-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ih28L9/dJ/8CVxZpqxDXnIYwDX/k12S9A/MmRtXyhJn0jReHth50b3tPf9Kv0FHL rbQjoYF2Fx1TK/dU45nsfw== 0000891020-97-001544.txt : 19971127 0000891020-97-001544.hdr.sgml : 19971127 ACCESSION NUMBER: 0000891020-97-001544 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19970831 FILED AS OF DATE: 19971126 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENWEST LTD CENTRAL INDEX KEY: 0000739608 STANDARD INDUSTRIAL CLASSIFICATION: GRAIN MILL PRODUCTS [2040] IRS NUMBER: 911221360 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-11488 FILM NUMBER: 97729007 BUSINESS ADDRESS: STREET 1: PO BOX 1688 CITY: BELLEVUE STATE: WA ZIP: 980095193 BUSINESS PHONE: 4254626000 MAIL ADDRESS: STREET 1: PO BOX 1688 CITY: BELLEVUE STATE: WA ZIP: 98009 10-K405 1 FORM 10-K FILED PURSUANT TO ITEM 405 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended August 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------------- ----------------------- Commission File Number 0-11488 Penford Corporation (formerly PENWEST, LTD.) - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Washington 91-1221360 ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 777-108th Avenue N.E., Suite 2390 Bellevue, Washington 98004-5193 ---------------------------------------- ---------- (Address of principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (425) 462-6000 -------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Title of each class Name of each exchange of which registered ------------------- ----------------------------------------- None None ---- ---- SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $1.00 par value Common Stock Purchase Rights Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes X No ------- ------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Page 1 2 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (continued) The aggregate market value of the Registrant's Common Stock held by non-affiliates as of October 17, 1997 was approximately $298 million. The number of shares of the Registrant's Common Stock (the Registrant's only outstanding class of stock) outstanding (net of treasury stock) as of October 17, 1997 was 7,269,141. DOCUMENTS INCORPORATED BY REFERENCE The Registrant's definitive Proxy Statement relating to the 1998 Annual Meeting of Shareholders is incorporated by reference into Part III of this Form 10-K. Page 2 3 PART I ITEM 1: BUSINESS a) GENERAL: Penford Corporation (Penford or the Company) was incorporated under the name PENWEST, LTD. in September 1983 and commenced operations on March 1, 1984. In connection with the plan described below, PENWEST, LTD. changed its name to Penford Corporation. Penford consists of the following business units: - Penford Products Co. (specialty carbohydrate chemicals for papermaking) - The history of Penford Products Co. can be traced to 1894. Penford Products Co. operates as a wholly-owned subsidiary of Penford. - Penwest Pharmaceuticals Co. (controlled release technology and pharmaceutical excipients) - In March 1991, Penford purchased the net assets of Edward Mendell Co., Inc. (Mendell). In connection with the plan discussed below, Mendell changed its name to Penwest Pharmaceuticals Co. (Penwest). Penwest is a wholly-owned subsidiary of Penford. - Penford Food Ingredients Co. (specialty food ingredient products) - In September 1991, Penford Food Ingredients Co. (formerly Penwest Foods Co.) was established to manufacture and market specialty carbohydrate-based food ingredients. Penford Food Ingredients is a division of Penford Products Co. On October 9, 1997, Penford announced a two stage plan designed to foster the growth potential of its pharmaceuticals business and separately, its paper and food ingredients businesses. Under the first stage of the plan, Penwest Pharmaceuticals Co. would sell up to 20% of its common stock through an initial public offering. Under the second stage of the plan, Penford would effect a tax-free spin-off to its shareholders of its remaining ownership of Penwest common shares, contingent upon satisfying certain conditions, including receipt of a tax ruling from the Internal Revenue Service or a written opinion from Ernst & Young LLP to the effect that, among other things, the spin-off will qualify as a tax-free distribution. The spin-off is anticipated to occur in the second quarter of calendar 1998. If the spin-off occurs, Penwest will no longer be a subsidiary of Penford. On October 21, 1997, Penwest filed a registration statement with the Securities and Exchange Commission for an initial public offering of 2,500,000 shares of common stock (approximately 15% of its outstanding common stock). The estimated initial public offering price is between $10.00 to $12.00 per share. An option will be granted to the underwriters to purchase up to 375,000 additional shares for the purpose of covering over-allotments, if any. Penford and Penwest have entered into a Separation Agreement setting forth the agreement of the parties with respect to the principal corporate transactions required to effect the separation of Penford's pharmaceutical business from its paper and food ingredients businesses, the initial public offering and the spin-off, and certain other agreements governing the relationship of the parties prior to and after the spin-off. Penford and Penwest will, prior to the completion of the initial public offering, also enter into other agreements that govern various interim and ongoing relationships. b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS: The Company's single business segment is developing, manufacturing and marketing carbohydrate-based specialty chemicals. These carbohydrate- based specialty chemicals are marketed and sold to three industries: paper, pharmaceuticals and food. Page 3 4 c) DESCRIPTION OF BUSINESS: BUSINESS UNITS 1. SPECIALTY CHEMICALS: PENFORD PRODUCTS CO. (PENFORD PRODUCTS) develops, manufactures and markets carbohydrate-based specialty chemical starches for papermaking. These starches are principally ethylated (chemically modified with ethylene oxide) and cationic (carrying a positive electrical charge) starches. Ethylated starches are used in coatings and as binders, providing strength and printability to fine white, magazine and catalog paper. Cationic starches are used at the "wet-end" of the paper machine, providing strong internal bonding of paper fibers. In addition, Penford Products' starch copolymers, a patented combination of synthetic and natural carbohydrate chemistry, are used in coating and binder applications in various segments of the paper industry. Starches produced by Penford Products are designed to improve the strength, quality and runnability of coated and uncoated paper. Penford Products' corn-based ethylated and cationic starches and starch copolymers are produced at its Cedar Rapids, Iowa facility. Penford Products' potato-based cationic starches are produced at its Idaho Falls, Idaho facility. Penford Products also sells specialty starch products to the domestic textile industry for warp sizing, which is a fiber bonding process for yarn and finished fabric, and for fabric sizing, which provides body and stiffness to textiles. Specialty chemical brand names of Penford Products for the paper industry include, among others, Penford(R) Gums, PENSIZE(R) and the Apollo(R) series. Penford Products' specialty chemicals for the paper industry are manufactured by a process known as corn wet milling, which is the process by which the various parts of corn are separated, refined and modified. The corn, after it is removed from the cob and cleaned, is placed in warm steepwater treated with sulfur dioxide, which causes the corn to swell and soften. The softened kernels pass through a mill which separates the corn's germ from its endosperm which contains the starch found in finished products. Water is added, producing a thick slurry. The germ is then separated from the slurry. After the germ has been washed and dried, the crude corn oil contained in the germ is removed and refined, yielding a fine quality salad and cooking oil, or a raw material for corn oil margarines. Germ meal is used in animal feed. The remaining mixture of hull and endosperm is then processed. Hull particles are screened out for animal feed, while the finer particles of gluten and starch pass through. The corn oil, germ meal and hull particles are all sold as by-products. The water slurry of starch and gluten is separated. The starch, which is more than 99 percent pure, is washed a third time to remove small quantities of solubles. Modified starches are created by adding chemical reagents and catalysts to the pure starch slurry. The modified starch is then filtered and dried and is ready for shipping. 2. PHARMACEUTICALS: PENWEST PHARMACEUTICALS CO. (Penwest) is engaged in the research, development and commercialization of novel drug delivery technologies. Penwest has developed its proprietary TIMERx (R) controlled release drug delivery technology. Penwest has applied TIMERx technology to the development of oral formulations of generic versions of controlled release drugs and branded controlled release versions of immediate release drugs. Each of these formulations has been developed under a collaborative arrangement with a pharmaceutical company. These formulations are in various stages of development and are subject to regulatory approval. Except for Cystrin CR(R) (described below), no product based on TIMERx technology has ever received regulatory approval for commercial sale. There can be no assurance that Penwest's controlled release product development efforts will be successfully completed, that required regulatory approvals will be obtained or that approved products will be successfully manufactured or marketed. In October 1997, Penwest's collaborator, Leiras OY, a Finnish subsidiary of Schering AG, received marketing approval in Finland for Cystrin CR(R) for the treatment of urinary incontinence. Page 4 5 In May 1997, Penwest's collaborator, Mylan Pharmaceuticals Inc. (Mylan), filed an abbreviated new drug application (ANDA) with the U.S. Food and Drug Administration (FDA) for the first generic version of the 30 mg dosage strength of Procardia XL(R), a leading cardiovascular drug for angina and hypertension. Penwest also manufactures and distributes excipients to the pharmaceutical and nutritional industries. Excipients are the inactive ingredients in tablets and capsules that enable tabletting of active drug ingredients by enhancing binding, lubrication and disintegration properties. Penwest's largest selling excipient product is EMCOCEL(R), a tabletting binder. In fiscal 1997, Penwest introduced PROSOLV SMCC(TM), which Penwest believes represents a new class of high functionality binders. Other excipient brand names include EMCOMPRESS(R), EMDEX(R), EXPLOTAB(R) and PRUV(R). Penwest operates facilities at Patterson, New York, Nastola, Finland, and Cedar Rapids, Iowa. 3. SPECIALTY FOOD INGREDIENT PRODUCTS: PENFORD FOOD INGREDIENTS CO. (PFI) develops, manufactures and markets specialty food ingredients to the food and confectionery industries. These ingredients include food grade potato and tapioca starch products as well as dextrose-based products such as specialty dried corn syrup. PFI is the only North American producer of food grade potato and tapioca starches. PFI, headquartered in Englewood, Colorado, maintains manufacturing facilities at Richland, Washington and Plover, Wisconsin for the food grade potato and tapioca starches, and at Cedar Rapids, Iowa for the dextrose products. Penford Food Ingredients' product brand names include CanTab(R), CarriDex(TM) and PenPlus(R). RAW MATERIALS Corn: The Penford Products corn wet milling plant is located in Cedar Rapids, Iowa, the middle of the U.S. corn belt. Accordingly, the plant has truck and rail delivered corn available throughout the year from a large number of corn dealers and farmers at prices related to the major U.S. grain markets. The cost of the corn to be purchased for fixed price business is generally hedged by entering into futures contracts. Cellulose Wood Pulp: Penwest's facilities at Nastola, Finland and Cedar Rapids, Iowa use high-grade dissolving wood pulp (cellulose) as their primary raw material to manufacture microcrystalline cellulose (EMCOCEL(R)). Penwest's supplier of cellulose is located in North America. Xanthan and Locust Bean Gums: Penwest's TIMERx drug delivery system consists primarily of two natural polysaccharides, xanthan and locust bean gums. Penwest purchases these gums from a sole source supplier. Potato Starch: The Idaho Falls, Idaho facility of Penford Products and the Richland, Washington facility of Penford Food Ingredients use co-products from potato processors that contain the starch used as the primary raw material to manufacture modified potato starches for papermaking and food applications. Suppliers of the raw material are located in North America, primarily in the northwest and midwest. Chemicals: The principal chemical used in modifying starch is ethylene oxide, a petrochemical derivative. Ethylene oxide is a commodity chemical, subject to price fluctuations due to market conditions. Corn, cellulose, xanthan and locust bean gums, potato starch and ethylene oxide are not generally subject to availability constraints. Approximately half of total manufacturing costs are the costs of corn, cellulose, xanthan and locust bean gums, potato starch and chemicals. The remaining portion consists primarily of utility and labor costs. PATENTS, TRADEMARKS AND TRADENAMES The Company owns several patents, trademarks, and tradenames. Penwest has been issued 17 U.S. patents and 40 foreign patents relating to its controlled release drug delivery technology. These patents Page 5 6 expire between 2008 and 2015. There can be no assurance that these patents will prevent other companies from developing similar or functionally equivalent products or from successfully challenging the validity of these patents. Further, there can be no assurance that the Company's processes or products will not infringe the patents of third parties. RESEARCH AND DEVELOPMENT Company-sponsored research and development costs of $8,057,000, $7,297,000 and $6,773,000 in fiscal 1997, 1996 and 1995, respectively, were charged to expense as incurred. ENVIRONMENTAL MATTERS The Company has adopted a Policy on Environmental Matters and has implemented a comprehensive corporate-wide environmental management program. The program is managed by the Corporate Director of Environmental, Health and Safety and is intended to ensure the Company's business is conducted in a safe and fiscally responsible manner that protects and preserves the health and safety of Company employees, the communities surrounding the Company's plants and the environment. The Company continues to monitor environmental legislation and regulations which may affect its operations. WORKING CAPITAL Working capital requirements of the Company are financed through operating cash flow, unsecured lines of credit, and an unsecured $35 million credit agreement. There was $20.3 million outstanding under the credit agreement at August 31, 1997. The Company also had uncommitted lines of credit totaling $15 million under which $6.0 million was outstanding at fiscal year end. PRINCIPAL CUSTOMERS The Company sells to approximately ninety major customers. Two customers, Georgia Pacific and Mead Paper, accounted for approximately 15% and 10%, respectively, of total sales in fiscal 1997. COMPETITION The Company competes with approximately five other companies that manufacture corn wet milling products, none of which is dominant in the ethylated starch business. Although Penford Products is one of the smaller corn wet millers, it is one of the major producers of specialty ethylated starches. Quality, service and price are the major competitive factors for Penford Products. The Company competes with numerous other companies that manufacture or distribute pharmaceutical excipients. Penwest's principal competitor in this market is FMC Corporation. Penwest has the second largest market share in sales of its primary excipient product, EMCOCEL(R), or microcrystalline cellulose. Quality, service and price are the major competitive factors for Mendell. The Company competes with numerous other companies in developing controlled release drug delivery systems for the pharmaceutical industry. Development expertise and proprietary technology are the major competitive factors for Penwest's controlled release drug delivery business. The Company competes with approximately four other companies that manufacture specialty food ingredients, all of whom have larger market shares. Application expertise, quality, service and price are the major competitive factors for Penford Food Ingredients. EMPLOYEES At October 17, 1997, Penford and its subsidiaries had 533 employees. Penford's specialty chemical and food ingredients operations, pharmaceuticals operations and executive office employed 398, 118 and 17 persons, respectively. Approximately 40% of the employees are represented by unions. Management believes its employee relations are good, with the most recent collective bargaining agreement completed in July, 1997. Page 6 7 METHODS OF DISTRIBUTION Penford Products, Penford Food Ingredients and Penwest use a direct sales force to market their products in North America. Penwest uses a combination of direct sales and distributors to market its excipient products outside North America. Pursuant to Penwest's collaborative agreements, Penwest's collaborators have responsibility for the marketing and distribution of controlled release pharmaceuticals using TIMERx technology. Penford Products' customers may purchase products through fixed-price contracts or formula-priced contracts for periods covering three months to five years or on a spot basis. Sales are approximately equally divided between fixed and formula price business with a remaining 10% consisting of spot sales. Products are shipped in either a bulk or bagged format. D) FOREIGN OPERATIONS AND EXPORT SALES: Penwest has a facility in Nastola, Finland. This operation is not significant to the consolidated Company. Sales from this facility were less than 5% of the Company's total sales in fiscal 1997. Export sales have accounted for less than 10% of the Company's total sales during each of the last three fiscal years. Page 7 8 ITEM 2: PROPERTIES (MAJOR) Registrant's executive offices, which are leased, are located at Suite 2390, 777-108th Avenue N.E., Bellevue, Washington 98004-5193. The Registrant's mailing address is, P.O. Box 1688, Bellevue, Washington 98009-1688. Other facilities are as follows:
Bldg. Area Land Area Owned/ Function of (Sq. Ft.) (Acres) Leased Facility --------- ------- ------ -------- SPECIALTY CHEMICALS AND FOOD INGREDIENTS - ---------------------------------------- Cedar Rapids, Iowa 707,000 29 Owned Manufacture of corn starch products Englewood, Colorado 45,000 3 Leased -- Expires Offices and April 2000, with research renewal option laboratories Idaho Falls, Idaho 31,000 6 Owned Manufacture of industrial potato starch products Richland, Washington 16,000 3 Leased -- Expires Manufacture of November 2014, food - grade potato with renewal optionstarch products Plover, Wisconsin 54,000 9 Owned Warehouse and collection of raw material The corn wet milling operation in Cedar Rapids, Iowa has operating capacity, measured in bushels ground, of 72,000 bushels per day. The grind operates continuously except for periodic maintenance. PHARMACEUTICAL EXCIPIENTS - ------------------------- Patterson, New York 55,000 15 Owned Warehouse, offices and research laboratories Nastola, Finland 15,000 2 Leased -- Manufacture of 2 years notice pharmaceutical required excipients Cedar Rapids, Iowa 35,000 1 Owned Manufacture of pharmaceutical excipients
All major properties are owned. Production facilities are well maintained and in good condition. The capacities of the plants are suitable and generally sufficient to meet current production requirements. Penford is continually undertaking a process of expanding and improving its property, plant and equipment. Page 8 9 ITEM 3: LEGAL PROCEEDINGS In May 1997, one of Penwest's collaborators, Mylan, filed an ANDA with the FDA for the 30 mg dosage strength of Nifedipine XL, a generic version of Procardia XL. Bayer AG (Bayer) and ALZA Corporation (ALZA) own patents listed for Procardia XL (the last of which expires in 2010), and Pfizer Inc. (Pfizer) holds the new drug application and markets the product. In connection with the ANDA filing, Mylan certified to the FDA that Nifedipine XL does not infringe these Bayer or ALZA patents and notified Bayer, ALZA and Pfizer of such certification. Bayer and Pfizer sued Mylan in the United States District Court for the Western District of Pennsylvania, alleging that Mylan's product infringes Bayer's patent. Penwest has been informed by Mylan that ALZA does not believe that the notice given to it complied with the requirements of the "Waxman-Hatch Act," which governs the filing of ANDAs. Mylan has advised the Company that it intends to contest vigorously the allegations made in the lawsuit. Delays in the commercialization of Nifedipine XL could occur because the FDA will not grant final marketing approval of Nifedipine XL until a final judgment on the patent suit is rendered in favor of Mylan by the district court, or in the event of an appeal, by the court of appeals, or until 30 months (or such longer or shorter period as the court may determine) have elapsed from the date of Mylan's certification, whichever is sooner. In 1993, Pfizer filed a "citizen's petition" with the FDA, claiming that its Procardia XL formulation constituted a unique delivery system and that a drug with a different release mechanism such as the TIMERx controlled release system cannot be considered the same dosage form and approved in an ANDA as bioequivalent to Procardia XL. In August 1997, the FDA rejected Pfizer's citizen's petition. In July 1997, Pfizer also sued the FDA in the District Court of the District of Columbia, claiming that the FDA's acceptance of Mylan's ANDA filing for Nifedipine XL was contrary to law, based primarily on the arguments stated in its citizen's petition. Mylan and Penwest have intervened as defendants in this suit. An outcome adverse to Mylan and Penwest would result in Mylan being required to file a suitability petition in order to maintain the ANDA filing or to file an NDA with respect to Nifedipine XL, each of which would be expensive and time consuming. An adverse outcome also would result in Nifedipine XL becoming ineligible for an "AB" rating from the FDA. Failure to obtain an AB rating from the FDA would indicate that for certain purposes Nifedipine XL would not be deemed to be therapeutically equivalent to the referenced branded drug and would not be relied upon by Medicaid and Medicare formularies for reimbursement. If any of such events occur, Mylan may terminate its efforts with respect to Nifedipine XL. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of shareholders during the fourth quarter of fiscal 1997. Page 9 10 EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Title ---- --- ----- Tod R. Hamachek 51 President and Chief Executive Officer of Registrant 1985 - current President and Chief Operating Officer of Registrant 1983 - 1985 Jeffrey T. Cook 41 Vice President-Finance and Chief Financial Officer of Registrant 1991 - current Treasurer of Registrant 1988 - 1991 Edmund O. Belsheim, Jr. 45 Vice President-Corporate Development and General Counsel and Corporate Secretary of Registrant 1996 - current Member, Bogle & Gates P.L.L.C. 1986 - 1996 Robert G. Widmaier, Ph.D. 49 Vice President-Technical Director and Chief Innovation Officer of Registrant 1990 - current Vice President-Technical Director of Registrant 1988 -1990 Francis C. Rydzewski 47 Vice President of Registrant and President and General Manager, Penford Products Co., a wholly-owned subsidiary of Registrant 1996 - current Executive Vice President of Operations, Penford Products Co., a wholly-owned subsidiary of Registrant 1995 - 1996 Global Business Director, Air Products 1972 - 1995 John V. Talley, Jr. 41 Vice President of Registrant and President and General Manager, Penwest Pharmaceuticals Co., a wholly-owned subsidiary of Registrant 1993 - current Vice President of Marketing, Sterling Drug 1992 - 1993 Vice President - Marketing, Hospital Products Division Sterling Drug 1989 - 1992
Page 10 11 Gregory C. Horn 49 Vice President of Registrant and President and General Manager, Penford Food Ingredients Co. 1995 - current Vice President of Marketing, Penford Products Co. 1993 - 1994 Vice President and General Manager, Sarah Lee Corporation 1992 - 1993 Vice President and General Manager, Churchill Industries 1990 - 1993
Page 11 12 PART II ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS Penford common stock, $1.00 par value, trades on the Nasdaq National Market under the symbol "PENW". On October 17, 1997, there were 1,134 shareholders of record. The high and low closing bid prices of the Company's common stock during the last two fiscal years are set forth below. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
MARKET PRICE HIGH LOW ---- --- 1996/1997 Quarter Ended November 30 $20.00 $17.50 Quarter Ended February 28 $20.25 $17.00 Quarter Ended May 31 $20.00 $18.25 Quarter Ended August 31 $34.50 $18.75 1995/1996 Quarter Ended November 30 $26.50 $24.00 Quarter Ended February 29 $25.75 $16.00 Quarter Ended May 31 $18.75 $18.00 Quarter Ended August 31 $20.00 $18.00
During each quarter in fiscal years 1997 and 1996, a $0.05 per share cash dividend was declared. The Company anticipates that it will continue to pay such quarterly dividends in the foreseeable future. Page 12 13 ITEM 6: SELECTED FINANCIAL DATA
Year Ended August 31 ------------------------------------------------------------------------------ (Thousands of dollars except per share data) 1997 1996 1995 1994 1993 - ------------------------------------------- --------- ---------- ---------- ---------- ---------- Operating Data: Sales $ 196,634 $ 194,474 $ 174,200 $ 158,787 $ 135,517 Gross margin percentage 25.7% 24.0% 27.5% 25.9% 26.4% Income from operations $ 13,970 $ 12,308 $ 14,973 $ 10,894 $ 9,110 Other income $ 1,200(1) $ $ 899(2) Net income $ 6,625 $ 5,052 $ 7,217 $ 6,120 $ 6,315 Earnings per share $ 0.93 $ 0.72 $ 1.03 $ 0.86 $ 0.88 Dividends declared per share $ 0.20 $ 0.20 $ 0.20 $ 0.20 $ 0.20 Average shares and equivalents outstanding 7,131,725 7,007,340 7,018,970 7,110,953 7,175,855 Balance Sheet Data: Net property, plant and equipment $ 130,374 $ 121,173 $ 111,440 $ 99,973 $ 96,250 Long-term debt 61,791 62,636 58,628 42,897 46,998 Shareholders' equity 89,101 78,138 71,982 67,165 62,490 Capital expenditures 21,493 21,472 23,019 13,259 31,266 Total assets 215,929 202,518 186,760 164,357 157,966
(1) Represents a pretax gain of $1.2 million related to the sale of Southern California air emission credits. (2) Represents a pretax gain of $899,000 related to the sale of assets of Pacific Cogeneration, Inc. Page 13 14 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Recent Developments On October 9, 1997, Penford announced a two stage plan designed to foster the growth potential of its pharmaceuticals business and separately, its paper and food ingredients businesses. Under the first stage of the plan, Penwest Pharmaceuticals Co. would sell up to 20% of its common stock through an initial public offering. Under the second stage of the plan, Penford would effect a tax-free spin-off to its shareholders of its remaining ownership of Penwest common shares, contingent upon satisfying certain conditions, including receipt of a tax ruling from the Internal Revenue Service or a written opinion from Ernst & Young LLP to the effect that, among other things, the spin-off will qualify as a tax-free distribution. The spin-off is anticipated to occur in the second quarter of calendar 1998. If the spin-off occurs, Penwest will no longer be a subsidiary of Penford. On October 21, 1997, Penwest filed a registration statement with the Securities and Exchange Commission for an initial public offering of 2,500,000 shares of common stock (approximately 15% of its outstanding common stock). The estimated initial public offering price is between $10.00 to $12.00 per share. An option will be granted to the underwriters to purchase up to 375,000 additional shares for the purpose of covering over-allotments, if any. Penford and Penwest have entered into a Separation Agreement setting forth the agreement of the parties with respect to the principal corporate transactions required to effect the separation of Penford's pharmaceutical business from its paper and food ingredients businesses, the initial public offering and the spin-off, and certain other agreements governing the relationship of the parties prior to and after the spin-off. Penford and Penwest will, prior to the completion of the initial public offering, also enter into other agreements that govern various interim and ongoing relationships. Penwest will retain the proceeds from the planned initial public offering. In addition, Penford will forgive all intercompany advances as of the closing of the offering. As of August 31, 1997, the intercompany balance approximated $35.2 million. Had the proposed plan been effected as of August 31, 1997, it is estimated that consolidated assets and shareholders' equity of Penford would have reflected a reduction of approximately $35.0 to $40.0 million, representing the net effects of the proposed distribution. Page 14 15 Comparison of Fiscal 1997 to 1996 Results of Operations Sales increased $2.2 million or 1.1% in fiscal 1997. The increase reflects higher volumes in each of the Company's divisions. The sales increase is partially offset by lower corn prices in 1997. Corn is a key component in Penford Products' paper chemical products, and changes in corn costs are generally passed through to customers. During 1997, corn prices generally trended down from the historical highs of late fiscal 1996. During 1997, Penford Products increased shipments of corn-based products by 6.0%, reflecting increased marketing efforts to certain key customers. Penford Food Ingredients volume increased by 31.0% primarily as a result of new customers for its french fry coating products. Penwest excipient sales were up slightly from 1996. Gross margin was 25.7% in 1997 compared to 24.0% in 1996. The increase reflects higher volumes primarily at Penford Products and Penford Food Ingredients, better corn pricing and the impact of manufacturing efficiencies implemented during the year. Operating expenses increased $2.1 million or 6.2%. General and administrative costs rose by $1.4 million primarily for company-wide information technology support and to build the infrastructure to support anticipated growth for the pharmaceuticals operations. Research and development expenses increased $700,000 or 10.4% , primarily due to increased spending at Penwest. These costs reflect an increased R&D headcount and greater expenditures for bioequivalence studies in the drug formulation development area at Penwest Pharmaceuticals. Consolidated R&D expenditures will be reduced significantly if the planned spin-off of Penwest is completed. Other income of $1.2 million represents a gain on the sale of Southern California air emission credits. Interest expense increased $222,000 or 4.4%, primarily due to higher outstanding debt balances. The effective tax rate was 33.2% in fiscal 1997 compared to 32.5% in the prior year. The effective rate is lower than the statutory rate primarily due to tax credits and the effects of the Company's foreign sales corporation. Comparison of Fiscal 1996 to 1995 Results of Operations Sales increased $20.3 million, or 11.7%, during fiscal 1996. The increase in sales reflected higher demand for the Company's core business. The increase was also due to unusually high corn costs, a key component used in pricing Penford Products' paper chemical products. Changes in corn costs are generally passed through to customers. During the year, Penford Products signed several multi-year contracts to sell products to customers representing significant volumes. Penwest increased sales volumes for EMCOCEL(R) during fiscal 1996 by 17%. This increase was primarily attributable to two new large customers. Potato starch volumes at Penford Food Ingredients increased by 75% in 1996 due to rapidly increasing demand for these starches for french fry coatings. Gross margins were 24.1% in 1996 compared with 27.5% in 1995. The decrease in gross margin is primarily due to the historically high price of corn which affected margins several ways. First, certain of the Company's sales are based on a recent average of published corn prices. Consequently, in periods of rapidly escalating prices, the Company is not able to recover the full amount of the increase in raw material costs under such contracts. Particularly in the fourth quarter, the Company's margin on fixed Page 15 16 price sales contracts was also negatively impacted by the high price of cash corn relative to the futures market driven by a severe supply/demand imbalance. Due to the short supply of corn, the market cash price reflected a high premium that had to be absorbed by the Company on its fixed price business. Lastly, lower margin dollars on higher unit sales prices also adversely impacted the gross margin percentage. The corn situation did improve in October as the new crop was harvested. In addition to the impact of corn, competitive and market factors put pressure on product pricing in the renewal of customer sales contracts making it difficult to maintain prior years gross margin levels. Operating expenses increased $1.6 million, or 4.8%. Research and development (R&D) expenses increased $524,000, or 7.7%, as a result of greater development spending at Penwest. Other income in 1995 reflects a gain on the sale of assets of the Companys subsidiary, Pacific Cogeneration, Inc. of $899,000. Net interest expense remained consistent with the prior year. The effective tax rate was 32.5% in fiscal 1996, compared with 35.0% in fiscal 1995. The reduction in the tax rate reflects a reduction in state taxes and an increased benefit from the Company's foreign sales corporation. Liquidity and Capital Resources The Company had working capital of $30.2 million at August 31, 1997. The Company has an unsecured $35 million credit agreement under which there was $20.3 million outstanding at the end of fiscal 1997. The Company also has $15 million of uncommitted lines with various banks that are used for overnight borrowings. These lines were used throughout the year, and there was $6.0 million outstanding at the end of fiscal 1997. Operating cash flow was $20.2 million, $12.9 million and $16.3 million in fiscal 1997, 1996 and 1995, respectively. Subsequent to the proposed spin-off, Penford Corporation will retain all rights and obligations under its various short and long-term borrowing arrangements, including amounts available under the credit agreement and uncommitted lines. Capital expenditures amounted to $21.5 million in fiscal 1997 compared to $21.5 million in fiscal 1996 and $23.0 million in fiscal 1995. Capital expansion has been funded from operating cash flows and borrowings under uncommitted lines. Significant capital projects during fiscal 1997 included capacity expansion at the Penford Food Ingredients' facility in Richland, Washington and the completion a new corn unloading facility for Penford Products in Cedar Rapids, Iowa. The remainder of the expenditures were for various improvements to manufacturing facilities. Planned capital expenditures in fiscal 1998 will primarily be directed to upgrades and modernization of certain Penford Products machinery and equipment and the expansion of processing capabilities at Penford Food Ingredients. Assuming completion of the proposed spin-off, capital expenditures in 1998 should be no greater than in fiscal 1997. The Company expects to fund capital expenditures from operating cash flows and from uncommitted lines of credit. Page 16 17 The Company commenced paying a quarterly cash dividend of $0.05 per share with the quarter ended February 28, 1992, and has paid such dividend each quarter thereafter. The Board of Directors reviews the dividend policy on a periodic basis. In April 1994, the Board of Directors authorized a stock repurchase program for the purchase of up to 500,000 shares of the outstanding common stock of the Company. The Company did not repurchase any of its common stock during fiscal 1997. Page 17 18 Forward-looking Statements The above discussion contains forward-looking statements concerning the proposed public offering and spin-off of Penwest and the anticipated activities and results of Penford. There are a variety of factors which could cause actual events to differ materially from those projected in the forward-looking statements, including without limitation, the risks that the public offering or the spin-off may not be completed as the result of future developments in Penford's or Penwest's business or conditions in the securities markets, failure to obtain necessary government rulings or approvals or third party consents or agreements or other unforeseen developments; competition; product development risk; patents and intellectual property matters (including patent infringement litigation, including the patent infringement suit brought by Bayer and Pfizer against Mylan (and described herein under Item 3: Legal Proceedings); dependence on collaborators; regulatory and manufacturing issues including the difficulties of obtaining FDA or other regulatory approvals; changes in raw material prices; or other unforeseen developments in the industries in which Penford operates. Accordingly, there can be no assurance that the public offering or spin-off will be completed, or that future activities or results as described will be as anticipated. The registration statement filed by Penwest with the Securities and Exchange Commission has not yet become effective. The securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. The discussion included herein shall not constitute an offer to sell or a solicitation of an offer to buy nor shall there be any sale of these securities in any state or jurisdiction, in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or jurisdiction. Page 18 19 ITEM 8: PENFORD CORPORATION CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS
August 31 (Thousands of dollars) 1997 1996 - -------------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents $ 176 Trade accounts receivable 27,181 $ 26,766 Inventories 21,835 20,531 Prepaid expenses and other 5,179 5,354 --------- --------- Total current assets 54,371 52,651 Property, plant and equipment: Land 4,834 4,014 Plant and equipment 210,037 185,499 Construction in progress 8,492 12,791 Less accumulated depreciation (92,989) (81,131) --------- --------- Net property, plant and equipment 130,374 121,173 Deferred income taxes 11,007 9,940 Restricted cash value of life insurance 12,691 11,432 Other assets 7,486 7,322 --------- --------- $ 215,929 $ 202,518 ========= ========= Liabilities and shareholders' equity Current liabilities: Bank overdraft, net $ 847 Accounts payable $ 10,089 10,344 Accrued liabilities 8,157 7,943 Current portion of long-term debt 5,955 4,127 --------- --------- Total current liabilities 24,201 23,261 Long-term debt 61,791 62,636 Other postretirement benefits 10,294 10,306 Deferred income taxes 22,136 20,980 Other liabilities 8,406 7,197 Commitments and Contingencies Shareholders' equity: Common stock, par value $1.00 per share, authorized 29,000,000 shares, issued 9,093,251 shares in 1997 and 8,677,165 in 1996, including treasury shares 9,093 8,677 Additional paid-in capital 18,466 13,633 Retained earnings 93,854 88,640 Treasury stock, at cost, 1,830,735 shares in 1997 and 1,832,752 in 1996 (30,604) (30,637) Note receivable from Savings and Stock Ownership Plan (639) (1,742) Cumulative translation adjustment (1,069) (433) --------- --------- Total shareholders' equity 89,101 78,138 --------- --------- $ 215,929 $ 202,518 ========= =========
The accompanying notes are an integral part of these statements. Page 19 20 CONSOLIDATED STATEMENTS OF INCOME
Year Ended August 31 (Thousands of dollars except per share data) 1997 1996 1995 - ---------------------------------------------------------------------------------------------- Sales $ 196,634 $ 194,474 $ 174,200 Cost of sales 146,081 147,711 126,341 ----------- ----------- ----------- Gross margin 50,553 46,763 47,859 Operating expenses 36,583 34,455 32,886 ----------- ----------- ----------- Income from operations 13,970 12,308 14,973 Other income 1,200 899 Investment income 72 277 418 Interest expense (5,323) (5,101) (5,183) ----------- ----------- ----------- Income before income taxes 9,919 7,484 11,107 Income taxes 3,294 2,432 3,890 ----------- ----------- ----------- Net income $ 6,625 $ 5,052 $ 7,217 =========== =========== =========== Weighted average common shares and equivalents outstanding 7,131,725 7,007,340 7,018,970 =========== =========== =========== Earnings per share $ 0.93 $ 0.72 $ 1.03 =========== =========== =========== Dividends declared per share $ 0.20 $ 0.20 $ 0.20 =========== =========== ===========
The accompanying notes are an integral part of these statements. Page 20 21 CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended August 31 (Thousands of dollars) 1997 1996 1995 - --------------------------------------------------------------------------------------- Operating activities: Net income $ 6,625 $ 5,052 $ 7,217 Adjustments to reconcile net income to net cash from operating activities Depreciation 12,436 11,739 10,375 Deferred income taxes 89 1,174 1,504 Gain on sale of assets (899) Stock compensation expense related to non- employee director stock options 246 Change in operating assets and liabilities Receivables (415) (2,823) (3,195) Inventories (1,304) (7,902) 2,525 Accounts payable and other 2,545 5,670 (1,181) -------- -------- -------- Net cash from operating activities 20,222 12,910 16,346 Investing activities: Acquisitions of fixed assets, net (21,493) (21,472) (23,019) Proceeds from sale of assets 2,500 Other 152 1,158 (530) -------- -------- -------- Net cash used by investing activities (21,341) (20,314) (21,049) Financing activities: Proceeds from unsecured line of credit 87,875 60,847 41,305 Payments on unsecured line of credit (87,765) (54,962) (41,305) Proceeds from long-term debt 5,000 15,250 20,000 Payments on long-term debt (4,127) (17,270) (4,100) Issuance (purchase) of treasury stock 37 (1,310) Exercise of stock options 3,671 876 75 Purchase of life insurance for officers' benefit plans (1,158) (2,501) (2,501) Payment of dividends (1,391) (1,017) (1,360) Other (132) -------- -------- -------- Net cash from financing activities 2,142 1,223 10,672 -------- -------- -------- Net increase (decrease) in cash 1,023 (6,181) 5,969 Cash (bank overdrafts) and cash equivalents at beginning of year (847) 5,334 (635) -------- -------- -------- Cash (bank overdrafts) and cash equivalents at end of year $ 176 $ (847) $ 5,334 ======== ======== ======== Supplemental disclosure of cash flow information Cash paid during the year for: Interest $ 5,924 $ 5,392 $ 4,976 Income taxes $ 1,273 $ 1,317 $ 2,052
The accompanying notes are an integral part of these statements. Page 21 22 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Note Receive- able from Total Additional Savings & Cumulative Share- Common Paid-In Retained Treasury Stock Translation holders' (Thousands of dollars) Stock Capital Earnings Stock Ownership Plan Adjustment Equity -------- -------- -------- -------- -------------- -------- -------- Balances, September 1, 1994 $ 8,577 $ 12,489 $ 79,128 $(29,327) $ (3,340) $ (362) $ 67,165 Net income 7,217 7,217 Exercise of stock options 14 61 75 Purchase of treasury stock (1,310) (1,310) Savings and Stock Ownership Plan activity 362 362 Translation loss (131) (131) Dividends declared (1,396) (1,396) -------- -------- -------- -------- -------- -------- -------- Balances, August 31, 1995 8,591 12,550 84,949 (30,637) (2,978) (493) 71,982 Net income 5,052 5,052 Exercise of stock options 86 790 876 Tax benefit of stock option exercises 293 293 Savings and Stock Ownership Plan activity 1,236 1,236 Translation gain 60 60 Dividends declared (1,361) (1,361) -------- -------- -------- -------- -------- -------- -------- Balances, August 31, 1996 8,677 13,633 88,640 (30,637) (1,742) (433) 78,138 Net income 6,625 6,625 Exercise of stock options 416 3,255 3,671 Tax benefit of stock option exercises 1,328 1,328 Stock compensation expense related to non-employee director stock options 246 246 Savings and Stock Ownership Plan activity 4 33 1,103 1,140 Translation loss (636) (636) Dividends declared (1,411) (1,411) -------- -------- -------- -------- -------- -------- -------- Balances, August 31, 1997 $ 9,093 $ 18,466 $ 93,854 $(30,604) $ (639) (1,069) $ 89,101 ======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these statements. Page 22 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business On October 9, 1997, Penford Corporation (formerly PENWEST, LTD.) announced a plan to establish its pharmaceutical operations as a separate, publicly owned company. In connection with the plan, PENWEST, LTD. changed its name to Penford Corporation (See Note L). Penford Corporation (Penford or the Company) is in the business of developing, manufacturing and marketing chemically modified carbohydrate-based specialty chemicals. The Company operates in three market lines: carbohydrate-based specialty chemicals used in paper manufacturing, pharmaceutical excipients and controlled release technology, and food ingredient products. Customers are primarily manufacturers in the paper industry, makers of prescription pharmaceuticals, over-the-counter drugs and vitamins, and processors in the food industry. Sales of the Company's products are generated using a combination of direct sales and distributor agreements. Basis of Presentation The consolidated financial statements include Penford and its wholly-owned subsidiaries. Material intercompany balances and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Certain amounts in the financial statements for prior years have been reclassified to conform with the current year presentation. These reclassifications had no effect on previously reported results of operations. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of less than three months when purchased to be cash equivalents. Cash equivalents consist of money market funds, short-term deposits, and commercial paper. Amounts reported in the balance sheets represent cost which approximates market value. Penford's cash management system includes a cash overdraft feature for uncleared checks in the disbursing accounts. Cash in the accompanying balance sheets represents the net amounts available to the disbursing accounts. Uncleared checks of $1,446,000 and $2,177,000 are netted against cash at August 31, 1997 and 1996, respectively. Page 23 24 Concentration of Credit Risk and Financial Instruments The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains an allowance for doubtful accounts which management believes is sufficient to cover potential credit losses. The carrying value of financial instruments including cash, receivables, and payables approximates market value at August 31, 1997. The fair market value of long-term debt is approximately $69.9 million at August 31, 1997 with a carrying value of $67.7 million. The carrying value of long-term debt approximated market value at August 31, 1996. The fair value of fixed rate, long-term debt is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowings. Penford Products' two largest customers individually accounted for approximately 15% and 10% of sales in fiscal 1997 and one customer represented approximately 14% of sales in fiscal 1996. No customers accounted for greater than 10% of total sales in years prior to 1996. Property, Plant and Equipment Property, plant and equipment are recorded at cost. Expenditures for maintenance and repairs are expensed as incurred. The Company uses the straight-line method to compute depreciation assuming average useful lives of three to forty years for financial reporting purposes. For income tax purposes, the Company generally uses accelerated depreciation methods. Interest is capitalized on major construction projects while in progress. Interest of $724,000, $300,000 and $209,000 was capitalized in 1997,1996 and 1995, respectively. Foreign Currencies Monetary assets and liabilities of the Company's foreign operations are translated into U.S. dollars at year-end exchange rates and revenue and expenses are translated at average exchange rates. Non-monetary assets and liabilities are converted at historical rates. In each instance, the functional currency is the local currency. Realized gains and losses from foreign currency transactions are included in the statements of income. Income Taxes The provision for income taxes includes federal and state taxes currently payable and deferred income taxes arising from temporary differences between financial and income tax reporting methods. Deferred taxes have been recorded using the liability method in recognition of these temporary differences. Revenue Recognition Sales revenue is recorded upon shipment of product. Page 24 25 Research and Development Research and development costs of $8,057,000, $7,297,000 and $6,773,000 in 1997, 1996 and 1995, respectively, were charged to expense as incurred. Earnings Per Common Share Earnings per common share were computed by dividing net income by the weighted average number of common shares and dilutive common share equivalents outstanding during the fiscal year. Outstanding stock options and stock appreciation rights are considered to be common share equivalents. In February 1997, the Financial Accounting Standards Board (FASB) issued Statement No. 128, Earnings per Share, which is required to be adopted in the second quarter of fiscal 1998. At that time, the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating primary earnings per share, the dilutive effect of stock options will be excluded. The impact is expected to result in increases of $0.02 , $0.02 and $0.04 to primary earnings per share for the fiscal years ended August 31, 1997, 1996 and 1995, respectively. The impact of Statement 128 on the calculation of fully diluted earnings per share is not expected to be material. Stock Compensation In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based Compensation." The Statement is effective for fiscal years beginning after December 15, 1995 and requires stock-based compensation expense to be measured using either the intrinsic-value method as prescribed by Accounting Principles Board ("APB") No. 25 or the fair-value method described in Statement No. 123. The Company has adopted Statement No. 123 in fiscal 1997 using the intrinsic-value method, which has no effect on the Company's financial position or results of operations (see Note E). Recent Accounting Standards The FASB has recently issued Statement No. 130 on Comprehensive Income and Statement No. 131 regarding disclosures of Business Segment Information. The aforementioned standards will require additional financial statement disclosure for all periods presented, but will not impact the Company's reported financial position or results of operations. The new standards will be adopted in fiscal 1999. Page 25 26 NOTE B INVENTORIES Inventories are stated at the lower of cost or market. Cost, which includes material, labor and manufacturing overhead costs, is determined by the first-in, first-out (FIFO) method. The Company generally follows a policy of hedging corn purchases related to fixed price sales contracts and certain anticipated corn purchases to minimize price risk due to market fluctuations and risk of crop failure. The instruments used are principally readily marketable exchange traded futures contracts which are designated as hedges. The changes in market value of such contracts have a high correlation to the price changes of the hedged commodity. Also, the underlying commodity can be delivered against such contracts. Gains or losses arising from open and closed hedging transactions are included in inventory as a cost of raw materials and reflected in the statements of income when the product is sold. Components of inventory are as follows:
August 31 (Thousands of dollars) 1997 1996 - -------------------------------------------------------------------------------- Raw materials, supplies and other $ 6,624 $ 6,170 Work in progress 886 685 Finished goods 14,325 13,676 ------- ------- Total inventories $21,835 $20,531 ======= =======
Page 26 27 NOTE C DEBT
August 31 (Thousands of dollars) 1997 1996 - -------------------------------------------------------------------------------------------- Unsecured credit agreement, maturity in fiscal 2000, 6.44% interest rate at August 31, 1997 $20,250 $15,250 Private placement, 7.93% interest rate, semiannual interest-only payments with principal payments beginning in fiscal 1997, final maturity in fiscal 2003 17,143 20,000 Private placement, 7.59% interest rate, semiannual interest-only payments on $10 million principal with payment in fiscal 1999, and 8.35% interest rate, semi-annual interest-only payments on $10 million principal with payment in fiscal 2007 20,000 20,000 Unsecured note, 9.4% interest rate, due in quarterly installments through December 1999 2,100 2,940 Note payable, 7.01% interest rate, quarterly principal and interest payments through October 1997 2,258 2,688 Lines of credit, average interest rate of 6.2% at August 31, 1997 5,995 5,885 ------- ------- 67,746 66,763 Less current portion 5,955 4,127 ------- ------- Net long-term debt $61,791 $62,636 ======= =======
Maturities of long-term debt for the fiscal years ending August 31, 1998 through 2002, and thereafter, are as follows (thousands of dollars): 1998 $5,955 1999 19,693 2000 23,527 2001 2,857 2002 2,857 Thereafter 12,857 --------- $ 67,746 =========
The unsecured credit agreement is a $35 million facility involving four banks. There was $20.3 million outstanding at fiscal year end, and borrowings mature on December 30, 1999. Borrowing rates available to the Company under the agreement are based on prime rate or the interbank offered rate depending on the selection of borrowing options. The unsecured credit agreement, the private placements, and other notes include, among other terms, various limitations on long-term indebtedness, minimum net worth and working capital ratios, and restrictions on Penford's ability to purchase or redeem its own stock. The unsecured credit agreement also requires the Company to maintain a minimum fixed charge coverage ratio. The Company has uncommitted lines of credit aggregating $15 million, which provide for financing at various floating rates of which $6.0 million was outstanding at August 31, 1997. Page 27 28 The Company enters into interest rate swap agreements to modify the interest characteristics of its outstanding debt. These agreements involve the exchange of interest payment streams without an exchange of the underlying principal amount. Net amounts paid or received are reflected as adjustments to interest expense. The fair values of the swap agreements are not recognized in the financial statements. In the event of default by a counterparty, the risk in these transactions is the cost of replacing the interest rate contract at current market rates. Management continually monitors the credit ratings of its counterparties, and believes the risk of incurring such losses is remote, and that if incurred, such losses would be immaterial. At August 31, 1997, approximately $25 million of the Company's outstanding debt was subject to interest rate swap agreements. Of this amount, $15 million involves floating rate to fixed rate swaps which effectively fix rates at approximately 9.0% and $10 million involves fixed rate to floating rate swaps, with the floating rate approximating 6.3% at August 31, 1997. The Company has hedged the interest rate risk on $8.9 million of its long-term debt using Treasury note futures. The cost of the hedge has been deferred and will be recognized as a component of interest expense over the life of the debt. The hedge results in an effective interest rate on the related long-term debt of approximately 9.5%. NOTE D LEASES Certain of the Company's property, plant, and equipment is leased under operating leases ranging from one to fifteen years with renewal options. Rental expense under operating leases was $4,418,000, $4,482,000 and $3,202,000 for fiscal years ended August 31, 1997, 1996 and 1995, respectively. Future minimum lease payments as of August 31, 1997 for noncancellable operating leases having initial lease terms of more than one year are as follows (thousands of dollars):
Years ending August 31 Operating Leases - ---------------------- ---------------- 1998 $ 4,043 1999 3,668 2000 2,423 2001 1,597 2002 1,365 Thereafter 8,109 --------- Total minimum lease payments $ 21,205 =========
Page 28 29 NOTE E: STOCK OPTIONS The Company has two stock option plans for which 1,500,000 shares of Common Stock have been authorized for grants of options: the 1994 Stock Option Plan (the "1994 Plan") and the Stock Option Plan for Non-Employee Directors (the "Directors' Plan"). The 1994 Plan replaced the 1984 Stock Option Plan (143,000 shares outstanding at August 31, 1997) which expired in February 1994, and provides for the granting of stock options at the fair market value of the Company's Common Stock on the date of grant. Either incentive stock options or non-qualified stock options are granted under the 1994 Plan. The incentive stock options generally vest over five years at the rate of 20% each year and expire 10 years from the date of grant. The non-qualified stock options generally vest over four years at the rate of 25% of each year and expire 10 years and 10 days from the date of grant. The Directors' Plan provides for the granting of non-qualified stock options at 75% of the fair market value of the Company's Common Stock on the date of grant for annual retainers and meeting fees in lieu of cash compensation at each Director's annual election. Options granted under the Directors' Plan vest six months after the grant date and expire at the earlier of ten years after the date of grant or three years after the date the non-employee director ceases to be a member of the Board. In addition, non-employee directors receive restricted stock under a restricted stock plan every three years. The restricted stock may be sold or otherwise transferred at the rate of 33.3% each year. Effective September 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," using the intrinsic-value method prescribed by APB Opinion No. 25, as allowed for in the Statement. Accordingly, no compensation expense has been recognized for the stock-based compensation plans other than for the Directors' Plan and restricted stock awards. Had compensation cost been recognized based on the fair value at the date of grant for options awarded in 1997 and 1996 under the Plans, pro forma amounts of the Company's net income and net income per share would have been as follows:
In Thousands, except per share data Fiscal 1997 Fiscal 1996 ----------- ----------- Net income - as reported $ 6,625 $ 5,052 Net income - pro forma $ 5,689 $ 4,696 Net income per share, primary - as reported $ 0.93 $ 0.72 Net income per share, primary - pro forma $ 0.80 $ 0.67
The fair value of each option grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: risk-free interest rates of 5.6% to 6.1%; expected option life of each vesting increment of 2.8 years for employees and 3.0 years for non- employee directors; expected volatility of 49%; and expected dividends of $0.20 per share. The weighted average fair value of options granted under the 1994 Plan during fiscal years 1997 and 1996 was $9.46 and $10.57, respectively. The weighted average fair value of options granted under the Directors' Plan during fiscal years 1997 and 1996 was $9.29 and $11.66, respectively. The effect of applying Statement No. 123 for providing pro forma disclosures for fiscal years 1997 and 1996 is not likely to be representative of the effects in future years Page 29 30 because the amounts above reflect only the options granted in 1997 and 1996 that vest over four to five years, and additional grants are made annually. Changes in stock options for the three years ended August 31 follow:
Wtd. Average Shares Option Price Range Exercise Price ------ ------------------ -------------- Fiscal 1995 Balance, September 1, 1994 615,859 $ 3.31 - 27.50 $ 11.22 Granted 271,000 20.75 - 22.75 21.02 Exercised (13,600) 3.31 - 22.60 5.43 Cancelled (25,800) 19.13 19.13 -------- Balance, August 31, 1995 847,459 3 31 - 27.50 14.66 -------- Options Exercisable 401,159 3.31 - 27.50 9.72 Fiscal 1996 Granted 117,944 $ 18.25 - 24.75 $ 19.30 Exercised (77,917) 5.59 - 22.63 9.17 Cancelled (38,300) 22.50 - 27.50 23.90 -------- Balance, August 31, 1996 849,186 5.83 - 24.75 15.08 -------- Options Exercisable 454,692 5.83 - 24.75 10.86 Fiscal 1997 Granted 332,848 $ 13.13 - 18.75 $ 17.44 Exercised (409,242) 5.83 - 22.75 8.66 Cancelled (22,800) 18.25 - 21.00 20.29 -------- Balance, August 31, 1997 749,992 13.13 - 24.75 19.47 -------- Options Exercisable 199,625 13.13 - 24.75 19.00 Shares available for future grant 890,808
The following table summarizes information concerning outstanding and exercisable options as of August 31, 1997:
Options Outstanding Options Exercisable ------------------------------------------ --------------------------- Wtd. Avg. Remaining Wtd. Avg Wtd.Avg. Range of Number of Contractual Exercise Number of Exercise Exercise Prices Options Life Price Options Price --------------- ------- ---- ----- ------- ----- $ 13.13 - 17.00 100,339 8.89 $ 14.95 53,455 $ 13.79 17.01 - 21.00 514,253 8.38 19.28 84,020 18.99 21.01 - 24.75 135,400 4.90 23.53 62,150 23.50 ------- ------- 749,992 199,625 ======= =======
Stock appreciation rights (SARs) to certain officers of the Company that were granted in December 1986 and fully vested as of August 31, 1996 were fully exercised during the first half of fiscal 1997. As a result of appreciation (depreciation) of Penford stock, compensation expense was charged (credited) for $(28,000), $(451,000) and $78,000 in 1997, 1996 and 1995, respectively. Page 30 31 NOTE F INCOME TAXES Income tax expense consists of the following:
Year Ended August 31 (Thousands of dollars) 1997 1996 1995 - -------------------------------------------------------------------------------- Current Federal $2,487 $1,091 $2,102 Foreign 409 80 4 State 309 87 232 ------ ------ ------ 3,205 1,258 2,338 Deferred Federal 85 1,108 1,459 State 4 66 93 ------ ------ ------ 89 1,174 1,552 ------ ------ ------ Total provision $3,294 $2,432 $3,890 ====== ====== ======
A reconciliation of the statutory federal tax to the actual provision is as follows:
Year Ended August 31 (Thousands of dollars) 1997 1996 1995 - ------------------------------------------------------------------------------- Statutory tax rate 34% 34% 34% Statutory tax $ 3,372 $ 2,545 $ 3,776 State taxes, net of federal benefit 238 101 215 Tax credits, including research and development credits (322) (313) Tax advantaged investment income (36) (47) Foreign sales corporation (244) (238) (232) Other 250 60 491 ------- ------- ------- Total provision $ 3,294 $ 2,432 $ 3,890 ======= ======= =======
The significant components of deferred tax assets and liabilities are as follows:
August 31 (Thousands of dollars) 1997 1996 - -------------------------------------------------------------------------------------------- Deferred tax assets: Alternative minimum tax credit $ 3,506 $ 3,257 Research and development credit 947 592 Postretirement benefits 3,706 3,660 Provisions for accrued expenses 1,780 2,431 Other 1,068 ------- ------ Total deferred tax assets 11,007 9,940 Deferred tax liabilities: Depreciation 19,830 19,453 Other 2,306 1,527 ------ ------ Total deferred tax liabilities 22,136 20,980 ------- ------ Net deferred tax liabilities $11,129 $11,040 ======= =======
Page 31 32 NOTE G PENSION AND OTHER EMPLOYEE BENEFITS Penford maintains two noncontributory defined benefit pension plans that cover substantially all employees. Benefits under the plan for hourly employees are primarily related to years of service. Benefits for salaried employees are primarily related to years of credited service and final average five-year earnings. Employees generally become eligible to participate in the plans after attaining age 21 and benefits normally become vested after five years of credited service. The Company's funding policy is to contribute amounts to the plans sufficient to meet or exceed the minimum requirements of the Employee Retirement Income Security Act of 1974. Assumptions used in the measurement of the projected benefit obligation included a discount rate of 7.5% in 1997 and 8.0% in 1996, and a rate of increase in compensation levels of 4.0% in 1997 and 5.0% in 1996 for the salaried employees. The expected long-term rate of return on plan assets is assumed to be 10.0% for 1997 and 9.0% for 1996 and 1995. Changes in the assumptions used in the measurement of the projected benefit obligation had the effect of reducing pension expense by $268,000 in 1997. Net periodic pension expense consisted of the following (in thousands):
Year Ended August 31 1997 1996 1995 - ---------------------------------------------------------------------------------------- Service cost of benefits earned during the year $ 632 $ 709 $ 603 Interest cost on projected benefit obligation 1,466 1,426 1,363 Actual return on plan assets (6,036) (2,278) (2,599) Net amortization and deferral 4,246 892 1,480 ------- ------- ------- Net pension expense $ 308 $ 749 $ 847 ======= ======= =======
The following table sets forth the funded status of both pension plans (in thousands):
August 31 1997 1996 - ---------------------------------------------------------------------------------- Actuarial present value of projected obligation, based on service to date and current salary levels: Vested $ 19,059 $ 17,089 Nonvested 963 529 -------- -------- Accumulated benefit obligation 20,022 17,618 Effect of projected salary increases 1,186 1,676 -------- -------- Projected benefit obligation 21,208 19,294 Plan assets at fair market value 24,639 19,931 -------- -------- Plan assets in excess of projected benefit obligation 3,431 637 Unrecognized actuarial net gain (5,216) (1,634) Balance of unrecognized net obligation at transition being amortized over 15 years 882 1,010 Unrecognized prior service cost 1,118 510 -------- -------- Net pension asset $ 215 $ 523 ======== ========
Assets of the pension plans are invested in units of common trust funds managed by Frank Russell Trust Company. The common trust funds own stocks, bonds and real estate. Page 32 33 Savings And Stock Ownership Plan The Company has a savings investment plan. The savings component, available to all employees, matches 75% of the employee's contribution up to 6% of the employee's pay, in the form of Penford common stock. During 1997, approximately 54,435 shares of stock were earned by plan participants. The savings component expense of the plan was $877,000, $722,000 and $520,000 for fiscal years 1997, 1996 and 1995, respectively. Compensation expense is recorded by the Company at the market value of shares contributed to the Plan. The plan also includes an annual profit-sharing component that is awarded by the Board of Directors based on achievement of predetermined corporate goals. This feature of the plan is available to all employees who meet the eligibility requirements of the plan. The profit-sharing expense, which reflects the market value of shares released by the plan to participants was $212,000, $514,000 and $402,000 for the fiscal years 1997, 1996 and 1995, respectively. The plan initially acquired the Penford common stock by issuing a note to the Company. The note is reflected as a reduction of shareholders' equity and is amortized ratably over the note term which expires in December 1999. The shares held by the plan are considered outstanding for purposes of calculating earnings per share. Dividends on shares held by the plan are allocated to participant accounts. Supplemental Executive Retirement Plan The Company sponsors a Supplemental Executive Retirement Plan (SERP), a non-qualified plan, which covers certain employees. For 1997, 1996 and 1995, the net pension expense accrued for the SERP was $622,000, $950,000 and $856,000 respectively. Health Care And Life Insurance Benefits The Company offers health care and life insurance benefits to most active employees. Costs incurred to provide these benefits are charged to expense when paid. Health care and life insurance expense was $2,778,000, $2,632,000 and $2,501,000 in 1997, 1996 and 1995, respectively. NOTE H OTHER POSTRETIREMENT BENEFITS Penford maintains two postretirement benefit plans that cover substantially all salaried and hourly retirees. Benefits under the plan for hourly employees include medical coverage, prescription drug coverage, and, to a certain grandfathered group, life insurance. Hourly participants contribute to the cost of the benefits based on a pension credit formula. Benefits under the plan for salaried employees include medical coverage and vision coverage. Salaried participants contribute, for the most part, 100% of the premiums. Presently the Company funds the current benefits on a cash basis and therefore there are no plan assets. Page 33 34 The following table sets forth the plan's status (in thousands of dollars): Accumulated postretirement benefit obligation:
August 31, 1997 August 31, 1996 --------------- --------------- Retirees $ 3,752 $ 3,838 Fully eligible active plan participants 621 589 Other active plan participants 2,415 2,093 ------- ------- Accumulated post retirement benefit obligation 6,788 6,520 Unrecognized actuarial net gain 3,506 3,786 ------- ------- Accrued postretirement benefit obligation $10,294 $10,306 ======= =======
Net periodic postretirement benefit costs include the following components:
Year Ended August 31 1997 1996 1995 ----- ----- ----- Service cost -- benefits earned during the period $ 210 $ 238 $ 186 Interest cost on accumulated postretirement benefit obligations 470 475 402 Net amortization and deferral (364) (298) (229) ----- ----- ----- Postretirement benefit expense $ 316 $ 415 $ 359 ===== ===== =====
Future benefit costs were estimated assuming medical costs would increase at a 9.5% annual rate for fiscal 1997, decreasing by one half of a percent ratably over the next eight years to a rate of 5.5%. A 1% increase in this annual trend rate would have increased the accumulated postretirement benefit obligation at August 31, 1997 by $1.1 million, with an increase of $128,000 in the annual 1997 postretirement benefit expense. The weighted average discount rate used to estimate the accumulated postretirement obligation was 7.5% and 8.0% in 1997 and 1996, respectively. The change in discount rate had the impact of decreasing the accumulated postretirement benefit obligation by $343,000. Page 34 35 NOTE I SHAREHOLDERS' EQUITY Unissued Preferred Stock There are 1,000,000 shares of $1.00 par value preferred stock authorized for issue; however, none are outstanding. Common Stock Purchase Rights On June 16, 1988, Penford distributed a dividend of one right (Right) for each outstanding share of Penford common stock. In May 1997 the Company amended its Shareholder Rights Plan. When exercisable, each Right will entitle its holder to buy one share of Penford's common stock at $100 per share. The Rights will become exercisable if a purchaser acquires 15% of Penford's common stock or makes an offer to acquire common stock. In the event that a purchaser acquires 15% of the common stock of Penford, each Right shall entitle the holder, other than the acquirer, to purchase one share of common stock of Penford for one half of the market price of the common stock. In the event that Penford is acquired in a merger or transfers 50% or more of its assets or earnings to any one entity, each Right entitles the holder to purchase common stock of the surviving or purchasing company having a market value of twice the exercise price of the Right. The Rights may be redeemed by Penford at a price of $0.01 per Right, and expire in June 2008. NOTE J OTHER EVENTS Sale of Air Credits In November 1996 the Company sold certain Southern California air emission credits and recognized a gain on the sale of $1.2 million, which is reflected as other income. Pacific Cogeneration, Inc. In fiscal 1995 the Company sold the assets of its subsidiary, Pacific Cogeneration, Inc. and recognized a gain on the sale of $899,000 which is reflected as other income. NOTE K QUARTERLY FINANCIAL DATA (UNAUDITED)
Fiscal 1997 First Second Third Fourth (Thousands of dollars except per share data) Quarter* Quarter Quarter Quarter Total - ------------------------------------------------------------------------------------------------------------------- Sales $49,310 $48,327 $49,993 $49,004 $196,634 Gross margin 10,810 12,198 13,994 13,551 50,553 Income from operations 2,220 3,073 4,176 4,501 13,970 Net income 1,407 1,256 1,812 2,150 6,625 Earnings per common share $ 0.20 $ 0.18 $ 0.26 $ 0.29 $ 0.93 Dividends declared $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.20
* First quarter results include a gain of $800,000 after-tax, or $0.11 per share, from the sale of Southern California air emission credits. Page 35 36
Fiscal 1996 First Second Third Fourth (Thousands of dollars except per share data) Quarter Quarter Quarter Quarter Total - ------------------------------------------------------------------------------------------------------------------------ Sales $ 45,624 $ 46,313 $ 49,106 $ 53,431 $194,474 Gross margin 12,168 11,129 11,541 11,925 46,763 Income from operations 3,601 2,571 2,748 3,388 12,308 Net income 1,748 908 1,030 1,366 5,052 Earnings per common share $ 0.25 $ 0.13 $ 0.15 $ 0.20 $ 0.72 Dividends declared $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.20
NOTE L SUBSEQUENT EVENT On October 9, 1997, Penford announced a two stage plan designed to foster the growth potential of its pharmaceuticals business and separately, its paper and food ingredients businesses. Under the first stage of the plan, Penwest Pharmaceuticals Co. (Penwest) would sell up to 20% of its common stock through an initial public offering. Under the second stage of the plan, Penford would effect a tax-free spin-off to its shareholders of its remaining ownership of Penwest common shares, contingent upon satisfying certain conditions, including receipt of a tax ruling from the Internal Revenue Service or a written opinion from Ernst & Young LLP to the effect that, among other things, the spin-off will qualify as a tax-free distribution. The spin-off is anticipated to occur in the second quarter of calendar 1998. If the spin-off occurs, Penwest will no longer be a subsidiary of Penford. On October 21, 1997, Penwest filed a registration statement with the Securities and Exchange Commission for an initial public offering of 2,500,000 shares of common stock (approximately 15% of its outstanding common stock). The estimated initial public offering price is between $10.00 to $12.00 per share. An option will be granted to the underwriters to purchase up to 375,000 additional shares for the purpose of covering over-allotments, if any. Penford and Penwest have entered into a Separation Agreement setting forth the agreement of the parties with respect to the principal corporate transactions required to effect the separation of Penford's pharmaceutical business from its paper and food ingredients businesses, the initial public offering and the spin-off, and certain other agreements governing the relationship of the parties prior to and after the spin-off. Penford and Penwest will, prior to the completion of the initial public offering, also enter into other agreements that govern various interim and ongoing relationships. Penwest will retain the proceeds from the planned initial public offering. In addition, Penford will forgive all intercompany advances as of the closing of the offering. As of August 31, 1997, the intercompany balance approximated $35.2 million. Had the proposed plan been effected as of August 31, 1997, it is estimated that consolidated assets and shareholders' equity of Penford would have reflected a reduction of approximately $35.0 to $40.0 million, representing the net effects of the proposed distribution. Summarized financial data of Penwest is as follows:
1997 1996 1995 -------- -------- -------- Sales $ 26,530 $ 26,456 $ 24,537 Loss from operations (2,970) (2,562) (1,233) Identifiable assets 38,583 35,316 33,580
Page 36 37 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders Penford Corporation. We have audited the accompanying consolidated balance sheets of Penford Corporation (formerly PENWEST, LTD.) as of August 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended August 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Penford Corporation (formerly PENWEST, LTD.) at August 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 31, 1997, in conformity with generally accepted accounting principles. Seattle, Washington October 17, 1997 ERNST & YOUNG LLP Page 37 38 REPORT OF MANAGEMENT The management of Penford Corporation has prepared and is responsible for the integrity and fairness of the financial statements and other financial information presented in this annual report. The statements have been prepared in accordance with generally accepted accounting principles and, to the extent appropriate, include amounts based on management's judgment and/or estimates. In order to fulfill its responsibilities for these financial statements and information, management maintains accounting systems and related internal controls. These controls are designed to provide reasonable assurance that transactions are properly authorized and recorded, that assets are safeguarded, and that financial records are reliably maintained. Ernst & Young LLP, independent auditors, is retained to audit the Company's consolidated financial statements. Their accompanying report is based on an audit conducted in accordance with generally accepted auditing standards, including a review of internal accounting controls and tests of accounting procedures and records to the extent necessary to support their audit. The Audit Committee of the Board of Directors, which is composed solely of outside directors, meets periodically with management and with the independent auditors to review the quality of financial reporting, the operation and development of the internal control systems, and the results of independent audits. The independent auditors periodically meet with the Audit Committee without the presence of management. Tod R. Hamachek President and Chief Executive Officer Jeffrey T. Cook Vice President, Finance and Chief Financial Officer Page 38 39 ITEM 9: CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT The information set forth under "Election of Directors" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders is incorporated herein by reference. Information regarding executive officers of the Company is set forth in Part I above and incorporated herein by reference. ITEM 11: EXECUTIVE COMPENSATION The information set forth under "Executive Compensation" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders is incorporated herein by reference. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders is incorporated herein by reference. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information relating to certain relationships and related transactions of the Company set forth under "Change-in-Control Arrangements" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders is incorporated herein by reference. PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Financial Statements The consolidated balance sheets as of August 31, 1997 and 1996 and the related statements of income, cash flows and shareholders' equity for each of the three years in the period ended August 31, 1997 and the report of independent auditors are included in Part II, Item 8. (a) (2) Financial Statement Schedules All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because they are not applicable or because the information is presented in the financial statements or notes thereto. Page 39 40 (a) (3) Exhibits See list of Exhibits on page 42. This list includes a subset containing each management contract, compensatory plan, or arrangement required to be filed as an exhibit to this report. (b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of the period covered by this report. Page 40 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 Date: November 25, 1997 /s/ TOD R. HAMACHEK ------------------ ---------------------------------------- Tod R. Hamachek, President and Chief Executive Officer Principal Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: November 25, 1997 /s/ TOD R. HAMACHEK ------------------ --------------------------------------- Tod R. Hamachek, President and Chief Executive Officer (Principal Executive Officer) Date: November 25, 1997 /s/ JEFFREY T. COOK ------------------ --------------------------------------- Jeffrey T. Cook, Chief Financial Office (Principal Financial Officer) Directors Richard E. Engebrecht* Paul E. Freiman* Tod R. Hamachek* Paul H. Hatfield By /s/ JEFFREY T. COOK Harry Mullikin* ---------------------------------- Sally G. Narodick* Attorney-in-Fact* William G. Parzybok, Jr.* Power of Attorney Dated N. Stewart Rogers* William K. Street* Date October 28, 1997 --------------------------------- Page 41 42 INDEX TO EXHIBITS Exhibits identified in parentheses below, on file with the Securities and Exchange Commission, are incorporated by reference. Exhibit No. Item (3.1) Restated Articles of Incorporation of Registrant (filed as an Exhibit to Registrant's Form 10-K for fiscal year ended August 31, 1995) 3.2 Articles of Amendment to Restated Articles of Incorporation of Registrant 3.3 Bylaws of Registrant as amended and restated as of October 20, 1997 (4.1) Amended and Restated Rights Agreement dated as of April 30, 1997 (filed as an Exhibit to Registrant's Amendment to Registration Statement on Form 8-A/A dated May 5, 1997) (10.1) Senior Note Agreement among Penford Corporation as Borrower and Mutual of Omaha and Affiliates as lenders, dated November 1, 1992 (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended February 28, 1993) (10.2) Term Loan Agreement among Penford Products Co., and Penford Corporation as Borrowers, and Wells Fargo Bank (formerly First Interstate Bank of Washington, N.A.) as Lender, dated September 27, 1990 (Registrant agrees to furnish a copy of this instrument to the Commission on request) (10.3) Loan Agreement among Penford Corporation as Borrower and Seattle-First National Bank as Lender, dated December 1, 1989 (Registrant agrees to furnish a copy of this instrument to the Commission on request) (10.4) Penford Corporation Supplemental Executive Retirement Plan, dated March 19, 1990 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991) (10.5) Penford Corporation Supplemental Survivor Benefit Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991) (10.6) Penford Corporation Deferred Compensation Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991) (10.7) Change of Control Agreements with Messrs. Hamachek, Cook, Widmaier, Talley, Horn, Rydzewski and Belsheim (a representative copy of these agreements is filed as an exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1995) Page 42 43 (10.8) Penford Corporation 1993 Non-Employee Director Restricted Stock Plan (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended November 30, 1993) (10.9) Note Agreement dated as of October 1, 1994 among Penford Corporation, Principal Mutual Life Insurance Company and TMG Life Insurance Company (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended February 28, 1995) (10.10) Penford Corporation 1994 Stock Option Plan as amended and restated as of January 21, 1997 (filed on Form S-8 dated March 17, 1997) (10.11) Credit Agreement dated as of December 22, 1995 among Penford Corporation, and its subsidiaries, Bank of America National Trust and Savings Association, ABN-AMRO Bank, N.V., The Bank of Nova Scotia, and Seattle-First National Bank (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended February 29, 1996) (10.12) Amendment to Credit Agreement dated as of May 7, 1997 among Penford Corporation, and its subsidiaries, Bank of America National Trust and Savings Association, ABN-AMRO Bank, N.V., The Bank of Nova Scotia, and Seattle-First National Bank (filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended May 31, 1997) (10.13) Penford Corporation Stock Option Plan for Non-Employee Directors (filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended May 31, 1996) 10.14 Separation Agreement dated as of November 10, 1997 between Registrant and Penwest Pharmaceuticals Co. 11 Statement Regarding Computation of Per-Share Earnings 21 Subsidiaries of the Registrant 23 Consent of Ernst & Young LLP, Independent Auditors 24 Power of Attorney 27 Financial Data Schedule Page 43 44 SUBSET OF THE INDEX TO EXHIBITS Executive Compensation Plans and Arrangements. This subset of the index to exhibits includes a subset containing each management contract, compensatory plan, or arrangement required to be filed as an exhibit to this Report. Exhibit No. Item (10.4) Penford Corporation Supplemental Executive Retirement Plan, dated March 19, 1990 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991, Commission File No. 0-11488) (10.5) Penford Corporation Supplemental Survivor Benefit Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991, Commission File No. 0-11488) (10.6) Penford Corporation Deferred Compensation Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991, Commission File No. 0-11488) (10.7) Agreements relating to compensation in the event of a change in control of the corporation between the Corporation and Messrs. Hamachek, Cook, Widmaier, Talley, Horn, and Rydzewski (a representative copy of these agreements filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1995, Commission File No. 0-11488) (10.8) Penford Corporation 1993 Non-Employee Director Restricted Stock Plan. (Filed as an Exhibit to Registrant's Form 10-Q for the quarter ended November 30, 1993, Commission File Number 0-11488) (10.10) Penford Corporation 1994 Stock Option Plan as amended and restated as of January 21, 1997 (filed on Form S-8, No. 33-58799, dated March 17, 1997) (10.13) Penford Corporation Stock Option Plan for Non-Employee Directors (filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended May 31, 1996, Commission File Number 0-11488) Page 44 EX-3.2 2 ARTICLES OF AMENDMENT 1 EXHIBIT 3.2 ARTICLES OF AMENDMENT OF PENWEST, LTD. Pursuant to RCW 23B.10.060, the undersigned corporation adopts the following Articles of Amendment to its Restated Articles of Incorporation: FIRST: The name of the corporation is PENWEST, LTD. (the "Corporation"). SECOND: The Restated Articles of Incorporation are hereby amended as follows: Article I is hereby deleted in its entirety and replaced with a new Article I to read as follows: ARTICLE I NAME The name of the corporation (the "Corporation") is Penford Corporation. THIRD: The foregoing amendment was adopted by the Board of Directors of the Corporation on October 8, 1997 in accordance with the provisions of RCW 23B.10.020. Shareholders action was not required. PENWEST, LTD. Date: October 10, 1997 By: /s/ EDMUND O. BELSHEIM, JR. -------------------------------- Name: Edmund O. Belsheim, Jr. Title: Vice President EX-3.3 3 BYLAWS OF REGISTRANT AS OF OCTOBER 20, 1997 1 EXHIBIT 3.3 AMENDED AND RESTATED BYLAWS OF PENFORD CORPORATION (A Washington Corporation) (Amended as of October 20, 1997) ARTICLE I CAPITAL STOCK 1.1 Stock Certificates Stock certificates of the Corporation shall be in such form as the Board of Directors may from time to time prescribe. Every stock certificate shall be signed by two officers designated by the Board of Directors and sealed with the corporate seal. All certificates shall be countersigned by a transfer agent and a registrar of the Corporation. Any and all signatures on any such certificate and the corporate seal upon any such certificate may be a facsimile. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he or she were such officer, transfer agent, or registrar at the date of issue. 1.2 Transfer of Shares The shares of stock of the Corporation shall be transferable on its books, or other appropriate records, kept for such purpose, by the holder thereof in person or by such holder's duly authorized attorney upon surrender and cancellation of such holder's certificates, properly endorsed, accompanied by authority to transfer. Upon surrender, as above provided, of a stock certificate, one or more new stock certificates for such aggregate number of shares of stock as equals the aggregate number of shares represented by the surrendered stock certificate shall be issued to the parties entitled thereto. 1.3 Holders of Stock of Record The Corporation shall be entitled to treat the holder of record of any share or shares of stock of the Corporation as the holder in fact thereof, and shall not be bound to recognize any claim to, or interest in, such shares on the part of any other person, whether or not the Corporation shall have express or other notice thereof. -1- 2 1.4 Rules and Regulations Concerning the Issue, Transfer, and Registration of Stock Certificates The Board of Directors of the Corporation shall have the power and authority to make all such rules and regulations as the Board may deem proper or expedient concerning the issue, transfer, and registration of stock certificates for shares of stock of the Corporation. The Board of Directors shall have the power and authority to appoint from time to time one, or more than one, transfer agent, and one, or more than one, registrar of transfers, and may require all stock certificates for shares of stock of the Corporation to be properly countersigned, and/or otherwise properly authenticated, by such transfer agent or registrar. 1.5 Rules and Regulations Concerning Lost and Destroyed Certificate A new certificate or certificates of stock may be issued in place of any certificate or certificates of stock theretofore issued by the Corporation and alleged to have been lost or destroyed, upon delivery to the Secretary of the Corporation or any authorized transfer agent of the Corporation of a written claim in the form of an affidavit stating all pertinent facts relating to the alleged loss or destruction of such certificate or certificates together with an open penalty indemnity bond, approved as provided below, written by a surety company approved by an executive officer of the Corporation and indemnifying against any claim that may be made against the Corporation for or in respect of the shares of stock represented by the certificate or certificates alleged to have been lost or destroyed. The penalty of such bond shall be unlimited as to time and amount and such bond must be approved by an executive officer of the Corporation. The Board of Directors may, in the discretion of a majority of the Board, however, direct the issuance of a certificate or certificates in place of any certificate or certificates alleged to have been lost or destroyed upon such lesser conditions or security. ARTICLE II MEETINGS OF SHAREHOLDERS 2.1 Place of Meetings of Shareholders The annual meetings of shareholders of the Corporation shall be held at such place as the Board of Directors may from time to time designate. The time and place of the meeting shall be stated in the notice to shareholders. 2.2 Annual Meetings of Shareholders -- Time -- Business The annual meeting of shareholders of the Corporation for the election of directors and for the transaction of any such other business as properly may be submitted to such annual meeting shall be held at the hour and on the date designated by the Board of Directors or the Executive Committee of the Board of Directors, such date to be within 180 days of the end of the fiscal year. -2- 3 Any and all business pertaining to the affairs of the Corporation may be transacted at any such annual meeting of shareholders or at any adjournment thereof, except only to the extent otherwise expressly proscribed by law. 2.3 Special Meetings of Shareholders Special meetings of the shareholders of the Corporation may be called at any time by the Board of Directors. 2.4 Quorum at Shareholders' Meetings The holders of record of a majority of the issued and outstanding shares of the stock of the Corporation present in person or represented by proxy at any shareholders' meeting and entitled to vote thereat shall constitute a quorum for the transaction of business at any such meeting, except as may otherwise be provided by law; but if there be less than a quorum present at any such meeting, the holders of a majority of the shares so present or represented at such meeting may adjourn the meeting from time to time. 2.5 Notice of Annual or Special Meetings of Shareholders Written notice stating the place, day, and hour of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called shall be given by or at the direction of the Board of Directors, the Chairman of the Board of Directors, the President, the Secretary, or an Assistant Secretary to each shareholder entitled to notice of or to vote at the meeting not less than 10 nor more than 60 days before the meeting, except that notice of a meeting to act on an amendment to the Articles of Incorporation, a plan of merger or share exchange, the sale, lease, exchange, or other disposition of all or substantially all of the Corporation's assets other than in the regular course of business, or the dissolution of the Corporation shall be given not less than 20 nor more than 60 days before such meeting. Such notice may be transmitted by mail, private carrier, personal delivery, telegraph, teletype, or communications equipment which transmits a facsimile of the notice to like equipment which receives and reproduces such notice. If these forms of written notice are impractical in the view of the Board of Directors, the Chairman of the Board of Directors, the President, the Secretary, or an Assistant Secretary, written notice may be transmitted by an advertisement in a newspaper of general circulation in the area of the Corporation's principal office. If such notice is mailed, it shall be deemed effective when deposited in the official government mail, first-class postage prepaid, properly addressed to the shareholder at such shareholder's address as it appears in the Corporation's current record of shareholders. Notice given in any other manner shall be deemed effective when dispatched to the shareholder's address, telephone number, or other number appearing on the records of the Corporation. Any notice given by publication as herein provided shall be deemed effective five days after first publication. -3- 4 2.6 Voting List of Shareholders and Fixing of Record Date for Voting and For Other Purposes At least 10 days before each meeting of shareholders, an alphabetical list of the shareholders entitled to notice of such meeting shall be made, arranged by voting group and by each class or series of shares therein, with the address of and number of shares held by each shareholder. This record shall be kept at the principal office of the Corporation for 10 days prior to such meeting, and shall be kept open at such meeting, for the inspection of any shareholder or any shareholder's agent. For the purpose of determining shareholders entitled to (a) notice of or to vote at any meeting of shareholders or any adjournment thereof, or (b) to receive payment of any dividend, or in order to make a determination of shareholders for any other purpose, the Board of Directors may fix a future date as the record date for any such determination. Such record date shall be not more than 70 days, and in case of a meeting of shareholders not less than 10 days, prior to the date on which the particular action requiring such determination is to be taken. If no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting, the record date shall be the day immediately preceding the date on which notice of the meeting is first given to shareholders. Such a determination shall apply to any adjournment of the meeting unless the Board of Directors fixes a new record date, which it shall do if the meeting is adjourned to a date more than 120 days after the date fixed for the original meeting. If no record date is set for the determination of shareholders entitled to receive payment of any stock dividend or distribution (other than one involving a purchase, redemption, or other acquisition of the Corporation's shares), the record date shall be the date the Board of Directors authorizes the stock dividend or distribution. 2.7 Officers of Meetings of Shareholders The President of the Corporation (or in his or her absence, the Chairman of the Board of Directors of the Corporation) may call any meeting of shareholders to order and shall be the Chairman thereof. If the Chairman of the Board of Directors and the President are absent from any such meeting, then a Vice President of the Corporation shall be the Chairman thereof and shall preside at such meeting. The Secretary of the Corporation, if present at any meeting of its shareholders, shall act as the Secretary of such meeting. If the Secretary is absent from any such meeting, the Chairman of such meeting may appoint a Secretary for the meeting. 2.8 Proper Business for Shareholders' Meetings At any annual or special meeting of the shareholders of the Corporation, only business properly brought before the meeting may be transacted. To be properly brought before an annual or special meeting, business or other proposals must be (i) specified in the notice of the meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (iii) otherwise properly brought before the meeting by a shareholder. For business to be properly -4- 5 brought before an annual meeting by a shareholder, written notice thereof must have been received by the Secretary of the Corporation from such shareholder not less than 120 days prior to the date corresponding to the date on which the Corporation mailed its proxy statement in connection with its previous year's annual meeting of shareholders. For business to be properly brought before a special meeting by a shareholder, or in the event the date of the annual meeting has been changed by more than 30 calendar days from the date contemplated at the time of the previous year's proxy statement, notice by the shareholder to be timely must be received by the Secretary of the Corporation not later than the close of business on the 10th day following the earlier of the day on which notice of the date of the scheduled meeting was mailed or the day on which public disclosure of such date was made. Any such notice shall set forth as to each matter the shareholder proposes to bring before the meeting (i) a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting, and the language of the proposal, (ii) the name and address of the shareholder proposing such business, (iii) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting, and (iv) any material interest of the shareholder in such business. Any such notice to the Corporation shall also comply with all applicable provisions of Regulation 14A under the Securities Exchange Act of 1934. No business shall be conducted at any meeting of shareholders except in accordance with this Section, and the Chairman of any meeting of shareholders and the Board of Directors may refuse to permit any business to be brought before the meeting without compliance with the foregoing procedures. ARTICLE III DIRECTORS 3.1 Number of Directors The authorized number of directors of the Corporation shall be not less than seven, nor more than fifteen. The Board of Directors, by resolution, shall fix the number of directors to constitute the whole Board of Directors of the Corporation, within the above limits, which number shall prevail until a resolution is adopted by the Board of Directors prescribing a different number of directors to be the authorized number of directors of the Corporation. 3.2 Qualifications of Directors Directors need not be shareholders of the Corporation or residents of the State of Washington. Each director of the Corporation shall be eligible to serve as a director until the annual meeting of shareholders immediately following such director's 72nd birthday. 3.3 Election of Directors -- Terms of Office The shareholders shall, at their annual meeting held each year, elect the class of directors of the Corporation as set forth in the Articles of Incorporation of the Corporation. -5- 6 3.4 Nominations of Directors for Election Nominations for the election of directors may be made by the Board of Directors or a committee appointed by the Board of Directors or, if the shareholders are, at the time, entitled to cumulate their votes in the election of directors in accordance with Article IX of the Articles of Incorporation of the Corporation, by a majority of the "Disinterested Directors" or by any shareholder who is the "Beneficial Owner" of one percent or more of the outstanding shares of "voting stock" of the Corporation as said terms are defined in the Articles of Incorporation in accordance with the following procedures. However, any such one percent shareholder at the time may nominate one or more persons for election as directors at a meeting only if written notice of such shareholder's intent to make such nomination or nominations has been given, either by personal delivery or by United States mail, postage prepaid, to the Secretary of the Corporation in accordance with the following procedures: For a nomination to be properly submitted before an annual meeting by a shareholder, written notice thereof must have been received by the Secretary of the Corporation from such shareholder not less than 120 days prior to the date corresponding to the date on which the Corporation mailed its proxy statement in connection with its previous year's annual meeting of shareholders. For a nomination to be properly submitted before a special meeting by a shareholder, or in the event the date of the annual meeting has been changed by more than 30 calendar days from the date contemplated at the time of the previous year's proxy statement, notice by the shareholder to be timely must be received by the Secretary of the Corporation not later than the close of business on the 10th day following the earlier of the day on which notice of the date of the scheduled meeting was mailed or the day on which public disclosure of such date was made. Each such notice to the Secretary shall set forth: (i) the name and address of record of the shareholder who intends to make the nomination; (ii) a representation that the shareholder is a holder of record of shares of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (iii) the name, age, business and residence addresses, and principal occupation or employment of each nominee; (iv) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (v) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission; and (vi) the consent of each nominee to serve as a director of the Corporation if so elected. The Corporation may require any proposed nominee to furnish such other information as may reasonably be required by the Corporation to determine the eligibility of such proposed nominee to serve as a director of the Corporation. The presiding officer of the meeting may, if the facts warrant, determine that a nomination was not made in accordance with the foregoing procedure, and if such officer should so determine, such officer shall so declare to the meeting and the defective nomination shall be disregarded. -6- 7 3.5 Failure to Elect Directors at Annual Meeting of the Shareholders If the class of directors of the Corporation to be elected at the annual meeting shall not be elected as herein provided at the annual meeting in any year of the shareholders of the Corporation, or at any adjournment of such annual meeting, then, in such event, the Corporation shall not for that reason be dissolved, but its directors at the time shall be deemed lawful directors of the Corporation for all purposes, and shall continue to hold office as directors until their successors, respectively, are duly elected and qualified. 3.6 Authority of the Board of Directors The business of the Corporation shall be managed by its Board of Directors, and such Board shall have and exercise full powers and authority in the management, control, regulation, and conduct of the property, interests, business transactions and affairs of the Corporation; provided, however, that the Executive Committee of the Board of Directors of the Corporation may exercise the power and authority of such Board pursuant but subject to (a) the limitations in Section 23B.08.250 of the Washington Business Corporation Act and (b) restrictions imposed by the Board of Directors pursuant to Article IV hereof. If the position, Chairman of the Board, is not designated as an office of the Corporation, then the Board may from time to time elect one of its members to act as Chairman. 3.7 Action by the Board of Directors or Any of Its Committees Without a Meeting Any action required or permitted to be taken at any meeting of the Board of Directors or of the Executive Committee or of any other committee of said Board may be taken without a meeting if a written consent describing the action taken is signed by all members of the Board or of such committee, as the case may be, and such written consent is filed with the minutes of said Board or of said committee. Action taken by such written consent is effective when the last director signs the consent, unless the consent specifies a later effective date. 3.8 Regular Meetings of the Board of Directors Meetings of the Board of Directors of the Corporation may be held at its corporate offices, or at such other place or places as may be authorized by such Board. Such Board shall also fix the time or times of such regular meetings. No notice of any regularly scheduled meeting need be given. The Chairman of the Board or the President may change the time and place of any regular meeting by giving reasonable notice thereof, in writing or by telephone, not later than 24 hours before the time originally fixed for such meeting. The Chairman of the Board shall act as Chairman of the meetings, but in his or her absence, the President shall act as Chairman. The Secretary of the Corporation shall act as Secretary of the meetings, but in his or her absence, the Chairman of the meeting shall appoint a Secretary of the meeting. -7- 8 3.9 Special Meetings of the Board of Directors Meetings of the Board of Directors of the Corporation may be held from time to time on written call thereof by the Chairman of the Board of Directors or the President made at any time at his or her own instance and discretion or on call thereof made by such number of its directors as equals a majority of its whole Board of Directors at the time. Any special meeting of the Board of Directors may be held at such time or at such place designated in said call. The time, place, and purpose of any special meeting of the Board of Directors to be held pursuant to call and notice shall be stated both in the call and the notice thereof, and no business other than that stated in such notice shall be transacted, or acted upon, at such special meeting. Reasonable notice of a special meeting shall be given in writing or by telephone by the person or persons calling the meeting, not later than 72 hours prior to the time set for the meeting; provided that the minimum notice period shall be 48 hours in the event of a tender or exchange offer to purchase securities of the Corporation. Any special meeting of the Board of Directors may be held at any time without previous call, or previous notice thereof, if all directors of the Corporation either attend such meeting, or consent in writing thereto, or if each director not present at such meeting waives notice thereof. Any and all business and matters pertaining to the affairs of the Corporation may be considered, transacted, and acted on at any special meeting so held without previous call or previous notice. 3.10 Quorum of Directors A majority of the members of the Board of Directors as constituted for the time being shall constitute a quorum for the transaction of business, but less than a quorum may adjourn any meeting from time to time until a quorum is present and without further notice being given. 3.11 Waiver of Notice of Meetings of the Board of Directors Any director of the Corporation may waive in writing at any time any such notice of any meeting of the Board of Directors of the Corporation as may be provided by the Washington Business Corporation Act or by these Bylaws to be given; and a written waiver thereof signed by any director entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to such notice legally given to such director. Attendance at any meeting of the Board of Directors of the Corporation by a director shall constitute waiver of notice of such meeting, unless such director at the beginning of the meeting, or promptly upon such director's arrival, objects to holding the meeting or transacting business thereat and does not thereafter vote for or assent to action taken at the meeting. 3.12 Fees to the Directors for Attending Meetings of the Board of Directors The directors of the Corporation shall be entitled, as directors, to receive an annual fee for service as directors and an attendance fee for meetings of the Board of Directors and for meetings of committees of the Board of Directors. Said fees shall be payable in the -8- 9 amounts and under provisions prescribed from time to time by resolution of the Board of Directors, and the Corporation is hereby authorized to pay such fees to each of its directors; provided, however, that no director of the Corporation shall be entitled to said fee if at the time he or she is otherwise employed by the Corporation at a regular monthly or annual salary as a full time employee. 3.13 Meeting by Telephone Members of the Board of Directors or any committee designated by these Bylaws or appointed by the Board of Directors may participate in a meeting of such Board or committee by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other at the same time, and participation by such means shall constitute presence at a meeting. ARTICLE IV COMMITTEES OF THE BOARD OF DIRECTORS 4.1 Creation of Committees The Board of Directors, by resolution adopted by the greater of a majority of the directors then in office and the number of directors required to take action in accordance with these Bylaws, may create one or more committees, including an Executive Committee, and appoint members to such committee from its own members. Each committee must have two or more members, who shall serve at the pleasure of the Board of Directors. 4.2 Authority of Committees Each committee shall have and may exercise the authority of the Board of Directors to the extent provided in the resolution of the Board creating the committee and any subsequent resolutions pertaining thereto, except that no committee shall have the authority to: (1) authorize or approve a distribution except according to a general formula or method prescribed by the Board, (2) approve or propose to shareholders actions or proposals required by the Washington Business Corporation Act to be approved by shareholders, (3) fill vacancies on the Board or on any committee, (4) adopt, amend, or repeal Bylaws, (5) amend the Articles of Incorporation, (6) approve a plan of merger not requiring shareholder approval, or (7) authorize or approve the issuance or sale or contract for sale of shares, or determine the designation and relative rights, preferences, and limitations of a class or series of shares, except that the Board may authorize a committee or a senior executive officer of the Corporation to do so within limits specifically prescribed by the Board. -9- 10 ARTICLE V OFFICERS AND THEIR POWERS AND DUTIES 5.1 Authorized Officers The officers of the Corporation shall consist of a President, one or more Vice Presidents (who may be designated as Vice Presidents, Senior Vice Presidents or Executive Vice Presidents), and a Secretary. The Corporation may have such additional officers (hereinafter in these Bylaws sometimes referred to as "additional officers") as its Board of Directors may deem necessary for its business and may appoint from time to time. The Board of Directors may designate one of the officers as the chief financial officer of the Corporation. The Board of Directors at any meeting of the Board may fill a vacancy in any office. The officers of the Corporation shall be elected at the first Board of Director's meeting held after the annual election of directors and they shall serve until the next annual election of officers, subject to the right of the Board of Directors to remove any officer at any time. The Board of Directors, by resolution duly adopted at any meeting thereof duly held, may authorize and direct that any office of the Corporation, except the offices of President and Secretary, may be left unfilled for any such period of time as the Board may fix in such resolution. 5.2 Qualifications of Officers No officer of the Corporation need be a shareholder therein. No officer of the Corporation, except the President, need be a director. 5.3 Powers and Duties of Officers The respective officers of the Corporation, subject, always, to control by its Board of Directors, shall have such power and authority and perform such duties in the management and conduct of its property, business, and affairs, as from time to time may be prescribed with respect to such officers, respectively, by and under any Section of these Bylaws, by resolution of the Board of Directors, or by the President. The Board of Directors may by appointment designate either the Chairman, if an officer of the Corporation, or the President as the Chief Executive Officer of the Corporation and either of said officers as the Chief Operating Officer of the Corporation. -10- 11 5.4 Powers and Duties of the Chief Executive Officer and the Chief Operating Officer The Chief Executive Officer of the Corporation shall have general charge and supervision of the business of the Corporation and shall see that all orders and resolutions of the Board of Directors and of the Executive Committee are carried out. The Chief Executive Officer shall designate the duties of all officers of the Corporation, which designations shall be subject to review by the Board of Directors; provided, however, that the specific duties assigned to the Chief Executive Officer, the Chief Operating Officer, and the Secretary shall not be changed except by amendment to these Bylaws and/or by resolution of the Board of Directors, as appropriate. The Chief Operating Officer of the Corporation shall have general supervisory authority and responsibility for the day to day operations of the Corporation. In the event of the death of either of the Chief Executive Officer or the Chief Operating Officer or the permanent disability preventing such officer from performing his or her duties, all officers normally reporting to such deceased or disabled officer shall report to the Executive Committee. The Chairman of the Board shall call a meeting of the Board to be held within 20 days of the date of such death or disability for the purpose of electing a new Chief Executive Officer or Chief Operating Officer, as the case may be. Either the Chief Executive Officer or the Chief Operating Officer may sign in the name of the Corporation all instruments required to be signed by the Corporation in the ordinary course of its business. Each such officer shall perform such other duties as may be assigned to such officer by the Board of Directors or by these Bylaws. 5.5 Compensation to Officers The Board of Directors shall have authority (a) to fix the compensation, whether in the form of salary or otherwise, of all officers and employees of the Corporation, either specifically or by formula applicable to particular classes of officers or employees, and (b) to authorize officers of the Corporation to fix the compensation of subordinate employees. The Board of Directors shall have authority to appoint a Compensation Committee and may delegate to such committee authority to review the compensation of all employees of the Corporation, and its subsidiaries. The Compensation Committee may also be authorized to make recommendations to the Board with respect to compensation of the corporate officers. -11- 12 ARTICLE VI MISCELLANEOUS 6.1 Corporate Seal The corporate seal of the Corporation shall be a seal consisting of two concentric circles, in the outer of which circles shall appear and be inscribed the following words: "PENFORD CORPORATION WASHINGTON", and in the inner of which circles shall appear and be inscribed the following words and figures: "CORPORATE SEAL 1997"; and such seal, as impressed on the margin thereof, shall be the corporate seal of the Corporation; provided, however, that at any time, and from time to time, such seal may be altered or a new corporate seal for the Corporation may be authorized and adopted, at the pleasure of its Board of Directors, by resolution duly adopted by such Board at any meeting thereof duly held. 6.2 Fiscal Year The fiscal year of the Corporation shall begin on September 1 and end on August 31 of each year. 6.3 Amendments These Bylaws may be amended, altered, or repealed, in whole or in part, or new Bylaws may be made for the Corporation from time to time by the affirmative vote of the majority of its whole Board of Directors at any meeting of such Board duly held, subject to the right and power of the shareholders of the Corporation to change or repeal such Bylaws. 6.4 Severability In the event that any provision of these Bylaws is determined by a court to require the Corporation to do or to fail to do an act which is in violation of applicable law, such provision shall be limited or modified in its application to the minimum extent necessary to avoid a violation of law, and, as so limited or modified, such provision and the balance of these Bylaws shall remain in full force and effect. -12- EX-10.14 4 SEPARATION AGREEMENT DATED AS OF NOVEMBER 10, 1997 1 EXHIBIT 10.14 SEPARATION AGREEMENT THIS SEPARATION AGREEMENT (the "Agreement") is made as of the 10th day of November, 1997 (the "Effective Date"), between PENFORD CORPORATION, a Washington corporation (previously known as PENWEST, LTD.) ("Penford"), and PENWEST PHARMACEUTICALS CO., a Washington corporation ("Penwest"). RECITALS WHEREAS, the Board of Directors of Penford has determined that it is in the best interest of Penford and its shareholders to separate the pharmaceutical division of its business from the food and paper division of its business; WHEREAS, it is the intention of Penford to contribute to Penwest certain assets and to assign certain liabilities, to transfer certain technology to Penwest and to make other arrangements to establish Penwest as a separate enterprise for the purpose of engaging in research, development and marketing of novel drug delivery technologies and sale and distribution of pharmaceutical excipients (the "Pharmaceutical Business"); WHEREAS, Penford and Penwest have determined that it is necessary and desirable, on the terms and conditions contemplated hereby (i) to cause Penwest to offer and sell for its own account in the IPO (as defined below) a limited number of shares of Penwest Common Stock (as defined below), and (ii) for Penford to distribute to shareholders of Penford the outstanding shares of Penwest Common Stock held by Penford following the IPO; WHEREAS, the Distribution (as defined below) is intended to qualify as a tax-free spin-off under Sections 355 and 368 of the Code (as defined below); and WHEREAS, Penford and Penwest have further determined that it is necessary and desirable to set forth the principal corporate transactions required to effect the Separation (as defined below), the IPO and the Distribution and to set forth other agreements that will govern certain other matters following the Separation, IPO and Distribution; NOW, THEREFORE, in consideration of the mutual covenants and agreements made herein, the parties hereto agree as follows: 2 ARTICLE I DEFINITIONS 1.1 GENERAL. As used in this Agreement and the Exhibits hereto, the following terms shall have the following meanings: ACTION: any action, suit, arbitration, inquiry, proceeding or investigation by or before any court, any governmental or other regulatory or administrative agency or commission or any arbitration tribunal. AFFILIATE: affiliate of any Person means a Person that controls, is controlled by, or is under common control with such Person. As used herein, "control" means the possession, directly or indirectly, of the power to direct or cause the direction of the management and polices of such entity, whether through ownership of voting securities or other interests, by contract or otherwise. AGENT: the distribution agent to be appointed by Penford to distribute to the shareholders of Penford the shares of Penwest Common Stock held by Penford pursuant to the Distribution. ANCILLARY AGREEMENTS: all of the agreements, instruments, understandings, assignments or other arrangements entered into in connection with the transactions contemplated hereby, including, without limitation, the Excipient Supply Agreement, the Services Agreement, the Tax Allocation Agreement, the Employee Benefits Agreement and the Trademark Assignment. CLOSING DATE: the first time any shares of Penwest Common Stock are sold to the Underwriters pursuant to the IPO in accordance with the terms of the Underwriting Agreement to be entered into between Penwest and the Underwriters. CODE: the Internal Revenue Code of 1986, as amended. COLLABORATIVE AGREEMENTS: include the following agreements: (a) Product Development and Supply Agreement between Penwest, Ltd., a Washington corporation ("Penwest, Ltd.") and Mylan Pharmaceuticals, Inc., a West Virginia corporation ("Mylan") dated August 17, 1994. (b) Sales and Distribution Agreement between Penwest, Ltd. and Mylan dated January 3, 1997. -2- 3 (c) Product Development and Supply Agreement between Penwest, Ltd. and Mylan dated August 3, 1995. (d) Product Development and Supply Agreement between Penwest, Ltd. and Mylan dated March 22, 1996. (e) Custom Blending Agreement between Boehringer Ingelheim Pharmaceuticals, Inc. and Penwest, Ltd. dated November 23, 1994. (f) Product Development and Supply Agreement between TIMERx Technologies, a Washington corporation ("TIMERx Technologies") and Kremers Urban Development Company ("Kremers") dated August 30, 1996. (g) Product Development and Supply Agreement between TIMERx Technologies and Kremers dated May 31, 1996. (h) Heads of Agreement and Development Agreement between TIMERx Technologies and Schwarz dated September 20, 1995. (i) Product Development, License and Supply Agreement between TIMERx Technologies and Sanofi Winthrop International S.A., a company incorporated under the laws of France dated February 28, 1997, as amended. (j) The Agreement between Edward Mendell Co., Inc. and Leiras OY dated July 27, 1992. (k) Letter of Consent between TIMERx Technologies and Leiras OY dated May 26, 1995. (l) Letter of Agreement between TIMERx Technologies and Leiras OY dated May 26, 1995. (m) Strategic Alliance Agreement between Penwest Pharmaceuticals Group and Endo Pharmaceuticals Inc., dated September 17, 1997. COMMISSION: the Securities and Exchange Commission. CONVEYANCE AND ASSUMPTION INSTRUMENTS: collectively, the various agreements, instruments and other documents entered into or to be entered into to effect the transfer, prior to the Closing Date and in the manner contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise, of Penwest Assets to Penwest (including, without limitation, the -3- 4 intellectual property rights and other assets described in the Registration Statement) and the assumption of Penwest Liabilities by Penwest, in both cases relating to the business of Penwest as described in the Registration Statement. DISTRIBUTION: the distribution by Penford on a pro rata basis to holders of Penford Common Stock of all of the outstanding shares of Penwest Common Stock owned by Penford on the Distribution Date as set forth in Article IV. DISTRIBUTION DATE: the date determined pursuant to Section 4.1 on which the Distribution occurs provided that such date shall occur on or after April 1, 1998. EMPLOYEE BENEFITS AGREEMENT: the Employee Benefits Agreement between Penford and Penwest providing for, among other things, participation by Penwest Employees in certain of the Penford employee benefit plans from the effective date of the Employee Benefits Agreement through December 31, 1997. EXCIPIENT SUPPLY AGREEMENT: the Excipient Supply Agreement between Penford and Penwest pursuant to which Penford will manufacture and supply exclusively to Penwest, and Penwest will purchase exclusively from Penford, all of Penwest's requirements for EMDEX and CANDEX. EMDEX/CANDEX: sugar based (Dextrate) binders. EXCHANGE ACT: the Securities Exchange Act of 1934, as amended. GOVERNMENTAL APPROVALS: any notices, reports or other filings to be made, or any consents, registrations, approvals, permits or authorizations to be obtained from any Governmental Authority. GOVERNMENTAL AUTHORITY: any federal, state, local, foreign or international court, government, department, commission, board, bureau, agency, official or other regulatory, administrative or governmental authority. IPO: the initial public offering by Penwest of shares of Penwest Common Stock pursuant to the Registration Statement. LIABILITIES: any and all debts, liabilities and obligations, absolute or contingent, matured or unmatured, liquidated or unliquidated, accrued or unaccrued, known or unknown, whenever arising (unless otherwise specified in this Agreement), including all costs and expenses relating thereto, and those debts, liabilities and obligations arising under any law, rule, regulation, Action, threatened Action, order or consent decree of any Governmental Authority or any award of any arbitrator of any kind, and those arising under any contract, commitment or undertaking. -4- 5 PENFORD COMMON STOCK: the Common Stock, par value $1.00 per share, of Penford. PENFORD MARKET CAPITALIZATION: the number of Penford's fully diluted shares outstanding (shares of Penford Common Stock outstanding, plus shares of Penford Common Stock issuable upon exercise of outstanding stock options) multiplied by the fair market value of Penford Common Stock (which shall equal the weighted average of the last reported price of Penford Common Stock on the Nasdaq National Market on the date on which the Penford Common Stock is first traded on the Nasdaq National Market at a price that does not reflect the value of the Penwest Common Stock held by Penford as set by the Nasdaq National Market (the "X Date") and the nineteen (19) trading days immediately following the X Date. PENWEST ASSETS: (a) any and all assets that are expressly contemplated by the Penwest Contracts or this Agreement or any other agreement or document contemplated by this Agreement (or any Schedule hereto or thereto) as assets to be transferred to Penwest; (b) any assets reflected in Penwest's balance sheet dated September 30, 1997 as assets of Penwest, subject to any dispositions of such assets subsequent to the date of such balance sheet; and (c) any and all assets owned or held immediately prior to the Closing Date by Penford that are used primarily in the Pharmaceutical Business. The intention of this clause (c) is only to rectify any inadvertent omission of transfer or conveyance of any assets that, had the parties given specific consideration to such asset as of the date hereof, would have otherwise been classified as a Penwest Asset. No asset shall be deemed to be a Penwest Asset solely as a result of this clause (c) if such asset is within the category or type of asset expressly covered by the subject matter of an Ancillary Agreement. PENWEST COMMON STOCK: the Common Stock, par value $0.001 per share, of Penwest. PENWEST CONTRACTS: the following contracts and agreements to which Penford is a party or by which its assets are bound, whether or not in writing: (a) any supply or vendor contracts or agreements that relate primarily to the Pharmaceutical Business; (b) the Collaborative Agreements; -5- 6 (c) any contract or agreement entered into by Penford or Penwest that relates primarily to the Pharmaceutical Business; (d) any contract or agreement entered into by Penford or Penwest with any federal, state and local government that relates primarily to the Pharmaceutical Business; (e) any contract or agreement that is otherwise expressly contemplated pursuant to this Agreement or any of the Ancillary Agreements to be assigned to Penwest; and (f) any guarantee, indemnity, representation, warranty or other Liability of Penford in respect of any other Penwest Contract, any Penwest Liability or the Pharmaceutical Business. PENWEST EMPLOYEES: Penwest Employees include Penwest's current employees and any other employees who are hired by Penwest prior to the Distribution Date. PENWEST MARKET CAPITALIZATION: the number of Penwest's fully diluted shares outstanding (shares of Penwest Common Stock outstanding, plus shares of Penwest Common Stock issuable upon exercise outstanding stock options) multiplied by the fair market value of the Penwest Common Stock (which shall equal the weighted average of the last reported price of Penwest Common Stock on the Nasdaq National Market on the X Date and the nineteen (19) trading days immediately following such X Date. PENWEST LIABILITIES: (a) any and all Liabilities that are expressly contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise (or the Schedules hereto or thereto) as Liabilities to be assumed by Penwest; (b) all Liabilities (other than taxes based on, or measured by reference to, net income), including any Liabilities related to Penwest Employees and product Liabilities, primarily relating to, arising out of or resulting from: (i) the operation of the Pharmaceutical Business, as conducted at any time prior to, on or after the Closing Date (including any Liability relating to, arising out of or resulting from any act or failure to act or any statement made by any director, officer, employee, agent or representatives (whether or not such act or failure to act or statement is or was within such Person's authority); or (ii) any Penwest Assets (including any Penwest Contracts); -6- 7 in any such case whether arising before, on or after the Closing Date; (c) all Liabilities, excluding any intercompany indebtedness forgiven pursuant to Section 2.5 of this Agreement, reflected as liabilities or obligations of Penwest in its balance sheet, subject to any discharge of such Liabilities subsequent to the date of such balance sheet. PERSON: an individual, a general or limited partnership, a corporation, a trust, a joint venture, an unincorporated organization, a limited liability entity, any other entity and any Governmental Authority. PROSPECTUS: each preliminary, final or supplemental prospectus forming a part of the Registration Statement. RECORD DATE: the close of business on the date to be determined by the Penford Board of Directors as the record date for determining shareholders of Penford entitled to receive shares of Penwest Common Stock. REGISTRATION STATEMENT: Registration Statement on Form S-1 to be filed under the Securities Act, pursuant to which 2,875,000 shares of Penwest Common Stock to be issued in the IPO will be registered, together with all amendments thereto. SECURITIES ACT: the Securities Act of 1933, as amended. SEPARATION: the transfer of the Penwest Assets to Penwest and the assumption by Penwest of the Penwest Liabilities, all as more fully described in this Agreement or any other agreement or document contemplated by this Agreement or otherwise. SERVICES AGREEMENT: the Services Agreement between Penford and Penwest providing for, among other things, the provision by Penford to Penwest of certain administrative and other services on a transitional basis. SUBSIDIARY: Subsidiary of any Person means any corporation or other organization whether incorporated or unincorporated of which at least a majority of the securities or interests having by the terms thereof ordinary voting power to elect at least a majority of the board of directors or other performing similar functions with respect to such corporation or other organization is directly or indirectly owned or controlled by such Person or by any one or more of its Subsidiaries, or by such Person and one or more of its Subsidiaries; provided, however, that no Person that is not directly or indirectly wholly-owned by any other Person shall be a Subsidiary of such other Person unless such other Person controls, or has the right, power or ability to control, that Person. -7- 8 TAX ALLOCATION AGREEMENT: the Tax Allocation Agreement between Penford and Penwest, providing for, among other things, the allocation of liabilities with respect to federal, state and local income taxes and the procedures for filing returns with respect to such taxes. TRADEMARK ASSIGNMENT: the Trademark Assignment between Penford and Penwest, providing for, among other things the assignment by Penford to Penwest of certain trademarks and related rights. UNDERWRITERS: the managing underwriters for the IPO. UNDERWRITING AGREEMENT: the underwriting agreement to be entered into between Penwest and the Underwriters with respect to the IPO. ARTICLE II THE SEPARATION 2.1 TRANSFER OF ASSETS AND ASSUMPTION OF LIABILITIES. (a) Penford hereby assigns, transfers, conveys and delivers to Penwest, and Penwest hereby accepts from Penford, all of Penford's right, title and interest in all Penwest Assets. (b) Penwest hereby assumes and agrees faithfully to perform and fulfill all the Penwest Liabilities, in accordance with their respective terms. Penwest shall be responsible for all Penwest Liabilities, regardless of when or where such liabilities arose or arise, or whether the facts on which they are based occurred prior to or subsequent to the date hereof, regardless of where or against whom such liabilities are asserted or determined (including any Penwest Liabilities arising out of claims made by Penford's or Penwest's respective shareholders, directors, officers, employees, agents, Subsidiaries or Affiliates against Penford or Penwest) or whether asserted or determined prior to the date hereof. (c) In the event that any time or from time to time (whether prior to or after the Distribution Date), any party hereto, shall receive or otherwise possess any asset that is allocated to any other Person pursuant to this Agreement or any Ancillary Agreement, such party shall promptly transfer, or cause to be transferred, such asset to the Person so entitled thereto. Prior to any such transfer, the Person receiving or possessing such asset shall hold such asset in trust for any such other Person. 2.2 TERMINATION OF AGREEMENTS. Except as otherwise provided or contemplated in this Agreement, Penwest and Penford hereby terminate any and all -8- 9 agreements, arrangements, commitments or understandings, whether or not in writing, between Penwest and Penford, effective as of the Closing Date; provided, however, to the extent any such agreement, arrangement, commitment or understanding is inconsistent with any Ancillary Agreement such termination shall be effective as of the date of effectiveness of the applicable Ancillary Agreement. No such terminated agreement, arrangement, commitment or understanding (including any provision thereof which purports to survive termination) shall be of any further force or effect after the Closing Date (or, to the extent contemplated by the proviso to the immediately preceding sentence, after the effective date of the applicable Ancillary Agreement). Each party shall, at the reasonable request of any other party, take, or cause to be taken, such other actions as may be necessary to effect the foregoing. 2.3 DOCUMENTS RELATING TO OTHER TRANSFERS OF ASSETS AND ASSUMPTION OF LIABILITIES. In furtherance of the assignment, transfer and conveyance of Penwest Assets and the assumption of Penwest Liabilities set forth in Section 2.1(a) and (b), simultaneously with the execution and delivery hereof or as promptly as practicable thereafter, (i) each of Penford and Penwest shall execute and deliver such bills of sale, stock powers, certificates of titles, assignments of contracts and other instruments of transfer, conveyance and assignment as and to the extent necessary to evidence the transfer, conveyance and assignment of all of Penford's right, title and interest in and to the Penwest Assets to Penwest and (ii) Penwest shall execute and deliver to Penford such bills of sale, stock powers, certificates of title, assumptions of contracts and other instruments of assumption as and to the extent necessary to evidence the valid and effective assumption of the Penwest Liabilities by Penwest. 2.4 ANCILLARY AGREEMENTS. Each of Penford and Penwest will execute and deliver all Ancillary Agreements to which it is a party which agreement will become effective upon the Closing Date, including but not limited to: (a) the Excipient Supply Agreement; (b) the Services Agreement; (c) the Tax Allocation Agreement; (d) the Employee Benefits Agreement; and (e) the Trademark Assignment. 2.5 FORGIVENESS OF INTERCOMPANY DEBT. Effective immediately prior to the Closing Date, Penford hereby forgives all existing remaining intercompany indebtedness owed by Penwest to Penford in order to provide an appropriate level of working capital and equity at Penwest as it is established as a separate stand alone company. Each of Penford and Penwest shall execute any documents and instruments necessary or appropriate to confirm such loan forgiveness. Penford and Penwest agree that Penford shall treat the loan forgiveness as a contribution to the capital of Penwest in constructive exchange for Penwest Common Stock, provided that no additional -9- 10 shares of Penwest Common Stock shall be issued or issuable in connection with or as a result of such contributions. 2.6 CONSENTS. Each party hereto understands and agrees that no party hereto is, in this Agreement or in any other agreement or document contemplated by this Agreement or otherwise, representing or warranting in any way that the obtaining of any consents or approvals, the execution and delivery of any agreements or the making of any filings or applications contemplated by this Agreement will satisfy the provisions of any or all applicable agreements or the requirements of any or all applicable laws or judgments, it being agreed and understood that the party to which any assets were or are transferred shall bear the economic and legal risk that any necessary consents or approvals are not obtained or that any requirements of laws or judgments are not complied with. Notwithstanding the foregoing, the parties shall use reasonable best efforts to obtain all consents and approvals, to enter into all agreements and to make all filings and applications which may be required for the consummation of the transactions contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise, including, without limitation, all applicable regulatory filings or consents under federal or state laws and all necessary consents, approvals, agreements, filings and applications. 2.7 REPRESENTATIONS OR WARRANTIES. Each of the parties hereto understands and agrees that no party hereto is, in this Agreement or in any other agreement or document contemplated by this Agreement or otherwise, making any representations or warranties with respect to any assets of such party, except that Penford represents and warrants to the best of its knowledge that the delivery of all Penwest Assets transferred or being transferred to Penwest pursuant to this Agreement or any other Conveyance and Assumption Instruments has vested or will vest good title to such assets in Penwest free and clear of all material liens, mortgages, pledges, security interests, restrictions, prior assignments, encumbrances and claims of any kind or nature whatsoever affecting such assets. 2.8 COLLABORATIVE AGREEMENTS. In the event that any transfer of Penford's rights to Penwest under any of the Collaborative Agreements would violate or is found to violate the terms of, or result in the loss of rights or imposition of penalty under, any Collaborative Agreement covered thereby, or would not be effective subsequent to the Distribution Date, such transfer shall be deemed null and void and, in lieu thereof, (i) Penford shall retain all rights and fulfill any obligations, at Penwest's expense, it may have to any third party under any such Collaborative Agreement, it being understood that to the extent practicable, Penwest shall fulfill such obligations on Penford's behalf, (ii) Penford shall pay over to Penwest any royalty or other payments it may receive from any third party pursuant to any such Collaborative Agreement and (iii) at the request and expense of Penwest Penford shall use all reasonable best efforts to arrange for the grant by the applicable third party of comparable rights to Penwest. -10- 11 ARTICLE III THE IPO AND ACTIONS PENDING THE IPO 3.1 TRANSACTIONS PRIOR TO THE IPO. (a) Subject to the conditions specified in Section 3.3, Penford and Penwest shall use their reasonable best efforts to consummate the IPO. Such actions shall include, but not necessarily be limited to, those specified in this Section 3.1. (b) Penwest shall file the Registration Statement, and such amendments or supplements thereto, as may be necessary in order to cause the same to become and remain effective as required by law or by the Underwriters, including, but not limited to, filing such amendments to the Registration Statement as may be required by the Underwriting Agreement, the Commission or federal or state securities laws. Penford and Penwest shall also cooperate in preparing, filing with the Commission and causing to become effective a registration statement registering the Penwest Common Stock under the Exchange Act, and any registration statements or amendments thereof which are required to reflect the establishment of, or amendments to, any employee benefit and other plans necessary or appropriate in connection with the Separation, the IPO, the Distribution or the other transactions contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise. (c) Penwest and Penford shall enter into the Underwriting Agreement, in form and substance reasonably satisfactory to them and shall comply with its obligations thereunder. (d) Penford and Penwest shall consult with each other and the Underwriters regarding the timing, pricing and other material matters with respect to the IPO. (e) Penwest shall use its reasonable best efforts to take all such action as may be necessary or appropriate under state securities and blue sky laws of the United States (and any comparable laws under any foreign jurisdictions) in connection with the IPO. (f) Penwest shall prepare, file and use reasonable best efforts to seek to make effective, an application for listing of the Penwest Common Stock issued in the IPO on the Nasdaq National Market, subject to official notice of issuance. (g) Penwest shall participate in the preparation of materials and presentations as the Underwriters shall deem necessary or desirable. -11- 12 (h) Penwest shall pay all third party costs, fees and expenses relating to the IPO, all of the reimbursable expenses of the Underwriters pursuant to the Underwriting Agreement, and all of the costs of producing, printing, mailing and otherwise distributing the Prospectus, and shall reimburse Penford for any such costs, fees and expenses to the extent paid by Penford. 3.2 PROCEEDS OF THE IPO. The IPO will be a primary offering of Penwest Common Stock and the net proceeds of the IPO will be retained by Penwest. 3.3 CONDITIONS PRECEDENT TO CONSUMMATION OF THE IPO. As soon as practicable after the date of this Agreement, the parties hereto shall use their reasonable best efforts to satisfy the following conditions to the consummation of the IPO. The obligations of the parties to consummate the IPO shall be conditioned on the satisfaction of the following conditions: (a) The Registration Statement shall have been filed and declared effective by the Commission, and there shall be no stop-order in effect with respect thereto. (b) The actions and filings with regard to state securities and blue sky laws of the United States shall have been taken and, where applicable, have become effective or been accepted. (c) The Penwest Common Stock to be issued in the IPO shall have been accepted for listing on the Nasdaq National Market, subject to official notice of issuance. (d) Penwest and Penford shall have entered into the Underwriting Agreement and all conditions to the obligations of Penwest and the Underwriters shall have been satisfied or waived. (e) Immediately following the IPO, Penford shall "control" Penwest within the meaning of Sections 355 and 368 of the Code, and all other conditions to permit the Distribution to qualify as a tax-free distribution to Penford, Penwest and Penford's shareholders shall, to the extent applicable as of the time of the IPO, be satisfied and there shall be no event or condition that is likely to cause any of such conditions not to be satisfied as of the time of the Distribution or thereafter. (f) No order, injunction or decree issued by any court or agency of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Separation or the IPO or any of the other transactions contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise shall be in effect. -12- 13 (g) Such other actions as the parties hereto may, based upon the advice of counsel, reasonably request to be taken prior to the Separation and the IPO in order to assure the successful completion of the Separation and the IPO and the other transactions contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise shall have been taken. (h) This Agreement shall not have been terminated. (i) A pricing committee of Penford directors designated by the Board of Directors of Penford shall have determined that the terms of the IPO are acceptable to Penford. ARTICLE IV THE DISTRIBUTION 4.1 THE DISTRIBUTION. (a) Subject to Section 4.3 hereof, on or prior to the Distribution Date, Penford will deliver to the Agent for the benefit of holders of record of Penford Common Stock on the Record Date, a single stock certificate, endorsed by Penford in blank, representing all of the outstanding shares of Penwest Common Stock then owned by Penford, and shall cause the transfer agent for the shares of Penford Common Stock to instruct the Agent to distribute on the Distribution Date the appropriate number of such shares of Penwest Common Stock to each such holder or designated transferee or transferees of such holder. (b) Subject to Section 4.4 hereof, each holder of Penford Common Stock on the Record Date (or such holder's designated transferee or transferees) shall be entitled to receive, in the Distribution, a number of shares of Penwest Common Stock equal to the number of outstanding shares of Penwest Common Stock owned by Penford on the Record Date multiplied by a fraction, the numerator of which is the number of shares of Penford Common Stock held by such holder on the Record Date, and the denominator of which is the number of shares of Penford Common Stock outstanding on the Record Date. (c) Penwest and Penford, as the case may be, will provide to the Agent all share certificates and any information required in order to complete the Distribution on the basis specified above. 4.2 ACTIONS PRIOR TO THE DISTRIBUTION. (a) Penford and Penwest shall prepare and mail, prior to the Distribution Date, to the holders of Penford Common Stock, such information -13- 14 concerning Penwest, its business, operations and management, the Distribution and such other matters as Penford and Penwest shall reasonably determine and as may be required by law. Penford and Penwest, as may be appropriate, will prepare and to the extent required under applicable law, will file with the Commission any such documentation which Penford determines are necessary or desirable to effectuate the Distribution and Penford and Penwest shall each use its reasonable best efforts to obtain all necessary approvals from the Commission with respect thereto. (b) In addition to their respective obligations under Section 4.2(a) above, Penford and Penwest shall take all other actions as may be necessary or appropriate under the securities or blue sky laws of the United States in connection with the Distribution. (c) Penford and Penwest shall use their reasonable best efforts to cause the conditions set forth in Section 4.3 to be satisfied and to effect the Distribution on the Distribution Date. (d) Penwest shall prepare and file, and shall use its reasonable best efforts to have approved, an application for the listing of the Penwest Common Stock to be distributed in the Distribution on the Nasdaq National Market. 4.3 CONDITIONS TO DISTRIBUTION. Penford shall have the sole discretion to determine the date of consummation of the Distribution at any time prior to the date six months after the Closing Date. Following the date six months after the Closing Date, Penford shall be obligated to effect the Distribution as promptly as practicable, subject to the satisfaction, or waiver by the Penford Board of Directors in its sole discretion, of the conditions set forth below. (a) A private letter ruling from the Internal Revenue Service (the "Private Letter Ruling") shall have been obtained, and shall continue in effect, or a written opinion from Ernst & Young LLP shall have been delivered, in either case to the effect that, among other things, the Distribution will qualify as a tax-free distribution for federal income tax purposes under Sections 355 and 368 of the Code, and such ruling or opinion shall be in form and substance satisfactory to Penford in its sole discretion. (b) Any material Governmental Approvals and consents necessary to consummate the Distribution shall have been obtained and shall be in full force and effect. (c) No order, injunction or decree issued by any court or agency of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Distribution shall be in effect and no other event outside the -14- 15 control of Penford shall have occurred or failed to occur that prevents the consummation of the Distribution. (d) The transactions contemplated hereby shall be in compliance with applicable federal and state securities laws. (e) Each of Penwest and Penford shall have received such consents, and shall have received executed copies of such agreements or amendments of agreements, as they shall deem necessary in connection with the completion of the transactions contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise. (f) All action and other documents and instruments deemed necessary or advisable in connection with the transactions contemplated hereby shall have been taken or executed, as the case may be, in form and substance satisfactory to Penford and Penwest. (g) No material adverse change shall have occurred with respect to the business or financial condition of Penford since August 31, 1997, or Penwest since September 30, 1997, which would, in the reasonable judgment of the Penford Board of Directors, make approval of the Distribution inadvisable. The foregoing conditions are for the sole benefit of Penford and shall not give rise to or create any duty on the part of Penford or the Penford Board of Directors to waive or not waive any such condition. 4.4 FRACTIONAL SHARES. As soon as practicable after the Distribution Date, Penford shall direct the Agent to determine the number of whole shares and fractional shares of Penwest Common Stock allocable to each holder of record of Penford Common Stock as of the Record Date, to aggregate all such fractional shares and sell the whole shares obtained thereby in open-market transactions in the Agent's sole discretion as to when, how, through which broker-dealer and at what price to make such sales, and to cause to be distributed to each such holder or for the benefit of each such holder, in lieu of any fractional share, such holder's ratable share of the proceeds of such sale, after making appropriate deductions of the amount required to be withheld for federal income tax purposes and after deducting an amount equal to all brokerage charges, commissions and transfer taxes attributed to such sale. Penford and the Agent shall use their reasonable best efforts to aggregate the shares of Penford Common Stock that may be held by any holder of record thereof through more than one account in determining the fractional share allocable to such holder. -15- 16 ARTICLE V ACKNOWLEDGEMENT OF MATERIAL FACTS 5.1 ORGANIZATION. Penford and Penwest acknowledge that each is duly organized, validly existing and in good standing under the laws of the State of Washington, with requisite corporate power to own their properties and assets and to carry on their respective businesses as presently conducted or contemplated. ARTICLE VI MISCELLANEOUS LIABILITIES AND INDEMNIFICATION 6.1 PENWEST LIABILITIES; INDEMNIFICATION. Penwest shall indemnify, defend and hold harmless Penford from and against any and all Liabilities arising out of or resulting from any of the following items (without duplication): (a) the employment of Penwest Employees; (b) the business of Penwest and the Penwest Assets; (c) purchase orders, accounts payable, accrued compensation and other accrued Penwest Liabilities and other agreements which relate to the business of Penwest and the Penwest Assets; and (d) any misstatement or omission of a material fact other than misstatements or omissions with respect to Penford based on information supplied in writing by Penford in any documents or filings prepared for purposes of compliance or qualification under applicable securities laws in connection with the Separation, IPO or Distribution and related transactions, including, without limitation, the Registration Statement. 6.2 PENFORD LIABILITIES; INDEMNIFICATION. Penford shall indemnify, defend and hold harmless Penwest from and against any and all Liabilities arising out of or resulting from any of the following items (without duplication): (a) the business of Penford and the Liabilities not assumed by Penwest under the terms of this Agreement or any other agreement or document contemplated by this Agreement; and (b) any misstatement or omission of a material fact with respect to Penford based on information supplied in writing by Penford in any documents or filings prepared for purposes of compliance or qualification under applicable -16- 17 securities laws in connection with the Separation, IPO or Distribution and related transactions, including, without limitation, the Registration Statement. 6.3 PROCEDURES FOR INDEMNIFICATION OF THIRD PARTY CLAIMS. (a) If any Person entitled to indemnification hereunder (an "Indemnitee") shall receive notice or otherwise learn of the assertion by a Person (including any Governmental Authority) of any claim or of the commencement by any such Person of any Action (collectively, a "Third Party Claim") with respect to which any party (an "Indemnifying Party") may be obligated to provide indemnification to such Indemnitee pursuant to Section 6.1 or 6.2, or any other Section of this Agreement or any other agreement or document contemplated by this Agreement or otherwise, such Indemnitee shall give such Indemnifying Party written notice thereof within twenty (20) days after becoming aware of such Third Party Claim. Any such notice shall describe the Third Party Claim in reasonable detail. Notwithstanding the foregoing, the failure of any Indemnitee or other Person to give notice as provided in this Section 6.3(a) shall not relieve the Indemnifying Party of its obligations under this Article VI, except to the extent that such Indemnifying Party is actually prejudiced by such failure to give notice. (b) An Indemnifying Party may elect to defend (and, unless the Indemnifying Party has specified any reservations or exceptions, to seek to settle or compromise), at such Indemnifying Party's own expense and by such Indemnifying Party's own counsel, any Third Party Claim. Within thirty (30) days after the receipt of notice from an Indemnitee in accordance with Section 6.3(a) (or sooner, if the nature of such Third Party Claim so requires), the Indemnifying Party shall notify the Indemnitee of its election whether the Indemnifying Party will assume responsibility for defending such Third Party Claim, which election shall specify any reservations or exceptions. After notice from an Indemnifying Party to an Indemnitee of its election to assume the defense of a Third Party Claim, such Indemnitee shall have the right to employ separate counsel and to participate in (but not control) the defense, compromise, or settlement thereof, but the fees and expenses of such counsel shall be the expense of such Indemnitee except as set forth in Section 6.3(c). (c) If an Indemnifying Party elects not to assume responsibility for defending a Third Party Claim, or fails to notify an Indemnitee of its election as provided in Section 6.3(b), such Indemnitee may defend such Third Party Claim at the cost and expense (including allocated costs of in-house counsel and other personnel) of the Indemnifying Party. (d) Unless the Indemnifying Party has failed to assume the defense of the Third Party Claim in accordance with the terms of this Agreement, no Indemnitee may settle or compromise any Third Party Claim without the consent of the Indemnifying Party. -17- 18 (e) No Indemnifying Party shall consent to entry of any judgment or enter into any settlement of the Third Party Claim without the consent of the Indemnitee if the effect thereof is to permit any injunction, declaratory judgment, other order or other nonmonetary relief to be entered, directly or indirectly, against any Indemnitee. 6.4 TAX LIABILITIES. Notwithstanding the provisions of Sections 6.1 and 6.2, all tax Liabilities relating to the business of Penwest and the Penwest Assets including, without limitation, income taxes, franchise taxes, sales taxes, use taxes, payroll taxes and employment taxes, shall be assumed by the party to whom the Liability has been allocated in the Tax Allocation Agreement. 6.5 ADDITIONAL MATTERS. (a) Any claim on account of a Liability which does not result from a Third Party Claim shall be asserted by written notice given by the Indemnitee to the Indemnifying Party. Such Indemnifying Party shall have a period of thirty (30) days after the receipt of such notice within which to respond thereto. If such Indemnifying Party does not respond within such thirty (30)-day period, such Indemnifying Party shall be deemed to have refused to accept responsibility to make payment. If such Indemnifying Party does not respond within such thirty (30)-day period or rejects such claim in whole or in part, such Indemnitee shall be free to pursue such remedies as may be available to such party as contemplated by this Agreement. (b) In the event of payment by or on behalf of any Indemnifying Party to any Indemnitee in connection with any Third Party Claim, such Indemnifying Party shall be subrogated to and shall stand in the place of such Indemnitee as to any events or circumstances in respect of which such Indemnitee may have the right, defense or claim relating to such Third Party Claim against any claimant or plaintiff asserting such Third Party Claim or against any other person. Such Indemnitee shall cooperate with such Indemnifying Party in a reasonable manner, and at the cost and expense (including allocated costs of in-house counsel and other personnel) of such Indemnifying Party, in prosecuting any subrogated right, defense or claim. (c) In the event of an Action in which the Indemnifying Party is not a named defendant, if either the Indemnitee or Indemnifying Party shall so request, the parties shall endeavor to substitute the Indemnifying Party for the named defendant. If such substitution or addition cannot be achieved for any reason or is not requested, the named defendant shall allow the Indemnifying Party to manage the Action as set forth in this Section and the Indemnifying Party shall fully indemnify the named defendant against all costs of defending the Action (including court costs, sanctions imposed by a court, attorneys' fees, experts' fees and all other -18- 19 external expenses, and the allocated costs of in-house counsel and other personnel), the costs of any judgment or settlement, and the cost of any interest or penalties relating to any judgment or settlement. 6.6 REMEDIES CUMULATIVE. The remedies provided in this Article VI shall be cumulative and shall not preclude assertion by an Indemnitee of any other rights or the seeking of any and all other remedies against any Indemnifying Party. ARTICLE VII ACCESS TO INFORMATION AND SERVICES 7.1 PROVISION OF CORPORATE RECORDS. Upon Penwest's request, Penford shall arrange as soon as practicable following the Effective Date for the delivery to Penwest of existing corporate records in the possession of Penford relating to the business of Penwest or assets to be transferred to Penwest, together with all active agreements and active litigation files relating to the businesses of Penwest, except to the extent such items are already in the possession of Penwest. Such records shall be the property of Penwest but shall be available to Penford for review and duplication until Penford shall notify Penwest in writing that such records are no longer of use to Penford. 7.2 ACCESS TO INFORMATION. From and after the Effective Date, Penford shall afford to Penwest and its authorized accountants, counsel and other designated representatives reasonable access (including using reasonable best efforts to give access to persons or firms possessing information) and duplicating rights during normal business hours to all records, books, contracts, instruments, computer data and other data and information (collectively, "Information") within Penford's possession relating to the businesses of Penwest, insofar as such access is reasonably required by Penwest. Penwest shall afford to Penford and its authorized accountants, counsel and other designated representatives reasonable access (including using reasonable best efforts to give access to persons or firms possessing Information) and duplicating rights during normal business hours to Information within Penwest's possession relating to the business of Penwest prior to the Distribution or to the business of Penford, insofar as such access is reasonably required by Penford. Information may be requested under this Article VII for, without limitation, audit, accounting, claims, litigation and tax purposes, as well as for purposes of fulfilling disclosure and reporting obligations and for performing the transactions contemplated in this Agreement or any other agreement or document contemplated by this Agreement or otherwise. 7.3 PENWEST SECURITIES FILINGS. For a period of three years following the Effective Date, each of Penwest and Penford shall provide to the other, promptly following such time at which such documents shall be filed with the Commission, -19- 20 copies of all documents which shall be filed by either Penwest or Penford, as the case may be, with the Commission pursuant to the periodic and interim reporting requirements of the Exchange Act and the rules and regulations of the Commission promulgated thereunder. 7.4 PRODUCTION OF WITNESSES. At all times from and after the Effective Date, each of Penford and Penwest shall use reasonable best efforts to make available to the other, upon written request, its officers, directors, employees and agents as witnesses to the extent that such persons may reasonably be required, in connection with legal, administrative or other proceedings in which the requesting party may from time to time be involved. 7.5 REIMBURSEMENT. Except to the extent otherwise contemplated by any Ancillary Agreement, a party providing information to the other party under this Article VII shall be entitled to receive from the recipient, upon the presentation of invoices therefor, payments for such amounts, relating to supplies, disbursements and other out-of-pocket expenses, as may be reasonably incurred in providing such information. 7.6 RETENTION OF RECORDS. For a period of six (6) years following the Effective Date, each of Penford and Penwest shall retain all Information relating to the other as of the Effective Date, except as otherwise required by law or set forth in an Ancillary Agreement or except to the extent that such Information is in the public domain or in the possession of the other party. 7.7 CONFIDENTIALITY. Subject to any contrary requirement of law and the right of each party to enforce its rights hereunder in any legal action, each party shall keep strictly confidential, and shall cause its employees and agents to keep strictly confidential, any Information of or concerning the other party which it or any of its agents or employees may acquire pursuant to, or in the course of performing its obligations under, any provisions of this Agreement or any Ancillary Agreement; provided, however, that such obligation to maintain confidentiality shall not apply to Information which (i) at the time of disclosure was in the public domain or (ii) was received by the receiving party from a third party who did not receive such Information from the disclosing party under an obligation of confidentiality. ARTICLE VIII COVENANTS 8.1 NASDAQ NATIONAL MARKET LISTING. Penwest hereby agrees to use its reasonable best efforts to effect and maintain the listing of the Penwest Common Stock on the Nasdaq National Market. -20- 21 8.2 ANCILLARY AGREEMENTS. The parties agree that they shall comply with and provide all services and take any and all actions required to be provided or taken by the terms of any and all of the Ancillary Agreements following the Closing Date. 8.3 SHARING OF UTILITIES (a) Penford agrees that Penwest shall be entitled to use and consume, in an amount reasonably required, at Penwest's Cedar Rapids facility certain utilities consisting of natural gas, electricity and steam from Penford's Cedar Rapids facility. Any material change in the provision of such utilities shall require six (6) months prior notice. (b) In connection with the sharing of utilities as described in Section 8.3(a), Penwest will reimburse Penford for its consumption of such utilities based on Penford's total cost (including maintenance) for each item and Penwest's fraction of the total consumption. (c) Penford will submit a monthly invoice to Penwest of all amounts owed by Penwest to Penford with respect to utilities consumed by Penwest pursuant to Section 8.3(a). The charges will be due when billed and shall be paid no later than thirty (30) days from the date of billing. 8.4 NON-COMPETITION (a) From the Effective Date to the longer of (i) five years or (ii) the termination of the Excipient Supply Agreement, neither Penford nor any of its Affiliates shall, directly or indirectly, manufacture, market, sell or distribute for inclusion in any pharmaceutical or nutritional product (including vitamins, minerals and cofactors, but excluding foods) any product having the same or substantially the same form, composition or applications as EMDEX or CANDEX or any similar sugar- based product. From the Effective Date to the longer of (i) five years or (ii) the termination of the Excipient Supply Agreement, neither Penwest nor any of its Affiliates shall, directly or indirectly, manufacture, market, sell or distribute for inclusion in any foods product any product having the same or substantially the same form, composition or applications as EMDEX or CANDEX or any similar sugar- based product. (b) For a period of five years from the Effective Date, Penford shall not directly or indirectly recruit or solicit any employee of Penwest, or induce or attempt to induce any employee of Penwest to terminate his or her employment with, or otherwise cease his or her relationship with, Penwest. For a period of five years from the Effective Date, Penwest shall not directly or indirectly recruit or solicit any employee of Penford, or induce or attempt to induce any employee of Penford to -21- 22 terminate his or her employment with, or otherwise cease his or her relationship with, Penford. (c) If any restriction set forth in Sections 8.4 (a) or (b) is found by any court of competent jurisdiction to be unenforceable because it extends for too long a period of time or over too great a range of activities or in too broad a geographic area, it shall be interpreted to extend only over the maximum period of time, range of activities or geographic area as to which it may be enforceable. (d) The restrictions contained in this Section 8.4 are necessary for the protection of the respective businesses and goodwill of Penwest and Penford and are considered by Penford and Penwest to be reasonable for such purpose. Penford and Penwest agree that any breach of this Section 8.4 is likely to cause Penwest or Penford, as the case may be, substantial and irrevocable damage and therefore, in the event of any such breach, Penwest or Penford, as the case may be, in addition to such other remedies which may be available, shall be entitled to specific performance and other injunctive relief. 8.5 STOCK OPTIONS. Prior to the Distribution Date, Penford shall (i) amend its stock plans to provide that, for purposes of such stock plans, the term employee shall include all Penwest Employees as of the Record Date, (ii) amend each Penford stock option held by a Penwest Employee as of the Record Date to provide that the option will continue to vest for so long as the Penwest Employee remains an employee of Penwest and (iii) effective as of the Distribution Date, make an adjustment to the exercise price of each Penford stock option outstanding as of the Record Date and make an adjustment to the number of shares of Penford Common Stock under each Penford stock option outstanding as of the Record Date. The adjustment to the exercise price of such stock option shall be applied by multiplying the exercise price of the option by a fraction, the numerator of which shall equal the Penford Market Capitalization and the denominator of which shall equal the sum of the Penford Market Capitalization and the Penwest Market Capitalization. The adjustment in the number of shares of Penford Common Stock shall be applied by multiplying the number of shares of Penford Common Stock under each Penford stock option as of the Record Date by a fraction, the numerator of which shall equal the sum of the Penford Market Capitalization and Penwest Market Capitalization and the denominator of which shall equal the Penford Market Capitalization. Thus, a holder of an option to purchase one share of Penford Common Stock at an exercise price of $10 per share shall have the exercise price of the option reduced from $10 per share to $6.66 per share (i.e., $10 x 200,000,000/300,000,000 = $6.66 and number of shares increased by 1.5 (i.e. 1 x 300,000,000/200,000,000 = 1.5)). -22- 23 8.6 REGISTRATION RIGHTS. (a) REGISTRATION OF SHARES. In the event that the Distribution has not occurred by September 30, 1998, upon the request of Penford, Penwest shall file with the SEC, as promptly as practicable, a resale registration statement (the "Resale Registration Statement"). Penford shall have the right to request up to three Resale Registration Statements, provided that Penwest shall have no obligation to file any such resale registration statement on or prior to a ninety (90) day period following the filing of any other registration statement by Penwest. Penwest shall use its reasonable best efforts to cause each Resale Registration Statement to be declared effective by the SEC as soon as practicable. If a Resale Registration Statement shall be withdrawn before effectiveness, it shall not be counted against Penford's right to request three registrations. (b) LIMITATIONS ON REGISTRATION RIGHTS. (i) Penwest may, by written notice to Penford, for a period of up to 45 days from the date of written notice, delay the filing or effectiveness of any of the Resale Registration Statements in the event that (1) Penwest is engaged in any activity or transaction that Penwest desires to keep confidential for business reasons, (2) the Penwest Board of Directors determines in good faith that the disclosure of such information would be detrimental to Penwest, and (3) the Penwest Board of Directors determines in good faith that the public disclosure requirements imposed on Penwest under the Securities Act in connection with any such Resale Registration Statement would require disclosure of such activity or transaction. (ii) If Penwest delays a Resale Registration Statement, Penwest shall, as promptly as practicable following the termination of the circumstances which entitled Penwest to do so, take such actions as may be necessary to file or reinstate the effectiveness of a Resale Registration Statement. If as a result thereof the prospectus included in a Resale Registration Statement has been amended to comply with the requirements of the Securities Act, Penwest shall enclose such revised prospectus with the notice to Penford given pursuant to this paragraph (ii), and Penford shall make no offers or sales of shares pursuant to a Resale Registration Statement other than by means of such revised prospectus. (c) REGISTRATION PROCEDURES. (i) In connection with the filing by Penwest of a Resale Registration Statement, Penwest shall furnish to Penford as many copies of the prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act as Penford shall reasonably request for the purpose of effecting the plan of distribution set forth therein. -23- 24 (ii) Penwest shall use its best efforts to register or qualify the Penwest Common Stock covered by a Resale Registration Statement under the securities laws of such states as Penford shall reasonably request; provided, however, that Penwest shall not be required in connection with this paragraph (ii) to qualify as a foreign corporation or execute a general consent to service of process in any jurisdiction. (iii) If Penwest has delivered preliminary or final prospectuses to Penford and after having done so the prospectus is amended to comply with the requirements of the Securities Act, Penwest shall promptly notify Penford and, if requested by Penwest, Penford shall immediately return all prospectuses to Penwest. Penwest shall promptly provide Penford with revised prospectuses. (iv) At the request of Penford, Penwest shall sign an underwriting agreement in customary form with managing underwriters selected by Penford, and shall cooperate with such managing underwriters in all reasonable respects to facilitate the distribution contemplated by Penford, including without limitation making available the books, records and personnel of Penwest for the purpose of the underwriters' "due diligence" and providing customary legal opinions and auditors' comfort letters. (v) Each of Penwest and Penford shall share in equal amounts the expenses incurred by Penwest in complying with its obligations under this Section 8.6, including all registration and filing fees, exchange listing fees, fees and expenses of counsel for Penwest, and fees and expenses of accountants for Penwest, but excluding (A) any brokerage fees, selling commissions or underwriting discounts incurred by Penford in connection with sales under a Resale Registration Statement and (B) the fees and expenses of any counsel retained by Penford. (d) If Penwest begins preparations to file a registration statement for sale of securities on a form in which common stock held by Penford may be included, Penwest shall notify Penford in writing at least thirty (30) days before filing the registration statement and shall include therein any Penwest Common Stock that Penford requested to be included. (e) REQUIREMENTS OF PENFORD. Penwest shall not be required to include any Penwest Common Stock owned by Penford in a Resale Registration Statement unless: (i) Penford furnishes to Penwest in writing such information regarding Penford as Penwest may reasonably request in writing in connection with the Resale Registration Statement or as shall be required in connection therewith by the SEC or any state securities law authorities; -24- 25 (ii) Penford shall have provided to Penwest its written agreement: (A) to indemnify Penwest and each of its directors and officers against, and hold Penwest and each of its directors and officers harmless from, any losses, claims, damages, expenses or liabilities (including reasonable attorneys fees) to which Penwest or such directors and officers may become subject by reason of any statement or omission in the Resale Registration Statement made in reliance upon, or in conformity with, any written statement by Penford furnished pursuant to this Section 8.6(e); and (B) to report to Penwest sales made pursuant to the Resale Registration Statement. (f) Penwest agrees to indemnify and hold harmless Penford against any losses, claims, damages, expenses or liabilities to which Penford may become subject by reason of any untrue statements of a material fact contained in the Resale Registration Statement or any omission to state therein a fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as such losses, claims, damages, expenses or liabilities arise out of or are based upon information furnished to Penwest in writing by or on behalf of Penford for use in the Resale Registration Statement. Penwest shall have the right to assume the defense and settlement of any claim or suit for which Penwest may be responsible for indemnification under this Section 8.6(f). (g) ASSIGNMENT OF RIGHTS. Penford may not assign any of its rights under this Section 8.6. 8.7 MUTUAL ASSURANCES. (a) In addition to the actions specifically provided for elsewhere in this Agreement or any other agreement or document contemplated by this Agreement or otherwise, Penford and Penwest agree to cooperate with respect to the implementation of this Agreement or any other agreement or document contemplated by this Agreement or otherwise, and to execute such further documents and instruments as may be necessary to consummate and make effective the transactions contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise; (b) Penford and Penwest shall arrange, attend and participate in joint meetings with corporate collaborators, suppliers, customers and others to the extent necessary to assure the orderly transition of the business and assets contemplated hereby, provided that nothing herein shall be deemed to obligate either Penford or -25- 26 Penwest to take any action or reach any understandings which may violate any applicable laws. (c) Penford and Penwest agree to take any reasonable actions necessary in order for the Distribution to qualify as a tax-free distribution pursuant to Sections 355 and 368 of the Code. (d) Penford and Penwest agree that they shall not take any action which could reasonably be expected to prevent the Distribution from qualifying as a tax-free distribution within the meaning of Sections 355 and 368 of the Code or any other transaction contemplated by this Agreement or any other agreement or document contemplated by this Agreement or otherwise which is intended by the parties to be tax-free from failing so to qualify. Without limiting the foregoing, after the Closing Date and on or prior to the Distribution Date, Penwest shall not issue or grant, directly or indirectly, any shares of Penwest Common Stock or any rights, warrants, options or other securities to purchase or acquire (whether upon conversion, exchange or otherwise) any shares of Penwest Common Stock (whether or not then exercisable, convertible or exchangeable). ARTICLE IX TERMINATION 9.1 TERMINATION BY MUTUAL CONSENT. This Agreement may be terminated at any time prior to the Distribution Date by the mutual consent of Penford and Penwest. 9.2 OTHER TERMINATION. This Agreement shall terminate if the Distribution Date shall not have occurred on or prior to December 31, 1998. 9.3 EFFECT OF TERMINATION. (a) In the event of any termination of this Agreement prior to the Closing Date, no party to this Agreement (or any of its directors or officers) shall have any Liability or further obligation to any other party. (b) In the event of any termination of this Agreement on or after the Closing Date, only the provisions of Article IV will terminate and the other provisions of this Agreement or any agreement or document contemplated by this Agreement or otherwise shall remain in full force and effect. -26- 27 ARTICLE X MISCELLANEOUS 10.1 GOVERNING LAW. This Agreement shall be governed by the laws of the State of Washington. 10.2 CONSTRUCTION. Each provision of this Agreement shall be interpreted in a manner to be effective and valid to the fullest extent permissible under applicable law. The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions of this Agreement which shall remain in full force and effect. 10.3 COUNTERPARTS. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement. 10.4 EXHIBITS. Exhibits to this Agreement shall be deemed to be an integral part hereof, and schedules or exhibits to such Exhibits shall be deemed to be an integral part thereof. 10.5 AMENDMENTS; WAIVERS. This Agreement may be amended or modified only in a writing executed on behalf of Penford and Penwest. No waiver shall operate to waive any further or future act and no failure to object of forbearance shall operate as a waiver. 10.6 NOTICES. Notices hereunder shall be effective if given in writing and delivered or mailed, postage prepaid, by registered or certified mail to: Penford Corporation 777-108th Avenue NE Suite 2390 Bellevue, WA 98004-5193 Attention: The President or to: Penwest Pharmaceuticals Co. 2981 Route 22 Patterson, NY 12563-9970 Attention: The President 10.7 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns, provided that this Agreement and the rights and obligations contained herein -27- 28 or in any exhibit or schedule hereto shall not be assignable, in whole or in part, without the prior written consent of the parties hereto and any attempt to effect any such assignment without such consent shall be void. 10.8 PUBLICITY. Prior to the Distribution, each of Penwest and Penford shall consult with each other prior to issuing any press releases or otherwise making public statements with respect to the IPO, the Distribution or any of the other transactions contemplated hereby and prior to making any filings with any Governmental Authority with respect thereto. 10.9 EXPENSES. Except as expressly set forth in this Agreement or in any other agreement or document contemplated by this Agreement or otherwise, whether or not the IPO or the Distribution is consummated, all third party fees, costs and expenses paid or incurred in connection with the Distribution will be paid by Penford. 10.10 HEADINGS. The article, section and paragraph headings contained in this Agreement and in the Ancillary Agreements are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement or any Ancillary Agreement. 10.11 ARBITRATION. Any dispute, controversy or claim arising out of or in connection with this Agreement or any of the Ancillary Agreements (including any questions of fraud or questions concerning the validity and enforceability of this Agreement or any of the Ancillary Agreements or any of the rights herein and therein conveyed), shall be determined and settled by arbitration in Seattle, Washington, pursuant to the rules then in effect of the American Arbitration Association as modified by this paragraph. Any award rendered shall be final and conclusive upon the parties and a judgment thereon may be entered in any court having competent jurisdiction. The party submitting such dispute shall give written notice to that effect to the other party, stating the dispute to be arbitrated and the name and address of a person designated to act as arbitrator on its behalf. Within fifteen (15) days after such notice, the other party shall give written notice to the first party stating the name and address of a person designated to act as an arbitrator on its behalf. In the event that the second party shall fail to notify the first party of its designation of an arbitrator within the time specified, then the first party shall request the American Arbitration Association to appoint a second arbitrator. The two arbitrators so chosen shall meet within fifteen (15) days after the second arbitrator has been appointed to appoint a third arbitrator. If the two arbitrators are unable to agree on the appointment of a third arbitrator within such fifteen (15) day period, either party may request the American Arbitration Association to appoint a third arbitrator. Each arbitrator appointed hereunder shall be independent of the parties and either party may disqualify an arbitrator who is or is affiliated with a supplier, customer or competitor of either party without the consent of the other party. Each -28- 29 arbitrator shall be reasonably knowledgeable regarding the area or areas in dispute. The arbitrators shall follow substantive rules of law and the Federal Rules of Evidence, require the parties to conduct discovery pursuant to the rules then in effect under the Federal Rules of Civil Procedure in an expeditious manner, cause testimony to be transcribed, and make an award accompanied by findings of fact and a statement of reasons for the decision. All costs and expenses, including attorney's fees, of all parties incurred in any dispute which is determined and/or settled by arbitration pursuant to this paragraph shall be borne by the party determined to be liable in respect of such dispute; provided, however, that if complete liability is not assessed against only one party, the parties shall share the total costs in proportion to their respective amounts of liability so determined. Except where clearly prevented by the area in dispute, both parties agree to continue performing their respective obligations under this Agreement while the dispute is being resolved. Each party, and the arbitrators, shall use their best efforts, subject to reasonable prosecution of the arbitration, court order and disclosure required under securities laws, to keep the subject matter of the arbitration and confidential information of each party confidential, and the arbitrators are authorized to impose such protective orders as they may deem appropriate for such purpose. 10.12 ENTIRE AGREEMENT. This Agreement contains the full understanding of the parties with respect to the subject matter hereof and supersedes all prior understandings and writings relating thereto. No waiver, alteration or modification of any of the provisions hereof shall be binding unless made in writing and signed by the parties. -29- 30 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. PENFORD CORPORATION By: /s/ JEFFREY T. COOK ----------------------- Jeffrey T. Cook Title: Vice President, Finance and Chief Financial Officer PENWEST PHARMACEUTICALS CO. By: /s/ TOD R. HAMACHEK ---------------------- Tod R. Hamachek Title: Chairman of the Board and Chief Executive Officer -30- EX-11 5 COMPUTATION OF PER-SHARE EARNINGS 1 Exhibit 11 PENFORD CORPORATION AND SUBSIDIARIES COMPUTATION OF PER-SHARE EARNINGS
Year Ended August 31 1997 1996 1995 ---------------------------------------------- PRIMARY: - -------- Net income $6,625,000 $5,052,000 7,217,000 ========== ========== ========== Weighted average number of shares outstanding 7,001,209 6,805,740 6,745,566 Net effect of diluted stock options 130,516 201,600 273,404 ---------- ---------- ---------- Weighted average common shares and equivalents outstanding 7,131,725 7,007,340 7,018,970 ========== ========== ========== Earnings per share: $ 0.93 $ 0.72 $ 1.03 ========== ========== ========== FULLY DILUTED: ---------- Net income $6,625,000 $5,052,000 $7,217,000 ========== ========== ========== Weighted average number of shares outstanding 7,001,209 6,805,740 6,745,566 Net effect of diluted stock options 143,275 194,352 279,333 ---------- ---------- ---------- Weighted average common shares and equivalents outstanding 7,144,484 7,000,092 7,024,899 ========== ========== ========== Earnings per share $ 0.93 $ 0.72 $ 1.03 ========== ========== ==========
Page 47 EX-21 6 SUBSIDIARIES OF THE REGISTRANT 1 Exhibit 21 SUBSIDIARIES OF THE REGISTRANT Year Ended August 31, 1997 Wholly owned subsidiaries of the registrant are: Penford Products Co. incorporated under the laws of the State of Delaware Penwest Pharmaceuticals Co. (formerly Edward Mendell Co., Inc.) incorporated under the laws of the State of Washington Mendell U.K. Ltd. incorporated under the laws of the United Kingdom Edward Mendell GmbH incorporated under the laws of Germany Edward Mendell Finland OY incorporated under the laws of Finland Penford Export Corporation All subsidiaries are included in the consolidated financial statements. Page 48 EX-23 7 CONSENT OF INDEPENDENT AUDITORS 1 Exhibit 23 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8, No. 33-58799) pertaining to the Penford Corporation 1994 Stock Option Plan and to the incorporation by reference in the Registration Statement (Form S-8, No. 33-88946) pertaining to the Penford Corporation Savings and Stock Ownership Plan of our report dated October 17, 1997, with respect to the consolidated financial statements of Penford Corporation included in the Annual Report (Form 10-K) for the year ended August 31, 1997. Seattle, Washington November 25, 1997 ERNST & YOUNG LLP Page 49 EX-24 8 POWER OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that each person whose signature appears below constitutes and appoints Tod R. Hamachek, Jeffrey T. Cook and each of them, severally as attorney-in-fact for him or her in any and all capacities, to sign the Annual Report on Form 10-K of Penford Corporation. for the fiscal year ended August 31, 1997, and to file same and any amendments, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done virtue hereof. SIGNATURE DATE /s/ RICHARD E. ENGEBRECHT October 28, 1997 - ---------------------------------------- ------------------------ Richard E. Engebrecht, Director /s/ PAUL E. FREIMAN October 28, 1997 - ---------------------------------------- ------------------------ Paul E. Freiman, Director /s/ TOD R. HAMACHEK October 28, 1997 - ---------------------------------------- ------------------------ Tod R. Hamachek, Director - ---------------------------------------- ------------------------ Paul H. Hatfield, Director /s/ HARRY MULLIKIN October 28, 1997 - ---------------------------------------- ------------------------ Harry Mullikin, Director /s/ SALLY G. NARODICK October 28, 1997 - ---------------------------------------- ------------------------ Sally G. Narodick, Director /s/ WILLIAM G. PARZYBOK, JR. October 28, 1997 - ---------------------------------------- ------------------------ William G. Parzybok, Jr., Director /s/ N. STEWART ROGERS October 28, 1997 - ---------------------------------------- ------------------------ N. Stewart Rogers, Director /s/ WILLIAM K. STREET October 28, 1997 - ---------------------------------------- ------------------------ William K. Street, Director Page 50 EX-27 9 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AT AUGUST 31, 1997, THE CONDENSED CONSOLIDATED STATEMENTS OF INCOME AT AUGUST 31, 1997, AND THE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW AT AUGUST 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS AUG-31-1997 SEP-01-1996 AUG-31-1997 0 176 27,181 0 21,835 54,371 130,374 0 215,929 24,201 0 0 0 9,093 80,008 215,929 196,634 196,634 146,081 146,081 36,583 0 5,323 9,919 3,294 6,625 0 0 0 6,625 0.93 0.93
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