                                                                      |   | 5,218                                      |    | 4,210 |   | 4,997 |   |
| Legal settlement                                                                                                                 |   | —                                     |    | (108 | ) | — |   |
| Debt restructuring  costs                                                                                                        |   | —                                     |    | 716 |   | — |   |
| Other general (income)  expense, net                                                                                             |   | 105                                        |    | (424 | ) | 57 |   |
|                                                                                                                             |   | 19,531                                     |    | 18,105 |   | 18,640 |   |
| Operating income (loss)                                                                                                          |   | (793                                       | )       | 4,802 |   | (447 | ) |
|                                                                                                                             |   |                                       |    |   |   |   |   |
| Other income (expense):                                                                                                          |   |                                       |    |   |   |   |   |
| Interest income                                                                                                                  |   | 11                                         |    | 33 |   | 91 |   |
| Interest expense                                                                                                                 |   | (4,420                                     | )       | (3,754 | ) | (2,433 | ) |
|                                                                                                                             |   | (4,409                                     | )       | (3,721 | ) | (2,342 | ) |
| Income (loss) before  cumulative effect of a change in accounting principle and preferred dividends                              |   | (5,202                                     | )       | 1,081 |   | (2,789 | ) |
| Cumulative effect of a  change in accounting for goodwill                                                                        |   | 411                                        |    | — |   | — |   |
| Income (loss) before  preferred dividends                                                                                        |   | (5,613                                     | )       | 1,081 |   | (2,789 | ) |
| Preferred dividends                                                                                                              |   | 5,177                                      |    | 4,955 |   | 4,367 |   |
| Net loss available for  common shareholders                                                                                      |   | $                                          | (10,790 | ) | $ | (3,874 | ) | $ | (7,156 | ) |
|                                                                                                                             |   |                                       |    |   |   |   |   |
| Basic and diluted  income (loss) per share before cumulative effect of a change in accounting  principle and preferred dividends |   | $                                          | (0.58   | ) | $ | 0.12 |   | $ | (0.31 | ) |
|                                                                                                                             |   |                                       |    |   |   |   |   |
| Basic and diluted loss  per share for cumulative effect of a change in accounting principle                                      |   | $                                          | (0.05   | ) | $ | — |   | $ | — |   |
|                                                                                                                             |   |                                       |    |   |   |   |   |
| Basic and diluted net  loss per share                                                                                            |   | $                                          | (1.20   | ) | $ | (0.43 | ) | $ | (0.80 | ) |
|                                                                                                                             |   |                                       |    |   |   |   |   |
| Weighted average shares  used in basic and diluted per share calculations                                                        |   | 9,002                                      |    | 9,002 |   | 9,000 |   |

 

The accompanying notes are an integral partof these statements.

 

F-4

----

 

GARDENBURGER, INC.

STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

For the Years Ended September 30, 2003, 2002and 2001 

(In thousands, except share amounts)

 
|                                    |   |       |   | **Additional****Paid-In****Capital** |   | **Retained****Deficit** |   | **Total****Shareholders’****Deficit** |   |
|-----------------------------------------|--------|------------|--------|--------------------------------------|--------|-------------------------|--------|--------------------------------------------|--------|
| **Common  Stock**                       |
| **Shares**                              |   | **Amount** |
|                                    |   |       |   |                                 |   |                    |   |                                       |   |   |   |
| **Balance  at September 30, 2000** |   | 8,972,601  |   | $                                    | 11,153 |                    | $      | 12,405                                     |   | $ | (57,869 | ) | $ | (34,311 | ) |
|                                    |   |       |   |                                 |   |                    |   |                                       |   |   |   |
| Exercise of common  stock options       |   | 29,500     |   | 36                                   |   | —                  |   | —                                     |   | 36 |   |
| Accrual of preferred  dividends         |   | —     |   | —                               |   | —                  |   | (4,367                                     | )      | (4,367 | ) |
| Loss before preferred  dividends        |   | —     |   | —                               |   | —                  |   | (2,789                                     | )      | (2,789 | ) |
| **Balance  at September 30, 2001** |   | 9,002,101  |   | 11,189                               |   | 12,405                  |   | (65,025                                    | )      | (41,431 | ) |
|                                    |   |       |   |                                 |   |                    |   |                                       |   |   |   |
| Issuance of warrants                    |   | —     |   | —                               |   | 95                      |   | —                                     |   | 95 |   |
| Accrual of preferred  dividends         |   | —     |   | —                               |   | —                  |   | (4,955                                     | )      | (4,955 | ) |
| Income before preferred  dividends      |   | —     |   | —                               |   | —                  |   | 1,081                                      |   | 1,081 |   |
| **Balance  at September 30, 2002** |   | 9,002,101  |   | 11,189                               |   | 12,500                  |   | (68,899                                    | )      | (45,210 | ) |
|                                    |   |       |   |                                 |   |                    |   |                                       |   |   |   |
| Accrual of preferred  dividends         |   | —     |   | —                               |   | —                  |   | (5,177                                     | )      | (5,177 | ) |
| Loss before preferred  dividends        |   | —     |   | —                               |   | —                  |   | (5,613                                     | )      | (5,613 | ) |
| **Balance  at September 30, 2003** |   | 9,002,101  |   | $                                    | 11,189 |                    | $      | 12,500                                     |   | $ | (79,689 | ) | $ | (56,000 | ) |

 

The accompanying notes are an integral partof these statements.

 

F-5

----

 

GARDENBURGER, INC.

STATEMENTS OF CASH FLOWS

(In thousands)

 
|                                                                                                                    |   | **For the Year Ended  September 30,** |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                                                    |   | **2003**                                   |   | **2002** |   | **2001** |   |
| Cash flows from  operating activities:                                                                                  |   |                                       |   |   |   |   |   |
| Income (loss) before  preferred dividends                                                                               |   | $                                          | (5,613 | ) | $ | 1,081 |   | $ | (2,789 | ) |
| Adjustments to  reconcile income (loss) before preferred dividends to net cash flows provided  by operating activities: |   |                                       |   |   |   |   |   |
| Depreciation and  amortization                                                                                          |   | 3,236                                      |   | 3,403 |   | 2,068 |   |
| Cumulative effect of a  change in accounting for goodwill                                                               |   | 411                                        |   | — |   | — |   |
| Accrual of  CapitalSource and Dresdner exit fees                                                                        |   | 1,349                                      |   | 1,006 |   | — |   |
| Other non-cash expenses                                                                                                 |   | —                                     |   | (208 | ) | 1,840 |   |
| (Gain) loss on sale of  fixed assets                                                                                    |   | 105                                        |   | (119 | ) | 131 |   |
| (Increase) decrease in:                                                                                                 |   |                                       |   |   |   |   |   |
| Accounts receivable,  net                                                                                               |   | 167                                        |   | 386 |   | 585 |   |
| Inventories, net                                                                                                        |   | (98                                        | )      | (1,762 | ) | 168 |   |
| Prepaid expenses                                                                                                        |   | (523                                       | )      | (496 | ) | 1,009 |   |
| Increase (decrease) in:                                                                                                 |   |                                       |   |   |   |   |   |
| Accounts payable                                                                                                        |   | 206                                        |   | 381 |   | 83 |   |
| Payroll and related  liabilities                                                                                        |   | (18                                        | )      | 63 |   | (752 | ) |
| Other accrued  liabilities                                                                                              |   | 2,077                                      |   | (593 | ) | (578 | ) |
| Net cash provided by  operating activities                                                                              |   | 1,299                                      |   | 3,142 |   | 1,765 |   |
|                                                                                                                    |   |                                       |   |   |   |   |   |
| Cash flows from  investing activities:                                                                                  |   |                                       |   |   |   |   |   |
| Payments for purchase  of property and equipment                                                                        |   | (1,962                                     | )      | (10,109 | ) | (683 | ) |
| Proceeds from sale of  property and equipment                                                                           |   | —                                     |   | 211 |   | 675 |   |
| Other assets, net                                                                                                       |   | —                                     |   | — |   | (4 | ) |
| Net cash used in  investing activities                                                                                  |   | (1,962                                     | )      | (9,898 | ) | (12 | ) |
|                                                                                                                    |   |                                       |   |   |   |   |   |
| Cash flows from  financing activities:                                                                                  |   |                                       |   |   |   |   |   |
| Proceeds from (payments  on) short-term note payable, net                                                               |   | 1,067                                      |   | (573 | ) | (902 | ) |
| Proceeds from long-term  debt                                                                                           |   | —                                     |   | 8,000 |   | — |   |
| Payments on long-term  debt                                                                                             |   | (1,902                                     | )      | (333 | ) | — |   |
| Capitalized financing  fees                                                                                             |   | —                                     |   | (643 | ) | — |   |
| Proceeds from exercise  of common stock options and warrants                                                            |   | —                                     |   | — |   | 36 |   |
| Net cash provided by  (used in) financing activities                                                                    |   | (835                                       | )      | 6,451 |   | (866 | ) |
|                                                                                                                    |   |                                       |   |   |   |   |   |
| Increase (decrease) in  cash and cash equivalents                                                                       |   | (1,498                                     | )      | (305 | ) | 887 |   |
|                                                                                                                    |   |                                       |   |   |   |   |   |
| Cash and cash  equivalents:                                                                                             |   |                                       |   |   |   |   |   |
| Beginning of period                                                                                                     |   | 2,760                                      |   | 3,065 |   | 2,178 |   |
| End of period                                                                                                           |   | $                                          | 1,262  |   | $ | 2,760 |   | $ | 3,065 |   |

 

The accompanying notes are an integral partof these statements.

 

F-6

----

 

**GARDENBURGER,INC.**

**NOTES TO FINANCIALSTATEMENTS**

 

**1.****                      ORGANIZATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

***Organization andNature of Operations***

 

Gardenburger, Inc. was incorporated in Oregon in 1985 to provide a lineof meatless food products in response to the public’s awareness of theimportance of diet to overall health and fitness.  Toward this end, we developed and now produce and distributefrozen, meatless food products, consisting of veggie burgers and soy-basedchicken, pork, and meatball products. Our products are sold principally to retail and food service customersthroughout the United States.

 

***Liquidity and Fiscal2004 Commitments***

 

We anticipate funding our 2004 commitments out of operating cash flowsand line of credit borrowings.  Based onour debt agreements (prior to the extension of the maturity dates as discussedin Note 16), cash required to meet our interest and principal paymentson our debt outstanding at September 30, 2003 totals approximately $5.4million in fiscal 2004 as follows (in thousands).  

 
| Interest deferred on  convertible notes at September 30, 2003      |   | $     | 845    |   |
|-------------------------------------------------------------------------|--------|-------|--------|--------|
| Additional interest on  interest deferred at September 30, 2003    |   | 21    |   |
| Fiscal 2004 interest on  convertible notes                              |   | 1,691 |   |
| Principal payment due on long-term  debt                                |   | 1,833 |   |
| Interest on long-term debt                                              |   | 561   |   |
| Estimated interest on  short-term note payable                          |   | 351   |   |
| Estimated unused line of  credit fee related to short term note payable |   | 48    |   |
| Total                                                                   |   | $     | 5,350  |   |

 

See also Note 16. Subsequent Event.

 

***Estimates***

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates. Management believes that the estimates used are reasonable.  Significant estimates made by managementinclude estimates for bad debts, excess and obsolete inventory, couponliabilities and other trade spending liabilities.

 

***Cash Equivalents***

 

Cash equivalents consist of highly liquid investments with maturitiesat the date of purchase of 90 days or less.

 

***FairValue of Financial Instruments***

 

The carrying amounts of our financialinstruments, including cash and cash equivalents, accounts receivable, accountspayable and accrued liabilities, approximate fair value due to the shortmaturities of these financial instruments. Our convertible notes are also considered a financial instrument,however, their fair value is not readily determinable due to their being heldby a single entity and the lack of a public trading market.

 

***Accounts Receivableand Allowances for Uncollectible Accounts***

 

Credit limits are established through aprocess of reviewing the financial history and stability of each customer.  We regularly evaluate the collectibility ofour trade receivable balances by monitoring past due balances.  If it is determined that a customer will beunable to meet its financial obligation, we record a specific reserve for baddebts to reduce the related receivable to the amount we expect to recover.  Historically, bad debts have not had amaterial effect on us.  If circumstancesrelated to specific customers deteriorate, our estimates of the recoverabilityof receivables associated with those customers could materially change.

 

F-7

----

 

***Inventories***

 

Inventories are valued at standard cost, which approximates the lowerof cost (using the first-in, first-out (FIFO) method) or market, and includematerials, labor and manufacturing overhead.

 

***Contract OriginationCosts***

 

Costs incurred for the origination of certain distribution and othercontracts are included as a prepaid asset on our balance sheet and amortizedover the life of the related contract, typically 12 months or less.  Such costs are refundable to us should thecontract be terminated prior to completion. At September 30, 2003 and 2002, prepaid assets included $513,000and $203,000, respectively, of contract origination costs.

 

***Property, Plant andEquipment***

 

Property, plant and equipment are stated at cost.  Significant improvements are capitalized andmaintenance and repairs are expensed. Depreciation and amortization areprovided using the straight-line method over the estimated useful lives of theassets.  Leasehold improvements areamortized over the lease term or the estimated useful life of the asset,whichever is shorter.  Property, plantand equipment arereviewed for impairment whenever events or circumstances indicate that thecarrying amount of assets may not be recoverable in accordance with Statementof Financial Accounting Standards (“SFAS”) No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets.” We evaluate recoverability ofproperty, plant and equipment to be held and used by comparing the carryingamount of an asset to estimated future net undiscounted cash flows to begenerated by the asset.  If such assetsare considered to be impaired, the impairment to be recognized is measured asthe amount by which the carrying amount of the assets exceeds the fair value ofthe assets.  We performed such ananalysis in the fourth quarter of fiscal 2003 and determined that no impairmentexisted.

 

Estimated useful lives are as follows:

 
| Buildings and improvements     |   | 3 - 40 years |
|--------------------------------|--------|--------------|
| Office furniture and equipment |   | 3 - 10 years |
| Machinery and equipment        |   | 7 - 30 years |
| Vehicles                       |   | 5 years      |

 

***Other Assets***

 

Other assets include deferred financing fees andtrademarks as of September 30, 2003. Deferredfinancing fees are being amortized over the maturity period of the relateddebt, and trademarks are being amortized using the straight-line method overforty years.  Deferred financing feesand trademarks are reviewed for impairment and changes in their estimatedremaining useful lives whenever events or circumstances indicate that thecarrying amount of assets may not be recoverable in accordance with SFAS No.144. We evaluate recoverability by comparing the carrying amount of the assetsto estimated future net undiscounted cash flows to be generated by theassets.  If such assets are consideredto be impaired, the impairment to be recognized is measured as the amount bywhich the carrying amount of the assets exceeds the fair value of theassets.  See also Note 2 New AccountingPronouncements regarding the adoption of SFAS No. 142 and the write-off of ourgoodwill balance.

 

**SegmentReporting**

 

We disclose segment information in accordance with SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information.”  Based upon definitions contained within SFASNo. 131, we have determined that we operate in one segment.  In addition, virtually all sales aredomestic, and all of our long-lived assets are located within the UnitedStates.

 

F-8

----

 

***Concentrations ofCredit Risk and Significant Customers***

 

We invest our excess cash with high credit quality financialinstitutions, which bear minimal risk, and, by policy, limit the amount ofcredit exposure to any one financial institution.

 

For fiscal 2003, three customers accounted for approximately 13percent, 12 percent and 9 percent of gross sales, respectively, andapproximately 18 percent, 5 percent and 11 percent of the accounts receivablebalance at September 30, 2003, respectively.

 

For fiscal 2002, three customers accounted for approximately 12percent, 11 percent and 10 percent of gross sales, respectively, andapproximately 14 percent, 7 percent and 13 percent of the accounts receivablebalance at September 30, 2002, respectively.

 

For fiscal 2001, two customers accounted for approximately 10 percentof gross sales each and approximately 18 percent and 13 percent of the accountsreceivable balance at September 30, 2001, respectively.

 

Historically, we have not incurred significant losses related toaccounts receivable.

 

***Revenue Recognitionand Sales Incentives***

 

Revenuefrom the sale of products is generally recognized at time of shipment to thecustomer.  Our revenue arrangements withour customers often include sales incentives and other promotional costs suchas coupons, volume-based discounts and off-invoice discounts. These costs aretypically referred to collectively as “trade spending.”  Pursuant to EITF No. 00-14, EITF No. 00-25and EITF No. 01-09, these costs are recorded at the later of when revenue isrecognized or when the sales incentive is offered, and are generally classifiedas a reduction of revenue.  We do notprovide for a sales returns or warranty allowance since, historically, salesreturns and warranty related costs have not been significant.

 

***Shipping and FreightCharges***

 

We incur costs related to shipping and handling of ourmanufactured products.  We expense thesecosts as incurred as a component of sales and marketing expense.  We also incur shipping and handling chargesrelated to the receipt of raw materials, which are recorded as a component ofcost of goods sold.  Payments receivedfrom customers for shipping and handling costs are included as a component ofnet sales upon recognition of the related sale.

 

***Advertising Costs***

 

Advertising costs, including media advertising, design and printing ofcoupons, and other advertising, which are included in sales and marketingexpense, are expensed when the advertising first takes place.  Advertising expense was approximately$572,000 in 2003, $1.1 million in 2002 and $232,000 in 2001.

 

***Slotting Fees***

 

Slotting agreements refer to oral arrangements pursuant to which theretail grocer allows our products to be placed on the store’s shelves inexchange for a slotting fee. Slotting fees associated with a new product or anew territory are initially recorded as a prepaid asset and the related expenseis recognized ratably over the 12-month period beginning with the initialintroduction of the product as an offset to sales.  Typically, 12 months is the minimum period during which aretailer agrees to allocate shelf space. If a slotting fee agreement were breached, we would pursue availablelegal remedies to enforce the agreement as appropriate.  Total slotting included in prepaid assets atSeptember 30, 2003 and 2002 was $1.1 million and $934,000, respectively.

 

***Research andDevelopment Costs***

 

Research and development costs are expensed as incurred. Research anddevelopment expense was approximately $235,000 in 2003, $222,000 in 2002 and$188,000 in 2001 and is included in sales and marketing expenses in the accompanyingstatements of operations.

 

F-9

----

 

***Net Loss Per Share***

 

Basic earnings (loss) per share (“EPS”) is calculated using theweighted average number of common shares outstanding for the period and dilutedEPS is computed using the weighted average number of common shares and dilutivecommon equivalent shares outstanding.

 

Basic EPS and diluted EPS are the same for all periodspresented since we were in a loss position in all periods.  Potentially dilutive securities that are notincluded in the diluted EPS calculation because they would be antidilutive areas follows (in thousands):

 
|                        |   | **September 30,** |   |
|-----------------------------|--------|------------------------|--------|
|                        |   | **2003**               |   | **2002** |   | **2001** |   |
| Stock options and warrants  |   | 5,045                  |   | 5,651 |   | 4,113 |   |
| Convertible notes           |   | 1,730                  |   | 1,775 |   | 1,709 |   |
| Convertible preferred stock |   | 4,062                  |   | 4,062 |   | 4,062 |   |
| Total                       |   | 10,837                 |   | 11,488 |   | 9,884 |   |

 

***ComprehensiveIncome Reporting***

 

SFAS No. 130, “Reporting ComprehensiveIncome” establishes standards for reporting and displaying comprehensive incomeand its components in a full set of general purpose financial statements. Theobjective of SFAS No. 130 is to report a measure of all changes in the equityof an enterprise that result from transactions and other economic events of theperiod other than transactions with owners. Comprehensive loss did not differfrom currently reported net loss in the periods presented.

 

***StockBased Compensation Plans***

 

We account for stock optionsusing the intrinsic value method as prescribed by Accounting Principles Board(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Pursuant toSFAS No. 148 “Accounting for Stock-Based Compensation - Transition andDisclosure,” which we adopted in January 2003, we have computed, for proforma disclosure purposes, the impact on net loss and net loss per share as ifwe had accounted for our stock-based compensation plans in accordance with thefair value method prescribed by SFAS No. 123 “Accounting for Stock-BasedCompensation” as follows (in thousands, except per share amounts):

 
|                                                                                                                   |   | **Year Ended September 30,** |    |
|------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                                                                                   |   | **2003**                          |    | **2002** |   | **2001** |   |
| Net loss available for  common shareholders, as reported                                                               |   | $                                 | (10,790 | ) | $ | (3,874 | ) | $ | (7,156 | ) |
| Deduct -  total stock-based employee compensation expense determined under the fair  value based method for all awards |   | (450                              | )       | (991 | ) | (1,703 | ) |
| Net loss, pro forma                                                                                                    |   | $                                 | (11,240 | ) | $ | (4,865 | ) | $ | (8,859 | ) |
|                                                                                                                   |   |                              |    |   |   |   |   |
| Basic and diluted net  loss per share - as reported                                                                    |   | $                                 | (1.20   | ) | $ | (0.43 | ) | $ | (0.80 | ) |
| Basic and diluted net  loss per share  pro forma                                                                  |   | $                                 | (1.25   | ) | $ | (0.54 | ) | $ | (0.98 | ) |

 

We used the Black-Scholes option pricingmodel and the following weighted average assumptions in calculating the valueof all options granted during the periods presented:

 
|                    |   | **Year Ended  September 30,** |   |
|-------------------------|--------|------------------------------------|--------|
|                    |   | **2002**                           |   | **2001** |   |
| Risk-free interest rate |   | 4.50                               | %      | 5.00 | % |
| Expected dividend yield |   | 0                                  | %      | 0 | % |
| Expected lives          |   | 6.0 years                          |   | 6.0 years |   |
| Expected volatility     |   | 96.53                              | %      | 78.26 | % |

 

Using the Black-Scholes methodology, the total valueof options granted during fiscal 2002 and 2001 was $336,000 and $1.1 million,respectively, which would be amortized on a pro forma basis over the vestingperiod of the options (typically three to five years).  The weighted average per share fair value ofoptions granted during 2002 and 2001 was $0.52 and $0.54, respectively.  There were no options granted during fiscal2003.

 

F-10

----

 

***Reclassifications***

 

Certainreclassifications have been made to the prior years’ amounts to conform to thecurrent year’s presentation.

 

As a result of the adoption of Emerging Issues Task Force(“EITF”) No. 01-09 “Accounting for Consideration Given by a Vendor to aCustomer or Reseller of the Vendor's Products” in fiscal 2002, wereclassified certain sales incentives from sales and marketing expense to netrevenues as follows for fiscal 2001:

 
|                                 |   | **2001** |   |
|--------------------------------------|--------|----------|--------|
| Net revenues as previously  reported |   | $        | 59,557 |   |
| Sales incentives                     |   | (8,806   | )      |
| Net revenues as adjusted             |   | $        | 50,751 |   |

 

Sales and marketing expense for the years ended September 30, 2001also decreased by the respective sales incentive amount indicated in the abovetable.

 

**2.****                            NEW ACCOUNTINGPRONOUNCEMENTS**

 

See Note 1 for a discussion of the adoption of SFAS No. 148.

 

***SFAS No. 141 andSFAS No. 142***

 

In July 2001, the FASB issued SFAS No.141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other IntangibleAssets.” SFAS No. 141 requires that the purchase method of accounting be usedfor all business combinations initiated after June 30, 2001.  SFAS No. 142 changes the accounting forgoodwill from an amortization method to an impairment-only approach. Thus,amortization of goodwill, including goodwill recorded in past businesscombinations, ceased upon adoption of this Statement in the first quarter offiscal 2003.  Pursuant to SFAS No. 142,we evaluated our goodwill balance for impairment upon adoption of SFAS No. 142utilizing the discounted cash flows method and determined that the entiregoodwill balance of $411,000 was permanently impaired.  Accordingly, we wrote off our entiregoodwill balance of $411,000 in the first quarter of fiscal 2003. Had weadopted SFAS No. 142 at the beginning of fiscal 2001, assuming no impairmentcharge, our net loss and net loss per share would have been as follows (inthousands, except per share amounts):

 
|                                              |   | **Year Ended  September 30,** |   |
|---------------------------------------------------|--------|------------------------------------|--------|
|                                              |   | **2002**                           |   | **2001** |   |
| Net loss, as reported                             |   | $                                  | (3,874 | ) | $ | (7,156 | ) |
| Add back amortization                             |   | 123                                |   | 123 |   |
| Net loss, as adjusted                             |   | $                                  | (3,751 | ) | $ | (7,033 | ) |
|                                              |   |                               |   |   |   |
| Basic and diluted net loss per share, as reported |   | $                                  | (0.43  | ) | $ | (0.80 | ) |
| Effect of amortization add back                   |   | 0.01                               |   | 0.02 |   |
| Basic and diluted net loss per share, as adjusted |   | $                                  | (0.42  | ) | $ | (0.78 | ) |

 

***SFASNo. 144***

 

In October 2001, the FASB issued SFASNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”which addresses financial accounting and reporting for the impairment ordisposal of long-lived assets. This Statement supersedes SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of,” and APB Opinion No. 30, “Reporting the Results ofOperations — Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions forthe Disposal of a Segment of a Business.” SFAS No. 144 became effective for fiscal years beginning afterDecember 15, 2001.  The adoption ofSFAS No. 144 in the first quarter of fiscal 2003 did not have any effect on ourfinancial position, cash flows or results of operations.

 

F-11

----

 

***SFASNo. 145***

 

In April 2002, the FASB issued SFAS No.145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASBStatement No. 13, and Technical Corrections,” which is effective fortransactions occurring after May 15, 2002 and fiscal years beginning afterMay 15, 2002.  SFAS No. 145 rescinds FASB Statement No. 4, “ReportingGains and Losses from Extinguishment of Debt” and an amendment of thatStatement, FASB Statement No. 64, “Extinguishments of Debt Made to SatisfySinking-Fund Requirements,” and amends FASB Statement No. 13, “Accounting forLeases.”  SFAS No. 145 no longer requires extinguishment of debt to beshown as an extraordinary item.  The adoption of SFAS No. 145 in the firstquarter of fiscal 2003 did not have any effect on our financial position, cashflows or results of operations, except for the reclassification of $716,000 ofdebt restructuring costs to operating expense from other expense in fiscal2002.

 

***SFASNo. 146***

 

In July 2002, the FASB issued SFAS No.146, “Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 addresses the financialaccounting and reporting for obligations associated with an exit activity,including restructuring, or with a disposal of long-lived assets.  Exit activities include, but are not limitedto, eliminating or reducing product lines, terminating employees and contractsand relocating plant facilities or personnel. SFAS No. 146 specifies that a company will record a liability for a costassociated with an exit or disposal activity only when that liability isincurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expressesonly management’s intended future actions and, therefore, does not meet therequirement for recognizing a liability and the related expense.  SFAS No. 146 is effective prospectively forexit or disposal activities initiated after December 31, 2002, withearlier adoption encouraged.  Inaccordance with SFAS No. 146, at September 30, 2003 we had an accrualrelated to the move of our corporate offices from Portland, Oregon to Irvine,California totaling $280,000.

 

***SFASNo. 150***

 

In May 2003, the FASB issued SFAS No.150, “Accounting for Certain Financial Instruments with Characteristics of BothLiabilities and Equity.”  SFAS No. 150establishes standards for how to classify and measure financial instrumentswith characteristics of both liabilities and equity.  It requires financial instruments that fall within its scope tobe classified as liabilities.  SFAS No.150 is effective as of June 1, 2003 for financial instruments entered intoor modified on or after that date and, for pre-existing financial instruments,as of July 1, 2003. However, in October 2003, the FASB deferredindefinitely the provisions of SFAS No. 150 that relate to mandatorilyredeemable, non-controlling interests. We have reviewed the provisions of SFAS No. 150 and have determined thatwe are accounting for our financial instruments that have characteristics ofboth debt and equity in accordance with the provisions of SFAS No. 150.

 

**3.         INVENTORIES**

 

Detail of inventories at September 30, 2003 and 2002 is as follows(in thousands):

 
|                   |   | **2003** |   | **2002** |   |
|------------------------|--------|----------|--------|----------|--------|
| Raw materials          |   | $        | 1,222  |     | $      | 1,761 |   |
| Packaging and supplies |   | 330      |   | 290      |   |
| Finished goods         |   | 7,639    |   | 7,042    |   |
|                   |   | $        | 9,191  |     | $      | 9,093 |   |

 

**4.         PREPAID EXPENSES**

 

Prepaid expenses included $1.1 million and $934,000 of prepaid slottingfees, net of accumulated amortization, at September 30, 2003 and 2002,respectively.

 

F-12

----

 

**5.         PROPERTY, PLANT AND EQUIPMENT**

 

Detail of property, plant and equipment atSeptember 30, 2003 and 2002 is as follows (in thousands):

 
|                           |   | **2003** |   | **2002** |   |
|--------------------------------|--------|----------|--------|----------|--------|
| Building and improvements      |   | $        | 1,547  |     | $      | 1,346 |   |
| Machinery and equipment        |   | 17,181   |   | 15,696   |   |
| Office furniture and equipment |   | 3,829    |   | 4,302    |   |
|                           |   | 22,557   |   | 21,344   |   |
| Less accumulated depreciation  |   | (10,588  | )      | (8,311   | )      |
|                           |   | $        | 11,969 |     | $      | 13,033 |   |

 

**6.         OTHER ASSETS**

 

At September 30, 2003, other assets primarily included deferredfinancing fees and trademarks. At September 30, 2002, other assets alsoincluded goodwill.  See Note 2 for adiscussion of the write-off of goodwill in the first quarter of fiscal 2003. The gross amount of deferred financing feesand trademarks and the related accumulated amortization were as follows (in thousands):

 
|                     |   | **September 30,** |   |
|--------------------------|--------|------------------------|--------|
|                     |   | **2003**               |   | **2002** |   |
| Deferred financing fees  |   | $                      | 1,689  |   | $ | 1,689 |   |
| Accumulated amortization |   | (1,329                 | )      | (1,024 | ) |
|                     |   | 360                    |   | 665 |   |
|                     |   |                   |   |   |   |
| Trademarks               |   | 415                    |   | 415 |   |
| Accumulated amortization |   | (68                    | )      | (58 | ) |
|                     |   | 347                    |   | 357 |   |
|                     |   | $                      | 707    |   | $ | 1,022 |   |

 

Amortization expense was as follows during fiscal 2003and 2002 (in thousands):

 
|                    |   | **Year Ended  September 30,** |   |
|-------------------------|--------|------------------------------------|--------|
|                    |   | **2003**                           |   | **2002** |   |
| Deferred financing fees |   | $                                  | 305    |   | $ | 308 |   |
| Trademarks              |   | $                                  | 10     |   | $ | 10 |   |

 

Amortization of the deferred financing fees andtrademarks is as follows over the next five fiscal years (in thousands):

 
|   |   | **Deferred  Financing  Fees** |   | **Trade-  marks** |   |
|--------|--------|-------------------------------|--------|-------------------|--------|
| 2004   |   | $                             | 277    |              | $      | 10 |   |
| 2005   |   | 83                            |   | 10                |   |
| 2006   |   | —                        |   | 10                |   |
| 2007   |   | —                        |   | 10                |   |
| 2008   |   | —                        |   | 10                |   |
|        |        |                               |        |                   |        |  |  |

 

**7.         OTHER CURRENT LIABILITIES**

 

Other current liabilities included $949,000 of accrued coupon liabilityand $845,000 of accrued interest at September 30, 2003.

 

F-13

----

 

**8.         LEASE COMMITMENTS**

 

Future minimum lease payments under operating leases atSeptember 30, 2003 are as follows (in thousands):

 
| **Year Ending September 30,** |   |   |   |
|------------------------------------|--------|--------|--------|
| 2004                               |   | $      | 702    |   |
| 2005                               |   | 665    |   |
| 2006                               |   | 678    |   |
| 2007                               |   | 548    |   |
| 2008                               |   | 134    |   |
| Thereafter                         |   | — |   |
| Total                              |   | $      | 2,727  |   |

 

Rental expense for the years ended September 30, 2003, 2002 and2001 was $773,000, $1.6 million and $3.8 million, respectively.

 

**9.****                                      REVOLVING CREDITAND TERM LOAN AND AMENDMENTS TO SUBORDINATED CONVERTIBLE NOTES AND CONVERTIBLEREDEEMABLE PREFERRED STOCK**

 

On January 10, 2002, we entered into a RevolvingCredit and Term Loan Agreement (as amended, the “Loan Agreement”) withCapitalSource Finance LLC (“CapitalSource”). We also completed extensions to the maturity date of our subordinatedconvertible notes and the earliest mandatory redemption date applicable to ouroutstanding convertible redeemable preferred stock. For a discussion ofamendments subsequent to September 30, 2003, see Note 16. SubsequentEvent.

 

The Loan Agreement provides for an $8.0 million termloan and a $7.0 million line of credit (together, “the Loans”).  The $8.0 million of proceeds from the termloan and $1.05 million of proceeds from the line of credit were applied topurchase our food processing, production and other equipment used at ourClearfield, Utah, production facility, which had been leased under operatingleases with Bank of America (“BA”) Leasing & Capital Corporation.  An additional $1.85 million of proceeds fromthe line of credit were used to repay our existing revolving credit facility,which was terminated, and certain fees of Wells Fargo Bank. The remainingbalance available on the line of credit is being used as needed for workingcapital.  We paid a closing fee of$300,000 to CapitalSource (the “Closing Fee”).

 

As a condition to obtaining the new financing, wenegotiated extensions to the maturities of our Convertible Senior SubordinatedNotes (“Convertible Notes”) held by Dresdner Kleinwort Benson Private EquityPartners LP (“Dresdner”) and the earliest mandatory redemption date of ourSeries A Convertible Preferred Stock (“Series A Stock”) and Series B ConvertiblePreferred Stock (“Series B Stock”) then held by various investors.

 

In order to obtain the extension of maturity of ourConvertible Notes from April 1, 2003, to March 31, 2005, we agreed toincrease the interest rate on the notes from 7 to 10 percent, to pay a20 percent premium at repayment or maturity of such notes, and to issue toDresdner a warrant to purchase 557,981 shares of our common stock at anexercise price of $0.28 per share.

 

To achieve the extension of the earliest mandatoryredemption date of our outstanding Series A and Series B preferred stock fromDecember 31, 2004 to March 31, 2006, we agreed to pay a10 percent premium on the accumulated liquidation preference andredemption price applicable to our preferred stock, payable upon redemption orany liquidation or deemed liquidation of Gardenburger.  In addition, we issued to preferredshareholders, pro rata in accordance with their holdings of preferred stock,warrants to purchase an aggregate of 557,981 shares of our common stock atan exercise price of $0.28 a share.  Weaccomplished the agreed changes to our preferred stock by creating two newseries of preferred stock designated as Series C Convertible PreferredStock (“Series C Stock”) and Series D Convertible Preferred Stock(“Series D Stock”) and exchanging shares of our outstanding Series AStock and Series B Stock for such newly created Series C Stock andSeries D Stock, respectively, on a five-for-one basis. Other than themodifications mentioned above, there were no substantive changes to the rightsand privileges of the Series A and Series B compared to Series C

 

F-14

----

 

and Series D. The 10 percent redemption premium, whichtotals $4.3 million, is being accreted over the redemption period.  At September 30, 2003, $1.8 million ofthe redemption premium has been accreted and is included in the preferred stockbalance on the balance sheet.  Theliquidation preference of the Series C and Series D Stock was $54.2 million atSeptember 30, 2003.

 

Farallon Partners, L.L.C., and its affiliates, whichtogether own approximately 30.8% of our Series C and Series D Stock, have asubstantial equity interest in CapitalSource Holdings LLC, which controlsCapitalSource.  An affiliate of Rosewood Capital III, L.P., which alsoowns approximately 30.8% of the Series C and Series D Stock, has a small (lessthan 2%) equity interest in CapitalSource Holdings LLC.  Two of ourdirectors are employed by an affiliate of Rosewood Capital III, L.P. Jason Fish, a director of Gardenburger until his resignation on January 8,2002, is President of CapitalSource Holdings LLC and was a managing member ofFarallon Partners, L.L.C. until June 2000.

 

***Terms of the LoanAgreement***

 

The Loan Agreement permits us to request advancesunder the $7.0 million line of credit up to the sum of 85 percent of eligiblereceivables and 60 percent of eligible inventory.  We must maintain a minimum balance under the line of credit of$1.0 million.  Advances will bearinterest at an annual rate of the greater of i) prime plus 2.50 percent,or 6.50 percent at September 30, 2003; or ii) 8 percent.  The line of credit expires December 15,2004.  At September 30, 2003, wehad $2.2 million outstanding under the line of credit at an interest rate of 8 percentand $4.8 million was available and will be used as needed for future operatingneeds.

 

The $8.0 million term loan bears interest at an annualrate of prime plus 4.50 percent; however, in no event will the interestrate be less than 10 percent.  Theinterest rate during fiscal 2003 was 10 percent.  Interest under the term loan is payable monthly.

 

Under the terms of the Loan Agreement, proceeds from asale of assets outside the ordinary course of business, from certain insurancerecoveries, or from other listed events must be used to prepay the Loans.  Also, we must apply a portion of all excesscash flow (see definition below) we receive to reduce the outstanding balanceof the term loan. As of September 30, 2003, we were not obligated to payCapitalSource any amounts under the excess cash flow provision. Upon a changeof control (see definition below), we must prepay the Loans in full.

 

Principal payments (prior to the extension of thematurity dates as discussed in Note 16), including a $750,000 exit fee,due under the term loan over the next five years are as follows (in thousands):

 
| **Year Ending September 30,** |   |   |   |
|------------------------------------|--------|--------|--------|
| 2004                               |   | $      | 1,833  |   |
| 2005                               |   | 5,233  |   |
| 2006                               |   | — |   |
| 2007                               |   | — |   |
| 2008                               |   | — |   |
| Total                              |   | $      | 7,066  |   |

 

Amounts due but not paid under the term loan will be automaticallydrawn from the line of credit, subject to availability.  At September 30, 2003, we had $6.3million of principal outstanding under this term loan at an interest rate of 10percent and $0.5 million of accrued exit fees as described below.

 

The Loans are secured by our assets, including,without limitation, our accounts receivable, inventory, equipment, intellectualproperty and bank deposits. The Loan Agreement contains cross defaultprovisions with respect to our other indebtedness, including the ConvertibleNotes.

 

We must pay to CapitalSource and any participatinglenders an unused line of credit fee equal to 0.083 percent per month of unusedamounts under the line of credit, which totaled $42,964 in fiscal 2003 and$35,044 in fiscal 2002.  In addition, wemust pay to CapitalSource, as agent under the Loan Agreement, a collateralmanagement fee of $4,167 per month. Upon the earlier of prepayment in full of the term loan or itsexpiration date, we will pay a $750,000 exit fee.  We may elect to prepay the

 

F-15

----

 

Loans at any time. The $750,000 exit fee is being amortized as additional interest expenseover the life of the Loans, increasing the effective interest rate on theLoans.

 

Pursuant to the Loan Agreement, we are required tomaintain compliance with the following financial covenants:

 

•                  a ratio of long-term indebtedness toearnings (as defined in the Loan Agreement) of not more than 2.5 to 1.00 (the“leverage ratio”);

•                  minimum earnings (as defined) of atleast $6.0 million for the prior twelve months calculated as of each quarter(the “minimum adjusted EBITDA”);

•                  a ratio of earnings (as defined) tofixed charges, such as debt service payments, capital expenditures and taxes,of not less than 1.25 to 1.00 (the “fixed charge coverage ratio”); andexcluding the $9.05 million buyout of its equipment capital leases duringfiscal 2002, our capital expenditures may not exceed in the aggregate i) $2.2million during fiscal 2002 and ii) $1.1 million during any fiscal yearthereafter.

 

During fiscal 2003, the debt covenants were amended toexclude certain equipment purchases during fiscal 2003 for purposes of thefinancial covenants relating to capital expenditure limits and the fixed chargecoverage ratio contained in the debt instruments.

 

In addition, we may not, among other restrictions, (1)incur any additional indebtedness other than accounts payable, except incertain limited circumstances, (2) create any liens on our assets,(3) invest in other entities, (4) pay dividends, redeem our capitalstock (including preferred stock), or make unscheduled payments under ourConvertible Notes (except as expressly permitted), (5) sell assets otherthan in the ordinary course, except in certain limited circumstances,(6) engage in any transaction with an affiliate, (7) amend our Articles of Incorporation orBylaws in a manner that would be adverse to CapitalSource, or (8) enter intoany contingent obligations or guarantee the obligations of another.

 

At September 30, 2003, we were out ofcompliance with the following debt covenants:

 
| **Covenant**                         |   | **Requirement** |   | **As calculated  September 30,  2003** |   | **Required by**             |   |
|--------------------------------------|--------|-----------------|--------|---------------------------------------------|--------|-----------------------------|--------|
| Minimum adjusted EBITDA              |   | $6.0 million    |   | $2.1million                                 |   | CapitalSource  and Dresdner |   |
| Maximum leverage ratio               |   | 2.50:1.00       |   | 3.97:1.00                                   |   | CapitalSource  and Dresdner |   |
| Minimum fixed charge  coverage ratio |   | 1.25:1.00       |   | 0.34:1.00                                   |   | CapitalSource  and Dresdner |   |

 

In December 2003, we received waivers ofcompliance from both CapitalSource and Dresdner for the non-compliance with thecovenants as of September 30, 2003. See Note 16 Subsequent Events for a discussion of amendments to our debtagreements in December 2003.

 

***Convertible Notes and Warrant Agreement with Dresdner***

 

We entered into a Second Amendment to NotePurchase Agreement, an Amended and Restated Convertible Senior SubordinatedNote (the “Restated Convertible Note”) with Dresdner, and a Warrant Agreement,each dated January 10, 2002, in connection with the extension of thematurity date under the Convertible Notes from April 1, 2003, toMarch 31, 2005.  In addition, underthe terms of the Restated Convertible Note, we agreed to (i) increase theinterest rate on the Convertible Notes from 7 to 10 percent and (ii) pay a20 percent premium on the principal plus accrued but unpaid interest onthe Convertible Notes at repayment or maturity.  The Restated Convertible Note remains convertible into commonstock at the election of the holder; the conversion price at September 30,2003 was $9.78 per share, which was not affected by the amendment.  Interest is payable in cash semi-annually tothe extent of availability under the CapitalSource line of credit.  At September 30, 2003, there was approximately$16.9 million of principal and $1.8 million of accrued exit fees included inconvertible notes payable on our balance sheet.

 

F-16

----

 

The exit fees are beingamortized as additional interest expense over the life of the loan, increasingthe effective interest rate on the loan.

 

In addition, we agreed withDresdner in September 2003 to the deferral of our interest paymenttotaling $845,000, which was due September 30, 2003 on the ConvertibleNote, to no later than December 31, 2003. Accordingly, we included the $845,000 on our balance sheet as ofSeptember 30, 2003 in other current liabilities.  The unpaid interest accrues interest at the rate of 10% per annumuntil paid.

 

We are required to apply a portion of excess cash flow(as defined below) to repay accrued interest and the outstanding principalamount of the Restated Convertible Note, subject to certain specifiedexceptions.  We must, at all times, pay50 percent of excess cash flow to pay down indebtedness to CapitalSourceand to Dresdner in specified proportions. As of September 30, 2003, we were not obligated to pay any amountsto Dresdner or CapitalSource under the excess cash flow provision.

 

The Note Purchase Agreement contains financialcovenants which are the same as those in the Loan Agreement, but in each caseslightly more favorable to us. The Restated Convertible Note also containssubordination provisions with respect to the Loans and cross default provisionswith respect to our other indebtedness, including the Loans.  See the discussion above regarding being outof compliance with our debt covenants at September 30, 2003.

 

In addition, under the terms of the Warrant Agreement,we issued to Dresdner an immediately exercisable warrant with a ten-year termto purchase 557,981 shares of our common stock at a price of $0.28 pershare, subject to anti-dilution adjustments. We granted registration rights to Dresdner with respect to sharesissuable upon exercise of its warrant.

 

***Series C and SeriesD Preferred Stock***

 

We and the holders of our outstanding Series AStock and Series B Stock entered into a Preferred Stock Exchange Agreementdated January 10, 2002 (the “Exchange Agreement”) in connection with theextension of the earliest date on which the holders of our preferred stockcould require that their shares be redeemed, and certain other changes.  This extension was a condition to fundingunder the Loan Agreement and closing of the Second Amendment to Note PurchaseAgreement.  Under the terms of theExchange Agreement, holders of Series A Stock and Series B Stock agreed toexchange all of their outstanding shares of Series A Stock and Series B Stockfor newly created Series C Stock and Series D Stock, respectively, at anexchange ratio of five shares of Series A Stock for each share of Series CStock and five shares of Series B Stock for each share of Series D Stock. Inaddition, we issued to preferred shareholders immediately exercisable warrantswith a ten-year term to purchase an aggregate of 557,981 shares of our commonstock, exercisable at a price of $0.28 per share, subject to anti-dilutionadjustments. We granted holders of our preferred stock registration rights withrespect to shares to be issued upon exercise of the warrants, including bothdemand and piggy-back registration rights.

 

The terms of each new series of Preferred Stockprovide participants in the exchange with identical rights, preferences, andprivileges as were applicable to the prior Series A Stock and Series B Stock,except that the terms of Series C Stock and Series D Stock provide for a 10percent premium on any liquidation or redemption and for an earliest date onwhich holders may require redemption of their shares of March 31, 2006,instead of December 31, 2004.  Thepremium is being accreted over the redemption period.  At September 30, 2003, we had accrued $1.8 million inrelation to the redemption premium.  Asa result of the exchange, we have outstanding 552,500 shares of Series CStock and 97,500 shares of Series D Stock, which are convertible into thesame number of common shares as the Series A Stock and Series B Stock prior tothe exchange.  No shares ofSeries A Stock and Series B Stock remain outstanding.

 

F-17

----

 

***Accounting forChanges to Convertible Notes and Preferred Stock***

 

We are accounting for the term revisions, includingthe fair value of the common stock warrants and exit fee premiums, inaccordance with SFAS No. 15 “Accounting by Debtors and Creditors for TroubledDebt Restructurings.”  Accordingly, weare accounting for the effects of the debt restructuring on a prospective basisfrom the date of restructuring and no gain or loss was recorded on the date ofrestructuring.  We computed an effectiveinterest rate and preferred dividend taking into consideration the imputedvalue of the revised terms, which is being applied as of the restructuring datethrough the maturity dates.

 

***Definitions***

 

Previously used terms are defined as follows:

 

•                  Excess Cash Flow – for any fiscalyear, this is an amount equal to the sum of: i) consolidated net income orloss; ii) depreciation, amortization, accrued non-cash interest expense and allother non-cash charges deducted in arriving at consolidated net income or loss;iii) net cash proceeds from the sale, lease, transfer or other disposition ofassets that is not reinvested in other collateralized assets or required to beapplied to mandatory prepayments or payments on the Loans; iv) the net loss onthe sale, lease, transfer or other disposition of assets; and v) the amount ofany tax credits or refunds received less the sum of a) non-financed capitalexpenditures; b) payments required by and paid on the Loans and voluntaryprepayments made on the Loans; c) the net gain on the sale, lease, transfer orother disposition of assets, other than sales in the ordinary course ofbusiness; and d) an amount equal to the increase in working capital during theperiod.

•                  Change of Control – the occurrence ofany of the following: i) a merger, consolidation, reorganization,recapitalization or share or interest exchange, sale or transfer or any othertransaction or series of transactions in which any person or group ofaffiliated persons or persons acting together, own more than 45% of thecombined voting power of our then outstanding securities, calculated on a fullydiluted basis; ii) a direct or indirect sale, transfer or other conveyance ordisposition, in any single transaction or series of transactions, of all orsubstantially all of our assets; iii) any change of control or sale ordisposition or similar event as defined in any document governing indebtednessof more than $50,000 of such person which gives the holder of such indebtednessthe right to accelerate or otherwise require payment of such indebtedness priorto the maturity date thereof; iv) Rosewood Capital III, L.P. and FarallonCapital Partners, L.P., or their affiliates, acting together, cease to have thevoting power to elect two directors to our Board of Directors; v) Scott C.Wallace ceases to be employed as our Chief Executive Officer or otherwisebecomes disabled and is not replaced within thirty days by an interim ChiefExecutive Officer, and within one hundred twenty days by a permanent ChiefExecutive Officer, each to the lender’s satisfaction, or any such replacementChief Executive Officer ceases such employment or otherwise becomes disabledunless replaced in the same time periods; and vi) a sale of Gardenburger.

•                  Earnings for the purpose ofcalculating financial covenants – net income or loss determined in conformitywith GAAP, plus: i) interest expense; ii) taxes on income, whether paid,payable or accrued; iii) depreciation expense; iv) amortization expense; v)non-cash dividends on preferred stock; vi) all other non-cash, non-recurringcharges and expenses, excluding accruals for cash expenses made in the ordinarycourse of business; and vii) certain agreed upon adjustments, all of theforegoing determined in accordance with GAAP, less all non-cash income.

 

**10.       INCOME TAXES**

 

We account for income taxes under SFAS No. 109, “*Accountingfor Income Taxes.” *Werealize tax benefits as a result of the exercise of non-qualified stock optionsand the exercise and subsequent sale of certain incentive stock options(disqualifying dispositions).  Forfinancial reporting purposes, any reduction in income tax obligations as aresult of these tax benefits is credited to additional paid-in capital.  There were no tax benefits realized relatedto stock options in fiscal 2003, 2002 or 2001.

 

F-18

----

 

Our provision (benefit) for income taxes is as follows (in thousands):

 
|     |   | **Year Ended  September 30,** |   |
|----------|--------|------------------------------------|--------|
|     |   | **2003**                           |   | **2002** |   | **2001** |   |
| CURRENT: |   |                               |   |   |   |   |   |
| Federal  |   | $                                  | (1,935 | ) | $ | 441 |   | $ | — |   |
| State    |   | (251                               | )      | 57 |   | — |   |
|     |   | (2,186                             | )      | 498 |   | — |   |
| DEFERRED |   | 2,186                              |   | (498 | ) | — |   |
|     |   | $                                  | — |   | $ | — |   | $ | — |   |

 

Total deferred income tax assets were $23.6 millionand $21.1 million and liabilities were $1.2 million and $935,000 atSeptember 30, 2003 and 2002, respectively, prior to the consideration ofany valuation allowance.  Individuallysignificant temporary differences are as follows (in thousands):

 
|                                          |   | **September 30,** |   |
|-----------------------------------------------|--------|------------------------|--------|
|                                          |   | **2003**               |   | **2002** |   |
| Net operating loss carryforwards              |   | $                      | 21,685 |   | $ | 19,119 |   |
| Provision for trade promotions and  discounts |   | 584                    |   | 719 |   |
| Book/tax depreciation difference              |   | (1,186                 | )      | (1,008 | ) |
|                                               |        |                        |        |  |  |  |  |

 

Total net deferred tax assets were $22.4 million and $20.2 million asof September 30, 2003 and 2002, respectively.  In accordance with SFAS No. 109, we have recorded a valuationallowance against the entire amount of net deferred tax assets as ofSeptember 30, 2003 and 2002 as a result of recurring operating losses in recent years.

 

We have tax net operating losscarryforwards, totaling $56.5 million, which expire as follows: 2013: $10.8million; 2019: $31.6 million; 2020: $3.0 million; 2021: $4.4 million; and 2022:$5.0 million.  However, in conjunctionwith the redemption of our Series A and Series B Convertible RedeemablePreferred Stock and the issuance of our Series C and Series D ConvertibleRedeemable Preferred Stock in January 2002, we experienced an ownershipchange as defined in the Internal Revenue Code and, accordingly, the use of ourpre-January 2002 net operating losses are subject to an annual limitationof approximately $2.4 million.  Our netoperating losses may be limited further in the future due to additional changesin the ownership of Gardenburger.

 

The reconciliation betweenthe effective tax rate and the statutory federal income tax rate is asfollows:

 
|                                            |   | **Year Ended  September 30,** |   |
|-------------------------------------------------|--------|------------------------------------|--------|
|                                            |   | **2003**                           |   | **2002** |   | **2001** |   |
| Statutory federal income tax rate               |   | (34.0                              | )%     | (34.0 | )% | (34.0 | )% |
| State taxes, net of federal income tax  benefit |   | (4.4                               | )      | (4.4 | ) | (4.4 | ) |
| Preferred dividends                             |   | 18.4                               |   | 49.1 |   | 23.4 |   |
| Trademark and goodwill amortization             |   | —                             |   | 0.9 |   | 0.5 |   |
| Meals and entertainment                         |   | 0.1                                |   | 0.4 |   | 0.2 |   |
| Effect of change in valuation allowance         |   | 20.2                               |   | (12.9 | ) | 14.2 |   |
| Other                                           |   | (0.3                               | )      | 0.9 |   | 0.1 |   |
| Effective tax rate                              |   | 0.0                                | %      | 0.0 | % | 0.0 | % |

 

**11.          CONVERTIBLE REDEEMABLE PREFERRED STOCK**

 

We have outstanding 552,500 shares of Series CStock and 97,500 shares of Series D Stock, which are convertible into2,762,500 and 1,300,000 shares (subject to antidilution adjustments) of ourcommon stock, respectively, at any time at the discretion of the holder.

 

The Series C and Series DStock may be redeemed at any time after March 31, 2006 at the election of the holders or, under certainconditions, at our discretion.  A10 percent premium will be paid on any liquidation or redemption of the SeriesC and Series D Stock. In addition, bothseries of preferred

 

F-19

----

 

stock are entitled to a 12 percent cumulative annualdividend payable upon redemption of the stock or in the event of a sale orliquidation of Gardenburger.

 

The differencebetween the aggregate consideration of $32.5 million and the net proceeds of$30.2 million received upon the original sale of the Series A and Series BStock is being accreted, in addition to the 10 percent premium that will bepaid upon redemption, as additional preferred dividends over the period untilredemption (March 31, 2006).

 

See Note 9 for additional information.

 

**12.          SHAREHOLDERS’ EQUITY**

 

***Preferred Stock***

 

We have authorized 5,000,000 shares of preferred stock, of which650,000 shares have been issued (see Note 11). Such stock may be issued by the Board of Directors in one or moreseries, with the preferences, limitations and rights of each series to bedetermined by the Board of Directors.

 

***Preferred SharePurchase Rights***

 

In April 1996, we declared a dividenddistribution of one preferred share purchase right on each outstanding share ofour common stock.  Each right, whenexercisable, will entitle shareholders to buy one one-hundredth of a share ofSeries A Junior Participating Preferred Stock at an exercise price of $47 pershare.  The rights will become exercisableif a person or group (an “Acquiring Person”) acquires 15 percent or more of ourcommon stock (with certain exceptions) or announces a tender offer for 15percent or more of the common stock. With the exception of certain cash tender offers, if a person becomes anAcquiring Person, or in the event of certain mergers with an Acquiring Person,the rights will become exercisable for shares of common stock with a marketvalue of two times the exercise price of the right. Our Board of Directors isentitled to redeem the rights at $.01 per right at any time before an AcquiringPerson has acquired 15 percent or more of the outstanding common stock.

 

***Restrictions onDividends***

 

No cash dividends may be paid on our common stockunless dividends have been paid on all outstanding shares of our Series C andSeries D Convertible Preferred Stock in an amount equal to 12% cumulativedividends accrued on such preferred shares through the record date for thecommon stock dividend (or, if greater, the amount of the common stock dividendpayable on the preferred shares on an as-converted basis). The quarterlydividend accruing on the preferred shares is $975,000.  In addition, we are prohibited from payingcash dividends or redeeming any of our capital stock under the terms of theLoan Agreement and the Restated Convertible Note held by Dresdner.

 

***Stock Plan Options***

 

In February 2001, our shareholders approved the 2001 StockIncentive Plan (the “2001 Plan”) to replace our 1992 First Amended and RestatedCombination Stock Option Plan (the “1992 Plan”), which was scheduled to expirein January 2002. Upon approval of the 2001 Plan, we no longer grantedawards under the 1992 Plan.  The 2001Plan provides for stock-based awards to employees, officers, directors andconsultants.  Awards that may be grantedunder the 2001 Plan include stock options, in the form of incentive stockoptions (“ISOs”) and non-statutory stock options (“NSOs”), stock appreciationrights, restricted awards, performance awards, and other stock-based awards.

 

The exercise price per share generally must be atleast 100 percent of the fair market value of a share of common stock on thedate the option is granted for ISOs, 75 percent for NSOs and 25 percent fordeferred compensation options. The Stock-Based Awards Committee of our Board ofDirectors determines the vesting and other terms of the awards under the 2001Plan.  Vesting for certain options mayaccelerate upon a change in control. Options granted under the 2001 Plan and the 1992 Plan generally vestover a three to five year period.

 

F-20

----

 

The 2001 Plan permits the issuance of up to 1,400,000million shares of our common stock plus 1,951,023 shares available under the1992 Plan.  In addition, if awardsgranted under the 1992 Plan are forfeited or expire, shares of common stockreserved for such forfeited or expired awards become available for issuanceunder the 2001 Plan.  As ofSeptember 30, 2003, we had 3,351,023 shares of common stock reserved forissuance under the 2001 Plan and the 1992 Plan combined.

 

Activity under the 1992 Plan and the 2001 Plan issummarized as follows (in thousands, except per share amounts):

 
|                                  |   | **Shares  Available  for Grant** |   | **Shares  Subject to  Options** |   | **Weighted  Average**** ****Exercise  Price** |   |
|---------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|----------------------------------------------------|--------|
| **Balances, September 30, 2000** |   | 546                              |   | 1,405                           |   | $                                                  | 8.86   |   |
| Additional shares reserved            |   | 1,400                            |   | —                          |   | —                                             |   |
| Options granted                       |   | (1,943                           | )      | 1,943                           |   | 0.80                                               |   |
| Options canceled                      |   | 535                              |   | (535                            | )      | 7.33                                               |   |
| **Balances, September 30, 2001** |   | 538                              |   | 2,813                           |   | 3.58                                               |   |
| Options granted                       |   | (645                             | )      | 645                             |   | 0.68                                               |   |
| Options canceled                      |   | 216                              |   | (216                            | )      | 2.84                                               |   |
| **Balances, September 30, 2002** |   | 109                              |   | 3,242                           |   | 3.05                                               |   |
| Options canceled                      |   | 606                              |   | (606                            | )      | 1.87                                               |   |
| **Balances, September 30, 2003** |   | 715                              |   | 2,636                           |   | $                                                  | 3.32   |   |

** **

***Non-Plan Options***

** **

On March 10, 1992, we granted a non-statutory stock option to ourthen Chief Executive Officer exercisable for 1,650,000 shares of our commonstock.  Such option was exercisable fora period of ten years from the date of grant at an exercise price of $1.00 pershare, the fair market value of our common stock on the date of grant.  On May 8, 2001, we extended theexercise period of the non-statutory stock option for an additional two yearsand on December 3, 2003, for an additional three years and this option nowexpires January 31, 2007.

 

Portions of the option have been exercised as follows:

 
| **Fiscal Year** |   | **Shares  Received  Upon Exercise** |   |
|-----------------|--------|-------------------------------------|--------|
| 1996            |   | 625,000                             |   |
| 2000            |   | 45,000                              |   |
| 2001            |   | 30,000                              |   |

 

At September 30, 2003, an option to purchase 950,000 shares ofcommon stock remained outstanding and exercisable in full and 950,000 shares ofour common stock werereserved for issuance under this option grant.

 

On April 14, 1996, we granted an optionto our then Chief Executive Officer exercisable for 300,000 shares of ourcommon stock.  Pursuant to the terms of theoriginal grant, such option is exercisable for a period of five years from theChief Executive Officer’s termination date of August 4, 2000 at anexercise price of $8.69 per share.  AtSeptember 30, 2003, the entire option remained outstanding, and we had300,000 shares of common stock reserved for issuance under this option grant.

 

During 1999, we granted options to certain employees and twoconsultants covering a total of 80,000 shares of our common stock at an averageexercise price of $11.16 per share.

 

Activity related to these options is as follows:

 
| **Fiscal Year** |   | **Shares  Cancelled** |   | **Average  Exercise  Price** |   |
|-----------------|--------|-----------------------|--------|------------------------------|--------|
| 2000            |   | 15,332                |   | $                            | 11.63  |   |
| 2001            |   | 22,001                |   | 11.35                        |   |
| 2002            |   | 6,667                 |   | 11.63                        |   |
|                 |        |                       |        |                              |        |  |

 

F-21

----

 

At September 30, 2003, options covering 36,000 shares of commonstock were outstanding at an average exercise price of $10.76 and 36,000 sharesof our common stock were reserved for issuance under these options.  The fair value of options granted tonon-employees was not material.

 

On March 1, 2000, we granted options to the members of our Boardof Directors covering a total of 14,500 shares of our common stock.  Such options are exercisable for a period often years from the date of grant at an exercise price of $5.69 per share,subject to a one-year vesting period. During fiscal 2001, options covering 7,000 shares of common stock werecanceled and at September 30, 2003, options covering 7,500 shares ofcommon stock were outstanding and reserved for issuance under these optiongrants.

 

The following table summarizes information about allstock options outstanding at September 30, 2003:

 
| **Options Outstanding**       |   | **Options Exercisable**             |   |
|-------------------------------|--------|-------------------------------------|--------|
| **Range of Exercise  Prices** |   | **Number  Outstanding  at 9/30/03** |   | **Weighted  Average  Remaining  Contractual  Life - Years** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares  Exercisable  at 9/30/03** |   | **Weighted  Average  Exercise  Price** |   |
| $0.4150 -  $1.3563            |   | 2,432,750                           |   | 4.9 |   | $ | 0.7318 |   | 1,545,297 |   | $ | 0.8292 |   |
| 1.3564 -  2.7125              |   | 290,583                             |   | 7.4 |   | 1.6492 |   | 159,832 |   | 1.6933 |   |
| 5.4251 -  6.7813              |   | 216,920                             |   | 4.9 |   | 6.4644 |   | 216,920 |   | 6.4644 |   |
| 6.7814 -  8.1375              |   | 229,000                             |   | 2.2 |   | 7.5839 |   | 229,000 |   | 7.5839 |   |
| 8.1376 -  9.4938              |   | 507,550                             |   | 2.0 |   | 8.7205 |   | 507,550 |   | 8.7205 |   |
| 9.4939 -  10.8500             |   | 37,420                              |   | 5.5 |   | 10.0625 |   | 37,420 |   | 10.0625 |   |
| 10.8501 -  12.2063            |   | 174,900                             |   | 1.4 |   | 11.6414 |   | 174,900 |   | 11.6414 |   |
| 12.2064 -  13.5625            |   | 40,000                              |   | 2.8 |   | 12.7188 |   | 40,000 |   | 12.7188 |   |
| $0.4150 -  $13.5625           |   | 3,929,123                           |   | 4.4 |   | $ | 3.244 |   | 2,910,919 |   | $ | 4.1356 |   |

 

At September 30, 2002 and 2001, options covering2,596,368 and 2,182,675 shares of our common stock, respectively, wereexercisable at weighted average exercise prices of $4.76 per share and $5.40per share, respectively.

 

***Warrants***

 

In January 2002, in conjunction with amendments to our ConvertibleNotes and Convertible Redeemable Preferred Stock, we issued warrantsexercisable for a total of 1,115,962 shares of our common stock at an exerciseprice of $0.28 per share.  The warrantsare immediately exercisable and expire 10 years from the date of grant.  As of September 30, 2003, none of thesewarrants had been exercised and we had 1,115,962 shares of our common stockreserved for future issuance related to these warrants. The value of the warrants, utilizing theBlack-Scholes methodology, was $95,000 and was expensed during fiscal 2002.

 

**13.          401(k) PLAN**

 

We have a 401(k) Salary Deferral Plan, which covers all employees whohave reached the age of 18. The covered employees may elect to have an amountdeducted from their wages for investment in a retirement plan.  We match 100 percent of employeecontributions up to two percent of compensation.  Our contribution to this plan was approximately $117,000 in 2003,$115,000 in 2002 and $124,000 in 2001.

 

F-22

----

 

**14.     SUPPLEMENTALCASH FLOW INFORMATION**

 

Supplemental disclosure of cash flow information is as follows (inthousands):

 
|                                                                                                       |   | **2003** |   | **2002** |   | **2001** |   |
|------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash paid during the period for interest                                                                   |   | $        | 2,017  |     | $      | 2,371    |   | $ | 322 |   |
| Cash paid during the period for income taxes                                                               |   | 7        |   | 12       |   | 5        |   |
| Issuance of additional Convertible Notes in lieu of  cash payment of interest expense on Convertible Notes |   | —   |   | —   |   | 2,364    |   |
| Non-cash preferred dividends                                                                               |   | 5,177    |   | 4,955    |   | 4,367    |   |
|                                                                                                            |        |          |        |          |        |          |        |  |  |  |

 

**15.     RELATEDPARTY TRANSACTIONS**

 

Farallon Partners, L.L.C., and its affiliates, whichtogether own approximately 30.8% of our Series C and Series D Stock, have asubstantial equity interest in CapitalSource Holdings LLC, which controlsCapitalSource (see Note 9).  An affiliate of Rosewood Capital III, L.P.,which also owns approximately 30.8% of our Series C and Series D Stock, has asmall (less than 2%) equity interest in CapitalSource Holdings LLC.  Twoof our directors are employed by an affiliate of Rosewood Capital III,L.P.  Jason Fish, a director until his resignation on January 8,2002, is President of CapitalSource Holdings LLC and was a managing member ofFarallon Partners, L.L.C. until June 2000.

 

Richard L. Mazer, a director, is Director and Chief Operating Officerof Ventura Foods, LLC.  Beginning in thelatter part of fiscal 2001, we began purchasing barbecue sauce from VenturaFoods and, during fiscal 2003, 2002 and 2001, we paid Ventura Foods $735,000,$380,000 and $22,000, respectively, for the barbecue sauce.

 

**16.     SUBSEQUENTEVENT**

 

In order to address issues relating to our ability tomeet our financial obligations and to address non-compliance with certain ofour financial covenants, we entered into amendments to our Loan Agreement withCapitalSource and our Convertible Notes held by Dresdner in late December 2003,following fiscal year-end.  See Note 9above for a discussion of the terms of the Loan Agreement and Convertible Notesas of September 30, 2003.

 

The amendments extend thematurity of the Loan Agreement from December 15, 2004 to January 31, 2007 andof the Convertible Notes from March 31, 2005 to June 15, 2007, subject to (i)shareholder approval of an amendment to our Restated Articles of Incorporation(“Articles”) or (ii) the exchange of all of our preferred stock for newpreferred stock, in each case giving us the right to extend the earliest datethat the holders of our preferred stock can demand redemption to June 30,2008.  If the required shareholderapproval of the Articles amendment is not received and we are not able toeffect an exchange of at least two-thirds of our outstanding shares ofpreferred stock for new preferred stock with the later redemption date, thematurity dates will revert to their original dates of December 15, 2004 for theLoan Agreement and March 31, 2005 for the Convertible Notes.  If the required shareholder approval is notobtained, but we are able to exchange at least two-thirds of our outstandingshares of preferred stock for new preferred stock with an earliest redemptiondate of June 30, 2008, the maturity date on our Loan Agreement will becomeDecember 10, 2005, while the maturity date on the Convertible Notes will becomeMarch 25, 2006. To be approved by shareholders, the Articles amendment must beapproved by the holders of our preferred stock voting as a separate votinggroup and by the holders of our preferred stock and common stock voting as asingle voting group.  We have receivednon-binding indications from holders of approximately 90% of our Series C andSeries D Stock that they intend to vote for the amendment of our Articles.

 

 

F-23

----

 

We also negotiated amendmentsto our financial covenants in the Loan Agreement and the Convertible Notes tolevels that we believe we will be able to achieve.  Beginning December 31, 2003, we are required under the LoanAgreement to maintain compliance with the following financial covenants,measured quarterly unless otherwise noted:

 

•                  amaximum ratio of long-termindebtedness to earnings (as defined below) ranging from a high of 3.60:1.00for the quarter ended March 31, 2004, to a low of 2.50:1.00 for each quarterending after June 30, 2004;

•                  minimumearnings for a rolling 12-monthperiod, as adjusted to exclude certain expenses and non-cash charges, rangingfrom a low of $3,000,000 for the quarter ended June 30, 2004, to a high of$6,000,000 for the quarter ended September 30, 2005, and thereafter (“minimumadjusted EBITDA”);

•                  aminimum senior fixed charge coverage ratio (which excludes from fixed chargesinterest expense and accrued premium on the Convertible Notes) ranging from alow of 0.90:1.00 for the quarter ended June 30, 2004, to a high of 1.57:1.00for the quarter ended June 30, 2005;

•                  aminimum fixed charge coverageratio of 1.10:1.00 for the quarter ended September 30, 2005 and 1.25:1.00thereafter; and

**•****                 **capitalexpenditures in an amount perfiscal year not exceeding $1,200,000 for the fiscal year ending September 30,2004, and $1,100,000 for fiscal years ending thereafter.

 

The financial covenantsapplicable to the Convertible Notes are similar, but in each case slightly lessrestrictive.

 

We also received waivers ofnon-compliance with our financial covenants as of September 30, 2003 fromCapitalSource and Dresdner and an agreement by Dresdner that future failures topay interest on the Convertible Notes when due will not be deemed, underspecified conditions, to be an event of default under the Convertible Notes.

 

In consideration of thematurity date extensions, the financial covenant amendments, and the waivers,we agreed to pay a loan amendment fee to CapitalSource of approximately$130,000 and to pay interest on the unpaid principal and accrued interest onthe Convertible Notes at the annual rate of 13% rather than 10%, which is thedefault interest rate provided in the notes beginning October 1, 2003, andcontinuing until our interest payments to Dresdner are brought current. TheLoan Agreement as amended prohibits us from paying interest to Dresdner priorto September 30, 2004, and permits us to pay interest to Dresdner on or afterSeptember 30, 2004, only if and to the extent that we comply with specifiedfinancial covenants and levels of capital availability.

 

 

F-24

----

 

Independent Auditors’ Report

 

The Board of DirectorsGardenburger, Inc.:

 

Under date of November 7, 2003,we reported on the balance sheets of Gardenburger, Inc. (an Oregon corporation)as of September 30, 2003 and 2002, and the related statements ofoperations, shareholders’ deficit and cash flows for each of the years in thetwo-year period ended September 30, 2003, which are included in this Form 10-Kfor the period ended September 30, 2003. In connection with our audits of the aforementioned financialstatements, we also audited the related financial statement schedule in thisForm 10-K for each of the years in the two-year period ended September 30,2003.  This financial statement scheduleis the responsibility of the Company’s management.  Our responsibility is to express an opinion on this financial statementschedule based on our audits.  Thefinancial statement schedule in this Form 10-K for the year ended September 30,2001 was audited by other auditors who ceased operations.  Those auditors expressed an unqualifiedopinion on the financial statement schedule.

 

In our opinion, such financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly, in all material respects, theinformation set forth therein.

 

As described in Note 2, thefinancial statements for each of the years ended September 30, 2002 and 2001have been revised to include the transitional disclosures required by Statementof Financial Accounting Standards No. 142, Goodwill and Other IntangibleAssets, which was adopted by the Company as of October 1, 2002.  As discussed above, the financial statementsof Gardenburger, Inc. for the year ended September 30, 2001 were audited byother auditors who have ceased operations.

 

As described in Note 1, thefinancial statements for the year ended September 30, 2001 have been restatedas a result of the adoption of EITF No. 01-09, Accounting for ConsiderationGiven by a Vendor to a Customer or a Reseller of the Vendor’s Products.  We audited the adjustments described in Note1 to the financial statements that were applied to restate the 2001 financialstatements and the transitional disclosures required by Statement of FinancialAccounting Standards No. 142, included in Note 2.  In our opinion, such disclosures and adjustments are appropriateand have been properly applied. However, we were not engaged to audit, reviewor apply any procedures to the 2001 financial statements of Gardenburger, Inc.other than with respect to such disclosures and adjustments and, accordingly,we do not express an opinion or any other form of assurance on the 2001financial statements taken as a whole.

 
| /s/ KPMG LLP                                                                                          |   |
|-------------------------------------------------------------------------------------------------------|--------|
| Portland, Oregon                                                                                      |
| November 7, 2003, except as to Note 16 to the financial statements  which is as of December 29, 2003. |

 

F-25

----

 

SCHEDULE II

 

GARDENBURGER, INC.

VALUATION AND QUALIFYING ACCOUNTS

YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(In thousands)

 
| **Column A**                             |   | **Column B**                         |   | **Column C**                        |   | **Column D**                              |   | **Column E**                 |   |
|------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|-------------------------------------------|--------|------------------------------|--------|
| **Description**                          |   | **Balance  at Beginning  of Period** |   | **Charged  to Costs and  Expenses** |   | **Charged to  Other Accounts-  Describe** |   | **Deductions -Describe (a)** |   | **Balance  at End  of Period** |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| **Year  Ended September 30, 2001:** |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| Reserves deducted from  asset accounts:  |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| Allowance for  uncollectible accounts    |   | $                                    | 264    |                                | $      | 40                                        |   | $                            | — |   | $ | 38 |   | $ | 266 |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| **Year  Ended September 30, 2002:** |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| Reserves deducted from  asset accounts:  |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| Allowance for  uncollectible accounts    |   | $                                    | 266    |                                | $      | —                                    |   | $                            | — |   | $ | 66 |   | $ | 200 |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| **Year  Ended September 30, 2003:** |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| Reserves deducted from  asset accounts:  |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
|                                     |   |                                 |   |                                |   |                                      |   |                         |   |   |   |
| Allowance for  uncollectible accounts    |   | $                                    | 200    |                                | $      | —                                    |   | $                            | — |   | $ | 7 |   | $ | 193 |   |

 

----

(a) Charges to the account included in this column are for the purposes forwhich the reserve was created.

 

F-26

----