Penford (PENX) 10-K/A 2011 FY Annual report (amended)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K/A

(Amendment No. 1)

(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, 2011

[   ] 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
Centennial, 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:

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, $1.00 par value	The NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  [  ]  No  [X]

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  [  ]  No  [X]

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 whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  [  ]  No  [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [X]

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

Large accelerated filer  [  ]	Accelerated filer  [X]	Non-accelerated filer  [  ]	Smaller reporting company  [  ]
		(Do not check if a smaller reporting company)

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

The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant as of February 28, 2011, the last business day of the Registrant’s second quarter of fiscal 2011, was approximately $64.6 million based upon the last sale price reported for such date on The NASDAQ Global Market. For purposes of making this calculation, Registrant has assumed that all the outstanding shares were held by non-affiliates, except for shares held by Registrant’s directors and officers and by each person who owns 10% or more of the outstanding Common Stock. However, this does not necessarily mean that there are not other persons who may be deemed to be affiliates of the Registrant.

The number of shares of the Registrant’s Common Stock outstanding as of November 3, 2011 was 11,346,601.

Documents Incorporated by Reference

Portions of the Registrant’s definitive Proxy Statement relating to the 2012 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

EXPLANATORY NOTE

Penford Corporation (also referred to as “Penford” or the “Company”) is filing this Amendment No. 1 (“Amendment No. 1”) to its Form 10-K for the fiscal year ended August 31, 2011 (“Form 10-K”), originally filed with the Securities and Exchange Commission on November 10, 2011 solely for the purpose of revising the Report of Independent Registered Public Accounting Firm KPMG LLP that appeared in Item 8 of Part II of the Form 10-K. The Company is also updating the Exhibit Index referenced in Item 15 of Part IV. The Company has filed as exhibits with this Amendment No. 1 currently dated consents of its independent registered public accounting firms and certifications of its principal executive and financial officers.

Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the complete text of Item 8 of Part II, as amended, is set forth below. This Amendment No. 1 speaks as of the original filing date of the Form 10-K and reflects only the changes discussed above. No other information or disclosures in the Form 10-K including the Company’s financial statements and the footnotes thereto, have been amended or updated by this Amendment No. 1.

2

Item 8:Financial Statements and Supplementary Data

TABLE OF CONTENTS

	Page
Consolidated Balance Sheets		4
Consolidated Statements of Operations		5
Consolidated Statements of Comprehensive Income (Loss)		5
Consolidated Statements of Cash Flows		6
Consolidated Statements of Shareholders’ Equity		8
Notes to Consolidated Financial Statements		9
Reports of Independent Registered Public Accounting Firms		37

3

Consolidated Balance Sheets

	August 31,
	2011			2010
(In thousands, except per share data)
Assets
Current assets:
Cash and cash equivalents	$	281		$	315
Trade accounts receivable, net		29,482			26,749
Inventories		32,733			19,849
Prepaid expenses		5,991			5,237
Income tax receivable		92			3,678
Other		5,498			5,287
Total current assets		74,077			61,115
Property, plant and equipment, net		107,372			111,930
Restricted cash value of life insurance		7,909			7,951
Deferred tax assets		12,695			16,493
Other assets		2,132			2,615
Other intangible assets, net		332			407
Goodwill, net		7,897			7,897
Total assets	$	212,414		$	208,408
Liabilities and Shareholders’ Equity
Current liabilities:
Cash overdraft, net	$	6,903		$	4,385
Current portion of long-term debt and capital lease obligations		421			429
Accounts payable		15,268			14,650
Accrued liabilities		7,563			6,536
Total current liabilities		30,155			26,000
Long-term debt and capital lease obligations		23,802			21,038
Redeemable preferred stock, Series A (Note 7)		38,982			34,104
Other postretirement benefits		16,193			16,891
Pension benefit liability		11,217			20,597
Other liabilities		6,600			6,206
Total liabilities		126,949			124,836
Commitments and contingencies
Shareholders’ equity:
Common stock, par value $1.00 per share, authorized 29,000 shares, issued 13,328 shares in 2011 and 29,000 shares, issued 13,354 in 2010, including treasury shares		13,243			13,190
Preferred stock, Series B (Note 5)		100			100
Additional paid-in capital		103,070			102,303
Retained earnings		9,368			14,586
Treasury stock, at cost, 1,981 shares		(32,757	)		(32,757	)
Accumulated other comprehensive loss		(7,559	)		(13,850	)
Total shareholders’ equity		85,465			83,572
Total liabilities and shareholders’ equity	$	212,414		$	208,408

The accompanying notes are an integral part of these statements.

4

Consolidated Statements of Operations

	Year Ended August 31,
	2011			2010			2009
	(Dollars in thousands, except share and per share data)
Sales	$	315,441		$	254,274		$	255,556
Cost of sales		281,606			230,820			243,265
Gross margin		33,835			23,454			12,291
Operating expenses		24,618			23,943			23,501
Research and development expenses		4,772			4,371			4,348
Flood related costs, net of insurance proceeds		-			-			(9,109	)
Income (loss) from operations		4,445			(4,860	)		(6,449	)
Interest expense		9,364			7,550			5,557
Other non-operating income (expense), net		115			(1,921	)		1,915
Loss from continuing operations before income taxes		(4,804	)		(14,331	)		(10,091	)
Income tax (benefit)		313			(4,702	)		(3,446	)
Loss from continuing operations		(5,117	)		(9,629	)		(6,645	)
Income (loss) from discontinued operations, net of tax		-			16,312			(58,142	)
Net income (loss)	$	(5,117	)	$	6,683		$	(64,787	)
Weighted average common shares and equivalents outstanding, basic and diluted		12,250,914			11,600,885			11,170,493
Earnings (loss) per common share:
Basic and diluted loss per share from continuing operations	$	(0.42	)	$	(0.84	)	$	(0.59	)
Basic and diluted earnings (loss) per share from discontinued operations		-			1.41			(5.21	)
Basic and diluted earnings (loss) per share	$	(0.42	)	$	0.57		$	(5.80	)
Dividends declared per common share	$	-		$	-		$	0.12

The accompanying notes are an integral part of these statements.

Consolidated Statements of Comprehensive Income (Loss)

	Year Ended August 31,
	2011			2010			2009
	(Dollars in thousands)
Net income (loss)	$	(5,117	)	$	6,683		$	(64,787	)
Other comprehensive income (loss):
Change in fair value of derivatives, net of tax benefit (expense) of $2,826, $530 and $(1,255)		(4,611	)		(864	)		2,047
Loss (gain) from derivative transactions reclassified into earnings from other comprehensive income, net of tax benefit (expense) of $3,630, $1,555 and $(1,837)		5,924			2,537			(2,998	)
Foreign currency translation adjustments		-			930			(7,635	)
Gain from foreign currency translation reclassified into earnings		-			(13,420	)		-
Actuarial gain (loss) on postretirement liabilities, net of tax benefit (expense) of $(2,450), $780 and $5,441		3,997			(1,272	)		(8,879	)
Loss from postretirement liabilities reclassified to earnings, net of tax benefit of $601, $645 and $119		981			1,053			194
Other comprehensive income (loss)		6,291			(11,036	)		(17,271	)
Total comprehensive income (loss)	$	1,174		$	(4,353	)	$	(82,058	)

The accompanying notes are an integral part of these statements.

5

Consolidated Statements of Cash Flows

	Year Ended August 31,
	2011			2010			2009
	(Dollars in thousands)
Operating activities:
Net income (loss)	$	(5,117	)	$	6,683		$	(64,787	)
Less: Net income (loss) from discontinued operations	$	—		$	16,312		$	(58,142	)
Net loss from continuing operations	$	(5,117	)	$	(9,629	)	$	(6,645	)
Adjustments to reconcile net loss from continuing operations to net cash provided by (used in ) operations:
Depreciation and amortization		14,415			14,791			14,455
Stock-based compensation		1,117			1,611			2,656
Loss (gain) on sale and disposal of assets		6			(2	)		(1,554	)
Deferred income tax expense (benefit)		142			(4,578	)		—
Loss (gain) on derivative transactions		(1,620	)		(3,134	)		3,457
Foreign currency transaction gain		—			(419	)		(127	)
Loss on early extinguishment of debt		—			1,049			—
Accrued interest on preferred stock (Series A)		3,859			1,452			—
Change in operating assets and liabilities:
Trade accounts receivable		(2,769	)		5,250			(20,111	)
Inventories		(11,264	)		1,405			4,760
Decrease (increase) in margin accounts		1,975			(502	)		2,299
Prepaid expenses		(754	)		(383	)		(1,429	)
Accounts payable and accrued liabilities		1,637			(598	)		(15,987	)
Income tax receivable		3,557			(138	)		4,222
Insurance recovery receivable		—			—			8,000
Other		(2,269	)		3,893			(5,176	)
Net cash flow provided by (used in) operating activities – continuing operations		2,915			10,068			(11,180	)
Investing activities:
Acquisitions of property, plant and equipment, net		(8,295	)		(5,980	)		(5,379	)
Proceeds from sale of dextrose product line		—			—			2,857
Net proceeds received from sale of discontinued operations and other		42			20,712			725
Net cash provided by (used in) investing activities – continuing operations		(8,253	)		14,732			(1,797	)
Financing activities:
Proceeds from revolving line of credit		38,550			30,700			55,931
Payments on revolving line of credit		(35,350	)		(58,033	)		(24,500	)
Proceeds from issuance of long-term debt		—			2,000			—
Payments on long-term debt		(200	)		(45,992	)		(7,750	)
Proceeds from issuance of preferred stock		—			40,000			—
Issuance costs of preferred stock		—			(1,995	)		—
Payments on capital lease obligations		(253	)		(245	)		(263	)
Payment of loan fees		—			(1,227	)		(1,574	)
Increase (decrease) in cash overdraft		2,518			4,385			(1,301	)
Payment of dividends		—			—			(2,026	)
Other		39			19			—
Net cash provided by (used in) financing activities – continuing operations		5,304			(30,388	)		18,517
Cash flows from discontinued operations:
Net cash (used in) provided by operating activities		—			6,329			(1,713	)
Net cash used in investing activities		—			(2,848	)		(290	)
Net cash (used in) provided by financing activities		—			(3,399	)		2,044
Effect of exchange rate changes on cash and cash equivalents		—			(353	)		59

6

Net cash (used in) provided by discontinued operations		—			(271	)		100
Increase (decrease) in cash and cash equivalents		(34	)		(5,859	)		5,640
Cash and cash equivalents of continuing operations , beginning of year		315			5,540			—
Cash balance of discontinued operations, beginning of year		—			634			534
Cash and cash equivalents, end of year		315			315			6,174
Less: cash balance of discontinued operations, end of year		—			—			634
Cash and cash equivalents of continuing operations, end of year	$	281		$	315		$	5,540
Supplemental disclosure of cash flow information
Cash paid during the year for:
Interest	$	3,815		$	4,939		$	3,596
Income taxes refunded, net	$	(3,373	)	$	(172	)	$	(10,300	)
Noncash investing and financing activities:
Capital lease obligations incurred for certain equipment leases	$	10		$	34		$	—

The accompanying notes are an integral part of these statements.

7

Consolidated Statements of Shareholders’ Equity

	Year Ended August 31,
	2011			2010			2009
	(Dollars in thousands)
Common stock
Balance, beginning of year	$	13,190		$	13,157		$	13,127
Issuance of restricted stock, net		53			33			30
Balance, end of year		13,243			13,190			13,157
Preferred stock
Balance, beginning of year		100			—			—
Issuance of preferred stock, Series B		—			100			—
Balance, end of year		100			100			—
Additional paid-in capital
Balance, beginning of year		102,303			93,829			91,443
Tax deficiency on stock option and awards		(297	)		(321	)		(256	)
Stock based compensation		1,117			1,586			2,672
Issuance of restricted stock, net		(53	)		(33	)		(30	)
Issuance of preferred stock		—			7,242			—
Balance, end of year		103,070			102,303			93,829
Retained earnings
Balance, beginning of year		14,586			7,944			74,092
Net income (loss)		(5,117	)		6,683			(64,787	)
Dividends declared		—			—			(1,352	)
Other		(101	)		(41	)		(9	)
Balance, end of year		9,368			14,586			7,944
Treasury stock		(32,757	)		(32,757	)		(32,757	)
Accumulated other comprehensive income (loss):
Balance, beginning of year		(13,850	)		(2,814	)		14,457
Change in fair value of derivatives, net of tax		(11,464	)		(864	)		2,047
Loss (gain) from derivative transactions reclassified into earnings from other comprehensive income, net of tax		12,777			2,537			(2,998	)
Foreign currency translation adjustments		—			930			(7,635	)
Gain from foreign currency translation reclassified into earnings		—			(13,420	)		—
Net (increase) decrease in postretirement liabilities, net of tax		4,978			(219	)		(8,685	)
Balance, end of year		(7,559	)		(13,850	)		(2,814	)
Total shareholders’ equity	$	85,465		$	83,572		$	79,359

The accompanying notes are an integral part of these statements.

8

Notes to Consolidated Financial Statements

Note 1 — Organization and Business and 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 and ethanol. Penford’s products provide convenient and cost-effective solutions derived 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 in developing applications to address customer needs. In addition, the Company has specialty processing capabilities for a variety of modified starches.

Penford manages its business in two segments. The Industrial Ingredients and Food Ingredients segments, located in the U.S., are broad categories of end-market users. The Industrial Ingredients segment is a supplier of chemically modified specialty starches to the paper and packaging industries and a producer of ethanol. The Food Ingredients segment is a developer and manufacturer of specialty starches and dextrin to the food manufacturing and food service industries. See Note 19 for financial information regarding the Company’s business segments.

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 reclassifications have been made to prior years’ financial statements in order to conform to the current year presentation.

Discontinued Operations

In August 2009, the Company committed to a plan to exit from the business conducted by the Company’s Australia/New Zealand Operations. On September 2, 2009, the Company completed the sale of Penford New Zealand Limited (“Penford New Zealand”). On November 27, 2009, the Company completed the sale of the operating assets of its subsidiary company Penford Australia Limited (“Penford Australia”), including its two remaining Australian plants. The financial results of the Australia/New Zealand Operations have been classified as discontinued operations in the consolidated statement of operations. See Note 17 for additional information regarding discontinued operations. At August 31, 2011, the remaining net assets of the Australia/New Zealand Operations, consisting of $0.3 million of cash and $0.8 million of other net assets, primarily a receivable from the purchaser of one of the Company’s Australian manufacturing facilities, have been reported as assets and liabilities of the continuing operations of the Company. Unless otherwise indicated, amounts and discussions in these notes pertain to the Company’s continuing operations.

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. Estimates are used in accounting for, among other things, the allowance for doubtful accounts, accruals, the determination of assumptions for pension and postretirement employee benefit costs, useful lives of property and equipment, the assessment of a potential impairment of goodwill, and income taxes including the determination of a need for a valuation allowance for deferred tax assets. Actual results may differ from previously estimated amounts.

9

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 fair value.

Cash Overdrafts

Cash overdrafts represent the amount by which outstanding checks issued, but not yet presented to banks for disbursement, exceed balances on deposit in the applicable bank accounts. The changes in cash overdrafts are included as a component of cash flows from financing activities in the consolidated statements of cash flows.

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. Penford estimates the allowance for uncollectible accounts based on historical experience, known troubled accounts, industry trends, economic conditions, how recently payments have been received, and ongoing credit evaluations of its customers. Activity in the allowance for doubtful accounts for fiscal 2011, 2010 and 2009 is as follows (dollars in thousands):

	Balance Beginning of Year		Charged to Costs and Expenses			Deductions and Other			Balance End of Year
Year ended August 31:
2011	$	350	$	958		$	(3	)	$	1,305
2010	$	605	$	(218	)	$	(37	)	$	350
2009	$	550	$	(2	)	$	57		$	605

Approximately 40%, 45% and 52% of the Company’s sales in fiscal 2011, 2010 and 2009, respectively, were made to customers who operate in the paper industry. This industry suffered an economic downturn, which has resulted in the closure of a number of mills. In fiscal 2011, the allowance for uncollectible accounts increased primarily related to two paper industry customers.

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

In accordance with Accounting Standards Codification (“ASC” or the “Codification”) 350, “Intangibles - Goodwill and Other,” goodwill is not amortized, but instead is tested for impairment at least annually or more frequently if there is an indication of impairment.

The Company evaluates its goodwill for impairment annually and whenever events or circumstances make it more likely than not that an impairment may have occurred. To determine whether goodwill is impaired, Penford compares the fair value of each reporting units to that report unit’s carrying amount. If the fair value of the reporting unit is greater than its carrying amount goodwill is not considered impaired. If the fair value of the reporting unit is lower than its carrying amount, Penford then compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill and if the carrying value is higher than the fair value, impairment is recorded. The implied fair value of a reporting unit is determined using a discounted cash flow method considering the Company’s market capitalization.

Patents are amortized using the straight-line method over their estimated period of benefit. At August 31, 2011, the weighted average remaining amortization period for patents is four years. Penford has no intangible assets with indefinite lives.

10

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. Equipment and vehicle leases generally have average useful lives ranging from three to twelve years and real estate between twelve to forty-six years. Depreciation, which includes depreciation of assets under capital leases, of $12.8 million, $13.1 million and $13.8 million was recorded in fiscal years 2011, 2010 and 2009, 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 fiscal years 2011, 2010 and 2009.

Income Taxes

The provision for income taxes includes federal and state taxes currently payable and deferred income taxes arising from temporary differences between financial and income tax reporting methods. Deferred taxes are recorded using the liability method in recognition of these temporary differences. A valuation allowance is provided to the extent that it is more likely than not that deferred tax assets will not be realized. The Company has not provided deferred taxes related to its investment in foreign subsidiaries, which are classified as discontinued operations, as it does not expect future distributions from the subsidiaries or repayments of permanent advances.

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. This transfer is considered complete when a sales agreement is in place, delivery has occurred, pricing is fixed or determinable and collection is reasonably assured. Costs associated with shipping and handling is included in cost of sales.

Research and Development

Research and development costs are expensed as incurred, except for costs of patents, which are capitalized and amortized over the lives of the patents. Research and development costs expensed were $4.8 million, $4.4 million and $4.3 million in fiscal 2011, 2010 and 2009, respectively.

Foreign Currency

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. Statement of Operations amounts are translated at average exchange rates prevailing during the year. The net foreign currency transaction gain (loss) recognized in earnings was $0.4 million and $0.1 million for fiscal years 2010 and 2009, respectively.

Derivatives

Penford uses derivative instruments to manage the exposures associated with commodity prices, interest rates and energy costs. The derivative instruments are reported at fair value in other current assets or accounts payable in the consolidated balance sheets.

For derivative instruments designated as fair value hedges, the gain or loss on the derivative instruments as well as the offsetting gain or loss on the hedged firm commitments are recognized in current earnings as a component of cost of goods sold. 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 (loss), net of applicable income taxes, and recognized in earnings when the hedged exposure affects earnings. The Company recognizes the gain or loss on the derivative instrument as a component of cost of goods sold in the period when the

11

finished goods produced from the hedged item are sold or, for interest rate swaps, as a component of interest expense in the period the forecasted transaction is reported in earnings. If it is determined that the derivative instruments used are no longer effective at offsetting changes in cash flows or fair value of the hedged item, then the changes in fair value would be recognized in current earnings as a component of cost of good sold or interest expense.

Significant Customer and Export Sales

The Company has several relatively large customers in each business segment. The Company’s sales of ethanol to its sole ethanol customer, Eco-Energy, Inc., represented approximately 34%, 27% and 21% of the Company’s net sales for fiscal years 2011, 2010 and 2009, respectively. Eco-Energy, Inc. is a marketer and distributor of bio-fuels in the United States and Canada. The Company’s second largest customer, Domtar, Inc., represented approximately 8%, 8% and 11% of the Company’s net sales for fiscal years 2011, 2010 and 2009, respectively. Domtar, Inc. and Eco-Energy are customers of the Company’s Industrial Ingredients business. Export sales accounted for approximately 9%, 9% and 8% of consolidated sales in fiscal 2011, 2010 and 2009, respectively.

Stock-Based Compensation

The Company recognizes stock-based compensation in accordance with Financial Accounting Standards Board (“FASB”) ASC 718, “Compensation – Stock Compensation.” The Company utilizes the Black-Scholes option-pricing model to determine the fair value of stock options on the date of grant. This model derives the fair value of stock options based on certain assumptions related to expected stock price volatility, expected option life, risk-free interest rate and dividend yield. See Note 10 for further detail.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-05,Comprehensive Income (“ASU 2011-05”). To increase the prominence of items reported in other comprehensive income, the FASB eliminated the option of presenting components of other comprehensive income as part of the statement of changes in stockholders’ equity. ASU 2011-05 requires that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Regardless of the presentation of the components of other comprehensive income, ASU 2011-05 requires that the Company present on the face of the financial statements the reclassification adjustments for items that are reclassified from other comprehensive income to net income. The requirements of ASU 2011-05 will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The implementation of ASU 2011-05 is not expected to have a material impact on the Company’s consolidated financial statements.

Note 2 — Inventories

Components of inventory are as follows:

	August 31,
	2011		2010
	(Dollars in thousands)
Raw materials	$	14,799	$	8,708
Work in progress		1,752		1,299
Finished goods		16,182		9,842
Total inventories	$	32,733	$	19,849

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. See Note 13.

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Note 3 – Property and equipment

Components of property and equipment are as follows:

	August 31,
	2011			2010
	(Dollars in thousands)
Land	$	10,552		$	10,307
Plant and equipment		330,273			324,904
Construction in progress		6,375			4,272
		347,200			339,483
Accumulated depreciation		(239,828	)		(227,553	)
Net property and equipment	$	107,372		$	111,930

The above table includes approximately $0.5 million and $0.7 million of equipment under capital leases for fiscal years 2011 and 2010, respectively.

Note 4 – Goodwill and other intangible assets

The Company’s goodwill of $7.9 million at August 31, 2011 and 2010, relates to the Company’s Food Ingredients reporting unit. The Company completed its evaluation of the carrying value of goodwill as of June 1, 2011 and determined there was no impairment to the recorded value of goodwill. In order to identify potential impairments, Penford compared the fair value of its Food Ingredients reporting unit with its carrying amount, including goodwill. Penford then compared the implied fair value of goodwill with the carrying amount of that goodwill. The implied fair value of the reporting unit was determined using the discounted cash flow method, the implied market capitalization method and the guideline company method. Since there was no indication of impairment, Penford was not required to complete the second step of the process which would measure the amount of any impairment. At June 1, 2011, the fair value of the Food Ingredients reporting unit was substantially in excess of its carrying value, and there are no changes in that conclusion as of August 31, 2011.

Penford’s intangible assets consist of patents which are being amortized over the weighted average remaining amortization period of four years as of August 31, 2011. There is no residual value associated with patents. The carrying amount and accumulated amortization of intangible assets are as follows (dollars in thousands):

	August 31, 2011				August 31, 2010
	Carrying     Amount		Accumulated Amortization		Carrying     Amount		Accumulated Amortization
Intangible assets:
Patents	$	1,768	$	1,436	$	1,768	$	1,361

Amortization expense related to intangible assets was $0.1 million in each of fiscal years 2011, 2010 and 2009. The estimated aggregate annual amortization expense for patents is not significant for the next five fiscal years, 2012 through 2016.

Note 5 — Preferred Stock Subject to Mandatory Redemption

On April 7, 2010, the Company issued $40 million of Series A 15% cumulative non-voting, non-convertible preferred stock (“Series A Preferred Stock”) and 100,000 shares of Series B voting convertible preferred stock (“Series B Preferred Stock”) in a private placement to Zell Credit Opportunities Master Fund, L.P., an investment fund managed by Equity Group Investments, a private investment firm (the “Investor”). Proceeds from the preferred stock issuance of $40.0 million were used to repay bank debt on April 8, 2010. The Company has 1,000,000 shares of authorized preferred stock, $1.00 par value, of which 200,000 shares are issued and outstanding at August 31, 2010 in two series as shown below.

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	Shares Issued     and Outstanding
Series A 15% Cumulative Non-Voting Non-Convertible Preferred Stock, redeemable		100,000
Series B Voting Convertible Preferred Stock		100,000

The Company recorded the Series A Preferred Stock and the Series B Preferred Stock at their relative fair values at the time of issuance. The Series A Preferred Stock of $32.3 million was recorded as a long-term liability due to its mandatory redemption feature and the Series B Preferred Stock of $7.7 million was recorded as equity. The discount on the Series A Preferred Stock is being amortized into income using the effective interest method over the contractual life of seven years. At August 31, 2011, the carrying value of the Series A Preferred Stock liability of $39.0 million includes $5.3 million of accrued dividends, and $1.4 million of discount accretion for the period from the date of issuance to August 31, 2011. The accrued dividends represent the 9% dividends that may be paid or accrued at the option of the Company. Dividends on the Series A Preferred Stock and the discount accretion are recorded as interest expense in the consolidated statements of operations.

The holders of the Series A Preferred Stock are entitled to cash dividends of 6% on the sum of the outstanding Series A Preferred Stock plus accrued and unpaid dividends. In addition, dividends equal to 9% of the outstanding Series A Preferred Stock may accrue or be paid currently at the discretion of the Company. Dividends are payable quarterly beginning May 31, 2010.

The Series A Preferred Stock is mandatorily redeemable on April 7, 2017 at a per share redemption price equal to the original issue price of $400 per share plus any accrued and unpaid dividends. At any time on or after April 7, 2012, the Company may redeem, in whole or in part, the shares of the Series A Preferred Stock at a per share redemption price of the original issue price plus any accrued and unpaid dividends.

The Company may not declare or pay any dividends on its common stock or incur new indebtedness that exceeds a specified ratio without first obtaining approval from the holders of a majority of the Series A Preferred Stock.

The Company also granted to the investor certain information and inspection rights and the right to elect one director to the Company’s Board of Directors while any shares of Series A Preferred Stock remain outstanding. On April 9, 2010, the Board of Directors, upon the recommendation of the investor, elected Matthew Zell, a Managing Director of Equity Group Investments, to be the director designated by the holders of the Series A Preferred Stock.

Note 6 — Debt

	August 31,
	2011		2010
	(Dollars in thousands)
Secured credit agreements — revolving loans, 3.40% weighted average interest rate at August 31, 2011	$	22,100	$	18,900
Iowa Department of Economic Development loans		1,633		1,834
Capital lease obligations		490		733
		24,223		21,467
Less: current portion and short-term borrowings		421		429
Long-term debt and capital lease obligations	$	23,802	$	21,038

In fiscal year 2007, Penford entered into a $145 million Second Amended and Restated Credit Agreement (the “2007 Agreement”) among the Company; Harris N.A. (which has been replaced by the Bank of Montreal); LaSalle Bank National Association (now Bank of America); Cooperative Centrale Raiffeisen-Boorleenbank B.A., “Rabobank Nederland” (New York Branch); U.S. Bank National Association; and the Australia and New Zealand Banking Group Limited.

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On April 7, 2010, the Company used the proceeds from the preferred stock issuance discussed above to pay a portion of the outstanding bank debt obligations under the 2007 Agreement. Also on April 7, 2010, the Company refinanced its bank debt. The Company entered into a $60 million Third Amended and Restated Credit Agreement (the “2010 Agreement”) among the Company; Penford Products Co.; Bank of Montreal; Bank of America National Association; and Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., “Rabobank Nederland” New York Branch.

The 2010 Agreement refinanced the unpaid debt remaining under the 2007 Agreement. Under the 2010 Agreement, the Company may borrow $60 million in revolving lines of credit. The lenders’ revolving credit loan commitment may be increased under certain conditions. On August 31, 2011, the Company had $22.1 million outstanding under the 2010 Agreement, which is subject to variable interest rates. Under the 2010 Agreement, there are no scheduled principal payments prior to maturity on April 7, 2015. Substantially all of the Company’s assets secure the 2010 Agreement.

Interest rates under the 2010 Agreement are based on either the London Interbank Offering Rates (“LIBOR”) or the prime rate, depending on the selection of available borrowing options under the 2010 Agreement. The Company may choose a borrowing rate of 1-month, 3-month or 6-month LIBOR. Pursuant to the 2010 Agreement, the interest rate margin over LIBOR ranges between 3% and 4%, depending upon the Total Funded Debt Ratio (as defined).

The 2010 Agreement provides that the Total Funded Debt Ratio, which is computed as funded debt divided by earnings before interest, taxes, depreciation and amortization (as defined in the 2010 Agreement) shall not exceed 3.00. In addition, the Company must maintain a Fixed Charge Coverage Ratio, as defined in the 2010 Agreement, of not less than 1.35. Annual capital expenditures are restricted to $15 million (excluding certain capital expenditures specified in the 2010 Agreement) if the Total Funded Debt Ratio is greater than 2.00 for two consecutive fiscal quarters. The Company’s obligations under the 2010 Agreement are secured by substantially all of the Company’s assets. Pursuant to the 2010 Agreement, the Company may not declare or pay dividends on, or make any other distributions in respect of, its common stock. The Company was in compliance with the covenants in the 2010 Agreement as of August 31, 2011.

In connection with the refinancing, the Company recorded a pre-tax non-cash charge to earnings of $1.0 million in the third quarter of fiscal 2010 related to unamortized transaction fees associated with the prior credit facility. The Company also terminated its interest rate swaps in the third quarter of fiscal 2010 and recorded a charge to earnings of $1.6 million.

During the first quarter of fiscal 2010, the Iowa Department of Economic Development (“IDED”) awarded financial assistance to the Company as a result of the temporary shutdown of the Cedar Rapids, Iowa plant in the fourth quarter of fiscal 2008 due to record flooding of the Cedar River. The IDED provided two five-year non interest bearing loans as follows: (1) a $1.0 million loan to be repaid in 60 equal monthly payments of $16,667 beginning December 1, 2009, and (2) a $1.0 million loan which is forgivable if the Company maintains certain levels of employment at the Cedar Rapids plant. The proceeds of these Iowa loans were used to repay outstanding debt under the 2007 Agreement in the first quarter of fiscal 2010. At August 31, 2011, the Company had $1.6 million outstanding related to the IDED loans.

The maturities of debt existing at August 31, 2011 for the fiscal years beginning with fiscal 2012 are as follows (dollars in thousands):

2012	$	421
2013		447
2014		203
2015		23,152
	$	24,223

Included in the Company’s long-term debt at August 31, 2011 is $0.5 million of capital lease obligations, of which $0.2 million is considered current portion of long-term debt. See Note 9.

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Note 7 — Stockholders’ Equity

Common Stock

	Year Ended August 31,
	2011		2010		2009
Common shares outstanding
Balance, beginning of year		13,189,581		13,157,387		13,127,369
Issuance of restricted stock, net		53,804		32,194		30,018
Balance, end of year		13,243,385		13,189,581		13,157,387

Preferred Stock, Series B

On April 7, 2010, the Company issued $40 million of Series A 15% cumulative non-voting, non-convertible preferred stock (“Series A Preferred Stock”) and 100,000 shares of Series B voting convertible preferred stock (“Series B Preferred Stock”) in a private placement to Zell Credit Opportunities Master Fund, L.P., an investment fund managed by Equity Group Investments, a private investment firm (the “Investor”). See Note 5 for further details. Series B Preferred Stock was recorded at its relative fair value of $7.7 million at the time of issuance and recorded as equity. The holders of the Series B Preferred Stock are entitled to dividends equal to the per share dividend declared and paid on the Company’s common stock times the number of shares of common stock into which the Series B Preferred Stock is then convertible. The Series B Preferred Stock is not redeemable and dividends on the Series B Preferred Stock are non-cumulative. In the event the Company voluntarily or involuntarily liquidates, dissolves or winds up, the holders of shares of Series B Preferred Stock at the time of such event shall be entitled to participate in any liquidating distribution based on the amount payable to holders of the Company’s common stock at the same time that distributions of assets are made to the holders of the common stock. Holders of the Series B Preferred Stock shall participate in such distributions on a basis as if each share of Series B Preferred Stock had been converted, immediately prior to such liquidating distribution, into the number of shares of common stock at the then applicable conversion rate.

At any time prior to April 7, 2020, at the option of the holder, the outstanding Series B Preferred Stock may be converted into shares of the Company’s common stock at a conversion rate of ten shares of common stock per one share of Series B Preferred Stock, subject to adjustment in the event of stock dividends, distributions, splits, reclassifications and the like. If any shares of Series B Preferred Stock have not been converted into shares of common stock prior to April 7, 2020, the shares of Series B Preferred Stock will automatically convert into shares of common stock. The holders of the Series B Preferred Stock shall have the right to one vote for each share of common stock into which the Series B Preferred Stock is convertible.

In connection with this investment, the Company also agreed to register the shares of Common Stock issuable upon conversion of the Series B Preferred Stock. The registration statement for these shares of Common Stock became effective on June 7, 2010.

Until April 7, 2012, the Investor may not acquire any additional shares of common stock, and may not, with limited exceptions, transfer the Series B Preferred Stock, or the Company’s Common Stock into which the Series B Preferred Stock is convertible.

Note 8 — Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive losses are as follows:

	August 31,
	2011			2010
	(Dollars in thousands)
Net unrealized loss on derivatives, net of tax	$	731		$	(582	)
Postretirement obligations, net of tax		(8,290	)		(13,268	)
	$	(7,559	)	$	(13,850	)

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Note 9 — Leases

Certain of the Company’s property, plant and equipment is leased under operating leases. Equipment and vehicle leases generally have lease terms ranging from one to fifteen years with renewal options and real estate leases range between five to twenty years with renewal options. In fiscal 2011, rental expense under operating leases was $5.4 million. In fiscal 2010, rental expense under operating leases was $6.0 million, net of sublease rental income of approximately $0.1 million and fiscal 2009; rental expense under operating leases was $6.8 million, net of sublease rental income of approximately $0.3 million. Future minimum lease payments for fiscal years beginning with fiscal year 2011 for noncancelable operating and capital leases having initial lease terms of more than one year are as follows (dollars in thousands):

	Capital Leases				Operating Leases Minimum Lease Payments
2012	$	258			$	3,330
2013		255				2,589
2014		3				1,786
2015		3				922
2016		—				622
Thereafter		—				305
Total minimum lease payments		519			$	9,554
				��
Less: amounts representing interest		(29	)
Net minimum lease payments	$	490

Note 10 — Stock-based Compensation Plans

Penford maintains the 2006 Long-Term Incentive Plan (the “2006 Incentive Plan”) pursuant to which various stock-based awards may be granted to employees, directors and consultants. As of August 31, 2011, the aggregate number of shares of the Company’s common stock that are available to be issued as awards under the 2006 Incentive Plan is 31,017. In addition, any shares previously granted under the 1994 Stock Option Plan which are subsequently forfeited or not exercised will be available for future grants under the 2006 Incentive Plan. Non-qualified stock options granted under the 2006 Incentive Plan generally vest ratably for periods from one to four years and expire seven years from the date of grant.

General Option Information

A summary of the stock option activity for the year ended August 31, 2011 is as follows:

	Number of Shares			Option Price Range		Weighted Average Exercise Price		Weighted Average Remaining Term (in years)		Aggregate Intrinsic Value
Outstanding Balance, August 31, 2010		1,264,564		$	7.59 — 21.73	$	15.07
Granted		98,000			4.66 — 6.88		6.59
Exercised		-
Cancelled		(28,679	)		6.88 — 17.07		11.40
Outstanding Balance, August 31, 2011		1,333,885			4.66 — 21.73		14.52		2.68	$	8,400
Options Exercisable at August 31, 2011		1,158,635		$	7.73 — 21.73	$	14.95		2.31	$	-

The aggregate intrinsic value disclosed in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $5.50 per share as of August 31, 2011 that would have been received by the option holders had all option holders exercised on that date. No stock options were exercised in fiscal years 2011, 2010 and 2009.

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Valuation and Expense Under ASC 718

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

Under the 2006 Incentive Plan, the Company granted 98,000 stock options during fiscal 2011, (i) 80,000 stock options which vest one year from the date of grant, and (ii) 18,000 stock options which vest ratably over four years. The Company estimated the fair value of stock options granted during fiscal 2011 using the following weighted-average assumptions and resulting in the following weighted-average grant date fair value:

	2011
Expected volatility	71%
Expected life (years)	4.3
Interest rate	1.1-2.8%
Dividend yield	0%
Weighted-average fair values	$3.62

No stock options were granted in fiscal years 2010 and 2009. As of August 31, 2011, the Company had $0.3 million of unrecognized compensation costs related to non-vested stock option awards that are expected to be recognized over a weighted average period of 1.1 years.

Restricted Stock Awards

The grant date fair value of the Company’s restricted stock awards is equal to the fair value of Penford’s common stock at the grant date. The following table summarizes the restricted stock award activity for the twelve months ended August 31, 2011 as follows:

	Number of Shares			Weighted Average Grant Date Fair Value
Nonvested at August 31, 2010		154,707		$	15.67
Granted		-
Vested		(70,475	)		16.87
Cancelled		-
Nonvested at August 31, 2011		84,232		$	14.67

No restricted stock awards were granted in fiscal year 2011. The weighted average grant date fair value of awards granted in fiscal years 2010 and 2009 was $6.60 and $10.12, respectively. The total fair value of awards vested in 2011, 2010, and 2009 was $1.2 million, $1.0 million and $1.1 million, respectively. On January 1, 2010 and 2009, each non-employee director received an award of 2,301 and 1,976 shares of restricted stock under the 2006 Incentive Plan at the last reported sale price of the stock on the preceding trading day, which vested one year from grant date of the award. The Company recognizes compensation cost for restricted stock ratably over the vesting period.

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As of August 31, 2011, the Company had $0.1 million of unrecognized compensation costs related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.1 years.

Compensation Expense

The Company recognizes stock-based compensation expense utilizing the accelerated multiple option approach over the requisite service period, which equals the vesting period. The following table summarizes the total stock-based compensation cost for fiscal years 2011, 2010 and 2009 and the effect on the Company’s consolidated statements of operations (dollars in thousands):

	2011			2010			2009
Cost of sales	$	130		$	170		$	307
Operating expenses		949			1,413			2,300
Research and development expenses		38			28			49
Income (loss) from discontinued operations		-			(25	)		16
Total stock-based compensation expense	$	1,117		$	1,586		$	2,672
Income tax benefit		(424	)		(603	)		(1,015	)
Total stock-based compensation expense, net of tax	$	693		$	983		$	1,657

Note 11 — Pensions and Other Postretirement Benefits

Penford maintains two noncontributory defined benefit pension plans that cover approximately 75% of its employees. The defined benefit pension plans for salaried and bargaining unit hourly employees were closed to new participants effective January 1, 2005 and August 1, 2004, respectively.

The Company also maintains a postretirement health care benefit plan covering its bargaining unit hourly retirees. Effective August 1, 2004, the Company’s postretirement health care benefit plan covering bargaining unit hourly employees was closed to new entrants and to any current employee who did not meet minimum requirements as to age plus years of service.

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Obligations and Funded Status

The following represents information summarizing the Company’s pension and other postretirement benefit plans. A measurement date of August 31, 2011 was used for all plans.

	Year Ended August 31,
	Pension Benefits						Other Benefits
	2011			2010			2011			2010
	(Dollars in thousands)
Change in benefit obligation:
Benefit obligation at September 1	$	48,875		$	43,861		$	17,580		$	18,345
Service cost		1,617			1,608			272			353
Interest cost		2,696			2,633			972			1,077
Plan participants’ contributions		—			—			134			145
Actuarial (gain) loss		(1,099	)		463			333			10
Change in assumptions		(2,560	)		2,215			(1,736	)		(1,668	)
Benefits paid		(1,984	)		(1,905	)		(631	)		(682	)
Benefit obligation at August 31	$	47,545		$	48,875		$	16,924		$	17,580
Change in plan assets:
Fair value of plan assets at September 1	$	28,278		$	25,818		$	—		$	—
Actual return on plan assets		3,618			991			—			—
Company contributions		6,416			3,374			497			537
Plan participants’ contributions		—			—			134			145
Benefits paid		(1,984	)		(1,905	)		(631	)		(682	)
Fair value of the plan assets at August 31	$	36,328		$	28,278		$	—		$	—
Funded status:
Net liability – Plan assets less than projected benefit obligation	$	(11,217	)	$	(20,597	)	$	(16,924	)	$	(17,580	)
Recognized as:
Current accrued benefit liability	$	—		$	—		$	(731	)	$	(689	)
Non-current accrued benefit liability		(11,217	)		(20,597	)		(16,193	)		(16,891	)
Net Amount Recognized	$	(11,217	)	$	(20,597	)	$	(16,924	)	$	(17,580	)

Accumulated other comprehensive loss consists of the following amounts that have not yet been recognized as components of net benefit cost (dollars in thousands):

	August 31, 2011					August 31, 2010
	Pension Benefits		Other Benefits			Pension Benefits		Other Benefits
Unrecognized prior service cost (credit)	$	1,545	$	(459	)	$	1,773	$	(611	)
Unrecognized net actuarial loss		11,545		740			18,029		2,208
Total	$	13,090	$	281		$	19,802	$	1,597

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 (dollars in thousands):

	August 31,
	2011		2010
Projected benefit obligation	$	47,545	$	48,875
Accumulated benefit obligation	$	46,113	$	46,142
Fair value of plan assets	$	36,328	$	28,278

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Net Periodic Benefit Cost

	Year Ended August 31,
	Pension Benefits									Other Benefits
	2011			2010			2009			2011			2010			2009
	(Dollars in thousands)
Components of net periodic benefit cost
Service cost	$	1,617		$	1,608		$	1,420		$	272		$	353		$	259
Interest cost		2,696			2,633			2,581			972			1,077			913
Expected return on plan assets		(2,234	)		(2,022	)		(2,428	)		—			—			—
Amortization of prior service cost		228			244			253			(152	)		(152	)		(152	)
Amortization of actuarial loss		1,441			1,312			211			65			294			-
Benefit cost	$	3,748		$	3,775		$	2,037		$	1,157		$	1,572		$	1,020

Assumptions

The Company assesses its benefit plan assumptions on a regular basis. Assumptions used in determining plan information are as follows:

	August 31,
	Pension Benefits									Other Benefits
	2011			2010			2009			2011			2010			2009
Weighted-average assumptions used to calculate net periodic expense:
Discount rate		5.64	%		5.98	%		6.92	%		5.64	%		5.98	%		6.92	%
Expected return on plan assets		8.00	%		8.00	%		8.00	%
Rate of compensation increase		4.00	%		4.00	%		4.00	%
Weighted-average assumptions used to calculate benefit obligations at August 31:
Discount rate		5.87	%		5.64	%		5.98	%		5.87	%		5.64	%		5.98	%
Expected return on plan assets		8.00	%		8.00	%		8.00	%
Rate of compensation increase		3.00	%		4.00	%		4.00	%

The expected long-term return on assets assumption for the pension plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term historical market rates of return as well as actual returns on the Company’s plan assets, and adjusts this information to reflect expected capital market trends. Penford also considers forward looking return expectations by asset class, the contribution of active management and management fees paid by the plans. The plan assets are held in qualified trusts and anticipated rates of return are not reduced for income taxes. The expected long-term return on assets assumption used to calculate net periodic pension expense was 8.0% for fiscal 2011. A decrease (increase) of 50 basis points in the expected return on assets assumptions would increase (decrease) pension expense by approximately $0.2 million based on the assets of the plans at August 31, 2011. The expected return on plan assets to be used in calculating fiscal 2012 pension expense is 8.0%.

The discount rate used by the Company in determining pension expense and pension obligations reflects the yield of high quality (AA or better rating by a recognized rating agency) corporate bonds whose cash flows are expected to match the timing and amounts of projected future benefit payments. The discount rates to determine net periodic expense used in 2009 (6.92%), 2010 (5.98%) and 2011 (5.64%) reflect the change in bond yields over the last several years. During fiscal 2011, bond yields rose and Penford has increased the discount rate for calculating its benefit obligations at August 31, 2011, as well as net periodic expense for fiscal 2012, to 5.87%. Lowering the discount rate by 25 basis points would increase pension expense by approximately $0.2 million and other postretirement benefit expense by less than $0.1 million.

Unrecognized net loss amounts reflect the difference between expected and actual returns on pension plan assets as well as the effects of changes in actuarial assumptions. Unrecognized net losses in excess of certain thresholds are amortized into net periodic pension and postretirement benefit expense over the average remaining service life of active employees. Amortization of unrecognized net loss amounts is expected to increase net pension expense by approximately $0.8 million in fiscal 2012. Amortization of unrecognized net losses is expected to increase net postretirement health care expense by less than $0.1 million in fiscal 2012.

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Assumed health care cost trend rates:	2011			2010			2009
Current health care trend assumption		8.00	%		8.00	%		9.00	%
Ultimate health care trend rate		4.50	%		4.50	%		4.75	%
Year ultimate health care trend is reached		2029			2028			2016

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:

	1-Percentage- Point Increase		1-Percentage- Point Decrease
	(Dollars in thousands)
Effect on total of service and interest cost components in fiscal 2011	$	199	$	(162	)
Effect on postretirement accumulated benefit obligation as of August 31, 2011	$	2,315	$	(1,945	)

Plan Assets

The weighted average asset allocations of the investment portfolio for the pension plans at August 31 are as follows:

	Target Allocation	August 31,
		2011	2010
U.S. equities	55%	56%	56%
International equities	15%	16%	16%
Fixed income investments	25%	26%	26%
Real estate	5%	2%	2%

The assets of the pension plans are invested in units of common trust funds actively managed by Russell Trust Company, a professional fund investment manager. The investment strategy for the defined benefit pension assets is to maintain a diversified asset allocation in order to minimize the risk of large losses and maximize the long-term risk-adjusted rate of return. No plan assets are invested in Penford shares. There are no plan assets for the Company’s postretirement health care plans.

See Note 13, “Fair Value Measurements and Derivative Instruments,” for a description of the fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The Company’s employee pension plan assets are principally comprised of the following types of investments:

Common collective trust funds: The fair value of these funds is based on the cumulative net asset value of their underlying investments. The investments in common collective trust funds are comprised of equity funds, fixed income funds and international equity funds. The funds are valued at net asset value based on the closing market value of the units bought or sold as of the valuation date and are classified in Level 2 of the fair value hierarchy.

Real estate equity funds: The real estate equity funds are composed of underlying investments in primarily nine established income-producing real estate funds and short-term investment funds. The underlying fund net asset values are based on the values of the real estate assets as determined by appraisal. The appraisals are conducted in accordance with Appraisal Institute guidelines including consideration of projected income and expenses of the property as well as recent sales of similar properties. The underlying funds value all real estate investments quarterly and all real estate investments are independently appraised at least once per year as required by the Global Investment Performance Standards. Redemption requests are considered quarterly and are subject to notice of 110 days. The real estate fund is included in Level 3 of the fair value hierarchy.

The following table presents the fair value of the pension plan’s assets by major asset category as of August 31, 2011.

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	Quoted Prices In Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(in thousands)
Common collective trust funds	$		$	35,651	$	-	$	35,651
Real estate equity funds		-		-		677		677
Fair value of plan assets	$	-	$	35,651	$	677	$	36,328

The following table summarizes the changes in fair value of the pension plan’s real estate equity fund (Level 3) for fiscal year ended August 31, 2011.

	Real Estate Equity Fund
	(in thousands)
Balance, August 31, 2010	$	566
Actual return on plan assets:
Relating to assets still held at the reporting date		111
Relating to assets sold during the period		-
Purchases and sales		-
Transfers in (out) of Level 3		-
Balance, August 31, 2011	$	677

Contributions and Benefit Payments

The Company’s funding policy for the defined benefit pension plans is to contribute amounts sufficient to meet the statutory funding requirements of the Employee Retirement Income Security Act of 1974 and the Pension Protection Act of 2006. The Company contributed $6.4 million, $3.4 million and $1.1 million in fiscal 2011, 2010 and 2009, respectively. The Company estimates that the minimum pension plan funding contribution during fiscal 2012 will be approximately $2.8 million.

Penford funds the benefit payments of its postretirement health care plans on a cash basis; therefore, the Company’s contributions to these plans in fiscal 2012 will approximate the benefit payments below.

Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include benefits attributable to estimate future employee service.

	Pension		Other Postretirement
	(Dollars in millions)
2012	$	2.1	$	0.7
2013		2.3		0.8
2014		2.4		0.9
2015		2.5		0.9
2016		2.6		1.0
2017-2021	$	15.8	$	6.1

Note 12 — Other Employee Benefits

Savings and Stock Ownership Plan

The Company has a defined contribution savings plan by which eligible employees can elect a maximum salary deferral of 16%. The plan provides a 100% match on the first 3% of salary contributions and a 50% match on the next 3% per employee. The Company’s matching contributions were $908,000, $897,000 and $935,000 for fiscal years 2011, 2010 and 2009, respectively.

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Deferred Compensation Plan

The Company provided its directors and certain employees the opportunity to defer a portion of their salary, bonus and fees. The plan was closed to new contributions effective January 31, 2011. The deferrals earn interest based on Moody’s current Corporate Bond Yield. Deferred compensation interest of $197,000, $204,000 and $231,000 was accrued in fiscal years 2011, 2010 and 2009, respectively.

Supplemental Executive Retirement Plan

The Company sponsors a supplemental executive retirement plan, a non-qualified plan, which covers certain employees. No current executive officers participate in this plan. For fiscal 2011, 2010 and 2009, the net periodic pension expense accrued for this plan was $370,000, $343,000 and $342,000, respectively. The accrued obligation related to the plan was $2.7 million and $2.5 million for fiscal years 2011 and 2010, respectively. The plan was amended in fiscal 2011 such that no participant in the plan would accrue any additional benefits after January 31, 2011.

Health Care and Life Insurance Benefits

The Company offers health care and life insurance benefits to most active employees. Costs incurred to provide these benefits are charged to expense as incurred. Health care and life insurance expense, net of employee contributions, was $4.5 million, $4.7 million and $4.3 million in fiscal years 2011, 2010 and 2009, respectively.

Note 13 — Fair Value Measurements and Derivative Instruments

Fair Value Measurements

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability (an exit price) in Penford’s principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A fair value hierarchy was established that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources outside the reporting entity. Unobservable inputs are inputs that reflect Penford’s own assumptions based on market data and on assumptions that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The three levels of inputs that may be used to measure fair value are:

• Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

• Level 2 inputs are other than quoted prices included within Level 1 that are observable for assets and liabilities such as (1) quoted prices for similar assets or liabilities in active markets, (2) quoted prices for identical or similar assets or liabilities in markets that are not active, or (3) inputs that are derived principally or corroborated by observable market date by correlation or other means.

• Level 3 inputs are unobservable inputs to the valuation methodology for the assets or liabilities.

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Presented below are the fair values of the Company’s derivatives as of August 31, 2011 and 2010:

As of August 31, 2011	(Level 1)			(Level 2)		(Level 3)		Total
	(in thousands)
Current assets (Other Current Assets):
Commodity derivatives(1)	$	(3,153	)	$	-	$	-	$	(3,153	)
(1) On the consolidated balance sheets, commodity derivative assets and liabilities have been offset by cash collateral due and paid under master netting arrangements which are recorded together in Other Current Assets. The cash collateral offset was $5.1 million at August 31, 2011.

As of August 31, 2010	(Level 1)			(Level 2)		(Level 3)		Total
	(in thousands)
Current assets (Other Current Assets):
Commodity derivatives(1)	$	(2,789	)	$	-	$	-	$	(2,789	)
(1) On the consolidated balance sheets, commodity derivative assets and liabilities have been offset by cash collateral due and paid under master netting arrangements which are recorded together in Other Current Assets. The cash collateral offset was $4.5 million at August 31, 2010.

Other Financial Instruments

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

In the first quarter of fiscal 2010, the Company received two non-interest bearing loans from the State of Iowa totaling $2.0 million. The carrying value of the debt at August 31, 2011 was $1.6 million and the fair value of the debt was estimated to be $1.4 million. See Note 6.

The fair value of the Series A Preferred Stock was determined using the market approach in comparing yields on similar debt securities. The discount on the Series A Preferred Stock is being amortized into income using the effective interest method over the contractual life of seven years. The carrying value of the Series A Preferred Stock at August 31, 2011 was $39.0 million and the estimated fair value was $43.3 million.

Interest Rate Swap Agreements

The Company used interest rate swaps to manage the variability of interest payments associated with its floating-rate debt obligations. The interest payable on the debt effectively became fixed at a certain rate and reduced the impact of future interest rate changes on future interest expense. Unrealized gains and losses on interest rate swaps were included in accumulated other comprehensive income (loss). The periodic settlements on the swaps were recorded as interest expense. At August 31, 2011, the Company had no outstanding interest rate swaps and no gains or losses remaining in other comprehensive income (loss).

Commodity Contracts

The Company uses forward contracts and readily marketable exchange-traded futures on corn and natural gas to manage the price risk of those inputs to its manufacturing process. The Company also uses futures contracts to manage the variability of the cash flows from the forecasted sales of ethanol. The Company has designated these instruments as hedges.

For derivative instruments designated as fair value hedges, the gain or loss on the derivative instruments as well as the offsetting gain or loss on the hedged firm commitments and/or inventory are recognized in current earnings as a component of cost of sales. 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 (loss), net of applicable income taxes, and recognized in earnings when the hedged exposure affects earnings. The Company recognizes the gain or loss on the derivative instrument as a component of cost of sales in the period when the finished goods produced from the hedged item are sold. If it is determined that the derivative instruments used are no longer effective at offsetting changes in the price of the hedged item, then the changes in fair value would be recognized in current earnings as a component of cost of goods sold.

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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. Penford also uses exchange-traded futures to hedge corn inventories and firm corn purchase contracts.

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 sudden market fluctuations, Penford generally enters into short-term purchase contracts or uses exchange-traded futures contracts to hedge exposure to natural gas price fluctuations. These futures contracts are designated as hedges.

Selling prices for ethanol fluctuate based on the availability and price of manufacturing inputs and the status of various government regulations and tax incentives. To reduce the risk of the price variability of ethanol, Penford enters into exchange-traded futures contracts to hedge exposure to ethanol price fluctuations. These futures contracts have been designated as hedges.

Hedged transactions are generally expected to occur within 12 months of the time the hedge is established. The deferred gain (loss), net of tax, recorded in other comprehensive income at August 31, 2011 that is expected to be reclassified into income within 12 months is $0.7 million.

As of August 31, 2011, Penford had purchased corn positions of 5.8 million bushels, of which 3.7 million bushels represented equivalent firm priced starch and ethanol sales contract volume, resulting in an open position of 2.1 million bushels.

As of August 31, 2011, the Company had the following outstanding futures contracts:

Corn Futures	2,875,000	Bushels
Natural Gas Futures	730,000	mmbtu (millions of British thermal units)
Ethanol Swaps	6,870,000	Gallons

The following tables provide information about the fair values of the Company’s derivatives, by contract type, as of August 31, 2011 and 2010.

	Assets					Liabilities
In thousands		Fair Value August 31					Fair Value August 31
	Balance Sheet Location	2011		2010		Balance Sheet Location	2011		2010
Cash Flow Hedges:
Corn Futures	Other Current Assets	$	137	$	-	Other Current Assets	$	-	$	-
Natural Gas Futures	Other Current Assets		-		-	Other Current Assets		454		1,082
Ethanol Futures	Other Current Assets		-		-	Other Current Assets		1,289		-
Fair Value Hedges:
Corn Futures	Other Current Assets		-		28	Other Current Assets		1,547		1,735
Total Derivatives Designated as Hedging Instruments		$	137	$	28		$	3,290	$	2,817

The following tables provide information about the effect of derivative instruments on the financial performance of the Company for the year ended August 31, 2011 and August 31, 2010.

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In thousands	Amount of Gain (Loss) Recognized in OCI						Amount of Gain (Loss) Reclassified from AOCI into Income						Amount of Gain (Loss) Recognized in Income
	Year Ended August 31						Year Ended August 31						Year Ended August 31
	2011			2010			2011			2010			2011			2010
Cash Flow Hedges:
Corn Futures(1)	$	(4,949	)	$	384		$	(7,418	)	$	349		$	(162	)	$	(194)
Natural Gas Futures(1)		(579	)		(3,170	)		(1,332	)		(2,168	)		(85	)		-
Ethanol Futures(1)		(1,909	)		(590	)		(804	)		(493	)		-			-
Interest Rate Contracts(2)(4)		-			(395	)		-			(662	)		-			(1,562)
FX Contracts(1)		-			-			-			(26	)		-			-
	$	(7,437	)	$	(3,771	)	$	(9,554	)	$	(3,000	)	$	(247	)	$	(1,756)
Fair Value Hedges:
Corn Futures(1) (3)													$	28		$	85
(1) Gains and losses reported in cost of goods sold (2) Gains and losses reported in interest expense (3) Hedged items are firm commitments and inventory (4) Amount of loss recognized in income was reported in non-operating income (expense)

Note 14 — Other Non-operating Income (Expense)

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

	Year Ended August 31,
	2011		2010			2009
	(Dollars in thousands)
Loss on extinguishment of debt	$	—	$	(1,049	)	$	—
Loss on interest rate swap termination		—		(1,562	)		—
Gain on sale of dextrose product line		—		—			1,562
Gain (loss) on foreign currency transactions		—		419			127
Other		115		271			226
	$	115	$	(1,921	)	$	1,915

On April 7, 2010, the Company refinanced its bank debt. See Note 6. In connection with the refinancing, the Company recorded a pre-tax non-cash charge to earnings of approximately $1.0 million in the third quarter of fiscal 2010 related to unamortized transaction fees associated with the prior credit facility. In addition, the Company terminated its interest rate swap agreements with several banks and recorded a loss of approximately $1.6 million.

In the second quarter of fiscal 2009, the Company’s Food Ingredients business segment sold assets related to its dextrose product line to a third-party purchaser for $2.9 million, net of transaction costs. The Company recorded a $1.6 million gain on the sale.

The Company recognized a gain (loss) on foreign currency transactions on Australian dollar denominated assets and liabilities as disclosed in the table above.

Note 15 — Income Taxes

The majority of the Company’s loss from continuing operations before income taxes for fiscal years 2011, 2010 and 2009 of $4.8 million, $14.3 million and $10.1 million, respectively, is related to the Company’s domestic operations. See Note 17 for foreign income (loss) before income taxes and foreign tax expense. The majority of the Company’s foreign operations are included in the discontinued operations presentation in the consolidated financial statements.

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Income tax expense (benefit) on continuing operations consists of the following:

	Year Ended August 31,
	2011		2010			2009
	(Dollars in thousands)
Current:
Federal	$	34	$	(332	)	$	(3,305	)
State		137		208			(141	)
		171		(124	)		(3,446	)
Deferred:
Federal		9		(4,447	)		291
State		133		(131	)		(291	)
		142		(4,578	)		-
Total	$	313	$	(4,702	)	$	(3,446	)

	Year Ended August 31,
	2011		2010			2009
	(Dollars in thousands)
Comprehensive tax expense (benefit) allocable to:
Income (loss) before taxes	$	313	$	(4,702	)	$	(3,446	)
Discontinued operations		-		(4,495	)		1,149
Comprehensive income (loss)		3,856		891			(5,906	)
	$	4,169	$	(8,306	)	$	(8,203	)

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

	Year Ended August 31,
	2011			2010			2009
	(Dollars in thousands)
Statutory tax rate		35	%		35	%		35	%
Statutory tax on income	$	(1,682	)	$	(5,016	)	$	(3,532	)
State taxes, net of federal benefit		52			33			(221	)
Non-deductible expenses related to preferred stock		2,687			1,020			-
Research credit		(195	)		(54	)		(181	)
Ethanol credit		(975	)		(975	)		-
Foreign tax loss with no benefit		200			34			-
Prior year true up		79			306			36
Unrecognized tax benefits		67			(139	)		422
Other		80			89			30
Total provision (benefit)	$	313		$	(4,702	)	$	(3,446	)

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

	August 31,
	2011		2010
	(Dollars in thousands)
Deferred tax assets:
Alternative minimum tax credit	$	3,108	$	3,108
Postretirement benefits		12,377		14,669
Provisions for accrued expenses		1,893		2,280
Stock-based compensation		2,357		2,392
Deferred flood losses		2,625		3,257
Net operating loss carryforward		8,242		9,497
Tax credit carryforwards		4,325		2,508
Other		2,487		2,374
Total deferred tax assets		37,414		40,085
Deferred tax liabilities:
Depreciation		21,678		21,659
Other		2,132		613
Total deferred tax liabilities		23,810		22,272
Net deferred tax assets	$	13,604	$	17,813
Recognized as:
Other current assets	$	909	$	1,320
Deferred tax asset		12,695		16,493
Total net deferred tax assets	$	13,604	$	17,813

At August 31, 2011, in the United States, the Company had a U.S. federal alternative minimum tax credit carryforward of $3.1 million with no expiration, research and development credit carryforwards of $1.3 million expiring 2025 through 2031, a small ethanol producer credit of $3.0 million expiring 2014, and a net operating loss carryforward of $20.6 million expiring in 2030. The Company also has U.S. state net operating loss carryforwards of $24.9 million with various expiration dates.

At August 31, 2011, the Company had $13.6 million of net deferred tax assets. A valuation allowance has not been provided on the net U.S. deferred tax assets as of August 31, 2011. The determination of the need for a valuation allowance requires significant judgment and estimates. The Company evaluates the requirement for a valuation allowance each quarter as the Company incurred book losses in fiscal 2009, 2010 and 2011. The Company’s losses in fiscal years 2008 and 2009 were incurred as a result of severe flooding in Cedar Rapids, Iowa, which shut down the Company’s manufacturing facility for most of the fourth quarter of fiscal 2008. The tax benefits of operating losses incurred in fiscal 2008 and 2009 have been carried back to offset taxable income in prior years. While there have been losses since 2008 for reasons indicated above, the Company believes that it is more likely than not that future operations will generate sufficient taxable income to realize its deferred tax assets. Dividends on the Series A Preferred Stock, as well as accretion of the related discount, which are included in interest expense in the Consolidated Statement of Operations, are not deductible for U.S. federal income tax purposes. There can be no assurance that management’s current plans will be achieved or that a valuation allowance will not be required in the future.

Deferred tax liabilities or assets are not recognized on temporary differences from undistributed earnings of foreign subsidiaries and from foreign exchange translation gains or losses on permanent advances to foreign subsidiaries as the Company does not expect that the divestiture of its foreign subsidiaries will result in any tax benefit or expense.

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The total amount of gross unrecognized tax benefits was $1.2 million at August 31, 2011, all of which, if recognized, would impact the Company’s effective tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (dollars in thousands):

	2011			2010
Unrecognized tax benefits at beginning of year	$	1,131		$	1,281
Additions for tax positions related to prior years		82			118
Reductions for tax positions related to prior years		-			-
Additions for tax positions related to current year		97			160
Reductions due to lapse of applicable statute of limitations		(90	)		(428	)
Settlements with taxing authorities		-			-
Unrecognized tax benefits at end of year	$	1,220		$	1,131

The Company’s policy is to recognize interest and penalty expense associated with uncertain tax positions as a component of income tax expense (benefit) in the consolidated statements of operations. As of August 31, 2011 and 2010, the Company had $0.2 million of accrued interest and penalties included in the long-term tax liability. During fiscal 2011, the Company increased the liability for unrecognized tax benefits by $22,000 for interest and $40,000 for penalties.

The Company files tax returns in the U.S. federal jurisdiction and various U.S. state jurisdictions, and is subject to examination by taxing authorities in all of those jurisdictions. From time to time, the Company’s tax returns are reviewed or audited by various U.S. state taxing authorities. The Company believes that adjustments, if any, resulting from these reviews or audits would not be material, individually or in the aggregate, to the Company’s financial position, results of operations or liquidity. It is reasonably possible that the amount of unrecognized tax benefits related to certain of the Company’s tax positions will increase or decrease in the next twelve months as audits or reviews are initiated and settled. At this time, an estimate of the range of a reasonably possible change cannot be made. In January 2011, the U.S. Internal Revenue Service (“IRS”) notified the Company that its tax refund of $3.5 million resulting from a carryback of tax losses from fiscal year 2009 to fiscal years 2006 and 2007 is being evaluated to determine whether the refund will be examined or accepted without examination. The Company has also been notified by the state of Alabama of an audit. The Company is not subject to income tax examinations by U.S. federal or state jurisdictions for fiscal years prior to 2007.

Note 16 — Earnings (loss) per Common Share

The Company applies ASC 260-10-45, “Participating Securities and the Two-Class Method” (“ASC 260-10-45”) which requires all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in undistributed earnings with common shareholders and, therefore, are included in computing earnings per share under the two-class method. Under the two-class method, net earnings are reduced by the amount of dividends declared in the period for each class of common stock and participating security. The remaining undistributed earnings are then allocated to common stock and participating securities, based on their respective rights to receive dividends. Restricted stock awards granted to certain employees and directors under the Company’s 2006 Incentive Plan which contain non-forfeitable rights to dividends at the same rate as common stock, are considered participating securities.

Basic earnings (loss) per share reflect only the weighted average common shares outstanding during the period. Diluted earnings (loss) per share reflect weighted average common shares outstanding and the effect of any dilutive common stock equivalent shares.Diluted earnings (loss) per share is calculated by dividing net income (loss) by the average common shares outstanding plus additional common shares that would have been outstanding assuming the exercise of in-the-money stock options, using the treasury stock method. The following table presents the reconciliation of income from continuing operations to income from continuing operations applicable to common shares and equivalents and the computation of diluted weighted average shares outstanding for the fiscal years 2011, 2010 and 2009.

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	Year Ended August 31,
	2011			2010			2009
	(in thousands)
Numerator:
Loss from continuing operations	$	(5,117	)	$	(9,629	)	$	(6,645	)
Less: Allocation to participating securities		-			(84	)		(11	)
Loss from continuing operations applicable to common shares and equivalents	$	(5,117	)	$	(9,713	)	$	(6,656	)
Income (loss) from discontinued operations	$	-		$	16,312		$	(58,142	)
Less: Allocation to participating securities		-			-			-
Income (loss) from discontinued operations applicable to common shares and equivalents	$	-		$	16,312		$	(58,142	)
Net income (loss)	$	(5,117	)	$	6,683		$	(64,787	)
Less: Allocation to participating securities		-			(84	)		(11	)
Net income (loss) applicable to common shares and equivalents	$	(5,117	)	$	6,599		$	(64,798	)
Denominator:
Weighted average common shares and equivalents outstanding, basic		12,251			11,601			11,170
Dilutive stock options and awards		-			-			-
Weighted average common shares and equivalents outstanding, diluted		12,251			11,601			11,170

The 100,000 shares of Series B Preferred Stock are included in the weighted average common shares and equivalents computation of basic earnings per share.

Weighted-average restricted stock awards of 98,158, 146,668 and 90,868 for fiscal years 2011, 2010 and 2009, respectively, were excluded from the calculation of diluted earnings per share because they were antidilutive. Weighted-average stock options omitted from the denominator of the earnings per share calculation because they were antidilutive were 1,325,945, 1,309,273 and 1,371,701 for 2011, 2010 and 2009, respectively.

Note 17 — Discontinued Operations

As discussed in Note 1, the Company sold its Australia/New Zealand operations in 2009. At August 31, 2011, the remaining net assets of the Australia/New Zealand Operations consist of $0.3 million of cash and $0.8 million of other net assets, primarily a receivable from the purchaser of one of the Company’s Australian manufacturing facilities. Proceeds from the sale included $2.0 million in escrow to be released in four equal installments. Penford Australia received the first two installments of $0.5 million each. The remaining escrowed payments of $1.0 million are subject to the buyer’s right to make warranty claims under the sale contract. In July 2011, the purchaser filed a claim with the Company for $787,000. The Company believes that the claim is without merit and intends to contest the claim vigorously. At August 31, 2011, no allowance relating to this $1.0 million receivable has been established.

The following table summarizes the financial information for discontinued operations related to the Australia/New Zealand Operations. Interest expense on debt directly attributable to the Australia/New Zealand Operations has been allocated to discontinued operations.

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	Year Ended August 31,
	2010			2009
	(Dollars in thousands)
Sales	$	16,992		$	78,030
Loss from operations	$	(1,848	)	$	(57,754	)
Interest expense		444			973
Gain on sale of assets		199			-
Reclassification of currency translation adjustments into earnings		13,420			-
Other non-operating income, net		490			1,734
Income (loss) from discontinued operations before taxes		11,817			(56,993	)
Income tax expense (benefit)		(4,495	)		1,149
Income (loss) from discontinued operations, net of tax	$	16,312		$	(58,142	)

The Company believes that it is more likely than not that the net deferred tax benefit of $11.0 million recorded for the Australian operations will not be realized. The Company’s discontinued Australian operations recorded a valuation allowance as of August 31, 2011 of $11.0 million against the entire Australian net deferred tax asset. The valuation allowance increased $0.1 million in fiscal 2011.

Note 18 — Cedar Rapids Flood

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

During fiscal years 2009 and 2008, the Company recorded flood restoration costs of $45.6 million, and insurance recoveries of $27.2 million. The components of the costs and recoveries for fiscal 2009 are as follows:

(Dollars in thousands)
Repairs of buildings and equipment	$	6,346
Site remediation		348
Write off of inventory and fixed assets		71
Other		820
		7,585
Insurance recoveries		(16,694)
Net flood recoveries	$	(9,109)

Note 19 — Segment Reporting

Financial information from continuing operations for the Company’s two segments, Industrial Ingredients and Food Ingredients, is presented below. Industrial Ingredients and Food Ingredients, are broad categories of end-market users served by the Company’s U.S. operations. The Industrial Ingredients segment provides carbohydrate-based starches for industrial applications, primarily in the paper and packaging products and fuel industries. The Food Ingredients segment produces specialty starches for food applications. A third 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. The accounting policies of the reportable segments are the same as those described in Note 1.

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	Year Ended August 31,
	2011			2010			2009
	(Dollars in thousands)
Sales
Industrial ingredients
Industrial Starch	$	127,471		$	115,681		$	131,709
Ethanol		105,730			68,335			54,817
	$	233,201		$	184,016		$	186,526
Food ingredients		82,240			70,258			69,030
	$	315,441		$	254,274		$	255,556
Depreciation and amortization
Industrial ingredients	$	10,812		$	10,850		$	11,081
Food ingredients		2,110			2,341			2,759
Corporate and other		1,493			1,600			615
	$	14,415		$	14,791		$	14,455
Income (loss) from continuing operations
Industrial ingredients	$	(4,718	)	$	(11,512	)	$	(11,154	)
Food ingredients		18,037			15,145			13,512
Corporate and other		(8,874	)		(8,493	)		(8,807	)
	$	4,445		$	(4,860	)	$	(6,449	)
Capital expenditures, net
Industrial ingredients	$	6,625		$	4,713		$	3,683
Food ingredients		1,663			1,267			1,696
Corporate and other		7			-			-
	$	8,295		$	5,980		$	5,379

	August 31,
	2011		2010
	(Dollars in thousands)
Total assets
Industrial ingredients	$	138,412	$	133,738
Food ingredients		42,252		36,542
Corporate and other		31,750		38,128
	$	212,414	$	208,408

At August 31, 2011, the remaining net assets of the Australia/New Zealand Operations, consisting of $0.3 million of cash and $0.8 million of other net assets, have been reported as assets of the continuing operations in “Corporate and other.” All other assets are located in the United States.

Reconciliation of income (loss) from operations for the Company’s segments to income (loss) before income taxes as reported in the consolidated financial statements follows:

	Year Ended August 31,
	2011			2010			2009
	(Dollars in thousands)
Income (loss) from operations	$	4,445		$	(4,860	)	$	(6,449	)
Interest expense		(9,364	)		(7,550	)		(5,557	)
Other non-operating income (expense)		115			(1,921	)		1,915
Loss from continuing operations before income taxes	$	(4,804	)	$	(14,331	)	$	(10,091	)

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Sales, attributed to the area to which the product was shipped, are as follows:

	Year Ended August 31,
	2011		2010		2009
	(Dollars in thousands)
United States	$	288,571	$	231,042	$	234,081
Canada		4,027		3,738		5,137
Mexico		9,221		6,996		5,552
Columbia		6,802		6,227		5,925
Other		6,820		6,271		4,861
Non-United States		26,870		23,232		21,475
Total	$	315,441	$	254,274	$	255,556

Note 20 — Quarterly Financial Data (Unaudited)

Fiscal 2011	First   Quarter		Second   Quarter			Third   Quarter			Fourth   Quarter			Total
	(Dollars in thousands, except per share data)
Sales	$	72,266	$	74,304		$	85,233		$	83,638		$	315,441
Cost of sales		63,009		67,461			74,815			76,321			281,606
Gross margin		9,257		6,843			10,418			7,317			33,835
Income (loss) from continuing operations		336		(1,575	)		(709	)		(3,169	)		(5,117	)
Income (loss) from discontinued operations		-		-			-			-			-
Net income (loss)		336		(1,575	)		(709	)		(3,169	)		(5,117	)
Earnings (loss) per common share:
Basic – continuing operations	$	0.03	$	(0.13	)	$	(0.06	)	$	(0.26	)	$	(0.42	)
Basic – discontinued operations		-		-			-			-			-
Basic earnings (loss) per share	$	0.03	$	(0.13	)	$	(0.06	)	$	(0.26	)	$	(0.42	)
Diluted – continuing operations	$	0.03	$	(0.13	)	$	(0.06	)	$	(0.26	)	$	(0.42	)
Diluted – discontinued operations		-		-			-			-			-
Diluted earnings (loss) per share	$	0.03	$	(0.13	)	$	(0.06	)	$	(0.26	)	$	(0.42	)
Dividends declared	$	-	$	-		$	-		$	-		$	-

Fiscal 2010	First   Quarter		Second   Quarter			Third   Quarter			Fourth   Quarter			Total
	(Dollars in thousands, except per share data)
Sales	$	67,070	$	62,293		$	61,909		$	63,002		$	254,274
Cost of sales		56,442		56,231			58,644			59,503			230,820
Gross margin		10,628		6,062			3,265			3,499			23,454
Income (loss) from continuing operations		1,056		(1,801	)		(5,758	)		(3,126	)		(9,629	)
Income (loss) from discontinued operations		3,482		13,048			(218	)		-			16,312
Net income (loss)		4,538		11,247			(5,976	)		(3,126	)		6,683
Earnings (loss) per common share:
Basic – continuing operations	$	0.09	$	(0.17	)	$	(0.49	)	$	(0.26	)	$	(0.84	)
Basic – discontinued operations		0.31		1.16			(0.02	)		-			1.41
Basic earnings (loss) per share	$	0.40	$	0.99		$	(0.51	)	$	(0.26	)	$	0.57
Diluted – continuing operations	$	0.09	$	(0.17	)	$	(0.49	)	$	(0.26	)	$	(0.84	)
Diluted – discontinued operations		0.31		1.16			(0.02	)		-			1.41
Diluted earnings (loss) per share	$	0.40	$	0.99		$	(0.51	)	$	(0.26	)	$	0.57
Dividends declared	$	-	$	-		$	-		$	-		$	-

In the second quarter of fiscal 2010, the liquidation of the remaining net assets of Penford Australia was substantially completed, as a result, $13.8 million of currency translation adjustments were reclassified from accumulated other comprehensive income into second quarter income (loss) from discontinued operations. See Note 17.

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Note 21 – Legal Proceedings and Contingencies

The Company filed suit on January 23, 2009 in the United States District Court for the Northern District of Iowa against two insurance companies, National Union Fire Insurance Company of Pittsburgh, Pennsylvania, owned by American International Group, Inc. (“AIG”), and ACE American Insurance Company (“ACE”), due to the insurers’ denial of certain insurance coverage for damages that the Company suffered from the flood that struck the Company’s Cedar Rapids, Iowa plant in June 2008. On January 19, 2010, the presiding judge ruled that flood coverage language contained in the applicable insurance policy was “ambiguous” and that the interpretation of the policy was “a question of fact reserved for a jury.” At the conclusion of the jury trial subsequently conducted in August 2010, the presiding judge dismissed the Company’s claims without issuing a written opinion. In the fall of 2010, the Company appealed the dismissal to the United States Court of Appeals for the Eighth Circuit. The Company’s appeal has not yet been decided. The Company cannot at this time determine the likelihood of any outcome of the appeal or estimate the amount of any judgment that might be awarded.

In June 2011, the Company was notified that a complaint had been filed in the United States District Court for the District of New Jersey alleging that certain pet chew products supplied to a customer by the Company’s subsidiary, Penford Products Co. (“Penford Products”), infringe upon a patent owned by T.F.H. Publications, Inc. (“TFH”). The customer requested that Penford Products defend this lawsuit pursuant to the terms of its supply agreement with Penford Products. The Company believes that its products do not infringe upon the patent and has commenced a defense of the lawsuit. The Company cannot at this time determine the likelihood of any outcome or estimate any damages that might be awarded.

In July 2011, the purchaser of the Company’s Lane Cove, New South Wales, Australia operating assets filed a claim for $787,000 pursuant to the sale agreement. See Note 17.

The Company regularly evaluates the status of claims and legal proceedings in which it is involved in order to assess whether a loss is probable or there is a reasonable possibility that a loss may have been incurred and to determine if accruals are appropriate. For the matters identified in the preceding two paragraphs, management is unable to provide additional information regarding any possible loss because, among other reasons, (i) the matters are in early stages; (ii) the Company currently believes that the claims are not adequately supported; and (iii) there are significant factual issues to be resolved. With regard to these matters, management does not believe, based on currently available information, that the eventual outcomes will have a material adverse effect on the Company’s financial condition, although the outcomes could be material to the Company’s operating results for any particular period, depending, in part, upon the operating results for such period.

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

Note 22 – Subsequent Event

On November 9, 2011, Penford Carolina, LLC, a Delaware limited liability company (“Purchaser”) and a wholly-owned subsidiary of Penford Corporation (“Penford”), entered into a Business Sale and Membership Interest Purchase Agreement (the “Purchase Agreement”) with each of R. Bentley Cheatham, Dwight Carlson and Steven P. Brower (collectively, the “ Sellers”) together with three limited liability companies owned by the Sellers.

Pursuant to the terms of the Purchase Agreement, at the closing Purchaser would acquire 100% of the limited liability company interests in Carolina Starches, LLC, a South Carolina limited liability company (“Carolina Starches”) wholly-owned by Sellers, in exchange for $6 million in cash (“Cash Payment”) and the assumption of $3.5 million in debt. As part of the transactions contemplated by the Purchase Agreement, Purchaser would enter into asset purchase agreements at the closing with two of the limited liability companies owned by the Sellers pursuant to which these companies would transfer to Purchaser substantially all of the their assets. Purchaser would also enter into a real property lease agreement at the closing with another limited liability company owned by Sellers, pursuant to which Purchaser will lease a facility from such company.

35

In addition to the Cash Payment, at the closing Penford would enter into a separate stock option agreement with each of the three Sellers pursuant to which Penford would grant each Seller an option to purchase up to 55,000 shares of the Company’s common stock, $1.00 par value per share (the “Shares”), at an exercise price equal to the closing per Share price as of the close of business on the closing date (the “Tranche A Option”), and a second option to purchase up to 50,000 Shares at an exercise price equal to the closing price per Share as of the close of business on the date that the earnout condition described below is satisfied (the “Tranche B Option”). Both the Tranche A Option and the Tranche B Option would be subject to three year vesting terms, with one-third of the options vesting on each anniversary of the grant date. The Tranche B Option also would be subject to an earnout condition requiring the earnings before interest and income taxes attributable to Carolina Starches to exceed a specified threshold. Penford anticipates completing the transactions contemplated by the Purchase Agreement in the second quarter of fiscal year 2012. The consummation of the transaction is subject to various customary conditions, which may be waived by the applicable parties, including conditions to closing that:

• Purchaser is satisfied with the results of certain due diligence inquiries regarding Carolina Starches and its related companies; and

• the absence of any material adverse change in the business, financial condition and operations of Carolina Starches and its related companies.

36

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

Penford Corporation:

We have audited the accompanying consolidated balance sheets of Penford Corporation and subsidiaries (the Company) as of August 31, 2011 and 2010, and the related consolidated statements of operations and comprehensive income (loss), cash flows, and shareholders’ equity for the years then ended. We also have audited Penford Corporation’s internal control over financial reporting as of August 31, 2011, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Penford Corporation’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in a reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Penford Corporation and subsidiaries as of August 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also in our opinion, Penford Corporation maintained, in all material respects, effective internal control over financial reporting as of August 31, 2011, based on criteria established inInternal Control – Integrated Framework issued by COSO.

/s/ KPMG LLP

Denver, Colorado

November 10, 2011

37

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Penford Corporation

We have audited the accompanying consolidated statements of operations, comprehensive loss, shareholders’ equity and cash flows of Penford Corporation for the year ended August 31, 2009. 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 audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (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 audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of Penford Corporation’s operations and its cash flows for the year ended August 31, 2009, in conformity with U.S. generally accepted accounting principles.

/s/ Ernst & Young LLP

Denver, Colorado

November 13, 2009,

except for Note 16, as to which the date is

November 11, 2010

38

PART IV

Item 15.  Exhibits and Financial Statement Schedules.

(a)(1)Financial Statements

Financial statements required to be filed for the registrant under Items 8 or 15 are included in Part II, Item 8.

(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 43.

(b)Exhibits

See Item 15(a)(3), above.

(c)Financial Statement Schedules

None

39

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, on this 19th day of July 2012.

PENFORD CORPORATION

/s/ Thomas D. Malkoski

Thomas D. Malkoski

President and Chief Executive Officer

40

INDEX TO EXHIBITS

Copies of exhibits can be obtained at no cost by writing to Penford Corporation, 7094 S. Revere Parkway, Centennial, Colorado 80112.

Exhibit No.	Item
23.1	Consent of Ernst & Young LLP
23.2	Consent of KPMG LLP
��     31.1	Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley act of 2002

41