**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-Q**

| **x**      | ** ** | **Quarterly Report Pursuant to Section 13 or 15(d)  of the Securities Exchange Act of 1934**  |
|------------|------------|-----------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                    |
| ** ** |       | **For the quarterly period ended October 31, 2006**                                           |
| ** ** |       | ** **                                                                                    |
| ** ** |       | **or**                                                                                        |
| ** ** |       | ** **                                                                                    |
| **o**      | ** ** | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |

 

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**Commission File No. 000-50111**

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**DAKOTA GROWERS PASTA COMPANY, INC.**

(Exactname of registrant as specified in its charter)

| **North Dakota**          |   | **45-0423511**                     |
|---------------------------|--------|------------------------------------|
| (State of  incorporation) |   | (IRS Employer  Identification No.) |

 

**One Pasta Avenue, Carrington, ND 58421**

(Addressof principal executive offices including zip code)

**(701) 652-2855**

(Registrant’stelephone number, including area code)

**NOT APPLICABLE**

(Formername, former address and former fiscal year, if changed since last report)

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.       Yesx No o

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

| Large accelerated filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|---------------------------------|--------|----------------------------|--------|--------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act)Yes  o  No  x

Asof December 15, 2006, the Registrant had 13,169,382 shares of common stock, parvalue $0.01 per share, outstanding.

 

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**PART I – FINANCIAL INFORMATION**

**ITEM 1 . FINANCIAL STATEMENTS**

**DAKOTA GROWERS PASTA COMPANY, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(In Thousands, Except ShareInformation)**
| ** **                                                                                                              | ** ** | **(Unaudited)**      | ** ** | ** **        | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|
| ** **                                                                                                              | ** ** | **October 31,** | ** ** | **July 31,** | ** ** |
| ** **                                                                                                              | ** ** | **2006**             | ** ** | **2006**          | ** ** |
| **ASSETS**                                                                                                              | ** ** | ** **           | ** ** | ** **        | ** ** |
|                                                                                                                    |       |                 |       |              |       |
| CURRENT ASSETS                                                                                                          |       |                 |       |              |       |
| Cash and cash  equivalents                                                                                              |       | $                    | 314        |              | $          | 343 |   |
|                                                                                                                    |       |                 |       |              |       |
| Trade accounts  receivable, less allowance for cash discounts and doubtful accounts of  $1,146 and $1,080, respectively |       | 15,909               |       | 14,441            |       |
|                                                                                                                    |       |                 |       |              |       |
| Other  receivables                                                                                                      |       | 115                  |       | 91                |       |
|                                                                                                                    |       |                 |       |              |       |
| Inventories                                                                                                             |       | 23,990               |       | 26,118            |       |
|                                                                                                                    |       |                 |       |              |       |
| Prepaid expenses                                                                                                        |       | 1,846                |       | 2,007             |       |
|                                                                                                                    |       |                 |       |              |       |
| Deferred income  taxes                                                                                                  |       | 955                  |       | 955               |       |
|                                                                                                                    |       |                 |       |              |       |
| Total current  assets                                                                                                   |       | 43,129               |       | 43,955            |       |
|                                                                                                                    |       |                 |       |              |       |
| PROPERTY AND EQUIPMENT                                                                                                  |       |                 |       |              |       |
| In service                                                                                                              |       | 122,803              |       | 124,035           |       |
| Construction in  progress                                                                                               |       | 4,600                |       | 4,093             |       |
|                                                                                                                    |       | 127,403              |       | 128,128           |       |
| Less accumulated  depreciation                                                                                          |       | (57,464              | )          | (57,198           | )          |
|                                                                                                                    |       |                 |       |              |       |
| Net property and  equipment                                                                                             |       | 69,939               |       | 70,930            |       |
|                                                                                                                    |       |                 |       |              |       |
| INVESTMENT IN  COOPERATIVE BANK                                                                                         |       | 1,515                |       | 1,515             |       |
|                                                                                                                    |       |                 |       |              |       |
| GOODWILL                                                                                                                |       | 16,654               |       | 16,654            |       |
|                                                                                                                    |       |                 |       |              |       |
| OTHER ASSETS                                                                                                            |       | 1,141                |       | 1,195             |       |
|                                                                                                                    |       |                 |       |              |       |
|                                                                                                                    |       | $                    | 132,378    |              | $          | 134,249 |   |

 

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**DAKOTA GROWERS PASTA COMPANY, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(In Thousands, Except Share Information)**
| ** **                                                                                                                            | ** ** | **(Unaudited)**      | ** ** | ** **        | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|
| ** **                                                                                                                            | ** ** | **October 31,** | ** ** | **July 31,** | ** ** |
| ** **                                                                                                                            | ** ** | **2006**             | ** ** | **2006**          | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                        | ** ** | ** **           | ** ** | ** **        | ** ** |
|                                                                                                                                  |       |                 |       |              |       |
| CURRENT  LIABILITIES                                                                                                                  |       |                 |       |              |       |
| Excess  outstanding checks over cash on deposit                                                                                       |       | $                    | 1,768      |              | $          | 704 |   |
| Accounts payable                                                                                                                      |       | 7,808                |       | 7,250             |       |
| Accrued  liabilities                                                                                                                  |       | 4,974                |       | 5,957             |       |
| Notes payable                                                                                                                         |       | 1,500                |       | —            |       |
| Current portion  of long-term debt                                                                                                    |       | 7,371                |       | 6,771             |       |
|                                                                                                                                  |       |                 |       |              |       |
| Total current  liabilities                                                                                                            |       | 23,421               |       | 20,682            |       |
|                                                                                                                                  |       |                 |       |              |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                        |       | —               |       | —            |       |
| LONG-TERM DEBT,  net of current portion                                                                                               |       | 22,674               |       | 28,545            |       |
| DEFERRED INCOME  TAXES                                                                                                                |       | 12,730               |       | 12,417            |       |
| OTHER  LIABILITIES                                                                                                                    |       | 21                   |       | 34                |       |
|                                                                                                                                  |       |                 |       |              |       |
| Total  liabilities                                                                                                                    |       | 58,846               |       | 61,678            |       |
|                                                                                                                                  |       |                 |       |              |       |
| NONCONTROLLING  INTERESTS                                                                                                             |       | 8,022                |       | 7,979             |       |
|                                                                                                                                  |       |                 |       |              |       |
| STOCKHOLDERS’  EQUITY                                                                                                            |       |                 |       |              |       |
| Series D  delivery preferred stock, non-cumulative, $.01 par  value, 11,340,841 authorized, 11,275,297 shares issued  and outstanding |       | 113                  |       | 113               |       |
| Common stock,  $.01 par value, 75,000,000 shares  authorized, 13,169,382 issued and outstanding                                       |       | 132                  |       | 132               |       |
| Additional  paid-in capital                                                                                                           |       | 62,896               |       | 62,872            |       |
| Retained  earnings                                                                                                                    |       | 2,369                |       | 1,475             |       |
|                                                                                                                                  |       |                 |       |              |       |
| Total  stockholders’ equity                                                                                                      |       | 65,510               |       | 64,592            |       |
|                                                                                                                                  |       |                 |       |              |       |
| Total liabilities and  stockholders’ equity                                                                                      |       | $                    | 132,378    |              | $          | 134,249 |   |

 

SeeNotes to Consolidated Financial Statements

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**DAKOTA GROWERS PASTA COMPANY,INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(In Thousands, Except Per Share Amounts)(Unaudited)**
| ** **                                                                           | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                           | ** ** | **October 31,**             | ** ** |
| ** **                                                                           | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Net revenues  (net of discounts and allowances   of $6,719 and $7,126, respectively) |       | $                                | 48,933     |   | $ | 44,072 |   |
|                                                                                 |       |                             |       |   |   |
| Cost of goods  sold                                                                  |       | 42,860                           |       | 38,832 |   |
|                                                                                 |       |                             |       |   |   |
| Gross profit                                                                         |       | 6,073                            |       | 5,240 |   |
|                                                                                 |       |                             |       |   |   |
| Marketing,  general and administrative expenses                                      |       | 3,242                            |       | 3,868 |   |
|                                                                                 |       |                             |       |   |   |
| Operating income                                                                     |       | 2,831                            |       | 1,372 |   |
|                                                                                 |       |                             |       |   |   |
| Other income  (expense)                                                              |       |                             |       |   |   |
| Interest and  other income                                                           |       | 8                                |       | 30 |   |
| Loss on  disposition of property, equipment and other assets                         |       | (670                             | )          | (585 | ) |
| Interest  expense, net                                                               |       | (664                             | )          | (549 | ) |
|                                                                                 |       |                             |       |   |   |
| Income before  noncontrolling interests and income taxes                             |       | 1,505                            |       | 268 |   |
|                                                                                 |       |                             |       |   |   |
| Noncontrolling  interests                                                            |       | (40                              | )          | 386 |   |
|                                                                                 |       |                             |       |   |   |
| Income before  income taxes                                                          |       | 1,465                            |       | 654 |   |
|                                                                                 |       |                             |       |   |   |
| Income tax  expense                                                                  |       | 571                              |       | 255 |   |
|                                                                                 |       |                             |       |   |   |
| Net income                                                                           |       | $                                | 894        |   | $ | 399 |   |
|                                                                                 |       |                             |       |   |   |
| Net income per  common share                                                         |       |                             |       |   |   |
| Basic                                                                                |       | $                                | 0.07       |   | $ | 0.03 |   |
|                                                                                 |       |                             |       |   |   |
| Diluted                                                                              |       | $                                | 0.07       |   | $ | 0.03 |   |
|                                                                                 |       |                             |       |   |   |
| Weighted average  common shares outstanding                                          |       |                             |       |   |   |
| Basic                                                                                |       | 13,169                           |       | 13,169 |   |
|                                                                                 |       |                             |       |   |   |
| Diluted                                                                              |       | 13,459                           |       | 13,570 |   |

 

SeeNotes to Consolidated Financial Statements

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**DAKOTA GROWERS PASTA COMPANY, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**
| ** **                                                                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                  | ** ** | **October 31,**             | ** ** |
| ** **                                                                  | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| OPERATING  ACTIVITIES                                                       |       |                             |       |   |   |
| Net income                                                                  |       | $                                | 894        |   | $ | 399 |   |
| Adjustments to  reconcile net income to net cash from operating activities: |       |                             |       |   |   |
| Depreciation and  amortization                                              |       | 1,865                            |       | 1,734 |   |
| Loss on  disposition of property, equipment and other assets                |       | 670                              |       | 585 |   |
| Noncontrolling  interests                                                   |       | 40                               |       | (386 | ) |
| Deferred income  taxes                                                      |       | 313                              |       | 101 |   |
| Stock-based  employee compensation                                          |       | 24                               |       | 5 |   |
| Changes in  assets and liabilities                                          |       |                             |       |   |   |
| Trade  receivables                                                          |       | (1,468                           | )          | (1,261 | ) |
| Other receivables                                                           |       | (24                              | )          | 275 |   |
| Inventories                                                                 |       | 2,128                            |       | 2,600 |   |
| Prepaid expenses                                                            |       | (81                              | )          | (917 | ) |
| Other assets                                                                |       | 3                                |       | 12 |   |
| Accounts payable                                                            |       | 558                              |       | 1,728 |   |
| Other accrued  liabilities                                                  |       | (983                             | )          | (248 | ) |
| NET CASH FROM  OPERATING ACTIVITIES                                         |       | 3,939                            |       | 4,627 |   |
|                                                                        |       |                             |       |   |   |
| INVESTING  ACTIVITIES                                                       |       |                             |       |   |   |
| Purchases of  property and equipment                                        |       | (1,171                           | )          | (6,766 | ) |
| Payments for  package design costs                                          |       | (93                              | )          | (50 | ) |
| Proceeds from  cooperative bank equity retirements                          |       | —                           |       | 107 |   |
| NET CASH USED  FOR INVESTING ACTIVITIES                                     |       | (1,264                           | )          | (6,709 | ) |
|                                                                        |       |                             |       |   |   |
| FINANCING  ACTIVITIES                                                       |       |                             |       |   |   |
| Net change in  excess outstanding checks over cash on deposit               |       | 1,064                            |       | (583 | ) |
| Net change in  short-term notes payable                                     |       | 1,500                            |       | 2,600 |   |
| Payments on  long-term debt                                                 |       | (5,271                           | )          | (4,771 | ) |
| Proceeds from  long-term debt                                               |       | —                           |       | 4,931 |   |
| Preferred stock  retirements                                                |       | —                           |       | (4 | ) |
| Investments by  noncontrolling interests                                    |       | 3                                |       | 25 |   |
| NET CASH FROM  (USED FOR) FINANCING ACTIVITIES                              |       | (2,704                           | )          | 2,198 |   |
|                                                                        |       |                             |       |   |   |
| NET CHANGE IN  CASH AND CASH EQUIVALENTS                                    |       | (29                              | )          | 116 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                             |       | 343                              |       | 229 |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                   |       | $                                | 314        |   | $ | 345 |   |
|                                                                        |       |                             |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                          |       |                             |       |   |   |
| Cash payments  for                                                          |       |                             |       |   |   |
| Interest (net of  amounts capitalized)                                      |       | $                                | 970        |   | $ | 906 |   |
|                                                                        |       |                             |       |   |   |
| Income taxes                                                                |       | $                                | 900        |   | $ | 252 |   |

 

SeeNotes to Consolidated Financial Statements

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**DAKOTA GROWERS PASTA COMPANY, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

The following notes should be read in conjunctionwith the notes to the financial statements for the year ended July 31, 2006 asfiled in the Company’s Form 10-K.

**NOTE 1 - ORGANIZATION**

Dakota Growers PastaCompany, Inc. (“Dakota Growers” or “the Company”) is a North Dakota corporationthat operates a milling and pasta manufacturing facility in Carrington, NorthDakota. In addition, the Company’s wholly-owned subsidiary, Primo Piatto, Inc.(“Primo Piatto”), a Minnesota corporation, operates a pasta manufacturingfacility in New Hope, Minnesota.

**NOTE 2 – FINANCIAL STATEMENT PRESENTATION**

The unauditedconsolidated financial statements included herein have been prepared pursuantto the rules and regulations of the Securities and Exchange Commission forquarterly reporting. Accordingly, they do not include all the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements. In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included. Operatingresults for the three months ended October 31, 2006 are not necessarilyindicative of the results that may be expected for the year ended July 31,2007. The unaudited consolidated financial statements included in this Form10-Q should be read in conjunction with the consolidated financial statementsand footnotes included in the Company’s Form 10-K for the year ended July 31,2006. The information contained in the balance sheet as of July 31, 2006 wasderived from the Company’s audited annual report for fiscal year 2006.Reclassifications have been made to facilitate comparability with currentpresentation. Such reclassifications have no effect on the net results ofoperations.

The financial informationpresented herein includes the consolidated balance sheets and results ofoperations of theCompany, its wholly-owned subsidiary Primo Piatto, Inc., and DNA DreamfieldsCompany, LLC (“DNA Dreamfields”), which the Company began to consolidate infiscal year 2005. All material inter-company accounts and transactions havebeen eliminated in the preparation of the consolidated financial statements.

**NOTE 3 – NEW ACCOUNTING STANDARDS**

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections”. SFAS 154replaces Accounting Principles Board Opinion No. 20, “Accounting Changes”and SFAS No. 3, “Reporting Accounting Changes in Interim FinancialStatements-An Amendment of APB Opinion No. 28”. SFAS 154 provides guidanceon the accounting for and reporting of accounting changes and errorcorrections. SFAS 154 requires “retrospective application” of the direct effectof a voluntary change in accounting principle to prior periods’ financialstatements where it is practicable to do so. SFAS 154 also redefines the term “restatement”to mean the correction of an error by revising previously issued financialstatements. SFAS 154 is effective for accounting changes and error correctionsmade in fiscal years beginning after December 15, 2005 unless adoptedearly. The adoption of this accounting standard did not have a material impacton the consolidated financial position, results of operations or cash flows,except to the extent that the statement subsequently requires retrospectiveapplication of a future item.

In June 2006, the FASB issued FASB Interpretation No. 48 (FIN No. 48), “Accountingfor Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109,”which clarifies the accounting for uncertainty in income taxes recognized inaccordance with SFAS No. 109, Accounting for Income Taxes. FIN No. 48 clarifiesthe application of SFAS No. 109 by defining criteria that an individual taxposition must meet for any part of the benefit of that position to berecognized in the financial statements. Additional, FIN No. 48 provides guidance on the measurement, de-recognition,classification and disclosure of tax positions along with the accounting forthe related interest and penalties. The provisions of FIN No. 48 are effectivefor the fiscal years beginning after

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December 15, 2006, with the cumulative effect of the change inaccounting principle recorded as an adjustment to opening retained earnings.The Company will be required to adopt FIN No. 48 for the fiscal year beginningAugust 1, 2007. TheCompany does not expect this Statement to have a material impact on itsfinancial statements upon adoption. However, future changes in the Company’s income tax situation may have amaterial impact on the Company’s financial statements as a result of thisStatement.

In September 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes aframework for measuring fair value and expands disclosure of fair valuemeasurements. SFAS No. 157 applies under other accounting pronouncements thatrequire or permit fair value measurements and accordingly, does not require anynew fair value measurements. SFAS No. 157 is effective for financial statementsissued for fiscal years beginning after November 15, 2007. We have not yetassessed the impact, if any, that the implementation of SFAS No. 157 will have onour consolidated results of operations or financial condition.

**NOTE 4 – INVENTORIES**

Inventories are valuedat lower of cost or market. Inventories as of October 31, 2006 include rawmaterials and packaging of $6,635,000 and finished goods of $17,355,000. Inventoriesat July 31, 2006 include raw materials and packaging of $6,529,000 and finishedgoods of $19,589,000.

###### **NOTE5 – LOAN AGREEMENTS**

The Company has a $25 million revolving creditfacility with CoBank that extends through May 30, 2007. Interest on therevolving line is currently charged at a variable rate established by CoBankbased on CoBank’s cost of funds, although the facility also allows for a fixedrate option. The balance outstanding under this revolving line of creditarrangement totaled $1.5 million as of October 31, 2006. There was no balanceoutstanding under this revolving line of credit arrangement as of July 31,2006. The Company had $23.5 million available for borrowings under the line ofcredit as of October 31, 2006.

The Company’s various debt agreements with CoBankand certain institutional note holders obligate the Company to maintain orachieve certain amounts of equity and certain financial ratios and imposecertain restrictions on the Company. The Company was in compliance with thesefinancial covenants as of October 31, 2006.

###### **NOTE6 – EARNINGS PER SHARE**

Basic earnings per share (EPS)is calculated by dividing net earnings on common stock by the weighted averagenumber of common shares outstanding during the period. Diluted EPS includes theeffect of all potentially dilutive securities, such as stock options andconvertible preferred stock.

Dilutive securities, consisting of stock options andconvertible preferred stock, included in the calculation of diluted weightedaverage common shares totaled 290,000 and 401,000 for the three months endedOctober 31, 2006 and 2005, respectively. As there is currently no establishedpublic trading market for the Company’s common stock, the Company has assumedthe proceeds from the exercise of stock options would reduce debt and, thus,interest expense.

**NOTE 7 –DNA DREAMFIELDS COMPANY, LLC**

EffectiveMay 1, 2005, the Company increased its ownership in DNA Dreamfields to46.7%. In conjunction with the Company’sincrease in ownership in DNA Dreamfields and changes in the DNADreamfields operating

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agreement and othercontractual agreements, the Companydetermined that DNA Dreamfields was a variable interest entity under FASBInterpretation No. 46(R), “Consolidation of Variable Interest Entities,” and thatthe Company was the primary beneficiary. Therefore, effective May 1, 2005,the Company began to include DNA Dreamfields in its consolidated financialstatements.

The Company entered into a “2005 Line of Credit Loan Agreement” withDNA Dreamfields in fiscal year 2005. Under that Agreement, the Companywill loan up to $5,000,000 to DNA Dreamfields, with DNA Dreamfields able torepay and reborrow amounts under the Line of Credit Loan Agreement from time totime. The Line of Credit Loan Agreement matures on May 31,2010. The balance outstanding related to advances to DNA Dreamfields underthe Line of Credit Loan Agreement totaled $2,239,000 and $2,184,000 as ofOctober 31, 2006 and July 31, 2006, respectively.  These inter-company amounts have beeneliminated in the preparation of the consolidated financial statements.

**NOTE 8 – STOCK OPTIONS**

Effective August 1, 2005, the Company adoptedStatement of Financial Accounting Standard No. 123 (revised 2004), “ShareBased Payment” (SFAS No. 123R). Under SFAS No. 123R, the Company isrequired to recognize, as expense, the estimated fair value of all share basedpayments to employees. In accordance with this standard, the Company haselected to recognize the compensation cost of all service based awards on astraight-line basis over the vesting period of the award. Performance basedawards are recognized ratably for each vesting tranche. The Company recordedstock-based employee compensation expense of $24,000 and $5,000, for the threemonths ended October 31, 2006 and October 31, 2005, respectively.

OnOctober 19, 2006, the Board of Directors granted incentive stock options topurchase 272,726 shares of the Company’s common stock at a per share exerciseprice of $5.00. The vesting of these options is subject to certain qualifications,including but not limited to, the continued employment of the optionee with theCompany. Subject to the foregoing qualifications and certain otherqualifications, fifty percent of these options vest on October 19,2007, twenty-five percent vest on October 19, 2008, and twenty-five percentvest on October 19, 2009.

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The following tables set forth information regarding stock optionsoutstanding and exercisable:

 
| ** **                       | ** ** | **Options to purchase Series C Convertible Preferred Stock** | ** ** |
|----------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Number of**                                                                              | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Series C**                                                                               | ** ** | **Option** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Convertible**                                                                                 | ** ** | **Price** | ** ** | **Exercise** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Preferred Shares**                                                                       | ** ** | **per Share** | ** ** | **Price** | ** ** | **Exercisable** | ** ** |
|                             |       |                                                                                            |       |   |   |   |   |   |   |
| Outstanding at  July 31, 2006    |       | 1,977                                                                                           |       | $100-$150 |   | $ | 117.35 |   | 1,977 |   |
| Exercised                        |       | —                                                                                          |       |   |   |   |   |   |   |
| Granted                          |       | —                                                                                          |       |   |   |   |   |   |   |
| Forfeited/Expired                |       | —                                                                                          |       |   |   |   |   |   |   |
| Outstanding at  October 31, 2006 |       | 1,977                                                                                           |       | $100-$150 |   | $ | 117.35 |   | 1,977 |   |

 
| ** **                       | ** ** | **Options to purchase Common Stock** | ** ** |
|----------------------------------|------------|----------------------------------------------------------|------------|
| ** **                       | ** ** | ** **                                               | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **                                               | ** ** | **Option** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Number of**                                       | ** ** | **Price** | ** ** | **Exercise** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Common Shares**                                   | ** ** | **per Share** | ** ** | **Price** | ** ** | **Exercisable** | ** ** |
|                             |       |                                                     |       |   |   |   |   |   |   |
| Outstanding at  July 31, 2006    |       | 385,837                                                  |       | $4.00-$6.25 |   | $ | 5.16 |   | 242,517 |   |
| Exercised                        |       | —                                                   |       |   |   |   |   |   |   |
| Granted                          |       | 272,726                                                  |       | $5.00 |   | $ | 5.00 |   |   |   |
| Forfeited/Expired                |       | —                                                   |       |   |   |   |   |   |   |
| Outstanding at  October 31, 2006 |       | 658,563                                                  |       | $4.00-$6.25 |   | $ | 5.09 |   | 242,517 |   |

 

The fair value of the stock options granted onOctober 19, 2006 was estimated at the date of grant using theBlack-Scholes option pricing model with the following weighted averageassumptions: risk free interest rate of 4.7%, expected dividend yield of 1.0%,expected life of 5 years and volatility of 25%;

A summary of the status of the Company’s issuedbut nonvested stock options as of October 31, 2006, and changes during thethree months ended October 31, 2006, is presented below:
| ** **                            | ** ** | ** ** | ** ** | **Weighted-Average** | ** ** |
|---------------------------------------|------------|------------|------------|----------------------|------------|
| ** **                            | ** ** | **Common** | ** ** | **Grant-Date**       | ** ** |
| **Nonvested Stock Options** | ** ** | **Shares** | ** ** | **Fair Value**  | ** ** |
|                                  |       |       |       |                 |       |
| Nonvested at  July 31, 2006           |       | 143,320    |       | $                    | 4.03       |   |
| Granted                               |       | 272,726    |       | $                    | 5.00       |   |
| Vested                                |       | —     |       |                 |       |
| Forfeited/Expired                     |       | —     |       |                 |       |
| Nonvested at October  31, 2006        |       | 416,046    |       | $                    | 4.67       |   |

 

As of October 31, 2006, there was approximately $481,000 of totalunrecognized compensation cost related to nonvested employee stockoptions.  That cost is expected to be recognized over a period of 3 years.

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**NOTE 9 – COMMITMENTS**

The Company forward contracts for a certain portion of its future durumwheat requirements. The Company had outstanding commitments for grain purchasestotaling $11,859,000 as of October 31, 2006, related to forward purchasecontracts. These contracts are set price contracts to deliver grain to theCompany’s mill, and are not derivative in nature as they have no net settlementprovision and are not transferable.

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

This Management’s Discussion and Analysisof Financial Condition and Results of Operations (MD&A) should be read inconjunction with the MD&A included in the Company’s Form 10-K for the yearended July 31, 2006.

**Forward-Looking Statements**

The following discussion containsforward-looking statements. Such forward-looking statements include, amongothers, those statements including the words “expect”, “anticipate”, “believe”,“may” and similar expressions. Such statements are based on assumptions by theCompany’s management as of the date of this Quarterly Report, and are subjectto risks and uncertainties, including those discussed in the Company’s Form10-K for the year ended July 31, 2006 under “Risk Factors,” that could causeactual results to differ materially from those anticipated. The Companycautions readers not to place undue reliance on such forward-lookingstatements. The Company will not update any forward-looking statements in thisQuarterly Report to reflect future events or developments.

**Summary**

Dakota Growersis the third largest pasta manufacturer in North America. The Company has twoproduction plants, located in Carrington, North Dakota and New Hope, Minnesota,and generates a majority of its revenues from manufacturing dry pasta for theretail store brand, foodservice and ingredient markets.  The Company’s cost of goods sold consistsmainly of raw materials (primarily durum wheat), packaging, and manufacturingand distribution costs.  The Companycompetes through low cost production, high product quality, flexibility andcustomer service.

Net income for the quarterended October 31, 2006 totaled $894,000 compared to $399,000 for the quarterended October 31, 2005.  Net earnings perbasic common share for the quarter ended October 31, 2006 were $0.07 per sharecompared to $0.03 per share for the quarter ended October 31, 2005.

The Company’s net revenuesincreased 11.0% for the quarter ended October 31, 2006 when compared to thesame period of the prior year.  Therevenue increase was the result of higher pasta sales volumes, particularly inthe ingredient market, and to a lesser extent higher per unit selling prices.Benefits derived from increased sales were partially offset by higher durumcosts. Durum prices increased significantly in the first quarter of fiscal year2007 when compared to fiscal year 2006 prices. The Company has generally been successful in obtaining sales priceincreases to offset the higher durum cost. However, if the Company is unable to pass through higher durum or otherinput costs on a timely basis, our financial results may be adversely affected.

**Critical Accounting Policies**

The accompanying discussion and analysisof our results of operations and financial condition are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires management to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. Theseestimates form the basis for making judgments about the carrying values ofassets and liabilities that are not readily apparent from other sources. Webase our estimates and judgments on historical experience and on various otherassumptions that we believe are reasonable under the circumstances. However,future events are subject to change and the best estimates and judgments mayrequire adjustment. For a complete description of the Company’s significantaccounting policies, please see Note 1 to the consolidated financial statementsincluded in the Company’s Form 10-K for the year ended July 31, 2006. Ourcritical accounting policies are those that have meaningful impact on thereporting of our financial condition and results, and that require significantmanagement judgment and estimates. These policies include our accounting for(a) allowance for doubtful accounts, (b) inventory valuation, (c) assetimpairment, and (d) income taxes.

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*Allowancefor Doubtful Accounts*

We evaluate the collectibility of ouraccounts receivable based on a combination of factors. In cases where we areaware of circumstances that may impair a specific customer’s ability to meetits financial obligations to us, we record a specific allowance against amountsdue to us, and thereby reduce the net recognized receivable to the amount wereasonably believe will be collected. For all other customers, we recognizeallowances for doubtful accounts based on the length of time the receivablesare past due and our historical experience. If the financial condition of ourcustomers deteriorates, additional allowances may be required in the futurethat could have an adverse impact on our future operating results.

*Inventory Valuation*

Inventoriesare stated at the lower of cost or market, determined on a first-in, first-out(FIFO) basis, using product specific standard costs. The Company analyzesvariances between actual manufacturing costs incurred and amounts absorbed atinventory standard costs. Inventory valuations are adjusted for these variancesas applicable. The Company regularly evaluates its inventories and recognizesinventory allowances for discontinued and slow-moving inventories based uponthese evaluations.

*Asset Impairment*

We are required to evaluate ourlong-lived assets, including goodwill, for impairment and write down the valueof any assets if they are determined to be impaired. Evaluating the impairmentof long-lived assets involves management judgment in estimating the future cashflows and fair values related to these assets. Future events could causemanagement to conclude that impairment indicators exist and that the value ofcertain long-lived assets is impaired.

*Income Taxes*

In determining income (loss) forfinancial statement purposes, management must make certain estimates andjudgments in calculating tax liabilities and in determining the recoverabilityof certain deferred tax assets. Deferred tax assets must be reduced by avaluation allowance if, based on the weight of available evidence, it is morelikely than not that some portion or all of the recorded deferred tax assetswill not be realized in future periods. Management believes it is likely thatthe deferred tax assets as of October 31, 2006 will be realized through thegeneration of future taxable income and tax planning strategies.

**Results of Operations**

*Comparison of the Three MonthsEnded October 31, 2006 and 2005*

***NetRevenues.***Net revenuestotaled $48.9 million for the three months ended October 31, 2006, an increaseof 11.0%, compared to $44.1 million for the three months ended October 31,2005. Overall, pasta sales volumes increased 7.0% along with an increase inpasta per unit selling prices of 2.9%. Revenues from the retail market, aportion of which includes co-pack and government sales, increased $0.5 million,or 2.5%, due to a 5.3% increase in average selling prices offset by a 2.7%decrease in volume. Foodservice revenues increased $0.4 million, or 3.0%, dueto a 8.5% increase in average selling prices offset by a 5.1% decrease in salesvolumes. Ingredient revenues increased $3.2 million, or 54.2%, due to a 49.3%volume gain and a 3.3% increase in average selling prices.

The Company markets semolina production in excess of its ownrequirements as well as durum wheat flour, other flour blends and by-productsof the durum milling process. Revenues from mill product sales totaled $3.2million for the three months ended October 31, 2006, an increase of $0.7million when compared to the same period of the prior year.

***Cost of Goods Sold.*** Cost ofgoods sold increased $4.0 million, or 10.4%, to $42.8 million for the threemonths ended October 31, 2006, compared to $38.8 million for the three monthsended October 31, 2005.  The increase wasprimarily due to higher sales volumes. Gross profit as a percentage of net revenues improved to 12.4% for

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the three months ended October 31, 2006from 11.9% for the three months ended October 31, 2005.Benefits realized were partially offset by higher durum costs which negativelyimpacted gross profit.

***Marketing, General, andAdministrative (“MG&A”) Expenses.*** MG&Aexpenses decreased 19.3%, to $3.2 million for the quarter ended October 31,2006, compared to $3.9 million for the quarter ended October 31, 2005. Thedecrease was primarily due to lower consumer advertising costs associated withDreamfieldsTM pastaproducts. MG&A expenses as a percentage of net revenues decreased to 6.6%for the quarter ended October 31, 2006, from 8.8% for the comparable quarter ofthe prior year.

***Loss on Disposition of Property,Equipment and Other Assets (“Loss on Disposition”). ***The Companyincurred losses on disposition of $0.7 million and $0.6 million during thethree months ended October 31, 2006 and October 31, 2005, respectively.   The losses were related to retirements ofcertain equipment in conjunction with capital projects at the New Hope,Minnesota facility.

***Interest Expense.*** Interestexpense for the three months ended October 31, 2006 totaled $0.7 million, up$0.1 million from the corresponding period of the prior year.

***Noncontrolling Interests. ***Noncontrollinginterests reflects the portion of the DNA Dreamfields Company, LLC net incomeor net loss allocable to other members of DNA Dreamfields.  The income allocated to other members for thethree months ended October 31, 2006 totaled $40,000 compared to the loss allocatedto the other members of $386,000 for the three months ended October 31, 2005.

***Income Taxes.***The income tax expense forthe three months ended October 31, 2006 and 2005 totaled $0.6 million and $0.3million, respectively, and reflects an effective corporate income tax rate ofapproximately 39%.

***Net Income. ***Net income for the three months ended October31, 2006 totaled $0.9 million, an increase of $0.5 million compared to the netincome of $0.4 million for the three months ended October 31, 2005.

**Liquidity and Capital Resources**

The Company’s primary sources ofliquidity are cash provided by operations and borrowings under its revolvingcredit facility. Working capital as of October 31, 2006 totaled $19.7 millioncompared to $23.3 million as of July 31, 2006.

TheCompany has a $25 million revolving credit facility with CoBank which extendsthrough May 30, 2007. The balance outstanding on the line of credit was $1.5million as of October 31, 2006, leaving $23.5 million available for borrowingsas of that date. There was no balance outstanding under this revolving line ofcredit arrangement as of July 31, 2006.

The Company’s various debt agreements with CoBank and certaininstitutional investors obligate the Company to maintain or achieve certainamounts of equity and certain financial ratios and impose certain restrictionson the Company. The Company was in compliance with these financial covenants asof October 31, 2006 and the date of this filing.

Net cash provided from operatingactivities totaled $3.9 million for the three months ended October 31, 2006compared to net cash provided by operating activities of $4.6 million for thethree months ended October 31, 2005. Significant items contributing to this change were inventories, tradereceivables and net income as adjusted for non-cash items.  Inventories decreased $2.1 million for thequarter ended October 31, 2006 as a result of strong sales volumes.

Net cash usedfor investing activities totaled $1.3 million and $6.7 million for the threemonths ended October 31, 2006 and 2005, respectively.  The majority of these cash outlays related tocapital expenditures for the New Hope facility.

Net cash used for financing activitiestotaled $2.7 million for the three months ended October 31, 2006,compared tonet cash from financing activities of $2.2 million for the three months endedOctober 31, 2005.  The $2.7

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million of net cash used for financingactivities for the quarter ended October 31, 2006 included $5.3 million inscheduled payments on long-term debt offset by an increase in short-term notespayable and excess outstanding checks over cash on deposit.

The Company entered into a “2005 Line ofCredit Loan Agreement” with DNA Dreamfields in fiscal year 2005, under whichthe Company will loan up to $5.0 million to DNA Dreamfields. The balanceoutstanding related to advances to DNA Dreamfields under the Line of CreditLoan Agreement totaled $2.2 million as of October 31, 2006 and July 31, 2006.

U.S. Customs and Border Protection (“Customs”)has distributed antidumping and countervailing duties assessed on certain pastaimported from Italy and Turkey to affected domestic producers pursuant to theContinued Dumping and Subsidy Offset Act of 2000 (the “Act”). The Companyreceived $1.3 million in December 2006 under the Act, which will berecognized as other income in the Company’s fiscal second quarter 2007. TheCompany cannot reasonably estimate the potential amount, if any, that it mayreceive under the Act in future periods as any such amount will be based uponfuture events over which the Company has little or no control, including, butnot limited to, the amount of expenditures by domestic pasta producers and theamount of antidumping and countervailing duties collected by Customs.

The following table summarizes the Company’s contractualobligations as of October 31, 2006 (in thousands):
| ** **                       | ** ** | ** ** | ** ** | **Payments**              | ** ** | **Payments**       | ** ** | **Payments**       | ** ** | **Payments**       | ** ** |
|----------------------------------|------------|------------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Due in Less** | ** ** | **Due in**    | ** ** | **Due in**    | ** ** | **Due After** | ** ** |
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Than 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **5 Years**   | ** ** |
|                             |       |       |       |                      |       |               |       |               |       |               |       |
| Long-term debt                   |       | $          | 30,045     |                      | $          | 7,371              |       | $                  | 19,974     |               | $          | 2,700 |   | $ | — |   |
| Durum purchase  obligations      |       | 11,859     |       | 11,859                    |       | —             |       | —             |       | —             |       |
| Warehouse  obligations           |       | 2,944      |       | 1,832                     |       | 1,112              |       | —             |       | —             |       |
| Operating leases                 |       | 1,095      |       | 701                       |       | 385                |       | 9                  |       | —             |       |
|                             |       |       |       |                      |       |               |       |               |       |               |       |
|                             |       | $          | 45,943     |                      | $          | 21,763             |       | $                  | 21,471     |               | $          | 2,709 |   | $ | — |   |

 

The Company forward contracts for acertain portion of its future durum wheat requirements. At October 31, 2006,the Company had outstanding commitments for grain purchases totaling $11.9million related to forward purchase contracts. These contracts are set pricecontracts to deliver grain to the Company’s mill, and are not derivative innature as they have no net settlement provision and are not transferable.

Management believes that net cashcurrently available and to be provided by operating activities, along withamounts available under the Company’s line of credit, will be sufficient tomeet the Company’s expected capital and liquidity requirements for theforeseeable future.

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

Market risk is therisk of loss to future earnings, to fair values or to future cash flows thatmay result from changes in the price of a financial instrument. The value of afinancial instrument may change as a result of changes in interest rates,commodity prices, exchange rates, equity prices and other market changes.Market risk is attributed to all market-risk sensitive financial instruments,including long-term debt.

The Company forward contracts for a certain portion of its future durumwheat requirements. These contracts are set price contracts to deliver grain tothe Company’s mill, and are not derivative in nature as they have no netsettlement provision and are not transferable. The Company does not believe itis subject to any material market risk exposure with respect to interest rates,commodity prices, exchange rates, equity prices, or other market changes thatwould require disclosure under this item.

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**ITEM4.  CONTROLS AND PROCEDURES**

***Evaluation ofDisclosure Controls and Procedures***

The Company’s ChiefExecutive Officer, Timothy J. Dodd, and Chief Financial Officer, Edward O.Irion, have evaluated the effectiveness of the Company’s disclosure controlsand procedures (as defined in Securities Exchange Act of 1934 Rules 13a-15(e)and 15d-15(e)) as of the end of the period covered by this report. Based uponthe review, they have concluded that these controls and procedures areeffective in alerting them, in a timely fashion, to information required to beincluded in the Company’s period Securities and Exchange Commissionfilings.  The design of any system ofcontrols and procedures is based in part upon certain assumptions about thelikelihood of future events.

***Changes inInternal Controls over Financial Reporting***

There were no changes in the Company’sinternal controls over financial reporting during the Company’s fiscal quarterended October 31, 2006 that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

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**PART II – OTHER INFORMATION**

**ITEM 1A. RISK FACTORS**

Therehave been no material changes from the risk factors disclosed in Part I,Item 1A, of the Company’s Annual Report on Form 10-K for the fiscal year endedJuly 31, 2006.

**ITEM 6. EXHIBITS**
| Exhibits   | ** ** | ** **                                                                                                                   |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                   |
| 31.1       |       | Certification of Chief Executive Officer required by  Securities and Exchange Commission Rule13a-14(a) or 15d-14(a).         |
|       |       |                                                                                                                         |
| 31.2       |       | Certification of Chief Financial Officer required by  Securities and Exchange Commission Rule 13a-14(a) or 15d-14(a).        |
|       |       |                                                                                                                         |
| 32.1       |       | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. |
|       |       |                                                                                                                         |
| 32.2       |       | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. |

 

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|   | DAKOTA GROWERS PASTA  COMPANY, INC. |
|--------|-------------------------------------|
|   |                                |
|   |                                |
|   | (Registrant)                        |

 
| Signature           | ** ** | **Title**                              | ** ** | **Date**           |
|---------------------|------------|----------------------------------------|------------|--------------------|
|                |       |                                   |       |               |
|                |       |                                   |       |               |
| /s/ Timothy J. Dodd |       | President and  Chief Executive Officer |       |               |
| Timothy J. Dodd     |       | (Principal  Executive                  |       | December 15,  2006 |
|                |       | Officer)                               |       |               |
|                |       |                                   |       |               |
|                |       |                                   |       |               |
| /s/ Edward O. Irion |       | Chief Financial  Officer               |       |               |
| Edward O. Irion     |       | (Principal  Financial and              |       | December 15,  2006 |
|                |       | Accounting Officer)                    |       |               |

 

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