PENFORD CORP - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED AUGUST 31, 2003

[ ] 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
(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 S. REVERE PARKWAY 80112-3932
ENGLEWOOD, COLORADO (Zip Code)
(Address of Principal Executive Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(303) 649-1900

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

COMMON STOCK, $1.00 PAR VALUE
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. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]

The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant as of October 31, 2003 was approximately $87.2
million. Shares of Common Stock held by each executive officer and director and
by each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes. The net number of shares of the Registrant's Common Stock (the
Registrant's only outstanding class of stock) outstanding as of October 31, 2003
was 8,634,516.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant's definitive Proxy Statement relating to the 2004 Annual
Meeting of Shareholders is incorporated by reference into Part III of this Form
10-K.
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PENFORD CORPORATION

FISCAL YEAR 2003 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

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PART I

ITEM 1: BUSINESS

DESCRIPTION OF BUSINESS

Penford Corporation ("Penford" or the "Company") is a developer,
manufacturer and marketer of specialty natural-based ingredient systems for
industrial and food applications. The Company uses its carbohydrate chemistry
expertise to develop ingredients with starch as a base for value-added
applications in several markets including papermaking and food products. The
Company manages its business in three segments. The first two, industrial
ingredients and food ingredients are broad categories of end-market users,
primarily served by the U.S. operations. The third segment is the geographically
separate operations in Australia and New Zealand. The Australian and New Zealand
operations are engaged primarily in the food ingredients business, although the
industrial market is an important and growing category. Financial information
about Penford's segments is included in Note 18 to the Consolidated Financial
Statements.

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

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

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

Penford is a Washington Corporation originally incorporated in September
1983. The Company commenced operations as a publicly-traded company on March 1,
1984.

ACQUISITION AND DISPOSITION OF OPERATIONS AND OTHER TRANSACTIONS

In November 2002, Penford sold certain assets of its resistant starch
business to National Starch Corporation ("National Starch"), a wholly-owned
subsidiary of Imperial Chemical Industries PLC of the U.K., for $2.5 million.

Penford also licensed to National Starch the exclusive rights to its
resistant starch intellectual property portfolio for applications in human
nutrition. Penford retained the rights to practice its intellectual property for
all non-human nutrition applications. Under the terms of the agreements, Penford
received an initial licensing fee of $2.25 million and will receive annual
royalties for a period of seven years or until a maximum of $11.0 million in
royalties has been received by Penford. The licensing fee will be amortized over
the life of the agreement. The royalty payments are subject to a minimum of $7
million over the first five years of the licensing agreement.

Penford also entered into a tolling arrangement under which it will
manufacture resistant starch products for National Starch, if requested by
National Starch. See Note 20 to the Consolidated Financial Statements.

Penford Australia Limited was acquired in September 2000. This acquisition
expanded Penford's product offerings to include corn-based food grade products.
Penford Australia also expanded the Company's global
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geographic market presence in Australia, Asia, and New Zealand. See Note 2 to
the Consolidated Financial Statements.

RAW MATERIALS

Corn: Penford's North American corn wet milling plant is located in Cedar
Rapids, Iowa, the middle of the U.S. corn belt. Accordingly, the plant has
truck-delivered corn available throughout the year from a number of suppliers at
prices related to the major U.S. grain markets.

Penford Australia's corn wet milling facilities in Lane Cove, Australia,
and Auckland, New Zealand are sourced through truck-delivered corn at contracted
prices with regional independent farmers and merchants. The corn sourced in
Australia and New Zealand is contracted prior to harvest March -- June. Corn
used in Australia is purchased and stored for use in both the current and
following year. The corn sourced in New Zealand is purchased forward for future
delivery. Some corn is also purchased from Australia and China to supplement the
corn sourced in New Zealand.

Potato Starch: The facilities in Idaho Falls, Idaho, Richland, Washington
and Plover, Wisconsin use starch recovered as by-products from potato processors
as the primary raw material to manufacture modified potato starches. The Company
enters into contracts typically having durations of one to five years with
potato processors in North America, primarily in Northwestern and Midwestern
United States and Eastern Canada, to acquire potato-based raw materials.

Wheat Products: Penford Australia's Tamworth facility uses wheat flour as
the primary raw material for the production of its wheat products such as wheat
starch, wheat gluten and glucose syrup. Tanker trucks from a local flourmill
supply wheat flour under a four-year supply agreement which expires in December
2007.

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

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

Corn, potato starch, wheat flour, chemicals and natural gas are not
presently subject to availability constraints, although drought conditions in
Australia are impacting the prices of corn and wheat in that area. Penford's
current potato starch requirements constitute a material portion of the
available North American supply. Penford estimates that it purchases
approximately 45-50% of the recovered starch in North America. It is possible
that, in the long term, continued growth in demand for potato starch-based
ingredients and new product development will result in capacity constraints.

Over half of the manufacturing costs are the costs of corn, potato starch,
wheat flour, chemicals and natural gas. The remaining portion consists of other
utility costs, labor costs and depreciation and maintenance costs related to
manufacturing plant and equipment. The prices of raw materials may fluctuate,
and increases in prices may affect Penford's business adversely. To mitigate
this risk, Penford hedges a portion of corn and gas purchases with futures and
options contracts in the U.S. and enters into short term supply agreements for
other production requirements in all locations.

RESEARCH AND DEVELOPMENT

Penford's research and development efforts cover a range of projects
including technical service work focused on specific customer support projects
requiring coordination with customers' research efforts to develop innovative
solutions to specific customer requirements. These projects are supplemented
with longer-term, new product development and commercialization initiatives.
Research and development expenses were $5.4 million, $6.0 million and $5.9
million for fiscal years ended August 31, 2003, 2002 and 2001, respectively.

At the end of fiscal 2003, Penford had 34 scientists, including 7 PhD's in
carbohydrate and polymer chemistry, who comprise a body of expert knowledge of
material characterization and molecular structure of

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various carbohydrates. This expertise is integral to commercializing new market
applications in all facets of Penford's business.

PATENTS, TRADEMARKS AND TRADENAME

Penford owns a number of patents, trademarks, and tradenames to protect
product development and commercialization findings that may provide a
competitive advantage in the marketplace. However, most of Penford's products
are currently made with technology that is broadly available to companies that
have the same level of scientific expertise and production capabilities as
Penford. Other companies may develop similar or functionally equivalent products
or may successfully challenge the validity of these patents. Also, Penford's
processes or products may infringe upon the patents of third parties.

Penford has approximately 194 current and pending patents, most of which
are related to base technologies in French fry coatings, coatings for the paper
industry, and high amylose resistant starch for food ingredients. Penford's
patents expire at various times between 2004 and 2020. The annual cost to renew
all of the Company's patents is approximately $0.2 million.

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

QUARTERLY FLUCTUATIONS

Penford's revenues and operating results vary from quarter to quarter. The
Company experiences seasonality with the Penford Australia operations. The
Company has lower sales volumes and gross margins in Australia and New Zealand's
summer months, which corresponds to Penford's second fiscal quarter. This
seasonal decline is caused by the closure of some customers' plants for public
holidays and maintenance during this period. Decreased consumption of some
foods, such as packaged bread, which use the Company's products also contribute
to this seasonal trend. Sales volumes of the food ingredients -- North America
products used in French fry coatings are also generally lower during the
Penford's second fiscal quarter due to decreased consumption of French fries
during the holiday season.

WORKING CAPITAL

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

Penford carries a longer supply of corn for its Australian operations.
Penford Australia uses an inventory financing credit agreement to purchase corn
at harvest in Australia for production requirements for the following year.
Subsequent to August 31, 2003, Penford refinanced its inventory financing
agreement. See Note 7 to the Consolidated Financial Statement.

ENVIRONMENTAL MATTERS

Penford's operations are governed by various Federal, state, local and
foreign environmental laws and regulations. In the United States, such laws and
regulations include the Clean Air Act, the Clean Water Act, the Resource
Conservation and Recovery Act, the EPA Oil Pollution Control Act, OSHA Hazardous
Materials regulations, the Toxic Substances Control Act, the Comprehensive
Environmental Response Compensation and Liability Act and the Superfund
Amendments and Reauthorization Act. In Australia, Penford is subject to the
environmental requirements of the Protection of the Environment Operations Act,
the Dangerous Goods Act, the Ozone Protection Act, the Environmentally Hazardous
Chemicals Act, and the Contaminated Land Management Act. In New Zealand, the
Company is subject to the Resource Management Act, the Dangerous Goods Act, the

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Hazardous Substances and New Organisms Act and the Ozone Protection Act. Permits
are required by the various environmental agencies which regulate the Company's
operations. Penford has obtained all necessary environmental permits required
for its operations. Penford's operations are in compliance with applicable
environmental laws and regulations in all material aspects of its business.
Penford estimates that annual compliance costs, excluding operational costs for
emission control devices, wastewater treatment or disposal fees, is $1.7
million.

Penford has adopted and implemented a comprehensive corporate-wide
environmental management program. The program is managed by the Corporate
Director of Environmental, Health and Safety and is designed to structure the
conduct of Penford's business in a safe and fiscally responsible manner that
protects and preserves the health and safety of employees, the communities
surrounding the Company's plants, and the environment. The Company continuously
monitors environmental legislation and regulations, which may affect any of
Penford's operations. See Item 3, Legal Proceedings.

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

PRINCIPAL CUSTOMERS

Penford sells to a variety of customers for applications in foods products,
papermaking, textiles, mining and other industrial uses. The Company has several
relatively large customers in each business segment. However, over the last
three years Penford has had only one customer that exceeded 10% of sales, and
that occurred in fiscal 2001. MeadWestvaco, a customer of the industrial
ingredients business, accounted for approximately 9%, 9% and 10% of total sales
in fiscal 2003, 2002 and 2001, respectively.

COMPETITION

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

EMPLOYEES

At August 31, 2003, Penford had 661 total employees. In North America,
Penford had 377 employees, of which approximately 45% are members of a trade
union. The collective bargaining agreement covering the Cedar Rapids-based
manufacturing workforce expires in August 2004. Penford Australia had 284
employees, of which 64% are members of trade unions in Australia and New
Zealand. These contracts generally have two year terms and were renegotiated in
2002 and now expire in fiscal 2004. Penford expects to successfully renegotiate
these agreements. Penford believes its employee relations are good company-wide.

SALES AND DISTRIBUTION

All sales are generated using a combination of direct sales and distributor
agreements. Penford supports its sales efforts with technical and advisory
assistance with the customers' use of the Company's products. Penford ships its
product promptly upon receipt of purchase orders from its customers and,
consequently, backlog is not significant.

Customers for industrial corn-based starch ingredients purchase products
through fixed-price contracts or formula-priced contracts for periods covering
three months to three years or on a spot basis. In fiscal 2003, approximately
65% of these sales are under fixed price contracts, with 35% representing
formula price and spot business.

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

FOREIGN OPERATIONS AND EXPORT SALES

Penford further expanded into foreign markets with its acquisition of
Penford Australia in September 2000. Penford Australia is the sole producer of
corn starch products in Australia and New Zealand. Competition is from imported
products, except in wheat flour based starches where there is one other producer
in Australia. Starches have the ability to be chemically and physically modified
to meet the wide range of demands (such as viscosity, resistance to arduous
processing conditions and clarity) required by the food industry. Penford
Australia has developed novel starch-based products, as evidenced by patents
obtained for high amylose maize starches for use as dietary fiber. Penford
Australia manufactures products used to enhance the quality of packaged food
products, generally through providing the texture and viscosity required by the
customer for products such as sauces and gravies. Penford Australia's starch
products are also used in industrial applications including mining, paper,
corrugating and building materials. The products used in the mining industry are
specifically used in the flotation process for extracting minerals from finely
ground hard rock ores. The starches assist in this process by selectively
adhering to elements of the ground rock to aid separation in air agitated
flotation cells. The Company's operations in Australia and New Zealand include
three manufacturing facilities for processing specialty corn starches and
wheat-related products. Further information about the acquisition of Penford
Australia and geographic information can be found in Notes 2 and 18 to the
Consolidated Financial Statements.

Export sales from Penford's businesses in the U.S. and Australia/New
Zealand accounted for approximately 22%, 16% and 18% of total sales in fiscal
2003, 2002 and 2001, respectively.

AVAILABLE INFORMATION

Penford's Internet address is www.penx.com. There the Company's provides
free access to Penford's annual report on 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and any amendments to those reports, as soon as
reasonably practicable after such material is filed electronically with, or
furnished to, the Securities and Exchange Commission ("SEC"). The Company's SEC
reports can be accessed through the investor relations section of the Web site.
The information found on Penford's Web site is not part of this or any other
report filed with or furnished to the SEC.

EXECUTIVE OFFICERS OF THE REGISTRANT

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

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Mr. Burns joined Penford in August 2003 as Vice President, Operations and
Supply Chain. From 2002 to August 2003, Mr. Burns was Operations Manager-Central
Area for Kraft Foods, Inc. and from 1996 to 2002 he was the North Area
Manager/Plant Manager for Nabisco, Inc./Kraft Foods. From 1993-1996, Mr. Burns
was the General Manager, Operations for Continental Baking Company, a subsidiary
of Ralston Purina which operated bread bakeries. Prior to 1993, Mr. Burns held
various management and operations positions with Nalley's Fine Foods, a
manufacturer of specialty foods, and Frito-Lay Company, a manufacturer and
marketer of snack foods.

Mr. Cordier joined Penford in July 2002 as Vice President and Chief
Financial Officer. Mr. Cordier was named Corporate Secretary in January 2003. He
came to Penford from Sensient Technologies, a manufacturer of specialty products
for the food, beverage, pharmaceutical and technology industries. He served as
Treasurer from 1995 to 1997 and as Vice President and Treasurer from 1997 to
1999. He completed his term at Sensient as Vice President, Administration from
1999 to 2002. During his tenure at Sensient, he had responsibility for treasury,
investor relations and finance functions. In his different positions, he also
managed other aspects of operations such as engineering, information technology
and marketing. From 1990 to 1995, he was employed in various financial
management positions at International Flavors & Fragrances, a manufacturer of
flavors and fragrances for the food, beverage and cosmetic industries.

Mr. Keeley joined Penford in July 2000 as President of the industrial
ingredients business. Before he joined Penford, he served as Strategic Business
Executive from 1999 to 2000 for Church & Dwight, a producer of sodium
bicarbonate. From 1996 to 1999, he served as Director of Marketing and Sales for
Gen Corp, a technology-based manufacturing company with businesses concentrating
in aerospace and defense, pharmaceutical fine chemicals and automotive. He
started his career with Dow Chemical Company, serving in various management
roles in sales, marketing and business development.

Dr. Kunerth has served as Penford's Chief Science Officer since 2000. From
1997 to 2000, he served in food science research management positions at
Monsanto Company, a provider of agricultural products and integrated solutions
for farmers. Before Monsanto, he was the Vice President of Technology at
Penford's food ingredients business from 1993 to 1997.

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

Mr. Randall has served as Vice President and General Manager of Penford
Food Ingredients since February 2003. Prior to joining Penford, Mr. Randall was
Vice President, Research & Development/Quality Assurance of Griffith
Laboratories, USA, a specialty foods ingredients business, from 1998 to 2003.
From 1993 to 1998, Mr. Randall served in various research and development
positions with KFC Corporation, a quick-service restaurant business, most
recently as Vice President, New Product Development. Prior to 1993 Mr. Randall
served in leadership positions at Romanoff International, Inc., a manufacturer
and marketer of gourmet specialty food products, and at Kraft/General Foods.

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ITEM 2: PROPERTIES

Penford's facilities as of August 31, 2003 are as follows:

Penford's production facilities are strategically located near the sources
of raw materials. The Company believes that facilities are maintained in good
condition and that the capacities of the plants are suitable and sufficient to
meet current production requirements. The Company invests in expansion,
improvement and maintenance of property, plant and equipment as required.

ITEM 3: LEGAL PROCEEDINGS

On November 1, 2000, the Environmental Protection Agency ("EPA") initiated
enforcement action in the grain processing industry for adequacy of emission
permitting and later included a review of excessive levels of volatile organic
compounds in the action. Penford was contacted by the EPA, but was not the
subject of a formal enforcement action, and no assessment was levied.
Discussions with the EPA were satisfactorily closed in fiscal 2003 with no
action being taken against Penford and no assessments levied.

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 2003.

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PART II

ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS

Penford's common stock, $1.00 par value, trades on The Nasdaq Stock Market
under the symbol "PENX." On October 31, 2003, there were 699 shareholders of
record. The high and low closing prices of Penford's common stock during the
last two fiscal years are set forth below. The quotations reflect inter-dealer
prices, without retail mark-up, markdown or commission and may not necessarily
represent actual transactions.

During each quarter of fiscal year 2003 and 2002, the Board of Directors
declared a $0.06 per share cash dividend. On October 29, 2003, the Board of
Directors declared a dividend of $0.06 per common share payable on December 5,
2003 to shareholders of record as of November 14, 2003. On a periodic basis, the
Board of Directors reviews the Company's dividend policy which is impacted by
Penford's earnings, financial condition, and cash and capital requirements.
Future dividend payments are at the discretion of the Board of Directors.
Penford has included the payment of dividends in its planning for fiscal 2004.

In March 2003, the Company sold 650,000 shares of common stock in a private
placement at $11.11 per share to the T. Rowe Price Small-Cap Value Fund.
Proceeds of the sale of $7.2 million were used to reduce debt by $6.8 million
and the majority of the remaining proceeds were used to pay the expenses of the
transaction, including placement fees and professional services fees. The shares
were registered under the Securities Act of 1933 on Form S-3 (File No.
333-104509) which was effective on July 14, 2003.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

The following table provides information regarding Penford's equity
compensation plans at August 31, 2003. The Company has no equity compensation
plans that have not been approved by security holders.

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ITEM 6: SELECTED FINANCIAL DATA

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

(1) Includes a gain of $1.9 million related to the sale of Hi-Maize assets. See
Note 20 to the Consolidated Financial Statements.

(2) Includes pretax charges of approximately $1.4 million related to a strategic
restructuring of business operations and $0.5 million related to the write
off of Penford's 1997 investment in an early stage technology company. See
Notes 14 and 16 to the Consolidated Financial Statements.

(3) Includes a loss on early extinguishment of debt of approximately $1.4
million related to the financing of the Penford Australia Ltd. acquisition.
See Note 14 to the Consolidated Financial Statements.

(4) Includes a pretax charge of approximately $1.6 million related to
restructure costs recorded in connection with an administrative workforce
reduction program.

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD-LOOKING STATEMENTS

The statements contained in this Annual Report on Form 10-K ("Annual
Report") that are not historical facts, including, but not limited to statements
found in the Notes to Consolidated Financial Statements and in Item
1 -- Business and Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations, are forward-looking statements that
represent management's beliefs and assumptions based on currently available
information. Forward-looking statements can be identified by the use of words
such as "believes," "may," "will," "looks," "should," "could," "anticipates,"
"expects," or comparable terminology or by discussions of strategies or trends.

Although the Company believes that the expectations reflected in such
forward-looking statements are reasonable, it cannot give any assurances that
these expectations will prove to be correct. Such statements by their nature
involve substantial risks and uncertainties that could significantly affect
expected results. Actual future results could differ materially from those
described in such forward-looking statements, and the Company disclaims any
intention or obligation to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. Among the
factors that could cause actual results to differ materially are the risks and
uncertainties discussed in this Annual Report, including those referenced above,
and those

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described from time to time in other filings with the Securities and Exchange
Commission which include, but are not limited to, competition; the possibility
of interruption of business activities due to equipment problems, accidents,
strikes, weather or other factors; product development risk; changes in corn and
other raw material prices and availability; changes in general economic
conditions or developments with respect to specific industries or customers
affecting demand for the Company's products including unfavorable shifts in
product mix; unanticipated costs, expenses or third party claims; the risk that
results may be affected by construction delays, cost overruns, technical
difficulties, nonperformance by contractors or changes in capital improvement
project requirements or specifications; interest rate and energy cost
volatility; foreign currency exchange rate fluctuations; or other unforeseen
developments in the industries in which Penford operates.

RESULTS OF OPERATIONS

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

FISCAL 2003 COMPARED TO FISCAL 2002

Industrial Ingredients -- North America

Sales in the industrial ingredients business rose 12% in 2003, a result of
higher sales volumes trends from the second half of fiscal 2002 that continued
into 2003. Sales volume increases contributed 9% to the increase in revenues
while improvements in pricing and product mix added an additional 3%. The
outlook for the paper-making industry in the U.S., the primary market for
Penford's industrial products remains soft.

Gross margin declined to 15.5% of sales in fiscal 2003 from 16.1% last year
primarily due to the rising cost of natural gas, which is used in drying
industrial starches. Increased natural gas prices reduced gross margin by $2.8
million and by 200 basis points as a percent of sales. Penford expects that the
unfavorable effects of increasing gas costs will continue into fiscal 2004.

Income from operations improved over fiscal year 2002 due to an increase in
gross margin of $1.5 million offset by a $1.0 million increase in operating
expenses. The increase in operating expenses was due to increases in salaries
and benefits, including a $0.3 million increase in pension expense.

Food Ingredients -- North America

Sales increased 3% over fiscal 2002, driven by a 7% increase in volumes
offset by a 4% deterioration in the product mix. The gross margin for fiscal
2003 declined by 260 basis points to 28.2%, primarily due to the soft

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demand for Penford's higher margin potato coatings which are used in
applications in the quick-service restaurant business.

The decrease in operating income is due to the decline in gross margin of
$0.8 million offset by a $0.2 million reduction in total operating expenses.
Operating expenses decreased primarily due to headcount reductions in research
and development.

Australia/New Zealand Operations

Reported sales rose 25% in 2003, primarily due to a strong Australian
dollar which increased revenue by 17%. Higher volumes increased sales by 4% and
gains in pricing and improvements in product mix added 4% to sales.

Margins deteriorated in 2003 primarily because grain prices increased due
to a severe drought in the region. Increased grain prices reduced gross margin
by $2.8 million and by 350 basis points as a percent of sales. Income from
operations was comparable to the prior year as the effects of stronger currency
translation were largely offset by the increase in grain prices.

Corporate Operating Expenses

Corporate operating expenses increased to $6.6 million in fiscal 2003 from
$5.7 million in fiscal 2002. During the first quarter of fiscal 2003, the
Company incurred increased compensation expense of approximately $0.8 million
for both current and outgoing officers of the Company. The compensation expense
for outgoing officers ceased at the end of the first quarter of fiscal 2003 as
these officers left the Company at that time.

Restructuring Costs

In the second quarter of fiscal 2002, the Company announced a strategic
restructuring of its business operations, including the relocation of its
headquarters from the State of Washington to Colorado. During the second quarter
of 2002, the Company recorded restructuring costs totaling $1.4 million
primarily related to severance and other exit activity expenses which are
included in income from operations. During fiscal 2003, the Company settled its
lease obligations and other exit activity expenses for less cost that had been
expected, and therefore, adjusted the restructuring reserve by $0.2 million.
Restructuring costs are shown separately in the Consolidated Statements of
Operations. See Note 16 to the Consolidated Financial Statements.

FISCAL 2002 COMPARED TO FISCAL 2001

Industrial Ingredients -- North America

12

Sales in the industrial ingredients business declined 1% in 2002, a result
of lower sales volumes trends from 2001 that continued into 2002. In the latter
half of 2002, volumes began to improve as customer demand improved and sales
volumes increased slightly over the prior year.

Gross margin improved in 2002 to 16.1% from 13.8% primarily due to the
decline in natural gas prices. Natural gas is the primary energy source for the
plants that produce industrial products. Lower volumes were partly offset by
lower prices on other raw materials inputs.

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

Food Ingredients -- North America

Sales increased 2% over fiscal 2001. Penford experienced an increase in
sales to a new global food service customer, primarily for French fry coatings.
The contract, implemented part way through fiscal 2001, was in place for a full
year for 2002. However, sales to other French fry coatings customers declined,
largely offsetting the positive impact of the new contract.

Gross margin did not change significantly from 2001. Income from operations
declined $0.5 million from 2001 due to a $0.6 million increase in research and
development costs.

Australia/New Zealand Operations

Reported sales increased 12% in 2002. This is due primarily to the
inclusion of only eleven months of operations in 2001 versus a full year for
2002 because of the September 29, 2000 acquisition date. Proforma sales assuming
twelve months of 2001 were comparable to 2002. Volumes increased, offsetting the
impact on reported sales of an unfavorable product mix shift. Volumes decreased
in two of the most profitable products in 2002 while increasing in several lower
margin products.

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

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

13

Corporate Operating Expenses

Corporate operating expenses decreased to $5.7 million from $5.9 million in
2001. Increases in personnel and recruiting costs of approximately $0.7 million
incurred in connection with hiring new corporate staff were offset by decreases
of $0.8 million in other corporate operating expenses. In 2001, the Company
incurred $0.3 million in legal and tax consulting costs which did not recur in
2002.

Restructuring Costs

In the second quarter of fiscal 2002, the Company announced a strategic
restructuring of its business operations, including the relocation of its
headquarters from the State of Washington to Colorado. During the second quarter
of 2002, the Company recorded restructuring costs totaling $1.4 million
primarily related to severance and other exit activity expenses. See Note 16 to
the Consolidated Financial Statements.

NON-OPERATING INCOME (EXPENSE)

Other non-operating income (expense) consists of the following:

In the first quarter of fiscal 2003, the Company sold certain assets of its
resistant starch Hi-maize business to National Starch Corporation ("National
Starch"). The Company recorded a $1.9 million gain on the sale of these assets.
The Company also licensed to National Starch the exclusive rights to its
resistant starch intellectual property portfolio 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 royalty agreement. In
addition, the Company will receive annual royalties for a period of seven years
or until a maximum of $11.0 million in royalties has been received by Penford.
The royalty payments are subject to a minimum of $7 million over the first five
years of the licensing agreement. The Company recognized $1.2 million in income
during fiscal 2003 related to the licensing fee and royalties.

In 2001, Penford invested in an early-stage technology company in the
business of developing data analytics software applications. Penford accounted
for its investment on the cost method. In 2002, with the continuing slowdown in
the technology business sector, Penford undertook an assessment of the fair
value of its investment. Penford considered a number of factors, including the
financial health and prospects of the investee, the prospects for receiving a
future return on Penford's investment, the adverse changes in the funding
environment for technology companies and the lack of marketability for the
investment. The assessment indicated that it was unlikely that Penford would
recover any of its then existing carrying amount and that an other than
temporary decline in the fair value of its investment had occurred. Penford
recorded an impairment charge of $0.5 million related to the complete write-off
of this investment.

In fiscal 2001, the Company incurred other charges of $533,000 for
transaction costs related to terminated joint venture discussions.

In fiscal 2001, the Company paid its private placement debt facilities
early in connection with a comprehensive refinancing to fund the acquisition of
Penford Australia. The early repayment of the debt required prepayment fees,
which resulted in a loss on early extinguishment of debt of $1.4 million. This
loss was

14

previously reported as an extraordinary item, net of tax in the Consolidated
Statements of Operations. Effective September 1, 2002, Penford adopted Statement
of Financial Accounting Standards ("SFAS") No. 145 which, among other things,
eliminated the requirement that all gains and losses from the early
extinguishment of debt were to be classified as an extraordinary item. Upon
adoption of SFAS No. 145, gains and losses from the early extinguishment of debt
are classified as an extraordinary item only if they meet the "unusual and
infrequent" criteria contain in Accounting Principles Board Opinion No. 30. In
addition, upon adoption of SFAS No. 145, all gains and losses from the early
extinguishment of debt that had previously been classified as an extraordinary
item are to be reassessed to determine if they would have met the "unusual and
infrequent" criteria. The Company has concluded that the previously recognized
loss on early extinguishment of debt in fiscal 2001 would not have met the
criteria for classification as an extraordinary item, and accordingly such loss
has been reclassified and reported as a component of income before extraordinary
item. This reclassification had no effect on the Company's reported net income
in fiscal 2001.

INTEREST AND TAXES

Interest expense was $5.5 million, $7.1 million and $10.2 million in 2003,
2002 and 2001, respectively. All of the Company's debt has variable interest
rates. The decline in interest expense over the last three years was driven by a
decrease in market interest rates and lower average debt balances.

The effective tax rate for 2003 was lower than the overall U.S. federal
statutory rate of 34% due to the benefits of the foreign sales corporation and
research and development tax credits. As discussed above, during fiscal 2003,
Penford recorded a $1.9 million gain on the sale of certain assets of its
Hi-maize business. Penford determined that, due to changes in Australian tax
legislation, no income taxes would be payable related to this gain and
accordingly, no income taxes have been provided on this gain See Notes 15 and 20
to the Consolidated Financial Statements.

The effective tax rate for 2002 was lower than the overall statutory rate
of 34% due to the benefits of the foreign sales corporation and research and
development tax credits. The effective rate for 2001 was higher than the
statutory rates due to state taxes and nondeductible goodwill amortization. See
Note 15 to the Consolidated Financial Statements.

ACQUISITION OF PENFORD AUSTRALIA

On September 29, 2000, the Company acquired Penford Australia for $54.2
million in cash, plus transaction costs of $1.7 million. Penford Australia is
the sole producer of corn starch products in Australia and New Zealand.
Competition is from imported products, except in wheat flour based starches
where there is one other producer in Australia.

The acquisition was recorded using the purchase method of accounting.
Accordingly, a portion of the purchase price was allocated to net tangible and
intangible assets acquired based on their estimated fair values. The balance of
the purchase price was recorded as goodwill. See Note 2 to the Consolidated
Financial Statements. Eleven months of Penford Australia's results of
operations, from the September 29, 2000 date of acquisition, are included in the
consolidated financial statements for the year ended August 31, 2001.

LIQUIDITY AND CAPITAL RESOURCES

At August 31, 2003, Penford had working capital of $42.0 million, excluding
current portion of debt, and $57.1 million outstanding under its revolving
credit and inventory financing credit facilities.

Cash flow from operations was $26.5 million, $25.4 million and $13.9
million in fiscal 2003, 2002 and 2001, respectively. The increase in operating
cash flows in 2002 over 2001 is due primarily to favorable changes in working
capital and improved profitability.

Capital expenditures were $8.8 million, $7.4 million and $12.3 million in
fiscal 2003, 2002 and 2001, respectively. In the past two years, capital
expenditures have been constrained by the limitations of the financial covenants
in the Company's then existing credit agreement. In fiscal 2004, subsequent to
the refinancing

15

discussed below, Penford expects to spend approximately $16 million for capital
projects, primarily for growth opportunities and to improve asset utilization.

Penford maintains two defined benefit pension plans in the U.S. In the last
three years, the value of the plans' assets has decreased primarily due to poor
performance from equity securities. The combination of negative actual
investment returns and declining discount rates have increased the Company's
underfunded plan status (plan assets compared to benefit obligations). Based on
the current underfunded status of the plans and the actuarial assumptions being
used for 2004, Penford estimates that it will be required to make minimum
contributions to the pension plans of $1.8 million during fiscal 2004 and $3.0
million during fiscal 2005.

Penford made term loan payments totaling $25.6 million during fiscal 2003.
The Company was required to use the net cash proceeds from the National Starch
transactions and the sale of common stock to reduce debt. The term loan payments
during fiscal 2003 included $4.1 million and $6.8 million related to the
National Starch transactions and the sale of common stock, respectively.

On October 7, 2003, Penford replaced its existing secured credit and
inventory financing credit facilities with a new $105 million secured credit
facility with a group of U.S. and Australian banks. The credit facility consists
of $50 million in term loans and $55 million in revolving lines of credit. The
revolving lines of credit expire on October 7, 2006 and the term loans expire on
October 7, 2008. Interest rates under the new credit facility are based on
either the London Interbank Offered Rates ("Libor") (or the Australian Bank Bill
Rate equivalent) or the prime rate, depending on the selection of borrowing
options. All of Penford's assets secure the credit facility and the new
agreement includes, among other things, financial covenants with limitations on
indebtedness and capital expenditures and maintenance of fixed charge and
leverage ratios. On October 7, 2003, Penford had approximately $21 million of
borrowing availability under its revolving lines of credit. The Company's debt
maturities at August 31, 2003 have been classified in the Consolidated Balance
Sheets in accordance with the repayment terms of the new bank financing.

In fiscal 2003, Penford paid dividends on its common stock of $1.9 million
at a quarterly rate of $0.06 per share. On October 29, 2003, the Board of
Directors declared a dividend of $0.06 per common share payable on December 5,
2003 to shareholders of record as of November 14, 2003. On a periodic basis, the
Board of Directors reviews the Company's dividend policy which is impacted by
the Company's earnings, financial condition and cash and capital requirements.
Future dividend payments are at the discretion of the Board of Directors.
Penford has included the continuation of quarterly dividends in the planning for
fiscal 2004.

The Company expects to generate sufficient cash from operations and to have
sufficient borrowing capacity and ability to fund its cash requirements during
fiscal 2004.

The Board of Directors has authorized a stock repurchase program for the
purchase of up to 500,000 shares of Penford's outstanding common stock.
Repurchases under the program to date have totaled 281,300 shares for $4.3
million in prior years. The Company did not purchase any of its common stock
during the last three fiscal years, and does not expect to do so in fiscal 2004.

CRITICAL ACCOUNTING POLICIES

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

In many cases, the accounting treatment of a particular transaction is
significantly dictated by generally accepted accounting principles and does not
require judgment or estimates. There are also areas in which management's
judgments in selecting among available alternatives would not produce a
materially different result. Management has reviewed the accounting policies and
related disclosures with the Audit committee. The notes to the consolidated
financial statements contain a summary of the Company's accounting policies.

16

However, the accounting policies that management believes are the most important
to the financial statements and that require the most difficult, subjective and
complex judgments include the following:

- Evaluation of the allowance for doubtful accounts receivable

- Hedging activities

- Benefit plans

- Valuation of goodwill

A description of each of these follows:

EVALUATION OF THE ALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE

Management makes judgments about the Company's ability to collect
outstanding receivables and provide allowances for the portion of receivables
that the Company may not be able to collect. Penford records an estimate of
accounts that will not be collected based upon a specific review of larger
accounts. For those accounts not specifically reviewed, Penford estimates
uncollectible amounts based on the age of the receivable compared to the terms
offered. If the estimates do not reflect the Company's future ability to collect
outstanding invoices, Penford may experience losses in excess of the reserves
established. At August 31, 2003 and 2002 the allowance for doubtful accounts
receivable was $538,000 and $345,000, respectively. The majority of the
allowance is related to the industrial ingredients business, and reflects the
economic downturn in the paper making industry.

HEDGING ACTIVITIES

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

The requirements for the designation of hedges are very complex, and
require judgments and analysis to qualify as hedges as defined by SFAS 133.
These judgments and analysis include an assessment that the derivative
instruments used are effective hedges of the underlying risks. If the Company
were to fail to meet the requirements of SFAS 133, or if these derivative
instruments are not designated as hedges, the Company would be required to mark
these contracts to market at each reporting date. Penford had deferred losses of
$431,000 at August 31, 2003 and a gain of $169,000 at August 31, 2002, which are
reflected in accumulated other comprehensive income (loss) in both years.

BENEFIT PLANS

Penford has stock option plans for its employees and directors. Because the
Company grants options to employees at the market price on date of grant,
Penford follows the policy of recording no compensation expense for those option
grants. An alternative financial reporting standard, SFAS 123, provides a
methodology for estimating the hypothetical compensation expense associated with
stock option grants, which expense is then amortized over the vesting period. As
required by SFAS 123, the Company has disclosed the pro forma impact of this
alternative accounting treatment in Note 1 to the Consolidated Financial
Statements.

Penford has defined benefit plans for its employees providing retirement
benefits and coverage for retiree health care. Qualified actuaries determine the
estimated cost of these plans annually. These actuarial estimates are based on
assumptions of the discount rate used to calculate the present value of future
payments, the expected investment return on plan assets, the estimate of future
increases in compensation rates and the estimate of increases in the cost of
medical care. The Company makes judgments about these assumptions based on
historical investment results and experience as well as available historical
market data and trends. However, if these assumptions are wrong, it could
materially affect the amounts reported in the financial statements. Disclosure
about these estimates and assumptions are included in Note 12 to the
Consolidated Financial Statements. See "Defined Benefit Plans" in this Item 7.

17

VALUATION OF GOODWILL

Penford is required to assess whether the value of goodwill reported on the
balance sheet has been impaired on an annual basis, or more often if conditions
exist that indicate that there might be an impairment. These assessments require
extensive and subjective judgments to assess the fair value of goodwill. While
the Company engages qualified valuation experts to assist in this process, their
work is based on the Company's estimates of future operating results and
allocation of goodwill to the business units. If future operating results differ
materially from the estimates, the value of goodwill could be adversely
impacted. See Note 6 to the Consolidated Financial Statements.

CONTRACTUAL OBLIGATIONS

As more fully described in Notes 7 and 10 to the Consolidated Financial
Statements, the Company is a party to various debt and lease agreements at
August 31, 2003 that contractually commit the Company to pay certain amounts in
the future.

Subsequent to August 31, 2003, Penford obtained bank financing on a
long-term basis for the purpose of refinancing its short-term obligations under
its existing secured credit and inventory financing credit facilities.
Accordingly, the contractual commitments below are presented in accordance with
the repayment terms of the new bank financing.

The following table summarizes such contractual commitments:

DEFINED BENEFIT PENSION PLANS

Penford maintains two defined benefit pension plans in the U.S.

The most significant assumptions used to determine pension expense and
pension obligations are the discount rate and the expected return on assets
assumption. The discount rate used by Penford in determining pension expense and
pension obligations is based on a review of high quality (Baa to Aaa) corporate
annualized bond yields (maturities of 20 or more years) and 30-year U.S.
Treasury rates.

The expected long-term return on assets assumption used in determining
pension expense is based on Penford's evaluation of historical market rates of
return and asset class return expectations. Penford's independent actuaries
provided the Company with projected returns, which were forward-looking, were
not based on historical returns and considered returns from active management
and fees paid from the plans. See Note 12 to the Consolidated Financial
Statements for the assumptions used by Penford.

Penford recorded pension expense (income) of $1.2 million, $0.2 million and
$(0.8) million in 2003, 2002 and 2001, respectively. Penford expects pension
expense to be approximately $1.7 million in fiscal 2004. The Company made no
cash contributions to the pension plans during fiscal 2002 or 2001. Cash
contributions of $0.3 million were made to the plans in fiscal 2003. Penford
estimates that it will be required to make minimum contributions to the pension
plans of $1.8 million during fiscal 2004 and $3.0 million during fiscal 2005.

The expected return on assets assumption was reduced by 1% to 9% for
pension expense for fiscal 2003. A 0.5% decrease (increase) in the expected
return on assets assumption would increase (decrease) pension expense by
approximately $0.1 million based on the plans' assets at August 31, 2003.

The discount rate used to determine pension expense reflects the decline in
bond yields over the past several years. Penford has lowered its discount rate
from 7.5% in fiscal 2003 to 6.4% for fiscal 2004. Lowering the discount rate by
0.25% would increase pension expense by approximately $0.1 million. Penford
bases its determination of pension expense on the fair value of plan assets as
well as the expected long-term return on

18

those assets. The difference between actual investment earnings and those
assumed is recognized in pension expense through amortization over the expected
future working lifetime of active employees. As of August 31, 2003, unrecognized
losses from all sources (assets and liabilities) were $8.0 million. The
estimated increase in future expense as a result of the amortization of these
losses is approximately $0.4 million.

RECENT ACCOUNTING PRONOUNCEMENTS

Effective September 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets." SFAS No. 144, which supercedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of," retains the fundamental provisions with respect to the recognition and
measurement of long-lived asset impairment but does not apply to goodwill and
other intangible assets. However, SFAS No. 144 provides expanded guidance with
respect to appropriate cash flows to be used to determine whether recognition of
any long-lived asset impairment is required, and if required, how to measure the
amount of the impairment. SFAS No. 144 also requires that any net assets to be
disposed of by sale be reported at the lower of carrying value or fair value
less cost to sell, and expands the reporting of discontinued operations. The
adoption of SFAS No. 144 had no effect on the Company's results of operations,
financial position or liquidity.

Effective September 1, 2002, the Company adopted SFAS No. 145, "Recission
of Financial Accounting Standards Board ("FASB") Statement No. 4, 44, and 62,
Amendment of FASB Statement No. 13, and Technical Corrections." Among other
things, this statement rescinds SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt," which requires all gains and losses from
extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations --
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions" ("APB No. 30") will
now be used to classify those gains and losses. The Company has concluded that
the previously recognized loss on early extinguishment of debt in fiscal 2001
would not have met the criteria for classification as an extraordinary item, and
accordingly such loss has been reclassified and reported as a component of
income before extraordinary item. This reclassification had no effect on the
Company's reported net income in fiscal 2001.

Effective January 1, 2003, the Company adopted SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires
that a liability for costs associated with exit or disposal activities be
recognized and measured initially at fair value only when the liability is
incurred. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The adoption of SFAS No. 146 did not have an
effect on the Company's financial position, results of operations or liquidity.

Effective December 1, 2002, the Company adopted FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN No. 45"). FIN No. 45
requires certain disclosures to be made by a guarantor effective for interim and
annual periods ending after December 15, 2002. FIN No. 45 also requires the
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation relating to the guarantee. The initial recognition
and measurement provisions of FIN No. 45 are applicable on a prospective basis
to guarantees issued or modified after December 31, 2002. The Company has no
guarantees which are subject to the recognition and measurement provisions of
FIN No. 45. The adoption of FIN No. 45 had no effect on the Company's reported
financial position, results of operations or liquidity. See Note 7 for
disclosure of parent company guarantee of subsidiary debt to a third party.

Effective March 1, 2003, the Company adopted the disclosure alternative
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," as
amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition
and Disclosure." The Company will continue to account for its stock-based
employee compensation related to stock options under the intrinsic value
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees" and its various interpretations. SFAS No. 148
requires prominent disclosure of the method used to account for stock-based
employee compensation, the amount of employee stock-based compensation cost
included in reported net income, and pro forma net

19

income and earnings per share as if the fair value recognition provisions of
SFAS No. 123 had been adopted. The adoption of SFAS No. 148 did not have an
effect on the Company's reported financial position, results of operations or
liquidity. See Note 1 to the Consolidated Financial Statements for the
disclosures required by SFAS No. 148.

In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51" ("FIN No. 46").
FIN No. 46 requires certain variable interest entities ("VIEs") to be
consolidated by the primary beneficiary of the entity if the equity investors in
the entity do not have the characteristics of a controlling financial interest
or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN No. 46 is effective for all new VIEs created or acquired after January 31,
2003. For VIEs created or acquired prior to February 1, 2003, the provisions of
FIN No. 46 must be applied for the first interim or annual period beginning
after June 15, 2003. The Company has not invested in any VIEs.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The Company adopted SFAS No. 149 effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003. There was no impact on the Company's results of operations,
financial position or liquidity from the adoption of SFAS No. 149.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 requires that certain financial instruments, which under previous
guidance were accounted for as equity, must now be accounted for as liabilities.
The financial instruments affected include mandatorily redeemable stock, certain
financial instruments that require or may require the issuer to buy back some of
its shares in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003 and must be applied to
existing financial instruments effective with the beginning of the first fiscal
period after June 15, 2003. The Company has no financial instruments within the
scope of SFAS No. 150.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS

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

INTEREST RATE RISK

The Company's exposure to market risk for changes in interest rates relates
to its variable-rate borrowings. All of Penford's long-term debt has variable
interest rates, which are set for periods of one to six months. The Company has
managed interest rates using interest rate swaps in the past, but there are no
such instruments outstanding as of August 31, 2003. If market interest rates for
the Company's debt had averaged 1% more than they did in fiscal 2003, the
Company's 2003 interest expense would have increased, and income before taxes
would have decreased by $0.9 million.

FOREIGN CURRENCY EXCHANGE RATES

The Company has U.S.-Australian and Australian-New Zealand dollar currency
exchange rate risks due to revenues and costs denominated in Australian and New
Zealand dollars with the Company's foreign operation, Penford Australia.
Currently, cash generated by Penford Australia's operations is used for capital
investment in

20

Australia and payment of debt denominated in Australian dollars. At August 31,
2003, approximately 31% of total debt was denominated in Australian dollars.

The Company has not maintained any derivative instruments to mitigate the
U.S.-Australian dollar currency exchange translation exposure. This position is
reviewed periodically, and based on the Company's review, may result in the
incorporation of derivative instruments in the Company's hedging strategy. The
currency exchange rate risk between Penford's Australian and New Zealand
operations is not significant. The impact of a 10% change in the foreign
currency exchange rates compared with the U.S. dollar would not have a
significant impact on reported net income for the year ended August 31, 2003.

From time to time, Penford enters into foreign exchange forward contracts
to manage exposure to receivables and payables denominated in currencies
different from the functional currencies of the selling entities. As of August
31, 2003, Penford did not have any foreign exchange forward contracts
outstanding. At that date, the Company had trade receivables of U.S. $0.6
million at Penford Australia.

COMMODITIES

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

Penford's net corn position in the U.S. consists primarily of inventories,
purchase contracts and exchange traded futures and options contracts that hedge
Penford's exposure to commodity price fluctuations. The fair value of the
position is based on quoted market prices. The Company has estimated its market
risk as the potential loss in fair value resulting from a hypothetical 10%
adverse change in prices. As of August 31, 2003 and 2002, the fair value of the
Company's net corn position was approximately $2.5 million and $0.2 million,
respectively. The market risk associated with a 10% adverse change in corn
prices at August 31, 2003 and 2002, is estimated at $250,000 and $21,000,
respectively.

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

Penford's exchange traded futures and options contracts hedge production
requirements. The fair value of these contracts is based on quoted market
prices. The Company has estimated its market risk as the potential loss in fair
value resulting from a hypothetical 10% adverse change in prices. As of August
31, 2003 and 2002, the fair value of the natural gas contracts was a loss of
approximately $0.7 million and $0.5 million, respectively. The market risk
associated with a 10% adverse change in natural gas prices at August 31, 2003
and 2002 is estimated at $66,000 and $45,000, respectively.

21

ITEM 8: PENFORD CORPORATION CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

22

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these statements.
23

CONSOLIDATED STATEMENTS OF OPERATIONS

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

The accompanying notes are an integral part of these statements.
24

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these statements.
25

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

The accompanying notes are an integral part of these statements.
26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS

Penford Corporation ("Penford" or the "Company") is a developer,
manufacturer and marketer of specialty natural-based ingredient systems for
industrial and food ingredient applications. The Company operates manufacturing
facilities in the United States, Australia, and New Zealand. Penford's products
provide binding and film-forming characteristics that improve customer's
products through convenient and cost-effective solutions made from renewable
sources. Sales of the Company's products are generated using a combination of
direct sales and distributor agreements.

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

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

BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of
Penford and its wholly owned subsidiaries. All material intercompany balances
and transactions have been eliminated. Certain prior period amounts have been
reclassified to conform with the current period presentation.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Actual results may
differ from previously estimated amounts.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of cash and temporary investments with
maturities of less than three months when purchased. Amounts are reported in the
balance sheets at cost, which approximates market value.

ALLOWANCE FOR DOUBTFUL ACCOUNTS AND CONCENTRATION OF CREDIT RISK

The allowance for doubtful accounts reflects the Company's best estimate of
probable losses in the accounts receivable balances. The Company determines the
allowances based on historical experience, known troubled accounts and ongoing
credit evaluations of its customers. Activity in the allowance for doubtful
accounts for fiscal 2003, 2002 and 2001 is as follows:

27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In 2001, there were write-offs of receivables of approximately $287,000 due
to bankruptcies in the customer base in the industrial ingredients and food
ingredients businesses. As a result of the write-offs in 2001, additional
allowances of approximately $288,000 were provided.

Approximately half of the Company's sales in fiscal 2003 were made to
customers who operate in the North American paper industry. This industry has
suffered an economic downturn, which has resulted in the closure of a number of
smaller mills. To date, the Company has not experienced any significant credit
losses as a result of these economic conditions.

FINANCIAL INSTRUMENTS

The carrying value of financial instruments including cash and cash
equivalents, receivables, payables and accrued liabilities approximates fair
value because of their short maturities. The Company's bank debt reprices with
changes in market interest rates and, accordingly, the carrying amount of such
debt approximates market value.

INVENTORIES

Inventory is stated at the lower of cost or market. Inventory is valued
using the first-in, first-out ("FIFO") method, which approximates actual cost.
Capitalized costs include materials, labor and manufacturing overhead related to
the purchase and production of inventories.

GOODWILL AND OTHER INTANGIBLE ASSETS

Beginning in fiscal 2002, with the adoption of Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets,"
goodwill is no longer amortized, but instead tested for impairment at least
annually. Prior to fiscal 2002, goodwill was amortized using the straight-line
method over its estimated period of benefit of 20 years.

Patents are amortized using the straight-line method over their estimated
period of benefit. At August 31, 2003, the weighted average remaining
amortization period for patents is 11 years. Intangible pension assets are not
being amortized. Penford has no intangible assets with indefinite lives.

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 expense assuming average useful
lives of three to forty years for financial reporting purposes. Depreciation of
$16,626,000, $17,116,000 and $17,002,000 was expensed in 2003, 2002 and 2001,
respectively. For income tax purposes, the Company generally uses accelerated
depreciation methods.

Interest is capitalized on major construction projects while in progress.
No interest was capitalized in 2003 and 2002, and $120,000 was capitalized in
2001.

INCOME TAXES

The provision for income taxes includes federal, state, and foreign taxes
currently payable and deferred income taxes arising from temporary differences
between financial and income tax reporting methods. Deferred taxes are recorded
using the liability method in recognition of these temporary differences.

REVENUE RECOGNITION

Revenue from sales of products and shipping and handling revenue are
recognized at the time goods are shipped, and title transfers to the customer.
Costs associated with shipping and handling are included in cost of sales.

28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

RESEARCH AND DEVELOPMENT

Research and development costs are expensed as incurred, except for costs
of patents, which are capitalized and amortized over the life of the patents.
Research and development costs expensed were $5.4 million, $6.0 million and $5.9
million in fiscal 2003, 2002 and 2001, respectively. Patent costs of $221,000,
$236,000 and $123,000 were capitalized in 2003, 2002 and 2001, respectively.

FOREIGN CURRENCY TRANSLATION

Assets and liabilities of subsidiaries whose functional currency is deemed
to be other than the U.S. dollar are translated at year end rates of exchange.
Resulting translation adjustments are accumulated in the currency translation
adjustments component of other comprehensive income. Income statement amounts
are translated at average exchange rates prevailing during the year.

DERIVATIVES

For derivative instruments designated as fair value hedges, the gain or
loss on the derivative instruments as well as the offsetting loss or gain on the
hedged firm commitments are recognized in current earnings. For derivative
instruments designated as cash flow hedges, the effective portion of the gain or
loss on the derivative instruments is reported as a component of other
comprehensive income, net of applicable income taxes, and recognized in earnings
in the period when the finished goods produced from the hedged item are sold.

SIGNIFICANT CUSTOMER AND EXPORT SALES

Sales to a customer, Meadwestvaco, comprised approximately 9%, 9% and 10%
of consolidated sales in fiscal 2003, 2002 and 2001, respectively. Export sales
accounted for approximately 22%, 16% and 18% of consolidated sales in fiscal
2003, 2002 and 2001, respectively.

STOCK-BASED COMPENSATION

Effective March 1, 2003, the Company adopted the disclosure alternative
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," as
amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition
and Disclosure." The Company will continue to account for its stock-based
employee compensation related to stock options under the intrinsic value
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees" and its various interpretations. SFAS No. 148
requires prominent disclosure of the method used to account for stock-based
employee compensation, the amount of employee stock-based compensation cost
included in reported net income, and pro forma net income and earnings per share
as if the fair value recognition provisions of SFAS No. 123 had been adopted.
The adoption of SFAS No. 148 did not have an effect on the Company's reported
financial position, results of operations or liquidity.

The Company uses the intrinsic-value method to record expense for stock
options. Accordingly, no compensation expense has been recognized for the
stock-based compensation plans other than for the Directors' Plan and restricted
stock awards.

The fair value of each option grant was estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions for fiscal
2003: risk-free interest rates of 1.2% to 4.4%; expected option life of each
vesting increment of 2.7 years for employees and 2.2 years for non-employee
directors; expected volatility of 61%; and expected dividends of $0.24 per
share. The weighted average fair value of options granted under the 1994 Plan
during fiscal years 2003, 2002 and 2001 was $7.09, $7.54 and 7.48, respectively.
The weighted average fair value of options granted under the Directors' Plan
during fiscal years 2003, 2002 and 2001 was $6.68, $5.56 and $8.85,
respectively.

29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table illustrates the effect on net income and earnings per
share if the Company had elected to recognize compensation expense consistent
with the provisions prescribed in SFAS No. 123:

Under SFAS No. 123, compensation expense is measured at the grant date
based on the value of the award and is recognized over the vesting period. The
effect of applying SFAS No. 123 for providing pro forma disclosures for the
fiscal 2003, 2002 and 2001 is not likely to be representative of the effects in
future years because the amounts above reflect compensation expense for options
granted in those and prior periods. Options are generally awarded annually and
the number and value of these options will affect the pro forma compensation
expense and earnings per share disclosures in future periods.

RECENT ACCOUNTING PRONOUNCEMENTS

Effective September 1, 2002, the Company adopted SFAS No. 144, "Accounting
for Impairment or Disposal of Long-Lived Assets." SFAS No. 144, which supercedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," retains the fundamental provisions with
respect to the recognition and measurement of long-lived asset impairment but
does not apply to goodwill and other intangible assets. However, SFAS No. 144
provides expanded guidance with respect to appropriate cash flows to be used to
determine whether recognition of any long-lived asset impairment is required,
and if required, how to measure the amount of the impairment. SFAS No. 144 also
requires that any net assets to be disposed of by sale be reported at the lower
of carrying value or fair value less cost to sell, and expands the reporting of
discontinued operations. The adoption of SFAS No. 144 had no effect on the
Company's results of operations, financial position or liquidity.

Effective September 1, 2002, Penford adopted SFAS No. 145, "Recission of
Financial Accounting Standards Board Statement No. 4, 44 and 62, Amendment of
FASB Statement No. 13, and Technical Corrections" ("SFAS No. 145") which, among
other things, eliminated the requirement that all gains and losses from the
early extinguishment of debt were to be classified as an extraordinary item.
Upon adoption of SFAS No. 145, gains and losses from the early extinguishment of
debt are now classified as an extraordinary item only if they meet the "unusual
and infrequent" criteria contained in Accounting Principles Board Opinion No.
30. In addition, upon adoption of SFAS No. 145, all gains and losses from the
early extinguishment of debt that had previously been classified as an
extraordinary item are to be reassessed to determine if they would have met the
"unusual and infrequent" criteria. The Company has concluded that the previously
recognized loss on early extinguishment of debt in fiscal 2001 would not have
met the criteria for classification as an extraordinary item, and accordingly
such loss has been reclassified and reported as a component of income before
extraordinary item. This reclassification had no effect on the Company's
reported net income in fiscal 2001.

30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Effective January 1, 2003, the Company adopted SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires
that a liability for costs associated with exit or disposal activities be
recognized and measured initially at fair value only when the liability is
incurred. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The adoption of SFAS No. 146 did not have an
effect on the Company's financial position, results of operations or liquidity.

Effective December 1, 2002, the Company adopted FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN No. 45"). FIN No. 45
requires certain disclosures to be made by a guarantor effective for interim and
annual periods ending after December 15, 2002. FIN No. 45 also requires the
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation relating to the guarantee. The initial recognition
and measurement provisions of FIN No. 45 are applicable on a prospective basis
to guarantees issued or modified after December 31, 2002. The Company has no
guarantees which are subject to the recognition and measurement provisions of
FIN No. 45. The adoption of FIN No. 45 had no effect on the Company's reported
financial position, results of operations or liquidity. See Note 7 for
disclosure of parent company guarantee of subsidiary debt to a third party.

In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51" ("FIN No. 46").
FIN No. 46 requires certain variable interest entities ("VIEs") to be
consolidated by the primary beneficiary of the entity if the equity investors in
the entity do not have the characteristics of a controlling financial interest
or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN No. 46 is effective for all new VIEs created or acquired after January 31,
2003. For VIEs created or acquired prior to February 1, 2003, the provisions of
FIN No. 46 must be applied for the first interim or annual period beginning
after June 15, 2003. The Company has not invested in any VIEs.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The Company adopted SFAS No. 149 effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003. There was no impact on the Company's financial position,
results of operations or liquidity from adopting SFAS No. 149.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 requires that certain financial instruments, which under previous
guidance were accounted for as equity, must now be accounted for as liabilities.
The financial instruments affected include mandatorily redeemable stock, certain
financial instruments that require or may require the issuer to buy back some of
its shares in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003 and must be applied to
existing financial instruments effective with the beginning of the first fiscal
period after June 15, 2003. The Company has no financial instruments within the
scope of SFAS No. 150.

31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2 -- ACQUISITION OF PENFORD AUSTRALIA

On September 29, 2000, Penford acquired Penford Australia for $54.2 million
in cash, plus transaction costs of approximately $1.7 million. The acquisition
was recorded using the purchase method of accounting. Accordingly, a portion of
the purchase price was allocated to net tangible and intangible assets acquired
based on their estimated fair values. The balance of the purchase price was
recorded as goodwill. Penford accounted for the purchase as follows:

Consideration given related to the purchase:
Cash...................................................... $ 54,195
Direct costs of acquisition............................... 1,691
--------
$ 55,886
--------
Fair market value of assets acquired:
Current assets............................................ $ 23,113
Property, plant and equipment............................. 30,498
Other assets.............................................. 2,340
Current liabilities....................................... (11,336)
Debt...................................................... (1,659)
Other long-term liabilities............................... (2,584)
--------
$ 40,372
--------
Goodwill.................................................... $ 15,514
========

Eleven months of Penford Australia's results of operations, from the
September 29, 2000 date of acquisition, are included in the consolidated
financial statements for the year ended August 31, 2001.

The following unaudited pro forma financial information presents the
combined results of operations of the Company and Penford Australia, as if the
acquisition had occurred on September 1, 2000. The unaudited pro forma financial
information does not necessarily reflect the results of operations that would
have occurred had the Company and Penford Australia constituted a single entity
during fiscal 2001 (dollars in thousands, except per share data).

Revenue..................................................... $232,601
Net loss.................................................... (700)
Loss per common share:
Basic..................................................... $ (0.09)
========
Diluted................................................... $ (0.09)
========

NOTE 3 -- INVENTORIES

Components of inventory are as follows:

32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

To reduce the price volatility of corn used in fulfilling some of its
starch sales contracts, Penford, from time to time, uses readily marketable
exchange-traded futures as well as forward cash corn purchases. The exchange-
traded futures are not purchased or sold for trading or speculative purposes and
are designated as hedges. The changes in market value of such contracts have
historically been, and are expected to continue to be, effective in offsetting
the price changes of the hedged commodity. Penford also at times uses
exchange-traded futures to hedge corn inventories. Hedges are designated as cash
flow hedges at the time the transaction is established and are recognized in
earnings in the time period for which the hedge was established. The amount of
ineffectiveness related to the Company's hedging activities was not material.

NOTE 4 -- PROPERTY AND EQUIPMENT

Components of property and equipment are as follows:

NOTE 5 -- INVESTMENTS

In 2001, Penford invested in an early-stage technology company in the
business of developing data analytics software applications. Penford accounted
for its investment on the cost method. In 2002, with the continuing slowdown in
the technology business sector, Penford undertook an assessment of the fair
value of its investment. Penford considered a number of factors, including the
financial health and prospects of the investee, the prospects for receiving a
future return on Penford's investment, the adverse changes in the funding
environment for technology companies and the lack of marketability for the
investment. The assessment indicated that it was unlikely that Penford would
recover any of its then existing carrying amount and that an other than
temporary decline in the fair value of its investment had occurred. Penford
recorded an impairment charge of $0.5 million related to the complete write-off
of this investment. This charge is included in non-operating income (expense) in
the Consolidated Statements of Operations.

NOTE 6 -- GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess of acquisition costs over the fair value of
the net assets of Penford Australia, which was acquired on September 29, 2000.
The Company evaluates annually, or more frequently if certain indicators are
present, the carrying value of its goodwill under provisions of SFAS No. 142,
adopted September 1, 2001.

Effective with the adoption of this standard, Penford is no longer
amortizing goodwill. The Company completed a transitional impairment test at
September 1, 2001 as well as the annual update as of June 1, 2003 and determined
there was no impairment to the recorded value of goodwill. In order to identify
potential impairments, Penford compared the fair value of each of its reporting
units with its carrying amount, including goodwill. Penford then compared the
implied fair value of its reporting units' goodwill with the carrying amount of
that goodwill. The implied fair value of the reporting units was determined
using primarily discounted cash flows. This testing was performed on Penford's
Food ingredients -- North America and the Australia/New Zealand operations
reporting units, which are the same as two of the Company's business segments.
Since there was no indication of impairment, Penford was not required to
complete the second step of the process which would

33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

measure the amount of any impairment. On a prospective basis, the Company is
required to continue to test its goodwill for impairment on an annual basis, or
more frequently if certain indicators arise.

The Company's goodwill of $18.4 million and $15.9 million at August 31,
2003 and 2002 respectively, represents the excess of acquisition costs over the
fair value of the net assets of Penford Australia. The increase in the carrying
value of goodwill since August 31, 2002 reflects the impact of exchange rate
fluctuations between the Australian and U.S. dollar on the translation of this
asset.

The following table provides a reconciliation of previously reported net
loss and loss per share for fiscal 2001 to adjusted amounts assuming that SFAS
No. 142 had been applied as of September 1, 2000 (dollars in thousands except
per share data):

Reported net loss........................................... $ (777)
Add: Goodwill amortization.................................. 463
------
Adjusted net loss........................................... $ (314)
======
Loss per common share, diluted:
Reported loss............................................. $(0.10)
Goodwill amortization..................................... 0.06
------
Adjusted loss............................................. $(0.04)
======

Penford's intangible assets consist of patents which are being amortized
over the weighted average remaining amortization period of 11 years as of August
31, 2003 and an intangible pension asset. There is no residual value associated
with patents. The carrying amount and accumulated amortization of intangible
assets are as follows:

- ---------------

(1) Not covered by the scope of SFAS No. 142

Amortization expense related to intangible assets was $0.1 million in each
of 2003, 2002 and 2001. The estimated aggregate annual amortization expense for
patents is approximately $0.1 million for each of the next five fiscal years,
2004-2008.

34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 7 -- DEBT

On November 15, 2000, a $130 million credit facility was completed to
finance the acquisition of Penford Australia and to replace existing credit
facilities. The combined credit facilities in the U.S. and Australia consisted
of $65 million in term loans, expiring October 31, 2003, and $65 million of
revolving lines of credit, expiring October 31, 2005. Borrowing rates available
under the credit facility were based on either the London Interbank Offered
Rates ("Libor") in the U.S. and the Bank Bill Rate in Australia or prime rate,
depending on the borrowing option. All of Penford's assets secured the credit
facility. The credit agreement included financial covenants with limitations on
indebtedness, minimum net worth and capital expenditures as well as maintenance
of leverage, interest and fixed charge coverage ratios. On November 26, 2002,
the Company's banks approved an amendment to the credit agreement to modify the
leverage ratio and to reduce scheduled term loan payments for fiscal 2003.
Penford was in compliance with the credit agreement covenants at August 31,
2003.

In September 2000, Penford Australia, a wholly-owned subsidiary of the
Company, obtained a revolving credit facility to finance grain inventory
purchases from a bank in Australia. Also in September 2000, as security for the
credit facility, the Company entered into a guarantee with the bank in
Australia. The inventory financing facility was also secured by the grain in
inventory. The guarantee continued until the inventory credit facility was
refinanced in October 2003 as discussed below. The maximum amount of future
payments under the guarantee at August 31, 2003 and 2002 was $5.3 million and
$6.6 million, respectively.

On October 7, 2003, Penford replaced its existing secured credit and
inventory financing credit facilities with a new $105 million secured credit
facility with a group of U.S. and Australian banks. The credit facility consists
of $50 million in term loans and $55 million in revolving lines of credit. The
revolving lines of credit expire on October 7, 2006 and the term loans expire on
October 7, 2008. Interest rates under the new credit facility are based on
either LIBOR (or the Australian BBSY equivalent) or the prime rate, depending on
the selection of borrowing options. All of Penford's assets secure the credit
facility and the new agreement includes, among other things, financial covenants
with limitations on indebtedness and capital expenditures and maintenance of
fixed charge and leverage ratios. Accordingly, the Company's short-term debt
obligations at August 31, 2003 have been classified as long-term debt and the
debt maturities below are shown in accordance with the repayment terms of the
new bank financing.

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At the time of the refinancing, Penford borrowed $50 million in term loans
and the remainder on its revolving lines of credit. The refinancing also revised
the scheduled term debt repayments. Based on this revised schedule, the
maturities of debt existing at August 31, 2003 for the fiscal years beginning
with fiscal 2004 are as follows (dollars in thousands):

2004........................................................ $ 3,000
2005........................................................ 4,750
2006........................................................ 5,750
2007........................................................ 35,696
2008 and thereafter......................................... 30,500
-------
$79,696
=======

NOTE 8 -- STOCKHOLDERS' EQUITY

COMMON STOCK

On March 14, 2003, the Company sold 650,000 shares of its common stock to
the T. Rowe Price Small-Cap Value Fund at $11.11 per share. In March 2003,
approximately $6.8 million of the proceeds were used to reduce the Company's
term loans outstanding. The Company incurred $0.3 million in placement fees and
professional services related to the common stock issuance.

COMMON STOCK PURCHASE RIGHTS

On June 16, 1988, Penford distributed a dividend of one right ("Right") for
each outstanding share of Penford common stock. 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 at a price of $100.
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 on June 16, 2008.

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 9 -- OTHER COMPREHENSIVE INCOME (LOSS)

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

The earnings associated with the Company's investment in Penford Australia
are considered to be permanently invested and no provision for U.S. income taxes
on the related translation adjustment has been provided.

NOTE 10 -- LEASES

Certain of the Company's property, plant and equipment is leased under
operating leases ranging from one to ten years with renewal options. Rental
expense under operating leases was $5.3 million, $5.4 million and $5.5 million
in 2003, 2002 and 2001, respectively. Future minimum lease payments for fiscal
years beginning with the fiscal year ending August 31, 2003 for noncancelable
operating leases having initial lease terms of more than one year are as follows
(dollars in thousands):

2004........................................................ $ 4,833
2005........................................................ 3,236
2006........................................................ 2,375
2007........................................................ 1,947
2008........................................................ 1,558
Thereafter.................................................. 3,013
-------
$16,962
=======

NOTE 11 -- STOCK-BASED COMPENSATION PLANS

As of August 31, 2003, the Company had two stock option plans for which
2,467,599 shares of common stock were 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 provides for the granting of incentive and non-qualified
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% 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. At each director's annual election, annual grants, retainers and
meeting fees may be received in the form of non-qualified stock options in lieu
of cash compensation. 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. In 2003, 2002
and 2001, the

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Company expensed approximately, $69,000, $92,000 and $98,000, respectively, in
non-cash compensation related to directors' deferred compensation and restricted
stock plans.

Changes in stock options for the three years ended August 31 follow:

The following table summarizes information concerning outstanding and
exercisable options as of August 31, 2003:

NOTE 12 -- PENSIONS AND OTHER POSTRETIREMENT BENEFITS

Penford maintains two noncontributory defined benefit pension plans that
cover substantially all North American employees and retirees. The Company's
funding policy for its defined benefit plans is to contribute amounts sufficient
to meet or exceed the minimum requirements of the Employee Retirement Income
Security Act of 1974. The Company made contributions to the pension plans of
$339,000 in fiscal 2003. No contributions were made during fiscal 2002 or fiscal
2001. 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.

38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company also maintains two other postretirement benefit plans covering
its hourly retirees, as well as a group of its past salaried retirees.
Presently, the Company funds the current benefits of its other postretirement
benefit plans on a cash basis, and therefore, there are no plan assets.

The following represents information summarizing the Company's pension and
other postretirement benefit plans:

39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Selected information related to the Company's defined benefit pension plans
that have benefit obligations in excess of fair value of plan assets is
presented below:

At August 31, 2003, the Company recorded an additional minimum pension
liability of $3,109,000 to reflect the excess of the accumulated benefit
obligations over the fair value of plan assets. This charge is reflected in
other comprehensive income, net of tax.

The assumed health care cost trend rate could have a significant effect on
the amounts reported. A one-percentage-point change in the assumed health care
cost trend rate would have the following effects (in thousands):

NOTE 13 -- OTHER EMPLOYEE BENEFITS

SAVINGS AND STOCK OWNERSHIP PLAN

The Company has a defined contribution savings plan where eligible North
American-based employees can elect a maximum salary deferral of 16%. The plan
provides a 100% match on the first 3% of salary contributions

40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and a 50% match on the next 3%. The Company's matching contributions were
$798,000, $796,000 and $692,000 for fiscal years 2003, 2002 and 2001,
respectively.

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. There were no profit-sharing contributions paid to
participants for fiscal years 2003, 2002 and 2001.

DEFERRED COMPENSATION PLAN

The Company provides its directors and certain employees the opportunity to
defer a portion of their salary, bonus and fees. The deferrals earn interest
based on Moody's current Corporate Bond Yield. Deferred compensation interest of
$275,000, $285,000 and $258,000 was accrued in 2003, 2002 and 2001,
respectively.

SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

The Company sponsors a supplemental executive retirement plan, a
non-qualified plan, which covers certain employees. For fiscal 2003, 2002 and
2001, the net periodic pension expense accrued for this plan was $26,000,
$399,000 and $423,000, respectively. The expense for fiscal 2003 is net of a
curtailment gain of $329,000 resulting from the termination of two participants
in the plan.

HEALTH CARE AND LIFE INSURANCE BENEFITS

The Company offers health care and life insurance benefits to most active
North American employees. Costs incurred to provide these benefits are charged
to expense as incurred. Health care and life insurance expense, net of employee
contributions, was $3,722,000, $3,548,000 and $3,358,000 in 2003, 2002 and 2001,
respectively.

SUPERANNUATION FUND

The Company contributes to superannuation funds on behalf of the employees
of Penford Australia. Australian law requires the Company to contribute at least
9% of each employee's eligible pay, whereas New Zealand law requires at least a
7.5% and 5% employer contribution for salaried and hourly employees,
respectively. The Company contributions to superannuation funds were $841,000,
$723,000 and $653,000 in 2003, 2002 and 2001, respectively.

NOTE 14 -- OTHER NON-OPERATING INCOME (EXPENSE)

Other non-operating income (expense) consists of the following:

42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Income tax expense (benefit) consists of the following:

A reconciliation of the statutory federal tax to the actual provision
(benefit) for taxes is as follows:

The effect of enacted tax legislation in 2002 of $1,213,000 related to
certain provisions of the Job Creation and Worker Assistance Act of 2002 which
permit the utilization of net operating losses incurred in 2001 to recoup
alternative minimum tax paid over an extended five year carryback period. The
impact of this legislation is a reduction of the benefit previously recorded for
loss carrybacks due to the difference in regular tax and alternative minimum tax
rates.

43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company recorded a $1.9 million gain on the sale of certain assets of
its Hi-maize business in fiscal 2003. The Company determined that, due to
changes in the Australian tax legislation, no income taxes would be payable
related to this gain and accordingly, no income taxes have been provided on this
gain.

The significant components of deferred tax assets and liabilities are as
follows:

The Company had research and development tax credit carryforwards of $0.1
million at August 31, 2003 that expire in fiscal years 2013 through 2023, and
federal alternative minimum tax credit carryforwards of $2.6 million, which do
not expire under current tax law.

NOTE 16 -- RESTRUCTURING COSTS

In the second quarter of fiscal 2002, the Company announced a strategic
restructuring of its business operations, including the relocation of its
headquarters from Washington to Colorado. As a result, the Company recorded
restructuring costs totaling $1.4 million related to severance and other exit
activity expenses, which are included in operating expenses. The restructuring
covers seven employees, six of which had been terminated as of August 31, 2003.
In the second and fourth quarter of fiscal 2003, the Company adjusted the
restructuring reserve due to settlement of its lease obligations and other exit
activity expenses for less cost than had been expected. All amounts accrued at
August 31, 2003 are expected to be paid in fiscal 2004.

44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table is an analysis of the reserve recorded for the 2003
restructuring (in thousands).

NOTE 17 -- EARNINGS (LOSS) PER COMMON SHARE

The following table presents the computation of basic and diluted earnings
(loss) per share:

Weighted-average stock options omitted from the denominator of the earnings
per share calculation because they were antidilutive were 489,730, 168,244 and
414,557 for 2003, 2002 and 2001, respectively.

NOTE 18 -- SEGMENT REPORTING

Financial information for the Company's three segments is presented below.
The first two segments, Industrial Ingredients -- North America and Food
Ingredients -- North America, are broad categories of end-market users,
primarily served by the Company's U.S. operations. The third segment is the
geographically separate operations in Australia and New Zealand. The Australian
and New Zealand operations are engaged primarily in the food ingredients
business, although the industrial market is an important and growing category
there. A fourth item for "corporate and other" activity has been presented to
provide reconciliation to amounts reported in the 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
consolidation entries. Intercompany sales between Australia/New Zealand
operations and Food Ingredients -- North America of $546,000 and $447,000 in
2003 and 2002, respectively, are eliminated in corporate and other since the
chief operating decision maker views segment results prior to intercompany
eliminations. All interest expense of the Company is included in corporate and
other and is

45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

not allocated to the other reportable segments. The accounting policies of the
reportable segments are the same as those described in Note 1.

46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Reconciliation of total income from operations for the Company's segments
to income before income taxes as reported in the consolidated financial
statements follows:

Information about the Company's operations by geographic area follows:

NOTE 19 -- QUARTERLY FINANCIAL DATA (UNAUDITED)

47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- ---------------

(1) First quarter fiscal 2003 operating results include a gain of $1.9 million
related to the sale of Hi-Maize(R) assets. See Note 20.

(2) Second quarter fiscal 2002 operating results include a charge of $1.4
million for costs related to the announcement of a strategic restructuring
of the Company's business operations. See Note 16.

(3) Fourth quarter fiscal 2002 operating results include a charge of $0.5
million for costs related to the write-off of a long-term investment. See
Note 14.

NOTE 20 -- TRANSACTIONS WITH NATIONAL STARCH

In November 2002, the Company sold certain assets of its resistant starch
Hi-maize(R) business to National Starch Corporation ("National Starch"), a
wholly-owned subsidiary of Imperial Chemical Industries PLC of the U.K., for
$2.25 million. The Company recorded a $1.9 million pre-tax gain on the sale of
these assets, which gain is included in net non-operating income (expense) in
the Consolidated Statements of Operations. In the fourth quarter of fiscal 2003,
the Company determined that, due to changes in Australian tax legislation, no
income taxes would be payable related to this gain and taxes of approximately
$0.3 million previously provided in the first quarter were reversed. See Note
15.

The Company also licensed to National Starch the exclusive rights to its
resistant starch intellectual property portfolio for applications in human
nutrition. The Company retained the rights to practice its resistant starch
intellectual property for all non-human nutrition applications. 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 royalty agreement. In addition, the Company will
receive annual royalty payments for a period of seven years or until a maximum
of $11.0 million in royalties is received by the Company. The amortization of
the initial licensing fee and royalty income, totaling $1.2 million for fiscal
2003, are included in net non-operating income (expense) in the Consolidated
Statements of Operations.

The Company also entered into a tolling arrangement under which the Company
will manufacture resistant starch products for National Starch, if requested by
National Starch. Sales of these products and the costs to manufacture pursuant
to this agreement are included in income from operations in the Consolidated
Statements of Operations.

48

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 as of August 31, 2003 and 2002, and the related consolidated
statements of operations, comprehensive income (loss), shareholders' equity, and
cash flows for each of the three years in the period ended August 31, 2003.
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 auditing standards generally
accepted in the United States. 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 at August 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended August 31, 2003, in conformity with accounting principles generally
accepted in the United States.

As discussed in Note 1 to the consolidated financial statements, effective
September 1, 2001, the Company changed its method of accounting for goodwill in
accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets."

/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP

Denver, Colorado
October 10, 2003

49

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES.

Penford management, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures pursuant to Rule 13a-14(c) of the Securities
Exchange Act of 1934 within 90 days prior to the date of this report. Based on
that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the disclosure controls and procedures are effective in ensuring
that all material information required to be filed in this annual report has
been made known to them in a timely fashion. There have been no significant
changes in internal controls, or in factors that could significantly affect
internal controls, subsequent to the date the Chief Executive Officer and Chief
Financial Officer completed their evaluation.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information set forth under the heading "Election of Directors" in the
definitive Proxy Statement for the 2004 Annual Meeting of Shareholders (the
"2004 Proxy Statement"), to be filed not later that 120 days after the end of
the fiscal year covered by this report, is incorporated herein by reference.
Information regarding the Executive Officers of the Registrant is set forth in
Part I, Item 1.

ITEM 11. EXECUTIVE COMPENSATION.

The information set forth under the heading "Executive Compensation" in the
2004 Proxy Statement is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.

The information set forth under the heading "Security Ownership of Certain
Beneficial Owners and Management" in the 2004 Proxy Statement is incorporated
herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information relating to certain relationships and related transactions
of the Company is set forth under the heading "Change-in-Control Arrangements"
in the 2004 Proxy Statement and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

Information concerning principal accountant fees and services appears under
the heading "Fees Paid to Ernst & Young LLP" in the 2004 Proxy Statement and is
incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)(1) Financial Statements

The consolidated balance sheets as of August 31, 2003 and 2002 and the
related statements of operations, cash flows and shareholders' equity for each
of the three years in the period ended August 31, 2003 and the report of
independent auditors are included in Part II, Item 8.

50

(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 the information is included in the Consolidated Financial
Statements in Part II, Item 8.

(3) Exhibits

See index to Exhibits on page 53.

(b) Reports on Form 8-K

Reports on Form 8-K filed by the Registrant for the quarter ended August
31, 2003:

(c) Exhibits

See Item 15(a)(3), above.

(d) Financial Statement Schedules

None

51

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

/s/ THOMAS D. MALKOSKI
--------------------------------------
Thomas D. Malkoski
Date: November 21, 2003

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears
below constitutes and appoints Thomas D. Malkoski, Steven O. Cordier and
Margaret Von der Schmidt 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, 2003, 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 by virtue hereof.

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.

52

INDEX TO EXHIBITS

Exhibits identified in parentheses below, on file with the Securities and
Exchange Commission, are incorporated by reference. Copies of exhibits can be
obtained at no cost by writing to Penford Corporation, 7094 S. Revere Parkway,
Englewood, Colorado 80112.

- ---------------

* Denotes management contract or compensatory plan or arrangement.