Penford (PENX) 10-Q 2014 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED November 30, 2013

OR

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

For the transition period from                    to                    

Commission File No. 0-11488

PENFORD CORPORATION

(Exact name of registrant as specified in its charter)

Washington	91-1221360
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

7094 South Revere Parkway,
Centennial, Colorado	80112-3932
(Address of Principal Executive Offices)	(Zip Code)

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

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

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

Large Accelerated Filer	¨	Accelerated Filer	x
Non-Accelerated Filer	¨  (Do not check if a smaller reporting company)	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 net number of shares of the Registrant’s common stock outstanding as of January 6, 2014 was 12,497,654.

PENFORD CORPORATION AND SUBSIDIARIES

INDEX

	Page
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets – November 30, 2013 and August 31, 2013		3
Condensed Consolidated Statements of Operations – Three Months ended November 30, 2013 and 2012		4
Condensed Consolidated Statements of Comprehensive Income (Loss) – Three Months ended November  30, 2013 and 2012		5
Condensed Consolidated Statements of Cash Flows – Three Months ended November 30, 2013 and 2012		6
Notes to Condensed Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3. Quantitative and Qualitative Disclosures About Market Risk		23
Item 4. Controls and Procedures		23
PART II—OTHER INFORMATION
Item 1. Legal Proceedings		25
Item 1A. Risk Factors		25
Item 6. Exhibits		25
Signatures		26

2

PART I—FINANCIAL INFORMATION

Item 1: Financial Statements

PENFORD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except per share data)	November 30, 2013			August 31, 2013
Assets
Current assets:
Cash and cash equivalents	$	197		$	221
Trade accounts receivable, net		41,083			43,432
Inventories		32,720			33,992
Prepaid expenses		2,765			3,100
Material and supplies		4,625			4,634
Other		4,761			4,735
Total current assets		86,151			90,114
Property, plant and equipment, net		112,059			112,141
Restricted cash value of life insurance		7,830			7,837
Deferred tax assets		4,735			4,987
Other assets		1,166			1,248
Other intangible assets, net		551			313
Goodwill, net		7,978			7,978
Total assets	$	220,470		$	224,618
Liabilities and Shareholders’ Equity
Current liabilities:
Cash overdraft, net	$	2,679		$	5,072
Current portion of long-term debt and capital lease obligations		347			231
Accounts payable		22,575			20,656
Short-term financing arrangements		924			1,474
Accrued liabilities		7,158			8,207
Total current liabilities		33,683			35,640
Long-term debt and capital lease obligations		69,798			72,739
Other postretirement benefits		16,660			16,596
Pension benefit liability		10,374			10,552
Other liabilities		6,222			6,198
Total liabilities		136,737			141,725
Shareholders’ equity:
Common stock, par value $1.00 per share, authorized 29,000 shares, issued 14,479 and 14,479 shares, respectively, including treasury shares		14,454			14,454
Preferred stock, par value $1.00 per share, authorized 1,000 shares, none issued		—			—
Additional paid-in capital		105,415			105,166
Retained earnings		4,137			3,649
Treasury stock, at cost, 1,981 shares		(32,757	)		(32,757	)
Accumulated other comprehensive loss		(7,516	)		(7,619	)
Total shareholders’ equity		83,733			82,893
Total liabilities and shareholders’ equity	$	220,470		$	224,618

The accompanying notes are an integral part of these statements.

3

PENFORD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three months ended November 30,
(In thousands, except per share data)	2013			2012
Sales	$	109,251		$	118,022
Cost of sales		98,542			104,764
Gross margin		10,709			13,258
Operating expenses		7,801			7,773
Research and development expenses		1,267			1,465
Income from operations		1,641			4,020
Interest expense		(813	)		(1,081	)
Other non-operating income (expense), net		8			(163	)
Income from operations before income taxes		836			2,776
Income tax expense		348			1,069
Net income	$	488		$	1,707
Weighted average common shares and equivalents outstanding:
Basic		12,473			12,307
Diluted		12,841			12,372
Earnings per common share:
Basic earnings per share	$	0.04		$	0.14
Diluted earnings per share	$	0.04		$	0.14

The accompanying notes are an integral part of these statements.

4

PENFORD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	Three months ended November 30,
(In thousands)	2013			2012
Net income	$	488		$	1,707
Other comprehensive income (loss) net of tax:
Change in fair value of derivatives, net of tax benefit (expense) of $746 and $(189)		(1,217	)		309
Loss (gain) from derivative transactions reclassified into earnings from accumulated other comprehensive income, net of tax benefit (expense) of $753 and $(1,339)		1,227			(2,186	)
Amortization of prior service cost, net of tax benefit of $7 and $8		13			14
Amortization of actuarial loss, net of tax benefit of $51 and $209		80			341
Other comprehensive income (loss)		103			(1,522	)
Total comprehensive income	$	591		$	185

The accompanying notes are an integral part of these statements.

5

PENFORD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three months ended
(In thousands)	November 30, 2013			November 30, 2012
Cash flows from operating activities:
Net income	$	488		$	1,707
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		3,291			3,383
Stock-based compensation		249			417
Loss on sale of fixed assets		—			12
Deferred income tax expense		209			965
Non-cash loss on hedging transactions		122			705
Excess tax benefit from stock-based compensation		(152	)		—
Change in assets and liabilities:
Trade accounts receivable		2,349			(2,397	)
Inventories		1,150			3,112
Prepaid expenses		335			43
Decrease (increase) in margin accounts		846			(2,969	)
Accounts payable and accrued liabilities		594			(416	)
Pension and other postretirement benefit contributions		(724	)		(129	)
Pension and other postretirement benefit costs		761			1,277
Other receivables		(976	)		935
Other		132			299
Net cash flow provided by operating activities		8,674			6,944
Cash flows from investing activities:
Acquisition of property, plant and equipment, net		(2,047	)		(3,425	)
Other		(272	)		—
Net cash used in investing activities		(2,319	)		(3,425	)
Cash flows from financing activities:
Proceeds from revolving line of credit		—			2,500
Payments on revolving line of credit		(3,500	)		(3,500	)
Payments of long-term debt		(50	)		(50	)
Payments under capital lease obligations		(39	)		(68	)
Payments on financing arrangements		(549	)		(697	)
Excess tax benefit from stock-based compensation		152			—
Decrease in cash overdraft		(2,393	)		(1,737	)
Net cash used in financing activities		(6,379	)		(3,552	)
Decrease in cash and cash equivalents		(24	)		(33	)
Cash and cash equivalents, beginning of period		221			154
Cash and cash equivalents, end of period	$	197		$	121

The accompanying notes are an integral part of these statements.

6

PENFORD CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1—BUSINESS

Penford Corporation (which, together with its subsidiary companies, is referred to herein as “Penford” or the “Company”) is a developer, manufacturer and marketer of specialty natural-based ingredient systems for food and industrial applications, including fuel grade 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 significant research and development capabilities, which are used in applying 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: Industrial Ingredients and Food Ingredients. These segments are based on broad categories of end-market users. The Industrial Ingredients segment is a supplier of specialty starches to the paper, packaging and other industries, and is a producer of fuel grade ethanol. The Industrial Ingredients segment also sells the by-products from its corn wet milling manufacturing operations, primarily germ, fiber and gluten to customers who use these by-products as animal feed or to produce corn oil. The Food Ingredients segment is a developer and manufacturer of specialty starches and dextrins for the food manufacturing and food service industries. See Note 10 for financial information regarding the Company’s business segments.

2—BASIS OF PRESENTATION

Consolidation

The accompanying condensed consolidated financial statements include the accounts of Penford and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated. The condensed consolidated balance sheet at November 30, 2013 and the condensed consolidated statements of operations, comprehensive income (loss) and cash flows for the interim periods ended November 30, 2013 and 2012 have been prepared by the Company without audit. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary to present fairly the financial information, have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The results of operations for interim periods are not necessarily indicative of the operating results of a full year or of future operations. Certain reclassifications have been made to prior year’s financial statements in order to conform to the current year presentation. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended August 31, 2013.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP 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, legal contingencies, the determination of fair value of net assets acquired in a business combination, 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 or long-lived assets, 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.

7

Accounting Pronouncements Adopted

In February 2013, the FASB issued guidance requiring entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Entities are required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. This guidance did not change the current requirements for reporting net income or other comprehensive income. The Company adopted this new guidance effective September 1, 2013 and the required disclosure is presented in Note 6.

In December 2011, the FASB issued guidance creating new disclosure requirements about the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The Company adopted this new guidance effective September 1, 2013 and the required disclosure is presented in Note 9.

In July 2013, the FASB issued guidance designed to reduce diversity in practice of financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The Company adopted this accounting presentation effective September 1, 2013. The Company complied with the prescribed accounting presentation in prior periods; therefore, the adoption of this guidance had no impact on the presentation of the Company’s financial statements.

3—BALANCE SHEET DETAILS

The components of inventory are as follows:

	November 30,		August 31,
	2013		2013
	(In thousands)
Raw materials	$	8,642	$	10,381
Work in progress		1,425		1,913
Finished goods		22,653		21,698
Total inventories	$	32,720	$	33,992

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

	November 30,			August 31,
	2013			2013
	(In thousands)
Land and land improvements	$	11,881		$	11,881
Plant and equipment		361,601			359,909
Construction in progress		5,546			5,255
		379,028			377,045
Accumulated depreciation		(266,969	)		(264,904	)
Net property, plant and equipment	$	112,059		$	112,141

At November 30, 2013 and August 31, 2013, the Company had approximately $1.0 million and $0.7 million, respectively, of payables related to property, plant and equipment which have been excluded from acquisitions of property, plant and equipment in the statement of cash flows.

8

Components of accrued liabilities are as follows:

	November 30,		August 31,
	2013		2013
	(In thousands)
Employee-related costs	$	2,592	$	3,931
Other accrued liabilities		4,566		4,276
Total accrued liabilities	$	7,158	$	8,207

Employee-related costs include accrued payroll, compensated absences, payroll taxes, benefits and incentives.

4—DEBT

As of November 30, 2013, the Company had $68.0 million outstanding on its $130 million secured revolving credit facility (the “2012 Agreement”) with a syndicate of banks. The lenders’ loan commitment may be increased under certain circumstances.

The maturity date for the revolving loans under the 2012 Agreement is July 9, 2017. Interest rates under the 2012 Agreement are based on either the London Interbank Offered Rate (“LIBOR”) or the prime rate, depending on the selection of available borrowing options under the 2012 Agreement. Pursuant to the 2012 Agreement, the interest rate margin over LIBOR can range between 2% and 4%, depending upon the ratio of the Company’s funded debt to earnings before interest, taxes, depreciation and amortization (defined in the 2012 Agreement as the “Total Leverage Ratio”).

The 2012 Agreement provides that the Total Leverage Ratio shall not exceed 3.50 through November 30, 2013; 3.25 through May 31, 2014; and 3.0 thereafter. In addition, the Company must maintain a Fixed Charge Coverage Ratio, as defined in the 2012 Agreement, of not less than 1.35. Annual capital expenditures will be restricted to $15 million if the Total Leverage Ratio is greater than 2.50 for two consecutive fiscal quarters. The Company’s obligations under the 2012 Agreement are secured by substantially all of the Company’s assets.

At November 30, 2013, the Company also had two non interest bearing loans from the Iowa Department of Economic Development (“IDED”). 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. At November 30, 2013, the Company had $1.2 million outstanding related to the IDED loans.

Pursuant to the 2012 Agreement, the Company may declare and pay dividends on its common stock in an amount not to exceed, in any consecutive four quarters, the lesser of $10 million or 50% of Free Cash Flow, as defined in the 2012 Agreement. As of November 30, 2013, the Company was not permitted to pay dividends.

5—INCOME TAXES

Effective Tax Rates

The Company’s effective tax rate for the first quarter of fiscal 2014 was 41.6%. The difference between the effective tax rate and the U.S. federal statutory rate was due to state income taxes and the effect of additions to the liability for uncertain tax positions described below.

The Company’s effective tax rate for the first quarter of fiscal 2013 was 38.5%. The difference between the effective tax rate and the U.S. federal statutory tax rate was primarily due to state income taxes.

Valuation Allowance

The tax valuation allowance at November 30, 2013 of $12.5 million is comprised of the following: (1) $10.9 million related to the discontinued Australian operations and (2) $1.6 million related primarily to the small ethanol producer tax credit carryforwards in the United States. Tax laws in the U.S. require that any net operating loss carryforwards be utilized before the Company can utilize the small ethanol producer tax credit carryforwards. Due to the expiration of the small ethanol producer tax credit carryforward period in 2014, the Company does not believe it has sufficient positive evidence to substantiate that the small ethanol tax credit carryforwards are realizable at a more-likely-than-not level of assurance.

9

At November 30, 2013, the Company had $6.4 million of net U. S. deferred tax assets. Other than for the ethanol tax credit carryforwards discussed above, a valuation allowance has not been provided on the net U.S. deferred tax assets as of November 30, 2013. 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. The Company believes that it is more likely than not that future operations and the reversal of existing taxable temporary differences will generate sufficient taxable income to realize its deferred tax assets, except for the small ethanol producer tax credit carryforwards, for which a valuation allowance has been provided.

Uncertain Tax Positions

In the quarter ended November 30, 2013, the amount of unrecognized tax benefits increased by approximately $38,000. The total amount of unrecognized tax benefits at November 30, 2013 was $0.7 million, all of which, if recognized, would favorably impact the effective tax rate. At November 30, 2013, the Company had $0.1 million of accrued interest and penalties included in the long-term tax liability.

Other

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 U.S. federal and 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. The Company is not subject to income tax examinations by U.S. federal or state jurisdictions for fiscal years prior to 2009.

6—OTHER COMPREHENSIVE INCOME (LOSS) (“OCI”)

The following tables provide a summary of the changes in accumulated other comprehensive income (loss) for the periods presented:

(In thousands)	Net Unrealized Gains (Losses) on Cash Flow Hedging Instruments, net of tax			Gains (Losses) on Postretirement Obligations, net of tax			Accumulated Other Comprehensive Loss
Balance at August 31, 2013	$	(856	)	$	(6,763	)	$	(7,619	)
Other comprehensive income (loss) before reclassification adjustments, net of tax		(1,217	)		—			(1,217	)
Amounts reclassified from accumulated other comprehensive income (loss), net of tax		1,227			93			1,320
Balance at November 30, 2013	$	(846	)	$	(6,670	)	$	(7,516	)

10

(In thousands)	Net Unrealized Gains (Losses) on Cash Flow Hedging Instruments, net of tax			Gains (Losses) on Postretirement Obligations, net of tax			Accumulated Other Comprehensive Loss
Balance at August 31, 2012	$	1,638		$	(17,231	)	$	(15,593	)
Other comprehensive income (loss) before reclassification adjustments, net of tax		309			—			309
Amounts reclassified from accumulated other comprehensive income (loss), net of tax		(2,186	)		355			(1,831	)
Balance at November 30, 2012	$	(239	)	$	(16,876	)	$	(17,115	)

Amounts reclassified from accumulated other comprehensive income (loss) were as follows:

		Three Months Ended November 30, 2013
(In thousands)	Location of Expense (Income) Recognized in Net Earnings	Before Tax Amount		Tax			Net of Tax Amount
Pension and other postretirement benefit plans:
Amortization of actuarial loss (gain)	Cost of sales	$	89	$	(35	)	$	54
Amortization of actuarial loss (gain)	Operating/R&D expenses		42		(16	)		26
Amortization of prior service cost	Cost of sales		2		(1	)		1
Amortization of prior service cost	Operating/R&D expenses		18		(6	)		12
Total reclassification adjustments			151		(58	)		93
Derivatives accounted for as hedges	Cost of sales		1,980		(753	)		1,227
Total reclassifications into income		$	2,131	$	(811	)	$	1,320

7—STOCK-BASED COMPENSATION

Stock Compensation Plans

Penford maintains the 2006 Long-Term Incentive Plan, as amended, (the “2006 Incentive Plan”) pursuant to which various stock-based awards may be granted to employees, directors and consultants. As of November 30, 2013, the aggregate number of shares of the Company’s common stock that were available to be issued as awards under the 2006 Incentive Plan was 465,882. 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 and restricted stock awards granted under the 2006 Incentive Plan generally vest ratably over one to four years and expire seven years from the date of grant.

11

General Option Information

A summary of the stock option activity for the three months ended November 30, 2013, is as follows:

	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Term (in years)		Aggregate Intrinsic Value
Outstanding Balance, August 31, 2013		1,517,588		$	10.30
Granted		—			—
Exercised		—			—
Cancelled		(77,000	)		13.50
Outstanding Balance, November 30, 2013		1,440,588			10.13		3.78	$	5,458,900
Options Exercisable at November 30, 2013		849,173		$	12.88		2.70	$	1,840,500

The aggregate intrinsic value disclosed in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $12.29 as of November 30, 2013 that would have been received by the option holders had all option holders exercised on that date. No stock options were exercised during the three months ended November 30, 2013. There were no stock option grants in the first three months of fiscal 2014.

As of November 30, 2013, the Company had $0.6 million of unrecognized compensation cost related to non-vested stock option awards that is expected to be recognized over a weighted average period of 1.2 years.

Restricted Stock Awards

The grant date fair value of each share 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 three months ended November 30, 2013 as follows:

	Number of Shares		Weighted Average Grant Date Fair Value
Nonvested at August 31, 2013		24,489	$	7.35
Granted		—		—
Vested		—		—
Cancelled		—		—
Nonvested at November 30, 2013		24,489	$	7.35

On January 1, 2013, each non-employee director received an award of 2,721 shares of restricted stock under the 2006 Incentive Plan at the closing stock price on December 31, 2012. The shares vest one year from the grant date of the award. The Company recognizes compensation cost for restricted stock ratably over the vesting period.

As of November 30, 2013, the Company had less than $0.1 million of unrecognized compensation cost related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 0.1 years.

12

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 and the effect on the Company’s Condensed Consolidated Statements of Operations (in thousands):

	Three months ended November 30,
	2013		2012
Cost of sales	$	—	$	—
Operating expenses		249		417
Research and development expenses		—		—
Total stock-based compensation expense	$	249	$	417
Income tax benefit		95		158
Total stock-based compensation expense, net of tax	$	154	$	259

8—PENSION AND POST-RETIREMENT BENEFIT PLANS

The components of the net periodic pension and post-retirement benefit costs are as follows:

Defined benefit pension plans	Three months ended November 30,
	2013			2012
	(in thousands)
Service cost	$	438		$	486
Interest cost		735			662
Expected return on plan assets		(813	)		(717	)
Amortization of prior service cost		58			60
Amortization of actuarial losses		131			483
Net periodic benefit cost	$	549		$	974
Post-retirement health care plans	Three months ended November 30,
	2013			2012
	(in thousands)
Service cost	$	28		$	59
Interest cost		222			215
Amortization of prior service credit		(38	)		(38	)
Amortization of actuarial losses		—			67
Net periodic benefit cost	$	212		$	303

13

9—FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS

Fair Value Measurements

Presented below are the fair values of the Company’s derivatives as of November 30, 2013 and August 31, 2013:

As of November 30, 2013	Level 1			Level 2		Level 3		Total
	(in thousands)
Current assets (Other):
Commodity derivatives	$	(1,145	)	$	—	$	—	$	(1,145	)

As of August 31, 2013	Level 1		Level 2		Level 3		Total
	(in thousands)
Current assets (Other):
Commodity derivatives	$	512	$	—	$	—	$	512

The following table reconciles the gross fair value of assets and liabilities subject to offsetting arrangements to the net amounts recorded in the Condensed Consolidated Balance Sheets as Other Current Assets.

In thousands	Gross Amounts of Recognized Assets		Gross Liabilities Offset in the Balance Sheet			Net Amount of Assets (Liabilities)			Cash Collateral on Deposit with Counterparty		Net Fair Value as Recorded in Balance Sheets
As of November 30, 2013
Commodity derivatives	$	87	$	(1,232	)	$	(1,145	)	$	2,527	$	1,382
As of August 31, 2013
Commodity derivatives	$	997	$	(485	)	$	512		$	1,700	$	2,212

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 data by correlation or other means.

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

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 reprices with changes in market interest rates and, accordingly, the carrying amount of such debt approximates fair value.

The Company has two non-interest bearing loans from the State of Iowa. The carrying value of the debt at November 30, 2013 was $1.2 million and the fair value of the debt was estimated to be $1.1 million. See Note 4. The fair values of these loans were calculated utilizing Level 2 inputs to a discounted cash flow model. The most significant input is the discount rate which was determined by comparing yields on corporate debentures for debt issuers with financial characteristics similar to Penford’s non-interest bearing loans.

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Commodity Contracts

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 sales.

To reduce the price volatility of corn used in fulfilling some of its starch sales contracts, Penford uses readily marketable exchange-traded futures as well as forward cash corn purchases. Penford also uses exchange-traded futures to hedge corn inventories, firm commitments to purchase corn and forecasted purchases of corn. The exchange-traded futures are not purchased or sold for trading or speculative purposes and are designated as hedges. These futures contracts were 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. Most of these futures contracts have been designated as hedges. Effective September 1, 2013, the Company ceased hedge accounting for certain ethanol futures contracts as they were not effective at offsetting changes in the selling prices of ethanol.

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 November 30, 2013 that is expected to be reclassified into income within 12 months is $(0.8) million.

As of November 30, 2013, the Company had the following outstanding futures contracts:

Corn Futures	4,375,000 Bushels
Ethanol Futures	9,690,000 Gallons
Natural Gas Futures	300,000 mmbtu (millions of British thermal units)

The following tables provide information about the fair values of the Company’s derivatives, by contract type, as of November 30, 2013 and August 31, 2013.

	Assets					Liabilities
In thousands		Fair Value					Fair Value
	Balance Sheet Location	Nov 30 2013		Aug 31 2013		Balance Sheet Location	Nov 30 2013		Aug 31 2013
Derivatives designated as hedging instruments:
Cash Flow Hedges:
Corn Futures	Other Current Assets	$	—	$	—	Other Current Assets	$	920	$	485
Ethanol Futures	Other Current Assets		—		997	Other Current Assets		312		—
Derivatives not designated as hedging instruments:
Natural Gas Futures	Other Current Assets		67		—	Other Current Assets		—		—
Ethanol Futures	Other Current Assets		20		—	Other Current Assets		—		—
		$	87	$	997		$	1,232	$	485

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The following tables provide information about the effect of derivative instruments on the financial performance of the Company for the three month periods ended November 30, 2013 and 2012.

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
	3 Months Ended Nov 30						3 Months Ended Nov 30					3 Months Ended Nov 30
	2013			2012			2013			2012		2013			2012
Derivatives designated as hedging instruments:
Cash Flow Hedges:
Corn Futures(1)	$	(2,048	)	$	(255	)	$	(2,512	)	$	3,432	$	(1,011	)	$	197
Ethanol Futures(1)		85			753			532			93		(1,584	)		(11	)
	$	(1,963	)	$	498		$	(1,980	)	$	3,525	$	(2,595	)	$	186
Fair Value Hedges:
Corn Futures(1) (2)												$	5		$	15
Derivatives not designated as hedging instruments:
Natural Gas Futures(1)													33			(171	)
Ethanol Futures(1)													20			—
												$	53		$	(171	)

(1) Gains and losses reported in cost of sales

(2) Hedged items are firm commitments and inventory

10—SEGMENT REPORTING

Financial information for the Company’s two segments, Industrial Ingredients and Food Ingredients, is presented below. These segments serve broad categories of end-market users. The Industrial Ingredients segment provides carbohydrate-based starches for industrial applications, primarily paper and packaging products and fuel grade ethanol. 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.

	Three months ended November 30
	2013			2012
	(In thousands)
Sales:
Industrial Ingredients
Industrial Starch	$	43,620		$	43,802
Ethanol		22,021			23,403
By-products		14,959			23,163
		80,600			90,368
Food Ingredients		28,651			27,654
	$	109,251		$	118,022
Income (loss) from operations:
Industrial Ingredients	$	(2,043	)	$	1,387
Food Ingredients		6,530			5,355
Corporate and other		(2,846	)		(2,722	)
	$	1,641		$	4,020

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	November 30,		August 31,
	2013		2013
	(In thousands)
Total assets:
Industrial Ingredients	$	128,145	$	133,120
Food Ingredients		69,662		68,550
Corporate and other		22,663		22,948
	$	220,470	$	224,618

11—EARNINGS PER SHARE

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

	Three months ended November 30
	2013			2012
	(In thousands)
Numerator:
Net income	$	488		$	1,707
Less: Allocation to participating securities		(1	)		(7	)
Net income applicable to common shares	$	487		$	1,700
Denominator:
Weighted average common shares outstanding, basic		12,473			12,307
Dilutive stock options and awards		368			65
Weighted average common shares outstanding, diluted		12,841			12,372

Weighted-average stock options to purchase 551,584 and 957,446 shares of common stock for the three months ended November 30, 2013 and 2012, respectively, were excluded from the calculation of diluted earnings per share because they were antidilutive.

12—LEGAL PROCEEDINGS AND CONTINGENCIES

As previously reported in the Company’s most recent Annual Report on Form 10-K and in prior filings, in June 2011 the Company was notified that a complaint had been filed against a customer of a Company subsidiary, Penford Products Co. (“Penford Products”), in the United States District Court for the District of New Jersey alleging that certain pet products supplied by Penford Products to the customer infringed upon a patent owned by T.F.H. Publications, Inc. (“Plaintiff”). The customer tendered the defense of this lawsuit to Penford Products pursuant to the terms of its supply agreement with Penford Products, and Penford Products commenced a defense at that time. In April 2012 the Plaintiff filed an amended complaint alleging that certain additional products made by Penford Products for the same customer infringed upon two of the Plaintiff’s patents. The complaint seeks an injunction against infringement of the Plaintiff’s patents as well as the recovery of certain damages. The court held a claim construction hearing on August 7, 2013 and the Company is awaiting the court’s decision regarding certain disputed patent claim terms. In November 2013 the Plaintiff filed an amended complaint adding Penford Products as a defendant in the case. The Company believes that its products do not infringe upon any of Plaintiff’s patents; however, the Company cannot at this time determine the likelihood of any outcome or estimate any damages that might be awarded.

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As previously reported in the Company’s most recent Annual Report on Form 10-K, in late August and early September, 2013 two of the Company’s subsidiaries, Penford Products and Carolina Starches, LLC (“Carolina Starches”), were served with separate complaints filed by Pirinate Consulting Group, LLC, as Litigation Trustee for the NP Creditor Litigation Trust, a successor in interest to the bankruptcy estate of NewPage Corporation, in the United States Bankruptcy Court for the District of Delaware seeking damages arising from alleged preferential transfers. The complaint filed against Penford Products seeks the recovery of alleged preferential transfers in the amount of approximately $778,000, together with other damages. The complaint filed against Carolina Starches seeks recovery of alleged preferential transfers of approximately $216,000, together with other damages. Answers which generally deny any liability in these matters have been filed. The Company believes that it has adequate defenses to these claims; however, the Company cannot at this time determine the likelihood of any outcome or estimate any damages that might be awarded.

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 this note above, management is unable to provide additional information regarding any possible loss because (i) the Company currently believes that the claims are not adequately supported, and (ii) there are significant factual and/or legal 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 expenses legal costs as incurred.

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.

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

Overview

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

Penford manages its business in two segments: Industrial Ingredients and Food Ingredients. These segments are based on broad categories of end-market users. See Note 10 to the Condensed Consolidated Financial Statements for additional information regarding the Company’s business segment operations.

In analyzing business trends, management considers a variety of performance and financial measures, including sales revenue growth, sales volume growth, and gross margins and operating income of the Company’s business segments.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Company’s condensed consolidated financial statements and the accompanying notes. The notes to the Condensed Consolidated Financial Statements referred to in this MD&A are included in Part I Item 1, “Financial Statements.”

Results of Operations

Executive Overview

• Consolidated sales decreased 7.4% to $109.3 million in the first quarter of fiscal 2014 from $118.0 million for the quarter ended November 30, 2013.

• The decrease in first quarter sales was primarily due to lower average unit selling pricing in the Industrial Ingredients segment, partially offset by volume growth in both business segments. The decline in Industrial Ingredients pricing was due to the decrease in corn costs as discussed below.

• Consolidated gross margin as a percent of sales was 9.8% compared to 11.2% a year ago.

• Bank debt outstanding at November 30, 2013 was down $3.5 million from August 31, 2013.

Industrial Ingredients

First quarter fiscal 2014 sales at the Company’s Industrial Ingredients business unit decreased $9.8 million, or 10.8%, to $80.6 million from $90.4 million during the first quarter of fiscal 2013. This decrease was primarily due to:

• Industrial starch sales in the three months ended November 30, 2013 of $43.6 million were comparable to last year’s first quarter sales of $43.8 million. Improvements in product mix were offset by a decrease in the corn costs passed through to customers.

• Ethanol sales declined $1.4 million, or 5.9%, to $22.0 million from $23.4 million on a 10% decrease in average unit selling prices partially offset by a 5% increase in volume.

• Sales of by-products declined 35% to $15.0 million from $23.2 million a year ago on a decrease in average unit selling prices. Selling prices of corn by-products declined as the cost of corn decreased with the new crop harvest.

Industrial Ingredients’ loss from operations for the first quarter of fiscal 2014 was $2.0 million, a decline of $3.4 million from operating income of $1.4 million in the first quarter of fiscal 2013. Gross margin for the first quarter of fiscal 2014 decreased $3.7 million to $1.4 million as lower pricing for industrial starch, ethanol and by-products outpaced the decline in corn costs. Manufacturing costs, primarily distribution and energy, rose $0.4 million in the first quarter. Operating and research and development expenses decreased by $0.3 million in the first quarter of fiscal 2014 due to lower employee costs.

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Food Ingredients

Fiscal 2014 first quarter sales for the Food Ingredients segment of $28.7 million increased 3.6%, or $1.0 million, over the first quarter of fiscal 2013, primarily due to higher volume. Average unit pricing was comparable to the prior year. Sales of non-coating applications expanded 10%, led by sales to the pet treats, gluten-free and soups/sauces/gravies end markets. Sales of non-coating value-added applications contributed nearly 70% of total segment revenues and accounted for all of the sales growth in the first quarter. Sales of coating applications declined 8% on a decrease in volume of 7% and a decrease in average unit pricing of 2%.

Operating income for the first quarter of fiscal 2014 at the Company’s Food Ingredients segment increased 22% to $6.5 million from $5.4 million in the same period last year due to an increase in gross margin of $1.1 million. Gross margin improved due to a decrease in manufacturing costs of $0.8 million and an increase in volume of $0.4 million, partially offset by an increase in raw material costs of $0.1 million. Operating and research and development expenses of $2.7 million were comparable to last year.

Corporate operating expenses

Corporate operating expenses for the first quarter of fiscal 2014 increased $0.1 million to $2.8 million from $2.7 million in the first quarter last year primarily due to an increase in professional fees.

Interest expense

Interest expense decreased $0.3 million compared to the first quarter last year due to a decrease in the average debt outstanding. Average outstanding bank debt was about $12 million lower in the first quarter of fiscal 2014 than in the same period a year ago.

Income taxes

The Company’s effective tax rate for the first quarter of fiscal 2014 was 41.6%. The difference between the effective tax rate and the U.S. federal statutory rate was due to state income taxes and the effect of additions to the liability for uncertain tax positions described below.

The tax valuation allowance at November 30, 2013 of $12.5 million is comprised of the following: (1) $10.9 million related to the discontinued Australian operations and (2) $1.6 million related primarily to the small ethanol producer tax credit carryforwards in the United States. Tax laws in the U.S. require that any net operating loss carryforwards be utilized before the Company can utilize the small ethanol producer tax credit carryforwards. Due to the near-term expiration of the small ethanol producer tax credit carryforward period, the Company does not believe it has sufficient positive evidence to substantiate that the small ethanol tax credit carryforwards are realizable at a more-likely-than-not level of assurance.

At November 30, 2013, the Company had $6.4 million of net deferred tax assets. Other than for the ethanol tax credit carryforwards discussed above, a valuation allowance has not been provided on the net U.S. deferred tax assets as of November 30, 2013. 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. The Company believes that it is more likely than not that future operations and the reversal of existing taxable temporary differences will generate sufficient taxable income to realize its deferred tax assets, except for the small ethanol producer tax credit carryforwards, for which a valuation allowance has been provided.

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Liquidity and Capital Resources

The Company’s primary sources of short- and long-term liquidity are cash flow from operations and its bank credit facility.

Operating Activities

Cash provided by operations was $8.7 million for the three months ended November 30, 2013 compared with $6.9 million for the same period last year. The increase in operating cash flow was due to a decrease in working capital requirements.

Investing Activities

Cash used in investing activities of $2.0 million was for investments in capital projects. See Note 3 to the Condensed Consolidated Financial Statements. The Company expects total capital expenditures for fiscal 2014 to be approximately $15-$18 million.

Financing Activities

As of November 30, 2013, the Company had $68.0 million outstanding on its $130 million secured revolving credit facility (the “2012 Agreement”) with a syndicate of banks. The lenders’ loan commitment may be increased under certain circumstances.

There are no scheduled principal payments prior to maturity of the credit facility on July 9, 2017. Interest rates under the 2012 Agreement are based on either LIBOR or the prime rate, depending on the selection of available borrowing options under the 2012 Agreement. Pursuant to the 2012 Agreement, the interest rate margin over LIBOR ranges between 2% and 4%, depending upon the Total Leverage Ratio, which is computed as funded debt divided by earnings before interest, taxes, depreciation and amortization (as set forth in the 2012 Agreement).

The 2012 Agreement provides that the Total Leverage Ratio shall not exceed 3.50 through November 30, 2013; 3.25 through May 31, 2014; and 3.0 thereafter. In addition, the Company must maintain a Fixed Charge Coverage Ratio, as defined in the 2012 Agreement, of not less than 1.35. Annual capital expenditures would be restricted to $15 million beginning in fiscal 2013 if the Total Leverage Ratio is greater than 2.50 for two consecutive fiscal quarters. The Company’s obligations under the 2012 Agreement are secured by substantially all of the Company’s assets.

Pursuant to the 2012 Agreement, the Company may declare and pay dividends on its common stock in an amount not to exceed, in any consecutive four quarters, the lesser of $10 million or 50% of Free Cash Flow, as defined in the 2012 Agreement. As of November 30, 2013, the Company was not permitted to pay dividends.

Contractual Obligations

The Company is a party to various debt and lease agreements at November 30, 2013 that contractually commit the Company to pay certain amounts in the future. The Company also has open purchase orders entered into in the ordinary course of business for raw materials, capital projects and other items, for which significant terms have been confirmed. There have been no material changes in the Company’s contractual obligations since August 31, 2013.

Off-Balance Sheet Arrangements

The Company had no off-balance sheet arrangements at November 30, 2013.

Critical Accounting Policies and Estimates

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The process of preparing financial statements requires management to make estimates, judgments and assumptions that affect the Company’s financial position and results of operations. These estimates, judgments and assumptions are based on the Company’s historical experience and management’s knowledge and understanding of the current facts and circumstances. See the Company’s Annual Report on Form 10-K for the fiscal

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year ended August 31, 2013 for a description of critical accounting policies and methods used in the preparation of the consolidated financial statements. Management believes that its estimates, judgments and assumptions are reasonable based upon information available at the time this report was prepared. To the extent there are material differences between estimates, judgments and assumptions and the actual results, the financial statements will be affected.

Forward-looking Statements

This Quarterly Report on Form 10-Q (“Quarterly Report”), including but not limited to statements found in the Notes to Condensed Consolidated Financial Statements and in Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains statements that are forward-looking statements within the meaning of the federal securities laws. In particular, statements pertaining to anticipated operations and business strategies contain forward-looking statements. Likewise, statements regarding anticipated changes in the Company’s business and anticipated market conditions are forward-looking statements. Forward-looking statements involve numerous risks and uncertainties and should not be relied upon as predictions of future events. Forward-looking statements depend on assumptions, dates or methods that may be incorrect or imprecise, and the Company may not be able to realize them. Forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates,” or “anticipates,” or the negative use of these words and phrases or similar words or phrases. Forward-looking statements can be identified by discussions of strategy, plans or intentions. Readers are cautioned not to place undue reliance on these forward-looking statements which are based on information available as of the date of this report. The Company does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of the filing of this Quarterly Report. Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this Quarterly Report, including those referenced in Part II Item 1A of this Quarterly Report, and those described from time to time in other filings made with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the year ended August 31, 2013, which include but are not limited to:

• competition;

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

• product development risk;

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

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

• unanticipated costs, expenses or third-party claims;

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

• interest rate, chemical and energy cost volatility;

• changes in returns on pension plan assets and/or assumptions used for determining employee benefit expense and obligations;

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

• the Company’s ability to successfully operate under and comply with the terms of its bank credit agreement, as amended; and

• other factors described in the Company’s Form 10-K Part I, Item 1A “Risk Factors.”

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Item 3: Quantitative and Qualitative Disclosures about Market Risk.

The Company is exposed to market risks from adverse changes in interest rates and commodity prices. There have been no material changes in the Company’s exposure to market risks from the disclosure in the Company’s Annual Report on Form 10-K for the year ended August 31, 2013.

Item 4: Controls and Procedures.

(a)Evaluation of Disclosure Controls and Procedures

The Company has established disclosure controls and procedures to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer (“Certifying Officers”), as appropriate, to allow timely decisions regarding required disclosure.

Management of the Company, with the participation and supervision of its Certifying Officers, evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based on the evaluation as of November 30, 2013, management has concluded that the Company’s disclosure controls and procedures were not effective because of the material weaknesses in the Company’s internal control over financial reporting described below.

(b)Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, is a process designed by, or under the supervision of, the chief executive officer and chief financial officer, or persons performing similar functions, and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of the Company’s financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes (i) maintaining records that in reasonable detail accurately and fairly reflect the Company’s transactions; (ii) providing reasonable assurance that transactions are recorded as necessary for preparation of the Company’s financial statements; (iii) providing reasonable assurance that receipts and expenditures of the Company’s assets are made in accordance with management’s authorization; and (iv) providing reasonable assurance that unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of the Company’s financial statements would be prevented or detected. 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. Accordingly, even effective internal control over financial reporting can only provide reasonable assurance of achieving their control objectives.

Under the supervision and with the participation of management, including the certifying officers, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting as of November 30, 2013. In making this assessment management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) inInternal Control—Integrated Framework (1992). Based on the evaluation performed, management identified the following material weaknesses in its internal control over financial reporting as of November 30, 2013. A material weakness, as defined in Rule 12b-2 under the Exchange Act, is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

Material Weakness Indentified Relating to Resources Necessary for Effective Internal Controls

The Company determined a material weakness related to the monitoring and implementation of internal controls over financial reporting existed. Specifically, the Company lacks sufficient resources to have an effective control function that involves assessments of risk at an appropriate level of detail, controls designed with the right level of precision and

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responsive to those risks, and control implementation, including evidence of operating effectiveness. As a result, there is at least a reasonable possibility that a material misstatement could occur in the interim and annual financial statements and not be prevented or detected

Material Weakness Identified Relating to Inventory

The Company determined that a material weakness in internal control over financial reporting existed relating to the effective design of controls over the accuracy of prices used to value ending inventory. Specifically the controls over the accuracy of prices used to value ending inventory were not designed effectively to detect errors in inventory unit costs. Furthermore, the Company’s control over reconciling inventory maintained at third party locations was not designed at the right level of precision to consider reconciling errors that could be material. As a result, there is at least a reasonable possibility that a material misstatement could occur in the interim and annual financial statements and not be detected as a result of the ineffective design of these controls.

Material Weakness Indentified Relating to Valuation of Long-Lived Assets

The Company determined that a material weakness in internal control over financial reporting existed because management’s review of long-lived asset impairment was not designed to operate at an appropriate level of precision to evaluate assets for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Furthermore, the documentation of the Company’s analysis did not contain sufficient supporting evidence to enable a reviewer to perform an effective timely review of the subjective assumptions inherent in this type of assessment. As a result, there is at least a reasonable possibility that a material misstatement could occur in the interim and annual financial statements and not be detected as a result of the ineffective design of this control.

Because of the above described material weaknesses in internal control over financial reporting, management concluded that its internal control over financial reporting was not effective as of November 30, 2013.

(c)Management’s Plans for Remediation of the Material Weaknesses

Management plans to take the following actions to remediate the material weaknesses:

1. Material Weakness Identified Related to Resources Necessary for Effective Internal Controls – The Company plans to improve its monitoring and implementation of internal controls over financial reporting to improve the overall effectiveness of its risk assessment process, design of controls, and evidence obtained to support the effectiveness of controls. The Company anticipates that it will be required to enhance necessary resources to sufficiently promote effective internal control over financial reporting throughout the organization.

2. Material Weakness Identified Related to Inventory—The Company plans to improve the design of the controls over the accuracy of prices used to value ending inventory and over the accuracy of inventory reconciliations for third party locations. The Company anticipates that additional resources will be required to enhance the design and operating effectiveness of these controls in the inventory process.

3. Material Weakness Identified Related to Valuation of Long-Lived Assets – The Company plans to improve the design of the controls to perform effective reviews over management’s long-lived asset impairment considerations. The Company anticipates that additional resources will be required to enhance the design of the controls over long-lived asset impairment considerations.

As management implements these plans, management may determine that additional steps may be necessary to remediate the material weaknesses.

(d)Changes in Internal Controls over Financial Reporting

There were no significant changes in the Company’s internal control over financial reporting that occurred during the quarter ended November 30, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1: Legal Proceedings

See Note 12 to the Company’s financial statements.

Item 1A: Risk Factors

The information set forth in this report should be read in conjunction with the risk factors discussed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended August 31, 2013. These risks could materially impact the Company’s business, financial condition and/or future results. The risks described in the Annual Report on Form 10-K and in this Item 1A are not the only risks facing the Company. Additional risks and uncertainties not currently known by the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.

Item 6: Exhibits.

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	Financial statements from the quarterly report on Form 10-Q of the Company for the three months ended November 30, 2013, filed on January 9, 2014, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Comprehensive Income (Loss), (iii) the Condensed Consolidated Statements of Operations, (iv) the Condensed Consolidated Statements of Cash Flows and (v) the Notes to Condensed Consolidated Financial Statements

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SIGNATURES

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

	Penford Corporation
	(Registrant)
January 9, 2014	/s/ Steven O. Cordier
	Steven O. Cordier Senior Vice President and Chief Financial Officer

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