UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended February 28, 2005

OR

Commission File No. 0-11488

PENFORD CORPORATION

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

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

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes þ    No o

The net number of shares of the Registrant’s common stock (the Registrant’s only outstanding class of stock) outstanding as of April 5, 2005 was 8,825,133.

PENFORD CORPORATION AND SUBSIDIARIES

INDEX

PART I — FINANCIAL INFORMATION

Item 1: Financial Statements

PENFORD CORPORATION AND SUBSIDIARIES

The accompanying notes are an integral part of these statements.

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PENFORD CORPORATION AND SUBSIDIARIES

(Unaudited)

The accompanying notes are an integral part of these statements.

4

PENFORD CORPORATION AND SUBSIDIARIES

(Unaudited)

The accompanying notes are an integral part of these statements.

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PENFORD CORPORATION AND SUBSIDIARIES

     1—BUSINESS

     Penford Corporation (“Penford” or the “Company”) is in the business of developing, manufacturing and marketing specialty natural-based ingredient systems for various applications, including papermaking, textiles and food products. The Company operates manufacturing facilities in the United States, Australia, and New Zealand. Penford’s products provide excellent binding and film-forming characteristics that make customers’ products better through natural, convenient and cost effective solutions. Sales of the Company’s products are generated using a combination of direct sales and distributor agreements.

     The Company has extensive research and development capabilities, which are used in understanding the complex chemistry of carbohydrate-based materials and their application. In addition, the Company has specialty processing capabilities for a variety of modified starches.

     2—BASIS OF PRESENTATION

     Consolidation

     The accompanying condensed consolidated financial statements include the accounts of Penford and its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated. The condensed consolidated balance sheet at February 28, 2005 and the condensed consolidated statements of operations and cash flows for the interim periods ended February 28, 2005 and February 29, 2004 have been prepared by the Company without audit. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, that are necessary to present fairly the financial information have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The results of operations for interim periods are not necessarily indicative of the operating results of a full year or of future operations. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended August 31, 2004.

     Recent Accounting Pronouncements

     In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 151, “Inventory Costs—an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151, which is effective for inventory costs incurred during years beginning after June 15, 2005, clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material, requiring that those items be recognized as current-period charges. In addition, SFAS No. 151 requires that allocation of fixed production overheads be based on the normal capacity of the production facilities. The adoption of SFAS No. 151 beginning September 1, 2005 is not expected to have a material effect on the Company’s results of operation, financial position or liquidity.

     In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R, which is effective for the first interim or annual period beginning after June 15, 2005, requires all share-based payments to employees, including grants of stock options, to be recognized in the financial statements based on their fair values. In addition, two transition alternatives are permitted at the time of adoption of this statement, restating prior year financial statements or recognizing adjustments to share-based liabilities as the cumulative effect of a change in accounting principle. The adoption of SFAS No. 123R will increase the Company’s compensation costs and share-based liabilities. The Company is studying the requirements of this standard and, at this time, cannot reasonably estimate the impact of SFAS No. 123R on its financial statements.

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     Stock-based Compensation

     The Company accounts for its stock-based employee compensation related to stock options under the intrinsic value recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its various interpretations. Accordingly, no compensation expense has been recognized for the stock-based compensation plans other than for the Directors’ Plan and restricted stock awards.

     The following table illustrates the effect on net income and earnings per share if the Company had elected to recognize compensation expense consistent with the provisions prescribed in FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), as amended. Under SFAS No. 123, compensation expense is measured at the grant date based on the value of the award and is recognized over the vesting period.

     3—INVENTORIES

     The components of inventory are as follows:

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     4—PROPERTY, PLANT AND EQUIPMENT

     Changes in Australian and New Zealand currency exchange rates have increased net property, plant and equipment in the first six months of fiscal 2005 by approximately $4.9 million.

     5—DEBT

     At February 28, 2005, the Company had $37.5 million outstanding under its revolving credit facilities and $46.1 million in term loans. Effective November 2004, Penford obtained an amendment to the funded debt ratio covenant, a ratio of earnings before interest, depreciation and taxes, as defined, to total debt, in its credit facility agreement. The Company’s lenders agreed to exclude $8.4 million, a majority of the nonrecurring strike-related costs, from the calculation of the funded debt ratio. The agreement was also amended to increase the funded debt ratio threshold to 3.5 for the first half of fiscal 2005, to 3.25 for the third quarter of fiscal 2005, and to 3.0 thereafter. The maximum capital expenditure level was reduced from $20 million to $15 million for fiscal 2005. Pursuant to the terms of the credit agreement, Penford’s borrowing ability was $8.1 million at February 28, 2005. The Company was in compliance as of February 28, 2005 and expects to be in compliance with these revised covenants for the remainder of fiscal 2005.

     6—TAXES

     The Company’s effective tax rate for the three and six months ended February 28, 2005 and the three and six months ended February 29, 2004 varied from the U.S. federal statutory rate primarily due to U.S. tax credits related to research and development and the favorable tax effect of export sales from the U.S. The second quarter 2005 tax benefit recorded included an adjustment increasing the tax benefit in Australia by $0.1 million after reconciling the fiscal 2004 tax return filed to the tax provision recorded in fiscal 2004.

     7—OTHER COMPREHENSIVE INCOME

     The components of total comprehensive income (loss) are as follows:

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     8—NON-OPERATING INCOME, NET

     Non-operating income, net consists of the following:

     In October 2003, Penford refinanced its existing secured credit and inventory financing credit agreements and wrote off the unamortized deferred transaction costs related to these credit agreements. In November 2002, the Company licensed the rights to its resistant starch intellectual property portfolio for applications in human nutrition. The initial licensing fee of $2.25 million received in November 2002 is being amortized over the life of the licensing agreement. In addition, the Company receives royalty income as a percentage of its licensee’s sales of resistant starch for a period of seven years or until a maximum of $11 million in royalties has been received by Penford. The royalty payments are subject to a minimum of $7 million over the first five years of the licensing agreement.

     9 – PENSION AND POST-RETIREMENT BENEFIT PLANS

     The following represents the net periodic pension and post-retirement benefit costs and related components in accordance with SFAS No. 132(R) for the three and six months ended February 28, 2005 and February 29, 2004.

     The net post-retirement benefit costs for the second quarter and first half of fiscal 2005 declined compared to the same periods last year due to plan changes retroactive to September 1, 2004 pursuant to a new union contract at the Company’s Iowa manufacturing facility.

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     10—SEGMENT REPORTING

     Financial information for the Company’s three segments is presented below. The first two segments, Industrial Ingredients—North America and Food Ingredients—North America, are broad categories of end-market users, primarily served by the Company’s U.S. operations. The third segment is the Company’s geographically separate operations in Australia and New Zealand, which are engaged primarily in the food ingredients business. A fourth item for “corporate and other” activity is presented to provide reconciliation to amounts reported in the condensed consolidated financial statements. Corporate and other represents the activities related to the corporate headquarters such as public company reporting, personnel costs of the executive management team, corporate-wide professional services and elimination and consolidation entries. The elimination of intercompany sales between Australia/New Zealand operations and Food Ingredients—North America of $172,000 and $718,000 for the three and six month periods ended February 28, 2005, respectively, and $74,000 and $267,000 in the three and six month periods ended February 29, 2004, respectively, is presented separately since the chief operating decision maker views segment results prior to intercompany eliminations.

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     11—EARNINGS (LOSS) PER SHARE

     Basic earnings (loss) per share reflects only the weighted average common shares outstanding during the period. Diluted earnings (loss) per share reflects weighted average common shares outstanding and the effect of any dilutive common stock equivalent shares. The following table presents the computation of diluted weighted average shares outstanding for the three and six months ended February 28, 2005 and February 29, 2004.

Diluted earnings per share is calculated by dividing net income by the average common shares outstanding plus additional common shares that would have been outstanding assuming the exercise of in-the-money stock options, using the treasury stock method. Weighted-average stock options to purchase 1,134,991 and 1,081,958 common stock for the three and six months ended February 28, 2005 and 267,000 and 300,000 common stock for the three and six months ended February 29, 2004 were excluded from the calculation of diluted earnings per share because they were antidilutive.

     12—LITIGATION

     In October 2004, Penford Products Co. (“Penford Products”), a wholly-owned subsidiary of the Company, was served with a lawsuit filed by Graphic Packaging International, Inc. (“Graphic”) in the Fourth Judicial District, Ouachita Parish, State of Louisiana. The petition seeks monetary damages for alleged breach of contract, negligence and tortious misrepresentation. These claims arise out of an alleged agreement obligating Penford Products to supply goods to Graphic and Penford Products’ alleged breach of such agreement together with conduct related to such alleged breach. Penford has filed its answer generally denying all liability and has countersued for damages. Discovery is proceeding in this case. The Company cannot determine the likelihood of the plaintiff prevailing or an estimate of damages, if any.

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Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

     The statements contained in this Quarterly Report on Form 10-Q (“Quarterly Report”) that are not historical facts, including, but not limited to statements found in the Notes to Condensed Consolidated Financial Statements and in Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, are forward-looking statements that represent management’s beliefs and assumptions based on currently available information. Forward-looking statements can be identified by the use of words such as “believes,” “may,” “will,” “looks,” “should,” “could,” “anticipates,” “expects,” or comparable terminology or by discussions of strategies or trends.

     Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it cannot give any assurances that these expectations will prove to be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly affect expected results. Actual future results could differ materially from those described in such forward-looking statements, and the Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this Quarterly Report, including those referenced above, and those described from time to time in other filings with the Securities and Exchange Commission which include, but are not limited to, competition; the possibility of interruption of business activities due to equipment problems, accidents, strikes, weather or other factors; product development risk; changes in corn and other raw material prices and availability; changes in general economic conditions or developments with respect to specific industries or customers affecting demand for the Company’s products including unfavorable shifts in product mix; unanticipated costs, including labor costs, expenses or third party claims; the risk that results may be affected by construction delays, cost overruns, technical difficulties, nonperformance by contractors or changes in capital improvement project requirements or specifications; interest rate and energy cost volatility; foreign currency exchange rate fluctuations; changes in assumptions used for determining employee benefit expense and obligations; or other unforeseen developments in the industries in which Penford operates.

Results of Operations

     Executive Overview

     Penford generates revenues, income and cash flows by developing, manufacturing and marketing specialty natural-based ingredient systems for industrial and food applications. The Company develops and manufactures ingredients with starch as a base which provide value-added applications to its customers. Penford’s starch products are manufactured primarily from corn, potatoes, and wheat, and are used as binders and coatings in paper and food production.

     In analyzing business trends, management considers a variety of performance and financial measures, including sales revenue growth, sales volume growth, gross margins and operating income of the Company’s business segments. Penford manages its business in three segments. The first two, Industrial Ingredients—North America and Food Ingredients—North America, are broad categories of end-market users, served by operations in the United States. The third segment is the Company’s operations in Australia and New Zealand, which operations are engaged primarily in the food ingredients business.

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     Consolidated sales for the three months ended February 28, 2005 increased 1% to $69.2 million from $68.5 million in the second quarter of fiscal 2004. Improved pricing in the North American operations and strong foreign exchange rates were offset by declines in Australian exports and lower volumes in the Industrial Ingredients segment. Gross margin as a percent of sales declined to 10.3% in the second quarter of fiscal 2005 from 14.5% in the same quarter last year due to higher energy and chemical costs and the incremental costs of reconfiguring manufacturing processes in Australia to streamline production and change the product mix.

     Sales for the first half of fiscal 2005 rose 5% to $141.3 million over the first half of fiscal 2004, reflecting favorable foreign exchange rates, which contributed 2% of the consolidated sales growth, sales volume improvement in the Australia/New Zealand business segment, and improved pricing and mix in North America. Operating income for the six months ended February 28, 2005 was a loss of $4.2 million compared to income of $4.8 million for the same six-month period last year. Gross margin as a percent of sales declined to 7.4% from 14.6% last year on $4 million of incremental operating costs related to the Cedar Rapids strike which was settled on October 17, 2004, and the higher energy and chemical costs and Australian manufacturing issues which impacted the second quarter of fiscal 2005.

     Fiscal 2005 second quarter and first half operating expenses increased by $0.5 million and $0.6 million, respectively, primarily due to increases in professional fees associated with the initial attestation on internal controls as required by the Sarbanes-Oxley Act of 2002. A discussion of segment results of operations follows.

     Sales

     Sales at the Company’s Industrial Ingredients—North America business unit of $35.6 million were comparable to sales in the second quarter of last year. Sales volumes declined 7% reflecting a softness in sales orders related to the labor strike in this business which ended mid-first quarter. The volume decrease was offset by improved unit pricing in core product categories and a 43% increase in sales of specialty starches. Sales of $70.8 million for the six-month period ended February 28, 2005 increased $2.4 million, or 3.6%, over the same period last year due to improved pricing and a 48% increase in specialty starch sales offset by a 2% volume decline.

     Sales of $21.9 million for the second quarter of fiscal 2005 at the Australia/New Zealand operations rose slightly over the second quarter of fiscal 2004. Stronger foreign currency exchange rates and a sales volume increase of 4% were offset by the impact of competitive pricing from imported products and unfavorable product mix. Fiscal 2005 year-to-date sales of $47.1 million grew 8% over the same period last year. Stronger Australian and New Zealand exchange rates contributed 5% of the revenue increase. The remainder of the increase is due to a 9% volume growth offset by unfavorable product mix and continued competition from imports.

     Second quarter fiscal 2005 sales for the Food Ingredients—North America business of $11.9 million rose $0.9 million, or 8%, compared to the second quarter of last year on volume increases and favorable product mix. Volume expansion contributed 6% to the quarter’s sales increase, with growth in sales of applications used in the dairy, meat and nutrition, or “low carbohydrate” markets. Sales for the first six months of fiscal 2005 increased $1.3 million, or 6%, over the prior year due to a 2% increase in sales volumes and favorable product mix.

     Income from operations

     Income from operations for the second quarter of 2005 at Penford’s Industrial Ingredients—North America business unit declined to $0.6 million from $1.6 million for the prior year quarter. Gross margin as a percent of sales was 9.6% in the quarter ended February 28, 2005 compared to 13.1% for the same period last year. The margin decline was due to continued high energy and chemical costs, which increased by $1.3 million over the prior year quarter, lower overall sales volumes and increases in unit manufacturing costs, partially offset by improved unit pricing and expanded sales of higher margin specialty starches. Income from operations for the first half of fiscal 2005 was a loss of $3.8 million compared to income of $3.1 million in fiscal 2004. The primary factors contributing to this decrease were the incremental costs of approximately $4 million related to the labor strike at the Company’s Iowa manufacturing facility which ended October 17, 2004, and increased energy and chemical costs of $2.3 million. The Company believes that the new union contract will bring labor costs, particularly the cost of benefits, in this business segment more in line with its industry peers over the next few years. Included in operating income for the

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second quarter and year-to-date fiscal 2004 was a $0.5 million pre-tax charge related to a workforce reduction in this business segment.

     Income from operations at the Company’s Australia/New Zealand operations was a loss of $0.3 million for the quarter ended February 28, 2005 compared to income of $1.5 million last year. Quarterly gross margin as a percent of sales decreased from 12.8% last year to 4.2% in the current year quarter. Fiscal 2005 year-to-date operating income decreased by $1.6 million to $0.2 million compared to the prior year period and gross margin as a percent of sales was 6.3% compared to 10.4% last year. The declines in gross margin and operating income for the three- and six-month periods ended February 28, 2005 are due to pricing pressures on domestic products from imports as the Australian and New Zealand currencies continue to strengthen, manufacturing problems as plant operations were reconfiguring processes and installing new equipment to improve product mix, and a decrease in higher margin “low carbohydrate” product applications. Included in operating income for the quarter and six months ended February 29, 2004 was $0.3 million of severance costs related to a workforce reduction.

     Second quarter income from operations at the Food Ingredients—North American business unit grew $0.4 million to $1.1 million from the comparable quarter last year and gross margin as a percent of sales improved to 23.8% from 21.9% last year on a quarterly sales volume increase of 6%, higher margins generated by “low carbohydrate” product applications, and higher plant utilization in the Company’s dextrose production facility. Fiscal 2005 year-to-date operating income and gross margin as a percent of sales both decreased slightly to $2.5 million and 24.1%, respectively, from $2.6 million and 25.8%, respectively, in the first half of fiscal 2004. Improvements in sales, product mix and costs in the second quarter only partially offset higher first quarter costs to manufacture dextrose and corn products during the strike in Iowa.

     Corporate operating expenses

     Corporate operating expenses for the second quarter and first six months of fiscal 2005 increased $0.3 million and $0.5 million, respectively, over the prior year periods due to increases in professional fees associated with the initial attestation on internal controls required by the Sarbanes-Oxley Act of 2002.

     Interest and taxes

     Fiscal 2005 interest expense rose $0.2 million in the second quarter and $0.3 million for the first six months compared to the same periods last year on slightly higher average floating interest rates in the U.S. and Australia.

     The Company’s effective tax rate for the three and six months ended February 28, 2005 and the three and six months ended February 29, 2004 varied from the U.S. federal statutory rate primarily due to U.S. tax credits related to research and development and the favorable tax effect of export sales from the U.S. The second quarter 2005 tax benefit recorded included an adjustment increasing the tax benefit in Australia by $0.1 million after reconciling the fiscal 2004 tax return filed to the tax provision recorded in fiscal 2004.

     Non-operating income, net

     Non-operating income, net consists of the following:

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     In October 2003, Penford refinanced its existing secured credit and inventory financing credit agreements and wrote off the unamortized deferred transaction costs related to these credit agreements. In November 2002, the Company licensed the rights to its resistant starch intellectual property portfolio for applications in human nutrition. The initial licensing fee of $2.25 million received in November 2002 is being amortized over the life of the licensing agreement. In addition, the Company receives royalty income as a percentage of its licensee’s sales of resistant starch for a period of seven years or until a maximum of $11 million in royalties has been received by Penford. The royalty payments are subject to a minimum of $7 million over the first five years of the licensing agreement.

Liquidity and Capital Resources

     Penford had working capital of $40.3 million at February 28, 2005 and August 31, 2004. Cash flow from operations was $3.2 million and $8.8 million for the six months ended February 28, 2005 and February 29, 2004, respectively. The decrease in cash flow from operations is primarily due to the decline in earnings in fiscal 2005.

     At February 28, 2005, the Company had $37.5 million outstanding under its revolving credit facilities and $46.1 million in term loans. Effective November 2004, Penford obtained an amendment to the funded debt ratio covenant, a ratio of earnings before interest, depreciation and taxes, as defined, to total debt, in its credit facility agreement. The Company’s lenders agreed to exclude $8.4 million, a majority of the nonrecurring strike-related costs, from the calculation of the funded debt ratio. The agreement was also amended to increase the funded debt ratio threshold to 3.5 for the first half of fiscal 2005, to 3.25 for the third quarter of fiscal 2005, and to 3.0 thereafter. The maximum capital expenditure level was reduced from $20 million to $15 million for fiscal 2005. Pursuant to the terms of the credit agreement, Penford’s borrowing ability was $8.1 million at February 28, 2005. The Company was in compliance as of February 28, 2005 and expects to be in compliance with these revised covenants for the remainder of fiscal 2005.

     The Company paid dividends of $1.1 million during the six months ended February 28, 2005, which represents a quarterly rate of $0.06 per share, the same per share dividend rate as the six months ended February 29, 2004. On January 28, 2005, the Board of Directors declared a dividend of $0.06 per common share payable on March 4, 2005 to shareholders of record as of February 11, 2005. Any future dividends will be paid at the discretion of the Company’s board of directors and will depend upon, among other things, earnings, financial condition, cash requirements and availability, and contractual requirements.

Recent Accounting Pronouncements

     In November 2004, the FASB issued Statement No. 151, “Inventory Costs—an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151, which is effective for inventory costs incurred during years beginning after June 15, 2005, clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material, requiring that those items be recognized as current-period charges. In addition, SFAS No. 151 requires that allocation of fixed production overheads be based on the normal capacity of the production facilities. The adoption of SFAS No. 151 beginning September 1, 2005 is not expected to have a material effect on the Company’s results of operation, financial position or liquidity.

     In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R, which is effective for the first interim or annual period beginning after June 15, 2005, requires all share-based payments to employees, including grants of stock options, to be recognized in the financial statements based on their fair values. In addition, two transition alternatives are permitted at the time of adoption of this statement, restating prior year financial statements or recognizing adjustments to share-based liabilities as the cumulative effect of a change in accounting principle. The adoption of SFAS No. 123R will increase the Company’s compensation costs and share-based liabilities. The Company is studying the requirements of this standard and, at this time, cannot reasonably estimate the impact of SFAS No. 123R on its financial statements.

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Risks and Uncertainties

The availability and cost of the agricultural products and agricultural by-products Penford purchases are vulnerable to weather and other factors beyond its control.

     Approximately 30% of Penford’s manufacturing costs are the costs of agricultural raw materials and agricultural by-products: corn, wheat flour, and potato starch. Weather conditions, plantings and global supply, among other things, have historically caused volatility in the supply and prices of these agricultural products. The Company may not be able to pass through any increases in the cost of agricultural raw materials to its customers. To manage the price volatility in the commodity markets, the Company may purchase inventory in advance or enter into exchange traded futures or options contracts. Despite these hedging activities, Penford may not be successful in limiting its exposure to market fluctuations in the cost of agricultural raw materials. Increases in the cost of corn, wheat flour, and potato starch due to weather conditions or other factors beyond Penford’s control and that cannot be passed through to customers will reduce Penford’s future profitability.

Increases in energy costs will reduce the Company’s profitability.

     Electricity and natural gas comprise approximately 15% of the cost of manufacturing the Company’s products in North America. Natural gas is used extensively in the Industrial Ingredients – North America business to dry the starch products. The prices of these inputs to the manufacturing process fluctuate based on anticipated changes in supply and demand, weather and the prices of alternative fuels. Penford may use short-term purchase contracts or exchange traded futures or option contracts to reduce the price volatility of natural gas. Penford may not be able to pass on increases in energy costs to its customers and margins and profitability would be adversely affected.

The loss of a major customer could have an adverse effect on Penford’s results of operations.

     None of the Company’s customers constituted 10% of sales in the last three fiscal years. However, in the six months of fiscal 2005, sales to the top ten customers and sales to the largest customer represented 46% and 8.8%, respectively, of total consolidated net sales. Customers place orders on an as-needed basis and generally can change their suppliers without penalty. If the Company lost one or more of its major customers, or if one or more of its customers significantly reduced its orders, sales and results of operations would be adversely affected.

In order to be successful, Penford must retain and motivate key employees.

     In order to be successful, the Company must retain and motivate executives and other key employees. In particular, hiring and retaining qualified personnel in management, research and development, sales and marketing, manufacturing and finance is critical to Penford’s future. Penford faces intense competition for its personnel needs. The loss of key employees could have a significant impact on the Company’s results of operations and stock price.

Changes in interest rates will affect Penford’s profitability.

     At February 28, 2005, approximately $73.3 million of the Company’s outstanding debt is subject to variable interest rates which move in direct proportion to the London InterBank Offered Rate (“LIBOR”) or the Australian Bank Bill Buying Rate (BBSY). Significant changes in these interest rates would materially affect Penford’s profitability.

Unanticipated changes in tax rates or exposure to additional income tax liabilities could affect Penford’s profitability.

     Penford is subject to income taxes in the United States, Australia and New Zealand. The effective tax rates could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities or changes in tax laws. The carrying value of deferred tax assets, which are predominantly in the United States, is dependent on Penford’s ability to generate future taxable income in the United States.

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Profitability is subject to risks associated with changes in foreign exchange currency rates.

     In the ordinary course of business, Penford is subject to risks associated with changing foreign exchange rates. For the six months ended February 28, 2005, approximately 33% of the Company’s revenue is denominated in currencies other than the U.S. dollar. Penford’s revenues and results of operations are affected by fluctuations in exchange rates between the U.S. dollar and the Australian and New Zealand dollars.

Provisions of Washington law could discourage or prevent a potential takeover.

     Penford is incorporated in the State of Washington and subject to the anti-takeover provisions of the Washington Business Corporation Act (the “Act”), which prohibits the Company from engaging in a ‘business combination” with an “interested shareholder” for a period of three years after the date of the transaction in which the person became an interested shareholder, unless the business combination is approved in a prescribed manner. The application of the anti-takeover provisions of the Act could have the effect of delaying or preventing a change of control in the ownership of the Company.

     Item 3: Quantitative and Qualitative Disclosures About Market Risk.

     The Company is exposed to market risks from adverse changes in interest rates, foreign currency exchange rates and commodity prices. Since August 31, 2004, there have been no significant changes in the Company’s exposure to market risks.

     Item 4: Controls and Procedures.

     Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective such that information related to the Company required to be disclosed in the Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

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PART II — OTHER INFORMATION

Item 1: Legal Proceedings

     See Note 12 to the Condensed Consolidated Financial Statements for a discussion of legal proceedings.

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

     The Company held its Annual Meeting of Shareholders on January 28, 2005. The only item voted upon at the meeting was the election of directors. The results of the election are shown below. Directors not elected at this meeting and whose term of office continued after the meeting are Jeffrey T. Cook, R. Randolph Devening, Paul H. Hatfield, Thomas D. Malkoski and Sally G. Narodick.

Item 6: Exhibits.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

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