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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Commission File Number 0-11488

Registrant’s telephone number, including area code: (303) 649-1900

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $1.00 par value

      Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

      The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant as of October 29, 2002 was approximately $85.5 million. Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The net number of shares of the Registrant’s Common Stock (the Registrant’s only outstanding class of stock) outstanding as of October 29, 2002 was 7,692,344.

Documents Incorporated by Reference

      The Registrant’s definitive Proxy Statement relating to the 2003 Annual Meeting of Shareholders is incorporated by reference into Part III of this Form 10-K.

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PENFORD CORPORATION

FISCAL YEAR 2002 FORM 10-K ANNUAL REPORT

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PART I

     Description of Business

      Penford is in the business of developing, manufacturing and marketing specialty natural-based ingredient systems for industrial and food applications. We use our carbohydrate chemistry expertise to develop functional ingredients with starch as a base for value-added applications in several markets including papermaking, textiles and food products. We manage our business in three segments. The first two, industrial ingredients and food ingredients are broad categories of end-market users, primarily served by our U.S. operations. The third segment is our geographically separate operations in Australia and New Zealand. Our Australian and New Zealand operations are engaged primarily in the food ingredients business, although the industrial market is an important and growing category there. Financial information about our segments is included in Note M to the consolidated financial statements.

      Penford’s family of products provides functional characteristics to the markets into which they are sold. Carbohydrate-based specialty starches possess binding and film-forming attributes that provide natural, convenient and cost-effective solutions that make our customers’ products perform better. We have extensive research and development capabilities, which are used in understanding the complex chemistry of carbohydrate-based materials and their application. In addition, we have specialty processing capabilities for a variety of modified starches, all of which have similar production methods.

      Specialty products for industrial applications are designed to improve the strength, quality and efficiencies in the manufacture of coated and uncoated paper and paper packaging products. These starches are principally ethylated (chemically modified with ethylene oxide) and cationic (carrying a positive electrical charge). Ethylated starches are used in coatings and as binders, providing strength and printability to fine white, magazine and catalog paper. Cationic and other liquid starches are generally used in the paper-forming process in paper production, providing strong bonding of paper fibers and other ingredients. Penford’s products are a cost-effective alternative to more expensive synthetic ingredients.

      Specialty starches produced for food applications are used in coatings to provide crispness, improved taste and texture and increased product life for products such as French fries sold in quick-service restaurants. Food-grade starch products are also used as moisture binders to reduce fat levels, modify texture and improve color and consistency in a variety of foods such as whole and processed meats, dry powdered mixes and other food and bakery products.

      Penford Corporation was incorporated in September 1983 and commenced operations as a publicly-traded company on March 1, 1984.

     Acquisition and Disposition of Operations and Other Transactions

      In November 2002, Penford licensed to National Starch Corporation, a wholly owned subsidiary of ICI of the UK, the exclusive rights to its resistant starch intellectual property portfolio for applications in human nutrition. We retained the rights to practice its intellectual property for all non-human nutrition applications. Under the terms of the agreements Penford will receive an initial payment and annual royalties for a period of five years. The initial cash proceeds to Penford are expected to be approximately $4.1 million, which is net of transaction expenses. The royalty payments are subject to a minimum of $7 million over the five-year term. In connection with this transaction we also entered into a tolling arrangement under which we will make resistant starch products for National Starch.

      Penford Australia Limited was acquired in September 2000. This acquisition expanded our product offerings to include corn-based food grade products. Penford Australia also expands our global geographic market presence in Australia, Asia, and New Zealand.

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      In 1998, we divested our pharmaceuticals operations in a tax-free distribution to shareholders. The divestiture was executed to maximize the growth potential of Penford’s specialty natural-based ingredient systems business, and separately, the pharmaceuticals business.

     Raw Materials

      Corn: Our North American corn wet milling plant is located in Cedar Rapids, Iowa, the middle of the U.S. corn belt. Accordingly, the plant has truck-delivered corn available throughout the year from a number of suppliers at prices related to the major U.S. grain markets. The cost of the corn to be purchased for fixed price sales contracts is generally hedged by entering into corn futures contracts.

      Penford Australia’s corn wet milling facilities in Lane Cove and Auckland, New Zealand are sourced through truck-delivered corn at contracted prices with regional independent farmers and merchants. Corn is purchased at harvest, March-June, and stored for use for the following year.

      Potato Starch: The facilities in Idaho Falls, Idaho, Richland, Washington and Plover, Wisconsin use by-products from potato processors that contain the starch used as the primary raw material to manufacture modified potato starches. We enter into contracts typically having durations of one to five years with potato processors in North America, primarily in the Northwest and Midwest, to acquire our potato-based raw materials.

      Wheat Products: Penford Australia’s Tamworth facility uses wheat flour as the primary raw material for the production of its wheat products such as wheat starch, wheat gluten and glucose syrup. Tanker trucks from a local flourmill supply wheat flour under a three-year supply agreement that assures supply, which expires September 30, 2003.

      Chemicals: The primary chemicals used in our manufacturing processes are commodity chemicals, subject to price fluctuations due to market conditions.

      Natural Gas: The primary energy source for most of our plants is natural gas. We contract our natural gas supply with regional suppliers, generally under short-term supply agreements, and at times use futures contracts to hedge the price of natural gas in North America.

      Corn, potato starch, wheat flour, chemicals and natural gas are not presently subject to availability constraints, although drought conditions in Australia are impacting the prices of corn and wheat in that area. Penford’s current potato starch requirements constitute a material portion of the available North American supply. There can be no assurance that in the long term, continued growth in demand for corn and potato starch-based ingredients and new product development will not result in capacity constraints.

      Over half of our manufacturing costs are the costs of corn, potato starch, wheat flour, chemicals and natural gas. The remaining portion consists primarily of other utility and labor costs. The prices of our raw materials may fluctuate, and there can be no assurance that prices will not change adversely. To mitigate this risk, we hedge a portion of corn and gas purchases with futures and options contracts in the U.S. and enter into short term supply agreements for other production requirements in all locations.

     Research and Development

      Our research and development efforts cover a range of projects including technical service work focused on specific customer support and projects requiring coordination with customers’ research efforts to develop innovative solutions to specific customer requirements. These projects are supplemented with longer-term, new product development and commercialization initiatives. Our research and development expenses were $6.0 million, $6.3 million, and $5.4 million for our fiscal years ended August 31, 2002, 2001 and 2000, respectively.

      At the end of fiscal 2002, Penford had 36 scientists, including 11 PhD’s in carbohydrate and polymer chemistry, who comprise a body of expert knowledge of material characterization and molecular structure of various carbohydrates. This expertise is integral to commercializing new market applications in all facets of our business.

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     Patents, Trademarks and Tradename

      We own a number of patents, trademarks, and tradenames to protect product development and commercialization findings that may provide a competitive advantage in our marketplace. However, most of our products are currently made with technology that is broadly available to companies that have the same level of scientific expertise and production capabilities as Penford. There can be no assurance that the patents we own and utilize will prevent other companies from developing similar or functionally equivalent products or from successfully challenging the validity of these patents. Further, there can be no assurance that our processes or products will not infringe upon the patents of third parties.

      Specialty starch ingredient brand names for our industrial applications include, among others, Penford® Gums, Pensize® binders, Penflex® sizing agent, Topcat® cationic additive, and the Apollo® starch series. Product brand names for our food ingredient applications include PenBind®, PenCling®, PenPlus® , CanTab®, MAPS™, Mazaca™ and Fieldcleer™.

     Quarterly Fluctuations

      Penford’s revenues and operating results vary from quarter to quarter. We experience seasonality with our Penford Australia operations. We have lower sales volumes and gross margins in Australia and New Zealand’s summer months, which corresponds to our second fiscal quarter. This seasonal decline is caused by the closure of some customers’ plants for public holidays and maintenance during this period. Decreased consumption of some foods, such as bread, which use our products also contribute to this seasonal trend.

     Working Capital

      Penford generally carries a 1-45 day supply of materials required for production, depending on the lead time for the specific items. We manufacture finished goods to customer orders or anticipated demand. We are therefore able to carry less than 30 days supply of most products. Terms for trade receivables and trade payables are standard for the industry and region and generally do not exceed 30-day terms except for trade receivables for export sales.

      We carry a longer supply of corn for our Australian operations. We use an inventory financing credit agreement to purchase corn at harvest in Australia for production requirements for the following year. In fiscal 2002, that purchasing activity increased to provide some of the input requirements for our operations in New Zealand to ensure adequate supply and to minimize exposure to the higher local prices in New Zealand due to increased demand for corn by the dairy feed industry.

     Environmental Matters

      Penford has adopted and implemented a comprehensive corporate-wide environmental management program. The program is managed by the Corporate Director of Environmental, Health and Safety and is designed to structure the conduct of our business in a safe and fiscally responsible manner that protects and preserves the health and safety of our employees, the communities surrounding our plants, and the environment. We continuously monitor environmental legislation and regulations, which may affect any of our operations. We are working with the Environmental Protection Agency on an ongoing enforcement initiative. See Item 3, Legal Proceedings for a further discussion of this matter.

      There have been no material impacts on our operations resulting from compliance with environmental regulations. No unusual expenditures for environmental facilities and programs are anticipated in the coming year.

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     Principal Customers

      We sell to a variety of customers for applications in papermaking, textiles and food products. We have several relatively significant customers in each of our businesses. However, over the last three years we had only one customer that exceeded 10% of sales, and that occurred in fiscal 2001 and 2000. MeadWestvaco, a customer of our industrial ingredients business, accounted for approximately 9%, 10% and 15% of total sales in fiscal 2002, 2001 and 2000, respectively.

     Competition

      We compete directly with approximately five other companies that manufacture specialty starches for the papermaking industry and approximately six other companies that manufacture specialty food ingredients. We compete indirectly with a larger number of companies that provide synthetic and natural-based ingredients to industrial and food customers. Although some of these competitors are larger companies, and have greater financial and technical resources, Penford holds a significant market share of our targeted, niche markets. Application expertise, quality, service and price are the major competitive factors for Penford.

     Employees

      At August 31, 2002, Penford had 670 total employees. In North America we had 365 employees, of which approximately 45% are members of a trade union. An extension of our collective bargaining agreement covering our Cedar Rapids-based manufacturing workforce expires in August 2003, and we expect to successfully renegotiate the agreements. Penford Australia had 305 employees, of which 64% are members of trade unions in Australia and New Zealand. These contracts generally have two year terms and were renegotiated in 2002 and now expire in fiscal 2004. We believe our employee relations are good company-wide.

     Sales and Distribution

      All sales are generated using a combination of direct sales and distributor agreements. We support our sales efforts with technical and advisory assistance in our customers’ use of our products. Penford ships its product promptly upon receipt of purchase orders from its customers and, consequently, backlog is not significant.

      Customers for industrial corn-based starch ingredients purchase products through fixed-price contracts or formula-priced contracts for periods covering three months to three years or on a spot basis. In fiscal 2002, approximately 65% of these sales are under fixed price contracts, with 35% representing formula price and spot business.

      Since our customers are generally other manufacturers and processors, most of our products are distributed via rail, truck or barge to customer facilities in bulk, except in Australia and New Zealand where most dry product is packaged in 25kg bags.

     Foreign Operations and Export Sales

      Penford further expanded into foreign markets with our acquisition of Penford Australia in September 2000. Penford Australia is the sole producer of corn starch products in Australia and New Zealand and is a leader in the research, development and commercialization of novel starch-based products. Penford Australia manufactures products used to enhance the functionality of packaged food products, as well as products used in the mining and paper industries. Our operations in Australia and New Zealand include three manufacturing facilities for processing specialty corn starches and wheat-related products. Further information about the acquisition of Penford Australia and geographic information can be found in Notes B and M of the Notes to Consolidated Financial Statements in Item 8 of this annual report.

      This geographic expansion subjects us to risks inherent in doing business in multiple countries with different legal and political policies. These risks include boycotts, political changes, currency fluctuations and possible restrictions, taxes and changes in currency exchange rates. Although we do not believe these risks to

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      Export sales from our businesses in the U.S. and Australia/ New Zealand accounted for approximately 16%, 18% and 13% of our total sales in fiscal 2002, 2001 and 2000, respectively.

Item 2:     Properties

      Our facilities as of August 31, 2002 are as follows:

      Our production facilities are strategically located near the sources of raw materials. We believe that our facilities are maintained in good condition and that the capacities of the plants are suitable and sufficient to meet current production requirements. We invest in expansion, improvement and maintenance of our property, plant and equipment as required.

Item 3:     Legal Proceedings

      A complaint filed in late November 1999 against Penford in the United States District Court for the District of Idaho has been resolved. The complaint sought civil penalties for alleged violations of the Clean Air Act and compensatory damages for alleged trespass, nuisance and personal injury claims. The Clean Air Act claims were dismissed with prejudice by the federal court’s Summary Judgment order dated July 24, 2001. Personal injury claims were dismissed with prejudice on summary judgment in May of 2002. Remaining property damage claims were resolved by mutual agreement.

      On November 1, 2000, the Environmental Protection Agency initiated enforcement action in the grain processing industry for adequacy of emission permitting and later included a review of excessive levels of volatile organic compounds in the action. Penford has been contacted, but is not currently the subject of a formal enforcement action, and no assessment has been levied. However, we working with the EPA to resolve any potential issues, and do not believe that resolution of these issues will result in any material adverse affect on the company.

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Item 4:     Submission of Matters to a Vote of Security Holders

      No matter was submitted to a vote of shareholders during the fourth quarter of fiscal 2002.

     Executive Officers of the Registrant

      Mr. Malkoski was named Chief Executive Officer in January 2002. He served as President and Chief Executive Officer of Griffith Laboratories, North America from 1997 to 2001. Formerly, he served as Vice President/ Managing Director of the Asia Pacific and South Pacific regions for Chiquita Brands International. Mr. Malkoski began his career at the Procter and Gamble Company spending twelve years progressing through major product category management responsibilities.

      Mr. Cook served as President and Chief Executive Officer from September 1998 to January 2002 and is serving as President until November 30, 2002. He was Penford’s Vice President, Finance and Chief Financial Officer from 1991 to August 1998, and was the Corporate Treasurer prior to that time.

      Mr. Cordier joined Penford in July 2002 as Chief Financial Officer. He came to Penford from Sensient Technologies. He served as Treasurer from 1995 to 1997 and as Vice President and Treasurer from 1997 to 1999. He completed his term at Sensient as Vice President, Administration. During his tenure at Sensient, he had responsibility for treasury, investor relations and finance functions. In his different positions, he also managed other aspects of operations such as engineering, information technology and marketing. From 1990 to 1995, he was employed at International Flavors & Fragrances in various financial management positions.

      Ms. Davidson has been the Vice President, Finance since February 2001. Prior to that, she served in the same role at The Cobalt Group, Inc. from 1996 to 2001. She was the Controller of Oceantrawl Inc. from 1990 to 1995, and was Vice President, Finance and Chief Financial Officer in 1996. Ms. Davidson is a CPA and began her professional career at Price Waterhouse.

      Mr. Horn joined Penford as Vice President of Marketing in 1993. Since 1995, he has served as the President of our food ingredients business in North America. Before Penford, he was Vice President and General Manager for Sara Lee Corporation.

      Mr. Keeley joined Penford in July 2000 as President of our industrial ingredients business. Before he joined Penford, he served as Strategic Business Executive for Church & Dwight for two years. From 1996 to 1999, he served as Director of Marketing and Sales for Gen Corp. He started his career with Dow Chemical Company, serving in various management roles in sales, marketing and business development.

      Dr. Kunerth has server as our Chief Science Officer since 2000. From 1997 to 2000, he worked at Monsanto Company in food science research management roles. Before Monsanto, he was the Vice President of Technology at Penford’s food ingredients business.

      Mr. Lowndes joined Penford as Managing Director of our Australian/ New Zealand operations when we acquired Penford Australian in September 2000. He served as General Manager of that business from 1995 to 2000 under the ownership of Goodman Fielder Ltd.

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PART II

      Penford common stock, $1.00 par value, trades on the Nasdaq Stock Market® under the symbol “PENX.” On October 29, 2002, there were 766 shareholders of record. The high and low closing prices of Penford’s common stock during the last two fiscal years are set forth below. The quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions.

      We have paid dividends to our shareholders since 1992. During each quarter of fiscal year 2002 and 2001, a $0.06 per share cash dividend was declared. Our the Board of Directors reviews our dividend policy on a periodic basis.

Notes:	Data for 1998 has been restated to reflect the distribution of 100% of the common stock of Penwest Pharmaceuticals Co. to the shareholders of Penford Corporation, which was completed on August 31, 1998.

	2001 data includes eleven months of Penford Australia’s results of operations from the September 29, 2000 date of acquisition.

(1)	Includes a pretax charge of approximately $1.4 million ($0.9 million after-tax, or $0.12 per share) related to a strategic restructuring of business operations and $0.5 million ($0.3 million after tax, or $0.04 per share) related to the write off of Penford’s 1997 investment in an early stage technology company.

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(2)	Includes an extraordinary loss on early extinguishment of debt of approximately $1.4 million ($0.9 million after-tax, or $0.12 per share) related to the financing of the Penford Australia Ltd. acquisition.
(3)	Includes a pretax charge of approximately $1.6 million ($1.0 million after-tax, or $0.13 per share) related to restructure costs recorded in connection with an administrative workforce reduction program.
(4)	Includes a pretax charge of approximately $1.9 million ($1.3 million after-tax, or $0.17 per share) related to restructure costs recorded in connection with the spin-off of Penwest Pharmaceuticals Co.

      This report contains forward-looking statements concerning Penford’s performance and financial results, including Penford’s ability to commercialize new specialty starches and value-added ingredients, maintenance or improvement of market share while developing new products targeted to a broader spectrum of the paper-making industry, maintenance of gross margins, increases resulting from added production capability for food-grade corn starches and diversified product offerings, focused marketing projects designed to increase sales of higher value-added products and improve profitability, expected levels of operating and research and development expenses, the level of anticipated interest rates, the expected level of our effective tax rate, the expectation that we will generate sufficient cash flow from operations to reduce our debt and not need to increase borrowings in the normal course of operations for the next fiscal year except for seasonal borrowings to purchase grain (and that we will have sufficient borrowing capacity and availability on our credit lines to funds those seasonal grain purchases), the ability to use cash generated from operations to fund the payment of accrued strategic restructuring costs, the anticipated level of capital investment, and the expectation that we will continue to pay a quarterly dividend. There are a variety of factors that could cause actual events or results to differ materially from those projected in the forward-looking statements, including, without limitation: competition; the possibility of interruption of business activities due to equipment problems, accidents, strikes, weather or other factors; product development risk; changes in corn and other raw material prices; changes in general economic conditions or developments with respect to specific industries or customers affecting demand for our products including unfavorable shifts in product mix; unanticipated costs, expenses or third party claims; the risk that results may be affected by construction delays, cost overruns, technical difficulties, nonperformance by contractors or changes in capital improvement project requirements or specifications; interest rate and energy cost volatility; foreign currency exchange rate fluctuations; or other unforeseen developments in the industries in which Penford operates. Accordingly, there can be no assurance that future activities or results will be as anticipated.

      Forward-looking statements are based on our estimates and opinions on the date the statements are made. We assume no obligation to update any forward-looking statements if circumstances or estimates or opinions should change.

      On September 29, 2000, we acquired Penford Australia for $54.2 million in cash, plus transaction costs of $1.7 million. Penford Australia is the sole producer of corn starch products in Australia and New Zealand and is a leader in the research, development and commercialization of novel starch-based ingredients. Penford Australia manufactures products used to enhance the functionality of food products, as well as products used in the mining and paper industries. Our operations in Australia and New Zealand include three manufacturing facilities for processing specialty corn starches and wheat products.

      The acquisition provided us with opportunities to develop, manufacture and market specialty carbohydrate-based ingredient systems for our food, paper and textile customers. We immediately added a line of food-grade corn starch items to our product portfolio. Until the acquisition, our food grade product line consisted primarily of potato-based product formulations.

      We also expanded our market access, as well as established a regional platform for manufacturing specialty starches for Asian and African markets. These capabilities further enhance Penford’s ability to

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      The acquisition was recorded using the purchase method of accounting. Accordingly, a portion of the purchase price was allocated to net tangible and intangible assets acquired based on their estimated fair values. The balance of the purchase price was recorded as goodwill. Eleven months of Penford Australia’s results of operations, from the September 29, 2000 date of acquisition, are included in the consolidated financial statements for the year ended August 31, 2001.

     Results of Operations

      While Penford is in the business of developing, manufacturing and marketing functional ingredients and previously reported results of operations as a single segment, we increasingly manage the business in three segments. The first two, industrial ingredients and food ingredients are broad categories of end-market users, primarily served by our U.S. operations. The third segment is our geographically separate operations in Australia and New Zealand. Our Australian and New Zealand operations are engaged primarily in the food ingredients business, although the industrial market is an important and growing category there. Therefore, we have expanded our reporting and analysis to present operating results by these three segments, Industrial Ingredients — North America, Food Ingredients — North America and Australia/ New Zealand.

     Fiscal 2002 Compared to Fiscal 2001

          Industrial Ingredients Business — North America

      Sales in our industrial business declined 1% in 2002, a result of lower sales volumes trends from 2001 that continued into 2002, a negative product mix shift and pricing. In the latter half of 2002, volumes began to improve as customer demand improved and sales volumes increased slightly over the prior year. The outlook for the paper-making industry, our primary market for our industrial products remains soft. However, we plan to maintain or improve our market share with increased penetration of existing products and by developing new products targeted to a broader spectrum of the paper-making industry. For example, we have commercialized a new liquid natural additive technology for packaging and paper market segments we have not historically targeted.

      Our gross margin improved this year to 16.1% from 13.8% primarily due to the decline in natural gas prices. Natural gas is the primary energy source for the plants that produce industrial products. Negative product mix shifts and pricing were partly offset by lower prices on other raw materials inputs. We expect to maintain our gross margins with higher sales volumes in fiscal 2003 being offset by increases in energy and chemicals costs.

      Income from operations improved significantly over fiscal year 2001 primarily because of the improvement in gross margin. Sales, administration, and research and development were down 6% in fiscal 2002 due to staffing reductions made at the end of 2001.

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          Food Ingredients Business — North America

      Sales increased 2% over fiscal 2001. We experienced an increase in sales to a new global food service customer, primarily for French fry coatings. The contract, implemented part way through fiscal 2001, was in place for a full year for 2002. However, sales to other French fry coatings customers declined, largely offsetting the positive impact of the new contract. We expect French fry coatings, over half of our business in 2002 to become a smaller relative part of our business as we further commercialize technologies for new products. We also added production capability for food-grade corn starches in North America, which will diversify our product offerings throughout the region.

      Our gross margin did not change significantly from 2001. The benefit realized from a decline in natural gas prices was offset by increases in other manufacturing costs. As a result, income from operations was comparable to the prior year.

          Australia/ New Zealand Operations

      Reported sales increased 12% in 2002. This is due primarily to the inclusion of only eleven months of operations in 2001 versus a full year for 2002 because of the September 29, 2000 acquisition date. Proforma sales assuming twelve months of 2001 were comparable to 2002. Volumes increased, offsetting the impact on reported sales of an unfavorable product mix shift. Volumes decreased in two of our most profitable products in 2002 while increasing in several lower margin products. A program was initiated at Penford Australia in 2002 to focus marketing projects on higher value-added products and to improve profitability.

      Our margins deteriorated in 2002 because wheat prices increased due to high export demand resulting from the weak Australian dollar. Additionally, corn costs increased in New Zealand due to stronger demand for feed grains in the dairy industry. The product mix shift also impacted margins.

      Income from operations improved as lower selling, administration, research and development costs totaling approximately $1 million offset the foregoing factors. The reduction in expenses resulted from our adoption of SFAS 142 effective the beginning of fiscal 2002 which requires that goodwill no longer be amortized.. Goodwill amortization expense was $0.7 million in 2001. In addition, we reduced staff at the end of 2001, and the cost of those staff reductions of $0.3 million were recognized in 2001.

     Corporate Overhead, Interest, Taxes and Other

      Corporate overhead expenses increased to $7.1 million from $5.9 million in 2001. This is due primarily to the $1.4 million cost of a strategic restructuring announced in January 2002, primarily for severance and lease termination costs. We also incurred $1.0 million of incremental transition expenses related to the strategic restructuring that do not qualify for inclusion in the restructure charge that are primarily for the costs of hiring new corporate staff and transition personnel costs. In 2001, we recorded a $0.5 million charge incurred in connection with terminated joint venture discussions.

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      In 2002, we also recorded a non-operating charge of $0.5 million related to the complete write-off of a 1997 investment in an early stage technology company.

      Interest expense was $7.1 million in 2002 compared to $10.2 million in 2001. This was due to lower market interest rates in the U.S. as well as lower average debt balances than in 2001.

      Our effective tax rate for 2002 was lower than the overall statutory rate of 34% due to the benefits of our foreign sales corporation and research and development tax credits. Our effective rate for 2001 was higher than our statutory rates due to state taxes and nondeductible goodwill amortization.

      Sales declined 11% in 2001 primarily due to lower product shipments to our customers in the paper industry, which was suffering from import competition and decreased demand for their products in the general economic slowdown. We also saw a decline in our average sales price resulting from a product mix shift and pricing.

      The primary factor in our gross margin decline was the increase in natural gas prices in 2001. Lower production volumes, the negative product mix shift and pricing concessions also contributed to the decline.

      As a result of the foregoing, our income from operations decreased. Operating expenses decreased by $0.4 million, including a $0.2 million charge related to a staffing reduction in the fourth quarter of 2001.

      Sales increased 29% in 2001 primarily due to the addition of a new global food service customer, as well as the success of several new products in various food industry market segments.

      Our gross margin declined primarily due to the increase in natural gas prices, offset in part by lower manufacturing costs achieved on higher production volumes.

      Income from operations increased 31% over 2000 due to increased sales. Operating expenses increased 9% to provide the cost of infrastructure needed to support increased business activity.

      We acquired Penford Australia subsequent to fiscal 2000. The pro forma impact of the acquisition is presented in Note B to the consolidated financials.

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      Corporate overhead increased to $5.9 million from $4.4 million in 2000. Operating expenses for 2001 included a $0.5 million charge for terminated joint venture discussions. Expenses also increased for corporate-wide employee benefit programs, insurance and professional fees.

      Interest expense was $10.2 million in 2001, compared to $4.8 million in the prior year. The increase was attributed to higher debt balances as a result of the acquisition of Penford Australia. Our effective interest rate in fiscal 2001 was consistent with the prior year.

      The effective tax rate in fiscal 2001 varied from statutory rates primarily due to higher state taxes and the non-deductible nature of the goodwill amortization related to the Penford Australia acquisition.

      During the first quarter of fiscal 2001, we paid our private placement debt facilities early in connection with a comprehensive refinancing to fund the acquisition of Penford Australia. The early repayment of the private placements required prepayment fees, which resulted in a loss on early extinguishment of debt of $1.4 million, which is presented as an extraordinary loss of $0.9 million, which is net of the related tax benefit of $0.5 million.

      At August 31, 2002, Penford had working capital of $15.1 million and $50.4 million outstanding under its revolving credit facilities and inventory financing credit agreement. We expect to generate sufficient cash flow from operations to reduce our outstanding debt and do not expect to increase borrowings in the normal course of operations during the year, except for seasonal borrowings related to grain purchasing for our Australian operations, generally in our third fiscal quarter. Discussion of unused capacity on our revolving credit facilities follows below.

      Cash flow from operations was $25.3 million, $13.5 million and $25.6 million in fiscal 2002, 2001 and 2000, respectively. The increase in operating cash flows in 2002 over 2001 is due primarily to favorable changes in working capital and improved profitability. In addition to normal operating expenses, we will use cash generated from operations to fund the payment of $1.3 million of accrued strategic restructuring costs.

      Capital expenditures were $7.4 million, $12.3 million and $17.5 million in fiscal 2002, 2001 and 2000, respectively. Capital expenditures in fiscal 2002 were primarily for improvements at the Company’s facility in Cedar Rapids, Iowa, including an investment in plant capability that allows us to manufacture food-grade products from corn and improve asset utilization. Over the past two years, due to the current operating environment and significant investments made in the prior two years, we reduced capital expenditures from previous levels. We expect that in the next fiscal year, our capital investments are not expected to exceed 2001 levels. This will consist of efficiency improvements at our Cedar Rapids facility, as well as at our other North American, Australian and New Zealand operations. We continue to make efficiency and safety improvements as required to maintain our operations in good working order.

      On September 29, 2000, we acquired operations in Australia and New Zealand for $55.9 million, which we financed through additional borrowings.

      On November 26, 2002, our banks approved an amendment to our credit agreements to modify the leverage ratio and to reduce scheduled term loan payments in 2003. In connection with this modification, we paid a fee of approximately $0.2 million..

      We made term loan payments totaling $15.2 million during fiscal 2002. For fiscal 2003, our banks have approved a revised loan amortization schedule, which reduces our scheduled term loan payments to $12.1 million. We are required to reduce our term loans by an additional $2.1 million in fiscal 2003 under prepayment clauses of our credit agreement. We are also required to use proceeds of $4.1 million from the National Starch transaction to repay our term loans.

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      Under the amended financial covenants of our credit agreements, we are required over the coming fiscal quarters to improve our leverage ratio (the ratio of our debt balance to the trailing four quarters of earnings before interest, taxes, depreciation and amortization). Although we have significantly improved earnings and reduced our borrowings over the past year, we have limited ability to borrow on available capacity under our existing credit lines until we improve our leverage ratio. However, as mentioned previously, we do not expect to increase our borrowings, other than seasonal borrowing related to grain purchasing from our Australian operations in the third quarter of next year. We anticipate that we will have sufficient borrowing capacity and availability on our credit lines to fund those seasonal grain purchases.

      Our financial covenants also restrict new indebtedness, require maintenance of minimum tangible net worth and limit annual capital expenditures to $15 million. In addition to the leverage ratio, we are also required to maintain interest coverage and fixed charges coverage ratios. Fixed charges include scheduled principal repayments, interest, rent, taxes, dividends and capital expenditures. If earnings fall below projected levels, we could be required to limit capital expenditures and/or dividends.

      Penford Australia uses an inventory financing credit agreement to purchase corn at harvest in Australia for production requirements for the following year. In fiscal 2002, that purchasing activity increased to provide some of the input requirements for our operations in New Zealand to ensure adequate supply and to minimize exposure to the higher local prices in New Zealand due to increased demand for corn by the dairy feed industry.

      In fiscal 2001, our financial activities revolved primarily around refinancing and additional borrowings for the acquisition of Penford Australia.

      In fiscal 2002, we paid dividends of $1.8 million to our shareholders at a quarterly rate of $0.06 per share. The Board of Directors reviews the dividend policy on a periodic basis, and we have included the continuation of quarterly dividends in our planning for fiscal 2003.

      The Board of Directors has authorized a stock repurchase program for the purchase of up to 500,000 shares of Penford’s outstanding common stock. Repurchases under the program to date have totaled 281,300 shares for $4.3 million in prior years. We did not purchase any of our common stock during fiscal 2002 or 2001, and do not expect to do so in fiscal 2003.

      Inflation has not had a material effect on Penford’s revenue and income from operations the past three years. Inflation is not expected to have a material impact in fiscal 2003.

      Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. These accounting principles require us to make estimates, judgments and assumptions to fairly present results of operations and financial position. We believe that our estimates, judgments and assumptions are reasonable based upon information available to us at the time this report was prepared. To the extent there are material differences between our estimates, judgments and assumptions and the actual results, our financial statements will be affected.

      In many cases, the accounting treatment of a particular transaction is significantly dictated by generally accepted accounting principles and does not require judgment or estimates. There are also areas in which management’s judgments in selecting among available alternatives would not produce a materially different result. Our chief financial officer has reviewed our accounting policies and related disclosures with our Audit committee. The notes to our consolidated financial statements contain a summary of our accounting policies. However, the accounting policies that we believe are the most important to our financial statements and that require the most difficult, subjective and complex judgments include the following:

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	•	Evaluation of the allowance for doubtful accounts receivable
	•	Hedging activities
	•	Benefit plans
	•	Valuation of goodwill

      A description of each of these follows:

      We make judgments about our ability to collect outstanding receivables and provide allowances for the portion of receivables that we may not be able to collect. We record our estimate of accounts that we will not be able to collect based upon a specific review of our larger accounts that make up approximately 64% of our accounts receivable. For those accounts not specifically reviewed, we estimate uncollectible amounts based on the age of the receivable compared to the terms offered. If our estimates do not reflect our future ability to collect outstanding invoices, we may experience losses in excess of the reserves we have established. At August 31, 2002 and 2001 our allowance for doubtful accounts receivable was $345,000 and $301,000, respectively. The majority of our allowance is related to our industrial ingredients business, and reflects the difficult economics in the paper making industry.

      We use derivatives, primarily futures contacts, to reduce our exposure to price fluctuations of commodities used in our manufacturing processes in the United States. We have elected to designate these activities as hedges. This election allows us to defer gains and losses on those derivative instruments until the underlying commodity is used in the production process.

      The requirements for our designation of hedges are very complex, and require judgments and analysis to qualify as hedges as defined by SFAS 133. These judgments and analysis include an assessment that the derivative instruments we use are effective hedges of the underlying risks. If we were to fail to meet the requirements of SFAS 133, or if we do not designate these derivative instruments as hedges, we would be required to mark these contracts to market at each reporting date. We had deferred gains of $169,000 and $31,000 at August 31, 2002 and 2001, respectively, which is reflected in accumulated other comprehensive income in both years.

      Penford has stock option plans for its employees and directors. Because we grant options to employees at the market price on date of grant, we follow the policy of recording no compensation expense for those option grants. An alternative financial reporting standard, SFAS 123, provides a methodology for estimating the hypothetical compensation expense associated with stock option grants, which expense is then amortized over the vesting period. As required by SFAS 123, we have disclosed the pro forma impact of this alternative accounting treatment in Note F to the consolidated financial statements.

      Penford has defined benefit plans for its employees providing retirement benefits and coverage for retiree health care. Qualified actuaries determine the estimated cost of these plans annually. These actuarial estimates are based on assumptions of the discount rate used to calculate the present value of future payments, the expected investment return on plan assets, the estimate of future increases in compensation rates and the estimate of increases in the cost of medical care. We make judgments about these assumptions based on our historical investment results and experience as well as available historical market data and trends. However, if these assumptions are wrong, it could materially affect the amounts reported in our financial statements. Disclosure about these estimates and assumptions are included in Note H to the consolidated financial statements.

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      We are required to assess whether the value of goodwill reported on our balance sheet has been impaired on an annual basis, or more often if conditions exist that indicate that there might be an impairment. These assessments require extensive and subjective judgments to assess the fair value of goodwill. While we engage qualified valuation experts to assist in this process, their work is based on our estimates of future operating results and allocation of goodwill to our business units. If future operating results differ materially from our estimates, the value of goodwill could be adversely impacted.

      Effective September 1, 2001, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 established new standards related to how acquired goodwill and other intangible assets are to be recorded upon their acquisition as well as how they are to be accounted for after they have been initially recognized in the financial statements. Effective with the adoption of this standard, Penford is no longer amortizing goodwill. We have completed the required transitional impairment test at September 1, 2001, as well as the annual update as of June 1, 2002 and determined there was no impairment to the recorded value of goodwill. Penford uses a fair value approach, using primarily discounted cash flows, to complete the impairment tests. On a prospective basis, we are required to continue to test our goodwill for impairment on an annual basis, or more frequently if certain indicators arise.

      In April 2002, FASB issued SFAS No. 145, “Rescission of FASB Statement No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections.” Among other things, this statement rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” will now be used to classify those gains and losses. We adopted SFAS No. 145 on September 1, 2002, and will be required to apply the new rules for these transactions in the future.

      In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that a liability for cost associated with exit or disposal activities be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect the adoption of SFAS 146 to have a material impact on our operating results or financial position.

Item 7A:     Quantitative and Qualitative Disclosures About Market Risk

      Penford is exposed to market risks that are inherent in the financial instruments that we use in the normal course of business. We may use various hedge instruments to manage or reduce market risk, but we do not use derivative financial instrument transactions for speculative purposes. Our primary market risks are discussed below.

      All of Penford’s long-term debt has variable interest rates, which are set for periods of one to six months. We have managed interest rates using interest rate swaps in the past, but there are no such instruments outstanding as of August 31, 2002. The carrying value of our variable-rate long-term debt as of August 31, 2002 of $96.4 million was approximately equal to the fair value.

      Our market risk has been calculated as the possible increase in fair value resulting from a hypothetical one-point change in interest rates. The market risk associated with a one-point change in interest rates at August 31, 2002 and 2001, is approximately $1.2 million and $2.1 million, respectively.

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      We have U.S.-Australian and Australian-New Zealand dollar currency exchange rate risks due to revenues and costs denominated in Australian and New Zealand dollars with our foreign operation, Penford Australia. Currently, cash generated by Penford Australia’s operations is used for capital investment in Australia and payment of debt denominated in Australian dollars. At August 31, 2002, approximately 33.9% of our total debt was denominated in Australian dollars.

      Because of the natural hedge created by our Australian borrowings, we have not maintained any derivative instruments to further mitigate our U.S.-Australian dollar currency exchange translation exposure. This position is reviewed periodically, and based on our review, may result in the incorporation of derivative instruments in our hedging strategy. Our currency exchange rate risk between our Australian and New Zealand operations is not significant. The impact of a 10% change in the foreign currency exchange rates compared with the U.S. dollar would not have a significant impact on reported net income for the year ended August 31, 2002.

      From time to time, we enter into foreign exchange forward contracts to manage our exposure to receivables denominated in currencies different from the functional currencies of the selling entities. As of August 31, 2002, we did not have any foreign exchange forward contracts outstanding. At that date, we had trade receivables of US$0.5 million at Penford Australia.

      The availability and price of corn, Penford’s most significant raw material, is subject to fluctuations due to unpredictable factors such as weather, plantings, domestic and foreign governmental farm programs and policies, changes in global demand and the worldwide production of corn. To reduce the price risk caused by market fluctuations, we generally follow a policy of using exchange-traded futures and options contracts to hedge our exposure to corn price fluctuations in North America. These futures and options contracts are designated as hedges. The changes in market value of these contracts have historically been, and are expected to continue to be, highly effective in offsetting the price changes in corn.

      Penford’s net corn position in the U.S. consists primarily of inventories, purchase contracts and exchange traded futures and options contracts that hedge Penford’s exposure to commodity price fluctuations. The fair value of the position is based on quoted market prices. We have estimated our market risk as the potential loss in fair value resulting from a hypothetical 10% adverse change in prices. As of August 31, 2002 and 2001, the fair value of our net corn position was approximately $0.2 million and $1.9 million, respectively. The market risk associated with a 10% adverse change in corn prices at August 31, 2002 and 2001, is estimated at $21,000 and $188,000, respectively.

      Over the past two years, prices for natural gas have increased over historic levels. Prices for natural gas fluctuate due to anticipated changes in supply and demand and movement of prices of related or alternative fuels. To reduce the price risk caused by market fluctuations, we generally enter into short-term purchase contracts or use exchange-traded futures and options contracts to hedge our exposure to natural gas price fluctuations. These futures and options contracts are designated as hedges. The changes in market value of these contracts have historically been, and are expected to continue to be, highly effective in offsetting the price changes in natural gas.

      Penford’s exchange traded futures and options contracts hedge production requirements. The fair value of these contracts is based on quoted market prices. We have estimated our market risk as the potential loss in fair value resulting from a hypothetical 10% adverse change in prices. As of August 31, 2002, the fair value of our natural gas contracts was a loss of approximately $0.5 million. The market risk associated with a 10% adverse change in natural gas prices at August 31, 2002 is estimated at $45,000. We did not have any natural gas derivatives positions at August 31, 2001.

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Item 8:     Penford Corporation Consolidated Financial Statements

Consolidated Balance Sheets

The accompanying notes are an integral part of these statements.

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Consolidated Statements of Operations

The accompanying notes are an integral part of these statements.

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Consolidated Statements of Cash Flows

The accompanying notes are an integral part of these statements.

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Consolidated Statements of Shareholders’ Equity