UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended February 28, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File No. 0-11488

PENFORD CORPORATION

(Exact name of registrant as specified in its charter)

Washington	91-1221360
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
7094 South Revere Parkway,
Centennial, Colorado	80112-3932
(Address of Principal Executive Offices)	(Zip Code)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o                    Accelerated Filer þ                    Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o     No þ

The net number of shares of the Registrant’s common stock (the Registrant’s only outstanding class of stock) outstanding as of April 5, 2007 was 8,981,795.

PENFORD CORPORATION AND SUBSIDIARIES

INDEX

	Page
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets – February 28, 2007 and August 31, 2006	3
Condensed Consolidated Statements of Operations – Three and Six Months ended February 28, 2007 and February 28, 2006	4
Condensed Consolidated Statements of Cash Flow – Six Months ended February 28, 2007 and February 28, 2006	5
Notes to Condensed Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3. Quantitative and Qualitative Disclosures About Market Risk	21
Item 4. Controls and Procedures	21
PART II—OTHER INFORMATION
Item 1A. Risk Factors	22
Item 4. Submission of Matters to a Vote of Security Holders	24
Item 6. Exhibits	24
Signatures	25
Certification of CEO Pusuant to Section 302
Certification of CFO Pusuant to Section 302
Certifications of CEO and CFO Pursuant to Section 906

2

PART I — FINANCIAL INFORMATION

Item 1: Financial Statements

PENFORD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	February 28,			August 31,
(In thousands, except per share data)	2007			2006
	(Unaudited)
ASSETS
Current assets:
Cash	$	2,715		$	939
Trade accounts receivable, net		50,598			44,593
Inventories		40,867			34,953
Prepaid expenses		3,833			4,649
Other		4,558			4,782
Total current assets		102,571			89,916
Property, plant and equipment, net		133,641			124,829
Restricted cash value of life insurance		10,344			10,278
Goodwill, net		22,740			21,871
Other intangible assets, net		2,757			2,785
Other assets		1,673			989
Total assets	$	273,726		$	250,668
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Cash overdraft, net	$	—		$	961
Current portion of long-term debt and capital lease obligations		4,057			4,295
Short-term borrowings		7,411			9,541
Accounts payable		32,380			31,686
Accrued liabilities		9,612			11,360
Total current liabilities		53,460			57,843
Long-term debt and capital lease obligations		74,239			53,171
Other post-retirement benefits		13,765			13,606
Deferred income taxes		4,587			5,924
Other liabilities		14,248			12,672
Total liabilities		160,299			143,216
Shareholders’ equity:
Preferred stock, par value $1.00 per share, authorized 1,000 shares, none issued		—			—
Common stock, par value $1.00 per share, authorized 29,000 shares, issued 10,953 and 10,909 shares, respectively		10,953			10,909
Additional paid-in capital		40,571			39,427
Retained earnings		81,335			78,131
Treasury stock, at cost, 1,981 shares		(32,757	)		(32,757	)
Accumulated other comprehensive income		13,325			11,742
Total shareholders’ equity		113,427			107,452
Total liabilities and shareholders’ equity	$	273,726		$	250,668

The accompanying notes are an integral part of these statements.

3

PENFORD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

	Three months ended					Six months ended
	February 28,		February 28,			February 28,		February 28,
(In thousands, except per share data)	2007		2006			2007		2006
Sales	$	85,241	$	77,078		$	170,741	$	154,981
Cost of sales		72,839		68,534			145,145		136,037
Gross margin		12,402		8,544			25,596		18,944
Operating expenses		7,333		6,671			14,433		14,408
Research and development expenses		1,578		1,571			3,150		3,008
Income from operations		3,491		302			8,013		1,528
Non-operating income, net		229		486			751		847
Interest expense		1,689		1,534			2,993		2,867
Income (loss) before income taxes		2,031		(746	)		5,771		(492	)
Income taxes (benefit)		325		(235	)		1,492		(176	)
Net income (loss)	$	1,706	$	(511	)	$	4,279	$	(316	)
Weighted average common shares and equivalents outstanding:
Basic		8,957		8,881			8,950		8,879
Diluted		9,152		8,881			9,103		8,879
Income (loss) per share:
Basic	$	0.19	$	(0.06	)	$	0.48	$	(0.04	)
Diluted	$	0.19	$	(0.06	)	$	0.47	$	(0.04	)
Dividends declared per common share	$	0.06	$	0.06		$	0.12	$	0.12

The accompanying notes are an integral part of these statements.

4

PENFORD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)

	Six Months Ended
	February 28,			February 28,
(In thousands)	2007			2006
Cash flows from operating activities:
Net income (loss)	$	4,279		$	(316	)
Adjustments to reconcile net income (loss) to net cash provided by operations:
Depreciation and amortization		7,896			7,671
Stock-based compensation		590			600
Loss (gain) on sale of fixed assets		142			(52	)
Deferred income taxes		(175	)		(413	)
Loss on derivative transactions		1,825			385
Other		(72	)		21
Change in assets and liabilities:
Trade accounts receivable		(5,221	)		(2,048	)
Prepaid expenses		846			938
Inventories		(8,290	)		82
Accounts payable and accrued liabilities		(88	)		(5,411	)
Taxes payable		(2,254	)		(280	)
Other		1,814			940
Net cash provided by operating activities		1,292			2,117
Cash flows from investing activities:
Investment in property, plant and equipment, net		(15,122	)		(10,003	)
Proceeds from sale of land		—			612
Other		(64	)		4
Net cash used in investing activities		(15,186	)		(9,387	)
Cash flows from financing activities:
Proceeds from short-term borrowings		5,143			—
Payments on short-term borrowings		(7,643	)		—
Proceeds from revolving line of credit		33,652			15,461
Payments on revolving line of credit		(15,339	)		—
Proceeds from long-term debt		4,200			—
Payments of long-term debt		(2,249	)		(1,994	)
Exercise of stock options		528			128
Payment of loan fees		(836	)		(16	)
Decrease in cash overdraft		(961	)		(777	)
Payment of dividends		(1,073	)		(1,064	)
Other		44			(5	)
Net cash provided by financing activities		15,466			11,733
Effect of exchange rate changes on cash and cash equivalents		204			2
Net increase in cash and cash equivalents		1,776			4,465
Cash and cash equivalents, beginning of period		939			5,367
Cash and cash equivalents, end of period	$	2,715		$	9,832

The accompanying notes are an integral part of these statements.

5

PENFORD CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     1—BUSINESS

     Penford Corporation (which, together with its subsidiary companies, is referred to herein as “Penford” or the “Company”) is a developer, manufacturer and marketer of specialty natural-based ingredient systems for industrial and food ingredient applications. The Company operates manufacturing facilities in the United States, Australia and New Zealand. The Company uses its carbohydrate chemistry expertise to develop ingredients with starch as a base for value-added applications in a variety of markets, including paper, packaging, food products, specialty chemicals and adhesives. 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 in developing applications to address customer needs. In addition, the Company has specialty processing capabilities for a variety of modified starches.

     Penford manages its business in three segments. The first two, industrial ingredients and food ingredients, are broad categories of end-market users, primarily served by the U.S. operations. The third segment is the geographically separate operations in Australia and New Zealand. The Australian and New Zealand operations are engaged primarily in the food ingredients business.

     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, 2007 and the condensed consolidated statements of operations and cash flows for the interim periods ended February 28, 2007 and 2006 have been prepared by the Company without audit. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which 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 U.S. 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. Certain prior period amounts have been reclassified to conform with the current period presentation. 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, 2006.

     Recent Accounting Pronouncements

     In June 2006, the Financial Accounting Standards Board (“FASB”) ratified the Emerging Issues Task Force (“EITF”) consensus on EITF Issue No. 06-2, “Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43.” EITF Issue No. 06-2 requires companies to accrue the costs of compensated absences under a sabbatical or similar benefit arrangement over the requisite service period. EITF Issue No. 06-2 is effective for years beginning after December 15, 2006. The Company is currently evaluating the impact that the adoption of EITF Issue No. 06-2 will have on its consolidated financial statements.

     In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for the uncertainty in income taxes recognized by prescribing a recognition threshold that a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, classification, interest and penalties, interim period accounting and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact that the adoption of FIN 48 will have on its consolidated financial statements.

6

     In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 (fiscal 2009). The Company is currently evaluating the impact that the adoption of SFAS 157 may have on its consolidated financial statements.

     In September 2006, the FASB issued Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132R” (“SFAS 158”). SFAS 158 requires companies to recognize the funded status of defined benefit pension and other postretirement plans as an asset or liability in the statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income in shareholders’ equity. SFAS 158 is effective for fiscal years ending after December 15, 2006. The Company is currently evaluating the impact that the adoption of SFAS 158 will have on its consolidated financial statements.

     In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB No. 115” (“SFAS 159”). SFAS 159 allows companies the option to measure financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact that the adoption of SFAS 159 may have on its consolidated financial statements.

     3—STOCK-BASED COMPENSATION

     Stock Compensation Plans

     Penford maintains the 2006 Long-Term Incentive Plan (the “2006 Incentive Plan”) pursuant to which various stock-based awards may be granted to employees, directors and consultants. Prior to the 2006 Incentive Plan, the Company awarded stock options to employees and officers through the Penford Corporation 1994 Stock Option Plan (the “1994 Plan”) and to members of its Board under the Stock Option Plan for Non-Employee Directors (the “Directors’ Plan”). The 1994 Plan was suspended when the 2006 Plan became effective. The Directors’ Plan expired in August 2005. As of February 28, 2007, the aggregate number of shares of the Company’s common stock that are available to be issued as awards under the 2006 Incentive Plan is 739,101. In addition, any shares previously granted under the 1994 Plan which are subsequently forfeited or not exercised will be available for future grants under the 2006 Incentive Plan.

     General Option Information

     A summary of the stock option activity for the six months ended February 28, 2007, is as follows:

						Weighted
				Weighted		Average
	Number of			Average		Remaining		Aggregate
	Shares			Exercise Price		Term (in years)		Intrinsic Value
Outstanding Balance, August 31, 2006		1,171,063		$	13.98
Granted		65,000			16.25
Exercised		(43,558	)		12.12
Cancelled		(14,625	)		13.13
Outstanding Balance, February 28, 2007		1,177,880		$	14.19		5.95	$	7,659,503
Options Exercisable at February 28, 2007		760,130		$	13.60		5.35	$	5,389,414

     The aggregate intrinsic value disclosed in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $20.69 as of February 28, 2007 that would have been received by the option holders had all option holders exercised on that date. The intrinsic value of options exercised during the three and six months ended February 28, 2007 was $117,300 and $206,900, respectively. The intrinsic value of options exercised during the three and six months ended February 28, 2006 was $14,400 for both periods.

7

     No stock options were granted during the second quarter of fiscal 2007 and 2006. The weighted average grant date fair value of stock options granted under the 2006 Incentive Plan during the six months ended February 28, 2007 was $6.74 and under the 1994 Plan during the six months ended February 28, 2006 was $6.93.

     As of February 28, 2007, the Company had $1.5 million of unrecognized compensation costs related to non-vested stock option awards that is expected to be recognized over a weighted average period of 1.6 years.

     The following table summarizes information concerning outstanding and exercisable options as of February 28, 2007:

	Options Outstanding						Options Exercisable
			Wtd. Avg.
			Remaining		Wtd. Avg.				Wtd. Avg.
	Number of		Contractual		Exercise		Number of		Exercise
Range of Exercise Prices	Options		Life (years)		Price		Options		Price
$    6.18 — 13.00		464,085		5.24	$	11.98		427,710	$	11.91
13.01 — 16.00		375,795		6.53		14.64		146,420		14.11
16.01 — 17.69		338,000		6.30		16.72		186,000		17.08
		1,177,880						760,130

     Valuation and Expense Under SFAS No. 123R

     On September 1, 2005, the Company adopted SFAS No. 123R which requires the measurement and recognition of compensation cost for all share-based payment awards made to employees and directors based on estimated fair values. The Company elected to use the modified prospective transition method for adopting SFAS No. 123R which requires the recognition of stock-based compensation cost on a prospective basis. Under this method, the provisions of SFAS No. 123R are applied to all awards granted after the adoption date and to awards not yet vested with unrecognized expense at the adoption date based on the estimated fair value at grant date as determined under the original provisions of SFAS No. 123.

     The Company utilizes the Black-Scholes option-pricing model to determine the fair value of stock options on the date of grant. This model derives the fair value of stock options based on certain assumptions related to expected stock price volatility, expected option life, risk-free interest rate and dividend yield. The Company’s expected volatility is based on the historical volatility of the Company’s stock price over the most recent period commensurate with the expected term of the stock option award. The estimated expected option life is based primarily on historical employee exercise patterns and considers whether and the extent to which the options are in-the-money. The risk-free interest rate assumption is based upon the U.S. Treasury yield curve appropriate for the term of the Company’s stock options awards and the selected dividend yield assumption was determined in view of the Company’s historical and estimated dividend payout. The Company has no reason to believe that the expected volatility of its stock price or its option exercise patterns would differ significantly from historical volatility or option exercises.

     For the six months ended February 28, 2007 and 2006, the fair value of the options was estimated on the date of grant using the following assumptions.

	Six Months Ended February 28,
	2006 Incentive Plan					1994 Plan
	2007			2006		2007		2006
Expected volatility		45	%		—		—		52	%
Expected life (years)		5.5			—		—		5.0
Interest rate (percent)		4.4-4.9			—		—		4.4-4.5
Dividend yield		1.5	%		—		—		1.7	%

     No stock options were granted under any stock option plan during the second quarter of fiscal 2007 and 2006. No stock options were granted under the 1994 Plan during the first six-month period of fiscal 2007 and no stock options were granted under the 2006 Incentive Plan during the six months ended February 28, 2006.

8

     The Company recognizes stock-based compensation expense utilizing the accelerated multiple option approach over the requisite service period, which equals the vesting period. The following table summarizes the stock-based compensation cost under SFAS No. 123R for the three and six months ended February 28, 2007 and 2006 and the effect on the Company’s Condensed Consolidated Statements of Operations (in thousands):

	Three Months Ended				Six Months Ended
	February 28,				February 28,
	2007		2006		2007		2006
Cost of sales	$	17	$	32	$	41	$	52
Operating expenses		260		242		518		504
Research and development expenses		3		11		10		23
Total stock-based compensation expense	$	280	$	285	$	569	$	579
Tax benefit		104		97		211		197
Total stock-based compensation expense, net of tax	$	176	$	188	$	358	$	382

     See Note 11 for stock-based compensation costs recognized in the financial statements of each business segment.

     Restricted Stock

     Non-employee directors receive restricted stock under the 1993 Non-Employee Director Restricted Stock Plan, which provides that beginning September 1, 1993 and every three years thereafter, each non-employee director shall receive $18,000 worth of common stock of the Company, based on the last reported sale price of the stock on the preceding trading day. One-third of the shares vest on each anniversary of the date of the award. The Company recognizes compensation cost for restricted stock ratably over the vesting period. In September 2005, 8,694 shares of restricted common stock of the Company were granted to the non-employee directors.

     4—INVENTORIES

     The components of inventory are as follows:

	February 28,		August 31,
	2007		2006
	(In thousands)
Raw materials	$	22,370	$	18,531
Work in progress		811		449
Finished goods		17,686		15,973
Total inventories	$	40,867	$	34,953

     5—PROPERTY, PLANT AND EQUIPMENT

     The components of property, plant and equipment are as follows:

	February 28,			August 31,
	2007			2006
	(In thousands)
Land	$	17,303		$	16,659
Plant and equipment		332,322			322,169
Construction in progress		11,532			7,078
		361,157			345,906
Accumulated depreciation		(227,516	)		(221,077	)
Net property, plant and equipment	$	133,641		$	124,829

     Changes in Australian and New Zealand currency exchange rates have increased net property, plant and equipment in the first six months of fiscal 2007 by approximately $1.6 million.

9

     For the first six months of fiscal 2007, the Company had $5.2 million of capital expenditures related to construction of the ethanol facility. As of February 28, 2007, the Company had a total of $5.9 million in capital expenditures related to the ethanol facility which includes $0.1 million in related capitalized interest costs.

     6—DEBT

     On October 5, 2006, the Company entered into a $145 million Second Amended and Restated Credit Agreement (the “Agreement”) among the Company; Harris N.A.; LaSalle Bank National Association; Cooperative Centrale Raiffeisen-Boorleenbank B.A., “Rabobank Nederland” (New York Branch); U.S. Bank National Association; and the Australia and New Zealand Banking Group Limited.

     The Agreement refinanced the Company’s previous $105 million secured term and revolving credit facilities. Under the Agreement, the Company may borrow $40 million in term loans and $60 million in revolving lines of credit. The lenders’ revolving credit loan commitment may be increased under certain conditions. In addition, the Agreement provides the Company with $45 million in new capital expansion funds which may be used by the Company to finance the construction of its planned ethanol production facility in Cedar Rapids, Iowa. The capital expansion funds may be borrowed as term loans from time to time prior to October 5, 2008.

     The final maturity date for the term and revolving loans under the Agreement is December 31, 2011. Beginning on December 31, 2006, the Company must repay the term loans in twenty equal quarterly installments of $1 million, with the remaining amount due at final maturity. The final maturity date for the capital expansion loans is December 31, 2012. Beginning on December 31, 2008, the Company must repay the capital expansion loans in equal quarterly installments of $1.25 million through September 30, 2009 and $2.5 million thereafter, with the remaining amount due at final maturity. Interest rates under the Agreement are based on either the London Interbank Offering Rates (“LIBOR”) in Australia or the U.S., or the prime rate, plus an applicable margin, depending on the selection of available borrowing options under the Agreement.

     The Agreement provides that the Total Funded Debt Ratio, which is computed as funded debt divided by earnings before interest, taxes, depreciation and amortization (as defined in the Agreement) shall not exceed 3.25 through February 28, 2007. Subsequent to February 28, 2007, the maximum Total Funded Debt Ratio varies between 3.00 and 4.50. In addition, the Company must maintain a minimum tangible net worth of $65 million, and a Fixed Charge Coverage Ratio, as defined in the Agreement, of not more than 1.50 in fiscal 2007, 1.25 in fiscal 2008 and 1.50 in fiscal 2009 and thereafter. Annual capital expenditures, exclusive of capital expenditures incurred in connection with the Company’s ethanol production facility, are limited to $20 million.

     The Company’s obligations under the Agreement are secured by substantially all of the Company’s assets and those of its principal domestic subsidiary, Penford Products Co.

     At February 28, 2007, the Company had $39.1 million and $39.0 million outstanding, respectively, under the revolving credit and term loan portions of its $145 million credit facility. Pursuant to the terms of the credit agreement, Penford’s additional borrowing ability was $42.5 million at February 28, 2007. In addition, the Company has not drawn down any of the $45 million in capital expansion loans available under the credit facility for the construction of the ethanol facility. The Company was in compliance with the covenants in its credit agreement as of February 28, 2007 and expects to be in compliance with the covenants for the remainder of fiscal 2007.

     The Company’s short-term borrowings consist of an Australian variable-rate revolving grain inventory financing facility with an Australian bank for a maximum of $31.7 million U.S. dollars at the exchange rate at February 28, 2007. The amount outstanding under this arrangement, which is classified as a current liability on the balance sheet, was $7.4 million at February 28, 2007.

     As of February 28, 2007, all of the Company’s outstanding debt, including amounts outstanding under the Australian grain inventory financing facility, is subject to variable interest rates. Under interest rate swap agreements with several banks, the Company has fixed its interest rates on $34.8 million of U.S. dollar denominated term debt at 4.18% plus the applicable margin under the Company’s credit agreement. As of February 28, 2007, the fair value of the interest rate swaps was $0.7 million.

10

     7—TAXES

     The Company’s effective tax rate for the three and six months ended February 28, 2007 and 2006 varied from the U.S. federal statutory rate primarily due to Australian tax incentives related to research and development, the favorable tax effect of export sales from the U.S. through the extraterritorial income exclusion, and the favorable tax effect of domestic (U.S.) production activities. In December 2006, the Tax Relief Healthcare Act of 2006 was enacted which retroactively reinstated and extended the research and development tax credit from January 1, 2006 through December 31, 2007. The Company recorded the tax effect of $0.2 million of research and development tax credits in the second quarter of 2007 related to fiscal 2006 and the first quarter of 2007.

     On a quarterly basis, the Company reviews its estimate of the effective income tax rate expected to be applicable for the full fiscal year. This rate is used to calculate income tax expense or benefit on current year-to-date pre-tax income or loss. Income tax expense or benefit for the current interim period is the difference between the computed year-to-date income tax amount and the tax expense or benefit reported for previous quarters. In reviewing its effective tax rate, the Company uses estimates of the amounts of permanent differences between book and tax accounting and projections of fiscal year pre-tax income or loss. Currently, the Company’s best estimate of the annual effective tax rate for fiscal 2007 is 26%.

     8—OTHER COMPREHENSIVE INCOME (LOSS)

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

	Three months ended						Six months ended
	February			February			February			February
	28, 2007			28, 2006			28, 2007			28, 2006
	(In thousands)
Net income (loss)	$	1,706		$	(511	)	$	4,279		$	(316	)
Foreign currency translation adjustments		987			(587	)		2,924			(1,080	)
Net unrealized gain (loss) on derivative instruments that qualify as cash flow hedges		(273	)		806			(1,341	)		1,113
Total comprehensive income (loss)	$	2,420		$	(292	)	$	5,862		$	(283	)

     9—NON-OPERATING INCOME, NET

     Non-operating income, net consists of the following:

	Three months ended					Six months ended
	February 28,			February 28,		February 28,			February 28,
	2007			2006		2007			2006
	(In thousands)
Royalty and licensing income	$	405		$	412	$	923		$	835
Gain (loss) on sale of assets		(142	)		54		(142	)		52
Other		(34	)		20		(30	)		(40	)
Total	$	229		$	486	$	751		$	847

     In November 2002, the Company exclusively licensed the rights to its resistant starch intellectual property portfolio (the “RS Patents”) 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. Under the terms of the 2002 license agreement, Penford also became entitled to receive annual royalties for a period of seven years or until a maximum of $11.0 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. The Company has recognized $7.6 million in royalty income from the inception of the agreement through February 28, 2007.

11

     In September 2006, in connection with the settlement of litigation in which Penford’s Australian subsidiary companies were plaintiffs, Penford received a one-time payment of $625,000 and granted a license to one of the defendants in this litigation under Penford’s RS Patents in certain non-human nutrition applications. In addition, Penford became entitled to receive additional royalties under a license of rights under the RS Patents in human nutrition applications granted to one of the defendants. As part of the settlement agreement, Penford is entitled to receive certain other benefits, including an acceleration and extension of certain royalties under its 2002 license. The Company is deferring and recognizing license income of $625,000 ratably over the remaining life of the patent license, which is estimated to be seven years.

10 — PENSION AND POST-RETIREMENT BENEFIT PLANS

     The components of the net periodic pension and post-retirement benefit costs for the three and six months ended February 28, 2007 and 2006 are as follows:

	Three months ended						Six months ended
	February 28,			February 28,			February 28,			February 28,
Defined benefit pension plans	2007			2006			2007			2006
	(In thousands)
Service cost	$	345		$	418		$	733		$	836
Interest cost		516			526			1,100			1,051
Expected return on plan assets		(593	)		(529	)		(1,186	)		(1,058	)
Amortization of prior service cost		47			46			93			93
Amortization of actuarial losses		48			150			96			301
Net periodic benefit cost	$	363		$	611		$	836		$	1,223

	Three months ended						Six months ended
	February 28,			February 28,			February 28,			February 28,
Post-retirement health care plans	2007			2006			2007			2006
	(In thousands)
Service cost	$	78		$	98		$	155		$	196
Interest cost		204			196			409			392
Amortization of prior service cost		(38	)		(38	)		(76	)		(76	)
Amortization of actuarial losses		—			36			—			72
Net periodic benefit cost	$	244		$	292		$	488		$	584

     11—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 Industrial Ingredients segment provides carbohydrate-based starches for industrial applications, primarily in the paper and packaging products industries. The Food Ingredients segment produces specialty starches for food applications. 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 is presented separately since the chief operating decision maker views segment results prior to intercompany eliminations.

12

	Three months ended						Six months ended
	February 28,						February 28,
	2007			2006			2007			2006
	(In thousands)
Sales:
Industrial Ingredients—North America	$	46,713		$	41,165		$	90,685		$	79,646
Food Ingredients—North America		14,561			13,567			29,801			28,657
Australia/New Zealand operations		24,104			22,442			50,628			47,077
Intercompany sales		(137	)		(96	)		(373	)		(399	)
	$	85,241		$	77,078		$	170,741		$	154,981
Income (loss) from operations:
Industrial Ingredients—North America	$	3,649		$	781		$	6,830		$	1,355
Food Ingredients—North America		2,160			1,485			5,013			3,886
Australia/New Zealand operations		(57	)		98			751			795
Corporate and other		(2,261	)		(2,062	)		(4,581	)		(4,508	)
	$	3,491		$	302		$	8,013		$	1,528

	February 28,		August 31,
	2007		2006
	(In thousands)
Total assets:
Industrial Ingredients–North America	$	120,040	$	98,733
Food Ingredients—North America		30,507		31,714
Australia/New Zealand operations		104,293		104,491
Corporate and other		18,886		15,730
	$	273,726	$	250,668

     The following table summarizes the stock-based compensation expense related to stock option awards by segment for the three and six months ended February 28, 2007 and 2006.

	Three months ended				Six months ended
	February 28,				February 28,
	2007		2006		2007		2006
	(In thousands)				(In thousands)
Industrial Ingredients–North America	$	68	$	54	$	136	$	120
Food Ingredients—North America		55		32		98		65
Australia/New Zealand operations		9		2		29		13
Corporate		148		197		306		381
	$	280	$	285	$	569	$	579

13

     12—EARNINGS PER SHARE

     Basic earnings per share reflect only the weighted average common shares outstanding during the period. Diluted earnings per share reflect weighted average common shares outstanding and the effect of any dilutive common stock equivalent shares. 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. The following table presents the computation of diluted weighted average shares outstanding for the three and six months ended February 28, 2007 and 2006.

	Three months ended				Six months ended
	February 28,				February 28,
	2007		2006		2007		2006
	(In thousands)
Weighted average common shares outstanding		8,957		8,881		8,950		8,879
Dilutive stock options		195		—		153		—
Weighted average common shares outstanding, assuming dilution		9,152		8,881		9,103		8,879

     Weighted-average stock options to purchase 265,000 and 303,453 shares of common stock for the three and six months ended February 28, 2007, and weighted-average stock options to purchase 1,188,313 and 1,164,726 shares of common stock for the three and six months ended February 28, 2006, were excluded from the calculation of diluted earnings per share because they were antidilutive.

     13—LEGAL PROCEEDINGS

     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 Court, 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 an answer generally denying all liability and has countersued for damages. During the second quarter of fiscal year 2007, the Company continued to vigorously defend against Graphic’s claim and to diligently prosecute its own claim against Graphic. Discovery by each party in this suit continues and a trial has been scheduled for mid-July 2007. Based upon discovery responses made by Graphic, Graphic is seeking damages of approximately $3.3 million. Penford is seeking damages of approximately $675,000. The Company is unable to assess the eventual outcome of this litigation at this time and, accordingly, it has not established any loss contingency for this matter.

     The Company is involved in various other claims and litigation arising in the normal course of business. In the judgment of management, which relies in part on information from the Company’s outside legal counsel, the ultimate resolution of these other actions will not materially affect the consolidated financial statements of the Company.

14

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 does not intend 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 in Item 1A in this Quarterly Report, and those described from time to time in other filings with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the year ended August 31, 2006, 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; unanticipated ethanol facility construction or procurement delays that could result in delay in the timing of the commencement of ethanol production; unexpected overruns; technical difficulties, nonperformance by contractors or mandated changes in project requirements or specifications; changes in general economic conditions or developments with respect to specific industries, markets or customers which affect demand for the Company’s products, including unfavorable shifts in product mix; adverse litigation results or unanticipated third party claims; interest rate, chemical and energy cost volatility; foreign currency exchange rate fluctuations; changes in assumptions used for determining employee benefit expense and obligations; changes in the assumptions used to determine the effective income tax rate; or other unforeseen developments in the industries in which Penford operates.

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 principally 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.

Results of Operations

     Executive Overview

     Consolidated sales for the three months ended February 28, 2007 increased 11% to $85.2 million from $77.1 million in the second quarter of fiscal 2006, primarily due to improved unit pricing and the pass-through impact on sales of higher corn costs, partially offset by a decline in sales volume in the Industrial Ingredients business. Gross margin as a percent of sales expanded to 14.5%, 340 basis points above the same period last year of 11.1% driven by revenue gains and favorable corn procurement in the Industrial Ingredients business. Income from operations rose to $3.5 million, a $3.2 million increase over the second quarter of fiscal 2006 due to gross margin improvements.

15

     Sales for the six months ended February 28, 2007 rose 10% to $170.7 million from $155.0 million in the same period last year, primarily due to improved unit pricing and the pass-through impact on sales of higher corn costs in the Industrial Ingredients business, and favorable foreign exchange rates in the Australia/New Zealand operations, partially offset by a 2% decline in consolidated sales volumes. Gross margin as percent of sales increased to 15.0% from 12.2% last year on favorable pricing and product mix in all business units, and improvements in production and unit natural gas costs in the North American operations. Operating income for the first half of fiscal 2007 increased $6.5 million compared to the same period last year as a result of improvements in gross margin.

     Fiscal 2007 second quarter operating expense as a percent of sales was comparable to the same quarter of fiscal 2006. Operating expenses for the six months ended February 28, 2007 were comparable to the first half of fiscal 2006. Higher professional fees and an increase in employee costs were offset by $0.6 million of severance costs in fiscal 2006 related to managerial changes in the Industrial Ingredients—North America and Australian operations. A discussion of segment results of operations and the effective tax rate follows.

     Sales

     Second quarter fiscal 2007 sales at the Company’s Industrial Ingredients—North America business unit increased $5.5 million, or 13.5%, to $46.7 million from $41.2 million over the same quarter last year. Sales volumes declined 11% as paper industry customers adjusted inventory levels. Increases in average unit selling prices contributed 6% to the sales growth and the pass-through impact from higher corn prices added another 16% to segment sales. Sales for the first half of fiscal 2007 rose 14%, or $11.0 million, to $90.7 million compared to sales of $79.6 million in the first six months of fiscal 2006. Higher unit selling prices and the pass-through impact of higher corn prices contributed a combined 17% increase in sales, partially offset by volume declines of 4%.

     Fiscal 2007 second quarter sales for the Food Ingredients—North America segment of $14.6 million increased 7.3%, or $1.0 million, from the second quarter of fiscal 2006, and year-to-date sales of $29.8 million improved 4% compared to $28.7 million in the same period last year. Sales growth for both periods of fiscal 2007 was driven by higher sales of applications for the protein market segment, which includes processed meats, and improved pricing and product mix.

     Sales at the Australia/New Zealand operations expanded 7.4%, or $1.7 million, in the second quarter of fiscal 2007 over the same period of fiscal 2006 on higher average unit pricing and favorable foreign currency exchange rates. Second quarter sales in local currency increased 2% over the same quarter of fiscal 2006. Year-to-date sales increased 7.5% to $50.6 million from $47.1 million last year primarily due to a sales volume increase of 5%. Stronger foreign currency exchange rates contributed 2% to the rise in sales for the first half of fiscal 2007. Sales in local currency increased 4%.

     Income from operations

     For the second quarter of fiscal 2007, income from operations at the Company’s Industrial Ingredients—North America business unit grew $2.9 million to $3.6 million compared to the same quarter last year. Second quarter fiscal 2007 gross margin as a percent of sales was 14.5%, a 520 basis point increase over the same quarter of fiscal 2006, primarily due to revenue gains related to favorable unit pricing and product mix, improvements in raw material corn procurement and reduced plant overhead costs, partially offset by a decline in sales volumes. Operating income for the six months ended February 28, 2007 increased by $5.5 million to $6.8 million compared to the first half of fiscal 2006. Six-month gross margin as a percent of sales rose to 14.1% in fiscal 2007 compared to 9.3% in the same period last year. Improvements in gross margin were driven by favorable unit pricing, improvements in raw material corn procurement, a 12% decline in unit natural gas costs, and reduced plant overhead costs, partially offset by a rise in chemical costs and a 4% decline in volumes.

     Income from operations for the second quarter of fiscal 2007 at the Food Ingredients—North America segment increased 46% from $1.5 million last year to $2.2 million. Gross margin as a percent of sales increased 390 basis points to 27.8% from 23.9% last year on favorable product mix and improved plant utilization rates. Operating expenses increased 7% on additional research and development costs and employee related costs. Year-to-date

16

income from operations rose to $5.0 million, a 29% increase over the same period last year. Gross margin as a percent of sales for the first half of fiscal 2007 increased to 29.7% from 26.1% in the previous year. Improved plant performance and lower energy costs contributed 2.6% to the margin expansion, with the remainder of the increase due to favorable product mix.

     Fiscal 2007 second quarter loss from operations at the Company’s Australia/New Zealand operations was $0.1 million compared to operating income of $0.1 million for the three months ended February 28, 2006. Gross margin as a percent of sales was comparable to the same period last year at 6.6%. Higher average unit pricing and favorable foreign currency rates were offset by an increase in raw material costs and plant overhead. Operating and research and development expenses increased 18% over the year ago quarter as the segment added personnel in executive management and sales. Income from operations for the first six months of fiscal 2007 was $0.8 million, comparable to the same period last year. First half 2007 gross margin as a percent of sales declined to 7.9% from 8.7% in the prior year period on higher plant overhead costs, partially offset by revenue gains. Operating and research and development expenses were comparable to last year as operating expenses for the first six months of fiscal 2006 included $0.4 million of employee severance costs.

     Corporate operating expenses

     Corporate operating expenses for the second quarter of fiscal 2007 increased to $2.3 million, a $0.2 million increase over the same period last year due to higher employee related costs and professional fees. For the six months ended February 28, 2007, corporate operating expenses were comparable to the six-month period of fiscal 2006.

     Interest expense

     Interest expense for the three and six-month periods ended February 28, 2007 and 2006 increased $0.2 million and $0.1 million, respectively, due to higher average debt balances. Increases in the interest rates during these periods were offset by a decline in the applicable interest rate margin pursuant to the credit agreement. The Company’s debt includes the amount outstanding under its grain inventory financing facility. Approximately $5.5 million of debt outstanding under the Company’s revolving credit facility at February 28, 2007 is attributable to the construction of the ethanol production plant. Interest expense of $0.1 million associated with the ethanol construction project was capitalized for the six months ended February 28, 2007. See Note 6 to the Condensed Consolidated Financial Statements.

     Income taxes

     The Company’s effective tax rate for the three and six months ended February 28, 2007 and 2006 varied from the U.S. federal statutory rate primarily due to Australian tax incentives related to research and development, the favorable tax effect of export sales from the U.S. through the extraterritorial income exclusion, and the favorable tax effect of domestic (U.S.) production activities. In December 2006, the Tax Relief Healthcare Act of 2006 was enacted in the U.S. which retroactively reinstated and extended the research and development tax credit from January 1, 2006 through December 31, 2007. The Company recorded the tax effect of $0.2 million of U.S. research and development tax credits in the second quarter of 2007 related to fiscal 2006 and the first quarter of 2007.

     On a quarterly basis, the Company reviews its estimate of the effective income tax rate expected to be applicable for the full fiscal year. This rate is used to calculate income tax expense or benefit on current year-to-date pre-tax income or loss. Income tax expense or benefit for the current interim period is the difference between the computed year-to-date income tax amount and the tax expense or benefit reported for previous quarters. In reviewing its effective tax rate, the Company uses estimates of the amounts of permanent differences between book and tax accounting and projections of fiscal year pre-tax income or loss. Currently, the Company’s best estimate of the annual effective tax rate for fiscal 2007 is 26%.

     The determination of the annual effective tax rate is based upon a number of estimates and judgments, including the estimated annual pretax income of the Company in each tax jurisdiction and the amounts of permanent differences between the book and tax accounting for various items. The Company’s interim tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and other items that cannot be estimated with any certainty. Therefore, there can be significant volatility in the interim provision for income tax expense.

17

     Non-operating income, net

     Non-operating income, net consists of the following:

	Three months ended					Six months ended
	February 28,			February 28,		February 28,			February 28,
	2007			2006		2007			2006
	(In thousands)
Royalty and licensing income	$	405		$	412	$	923		$	835
Gain (loss) on sale of assets		(142	)		54		(142	)		52
Other		(34	)		20		(30	)		(40	)
Total	$	229		$	486	$	751		$	847

     See Note 9 to the Condensed Consolidated Financial Statements in Item 1 for information on the Company’s royalty and licensing income.

Liquidity and Capital Resources

     On October 5, 2006, the Company entered into a $145 million Second Amended and Restated Credit Agreement. See Note 6 to the Condensed Consolidated Financial Statements.

     At February 28, 2007, the Company had $39.1 million and $39.0 million outstanding, respectively, under the revolving credit and term loan portions of its $145 million credit facility. At February 28, 2007, the Company had borrowed $5.5 million on its revolving credit facility to fund construction of the ethanol plant. Pursuant to the terms of the credit agreement, Penford’s additional borrowing ability was $42.5 million at February 28, 2007. In addition, at February 28, 2007, the Company had not drawn down any of the $45 million in capital expansion loans available under the credit facility for the construction of the ethanol facility. The Company was in compliance with the covenants in its credit agreement as of February 28, 2007 and expects to be in compliance with the covenants for the remainder of fiscal 2007.

     The Company’s short-term borrowings consist of an Australian variable-rate revolving grain inventory financing facility with an Australian bank for a maximum of $31.7 million U.S. dollars at the exchange rate at February 28, 2007. The amount outstanding under this arrangement, which is classified as a current liability on the balance sheet, was $7.4 million at February 28, 2007.

     As of February 28, 2007, all of the Company’s outstanding debt, including amounts outstanding under the Australian grain inventory financing facility, is subject to variable interest rates. Under interest rate swap agreements with several banks, the Company has fixed its interest rates on $34.8 million of U.S. dollar denominated term debt at 4.18% plus the applicable margin under the Company’s credit agreement. As of February 28, 2007, the fair value of the interest rate swaps was $0.7 million.

     Penford had working capital of $49.1 million and $32.1 million at February 28, 2007 and August 31, 2006, respectively. Accounts receivable increased by $6.0 million, primarily due to more favorable unit sales prices in the second quarter of fiscal 2007 and increases in raw material corn costs which are passed through to some customers in the Industrial Ingredients—North America business, and stronger foreign currency exchange rates in Australia/New Zealand. Inventory increased approximately $5.9 million, primarily in the Industrial Ingredients—North America segment, due to an increase in physical corn inventories and an increase in raw material corn costs. Cash provided by operations was $1.3 million and $2.1 million, respectively, for the six months ended February 28, 2007 and 2006. Total debt outstanding increased by $18.7 million during the first six months of fiscal 2007 primarily to fund $15 million in capital expenditures. For the first half of fiscal 2007, the Company had $5.2 million of capital expenditures related to the ethanol facility. As of February 28, 2007, the Company had a total of $5.9 million in capital expenditures related to the ethanol facility which includes $0.1 million in related capitalized interest costs. Currently, the Company estimates its capital expenditures in fiscal 2007 related to the ethanol facility to be $31 million.

18

     The Company paid dividends of $1.1 million during the six months ended February 28, 2007, which represents a quarterly rate of $0.06 per share. On January 25, 2007, the Board of Directors declared a dividend of $0.06 per common share payable on March 2, 2007 to shareholders of record as of February 9, 2007. 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.

Contractual Obligations

     The Company is a party to various debt and lease agreements at February 28, 2007 that contractually commit the Company to pay certain amounts in the future. The Company also has open purchase orders entered into in the ordinary course of business for raw materials, capital projects and other items, for which significant terms have been confirmed. The following table summarizes changes in the Company’s contractual commitments since August 31, 2006 (in millions of dollars).

	2007		2008-2009		2010-2011		2012 & After		Total
Long-term Debt and Capital Lease Obligations	$	2,029	$	8,116	$	8,021	$	60,130	$	78,296
Purchase Orders — Ethanol Construction		10,039		2,510		—		—		12,549
Rail Car Leases—Ethanol		—		2,059		2,574		2,612		7,245
	$	12,068	$	12,685	$	10,595	$	62,742	$	98,090

     The Company had no off-balance sheet arrangements at February 28, 2007.

Recent Accounting Pronouncements

     See Note 2 to the Condensed Consolidated Financial Statements in Item 1 for a description of recent accounting pronouncements, which information is incorporated by reference.

Critical Accounting Policies

     The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. These accounting principles require management to make estimates, judgments and assumptions to fairly present results of operations and financial position. Note 1 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended August 31, 2006 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. Management believes that its estimates, judgments and assumptions are reasonable based upon information available at the time this report was prepared. To the extent there are material differences between estimates, judgments and assumptions and the actual results, the financial statements will be affected.

     In many cases, the accounting treatment of a particular transaction is significantly dictated by U.S. 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. Management has reviewed the accounting policies and related disclosures with the Audit Committee. The accounting policies that management believes are the most important to the financial statements and that require the most difficult, subjective and complex judgments include the following:

• Evaluation of the allowance for doubtful accounts receivable

• Hedging activities

• Benefit plans

• Valuation of goodwill

• Self-insurance program

19

• Income taxes

• Stock-based compensation

     A description of each of these follows:

     Evaluation of the Allowance for Doubtful Accounts Receivable

     Management makes judgments about the Company’s ability to collect outstanding receivables and provides allowances for the portion of receivables that the Company may not be able to collect. Penford estimates the allowance for uncollectible accounts based on historical experience, known troubled accounts, industry trends, economic conditions, how recently payments have been received, and ongoing credit evaluations of its customers. If the estimates do not reflect the Company’s future ability to collect outstanding invoices, Penford may experience losses in excess of the reserves established. At February 28, 2007, the allowance for doubtful accounts receivable was $0.5 million.

     Hedging Activities

     Penford uses derivative instruments, primarily futures contracts, to reduce exposure to price fluctuations of commodities used in the manufacturing processes in the United States. Penford has elected to designate these activities as hedges. This election allows the Company to defer gains and losses on those derivative instruments until the underlying commodity is used in the production process. To reduce exposure to variable short-term interest rates, Penford uses interest rate swap agreements.

     The requirements for the designation of hedges are very complex, and require judgments and analyses to qualify as hedges as defined by Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“SFAS No. 133”). These judgments and analyses include an assessment that the derivative instruments used are effective hedges of the underlying risks. If the Company were to fail to meet the requirements of SFAS No. 133, or if these derivative instruments are not designated as hedges, the Company would be required to mark these contracts to market at each reporting date. Penford had deferred losses, net of tax, of $0.9 million at February 28, 2007, which are reflected in accumulated other comprehensive income.

     Benefit Plans

     Penford has defined benefit plans for its U.S. 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. The Company makes judgments about these assumptions based on 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 the financial statements.

     Valuation of Goodwill

     Penford is required to assess, on an annual basis, whether the value of goodwill reported on the balance sheet has been impaired, 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 the Company engages qualified valuation experts to assist in this process, their work is based on the Company’s estimates of future operating results and allocation of goodwill to the business units. If future operating results differ materially from the estimates, the value of goodwill could be adversely impacted.

     Self-insurance Program

     The Company maintains a self-insurance program covering portions of workers’ compensation and group health liability costs. The amounts in excess of the self-insured levels are fully insured by third party insurers. Liabilities associated with these risks are estimated in part by considering historical claims experience, severity factors and

20

other actuarial assumptions. Projections of future losses are inherently uncertain because of the random nature of insurance claims occurrences and changes that could occur in actuarial assumptions. The financial results of the Company could be significantly affected if future claims and assumptions differ from those used in determining these liabilities.

     Income Taxes

     The determination of the Company’s provision for income taxes requires significant judgment, the use of estimates and the interpretation and application of complex tax laws. The Company’s provision for income taxes reflects a combination of income earned and taxed in the various U.S. federal and state, as well as Australian and New Zealand, taxing jurisdictions. Jurisdictional tax law changes, increases or decreases in permanent differences between book and tax items, accruals or adjustments of accruals for tax contingencies or valuation allowances, and the Company’s change in the mix of earnings from these taxing jurisdictions all affect the overall effective tax rate.

     In evaluating the exposures connected with the various tax filing positions, the Company establishes an accrual, when, despite management’s belief that the Company’s tax return positions are supportable, management believes that certain positions may be successfully challenged and a loss is probable. When facts and circumstances change, these accruals are adjusted.

     Stock-Based Compensation

     Beginning September 1, 2005, the Company recognizes stock-based compensation in accordance with SFAS No. 123R, “Share-Based Payment.” Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period of the award. Determining the appropriate fair value model and calculating the fair value of the share-based awards at the date of grant requires judgment, including estimating stock price volatility, forfeiture rates, the risk-free interest rate, dividends and expected option life.

     If circumstances change, and the Company uses different assumptions for volatility, interest, dividends and option life in estimating the fair value of stock-based awards granted in future periods, stock-based compensation expense may differ significantly from the expense recorded in the current period. SFAS No. 123R requires forfeitures to be estimated at the date of grant and revised in subsequent periods if actual forfeitures differ from those estimated. Therefore, if actual forfeiture rates differ significantly from those estimated, the Company’s results of operations could be materially impacted.

     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. There have been no significant changes in the Company’s exposure to market risks since August 31, 2006.

     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 required by Rule 13a-15(b) of 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 as of February 28, 2007. There were no changes in the Company’s internal control over financial reporting during the quarter ended February 28, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

21

PART II — OTHER INFORMATION

     Item 1A Risk Factors

     Increases in energy and chemical costs may reduce the Company’s profitability.

     Energy and chemicals comprise approximately 13% and 11%, respectively, of the cost of manufacturing the Company’s products in the first six months of fiscal 2007. Natural gas is used extensively in the Industrial Ingredients – North America business to dry starch products, and, to a lesser extent, in the Company’s other business segments. Chemicals are used in all of Penford’s businesses to modify starch for specific product applications and customer requirements. 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, including petroleum. Penford may use short-term purchase contracts or exchange traded futures or option contracts to reduce the price volatility of natural gas; however, these strategies are not available for the chemicals the Company purchases. Penford may not be able to pass on increases in energy and chemical costs to its customers and margins and profitability would be adversely affected.

     The availability and cost of agricultural products Penford purchases are vulnerable to weather and other factors beyond its control. The Company’s ability to pass through cost increases for these products is limited by worldwide competition and other factors.

     In the first six months of fiscal 2007, approximately 31% of Penford’s manufacturing costs were the costs of agricultural raw materials, corn, wheat flour and maize. Weather conditions, plantings and global supply, among other things, have historically caused volatility in the supply and prices of these agricultural products. Due to local and/or international competition, particularly in its Australia/New Zealand operations, the Company may not be able to pass through the increases in the cost of agricultural raw materials to its customers. To manage 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, maize 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. Last year, growing regions in Australia experienced the second significant drought in the past five years, reducing crop yields and increasing acquisition costs for grain raw materials.

     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 years. However, in the first six months of fiscal 2007, sales to the top ten customers and sales to the largest customer represented 43% and 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.

     Changes in interest rates will affect Penford’s profitability.

     At February 28, 2007, all of the Company’s outstanding debt, including amounts outstanding under the Australian grain inventory financing facility, was subject to variable interest rates which move in direct relation to the U.S. or Australian London InterBank Offered Rate (“LIBOR”), the Australian bank bill rate (“BBSY”), or the prime rate in the U.S., depending on the selection of borrowing options. Significant changes in these interest rates would materially affect Penford’s profitability. The Company has fixed the interest rates on approximately 40% of its debt outstanding at February 28, 2007 through interest rate swaps.

     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 Company’s 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

22

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. The amount of income taxes paid is subject to the Company’s interpretation of applicable tax laws in the jurisdictions in which Penford operates. The Company is subject to audits by tax authorities. While the Company believes it has complied with all applicable income tax laws, there can be no assurance that a tax authority will not have a different interpretation of the law or that any additional taxes imposed as a result of tax audits will not have an adverse effect on the Company’s results of operations.

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

     In the ordinary course of business, Penford is subject to risks associated with changing foreign exchange rates. In the first six months of fiscal 2007, approximately 30% of the Company’s revenue was 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 other currencies. The Australian dollar has increased more than 50% over the last five years, challenging local manufacturer’s ability to remain price competitive with offshore producers.

     The Company may not be able to implement ethanol production as planned or at all.

     Penford’s ability to implement ethanol production as planned is subject to uncertainty. The Company announced this project in June 2006 and a considerable amount of work is in the preliminary stages. The Company has secured $45 million of financing for this project which it believes is adequate for completion; however, the Company could face financial risks if this amount of financing is not sufficient to complete the construction of the ethanol facility. The Company may be adversely affected by environmental, health and safety laws, regulations and liabilities in implementing ethanol production. Changes in the markets for ethanol and/or legislation and regulations could materially and adversely affect ethanol demand. There is no assurance that sufficient demand for ethanol will develop to permit profitable operation of the ethanol production facility.

     The Company’s results of operations could be adversely affected by litigation and other contingencies

     The Company faces risks arising from litigation matters in which various factors or developments can lead to changes in current estimates of liabilities, such as final adverse judgments, significant settlements or changes in applicable law. A future adverse outcome, ruling or unfavorable development could result in future charges that could have a material effect on the Company’s financial results.

     Changes in worldwide economic conditions and government laws and policies could adversely affect the Company’s financial results.

     Approximately 30% of the Company’s revenues are derived from its operations in Australia and New Zealand. These operations market their products throughout the Asia Pacific region. Continued growth and profitability will require further international expansion. The outlook for these businesses could change at any time and the Company’s results could be affected by changes in business conditions, trade, monetary and fiscal policies, laws and regulations, or other activities of governments, agencies or similar organizations. International risks and uncertainties, including changing social and economic conditions, political hostilities and war, could lead to reduced international sales and profitability.

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

     Washington law imposes restrictions on certain transactions between a corporation and certain significant shareholders. The Washington Business Corporation Act generally prohibits a “target corporation” from engaging in certain significant business transactions with an “acquiring person,” which is defined as a person or group of persons that beneficially owns 10% or more of the voting securities of the target corporation, for a period of five years after such acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation’s board of directors prior to the time of the acquisition. Such prohibited transactions include, among other things, (1) a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from, the acquiring person; (2) a termination of 5% or more of the employees of the target corporation as a result of the acquiring person’s acquisition of 10% or more of the shares; and (3) allowing the acquiring person to receive any disproportionate benefit as a shareholder.

23

     After the five year period, a “significant business transaction” may occur if it complies with “fair price” provisions specified in the statute. A corporation may not “opt out” of this statute. This provision may have the effect of delaying, deterring or preventing a change of control in the ownership of the Company.

     Other uncertainties

     The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. These accounting principles require management to make estimates, judgments and assumptions to fairly present results of operations and financial position. Management believes that its estimates, judgments and assumptions are reasonable based upon information available at the time this report was prepared. However, these estimates, judgments and assumptions could change at any time based on new information. In addition, to the extent there are material differences between estimates, judgments and assumptions and actual results, the financial statements will be affected. See “Critical Accounting Policies” in Item 2 of Part I.

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

     The Company held its Annual Meeting of Shareholders on January 24, 2007. The first 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 William E. Buchholz, R. Randolph Devening, Paul H. Hatfield, John C. Hunter III, and James E. Warjone.

			Percent of					Percent of
Director	Votes For		Total Shares			Votes Withheld		Total Shares
Jeffrey T. Cook		8,005,205		89.4	%		175,728		2.0	%
Thomas D. Malkoski		7,919,348		88.4	%		261,585		2.9	%
Sally G. Narodick		7,883,619		88.0	%		297,314		3.3	%

     The second item voted upon at the meeting was the ratification of Ernst & Young LLP as the Independent Registered Public Accounting Firm. The results of the voting on the proposal are as follows:

	Votes				Broker
Votes For	Against		Abstain		Non-Votes
7,574,609		599,065		7,258		773,455

     Item 6: Exhibits.

     (d) Exhibits

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

24

SIGNATURES

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

	Penford Corporation (Registrant)
April 9, 2007	/s/ Steven O. Cordier
	Steven O. Cordier
	Senior Vice President and Chief Financial Officer

25

EXHIBIT INDEX

Exhibit No.	Description
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002