§ 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;

§ the amount and timing of expenditures for flood restoration costs and related insurance recoveries;

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

§ unanticipated costs, expenses or third-party claims;

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

§ interest rate, chemical and energy cost volatility;

§ foreign currency exchange rate fluctuations;

§ changes in 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, or

§ other factors described in Part I, Item 1A "Risk Factors."

Overview
Penford generates revenues, income and cash flows by developing, manufacturing and marketing specialty natural-based ingredient systems for industrial and food applications and for 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, potatoes, and wheat.
In analyzing business trends, management considers a variety of performance and financial measures, including sales revenue growth, sales volume growth, gross margins and operating income of the Company's business segments. Penford manages its business in three segments. The first two, Industrial Ingredients-North America and Food Ingredients-North America, are broad categories of end-market users, served by operations in the United States. The third segment is comprised of the Company's operations in Australia and New Zealand, which operations are engaged primarily in the food ingredients business. See Notes 1 and 14 to the Condensed Consolidated Financial Statements for additional information regarding the Company's business segment operations.
Impact of Cedar Rapids Flood
On June 12, 2008, the Company's Industrial Ingredients - North America plant in Cedar Rapids, Iowa was temporarily shut down due to record flooding of the Cedar River and government-ordered mandatory evacuation of the plant and surrounding areas. By the end of the first quarter of fiscal 2009, the facility's processing rate had reached pre-flood levels. The Company has begun to resupply its industrial starch customers under existing contracts.
During the first quarter of fiscal 2009, the Company recorded $6.8 million of flood restoration costs which are recognized, net of insurance recoveries of $11.0 million, in income from operations in the financial statements. The total direct costs of the flood since June 2008 were $44.8 million, which included ongoing expenses during the time the plant was shut down, but do not include lost profits. The Company estimates that the direct costs of the flood will total approximately $45 - 47 million. See Note 3 to the Condensed Consolidated Financial Statements for details of the restoration costs.
During the first quarter of fiscal 2009, the Company recognized $11.0 million of insurance recoveries, of which $8.5 million was received subsequent to November 30, 2008 and recorded as a receivable at that date. These recoveries have been recorded as an offset to the losses caused by the flooding. Insurance proceeds are recognized in the financial statements when realization of the recoveries is deemed probable. The insurance recoveries recognized to date total $21.5 million.
The effect of the flood on the financial results of the Company on a quarter-to-quarter basis in fiscal 2009 will depend on the timing and amount of the remaining expenditures and insurance recoveries. The Company will continue to process its claim for flood losses under its insurance policies, but is unable to estimate the amount or timing of future recoveries. The amount ultimately recovered from the Company's insurers may be materially more or less than the Company's direct costs of the flood.
Accounting Changes
Effective September 1, 2008, the Company adopted FASB Statement No. 157, "Fair Value Measurements" ("SFAS 157"), for financial assets and liabilities carried at fair value that are recognized or disclosed at fair value in the financial statements on a recurring basis. SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. The adoption did not have a material impact on the company's financial statements. See Note 12. Due to the issuance of FASB Staff Position No. 157-2 ("FSP 157-2"), the effective date of SFAS 157 has been deferred to fiscal years beginning after November 15, 2008 (fiscal 2010) for non-recurring, nonfinancial assets and liabilities that are recognized or disclosed at fair value. The Company is continuing to evaluate the impact of adopting these provisions in fiscal 2010. In October 2008, the FASB issued FSP FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active" ("FSP 157-3"). FSP 157-3 clarifies the application of SFAS 157 and addresses how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP 157-3 was effective upon issuance. The implementation of this standard did not have an impact on the Company's consolidated financial statements.
In February 2007, the FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB No. 115" ("SFAS 159") which allows companies the

option to measure certain financial assets and financial liabilities at fair value at specified election dates. The Company adopted SFAS 159 and elected not to measure any additional financial instruments and other items at fair value. Results of Operations
Executive Overview
Consolidated sales for the three months ended November 30, 2008 declined by 15% to $80.7 million from $94.9 million in the first quarter of fiscal 2008, primarily due to volume declines (a) in the Industrial Ingredients business related to the Cedar Rapids flood discussed above and (b) in the Australian/New Zealand Operations due to a shift to higher return product lines. Volume declines and the effects of a $4.8 million unfavorable foreign currency exchange rate change were partially offset by improved unit pricing and favorable product mix of approximately $5.7 million, and the pass-through impact on sales of higher corn costs in the Industrial Ingredients business, which added $3.4 million to total sales. Gross margin as a percent of sales declined to 6.7% from 17.1% in the same period last year, primarily driven by the revenue declines discussed above, by higher raw material costs for all three business segments, and by higher manufacturing costs driven by higher energy costs, repair and maintenance expenses and lower plant utilization rates at the Company's Australian and Industrial Ingredients businesses.
Income from operations was $0.8 million compared to $5.8 million in the first quarter of fiscal 2008 due to the gross margin decline, partially offset by $11.0 million of insurance recoveries, net of $6.8 million of flood remediation costs. Research and development expenses declined by $0.5 million due to lower employee-related costs and lower product trial activity compared to first quarter of fiscal 2008. Operating income for the first quarter of fiscal 2008 included $1.2 million of severance costs related to reconfiguring the Australia/New Zealand business. See Note 13 to the Condensed Consolidated Financial Statements. A discussion of segment results of operations and the effective tax rate follows.
Industrial Ingredients-North America
First quarter sales of fiscal 2009 at the Company's Industrial Ingredients-North America business unit declined by $7.4 million, or 15.0%, to $41.8 million from $49.2 million over the same quarter last year. Sales volume declines as a result of the Cedar Rapids flood, contributed approximately $11.6 million to lower sales. Offsetting the volume effect were improvements in average unit selling prices and the pass-through effect of higher corn costs of $4.2 million. See "Overview" above and Note 3 to the Condensed Consolidated Financial Statements for further details on the Cedar Rapids flood impact. The start-up of ethanol production, which began in the third quarter of fiscal 2008, recommenced at the end of September 2008 and contributed $9.6 million to first quarter 2009 revenue.
Gross margin was $0.1 million compared to $8.6 million in the same quarter last year, primarily due to lower volumes of industrial starches offset by increased sales of lower margin ethanol, manufacturing input yield inefficiencies due to the start up of operations subsequent to the flood recovery at the Cedar Rapids plant, higher chemical and natural gas costs, and higher repair and maintenance costs, partially offset by favorable unit pricing. First quarter 2009 manufacturing costs reflect the impact of separating and recognizing in fiscal 2008 $2.9 million in hedge gains for corn and natural gas deliveries that were consumed in the quarter ended November 30, 2008.
Income from operations of $1.8 million for the first quarter of fiscal 2009 included $11.0 million of insurance recoveries, offset by $6.8 million of flood remediation costs, compared to operating income of $5.7 million for the first quarter of fiscal 2008. Operating expenses were comparable to the same quarter last year and research and development expenses declined by $0.2 million due to lower employee related costs.
Food Ingredients-North America
Sales for the first quarter of fiscal 2009 for the Food Ingredients-North America segment were $17.7 million, an increase of $1.7 million or 10.4% over the same period last year. The sales expansion was due to improved pricing and product mix and higher sales of applications for the dairy/cheese and sauces and gravies end markets. First quarter fiscal 2009 income from operations rose 28.1% to $3.4 million compared to first quarter of last year. Gross margin improved $0.7 million over the same period last year, driven by sales growth and lower manufacturing costs, partially offset by higher raw material potato starch costs of approximately $0.4 million.

Australia/New Zealand Operations
Sales for the first quarter of fiscal 2009 at the Australia/New Zealand Operations decreased $8.6 million, or 29%, compared with the same quarter of fiscal 2008. The sales decline is attributable to a 23% decline in sales volume resulting from a change in sales mix to focus on products with higher returns and a $4.8 million impact from an 18% decline in the average quarterly foreign currency exchange rates, partially offset by an increase in average unit selling prices. Sales in local currency declined 13% over the same quarter last year.
Gross margin decreased by $3.2 million primarily due to the effect of lower sales volumes and plant utilization of $1.6 million, continued high costs for wheat and corn of approximately $3.5 million as a result of a regional drought, and higher manufacturing costs related to increases in other raw materials and chemical and energy costs of $0.6 million. These increases were offset by the favorable impact from higher unit pricing and more favorable product mix of $2.5 million. Loss from operations was $1.5 million for the first quarter of fiscal 2009 compared to a loss of $0.1 million in same period last year. Included in the segment's operating loss for the first quarter of fiscal 2008 were restructuring costs of $1.2 million. See Note 13 to the Condensed Consolidated Financial Statements.
Corporate operating expenses
Corporate operating expenses for the first quarter of fiscal 2009 were $2.8 million, a $0.3 million increase compared to first quarter of last year, due to higher professional fees.
Interest expense
Interest expense for the first quarter of fiscal 2009 increased $0.2 million due to higher average debt balances. Interest costs related to construction of the ethanol manufacturing plant were capitalized until May 2008, when the facility began commercial production. Interest capitalized was $0.3 million for the three months ended November 30, 2007.
Income taxes
The Company's effective tax rate for the three months ended November 30, 2008 was 57%, an increase from the 36% effective tax rate in the first quarter of fiscal 2008. In October 2008, the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 retroactively reinstated and extended the research and development tax credit from January 1, 2008 through December 31, 2009. The effective tax rate for the three months ended November 30, 2008 reflected a tax benefit of $0.2 million applicable to the period January 1, 2008 through August 31, 2008.
On a quarterly basis, the Company reviews its estimate of the effective income tax rate expected to be applicable for the full fiscal year. This rate is used to calculate income tax expense or benefit on current year-to-date pre-tax income or loss. Income tax expense or benefit for the current interim period is the difference between the computed year-to-date income tax amount and the tax expense or benefit reported for previous quarters. In reviewing its effective tax rate, the Company uses estimates of the amounts of permanent differences between book and tax accounting and projections of fiscal year pre-tax income or loss. Adjustments to the Company's tax expense related to the prior fiscal year, amounts recorded in accordance with FIN 48 and changes in tax rates are treated as discrete items and are recorded in the period in which they arise.
The determination of the annual effective tax rate applied to current year income or loss before income tax is based upon a number of estimates and judgments, including the estimated annual pretax income of the Company in each tax jurisdiction and the amounts of permanent differences between the book and tax accounting for various items. The Company's interim tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits, judgments regarding uncertain tax positions and other items that cannot be estimated with any certainty. Therefore, there can be significant volatility in the interim provision for income tax expense.

Non-operating income (loss), net
Non-operating income (loss), net consists of the following:

                                                     Three months ended
                                         November 30, 2008         November 30, 2007
                                                       (In thousands)
Royalty and licensing income            $               410       $               451
Loss on foreign currency transactions                  (613 )                       -
Other                                                    (7 )                      13

Total                                   $              (210 )     $               464

During the three months ended November 30, 2008, the Company recognized a net foreign currency transaction loss on Australian dollar denominated assets and liabilities as disclosed in the table above. See Note 10 to the Condensed Consolidated Financial Statements for information on the Company's royalty and licensing income.
Liquidity and Capital Resources
The Company's primary sources of short- and long-term liquidity are cash flow from operations and its revolving line of credit, which expires in 2011. The Company expects to generate sufficient cash flow from operations and to have sufficient borrowing capacity and ability to fund its cash requirements during fiscal 2009.
In June 2008, the Company's manufacturing facilities in Cedar Rapids, Iowa were shut down and evacuated due to flooding of the plant and surrounding areas. See the "Overview" section of this Part I, Item 2 for a discussion of the Company's liquidity as a result of the flood.
Penford had working capital of $44.2 million and $38.1 million at November 30, 2008 and August 31, 2008, respectively. Cash used in operations was $7.2 million for the three months ended November 30, 2008 compared to cash provided by operations of $13.7 million for the three months ended November 30, 2007. The decline in cash flow from operations is primarily due to a decrease in earnings over the prior year's first quarter and the impact of higher working capital balances. Trade and insurance receivables expanded as the Company's Industrial Ingredients sales recovered after operations were restarted in September and October 2008.
In fiscal 2007, the Company entered into a $145 million Second Amended and Restated Credit Agreement (the "2007 Agreement"). See Note 7 to the Condensed Consolidated Financial Statements. At November 30, 2008, the Company had $20.0 million and $8.4 million outstanding, respectively, under the revolving credit and term loan portions of its credit facility. During the three months ended November 30, 2008, debt, including the effects of foreign currency exchange rates, expanded $6.0 million to fund flood restoration costs and other working capital requirements. In addition, the Company had borrowed $44.2 million of the $45 million in capital expansion loans available under the credit facility for the construction of the ethanol facility. The Company's ability to borrow under its $60 million revolving credit facility is subject to the Company's compliance with, and is limited by, the covenants in the 2007 Agreement.
During the fourth quarter of fiscal 2008, the Company sought and obtained an amendment to the 2007 Agreement to address the impact of the Cedar Rapids flood. Effective July 9, 2008, the 2007 Agreement was amended to temporarily adjust the calculation of selected covenant formulas for the costs of the flood damage and the associated property damage and business interruption insurance recoveries. The Fixed Charge Coverage Ratio was reduced to 1.25 through November 30, 2008 and 1.50 thereafter as defined in the 2007 Agreement.
The Company's short-term borrowings consist of an Australian variable-rate grain inventory financing facility with an Australian bank for a maximum of $26.3 million U.S. dollars at the exchange rate at November 30, 2008. The amount outstanding under this arrangement, which is classified as a current liability on the balance sheet, was $0.9 million at November 30, 2008.
As of November 30, 2008, all of the Company's outstanding debt, including amounts outstanding under the Australian grain inventory financing facility, is subject to variable interest rates. Under interest rate swap agreements with several banks, the Company has fixed its interest rates on U.S. dollar-denominated debt of $26.8 million at 4.18% and $5.2 million at 5.08%, plus the applicable margin under the 2007 Agreement. At November 30, 2008, the fair value of the interest rate swaps was recorded in the balance sheet as a liability of $1.7 million.

The Company paid dividends of $0.7 million during the three months ended November 30, 2008, which represents a quarterly rate of $0.06 per share. On October 29, 2008, the Board of Directors declared a dividend of $0.06 per common share payable on December 5, 2008 to shareholders of record as of November 14, 2008. Any future dividends will be paid at the discretion of the Company's board of directors and will depend upon, among other things, earnings, financial condition, cash requirements and availability, and contractual requirements. Pursuant to the 2007 Agreement, the Company may not declare or pay dividends on, or make any other distributions in respect of, its common stock in excess of $8 million in any fiscal year or if there exists a Default or Event of Default as defined in the 2007 Agreement.
Contractual Obligations
The Company is a party to various debt and lease agreements at November 30, 2008 that contractually commit the Company to pay certain amounts in the future. The Company also has open purchase orders entered into in the ordinary course of business for raw materials, capital projects and other items, for which significant terms have been confirmed. As of November 30, 2008, there have been no material changes in the Company's contractual obligations since August 31, 2008.
Pension Contributions
In light of the temporary pension funding relief provided by the Worker, Retiree and Employer Recovery Act of 2008 (the "Act"), which was enacted in December 2008, the Company currently estimates that the minimum funding contributions to its defined benefit pension plans for plan year 2009 (calendar year 2009) will be $2.4 million, a reduction of $1.1 million from the $3.5 million disclosed in the Company's Annual Report on Form 10-K for the year ended August 31, 2008. The payments are estimated to be $0.4 million in each of fiscal years 2009 and 2010 and $1.6 million in fiscal year 2011. Off-Balance Sheet Arrangements
The Company had no off-balance sheet arrangements at November 30, 2008. Recent Accounting Pronouncements
In December 2007, the FASB issued Statement No. 141R (revised 2007), "Business Combinations" ("SFAS 141R") and Statement No. 160, "Non-Controlling Interest in Consolidated Financial Statements, an Amendment of ARB No. 51" ("SFAS 160"). These new standards establish principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, any non-controlling interests, and goodwill acquired in a business combination. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. The requirements of SFAS 141R and SFAS No. 160 are effective for fiscal years beginning after December 15, 2008 (fiscal 2010), and, except for the presentation and disclosure requirements of SFAS 160, are to be applied prospectively.
In March 2008, the FASB issued Statement No. 161, "Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB No. 133" ("SFAS 161"). SFAS 161 requires additional disclosures about the objectives for using derivative instruments and hedging activities, method of accounting for such instruments under SFAS 133 and its related interpretations, the effect of derivative instruments and related hedged items on financial position, results of operations, and cash flows, and a tabular disclosure of the fair values of derivative instruments and their gains and losses. For the Company, SFAS 161 is effective December 1, 2008 and will result in additional disclosures in the notes to the consolidated financial statements.
In May 2008, the FASB issued Statement No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 will become effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The

Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles." The Company does not expect the adoption of SFAS 162 to have a material effect on its consolidated financial statements.
In June 2008, the FASB issued FSP Emerging Issues Task Force ("EITF") 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities ("FSP EITF 03-6-1"). FSP EITF 03-6-1 addresses whether unvested share-based payment awards that contain rights to nonforfeitable dividends are participating securities prior to vesting and, therefore, included in the computation of earnings per share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 (fiscal 2010). The Company is currently evaluating the impact of adopting FSP EITF 03-6-1 on the Company's consolidated financial statements.
Critical Accounting Policies
The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The process of preparing financial statements requires management to make estimates, judgments and assumptions that affect the Company's financial position and results of operations. These estimates, judgments and assumptions are based on the Company's historical experience and management's knowledge and understanding of the current facts and circumstances. Note 1 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended August 31, 2008 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. Management believes that its estimates, judgments and assumptions are reasonable based upon information available at the time this report was prepared. To the extent there . . .