** **

**UNITED STATES**

**SECURITIES 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, 2004**             |
|   |       |                                                          |
|   |       | **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 its charter)

 
| **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)

 

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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 during thepreceding 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           No o

 

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).

Yeso     No ý

 

Theaggregate market value of the voting and non-voting common equity held by non-affiliatesof the Registrant was $2,092,203 computed by reference to the last sales priceas reported by the NASD’s OTC Bulletin Board ($0.30) as of the last businessday of the Registrant’s most recently completed second fiscal quarter, March 31,2004.

 

Thenumber of shares outstanding of the Registrant’s Common Stock as of February 17,2005 was 9,002,101 shares.

 

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** **

**Documents Incorporated by Reference**

 

None.

** **

** **

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**GARDENBURGER,INC.**

**2004 FORM10-K ANNUAL REPORT**

**TABLE OFCONTENTS**

** **
|       | **PART I**                                                                                                          | **Page**   |
|------------|---------------------------------------------------------------------------------------------------------------------|------------|
|       |                                                                                                                |       |   |
| Item 1.    | Business                                                                                                            | 2          |   |
|       |                                                                                                                |       |   |
| Item 2.    | Properties                                                                                                          | 15         |   |
|       |                                                                                                                |       |   |
| Item 3.    | Legal Proceedings                                                                                                   | 16         |   |
|       |                                                                                                                |       |   |
| Item 4.    | Submission of Matters  to a Vote of Security Holders                                                                | 16         |   |
|       |                                                                                                                |       |   |
|       | **PART II**                                                                                                         | ** ** | ** ** |
|       |                                                                                                                |       |   |
| Item 5.    | Market for Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities | 16         |   |
|       |                                                                                                                |       |   |
| Item 6.    | Selected Financial Data                                                                                             | 17         |   |
|       |                                                                                                                |       |   |
| Item 7.    | Management’s Discussion  and Analysis of Financial Condition and Results of Operations                         | 18         |   |
|       |                                                                                                                |       |   |
| Item 7A.   | Quantitative and  Qualitative Disclosures About Market Risk                                                         | 30         |   |
|       |                                                                                                                |       |   |
| Item 8.    | Financial Statements  and Supplementary Data                                                                        | 30         |   |
|       |                                                                                                                |       |   |
| Item 9.    | Changes in and  Disagreements With Accountants on Accounting and Financial Disclosure                               | 31         |   |
|       |                                                                                                                |       |   |
| Item 9A.   | Controls and Procedures                                                                                             | 31         |   |
|       |                                                                                                                |       |   |
| Item 9B.   | Other Information                                                                                                   | 33         |   |
|       |                                                                                                                |       |   |
|       | **PART  III**                                                                                                       | ** ** | ** ** |
|       |                                                                                                                |       |   |
| Item 10.   | Directors and Executive  Officers of the Registrant                                                                 | 33         |   |
|       |                                                                                                                |       |   |
| Item 11.   | Executive Compensation                                                                                              | 36         |   |
|       |                                                                                                                |       |   |
| Item 12.   | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                     | 40         |   |
|       |                                                                                                                |       |   |
| Item 13.   | Certain Relationships  and Related Transactions                                                                     | 42         |   |
|       |                                                                                                                |       |   |
| Item 14.   | Principal Accountant  Fees and Services                                                                             | 43         |   |
|       |                                                                                                                |       |   |
|       | **PART IV**                                                                                                         | ** ** | ** ** |
|       |                                                                                                                |       |   |
| Item 15.   | Exhibits, Financial  Statement Schedules                                                                            | 43         |   |
|       |                                                                                                                |       |   |
| Signatures |                                                                                                                | 48         |   |

** **

1

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**PART I**

** **

**Item 1.  Business**

 

**Where You Can Find MoreInformation**

We file annual, quarterlyand special reports, proxy statements and other information with the Securitiesand Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 asamended (“Exchange Act”). You can inspect and copy our reports, proxystatements, and other information filed with the SEC at the offices of the SEC’sPublic Reference Room in Washington, D.C. Please call the SEC at 1-800-SEC-0330for further information on the Public Reference Room. The SEC maintains anInternet site at http://www.sec.gov/ where you can obtain most of our SECfilings. We also make available, free of charge on our website atwww.gardenburger.com, our annual reports on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K, and amendments to those reports filedor furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon asreasonably practicable after they are filed electronically with the SEC. The information found on our website is not part of this Form 10-K. You canalso obtain copies of these reports by contacting Investor Relations at (949)255-2000.

 

**General**

Gardenburger, Inc. wasorganized in 1985 as an Oregon corporation under the name Wholesome &Hearty Foods, Inc. and completed its initial public offering in 1992.  In October 1997 we changed our name toGardenburger, Inc; and, as our product line expanded to include meatalternative offerings beyond veggie burgers, began doing business in 2002 asGardenburger Authentic Foods Company. Our common stock trades on the over-the-counter market and is quoted onthe NASD’s OTC Bulletin Board.

 

**Overview**

We believe we are one ofthe leading producers and marketers of meat alternative products and brandedveggie burgers. The Gardenburger® product line is a national brand in theretail grocery, food service, club store and natural foods channels ofdistribution and features core burger offerings such as the OriginalGardenburger® veggie burger, meatless soy burgers such as Gardenburger FlameGrilled, and innovative meatless specialty items and new Gardenburger Meals.

 

Several factors beyondhealthy eating have contributed to the growth of meat substitutes over the pastfive years.  Consumer reaction to badpublicity related to meat recalls and the heightened publicity surrounding meatfarming practices and their effect on human health and the environment hasfueled the growth of imitation meat sales in the United States and Canada.  However, the popularity of protein based lowcarbohydrate diets like Atkins and South Beach have positively impacted thesales of beef, pork and chicken and have negatively impacted the meatlesscategory.  We were a pioneer in themeatless burger segment of the category and, in tandem with recent consumertrends favoring low-carbohydrate foods, have expanded our product offerings toinclude center-of-the-plate, soy-based meatless specialties and entrees. Inaddition, we reformulated our veggie burgers to reduce carbohydrates whileincreasing protein and improving taste.

 

Approximately 69% of ourgross sales are attributable to the Gardenburger® veggie burger and soy burgerproducts, with the remaining 31% of our gross sales attributable to our newermeat alternative products. Consumers have been moving to the wider range ofmeat alternative products becoming available in the marketplace.  In response to this development in consumertastes, in fiscal 2003 we added five new products, including BBQ Chik’n andMeatless Meatloaf.  In the third quarterof fiscal 2004, we introduced a new line of six microwaveable meatless entreesto capitalize on the consumers’ need for convenience.

 

While we believeGardenburger enjoys solid brand awareness, our industry is highly competitiveand includes both large food companies and smaller independentmanufacturers.  In the first quarter offiscal 2004, we began shipping reformulated grain burgers and using redesignedpackaging consistent with our efforts to position our products as supporting a100% natural and healthy lifestyle.  Fatgram, protein

 

2

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gram and net carbohydrategram information have been added to the front of the packaging to helpconsumers better understand the nutritional value of our products.  Weight Watcher points and diabetic exchangesare included on the back of the package to support popular diet plans.

 

We intend to continue asan innovative force in the meat alternative category with the objective ofbeing a leading provider of meatless meal alternatives in the four primarydistribution channels in which we distribute our products: retail grocerystores; food service, including restaurants, universities and other commercialoutlets; club stores; and natural foods outlets. We currently distribute ourproducts through more than 24,000 retail outlets, 30,000 food service outlets,265 club store locations and 3,500 natural foods stores.

 

Within the retailgrocery channel, our largest channel of distribution, we have approximately190,000 retail grocery placements of our products, representing an allcommodity volume (“ACV”)(1) penetration of approximately 79% as of September30, 2004, with an average of 7.9 product variations available in each retailoutlet.  Each product is commonlyreferred to as a stock keeping unit (“SKU”).

** **

**Business Strategy**

In recent years, we haveseen increased competition in the meat alternative category, including theveggie burger segment, and have seen our market share of meat alternativeburgers decline due to heavy spending by competitors and changes in consumers’eating habits.  Our business strategyconsists of the following key elements:

 

***Focuson Achieving Profitability. ***Weare focused on achieving near-term profitability.  In furtherance of this goal, fixed overheadis closely monitored and, in November 2003, our Portland, Oregon administrativeoffice was closed with four positions eliminated, certain positions relocatedto our Utah manufacturing facility and the remainder relocated to a new,smaller office in Irvine, California. Trade and marketing spending is focusedon new product support and incentives to customers and end consumers as webelieve this approach has the quickest and most direct impact on sales. Thereis no assurance that we will be able to successfully achieve near-termprofitability or maintain our market share in the veggie burger segment,particularly given the current highly competitive retail market.

 

***IntroduceNew Products Beyond Veggie Burgers.****** ***Asdiscussed above, we continue to move beyond the veggie burger segment of themeat alternative category. While veggie burger category sales have declined thepast 18 months, consumers are adding new items to their menu with increasingfrequency and the meat alternative category volume is primarily found in thenon-burger segment.  We believe that ournew product introductions in other segments of the meat alternative category,such as entrees, will support our efforts to maintain a strong position in allchannels and reinforce our brand equity.

 

***IncreaseKey Channel Penetration.**** *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 a strongbrand position in these channels with profitability in all channels.  We recognize that increased competition inthe grocery channel may result in a loss of grocery market share.  We are pursuing profitable growth in the foodservice channel where we have a strong market position across key businesssegments.  We were selected as a vendorof choice in the Sysco Corporation launch of its Moonrose Vegetarian line, aprivate label brand of premium products targeted at the emergent food servicenatural foods segment. In addition, we believe that other distributionchannels, such as sandwich chains, K-12 schools and colleges and universities,present growth opportunities, and we continue to actively pursue theseopportunities through sales calls to potential customers and research intoproduct types that best suit the particular markets.

 

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(1) ACV calculates the percentage of U.S. stores that carry at leastone Gardenburger product. 

 

3

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## **Products**

Gardenburger iscommitted to offering great tasting, better-for-you, convenient meatless foodchoices to consumers.  All of ourproducts are frozen and include: grain-based and soy-based veggie burgers,which are offered in eleven varieties, and include specialized burger productsin certain channels, including Gardenburger SubTM for food service andGardenVegan® for natural food stores.  Wealso offer a variety of meat analog products including Chik’n Grill, MeatlessRiblets, Meatless Meatloaf, and Herb Crusted Cutlet, all of which imitate thetaste and texture of meat, chicken or pork products. In addition, in the thirdquarter of fiscal 2004, we introduced a new line of six microwaveable meatlessentrees in the retail and natural food channels to capitalize on the consumers’need for convenience.

 

The recipes for ourproducts are proprietary, although they contain commonly knowningredients.  Veggie-grain based burgerscontain fresh mushrooms, brown rice or other whole grains, onions, rolled oats,cheeses, bulgur wheat, natural seasonings and spices.  Soy-based products are seasoned to taste likechicken, pork or beef.  All of our meatalternative products are considerably lower in fat and calories than respectivemeat products of comparable weight, are good sources of protein and are 100%natural.

 

Our products are asfollows:

 

**Retail Grocery Burger Products**

** **

| **Product**                                                                    | ** ** | **Characterizing Ingredients**                                               | ** ** | **Fat** | ** ** | **Calories** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|---------|------------|--------------|------------|
| The Original  Gardenburger® sold in boxes of 4/2.5 oz. servings           |       | Mushrooms, brown rice, soy, onions, rolled oats and  low-fat cheese          |       | 2g      |       | 90           |       |
|                                                                           |       |                                                                         |       |    |       |         |       |
| Gardenburger  Black BeanTM sold in boxes of 4/2.5 oz. servings             |       | Black beans, soy, brown rice, Anaheim chilies,  onions, cumin, cilantro      |       | 2g      |       | 80           |       |
|                                                                           |       |                                                                         |       |    |       |         |       |
| Gardenburger  Veggie Medley® sold in boxes of 4/2.5 oz. servings          |       | Soy, mushrooms, rolled oats, broccoli, carrots, red  and yellow bell peppers |       | 2g      |       | 90           |       |
|                                                                           |       |                                                                         |       |    |       |         |       |
| Gardenburger  Savory PortabellaTM sold in boxes of 4/2.5 oz. servings      |       | Portabella mushrooms, wild rice, soy, blue cheese,  kashi blend              |       | 2.5g    |       | 100          |       |
|                                                                           |       |                                                                         |       |    |       |         |       |
| Gardenburger  Sun-Dried Tomato BasilTM sold in boxes of 4/2.5 oz. servings |       | Sun-dried tomatoes, soy, mushrooms, rolled oats,  mozzarella cheese, basil   |       | 3g      |       | 100          |       |
|                                                                           |       |                                                                         |       |    |       |         |       |
| Gardenburger  GardenVegan® sold in boxes of 4/2.5 oz. servings            |       | Bulger wheat, brown rice, mushrooms, onions                                  |       | 1g      |       | 100          |       |
|                                                                           |       |                                                                         |       |    |       |         |       |
| Gardenburger  Homestyle ClassicTM sold in boxes of 4/2.5 oz. servings      |       | Soy, onion, garlic                                                           |       | 5g      |       | 110          |       |
|                                                                           |       |                                                                         |       |    |       |         |       |
| Gardenburger  Flame Grilled® sold in boxes of 4/2.5 oz. servings          |       | Soy, natural grill flavor                                                    |       | 4g      |       | 120          |       |

 

4

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**Retail Grocery MeatlessSpecialty Products**

 

| **Product**                                                                        | ** ** | **Description**                                | ** ** | **Characterizing Ingredients**                                              | ** ** | **Fat** | ** ** | **Calories** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|---------|------------|--------------|------------|
| Gardenburger  Flame Grilled Chik’nTM sold in boxes of 4/2.5 oz. servings  |       | Flame grilled meatless chicken                 |       | Soy, wheat gluten, sautéed vegetables and herbs                        |       | 2.5g    |       | 100          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger BBQ  Chik’nTM sold in 10 oz. packages                        |       | Meatless chicken with sauce                    |       | Soy, wheat gluten, barbecue sauce                                           |       | 8g      |       | 250          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Buffalo Chik’n WingsTM sold in 10 oz. packages              |       | Meatless chicken wings in hot sauce            |       | Soy, wheat gluten, pepper sauce                                             |       | 12g     |       | 180          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Country Fried Chik’n with Creamy Pepper GravyTM             |       | Meatless breaded chicken cutlet with gravy     |       | Breading, soy, wheat gluten, cream gravy                                    |       | 9g      |       | 190          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Meatless RibletsTM sold in boxes of 2/5 oz. servings             |       | Meatless pork rib with sauce                   |       | Soy, wheat gluten, barbecue sauce                                           |       | 5g      |       | 160          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Sweet & Sour PorkTM sold in 10 oz. packages                  |       | Meatless pork pieces in sweet & sour sauce |       | Soy, wheat gluten, sweet & sour sauce, green  peppers, onion, pineapple |       | 2g      |       | 170          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Herb Crusted Chicken PattyTM sold in boxes of 4/2.5 oz. servings |       | Meatless breaded chicken patty                 |       | Breading, soy, wheat gluten                                                 |       | 9g      |       | 170          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Breakfast SausageTM sold in boxes of 6/1.5 oz. patties           |       | Meatless breakfast sausage                     |       | Soy                                                                         |       | 3.5g    |       | 50           |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Meatless MeatballsTM sold in 10 oz. packages                     |       | Meatless herbed meatballs                      |       | Soy, bread crumbs, parmesan cheese                                          |       | 4.5g    |       | 110          |       |
|                                                                               |       |                                           |       |                                                                        |       |    |       |         |       |
| Gardenburger  Meatless MeatloafTM sold in 10 oz. packages                      |       | Meatless meatloaf with brown gravy             |       | Soy, green pepper, onion, brown gravy                                       |       | 3.5g    |       | 130          |       |

 

5

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**Retail Grocery Meatless Meals**

 

| **Product**                                               | ** ** | **Characterizing Ingredients**                                                            | ** ** | **Fat** | ** ** | **Calories** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|---------|------------|--------------|------------|
| Meatless Citrus  Glazed Chicken With Green Beans and Rice |       | Soy, wheat gluten, brown and wild rice, green beans,  citrus glaze                        |       | 2g      |       | 220          |       |
|                                                      |       |                                                                                      |       |    |       |         |       |
| Meatless Herb  Grilled Chicken With Vegetables            |       | Soy, wheat gluten, roasted zucchini, squash, green,  red and yellow peppers, butter sauce |       | 5g      |       | 220          |       |
|                                                      |       |                                                                                      |       |    |       |         |       |
| Meatless  Meatballs With Penne Marinara                   |       | Soy, breadcrumbs, parmesan cheese, penne pasta,  tomato sauce                             |       | 4.5g    |       | 300          |       |
|                                                      |       |                                                                                      |       |    |       |         |       |
| Meatless  Meatloaf With Broccoli and Red Peppers          |       | Soy, green pepper, onion, brown gravy, broccoli  florets, red peppers                     |       | 4.5g    |       | 180          |       |
|                                                      |       |                                                                                      |       |    |       |         |       |
| Meatless  Southwestern Chicken With Vegetables            |       | Soy, wheat gluten, black beans, corn, grilled  peppers, enchilada sauce                   |       | 1.5g    |       | 210          |       |
|                                                      |       |                                                                                      |       |    |       |         |       |
| Meatless Sweet  and Sour Pork With Rice                   |       | Soy, wheat gluten, sweet and sour sauce, green  peppers, onion, pineapple, brown rice     |       | 4g      |       | 310          |       |

 

**Club Channel Products**

 
| **Product**                                                           | ** ** | **Description**            | ** ** | **Characterizing Ingredients**                                      | ** ** | **Fat** | ** ** | **Calories** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------|------------|---------|------------|--------------|------------|
| Original  Gardenburger sold in packages of 17/3.5 oz. servings        |       | Veggie-grain style burger  |       | Mushrooms, brown rice, soy, onions, rolled oats and  low-fat cheese |       | 4g      |       | 130          |       |
|                                                                  |       |                       |       |                                                                |       |    |       |         |       |
| Gardenburger  Meatless Riblets sold in packages of 8/5.0 oz. servings |       | Analog pork rib with sauce |       | Soy, wheat gluten, barbecue sauce                                   |       | 5g      |       | 210          |       |

 

6

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**Food Service 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, soy                                     |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 60/2.5 oz.  Original Gardenburger                     |       | Veggie-grain style burger        |       | Mushrooms, brown rice, onions, rolled oats and  low-fat cheese, soy                                     |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 36/5.0 oz. Original Gardenburger                      |       | Veggie-grain style burger        |       | Mushrooms, brown rice, onions, rolled oats and  low-fat cheese, soy                                     |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/2.75 oz. Gardenburger SubTM                    |       | Veggie-grain style burger        |       | Mushrooms, brown rice, onions, rolled oats, red bell  pepper and cheese                                 |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.4 oz.  Gardenburger Veggie Vegan®           |       | Veggie-grain style burger        |       | Soy, mushrooms, rolled oats, broccoli, carrots, red  and yellow bell peppers                            |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.4 oz.  Gardenburger Santa Fe®               |       | Gourmet burger                   |       | Black beans, Anaheim chilies, red and yellow bell  peppers, corn, mushrooms, onion                      |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/2.75 oz.  GardenFresh                              |       | Veggie-grain style burger        |       | Soy, mushrooms, onions, water chestnuts, carrots, and  bell peppers                                     |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.4 oz.  GardenFresh                               |       | Veggie-grain style burger        |       | Soy, mushrooms, onions, water chestnuts, carrots,  and bell peppers                                     |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.4 oz. Flame  Grilled SoyTM                   |       | Flame grilled meatless burger    |       | Soy, natural grill flavor                                                                               |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.4 oz.  Gardenburger Fire Roasted Vegetable® |       | Gourmet burger                   |       | Roasted garlic, sun-dried tomatoes, brown rice,  mushrooms, roasted peppers, corn, roasted bell peppers |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 106/1.5 oz.  GardenSausage®                      |       | Meatless sausage patty           |       | Soy, vegetarian sausage flavor                                                                          |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 53/3.0 oz.  Chik’n GrillTM                   |       | Flame grilled meatless chicken   |       | Soy, sautéed vegetables and herbs                                                                  |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 1/10# (220  Nuggets) Chik’n NuggetsTM        |       | Breaded meatless chicken nuggets |       | Breading, soy, wheat gluten                                                                             |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.4 oz. Diner  Deluxe BurgerTM                 |       | Fried meatless burger            |       | Soy protein                                                                                             |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/2.75 oz.  Gardenburger Black Bean                  |       | Gourmet burger                   |       | Soy, black beans, brown rice, Anaheim chiles, onion,  corn, cilantro                                    |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.4 oz.  Gardenburger Black Bean                   |       | Gourmet burger                   |       | Soy, black beans, brown rice, Anaheim chiles, onion,  corn, cilantro                                    |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/2.75 oz.  Flame Grilled Sub PattyTM            |       | Flame grilled meatless burger    |       | Soy, natural grill flavor                                                                               |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 53/3.0 oz. Naked  Riblets                             |       | Meatless riblet                  |       | Soy, vegetarian sausage flavor, and spices                                                              |       |
|                                                  |       |                             |       |                                                                                                    |       |
| 48/3.0 oz. Herb  Crusted Chicken Patty                |       | Breaded Meatless Chicken Patty   |       | Soy, breadcrumbs, herbs and spices, and natural  hickory smoke flavor                                   |       |

 

7

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**Distribution**

We primarily distributeour products into four channels: retail grocery, food service, club stores andnatural foods stores.

 

***RetailGrocery****.* Gardenburgerproducts can now be found in more than 24,000 grocery stores with over 190,000placements.  Our ACV penetration in theU.S. retail grocery channel was approximately 79% as of September 30, 2004,with an average of 7.9 SKUs.  Ourproducts are currently carried in the majority of the major U.S. retail grocerychains.

 

***FoodService****.* We distributeour products to more than 30,000 food service outlets throughout the U.S. andCanada, including restaurant chains such as Applebee’s, Fuddruckers, Red Robin,Subway and T.G.I. Friday’s.  In many ofthese restaurants, the Gardenburger brand name appears on the menu.  Additional points of food servicedistribution include academic institutions, hotels, 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.

 

***ClubStores.***Our products are distributed to club stores withover 265 locations, primarily Costco. Currently, these stores carry the Original Gardenburger.

 

Net sales to Costcodecreased by $3.2 million, or 41%, in fiscal 2004 compared to fiscal 2003 as aresult of Costco’s decision to remove the Kirkland Signature co-branding labelfrom our Gardenburger original packaging, effective the second quarter offiscal 2004, which means that our product is no longer required to be carriedby all Costco stores.  After numerousregional presentations, approximately 80% to 85% of the Costco stores haveagreed to carry our Gardenburger product going forward.

 

***NaturalFoods.***Our products are distributed to more than 3,500natural food stores, including Whole Foods and Wild Oats.  We utilize food brokers that specialize innatural foods stores.

 

Our ability to expanddistribution in each of the described channels will depend in part on consumerpreferences, and to a certain extent on continuation of the current trends ofhealth awareness.  There is always a riskthat further development of low fat red or white meat products or technologicaladvances that 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 inNorth America, primarily through more than 100 independent, commissioned foodbrokers and 1,000 active distributors. The retail food brokers are independentsales organizations, which have close working relationships with the leadinggrocery chains, club stores and natural food stores. The food brokers arrangefor sales of Gardenburger 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-cancelablelong-term contracts with our food brokers or distributors and occasionallychange brokers or distributors in an effort to increase coverage in ageographic region.  We could experience asubstantial temporary or permanent decline in net sales if one or more of ourmajor food brokers or distributors were to discontinue handling our products,go out of business, or decide to emphasize distributing products of ourcompetitors.

 

8

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Contract ManagementCompanies, which manage cafeterias and other institutional eatingestablishments, also purchase our products. Examples of the additional pointsof food service distribution reached through the Contract Management Companiesinclude academic institutions, hotels, amusement parks and sports stadiums.Contract Management Companies typically purchase our products throughdistributors and provide us with an additional means to distribute ourproducts.

 

The following tablelists selected retailers, distributors and food service outlets that offer ourproducts for sale to consumers:

## **Retail**

## ** **

## **Grocery**

## **A&P**

## **AWG**

## **Albertsons**

## **BurrisFoods Wholesale**

## **C&SWholesale**

## **CubStores**

## **Demoulas**

## **Dillon’sStores**

## **Dominick’s**

## **FlemingWholesale**

## **FredMeyer**

## **GiantEagle**

## **GiantFood**

## **Hannaford**

## **Jewel**

## **King/Cullen**

## **KingSoopers**

## **Kroger**

## **Marsh**

## **Meijers**

## **PublixSuper Markets**

## **QFC**

## **RainbowFoods**

## **Raley’s**

## **Ralph’s**

## **Randall’s**

## **Safeway**

## **Shaw’s**

## **Smith’s**

## **Shoprite**

## **Stopand Shop**

## **SupervaluWholesale**

Thriftway

## **Tops**

## **Von’s**

## **Wakefern**

## **Wal-Mart**

## **Wegmans**

## **WhiteRose Wholesale**

Winn-Dixie

## ** **

## **NaturalFoods**

## **WildOats**

## **WholeFoods**

## ** **

## **ClubStores**

## **Costco**

## ** **

## **FoodService**

## ** **

## **Distributors**

## **FoodServices of America**

## **DotFoods**

## **Sysco**

## **GordonFood Service**

## **ReinhartFood Service**

## **U. S.Foodservice**

 

## **Restaurants**

## **Applebee’s**

## **Arctic Circle**

## **A&W**

## **Burgerville**

## **Friendly’s**

## **Dairy Queen**

## **Damon’s**

## **Flamers**

## **Foster Freeze**

## **Fuddruckers**

## **IHOP**

## **Lyons**

## **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**

## ** **

## **ContractManagement Companies**

## **ARAMARK**

## **Avendra**

## **Foodbuy**

## **Gukenheimer**

## **Sodexho**

 

9

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Our sales by region wereas follows:

 
| ** ** | ** ** | **% of Gross Sales** | ** ** |
|------------|------------|----------------------|------------|
| **Region** | ** ** | **FY 2004**          | ** ** | **FY 2003** | ** ** | **FY 2002** | ** ** |
| Northeast  |       | 27                   | %          | 24 | % | 31 | % |
| Midwest    |       | 20                   |       | 18 |   | 16 |   |
| Northwest  |       | 20                   |       | 26 |   | 36 |   |
| Southwest  |       | 16                   |       | 12 |   | 5 |   |
| Southeast  |       | 14                   |       | 16 |   | 8 |   |
| Canada     |       | 3                    |       | 4 |   | 4 |   |
|       |       | 100%                 |       | 100 | % | 100 | % |

 

To date, we have focusedour sales efforts primarily in North America, and international sales have notbeen material.

 

##### **Salesand 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 forceis located strategically in our primary geographic sales regions and inproximity to our brokers and is divided into a food service division and aretail and club division.  The regionalsales directors have substantial sales and industry experience. These regionalsales directors coordinate the efforts of the food brokers and distributors.

 

***Marketing. ***Our marketing effortsfocus on key seasonal periods for healthy eating.  Factors such as the aging population, obesityconcerns and consumer interest in good-for-you products continue to stimulatepositive consumer acceptance. We utilize free standing inserts, targetedmarketing, website communication and in-store advertising to market ourproducts.

 

**Research and Development**

Our research anddevelopment activities are focused on the development of new meat alternativeproducts outside the veggie burger sub-category of the meat alternative market,as well as improvement and increased efficiency in the manufacturingprocess.  We continue to developnon-burger items such as breakfast sausage, cutlets and nuggets to meet theneeds of the variety-seeking consumer. We conduct our research and developmentactivities at our facilities in Clearfield, Utah.  In fiscal 2004, 2003 and 2002, we spentapproximately $272,000, $235,000 and $222,000, respectively, on research anddevelopment activities, which are included in sales and marketing expense.

 

**Manufacturing**

Our 120,000 square-footClearfield facility handles multiple manufacturing lines for our products.  We believe the Clearfield facility will beable to support our growth plans for the foreseeable future.

 

The manufacturingprocess involves cleaning, chopping and mixing the ingredients; then forming,baking and quick-freezing the products and finally packaging them. Themanufacturing process at our Clearfield facility is highly automated, mixing andbaking products in assembly-line fashion with minimal human interaction.  The Clearfield facility also utilizesnewly-developed, proprietary ovens that quickly cook the products.  Products are shipped, fully cooked, frozenand packaged, via temperature controlled trucks to distributors throughoutNorth America.

 

10

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We consider food safetya high priority and have prepared, in conjunction with government agencies, aHazard Analysis and Critical Control Point (“HACCP”) system and other programsdirected at ensuring the safety of our products.  HACCP is a comprehensive system that foodcompanies use to monitor specific steps in food production to identify safetyissues.  Using this type of system, wecan focus on the areas in which greatest risks exist and implement preventivemeasures.

 

A significant disruptionin our Clearfield facility’s production capacity as a result of, for instance,fire, severe weather, regulatory actions, work stoppages or other factors,could disable our capacity to manufacture our products.  If our meat alternative products become lessavailable, consumers may switch to another brand of products and grocery storesmay reduce shelf space allocated to our products.  Any significant unplanned disruption inmanufacturing would likely have a material adverse effect on our results ofoperations and financial condition.

 

**Seasonality**

The third and fourthquarters of our fiscal year typically have stronger sales due to the impact ofthe summer grilling season on our veggie burger business.  We typically build inventories during thefirst and second quarters of each fiscal year in anticipation of increasedsales in the third and fourth fiscal quarters, although in fiscal 2005, we planto reduce inventory levels that have built up over the 2002 to 2004 time period.

 

**Competition**

The market for veggieburgers and other meat alternative products is highly competitive. Our productscompete primarily on the basis of brand preference, taste, innovation, qualityof natural ingredients, ease of preparation, availability, price and consumerawareness. We believe that our products compare favorably to those offered byour competitors in all of these areas. We price our products competitively to our primary competitors. Thecalorie and fat content of Gardenburger® products is generally equivalent tothat of competitors’ products. According to AC Nielsen, sales of ourGardenburger products represented 10.5% and 10.7% of meatless category salesduring fiscal 2004 and fiscal 2003, respectively.

 

We believe that ourprincipal competitors are The Kellogg Company, which distributes its productsunder the “Morningstar Farms” brand name to the food service, retail grocery,club and natural food channels; and Kraft Foods, which distributes soy-basedmeat analog products primarily in the food service, retail grocery, club andnatural food channels under the “Boca Burger” label.   These companies have substantially greaterfinancial and marketing resources than us. In addition, other major national food products companies could decideto produce meat alternative products at any time in the future.

 

Our products alsocompete indirectly with other low fat meat products, such as ConAgra’s HealthyChoice 96% Extra Lean Ground Beef burger, and chicken or turkey based low fatproducts distributed by several large companies such as Tyson Foods, and withfrozen, mass-produced low calorie/low fat entrees, including national brandssuch as Healthy Choice, Lean Cuisine and Smart Ones. Large companies withsubstantially greater financial resources, name recognition and marketingresources than us produce these products.

 

**Significant Customers**

Sysco Foods, Dot Foods,Inc. and C&S Wholesale Grocers, Inc. accounted for approximately 12%, 10%and 8%, respectively, of our fiscal 2004 gross revenue before tradediscounts.  At September 30, 2004, SyscoFoods (“Sysco”), Dot Foods, Inc. (“Dot”) and C&S Wholesale Grocers, Inc. (“C&S”)accounted for approximately 7%, 12% and 14% of the gross outstanding accountsreceivable balance, respectively.

 

Sysco is a food servicedistributor and sells our products to restaurants, hotels, and other foodservice customers. Dot is a redistributor; they sell our products to other,smaller distributors.  C&S is a retailfood distributor and sells our products to grocery stores. The loss of thesecustomers could have a material adverse effect on our business; however, thereare competing distributors through which our products could be purchased by theend users.

 

11

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#### **Sources of Supply**

We use naturalingredients such as mushrooms, oats, rice, onions and soy protein.  These are common agricultural items typicallyavailable in most parts of the United States. In addition, we use packaging and other materials that are common in thefood industry.  As a result, we believe,but cannot guarantee, that our sources of supply are reasonably reliable andthat we are at no greater risk regarding supply issues than other similar foodprocessors and producers.

 

**Employees**

After a reduction inforce was implemented in early October 2004, we had approximately 172 full-timeequivalent employees, with approximately 144 of them employed at our Clearfieldfacility.  None of our employees aresubject to a collective bargaining agreement, and we believe our relations withour employees to be good.

 

**Intellectual Property**

We have approximately 22 U.S.registered trademarks, including “Gardenburger,” “Gardenburger Hamburger Classic,”and “GardenSausage.”  We have registeredcertain trademarks in Australia, Canada, France, Germany, Japan, Mexico and theUnited Kingdom, along with other smaller countries.

 

We actively monitor useof our trademarks by food service customers and others and take action webelieve appropriate to halt infringement or improper usage. We defend ourintellectual property aggressively and, from time to time, have been engaged ininfringement 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. Any large expenditure or loss of rightscould have a material adverse effect on our results of operations, cash flowsand financial position.

 

We generally do not seekpatents for our recipes or production methods and, therefore, can protect themonly as trade secrets.  Some or all ofthese trade secrets could be obtained by others or could enter the publicdomain, which could place us at a competitive disadvantage.

 

##### **In aneffort to protect our trade secrets, all of our employees sign an “EmployeesProprietary Rights and Confidentiality Agreement,” which states that they willnot disclose our manufacturing processes, recipes, customer lists or otherconfidential material vital to our business. In addition, senior sales, marketing and administrative personnel signnon-compete agreements, which prohibit them from working for a competitor forspecified periods of time upon the termination of their employment withGardenburger.**

##### ** **

##### **ManagementInformation Systems**

We utilize a single Baanenterprise resource planning system, which is expected to meet our informationsystem needs for the foreseeable future. In addition to integrating manufacturing, sales and accountingfunctions, the Baan system provides real-time information for managementanalysis and use in operations.  The Baansystem aids management with production planning (planning of raw material purchases)and demand forecasting (matching supply to distribution centers with ordervolume) capabilities.  The Baan systemalso includes pallet tagging, bar coding and scanning applications thatfacilitate tracking of raw materials and finished goods through ourmanufacturing operation.  The Baan systemenables us to use electronic data interchange (“EDI”) if desired by customersand suppliers, which we believe expedites order entry, payment and cashcollection processes.

 

##### **GovernmentRegulation**

The manufacturing,packaging, storage, distribution and labeling of food products are subject toextensive federal and state laws and regulations.  The FDA has issued regulations governing theingredients that may be used in food products, the content of labels on foodproducts and the labeling claims that may be made for foods.  Foods may only include additives, colors andingredients that are either approved by the FDA or generally recognized assafe.  Our products must be manufacturedin compliance with the FDA’s current Good Manufacturing Practice regulationsapplicable to food.

 

12

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Regulators have broadpowers to protect public health, including the power to inspect our productsand facilities, to order the shutdown of a facility or to seize or stop shipmentof our products and order a recall of previously shipped products, as well asthe power to impose substantial fines and seek criminal sanctions against us orour officers.  While we currently carry$1 million of insurance against the cost of a product recall, a significantrecall could have an adverse effect on our results of operations, cash flowsand financial condition. In addition, negative publicity may result ifregulators take any of the foregoing actions against us or if we were tovoluntarily recall products to avoid regulatory enforcement.

 

##### **Insurance**

We maintain insuranceagainst various risks related to our business. This includes property and casualty, business interruption, director andofficer liability, food spoilage, product liability, product recalls andworkers’ compensation insurance.  Wecurrently maintain $1 million of product recall insurance coverage, $2 millionof product liability insurance coverage and $20 million of general umbrellacoverage.  We consider our policiesadequate to cover the major risks in our business, but there can be noassurance that this coverage will be sufficient to cover the cost of defense ordamages in the event of a significant product liability claim.

 

**Risk Factors**

This Annual Report onForm 10-K contains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  Our actual results may differmaterially from the results projected in the forward-looking statements.  Factors that might cause such a differenceinclude, but are not limited to, the following:

 

***Oursuccess depends on our ability to attract and retain key personnel.***

We believe that oursuccess will depend, in part, on the continuing services of our key managementpersonnel.  The loss of the services ofkey personnel could have a material impact on our financial results.  Additionally, our success may depend on ourability to attract and retain additional skilled management personnel.

 

***Oursuccess depends on our ability to judge the impact of competitive products andpricing.***

Successful operation ofour business requires the ability to identify the effects of product andpricing trends.  If we are unable toevaluate the impact of product or pricing trends effectively, we may fail toimplement strategies allowing us to capitalize on those trends, which mayresult in decreased sales or increased costs.

 

***Oursuccess depends on our ability to compete with our competitors.***

The foodservice industryis intensely competitive with respect to the quality and value of food productsoffered and price.  Many of ourcompetitors have substantially greater financial, marketing, operating andother resources than we have, which may give them competitive advantages.  Our competitors could also make changes topricing or other marketing strategies which may impact us detrimentally. As ourcompetitors expand operations, we expect competition to intensify. Suchincreased competition could have a material adverse effect on our financialposition and results of operations.

 

***Weface commodity price and availability risks.***

We purchase energy andagricultural products that are subject to price volatility caused by weather,market conditions and other factors that are not predictable or within ourcontrol. Increases in commodity prices could result in lower operating margins.Occasionally, the availability of commodities can be limited due tocircumstances beyond our control. If we are unable to obtain such commodities,we may be unable to offer related products, which would have a negative impacton our profitability.

 

13

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***Wedepend on our suppliers to deliver quality products to us timely.***

Our profitability isdependent on, among other things, our continuing ability to offer fresh,high-quality food at moderate prices. Our dependence on frequent deliveries of food and paper productssubjects our business to the risk that shortages or interruptions in supply,caused by adverse weather or other conditions, could adversely affect theavailability, quality and cost of ingredients. Any disruption in these distribution services could have a materialadverse effect on our financial position and results of operations.

 

***Consumerpreferences and perceptions may have significant effects on our business.***

Foodservice businessesare often affected by changes in consumer tastes and perceptions.  Foodservice businesses such as ours can alsobe affected materially and adversely by publicity resulting from poor foodquality, illness, injury or other health concerns or operating issues stemmingfrom one or a limited number of products. We can be similarly affected by consumer concerns with respect to thenutritional value of our products.

 

***Ourbusiness may be impacted by increased insurance costs.***

We may be negativelyaffected by rising healthcare costs. Although we seek to manage our claims to prevent increases, suchincreases can occur unexpectedly and without regard to our efforts to limitthem. If such increases occur, we may be unable to pass them along to theconsumer through product price increases, resulting in decreased operatingresults.

 

***Thenature of our business exposes us to potential litigation.***

We have thousands ofinteractions or transactions each day with vendors, customers, employees andothers.  In the ordinary course ofbusiness, disputes may arise for a number of reasons.  We may also be subject to liability claims orproduct recalls for products to be distributed in the future or products that havealready been distributed.  We cannot becertain that we will prevail in every legal action brought against us.

 

***Governmentalregulations may change and require us to incur substantial expenditures tocomply.***

We are subject togovernmental regulation at the federal, state and local level in many areas ofour business, such as food safety and sanitation, environmental issues andminimum wage.  Governmental entities maychange regulations that may require us to incur substantial cost increases inorder to comply with such laws and regulations. While we endeavor to comply with all applicable laws and regulations, wecannot assure you that we are in full compliance with all laws and regulationsat all times or that we will be able to comply with any future laws orregulations.  If we fail to comply withapplicable laws and regulations, we may be subject to sanctions or civilremedies, including fines and injunctions. The cost of compliance or theconsequences of non-compliance could have a material adverse effect on ourbusiness and results of operations.

 

***Compliancewith environmental laws may affect our financial condition.***

We are subject to variousfederal, state and local environmental laws. These laws govern discharges to air and water, as well as handling anddisposal practices for solid and hazardous wastes.  These laws may also impose liability fordamages from and the costs of cleaning up sites of spills, disposals or otherreleases of hazardous materials.  We maybe responsible for environmental conditions or contamination relating to ourfacilities and the land on which our facilities are located, regardless ofwhether we lease or own the facility or land in question and regardless ofwhether such environmental conditions were created by us or by a prior owner ortenant.  The costs of any cleanup couldbe significant and have a material adverse effect on our financial position andresults of operations.

 

***We havereceived a “going concern” opinion from our independent registered publicaccounting firm, which may negatively impact our business.***

We have received a reportfrom our independent registered public accounting firm regarding our financialstatements for the fiscal year ended September 30, 2004 that included anexplanatory paragraph which stated that the financial statements have beenprepared assuming we will continue as a going concern. The explanatoryparagraph stated that our working capital deficiency, negative operating cashflow, and

 

14

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substantial recurringlosses have raised substantial doubt about our ability to continue as a goingconcern.  As a result of our financialcondition, we may find it difficult to operate our business in a normalfashion.  In addition, our ability tocontinue as a going concern could adversely affect our ability to enter intocollaborative relationships with business partners and our ability to sell ourproducts and could have a material adverse effect on our business, financialcondition and results of operations.

 

***Evolvingregulation of corporate governance and public disclosure may result inadditional expenses and continuing uncertainty.***

Changing laws,regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulationsare creating uncertainty for companies such as ours. These new or changed laws,regulations and standards are subject to varying interpretations in many casesdue to their lack of specificity, and, as a result, their application inpractice may evolve over time as new guidance is provided by regulatory andgoverning bodies, which could result in continuing uncertainty regardingcompliance matters and higher costs necessitated by ongoing revisions todisclosure and governance practices. We are committed to maintaining highstandards of corporate governance and public disclosure. As a result, we intendto invest resources to comply with evolving laws, regulations and standards,and this investment may result in increased general and administrative expensesand a diversion of management time and attention from revenue-generatingactivities to compliance activities.  Ifour efforts to comply with new or changed laws, regulations and standardsdiffer from the activities intended by regulatory or governing bodies due toambiguities related to practice, our reputation may be harmed.

 

***We may have difficulty implementing, in a timely manner, theinternal controls procedures necessary to allow our management to report on theeffectiveness of our internal controls.***

Pursuant to Section 404of Sarbanes-Oxley, we will be required to furnish an internal controls reportof management’s assessment of the effectiveness of our internal controls aspart of our Annual Report on Form 10-K for the fiscal year ended September 30,2005. Our auditors will then be required to attest to, and report on, ourassessment. In order to issue our report, our management must document both thedesign of our internal controls and the testing processes that supportmanagement’s evaluation and conclusion. Our management has begun the necessaryprocesses and procedures for issuing its report on our internal controls.However, we may face significant challenges in implementing the requiredprocesses and procedures. There can be no assurance that we will be able tocomplete the work necessary for our management to issue its management reportin a timely manner, or that management will be able to report that our internalcontrols over financial reporting are effective.

 

**Item 2.  Properties**

 

We lease approximately 5,200square feet of administrative office space in Irvine, California pursuant to anoperating lease with an initial term of three years. Current monthly rent isapproximately $10,800.  This leaseexpires October 31, 2006 and has one renewal option for 24 months.

 

We lease 120,000 squarefeet of production space at Freeport Center, Building A-16, in Clearfield,Utah, pursuant to a lease that will terminate on December 31, 2007.  We have the option to renew the lease for oneadditional five-year term commencing January 1, 2008.  The monthly rent on this facility iscurrently $33,500.  Our Clearfield, Utahproduction facility can support sales levels of approximately $220 million atcurrent pricing levels.  Given ourcurrent level of sales, we are operating the facility at approximately 30% ofoverall capacity.

 

We also lease 22,000square feet of storage space at the Freeport Center in Clearfield on amonth-to-month basis.  The monthly rentfor the storage space is approximately $7,500.

 

15

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**Item 3.  Legal Proceedings**

 

There are currently nomaterial, pending legal proceedings to which we are a party.  From time to time, we become involved inordinary, routine or regulatory legal proceedings incidental to our business.

 

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

 

No matters were submittedto a vote of security holders during the quarter ended September 30, 2004.

 

###### **PART II**

###### ** **

**Item 5.  Market for Registrant’s Common Equity,Related Stockholder Matters and Issuer Purchases of Equity Securities**

 

Our common stock tradeson the over-the-counter market and is quoted on the NASD’s OTC BulletinBoard.  Over-the-counter marketquotations reflect inter-dealer prices, without retail mark-up, mark-down orcommission and may not necessarily represent actual transactions. The high andlow bid quotations for the last two fiscal years were as follows:

 
| **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    |       |
|                  |            |          |            |         |            |  |  |

 
| **Fiscal  2004** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|----------|------------|---------|------------|
| Quarter 1        |       | $        | 0.54       |    | $          | 0.20 |   |
| Quarter 2        |       | 0.40     |       | 0.27    |       |
| Quarter 3        |       | 0.36     |       | 0.21    |       |
| Quarter 4        |       | 0.28     |       | 0.16    |       |
|                  |            |          |            |         |            |  |  |

 

The number ofshareholders of record and approximate number of beneficial owners of our commonstock at February 14, 2005 were 689 and 4,000, respectively.

 

There were no cashdividends declared or paid in fiscal 2004 or 2003 on our common stock and we donot anticipate declaring cash dividends on our common stock in the foreseeablefuture.  Under the terms of our loanagreement with CapitalSource Finance LLC, we may not pay any cash dividends orother distributions with respect to, or redeem any of, our capital stock.  We also may not, without the consent of AnnexHoldings I LP (“Annex”), the current holder of our convertible seniorsubordinated note, declare or pay any cash dividends or make any distributionswith respect to our capital stock or other equity securities to the extent thatat least $5 million in principal amount remains outstanding under ourconvertible senior subordinated note and Annex owns a majority of the thenoutstanding principal amount of such notes.

 

In addition, no cashdividends may be paid on our common stock unless dividends have been paid onall outstanding shares of our Series C and Series D Convertible Preferred Stockin an amount equal to 12% cumulative dividends accrued on such preferred sharesthrough the record date for the common stock dividend (or, if greater, theamount of the common stock dividend payable on the preferred shares on anas-converted basis). The quarterly dividend accruing on the preferred shares is$975,000.

 

There were no sales ofunregistered securities during fiscal 2004 and we did not purchase any of our outstandingsecurities during the fourth quarter of fiscal 2004.

 

Informationregarding securities authorized for issuance under equity compensation plans isincluded in Item 12.

 

16

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

 
| ** **                                                                                     | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| **In thousands, except per share amounts**                                                     | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ***Statement  of Operations Data(1)***                                                         |       |                         |       |   |   |   |   |   |   |   |   |
| Net sales                                                                                      |       | $                            | 48,580     |   | $ | 49,447 |   | $ | 54,596 |   | $ | 50,751 |   | $ | 61,113 |   |
| Gross margin                                                                                   |       | 16,307                       |       | 18,738 |   | 22,907 |   | 18,193 |   | 24,976 |   |
| Sales and  marketing expense                                                                   |       | 13,844                       |       | 14,208 |   | 13,711 |   | 13,586 |   | 18,358 |   |
| General and  administrative expense                                                            |       | 3,898                        |       | 5,218 |   | 4,210 |   | 4,997 |   | 7,304 |   |
| Other operating  expense (income), net                                                         |       | (16                          | )          | 105 |   | 184 |   | 57 |   | 303 |   |
| Operating income  (loss)                                                                       |       | (1,419                       | )          | (793 | ) | 4,802 |   | (447 | ) | (989 | ) |
| Other expense,  net                                                                            |       | (4,618                       | )          | (4,409 | ) | (3,721 | ) | (2,342 | ) | (1,698 | ) |
| Cumulative  effect of a change in accounting for slotting fees                                 |       | (1,150                       | )          | — |   | — |   | — |   | — |   |
| Cumulative  effect of a change in accounting for goodwill                                      |       | —                       |       | (411 | ) | — |   | — |   | — |   |
| Preferred  dividends and accretion                                                             |       | 4,839                        |       | 5,177 |   | 4,955 |   | 4,367 |   | 12,492 |   |
| Net loss  applicable to common shareholders                                                    |       | $                            | (12,026    | ) | $ | (10,790 | ) | $ | (3,874 | ) | $ | (7,156 | ) | $ | (32,653 | ) |
|                                                                                           |       |                         |       |   |   |   |   |   |   |   |   |
| Basic and diluted  loss per share before cumulative effect of a change in accounting principle |       | $                            | (1.21      | ) | $ | (1.15 | ) | $ | (0.43 | ) | $ | (0.80 | ) | $ | (3.67 | ) |
| Basic and  diluted loss per share for cumulative effect of a change in accounting  principle   |       | (0.13                        | )          | (0.05 | ) | — |   | — |   | — |   |
| Basic and  diluted net loss per share applicable to common shareholders                        |       | $                            | (1.34      | ) | $ | (1.20 | ) | $ | (0.43 | ) | $ | (0.80 | ) | $ | (3.67 | ) |
|                                                                                           |       |                         |       |   |   |   |   |   |   |   |   |
| ***Balance  Sheet Data***                                                                      |       |                         |       |   |   |   |   |   |   |   |   |
| Working capital  (deficit)                                                                     |       | $                            | (616       | ) | $ | 5,937 |   | $ | 10,245 |   | $ | 9,857 |   | $ | 8,058 |   |
| Total assets                                                                                   |       | 24,484                       |       | 28,228 |   | 31,062 |   | 22,061 |   | 25,160 |   |
| Long-term debt,  less current maturities                                                       |       | 3,513                        |       | 4,979 |   | 6,540 |   | — |   | — |   |
| Convertible note  payable                                                                      |       | 19,392                       |       | 18,672 |   | 17,596 |   | 17,364 |   | 15,000 |   |
| Convertible  redeemable preferred stock                                                        |       | 55,851                       |       | 51,012 |   | 45,835 |   | 40,880 |   | 36,513 |   |
| Total  shareholders’ deficit                                                              |       | (68,026                      | )          | (56,000 | ) | (45,210 | ) | (41,431 | ) | (34,311 | ) |
|                                                                                                |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Revenues and sales and marketing expenses eachdecreased by $8,806 and $9,930, respectively, in fiscal 2001 and 2000 uponadoption of FASB EITF 00-14, “Accounting for Certain Sales Incentives,” andEITF 00-25, “Vendor Income Statement Characterization of Consideration Paid toa Reseller of the Vendor’s Products.”

 

17

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

 

**Forward-Looking Statements**

This Annual Report onForm 10-K contains certain forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of the SecuritiesExchange Act of 1934 and we intend that such forward-looking statements besubject to the safe harbors created thereby. Words such as “may,” “will,” “expect,”“believe,” “anticipate,” “intend,” “could,” “estimate,” “should,” or “continue”or the negative or other variations thereof or comparable terminology areintended to identify forward-looking statements. In addition, any statementsthat refer to projections of our future financial performance, trends in ourbusinesses, or other characterizations of future events or circumstances areforward-looking statements.  The forward-looking statements includedherein are based on current expectations and involve a number of risks anduncertainties, all of which are difficult or impossible to predict accuratelyand many of which are beyond our control. As such, our actual results may differ significantly from thoseexpressed in any forward-looking statements.  Factors that may cause orcontribute to such differences include, but are not limited to: (i)consumers’ concerns or adverse publicity regarding our products; (ii)effectiveness of operating initiatives and advertising and promotional efforts;(iii) changes in consumer preferences; (iv) the availability and pricing ofcompetitive products; (v) changes in our suppliers’ ability to provide qualityand timely products to us; (vi) availability of financing; (vii) newlegislation or government regulation concerning packaging or our ability toproduce or sell our products; (viii) the availability of distributors, such asretail grocery stores, food services outlets, such as restaurants, club storesand natural food stores to carry our products; (ix) the success of our researchand development activities to develop new meat alternative products; (x) the availabilityof our manufacturing facilities; and (xi) the costs to protect our intellectualproperty rights.  Readers shouldcarefully consider these risks, as well as the additional risks described elsewherein this Annual Report on Form 10-K.  Weundertake no obligation to revise the forward-looking statements containedherein to reflect events or circumstances after the date hereof or to reflectthe occurrence of unanticipated events.

 

**General**

Approximately 69% of ourgross sales were attributable to the Gardenburger® veggie burger and soy burgerproducts, with the remaining 31% of our gross sales attributable to our newermeat alternative products during fiscal 2004. Consumers have been moving to thewider range of meat alternative products becoming available in the marketplace.In response to this development in consumer tastes, in fiscal 2003, we addedfive new products, including BBQ Chik’n and Meatless Meatloaf.  In the third quarter of fiscal 2004, weintroduced a new line of six microwaveable meatless entrees to capitalize onthe consumers’ need for convenience.  Salesof this new line of Gardenburger Meals added $2.3 million of net sales aftershipments began in June 2004.

 

Our results have been,and continue to be, adversely affected by consumer trends favoring alow-carbohydrate diet.  This shift inconsumer demand contributed to an 8.7% decrease and an 11% decrease,respectively, in sales of our veggie burger products in fiscal 2004 compared tofiscal 2003 and in fiscal 2003 compared to fiscal 2002.  In response, we reformulated our veggieburgers to reduce carbohydrates while increasing protein and improving taste.Demand for veggie burgers may continue to decrease in the future.  In addition, effective the second quarter offiscal 2004, the Costco club stores ceased to require system-wide distributionof The Original Gardenburger® product, which resulted in a $3.2 million, or 41%,decrease in sales to Costco in fiscal 2004 compared to fiscal 2003.  Beginning in fiscal 2002, we launched avariety of new soy-based, meat alternative product offerings.  Sales of meat alternative products launchedsince the end of fiscal 2003 contributed approximately $5.2 million, includingthe $2.3 million of entree sales discussed above, to our net sales in fiscal 2004.  We expect sales of our meat alternativeproducts, including our new entrees, to continue to increase. We also expectour new packaging, which started shipping at the end of the first quarter offiscal 2004, to increase consumers’ awareness of how our products can fit intotheir diet choices and lifestyles, including low carbohydrate choices.

 

18

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**Results of Operations**

 

The following table is derived from our Statements ofOperations for the periods indicated and presents our results of operations indollars, as well as a percentage of net sales (dollars in thousands).

 
| **Year Ended  September 30,**                                                                                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                                                             |       |     |       |     |       |     |       |
| Net sales                                                                                                                        |       | $        | 48,580     |     | $          | 49,447   |       | $ | 54,596 |   |
| Cost of goods  sold                                                                                                              |       | 32,273   |       | 30,709   |       | 31,689   |       |
| Gross margin                                                                                                                     |       | 16,307   |       | 18,738   |       | 22,907   |       |
| Sales and  marketing expense                                                                                                     |       | 13,844   |       | 14,208   |       | 13,711   |       |
| General and  administrative expense                                                                                              |       | 3,898    |       | 5,218    |       | 4,210    |       |
| Other operating  expense (income), net                                                                                           |       | (16      | )          | 105      |       | 184      |       |
| Operating income  (loss)                                                                                                         |       | (1,419   | )          | (793     | )          | 4,802    |       |
| Other expense,  net                                                                                                              |       | (4,618   | )          | (4,409   | )          | (3,721   | )          |
| Income (loss)  before cumulative effect of a change in accounting for slotting fees and  goodwill and before preferred dividends |       | (6,037   | )          | (5,202   | )          | 1,081    |       |
| Cumulative  effect of a change in accounting for slotting fees                                                                   |       | (1,150   | )          | —   |       | —   |       |
| Cumulative  effect of a change in accounting for goodwill                                                                        |       | —   |       | (411     | )          | —   |       |
| Net income  (loss)                                                                                                               |       | (7,187   | )          | (5,613   | )          | 1,081    |       |
| Preferred  dividends and accretion                                                                                               |       | 4,839    |       | 5,177    |       | 4,955    |       |
| Net loss  applicable to common shareholders                                                                                      |       | $        | (12,026    | )        | $          | (10,790  | )          | $ | (3,874 | ) |
|                                                                                                                                  |            |          |            |          |            |          |            |  |  |  |  |  |  |

 
| **Year Ended  September 30,**                                                                                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| (amounts may not  add due to rounding)                                                                                           |       |     |       |     |       |     |       |
| Net sales                                                                                                                        |       | 100.0    | %          | 100.0    | %          | 100.0    | %          |
| Cost of goods  sold                                                                                                              |       | 66.4     |       | 62.1     |       | 58.0     |       |
| Gross margin                                                                                                                     |       | 33.6     |       | 37.9     |       | 42.0     |       |
| Sales and  marketing expense                                                                                                     |       | 28.5     |       | 28.7     |       | 25.1     |       |
| General and  administrative expense                                                                                              |       | 8.0      |       | 10.6     |       | 7.7      |       |
| Other operating  expense (income), net                                                                                           |       | —   |       | 0.2      |       | 0.3      |       |
| Operating income  (loss)                                                                                                         |       | (2.9     | )          | (1.6     | )          | 8.8      |       |
| Other expense,  net                                                                                                              |       | (9.5     | )          | (8.9     | )          | (6.8     | )          |
| Income (loss)  before cumulative effect of a change in accounting for slotting fees and  goodwill and before preferred dividends |       | (12.4    | )          | (10.5    | )          | 2.0      |       |
| Cumulative  effect of a change in accounting for slotting fees                                                                   |       | (2.4     | )          | —   |       | —   |       |
| Cumulative  effect of a change in accounting for goodwill                                                                        |       | —   |       | (0.8     | )          | —   |       |
| Net income  (loss)                                                                                                               |       | (14.8    | )          | (11.3    | )          | 2.0      |       |
| Preferred  dividends and accretion                                                                                               |       | (10.0    | )          | (10.5    | )          | (9.1     | )          |
| Net loss  applicable to common shareholders                                                                                      |       | (24.8    | )%         | (21.8    | )%         | (7.1     | )%         |

 

***Net Sales***

The decrease in net salesin fiscal 2004 compared to fiscal 2003 is a result of an 8.7% decrease in salesof our veggie burger products, a decrease in sales to Costco and an increase intrade spending, offset in part by continuing growth in meat alternativeproducts, including our new entrees.

 

Sales of productslaunched after the end of fiscal 2003, which are all meat alternative products,contributed $5.2 million to our net sales in fiscal 2004.

 

Net sales to Costcodecreased by $3.2 million, or 41%, in fiscal 2004 compared to fiscal 2003 as aresult of Costco’s decision to remove the Kirkland Signature co-branding labelfrom our Gardenburger original packaging, effective the second quarter offiscal 2004, which means that our product is no longer required to be carriedby all Costco stores.  After numerousregional presentations, approximately 80% to 85% of the Costco stores haveagreed to carry our Gardenburger product going forward.

 

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The decrease in fiscal2003 compared to fiscal 2002 was due to an 11% decrease in sales of veggieburger products, primarily due to lower unit sales, and increased tradespending, offset in part by increased unit sales of new products. Sales of ournew Herb Crusted CutletTM and Crispy NuggetsTM products, which began sellingduring the fourth quarter of fiscal 2002, accounted for $2.4 million of oursales during fiscal 2003 compared to $219,000 in fiscal 2002.  We launched two additional products in thesecond quarter of fiscal 2003, our BBQ Chik’n and Meatless Meatloaf, which hadsales of $1.8 million in fiscal 2003.

 

Trade spending totaled $12.1million in fiscal 2004, $11.8 million in fiscal 2003 and $9.5 million in fiscal2002. Trade spending includes promotions, discounts, contract origination feesand slotting fees. Pursuant to EITF No. 01-9 “Accounting for ConsiderationGiven by a Vendor to a Customer or a Reseller of the Vendor’s Products,” thesecosts are recorded at the later of when revenue is recognized or when the salesincentive is offered, and are generally classified as a reduction of revenue.

 

***GrossMargin***

The decreases in grossmargin and gross margin as a percentage of net sales in fiscal 2004 compared tofiscal 2003 are due to decreased veggie burger sales, which have lowerproduction costs than our other products, unfavorable manufacturing variances,which primarily resulted from inefficiencies related to the introduction of ournew entrees in the third quarter of fiscal 2004, and higher trade spending.  Except for an increase in certain commodityprices, primarily cheese, and certain shipping materials, we have notexperienced material changes to our raw material costs in fiscal 2004 comparedto fiscal 2003.  We have not made any materialselling price changes in fiscal 2004 compared to fiscal 2003, and we do notanticipate any material selling price changes in fiscal 2005.

 

The decrease in grossmargin in fiscal 2003 compared to fiscal 2002 is due primarily to lower unitsales as discussed above and lower gross margin as a percentage of net sales infiscal 2003 compared to fiscal 2002.

 

The lower gross marginpercentage 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 early January 2002.

 

These factors were offsetin part by reduced lease expense in fiscal 2003 due to the termination of theClearfield equipment operating leases.

 

***Salesand Marketing Expense***

Sales and marketingexpense in fiscal 2004 includes approximately $57,000 of costs related to ourmove to Irvine, California from Portland, Oregon compared to $150,000 of suchcosts in fiscal 2003. Sales and marketing expenditures in fiscal 2004 alsoinclude certain termination and recruitment costs related to changes in certainsales positions.  The decrease in salesand marketing expense in fiscal 2004 compared to fiscal 2003 was primarily dueto the following:

•                  a$282,000 decrease in in-store product demonstration expense in the club storechannel;

•                  a$236,000 decrease in coupon design, production and insertion costs attributableto one fewer coupon drop;

•                  a$173,000 decrease in severance pay;

•                  a$136,000 decrease in inventory storage costs achieved through better inventorymanagement;

•                  a$117,000 decrease in sales commission and broker incentives expense due tonegotiating lower commission rates for some brokers and restricting someincentive programs;

•                  a$99,000 decrease in product contributions; and

 

20

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•                  a$95,000 decrease in advertising agency fees by eliminating the use of anadvertising agency for the retail sales channel.

 

These decreases werepartially offset by the following:

•                  a$111,000 increase in travel expense;

•                  a$190,000 increase in sales bonuses; and

•                  a$218,000 increase in freight delivery costs.

 

The increase in sales andmarketing expenditures in fiscal 2003 compared to fiscal 2002 are primarily dueto the following:

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

•                  a$220,000 increase in in-store product demonstration and sampling expense in theclub channel;

•                  a$600,000 increase in other trade promotions; and

•                  $150,000of costs, primarily severance, related to the relocation of our corporateoffices from Portland, Oregon to Irvine, California.

 

These increases werepartially offset by the following:

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

•                  a$775,000 decrease in media spending as we moved away from this type ofadvertising and increased our trade spending.

 

***Generaland Administrative Expense***

The decrease in generaland administrative expense in fiscal 2004 compared to fiscal 2003 is primarilydue to the following:

•                  a$688,000 decrease in costs incurred for outside services and legal fees;

•                  a$100,000 decrease in bad debt expense;

•                  a$364,000 decrease in depreciation expense due primarily to the elimination ofdepreciation related to our computer system, which has reached the end of itsdepreciable life; and

•                  a$70,000 reduction in rent expense due to our move to smaller quarters inIrvine, California.

 

The increase in generaland administrative expense in fiscal 2003 compared to fiscal 2002 is dueprimarily to a $650,000 increase in costs incurred in development of along-term business strategy, which primarily included costs related to ourfailed attempt to sell the Company, and $300,000 of costs related to the relocationof our corporate offices from Portland, Oregon to Irvine, California.  We did not have any relocation expenses in fiscal2002.

 

***LegalSettlement***

Legal settlement of$108,000 in fiscal 2002 relates to a settlement received from a raw materialsupplier due to an August 2001 recall of our Chik’n Grill product due to theomission of sulfites, which are known allergens, from the ingredient label.  The raw material supplier reimbursed us forlost operating profits associated with the recall. This is a final settlementand no further amounts will be received from this supplier related to thisrecall.

 

***Debt RestructuringCosts***

Debt restructuring costsof $716,000 in fiscal 2002 include an early termination fee of $175,000 for ourprevious line of credit facility, the write-off of $279,000 of unamortizedfinancing fees, $95,000 for the value of common stock warrants issued inconnection with the restructuring of our Restated Convertible SeniorSubordinated Notes (the “Convertible Note”) and preferred stock and $167,000 oflegal fees.

 

21

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***OtherOperating Expense (Income), Net***

Other operating income of$16,000 in fiscal 2004 represents a gain on the sale of other assets.

 

Other operating expenseof $105,000 in fiscal 2003 represents losses on the disposal of fixed assets.

 

Other operating income infiscal 2002 includes $303,000 related to the reversal of restructuringreserves, which were established in fiscal 1999 and, in the first quarter offiscal 2002, were determined to no longer be required, as well as $117,000related to the recognition of a deferred gain on our Clearfield operating leaseupon its early termination in conjunction with our purchase of the relatedequipment.

 

***InterestExpense***

In connection with theamendment of our senior and subordinated debt instruments in December 2003, theinterest rate on our subordinated debt increased to 13% from 10%, retroactiveto October 1, 2003, until our interest payments are current, which is notexpected to occur during fiscal 2005. This increase in rate increased ourinterest expense by approximately $127,000 per quarter in fiscal 2004 comparedto fiscal 2003.

 

In March 2004, weamended our Articles of Incorporation to extend the earliest mandatoryredemption date of our Series C and Series D convertible preferred stock to aslate as June 30, 2008.  As a result, wealso extended the maturity dates under our CapitalSource Loan Agreement and ourConvertible Note to January 31, 2007 and June 15, 2007, respectively. Theextended maturity dates decreased our interest expense related to exit fees byapproximately $186,000 per quarter to approximately $112,000 per quarter.

 

The increase in interestexpense in fiscal 2003 compared to fiscal 2002 is due to an increase inoutstanding debt as a result of the purchase of manufacturing equipment inJanuary 2002 utilizing an $8.0 million term loan, as well as an increase in theoutstanding balance on our line of credit.

 

***Income Taxes***

A valuation allowance hasbeen recorded for the full amount of deferred tax assets due to the uncertaintyregarding the realization of the net deferred tax assets consisting primarilyof net operating loss and credit carryforwards. Accordingly, no benefit has been recorded related to our losses infiscal 2004, 2003 or 2002.

 

***CumulativeEffect of Change in Accounting for Slotting Fees***

Slotting fees refer tooral arrangements pursuant to which the retail grocer allows our products to beplaced on the store’s shelves in exchange for a slotting fee. As reported inprior filings, slotting fees were initially recorded as a prepaid asset and therelated expense was recognized ratably over a 12-month period beginning twomonths following product shipment as an offset to sales.  Typically, 12 months is the estimated minimumperiod during which a retailer agrees to allocate shelf space.  However, given that there are no writtencontractual commitments requiring the retail grocers to allocate shelf spacefor twelve months, in fiscal 2004, we determined that it was a preferableaccounting method to expense the slotting fees at the time revenue isrecognized.  We recorded a cumulativeeffect of a change in accounting for slotting fees totaling $1.2 million andrecorded the amount as if the change in accounting principle had taken effecton October 1, 2003.  Accordingly, theeffect of the change is recorded in the fiscal 2004 quarterly data presentedherein.

 

***CumulativeEffect of Change in Accounting for Goodwill***

In accordance with theadoption provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” inthe first quarter of fiscal 2003, we tested the carrying value of our goodwillutilizing a discounted cash flow analysis and determined that the remainingbalance of $411,000 should be written off. There was no goodwill on our balance sheet at September 30, 2004 or2003.

 

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***PreferredDividends and Accretion***

As approved by ourshareholders at our 2004 Annual Shareholder Meeting in March 2004, the terms ofour Series C and Series D convertible preferred stock were amended to defer theearliest date on which holders may require redemption of their shares of SeriesC and Series D convertible preferred stock to as late as June 30, 2008 insteadof March 31, 2006. Accordingly, the amount of the 10% redemption premiumnot previously accreted will be accreted over a longer period of time, whichreduced our quarterly preferred dividend and accretion charge from $1.3 millionto approximately $1.2 million beginning in the third quarter of fiscal 2004.

 

Due to the addition of a10% exit premium in conjunction with the changes made to the outstandingpreferred stock during the second quarter of fiscal 2002, the quarterlydividend and accretion charge increased from $1.1 million to $1.3 million.

 

Detail of our preferreddividends and accretion is as follows (in thousands):

 
| ** **                            | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| 12% cumulative  dividends             |       | $                            | 3,900      |   | $ | 3,900 |   | $ | 3,900 |   |
| Accretion of 10%  redemption premium  |       | 769                          |       | 1,022 |   | 741 |   |
| Accretion of  original issue discount |       | 170                          |       | 255 |   | 314 |   |
|                                  |       | $                            | 4,839      |   | $ | 5,177 |   | $ | 4,955 |   |

 

***Inflation***

We believe that theimpact of inflation was not material for fiscal years 2004, 2003 and 2002.

 

**Liquidity and Capital Resources**

Our financial statementshave been presented on a going concern basis, which contemplates therealization of assets and satisfaction of liabilities in the normal course ofbusiness.  As shown in the 2004 financialstatements, we incurred net losses applicable to common shareholders for fiscalyears 2004, 2003 and 2002 and had a total shareholders’ deficit at September30, 2004.  We are highly leveraged andhave significant annual interest and dividend accruals related to ourconvertible note payable and convertible redeemable preferred stock, which,although not payable until June 2007 and June 2008, respectively, contribute toour net losses and shareholders’ deficit.

 

During the fourth quarterof fiscal 2004, we experienced sales declines due to one of our majorcompetitors initiating a program of price discounting at unprecedented levels.These sales declines resulted in operating performance that was lower than ourplans.  When combined with thesignificant cash outlays for capital expenditures, slotting fees and otherproduct introduction costs associated with the launch of our new microwavablemeals, these events caused a higher than expected use of our line of credit.  We ended fiscal 2004 with $4.8 millionoutstanding on the line of credit, compared to $2.2 million at the end offiscal 2003.

 

At September 30, 2004, wehad $1.7 million available on our line of credit.  Cash required to meet our required interest andprincipal payments on our debt outstanding at September 30, 2004 totalsapproximately $2.8 million in the next twelve months as follows (in thousands):

 
| Principal  payments due on long-term debt                               |   | $   | 2,000  |   |
|-------------------------------------------------------------------------|--------|-----|--------|--------|
| Interest on  long-term debt                                             |   | 378 |   |
| Estimated interest  on short-term note payable                          |   | 413 |   |
| Estimated unused  line of credit fee related to short term note payable |   | 36  |   |
| Total                                                                   |   | $   | 2,827  |   |

 

These factors raisesubstantial doubt about our ability to continue as a going concern.

 

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To improve our cash flowand liquidity, we have identified the following initiatives, among others forfiscal 2005 (unaudited):

•                  Areduction of $2 million in finished goods inventories which were built up overthe 2002-2004 timeframe;

•                  Areduction in slotting fees from approximately $3.1 million in 2004 to a planned$737,000 in 2005;

•                  Areduction in capital expenditures from approximately $1.4 million in 2004 to aplanned $325,000 in 2005;

•                  Thecompletion on October 1, 2004 of a reduction in force at our manufacturingfacility;

•                  Aban on non-essential travel and other administrative costs;

•                  Thenegotiation of extended payment terms with several of our major vendors; and

•                  Theinstitution of additional cash management and tracking procedures.

 

We also negotiatedwaivers with CapitalSource Finance LLC (“CapitalSource”) and Annex Holdings ILP (“Annex”) for all 2004 covenant defaults and set new financial covenantsgoing forward which we expect to achieve. In addition, CapitalSource has agreed to provide a $500,000 over advancefacility from February 18, 2005 to May 31, 2005 as part of the loan amendments. We agreed to pay CapitalSource a fee of$110,000 in connection with the amendment and a fee of $25,000 for theadditional availability under the revolving credit facility.  In addition, we are required to pay a$500,000 fee to CapitalSource if our ratio of total debt under the LoanAgreement plus the Convertible Note with Annex to earnings (as defined) exceeds1.25:1.00 as of September 30, 2005 and a $250,000 fee if such ratio exceeds1.25:1.00 as of the end of each quarterly period thereafter.  Based on our current total debt level, it islikely that these fees will be paid.  SeeNote 19 of Notes to Financial Statements for a discussion of the amendments.

 

As a result of thevarious initiatives, during the first quarter of fiscal 2005, we were able toreduce our line of credit by $497,000 (unaudited), make scheduled principalpayments of $500,000 (unaudited) on our long-term debt and fund all interestpayments on our CapitalSource debt.

 

We anticipate funding ourcash commitments for the next twelve month period out of operating cash flowsand line of credit borrowings, bolstered by the impact of the cash initiativesand over advance facility discussed above. There can be no assurance that our various sources of cash will besufficient to sustain operations.

 

Our financial statementshave been prepared assuming that we will continue as a going concern and do notinclude any adjustments relating to the recoverability and classification ofrecorded asset amounts or the amounts and classification of liabilities thatmight be necessary should we be unable to continue as a going concern.  Our continuation as a going concern isdependent on our ability to generate sufficient cash flow to meet ourobligations on a timely basis, to comply with the terms of our financingagreements and ultimately to attain profitable operations.

 

At September 30, 2004,working capital was a negative $0.6 million. Working capital decreased by $6.6 million at September 30, 2004 comparedto September 30, 2003 and the current ratio decreased to 1.0:1 from 1.6:1.  The decrease in working capital in 2004includes the write-off of $1.2 million of prepaid slotting fees resulting fromthe cumulative effect adjustment. In addition, working capital has been reducedby $3.2 million in accrued interest on our Convertible Note, which is notcurrently eligible for payment.

 

Cash and cash equivalentsat September 30, 2004 decreased $1.1 million from September 30, 2003, primarilydue to $572,000 used in operations, $1.4 million used for the purchase ofequipment, $1.5 million used for payments on long-term debt and $315,000 usedto pay financing fees related to our debt amendments, offset by $2.6 million ofnet proceeds from our line of credit and $113,000 of proceeds from the sale ofassets.

 

Accounts receivable decreased$112,000 to $2.8 million at September 30, 2004 from $3.0 million at September30, 2003.  Decreases due to lower net salesin the fourth quarter of 2004 compared to the fourth quarter of 2003 weremostly offset by a $176,000 increase in other receivables (primarily insurancereceivables) and an $89,000 reduction in our allowance for bad debts. Dayssales outstanding were approximately 22 days at September 30, 2004 compared toapproximately 20 days at September 30, 2003.

 

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Inventories decreased $0.2million to $9.0 million at September 30, 2004 compared to $9.2 million atSeptember 30, 2003.  Inventory turnedapproximately 3.9 times on an annualized basis in the fourth quarter of fiscal2004 compared to approximately 3.4 times in the fourth quarter of fiscal2003.  Inventories have grown $1.6 millionover the last three years, and we intend to decrease production and reduce ourinventories during fiscal 2005.

 

Prepaid expenses decreased$0.9 million to $1.2 million at September 30, 2004 compared to $2.1 million atSeptember 30, 2003, due primarily to a $1.2 million decrease in prepaid slottingfees as a result of our change in accounting.

 

Other current liabilitiesincreased $1.3 million to $3.6 million at September 30, 2004 compared to $2.3million at September 30, 2003, due primarily to $3.2 million of accruedinterest due on our Convertible Note at September 30, 2004 compared to $845,000of such accrued interest at September 30, 2003. This increase was partially offset by a $937,000 decrease in couponliability and a $340,000 decrease in accrued severance.

 

Capital expenditures of $1.4million during fiscal 2004 were primarily used for manufacturing equipmentrelating to the introduction of our six microwaveable entrée products in thethird quarter of fiscal 2004.  As amendedin August 2004, our CapitalSource Loan Agreement limited our fiscal 2004capital expenditures to $1.55 million. The Loan Agreement limits our fiscal 2005 capital expenditures to $1.1million.  We anticipate spendingapproximately $0.3 million on capital expenditures in fiscal 2005 primarily formanufacturing equipment.

 

Other long-term assetsinclude unamortized capitalized financing fees totaling $359,000 at September30, 2004, which are currently being amortized at the rate of approximately$50,000 per quarter.

 

Our Loan Agreement withCapitalSource provides for an $8.0 million term loan and a $7.0 million line ofcredit (together, “the Loans”).  The LoanAgreement permits us to request advances under the $7.0 million line of creditup to the sum of 85% of eligible receivables and 60% of eligibleinventory.  At September 30, 2004, therewas approximately $1.7 million remaining available on the CapitalSource line ofcredit, which will be used as needed for working capital.  The balance outstanding of $5.5 million onthe term loan includes $652,000 of accrued exit fees at September 30, 2004.

 

In September 2004,Dresdner Kleinwort Benson Private Equity Partners LP (“Dresdner”), the originalholder of our Convertible Note, transferred all rights, including interestaccrued from September 30, 2001, pursuant to the Convertible Note, to AnnexHoldings I LP (“Annex”). We have approximately $16.9 million of principal and$2.5 million of accretion related to exit fees due on the Convertible Note asof September 30, 2004. The Convertible Note requires payment of a 20% premiumon the principal 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, 2004 was $9.78 per share.

 

Pursuant to theCapitalSource Loan Agreement and Convertible Note, as amended, we currentlyrecord quarterly interest expense of approximately $21,000 and $91,000,respectively, for the accretion related to the exit fees. These amounts areadded to the long-term debt and Convertible Note balances, respectively.

 

In September 2003,Dresdner agreed to permit the deferral of our September 30, 2003 interestpayment, which totaled $845,000, to December 31, 2003.  In December 2003, this interest payment wasfurther deferred to no earlier than September 30, 2004.  In addition, $576,000 was accrued in each ofthe first and second quarters of fiscal 2004, and $604,000 was accrued in thethird and fourth quarters of fiscal 2004. Accordingly, we included the total of $3.2 million and $845,000,respectively, on our balance sheets as of September 30, 2004 and September 30,2003 in other current liabilities.

 

In order to addressissues relating to our ability to meet our financial obligations and to addressnon-compliance with certain of our financial covenants, we entered intoamendments to our Loan

 

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Agreement withCapitalSource and our Convertible Note, which was then held by Dresdner, inlate December 2003.  The amendments werecontingent upon amending our Articles of Incorporation to extend the date onwhich our holders of Series C and Series D convertible preferred stock couldredeem their shares of preferred stock, which shareholder approval was obtainedat our Annual Shareholder Meeting in March 2004.

 

The amendments extend thematurity of the Loan Agreement from December 15, 2004 to January 31, 2007 andof the Convertible Note from March 31, 2005 to June 15, 2007.

 

In late December 2003, wealso negotiated amendments to our financial covenants in the Loan Agreement andthe Convertible Note.  Beginning December31, 2003, we are required under the Loan Agreement to maintain compliance withthe following financial covenants (in some cases as further modified by theamendments entered into on August 13, 2004, discussed below), measuredquarterly unless otherwise noted:

•                  amaximum ratio of long-term indebtedness to earnings (as defined below) rangingfrom a high of 3.60:1.00 for the quarter ended March 31, 2004,  to a low of 2.50:1.00 for each quarter endingon or after June 30, 2004;

•                  minimumearnings for a rolling 12-month period, as adjusted to exclude certain expensesand non-cash charges, ranging from a low of $3,000,000 for the quarter endedJune 30, 2004, to a high of $6,000,000 for the quarter ending September 30,2005, and thereafter (“minimum adjusted EBITDA”);

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

•                  aminimum fixed charge coverage ratio of 1.10:1.00 for the quarter endingSeptember 30, 2005 and 1.25:1.00 thereafter; and

•                  capitalexpenditures in an amount per fiscal year not exceeding $1,200,000 for thefiscal year ending September 30, 2004, and $1,100,000 for fiscal years endingthereafter.

 

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

 

In consideration of thematurity date extensions, the financial covenant amendments, and the waivers receivedfor prior violations discussed above, we paid a loan amendment fee toCapitalSource of approximately $130,000 and agreed to pay interest on theunpaid principal and accrued interest on the Convertible Note at the annualrate of 13% rather than 10%, which is the default interest rate provided in thenote, beginning October 1, 2003, and continuing until our interest payments to Annexare brought current. The Loan Agreement, as amended, prohibits us from payingaccrued interest on the Convertible Note to Annex prior to September 30, 2004,and permits us to pay interest to Annex on or after September 30, 2004, only ifand to the extent that we comply with specified financial covenants and levelsof capital availability. Interest due Annex at September 30, 2004 totaledapproximately $3.2 million and is included in other current liabilities on ourbalance sheet.

 

We also received anagreement that future failures to pay interest on the Convertible Note when duewill not be deemed, under specified conditions, to be an event of default underthe Convertible Note.

 

In addition to theDecember 2003 amendments discussed above, on August 13, 2004, we entered intoan amendment of our Loan Agreement with CapitalSource, and an amendment of ourConvertible Note. These amendments were not subject to shareholder approval.Under the amendment of the Loan Agreement, we are now required to comply withthe following financial covenants:

•                  if repaymentor termination occur on or before August 13, 2005, a termination fee is due(unless CapitalSource is the lender in the credit facility which replaces orrefinances the Loan Agreement) equal to 1% of the sum of (A) the maximum amountof the revolving credit facility under the Loan Agreement and (B) theoutstanding balance of the term loan under the Loan 

 

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Agreement, minus theamount of scheduled principal payments made between August 13, 2004 and thedate of such repayment or termination;

•                  capitalexpenditures in an amount per fiscal year not exceeding $1,550,000 for thefiscal year ending September 30, 2004, and $1,100,000 for fiscal years endingthereafter; and

•                  a minimumsenior fixed charge coverage ratio for the following quarterly periods: a ratioof 1.35:1.00 for the quarter ended September 30, 2004, a ratio of 1.25:1.00 forthe quarter ended December 31, 2004, a ratio of 1.48:1.00 for the quarter endedMarch 31, 2005, and a ratio of 1.57:1.00 for the quarter ended June 30, 2005.

 

The financial covenantsregarding capital expenditure limitations and minimum senior fixed chargecoverage ratios applicable to the Convertible Note (as amended) are similar,but in each case slightly less restrictive.

 

At September 30, 2004, wewere out of compliance with the following debt covenants:

 
| **Covenant**                                | ** ** | **Requirement**             | ** ** | **As calculated  September 30,  2004** | ** **   | **Required by** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|----------------------------------------|--------------|-----------------|------------|
| Minimum adjusted  EBITDA                    |       | $4.9 million/  $4.4 million |       |                                   | $0.6 million |            |       | Loan Agreement/  Convertible Note |   |
| Maximum leverage  ratio                     |       | 2.50:1.00/  2.75:1.00       |       |                                   | 16.41:1.00   |            |       | Loan Agreement/  Convertible Note |   |
| Minimum senior  fixed charge coverage ratio |       | 1.35:1.00/  1.22:1.00       |       |                                   | 0.15:1.00    |            |       | Loan Agreement/  Convertible Note |   |

 

In order to addressissues relating 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 Annex on February 18, 2005, following fiscal year-end.  See Note 19 of Notes to Financial Statementsfor a discussion of the amendments.

 

**Contractual Payment Obligations**

Principal payments underour term loan, our Convertible Note and our operating leases aresignificant.  A schedule of paymentsremaining due at September 30, 2004 in the next five fiscal years, includingexit fees of $750,000 for the term loan and approximately $3.5 million for theConvertible Note, is as follows (in thousands): 

 
| ** **                  | ** ** | **Total** | ** ** | **Fiscal 2005** | ** ** | **Fiscal  2006-2007** | ** ** | **Fiscal  2008-2009** | ** ** | **Thereafter** | ** ** |
|-----------------------------|------------|-----------|------------|-----------------|------------|-----------------------|------------|-----------------------|------------|----------------|------------|
| Term Loan                   |       | $         | 5,611      |            | $          | 2,000                 |       | $                     | 3,611      |           | $          | — |   | $ | — |   |
| Convertible Note            |       | 20,379    |       | —          |       | 20,379                |       | —                |       | —         |       |
| Operating Leases            |       | 2,112     |       | 684             |       | 1,269                 |       | 159                   |       | —         |       |
| Purchase Order  Obligations |       | 794       |       | 794             |       | —                |       | —                |       | —         |       |
| License  Agreement          |       | 346       |       | 75              |       | 150                   |       | 121                   |       | —         |       |
| Retention  Agreements       |       | 1,445     |       | —          |       | 1,445                 |       | —                |       | —         |       |
| Total                       |       | $         | 30,687     |            | $          | 3,553                 |       | $                     | 26,854     |           | $          | 280 |   | $ | — |   |

 

We have 552,500 shares ofSeries C Convertible Preferred Stock and 97,500 shares of Series D ConvertiblePreferred Stock outstanding. The Series C preferred shares are convertible intocommon stock at a price of $10 per share and the Series D preferred shares areconvertible at $3.75 per share (subject to antidilution adjustments), in eachcase based on a base price of $50.00 per share, at any time at the discretionof the holder.  Both series of preferredstock are entitled to a 12% cumulative annual dividend payable upon redemptionof the stock or in the event of a sale or liquidation of Gardenburger.  The terms of the Series C and Series D Stockprovide for a 10% premium on any liquidation or redemption.  As approved by our shareholders at our March2004 Annual Shareholders Meeting, the earliest date on which holders mayrequire redemption of their shares was deferred from March 31, 2006 to aslate as June 30, 2008, at which point they may be redeemed at the election ofthe holders or, under certain conditions, at our discretion. The 10% redemptionpremium, which totals $4.3 million, is being accreted over the redemptionperiod.  At September 30, 2004, $2.5million of the

 

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redemption premium hasbeen accreted and is included in the preferred stock balance on the balancesheet. The liquidation preference of the Series C and Series D Stock was $58.1million at September 30, 2004.

 

**Seasonality**

The third and fourthquarters of our fiscal year typically have stronger sales due to the summergrilling season.  We typically buildinventories during the first and second quarters of each fiscal year inanticipation of increased sales in the third and fourth fiscal quarters,although in fiscal 2005, we plan to reduce inventory levels that have built upover the 2002 to 2004 time period.

 

**New Accounting Pronouncements**

 

***EITF 04-8***

In October 2004, the FASB ratifiedEITF 04-8, “Accounting Issues Related to Certain Features of ContingentlyConvertible Debt and the Effect on Diluted Earnings Per Share.”  The new rules require companies to includeshares issuable upon conversion of contingently convertible debt in theirdiluted earnings per share (EPS) calculations regardless of whether the debthas a market price trigger that is above the current fair market value of thecompany’s common stock that makes the debt currently not convertible. The newrules are effective for reporting periods ending on or after December 15, 2004.

 

The shares issuable upon conversionof our Convertible Note were previously required, and are still required underthe new rules, to be included in our diluted EPS calculation, if the effect ofthe conversion is dilutive (e.g., the EPS calculation including the deemedconversion of the notes is lower than the EPS calculation excluding such deemedconversion). Given that the current impact of our Convertible Note on ourdiluted EPS calculations is anti-dilutive, the shares issuable upon conversion areexcluded from our reported diluted EPS calculations and, as long as they remainanti-dilutive, shall remain excluded from our diluted EPS calculations underthe new rules.

 

***SFAS No. 151***

In November 2004, the FASB issuedSFAS No. 151, “Inventory Costs: an amendment of ARB No. 43, Chapter 4,” toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs and wasted material.  SFASNo. 151 is effective for inventory costs incurred during fiscal years beginningafter June 15, 2005.  We do not believethe provisions of SFAS No. 151, when applied, will have a material impact onour financial position or results of operations.

 

***SFAS No. 123R***

In December 2004, the FASB issuedSFAS No. 123R, “Share-Based Payment: an amendment of FASB Statements No. 123and 95,” which requires companies to recognize in their income statement thegrant-date fair value of stock options and other equity-based compensationissued to employees.  SFAS No. 123R iseffective for interim or annual periods beginning after June 15, 2005.  Accordingly, we will adopt SFAS No. 123R inour fourth quarter of fiscal 2005. Unamortized stock-based compensation expense,on a pro forma basis, as of September 30, 2004 totaled $355,000, with $165,000to be amortized in fiscal 2005 (including $41,000 in the fourth quarter offiscal 2005), $144,000 to be amortized in fiscal 2006 and $46,000 to beamortized in fiscal 2007.

 

**Critical Accounting Policies and Estimates**

The discussion andanalysis of our financial condition and results of operations are based uponour financial statements, which have been prepared in accordance with thestandards of the Public Company Accounting Oversight Board (United States).  The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates, including those relatedto inventory reserves and allowance for doubtful accounts. We base ourestimates on historical experience and on various other assumptions. Actualresults may differ from these estimates if conditions turn out differently fromour assumptions.  We believe thefollowing critical accounting policies and the related judgments and estimatesaffect the preparation of our financial statements.

 

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***RevenueRecognition***

In accordance with StaffAccounting Bulletin No. 104, Revenue Recognition (“SAB 104”), revenues arerecognized upon passage of title to the customer, typically upon productpick-up, shipment or delivery to customers.

 

Our revenue arrangementswith our customers often include sales incentives and other promotional costssuch as coupons, volume-based discounts, slotting fees and off-invoicediscounts. These costs are typically referred to collectively as “tradespending.”  Pursuant to EITF No. 00-14,EITF No. 00-25 and EITF No. 01-09, “Accounting for Consideration Given by aVendor to a Customer (Including a Reseller of the Vendor’s Products),” thesecosts are recorded when revenue is recognized and are generally classified as areduction of revenue.  We do not providefor a sales returns since, historically, sales returns have not beensignificant.

 

***TradeSpending***

Certain trade spending itemsare subject to estimation (i.e. volume discounts). Estimated trade spending isreviewed and recorded on a monthly basis based on information provided by ourregional sales managers as to the types of arrangements that have been madewith our customers and are recorded on the balance sheet as an offset to tradereceivables.  Actual dollar amountsassociated with trade spending can vary with sales volumes achieved and otherfactors.  Accordingly, the ultimateliabilities associated with trade spending may materially differ from thoserecorded due to changes in estimates and actual results achieved.

 

***SlottingFees***

Slotting fees refer tooral arrangements pursuant to which the retail grocer allows our products to beplaced on the store’s shelves in exchange for a slotting fee. As reported inprior filings, slotting fees were initially recorded as a prepaid asset and therelated expense was recognized ratably over a 12-month period beginning twomonths following product shipment as an offset to sales. Typically, 12 monthsis the estimated minimum period during which a retailer agrees to allocateshelf space.  However, given that thereare no written contractual commitments requiring the retail grocers to allocateshelf space for twelve months, in fiscal 2004, we determined that it was a preferableaccounting method to expense the slotting fees at the time the revenue isrecognized.  Accordingly, there were noslotting fees included in prepaid assets at September 30, 2004, while $1.2million was included at September 30, 2003. The $1.2 million of slotting fees capitalized on our balance sheet atSeptember 30, 2003 was expensed in the first quarter of fiscal 2004 as a changein accounting principle.  

 

***InventoryValuation Allowance***

We regularly evaluate therealizability of our inventory based on a combination of factors including thefollowing: historical usage rates, forecasted sales or usage, historicalspoilage rates and other factors.  Rawmaterials are reviewed periodically by our operating personnel for spoilage.  Finished goods are reviewed periodically byoperating personnel to determine if inventory carrying costs exceed marketselling prices.  If circumstances relatedto our inventories change, our estimates of the realizability of inventorycould materially change. Our inventory valuation allowance totaled $140,000 and$138,000 at September 30, 2004 and 2003, respectively.  We have not experienced material lossesrelated to our inventories in the past and believe that the current level of valuationallowance is adequate.

 

***AccountsReceivable and Allowances for Uncollectible Accounts***

Credit limits areestablished through a process of reviewing the financial history and stabilityof each customer.  We regularly evaluatethe collectibility of our trade receivable balances by monitoring past duebalances.  If it is determined that acustomer will be unable to meet its financial obligation, we record a specificreserve for bad debts to reduce the related receivable to the amount we expectto recover.  Historically, bad debts havenot had a material effect on us.  Ifcircumstances related to specific customers deteriorate, our estimates of therecoverability of receivables associated with those customers could materiallychange.

 

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**Off-Balance Sheet Arrangements**

We do not have anyoff-balance sheet arrangements that have or are reasonably likely to have amaterial current or future effect on our financial condition, changes infinancial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources.

 

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

 

Amounts outstanding underour Loan Agreement bear interest at rates tied to the prime rate with a minimumrate of 10% on the term loan and 8% on the line of credit. At September 30,2004, we had $4.9 million outstanding at an interest rate of 10% on the termloan and $4.8 million outstanding at an interest rate of 8% on the line ofcredit.  A hypothetical 10% increase inthe prime rate would not have any effect on the interest rates currently beingcharged under the Loan Agreement because the prime rate would still be belowthe minimum rates charged on the term loan and line of credit.

 

Our Convertible Note isat a fixed interest rate and, therefore, a change in market interest rateswould not affect interest expense related to the Convertible Note.

 

We do not currentlyutilize, nor do we anticipate utilizing, derivative financial instruments.

 

**Item 8.  Financial Statements and SupplementaryData**

 

The financial statementsand notes thereto required by this item begin on page F-1 as listed in Item 15of Part IV of this document. In fiscal 2004, we changed our accounting policyregarding accounting for slotting fees. See Note 3. of Notes to Financial Statements.  In accordance with Accounting PrinciplesBoard Opinion (“APB”) 20, “Accounting Changes,” the cumulative effect of thechange in accounting for slotting fees is reflected in the first quarter offiscal 2004.  The unaudited quarterlyresults for the first, second and third quarters of fiscal 2004 are restated forthis change in accounting policy as indicated below.  Unaudited quarterly financial data**for each of the four quarters in the period ended September30, 2004 is as follows:

 
| **In thousands, except per share data**                                              | ** ** | **1st Quarter  (Restated)** | ** ** | **2nd Quarter  (Restated)** | ** ** | **3rd Quarter  (Restated)** | ** ** | **4th Quarter** | *** *** |
|--------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------|--------------|
| ** **                                                                           | ** ** | **(Unaudited)**             | ** ** | **(Unaudited)**             | ** ** | **(Unaudited)**             | ** ** | **(Unaudited)** | *** *** |
| **2004**                                                                             |       |                        |       |                        |       |                        |       |            | * *     |
| Net sales, as  reported                                                              |       | $                           | 10,761     |                        | $          | 12,584                      |       | $               | 14,240       |   | $ | 10,787 |   |
| Effect of change  in accounting for slotting fees                                    |       | 9                           |       | 330                         |       | (131                        | )          | n/a             |         |
| Net sales, as  adjusted                                                              |       | 10,770                      |       | 12,914                      |       | 14,109                      |       | 10,787          |         |
| Gross margin, as  adjusted                                                           |       | 4,206                       |       | 4,792                       |       | 5,177                       |       | 2,132           |         |
|                                                                                 |       |                        |       |                        |       |                        |       |            |         |
| Net loss applicable  to common shareholders, as reported                             |       | (3,024                      | )          | (2,519                      | )          | (1,041                      | )          | (4,500          | )            |
| Effect of change  in accounting for slotting fees                                    |       | (1,141                      | )          | 330                         |       | (131                        | )          | n/a             |         |
| Net loss  applicable to common shareholders, as adjusted                             |       | (4,165                      | )          | (2,189                      | )          | (1,172                      | )          | (4,500          | )            |
|                                                                                 |       |                        |       |                        |       |                        |       |            |         |
| Basic and  diluted net loss per share applicable to common shareholders, as reported |       | (0.34                       | )          | (0.28                       | )          | (0.12                       | )          | (0.50           | )            |
| Effect of change  in accounting for slotting fees                                    |       | (0.13                       | )          | 0.04                        |       | (0.01                       | )          | n/a             |         |
| Basic and  diluted net loss per share applicable to common shareholders, adjusted(1) |       | (0.46                       | )          | (0.24                       | )          | (0.13                       | )          | (0.50           | )            |
|                                                                                 |       |                        |       |                        |       |                        |       |            |         |
| **2003**                                                                             |       |                        |       |                        |       |                        |       |            |         |
| Net sales                                                                            |       | $                           | 8,989      |                        | $          | 12,408                      |       | $               | 15,040       |   | $ | 13,010 |   |
| Gross margin                                                                         |       | 3,364                       |       | 4,367                       |       | 6,551                       |       | 4,456           |         |
| Net loss  applicable to common shareholders                                          |       | (3,626                      | )          | (2,476                      | )          | (856                        | )          | (3,832          | )            |
| Basic and  diluted net loss per share applicable to common shareholders              |       | (0.40                       | )          | (0.28                       | )          | (0.10                       | )          | (0.43           | )            |

 

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(1)          Per share amounts may not add due to rounding.

 

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

 

Effective June 25, 2004,based on a recommendation of the Audit Committee of our Board of Directors, wedismissed our independent public accountants, KPMG LLP.  KPMG LLP’s reports on our financialstatements for the past two fiscal years ended September 30, 2003 did notcontain an adverse opinion or disclaimer of opinion and were not qualified ormodified as to uncertainty, audit scope or accounting principles. During the twofiscal years ended September 30, 2003 and during the subsequent interim periodthrough the date of dismissal, June 25, 2004, there were not any disagreementsbetween us and KPMG LLP on any matters of accounting principles or practices,financial statement disclosure or auditing scope or procedure, or anyreportable events as defined under Item 304(a)(1)(v) of Regulation S-Kpromulgated by the Securities and Exchange Commission.

 

A copy of a letteraddressed to the Securities and Exchange Commission from KPMG LLP stating thatit agrees with the above statements is incorporated by reference into this Form10-K as Exhibit 16.

 

Also effective June 25,2004, based upon a recommendation of the Audit Committee of our Board ofDirectors, we engaged the firm of BDO Seidman, LLP to be our independent registeredpublic accounting firm. We did not consult BDO Seidman, LLP prior to June 25,2004 with respect to the application of accounting principles to a specifiedtransaction, either completed or proposed, or the type of audit opinion thatmight be rendered on our financial statements, or concerning any disagreementor reportable event with KPMG LLP.

 

**Item 9A.  Controls and Procedures**

 

During the course oftheir audit of our financial statements for the year ended September 30, 2004,our independent registered public accounting firm, BDO Seidman, LLP, advisedmanagement and the Audit Committee of our Board of Directors that they hadidentified certain deficiencies in internal control over financialreporting.  Certain of these deficienciesare considered to be “material deficiencies” as defined under the standardsestablished by the Public Company Accounting Oversight Board. These “material deficiencies”relate to cash and cash disbursements and accounts payable cycles, inventoryand revenue cycles and financial reporting. BDO Seidman, LLP also identified certain “significant deficiencies” thatdo not rise to the level of material deficiency.  These “significant deficiencies” involvematters relating to the design or operation of internal control that, in thejudgment of BDO Seidman, LLP, could adversely affect the organization’s abilityto record, process, summarize and report financial data consistent with theassertions of management in the financial statements.  These significant deficiencies relate tosegregation of duties, lack of current accounting manual, maintenance ofimportant documents, discrepancies between our fixed asset ledger and generalledger, discrepancies with our stated capitalization policy, human resourceemployee’s ability to enter employees, change salaries and issue checks,documentation of management’s review of journal entries and informationtechnology policies and procedures.

 

We are in the process ofundertaking steps to remedy these material deficiencies and significantdeficiencies, including:

 

•                  InOctober 2004, we retained an independent third party consultant to assist inthe preparation of our compliance with Rule 404 of the Sarbanes-Oxley Act of2002.

•                  InNovember 2004, we hired a Manager of Business Systems and Analysis responsiblefor, among other things, providing support for Sarbanes-Oxley compliance.  The individual assists the Chief FinancialOfficer and Controller and provides additional segregation of duties consistentwith our objectives.

•                  Weimplemented procedures whereby all new vendors must be authorized by either theController or the Chief Financial Officer, and a new vendor add or change formis currently being developed.

 

 

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•                  Akey-controlled security device for the laser check signature printer is nowkept locked, preventing unauthorized use. In addition, unprinted check stock isnow maintained in a locked file cabinet.

•                  Welowered our manual, second signature requirement on all checks from $50,000 to$25,000, and all printed checks, along with voucher packages, are reviewed byour Controller prior to mailing.  Newprocedures also require check copies to be filed with the supporting voucherpackages.

•                  Thereview and sign-off on all monthly bank reconciliations by the Controller andChief Financial Officer has been instituted.

•                  Wehave amended our capitalization policy to include leasehold improvements.

•                  Weare changing the organizational reporting relationship of our payroll clerk andeliminating the payroll responsibility from human resources.

•                  InApril 2005, we will be moving inventory out of a third party warehouse that wasnot able to prepare a listing of inventory on hand.

•                  Wewill create a bill of materials audit trail by printing out a hard copy of thebill of materials prior to making any changes.

•                  Atthe end of each quarter, we are now determining the amount of sales shipped andinvoiced, but not received by our customers.

•                  Weare adjusting our inventory tag control procedures so that tag numbers are moredifficult to miskey.

•                  Ourmonthly finished goods inventory reconciliation will now be reviewed andapproved by our Chief Operating Officer.

•                  Wehave adopted new accounting policies for reporting of slotting fees so thatthese fees will be expensed as incurred. In addition, we have instituted new procedures with our sales team togather more accurate information regarding slotting fees.

•                  Inconnection with our work with our Sarbanes-Oxley consultant, we are reviewingfor proper segregation of duties, documenting our accounting policies andprocedures through narrative and flowchart support and preparing an IT policyand procedures manual to document all of our updated IT procedures.

•                  Aspart of our efforts to improve IT controls, we have made our password controlsmore stringent; we have mapped our user access for department head approval; weare working to formalize our change control process in part by forming an ITCommunity group; we have established a service request database to log problemcalls; and we have improved our procedures for handling back-up tapes.

 

We have discussed ourcorrective actions and future plans with our Audit Committee and BDO Seidman,LLP and, as of the date of this Annual Report on Form 10-K, we believe theactions outlined above should correct the deficiencies in internal controlsthat are considered to be material deficiencies.

 

Other than the changesnoted above, 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.

 

Further, our managementhas evaluated, under the supervision and with the participation of ourPresident and Chief Executive Officer and Senior Vice President and ChiefFinancial Officer, the effectiveness of our disclosure controls and proceduresas of the end of the period covered by this report pursuant to Rule 13a-15(b)under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on thatevaluation, our President and Chief Executive Officer and Senior Vice Presidentand Chief Financial Officer have concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures did not providereasonable assurance of effectiveness because of the material deficiencies identifiedabove.

 

Pursuant to Section 404of Sarbanes-Oxley, we will be required to furnish an internal controls reportof management’s assessment of the effectiveness of our internal controls aspart of our Annual Report on Form 10-K for the fiscal year ending September 30,2005. Our auditors will then be required to

 

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attest to, and report on,our assessment. In order to issue our report, our management must document boththe design of our internal controls and the testing processes that supportmanagement’s evaluation and conclusion. Our management has begun the necessaryprocesses and procedures for issuing its report on our internal controls.However, we may face significant challenges in implementing the requiredprocesses and procedures. There can be no assurance that we will be able tocomplete the work necessary for our management to issue its management reportin a timely manner, or that management will be able to report that our internalcontrols over financial reporting are effective.

 

The statements containedin Exhibit 31.1 and 31.2 should be considered in light of, and read togetherwith, the information set forth in this Item 9A.

 

**Item 9B.  Other Information**

 

None.

 

**PART III**

 

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

 

**Board of Directors**

 
| **Name**                       | ** ** | **Position**                                                  | ** ** | **Age** | ** ** | **Director Since** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------|------------|---------|------------|--------------------|------------|
| Charles E.  Bergeron (1), (2)  |       | Director                                                      |       | 59      |       | 2003               |       |
| Alexander P.  Coleman (1), (2) |       | Director                                                      |       | 37      |       | 1998               |       |
| Barry E. Krantz  (2), (3)      |       | Director                                                      |       | 60      |       | 2004               |       |
| Richard L. Mazer  (1), (2)     |       | Director                                                      |       | 59      |       | 1998               |       |
| Scott C. Wallace  (3)          |       | President, Chief  Executive Officer and Chairman of the Board |       | 49      |       | 2001               |       |
| Paul F. Wenner  (3)            |       | Founder and Director                                          |       | 57      |       | 1985               |       |

 

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(1)          Member ofthe Audit Committee.

(2)          Member ofthe Executive Personnel and Compensation Committee.

(3)          Member ofthe Nominating and Governance Committee.

 

Each of these individuals is presently serving on our Board ofDirectors.  There are no familyrelationships among our executive officers and Directors.

 

**Charles E. Bergeron**has been Managing Director of Fuller Trident Group – Oregon, a regional investment banking firm, located in Portland, Oregon, since April 2003.  He was Chief Financial Officer of Epitope, Inc. (predecessor to OraSure Technologies, Inc.), a developer, manufacturer and marketer of oral specimen collection devices and diagnostic products, from January 1998 to December 2000 and Interim President from October 1999 to February 2000. He had previously served as Chief Financial Officer of Epitope Medical Products, a wholly-owned subsidiary of Epitope, Inc., from September 1997 to January 1998.  Mr. Bergeron joined Epitope, Inc. in August 1993 as President and Chief Executive Officer of Agrimax Floral Products, Inc., then a wholly-owned subsidiary of Epitope, Inc.  From 1978 to 1992, Mr. Bergeron was Senior Vice President, Finance of Freightliner Corporation, a Portland, Oregon, truck manufacturer. He holds a B.S. degree in management engineering and an M.S. degree in management science from Rensselaer Polytechnic Institute and an M.B.A. degree from Columbia University.

 

**Alexander P. Coleman**isa Managing Partner of Annex Capital Management LLC (“Annex”), a private equityfirm specializing in the acquisition of direct equity, mezzanine and distressedsenior debt portfolios in the secondary market. From 1996 to 2004, Mr. Coleman was a Managing Investment Partner forDresdner Kleinwort Capital LLC, the North American direct investment group ofDresdner Bank AG.  Prior to that,Mr. Coleman was with Citibank NA, including Citicorp Venture Capital.  Mr. Coleman was designated as a nominee forelection as a Director pursuant to the agreement between

 

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Gardenburger and DresdnerKleinwort Benson Private Equity Partners LP (“Dresdner”) under which Dresdneracquired $15,000,000 principal amount of a Convertible Senior Subordinated Noteissued by Gardenburger in March 1998. Mr. Coleman received an M.B.A. from the University of Cambridge and aB.A. in Economics from the University of Vermont.  Of the other companies for which Mr. Colemanserves as a Director, those which have publicly registered securities include:KMC Telecom, Inc., and Remy, Inc.

 

**Barry E. Krantz**hasserved as a Director of Gardenburgersince July 2004. From August 1995 to present, Mr. Krantz has been self-employedserving on the Board of Directors of and/or consulting with several of themajor restaurant chains in the United States and internationally. Mr. Krantzhas spent more than 20 years in various executive positions within thefoodservice industry. From January 1994 to August 1995, Mr. Krantz served asPresident and Chief Operating Officer of Family Restaurants, Inc., a $1.2billion company that owned and operated the El Torito, Chi-Chi’s, Reuben’s,Charley Brown’s, Coco’s, Carrows and jojos chains. From March 1993 to January1994, Mr. Krantz served as the Chief Operating Officer for RestaurantEnterprises Group, and served as President of its Family Restaurant Divisionfrom January 1989 to January 1994. From January 1979 to January 1987, Mr.Krantz was the Senior Vice President of Marketing and Concept Development forDenny’s Restaurants. Mr. Krantz received a B.A. degree from the University ofPennsylvania and an M.B.A. from the Stanford University Graduate School ofBusiness. Before starting a career in the food service industry, Mr. Krantzheld a variety of product management positions at General Foods Corporation andsenior account management positions at several major advertising agencies. Mr.Krantz is also on the Board of Directors of Worldwide Restaurant Concepts, Inc.and Fresh Choice, Inc.

 

**Richard L. Mazer**isthe President and Chief Operating Officer of Ventura Foods, LLC, a foodprocessor, where he has worked since December 1997.  Mr. Mazer has been involved in the foodindustry for more than 20 years, including through his strategic and financialconsulting company, The Mazer Group, from 1992 to 1997.  Mr. Mazer received B.S. degrees in Economicsand Management from Massachusetts Institute of Technology.

 

**Scott C. Wallace**joined Gardenburger as President and Chief Executive Officer onJanuary 15, 2001.  Mr. Wallace alsobecame Chairman of the Board in May 2002. Prior to joining Gardenburger, Mr. Wallace served in variouspositions at Mauna Loa Macadamia Nut Corporation (“Mauna Loa”) since 1994,including President and Chief Executive Officer beginning in 1999, Presidentand Chief Operating Officer from 1998 to 1999, and as President – North AmericaDivision prior to that.  Before acceptinga position at Mauna Loa, Mr. Wallace held a management position at E.J. BrachCorporation, a candy producer, for six years, and sales positions at EastmanKodak Company, a manufacturer of camera equipment, and Procter and Gamble, aconsumer products company.  Mr. Wallacereceived a B.S. in Economics from San Francisco State University.

 

**Paul F. Wenner**founded Gardenburger in 1985 as a sole proprietorship and acted as its VicePresident from the date of its incorporation until December 1989, when hebecame President, Chief Executive Officer and Chairman of the Board.  From 1994 to May 2004, Mr. Wenner was ourChief Creative Officer, providing advice regarding new product development andassisting with marketing efforts.  Mr.Wenner relinquished his duties as President in 1994 and as Chairman of theBoard in 1995 and as Chief Creative Officer in 2004.  From 1980 through 1984, he owned and operatedthe Garden House Restaurant and Gourmet Cooking School, where he developed theGardenburger® veggie patty.  The schoolwas affiliated with Mt. Hood Community College’s evening educationalcurriculum.  Mr. Wenner received twoAssociate of Arts degrees from Mt. Hood Community College.

 

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The following tableidentifies our current executive officers, the positions they hold, and theyear in which they began serving in their respective capacities.  Our executive officers are elected by theBoard of Directors annually to hold office until their successors are electedand qualified.

 

**Executive Officers**

 
| **Name**                | ** ** | **Age** | ** ** | **Current Position(s) with Company**                          | ** ** | **Officer Since** | ** ** |
|-------------------------|------------|---------|------------|---------------------------------------------------------------|------------|-------------------|------------|
| Scott C. Wallace        |       | 49      |       | Chief Executive  Officer, President and Chairman of the Board |       | 2001              |       |
| James W. Linford        |       | 57      |       | Senior Vice  President and Chief Operating Officer            |       | 1997              |       |
| Robert T.  Trebing, Jr. |       | 55      |       | Senior Vice  President and Chief Financial Officer            |       | 2003              |       |

 

For biographicalinformation for Scott C. Wallace, see “Board of Directors” above.

 

**James W.Linford**joined Gardenburger in March 1997 as Vice Presidentof Supply Chain, responsible for our manufacturing operations andlogistics.  Upon the resignation of ourChief Executive Officer in August 2000 and until Mr. Wallace joinedGardenburger in January 2001, Mr. Linford served as Interim President and ChiefExecutive Officer.  In January 2001, Mr.Linford was named Senior Vice President and Chief Operating Officer.  He was Vice President and General Manager ofCH2M Hill Food Group from 1995 to 1997, Director of Manufacturing for OceanSpray Cranberries from 1993 to 1995 and General Manager of Operations forOre-Ida Foods, a division of the Heinz Company, from 1987 to 1993.  Mr. Linford also serves on the Board ofDirectors of Portland Brewing Company.

 

**Robert T.Trebing, Jr., C.P.A. (inactive status)**joined Gardenburger inNovember 2003 as Senior Vice President and Chief Financial Officer.  Prior to joining Gardenburger, Mr. Trebingserved as Executive Vice President and Chief Financial Officer of Prandium,Inc., a company engaged in the operation of restaurants in the full-service andfast-casual segments, since April 1997. From December 2002 to February 2003, Mr. Trebing also served as theActing President and Chief Executive Officer of Prandium, Inc.  He also served as President of Chi-Chi’s,Inc., Koo Koo Roo, Inc. and The Hamlet Group, Inc., all restaurant chains andwholly-owned subsidiaries of Prandium, Inc., since December 30, 2002.  Mr. Trebing served in various other positionsat Prandium, Inc., since its founding in 1986. Mr. Trebing received a B.A. from California State University atFullerton and an M.B.A. from the University of Southern California.

 

**Audit Committee**

We have a standing Finance and AuditCommittee (the “Audit Committee”), which, during fiscal 2004, wascomposed of Mr. Bergeron (Committee Chair), Mr. Coleman and Mr. Mazer.

 

**Audit Committee Financial Expert**

As required by theSarbanes-Oxley Act of 2002, our Board of Directors has determined that onemember of our Audit Committee, Charles E. Bergeron, has the qualifications tobe an “audit committee financial expert” as defined in the SEC’s rules andregulations and also meets the standards of independence adopted by the SEC formembership on an audit committee.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) of theExchange Act requires our Directors and executive officers and persons who ownmore than 10% of the outstanding shares of our common stock (“10% shareholders”),to file with the SEC initial reports of beneficial ownership and reports ofchanges in beneficial ownership of shares of our common stock and other equitysecurities. To the best of our knowledge, based solely on review of the copiesof such reports furnished to us or otherwise in our files and on writtenrepresentations from our Directors and executive officers, our officers,Directors and 10% shareholders complied with all applicable Section 16(a)filing requirements during fiscal 2004 except that Mr. Krantz, a Director,failed to timely file a Form 3, Initial Statement of Beneficial Ownership ofSecurities.

 

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**Code of Ethics**

We adopted a Code ofEthics that applies to all of our employees, including our principal executiveofficer and our principal financial and accounting officer.  We have filed a copy of our Code of Ethics asExhibit 14 to our Annual Report on Form 10-K for our fiscal year endedSeptember 30, 2003. We will provide, free of charge to any person, a copy ofour Code of Ethics.  Requests should besent to:  Secretary, Gardenburger, Inc.,15615 Alton Parkway, Suite 350, Irvine, California 92618.

 

**Item 11.  Executive Compensation**

 

**Director Compensation**

During fiscal 2004, fournon-employee Directors, Messrs. Bergeron, Kesselman, Mazer and Wenner, receivedfees for their participation on our Board of Directors and Committees.  Mr. Bergeron received a total of $28,000, Mr.Mazer received a total of $20,000, Mr. Kesselman, who resigned from the Boardof Directors in December 2003, received a total of $7,000 and Mr. Wenner, whobecame a non-employee director in May 2004, received a total of $3,000. Noother directors received compensation for their participation on the Board ofDirectors.  All non-employee Directorsare reimbursed for their expenses incurred in attending meetings of the Boardof Directors.

 

## **We also have a licensingagreement with Mr. Wenner, which expires in May 2009.  Pursuant to the agreement, Mr. Wenner grantsto us an exclusive, royalty-free, worldwide license to make use of, copy,reproduce, modify, adapt, distribute, transmit, broadcast, display, exhibit,project and otherwise exploit certain of Mr. Wenner’s property.  In exchange, we pay Mr. Wenner $75,000 perannum.  The agreement also provides that,during the term of the agreement, Mr. Wenner shall make, at dates and timesreasonably agreed to by each of Mr. Wenner and us, certain personal appearancesfor which Mr. Wenner shall be compensated at the rate of $500 per day, plus allreasonable and necessary expenses (including coach air travel, hotelaccommodations and meal expenses) incurred by Mr. Wenner in connection withsuch personal appearances.  Mr. Wenner receivedapproximately $29,000 pursuant to this agreement in fiscal 2004.**

## ** **

**Executive Officer Compensation**

 

***SummaryCompensation Table***

The following tableprovides information for the fiscal years indicated concerning compensationearned by our Chief Executive Officer and our other executive officers whosesalary and bonus during fiscal 2004 exceeded $100,000 (collectively referred toas the “named executive officers”).

 
| ** **                      | ** ** | ** ** | ** ** | ** **              | ** ** | **Long Term  Compensation  Awards** | ** ** | ** **             | ** ** |
|---------------------------------|------------|------------|------------|-------------------------|------------|-------------------------------------|------------|------------------------|------------|
| ** **                      | ** ** | **Fiscal** | ** ** | **Annual Compensation** | ** ** | **Securities  Underlying**          | ** ** | **All Other  Compen-** | ** ** |
| **Name and Principal Position** | ** ** | **Year**   | ** ** | **Salary (A)**          | ** ** | **Bonus**                           | ** ** | **Options (#)**        | ** ** | **sation (B)** | ** ** |
| Scott C. Wallace                |       | 2004       |       | $                       | 283,800    |                                | $          | 68,640                 |       | — |   | $ | 6,964 |   |
| Chief Executive  Officer,       |       | 2003       |       | 270,092                 |       | —                              |       | —                 |       | 5,858 |   |
| President and  Chairman of the  |       | 2002       |       | 252,923                 |       | 15,000                              |       | —                 |       | 6,856 |   |
| Board                           |       |       |       |                    |       |                                |       |                   |       |   |   |
|                            |       |       |       |                    |       |                                |       |                   |       |   |   |
| James W. Linford                |       | 2004       |       | 209,423                 |       | 45,630                              |       | —                 |       | 5,519 |   |
| Senior Vice  President and      |       | 2003       |       | 199,500                 |       | —                              |       | —                 |       | 4,745 |   |
| Chief Operating  Officer        |       | 2002       |       | 183,673                 |       | —                              |       | —                 |       | 3,330 |   |
|                            |       |       |       |                    |       |                                |       |                   |       |   |   |
| Robert T.  Trebing, Jr. (C)     |       | 2004       |       | 203,231                 |       | 40,000                              |       | —                 |       | 6,550 |   |
| Senior Vice  President          |       | 2003       |       | —                  |       | —                              |       | —                 |       | — |   |
| and Chief  Financial Officer    |       | 2002       |       | —                  |       | —                              |       | —                 |       | — |   |
|                                 |            |            |            |                         |            |                                     |            |                        |            |  |  |  |  |  |

 

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(A)           Amounts shown include cash compensation earnedin each respective year, including amounts deferred at the election of thenamed executive officer pursuant to our 401(k) Plan.

 

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(B)             Amounts included in this column for fiscal2004 are as follows:

 
| **Name**    | ** ** | **401(k) Matching** | ** ** | **Life Insurance  Premiums** | ** ** |
|-------------|------------|---------------------|------------|------------------------------|------------|
| Mr. Wallace |       | $                   | 5,289      |                         | $          | 1,675 |   |
| Mr. Linford |       | 4,614               |       | 905                          |       |
| Mr. Trebing |       | 4,865               |       | 1,685                        |       |
|             |            |                     |            |                              |            |  |  |

 

(C)             Mr. Trebing’s employment with Gardenburgerbegan in November 2003.

 

***StockOptions Granted***

There were no stockoptions granted to the named executive officers during fiscal 2004.

 

***OptionExercises and Holdings***

The following tableprovides information concerning unexercised options held at September 30, 2004with respect to the named executive officers. No named executive officers exercised any options during fiscal 2004.

 

**AggregatedOption Exercises in Last Fiscal Year**

**andFiscal Year-End Option Values**

 
| ** **              | ** ** | **Number of  Securities Underlying  Unexercised Options  At September 30, 2004 (#)** | ** ** | **Value of Unexercised  In-The-Money Options  At September 30, 2004 (A)** | ** ** |
|-------------------------|------------|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| **Name**                | ** ** | **Exercisable**                                                                      | ** ** | **Unexercisable**                                                         | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Scott C. Wallace        |       | 112,500                                                                              |       | 37,500                                                                    |       | $ | — |   | $ | — |   |
| James W. Linford        |       | 207,420                                                                              |       | 40,000                                                                    |       | — |   | — |   |
| Robert T.  Trebing, Jr. |       | —                                                                               |       | —                                                                    |       | — |   | — |   |
|                         |            |                                                                                      |            |                                                                           |            |  |  |  |  |  |  |

 

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(A)           Basedon the market price of the underlying securities at September 30, 2004, $0.16per share.

 

**Employment, Severance and Changein Control Arrangements**

 

**ScottC. Wallace**

Gardenburger entered intoan agreement with Scott C. Wallace dated February 24, 2004 regarding the termsof his employment as President and Chief Executive Officer of Gardenburger.Pursuant to the agreement, Mr. Wallace’s base salary is currently $286,000per year and is subject to annual review by the Compensation Committee andsubject to adjustment by the Board of Directors in its sole discretion.  Mr. Wallace is also entitled toparticipate in our 401(k) plan, stock incentive plan and health and welfarebenefit programs made available to other officers and to four weeks’ paidvacation annually.

 

Mr. Wallace will beentitled to severance equal to one year’s base salary payable over 12 monthsand continuation of all health and welfare benefits for one year in the eventof involuntary termination other than for cause or due to death ordisability.  As used in Mr. Wallace’semployment agreement, “cause” means (1) any fraud or dishonesty byMr. Wallace involving Gardenburger, (2) willful misconduct or grossnegligence in connection with performance of his duties, (3) his conviction forcommitting a felony, (4) the commission by Mr. Wallace of any act indirect competition with or materially detrimental to the best interests ofGardenburger, or (5) willful and continued failure by Mr. Wallace tosubstantially perform his duties after delivery of a written demand specifyingthe duties which have not been substantially performed.

 

The agreement providesfor a special bonus payable upon the completion of a sale of Gardenburger.  The special bonus will be equal to onepercent (1%) of the sale price up to $100 million and two percent (2%)of the portion, if any, of the sale price in excess of $100 million.  Mr. Wallace has the right, in his solediscretion, to waive receipt of any portion of the special bonus if, and to theextent that, he determines that a reduction in the special bonus would give himan income tax benefit.

 

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The agreement alsoprovides that if Mr. Wallace’s employment is terminated for other than causefollowing a change in control, or if he terminates his employment for “goodreason,” he shall be paid an amount equal to his annual base salary currentlyin effect, or, if higher, his annual base salary as in effect prior to anyreduction within twelve months preceding termination, payable as a lumpsum.  He shall also receive continuationof all health and welfare benefits for a twelve-month period followingtermination.

 

“Good reason” means the undertaking of any of the following without Mr.Wallace’s consent:  (i) relocation of hisplace of employment more than 25 miles from the location he is currently performinghis duties; (ii) the reduction by more than 10% of his base compensation notrelated to a reduction in the salaries of all executive officers ofGardenburger; (iii) the significant change or reduction of his duties thatresults in any diminution or adverse change of his position, status orcircumstances; or (iv) providing Mr. Wallace continues his employment withGardenburger through the 90-day period following the change in control, anytermination by Mr. Wallace of his position with Gardenburger or its successorthat is effective on or within the 30 days following expiration of a 90-dayperiod following the change in control for any reason or for no reason willconstitute “good reason.”  For thispurpose, if Mr. Wallace is terminated by Gardenburger without cause before thechange in control and such termination is in connection with the change incontrol, Mr. Wallace will be deemed to have continued his employment throughthe change in control date.

 

The agreement contains athree-year non-compete clause following termination.

 

**James W. Linford**

Gardenburger entered intoan employment agreement with Mr. Linford dated February 26, 2004.  Pursuant to the agreement, Mr. Linford’scurrent base salary is $211,000 per year and is subject to annual review by theCompensation Committee and subject to adjustment by the Board of Directors inits sole discretion.  Mr. Linford isalso entitled to participate in our 401(k) plan, stock incentive plan andhealth and welfare benefit programs made available to other officers and tofour weeks’ paid vacation annually.

 

Mr. Linford will beentitled to severance equal to one year’s base salary payable over 12 monthsand continuation of all health and welfare benefits for one year in the eventof involuntary termination other than for cause (as defined above) or due todeath or disability.

 

The agreement providesfor a special bonus payable upon the completion of a sale of Gardenburger.  The special bonus will be equal to onequarter of one percent (0.25%) of the sale price up to $100 million andone half of one percent (0.5%) of the portion, if any, of the sale pricein excess of $100 million.

 

The agreement alsoprovides that if Mr. Linford’s employment is terminated for other than causefollowing a change in control, or if he terminates his employment for “goodreason,” (as defined above) he shall be paid an amount equal to his annual basesalary currently in effect, or, if higher, his annual base salary as in effectprior to any reduction within twelve months preceding termination, payable as alump sum.  He shall also receivecontinuation of all health and welfare benefits for a twelve-month periodfollowing termination.

 

The agreement contains athree-year non-compete clause following termination.

 

**Robert T. Trebing, Jr.**

Gardenburger entered intoan employment agreement with Mr. Trebing dated February 26, 2004.  Pursuant to the agreement, Mr. Trebing’sbase salary is currently $204,000 per year and is subject to annual review bythe Compensation Committee and subject to adjustment by the Board of Directorsin its sole discretion.  Mr. Trebingis also entitled to participate in our 401(k) plan, stock incentive plan andhealth and welfare benefit programs made available to other officers and to threeweeks’ paid vacation annually.

 

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Mr. Trebing will beentitled to severance equal to one year’s base salary payable over 12 monthsand continuation of all health and welfare benefits for one year in the eventof involuntary termination other than for cause (as defined above) or due todeath or disability.

 

The agreement providesfor a special bonus payable upon the completion of a sale of Gardenburger.  The special bonus will be equal to onequarter of one percent (0.25%) of the sale price.

 

The agreement alsoprovides that if Mr. Trebing’s employment is terminated for other than causefollowing a change in control, or if he terminates his employment for “goodreason,” (as defined above) he shall be paid an amount equal to his annual basesalary currently in effect, or, if higher, his annual base salary as in effectprior to any reduction within twelve months preceding termination, payable as alump sum.  He shall also receivecontinuation of all health and welfare benefits for a twelve-month periodfollowing termination. The agreement contains a three-year non-compete clausefollowing termination.

 

**RetentionAgreements**

We entered into RetentionAgreements with each of Mr. Wallace, Mr. Linford and Mr. Trebing on January 27,2005.  The Retention Agreements provide incentivefor each of the executive officers to continue to be employed by Gardenburger,Inc. through and following a change in control or going privatetransaction.  The agreements provide forpayment of a retention bonus on the earlier of (1) the date of a change ofcontrol, (2) the date of a going private transaction or (3) the secondanniversary of the effective date of the agreement.  If a change in control or going privatetransaction occurs during the first eighteen months following the effectivedate of the agreement, the executive officer receives a lump sum payment equalto twelve months of base salary.  If achange in control or going private transaction occurs after the eighteen monthanniversary of the agreement or if the executive officer remains continuouslyemployed by Gardenburger, Inc. through the second anniversary of the effectivedate of the agreement, the executive officer receives a lump sum payment equalto sixteen months of base salary.  Theseretention bonuses are subject to certain conditions set forth in theagreements.

 

**Vesting of Options**

Certain options grantedto the named executive officers contain provisions that such options willimmediately become exercisable as to shares not previously vested upon (i)termination of employment as a result of the optionee’s death or disability or(ii) termination of employment without cause or for good reason following achange in control.

 

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

 

The following table sets forth, as of December 31, 2004, certaininformation furnished to us with respect to beneficial ownership of our commonstock and preferred stock by (i) each Director and Director nominee, (ii) the“named executive officers” (as defined under “Executive Compensation”), (iii)all persons known by us to be beneficial owners of 5% or more of ouroutstanding common stock or preferred stock, and (iv) all executive officersand Directors as a group.  Unlessotherwise indicated below, the address of each person listed below is 15615Alton Parkway, Suite 350, Irvine, California 92618.

 
| ** **                                                                                                   | ** ** | **Amount and Nature of Beneficial Ownership (A)** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **Name and Address of Beneficial Owner**                                                                     | ** ** | **Shares of  Common  Stock (B)**                  | ** ** | **Percentage  of  Class** | ** ** | **Shares of  Preferred  Stock** | ** ** | **Percentage  of  Class** | ** ** |
| Annex Capital Management LLC  (C)1301 Avenue of the Americas  New York, New York 10019-6163                  |       | 2,287,835                                         |       | 20.3 | % | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Alexander P. Coleman (C)                                                                                     |       | 2,307,335                                         |       | 20.4 | % | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Gruber & McBaine Capital Management LLC (D)  50 Osgood Place, Penthouse  San Francisco, California 94133 |       | 1,659,185                                         |       | 18.2 | % | 15,000 |   | 2.3 | % |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Rosewood Capital III, L.P. (E)  One Maritime Plaza, Suite 1330  San Francisco, California 94111              |       | 1,459,238                                         |       | 14.0 | % | 206,000 |   | 31.7 | % |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Paul F. Wenner                                                                                               |       | 1,344,180                                         |       | 13.5 | % | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Farallon Partners, L.L.C. (F)  One Maritime Plaza, Suite 1325  San Francisco, California 94111               |       | 1,012,233                                         |       | 10.1 | % | 142,000 |   | 21.8 | % |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Farallon Capital Management,  L.L.C. (F)One Maritime Plaza, Suite 1325  San Francisco, California 94111      |       | 370,552                                           |       | 4.0 | % | 52,000 |   | 8.0 | % |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| MidOcean Capital Investors, L.P. (G)  320 Park Avenue, 17th Floor  New York, New York 10022                  |       | 710,868                                           |       | 7.3 | % | 100,000 |   | 15.4 | % |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| James W. Linford (H)                                                                                         |       | 269,834                                           |       | 2.9 | % | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Scott C. Wallace (I)                                                                                         |       | 156,244                                           |       | 1.7 | % | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Richard L. Mazer                                                                                             |       | 62,500                                            |       |   | * | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Robert T. Trebing, Jr.                                                                                       |       | —                                            |       | — |   | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Charles E. Bergeron                                                                                          |       | —                                            |       | — |   | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| Barry E. Krantz                                                                                              |       | —                                            |       | — |   | — |   | — |   |
|                                                                                                         |       |                                              |       |   |   |   |   |   |   |
| All current executive officers and Directors as a  group (8 persons)(J)                                      |       | 4,140,093                                         |       | 32.7 | % | — |   | — |   |

 

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* Less than one percent

 

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(A)           Applicable percentage of ownership is based on9,002,101 shares of common stock and 650,000 shares of preferred stockoutstanding as of December 31, 2004. Beneficial ownership is determined in accordance with the rules of theSecurities and Exchange Commission (the “SEC”), and is based on voting andinvestment power with respect to shares. Shares of common stock subject to options, warrants or other convertiblesecurities that are exercisable currently or within 60 days after December 31,2004 are deemed outstanding for purposes of computing the percentage ownershipof the person or group holding such options, warrants or convertiblesecurities, but are not deemed outstanding for computing the percentage of any otherperson.  Unless otherwise indicated, tothe best of our knowledge, each of the persons named above has sole voting andinvestment power with respect to all shares shown as being beneficially ownedby them.

 

(B)             Includes shares of common stock subject tooptions exercisable within 60 days after December 31, 2004 as follows:

 
| **Name**                                                 | ** ** | **Number of Options** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|
| Mr. Wenner                                               |       | 953,000               |       |
| Mr. Linford                                              |       | 207,420               |       |
| Mr. Wallace                                              |       | 150,000               |       |
| Mr. Coleman                                              |       | 19,500                |       |
| Mr. Mazer                                                |       | 50,500                |       |
|                                                     |       |                  |       |
| All current  executive officers and Directors as a group |       | 1,380,420             |       |

 

(C)             Includes 1,729,854 shares of common stock thatAnnex has the right to acquire upon conversion of the Convertible Notes.  The conversion price was $9.78 as of December31, 2004.  Also includes warrants topurchase 557,981 shares of our common stock. Mr. Coleman is an Authorized Person and Managing Investment Partner forAnnex.  Mr. Coleman disclaimsbeneficial ownership of all shares owned by Annex.

 

(D)            Gruber & McBaine Capital Management, LLC (“GMCM”),has shared voting and dispositive power with respect to 1,503,685 shares ofcommon stock. Jon D. Gruber and J. Patterson McBaine are the managersof GMCM, an investment adviser, and Thomas O. Lloyd-Butler is a member ofGMCM.  Mr. Gruber has sole voting anddispositive power as to 116,850 shares of common stock and Mr. McBaine has solevoting and dispositive power as to 155,500 shares of common stock. Alsoincludes 15,000 shares of preferred stock (convertible into 93,754 shares ofcommon stock) which GMCM and its affiliates either own or with respect to whichthey have voting or dispositive power and warrants to purchase 12,877 shares ofcommon stock issued to GMCM and its affiliates.

 

(E)              Includes 1,287,552 shares of common stockissuable upon conversion of 206,000 shares of preferred stock and warrants topurchase 171,686 shares of common stock.

 

(F)              Each of the entitiesaffiliated with Farallon Partners, L.L.C. (“FPLLC”) and the accounts managed byFarallon Capital Management, L.L.C. (“FCMLLC”), a registered investment adviser(together such entities and accounts, “Farallon”), that acquired shares ofpreferred stock holds such securities directly in its own name.  In addition, two of such entities own anaggregate of 3,700 shares of common stock. FPLLC, as the general partner of certain of such entities, and FCMLLC,pursuant to investment management agreements, each may, for purposes of Rule13d-3 under the Securities Exchange Act of 1934 (the “Exchange Act”), be deemedto own beneficially the shares held by such entities and accounts, as well asthe shares of common stock into which the shares of preferred stock areconvertible.  Each of FCMLLC and FPLLC,and each managing member thereof, disclaim any beneficial ownership of suchshares.  All of the above-mentioned entitiesand persons disclaim group attribution. The 142,000 and 52,000 shares of preferred stock owned by FPLLC andFCMLLC, respectively, are convertible into 887,536 and 325,013 shares of commonstock, respectively.  Also includeswarrants to purchase 121,897 shares of common stock held by FPLLC and warrantsfor 44,639 shares of common stock held by FCMLLC.  The following people have shared voting anddispositive power with respect to the Farallon shares as managing members ofFPLLC and FCMLLC: Joseph F. Downes, Enrique H. Boilini, David I. Cohen, Chan R.Ding, William F. Duhamel, Charles E. Ellwein, Richard B. Fried, Monica R.Landry, William F. Mellin, Stephen L. Millham, Rajiv A. Patel, Derek Schrier,Thomas F. Steyer and Mark C. Wehrly.

 

(G)             Includes 100,000 sharesof preferred stock, which are currently convertible into 625,025 shares ofcommon stock and warrants to purchase 85,843 shares of common stock held byMidOcean Capital Investors, L.P. Ultramar Capital, Ltd., MidOcean Capital Partners, L.P, Existing FundGP, Ltd., MidOcean Partners, LP and MidOcean Associates, SPC may all be deemedto be beneficial owners of the shares as a result of their direct or indirectcontrol relationship with MidOcean Capital Investors, L.P. MidOcean CapitalPartners, L.P. is the general partner of MidOcean Capital Investors, L.P.  Existing Fund GP, Ltd. is the general partnerof MidOcean Capital Partners, L.P. MidOcean Partners, LP is the sole owner ofExisting Fund GP, Ltd. and MidOcean Associates, SPC is the general partner ofMidOcean Partners, LP.   J. Edward Virtuemay be deemed the beneficial owner of the shares because he indirectly controlsthe securities, but disclaims beneficial ownership except to the extent of hispecuniary interest therein.

 

(H)            Includes 51,414 shares held in Mr. Linford’s401(k) Plan account.

 

(I)                 Includes 6,244 shares held in Mr. Wallace’s401(k) Plan account.

 

(J)                Included in the shares of common stock are theshares beneficially owned by Annex.

 

41

----

 

Thefollowing table sets forth information, as of September 30, 2004, about sharesof our common stock that may be issued upon the exercise of options grantedunder our equity compensation plans and arrangements, divided between plansapproved by our shareholders and plans or arrangements not submitted to ourshareholders for approval.

 

** **
| **Plan Category**                                       | ** ** | **Number of  securities to be  issued upon  exercise of  outstanding  options, warrants  and rights** | ** ** | **Weighted average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  first column)** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by shareholders     |       | 1,734,320                                                                                             |       | $                                                                                   | 3.50       |                                                                                                                                                    | 1,616,703  |   |
|                                                    |       |                                                                                                  |       |                                                                                |       |                                                                                                                                                    |       |
| Equity  compensation plans not approved by shareholders |       | 2,404,962                                                                                             | (1)        | $                                                                                   | 1.80       |                                                                                                                                                    | —     |   |
| Total                                                   |       | 4,139,282                                                                                             |       | $                                                                                   | 2.51       |                                                                                                                                                    | 1,616,703  |   |

 

----

(1)               Includes1,115,962 warrants exercisable for our common stock at $0.28 per share plusoptions granted pursuant to plans not approved by our shareholders.  See Note 15 of Notes to Financial Statementsunder the heading “Non-Plan Options” for a description of the material terms ofoptions granted without shareholder approval and not requiring shareholderapproval, which information is incorporated herein by reference.

 

**Item 13.  Certain Relationships and RelatedTransactions**

 

**Certain Relationships and RelatedTransactions**

Mr. Mazer is Presidentand Chief Operating Officer of Ventura Foods, LLC.  We purchased barbecue sauce from VenturaFoods totaling $668,000 in fiscal 2004. We believe that the price paid to Ventura Foods is fair in comparison with prices that would be paid to an independentthird party for similar barbecue sauce.

 

Mr. Coleman isManaging Partner of Annex Capital Management LLC to which we are indebted inthe principal amount of approximately $16.9 million plus accrued but unpaidinterest related to this debt.  This debtcurrently bears interest at the annual rate of 13%.

 

We also have a licensing agreement with Mr. Wenner, which is describedunder the heading “Director Compensation” in Item 11. above.

 

**Compensation Committee Interlocksand Insider Participation**

During fiscal 2004,Directors who served on the Compensation Committee included Messrs. Bergeron,Coleman, Krantz and Mazer.  None of theseindividuals is, or has been in the past, an officer or employee ofGardenburger.

 

42

----

 

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

 

The following fees areanticipated to be paid to BDO Seidman, LLP related to fiscal 2004 and were paidto KPMG LLP related to fiscal 2003:  

 
| ** **          | ** ** | **2004** | ** ** | **%  approved  by Audit  Committee** | ** ** | **2003** | ** ** | **%  approved  by Audit  Committee** | ** ** |
|---------------------|------------|----------|------------|--------------------------------------|------------|----------|------------|--------------------------------------|------------|
| Audit Fees          |       | $        | 340,000    |                                 | 100        | %        | $          | 129,000                              |       | 100 | % |
| Audit Related  Fees |       | —   |       | —                               |       | —   |       | —                               |       |
| Tax Fees (A)        |       | 580      |       | 100                                  | %          | 77,000   |       | 100                                  | %          |
| All Other Fees (B)  |       | 11,452   |       | 100                                  | %          | 19,000   |       | 100                                  | %          |
|                |       | $        | 352,032    |                                 |       |     | $          | 225,000                              |       |   |   |

 

----

(A)           Consists of corporate tax compliance assistance and other taxconsulting, which is customarily provided by a company’s independent registeredpublic accountant.

 

(B)             Consists of fees for the audit of our employeebenefit plan and other miscellaneous consulting services.

 

**Pre-ApprovalPolicies**

Prior to retaining BDOSeidman, LLP to provide services, we discuss the services with the Chairman ofthe Audit Committee. The Chairman then reviews the request and, if the Chairmandetermines it necessary, he discusses the potential services with the otherAudit Committee members. The decision is then communicated to the Board ofDirectors and, if approved, it is formally approved at the next Audit Committeemeeting.

 

**PART IV**

 

**Item 15.  Exhibits, Financial Statement Schedules**

 
| **Financial Statements and  Schedules**                                                        |                               | Page   |   |
|------------------------------------------------------------------------------------------------|------------------------------------|--------|--------|
|                                                                                           |                               |   |   |
| Report of BDO Seidman, LLP, Independent Registered  Public Accounting Firm                     |                               | F-1    |   |
|                                                                                           |                               |   |   |
| Report of KPMG LLP, Independent Registered Public  Accounting Firm                             |                               | F-2    |   |
|                                                                                           |                               |   |   |
| Balance Sheets – September 30, 2004 and 2003                                              |                               | F-3    |   |
|                                                                                           |                               |   |   |
| Statements of Operations – Years ended September  30, 2004, 2003 and 2002                 |                               | F-4    |   |
|                                                                                           |                               |   |   |
| Statements of Shareholders’ Deficit – Years ended  September 30, 2004, 2003 and 2002 |                               | F-5    |   |
|                                                                                           |                               |   |   |
| Statements of Cash Flows - Years ended September  30, 2004, 2003 and 2002                      |                               | F-6    |   |
|                                                                                           |                               |   |   |
| Notes to Financial Statements                                                                  |                               | F-7    |   |
|                                                                                           |                               |   |   |
| Schedule II                                                                                    | Valuation and Qualifying  Accounts |   | F-27   |   |
|                                                                                                |                                    |        |        |  |

 

**Exhibits**

The exhibits filed as apart of this report are listed below and this list is intended to comprise theexhibit index:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                          |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Restated  Articles of Incorporation, as amended through March 23, 2004 (22)                                                              |
|            |       |                                                                                                                                     |
| 3.2             |       | 1995  Restated Bylaws, as amended July 13, 1999 (10)                                                                                     |
|            |       |                                                                                                                                     |
| 10.1            |       | Amended  and Restated Rights Agreement between Gardenburger, Inc. and First Chicago  Trust Company of New York, dated July 15, 1999 (10) |

 

43

----

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                 |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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 Gardenburger, Inc., dated effective as of January 2,  2002 (13)                                 |
|            |       |                                                                                                                                                                                                                                            |
| 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  Gardenburger, Inc. and EquiServe Trust Company, N.A. (successor to First  Chicago Trust company of New York (13) |
|            |       |                                                                                                                                                                                                                                            |
| 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  Gardenburger, Inc. and EquiServe Trust Company, N.A. (16)                                                          |
|            |       |                                                                                                                                                                                                                                            |
| 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  Gardenburger, Inc. and EquiServe Trust Company, N.A. (19)                                                         |
|            |       |                                                                                                                                                                                                                                            |
| 10.6            |       | Office Space Lease by and between The Irvine Company  and Gardenburger, Inc. dated August 21, 2003. (20)                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                            |
| 10.7            |       | Facility Lease by and between Freeport Center  Associates, a Utah general partnership and Gardenburger, Inc., dated May 28,  1997. (2)                                                                                                          |
|            |       |                                                                                                                                                                                                                                            |
| 10.8            |       | Addendum, dated August 1, 1997, to Facility Lease by  and between Freeport Center Associates and Gardenburger,  Inc. (3)                                                                                                                        |
|            |       |                                                                                                                                                                                                                                            |
| 10.9            |       | Lease Extension, dated October 17, 2002, to Facility  Lease dated May 28, 1997 by and between Freeport Center Associates and  Gardenburger, Inc. (16)                                                                                           |
|            |       |                                                                                                                                                                                                                                            |
| 10.10           |       | Warehouse Lease between Freeport Center Associates  and Gardenburger, Inc., dated January 25, 1999 (7)                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                            |
| 10.11           |       | Note Purchase Agreement, dated as of March 27, 1998,  between Gardenburger, Inc. and Dresdner Kleinwort Benson Private Equity  Partners L.P. (4)                                                                                                |
|            |       |                                                                                                                                                                                                                                            |
| 10.12           |       | First Amendment to Note Purchase Agreement, dated  December 30, 1999, between Gardenburger, Inc. and Dresdner Kleinwort Benson  Private Equity Partners L.P. (11)                                                                               |
|            |       |                                                                                                                                                                                                                                            |
| 10.13           |       | 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 Gardenburger, Inc. (14)                                        |
|            |       |                                                                                                                                                                                                                                            |
| 10.14           |       | 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 Gardenburger, Inc. (16)                                       |
|            |       |                                                                                                                                                                                                                                            |
| 10.15           |       | 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. (17)                            |
|            |       |                                                                                                                                                                                                                                            |
| 10.16           |       | Fifth Amendment, dated as of December 29, 2003, to  Note Purchase Agreement, dated as of March 27, 1998, between Gardenburger,  Inc. and Dresdner Kleinwort Benson Private Equity Partners, L.P. (21)                                           |
|            |       |                                                                                                                                                                                                                                            |
| 10.17           |       | Sixth Amendment, dated as of August 13, 2004, to  Note Purchase Agreement, dated as of March 27, 1998, between Gardenburger,  Inc. and Dresdner Kleinwort Benson Private Equity Partners, L.P.                                                  |
|            |       |                                                                                                                                                                                                                                            |
| 10.18           |       | Amended and Restated Convertible Senior Subordinated  Note dated January 10, 2002, issued by Gardenburger, Inc. to Dresdner  Kleinwort Benson Private Equity Partners L.P. (14)                                                                 |
|            |       |                                                                                                                                                                                                                                            |
| 10.19           |       | First Amendment, dated as of December 29, 2003, to  Amended and Restated Convertible Senior Subordinated Note, dated as of  January 10, 2002, between Gardenburger, Inc. and Dresdner Kleinwort Benson  Private Equity Partners, L.P. (21)      |
|            |       |                                                                                                                                                                                                                                            |
| 10.20           |       | Second Amended and Restated Convertible Senior  Subordinated Note dated September 2, 2004, issued by Gardenburger, Inc. to  Annex Holdings I LP.                                                                                                |
|            |       |                                                                                                                                                                                                                                            |
| 10.21           |       | Instrument of Adherence, dated as of September 2,  2004, between Dresdner Kleinwort Benson Private Equity Partners, L.P. and  Annex Holdings I LP.                                                                                              |

 

44

----

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                 |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.22           |       | Warrant Agreement, dated as of January 10, 2002,  between Dresdner Kleinwort Benson Private Equity Partners L.P. and  Gardenburger, Inc. (14)                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.23           |       | Form of Warrant issued to Dresdner Kleinwort Benson  Private Equity Partners L.P. and holders of Gardenburger Inc.’s preferred  stock (14)                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.24           |       | Amended and Restated Warrant, issued to Annex Holdings  I LP, dated September 2, 2004.                                                                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.25           |       | Registration Rights Agreement, dated as of March 27,  1998, between Gardenburger, Inc. and Dresdner Kleinwort Benson Private Equity  Partners L.P. (4)                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.26           |       | 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 Gardenburger, Inc. (14)                                                                       |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.27           |       | 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 (14)                                                                  |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.28           |       | 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 Gardenburger, Inc. (16)                                                                                     |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.29           |       | Second Amendment, dated December 31, 2002, to  Revolving Credit and Term Loan Agreement, dated January 10, 2002, between  CapitalSource Finance LLC and Gardenburger, Inc. (17)                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.30           |       | Third Amendment, dated March 31, 2003, to Revolving  Credit and Term Loan Agreement, dated January 10, 2002, between CapitalSource  Finance LLC and Gardenburger, Inc. (18)                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.31           |       | Fourth Amendment, dated as of December 29, 2003, to  Revolving Credit and Term Loan Agreement dated as of January 10, 2002,  between Gardenburger, Inc. and CapitalSource Finance LLC (21)                                                                                      |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.32           |       | Fifth Amendment, dated April 8, 2004, to Revolving  Credit and Term Loan Agreement dated January 10, 2002 between CapitalSource  Finance LLC and Gardenburger, Inc. (22)                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.33           |       | Sixth Amendment, dated August 13, 2004, to Revolving  Credit and Term Loan Agreement dated January 10, 2002 between CapitalSource  Finance LLC and Gardenburger, Inc.                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.34           |       | Seventh Amendment, dated November 29, 2004, to  Revolving Credit and Term Loan Agreement dated January 10, 2002 between  CapitalSource Finance LLC and Gardenburger, Inc.                                                                                                       |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.35           |       | 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 (6) |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.36           |       | Amendment and Waiver of Stock Purchase Agreement,  dated April 14, 1999, by and between Gardenburger, Inc., and the  Purchasers identified on Exhibit A thereto (8)                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.37           |       | Investor Rights Agreement, dated April 14,  1999, by and between Gardenburger, Inc., and the investors identified on  Exhibit A thereto (8)                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.38           |       | Preferred Stock Exchange Agreement, dated as of  January 10, 2002, by and among the Company and the holders of its preferred  stock (14)                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.39           |       | Registration Rights Agreement, dated as of January  10, 2002, by and among the Company and the holders of its preferred stock  (14)                                                                                                                                             |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.40           |       | Paul F. Wenner Stock Option Agreement dated January  20, 1992 (1) (5)                                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.41           |       | Amendment, effective May 8, 2001, to Stock Option  Agreement dated January 20, 1992 between Gardenburger, Inc. and Paul F.  Wenner (5) (12)                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.42           |       | Amendment No. 2, dated as of December 22, 2003, to  Stock Option Agreement dated January 20, 1992, between Gardenburger, Inc. and  Paul F. Wenner (5) (21)                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.43           |       | Amendment No. 3, dated May 12, 2004, to Stock Option  Agreement dated January 20, 1992, between Gardenburger, Inc. and Paul F.  Wenner (5) (22)                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                            |
| 10.44           |       | 1992 First Amended and Restated Combination Stock  Option Plan, as amended (“1992 Plan”) (5) (9)                                                                                                                                                                      |

 

45

----

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                            |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|
| 10.45           |       | Form of Incentive Stock Option Agreement for Option  grants to executive officers under 1992 Plan after  May 24, 1995 (5) (7)              |
|            |       |                                                                                                                                       |
| 10.46           |       | Form of Non-Statutory Stock Option Agreement for  Option grants to executive officers under 1992 Plan after May 24, 1995 (5)  (7)          |
|            |       |                                                                                                                                       |
| 10.47           |       | Incentive Stock Option Agreement with Scott C.  Wallace dated January 15, 2001 (5) (15)                                                    |
|            |       |                                                                                                                                       |
| 10.48           |       | 2001 Stock Incentive Plan as Amended and Restated  Effective June 1, 2001 (“2001 Plan”) (5) (12)                                 |
|            |       |                                                                                                                                       |
| 10.49           |       | Form of Award Agreement under the Gardenburger, Inc.  2001 Stock Incentive Plan (5) (18)                                                   |
|            |       |                                                                                                                                       |
| 10.50           |       | Form of Director Nonqualified Stock Option Agreement  under 2001 Plan (5) (15)                                                             |
|            |       |                                                                                                                                       |
| 10.51           |       | Employment Agreement dated February 24, 2004 between  Gardenburger, Inc. and Scott C. Wallace (5) (22)                                     |
|            |       |                                                                                                                                       |
| 10.52           |       | Employment Agreement, dated February 26, 2004,  between Gardenburger, Inc. and  James W. Linford (5) (22)                                  |
|            |       |                                                                                                                                       |
| 10.53           | ** ** | Employment Agreement dated February 26, 2004 by and  between Gardenburger, Inc. and  Robert T. Trebing, Jr. (5) (22)                       |
|            |       |                                                                                                                                       |
| 10.54           |       | Form of Indemnification Agreement between  Gardenburger, Inc. and its Officers and Directors (5) (7)                                       |
|            |       |                                                                                                                                       |
| 10.55           | ** ** | Option Agreement dated April 14, 1996 between  Gardenburger, Inc. and Lyle G. Hubbard relating to 300,000 shares of common  stock (5) (16) |
|            |       |                                                                                                                                       |
| 10.56           |       | Licensing Agreement, dated May 12, 2004, between  Gardenburger, Inc. and Paul F. Wenner (22)                                               |
|            |       |                                                                                                                                       |
| 10.57           |       | 2004 Annual Senior Executive Bonus Plan (5)                                                                                                |
|            |       |                                                                                                                                       |
| 10.58           |       | Retention Agreement, dated January 27, 2005, by and  between Gardenburger, Inc. and Scott C. Wallace (5) (24)                              |
|            |       |                                                                                                                                       |
| 10.59           |       | Retention Agreement, dated January 27, 2005, by and  between Gardenburger, Inc. and James W. Linford (5) (24)                              |
|            |       |                                                                                                                                       |
| 10.60           |       | Retention Agreement, dated January 27, 2005, by and  between Gardenburger, Inc. and Robert T. Trebing, Jr. (5) (24)                        |
|            |       |                                                                                                                                       |
| 10.61           |       | Employment Agreement, dated February 26, 2004, by  and between Gardenburger, Inc. and Robert Dixon (5) (24)                                |
|            |       |                                                                                                                                       |
| 10.62           |       | Employment Agreement, dated February 26, 2004, by  and between Gardenburger, Inc. and Lori Luke (5) (24)                                   |
|            |       |                                                                                                                                       |
| 10.63           |       | Retention Agreement, dated January 27, 2005, by and  between Gardenburger, Inc. and Robert Dixon (5) (24)                                  |
|            |       |                                                                                                                                       |
| 10.64           |       | Retention Agreement, dated January 27, 2005, by and  between Gardenburger, Inc. and Lori Luke (5) (24)                                     |
|            |       |                                                                                                                                       |
| 14              | ** ** | Code of Ethics (20)                                                                                                                        |
|            | ** ** | ** **                                                                                                                                 |
| 16              | ** ** | Letter re: Change in Certifying Accountant (23)                                                                                            |
|            | ** ** | ** **                                                                                                                                 |
| 18              | ** ** | Letter re: Change in Accounting Principle                                                                                                  |
|            | ** ** | ** **                                                                                                                                 |
| 23.1            |       | Consent of BDO Seidman, LLP, Independent Registered  Public Accounting Firm                                                                |

 

46

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| **Exhibit No.** | ** ** | **Description**                                                                                                                 |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------|
| 23.2            |       | Consent  of KPMG LLP                                                                                                            |
|            |       |                                                                                                                            |
| 31.1            |       | Certification  of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) of  the Securities Exchange Act of 1934. |
|            |       |                                                                                                                            |
| 31.2            |       | Certification  of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) of  the Securities Exchange Act of 1934. |
|            |       |                                                                                                                            |
| 32              |       | Certification  Pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act  of 1934 and 18 U.S.C. Section 1350. |

 

----

(1)                    Incorporated by reference to the Company’s1992 Form 10-K Annual Report, filed March 23, 1993.

(2)                    Incorporated by reference to the Company’sForm 10-Q Quarterly Report for the quarter ended June 30, 1997, filed August14, 1997

(3)                    Incorporated by reference to the Company’s1997 Form 10-K Annual Report, filed March 31, 1998.

(4)                    Incorporated by reference to the Company’sForm 10-Q for the quarter ended March 31, 1998, filed May 15, 1998.

(5)                    Management contract or compensatory plan orarrangement.

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

(7)                    Incorporated by reference to the Company’sForm 10-K for the year ended December 31, 1998, filed March 31, 1999.

(8)                    Incorporated by reference to the Company’sForm 10-Q for the quarter ended March 31, 1999, filed May 17, 1999.

(9)                    Incorporated by reference to the Company’sForm 10-Q for the quarter ended June 30, 1999, filed August 13, 1999.

(10)              Incorporatedby reference to the Company’s Registration Statement on Form S-8 (No.333-92665), filed December 13, 1999.

(11)              Incorporatedby reference to the Company’s Form 10-Q for the quarter ended December 31,1999, filed February 9, 2000.

(12)              Incorporatedby reference to the Company’s Form 10-Q for the quarter ended December 31,2001, filed February 13, 2002.

(13)              Incorporatedby reference to the Company’s Form 10-Q for the quarter ended June 30, 2002,filed August 9, 2002.

(14)              Incorporatedby reference to the Company’s Form 8-K dated January 10, 2002 and filed January17, 2002.

(15)              Incorporatedby reference to the Company’s 2001 Form 10-K Annual Report, filed December 10,2001.

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

(17)              Incorporatedby reference to the Company’s Quarterly Report on Form 10-Q for the quarterended December 31, 2002, filed February 13, 2003.

(18)              Incorporatedby reference to the Company’s Quarterly Report on Form 10-Q for the quarterended March 31, 2003, filed May 14, 2003.

(19)              Incorporatedby reference to the Company’s Form 8-K dated August 18, 2003 and filed August19, 2003.

(20)              Incorporatedby reference to the Company’s Form 10-K for the year ended September 30, 2003and filed December 29, 2003.

(21)              Incorporatedby reference to the Company’s Form 10-Q for the quarter ended December 31, 2003and filed February 17, 2004.

(22)              Incorporatedby reference to the Company’s Form 10-Q for the quarter ended June 30, 2004 andfiled August 16, 2004.

(23)              Incorporatedby reference to the Company’s Form 8-K dated June 25, 2004 and filed July 2,2004.

(24)              Incorporatedby reference to the Company’s Form 8-K dated January 27, 2005 and filedFebruary 1, 2005.

 

47

----

 

**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

Date: February 18, 2005

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

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities indicated on February 18, 2005.

 
| **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/ CHARLES E. BERGERON     |       |      | Director |
| Charles E. Bergeron         |       |      |   |
|                        |       |      |   |
|                        |       |      |   |
| /s/ ALEXANDER P.  COLEMAN   |       |      | Director |
| Alexander P. Coleman        |       |      |   |
|                        |       |      |   |
|                        |       |      |   |
| /s/ BARRY E. KRANTZ         |       |      | Director |
| Barry E. Krantz             |       |      |   |
|                        |       |      |   |
|                        |       |      |   |
| /s/ RICHARD L. MAZER        |       |      | Director |
| Richard L. Mazer            |       |      |   |
|                        |       |      |   |
|                        |       |      |   |
| /s/ PAUL F. WENNER          |       |      | Founder and Director |
| Paul F. Wenner              |       |      |   |

 

48

----

 

Report of IndependentRegistered Public Accounting Firm

 

The Board of DirectorsGardenburger, Inc.:

 

We have audited the accompanying balance sheet of Gardenburger, Inc.(the “Company”) (an Oregon corporation) as of September 30, 2004, andthe related statements of operations, shareholders’ deficit and cash flows forthe year then ended.  In connection withour audit of the financial statements, we also have audited the supplementaryinformation included in Schedule II. These financial statements and the financial statement schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements and financial statement schedule basedon our audit. The financial statements and financial statement schedule ofGardenburger, Inc. for the years ended September 30, 2003 and 2002 and asof September 30, 2003 were audited by another independent registeredpublic accounting firm.  That firmexpressed an unqualified opinion on those financial statements in their reportdated November 7, 2003, except as to Note 16 to those financialstatements, which was as of December 29, 2003.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of Gardenburger, Inc.as of September 30, 2004, and the results of its operations and its cashflows for the year then ended in conformity with accounting principlesgenerally accepted in the United States. Also in our opinion, the related financial statement schedule, whenconsidered in relation to the basic financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 

As described in Note 3 to the financial statements for the year ended September 30,2004, the Company changed its method of accounting for slotting fees as of October 1,2003.

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 2 to thefinancial statements, the Company has a working capital deficiency, negativeoperating cash flow, and has suffered substantial recurring losses.  These matters, among others, raisesubstantial doubt about the Company’s ability to continue as a goingconcern.  Management’s plans in regard tothese matters are described in Note 2. The financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

 
| /s/ BDO  Seidman, LLP   |   |
|-------------------------|--------|
| Costa Mesa,  California |

December 29, 2004, except for Note 19 as to which the date is February 18,2005.

 

F-1

----

 

Reportof Independent Registered Public Accountants

 

The Board of DirectorsGardenburger, Inc.:

 

We have audited the accompanying balancesheet of Gardenburger, Inc. (an Oregon corporation) as ofSeptember 30, 2003, and the related statements of operations,shareholders’ deficit and cash flows for each of the years in the two-yearperiod ended September 30, 2003.  Inconnection with our audits of the financial statements, we also have auditedfinancial statement schedule II. These financial statements and financial statementschedule are the responsibility of the Company’s management. Our responsibilityis to express an opinion on these financial statements and financial statementschedule based on our audits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statementsreferred to above present fairly, in all material respects, the financialposition of Gardenburger, Inc. as of September 30, 2003, and the results of itsoperations and its cash flows for each of the years in the two-year periodended September 30, 2003 in conformity with U.S. generally accepted accountingprinciples.  Also in our opinion, therelated financial statement schedule, when considered in relation to the basicfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

 

As described in Note 3, the financialstatements for the year ended September 30, 2002 have been revised to includethe transitional disclosures required by Statement of Financial AccountingStandards No. 142, *Goodwill and OtherIntangible Assets*, which was adopted by the Company as of October 1,2002.

 

 

/s/ KPMG LLP

Portland, Oregon

November7, 2003

 

F-2

----

 

GARDENBURGER, INC.

BALANCE SHEETS

(In thousands, except shareamounts)

 
| ** **                                                                                                                                                                | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                | ** ** | **2004**               | ** ** | **2003** | ** ** |
| **Assets**                                                                                                                                                                |       |                   |       |   |   |
| Current  Assets:                                                                                                                                                          |       |                   |       |   |   |
| Cash and  cash equivalents                                                                                                                                                |       | $                      | 5          |   | $ | 1,070 |   |
| Restricted  cash                                                                                                                                                          |       | 166                    |       | 192 |   |
| Accounts  receivable, net of allowances of $104 and $193 at September 30, 2004 and  2003, respectively                                                               |       | 2,848                  |       | 2,960 |   |
| Inventories,  net                                                                                                                                                         |       | 8,964                  |       | 9,191 |   |
| Prepaid  expenses                                                                                                                                                         |       | 1,155                  |       | 2,089 |   |
| Total  current assets                                                                                                                                                     |       | 13,138                 |       | 15,502 |   |
|                                                                                                                                                                      |       |                   |       |   |   |
| Machinery,  equipment and leasehold improvements, net of accumulated depreciation of  $13,303 and $10,588 at September 30, 2004 and 2003, respectively               |       | 10,650                 |       | 11,969 |   |
| Other  assets, net of accumulated amortization of $1,725 and $1,397 at September 30,  2004 and 2003, respectively                                                    |       | 696                    |       | 757 |   |
| Total assets                                                                                                                                                              |       | $                      | 24,484     |   | $ | 28,228 |   |
|                                                                                                                                                                      |       |                   |       |   |   |
| **Liabilities  and Shareholders’ Deficit**                                                                                                                           |       |                   |       |   |   |
| Current  Liabilities:                                                                                                                                                     |       |                   |       |   |   |
| Short-term  note payable                                                                                                                                                  |       | $                      | 4,791      |   | $ | 2,183 |   |
| Current  portion of long-term debt                                                                                                                                        |       | 2,000                  |       | 1,833 |   |
| Accounts  payable                                                                                                                                                         |       | 2,905                  |       | 2,546 |   |
| Accrued  payroll and employee benefits                                                                                                                                    |       | 475                    |       | 704 |   |
| Other  current liabilities                                                                                                                                                |       | 3,583                  |       | 2,299 |   |
| Total  current liabilities                                                                                                                                                |       | 13,754                 |       | 9,565 |   |
|                                                                                                                                                                      |       |                   |       |   |   |
| Long-term  debt, less current maturities                                                                                                                                  |       | 3,513                  |       | 4,979 |   |
| Convertible  note payable                                                                                                                                                 |       | 19,392                 |       | 18,672 |   |
| Total  long-term debt                                                                                                                                                     |       | 22,905                 |       | 23,651 |   |
|                                                                                                                                                                      |       |                   |       |   |   |
| Convertible  redeemable preferred stock, liquidation preference of $58,104 and $54,204 at September 30,  2004 and 2003, respectively, and 650,000 shares outstanding |       | 55,851                 |       | 51,012 |   |
|                                                                                                                                                                      |       |                   |       |   |   |
| Commitments,  contingencies and subsequent events                                                                                                                         |       |                   |       |   |   |
|                                                                                                                                                                      |       |                   |       |   |   |
| Shareholders’  Deficit:                                                                                                                                              |       |                   |       |   |   |
| Preferred  stock, no par value, 5,000,000 shares authorized                                                                                                               |       | —                 |       | — |   |
| Common  stock, no par value, 25,000,000 shares authorized; 9,002,101 shares issued  and outstanding at September 30, 2004 and 2003                                   |       | 11,189                 |       | 11,189 |   |
| Additional  paid-in capital                                                                                                                                               |       | 12,500                 |       | 12,500 |   |
| Accumulated  deficit                                                                                                                                                      |       | (91,715                | )          | (79,689 | ) |
| Total  shareholders’ deficit                                                                                                                                         |       | (68,026                | )          | (56,000 | ) |
| Total  liabilities and shareholders’ deficit                                                                                                                         |       | $                      | 24,484     |   | $ | 28,228 |   |

 

See accompanying notes tofinancial statements.

 

F-3

----

 

GARDENBURGER, INC.

STATEMENTS OF OPERATIONS

(In thousands, except share andper share amounts)

 
| ** **                                                                                           | ** ** | **For the Year Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                 |       |                                      |       |   |   |   |   |
| Net sales                                                                                            |       | $                                         | 48,580     |   | $ | 49,447 |   | $ | 54,596 |   |
| Cost of  goods sold                                                                                  |       | 32,273                                    |       | 30,709 |   | 31,689 |   |
| Gross margin                                                                                         |       | 16,307                                    |       | 18,738 |   | 22,907 |   |
|                                                                                                 |       |                                      |       |   |   |   |   |
| Operating  expenses:                                                                                 |       |                                      |       |   |   |   |   |
| Sales and  marketing                                                                                 |       | 13,844                                    |       | 14,208 |   | 13,711 |   |
| General and  administrative                                                                          |       | 3,898                                     |       | 5,218 |   | 4,210 |   |
| Legal  settlement                                                                                    |       | —                                    |       | — |   | (108 | ) |
| Debt  restructuring costs                                                                            |       | —                                    |       | — |   | 716 |   |
| Other  operating expense (income), net                                                               |       | (16                                       | )          | 105 |   | (424 | ) |
|                                                                                                 |       | 17,726                                    |       | 19,531 |   | 18,105 |   |
| Operating  income (loss)                                                                             |       | (1,419                                    | )          | (793 | ) | 4,802 |   |
|                                                                                                 |       |                                      |       |   |   |   |   |
| Other income  (expense):                                                                             |       |                                      |       |   |   |   |   |
| Interest  income                                                                                     |       | 2                                         |       | 11 |   | 33 |   |
| Interest  expense                                                                                    |       | (4,620                                    | )          | (4,420 | ) | (3,754 | ) |
|                                                                                                 |       | (4,618                                    | )          | (4,409 | ) | (3,721 | ) |
| Income  (loss) before cumulative effect of a change in accounting principle and  preferred dividends |       | (6,037                                    | )          | (5,202 | ) | 1,081 |   |
| Cumulative  effect of a change in accounting for slotting fees                                       |       | (1,150                                    | )          | — |   | — |   |
| Cumulative  effect of a change in accounting for goodwill                                            |       | —                                    |       | (411 | ) | — |   |
| Net income  (loss)                                                                                   |       | (7,187                                    | )          | (5,613 | ) | 1,081 |   |
| Preferred  dividends and accretion                                                                   |       | 4,839                                     |       | 5,177 |   | 4,955 |   |
| Net loss  applicable to common shareholders                                                          |       | $                                         | (12,026    | ) | $ | (10,790 | ) | $ | (3,874 | ) |
|                                                                                                 |       |                                      |       |   |   |   |   |
| Basic and  diluted loss per share before cumulative effect of a change in accounting  principle      |       | $                                         | (1.21      | ) | $ | (1.15 | ) | $ | (0.43 | ) |
|                                                                                                 |       |                                      |       |   |   |   |   |
| Basic and  diluted loss per share for cumulative effect of a change in accounting  principle         |       | $                                         | (0.13      | ) | $ | (0.05 | ) | $ | — |   |
|                                                                                                 |       |                                      |       |   |   |   |   |
| Basic and  diluted net loss per share applicable to common shareholders                              |       | $                                         | (1.34      | ) | $ | (1.20 | ) | $ | (0.43 | ) |
|                                                                                                 |       |                                      |       |   |   |   |   |
| Weighted  average shares used in basic and diluted per share calculations                            |       | 9,002,101                                 |       | 9,002,101 |   | 9,002,101 |   |

 

See accompanying notes tofinancial statements.

 

F-4

----

 

GARDENBURGER, INC.

STATEMENTS OF SHAREHOLDERS’DEFICIT

(In thousands, except shareamounts)

 
| ** **                              | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Retained** | ** ** | **Total  Shareholders’** | ** ** |
|-----------------------------------------|------------|------------------|------------|-------------------------|------------|--------------|------------|-------------------------------|------------|
| ** **                              | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**  | ** ** | **Deficit**                   | ** ** | **Deficit** | ** ** |
|                                    |       |             |       |                    |       |         |       |                          |       |   |   |
| **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 | ) |
| Net income                              |       | —           |       | —                  |       | —       |       | 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 | ) |
| Net loss                                |       | —           |       | —                  |       | —       |       | (5,613                        | )          | (5,613 | ) |
| **Balance  at September 30, 2003** |       | 9,002,101        |       | 11,189                  |       | 12,500       |       | (79,689                       | )          | (56,000 | ) |
|                                    |       |             |       |                    |       |         |       |                          |       |   |   |
| Accrual of  preferred dividends         |       | —           |       | —                  |       | —       |       | (4,839                        | )          | (4,839 | ) |
| Net loss                                |       | —           |       | —                  |       | —       |       | (7,187                        | )          | (7,187 | ) |
| **Balance  at September 30, 2004** |       | 9,002,101        |       | $                       | 11,189     |         | $          | 12,500                        |       | $ | (91,715 | ) | $ | (68,026 | ) |

 

See accompanying notes tofinancial statements.

 

F-5

----

 

GARDENBURGER, INC.

STATEMENTS OF CASH FLOWS

(In thousands)

 
| ** **                                                                                             | ** ** | **For the Year Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows  from operating activities:                                                                 |       |                                      |       |   |   |   |   |
| Net income  (loss)                                                                                     |       | $                                         | (7,187     | ) | $ | (5,613 | ) | $ | 1,081 |   |
| Adjustments  to reconcile income (loss) to net cash flows provided by (used in) operating  activities: |       |                                      |       |   |   |   |   |
| Depreciation  and amortization                                                                         |       | 3,043                                     |       | 3,236 |   | 3,403 |   |
| Cumulative  effect of a change in accounting for slotting fees                                         |       | 1,150                                     |       | — |   | — |   |
| Cumulative  effect of a change in accounting for goodwill                                              |       | —                                    |       | 411 |   | — |   |
| Accrual of  long-term debt and convertible note payable exit fees                                      |       | 875                                       |       | 1,349 |   | 1,006 |   |
| (Gain) loss  on sale of other assets                                                                   |       | (16                                       | )          | 105 |   | (119 | ) |
| Other  non-cash income                                                                                 |       | —                                    |       | — |   | (208 | ) |
| (Increase)  decrease in:                                                                               |       |                                      |       |   |   |   |   |
| Restricted  cash                                                                                       |       | 26                                        |       | 225 |   | (358 | ) |
| Accounts  receivable, net                                                                              |       | 112                                       |       | 167 |   | 386 |   |
| Inventories,  net                                                                                      |       | 227                                       |       | (98 | ) | (1,762 | ) |
| Prepaid  expenses                                                                                      |       | (216                                      | )          | (523 | ) | (496 | ) |
| Increase  (decrease) in:                                                                               |       |                                      |       |   |   |   |   |
| Accounts  payable                                                                                      |       | 359                                       |       | 206 |   | 381 |   |
| Accrued  payroll and employee benefits                                                                 |       | (229                                      | )          | (18 | ) | 63 |   |
| Other  current liabilities                                                                             |       | 1,284                                     |       | 2,077 |   | (593 | ) |
| Net cash  provided by (used in) operating activities                                                   |       | (572                                      | )          | 1,524 |   | 2,784 |   |
|                                                                                                   |       |                                      |       |   |   |   |   |
| Cash flows  from investing activities:                                                                 |       |                                      |       |   |   |   |   |
| Payments for  purchase of machinery, equipment and leasehold improvements                              |       | (1,444                                    | )          | (1,962 | ) | (10,109 | ) |
| Proceeds  from sale of other assets                                                                    |       | 113                                       |       | — |   | 211 |   |
| Net cash  used in investing activities                                                                 |       | (1,331                                    | )          | (1,962 | ) | (9,898 | ) |
|                                                                                                   |       |                                      |       |   |   |   |   |
| Cash flows  from financing activities:                                                                 |       |                                      |       |   |   |   |   |
| Proceeds  from (payments on) line of credit, net                                                       |       | 2,608                                     |       | 1,067 |   | (573 | ) |
| Proceeds  from long-term debt                                                                          |       | —                                    |       | — |   | 8,000 |   |
| Payments on  long-term debt                                                                            |       | (1,455                                    | )          | (1,902 | ) | (333 | ) |
| Capitalized  financing fees                                                                            |       | (315                                      | )          | — |   | (643 | ) |
| Net cash  provided by (used in) financing activities                                                   |       | 838                                       |       | (835 | ) | 6,451 |   |
|                                                                                                   |       |                                      |       |   |   |   |   |
| Decrease in  cash and cash equivalents                                                                 |       | (1,065                                    | )          | (1,273 | ) | (663 | ) |
|                                                                                                   |       |                                      |       |   |   |   |   |
| Cash and  cash equivalents:                                                                            |       |                                      |       |   |   |   |   |
| Beginning of  period                                                                                   |       | 1,070                                     |       | 2,343 |   | 3,006 |   |
| End of  period                                                                                         |       | $                                         | 5          |   | $ | 1,070 |   | $ | 2,343 |   |

 

See accompanying notes tofinancial statements.

 

F-6

----

 

**GARDENBURGER,INC.**

**NOTES TOFINANCIAL STATEMENTS**

 

**1.****                                         ORGANIZATIONAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

***Organization and Nature 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 produceand distribute frozen, meatless food products, consisting of veggie burgers andsoy-based: i) burgers; ii) chicken; iii) pork; and iv) other products.  Our products are sold principally to retailand food service customers throughout the United States.

 

***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 materially differ from those estimates.  Management believes that the estimates usedare reasonable.  Significant estimatesmade by management include estimates for bad debts, excess and obsoleteinventory, coupon liabilities 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.

 

***Restricted Cash***

Pursuant to our line of credit agreement, cash receipts related to ouraccounts receivable are deposited into a lockbox and are then applied againstour line of credit balance, generally the next business day.  Accordingly, cash in our lockbox isconsidered restricted.

 

***Fair Value of Financial Instruments***

The carrying amounts of our financial instruments, including cash andcash equivalents, restricted cash, accounts receivable, accounts payable andaccrued liabilities, approximate fair value due to the short maturities ofthese financial instruments.  Ourconvertible notes are also considered a financial instrument, however, theirfair value is not readily determinable due to their being held by a singleentity and the lack of a public trading market.

 

***Accounts Receivable and Allowances forUncollectible Accounts***

Credit limits are established through a process of reviewing thefinancial 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.

 

***Inventories***

Inventories are valued at the lower of cost (based on standard costs,which approximate the first-in, first-out (FIFO) method) or market, and includematerials, labor and manufacturing overhead.

 

***Contract Origination Costs***

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. Such costs are refundable to us shouldthe contract be terminated prior to completion. At September 30, 2004 and 2003, prepaid assets included $209,000and $513,000, respectively, of contract origination costs.

 

F-7

----

 

***Machinery, Equipment and LeaseholdImprovements***

Machinery and equipment and leasehold improvements are stated atcost.  Significant improvements arecapitalized and maintenance and repairs are expensed. Depreciation andamortization are provided using the straight-line method over the estimateduseful lives of the assets.  Leaseholdimprovements are amortized over the lease term or the estimated useful life ofthe asset, whichever is shorter. Machinery and equipment are reviewed for impairment whenever events orcircumstances indicate that the carrying amount of assets may not berecoverable in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” Weevaluate recoverability of property, plant and equipment to be held and used bycomparing the carrying amount of an asset to estimated future net undiscountedcash flows to be generated by the asset. If such assets are considered to beimpaired, the impairment to be recognized is measured as the amount by whichthe carrying amount of the assets exceeds the fair value of the assets.  We performed such an analysis in the fourthquarter of fiscal 2004 and determined that no impairment existed.

 

Estimated useful lives are as follows:

 
| Leasehold  improvements         |   | 5 - 12 years |   |
|---------------------------------|--------|--------------|--------|
| Office  furniture and equipment |   | 3 - 10 years |   |
| Machinery  and equipment        |   | 3 - 15 years |   |
| Vehicles                        |   | 5 years      |   |

 

***Other Assets***

Other assets include deferred financing feesand trademarks.  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 fees are considered to be associated with therespective debt and are not subject to impairment testing in accordance withSFAS No. 144. Trademarks are reviewed for impairment and changes in theirestimated remaining useful lives whenever events or circumstances indicate thatthe carrying amount of assets may not be recoverable in accordance with SFASNo. 144. We evaluate recoverability by comparing the carrying amount of theassets to estimated future net undiscounted cash flows to be generated by theassets.  If such assets are considered tobe impaired, the impairment to be recognized is measured as the amount by whichthe carrying amount of the assets exceeds the fair value of the assets.  See also Note 3 regarding the write-off ofour goodwill balance.

 

# ***Segmentand Enterprise-Wide Reporting***

We disclose segment enterprise-wide information in accordance with SFASNo. 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.

 

***Concentrations of Credit Risk and SignificantCustomers***

We invest any 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 2004, three customers accounted for approximately 12%, 10%and 8% of gross sales, respectively, and approximately 7%, 12% and 14% of thegross accounts receivable balance at September 30, 2004, respectively.

 

For fiscal 2003, three customers accounted for approximately 13%, 12%and 9% of gross sales, respectively, and approximately 18%, 5% and 11% of thegross accounts receivable balance at September 30, 2003, respectively.

 

For fiscal 2002, three customers accounted for approximately 12%, 11%and 10% of gross sales, respectively, and approximately 14%, 7% and 13% of thegross accounts receivable balance at September 30, 2002, respectively.

 

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

 

F-8

----

 

***Revenue Recognition and Sales Incentives***

In accordance with Staff AccountingBulletin No. 104, Revenue Recognition (“SAB 104”), revenues are recognized uponpassage of title to the customer, typically upon product pick-up, shipment ordelivery to customers.

 

Our revenue arrangements with our customersoften include sales incentives and other promotional costs such as coupons,volume-based discounts, slotting fees and off-invoice discounts. These costsare typically referred to collectively as “trade spending.”  Pursuant to EITF No. 00-14, EITF No. 00-25and EITF No. 01-09, these costs are recorded when revenue is recognized and aregenerally classified as a reduction of revenue. We do not provide for sales returns since, historically, sales returnshave not been significant.  See also Note3. for a discussion of a change in accounting for slotting fees.

 

***Trade Spending***

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 liabilitiesassociated with trade spending may materially differ from those recorded due tochanges in estimates and actual results achieved.

 

***Slotting Fees***

Slotting fees refer to oral arrangements pursuant to which the retailgrocer allows our products to be placed on the store’s shelves in exchange fora slotting fee. As reported in prior filings, slotting fees were initiallyrecorded as a prepaid asset and the related expense was recognized ratably overa 12-month period beginning two months following product shipment as an offsetto sales.  Typically, 12 months is theestimated minimum period during which a retailer agrees to allocate shelfspace.  However, given that there are nowritten contractual commitments requiring the retail grocers to allocate shelfspace for twelve months, in fiscal 2004, we determined that it was a preferableaccounting method to expense the slotting fees at the time revenue isrecognized.  See Note 3 for additionalinformation regarding this change in accounting principle.  Accordingly, there were no slotting fees includedin prepaid assets at September 30, 2004, while $1.2 million was includedat September 30, 2003.  The $1.2million of slotting fees capitalized on our balance sheet at September 30,2003 was expensed in the first quarter of fiscal 2004 as a change in accountingprinciple.

 

***Shipping and FreightCharges***

We incur costs related to shipping andhandling of our manufactured products, which amounted to $1.6 million, $1.4million and $1.3 million for fiscal 2004, 2003 and 2002, respectively.  We expense these costs as incurred as acomponent of sales and marketing expense. We also incur shipping and handling charges related to the receipt ofraw materials, which are recorded as a component of cost of goods sold.  Payments received from customers for shippingand handling costs are included as a component of net sales upon recognition ofthe 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$602,000 in fiscal 2004, $572,000 in fiscal 2003 and $1.1 million in fiscal2002.

 

***Spoils Costs***

Expenses for spoils, which are incurred after our products are receivedby our customers, were approximately $385,000 in fiscal 2004, $293,000 infiscal 2003 and $280,000 in fiscal 2002 and are included in sales and marketingexpense.

 

F-9

----

 

***Research and Development Costs***

Research and development costs are expensed as incurred. Research anddevelopment expense was approximately $272,000 in fiscal 2004, $235,000 infiscal 2003 and $222,000 in fiscal 2002 and is included in sales and marketingexpenses in the accompanying statements of operations.

 

***Net Loss Per Share***

Basic loss per share is calculated using the weighted average number ofcommon shares outstanding for the period and diluted loss per share is computedusing the weighted average number of common shares and dilutive commonequivalent shares outstanding.

 

Basic net loss per shareand diluted net loss per share are the same for all periods presented since wewere in a loss position in all periods. Potentially dilutive securities that are not included in the dilutedloss per share calculations because they would be antidilutive are as follows(in thousands):

 
| ** **                   | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------|------------|-----------------------------------|------------|
| ** **                   | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Stock  options               |       | 3,023                             |       | 3,929 |   | 4,535 |   |
| Stock  warrants              |       | 1,116                             |       | 1,116 |   | 1,116 |   |
| Convertible  notes           |       | 1,730                             |       | 1,730 |   | 1,775 |   |
| Convertible  preferred stock |       | 4,062                             |       | 4,062 |   | 4,062 |   |
| Total                        |       | 9,931                             |       | 10,837 |   | 11,488 |   |

 

***Comprehensive Income Reporting***

SFAS No. 130, “Reporting Comprehensive Income” establishes standardsfor reporting and displaying comprehensive income and its components in a fullset of general purpose financial statements. The objective of SFAS No. 130 isto report a measure of all changes in the equity of an enterprise that resultfrom transactions and other economic events of the period other thantransactions with owners. Comprehensive loss did not differ from currentlyreported net loss in the periods presented.

 

***Stock Based Compensation Plans***

We account for stock options using the intrinsic value method asprescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting forStock Issued to Employees.”  Pursuant toSFAS No. 148 “Accounting for Stock-Based Compensation - Transition andDisclosure,” we have computed, for pro forma disclosure purposes, the impact onnet loss and net loss per share as if we had accounted for our stock-basedcompensation plans in accordance with the fair value method prescribed by SFASNo. 123 “Accounting for Stock-Based Compensation” as follows (in thousands,except per share amounts):

 
| ** **                                                                                                             | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                             | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss  applicable to common shareholders, as reported                                                               |       | $                                 | (12,026    | ) | $ | (10,790 | ) | $ | (3,874 | ) |
| Deduct -  total stock-based employee compensation expense determined under the fair  value based method for all awards |       | (201                              | )          | (450 | ) | (991 | ) |
| Net loss,  pro forma                                                                                                   |       | $                                 | (12,227    | ) | $ | (11,240 | ) | $ | (4,865 | ) |
|                                                                                                                   |       |                              |       |   |   |   |   |
| Basic and  diluted net loss per share applicable to common shareholders – as reported                             |       | $                                 | (1.34      | ) | $ | (1.20 | ) | $ | (0.43 | ) |
| Basic and  diluted net loss per share applicable to common shareholders – pro forma                               |       | $                                 | (1.36      | ) | $ | (1.25 | ) | $ | (0.54 | ) |

 

We used the Black-Scholes option pricing model and the followingweighted average assumptions in calculating the value of all options grantedduring the year ended September 30, 2002:

 
| Risk-free interest rate  |   | 4.50      | %      |
|--------------------------|--------|-----------|--------|
| Expected  dividend yield |   | 0         | %      |
| Expected  lives          |   | 6.0 years |   |
| Expected  volatility     |   | 96.53     | %      |

 

F-10

----

 

Using the Black-Scholesmethodology, the total value of options granted during fiscal 2002 was$336,000, which would be amortized on a pro forma basis over the vesting periodof the options (typically three to five years). The weighted average per share fair value of options granted duringfiscal 2002 was $0.52.  There were nooptions granted during fiscal 2004 or 2003.

 

***Reclassifications***

Certain reclassifications have been made to the prior year amounts toconform to the current year presentation.

 

**2.****                                      BASISOF PRESENTATION**

 

Our financial statements have been presented on a going concern basis,which contemplates the realization of assets and satisfaction of liabilities inthe normal course of business.  As shownin the 2004 financial statements, we incurred net losses applicable to commonshareholders for fiscal years 2004, 2003 and 2002 and had a total shareholders’deficit at September 30, 2004.  Weare highly leveraged and have significant annual interest and dividend accrualsrelated to our convertible note payable and convertible redeemable preferredstock, which, although not  payable untilJune 2007 and June 2008, respectively, contribute to our net lossesand shareholders’ deficit.

 

During the fourth quarter of fiscal 2004, we experienced sales declinesdue to one of our major competitors initiating a program of price discountingat unprecedented levels.  These salesdeclines resulted in operating performance that was lower than our plans.  When combined with the significant cashoutlays for capital expenditures, slotting fees and other product introductioncosts associated with the launch of our new microwavable meals, these eventscaused a higher than expected use of our line of credit.  We ended fiscal 2004 with $4.8 millionoutstanding on the line of credit, compared to $2.2 million at the end offiscal 2003.

 

At September 30, 2004, we had $1.7 million available on our lineof credit.  Cash required to meet our requiredinterest and principal payments on our debt outstanding at September 30,2004 totals approximately $2.8 million in the next twelve months as follows (inthousands):

 
| Principal payments due on long-term debt                                |   | $   | 2,000  | ** ** |
|-------------------------------------------------------------------------|--------|-----|--------|------------|
| Interest on  long-term debt                                             |   | 378 |   |
| Estimated  interest on short-term note payable                          |   | 413 |   |
| Estimated  unused line of credit fee related to short term note payable |   | 36  |   |
| Total                                                                   |   | $   | 2,827  |       |

 

These factors raise substantial doubt about our ability to continue asa going concern.

 

To improve our cash flow and liquidity, we have identified thefollowing initiatives, among others for fiscal 2005 (unaudited):

•                  Areduction of $2 million in finished goods inventories which were built up overthe 2002-2004 timeframe;

•                  Areduction in slotting fees from approximately $3.1 million in 2004 to a planned$737,000 in 2005;

•                  Areduction in capital expenditures from approximately $1.4 million in 2004 to aplanned $325,000 in 2005;

•                  Thecompletion on October 1, 2004 of a reduction in force at our manufacturingfacility;

•                  Aban on non-essential travel and other administrative costs;

•                  Thenegotiation of extended payment terms with several of our major vendors; and

•                  Theinstitution of additional cash management and tracking procedures.

 

We also negotiated waivers with CapitalSource Finance LLC (“CapitalSource”)and Annex Holdings I LP (“Annex”) for all 2004 covenant defaults and set newfinancial covenants going forward which we expect to achieve.  In addition, CapitalSource has agreed toprovide a $500,000 over advance facility from February 18, 2005 to May 31, 2005as part of the loan amendments.  Weagreed to pay CapitalSource a fee of $110,000 in connection with the amendmentand a fee of $25,000 for the additional availability under the revolving creditfacility.  In addition, we are requiredto pay a $500,000 fee to CapitalSource if our ratio of total debt under theLoan Agreement plus the Convertible Note with Annex to earnings (as defined)exceeds 1.25:1.00 as of September 30, 2005 and a $250,000 fee if such ratioexceeds 1.25:1.00 as of the end of each quarterly period thereafter.  Based on our current total debt level, it islikely that these fees will be paid.

 

F-11

----

 

As a result of the various initiatives, during the first quarter offiscal 2005, we were able to reduce our line of credit by $497,000 (unaudited),make scheduled principal payments of $500,000 (unaudited) on our long-term debtand fund all interest payments on our CapitalSource debt.

 

We anticipate funding our cash commitments for the next twelve monthperiod out of operating cash flows and line of credit borrowings, bolstered bythe impact of the cash initiatives and over advance facility discussedabove.  There can be no assurance thatour various sources of cash will be sufficient to sustain operations.

 

Our financial statements have been prepared assuming that we willcontinue as a going concern and do not include any adjustments relating to therecoverability and classification of recorded asset amounts or the amounts andclassification of liabilities that might be necessary should we be unable tocontinue as a going concern.  Ourcontinuation as a going concern is dependent on our ability to generatesufficient cash flow to meet our obligations on a timely basis, to comply withthe terms of our financing agreements and ultimately to attain profitableoperations.

 

See also Note19. Subsequent Events.

 

**3.****                                      CHANGEIN ACCOUNTING PRINCIPLE**

 

***Accounting for Slotting Fees***

Slotting fees refer to oral arrangements pursuant to which the retailgrocer allows our products to be placed on the store’s shelves in exchange fora slotting fee. As reported in previous filings, slotting fees were initiallyrecorded as a prepaid asset and the related expense was recognized ratably overa 12-month period beginning two months following product shipment as an offsetto sales.  Typically, 12 months is theestimated minimum period during which a retailer agrees to allocate shelfspace.  However, given that there are nowritten contractual commitments requiring the retail grocers to allocate shelfspace for twelve months, in fiscal 2004, we determined that it was a preferableaccounting method to expense the slotting fees at the time revenue isrecognized.  In accordance withAccounting Principles Board Opinion (“APB”) 20, “Accounting Changes,” thecumulative effect of the change in accounting for slotting fees is reflected inthe first quarter of fiscal 2004.  Theunaudited quarterly results for the first, second and third quarters of fiscal2004 are restated for this change in accounting policy as indicated below (inthousands, except per share data):

 
| *** ***                                                                                                                          | *** *** | **1st Quarter**             | ** ** | **2nd Quarter**             | ** ** | **3rd Quarter**             | ** ** | **4th Quarter** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|--------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------|------------|
| *** ***                                                                                                                          | *** *** | **(Restated)  (Unaudited)** | ** ** | **(Restated)  (Unaudited)** | ** ** | **(Restated)  (Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| Income  (loss) before cumulative effect of a change in accounting principle and  preferred dividends, as reported                     |         | $                           | (1,730     | )                           | $          | (1,225                      | )          | $               | 108        |   | $ | (3,398 | ) |
| Adjustment  to record actual slotting fees incurred                                                                                   |         | 9                           |       | 330                         |       | (131                        | )          | n/a             |       |
| Loss before  cumulative effect of a change in accounting principle and preferred  dividends, as adjusted                              |         | (1,721                      | )          | (895                        | )          | (23                         | )          | (3,398          | )          |
| Cumulative  effect of a change in accounting for slotting fees                                                                        |         | (1,150                      | )          | —                      |       | —                      |       | —          |       |
| Preferred  dividends                                                                                                                  |         | 1,294                       |       | 1,294                       |       | 1,149                       |       | 1,102           |       |
| Net loss  applicable to common shareholders                                                                                           |         | $                           | (4,165     | )                           | $          | (2,189                      | )          | $               | (1,172     | ) | $ | (4,500 | ) |
| Basic and  diluted net loss per share applicable to common shareholders, as reported                                                  |         | $                           | (0.34      | )                           | $          | (0.28                       | )          | $               | (0.12      | ) | $ | (0.50 | ) |
| Adjustment  for reversal of period slotting fee additions and amortization and cumulative  effect of a change in accounting principle |         | $                           | (0.13      | )                           | $          | 0.04                        |       | $               | (0.01      | ) | $ | n/a |   |
| Basic and  diluted net loss per share applicable to common shareholders, as adjusted (1)                                              |         | $                           | (0.46      | )                           | $          | (0.24                       | )          | $               | (0.13      | ) | $ | (0.50 | ) |

 

----

(1)          Per share amounts may not add due to rounding.

 

F-12

----

 

Pro forma results for fiscal 2003 and 2002, assuming the change inaccounting for slotting fees occurred on October 1, 2001, the first day offiscal 2002, are as follows (in thousands, except per share data):

 
| ** **                                                                                                        | ** ** | **Fiscal 2003** | ** ** | **Fiscal 2002** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
| Income  (loss) before cumulative effect of a change in accounting principle and  preferred dividends, as reported |       | $               | (5,202     | )               | $          | 1,081 |   |
| Adjustment  to record actual slotting fees incurred                                                               |       | (216            | )          | (474            | )          |
| Income  (loss) before cumulative effect of a change in accounting principle and  preferred dividends, pro forma   |       | $               | (5,418     | )               | $          | 607 |   |
|                                                                                                              |       |            |       |            |       |
| Net loss  applicable to common shareholders, as reported                                                          |       | $               | (10,790    | )               | $          | (3,874 | ) |
| Adjustment  to record actual slotting fees incurred                                                               |       | (216            | )          | (474            | )          |
| Net loss  applicable to common shareholders, pro forma                                                            |       | $               | (11,006    | )               | $          | (4,348 | ) |
|                                                                                                              |       |            |       |            |       |
| Basic and  diluted loss per share before cumulative effect of a change in accounting  principle, as reported      |       | $               | (1.15      | )               | $          | (0.43 | ) |
| Adjustment  to record actual slotting fees incurred                                                               |       | (0.02           | )          | (0.05           | )          |
| Basic and  diluted loss per share before cumulative effect of a change in accounting  principle, pro forma(1)     |       | $               | (1.18      | )               | $          | (0.48 | ) |
|                                                                                                              |       |            |       |            |       |
| Basic and  diluted net loss per share applicable to common shareholders, as reported                              |       | $               | (1.20      | )               | $          | (0.43 | ) |
| Adjustment  to record actual slotting fees incurred                                                               |       | $               | (0.02      | )               | $          | (0.05 | ) |
| Basic and  diluted net loss per share applicable to common shareholders, pro forma                                |       | $               | (1.22      | )               | $          | (0.48 | ) |

 

----

(1)          Per share amounts may not add due to rounding.

 

***Accounting for Goodwill Impairment***

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, “Goodwill and OtherIntangible Assets,” we evaluated our goodwill balance for impairment upon theadoption of SFAS No. 142 in the first quarter of fiscal 2003 utilizing thediscounted cash flows method and determined that the entire goodwill balance of$411,000 was permanently impaired. Accordingly, we wrote off our entire goodwill balance of $411,000 in thefirst quarter of fiscal 2003.

 

Had we adopted SFAS No. 142 at the beginningof fiscal 2002, assuming no impairment charge, our net loss and net loss pershare would have been as follows (in thousands, except per share amounts):

 
| ** **                                                                           | ** ** | **Year Ended  September 30,  2002** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| Net loss, as  reported                                                               |       | $                                        | (3,874     | ) |
| Add back  amortization                                                               |       | 123                                      |       |
| Net loss, as  adjusted                                                               |       | $                                        | (3,751     | ) |
|                                                                                 |       |                                     |       |
| Basic and  diluted net loss per share applicable to common shareholders, as reported |       | $                                        | (0.43      | ) |
| Effect of  amortization add back                                                     |       | 0.01                                     |       |
| Basic and  diluted net loss per share applicable to common shareholders, as adjusted |       | $                                        | (0.42      | ) |

 

F-13

----

 

**4.****                                      NEWACCOUNTING PRONOUNCEMENTS**

 

***EITF 04-8***

In October 2004, the FASB ratified EITF 04-8, “Accounting IssuesRelated to Certain Features of Contingently Convertible Debt and the Effect onDiluted Earnings Per Share.”  The newrules require companies to include shares issuable upon conversion ofcontingently convertible debt in their diluted earnings per share (EPS)calculations regardless of whether the debt has a market price trigger that isabove the current fair market value of the company’s common stock that makesthe debt currently not convertible. The new rules are effective for reportingperiods ending on or after December 15, 2004.

 

The shares issuable upon conversion of our Convertible Note werepreviously required, and are still required under the new rules, to be includedin our diluted EPS calculation, if the effect of the conversion is dilutive(e.g., the EPS calculation including the deemed conversion of the notes islower than the EPS calculation excluding such deemed conversion). Given thatthe current impact of our Convertible Note on our diluted EPS calculations isanti-dilutive, the shares issuable upon conversion are excluded from ourreported diluted EPS calculations and, as long as they remain anti-dilutive,shall remain excluded from our diluted EPS calculations under the new rules.

 

***SFAS No. 151***

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs:an amendment of ARB No. 43, Chapter 4,” to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs and wastedmaterial.  SFAS No. 151 is effective forinventory costs incurred during fiscal years beginning after June 15,2005.  We do not believe the provisionsof SFAS No. 151, when applied, will have a material impact on our financialposition or results of operations.

 

***SFAS No. 123R***

In December 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment: an amendment of FASB Statements No. 123 and 95,” which requirescompanies to recognize in their income statement the grant-date fair value ofstock options and other equity-based compensation issued to employees.  SFAS No. 123R is effective for interim orannual periods beginning after June 15, 2005.  Accordingly, we will adopt SFAS No. 123R inour fourth quarter of fiscal 2005. Unamortized stock-based compensationexpense, on a pro forma basis, as of September 30, 2004 totaled $355,000,with $165,000 to be amortized in fiscal 2005 (including $41,000 in the fourthquarter of fiscal 2005), $144,000 to be amortized in fiscal 2006 and $46,000 tobe amortized in fiscal 2007.

 

**5.             INVENTORIES**

 

Detail of inventories at September 30, 2004 and 2003 is as follows(in thousands):

 
| ** **              | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Raw  materials          |       | $        | 967        |     | $          | 1,222 |   |
| Packaging  and supplies |       | 426      |       | 330      |       |
| Finished  goods         |       | 7,571    |       | 7,639    |       |
|                    |       | $        | 8,964      |     | $          | 9,191 |   |

 

**6.****                                      PREPAIDEXPENSES**

 

Prepaid expenses included $1.2 million of prepaid slotting fees, net ofaccumulated amortization, at September 30, 2003.  See also Note 3.  No other individual items represented 5% ormore of the total current assets balance at September 30, 2004 or 2003.

 

F-14

----

 

**7.****                                      MACHINERY,EQUIPMENT AND LEASEHOLD IMPROVEMENTS**

 

Detail of machinery andequipment and leasehold improvements at September 30, 2004 and 2003 is asfollows (in thousands):

 
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Machinery  and equipment        |       | $        | 18,415     |     | $          | 17,181 |   |
| Office  furniture and equipment |       | 3,869    |       | 3,829    |       |
| Leasehold  improvements         |       | 1,550    |       | 1,547    |       |
|                            |       | 23,834   |       | 22,557   |       |
| Construction  in progress       |       | 119      |       | —   |       |
|                            |       | 23,953   |       | 22,557   |       |
| Less  accumulated depreciation  |       | (13,303  | )          | (10,588  | )          |
|                            |       | $        | 10,650     |     | $          | 11,969 |   |

 

**8.****                                      OTHERASSETS**

 

Otherassets primarily include deferred financing fees and trademarks. Thegross amount of deferred financing fees and trademarks and the relatedaccumulated amortization were as follows (in thousands):

 
| ** **                | ** ** | **September 30,** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **2004**               | ** ** | **2003** | ** ** |
| Deferred  financing fees  |       | $                      | 2,006      |   | $ | 1,689 |   |
| Accumulated  amortization |       | (1,647                 | )          | (1,329 | ) |
|                      |       | 359                    |       | 360 |   |
|                      |       |                   |       |   |   |
| Trademarks                |       | 415                    |       | 415 |   |
| Accumulated  amortization |       | (78                    | )          | (68 | ) |
|                      |       | 337                    |       | 347 |   |
|                      |       | $                      | 696        |   | $ | 707 |   |

 

Amortization expense wasas follows during fiscal 2004 and 2003 (in thousands):

 
| ** **               | ** ** | **Year Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| Deferred  financing fees |       | $                                  | 318        |   | $ | 305 |   |
| Trademarks               |       | $                                  | 10         |   | $ | 10 |   |

 

Amortization of thedeferred financing fees and trademarks is as follows over the next five fiscalyears (in thousands):

 
| ** ** | ** ** | **Deferred  Financing  Fees** | ** ** | **Trade-  Marks** | ** ** |
|------------|------------|-------------------------------|------------|-------------------|------------|
| 2005       |       | $                             | 179        |              | $          | 10 |   |
| 2006       |       | 149                           |       | 10                |       |
| 2007       |       | 31                            |       | 10                |       |
| 2008       |       | —                        |       | 10                |       |
| 2009       |       | —                        |       | 10                |       |
|            |            |                               |            |                   |            |  |  |

 

**9.****                                      OTHERCURRENT LIABILITIES**

 

Other current liabilities include the following (in thousands):

 
| ** **                | ** ** | **September 30,** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **2004**               | ** ** | **2003** | ** ** |
| Accrued  coupon liability |       | $                      | 11         |   | $ | 949 |   |
| Accrued  interest         |       | $                      | 3,288      |   | $ | 845 |   |

 

F-15

----

 

In addition, other current liabilities at September 30, 2003included $280,000 related to the moveof our corporate offices from Portland, Oregon to Irvine, California pursuantto SFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities.”

 

**10.****                               COMMITMENTSAND CONTINGENCIES**

 

***Operating Leases***

The Company leases its operating facilities and corporate offices.  Additionally, the Company leases certainequipment.  Future minimum lease paymentsunder operating leases at September 30, 2004 are as follows (inthousands):

 
| **Year Ending September 30,** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2005                               |       | $          | 684        |   |
| 2006                               |       | 694        |       |
| 2007                               |       | 575        |       |
| 2008                               |       | 150        |       |
| 2009                               |       | 9          |       |
| Thereafter                         |       | —     |       |
| Total                              |       | $          | 2,112      |   |

 

Rental expense for the years ended September 30, 2004, 2003 and2002 was $661,000, $773,000 and $1.6 million, respectively.

 

***Contractual Obligations***

Principal payments under our term loan, our Convertible Note and ouroperating leases are significant.  A schedule ofpayments remaining due at September 30, 2004 in the next five fiscalyears, including exit fees of $750,000 for the term loan and approximately $3.5million for the Convertible Note, is as follows (in thousands):

 
| ** **                  | ** ** | **Total** | ** ** | **Fiscal 2005** | ** ** | **Fiscal  2006-2007** | ** ** | **Fiscal  2008-2009** | ** ** | **Thereafter** | ** ** |
|-----------------------------|------------|-----------|------------|-----------------|------------|-----------------------|------------|-----------------------|------------|----------------|------------|
| Term Loan                   |       | $         | 5,611      |            | $          | 2,000                 |       | $                     | 3,611      |           | $          | — |   | $ | — |   |
| Convertible  Note           |       | 20,379    |       | —          |       | 20,379                |       | —                |       | —         |       |
| Operating  Leases           |       | 2,112     |       | 684             |       | 1,269                 |       | 159                   |       | —         |       |
| Purchase  Order Obligations |       | 794       |       | 794             |       | —                |       | —                |       | —         |       |
| License Agreement           |       | 346       |       | 75              |       | 150                   |       | 121                   |       | —         |       |
| Retention  Agreements       |       | 1,445     |       | —          |       | 1,445                 |       | —                |       | —         |       |
| Total                       |       | $         | 30,687     |            | $          | 3,553                 |       | $                     | 26,854     |           | $          | 280 |   | $ | — |   |

 

In addition, we haveemployment, severance and change-in-control agreements with our executiveofficers and certain other employees, which provide for benefits upon, amongother things, a sale of Gardenburger. See also Note 19.

 

In the normal course ofbusiness, we offer customers trade spending incentives.

 

**11.****                              ****REVOLVING CREDIT AND TERM LOAN**

 

On January 10,2002, we entered into a Revolving Credit and Term Loan Agreement (as amended,the “Loan Agreement”) with CapitalSource Finance LLC (“CapitalSource”).  The Loan Agreement provides for an $8.0million term loan and a $7.0 million line of credit (together, “the Loans”).  We paid a closing fee of $300,000 toCapitalSource (the “Closing Fee”) in January 2002.

 

Pursuant to the LoanAgreement, cash receipts related to our accounts receivable are deposited intoa lockbox and are then applied against our line of credit balance, generallythe next business day.  Accordingly, cashin our lockbox is considered restricted.

 

F-16

----

 

In order to addressissues relating to our ability to meet our financial obligations and to addressnon-compliance with certain of our financial covenants, we entered intoamendments to the Loan Agreement in late December 2003.  The amendments, which extend the maturity ofthe Loan Agreement from December 15, 2004 to January 31, 2007, wereapproved by our shareholders at our Annual Shareholder Meeting in March 2004.

 

In December 2003and in August 2004, we also negotiated amendments to our financialcovenants in the Loan Agreement. These amendments were not subject toshareholder approval.  Accordingly, weare required under the Loan Agreement to maintain compliance with the followingfinancial covenants, measured quarterly unless otherwise noted:

 

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

•                  minimumearnings for a rolling 12-month period, as adjusted to exclude certain expensesand non-cash charges, ranging from a low of $3,000,000 for the quarter ended June 30,2004, to a high of $6,000,000 for the quarter ending September 30, 2005,and thereafter (“minimum adjusted EBITDA”);

•                  aminimum senior fixed charge coverage ratio for the following quarterly periods:a ratio of 1.35:1.00 for the quarter ended September 30, 2004, a ratio of1.25:1.00 for the quarter ended December 31, 2004, a ratio of 1.48:1.00for the quarter ended March 31, 2005, and a ratio of 1.57:1.00 for thequarter ended June 30, 2005;

•                  aminimum fixed charge coverage ratio of 1.10:1.00 for the quarter ending September 30,2005 and 1.25:1.00 thereafter; and

•                  capitalexpenditures in an amount per fiscal year not exceeding $1,550,000 for thefiscal year ending September 30, 2004, and $1,100,000 for fiscal yearsending thereafter; and

•                  ifrepayment or termination occur on or before August 13, 2005, a terminationfee is due (unless CapitalSource is the lender in the credit facility whichreplaces or refinances the Loan Agreement) equal to 1% of the sum of (A) themaximum amount of the revolving credit facility under the Loan Agreement and(B) the outstanding balance of the term loan under the Loan Agreement, minusthe amount of scheduled principal payments made between August 13, 2004and the date of such repayment or termination.

 

In addition, we may not,among other restrictions, (1) incur any additional indebtedness other thanaccounts payable, except in certain limited circumstances, (2) create anyliens on our assets, (3) invest in other entities, (4) pay dividends,redeem our capital stock (including preferred stock), or make unscheduledpayments under our Convertible Note (except as expressly permitted),(5) sell assets other than in the ordinary course, except in certainlimited circumstances, (6) engage in any transaction with an affiliate,(7) amend our Articles of Incorporation or Bylaws in a manner that wouldbe adverse to CapitalSource, or (8) enter into any contingent obligations orguarantee the obligations of another.

 

Earnings for the purposeof calculating financial covenants is calculated as follows: net income or lossdetermined in conformity with GAAP, plus: i) interest expense; ii) taxes onincome, whether paid, payable or accrued; iii) depreciation expense; iv)amortization expense; v) non-cash dividends on preferred stock; vi) all othernon-cash, non-recurring charges and expenses, excluding accruals for cashexpenses made in the ordinary course of business; and vii) certain agreed uponadjustments, all of the foregoing determined in accordance with GAAP, less allnon-cash income.

 

In consideration of thematurity date extensions, the financial covenant amendments and the waiversreceived for prior violations, we paid a loan amendment fee to CapitalSource ofapproximately $130,000 in fiscal 2004. The Loan Agreement, as amended,prohibits us from paying accrued interest on the Restated Convertible SeniorSubordinated Notes (the “Convertible Note”) prior to September 30, 2004,and permits us to pay interest on the Convertible Note on or after September 30,2004, only if, and to the extent that, we comply with specified financialcovenants and levels of capital availability.

 

F-17

----

 

As of September 30, 2004 we were out of compliance with theminimum adjusted EBITDA covenant.  Therequirement as of September 30, 2004 was a minimum of $4.9 million and ouractual was $0.6 million. We were also out of compliance with the maximumleverage ratio covenant in the Loan Agreement. Our maximum leverage ratio was 16.41 at September 30, 2004 and therequirement in the Loan Agreement is to be no more than 2.50. We were also outof compliance with the senior fixed charge coverage ratio covenant in the LoanAgreement. Our senior fixed charge coverage ratio was 0.15 at September 30,2004 and the requirement in the Loan Agreement is to be no less than 1.35.

 

On February 18, 2005, we entered into an amendment of our LoanAgreement with CapitalSource.  Thisamendment included waivers of the September 30, 2004 non-compliance withthe covenants in the Loan Agreement referenced in the preceding paragraph.   See also Note 19. Subsequent Events.

 

Principal payments,including a $750,000 exit fee, due under the term loan over the next five yearsare as follows (in thousands):

 
| **Year Ending September 30,** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2005                               |       | $          | 2,000      |   |
| 2006                               |       | 2,000      |       |
| 2007                               |       | 1,611      |       |
| 2008                               |       | —     |       |
| 2009                               |       | —     |       |
| Total                              |       | $          | 5,611      |   |

 

Amounts due but not paidunder the term loan will be automatically drawn from the line of credit,subject to availability.  At September 30,2004, we had $4.9 million of principal outstanding under this term loan at aninterest rate of 10% and $652,000 of accrued exit fees.

 

The Loans are secured byour assets, including, without limitation, our accounts receivable, inventory,equipment, intellectual property and bank deposits. The Loan Agreement containscross default provisions with respect to our other indebtedness, including theConvertible Note.

 

We must pay toCapitalSource and any participating lenders an unused line of credit fee equalto 0.083% per month of unused amounts under the line of credit, which totaled$32,116 in fiscal 2004, $42,964 in fiscal 2003 and $35,044 in fiscal 2002.  In addition, we must pay to CapitalSource, asagent under the Loan Agreement, a collateral management fee of $4,167 permonth.  Upon the earlier of prepayment infull of the term loan or its expiration date, we will pay a $750,000 exitfee.  We may elect to prepay the Loans atany time.  The $750,000 exit fee is beingamortized as additional interest expense over the life of the Loans, increasingthe effective interest rate on the Loans.

 

See also Note 19.Subsequent Events.

 

**12.****                              ****CONVERTIBLE SENIOR SUBORDINATED NOTES AND WARRANTS**

 

In September 2004, Dresdner Kleinwort Benson Private Equity PartnersLP (“Dresdner”), the original holder of our Convertible Note, transferred allrights, including interest accrued from September 30, 2001, pursuant tothe Convertible Note, to Annex Holdings I LP (“Annex”).  There were no changes to the terms of the ConvertibleNote upon this transfer.

 

At September 30, 2004, there was approximately $16.9 million ofprincipal and $2.5 million of accrued exit fees included in convertible notepayable on our balance sheet related to our Convertible Note. Under the terms ofthe Convertible Note, we agreed to (i) increase the interest rate from 7%to 10%, effective January 10, 2002, and to 13%, effective October 1,2003; and (ii) pay a 20% premium, or exit fee, on the principal plus accruedbut unpaid interest at repayment or maturity. The Convertible Note is convertible into common stock at the election ofthe holder; the conversion price at September 30, 2004 was $9.78 pershare.

 

F-18

----

 

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

 

Interest is payable in cash semi-annually to the extent of availabilityunder the CapitalSource line of credit. However, in September 2003, Dresdner agreed to permit the deferralof our September 30, 2003 interest payment, which totaled $845,000, to December 31,2003.  In December 2003, thisinterest payment was further deferred to no earlier than September 30,2004.  In addition, $576,000 was accrued ineach of the first and second quarters of fiscal 2004, and $604,000 was accruedin each of the third and fourth quarters of fiscal 2004.  Accordingly, we included the total of $3.2million and $845,000, respectively, on our balance sheets as of September 30,2004 and September 30, 2003 in other current liabilities.

 

We are required to applya portion of excess cash flow (as defined below) to repay accrued interest andthe outstanding principal amount of the Restated Convertible Note, subject tocertain specified exceptions. We must, at all times, pay 50% of excess cashflow to pay down indebtedness to CapitalSource and to Annex in specifiedproportions. As of September 30, 2004, we were not obligated to pay anyamounts to Annex or CapitalSource under the excess cash flow provision.

 

Excess cash flow for anyfiscal year is defined as an amount equal to the sum of: i) consolidated netincome or loss; ii) depreciation, amortization, accrued non-cash interestexpense and all other non-cash charges deducted in arriving at consolidated netincome or loss; iii) net cash proceeds from the sale, lease, transfer or otherdisposition of assets that is not reinvested in other collateralized assets orrequired to be applied to mandatory prepayments or payments on the Loans; iv)the net loss on the sale, lease, transfer or other disposition of assets; andv) the amount of any tax credits or refunds received less the sum of a)non-financed capital expenditures; b) payments required by and paid on theLoans and voluntary prepayments made on the Loans; c) the net gain on the sale,lease, transfer or other disposition of assets, other than sales in theordinary course of business; and d) an amount equal to the increase in workingcapital during the period.

 

The Convertible Note contains financial covenants which are the same asthose in the Loan Agreement, but in each case slightly more favorable to us.The Convertible Note also contains subordination provisions with respect to theLoans and cross default provisions with respect to our other indebtedness,including the Loans.

 

As of September 30, 2004 we were out of compliance with theminimum adjusted EBITDA covenant.  Therequirement as of September 30, 2004 was a minimum of $4.4 million and ouractual was $0.6 million.  We were alsoout of compliance with the maximum leverage ratio covenant in the ConvertibleNote.  Our maximum leverage ratio was16.41 at September 30, 2004 and the requirement in the Convertible Note isto be no more than 2.75. We were also out of compliance with the senior fixedcharge coverage ratio covenant in the Convertible Note.  Our senior fixed charge coverage ratio was0.15 at September 30, 2004 and the requirement in the Convertible Note isto be no less than 1.22.

 

On February 18, 2005, we entered into an amendment of ourConvertible Note with Annex. This amendment included a waiver of the September 30,2004 non-compliance with the covenants in the Convertible Note referenced inthe preceding paragraph.  See also Note19. Subsequent Events.

 

In addition, under theterms of the Warrant Agreement, which was issued in January 2002 inconnection with certain term revisions to the Convertible Note, we issued animmediately exercisable warrant with a ten-year term to purchase557,981 shares of our common stock at a price of $0.28 per share, subjectto anti-dilution adjustments.  Annex hasregistration rights with respect to shares issuable upon exercise of thiswarrant.

 

F-19

----

 

We accounted for theterm revisions, including the exit fee premiums, in accordance with SFAS No. 15“Accounting by Debtors and Creditors for Troubled Debt Restructurings.”Accordingly, we accounted for the effects of the term revisions on aprospective basis from the date of the revisions and no gain or loss wasrecorded on that date.  We computed aneffective interest rate taking into consideration the imputed value of therevised terms, which was applied as of the revision date through the maturity date.

 

See also Note 19.Subsequent Events.

 

**13.****                              ****CONVERTIBLE REDEEMABLE PREFERRED STOCK**

 

We have outstanding552,500 shares of Series C Convertible Redeemable Preferred Stock (“SeriesC Stock”) with a face value of $27.6 million and 97,500 shares of Series DConvertible Redeemable Preferred Stock (“Series D Stock”) with a face value of$4.9 million, which are convertible into 2,762,500 and 1,300,000 shares(subject to antidilution adjustments) of our common stock, respectively, at anytime at the discretion of the holder.

 

The terms of the Series CStock and Series D Stock provide for a 10% premium on any liquidation orredemption, which totals $4.3 million. The premium is being accreted over theredemption period.  At September 30,2004, we had accrued $2.5 million in relation to the redemption premium, whichis included in the preferred stock balance on the balance sheet.  The liquidation preference of the Series Cand Series D Stock was $58.1 million at September 30, 2004.

 

As approved by ourshareholders at our 2004 Annual Shareholder Meeting in March 2004, theterms of our Series C Stock and Series D Stock were amended to defer theearliest date on which holders may require redemption of their shares of SeriesC Stock and Series D Stock to as late as June 30, 2008 instead of March 31,2006. Accordingly, the amount of the 10% redemption premium not previouslyaccreted will be accreted over a longer period of time, which reduced ourquarterly preferred dividend charge from $1.3 million to approximately $1.2million beginning in the third quarter of fiscal 2004. Detail of our preferreddividends is as follows (in thousands):

 
| ** **                            | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| 12%  cumulative dividends             |       | $                                 | 3,900      |   | $ | 3,900 |   | $ | 3,900 |   |
| Accretion of 10% redemption premium   |       | 769                               |       | 1,022 |   | 741 |   |
| Accretion of  original issue discount |       | 170                               |       | 255 |   | 314 |   |
|                                  |       | $                                 | 4,839      |   | $ | 5,177 |   | $ | 4,955 |   |

 

Farallon Partners,L.L.C., and its affiliates, which together own approximately 30.8% of ourSeries C and Series D Stock, have a substantial equity interest inCapitalSource Holdings LLC, which controls CapitalSource.  An affiliate ofRosewood Capital III, L.P., which also owns approximately 30.8% of the Series Cand Series D Stock, has a small (less than 2%) equity interest in CapitalSourceHoldings LLC.  Two of our former directors are employed by an affiliate ofRosewood Capital III, L.P.  These directors resigned from our Board ofDirectors effective October 4, 2004.

 

F-20

----

 

**14.****                               INCOMETAXES**

 

We account for incometaxes under SFAS No. 109, “*Accounting for IncomeTaxes.” *We realize taxbenefits as a result of the exercise of non-qualified stock options and theexercise and subsequent sale of certain incentive stock options (disqualifyingdispositions).  For financial reportingpurposes, any reduction in income tax obligations as a result of these taxbenefits is credited to additional paid-in capital.  There were no tax benefits realized relatedto stock options in fiscal 2004, 2003 or 2002.

 

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

 
| ** ** | ** ** | **Year Ended September 30,** | ** ** |
|------------|------------|-----------------------------------|------------|
| ** ** | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| CURRENT:   |       |                              |       |   |   |   |   |
| Federal    |       | $                                 | —     |   | $ | — |   | $ | — |   |
| State      |       | —                            |       | — |   | — |   |
|       |       | —                            |       | — |   | — |   |
| DEFERRED   |       | —                            |       | — |   | — |   |
|       |       | $                                 | —     |   | $ | — |   | $ | — |   |

 

Total deferred incometax assets were $25.3 million and $23.6 million at September 30, 2004 and2003, respectively, and deferred income tax liabilities were $1.2 million atboth September 30, 2004 and 2003, prior to the consideration of anyvaluation allowance.  Individuallysignificant deferred tax assets and liabilities are as follows (in thousands):

 
| ** **                                         | ** ** | **September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | **2004**               | ** ** | **2003** | ** ** |
| Net  operating loss carryforwards                  |       | $                      | 23,376     |   | $ | 21,685 |   |
| Provision  for trade promotions and discounts      |       | 825                    |       | 584 |   |
| Book/tax  depreciation and amortization difference |       | (1,187                 | )          | (1,186 | ) |
| Other                                              |       | 1,101                  |       | 1,283 |   |
|                                               |       | 24,115                 |       | 22,366 |   |
| Valuation  allowance                               |       | (24,115                | )          | (22,366 | ) |
| Net deferred  tax balance                          |       | $                      | —     |   | $ | — |   |

 

In accordance with SFAS No. 109, we have recorded a valuation allowanceagainst the entire amount of net deferred tax assets as of September 30,2004 and 2003 as a result of recurring operating losses in recent years.

 

We have tax net operating loss carryforwards, totaling $60.9 million, which expire as follows: 2012: $1.4 million; 2018: $10.4 million; 2019: $31.6 million; 2020: $3.0 million; 2021: $4.4 million; 2022: $0.6 million; 2023: $6.8 million; and 2024: $2.7 million.  However, in conjunction with the redemption of our Series A and Series B Convertible Redeemable Preferred Stock and the issuance of our Series C and Series D Convertible Redeemable Preferred Stock in January 2002, we experienced an ownership change as defined in the Internal Revenue Code and, accordingly, the use of our pre-January 2002 net operating losses are subject to an annual limitation of approximately $2.4 million.  Our net operating losses may be limited further in the future due to additional changes in the ownership of Gardenburger.

 

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

 
| ** **                                      | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                      | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| 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                            |       | 15.5                              |       | 18.4 |   | 49.1 |   |
| Slotting  fees                                  |       | 2.9                               |       | — |   | — |   |
| Trademark  and goodwill amortization            |       | —                            |       | — |   | 0.9 |   |
| Meals and  entertainment                        |       | 0.1                               |       | 0.1 |   | 0.4 |   |
| Effect of  change in valuation allowance        |       | 19.9                              |       | 20.2 |   | (12.9 | ) |
| Other                                           |       | —                            |       | (0.3 | ) | 0.9 |   |
| Effective  tax rate                             |       | 0.0                               | %          | 0.0 | % | 0.0 | % |

 

F-21

----

 

**15.****                               SHAREHOLDERS’EQUITY**

 

***Preferred Stock***

We have authorized 5,000,000 shares of preferred stock, of which650,000 shares have been issued (see Note 13). 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 Share Purchase Rights***

In April 1996, wedeclared a dividend distribution of one preferred share purchase right on eachoutstanding share of our common stock. Each right, when exercisable, will entitle shareholders to buy oneone-hundredth of a share of Series A Junior Participating Preferred Stock at anexercise price of $47 per share. The rights will become exercisable if a personor group (an “Acquiring Person”) acquires 15% or more of our common stock (withcertain exceptions) or announces a tender offer for 15% or more of the commonstock.  With the exception of certaincash tender offers, if a person becomes an Acquiring Person, or in the event ofcertain mergers with an Acquiring Person, the rights will become exercisablefor shares of common stock with a market value of two times the exercise priceof the right. Our Board of Directors is entitled to redeem the rights at $.01per right at any time before an Acquiring Person has acquired 15% or more ofthe outstanding common stock.

 

***Restrictions onDividends***

No cash dividends may bepaid on our common stock unless dividends have been paid on all outstandingshares of our Series C Stock and Series D 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.  In addition, we are prohibited from payingcash dividends or redeeming any of our capital stock under the terms of theLoan Agreement and the Convertible Note.

 

***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 stock options(“ISOs”) and non-statutory stock options (“NSOs”), stock appreciation rights,restricted awards, performance awards, and other stock-based awards.

 

The exercise price pershare generally must be at least 100% of the fair market value of a share of commonstock on the date the option is granted for ISOs, 75% for NSOs and 25% fordeferred compensation options. The Executive Personnel and CompensationCommittee of our Board of Directors determines the vesting and other terms ofthe awards under the 2001 Plan.  Vestingfor certain options may accelerate upon a change in control.  Options granted under the 2001 Plan and the1992 Plan generally vest over a three to five year period.

 

The 2001 Plan permitsthe issuance of up to 1,400,000 shares of our common stock plus 1,951,023shares available under the 1992 Plan.  Inaddition, if awards granted under the 1992 Plan are forfeited or expire, sharesof common stock reserved for such forfeited or expired awards become availablefor issuance under the 2001 Plan.  As of September 30, 2004, we had3,351,023 shares of common stock reserved for issuance under the 2001 Plan andthe 1992 Plan combined.

 

F-22

----

 

Activity under the 1992Plan and the 2001 Plan is summarized as follows (in thousands, except per shareamounts):

 
| ** **                             | ** ** | **Shares Available  for Grant** | ** ** | **Shares Subject to  Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|--------------------------------------|------------|
| **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                                 |       |
| Options  canceled                      |       | 902                             |       | (902                           | )          | 3.10                                 |       |
| **Balances,  September 30, 2004** |       | 1,617                           |       | 1,734                          |       | $                                    | 3.50       |   |

 

***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 for aperiod 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 the exerciseperiod of the non-statutory stock option for an additional two years and on December 3,2003, for an additional three years and this option now expires January 31,2007.  We did not recognize anycompensation expense upon making any of the changes to the expiration date ofthis stock option since the individual was still an employee and director andthe exercise price of the stock option was greater than the fair market valueof our common stock on the dates that the changes were made.

 

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, 2004, an option to purchase 950,000 shares ofcommon stock remained outstanding and exercisable in full and 950,000 shares ofour common stock were reserved for issuance under this option grant.

 

On April 14, 1996, we granted an option to our then ChiefExecutive Officer exercisable for 300,000 shares of our common stock.  Pursuant to the terms of the original grant,such option is exercisable for a period of five years from the Chief ExecutiveOfficer’s termination date of August 4, 2000 at an exercise price of $8.69per share.  At September 30, 2004,the entire option remained outstanding, and we had 300,000 shares of commonstock 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                        |       |
| 2003            |       | —                |       | —                       |       |
| 2004            |       | 3,000                 |       | 11.63                        |       |
|                 |            |                       |            |                              |            |  |

 

F-23

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At September 30, 2004, options covering 33,000 shares of commonstock were outstanding at an average exercise price of $10.68 and 33,000 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 2004 and fiscal 2001, options covering 1,500 and 7,000shares of common stock were canceled, respectively, and at September 30,2004, options covering 6,000 shares of common stock were outstanding andreserved for issuance under these option grants.

 

The following tablesummarizes information about all stock options outstanding at September 30,2004:

 
| **Options Outstanding**       | ** ** | **Options Exercisable**             | ** ** |
|-------------------------------|------------|-------------------------------------|------------|
| **Range of Exercise  Prices** | ** ** | **Number  Outstanding  at 9/30/04** | ** ** | **Weighted  Average  Remaining Contractual  Life - Years** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares  Exercisable  at 9/30/04** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.4150                       | - $1.3563  |                                |       | 1,898,900 |   | 4.7 |   | $ | 0.7851 |   | 1,516,200 |   | $ | 0.8398 |   |
| 1.3564                        | - 2.7125   |                                |       | 140,500 |   | 6.0 |   | 1.7185 |   | 140,500 |   | 1.7185 |   |
| 5.4251                        | - 6.7813   |                                |       | 163,000 |   | 3.8 |   | 6.4746 |   | 163,000 |   | 6.4746 |   |
| 6.7814                        | - 8.1375   |                                |       | 220,000 |   | 1.0 |   | 7.5746 |   | 220,000 |   | 7.5746 |   |
| 8.1376                        | - 9.4938   |                                |       | 477,000 |   | 1.0 |   | 8.7051 |   | 477,000 |   | 8.7051 |   |
| 9.4939                        | - 10.8500  |                                |       | 37,420 |   | 4.5 |   | 10.0625 |   | 37,420 |   | 10.0625 |   |
| 10.8501                       | - 12.2063  |                                |       | 57,500 |   | 2.4 |   | 11.6261 |   | 57,500 |   | 11.6261 |   |
| 12.2064                       | - 13.1250  |                                |       | 29,000 |   | 1.5 |   | 12.7371 |   | 29,000 |   | 12.7371 |   |
| $0.4150                       | - $13.1250 |                                |       | 3,023,320 |   | 3.8 |   | $ | 3.3145 |   | 2,640,620 |   | $ | 3.7125 |   |

 

At September 30,2003 and 2002, options covering 2,910,919 and 2,596,368 shares of our commonstock, respectively, were exercisable at weighted average exercise prices of$4.14 per share and $4.76 per share, respectively.

 

***Warrants***

In January 2002, in conjunction with amendments to our ConvertibleNote and Convertible Redeemable Preferred Stock, we issued warrants exercisablefor a total of 1,115,962 shares of our common stock at an exercise price of$0.28 per share.  The warrants areimmediately exercisable and expire 10 years from the date of grant.  As of September 30, 2004, 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 thewarrants, utilizing the Black-Scholes methodology, was $95,000 and was expensedduring fiscal 2002.

 

**16.****                               401(k)PLAN**

 

We have a 401(k) Salary Deferral Plan, which covers all eligibleemployees who have reached the age of 18. The covered employees may elect tohave an amount deducted from their wages for investment in a retirement plan.We match 100% of employee contributions up to 2% of compensation.  Our contribution to this plan wasapproximately $107,000 in 2004, $117,000 in 2003 and $115,000 in 2002.

 

F-24

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**17.****                               SUPPLEMENTALCASH FLOW INFORMATION**

 

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

 
| ** **                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash paid  during the period for interest     |       | $        | 983        |     | $          | 2,017    |       | $ | 2,371 |   |
| Cash paid  during the period for income taxes |       | 5        |       | 7        |       | 12       |       |
| Non-cash  preferred dividends                 |       | 4,839    |       | 5,177    |       | 4,955    |       |
|                                               |            |          |            |          |            |          |            |  |  |  |

 

**18.****                               RELATEDPARTY TRANSACTIONS**

 

Farallon Partners,L.L.C., and its affiliates, which together own approximately 30.8% of ourSeries C Stock and Series D Stock, have a substantial equity interest inCapitalSource Holdings LLC, which controls CapitalSource (see Note 11). An affiliate of Rosewood Capital III, L.P., which also owns approximately 30.8%of our Series C Stock and Series D Stock, has a small (less than 2%) equityinterest in CapitalSource Holdings LLC.  Two of our former directors areemployed by an affiliate of Rosewood Capital III, L.P.  These directorsresigned from our Board of Directors effective October 4, 2004.

 

Richard L. Mazer, adirector, is President and Chief Operating Officer of Ventura Foods, LLC.  We purchased barbecue sauce from VenturaFoods totaling $668,000, $735,000 and $380,000 in fiscal 2004, 2003 and 2002,respectively.  At September 30, 2004and 2003, we owed Ventura Foods LLC $0 and $26,000, respectively, related topurchases of the barbecue sauce. We believe that the price paid to VenturaFoods is fair in comparison with pricesthat would be paid to an independent third party for similar barbecue sauce.

 

Mr. Coleman, aDirector, is Managing Partner of Annex Capital Management LLC to which we areindebted in the principal amount of approximately $16.9 million plus accruedbut unpaid interest related to this debt. This debt currently bears interest at the annual rate of 13%.

 

## **We entered into a licensingagreement with Mr. Wenner, a Director, in fiscal 2004, which expires in May 2009.  Pursuant to the agreement, Mr. Wenner grantsto us an exclusive, royalty-free, worldwide license to make use of, copy,reproduce, modify, adapt, distribute, transmit, broadcast, display, exhibit,project and otherwise exploit certain of Mr. Wenner’s property.  In exchange, we pay Mr. Wenner $75,000 perannum.  The agreement also provides that,during the term of the agreement, Mr. Wenner shall make, at dates and timesreasonably agreed to by each of Mr. Wenner and us, certain personal appearancesfor which Mr. Wenner shall be compensated at the rate of $500 per day, plus allreasonable and necessary expenses (including coach air travel, hotelaccommodations and meal expenses) incurred by Mr. Wenner in connection withsuch personal appearances.  Mr. Wennerreceived approximately $29,000 pursuant to this agreement in fiscal 2004.**

## ** **

**19.****                               SUBSEQUENTEVENTS**

 

**Retention Agreements**

We entered into Retention Agreements with each of Mr. Wallace, Mr.Linford and Mr. Trebing on January 27, 2005.  The Retention Agreements provide incentive for each of the executiveofficers to continue to be employed by Gardenburger, Inc. through and followinga change in control or going private transaction.  The agreements provide for payment of aretention bonus on the earlier of (1) the date of a change of control, (2) thedate of a going private transaction or (3) the second anniversary of theeffective date of the agreement.  If achange in control or going private transaction occurs during the first eighteenmonths following the effective date of the agreement, the executive officerreceives a lump sum payment equal to twelve months of base salary.  If a change in control or going privatetransaction occurs after the eighteen month anniversary of the agreement or ifthe executive officer remains continuously employed by Gardenburger, Inc.through the second anniversary of the effective date of the agreement, theexecutive officer receives a lump sum payment equal to sixteen months of basesalary.  These retention bonuses aresubject to certain conditions set forth in the agreements.

 

F-25

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**Amendments to Debt Agreements**

In order to address issues relating to our ability to meet ourfinancial obligations and to address non-compliance with certain of ourfinancial covenants, we entered into amendments to our Loan Agreement withCapitalSource and our Note Purchase Agreement with Annex on February 18,2005.

 

Pursuant to the amendment to our Loan Agreement, CapitalSource agreedto waive our non-compliance with certain financial covenants as of September 30,2004 and December 31, 2004 and to provide additional availability of up to$500,000 under the revolving credit facility from February 18, 2005 to May31, 2005.  Interest on outstanding advancesunder the revolving notes shall continue to be payable monthly in arrears at anannual rate of prime rate plus 2.50%, except that from February 18, 2005to May 31, 2005, interest shall be payable at an annual rate of prime rate plus4.50%.  After May 31, 2005, the interestrate will revert back to the annual rate of prime rate plus 2.50% unless any ofthe additional $500,000 amount is outstanding, in which case interest shall bepayable at an annual rate of prime rate plus 4.50%.  In any event, interest on outstandingadvances under the revolving notes shall not be less than 8.00%. We agreed topay CapitalSource a fee of $110,000 in connection with the amendment and a feeof $25,000 for the additional availability under the revolving credit facility.  In addition, we are required to pay a$500,000 fee to CapitalSource if our ratio of total debt under the LoanAgreement plus the Convertible Note with Annex to earnings (as defined below)exceeds 1.25:1.00 as of September 30, 2005 and a $250,000 fee if suchratio exceeds 1.25:1.00 as of the end of each quarterly period thereafter.  Under the amendment, we are now required tocomply with the following financial covenants:

•                  Ratioof aggregate indebtedness under the Loan Agreement to earnings (as definedbelow) shall not exceed a ratio of 1.50:1.00 as of September 30, 2005 anda ratio of 1.25:1.00 as of December 31, 2005 and each quarterly periodthereafter;

•                  Minimumearnings (as defined below), as adjusted to exclude certain expenses andnon-cash charges, for the following periods: ($1.0) million for the quarterly period ending March 31, 2005, $1.6million for the quarterly period ending June 30, 2005, and $3.5 millionfor the fiscal year ending September 30, 2005 and each rollingtwelve-month period on a quarterly basis thereafter;

•                  Capitalexpenditures must not exceed $150,000 for the quarterly period ending March 31,2005, $100,000 for the quarterly period ending June 30, 2005, $100,000 forthe quarterly period ending September 30, 2005, and $600,000 for eachfiscal year thereafter; and

•                  Thefixed charge coverage ratio shall not be less than a ratio of 1.10:1.00 as of September 30,2005 and a ratio of 1.15:1.00 as of December 31, 2005 and each quarterlyperiod thereafter.

 

Earnings for the purpose of calculating financial covenants iscalculated as follows:  net income orloss determined in accordance with GAAP, plus (a) interest expense, (b) taxeson income, whether paid, payable or accrued, (c) depreciation expense, (d)amortization expense, (e) non-cash dividends on preferred stock, and (f) allother non-cash, non-recurring charges and expenses, excluding accruals for cashexpenses made in the ordinary course of business, all of the foregoingdetermined in accordance with GAAP, less all non-cash income.

 

Pursuantto the amendment to our Note Purchase Agreement, Annex agreed to waive ournon-compliance with certain financial covenants, and to consent to theamendment to the Loan Agreement.  Underthe terms of the amendment, interest on all outstanding amounts under the NotePurchase Agreement and the Convertible Note will accrue at the rate of 15% perannum.  We agreed to pay Annex a fee of$250,000 in connection with the amendment. In addition, we are required to pay a $1.0 million fee to Annex if ourratio of total debt under the Loan Agreement plus the Convertible Note withAnnex to earnings (as defined above) exceeds 1.25:1.00 as of September 30, 2005and a $500,000 fee if such ratio exceeds 1.25:1.00 as of the end of eachquarterly period thereafter.  These feeswill be added to the principal amount due under the Note Purchase Agreement andthe Convertible Note.  The financialcovenants applicable to the Note Purchase Agreement and the Convertible Noteare similar, but in each case slightly less restrictive than those in the LoanAgreement.  The amendment also providesthat we may not make and Annex may not receive any payment or distributionuntil the earlier of (i) the date that CapitalSource has been paid in fullunder the Loan Agreement and (ii) if the maturity date of the term loan or therevolving facility under the Loan Agreement is extended beyond the maturitydate under the Convertible Note, the date of maturity under the ConvertibleNote. In addition, prior to August 16, 2005, Annex may not exercise anycollection or enforcement rights and remedies they may have, if any, under theConvertible Note.

 

F-26

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GARDENBURGER, INC.

VALUATION AND QUALIFYINGACCOUNTS

YEARS ENDED SEPTEMBER 30,2004, 2003 AND 2002

(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, 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 |   |
|                                     |       |                                 |       |                                |       |                                       |       |                           |       |   |   |
| **Year  Ended September 30, 2004:** |       |                                 |       |                                |       |                                       |       |                           |       |   |   |
|                                     |       |                                 |       |                                |       |                                       |       |                           |       |   |   |
| Reserves  deducted from asset accounts:  |       |                                 |       |                                |       |                                       |       |                           |       |   |   |
|                                     |       |                                 |       |                                |       |                                       |       |                           |       |   |   |
| Allowance  for uncollectible accounts    |       | $                                    | 193        |                                | $          | —                                     |       | $                              | —     |   | $ | 89 |   | $ | 104 |   |

 

----

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

 

F-27

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