e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended May 31, 2008


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

For the transition period from _______________ to _______________

Commission File No. 0-11488

PENFORD CORPORATION

(Exact name of registrant as specified in its charter)


Washington		91-1221360

(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

7094 South Revere Parkway,
Centennial, Colorado		80112-3932

(Address of Principal Executive Offices)		(Zip Code)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer þ

Non-accelerated filer o
(Do not check if a smaller reporting company)

Smaller reporting company o

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

The net number of shares of the Registrant’s common stock (the Registrant’s only outstanding class of stock) outstanding as of July 7, 2008 was 11,249,801.

PART I — FINANCIAL INFORMATION

Item 1: Financial Statements

PENFORD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS


	May 31,			August 31,
(In thousands, except per share data)	2008			2007
	(Unaudited)
ASSETS
Current assets:
Cash	$	—		$	—
Trade accounts receivable, net		59,505			54,333
Inventories		57,234			39,537
Prepaid expenses		6,763			5,025
Other		4,712			6,384

Total current assets		128,214			105,279

Property, plant and equipment, net		178,932			146,663
Restricted cash value of life insurance		10,456			10,366
Goodwill, net		28,844			23,477
Other intangible assets, net		872			878
Other assets		1,171			1,725

Total assets	$	348,489		$	288,388


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Cash overdraft, net	$	1,398		$	5,468
Current portion of long-term debt and capital lease obligations		6,587			4,056
Short-term borrowings		1,397			7,218
Accounts payable		38,575			32,410
Accrued liabilities		6,285			17,094

Total current liabilities		54,242			66,246

Long-term debt and capital lease obligations		68,022			63,403
Other post-retirement benefits		13,210			12,814
Deferred income taxes		2,150			3,140
Other liabilities		17,698			17,109

Total liabilities		155,322			162,712

Shareholders’ equity:
Preferred stock, par value $1.00 per share, authorized 1,000 shares, none issued		—			—
Common stock, par value $1.00 per share, authorized 29,000 shares, issued 13,124 and 11,099 shares, respectively		13,124			11,099
Additional paid-in capital		90,763			43,902
Retained earnings		95,648			89,486
Treasury stock, at cost, 1,981 shares		(32,757	)		(32,757	)
Accumulated other comprehensive income		26,389			13,946

Total shareholders’ equity		193,167			125,676

Total liabilities and shareholders’ equity	$	348,489		$	288,388

The accompanying notes are an integral part of these statements.

PENFORD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)


	Three months ended				Nine months ended
	May 31,		May 31,		May 31,		May 31,
(In thousands, except per share data)	2008		2007		2008		2007

Sales	$	102,799	$	95,406	$	285,549	$	266,147

Cost of sales		87,260		76,838		242,252		221,983

Gross margin		15,539		18,568		43,297		44,164

Operating expenses		7,267		8,375		21,173		22,808
Research and development expenses		2,004		1,737		6,099		4,886
Restructure costs		27		—		1,356		—
Litigation expense		1,411		—		1,411		—


Income from operations		4,830		8,456		13,258		16,470

Non-operating income, net		336		344		1,590		1,095
Interest expense		782		1,443		2,649		4,437


Income before income taxes		4,384		7,357		12,199		13,128

Income taxes		1,679		2,402		4,017		3,894


Net income	$	2,705	$	4,955	$	8,182	$	9,234


Weighted average common shares and equivalents outstanding:
Basic		11,129		8,984		10,371		8,962
Diluted		11,446		9,258		10,743		9,159

Income per share:
Basic	$	0.24	$	0.55	$	0.79	$	1.03
Diluted	$	0.24	$	0.54	$	0.76	$	1.01

Dividends declared per common share	$	0.06	$	0.06	$	0.18	$	0.18

The accompanying notes are an integral part of these statements.

PENFORD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)


	Nine Months Ended
(In thousands)	May 31, 2008			May 31, 2007
Cash flows from operating activities:
Net income	$	8,182		$	9,234
Adjustments to reconcile net income to net cash provided by (used in) operations:
Depreciation and amortization		12,182			11,798
Stock-based compensation		1,638			870
Loss (gain) on sale of fixed assets		(6	)		336
Deferred income taxes		(2,103	)		(695	)
Loss (gain) on derivative transactions		4,442			(366	)
Foreign currency transaction gain		(1,126	)		—
Other		(81	)		(121	)
Change in assets and liabilities:
Trade accounts receivable		(2,880	)		(5,943	)
Prepaid expenses		(1,580	)		(463	)
Inventories		(14,812	)		(4,598	)
Accounts payable and accrued liabilities		(2,149	)		(2,296	)
Taxes payable		(5,031	)		1,690
Other		112			2,081


Net cash provided by (used in) operating activities		(3,212	)		11,527


Cash flows from investing activities:
Investment in property, plant and equipment, net		(37,482	)		(22,101	)
Other		(90	)		(75	)


Net cash used in investing activities		(37,572	)		(22,176	)


Cash flows from financing activities:
Proceeds from short-term borrowings		5,871			7,785
Payments on short-term borrowings		(12,395	)		(9,497	)
Proceeds from revolving line of credit		61,029			42,267
Payments on revolving line of credit		(28,052	)		(29,982	)
Proceeds from long-term debt		—			4,200
Payments of long-term debt		(26,625	)		(3,249	)
Payments under capital lease obligation		(50	)		(42	)
Exercise of stock options		322			723
Net proceeds from issuance of common stock		46,844			—
Payment of loan fees		—			(836	)
Increase (decrease) in cash overdraft		(4,070	)		2,093
Payment of dividends		(1,774	)		(1,610	)
Other		94			116


Net cash provided by financing activities		41,194			11,968


Effect of exchange rate changes on cash and cash equivalents		(410	)		(866	)


Net increase in cash and cash equivalents		—			453
Cash and cash equivalents, beginning of period		—			939

Cash and cash equivalents, end of period	$	—		$	1,392

The accompanying notes are an integral part of these statements.

PENFORD CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1—BUSINESS

Penford Corporation (which, together with its subsidiary companies, is referred to herein as “Penford” or the “Company”) is a developer, manufacturer and marketer of specialty natural-based ingredient systems for many industrial and food ingredient applications. The Company operates manufacturing facilities in the United States, Australia and New Zealand.

Penford operates in three business segments, each utilizing its carbohydrate chemistry expertise to develop starch-based ingredients for value-added applications in several markets that improve the quality and performance of customers’ products, including papermaking and food products. The first two, industrial ingredients and food ingredients, are broad categories of end-market users, primarily served by the Company’s United States operations. The third segment consists of geographically separate operations in Australia and New Zealand. The Australian and New Zealand operations are engaged primarily in the food ingredients business.

The Company has extensive research and development capabilities, which are used in understanding the complex chemistry of carbohydrate-based materials and in developing applications to address customer needs.

On June 12, 2008, the Company’s Cedar Rapids, Iowa plant was temporarily shut down due to record flooding of the Cedar River and government-ordered mandatory evacuation of the plant and surrounding areas. See Note 16.

2—BASIS OF PRESENTATION

Consolidation

The accompanying condensed consolidated financial statements include the accounts of Penford and its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated. The condensed consolidated balance sheet at May 31, 2008 and the condensed consolidated statements of operations and cash flows for the interim periods ended May 31, 2008 and 2007 have been prepared by the Company without audit. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary to present fairly the financial information, have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles, have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The results of operations for interim periods are not necessarily indicative of the operating results of a full year or of future operations. Certain prior period amounts have been reclassified to conform to the current period presentation. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended August 31, 2007.

Accounting Changes

The Company adopted the provisions of Emerging Issues Task Force (“EITF”) Issue No. 06-2, “Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43,” effective September 1, 2007. EITF Issue No. 06-2 requires companies to accrue the costs of compensated absences under a sabbatical or similar benefit arrangement over the requisite service period. Upon adoption, the Company recognized a $0.1 million charge to beginning retained earnings as a cumulative effect of a change in accounting principle.

Effective September 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for the uncertainty in income taxes recognized by prescribing a recognition threshold that a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, classification, interest and penalties, interim period accounting and disclosure. The impact of adopting FIN 48 is discussed in Note 7.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 (fiscal 2009). In February 2008, the FASB issued Staff Position No. 157-2 (“FSP 157-2”) which provided a one-year delayed application of SFAS 159 for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). For those items within the scope of FSP 157-2, the effective date of SFAS 157 has been deferred to fiscal years beginning after November 15, 2008 (fiscal 2010). The Company is evaluating the impact that adopting this statement may have on its consolidated financial statements.

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB No. 115” (“SFAS 159”). SFAS 159 allows companies the option to measure financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007 (fiscal 2009). The Company is currently evaluating the impact that the adoption of SFAS 159 may have on its consolidated financial statements.

In December 2007, the FASB issued Statement No. 141R (revised 2007), “Business Combinations” (“SFAS 141R”) and Statement No. 160, “Non-Controlling Interest in Consolidated Financial Statements, an Amendment of ARB No. 51” (“SFAS 160”). These new standards establish principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, any non-controlling interests, and goodwill acquired in a business combination. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. The requirements of SFAS 141R and SFAS No. 160 are effective for fiscal years beginning after December 15, 2008 (fiscal 2010), and, except for the presentation and disclosure requirements of SFAS 160, are to be applied prospectively.

In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB No. 133” (“SFAS 161”). SFAS 161 requires additional disclosures about the objectives for using derivative instruments and hedging activities, method of accounting for such instruments under SFAS 133 and its related interpretations, the effect of derivative instruments and related hedged items on financial position, results of operations, and cash flows, and a tabular disclosure of the fair values of derivative instruments and their gains and losses, SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008 (fiscal 2010). The Company is currently evaluating the impact that the adoption of SFAS 161 may have on its consolidated financial statements.

In May 2008, the FASB issued Statement No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company does not expect the adoption of SFAS 162 to have a material effect on its consolidated financial statements.

3—STOCK-BASED COMPENSATION

Stock Compensation Plans

Penford maintains the 2006 Long-Term Incentive Plan (the “2006 Incentive Plan”) pursuant to which various stock-based awards may be granted to employees, directors and consultants. Prior to the 2006 Incentive Plan, the Company awarded stock options to employees and officers through the Penford Corporation 1994 Stock Option Plan (the “1994 Plan”) and to members of its Board under the Stock Option Plan for Non-Employee Directors (the “Directors’ Plan”). The 1994 Plan was suspended when the 2006 Plan became effective. The Directors’ Plan expired in August 2005. As of May 31, 2008, the aggregate number of shares of the Company’s common stock that

are available to be issued as awards under the 2006 Incentive Plan is 568,276. In addition, any shares previously granted under the 1994 Plan which are subsequently forfeited or not exercised will be available for future grants under the 2006 Incentive Plan.

Stock Option Awards

A summary of the stock option activity for the nine months ended May 31, 2008, is as follows:


						Weighted Average		Aggregate
	Number of			Weighted Average		Remaining Term		Intrinsic
	Shares			Exercise Price		(in years)		Value


Outstanding Balance, August 31, 2007		1,033,977		$	14.25
Granted		10,000			21.73
Exercised		(25,611	)		12.58
Cancelled		(1,000	)		16.34

Outstanding Balance, May 31, 2008		1,017,366		$	14.37		4.91	$	7,550,300

Options Exercisable at May 31, 2008		788,116		$	13.94		4.62	$	6,186,100

Under the 2006 Incentive Plan, options to purchase 10,000 shares of the Company’s common stock were granted during the nine months ended May 31, 2008 with a weighted average grant date fair value of $8.45. The aggregate intrinsic value disclosed in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $21.79 as of May 31, 2008 that would have been received by the option holders had all option holders exercised on that date.

As of May 31, 2008, the Company had $0.7 million of unrecognized compensation costs related to non-vested stock option awards that is expected to be recognized over a weighted average period of 1.4 years.

Restricted Stock Awards

The grant date fair value of the Company’s restricted stock awards is equal to the fair value of Penford’s common stock at the grant date. The following table summarizes the restricted stock award activity for the nine months ended May 31, 2008 as follows:


				Weighted
				Average
	Number of			Grant Date
	Shares			Fair Value

Nonvested at August 31, 2007		5,796		$	14.50
Granted		106,467			34.69
Vested		(2,898	)		14.50
Cancelled		—			—

Nonvested at May 31, 2008		109,365		$	34.15

On January 1, 2008, each non-employee director received an award of 781 shares of restricted stock under the 2006 Incentive Plan at the last reported sale price of the stock on the preceding trading day, which will vest one year from grant date of the award. The Company recognizes compensation cost for restricted stock ratably over the vesting period.

As of May 31, 2008, the Company had $2.6 million of unrecognized compensation costs related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.7 years.

Compensation Expense

The Company recognizes stock-based compensation expense utilizing the accelerated multiple option approach over the requisite service period, which equals the vesting period. The following table summarizes the total stock-

based compensation cost under SFAS No. 123R for the three and nine months ended May 31, 2008 and May 31, 2007 and the effect on the Company’s Condensed Consolidated Statements of Operations (in thousands):


	Three Months Ended				Nine Months Ended
	May 31,				May 31,
	2008		2007		2008		2007

Cost of sales	$	48	$	25	$	134	$	66
Operating expenses		591		249		1,488		789
Research and development expenses		10		5		16		15

Total stock-based compensation expense	$	649	$	279	$	1,638	$	870
Tax benefit		247		103		622		322

Total stock-based compensation expense, net of tax	$	402	$	176	$	1,016	$	548

See Note 13 for stock-based compensation costs recognized in the financial statements of each business segment.

4—INVENTORIES

The components of inventory are as follows:


	May 31,		August 31,
	2008		2007
	(In thousands)
Raw materials	$	28,297	$	17,438
Work in progress		977		720
Finished goods		27,960		21,379

Total inventories	$	57,234	$	39,537

Inventory increased approximately $17.7 million, primarily in the Industrial Ingredients—North America segment, due to an increase in physical corn inventories, raw material corn costs and readily marketable exchange-traded futures, and stronger foreign currency exchange rates in Australia/New Zealand.

To reduce the price volatility of corn used in fulfilling some of its starch sales contracts, Penford uses readily marketable exchange-trade futures contracts which are designated as fair value hedges. Both the corn purchase contracts and the futures contracts are recorded at fair value and the gain or loss is recognized in the income statement. For the nine months ended May 31, 2008 and 2007, non-cash gain (loss) recorded in the statement of operations was $(4.4) million and $0.4 million, respectively.

5—PROPERTY, PLANT AND EQUIPMENT

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


	May 31,			August 31,
	2008			2007
	(In thousands)
Land	$	22,289		$	17,694
Plant and equipment		400,330			338,496
Construction in progress		10,604			27,433

		433,223			383,623
Accumulated depreciation		(254,291	)		(236,960	)

Net property, plant and equipment	$	178,932		$	146,663

Changes in Australian and New Zealand currency exchange rates have increased net property, plant and equipment in the first nine months of fiscal 2008 by approximately $6.8 million.

During the first nine months of fiscal 2008, the Company had $26.8 million of capital expenditures related to construction of the ethanol production facility, which was placed in service in May 2008. As of May 31, 2008, the Company had a total of $46.9 million in capital expenditures related to the ethanol production facility which includes $1.5 million in related capitalized interest costs.

6—DEBT

In fiscal 2007, the Company entered into a Second Amended and Restated Credit Agreement (the “2007 Agreement”) among the Company; Harris N.A.; LaSalle Bank National Association; Cooperative Centrale Raiffeisen-Boorleenbank B.A., “Rabobank Nederland” (New York Branch); U.S. Bank National Association; and the Australia and New Zealand Banking Group Limited.

Due to the expected impact of the flood described in Note 16 on the Company’s results of operations during its fourth quarter of fiscal 2008, the Company sought and has obtained an amendment to the 2007 Agreement. Effective July 9, 2008, the 2007 Agreement was amended to temporarily adjust the calculation of selected covenant formulas for the costs of the flood damage and the associated property damage and business interruption insurance recoveries. The Company expects to be in compliance with the amended covenants at August 31, 2008.

The Company’s short-term borrowings consist of an Australian variable-rate grain inventory financing facility with an Australian bank for a maximum of $38.2 million U.S. dollars at the exchange rate at May 31, 2008. The amount outstanding under this arrangement, which is classified as a current liability on the balance sheet, was $1.4 million at May 31, 2008.

As of May 31, 2008, all of the Company’s outstanding debt, including amounts outstanding under the Australian grain inventory financing facility, is subject to variable interest rates. Under interest rate swap agreements with several banks, the Company has fixed its interest rates on U.S. dollar-denominated debt of $29.2 million at 4.18% and $4.8 million at 5.08%, plus the applicable margin under the 2007 Agreement. At May 31, 2008, the fair value of the interest rate swaps was recorded in the balance sheet as a liability of $0.8 million.

In December 2007, the Company completed a public offering of common stock resulting in the issuance of 2,000,000 additional common shares at a price to the public of $25.00 per share. The Company received approximately $47.2 million of net proceeds (net of $2.8 million of expenses related to the offering) from the sale of 2,000,000 shares. The proceeds were used to reduce the Company’s outstanding debt. Pursuant to the terms of the Company’s credit facility agreement, half of the net proceeds, $23.6 million, were used to repay amounts outstanding under the term loan portion of the Company’s credit facility. The remaining net proceeds were used to repay $22.8 million and $0.8 million, respectively, of amounts due under the revolving credit and capital expansion loan portions of the credit facility.

7—INCOME TAXES

FIN 48

On September 1, 2007, the Company adopted FIN 48. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on de-recognition, measurement, classification, interest and penalties and transition issues. FIN 48 contains a two-step process for recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the available evidence indicates that it is more likely than not that the position will be sustained on audit, including related appeals or litigation. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

As a result of the implementation of FIN 48 on September 1, 2007, Penford reclassified $0.9 million of previously recorded tax reserves from a current income tax liability to a long-term liability for unrecognized tax benefits. The Company reclassified unrecognized tax benefits for which it does not anticipate the payment or receipt of cash within one year. The Company historically classified unrecognized tax benefits in current income taxes payable. There was no change in retained earnings resulting from the adoption of FIN 48. The Company’s policy is to recognize interest and penalty expense associated with uncertain tax positions as a component of income tax expense in the consolidated statements of operations. As of September 1, 2007, the Company had $0.2 million of accrued interest and penalties included in the long-term tax liability.

At September 1, 2007, the liability for unrecognized tax benefits was $0.9 million, all of which would affect the effective tax rate if realized. During the nine months ended May 31, 2008, the Company increased its liability for gross unrecognized tax benefits by $0.1 million, and reduced the liability by (i) $0.2 million as a result of the expiration of the applicable statutes of limitations, and (ii) $0.2 million relating to settlements with taxing authorities.

The Company files tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions, and the federal jurisdictions in Australia and New Zealand, and is subject to examination by taxing authorities in all of those jurisdictions. From time to time, the Company’s tax returns are reviewed or audited by various U.S. state taxing authorities. The Company believes that adjustments, if any, resulting from these reviews or audits would not be material, individually or in the aggregate, to the Company’s financial position, results of operations or liquidity. Currently, one U.S. state has notified the Company that it intends to audit its tax returns for fiscal years 2005 through 2007. With few exceptions, the Company is not subject to income tax examinations by federal, state or foreign jurisdictions for fiscal years prior to 2003.

Effective Tax Rate

The Company’s effective tax rates of 38% and 33% for the three and nine months ended May 31, 2008, respectively, differed from the U.S. federal statutory rate primarily due to the impact of the adjustments to unrecognized tax benefits discussed in Note 7 to the Condensed Consolidated Financial Statements, the favorable tax effect of domestic (U.S.) production activities, Australian tax incentives related to research and development, and an increase in the prior year’s estimate of tax expense of $0.2 million.

The Company’s effective tax rates of 33% and 30% for the three and nine months ended May 31, 2007, respectively, varied from the U.S. federal statutory rate primarily due to U.S. federal and Australian tax incentives related to research and development, the favorable tax effect of export sales from the U.S. through the extraterritorial income exclusion, and the favorable tax effect of domestic (U.S.) production activities. In December 2006, the Tax Relief Healthcare Act of 2006 was enacted which retroactively reinstated and extended the research and development tax credit from January 1, 2006 through December 31, 2007. The Company recorded the tax effect of $0.2 million of research and development tax credits in the second quarter of 2007 related to the prior fiscal year.

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

fiscal year pre-tax income or loss. Adjustments to the Company’s tax expense related to the prior fiscal year, amounts recorded in accordance with FIN 48 and changes in tax rates are treated as discrete items and are recorded in the period in which they arise. These adjustments are not included in the Company’s estimate of the effective tax rate for the current year.

8—STOCKHOLDERS’ EQUITY

In December 2007, the Company completed a public offering of common stock resulting in the issuance of 2,000,000 common shares at a price to the public of $25.00 per share. The Company received approximately $47.2 million of net proceeds (net of $2.8 million of expenses related to the offering) from the sale of the shares. This transaction increased the recorded amounts of common stock by $2.0 million and increased additional paid-in capital by $45.2 million in the second quarter of fiscal 2008.

9—OTHER COMPREHENSIVE INCOME

The components of total comprehensive income are as follows:


	Three months ended					Nine months ended
	May 31, 2008			May 31, 2007		May 31, 2008		May 31, 2007
	(In thousands)

Net income	$	2,705		$	4,955	$	8,182	$	9,234
Foreign currency translation adjustments		(274	)		2,418		10,795		5,343
Net unrealized gain on derivative instruments that qualify as cash flow hedges, net of tax		292			1,708		1,648		367

Total comprehensive income	$	2,723		$	9,081	$	20,625	$	14,944

10—NON-OPERATING INCOME, NET

Non-operating income, net consists of the following:


	Three months ended						Nine months ended
	May 31, 2008			May 31, 2007			May 31, 2008		May 31, 2007
	(In thousands)

Royalty and licensing income	$	465		$	486		$	1,320	$	1,409
Gain (loss) on sale of assets		5			(194	)		6		(336	)
Gain (loss) on foreign currency transactions		(236	)		—			208		—
Other		102			52			56		22

Total	$	336		$	344		$	1,590	$	1,095

During the three and nine months ended May 31, 2008, the Company recognized a foreign currency transaction gain (loss) on Australian dollar denominated assets as disclosed in the table above.

In fiscal 2003, the Company exclusively licensed to National Starch and Chemical Investment Holdings Corporation (“National Starch”) certain rights to its resistant starch patent portfolio (the “RS Patents”) for applications in human nutrition. Under the terms of the licensing agreement, the Company received an initial licensing fee of $2.25 million ($1.6 million net of transaction expenses) which is being amortized over the life of the agreement. The Company has recognized $9.9 million in royalty income from the inception of the agreement through May 31, 2008.

In the first quarter of fiscal 2007, in connection with the settlement of litigation in which Penford’s Australian subsidiary companies were plaintiffs, Penford received a one-time payment of $625,000 and granted a license to one of the defendants in this litigation under Penford’s RS Patents in certain non-human nutrition applications. In addition,

Penford became entitled to receive additional royalties under a license of rights under the RS Patents in human nutrition applications granted to one of the defendants. As part of the settlement agreement, Penford became entitled to receive certain other benefits, including an acceleration and extension of certain royalties under its license agreement with National Starch. The Company is deferring and recognizing license income of $625,000 ratably over the remaining life of the license agreement, which, at that time, was estimated to be seven years.

11 — PENSION AND POST-RETIREMENT BENEFIT PLANS

The components of the net periodic pension and post-retirement benefit costs for the three and nine months ended May 31, 2008 and 2007 are as follows:


Defined benefit pension plans	Three months ended						Nine months ended
	May 31, 2008			May 31, 2007			May 31, 2008			May 31, 2007
	(In thousands)

Service cost	$	371		$	345		$	1,113		$	733
Interest cost		622			516			1,868			1,100
Expected return on plan assets		(663	)		(593	)		(1,989	)		(1,186	)
Amortization of prior service cost		64			47			190			93
Amortization of actuarial losses		12			48			38			96

Net periodic benefit cost	$	406		$	363		$	1,220		$	836


Post-retirement health care plans	Three months ended						Nine months ended
	May 31, 2008			May 31, 2007			May 31, 2008			May 31, 2007
	(In thousands)

Service cost	$	77		$	78		$	233		$	155
Interest cost		214			204			640			409
Amortization of prior service cost		(38	)		(38	)		(114	)		(76	)

Net periodic benefit cost	$	253		$	244		$	759		$	488

12—RESTRUCTURING COSTS

In the first quarter of fiscal 2008, in connection with reconfiguring the Company’s Australian business, a workforce reduction was implemented in the Company’s two Australian operating facilities. In connection therewith, $1.2 million in employee severance costs and related benefits were charged to operating income in the first quarter and are shown as restructuring costs in the condensed consolidated statement of operations. As of May 31, 2008, all severance and related costs were paid.

In the second and third quarters of fiscal 2008, the Company’s Australian business recorded restructure charges totaling $0.2 million related to workforce reductions implemented at its New Zealand operations. As of May 31, 2008, all severance and related costs had been paid.

13—SEGMENT REPORTING

Financial information for the Company’s three segments is presented below. The first two segments, Industrial Ingredients—North America and Food Ingredients—North America, are broad categories of end-market users, primarily served by the Company’s U.S. operations. The Industrial Ingredients segment provides carbohydrate-based starches for industrial applications, primarily in the paper and packaging products industries, and ethanol products. The Food Ingredients segment produces specialty starches for food applications. The third segment is the Company’s geographically separate operations in Australia and New Zealand, which are engaged primarily in the food ingredients business. A fourth item for “corporate and other” activity is presented to provide reconciliation to amounts reported in the condensed consolidated financial statements. Corporate and other represents the activities related to the corporate headquarters such as public company reporting, personnel costs of the executive management team, corporate-wide professional services and elimination and consolidation entries. The elimination of intercompany sales between

Australia/New Zealand operations and Food Ingredients—North America is presented separately since the chief operating decision maker views segment results prior to intercompany eliminations.


	Three months ended						Nine months ended
	May 31,						May 31,
	2008			2007			2008			2007
	(In thousands)
Sales:
Industrial Ingredients—North America	$	60,861		$	52,965		$	159,147		$	143,650
Food Ingredients—North America		17,139			17,091			48,857			46,892
Australia/New Zealand operations		25,096			25,668			78,498			76,296
Intercompany sales		(297	)		(318	)		(953	)		(691	)

	$	102,799		$	95,406		$	285,549		$	266,147


Income (loss) from operations:
Industrial Ingredients—North America	$	5,094		$	7,066		$	15,358		$	13,896
Food Ingredients—North America		2,830			2,918			7,689			7,931
Australia/New Zealand operations		(874	)		856			(2,994	)		1,607
Corporate and other		(2,220	)		(2,384	)		(6,795	)		(6,964	)

	$	4,830		$	8,456		$	13,258		$	16,470


	May 31,		August 31,
	2008		2007
	(In thousands)
Total assets:
Industrial Ingredients—North America	$	177,234	$	133,187
Food Ingredients—North America		35,328		33,684
Australia/New Zealand operations		123,544		108,084
Corporate and other		12,383		13,433

	$	348,489	$	288,388

The following table summarizes the stock-based compensation expense related to stock option and restricted stock awards by segment for the three and nine months ended May 31, 2008 and 2007.


	Three months ended				Nine months ended
	May 31,				May 31,
	2008		2007		2008		2007
	(In thousands)				(In thousands)

Industrial Ingredients—North America	$	160	$	69	$	399	$	205
Food Ingredients—North America		84		49		224		147
Australia/New Zealand operations		8		13		27		42
Corporate		397		149		988		476

	$	649	$	280	$	1,638	$	870

Penford sells to a variety of customers and has several relatively large customers in each business segment. In fiscal 2007, the Company’s largest customer, Domtar, Inc., represented approximately 12% of consolidated net sales. For the nine months ended May 31, 2008, Domtar, Inc. represented approximately 12% of consolidated net sales. Domtar, Inc. is a customer of the Company’s Industrial Ingredients—North America business.

14—EARNINGS PER SHARE

Basic earnings per share reflect only the weighted average common shares outstanding during the period. Diluted earnings per share reflect weighted average common shares outstanding and the effect of any dilutive common stock equivalent shares. The following table presents the computation of diluted weighted average shares outstanding for the three and nine months ended May 31, 2008 and 2007.


	Three months ended				Nine months ended
	May 31,				May 31,
	2008		2007		2008		2007
			(In thousands)
Weighted average common shares outstanding		11,129		8,984		10,371		8,962
Dilutive stock options and awards		317		274		372		197


Weighted average common shares outstanding, assuming dilution		11,446		9,258		10,743		9,159

Weighted-average restricted stock awards of 5,467 and 3,033 shares for the three and nine months ended May 31, 2008, were excluded from the calculation of diluted earnings per share because they were antidilutive. Weighted-average stock options to purchase 6,739 and 2,263 shares of common stock for the three and nine months ended May 31, 2008, and weighted-average stock options to purchase 68,261 and 201,813 shares of common stock for the three and nine months ended May 31, 2007, were excluded from the calculation of diluted earnings per share because they were antidilutive.

15—LEGAL PROCEEDINGS

In October 2004, Penford Products Co. (“Penford Products”), a wholly-owned subsidiary of the Company, was sued by Graphic Packaging International, Inc. (“Graphic”) in the Fourth Judicial District Court, Ouachita Parish, Louisiana. Graphic sought monetary damages for Penford Products’ alleged breach of an agreement to supply Graphic with certain starch products during the 2004 strike affecting the Penford Products Cedar Rapids, Iowa plant. The case was tried before a judge of the above-noted court in October 2007. On May 5, 2008, the Company received notice the trial judge ruled in favor of Graphic and found Penford Products liable for alleged damages in the amount of $3,242,302, as well as pre-and post-judgment interest and costs that were alleged to be in an amount in excess of $810,000. After evaluating its options, the Company elected to satisfy the judgment and waive appeal rights by paying Graphic the sum of $3,810,837. The Company had previously reserved $2.4 million against this matter.

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

16—SUBSEQUENT EVENT

As reported by the Company on Form 8-K filed with the Securities and Exchange Commission on June 13, 2008 and Form 8-K filed on June 20, 2008, on June 12, 2008, the Company’s Cedar Rapids, Iowa plant, owned and operated by its principal subsidiary, Penford Products Co., was temporarily shut down due to record flooding of the Cedar River and government-ordered mandatory evacuation of the plant and surrounding areas.

The Company expects that production start-up in Cedar Rapids will occur in stages as processes and sections within the plant become operational. The Company expects to resume production of certain Liquid Natural Additive products in mid-July using its pilot plant facility, which was not heavily damaged by the flood. However, the Company continues to project that its main production facility will not manufacture significant industrial starch or ethanol volumes before the end of August 2008. As a result, the Industrial Ingredients — North America segment is not expected to contribute significantly to earnings during the fourth quarter of fiscal 2008.

Potato starch operations were not affected by the flood in Cedar Rapids. Food corn starches will be supplied from other Company locations. Dextrose manufacturing, which occurred in Cedar Rapids, has been suspended. Rice and tapioca starch ingredients were not impacted.

The Company continues to assess damages caused by the flood and evaluate potential insurance recoveries from its property damage and business interruption policies. Preliminary estimates are subject to numerous assumptions regarding the cost and timing to repair and refurbish or replace numerous items of equipment and processes. Achieving estimated outcomes is dependent on the availability of materials and resources which are outside of Penford’s control. While any estimate of the cost to return the facility to optimal operating conditions is subject to factors outside Penford’s control as well as other significant uncertainties, the Company currently estimates this cost to be in the range of $45 million.

The effect of the flood on the financial results of the Company on a quarter-to-quarter or year-to-year basis will depend on the timing and amount of the expenditures and insurance recoveries. The Company currently plans to expense most of the costs related to recovery as they are determined, primarily during the fourth quarter of fiscal 2008.

The Company maintains property damage and business interruption insurance coverage applicable to the plant. Subject to the terms of the Company’s policies and the applicable deductibles, the Company has initially estimated that it should be able to recover at least $30 to $35 million under its property damage and business interruptions insurance policies. The actual amount ultimately recovered may vary from this estimate, and, as a result, the Company is unable to provide assurance as to the amount or timing of the ultimate recoveries under its policies.

The Company expects that the flood will significantly affect its financial results for at least the remainder of its fiscal year 2008, which ends on August 31, 2008. The Company believes that it has sufficient financial and other resources to enable it to restore the plant and resume supplying its customers.

Due to the expected impact of the flood on the Company’s results of operations during its fourth quarter of fiscal 2008, the Company sought and has obtained an amendment to the 2007 Agreement with the banks identified in Note 6. Effective July 9, 2008, the 2007 Agreement was amended to temporarily adjust the calculation of selected covenant formulas for the costs of the flood damage and the associated property damage and business interruption insurance recoveries. The Company expects to be in compliance with the amended covenants at August 31, 2008.

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

Forward-looking Statements

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

Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it cannot give any assurances that these expectations will prove to be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly affect expected results. Actual future results could differ materially from those described in such forward-looking statements, and the Company does not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this Quarterly Report, including those referenced in Item 1A in this Quarterly Report, and those described from time to time in other filings with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the year ended August 31, 2007, which include, but are not limited to:

	•		expectations regarding the timing and cost of restoring the Cedar Rapids facility to full production, the timing and amount of insurance recoveries, the amount of total losses sustained, and the impact on the Company’s financial results due to the severe flooding in Cedar Rapids, Iowa in June 2008;

	•		competition;

	•		the possibility of interruption of business activities due to equipment problems, accidents, strikes, weather or other factors;

	•		product development risk;

	•		changes in corn and other raw material prices and availability;

	•		changes in general economic conditions or developments with respect to specific industries or customers affecting demand for the Company’s products including unfavorable shifts in product mix;

	•		unanticipated costs, expenses or third-party claims;

	•		the risk that results may be affected by construction delays, cost overruns, technical difficulties, nonperformance by contractors or changes in capital improvement project requirements or specifications;

	•		interest rate, chemical and energy cost volatility;

	•		foreign currency exchange rate fluctuations;

	•		changes in assumptions used for determining employee benefit expense and obligations; or

	•		other unforeseen developments in the industries in which Penford operates.

Overview

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

In analyzing business trends, management considers a variety of performance and financial measures, including sales revenue growth, sales volume growth, gross margins and operating income of the Company’s business segments. Penford manages its business in three segments. The first two, Industrial Ingredients—North America and Food Ingredients—North America, are broad categories of end-market users, served by operations in the United States. The third segment is comprised of the Company’s operations in Australia and New Zealand, which operations are engaged primarily in the food ingredients business. See Notes 1 and 13 to the Condensed Consolidated Financial Statements for additional information regarding the Company’s business segment operations.

Cedar River Flooding

On June 12, 2008, the Company’s Cedar Rapids, Iowa plant, owned and operated by its principal subsidiary, Penford Products Co., was temporarily shut down due to record flooding of the Cedar River and government-ordered mandatory evacuation of the plant and surrounding areas. The Cedar Rapids plant, which produces almost all of the revenues of the Industrial Ingredients — North America segment, or approximately 55% of the total Company revenues, has sustained significant damage. Penford employees and outside contractors are currently evaluating and remediating flood damage to buildings, equipment and processes.

The Company expects that production start-up in Cedar Rapids will occur in stages as processes and sections within the plant become operational. The Company expects to resume production of certain Liquid Natural Additive products in mid-July using its pilot plant facility which was not heavily damaged by the flood. However, the Company continues to project that its main production facility will not manufacture significant industrial starch or ethanol volumes before the end of August 2008. As a result, the Industrial Ingredients — North America segment is not expected to contribute significantly to earnings during the fourth quarter of fiscal 2008.

Accounting Changes

Results of Operations

Executive Overview

Consolidated sales for the three months ended May 31, 2008 improved 7.8% to $102.8 million from $95.4 million in the third quarter of fiscal 2007 due to an increase of $9.2 million related to improved unit pricing and favorable product mix in all business units, the impact on revenues of passing through higher corn costs to customers in the Industrial Ingredients business, the start-up of ethanol production in May 2008, and favorable Australian and New Zealand foreign currency exchange rates, offset by a decline in sales volumes of $1.8 million. Gross margin as a percent of sales for the third quarter of fiscal 2008 declined to 15.1% compared to the same period last year of 19.5% primarily due to higher raw material and other manufacturing input costs. Income from operations was $4.8 million, $3.6 million lower compared to the third quarter of fiscal 2007 due to gross margin declines and litigation settlement costs of $1.4 million. See Note 15 to the Condensed Consolidated Financial Statements.

Consolidated sales for the nine months ended May 31, 2008 increased 7.3% to $285.5 million from $266.1 million in the same period last year due to favorable pricing and product mix in all businesses of $22.1 million, stronger currency exchange rates and the impact of higher corn costs totaling $12.8 million, offset by sales volume declines of $15.5 million, primarily in the Australia/New Zealand operations as the business rationalized product offerings and manufacturing. Gross margin as a percent of sales for the nine months ended May 31, 2008 was 15.2%, down 2.0% compared to the same period last year, as revenue gains were offset by higher raw material costs for all three business segments and higher manufacturing expense related to higher energy usage costs as well as increased repair and maintenance costs resulting from the severe weather in the Midwest. Operating income for the first nine months of fiscal 2008 was $13.3 million, a $3.2 million decline over the same period last year due to gross margin declines and litigation settlement costs of $1.4 million. Research and development expenses increased by $1.2 million on additional headcount and increased spending for product development activities. Operating income for the first nine months of fiscal 2008 included $1.3 million of severance costs related to reconfiguring the Australia/New Zealand business. See Note 12 to the Condensed Consolidated Financial Statements.

A discussion of segment results of operations and the effective tax rate follows.

Industrial Ingredients—North America

Sales for the third quarter of fiscal 2008 at the Company’s Industrial Ingredients—North America business unit improved $7.9 million, or 14.9%, to $60.9 million from $53.0 million over the same quarter last year. Favorable pricing and mix, as well as the pass-through effect of higher corn costs added $3.2 million to revenue growth. Volume growth came from 1.9 million gallons of ethanol sales which began in May 2008 and added $4.7 million to third quarter revenue. Income from operations for the third quarter of fiscal 2008 at the Company’s Industrial Ingredients—North America business unit declined $2.0 million to $5.1 million compared to third quarter fiscal 2007 operating income of $7.1 million. Third quarter fiscal 2008 gross margin as a percent of sales declined to 15.4% compared to 20.4% in the same quarter of fiscal 2007, primarily due to higher chemical and natural gas costs and start-up expenses for ethanol production, partially offset by favorable unit pricing and product mix and volume growth from sales of ethanol products. Operating expenses increased $0.3 million due to litigation settlement expense of $1.4 million, partially offset by lower

professional fees and employee-related costs. Research and development expenses increased by $0.2 million on expanded activity related to the specialty starch product lines.

Sales for the first nine months of fiscal 2008 improved 10.8% to $159.1 million compared to sales of $143.7 million in the same period last year. Increases in average unit selling prices and improved product mix contributed approximately 7% to sales growth and the pass-through impact on revenues from higher corn costs added another 2%. Volumes improved with added ethanol sales, partially offset by a 2% reduction in core starch products. Income from operations for the nine months ended May 31, 2008 improved $1.5 million to $15.4 million compared to the same nine-month period of fiscal 2007. Gross margin improved $1.8 million, and as a percent of sales was 15.9%, compared to 16.4% for the same period a year ago. The impact of improved unit pricing and product mix of $7.8 million was partially offset by unfavorable corn procurement and chemical costs of $2.7 million. Also reducing gross margin were higher repair and maintenance expenses, lower natural gas yields and production inefficiencies caused by severe weather in the Midwest, and the start-up costs of ethanol production totaling $3.4 million. Operating expenses declined by $0.4 million on lower professional fees and employee-related costs, partially offset by litigation resolution expenses of $1.4 million. Research and development expenses increased $0.7 million.

In the third quarter of fiscal 2008, litigation described in Note 15 to the Condensed Consolidated Financial Statements was resolved, resulting in a $1.4 million charge to operating income. The Company had reserved $2.4 million related to this matter at August 31, 2007. The Company paid the $3.8 judgment in May 2008.

On June 12, 2008, the Company’s Cedar Rapids, Iowa manufacturing facility, which produces almost all of the revenues of the Industrial Ingredients — North America segment, was shut down as a result of flooding of the Cedar River. See “Overview” above and Note 16 to the Condensed Consolidated Financial Statements.

Food Ingredients—North America

Fiscal 2008 third quarter sales for the Food Ingredients—North America segment of $17.1 million were comparable to the same period last year as higher average unit pricing and improved mix were offset by a decline in sales volume. Third quarter fiscal 2008 income from operations was $2.8 million, a $0.1 million decline compared with the third quarter of fiscal 2007 due to lower gross margins. Gross margins were negatively affected by higher potato starch and corn costs.

Sales for the nine months ended May 31, 2008 rose 4.2%, or $2.0 million, over the same period a year ago to $48.9 million. Improved pricing and product mix contributed $4.1 million to sales growth with higher sales of applications for the dairy/cheese market segment and the pet chew/treats product lines. Sales volumes declined 4%. Income from operations for the nine-month period ended May 31, 2008 declined by $0.2 million over the same period last year to $7.7 million. Gross margin decreased $0.2 million as improved pricing and product mix were more than offset by higher raw material costs and lower volumes. Operating expenses and research activities were comparable to the same period last year as lower employee-related costs were offset by higher expenditures for product trials.

The Food Ingredients — North America segment was minimally affected by the Cedar Rapids flooding. Dextrose manufacturing, which occurred in Cedar Rapids, has been suspended. Potato starch operations and rice and tapioca ingredients were not impacted.

Australia/New Zealand Operations

Sales at the Australia/New Zealand operations decreased 2.2%, or $0.6 million, in the third quarter of fiscal 2008 compared with the same period of fiscal 2007. The business continues to experience the impact of a regional drought that reduced the harvest for critical grain inputs and contributed to a 30% increase in the price of wheat and corn raw materials compared with a year ago. Limited grain supplies also required temporarily importing starch and corn from outside Australia. Processing the material from these sources increased manufacturing costs by $1.0 million during the quarter. Additionally, the Australian Dollar and New Zealand Dollar have appreciated by 51% and 41% respectively, over the past five years, supporting increased price competition for the Company’s domestic products and restricting export opportunities. The business has responded to these conditions by raising selling prices and changing the sales mix to focus on those products which will produce higher long-term returns for the Company while reconfiguring its manufacturing processes to reduce production costs. As a result of these factors, sales volumes have declined and fiscal 2008 third quarter sales in local currency are 14.9% lower than the same quarter a year ago. Gross margin decreased by

$1.4 million to $1.2 million, and as a percent of sales, declined to 5.0% from 10.4% in the prior year’s third quarter. The decline in margin from the previous year’s third quarter reflects higher raw material costs of $3.2 million and incremental manufacturing costs, partially offset by favorable revenue impacts of $1.5 million. Loss from operations at the Company’s Australia/New Zealand business for the quarter ended May 31, 2008 was $0.9 million compared to operating income of $0.9 million in the same period of fiscal 2007.

Sales for the nine months ended May 31, 2008 increased 2.9% to $78.5 million from $76.3 million last year, primarily due to higher average unit pricing and favorable product mix, which contributed 11% to sales improvement, and stronger average quarterly foreign currency exchange rates which appreciated approximately 15% over last year. Sales in local currency declined 10.2%. The business continues to experience high grain costs, limited grain supplies and increased processing costs of imported raw materials as described above. Fiscal year 2008 year-to-date gross margin declined $2.4 million compared with the same period a year ago due to increased raw material grain costs of $5.3 million, higher manufacturing costs related to imported materials of approximately $2.1 million, partially offset by favorable net unit pricing, product mix and volume changes of $4.4 million. Operating expenses increased $0.9 million over the first nine months of fiscal 2007 due to higher research and development expenses and employee-related costs. Included in the segment’s operating loss for the first nine months of fiscal 2008 were restructuring costs of $1.4 million. See Note 12 to the Condensed Consolidated Financial Statements. Operating loss for the nine months ended May 31, 2008 was $3.0 million, compared to operating income of $1.6 million in the same period last year.

Corporate operating expenses

Corporate operating expenses of $2.2 million for the quarter ended May 31, 2008 declined by $0.2 million compared to the same period of fiscal 2007 on lower employee-related costs. Decreased employee-related costs also resulted in the $0.2 million decline in corporate expenses for the nine months ended May 31, 2008 compared with the same period a year ago.

Interest expense

Interest expense for the three- and nine-month periods ended May 31, 2008 declined $0.7 and $1.8 million, respectively, from the same periods last year on lower average debt balances, excluding ethanol-related debt borrowings, and a decline in U.S. interest rates from a year ago. Interest expense related to construction of the ethanol manufacturing plant was capitalized until May 2008, when the facility began commercial production. Interest capitalized was $0.3 million and $0.1 million for the quarters ended May 31, 2008 and 2007, respectively, and $1.1 million and $0.2 million for the nine months ended May 31, 2008 and 2007, respectively. The Company’s debt includes the amount outstanding under its grain inventory financing facility. See Note 6 to the Condensed Consolidated Financial Statements.

Income taxes

The Company’s effective tax rates of 38% and 33% for the three and nine month periods ended May 31, 2008, respectively, differed from the U.S. federal statutory rate primarily due to the impact of the adjustments to unrecognized tax benefits discussed in Note 7 to the Condensed Consolidated Financial Statements, the favorable tax effect of domestic (U.S.) production activities, Australian tax incentives related to research and development, and an increase in the prior year’s estimate of tax expense of $0.2 million.

Company uses estimates of the amounts of permanent differences between book and tax accounting and projections of fiscal year pre-tax income or loss. Adjustments to the Company’s tax expense related to the prior fiscal year, amounts recorded in accordance with FIN 48 and changes in tax rates are treated as discrete items and are recorded in the period in which they arise.

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

Non-operating income, net

Non-operating income, net consists of the following:


	Three months ended						Nine months ended
	May 31, 2008			May 31, 2007			May 31, 2008		May 31, 2007
				(In thousands)
Royalty and licensing income	$	465		$	486		$	1,320	$	1,409
Gain (loss) on sale of assets		5			(194	)		6		(336	)
Gain (loss) on foreign currency transactions		(236	)		—			208		—
Other		102			52			56		22

Total	$	336		$	344		$	1,590	$	1,095

During the three and nine months ended May 31, 2008, the Company recognized a foreign currency transaction gain (loss) on Australian dollar denominated assets as disclosed in the table above. See Note 10 to the Condensed Consolidated Financial Statements for information on the Company’s royalty and licensing income.

Liquidity and Capital Resources

On June 12, 2008, the Company’s facilities in Cedar Rapids, Iowa were shut down and evacuated due to flooding of the plant and surrounding areas. See the “Overview” section of this Part I, Item 2 for a discussion of the Company’s liquidity as a result of the flood.

In fiscal 2007, the Company entered into a Second Amended and Restated Credit Agreement (the “2007” Agreement”). See Note 6 to the Condensed Consolidated Financial Statements.

At May 31, 2008, the Company had $20.9 million and $10.4 million outstanding, respectively, under the revolving credit and term loan portions of its credit facility. In addition, the Company had borrowed $43.2 million of the $45 million in capital expansion loans available under the credit facility for the construction of the ethanol facility. Pursuant to the terms of the 2007 Agreement, Penford’s additional borrowing ability as of May 31, 2008 was $1.8 million under the capital expansion facility and $39.1 million under the revolving credit facility. The Company was in compliance with the covenants in the agreement as of May 31, 2008. Due to the expected impact of the flood on the Company’s results of operations during its fourth quarter of fiscal 2008, the Company sought and has obtained an amendment to the 2007 Agreement with the banks identified in Note 6. Effective July 9, 2008, the 2007 Agreement was amended to temporarily adjust the calculation of selected covenant formulas for the costs of the flood damage and the associated property damage and business interruption insurance recoveries. The Company expects to be in compliance with the amended covenants at August 31, 2008.

The Company’s short-term borrowings consist of an Australian variable-rate revolving grain inventory financing facility with an Australian bank for a maximum of $38.2 million U.S. dollars at the exchange rate at May 31, 2008. The amount outstanding under this arrangement, which is classified as a current liability on the balance sheet, was $1.4 million at May 31, 2008.

As of May 31, 2008, all of the Company’s outstanding debt, including amounts outstanding under the Australian grain inventory financing facility, was subject to variable interest rates. Under interest rate swap agreements with several banks, the Company has fixed its interest rates on U.S. dollar denominated debt of $29.2 million at 4.18% and $4.8 million at 5.08%, plus the applicable margin under the Company’s credit agreement. At May 31, 2008, the fair value of the interest rate swaps was recorded in the balance sheet as a liability of $0.8 million.

Penford had working capital of $74.0 million and $39.0 million at May 31, 2008 and August 31, 2007, respectively. Inventory increased approximately $17.7 million, primarily in the Industrial Ingredients—North America segment, due to an increase in physical corn inventories, raw material corn costs and readily marketable exchange-traded futures, and stronger foreign currency exchange rates in Australia/New Zealand. Accrued liabilities declined by $10.8 million due to the payment of employee incentives and the payment upon resolution of litigation discussed in Note 15 to the Condensed Consolidated Financial Statements. Cash used in operations was $3.2 million for the nine months ended May 31, 2008 compared with cash provided by operations of $11.5 million for the nine months ended May 31, 2007. The decline in cash flow from operations is primarily due to the increase in working capital discussed above.

For the first nine months of fiscal 2008, the Company had $26.8 million of capital expenditures related to the construction of the ethanol facility. As of May 31, 2008 the Company had a total of $46.9 million in capital expenditures related to the ethanol facility which included $1.5 million in capitalized interest costs.

The Company paid dividends of $1.8 million during the nine months ended May 31, 2008, which represents a quarterly rate of $0.06 per share. On June 25, 2008, the Board of Directors declared a dividend of $0.06 per common share payable on September 5, 2008 to shareholders of record at the close of business August 15, 2008. Any future dividends will be paid at the discretion of the Company’s board of directors and will depend upon, among other things, earnings, financial condition, cash requirements and availability, and contractual requirements.

Contractual Obligations

The Company is a party to various debt and lease agreements at May 31, 2008 that contractually commit the Company to pay certain amounts in the future. The Company also has open purchase orders entered into in the ordinary course of business for raw materials, capital projects and other items, for which significant terms have been confirmed. As of May 31, 2008, there have been no material changes in the Company’s contractual obligations since August 31, 2007, except for changes in the obligations for long-term debt and capital leases.

As discussed above, proceeds from the sale of common stock were used to reduce long-term debt contractual obligations by $47.2 million. As of May 31, 2008, the remaining contractual obligations for long-term debt and capital leases are as follows (in thousands):


2008	$	1,030
2009 — 2010		22,009
2011 — 2012		42,267
2013 & After		10,700

	$	76,006

Off-Balance Sheet Arrangements

The Company had no off-balance sheet arrangements at May 31, 2008.

Recent Accounting Pronouncements

Critical Accounting Policies and Estimates

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The process of preparing financial statements requires management to make estimates, judgments and assumptions that affect the Company’s financial position and results of operations. These estimates, judgments and assumptions are based on the Company’s historical experience and management’s knowledge and understanding of the current facts and circumstances. Note 1 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended August 31, 2007 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. Management believes that its estimates, judgments and assumptions are reasonable based upon information available at the time this report was prepared. To the extent there are material differences between estimates, judgments and assumptions and the actual results, the financial statements will be affected.

During the nine months ended May 31, 2008, there have been no significant changes to the items disclosed as critical accounting policies and estimates in Item 7 of the Annual Report on Form 10-K for the year ended August 31, 2007, except as described below.

Income Taxes

Effective September 1, 2007, the Company adopted FIN 48. See discussion in Note 7 to the Condensed Consolidated Financial Statements. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. As a result of the implementation of FIN 48, the Company recognizes liabilities for uncertain tax positions based on the two-step process prescribed by the interpretation. The first step is to evaluate the tax position for recognition by determining if the available evidence indicates that it is more likely than not that the position will be sustained on audit, including related appeals or litigation. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as this requires management to determine the probability of various possible outcomes. The Company evaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts and circumstances, changes in tax law, effectively settled audit issues and new audit activity. Such changes in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

Item 3: Quantitative and Qualitative Disclosures about Market Risk.

The Company is exposed to market risks from adverse changes in interest rates, foreign currency exchange rates and commodity prices. There have been no material changes in the Company’s exposure to market risks since August 31, 2007.

Item 4: Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Penford’s management, with the participation of its chief executive officer and chief financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of May 31, 2008. Based on management’s evaluation, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended May 31, 2008 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1: Legal Proceedings

Item 1A: Risk Factors

The information set forth in this report should be read in conjunction with the risk factors discussed under the heading “Factors that May Affect Business and Future Results” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended August 31, 2007, which could materially impact the Company’s business, financial condition and future results.

In addition to the risk factors described in the Annual Report on Form 10-K, the following risk factor should be considered:

All of the material effects on the Company of the June 2008 flood affecting the Company’s Cedar Rapids, Iowa plant are not presently known. As described in this report, because of the flood, the Company was required to shut down the plant, and the plant suffered severe damage. The cost to remediate the flood damage is currently estimated to be approximately $45 million; however, this is only an estimate. There is no assurance that the actual cost to remediate the flood damage will not exceed the current estimate. It is expected that the flood will substantially affect the Company’s results of operations for at least the remainder of the Company’s fiscal year. However, the full amount and extent of the damages and losses suffered, the amount of any recovery under the Company’s insurance policies, and other important factors are not fully known at this time. While the Company currently believes that it has adequate resources to recover from the flood, such a recovery will require the Company to successfully repair and restart the plant, as well as resume service to its customers.

The risks described or referred to herein are not the only risks facing the Company. Additional risks and uncertainties not currently known by the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.

Item 6: Exhibits.

(d) Exhibits



10.1		First Amendment to Second Amended and Restated Credit Agreement

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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


	Page
PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets — May 31, 2008 and August 31, 2007		3

Condensed Consolidated Statements of Operations — Three and Nine Months ended May 31, 2008 and May 31, 2007		4

Condensed Consolidated Statements of Cash Flow — Nine Months ended May 31, 2008 and May 31, 2007		5

Notes to Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17

Item 3. Quantitative and Qualitative Disclosures About Market Risk		25

Item 4. Controls and Procedures		25

PART II—OTHER INFORMATION

Item 1. Legal Proceedings		26

Item 1A. Risk Factors		26

Item 6. Exhibits		26

Signatures		27
First Amendment to Second Amended and Restated Credit Agreement
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certifications of CEO and CFO Pursuant to Section 1350



		Penford Corporation
		(Registrant)

July 10, 2008		/s/ Steven O. Cordier
		Steven O. Cordier
		Senior Vice President and Chief Financial Officer


		Fixed Charge Coverage
		Ratio shall not be Less
From and Including	To and Including	than

August 31, 2006	August 31, 2007	1.50 to 1.0

September 1, 2007	November 31, 2008	1.25 to 1.0

December 1, 2008	At all times thereafter	1.50 to 1.0


	“Borrower” Penford Corporation
	By
		Name
		Title

	“Guarantors” Penford Products Co.
	By
		Name
		Title


	“Lenders”

	Harris N.A., in its individual capacity as a Lender, as L/C Issuer, and as Administrative Agent
	By
		Name
		Title

	U.S. Bank National Association
	By
		Name
		Title

	LaSalle Bank National Association
	By
		Name
		Title

	Cooperative Centrale Raiffeisen-Boerenleenbank B.A., “Rabobank Nederland,” New York Branch
	By
		Name
		Title


	By
		Name
		Title

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Exhibit No.		Description

	10.1	First Amendment to Second Amended and Restated Credit Agreement

	31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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


A.	Total Funded Debt Ratio (Section 8.22(a))

	1.	Total Funded Debt	$
	2.	Net Income for past 4 quarters	$
	3.	Interest Expense for past 4 quarters	$
	4.	Income taxes for past 4 quarters	$
	5.	Depreciation and Amortization Expense for past 4 quarters	$
	6.	Non-cash Loss (Gain) realized on sale/disposition of assets [Loss shall be identified by a positive number; Gains shall be identified by a negative number]	$
	7.	Non-cash stock compensation charges for past 4 quarters	$
	8.	Flood-related charges for past 4 quarters	$
	9.	Sum of Lines A2, A3, A4, A5, A6, A7 and A8	$
	10.	Flood-related insurance proceeds received during past 4 quarters	$
	11.	Line A9 minus A10 (“EBITDA”)	$
	12.	Ratio of Line A1 to A11		___:1.0
	13.	Line A12 ratio must not exceed		___:1.0
	14.	The Borrower is in compliance (circle yes or no)	yes/no

B.	Fixed Charge Coverage Ratio (Section 8.22(b))
	1.	EBITDA (Line A11 above)	$
	2.	Principal payments made in cash during past 4 quarters	$


	3.	Interest Expense for past 4 quarters paid in cash	$
	4.	Restricted Payments for past 4 quarters made in cash	$
	5.	Income taxes for 4 quarters paid in cash	$
	6.	Sum of Lines B2, B3, B4, and B5	$
	7.	Ratio of Line B1 to Line B6		___:1.0
	8.	Line B7 ratio must not be less than		1.50:1.0
	9.	The Borrower is in compliance (circle yes or no)	yes/no

C.	Leverage Ratio (Section 8.22(c))
	1.	Net Worth	$
	2.	Intangible Assets	$
	3.	Write-up of assets	$
	4.	Line C1 minus the sum of Lines C2 and C3	$
	5.	Line C4 ratio must not be less than	$65,000,000
	6.	The Borrower is in compliance (circle yes or no)	yes/no

D.	Capital Expenditures (Section 8.22(d))
	1.	Year-to-date Capital Expenditures (net of permitted exclusions other than for the Ethanol Facility)	$
	2.	Year-to-date Capital Expenditures for Ethanol Facility	$
	3.	Line D1 minus Line D2	$
	4.	Maximum permitted amount	$
	5.	The Borrower is in compliance (circle yes or no)	yes/no


	PENFORD CORPORATION
Date: July 10, 2008	/s/ Thomas D. Malkoski
	Thomas D. Malkoski
	Chief Executive Officer


/s/ Steven O. Cordier
Steven O. Cordier
Chief Financial Officer