**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-K**

 

| **ý** | **Annual Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934**     |
|------------|-----------------------------------------------------------------------------------------------|
|       |                                                                                          |
|       | **For  the fiscal year ended July 31, 2002**                                                  |
|       |                                                                                          |
|       | **or**                                                                                        |
|       |                                                                                          |
| **o**      | **Transition Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934** |

 

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**CommissionFile No. 333-81946**

 

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| **DAKOTA  GROWERS PASTA COMPANY, INC.**                      |
|--------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)      |
|                                                         |
| **North Dakota**                                             |   | **45-0423511** |
| (State of  incorporation)                                    |   | (IRS Employer  Identification No.) |
|                                                         |
| **One Pasta Avenue, Carrington, ND  58421**                  |
| (Address of principal  executive offices including zip code) |
|                                                         |
| **(701) 652-2855**                                           |
| (Registrant’s telephone  number, including area code)   |
|                                                         |
| Securities Registered Pursuant To Section 12(b) Of The Act:  |
| **NONE**                                                     |
|                                                         |
| Securities Registered Pursuant To Section 12(g) Of The Act:  |
| **NONE**                                                     |

 

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Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months, and (2) has been subjectto such filing requirements for the past 90days.     Yes ý  No o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of Registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. ý

 

There is no established public market for theRegistrant’s common stock. Although there is a limited, private market forshares of the Registrant’s common stock, the Registrant does not obtaininformation regarding the transfer price in transactions between itsshareholders and therefore is unable to estimate the aggregate market value ofthe Registrant’s common shares held by non-affiliates. As of October 25, 2002,the Registrant had 12,554,746 shares of common stock, par value $0.01 pershare, outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

None.

 

 

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**PART I.**

 

**Forward-LookingStatements**

 

This report contains forward-looking statements basedupon assumptions by the management of Dakota Growers Pasta Company, Inc. (“theCompany”, “Dakota Growers” or “we”), a North Dakota corporation formerly knownas Dakota Growers Restructuring Company, Inc. and the successor to DakotaGrowers Pasta Company, a North Dakota cooperative, as of the date of thisAnnual Report, including assumptions about risks and uncertainties faced by theCompany. When used in this report, the words “believe,” “expect,” “anticipate,”“will” and similar verbs or expressions are intended to identify suchforward-looking statements. If management’s assumptions prove incorrect orshould unanticipated circumstances arise, the Company’s actual results coulddiffer materially from those anticipated. These differences could be caused bya number of factors or combination of factors including, but not limited to,those factors described in the “Risk Factors” section of this report. Readersare strongly urged to consider such factors when evaluating any forward-lookingstatement. The Company undertakes no obligation to update any forward-lookingstatements in this report to reflect future events or developments.

 

**ITEM 1.****               BUSINESS**

 

**Introduction**

 

The Company is a North Dakota corporation that wasorganized on January 30, 2002 for the specific purpose of consummating theconversion of Dakota Growers Pasta Company, a North Dakota cooperative (the“Cooperative”), into a corporation. The conversion of the Cooperative from a cooperativeto a corporation was completed effective July 1, 2002, with the Company beingthe ultimate surviving entity in the conversion. See Part I, Item 4 for a moredetailed discussion of the conversion. The Company operates as theCooperative’s successor and its operations are a continuance of the operationsof the Cooperative.

 

As part of the conversion, members of the Cooperativeand other holders of equity rights received shares of Common Stock, Series DDelivery Preferred Stock, or both, in exchange for their Membership Stock,Equity Stock and other equity rights in the Cooperative.

 

Membership under the Cooperative was limited toagricultural producers, and each member was required to enter into a GrowersAgreement with the Cooperative. The Growers Agreement obligated the member todeliver one bushel of durum wheat during each processing year for each share ofcooperative Equity Stock owned by that member, subject to a pro rata downwardadjustment depending on the production needs of the Cooperative. The obligationto deliver durum wheat ceased upon conversion to a corporation. The ownershiplimitations associated with membership under the Cooperative were removed withthe conversion. Ownership of shares of Common Stock may be transferred subjectonly to the requirements of the applicable securities laws. Holders of Series DDelivery Preferred Stock have a delivery right, but not a delivery obligation,to sell durum to the Company. The Company must approve all transfers of sharesof Series D Delivery Preferred Stock.

 

The Company owns and operates a vertically integrated,state-of-the-art durum wheat milling and pasta production facility inCarrington, North Dakota. The facility, which became operational in 1994,currently has the capacity to grind in excess of twelve million bushels ofgrain annually and to produce approximately 275 million pounds of pastaannually. In February 1998, the Company acquired all of the outstanding stockof Primo Piatto, Inc. (“Primo Piatto”) a Minnesota corporation engaged in pastamanufacturing. Primo Piatto, being operated as the Minnesota Division of theCompany, currently operates a pasta production plant in New Hope, Minnesota.The Company closed its Minneapolis, Minnesota factory in fiscal year 2001. TheCompany currently has annual pasta production capacity of approximately 440million pounds.

 

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**PastaIndustry and Markets**

 

North American annual dry pasta consumption isapproximately 4.5 billion pounds. Pasta is widely recognized as a “healthy”food that is easily prepared and inexpensive in comparison to other types offoods. According to the U.S. Department of Commerce, American consumersincreased their average consumption of pasta during the 1990’s at an annualizedgrowth rate of approximately 2% to 3%. However, based on the Company’s analysisof the marketplace and trade and industry information, the Company believesgrowth in dry pasta consumption has slowed due to consumer trends. In additionto the domestic market for dry pasta, much smaller domestic markets exist forrefrigerated and frozen pasta.

 

The Pasta industry identifies domestic dry pasta intotwo basic markets: retail and institutional. The Company recognizes theinstitutional market as being comprised of ingredient and foodservice sales.

 

*RetailMarket*

 

The Retail market, whichincludes sales of branded and private label pasta to grocery stores, clubstores, mass merchants and other consumer retail operations, represents anestimated 35% of the total market for dry pasta in the United States.Approximately 60% of the Retail market is represented by established nationalor regional pasta brands. New World Pasta Company, American Italian PastaCompany, and Barilla account for a majority of the branded retail market. TheCompany focuses almost all of its Retail marketing efforts on private labelsales. The market leaders in private label sales are Dakota Growers andAmerican Italian Pasta Company. A small portion of the Retail market consistsof sales to federal and state government entities.

 

*IngredientMarket*

 

The Ingredient market of the drypasta industry consists of pasta used by food processors. Those entities usedry pasta as an ingredient or component in a further-processed or combinationfood product. Such food products include dry pasta dinners, including macaroniand cheese, frozen entrees, refrigerated salads, canned entrees, baby food, andcanned and dry soups. The Ingredient market represents about 48% of the totaldomestic dry pasta industry. The size of the Ingredient market is influenced bythe number of food processors that choose to produce pasta internally ratherthan outsource.

 

*FoodserviceMarket*

 

The Foodservice market consistsof sales of dry pasta to food preparation operations such as restaurants,hotels, colleges and universities, elementary and secondary schools, airlines,in-plant and in-office cafeteria facilities, transportation services, and otheraway-from-home eating places. The Foodservice market represents about 17% ofthe total domestic dry pasta industry. Marketing dry pasta to this marketgenerally consists of selling to a network of competitive distributionorganizations and buying groups, and selling dry pasta to individual restaurantchains and other operator organizations. A small portion of the Foodservicemarket consists of sales to federal and state government entities.

 

**Co-PackArrangements**

 

A portion of each end-usermarket is supplied under “co-pack” arrangements between pasta manufacturers.These agreements involve the sale of dry pasta products between pastamanufacturers in order to supply short-term volume deficiencies suchmanufacturers suffer from time to time in meeting customer requirements, and toutilize particular areas of expertise which may be more cost beneficial thanself-manufacturing. Opportunities for co-pack arrangements had decreased inrecent years due to the excess production capacity in the United States pastaproduction industry. However, industry changes within the past year haveexpanded opportunities for co-pack arrangements, and the Company continues toexplore opportunities in the co-pack area. Co-pack sales comprised approximately 6% of total sales for the yearended July 31, 2002.

 

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**Productionand Products**

 

The Company purchases durumwheat from holders of the Company’s Series D Delivery Preferred Stock and onthe open market. The durum wheat is used in the production of semolina that isthen used by the Company to produce dry pasta products.

 

Upon delivery, the durum wheatis sampled, weighed, pre-cleaned and unloaded into the mill’s grain silos. Fromthe grain silos, the durum wheat is pre-blended and conveyed into the mill’sfinal mix bins, which use electronic mass flow controllers for precisionblending and flow rate control. The wheat then proceeds to the cleaning andtempering sections of the mill. In those sections of the process, foreigngrains and weed seeds are removed and the durum wheat is dampened to theoptimum moisture level required for milling. From the tempering bins, thecleaned and tempered durum wheat is conveyed to the mill section wheregrinding, sifting and purifying is completed to produce a high qualitysemolina. In addition to the semolina, five additional categories of productresult from the overall durum wheat milling and blending process: granulars,first clear (higher grade) flour, second clear (lower grade) flour,semolina/durum wheat flour blends, and mill feed.  Mill feed and most second clear flour are sold primarily foranimal feed.

 

The semolina is then conveyed tothe Company’s pasta production facilities or transferred to truck and railload-out facilities for shipment to the Company’s Minnesota operations or saleto other U.S. pasta manufacturers. The first clear flour is either blended withsemolina or transferred to rail and truck load-out bulk bins for sale to otherusers.

 

Pasta production is basically amixing, extrusion and drying process. The primary ingredients are semolina andwater, although egg, tomato, spinach or other ingredients may be added toproduce certain products.  Individualshapes are the result of extruding this pasta “dough” through differentdies.  Each pasta production lineoperates independently and produces either long or short good items, thedifference being in the way they are conveyed through the drying operation.Both processes utilize continuous ultra high temperature dryers andcoolers.  Consistent monitoring andcontrol is a key element in this process. The entire pasta production process is controlled by programmable logiccontrollers located in control panels at the beginning of each production line,allowing for efficient operation and monitoring.

 

The finished dry pasta isconveyed to various continuous box and film packaging machines. Dry pasta ispacked to meet different markets and customer requirements, with containersranging in size from 8-ounce cartons and bags to 2,000 pound totes. Thepackaged product is conveyed through metal detectors, check weighers and automaticcase packers. From the case packers, the case travels past jet print coders toautomated palletizing and stretch wrapping operations.

 

The pasta products manufacturedby the Company consist of over 80 different shapes and are sold to customers inall markets. In addition to the dry pasta produced by the Company, it purchasesadditional dry pasta shapes from other manufacturers and resells them. Thispractice is widely followed by many pasta manufacturers for efficiency reasonsand allows distribution of wider product lines to the Company’s customers.Outside purchases of pasta, excluding imports, comprise approximately 1% oftotal sales. The Company does not anticipate any significant change in itsoutside purchases of pasta in the foreseeable future.

 

The Company has an agreement with Gruppo Euricom, thesecond largest pasta manufacturer in Italy, to be the exclusive distributor ofGruppo Euricom’s Italian pasta and rice products in the United States andCanada.  These products are primarilyprivate label retail and foodservice products. Sales of imported productcomprised roughly 1% of net sales in fiscal 2002.

 

The Company’s Carrington, NorthDakota facilities have been certified by Farm Verified Organics, which allowsthe Company to offer 100% organic pasta and semolina. The Company’s facilitiesallow for the isolation of the durum, semolina and pasta to enable thiscertification.

 

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The Company’s products aremanufactured using a comprehensive Hazard Analysis Critical Control Point(HACCP) program, which requires strict monitoring in all aspects of themanufacturing process, to ensure food quality and safety. We believe thatmeeting HACCP standards strengthens customer confidence in the quality of ourproducts. We produce high-quality pasta in accordance with FDA GoodManufacturing Practices and received a perfect score on the USDA Total QualitySystems Audit conducted in June 2002.

 

In addition to its pastaproducts, the Company has in the past sold semolina and durum wheat flour toother pasta manufacturers in bulk truckload or railcar quantities. Such salesrepresented approximately 3% of total net revenues in fiscal year 2002.

 

The cost of production of drypasta is significantly impacted by changes in durum wheat prices. The cost ofmilling quality durum wheat steadily increased from the time the Cooperativewas organized and remained at high levels through 1996. A significant 1996 cropled to a reduction in prices in 1997, when the 1997 crop was significantlysmaller and durum wheat prices again increased. Worldwide, many durumwheat-producing areas reported large crops for 1998 and 1999, which led toextremely lower durum wheat prices. The quality of the 2000 crop in NorthDakota and Canada, especially in North Dakota, was lower than in past years,which lead to an increase in the price of milling quality durum. United Statesdurum production was down in 2001 and 2002. In recent months, durum wheat cashprices have increased $1 to $2 per bushel. Such volatility with respect to theprice of the basic raw material for the Company’s products leaves it subject towide variation in its costs from year to year. As a result, factors whichimpact the size and quality of the durum wheat crop and the availability ofsuch wheat in the United States and Canada can have a significant impact on theCompany, and may have a material adverse impact. Those factors include suchvariables as the weather in durum wheat production areas in the United States,Canada and other parts of the world, and import and export policies andregulations.

 

Due to the intense competitionpresent in the market for pasta products, pasta manufacturers have in the lastseveral years been unable to fully implement price increases for their drypasta products in periods when higher durum wheat prices impacted the cost ofpasta production. The Company believes that such competition results primarilyfrom excess production capacity in the domestic pasta industry or fromstrategic actions relating to market share.

 

**Sales,Marketing and Customers**

 

The Company markets its products through direct sales,supplemented by the efforts of brokers retained by the Company. These brokersreceive a commission upon sale of the Company’s products. The Company’s pastaproducts are distributed on a broad basis throughout the United States. TheCompany does not directly export its pasta products, although several of itscustomers have exported minor quantities. U.S. Foodservice accounted forapproximately 12% of revenues for the year ended July 31, 2002. No customerrepresented greater than 10% of revenues for the years ended July 31, 2001 and2000. The Company’s top 10 customers accounted for 51% of revenues in fiscalyear 2002, 48% of revenues in fiscal year 2001 and 49% of revenues in fiscalyear 2000. Pasta volumes consisted of 66% Retail, 21% Foodservice, and 13%Ingredient for fiscal year 2002, 63% Retail, 21% Foodservice, and 16%Ingredient for fiscal year 2001, and 60% Retail, 20% Foodservice, and 20%Ingredient for fiscal year 2000.

 

The Company sells most of its pasta under “purchaseorders”, whereby the customer and the Company are not obligated for anypre-determined length of time. Occasionally, a pricing commitment is agreed towith a term of one year or less. The Company has entered into long-termmarketing agreements, including volume and pricing commitments, with U.S.Foodservice and Safeway, Inc. through December 31, 2006 and August 31, 2006,respectively. The Company has entered into an agreement with Gruppo Euricom(“EU”), the second largest pasta manufacturer in Italy, to be the exclusivedistributor of EU’s Italian pasta and rice products in the United States andCanada with an initial term through August 2006. These products are primarilysold in the private label retail and foodservice markets.

 

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**Series DDelivery Preferred Stock Delivery Rights**

 

Each share of Series D Delivery Preferred Stock of theCompany gives its holder the privilege, but not the obligation, to deliver onebushel of durum wheat to the Company each fiscal year on a “first-come,first-served” basis.  From time to timethe Company will post notices to the market on its Web site (holders may alsotelephone the Company for information on market notices) for the purchase ofdurum wheat. During the 24-hour period following the posting of any marketnotice and to the extent that the Company’s durum wheat requirements as setforth in the market notice have not been fulfilled by other holders of Series DDelivery Preferred Stock, holders of Series D Delivery Preferred Stock have theright to (i) accept the Company’s offer to purchase durum wheat and (ii)deliver durum wheat to the Company on such terms and conditions as are setforth in the market notice.  However, inany given fiscal year of the Company, the first-come, first-served privilege todeliver durum wheat shall be exercisable to deliver one bushel of durum wheat****onlyonce with respect to each share of Series D Delivery Preferred Stock. Duringthe 24-hour period following the posting of any market notice, the Company willnot purchase durum wheat from non-holders of Series D Delivery Preferred Stockto fulfill the Company’s durum wheat requirements as set forth in the marketnotice.  If, after the lapse of acertain amount of time (not less than one day), holders of Series D DeliveryPreferred Stock have not sold to the Company all of the durum wheat requestedin the notice, the Company will fulfill its remaining requirements outside ofthe Series D Delivery Preferred Stock delivery privilege.

 

Because the privilege of a holder of Series D DeliveryPreferred Stock to deliver durum wheat to the Company only arises if theCompany actually requires durum, the privilege is not absolute.  Any and all durum wheat delivered by aholder of Series D Delivery Preferred Stock to the Company shall conform toquality specifications established by the Company.

 

**Competition**

 

*Overview*

 

The markets for semolina/durumwheat flour and pasta are highly competitive in most markets and geographicregions. The intensity of competition varies from time to time as a result of anumber of factors, including: (1) the degree of industry capacity utilization,(2) comparative product distribution costs, (3) ability to render distinctiveservice to customers, (4) the price of raw materials, primarily durum wheat,and (5) a distinguishing or unique ability to provide consistent productquality in line with customer specifications. The Company believes that, in a broad sense, the most influential factoron the intensity of competitive conditions is industry capacityutilization.  It should be noted thatdetailed information regarding pasta production is somewhat difficult to obtain,as many pasta producers are closely-held enterprises.

 

*Competitionin the Pasta Market*

 

The pasta market is highlycompetitive and includes several well-established enterprises. Thosecompetitors are primarily independent companies and, to a lesser extent,divisions or subsidiaries of other, larger, food products companies. Inaddition, according to United States government data, the overall U.S. pastamarket has experienced rapid penetration by foreign suppliers, particularly inthe last four to five years. Those suppliers include Italian, Turkish andMexican enterprises.

 

The Company markets in theretail area primarily as a private label supplier. The Company’s Dakota GrowersPasta Co. label to date has slight penetration in local area markets in theDakotas and Minnesota. The Zia Briosa label is marketed through club stores onthe West Coast and its Pasta Sanita label is sold in small niches ranging fromthe upper Midwest to select markets in the Northeast United States.

 

The Company’s top competitors inthe private label retail market include American Italian Pasta Company and NewWorld Pasta Company. These private label retail sales compete with retailbranded products distributed primarily by American Italian Pasta (Muellers,R&F, Anthony’s brands et al), New World Pasta (Ronzoni, San Georgio, 

 

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Skinner, American Beauty, Creamette, Princebrands et al), Barilla and a variety of smaller domestic and imported brands.

 

In the foodservice area, theCompany also markets its pasta primarily as a private label supplier, includingsales to three of the largest foodservice distributors in the country undertheir labels. The Company’s “DakotaGrowers” foodservice brand is sold throughout the U.S. to independentdistributors and national chain accounts.

 

The Company focuses a majority of its ingredientmarketing efforts on companies that do not also manufacture the dry pastaingredient for their end-products.

 

In the institutional market, the Company’s topcompetitors include American Italian Pasta, Philadelphia Macaroni Co. Inc., andA. Zerega’s Sons, Inc., as well as foreign competitors that sell product in theUnited States.  Approximately 20% oftotal domestic industry production capacity is represented by the largestself-suppliers, which include Kraft Foods, Campbell Soup Company, ConAgra,Inc., Pillsbury and Stouffers Corporation.

 

The competitive environment inour industry depends largely on the aggregate industry capacity relative toaggregate demand for pasta products. The pasta manufacturing industry hasexperienced capacity changes and restructuring in recent years. The Companybelieves that current pasta production capacity exceeds the current demand forpasta as several domestic pasta producers have completed production capacityadditions in recent years. American Italian Pasta Company is completingconstruction of a pasta production facility in Arizona. New World Pasta Companyhas recently closed certain production facilities, and has announced plans topossibly close an additional facility, which may help to rationalize pastaproduction with current demand.

 

*Competitionin the Semolina and Durum Wheat Flour Market*

 

Given thecommodity nature of the market for semolina and durum flour, sales volume islargely dependent on delivered price when adequate supply conditions exist.Italgrani USA, Inc., Horizon Milling, LLC and Miller Milling collectively arebelieved to represent approximately 40% of total domestic milling capacity. TheCompany’s current milling operation represents about 15% of total domesticmilling capacity. Most of the durum milling capacity in the United States iseither part of an integrated pasta production facility or in an alliance withpasta manufacturers. The Company believes that the integration of its millingand pasta production facilities enables it to compete more effectively withthose competitors who also have integrated facilities.

 

**GovernmentRegulation**

 

*TradePolicies*

 

Governmentalpolicies and regulations, including those impacting the amount of durum wheatimported from Canada, may affect the operations of the Company and the volumeof pasta imports. United States government farm policies also affect durumplantings and thus can have a significant impact on the market price of durum.

 

Pricing policyactions by the Canadian Wheat Board have resulted in complaints from durumgrowers in the United States, and a continuing dispute over possiblerestrictions on durum wheat imports. In response to a petition filed by theNorth Dakota Wheat Commission (“Wheat Commission”), on October 23, 2000, theOffice of the United States Trade Representative announced the initiation of aSection 301 investigation. The United States Trade Representative issued anaffirmative finding that the wheat trading practices of the Canadian governmentand the Canadian Wheat Board, among other things, are unreasonable and restrictUnited States commerce. The United States Trade Representative announced thatit will pursue multiple courses of action to remedy the practices of theCanadian government and Canadian Wheat Board, including the following:

 

•                  examining the potential for a dispute settlementcase against the Canadian Wheat Board in the World Trade Organization;

 

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•                       working in unison with the United States wheatindustry to determine the possibility of filing United States countervailingand antidumping protections;

•                       identifying impediments to United States wheatentering Canada and relating them to the Canadian government in an effort to negotiatefair trade policies; and

•                       pursuing reform of monopoly state tradingenterprises in the World Trade Organization agricultural negotiations scheduledto take place late in 2002.

 

In September 2002, the U.S.Durum Growers Association and the Wheat Commission filed petitions for theimposition of countervailing and antidumping duties on durum and hard redspring wheat marketed by the Canadian Wheat Board. In response to thepetitions, the U.S. International Trade Commission  (“ITC”) commenced the preliminary phase of the countervailingduty and antidumping investigations. The Company anticipates the ITC will issuea preliminary determination by late October 2002 as to whether there is a“reasonable indication” that an industry in the United States is materiallyinjured or threatened with material injury, or the establishment of a businessin the United States is materially retarded, by reason of the Canadian wheatimports.

 

If restrictions are implemented,it could impact both the milling and pasta areas of the Company’s businessoperations in a variety of ways.

 

Lower durum wheat prices couldultimately lead to reduced pasta production costs and provide opportunity forincreased profitability for pasta manufacturers without requiring priceincreases for finished pasta products, while higher durum prices could triggerprice increases or reduced margins dependent on the industry capacityutilization and pasta import levels. Conversely, the Company believes lowerdurum wheat prices have in the past allowed certain pasta producers to lowertheir prices and price proposals with reduced risk in efforts to gain marketshare.

 

Domestic pasta prices are also influenced bycompetition from foreign pasta producers, and as such, by the trade policies ofboth the U.S. government and foreign governments. The U.S. Customs Service(Customs) published, on July 3, 2002, a notice of intention to distributeantidumping and countervailing duties assessed on certain pasta imported fromItaly and Turkey from October 1, 2001 to September 30, 2002, to affecteddomestic producers pursuant to the Continued Dumping and Subsidy Offset Act of2000 (the “Act”). At this time, indications are that the Company will receive apayment under this Act in the latter portion of calendar year 2002, though wecannot reasonably estimate the potential amount to be received at this time orstate with certainty whether any payment will be received in future periods.Though these duties may enable the Company to compete more favorably againstItalian and Turkish producers in the U.S. pasta market, there is no assuranceas to the length of time these duties will be maintained, or that foreignproducers will not sell competing products in the United States at prices lowerthan those of the Company.

 

*Foodand Drug Administration Regulation*

 

As a producer of products intended for humanconsumption, the Company’s operations are subject to certain federal and stateregulations, including regulations promulgated by the United States Food andDrug Administration. The Company believes that it is in material compliancewith the applicable regulatory requirements.

 

*EnvironmentalRegulation*

 

Dakota Growers is subject to extensive federal andstate environmental laws and regulations with respect to water and air quality,solid waste disposal and odor and noise control. The Company conducts anon-going control program designed to meet these environmental laws andregulations. There are no pending regulatory enforcement actions and theCompany believes that it is in substantial compliance with applicableenvironmental laws and regulations.

 

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The Company cannot predict whether future changes inenvironmental laws or regulations might increase the cost of operating itsfacilities and conducting its business. Any such changes could have adversefinancial consequences for the Company and its members.

 

**IntellectualProperty Rights**

 

The Company relies on a combination of trade secret,trademark law, nondisclosure agreements and technical measures to establish andprotect its proprietary rights to its products and processes. The Company ownsthe following trademarks that have been registered with the United StatesPatent and Trademark Office for the sale of dry pasta: Pasta Growers®, PastaSanita®, Zia Briosa® and Dakota Growers Pasta Co.®.

 

**ResearchAnd Development**

 

The Company supports research and development programsin North Dakota that focus on improved varieties of durum wheat. In fiscal year1999, Dakota Growers hired an agronomist and initiated a long-term project ofsmall plot, replicated variety trial research, as well as field-scale fungicideresearch. In connection with plant breeders and researchers, the Company isworking to develop scab-resistant, high-gluten durum varieties. The Company, aspart of its operations, maintains a modern, well-equipped laboratory facilitydesigned primarily to evaluate and maintain high quality standards for incomingraw materials, ongoing product manufacturing, and development of new pastashapes.

 

**Employees**

 

As of October 1, 2002, the Company had 430 employees,130 of which are covered by collective bargaining agreements at its PrimoPiatto, Inc. subsidiary. These collective bargaining agreements expire onDecember 1, 2004 and October 1, 2005. The Company considers its employeerelations to be very good.

 

**RiskFactors**

 

The following are important factors that could causeactual results to differ materially from those expressed in any forward-lookingstatements made by or on behalf of the Company. Additional risks that we do notyet know of, or currently believe are immaterial, may also impair the businessoperations of the Company.

 

***Competitive Environment***

 

Both the U.S. pasta industry and world pasta industryare extremely competitive. The Company competes in all dry pasta markets –retail store brand, foodservice and ingredient, with larger, national andinternational food companies. Competition within the pasta industry is largelydependent upon the relationship of overall industry production capacity tooverall market demand for pasta. The pasta industry in the U.S. as well as inItaly is faced with excess production capacity. While New World Pasta Company has recently closed certain production facilitiesand has announced plans to possibly close an additional facility, which mayhelp to rationalize pasta production with current demand, American ItalianPasta Company is completing construction of a pasta production facility inArizona. Some companies have long-term, high volume contracts, whichguarantee a specified amount of volume over the term of the contract. Othercompetitors have retail brand equity and larger amounts of marketing dollars tocompete against imported and store brand products. The competitive environment,especially in the retail and ingredient markets, has in the past, and may inthe future, put pressure on profitability to maintain market share. The Companyhas and will continue to apply, where possible, cost saving measures to remaincompetitive. With these uncertainties, there is no guarantee that the Companycan continue to grow and operate profitably in the future.

 

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***No Public Market for Shares of theCompany’s Common Stock and Preferred Stock***

 

There is currently no establishedpublic trading market for the shares of Common Stock and Preferred Stock of theCompany, and an active trading market may never develop. The Companymaintains no obligation to seek or to obtain a listing on a national market. As a result, you may not be able to readilyresell your shares in the Company.

 

***Technology***

 

The Company believes that its overall commitment tomaintaining and upgrading pasta manufacturing, milling and packaging equipmentis necessary to keep a competitive edge in the pasta industry. In addition, italso acknowledges that ongoing computer system upgrades to better service thedemands of its customers are important to long-term success and profitability.The Company may be negatively impacted if it is unable to consistently keeppace with the industry in these areas.

 

***Pasta, Semolina, Durum Wheat and By-ProductPrices***

 

The Company’s profitability is directly related to themarket price of dry pasta, semolina, durum wheat and mill feed by-products,matters over which the Company has little or no control. The supply and priceof durum wheat are subject to market conditions and are influenced by manyfactors beyond our control including weather patterns affecting durum wheatproduction, governmental programs and regulations, insects, and plant diseases.Such volatility with respect to the price of the basic raw material for theCompany’s products leaves the Company subject to wide variation in its costsfrom year to year. Future increases in durum costs could have a material adverseeffect on operating profits unless we are able to pass cost increases on to ourcustomers. Competitive pressures often limit our ability to increase prices inresponse to higher input costs. The Company has capacity to sell durum semolinato other pasta producers. Such sales are currently being made at highlycompetitive prices. By-products of the milling process compete with other feedproducts, and fluctuate significantly in price with the availability of thesecompeting feed products.

 

***Product Concentration***

 

The Company competes exclusively in the dry pastaindustry, with a significant portion of sales concentrated in the retail andfoodservice private label markets. Any decline in pricing or consumerpreference for dry pasta could have a significant impact on the Company’sability to grow or remain profitable in the future.

 

***Government Regulation And Trade Policies***

 

Dakota Growers is subject to extensive federal andstate environmental laws and regulations with respect to water and air quality,solid-waste disposal and odor and noise control. The Company conducts anon-going program designed to comply with these laws and regulations. There areno pending regulatory enforcement actions against the Company, and the Companybelieves that it currently is and will continue to be in substantial compliancewith all applicable environmental laws and regulations.

 

As a producer of products intended for humanconsumption, the Company’s operations are subject to certain federal and stateregulations, including regulations promulgated by the U.S. Food and DrugAdministration. The Company believes that it is in material compliance with allapplicable regulatory requirements relating to food quality and safety.

 

The operations of the Company may be affected bygovernmental trade policies and regulations, including those impacting theamount of durum wheat imported from Canada. Domestic pasta prices are alsoinfluenced by competition from foreign pasta producers, and as such, by thetrade policies of both the U.S. government and foreign governments.

 

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***Restrictive Loan Covenants***

 

The Company’s loan agreements with CoBank andinstitutional investors obligate the Company to maintain or achieve certainamounts of equity and working capital and achieve certain financial ratios. Tothe extent that the Company is unable in the future to satisfy the variousconditions specified in the loan agreements, the Company’s ability todistribute dividends to its shareholders may be restricted. The failure tocomply with the various loan covenants may result in interest rate penalties,restrict the Company’s corporate activities or result in a default by theCompany which may have a material adverse affect on the Company’s liquidity.

 

***Board Of Directors Discretion RegardingDividends***

 

The Board of Directors of the Company has absolutediscretion to determine the manner and amount of payment of dividends on sharesof Common Stock and, subject to certain exceptions, Preferred Stock.

 

***Retroactive Tax Treatment***

 

Subchapter T ofthe Internal Revenue Code sets forth rules for the tax treatment ofcooperatives and applies both to cooperatives exempt from tax under Section 521of the Internal Revenue Code and to nonexempt corporations operating on a cooperativebasis. The Cooperative was a nonexempt cooperative prior to conversion to acorporation effective July 1, 2002. As a nonexempt cooperative, it was nottaxed on amounts of patronage sourced income withheld from its members in theform of qualified per-unit retains or on amounts distributed to its members inthe form of Qualified Written Notices of Allocation. Consequently, such amountswere taxed directly to the members. However, income attributable tonon-patronage sources was taxed at the Cooperative level and again ifdistributed to the Cooperative’s members as dividends. If the Cooperative wasnot entitled to be taxed under Subchapter T or if significant portions ofincome were from non-patronage sources, its income would be taxed when earned bythe Cooperative and the members would be taxed when dividends were distributed.

 

From time to time, the InternalRevenue Service challenges the tax status of cooperatives, taking the positionthat the challenged entities are not operating on a cooperative basis and aretherefore not entitled to the tax treatment described above. Those challengescan be based on a variety of factors, including the nature of the cooperative’sbusiness, its interaction with its members and the portion of its business donefor or with its members. The impact of most such challenges, regardless of thefactor on which the challenge is based, is that the Internal Revenue Serviceseeks to assert that some or all of a cooperative’s income does not arise froma “patronage” transaction. As any income derived from non-patronage sources issubject to taxation at the entity level, the effect of a successful challengeis that the cooperative would be taxed as a corporation. If the InternalRevenue Service successfully challenged the Cooperative’s tax status as it wasoperating before the conversion, retroactive taxation at both the entity leveland the shareholder level could have a material, adverse impact on the Company.

 

**ITEM 2.****               PROPERTIESAND PROCESSING FACILITIES**

 

Dakota Growers operates a vertically integrated, stateof the art durum milling and pasta manufacturing plant in Carrington, NorthDakota, and a pasta production facility in New Hope, Minnesota through itswholly owned subsidiary Primo Piatto, Inc. The Company closed its Minneapolis,Minnesota factory in February 2001 and has terminated its lease on theproperty.

 

The Carrington mill became operational in January1994, was expanded in 1996 and again in 1999. It has the capacity to grind40,000 bushels of durum per day, and over twelve million bushels per year. Ithas grain silos with a capacity to hold 620,000 bushels. Its semolinaproduction capability meets the requirements of all of the Company’s pastamanufacturing capacity, with excess capacity available for semolina sales toother producers.

 

The Carrington pasta operations, initially operationalin January 1994, have been expanded in 1997 and 1998. The plant now has sevenpasta production lines, three operated as long goods lines and four of whichare short goods lines. Electronic control scales are used throughout thefacility to continuously track production and yields.

 

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A central computer control room allows one operator to monitorefficiently both the milling and the pasta operations. Total dry pastamanufacturing capacity is 275 million pounds annually. The Company owns thephysical plant in Carrington, and the land on which it is located.

 

The Company’s Primo Piatto, Inc. subsidiary operates apasta production facility in New Hope, Minnesota. This facility contains sixproduction lines capable of producing approximately 165 million pounds of drypasta each year, predominantly in retail packaging. A lasagna line installed atthe New Hope, Minnesota plant became operational in February 2001. There is adirect Canadian Pacific rail line connecting the New Hope factory to theCarrington milling facility. This highly automated, cost effective processingand packaging facility has gone through significant upgrades within the lastdecade. Primo Piatto owns the physical plant and land at the New Hope facility.

 

The Company owns the warehousing at the Carrington andNew Hope plants. These facilities are supplemented by public warehouses inCalifornia, Kansas, Kentucky, Minnesota, New York, North Dakota, Oregon, Utahand Washington where inventory is maintained and redistributed for the needs ofspecific customers.

 

**ITEM 3.****               LEGALPROCEEDINGS**

 

From time to time and in the ordinary course of itsbusiness, the Company is named as a defendant in legal proceedings related tovarious issues, including worker’s compensation claims, tort claims andcontractual disputes. Other than such routine litigation, the Company is notcurrently involved in any material legal proceedings. In addition, the Companyis not aware of other potential claims that could result in the commencement oflegal proceedings. The Company carries insurance that provides protectionagainst certain types of claims, up to the policy limits of the Company’sinsurance.

 

**ITEM 4.****               SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

A Special Meeting was held on May 23, 2002 to voteupon the proposed conversion of the Company’s predecessor, Dakota Growers PastaCompany, from a cooperative into a North Dakota corporation. The Cooperative’smembers approved the proposal by a vote of 693 in favor and 146 opposed.

 

In conjunction with the approval of the conversion ofDakota Growers Pasta from a cooperative to a North Dakota corporation, themembers approved and ratified:

 

• A Second Amended and Restated Plan of Merger(the “Plan of Merger”) by and between the Cooperative and Dakota Growers PastaRestructuring Cooperative, a newly-formed Colorado cooperative.

 

• The Second Amended and Restated TransactionAgreement (the “Transaction Agreement”), dated as of April 18, 2002, by andamong the Cooperative, Dakota Growers Pasta Restructuring Cooperative, aColorado cooperative, Dakota Growers Corporation, a Colorado corporation andthe Company, but solely to the extent that the Transaction Agreement relates tothe proposed merger described in the Plan of Merger specified above.

 

• An amendment to the Cooperative “GrowersAgreement” adopted by the Board of Directors, the effect of which was toterminate the Growers Agreement upon the approval and consummation of anymerger transaction (or series of transactions) in which the North Dakotacooperative is not the surviving entity and in which the surviving entity’sgoverning documents do not require the delivery of durum wheat as a condition ofownership in such entity.

 

The Cooperative formed three wholly-owned subsidiariesto effectuate the conversion: Dakota Growers Pasta Restructuring Cooperative, aColorado cooperative, Dakota Growers Corporation, a Colorado corporation andthe Company. With the approval of the Plan of Merger between the Cooperativeand the Colorado cooperative, immediately after the consummation of the mergerand without further action by members of the North Dakota cooperative, theColorado cooperative merged with and into the Colorado corporation and,immediately

 

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thereafter, the Colorado corporation merged with and into the Company.The conversion was completed effective July 1, 2002.

 

As a result of the mergers:

 

•        The North Dakotacorporation is the surviving entity.

 

•        Members of the NorthDakota cooperative became shareholders of the North Dakota corporation andreceived:

 

•        twenty-five shares ofCommon Stock of the North Dakota corporation for each share of the North Dakotacooperative’s Membership Stock they held as of the effective date of themerger;

 

•        a number of shares ofCommon Stock, $.01 par value per share, of the North Dakota corporation equalto the number of shares of the North Dakota cooperative’s Equity Stock theyheld as of the effective date of the merger;

 

•        a number of shares ofSeries D Delivery Preferred Stock, $.01 par value per share, of the NorthDakota corporation equal to the number of shares of the North Dakotacooperative’s Equity Stock they held as of the effective date of the merger;

 

•        holders of Non-QualifiedWritten Notices of Allocation (a form of members’ equity that representspatronage income that was allocated among the members of the cooperative asnon-cash patronage dividends) received one share of Common Stock of the NorthDakota corporation for every $7.36 of Non-Qualified Written Notices ofAllocation held in their name in the records of the North Dakota cooperative;

 

•        to the extent that theyheld Series A 6% Redeemable Non-Cumulative Preferred Stock or Series B 2%Redeemable Non-Cumulative Preferred Stock of the North Dakota cooperative as ofthe effective date of the merger, an equal number of shares of Series A 6%Redeemable Cumulative Preferred Stock, $100 par value per share, or Series B 2%Redeemable Non-Cumulative Preferred Stock, $100 par value per share, asapplicable, of the North Dakota corporation; and

 

•        holders of options topurchase Series C 6% Convertible Non-Cumulative Preferred Stock of the NorthDakota cooperative as of the effective date of the merger received options topurchase a like number of Series C 6% Convertible Non-Cumulative PreferredStock of the North Dakota corporation.

 

For more information regarding the conversion from aNorth Dakota cooperative to a North Dakota corporation please refer to theRegistration Statement on Form S-4 (File No. 333-81946) filed with the UnitedStates Securities and Exchange Commission by Dakota Growers RestructuringCompany, Inc.

 

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**PART II.**

 

**ITEM 5.****                        MARKETFOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS**

 

There is no established public market for theCompany’s Common Stock or Preferred Stock. See “Item 4. Submission of Mattersto a Vote of Security Holders” regarding Common and Preferred Stock received byshareholders in conjunction with the conversion from a cooperative to acorporation.

 

As of October 1, 2002 there were 1,305 holders ofCommon Stock.

 

As a cooperative, qualified patronage dividends hadbeen declared and paid in prior years, though none within the last two fiscalyears. We anticipate that dividends paid by the Company will be lower than thepatronage distributions previously received from the cooperative. Corporatedividends are affected by the amount of income taxes on corporate earnings. Weanticipate that dividends will also be reduced compared to historicalcooperative patronage distributions as the Board of Directors reinvests alarger portion of the entity’s earnings to fund debt repayments, strategicacquisitions, market expansions, working capital requirements, equipmentacquisitions, cost-saving measures and efficiencies.

 

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**ITEM 6.****               SELECTEDFINANCIAL DATA**

 

The selected financial data presented below for thefiscal years ended July 31, 1998, 1999, 2000, 2001 and 2002 has been derivedfrom the audited consolidated financial statements of the Company (and theCooperative for periods presented prior to the conversion from a cooperative toa corporation). The conversion of Dakota Growers Pasta Company from acooperative to a corporation was completed effective July 1, 2002. Theconversion was accounted for as an exchange between related parties. Therefore,no gain or loss was recognized at the time of conversion and the book value ofthe assets and liabilities of the Cooperative carried over to the Company. Uponconversion, the Company recorded deferred tax assets and liabilities for thetax effects of any temporary differences existing between income tax andfinancial reporting on the date of the change. Prior to conversion, theCooperative had not recorded deferred taxes for temporary differences that werelikely to be eliminated through patronage allocations. In recording such deferredtax assets and liabilities upon conversion to a corporation, the Companyrecorded a nonrecurring, non-cash income tax charge of $6.1 million. Theselected financial data set forth in this section should be read in conjunctionwith the Company’s consolidated financial statements and related notes and“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” included elsewhere in this report.

 

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**SELECTEDFINANCIAL DATA**

**(In thousands,except per share data and ratios)**

 
|                                                                                                       |   | **Fiscal year ended July 31** |    |
|------------------------------------------------------------------------------------------------------------|--------|-------------------------------|---------|
|                                                                                                       |   | **1998**                      |    | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
| **INCOME STATEMENT DATA**                                                                                  |   |                          |    |   |   |   |   |   |   |   |   |
| Net revenues                                                                                               |   | $                             | 119,621 |   | $ | 124,869 |   | $ | 136,862 |   | $ | 135,921 |   | $ | 152,465 |   |
| Cost of goods sold                                                                                         |   | 100,229                       |    | 106,062 |   | 116,890 |   | 124,811 |   | 130,502 |   |
| Gross profit                                                                                               |   | 19,392                        |    | 18,807 |   | 19,972 |   | 11,110 |   | 21,963 |   |
| Marketing, general and administrative expenses                                                             |   | 6,754                         |    | 7,886 |   | 9,713 |   | 9,631 |   | 9,382 |   |
| Operating income                                                                                           |   | 12,638                        |    | 10,921 |   | 10,259 |   | 1,479 |   | 12,581 |   |
| Other expense                                                                                              |   | (3,264                        | )       | (2,434 | ) | (3,929 | ) | (3,574 | ) | (3,365 | ) |
| Income (loss) before income taxes                                                                          |   | 9,374                         |    | 8,487 |   | 6,330 |   | (2,095 | ) | 9,216 |   |
| Charge to record deferred taxes upon conversion from  a cooperative to a corporation(4)                    |   | —                        |    | — |   | — |   | — |   | 6,105 |   |
| Income tax expense (benefit)                                                                               |   | —                        |    | 499 |   | (1,298 | ) | (311 | ) | 1,277 |   |
| Income (loss) before cumulative effect of change in  accounting principle                                  |   | 9,374                         |    | 7,988 |   | 7,628 |   | (1,784 | ) | 1,834 |   |
| Cumulative effect on prior years (to July 31, 1998)  of changing to a different inventory valuation method |   | —                        |    | (3,429 | ) | — |   | — |   | — |   |
| Net income (loss)                                                                                          |   | 9,374                         |    | 4,559 |   | 7,628 |   | (1,784 | ) | 1,834 |   |
| Dividends on preferred stock                                                                               |   | 15                            |    | 143 |   | 4 |   | 15 |   | 10 |   |
| Net earnings (loss) on common/equity stock                                                                 |   | $                             | 9,359   |   | $ | 4,416 |   | $ | 7,624 |   | $ | (1,799 | ) | $ | 1,824 |   |
|                                                                                                       |   |                          |    |   |   |   |   |   |   |   |   |
| Weighted average common/equity shares outstanding(1)                                                       |   | 7,356                         |    | 8,603 |   | 11,166 |   | 11,253 |   | 11,382 |   |
|                                                                                                       |   |                          |    |   |   |   |   |   |   |   |   |
| Net earnings (loss) per common/equity share  outstanding before cumulative effect of accounting change(1)  |   | $                             | 1.27    |   | $ | 0.91 |   | $ | 0.68 |   | $ | (0.16 | ) | $ | 0.16 |   |
|                                                                                                       |   |                          |    |   |   |   |   |   |   |   |   |
| Patronage and other dividends per average  common/equity share outstanding(1)                              |   |                          |    |   |   |   |   |   |   |   |   |
| Declared(2)                                                                                                |   | $                             | 1.00    |   | $ | 0.86 |   | $ | 0.40 |   | $ | — |   | $ | — |   |
| Distributed(2)                                                                                             |   | 1.00                          |    | 0.86 |   | 0.40 |   | — |   | — |   |
|                                                                                                       |   |                          |    |   |   |   |   |   |   |   |   |
| Pro forma amounts assuming the inventory valuation  method adopted in 1999 is applied retroactively(3)     |   |                          |    |   |   |   |   |   |   |   |   |
| Net earnings (loss) on common/equity stock                                                                 |   | $                             | 6,731   |   | $ | 7,845 |   | $ | 7,624 |   | $ | (1,799 | ) | $ | 1,824 |   |
|                                                                                                       |   |                          |    |   |   |   |   |   |   |   |   |
| Net earnings (loss) per common/equity share  outstanding(1)                                                |   | $                             | 0.92    |   | $ | 0.91 |   | $ | 0.68 |   | $ | (0.16 | ) | $ | 0.16 |   |

 

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| **BALANCE SHEET DATA**                          |   |    |   |    |   |    |   |    |   |    |   |
|-------------------------------------------------|--------|---------|--------|---------|--------|---------|--------|---------|--------|---------|--------|
| Cash                                            |   | $       | 182    |    | $      | 3,425   |   | $       | 1,725  |    | $      | 3 |   | $ | 2,866 |   |
| Working capital                                 |   | 22,813  |   | 31,065  |   | 25,089  |   | 14,420  |   | 23,013  |   |
| Total assets                                    |   | 124,537 |   | 135,873 |   | 131,857 |   | 128,658 |   | 125,541 |   |
| Long-term debt (excluding current maturities)   |   | 66,056  |   | 59,116  |   | 51,626  |   | 47,594  |   | 38,274  |   |
| Redeemable preferred stock                      |   | 253     |   | 53      |   | 126     |   | 113     |   | 54      |   |
| Stockholders’ equity                       |   | 36,875  |   | 58,982  |   | 60,533  |   | 54,267  |   | 56,090  |   |
|                                            |   |    |   |    |   |    |   |    |   |    |   |
| **OPERATING DATA**                              |   |    |   |    |   |    |   |    |   |    |   |
| Ratio of long-term debt to stockholders' equity |   | 1.79x   |   | 1.00x   |   | .85x    |   | .88x    |   | .68x    |   |
|                                                 |        |         |        |         |        |         |        |         |        |         |        |  |  |  |  |  |

 

 

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(1)               Adjusted for theimpact of the 3-for-2 stock split effective August 1, 1997.

(2)               As a cooperative,qualified patronage declarations were made in October of each year based on thepatronage earnings and average shares for the prior fiscal year ending July 31.Amounts shown for each fiscal year were declared and paid in the followingfiscal year. Amounts reflected above include only dividends on equity stock andqualified patronage declarations, and exclude Non-Qualified Written Notices ofAllocation to each member’s account as a cooperative.

(3)               The Company changedits method of computing inventory valuations in the third quarter of fiscalyear 1999 from the net realizable value method to the lower of cost or marketmethod, determined on a first-in, first-out basis, using product specificstandard costs. The impact of the change on prior years (to July 31, 1998) of$3,429,000 was included as a charge against income for the year ended July 31,1999.

(4)               Upon conversionfrom a cooperative to a corporation effective July 1, 2002, the Companyrecorded deferred tax assets and liabilities for the tax effects of anytemporary differences existing between income tax and financial reporting onthe date of the change. Prior to conversion, the Cooperative had not recordeddeferred taxes for temporary differences that were likely to be eliminatedthrough patronage allocations. In recording such deferred tax assets andliabilities upon conversion to a corporation, the Company recorded anonrecurring, non-cash income tax charge of $6,105,000 during the year endedJuly 31, 2002.

 

**ITEM 7.****                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Forward-LookingStatements**

 

The following discussion contains forward-lookingstatements. Such statements are based on assumptions by the Company’s management,as of the date of this report, and are subject to risks and uncertainties,including those discussed under “Risk Factors” in this report, that could causeactual results to differ materially from those anticipated. The Companycautions readers not to place undue reliance on such forward-lookingstatements.

 

**Summary**

 

Dakota Growers is the third largest pasta manufacturerin North America, and is the successor to the Cooperative by virtue of theCooperative’s conversion to a corporation. The Company’s core strength remainsmanufacturing pasta for retail store brands and the foodservice industry,though we serve and continually look for opportunities in all dry pastamarkets. We are implementing an identity preservation program to provide ourcustomers food safety, traceability and quality during every step from thefield to the plate. The Company has 

 

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implemented a certified organic program and markets organic pastathrough its Dakota Growers Pasta Co.® retail label, as well as intothe private label retail, foodservice, and ingredient markets of the pastaindustry. Imported pasta is distributed via an exclusive agreement with GruppoEuricom, the second largest pasta manufacturer in Italy.

 

The comparability of current year results versus thosein prior years was affected by the income tax status change associated with theconversion from a cooperative to a corporation. Income before income taxestotaled $9.2 million for fiscal year 2002, up $11.3 million compared to the$2.1 million net loss before income taxes incurred for fiscal year 2001.

 

Dakota Grower’s improved performance resulted fromrevenue growth combined with operational improvements, which reduced operatingcosts and increased supply chain efficiencies. Pricing within the dry pastaindustry remains extremely competitive. Industry changes during fiscal year2002 have expanded opportunities for co-pack arrangements, which involve thesale of dry pasta products to other pasta manufacturers. The Company iscontinuing to explore opportunities in the co-pack area as well as other drypasta markets.

 

As the Company considers its expected performance infiscal year 2003, it has identified certain factors which may impact itsresults during the early portions of fiscal 2003. Unforeseen weather-relatedissues with the 2002 durum crop have led to rising durum prices, which haveincreased roughly 40% since July 31, 2002. We anticipate passing through thehigher cost of durum via increased sales prices, though there is uncertainty asto whether the Company will be able to fully recover higher durum costs on atimely basis. The Company is in the process of restructuring certain forwardwarehouse arrangements to realize further supply chain efficiencies and betterserve our customers. Costs associated with the forward warehouse restructuringprimarily relate to increased freight costs to transfer product, all of whichwill be incurred in the first quarter of fiscal 2003. We anticipate netearnings for the first quarter of fiscal 2003 will be lower than the comparableperiod of the previous year due to the impact of durum cost increases andforward warehouse restructuring.

 

**Conversion**

 

The Company is a North Dakota corporation that wasorganized on January 30, 2002 for the specific purpose of consummating theconversion of the Cooperative into a corporation. The conversion of theCooperative from a cooperative to a corporation was completed effective July 1,2002, with the Company being the ultimate surviving entity in the conversion.See Part I, Item 4 for a more detailed discussion of the conversion. TheCompany operates as the Cooperative’s successor and its operations are acontinuance of the operations of the Cooperative.

 

The conversion was accounted for as an exchangebetween related parties. Therefore, no gain or loss was recognized at the timeof conversion and the book value of the assets and liabilities of theCooperative carried over to the Company. Upon conversion, the Company recordeddeferred tax assets and liabilities for the tax effects of any temporarydifferences existing between income tax and financial reporting on the date ofthe change. Prior to conversion, the Cooperative had not recorded deferredtaxes for temporary differences that were likely to be eliminated throughpatronage allocations. In recording such deferred tax assets and liabilitiesupon conversion to a corporation, the Company recorded a nonrecurring, non-cashincome tax charge of $6.1 million. Including the effect of the aforementioned$6.1 million income tax charge, the Company had net income of $1.8 million forthe year ended July 31, 2002 compared to a net loss of $1.8 million incurredfor the year ended July 31, 2001.

 

**Effectof Change in Accounting Estimate**

 

Effective August 1, 1999, the Company changed theperiod over which it depreciates certain mill and pasta production equipmentfrom 15 years to 20 years. The Company feels the change better reflects theuseful life of the related equipment and is comparable to industry practice forsimilar equipment. The change in accounting estimate increased net income forthe year ended July 31, 2000 by $917,000.

 

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**ResultsOf Operations**

 

*Comparisonof Fiscal Years ended July 31, 2002 and 2001*

 

***Net Revenues.*** Net revenues totaled $152.5 millionfor the year ended July 31, 2002, an increase of $17.0 million, or 12.2%,compared to $135.9 million for the year ended July 31, 2001. The increase wasprimarily due to higher pasta sales volumes.

 

Revenues from the retail market, a portion of whichincludes co-pack and governmental sales, increased $8.3 million, or 9.9%, as aresult of a 12.0% increase in sales volumes offset by lower per unit sellingprices.  Foodservice revenues increased$4.8 million, or 17.4%, primarily due to volume growth of 16.6%. Growth in thefoodservice market continues to be driven by expansions and acquisitions by ourcustomers. Ingredient revenues decreased $1.8 million, or 12.0%, mainly as aresult of a 13.4% decrease in sales volumes. The ingredient sales volumedecline resulted primarily from the loss of two customers in this market due tocompetitive pricing issues. The Company anticipates highly competitive pricingwill continue in the ingredient market.

 

The Company markets semolinaproduction in excess of its own requirements as well as by-products of thedurum milling process. Revenues from semolina and by-product sales for theyear ended July 31, 2002, increased $5.3 million from the prior year as aresult of increases in both sales volumes and per unit selling prices.

 

***Cost of Goods Sold.***Cost of goods soldtotaled $130.5 million for the year ended July 31, 2002, an increase of 4.6%compared to the $124.8 million reported for the year ended July 31, 2001. The$5.7 million increase resulted mainly from revenue growth offset by lowerconversion costs, due to operational improvements, and logistics savings. Grossprofit as a percentage of net revenues increased from 8.2% to 14.4% as a resultof these factors.

 

***Marketing, General and Administrative (“MG&A”) Expenses.***MG&A expenses for the year ended July 31, 2002totaled $9.4 million, down slightly from $9.6 million for the year ended July31, 2001. MG&A expenses as a percentage of net revenues decreased from 7.1%to 6.2%.

 

***Interest Expense.***Interest expense forthe year ended July 31, 2002, was $3.9 million, down slightly from the prioryear primarily due to lower average outstanding debt levels. Cash and equitypatronage refunds received from CoBank totaling $228,000 and $248,000 have beennetted against interest expense for the years ended July 31, 2002 and 2001,respectively.

 

***Income Taxes.***Upon conversion to acorporation, the Company recorded deferred tax assets and liabilities for thetax effects of any temporary differences existing between income tax andfinancial reporting on the date of the change. Prior to conversion, theCooperative had not recorded deferred taxes for temporary differences that werelikely to be eliminated through patronage allocations. In recording suchdeferred tax assets and liabilities upon conversion to a corporation, theCompany recorded a nonrecurring, non-cash income tax charge of $6.1 million. Asthe Company will not operate on a cooperative basis after the conversion, itwill be taxable as a “C corporation.” As such, it will no longer pay deductiblepatronage dividends and any distributions to the shareholders will be treatedas nondeductible dividends. Income tax expense for the year ending July 31,2002, excluding the charge to record deferred taxes upon conversion notedabove, was $1.3 million. Such expense related to income taxes on nonpatronagenet earnings while a cooperative and corporate net income.

 

***Net Income (Loss).*** Net income for theyear ended July 31, 2002 was $1.8 million compared to a $1.8 million net lossincurred for the year ended July 31, 2001. The $3.6 million increase resultedprimarily from higher sales volumes combined with increased gross margins dueto cost reductions, offset by the $6.1 million deferred income tax charge,noted above.

 

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*Comparisonof Fiscal Years ended July 31, 2001 and 2000*

 

***Net Revenues.***Net revenues totaled $135.9 million for the fiscal year ended July 31,2001, a decrease of $0.9 million, or 0.7%, from the prior year. The decreasewas primarily due to lower pasta and semolina sales volumes. Volume declineswere partially offset by a small increase in pasta average sales prices of0.8%, a result of price increases obtained in attempting to pass-through highermaterial and operating costs.

 

Revenues from the retail marketincreased $2.4 million, or 3.0%, primarily due to volume increases of 4.3%offset partially by lower average selling prices. Growth in the club storemarket was particularly strong. Foodservice revenues increased by $1.4 million,or 5.3%, on volume growth of 3.0% and an increase in average selling prices of2.3%. Volume growth in foodservice continues to be driven by expansions andacquisitions by our current customers. Ingredient revenues decreased $4.0million, or 20.7%, mainly as a result of a 20.8% sales volume decrease. Theingredient sales volume decline resulted primarily from the loss of onecustomer in this market due to competitive pricing issues.

 

Revenues from semolina andby-product sales were down $0.7 million from the prior year mainly due toreductions in semolina sales volumes.

 

***Cost of Goods Sold.***  Cost of goods sold increased 6.8% to $124.8million. A majority of the $7.9 million increase was due to increases in durum,packaging, freight, and utility costs. As a result of competitive pressureswithin the pasta industry, the Company was unable to fully cover increasedinput costs through sales price increases. Gross profit as a percentage of netrevenues decreased from 14.6% to 8.2% reflecting reduced profitability due tohigher manufacturing input costs.

 

***Marketing, General and Administrative (“MG&A”) Expenses.***MG&A expenses totaled $9.6 million forthe year ended July 31, 2001, down slightly from the prior year. MG&Aexpenses as a percentage of net revenues remained consistent at 7.1%.

 

***Interest Expense.***Interest expense, including patronage credits andadjustments, decreased $0.4 million. The Company recorded a patronage credit tointerest expense of $248,000 for the year ended July 31, 2001, and a net chargeto interest expense of $68,000 related to adjustments for estimated patronagerefunds from and investments in cooperative banks for the year ended July 31,2000, accounting for a majority of the change.

 

***Income Taxes.***An income tax benefit of $311,000 was recorded for the year ending July31, 2001 related primarily to a reduction in deferred tax liabilities. Anincome tax benefit of $1,298,000 was recorded for the year ended July 31, 2000,of which $407,000 related to current income tax benefits while $891,000 relatedto changes in deferred income taxes. The current income tax benefit recordedfor fiscal 2000 was primarily a reversal of the income tax expense recorded infiscal 1999, which resulted from a reclassification of approximately $2.0million of income from non-patronage to patronage for gains on sale ofproperties in fiscal 1999. The reclassification was based on cooperative incometax developments taking place in the second quarter of fiscal 2000. The deferredincome tax benefit related primarily to a reduction in deferred income taxliabilities associated with differences between the book and tax basis ofproperty and equipment.

 

***Net Income (Loss).***  The Company incurred a net loss of $1.8 millionfor the year ended July 31, 2001 compared to net income of $7.6 million for theyear ended July 31, 2000. The net loss resulted from a reduction in netrevenues combined with higher manufacturing input costs as noted above.

 

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**Liquidityand Capital Resources**

 

The Company meets its liquidity requirements from cashprovided by operations, short-term borrowings under its credit facility, andoutside debt financing. Working capital as of July 31, 2002 was $23.0 millioncompared to $14.4 million as of July 31, 2001.

 

The Company utilizes financing on a short-term basisto fund operations and capital projects until permanent financing is issued. OnFebruary 15, 2002, a $19 million revolving credit facility was secured withCoBank, ACB (“CoBank” or “the Bank”) covering the period from March 1, 2002through February 25, 2003. The revolving line has a variable interest rate notto exceed CoBank’s National Variable Rate plus 1% and is secured by property,equipment, and current assets of the Company. The Company had no balanceoutstanding under its revolving line of credit at July 31, 2002. The balanceoutstanding under the line of credit agreement as of July 31, 2001 was $8.1million.

 

The Company’s long-term financing is provided throughvarious secured term loans and secured notes with the Bank and institutionalinvestors. Variable interest rates on term and seasonal loans are based on theBank’s cost of funds. Debt service requirements will be increasing beginning infiscal year 2003 in relation to previous years as minimum principal paymentsdue on long-term debt total $9.3 million for fiscal 2003, $10.0 million forfiscal 2004 and $7.2 million for fiscal 2005. The first principal payment onthe institutional senior secured notes totaling $3,571,000 was made August 1,2002.

 

The various debt agreements with the Bank andinstitutional investors obligate the Company to maintain or achieve certainamounts of equity and certain financial ratios and impose restrictions on theCompany. The Company is required to maintain a current ratio of 1.35 to 1.00, along term debt to net worth ratio (adjusted to reflect a current ratio of1.35:1.00) of not greater than 1.10 to 1.00, and a debt service coverage ratioof not less than 1.25 to 1.00, measured at the end of each fiscal year. TheCompany cannot pay dividends on capital stock in excess of minimum requirementsif such action will cause noncompliance with any financial condition, withoutthe prior written consent of the Bank. The Company’s consolidated net worth maynot be less than the sum of (a) $27,000,000 plus (b) an aggregate amount equalto 30% of consolidated net income for each completed fiscal year beginning withthe fiscal year ended July 31, 1998. The Company’s trailing twelve month ratioof consolidated cash flow to consolidated fixed charges may not be less than2.00 to 1.00 at the end of each fiscal quarter. The Company entered into aWaiver and Second Amendment to the Note Purchase Agreement and Notes effectiveJune 1, 2001, whereby the events of default that existed in previous periodsunder Section 10.4(b) of the Note Purchase Agreement (as amended by the Waiverand First Amendment dated November 28, 2000) relating to the consolidatedfunded debt to consolidated funded cash flow ratio were waived. The Waiver andSecond Amendment requires that the ratio of consolidated funded debt toconsolidated cash flow not exceed 4.25 to 1.00 for the period from May 1, 2001to and including July 31, 2001, 3.75 to 1.00 for the period from August 1, 2001to and including October 31, 2001, 3.25 to 1.00 for the period from November 1,2001 to and including January 31, 2002 and 3.00 to 1.00 at all timesthereafter, in each case determined as of the end of each fiscal quarter forthe immediately preceding four fiscal quarters, treating such period of fourfiscal quarters as a single accounting period. The Notes were amended such thatthe rate of interest on the unpaid balance was increased by one percent at anytime that either (a) the ratio of the Company’s consolidated funded debt toconsolidated cash flow is greater than 3.00 to 1.00 as of the end of eachfiscal quarter for the immediately preceding four fiscal quarters or (b) theSecurities Valuation Office of the National Association of InsuranceCommissioners has not assigned a designation category of “1” or “2” to theNotes. The one percent interest rate increase became effective August 1, 2001,amending the interest rate on the Series A Notes to 8.04% and the interest rateon the Series B Notes to 8.14% pursuant to the above. The 8.04% and 8.14% ratesremain in effect, though the Company’s consolidated funded debt to consolidatecash flow was below 3.00 to 1.00 at July 31, 2002. The Company was incompliance with all debt covenants (as amended) as of July 31, 2002 and thedate of this filing.

 

We anticipate that dividends paid by the Company willbe lower than the patronage distributions previously received from theCooperative. Corporate dividends are affected by the amount of income taxes oncorporate earnings. We anticipate that dividends will also be reduced comparedto historical cooperative patronage

 

21

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distributions as the Board of Directors reinvests a larger portion ofthe entity’s earnings to fund debt repayments, strategic acquisitions, marketexpansions, working capital requirements, equipment acquisitions, cost-savingmeasures and efficiencies.

 

Net cash provided by operationstotaled $10.8 million for the year ended July 31, 2002, compared to $4.4million for the year ended July 31, 2001 and $15.4 million for the year endedJuly 31, 2000. The $6.4 million increase from fiscal 2001 to fiscal 2002 wasmainly due to the increase in net income (excluding non-cash deferred incometax adjustments). The $11.0 million decrease from fiscal year 2000 to 2001primarily resulted from the decrease in net income and increased payments underlong-term marketing agreements. Payments made under long-term marketingagreements totaled $2.3 million, $5.0 million and $1.5 million for the yearsended July 31, 2002, 2001 and 2000, respectively.

 

Net cash from investing activities totaled $2.9million for the year ended July 31, 2002, and resulted primarily from proceedsreceived on the sale of certain pasta production equipment under asale-leaseback transaction, offset by payments made for milling and pastaequipment, intangible assets and package design costs. The sale-leasebacktransaction generated $5.0 million in available funds, which were used to secureand expand the Company’s sales efforts. Net cash used in investing activitiestotaled $3.4 million and $5.4 million for the years ended July 31, 2001 and2000, respectively. Expenditures for thepurchase of property and equipment totaled $1.1 million, $4.0 million and $5.3million for the years ended July 31, 2002, 2001, and 2000, respectively. Asignificant portion of the equipment expenditures for fiscal years 2001 and2000 related to the installation of a lasagna line in the New Hope, Minnesotaplant. Most of the Company’s technology assets are placed under leaseagreements, which allow the Company to stay relatively current with changingtechnologies.

 

Net cash used for financingactivities totaled $10.8 million for the year ended July 31, 2002, mainlyrelated to payments made on our credit facility and long-term debt.  Netcash used for financing activities were $2.7 million and $11.7 million for theyears ended July 31, 2001 and 2000, respectively, and related primarily topayments for long term debt and patronage distributions offset by proceeds fromshort term financing. Cash patronage distributions to members of theCooperative totaled $4.5 million and $7.4 million for the years ended July 31,2001 and 2000, respectively.

 

The Company forward contracts for a certain portion ofits future durum wheat requirements. At July 31, 2002, the Company hadoutstanding commitments for grain purchases totaling $5,356,000 related toforward purchase contracts. These contracts are set price contracts to delivergrain to the Company’s mill, and are not derivative in nature as they have nonet settlement provision and are not transferable. We currently anticipate capital expenditures in fiscal year 2003 tototal approximately $4 million, primarily for pasta line upgrades and costreduction projects. Pursuant to a warehouse agreement with Sky Logistics &Distribution, Inc. (Sky), the Company is obligated to minimum monthly storageand handling volumes totaling approximately $110,000 per month. This agreementexpires October 31, 2004. The Company has also transferred the obligation for acertain building lease to Sky. If Sky were unable to perform under the existinglease, Dakota Growers would be obligated to make payments under this lease overthe remaining term. Current monthly payments under this lease totalapproximately $67,000, and the lease expires April 30, 2004. As of July31, 2002, the Company had commitments to pay $5.0 million under long-termcustomer marketing agreements at various times through December 31, 2002. TheCompany expects to fund these commitments through cash from operations andborrowings under its credit facility.

 

22

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Payments due under contractual obligations and othercommitments as of July 31, 2002 are as follows (in thousands):

 
| **Years  ending July 31,** |   | **Long-term  Debt** |   | **Operating  Leases** |   | **Long-term  Customer  Marketing  Agreements** |   | **Total** |   |
|----------------------------|--------|---------------------|--------|-----------------------|--------|------------------------------------------------|--------|-----------|--------|
|                       |   |                |   |                  |   |                                           |   |      |   |
| 2003                       |   | $                   | 9,320  |                  | $      | 1,404                                          |   | $         | 5,000  |   | $ | 15,724 |   |
| 2004                       |   | 10,011              |   | 1,040                 |   | —                                         |   | 11,051    |   |
| 2005                       |   | 7,176               |   | 953                   |   | —                                         |   | 8,129     |   |
| 2006                       |   | 4,771               |   | 875                   |   | —                                         |   | 5,646     |   |
| 2007                       |   | 4,771               |   | 576                   |   | —                                         |   | 5,347     |   |
| Thereafter                 |   | 11,545              |   | —                |   | —                                         |   | 11,545    |   |
|                       |   |                |   |                  |   |                                           |   |      |   |
|                       |   | $                   | 47,594 |                  | $      | 4,848                                          |   | $         | 5,000  |   | $ | 57,442 |   |

 

Management believes that net cash currently availableand to be provided by operating activities, along with its available line ofcredit, will be sufficient to meet the Company’s expected capital and liquidityrequirements for the foreseeable future.

 

The U.S. Customs Service (Customs) published, on July3, 2002, a notice of intention to distribute antidumping and countervailingduties assessed on certain pasta imported from Italy and Turkey from October 1,2001 to September 30, 2002, to affected domestic producers pursuant to theContinued Dumping and Subsidy Offset Act of 2000 (the “Act”). At this time,indications are that the Company will receive a payment under this Act in thelatter portion of calendar year 2002, though we cannot reasonably estimate thepotential amount to be received at this time or state with certainty whetherany payment will be received in future periods.

 

**Recently Issued Accounting Standards**

 

In October 2001, the Financial Accounting StandardsBoard (FASB) issued Statement No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets.” This statement will supersede SFAS StatementNo. 121, “Accounting for the Impairment of Long-Lived Assets and for theLong-Lived Assets to Be Disposed Of”, providing one accounting model for thereview of asset impairment. Statement No. 144 retains much of the recognitionand measurement provisions of Statement No. 121, but removes goodwill from itsscope. It also requires long-lived assets to be disposed of other than by saleto be considered as held and used until disposed of, requiring the depreciablelife to be adjusted as an accounting change. Criteria to classify long-livedassets to be disposed of by sale has changed from SFAS Statement No. 121, butthese costs will continue to be reported at the lower of their carrying amountor fair value less cost to sell, and will cease to be depreciated. Statement144 will also supercede the section of the Accounting Principles Board (APB)Opinion No. 30, which prescribes reporting for the effects of a disposal of asegment of a business. This statement retains the basic presentation provisionsof the opinion, but requires losses on a disposal or discontinued operation tobe recognized as incurred. It also broadens the definition of a discontinuedoperation to include a component of an entity. The provisions of Statement 144are effective for financial statements issued for fiscal years beginning afterDecember 15, 2001. This statement is not expected to have a material impact onthe Company’s financial statements.

 

In July 2001, the FASB issued Statement No. 143, “Accountingfor Asset Retirement Obligations.” The objective of this statement is toprovide accounting guidance for legal obligations associated with theretirement of long-lived assets by requiring the fair value of a liability forthe asset retirement obligation to be recognized in the period in which it isincurred. When the liability is initially recognized, the asset retirementcosts should also be capitalized by increasing the carrying amount of therelated long-lived asset. The liability is then accreted to its present valueeach period and the capitalized costs are depreciated over the useful life ofthe associated asset. This

 

23

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statement is effective for fiscal years beginning after June 15, 2002,and is not expected to have a material impact on the Company’s financialstatements.

 

In June 2002, the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities.” ThisStatement addresses financial accounting and reporting for costs associatedwith exit or disposal activities and nullifies Emerging Issues Task Force(EITF) Issue No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (including Certain Costs Incurred ina Restructuring).” This Statement requires that a liability for a costassociated with an exit or disposal activity be recognized when the liabilityis incurred and can be measured at fair value. The provisions of this Statementare effective prospectively for exit or disposal activities initiated afterDecember 31, 2002. The Company does not expect this statement to have amaterial impact on the financial statements.

 

In November 2001, the Emerging Issues Task Force(“EITF”) finalized Issue No. 01-9 “Accounting for Consideration Given by aVendor to a Customer (Including a Reseller of the Vendor’s Products),” whichcodified the matters discussed in Issue No. 00-14, “Accounting for CertainSales Incentives” and Issue No. 00-25, “Vendor Income Statement Characterizationof Consideration Paid to a Reseller of the Vendor’s Products.” Issue No. 01-9provides guidance on accounting for certain promotional activities, as well asthe accounting for certain consideration from a vendor to an entity thatresells the vendor’s products. The provisions of this EITF are effective forfinancial statements issued after December 15, 2001. The Company has accountedfor promotional activities in a manner consistent with the guidelinesestablished under Issue No. 01-9, and the pronouncement does not have amaterial impact on the Company’s financial statement reporting.

 

In December 2001, the AICPA issued SOP 01-6,“Accounting by Certain Entities (Including Entities with Trade Receivables)That Lend to or Finance the Activities of Others.” This statement addressesdisclosures on accounting policies relating to trade accounts and loansreceivable and is effective prospectively for financial statements issued forfiscal years beginning after December 15, 2001. The Company does not expectthis statement to have a material effect on the financial statements.

 

**ITEM 7A.****               QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risk is the risk of loss to future earnings, tofair values or to future cash flows that may result from changes in the priceof a financial instrument. The value of a financial instrument may change as aresult of changes in interest rates, commodity prices, exchange rates, equityprices and other market changes. Market risk is attributed to all market-risksensitive financial instruments, including long-term debt.

 

The Company does not believe it is subject to anymaterial market risk exposure with respect to interest rates, commodity prices,exchange rates, equity prices, or other market changes that would requiredisclosure.

 

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**ITEM 8.****                        FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OFDAKOTA GROWERS PASTA COMPANY, INC.**

 
| Report of Independent  Auditors                                  |
|------------------------------------------------------------------|
|                                                             |
| Consolidated Balance Sheets                                      |
|                                                             |
| Consolidated  Statements of Operations                           |
|                                                             |
| Consolidated  Statements of Changes in Stockholders’ Equity |
|                                                             |
| Consolidated  Statements of Cash Flows                           |
|                                                             |
| Notes to  Consolidated Financial Statements                      |

 

25

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**INDEPENDENT AUDITOR’S REPORT**

 

The Board of Directors

Dakota Growers Pasta Company, Inc.

Carrington, North Dakota

 

We have audited the accompanying consolidated balance sheets of Dakota Growers Pasta Company, Inc. (aNorth Dakota corporation) as of July 31, 2002 and 2001, and the relatedconsolidated statements of operations, changes in stockholders’ equity and cashflows for the years ended July 31, 2002, 2001 and 2000. These consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we planand perform the audit to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall consolidated financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of Dakota Growers Pasta Company, Inc.****asof July 31, 2002 and 2001, and the results of their operations and their cashflows for the years ended July 31, 2002, 2001 and 2000, in conformity withaccounting principles generally accepted in the United States of America.

 
| /s/ Eide Bailly LLP |   |
|---------------------|--------|
|                |
| Fargo, North Dakota |
| September 12, 2002  |

 

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**DAKOTA GROWERS PASTA COMPANY, INC.**

**CONSOLIDATED BALANCE SHEETS**

**JULY 31, 2002 AND 2001**

**(In Thousands, Except ShareInformation)**

 
|                                                                                                  |   | **2002** |    | **2001** |   |
|-------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
|                                                                                                  |   |     |    |     |   |
| **ASSETS**                                                                                            |   |     |    |     |   |
|                                                                                                  |   |     |    |     |   |
| CURRENT ASSETS                                                                                        |   |     |    |     |   |
| Cash and cash  equivalents                                                                            |   | $        | 2,866   |     | $      | 3 |   |
|                                                                                                  |   |     |    |     |   |
| Short-term  investments (restricted)                                                                  |   | 1,974    |    | 1,974    |   |
|                                                                                                  |   |     |    |     |   |
| Trade accounts  receivable, less allowance for cash discounts and doubtful accounts of $792  and $610 |   | 16,504   |    | 11,560   |   |
|                                                                                                  |   |     |    |     |   |
| Other  receivables                                                                                    |   | 360      |    | 1,138    |   |
|                                                                                                  |   |     |    |     |   |
| Inventories                                                                                           |   | 19,636   |    | 21,050   |   |
|                                                                                                  |   |     |    |     |   |
| Prepaid expenses                                                                                      |   | 2,258    |    | 1,602    |   |
|                                                                                                  |   |     |    |     |   |
| Deferred income  taxes                                                                                |   | 466      |    | —   |   |
|                                                                                                  |   |     |    |     |   |
| Total current  assets                                                                                 |   | 44,064   |    | 37,327   |   |
|                                                                                                  |   |     |    |     |   |
| PROPERTY AND  EQUIPMENT                                                                               |   |     |    |     |   |
| In service                                                                                            |   | 106,885  |    | 114,984  |   |
| Construction in  process                                                                              |   | 371      |    | 108      |   |
|                                                                                                  |   | 107,256  |    | 115,092  |   |
| Less accumulated  depreciation                                                                        |   | (35,762  | )       | (33,367  | )      |
|                                                                                                  |   |     |    |     |   |
| Net property and  equipment                                                                           |   | 71,494   |    | 81,725   |   |
|                                                                                                  |   |     |    |     |   |
| INVESTMENT IN  COOPERATIVE BANKS                                                                      |   | 2,350    |    | 2,211    |   |
|                                                                                                  |   |     |    |     |   |
| INTANGIBLE  ASSETS                                                                                    |   | 686      |    | —   |   |
|                                                                                                  |   |     |    |     |   |
| OTHER ASSETS                                                                                          |   | 6,947    |    | 7,395    |   |
|                                                                                                  |   |     |    |     |   |
|                                                                                                  |   | $        | 125,541 |     | $      | 128,658 |   |

 

27

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|                                                                                                                                                                                                                                           |   | **2002** |    | **2001** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                 |   |     |    |     |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| CURRENT  LIABILITIES                                                                                                                                                                                                                           |   |     |    |     |   |
| Notes payable                                                                                                                                                                                                                                  |   | $        | —  |     | $      | 8,100 |   |
| Current portion  of long-term debt                                                                                                                                                                                                             |   | 9,320    |    | 2,657    |   |
| Accounts payable                                                                                                                                                                                                                               |   | 6,471    |    | 4,400    |   |
| Excess  outstanding checks over cash on deposit                                                                                                                                                                                                |   | —   |    | 1,072    |   |
| Accrued grower  payments                                                                                                                                                                                                                       |   | —   |    | 969      |   |
| Accrued  liabilities                                                                                                                                                                                                                           |   | 5,260    |    | 5,709    |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| Total current  liabilities                                                                                                                                                                                                                     |   | 21,051   |    | 22,907   |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                                                                                 |   | —   |    | —   |   |
| LONG-TERM DEBT,  net of current portion                                                                                                                                                                                                        |   | 38,274   |    | 47,594   |   |
| DEFERRED INCOME  TAXES                                                                                                                                                                                                                         |   | 9,833    |    | 3,777    |   |
| OTHER  LIABILITIES                                                                                                                                                                                                                             |   | 239      |    | —   |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| Total  liabilities                                                                                                                                                                                                                             |   | 69,397   |    | 74,278   |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| REDEEMABLE  PREFERRED STOCK                                                                                                                                                                                                                    |   |     |    |     |   |
| Series A, 6%  cumulative, $100 par value, 533 and 800 shares authorized as of July 31, 2002  and 2001, respectively; 467 and 600 shares issued and outstanding as of July  31, 2002 and 2001, respectively                                     |   | 47       |    | 60       |   |
| Series B, 2%  non-cumulative, $100 par value, 525 and 2,700 shares authorized as of July  31, 2002 and 2001, respectively; 75 and 525 shares issued and outstanding as  of July 31, 2002 and 2001, respectively                                |   | 7        |    | 53       |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| Total redeemable  preferred stock                                                                                                                                                                                                              |   | 54       |    | 113      |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| STOCKHOLDERS’  EQUITY                                                                                                                                                                                                                     |   |     |    |     |   |
| Series C  convertible preferred stock, 6% non-cumulative, $100 par value, 2,045 and  15,000 shares authorized as of July 31, 2002 and 2001, respectively; 0 and  924 shares issued and outstanding as of July 31, 2002 and 2001, respectively  |   | —   |    | 92       |   |
| Series D  delivery preferred stock, non-cumulative, $.01 par value, 11,324,377 and 0  shares authorized as of July 31, 2002 and 2001, respectively; 11,275,297 and  0 shares issued and outstanding as of July 31, 2002 and 2001, respectively |   | 113      |    | —   |   |
| Membership  stock, $125 par value, 0 and 2,000 shares authorized as of July 31, 2002 and  2001, respectively; 0 and 1,156 shares issued and outstanding as of July 31,  2002 and 2001, respectively                                            |   | —   |    | 144      |   |
| Equity stock,  $2.50 par value, 0 and 25,000,000 shares authorized as of July 31, 2002 and  2001, respectively; 0 and 11,253,121 shares issued and outstanding as of July  31, 2002 and 2001, respectively                                     |   | —   |    | 28,133   |   |
| Common stock,  $.01 par value, 75,000,000 and 0 shares authorized as of July 31, 2002 and  2001, respectively; 12,554,746 and 0 issued and outstanding as of July 31,  2002 and 2001, respectively                                             |   | 126      |    | —   |   |
| Additional  paid-in capital                                                                                                                                                                                                                    |   | 60,188   |    | 22,876   |   |
| Accumulated  deficit                                                                                                                                                                                                                           |   | (4,337   | )       | —   |   |
| Accumulated  allocated earnings                                                                                                                                                                                                                |   | —   |    | 4,596    |   |
| Accumulated  unallocated earnings                                                                                                                                                                                                              |   | —   |    | (1,574   | )      |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| Total  stockholders’ equity                                                                                                                                                                                                               |   | 56,090   |    | 54,267   |   |
|                                                                                                                                                                                                                                           |   |     |    |     |   |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                               |   | $        | 125,541 |     | $      | 128,658 |   |

 

See Notes to Consolidated Financial Statements

 

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**DAKOTA GROWERS PASTA COMPANY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**YEARS ENDED JULY 31, 2002, 2001, AND2000**

**(In Thousands, Except Per ShareAmounts)**

 
|                                                                                                                   |   | **2002** |    | **2001** |   | **2000** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
|                                                                                                                   |   |     |    |     |   |     |   |
| Net revenues  (net of discounts and allowances of $17,056, $17,312 and $20,899 for 2002,  2001 and 2000, respectively) |   | $        | 152,465 |     | $      | 135,921  |   | $ | 136,862 |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Cost of goods  sold                                                                                                    |   | 130,502  |    | 124,811  |   | 116,890  |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Gross profit                                                                                                           |   | 21,963   |    | 11,110   |   | 19,972   |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Marketing,  general and administrative expenses                                                                        |   | 9,382    |    | 9,631    |   | 9,713    |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Operating income                                                                                                       |   | 12,581   |    | 1,479    |   | 10,259   |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Other income  (expense)                                                                                                |   |     |    |     |   |     |   |
| Interest and  other income                                                                                             |   | 477      |    | 373      |   | 645      |   |
| Gain (loss) on  sale of property, equipment and other assets                                                           |   | 23       |    | 201      |   | (52      | )      |
| Interest  expense, net                                                                                                 |   | (3,865   | )       | (4,148   | )      | (4,522   | )      |
|                                                                                                                   |   |     |    |     |   |     |   |
| Income (loss)  before income taxes                                                                                     |   | 9,216    |    | (2,095   | )      | 6,330    |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Charge to record  deferred taxes upon conversion from a cooperative to a corporation                                   |   | 6,105    |    | —   |   | —   |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Income tax  expense (benefit)                                                                                          |   | 1,277    |    | (311     | )      | (1,298   | )      |
|                                                                                                                   |   |     |    |     |   |     |   |
| Net income  (loss)                                                                                                     |   | 1,834    |    | (1,784   | )      | 7,628    |   |
| Dividends on  preferred stock                                                                                          |   | 10       |    | 15       |   | 4        |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Net earnings  (loss) on common/equity stock                                                                            |   | $        | 1,824   |     | $      | (1,799   | )      | $ | 7,624 |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Net earnings  (loss) per common/equity share                                                                           |   |     |    |     |   |     |   |
| Basic                                                                                                                  |   | $        | 0.16    |     | $      | (0.16    | )      | $ | 0.68 |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Diluted                                                                                                                |   | $        | 0.16    |     | $      | (0.16    | )      | $ | 0.68 |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Weighted average  common/equity shares outstanding                                                                     |   |     |    |     |   |     |   |
| Basic                                                                                                                  |   | 11,382   |    | 11,253   |   | 11,166   |   |
|                                                                                                                   |   |     |    |     |   |     |   |
| Diluted                                                                                                                |   | 11,415   |    | 11,275   |   | 11,225   |   |

 

See Notes to Consolidated Financial Statements

 

29

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**DAKOTA GROWERS PASTA COMPANY, INC.**

**CONSOLIDATED STATEMENTS OF CHANGES INSTOCKHOLDERS’ EQUITY**

**YEARS ENDED JULY 31, 2002, 2001 AND2000**

**(In Thousands, Except ShareInformation)**

 
|                                                                                                                                                              |   | **Number of shares**                        |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                                                                                                              |   | **Series C  Convertible  Preferred  Stock** |   | **Series D  Delivery  Preferred  Stock** |   | **Membership  Stock** |   | **Equity  Stock** |   | **Common  Stock** |   |
|                                                                                                                                                              |   |                                        |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY 31, 1999                                                                                                                                            |   | —                                      |   | — |   | 1,152 |   | 11,097,409 |   | — |   |
| Preferred dividends declared                                                                                                                                      |   | —                                      |   | — |   | — |   | — |   | — |   |
| Net membership stock issued                                                                                                                                       |   | —                                      |   | — |   | 6 |   | — |   | — |   |
| Reclass to Series A  redeemable preferred stock                                                                                                                   |   | —                                      |   | — |   | — |   | — |   | — |   |
| Series C preferred stock  issued                                                                                                                                  |   | 7,412                                       |   | — |   | — |   | — |   | — |   |
| Series C preferred stock  converted to equity stock                                                                                                               |   | (6,488                                      | )      | — |   | — |   | 155,712 |   | — |   |
| Net income for the year  ended July 31, 2000                                                                                                                      |   | —                                      |   | — |   | — |   | — |   | — |   |
| Patronage allocations                                                                                                                                             |   | —                                      |   | — |   | — |   | — |   | — |   |
| Cumulative effect of  accounting change allocated against non-qualified accumulate earnings                                                                       |   | —                                      |   | — |   | — |   | — |   | — |   |
| Patronage paid                                                                                                                                                    |   | —                                      |   | — |   | — |   | — |   | — |   |
|                                                                                                                                                              |   |                                        |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY 31, 2000                                                                                                                                            |   | 924                                         |   | — |   | 1,158 |   | 11,253,121 |   | — |   |
| Preferred dividends  declared                                                                                                                                     |   | —                                      |   | — |   | — |   | — |   | — |   |
| Net membership stock  retired                                                                                                                                     |   | —                                      |   | — |   | (2 | ) | — |   | — |   |
| Net loss for the year ended  July 31, 2001                                                                                                                        |   | —                                      |   | — |   | — |   | — |   | — |   |
| Patronage allocations                                                                                                                                             |   | —                                      |   | — |   | — |   | — |   | — |   |
| Patronage paid                                                                                                                                                    |   | —                                      |   | — |   | — |   | — |   | — |   |
|                                                                                                                                                              |   |                                        |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY 31, 2001                                                                                                                                            |   | 924                                         |   | — |   | 1,156 |   | 11,253,121 |   | — |   |
| Preferred dividends  declared                                                                                                                                     |   | —                                      |   | — |   | — |   | — |   | — |   |
| Net membership stock  retired                                                                                                                                     |   | —                                      |   | — |   | (9 | ) | — |   | — |   |
| Series C preferred stock  converted to equity stock                                                                                                               |   | (924                                        | )      | — |   | — |   | 22,176 |   | — |   |
| Net income for the eleven  months ended June 30, 2002 (represents net income while a cooperative)                                                                 |   | —                                      |   | — |   | — |   | — |   | — |   |
| Patronage allocations                                                                                                                                             |   | —                                      |   | — |   | — |   | — |   | — |   |
| Equity adjustments for  conversion from a cooperative to a corporation                                                                                            |   | —                                      |   | 11,275,297 |   | (1,147 | ) | (11,275,297 | ) | 12,554,746 |   |
| Net loss for the month  ended July 31, 2002 (represents net income after conversion to a corporation,  including charge to record deferred taxes upon conversion) |   | —                                      |   | — |   | — |   | — |   | — |   |
|                                                                                                                                                              |   |                                        |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY 31, 2002                                                                                                                                            |   | —                                      |   | 11,275,297 |   | — |   | — |   | 12,554,746 |   |

 

30

----

 

 
|                                                                                                                                                              |   | **Series C  Convertible  Preferred  Stock** |          | **Series D  Delivery  Preferred  Stock** |           | **Membership  Stock** |   | **Equity  Stock** |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Deficit** |   | **Allocated  Accumulated Earnings** |   | **Unallocated Accumulated  Earnings (Deficit)** |   | **Total** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|---------------|------------------------------------------|----------------|-----------------------|--------|-------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------|--------|-------------------------------------|--------|-------------------------------------------------|--------|-----------|--------|
| **Qualified**                                                                                                                                                     |   | **Non-Qualified**                           | **Patronage** |                                     | **Non-member** |
|                                                                                                                                                              |   |                                        |          |                                     |           |                  |   |              |   |              |   |                             |   |                     |   |                                |   |                                            |   |      |   |   |   |   |   |
| BALANCE, JULY 31, 1999                                                                                                                                            |   | $                                           | —        |                                     | $              | —                |   | $                 | 144    |              | $      | 27,743                           |   | $                        | — |                                | $      | 22,074                                          |   | $         | — |   | $ | — |   | $ | 4,896 |   | $ | 4,852 |   | $ | (727 | ) | $ | 58,982 |   |
| Preferred dividends declared                                                                                                                                      |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | (4        | )      | — |   | (4 | ) |
| Net membership stock issued                                                                                                                                       |   | —                                      |          | —                                   |           | 1                     |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | —    |   | — |   | 1 |   |
| Reclass to Series A  redeemable preferred stock                                                                                                                   |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | (22                              | )      | —                   |   | —                              |   | —                                          |   | —    |   | — |   | (22 | ) |
| Series C preferred stock  issued                                                                                                                                  |   | 741                                         |          | —                                   |           | —                |   | —            |   | —            |   | 565                              |   | —                   |   | —                              |   | —                                          |   | —    |   | — |   | 1,306 |   |
| Series C preferred stock  converted to equity stock                                                                                                               |   | (649                                        | )             | —                                   |           | —                |   | 390               |   | —            |   | 259                              |   | —                   |   | —                              |   | —                                          |   | —    |   | — |   | — |   |
| Net income for the year  ended July 31, 2000                                                                                                                      |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | 7,134     |   | 494 |   | 7,628 |   |
| Patronage allocations                                                                                                                                             |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | 3,929                               |   | 464                                             |   | (4,393    | )      | — |   | — |   |
| Cumulative effect of  accounting change allocated against non-qualified accumulated earnings                                                                      |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | 3,429                               |   | (3,429                                          | )      | —    |   | — |   | — |   |
| Patronage paid                                                                                                                                                    |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | (7,358                              | )      | —                                          |   | —    |   | — |   | (7,358 | ) |
| BALANCE, JULY 31, 2000                                                                                                                                            |   | $                                           | 92            |                                     | $              | —                |   | $                 | 145    |              | $      | 28,133                           |   | $                        | — |                                | $      | 22,876                                          |   | $         | — |   | $ | — |   | $ | 1,931 |   | $ | 7,589 |   | $ | (233 | ) | $ | 60,533 |   |
| Preferred dividends declared                                                                                                                                      |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | (15       | )      | — |   | (15 | ) |
| Net membership stock retired                                                                                                                                      |   | —                                      |          | —                                   |           | (1                    | )      | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | —    |   | — |   | (1 | ) |
| Net loss for the year ended  July 31, 2001                                                                                                                        |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | (1,542    | )      | (242 | ) | (1,784 | ) |
| Patronage allocations                                                                                                                                             |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | 4,466                               |   | 2,665                                           |   | (7,131    | )      | — |   | — |   |
| Patronage paid                                                                                                                                                    |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | (4,466                              | )      | —                                          |   | —    |   | — |   | (4,466 | ) |
| BALANCE, JULY 31, 2001                                                                                                                                            |   | $                                           | 92            |                                     | $              | —                |   | $                 | 144    |              | $      | 28,133                           |   | $                        | — |                                | $      | 22,876                                          |   | $         | — |   | $ | — |   | $ | 4,596 |   | $ | (1,099 | ) | $ | (475 | ) | $ | 54,267 |   |
| Preferred dividends declared                                                                                                                                      |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | (9        | )      | (1 | ) | (10 | ) |
| Net membership stock retired                                                                                                                                      |   | —                                      |          | —                                   |           | (1                    | )      | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | —    |   | — |   | (1 | ) |
| Series C preferred stock  converted to equity stock                                                                                                               |   | (92                                         | )             | —                                   |           | —                |   | 55                |   | —            |   | 37                               |   | —                   |   | —                              |   | —                                          |   | —    |   | — |   | — |   |
| Net income for the eleven  months ended June 30, 2002 (represents net income while a cooperative)                                                                 |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | —                                          |   | 6,137     |   | 1,419 |   | 7,556 |   |
| Patronage allocations                                                                                                                                             |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | —                   |   | —                              |   | 4,586                                           |   | (4,586    | )      | — |   | — |   |
| Equity adjustments for  conversion from a cooperative to a corporation                                                                                            |   | —                                      |          | 113                                      |           | (143                  | )      | (28,188           | )      | 126               |   | 37,275                           |   | 1,385                    |   | —                              |   | (9,182                                          | )      | (443      | )      | (943 | ) | — |   |
| Net loss for the month ended  July 31, 2002 (represents net income after conversion to a corporation,  including charge to record deferred taxes upon conversion) |   | —                                      |          | —                                   |           | —                |   | —            |   | —            |   | —                           |   | (5,722                   | )      | —                              |   | —                                          |   | —    |   | — |   | (5,722 | ) |
| BALANCE, JULY 31, 2002                                                                                                                                            |   | $                                           | —        |                                     | $              | 113                   |   | $                 | — |              | $      | —                           |   | $                        | 126    |                                | $      | 60,188                                          |   | $         | (4,337 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 56,090 |   |
|                                                                                                                                                                   |        |                                             |               |                                          |                |                       |        |                   |        |                   |        |                                  |        |                          |        |                                     |        |                                                 |        |           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See Notes to Consolidated Financial Statements

31

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**DAKOTAGROWERS PASTA COMPANY, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YEARSENDED JULY 31, 2002, 2001 AND 2000**

**(InThousands)**

 
|                                                                               |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| OPERATING  ACTIVITIES                                                              |   |     |   |     |   |     |   |
| Net income (loss)                                                                  |   | $        | 1,834  |     | $      | (1,784   | )      | $ | 7,628 |   |
| Adjustments to reconcile net  income (loss) to net cash from operating activities: |   |     |   |     |   |     |   |
| Depreciation and  amortization                                                     |   | 8,813    |   | 8,859    |   | 7,853    |   |
| Undistributed patronage  capital from cooperatives                                 |   | (139     | )      | (204     | )      | 18       |   |
| Cooperative bank stock  valuation adjustment                                       |   | —   |   | —   |   | 36       |   |
| (Gain) loss on sale of  property, equipment and other assets                       |   | (23      | )      | (201     | )      | 52       |   |
| Deferred income taxes                                                              |   | 5,590    |   | (318     | )      | (891     | )      |
| Payments for long-term  marketing costs                                            |   | (2,250   | )      | (5,038   | )      | (1,463   | )      |
| Changes in assets and  liabilities                                                 |   |     |   |     |   |     |   |
| Trade receivables                                                                  |   | (4,944   | )      | 1,330    |   | 2,953    |   |
| Other receivables                                                                  |   | 778      |   | (545     | )      | 1,158    |   |
| Inventories                                                                        |   | 1,414    |   | 731      |   | (3,100   | )      |
| Prepaid expenses                                                                   |   | 71       |   | 40       |   | 88       |   |
| Other assets                                                                       |   | 49       |   | (100     | )      | 111      |   |
| Accounts payable                                                                   |   | 2,071    |   | 296      |   | 244      |   |
| Excess outstanding checks  over cash on deposit                                    |   | (1,072   | )      | 1,072    |   | —   |   |
| Grower payables                                                                    |   | (969     | )      | (318     | )      | 168      |   |
| Other accrued liabilities                                                          |   | (449     | )      | 602      |   | 544      |   |
|                                                                               |   |     |   |     |   |     |   |
| NET CASH FROM OPERATING  ACTIVITIES                                                |   | 10,774   |   | 4,422    |   | 15,399   |   |
|                                                                               |   |     |   |     |   |     |   |
| INVESTING ACTIVITIES                                                               |   |     |   |     |   |     |   |
| Purchases of property and  equipment                                               |   | (1,085   | )      | (4,005   | )      | (5,278   | )      |
| Proceeds from sale of  property, equipment and other assets                        |   | 5,079    |   | 1,050    |   | 121      |   |
| Receipts on note  receivable                                                       |   | —   |   | —   |   | 1,884    |   |
| Net purchase of short-term  investments                                            |   | —   |   | —   |   | (1,461   | )      |
| Purchases of intangible  assets                                                    |   | (735     | )      | —   |   | —   |   |
| Payments for package  design costs                                                 |   | (343     | )      | (440     | )      | (656     | )      |
|                                                                               |   |     |   |     |   |     |   |
| NET CASH FROM (USED FOR)  INVESTING ACTIVITIES                                     |   | 2,916    |   | (3,395   | )      | (5,390   | )      |
|                                                                               |   |     |   |     |   |     |   |
| FINANCING ACTIVITIES                                                               |   |     |   |     |   |     |   |
| Net change in short-term  notes payable                                            |   | (8,100   | )      | 6,225    |   | 1,875    |   |
| Payments on long-term debt                                                         |   | (2,657   | )      | (4,479   | )      | (7,580   | )      |
| Preferred stock issued                                                             |   | —   |   | —   |   | 58       |   |
| Preferred stock  retirements                                                       |   | (59      | )      | (13      | )      | (7       | )      |
| Dividends paid on  preferred stock                                                 |   | (10      | )      | (15      | )      | (4       | )      |
| Memberships issued                                                                 |   | 1        |   | —   |   | 3        |   |
| Memberships retired                                                                |   | (2       | )      | (1       | )      | (2       | )      |
| Options exercised                                                                  |   | —   |   | —   |   | 1,306    |   |
| Patronage distributions                                                            |   | —   |   | (4,466   | )      | (7,358   | )      |
|                                                                               |   |     |   |     |   |     |   |
| NET CASH USED FOR  FINANCING ACTIVITIES                                            |   | (10,827  | )      | (2,749   | )      | (11,709  | )      |
|                                                                               |   |     |   |     |   |     |   |
| NET CHANGE IN CASH AND  CASH EQUIVALENTS                                           |   | 2,863    |   | (1,722   | )      | (1,700   | )      |
|                                                                               |   |     |   |     |   |     |   |
| CASH AND CASH EQUIVALENTS,  BEGINNING OF YEAR                                      |   | 3        |   | 1,725    |   | 3,425    |   |
|                                                                               |   |     |   |     |   |     |   |
| CASH AND CASH EQUIVALENTS,  END OF YEAR                                            |   | $        | 2,866  |     | $      | 3        |   | $ | 1,725 |   |
|                                                                               |   |     |   |     |   |     |   |
| SUPPLEMENTAL DISCLOSURES  OF CASH FLOW INFORMATION                                 |   |     |   |     |   |     |   |
| Cash payments for                                                                  |   |     |   |     |   |     |   |
| Interest (net of amounts  capitalized)                                             |   | $        | 3,742  |     | $      | 4,375    |   | $ | 3,443 |   |
|                                                                               |   |     |   |     |   |     |   |
| Income taxes (refunded)                                                            |   | $        | 1,720  |     | $      | (21      | )      | $ | 548 |   |
|                                                                               |   |     |   |     |   |     |   |
| SUPPLEMENTAL DISCLOSURES  OF NONCASH INVESTING AND FINANCING ACTIVITIES            |   |     |   |     |   |     |   |
| Deferred gain on  sale-leaseback transaction                                       |   | $        | 256    |     |   |     |   |   |

 

See Notes to Consolidated Financial Statements

 

32

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**DAKOTA GROWERS PASTA COMPANY, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**YEARS ENDED JULY 31, 2002, 2001 AND2000**

** **

**NOTE 1 - NATURE OF BUSINESS AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

*Conversionand Nature of Business*

 

The conversion of Dakota Growers Pasta Company, aNorth Dakota cooperative (the “Cooperative”), from a cooperative to acorporation was completed effective July 1, 2002, with Dakota Growers PastaCompany, Inc. (formerly known as Dakota Growers Restructuring Company, Inc.), aNorth Dakota corporation (the “Company”), being the ultimate surviving entityin the conversion. The conversion was effected through a series of mergersamong the Cooperative and three of its wholly-owned subsidiaries: DakotaGrowers Pasta Restructuring Cooperative, a Colorado cooperative (the “ColoradoCooperative”), Dakota Growers Corporation, a Colorado corporation (the“Colorado Corporation”), and the Company. The Cooperative merged with and intothe Colorado Cooperative, with the Colorado Cooperative surviving such merger,and thereafter the Colorado Cooperative merged with and into the ColoradoCorporation, with the Colorado Corporation surviving such merger, andthereafter the Colorado Corporation merged with and into the Company, with theCompany surviving such merger. Following the conversion, the Company changed its name to Dakota GrowersPasta Company, Inc. The Company operates as the Cooperative’s successor and itsoperations are a continuance of the operations of the Cooperative.

 

The conversion described above was accounted for as anexchange between related parties. Therefore, no gain or loss was recognized atthe time of conversion and the book value of the assets and liabilities of theCooperative carried over to the Company. Upon conversion, the Company recordeddeferred tax assets and liabilities for the tax effects of any temporarydifferences existing between income tax and financial reporting on the date ofthe change. Prior to conversion, the Cooperative had not recorded deferredtaxes for temporary differences that were likely to be eliminated throughpatronage allocations. In recording such deferred tax assets and liabilitiesupon conversion to a corporation, the Company recorded a nonrecurring, non-cashincome tax charge of approximately $6.1 million (see Note 7).

 

The Company operates milling facilities in Carrington,North Dakota, and pasta manufacturing facilities in Carrington, North Dakotaand New Hope, Minnesota.

 

*Principlesof Consolidation*

 

The consolidated financial statements include theaccounts of the Company and Primo Piatto, Inc. (Primo), its wholly ownedsubsidiary. All significant inter-company accounts and transactions have beeneliminated in the preparation of the consolidated financial statements.

 

*Estimates*

 

The preparation of consolidated financial statementsin conformity with generally accepted accounting principles requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities at the date of the consolidated financial statements andreported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates.

 

*Reclassifications*

 

Reclassifications have been made to the financial statements as of July31, 2001 and for the years ended July 31, 2001 and 2000 to facilitatecomparability with the statements as of and for the year ended July 31, 2002.Such reclassifications have no effect on the net result of operations.

 

33

----

 

*Risksand Uncertainties*

 

The Company grants unsecured credit to certaincustomers who meet the Company’s credit requirements. Credit losses are providedfor in the financial statements. Trade accounts receivable are presented net ofallowances for cash discounts and doubtful accounts, which totaled $792,000 and$610,000 as of July 31, 2002 and 2001, respectively. At July 31, 2002, onecustomer accounted for approximately 33% of accounts receivable. One customeralso accounted for approximately 12% of revenues for the year ended July 31,2002. No customer represented greater than 10% of accounts receivable orrevenues as of and for the years ended July 31, 2001 and 2000.

 

Under the cooperative structure, durum wheatrequirements were provided through the delivery of grain pursuant to a GrowersAgreement between the Cooperative and its members. As a corporation, theCompany’s shareholders are not obligated to deliver durum for productionrequirements. The Company attempts to minimize the effects of durum wheat costfluctuations mainly through forward contracting and through agreements withcertain customers that provide for price adjustments based on raw material costchanges. Such efforts, while undertaken to attempt to minimize the risksassociated with increasing durum costs on profitability, may temporarilyprevent the Company from recognizing the benefits of declining durum prices.

 

Most of the Company’s currently outstanding debtinstruments have fixed interest rates to maturity. If the Company’s operationsrequire additional debt issuance, any changes in interest rates may have animpact on future results.

 

The Company’s cash balances are maintained in variousbank deposit accounts. The deposit accounts may exceed federally insured limitsat various times throughout the year.

 

*CommoditiesFutures Contracts*

 

Statement of Financial AccountingStandards (SFAS) No. 133, “Accounting for Derivative Instruments and HedgingActivities” was effective for the Company in fiscal 2001. The Company did notenter into any material commodities futures contracts during fiscal years 2002,2001 and 2000, and no material futures contracts were outstanding as of July 31,2002 and 2001.

 

*Impairmentof Long-Lived Assets and Long-Lived Assets to be Disposed Of*

 

The Company accounts for long-lived assets inaccordance with the provisions of SFAS No. 121, “Accounting for the Impairmentof Long-Lived Assets and for Long-Lived Assets to be Disposed Of.” Thisstatement requires that long-lived assets and certain identifiable intangiblesbe reviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. Recoverability ofassets to be held and used is measured by a comparison of the carrying amountof an asset to future net cash flows expected to be generated by the asset. Ifsuch assets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the assets exceeds thefair value of the assets. Assets to be disposed of are reported at the lower ofthe carrying amount or fair value less costs to sell.

 

*RevenueRecognition*

 

Revenues are recognized when risk of loss transfers,which occurs when goods are shipped. Pricing terms, including promotions andrebates, are final at that time. Revenues include amounts billed for productsas well as any associated shipping costs billed to deliver such products.

 

34

----

 

The Company provides allowances for annual promotionalprograms based upon annual sales volumes. Revenues are presented net ofdiscounts and allowances of $17,056,000, $17,312,000 and $20,899,000 for the yearsended July 31, 2002, 2001 and 2000, respectively.

 

*Cashand Cash Equivalents*

 

Cash and cash equivalents include cash on hand and infinancial institutions, and investments with maturities of less than 90 days.

 

*Short-termInvestments (Restricted)*

 

Short-term investments (restricted) representcertificates of deposit that are pledged as security for loans made by afinancial institution, which has restricted such investments, to officers ofthe Company to exercise stock options. These loans totaled $1,974,000 as ofJuly 31, 2002 and 2001 and mature December 1, 2002. The Company expects theseloans will be fully satisfied by the officers.

 

*Inventories*

 

Inventories are stated at the lower of cost or market,determined on a first-in, first-out (FIFO) basis, using product specificstandard costs. The major components of inventories as of July 31, 2002 and2001 are as follows (in thousands):

 
|                      |   | **2002** |   | **2001** |   |
|---------------------------|--------|----------|--------|----------|--------|
|                      |   |     |   |     |   |
| Durum                     |   | $        | 1,538  |     | $      | 2,010 |   |
| Finished goods            |   | 14,343   |   | 15,340   |   |
| Packaging and ingredients |   | 3,755    |   | 3,700    |   |
|                      |   |     |   |     |   |
|                      |   | $        | 19,636 |     | $      | 21,050 |   |

 

*Propertyand Equipment*

 

Property and equipment are stated at cost.Expenditures for renewals and improvements that significantly add to theproductive capacity or extend the useful life of an asset are capitalized.Expenditures for maintenance and repairs are charged to expense as incurred.When depreciable properties are retired or sold, the cost and relatedaccumulated depreciation are eliminated from the accounts and the resultantgain or loss is reflected in income.

 

Interest is capitalized on construction projects ofhigher cost and longer duration. Interest capitalized totaled $6,000, $112,000and $115,000 for the years ended July 31, 2002, 2001 and 2000.

 

The initial acquisition of land by the Company isstated at the estimated fair value of the land at acquisition. Subsequent landacquisitions are recorded at cost.

 

Depreciation is provided for over the estimated usefullives of the individual assets using the straight-line method. The estimateduseful lives used in the computation of depreciation expense range from 3 to 40years. Depreciation expense totaled $6,572,000, $7,003,000 and $6,702,000 forthe years ended July 31, 2002, 2001 and 2000, respectively.

 

35

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Effective August 1, 1999, the Company changed theperiod over which it depreciates certain mill and pasta production equipmentfrom 15 years to 20 years. The Company feels the change better reflects theuseful life of the related equipment and is comparable to industry practice forsimilar equipment. The change in accounting estimate increased net income forthe year ended July 31, 2000 by $917,000.

 

Details relative to property and equipment are asfollows (in thousands):

 
|                               |   | **2002** |   | **2001** |   |
|------------------------------------|--------|----------|--------|----------|--------|
|                               |   |     |   |     |   |
| Land and improvements              |   | $        | 2,865  |     | $      | 2,865 |   |
| Buildings                          |   | 22,003   |   | 21,998   |   |
| Equipment                          |   | 82,017   |   | 90,121   |   |
|                               |   |     |   |     |   |
| Property and equipment in  service |   | 106,885  |   | 114,984  |   |
| Construction in process            |   | 371      |   | 108      |   |
| Less accumulated  depreciation     |   | (35,762  | )      | (33,367  | )      |
|                               |   |     |   |     |   |
|                               |   | $        | 71,494 |     | $      | 81,725 |   |

 

*Investments in Cooperative Banks*

 

Investments in cooperative banks are stated at cost,plus unredeemed patronage refunds received in the form of capital stock.Patronage refunds estimated to be received are shown as other receivables orother assets.

 

The Company was notified of reductions in itsestimated patronage refunds from CoBank, ACB (CoBank) as well as its investmentin CoBank during fiscal year 2000. The Company has included a charge againstincome for the adjustment of its estimated patronage refunds totaling $23,000for the year ended July 31, 2000. The Company also recorded a write down of thevalue of its investment in CoBank, which includes the former St. Paul Bank forCooperatives, totaling $36,000 for the year ended July 31, 2000.

 

*Intangible Assets*

 

The Company acquired certain intangible assets for$735,000 during the third quarter of fiscal year 2002. Such intangiblesconsisted mainly of customer-based intangibles and covenants not to compete.The Company believes these assets have a finite life and, in accordance withSFAS No. 142, “Goodwill and Other Intangible Assets,” is amortizing the amountson a straight-line basis over a five-year estimated useful life. Amortizationexpense for the year ended July 31, 2002 totaled $49,000.

 

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Details relative to intangible assets are as follows(in thousands):

 
|                       |   | **2002** |    | **2001** |   |
|----------------------------|--------|----------|---------|----------|--------|
|                       |   |     |    |     |   |
| Gross Amount:              |   |     |    |     |   |
| Customer-based intangibles |   | $        | 405     |     | $      | — |   |
| Covenants not to compete   |   | 330      |    | —   |   |
|                       |   | 735      |    | —   |   |
| Accumulated Amortization:  |   |     |    |     |   |
| Customer-based intangibles |   | (27      | )       | —   |   |
| Covenants not to compete   |   | (22      | )       | —   |   |
|                       |   | (49      | )  | —   |   |
| Net:                       |   |     |    |     |   |
| Customer-based intangibles |   | 378      |    | —   |   |
| Covenants not to compete   |   | 308      |    | —   |   |
|                       |   |     |    |     |   |
|                       |   | $        | 686     |     | $      | — |   |

 

The estimated amortization expense for each of thefiscal years ending July 31 is as follows (in thousands):

 

| 2003   |   | $      | 147    |   |
|--------|--------|--------|--------|--------|
| 2004   |   | 147    |   |
| 2005   |   | 147    |   |
| 2006   |   | 147    |   |
| 2007   |   | 98     |   |
|   |   |   |   |
|   |   | $      | 686    |   |

 

*OtherAssets*

 

The Company capitalizes package design costs, whichrelate to certain third party costs to design artwork and to produce die platesand negatives necessary to manufacture and print packaging materials accordingto Company and customer specifications. These costs are amortized ratably overthree to five year periods based on estimated useful life. Minor revisions areexpensed as incurred. If a product design is discontinued or replaced prior tothe end of the amortization period, the remaining unamortized balance ischarged to expense. Package design costs are presented net of accumulatedamortization totaling $2,918,000 and $2,263,000 as of July 31, 2002 and 2001,respectively.

 

Prepaid marketing costs relate to payments made tocertain customers covering contract terms and pricing for varying periods extendingbeyond one year. These costs are amortized in proportion to sales volumes overthe term of the agreement.

 

The debt issuance costs relate to expendituresincurred in obtaining long-term debt. These costs are being amortized over theterm of the related debt based on the effective interest rate.

 

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The breakdown of other assets, net of accumulatedamortization, is as follows (in thousands):

 
|                    |   | **2002** |   | **2001** |   |
|-------------------------|--------|----------|--------|----------|--------|
|                    |   |     |   |     |   |
| Package design costs    |   | $        | 821    |     | $      | 1,265 |   |
| Prepaid marketing costs |   | 5,855    |   | 5,780    |   |
| Debt issuance costs     |   | 122      |   | 152      |   |
| Other                   |   | 149      |   | 198      |   |
|                    |   |     |   |     |   |
|                    |   | $        | 6,947  |     | $      | 7,395 |   |

 

*AccruedGrower Payments*

 

Accrued grower payments at July 31, 2001 representamounts due to growers for amounts withheld from durum purchases pursuant tothe Growers Agreement in effect under the cooperative structure. As acorporation, the Company’s shareholders are not obligated to deliver durum forproduction requirements.

 

The durum delivery system included deliveries made throughNorthern Grains Institute (NGI), a North Dakota non-profit company, through thedate of conversion to a corporation. NGI administered the delivery arrangementsand acted as each member’s grain handling and delivery agent for purposes ofsatisfying that member’s obligations under the Growers Agreement with theCooperative. NGI was responsible for arranging the logistics of durumdeliveries and handling payment and accounting matters. NGI acted only as theagent for the member, and the member retained the economic risk and legalliability for such deliveries under the Growers Agreement.

 

*AccruedLiabilities*

 

Accrued liabilities consisted of the following (inthousands):

 
|                      |   | **2002** |   | **2001** |   |
|---------------------------|--------|----------|--------|----------|--------|
|                      |   |     |   |     |   |
| Accrued promotional costs |   | $        | 1,519  |     | $      | 2,033 |   |
| Accrued interest          |   | 1,252    |   | 1,159    |   |
| Accrued freight           |   | 733      |   | 800      |   |
| Other                     |   | 1,756    |   | 1,717    |   |
|                      |   |     |   |     |   |
|                      |   | $        | 5,260  |     | $      | 5,709 |   |

 

*Shipping and Handling Costs*

 

Shipping and handling costsare included in cost of product sold upon shipment of the Company’sproduct to its customers.

 

*Advertising*

 

Costs of advertising are immaterial and expensed asincurred.

 

38

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*InterestExpense, Net*

 

The Company earns patronage refunds from itspatronage-based debt issued through cooperative banks based on its share of thenet interest income earned by the banks. These patronage refunds received orestimated to be received are applied against interest expense. The Companyrecorded a net credit to interest expense of $228,000 and $248,000 for the yearsended July 31, 2002 and 2001, respectively. The Company recorded a charge tointerest expense of $68,000 for the year ended July 31, 2000.

 

*IncomeTaxes*

 

Income taxes are provided for the tax effects oftransactions reported in the financial statements and consist of taxescurrently due plus deferred taxes. Deferred tax assets and liabilities aredetermined based on differences between the financial reporting and tax basesof assets and liabilities, and are measured using the enacted tax ratesexpected to apply when the differences are expected to reverse. Deferred taxassets and liabilities represent the future tax return consequences of thosedifferences, which will either be taxable or deductible when the assets andliabilities are recovered or settled.

 

Prior to the conversion, the Company was taxed as anon-exempt cooperative for federal income tax purposes. Business conducted withthe Cooperative’s members constituted patronage business as defined by theInternal Revenue Code. The Cooperative calculated income from patronage sourcesbased on income derived from bushels of durum delivered by Cooperative members.Non-patronage income was derived from the resale of wheat flour containingspring wheat flour purchased from non-members, the resale of pasta purchasedfrom non-members, the resale of semolina purchased from non-members, rentalincome, certain amounts of interest income, and any income taxes assessed onnon-member business.

 

The Cooperative was subject to income taxes onearnings from non-patronage sources and patronage earnings not qualified to theCooperative’s members. Cooperative organizations have 8 1⁄2 months after theirfiscal year-end to make qualified patronage allocations in the form of writtennotices of allocation or cash. As a cooperative, the provision for income taxesrelated to the results of operations from non-patronage business, state incometaxes and certain other permanent and temporary differences between financialand income tax reporting.

 

*Stockholders’Equity/Members’ Investment*

 

Under the cooperative structure, accumulatedunallocated earnings represented cumulative net income which had not beenallocated to members, while accumulated non-qualified allocated earningsrepresented earnings which had been allocated to members based on patronage butnot distributed or qualified for income tax purposes.

 

Cooperative organizations have 8 1⁄2 months after theirfiscal year-end to make patronage allocations in the form of written notices ofallocation or cash. As such, these allocations are reflected in the financialstatements in the period in which such allocations were declared by the Boardof Directors.

 

*StockOptions*

 

The Company has elected to follow AccountingPrinciples Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees”and related interpretations in accounting for its employee stock options andhas adopted the pro forma disclosure requirements under SFAS No. 123,“Accounting for Stock-Based Compensation.” The Company has not recognized anycompensation expense under APB No. 25 upon the granting or exercise of stockoptions because the exercise price is equal to or greater than the market priceof the underlying stock on the date of grant.

 

39

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*Earningsper Share*

 

The Company has presented earnings per share (EPS) forthe years ended July 31, 2002, 2001 and 2000 using the guidelines establishedin Statement of Financial Accounting Standards No. 128, “Earnings per Share.”Basic EPS is calculated by dividing net earnings on common/equity stock by theweighted average number of common/equity shares effective and outstandingduring the period. Diluted EPS includes the effect of all potentially dilutivesecurities, such as options and convertible preferred stock.

 

Dilutive securities, consisting of options andconvertible preferred stock, included in the calculation of diluted weightedaverage common/equity shares were 33,000 in fiscal 2002, 22,000 in fiscal year2001 and 59,000 in fiscal year 2000. Because the Company’s stock is only tradedin a small secondary market through private transactions, the Company hasassumed the proceeds from the exercise of stock options would reduce debt and,thus, interest expense.

 

*Recently Issued Accounting Standards*

 

In October 2001, the Financial Accounting Standards Board (FASB) issuedStatement No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.” This statement will supersede SFAS Statement No. 121, “Accounting forthe Impairment of Long-Lived Assets and for the Long-Lived Assets to BeDisposed Of”, providing one accounting model for the review of assetimpairment. Statement No. 144 retains much of the recognition and measurementprovisions of Statement No. 121, but removes goodwill from its scope. It alsorequires long-lived assets to be disposed of other than by sale to beconsidered as held and used until disposed of, requiring the depreciable lifeto be adjusted as an accounting change. Criteria to classify long-lived assetsto be disposed of by sale has changed from SFAS Statement No. 121, but thesecosts will continue to be reported at the lower of their carrying amount orfair value less cost to sell, and will cease to be depreciated. Statement 144will also supercede the section of the Accounting Principles Board (APB)Opinion No. 30, which prescribes reporting for the effects of a disposal of asegment of a business. This statement retains the basic presentation provisionsof the opinion, but requires losses on a disposal or discontinued operation tobe recognized as incurred. It also broadens the definition of a discontinuedoperation to include a component of an entity. The provisions of Statement 144are effective for financial statements issued for fiscal years beginning afterDecember 15, 2001. This statement is not expected to have a material impact onthe Company’s financial statements.

 

In July 2001, the FASB issued Statement No. 143, “Accounting for AssetRetirement Obligations.” The objective of this statement is to provideaccounting guidance for legal obligations associated with the retirement oflong-lived assets by requiring the fair value of a liability for the assetretirement obligation to be recognized in the period in which it is incurred.When the liability is initially recognized, the asset retirement costs shouldalso be capitalized by increasing the carrying amount of the related long-livedasset. The liability is then accreted to its present value each period and thecapitalized costs are depreciated over the useful life of the associated asset.This statement is effective for fiscal years beginning after June 15, 2002, andis not expected to have a material impact on the Company’s financialstatements.

 

In June 2002, the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities.” ThisStatement addresses financial accounting and reporting for costs associatedwith exit or disposal activities and nullifies Emerging Issues Task Force(EITF) Issue No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (including Certain Costs Incurredin a Restructuring).” This Statement requires that a liability for a costassociated with an exit or disposal activity be recognized when the liabilityis incurred and can be measured at fair value. The provisions of this Statementare effective prospectively for exit or disposal activities initiated afterDecember 31, 2002. The Company does not expect this statement to have amaterial impact on the financial statements.

 

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In November 2001, the Emerging Issues Task Force(“EITF”) finalized Issue No. 01-9 “Accounting for Consideration Given by aVendor to a Customer (Including a Reseller of the Vendor’s Products),” whichcodified the matters discussed in Issue No. 00-14, “Accounting for CertainSales Incentives” and Issue No. 00-25, “Vendor Income StatementCharacterization of Consideration Paid to a Reseller of the Vendor’s Products.”Issue No. 01-9 provides guidance on accounting for certain promotionalactivities, as well as the accounting for certain consideration from a vendorto an entity that resells the vendor’s products. The provisions of this EITFare effective for financial statements issued after December 15, 2001. TheCompany has accounted for promotional activities in a manner consistent withthe guidelines established under Issue No. 01-9, and the pronouncement does nothave a material impact on the Company’s financial statement reporting.

 

In December 2001, the AICPA issued SOP 01-6,“Accounting by Certain Entities (Including Entities with Trade Receivables)That Lend to or Finance the Activities of Others.” This statement addressesdisclosures on accounting policies relating to trade accounts and loansreceivable and is effective prospectively for financial statements issued forfiscal years beginning after December 15, 2001. The Company does not expectthis statement to have a material effect on the financial statements.

 

**NOTE 2 - SHORT-TERM NOTES PAYABLE**

 

The Company has a $19 million revolving creditfacility with CoBank, which matures on February 25, 2003. The revolving linehas a variable interest rate (4.06% at July 31, 2002) not to exceed CoBank’sNational Variable Rate plus 1% and is secured by property, equipment, andcurrent assets of the Company. There was no balance outstanding on the line atJuly 31, 2002. The balance outstanding as of July 31, 2001 was $8,100,000.

 

Weighted average interest rates on short-termborrowings for the years ended July 31, 2002, 2001 and 2000 are as follows:

 
|                             |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                             |   |     |   |     |   |     |   |
| Weighted average interest  rates |   | 5.12     | %      | 6.97     | %      | 7.82     | %      |

 

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**NOTE 3 - LONG-TERM DEBT**

 

Informationregarding long-term debt at July 31, 2002 and 2001 is as follows (inthousands):

 
|                                                                                                                                                                                                                                                    |   | **2002** |   | **2001** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|------------|
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Term loans from  cooperative banks due in quarterly installments of $685,000 plus interest  through December 31, 2004, interest at 8.68% to 8.76%, collateralized by  property and equipment                                                            |   | $        | 6,000  |     | $          | 6,000 |   |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Term loans from  cooperative banks due in quarterly installments of $625,000 plus interest  through December 31, 2004, variable interest on $1,125,000 (4.58% at July 31,  2002), remainder at 8.68% to 8.76%, collateralized by property and equipment |   | 6,125    |   | 7,375    |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Non-patronage term loan  from cooperative banks due in annual principal installments of $1,200,000  through September 30, 2008, interest at 5.71%, collateralized by property and  equipment                                                            |   | 8,400    |   | 9,600    |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Senior Secured Guaranteed  Notes, Series A, due in annual principal installments of $2,571,000  commencing August 1, 2002 through August 1, 2008, interest at 8.04%,  collateralized by property and equipment                                          |   | 18,000   |   | 18,000   |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Senior Secured Guaranteed  Notes, Series B, due in annual principal installments of $1,000,000  commencing August 1, 2002 through August 1, 2010, interest at 8.14%,  collateralized by property and equipment                                          |   | 9,000    |   | 9,000    |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Capital lease, three year  term through March 1, 2002, Imputed interest at 9.1%                                                                                                                                                                         |   | —   |   | 124      |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Term loan from the City of  Carrington, due in monthly installments through April 2003, interest rate of  4%                                                                                                                                            |   | 49       |   | 112      |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Convertible debt from  Northern Plains Cooperative, due in annual installments through 2003,  non-interest bearing                                                                                                                                      |   | 10       |   | 20       |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Convertible debt from  Dakota Central Telecommunications, due in annual installments through 2003,  non-interest bearing                                                                                                                                |   | 10       |   | 20       |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Total long-term debt                                                                                                                                                                                                                                    |   | 47,594   |   | 50,251   |       |
| Less current portion                                                                                                                                                                                                                                    |   | 9,320    |   | 2,657    |       |
|                                                                                                                                                                                                                                                    |   |     |   |     |       |
| Net long-term debt                                                                                                                                                                                                                                      |   | $        | 38,274 |     | $          | 47,594 |   |

 

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As of July 31, 2002, the Company has prepaid $760,000,or approximately one quarterly installment on one term loan due to CoBank. Theprepayment amount is reflected in the aggregate future maturities schedulepresent herein.

 

Aggregate future maturities required on long-term debtare as follows (in thousands):

 
| **Years ending July 31,** |   |   |   |
|---------------------------|--------|--------|--------|
|                      |   |   |   |
| 2003                      |   | $      | 9,320  |   |
| 2004                      |   | 10,011 |   |
| 2005                      |   | 7,176  |   |
| 2006                      |   | 4,771  |   |
| 2007                      |   | 4,771  |   |
| Thereafter                |   | 11,545 |   |
|                      |   |   |   |
|                      |   | $      | 47,594 |   |

 

The Company has an $8,400,000 letter of creditcommitment with CoBank, securing the non-patronage loan from CoBank. The letterof credit commitment is subject to a commitment fee of 1.0% on an annualizedbasis and expires December 31, 2008. Advances on the letter of creditcommitment are payable on demand.

 

The Company’s loan agreements with its lenders contain certaincovenants related to, among other matters, the maintenance of certain workingcapital, leverage, and debt service ratios and a minimum net worth requirement.The Company was in compliance with these loan covenants (as amended) as of July31, 2002. The Company entered into a Waiver and Second Amendment to the NotePurchase Agreement and Notes effective June 1, 2001. The Notes were amendedsuch that the rate of interest on the unpaid balance was increased by onepercent at any time that either (a) the ratio of the Company’s consolidatedfunded debt to consolidated cash flow is greater than 3.00 to 1.00 as of theend of each fiscal quarter for the immediately preceding four fiscal quartersor (b) the Securities Valuation Office of the National Association of InsuranceCommissioners has not assigned a designation category of “1” or “2” to theNotes. The one percent interest rate increase became effective August 1, 2001,amending the interest rate on the Series A Notes to 8.04% and the interest rateon the Series B Notes to 8.14% pursuant to the above.

 

The Company has convertible debt related to twonon-interest bearing notes with annual installments of $10,000 each. Per theloan agreements, from March 1, 1995 through February 1, 2003, the Company shallhave the privilege of converting the unpaid balance of indebtedness into seriesB preferred stock. The holders of the debt do not have the option to convertthis debt.

 

The Company incurred $4,099,000, $4,508,000 and$4,569,000 of interest on long and short-term debt and other obligations infiscal years 2002, 2001 and 2000, respectively, of which $6,000, $112,000 and$115,000 was capitalized in the respective periods. Patronage income fromcooperative banks of $228,000 and $248,000 was netted against interest expenseon the statement of operations for the years ended July 31, 2002 and 2001,respectively. A charge from cooperative banks of $68,000 was included ininterest expense in fiscal year 2000.

 

**NOTE 4 - STOCKHOLDERS’ EQUITY**

 

Following the conversion from a cooperative to acorporation, the Company is authorized to issue 75,000,000 shares of CommonStock, $.01 par value per share, 533 shares of Series A Preferred Stock, $100par value per share, 525****shares of Series B Preferred Stock, $100par value per share, 2,045 shares of Series C Preferred Stock, $100 par valueper share, 11,324,377 shares of Series D Delivery Preferred Stock, $.01 parvalue per share,

 

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130,000 shares of Series E Junior ParticipatingPreferred Stock, $.01 par value per share, and 13,672,520****shares of undesignated preferredstock, $.01 par value per share.

 

As a result of the mergers undertaken to effect thechange from a cooperative to a corporation, members of the Cooperativereceived: (i) twenty-five shares of Common Stock of the Company for each shareof the Cooperative’s Membership Stock they held as of the effective date of theconversion; (ii) a number of shares of Common Stock, $.01 par value per share,of the Company equal to the number of shares of the Cooperative’s Equity Stockthey held as of the effective date of the conversion; (iii) a number of sharesof Series D Delivery Preferred Stock, $.01 par value per share, of the Companyequal to the number of shares of the Cooperative’s Equity Stock they held as ofthe effective date of the conversion; and (iv) one share of Common Stock of theCompany for each $7.36 of Non-Qualified Written Notices of Allocation held inthe member’s name on the records of the Cooperative. To the extent thatshareholders of the Cooperative held Series A Preferred Stock or Series B PreferredStock of the Cooperative as of the effective date of the conversion, theyreceived a number of shares of Series A Preferred Stock or Series B PreferredStock, as applicable, of the Company equal to the number of shares of theCooperative’s Series A Preferred Stock or Series B Preferred Stock, asapplicable, held as of such effective date. Persons who held options to acquireSeries C Preferred Stock of the Cooperative had those options convertedautomatically into options containing the same terms with regard to Series CPreferred Stock of the Company.

 

Prior to the conversion, under the terms of theCooperative’s bylaws, the Cooperative’s net income, determined in accordancewith generally accepted accounting principles consistently applied, was distributedannually based on the volume of patronage business (bushels of durum delivered,which approximates one bushel of durum per equity share). The distribution wasin the form of cash or credits to each member-producer’s patronage creditaccount, which was established on the books of the Cooperative as determined bythe Board of Directors. Equity requirements of the Cooperative could beretained as unallocated earnings, or retained from amounts due to patrons andcredited to members’ investments in the form of unit retains or undistributedallocated patronage. In the event of a net loss in any fiscal year under thecooperative structure, the Cooperative could first offset the net loss againstany earned unallocated surplus. If the net loss exceeded the earned unallocatedsurplus, the Cooperative could elect to recover the net loss from prior orsubsequent years net margins or savings.

 

Prior to conversion to a corporation, the net incomeallocable to patronage business totaled $6,137,000 and $7,134,000 for the yearsended July 31, 2002 and 2000, respectively. The net loss allocable to patronagebusiness totaled $1,542,000 for the year ended July 31, 2001.

 

In April 2002, the Cooperative’s Board of Directorsauthorized a non-qualified patronage allocation of $4,586,000 representing thepatronage earnings as a cooperative for fiscal 2002 offset by the patronage netloss for fiscal year 2001.

 

The Board of Directors of the Cooperative authorized aqualified patronage allocation of $4,466,000 ($.4284 per bushel acquired or$.40 per average outstanding equity share) for fiscal year 2000 at its November2000 meeting. The total qualified patronage allocation was paid in cash onNovember 30, 2000. The Board also voted to allocate, on a non-qualified basis,the remainder of the fiscal 2000 patronage earnings totaling $2,665,000. Intaking these actions, the Board of Directors rescinded the patronageallocations authorized at the October 2000 meeting as reported in the Company’sForm 10-K for the year ended July 31, 2000.

 

The Board of Directors of the Cooperative authorized aqualified patronage allocation of $5,787,000 ($.70 per bushel) and declared adividend on equity stock of $.10 per share in October 1999. In addition, theBoard voted to allocate the $3,429,000 cumulative effect of the change inaccounting principle proportionately against prior non-qualified, allocatedaccumulated earnings. The qualified patronage allocation and dividendauthorized in October 1999 were rescinded by the Board at the January 2000 meetingin response to the reclassification of $2,000,000 of

 

44

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income from nonpatronage to patronage for the yearended July 31, 1999. The Board then voted to qualify and allocate $7,358,000($.89 per bushel acquired or $.86 per average outstanding equity share) of therevised core patronage income for fiscal year 1999. The total qualifiedpatronage allocation was paid in cash, of which a portion was paid in November1999 and the remainder in January 2000. The Board also voted to allocate, on anon-qualified basis, the remainder of the fiscal 1999 patronage earnings beforecumulative effect of the change in accounting principle, which totaled$464,000.

 

Holders of Series C PreferredStock shall receive payment of a non-cumulative annual dividend at the rate of6% of the $100 par value on each share of Series C Preferred Stock. Each shareof Series C Preferred Stock is convertible into 24 shares of Common Stock and24 shares of Series D Delivery Preferred Stock of the Company. The conversionratio shall be proportionately adjusted at any time the outstanding shares ofCommon Stock are increased or decreased without payment by or to the Company orthe Company’s shareholders.

 

Each share of Series D Delivery Preferred Stock of theCompany gives its holder the privilege, but not the obligation, to deliver onebushel of durum wheat to the Company each year on a “first-come, first-served”basis. Because the privilege of a holder of Series D Delivery Preferred Stock todeliver durum wheat to the Company only arises if the Company requires durum,the privilege is not absolute. Holders ofSeries D Delivery Preferred Stock will be entitled to receive, if and whendeclared by the Board of Directors, a non-cumulative annual dividend of up to$.04 per share on each share of Series D Delivery Preferred Stock held by suchholder.  The Company must pay holders ofSeries D Delivery Preferred Stock a dividend of at least $.01 per share beforepaying any dividends on Common Stock.

 

The Board of Directors of the Company adopted a Rights Plan that becameeffective upon consummation of the conversion. Under the Rights Plan, the Boardof Directors of the Company has declared a dividend of one purchase right (a“Right”) for each outstanding share of Common Stock held of record immediatelyfollowing the conversion.  Each Rightwill entitle the holder to purchase from the Company one-hundredth of one shareof Series E Junior Participating Preferred Stock at a specified price, subjectto certain adjustments. The Rights will not become exercisable, and will not betransferable apart from the Company’s shares of Common Stock, until a person orgroup has acquired 15% or more of the Company’s Common Stock or has commenced atender or exchange offer for 15% or more of the Company’s Common Stock.  In those events, each Right will entitle theholder (other than the acquiring person or group) to receive, upon exercise,common shares of either the Company or the acquiring company having value equalto two times the exercise price of the Right. The Rights issued under theRights Plan will be redeemable by the Company’s Board of Directors in certaincircumstances and will expire ten years from the date of adoption.

 

**NOTE 5 - REDEEMABLE PREFERRED STOCK**

 

The Cooperative issued 800 shares of Series APreferred Stock in fiscal 2000, of which 333 shares had been redeemed as ofJuly 31, 2002. Each share of Series A Preferred Stock entitles its holder toreceive a cumulative annual dividend of 6% of the $100 par value per share. TheSeries A Preferred Stock is scheduled to be redeemed ratably on a quarterlybasis through December 2005.

 

Each share of Series B Preferred Stock entitles itsholder to receive a non-cumulative annual dividend of 2% of the $100 par valueper share when and as declared by the Board of Directors. 450 shares of theSeries B Preferred Stock were redeemed in fiscal year 2002. The 75 shares ofoutstanding Series B Preferred Stock may be redeemed, in whole or in part, atthe option of the Company at any time at the redemption price of $100 pershare, plus any declared but unpaid dividends. The holder may require theCompany to redeem all or a said portion of the shares for $100 per share, plusany declared but unpaid dividends.

 

45

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**NOTE 6 - EMPLOYEE BENEFIT PLANS**

 

Dakota Growers Pasta Company, Inc. and Primo Piatto,Inc. have a 401(k) plan that covers employees who have met age and servicerequirements. The plan covers employees who have reached 21 years of age andcompleted six months of service as defined in the plan document. The Companymatches 100% on the first 2% of the employees’ elected deferral, 50% on thenext 1%, and 25% on the next 4%. Employer contributions to the plan totaled$319,000, $342,000 and $291,000 for the years ended July 31, 2002, 2001 and2000, respectively.

 

Primo Piatto, Inc. is also required to contribute to amulti-employer pension plan covering certain hourly employees subject to acollective bargaining agreement. Such employees may also participate in the401(k) plan but are excluded from amounts contributed by Primo. Contributionsfor the years ended July 31, 2002, 2001 and 2000 totaled $72,000, $99,000 and$74,000, respectively.

 

**NOTE 7 - INCOME TAXES**

 

The conversion from a cooperative to a corporationeffectuated via a series of mergers is treated under Code Section 368(a)(1)(F)as a reorganization. A corporation that survives a reorganization defined inCode Section 368(a)(1)(F) is treated for tax purposes as a continuation of itspredecessor, accordingly, the Company will retain the fiscal year, accountingmethods, tax elections and other tax attributes of the Cooperative.  However, because it will not operate on acooperative basis after the conversion, the Company will be taxable as a “Ccorporation.” As such, it will no longer pay deductible patronage dividends andany distributions to the shareholders will be treated as nondeductibledividends.

 

The Cooperative was a non-exempt cooperative asdefined by Section 1381(a)(2) of the Internal Revenue Code. Accordingly, netmargins from business done with member patrons, which were allocated and paidas prescribed in Section 1382 of the Code (hereafter referred to as“qualified”), were taxable to the members and not to the Cooperative. Netmargins and member allocations were determined on the basis of accounting usedfor financial reporting purposes. To the extent that net margins were notqualified as stated above or arose from business done with non-members, theCooperative had taxable income subject to corporate income tax rates.

 

Upon conversion to a corporation, the Company recordeddeferred tax assets and liabilities for the tax effects of any temporarydifferences existing between income tax and financial reporting on the date ofthe change. Prior to conversion, the Cooperative had not recorded deferredtaxes for temporary differences that were likely to be eliminated throughpatronage allocations. In recording such deferred tax assets and liabilitiesupon conversion to a corporation, the Company recorded a nonrecurring, non-cashincome tax charge of $6,105,000.

 

46

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Significant components of the Company’s deferred taxassets and liabilities as of July 31, 2002 and 2001 related to temporarydifferences are as follows (in thousands):

 
|                                          |   | **2002** |   | **2001** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|
|                                          |   |     |   |     |   |
| Deferred tax assets                           |   |     |   |     |   |
| AMT  credit carryforward                      |   | $        | 831    |     | $      | 20 |   |
| Nonpatronage net operating  loss carryforward |   | —   |   | 266      |   |
| Accounts receivable  allowances               |   | 237      |   | —   |   |
| Accrued expenses and other  reserves          |   | 323      |   | —   |   |
|                                          |   | 1,391    |   | 286      |   |
| Less valuation allowance                      |   | —   |   | (286     | )      |
|                                          |   |     |   |     |   |
| Total deferred tax assets                     |   | 1,391    |   | —   |   |
|                                          |   |     |   |     |   |
| Deferred tax liabilities                      |   |     |   |     |   |
| Property and equipment                        |   | (10,758  | )      | (3,777   | )      |
|                                          |   |     |   |     |   |
| Net deferred tax  liabilities                 |   | $        | (9,367 | )        | $      | (3,777 | ) |

 

Classified in the accompanying balance sheets as follows:

 
|                          |   | **2002** |   | **2001** |   |
|-------------------------------|--------|----------|--------|----------|--------|
|                          |   |     |   |     |   |
| Current assets                |   | $        | 466    |     | $      | — |   |
| Noncurrent liabilities        |   | (9,833   | )      | (3,777   | )      |
|                          |   |     |   |     |   |
| Net deferred tax  liabilities |   | $        | (9,367 | )        | $      | (3,777 | ) |

 

The Company has an AMT credit carryforward of $831,000 at July 31,2002, which may be carried forward indefinitely. Management believes it is morelikely than not that the deferred tax assets as of July 31, 2002 will berealized through the generation of future taxable income and tax planningstrategies.

 

Income tax expense (benefit) consists of the following(in thousands):

 
|                                                                                 |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                                                 |   |     |   |     |   |     |   |
| Current income tax expense  (benefit)                                                |   | $        | 1,792  |     | $      | 7        |   | $ | (407 | ) |
| Deferred income taxes                                                                |   | (515     | )      | (318     | )      | (891     | )      |
|                                                                                 |   | 1,277    |   | (311     | )      | (1,298   | )      |
| Charge to record deferred  taxes upon conversion from a cooperative to a corporation |   | 6,105    |   | —   |   | —   |   |
|                                                                                 |   |     |   |     |   |     |   |
| Income tax expense  (benefit)                                                        |   | $        | 7,382  |     | $      | (311     | )      | $ | (1,298 | ) |

 

The current income tax benefit for the year ended July31, 2000 relates primarily to an overaccrual of income taxes for the year endedJuly 31, 1999. $2,000,000 of income relating to the year ended July 31, 1999was reclassified from nonpatronage to patronage based on cooperative income taxdevelopments taking place in the second quarter of fiscal year 2000, subsequentto the publishing of the July 31, 1999 financial statements.

 

47

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The reconciliation of the federal statutory income taxrate to the effective income tax rate for the years ended July 31, 2002, 2001and 2000 is as follows:

 
|                                                                                 |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                                                 |   |     |   |     |   |     |   |
| Federal  statutory income tax rate                                                   |   | 34.0     | %      | (34.0    | )%     | 34.0     | %      |
| Adjustment of prior year  accrual                                                    |   | —   |   | —   |   | (6.9     | )      |
| State income tax expense,  net of federal income tax benefit                         |   | 5.0      |   | (5.0     | )      | 5.0      |   |
| Patronage (earnings) loss                                                            |   | (25.1    | )      | 34.5     |   | (39.0    | )      |
| Adjustment of deferred  taxes (patronage versus nonpatronage use of property)        |   | —   |   | (15.2    | )      | (13.6    | )      |
| Charge to record deferred  taxes upon conversion from a cooperative to a corporation |   | 66.0     |   | —   |   | —   |   |
| Other (net)                                                                          |   | 0.2      |   | 4.9      |   | —   |   |
|                                                                                 |   |     |   |     |   |     |   |
| Effective income tax rate                                                            |   | 80.1     | %      | (14.8    | )%     | (20.5    | )%     |

 

**NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The fair value of a financial instrument is generallydefined as the amount at which the instrument could be exchanged in a currenttransaction between willing parties, other than in a forced liquidation sale.Quoted market prices are generally not available for the Company’s financialinstruments. Accordingly, fair values are based on judgments regardinganticipated cash flows, future expected loss experience, current economicconditions, risk characteristics of various financial instruments and otherfactors. These estimates involve uncertainties and matters of judgment, and thereforecannot be determined with precision. Changes in assumptions could significantlyaffect the estimates.

 

The carrying amount of cash and cash equivalents,receivables, payables, short-term debt and other current liabilitiesapproximates fair value because of the short maturity and/or frequent repricingof those instruments.

 

The Company believes it is not practical to estimatethe fair value of the securities of non-subsidiary cooperatives withoutincurring excessive costs because there is no established market for thesesecurities and it is inappropriate to estimate future cash flows, which arelargely dependent on future patronage earnings of the non-subsidiarycooperatives.

 

Based upon current borrowing rates with similarmaturities, the fair value of the long-term debt and capital leasesapproximates the carrying value as of July 31, 2002 and 2001.

 

48

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**NOTE 9 -OPERATING LEASES**

 

The Company leases various items of equipment,primarily rail cars, pasta equipment, forklifts and computers.

 

Future obligations for the above leases for the fiscalyears ended July 31 are as follows (in thousands):

 

| 2003   |   | $      | 1,404  |   |
|--------|--------|--------|--------|--------|
| 2004   |   | 1,040  |   |
| 2005   |   | 953    |   |
| 2006   |   | 875    |   |
| 2007   |   | 576    |   |
|   |   |   |   |
|   |   | $      | 4,848  |   |

 

Lease expense totaled $1,014,000, $988,000 and$907,000 for the years ended July 31, 2002, 2001 and 2000, respectively.

 

**NOTE 10 - SALE-LEASEBACK**

 

The Company entered into a sale-leasebacktransaction effective March 29, 2002, for certain pasta production equipment.Proceeds from the sale totaled $5 million. The lease, which is classified asoperating, sets forth an initial term of five years and calls for leasepayments of $72,000 per month. At the end of the initial lease term, theCompany may renew the lease at fair rental value, terminate the lease andsurrender the equipment with the payment of a 10% of equipment cost remarketingfee, or purchase the equipment for $1,750,000. The Company realized a gain on the sale of $255,000, which was deferredand will be amortized in proportion to the gross rentals charged to expenseover the five-year lease term. Minimum rentals required under the lease, whichare also included in the future lease obligations disclosed in Note 9, forfiscal years ending July 31 are as follows (in thousands):

 

| 2003   |   | $      | 863    |   |
|--------|--------|--------|--------|--------|
| 2004   |   | 863    |   |
| 2005   |   | 863    |   |
| 2006   |   | 863    |   |
| 2007   |   | 576    |   |
|   |   |   |   |
|   |   | $      | 4,028  |   |

 

**NOTE 11 - COMMITMENTS AND CONTINGENCIES**

 

The Company forward contracts for a certain portion ofits future durum wheat requirements. At July 31, 2002, the Company hadoutstanding commitments for grain purchases totaling $5,356,000 related toforward purchase contracts. These contracts are set price contracts to delivergrain to the Company’s mill, and are not derivative in nature as they have nonet settlement provision and are not transferable.

 

Pursuant to a warehouse agreement with Sky Logistics& Distribution, Inc. (Sky), the Company is obligated to minimum monthlystorage and handling volumes totaling approximately $1.3 million for fiscalyears 2003 and 2004. This agreement expires October 31, 2004. The Company hasalso transferred the obligation for a certain building lease to Sky. If Skywere unable to perform under the existing lease, the Company would be obligatedto make payments under this lease over the remaining term. Current monthlypayments under this lease total approximately $67,000, and the lease expiresApril 30, 2004.

 

49

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The Company has entered into long-term marketingagreements, which include volume and pricing commitments, with U.S. Foodserviceand Safeway, Inc. through December 31, 2006 and August 31, 2006, respectively.The Company entered into a co-packing agreement with New World Pasta Company,which includes co-pack product volume and pricing commitments. The Company hasalso entered into an agreement with Gruppo Euricom (“EU”), an Italian pastamanufacturer, to be the exclusive distributor of EU’s Italian pasta and riceproducts in the United States and Canada with an initial term through August2006. These products are primarily sold in the private label retail andfoodservice markets.

 

As of July 31, 2002, the Company has commitments topay $5.0 million under long-term customer marketing agreements at various timesthrough December 31, 2002.

 

The Company is subject to various lawsuits and claimswhich arise in the ordinary course of its business. While the results of suchlitigation and claims cannot be predicted with certainty, management believesthe disposition of all such proceedings, individually or in aggregate, shouldnot have a material adverse effect on the Company’s financial position, resultsof operations or cash flows

 

**NOTE 12 - STOCK OPTION PLAN**

 

On January 31, 1997 the Cooperative’s CompensationCommittee of the Board of Directors (the “Compensation Committee”) adopted theDakota Growers Incentive Stock Option Plan (the “Plan”). The purpose of thePlan is to provide benefits to participants in the form of additionalcompensation for services which have been or will be rendered as an inducementfor continuing as employees of the Company. The Plan was ratified by theCooperative members at the annual meeting in January 1998.

 

The Compensation Committee administers the Plan. TheCompensation Committee or the Board of Directors has the power to determine thekey management employees of the Company to receive options and the number ofshares to be optioned to each of the employees.

 

Options granted under the Plan are for the purchase ofSeries C Convertible Preferred Stock at fair market value, which wereconvertible into Equity Stock as a cooperative, and are now convertible intoCommon Stock and Series D Delivery Preferred Stock as a corporation at theoption of the employee, under the applicable conversion ratio. The maximumnumber of preferred shares that may be issued pursuant to options granted underthe Plan is fifteen thousand (15,000), of which 14,314 have been issued as ofJuly 31, 2002.

 

Each share of Series C PreferredStock is convertible into 24 shares of Common Stock and 24 shares of Series DDelivery Preferred Stock of the Company. The conversion ratio isproportionately adjusted if the Company increases the outstanding shares ofCommon Stock or Series D Delivery Preferred Stock, as applicable, without payment by or to the Company or the Company’sshareholders for such additional shares (e.g. stock split, stockdividend or other action).

 

Options granted under this Plan must be exercisedwithin ten years from the date such options are granted. Options areexercisable only by the employee during the employee’s lifetime. In the eventof the employee’s termination with the Company, all exercisable options may beexercised within 90 days of the termination date. If not exercised, suchoptions lapse. The employee must sell or dispose of the Series C PreferredStock, or if converted, the related Common Stock or Series D Delivery PreferredStock, within 15 months from the date of employment termination.

 

If the preferred stock is changed into another kind ofcapital stock or debt as a result of any capital reorganization,reclassification or any merger or consolidation with another entity in whichthe Company is not the surviving

 

50

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entity, the option entitles the employee to acquire,upon exercise, the kind and number of shares of stock or other securities orproperty to which the employee would have been entitled if he had held thepreferred stock issuable upon the exercise of this option immediately prior tosuch capital reorganization, reclassification, merger or consolidation.

 

The following table sets out information on options outstanding andexercisable:

 
|                          |   | **Number of  Shares** |   | **Option  Price  per Share** |   | **Weighted  Average  Exercise  Price** |   | **Exercisable** |   |
|-------------------------------|--------|-----------------------|--------|------------------------------|--------|----------------------------------------|--------|-----------------|--------|
|                          |   |                  |   |                         |   |                                   |   |            |   |
| Outstanding at July 31,  1999 |   | 3,045                 |   | $100 - $150                  |   | $                                      | 108.84 |            | 958    |   |
| Exercised                     |   | (7,412                | )      | $150 - $180                  |   | $                                      | 176.12 |            |   |   |
| Granted                       |   | 8,142                 |   | $180                         |   | $                                      | 180.00 |            |   |   |
| Canceled/Expired              |   | (3,775                | )      | $100 - $180                  |   | $                                      | 157.95 |            |   |   |
|                          |   |                  |   |                         |   |                                   |   |            |   |
| Outstanding at July 31,  2000 |   | —                |   |                         |   |                                   |   |            |   |
| Exercised                     |   | —                |   |                         |   |                                   |   |            |   |
| Granted                       |   | —                |   |                         |   |                                   |   |            |   |
| Canceled/Expired              |   | —                |   |                         |   |                                   |   |            |   |
|                          |   |                  |   |                         |   |                                   |   |            |   |
| Outstanding at July 31,  2001 |   | —                |   |                         |   |                                   |   |            |   |
| Exercised                     |   | —                |   |                         |   |                                   |   |            |   |
| Granted                       |   | 2,045                 |   | $100                         |   | $                                      | 100.00 |            |   |   |
| Canceled/Expired              |   | —                |   |                         |   |                                   |   |            |   |
|                          |   |                  |   |                         |   |                                   |   |            |   |
| Outstanding at July 31,  2002 |   | 2,045                 |   | $100                         |   | $                                      | 100.00 |            | 2,045  |   |

 

The options unexercised at July 31, 2002 are scheduled to expire onDecember 1, 2011. The Company applies APB No. 25 in accounting for employeestock options. Accordingly, no compensation expense was recorded during theyears ended July 31, 2002, 2001 and 2000 related to the issuance or exercise ofstock options. The fair value of the stock options granted during 2002 and 2000was estimated at the date of grant using the Black-Scholes option pricing modelwith the following weighted average assumptions (excluding a volatilityassumption): 2002 - risk free interest rate of 3.6%, expected dividend yield ofzero and an expected life of 3 years; 2000 - risk free interest rate of 6.0%,expected dividend yield of zero and an expected life of 3 years. The pro formaapplication of Statement of Financial Accounting Standard (SFAS) No. 123“Accounting for Stock-Based Compensation” would not have had a material impacton net income and earnings per share for the periods presented.

 

**NOTE 13 - RELATED PARTY TRANSACTIONS**

 

Priorto the conversion to a corporation, each of the Cooperative’s directors and those officers who held membershipin the Cooperative were alsoagricultural producers and members of the Cooperative.  Byvirtue of their membership status and ownership of cooperative Equity Stock,each such director and officer was obligated to deliver durum wheat to the Cooperative. However, the amount and terms of the paymentsreceived by those directors and officers (or the entities they represent) weremade on exactly the same basis as those received by other members of the Cooperative for the delivery of their durum wheat.

 

The Company has advanced funds to certain officers under promissory agreements tocover personal (unaudited) alternative minimum taxes and other costs generatedas a result of these officers exercising stock options. Interest

 

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on the advances is charged at the applicablefederal rate as published by the Internal Revenue Service. Amounts due fromofficers as of July 31, 2002 and 2001 totaled $190,000 and $163,000,respectively.

 

**NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED)**

 

Summary quarterly results are as follows (inthousands, except per share amounts):

 
|                                               |   | **First  Quarter** |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   |
|----------------------------------------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|
|                                               |   |               |   |                |   |               |   |                |   |
| Year ended July 31, 2002:                          |   |               |   |                |   |               |   |                |   |
|                                               |   |               |   |                |   |               |   |                |   |
| Net revenues                                       |   | $                  | 37,546 |                | $      | 37,020             |   | $                   | 37,668 |   | $ | 40,231 |   |
| Gross profit                                       |   | 5,904              |   | 4,997               |   | 5,654              |   | 5,408               |   |
| Operating income                                   |   | 3,475              |   | 2,616               |   | 3,180              |   | 3,310               |   |
| Net income (loss)                                  |   | 2,558              |   | 1,733               |   | 2,204              |   | (4,661              | )      |
| Basic net earnings (loss)  per common/equity share |   | 0.23               |   | 0.15                |   | 0.20               |   | (0.40               | )      |
|                                               |   |               |   |                |   |               |   |                |   |
| Year ended July 31, 2001:                          |   |               |   |                |   |               |   |                |   |
|                                               |   |               |   |                |   |               |   |                |   |
| Net revenues                                       |   | $                  | 33,283 |                | $      | 31,632             |   | $                   | 34,100 |   | $ | 36,906 |   |
| Gross profit                                       |   | 2,336              |   | 1,622               |   | 1,978              |   | 5,174               |   |
| Operating income (loss)                            |   | (267               | )      | (847                | )      | (280               | )      | 2,873               |   |
| Net income (loss)                                  |   | (1,102             | )      | (1,783              | )      | (1,012             | )      | 2,113               |   |
| Basic net earnings (loss)  per common/equity share |   | (0.10              | )      | (0.16               | )      | (0.09              | )      | 0.19                |   |

 

The above quarterly financial data is unaudited,but in the opinion of management, all adjustments necessary for a fairpresentation of the selected data for these interim periods presented have beenincluded. A non-cash, nonrecurring charge of $6.1 million to record deferredtaxes upon conversion from a cooperative to a corporation was recorded in thefourth quarter of fiscal year 2002.

 

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**ITEM 9.****                        DISAGREEMENTSON ACCOUNTING AND FINANCIAL DISCLOSURE.**

 

None.

 

**PART III.**

 

**ITEM 10.****                 DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

**Board ofDirectors**

 

The Board of Directors consists of nine directors,each of whom was previously a director of the Cooperative. The Board of Directors is divided into threeclasses: Class I, Class II and Class III. There is an equal number ofdirectors in each of Class I, Class II and Class III, except that, if the Boardof Directors consists of a number of directors such that mathematically therecannot be a equal number of directors in each of Class I, Class II and ClassIII, then the one remaining director shall be made a member of Class I and, ifthere is more than one remaining director, the first remaining director shallbe made a member of Class I and the second remaining director shall be made amember of Class II.  Each director ineach of Class I, Class II and Class III will hold office until the thirdregular meeting of shareholders following the regular meeting of theshareholders at which such director or such director’s predecessor was elected,until his successor shall have been elected and shall qualify, or until heresigns or is removed.  Each initialdirector who is a member of Class I shall hold office until the Company’sregular meeting of shareholders in 2003, each initial director who is a memberof Class II shall hold office until the Company’s regular meeting ofshareholders in 2004 and each initial director who is a member of Class IIIshall hold office until the Company’s regular meeting in 2005.

 

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The table below sets forth certain informationconcerning the directors of the Company. The directors have been elected toserve three-year terms expiring at the annual meeting in the calendar yearsindicated in the table below.

 
| **Name**                |   | **Age** |   | **Term  Expires** |   |
|-------------------------|--------|---------|--------|-------------------|--------|
|                    |   |    |   |              |   |
| John  S. Dalrymple, III |   | 54      |   | 2003              |   |
|                    |   |    |   |              |   |
| Allyn K. Hart           |   | 63      |   | 2005              |   |
|                    |   |    |   |              |   |
| Roger A. Kenner         |   | 53      |   | 2004              |   |
|                    |   |    |   |              |   |
| James F. Link           |   | 75      |   | 2003              |   |
|                    |   |    |   |              |   |
| Eugene J. Nicholas      |   | 57      |   | 2004              |   |
|                    |   |    |   |              |   |
| John D. Rice, Jr.       |   | 48      |   | 2003              |   |
|                    |   |    |   |              |   |
| Jeffrey O. Topp         |   | 43      |   | 2004              |   |
|                    |   |    |   |              |   |
| Curtis R. Trulson       |   | 50      |   | 2005              |   |
|                    |   |    |   |              |   |
| Michael E. Warner       |   | 52      |   | 2005              |   |

 

**John S. Dalrymple III.**  Mr.Dalrymple has been Chairman of the Board of Directors since 1991. He becameLieutenant Governor of North Dakota in 2000. Mr. Dalrymple had been a staterepresentative since 1984 and served as Chairman of the House AppropriationsCommittee and of the Budget Section of the North Dakota House ofRepresentatives. He previously served on the board of directors of Spring WheatBakers and the U.S. Durum Growers Association. He has been a farmer in theCasselton area since 1971.  Heserves on the board of directors of the U.S. Chamber of Commerce.

 

**Allyn K. Hart.**  Mr. Hart has been a director of the Company since 1991. He hasbeen a farmer in the Cavalier County area since 1961.

 

**Roger A. Kenner.**  Mr. Kenner has been adirector of the Company since 1991. Mr. Kenner is chairman of Golden PlainsFrozen Foods LLC and is a director of Blue Cross Blue Shield of North Dakota.He has been a farmer and certified seed producer in the Leeds area since 1964.

 

**James F. Link.**  Mr. Link has been a directorof the Company since 1991. Mr. Link has served on the boards of directors ofFarm Credit and Minn-Dak Farmers cooperative, including 15 years as itschairman.  Mr. Link served on thePro-Gold high-fructose corn plant development committee. He has been a farmerin the Wahpeton area since 1947.

 

**Eugene J. Nicholas.**  Mr.Nicholas has been a director of the Company since 1991.  Mr. Nicholas has been a state representativesince 1974, and serves as chairman of the North Dakota House of RepresentativesAgriculture Committee. Mr. Nicholas also serves on the board of directors ofCountry Bank USA, Cando, North Dakota, and the board of governors of GoldenPlains Frozen Foods LLC. Mr. Nicholas previously served on the board ofdirectors of the U.S. Durum Growers Association.

 

**John D. Rice, Jr.**  Mr. Rice is the vice-chairmanof the Board of Directors and has been a director of the Company since1991.  He also served on the boards ofdirectors of National Pasta Association and U.S. Durum Growers Association. Hehas been a farmer in the Maddock, North Dakota area since 1968.

 

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**Jeffrey O. Topp.** Mr. Topp has been a directorof the Company since 1991. He serveson the board of directors of Farmers Elevator, Inc. in Grace City, NorthDakota. He is a partner in T-T Ranch and has been a farmer in the Grace Cityarea since 1978.

 

**Curtis R. Trulson.** Mr.Trulson has been a director of the Company since 1991. He previously served onthe boards of directors of the National Association of Wheat Growers and theNorth Dakota Grain Growers Association including service as its President.  He has been a farmer in Mountrail County,North Dakota, since 1975.

 

**Michael E. Warner.**  Mr.Warner has been a director of the Company since 1992. Mr. Warner has been afarmer in the Hillsboro, North Dakota area since 1967. Mr. Warner is chairman ofthe board of directors of Spring Wheat Bakers. He serves on the board ofdirectors of Warner Equipment Co., and as a  trustee of Meritcare Health Systems of Fargo, North Dakota. Mr. Warnerserved on the board of directors of American Crystal Sugar Company from 1989through 1996.

 

**Committees of the Board of Directors**

 

The compensation committee makes recommendations tothe Board of Directors of the Company regarding stock and compensation plans,approves transactions of certain officers and grants stock options.  Messrs. Dalrymple, Trulson and Warner aremembers of the compensation committee.

 

Messrs. Dalrymple, Trulson and Warner are members ofthe audit committee.  The auditcommittee makes recommendations to the Board of Directors of the Companyregarding the selection of independent auditors, reviews the scope of audit andother services by the independent auditors, reviews the accounting principlesand auditing practices and procedures to be used for the Company’s financialstatements and reviews the results of those audits.

 

The nomination committee isresponsible for recommending nominees to the Board of Directors of the Company.Under the Company’s current bylaws, the nomination committee consists of theCompany’s Chairman, Vice Chairman, and Chief Executive Officer.

 

**Compensationof Directors**

 

The Companyprovides its directors with minimal compensation, consisting of (i) a per diempayment of $200 (except for the Chairman who will receive $250 per day) for anyday on which a director undertakes activities on the Company’s behalf,including board meetings and other functions of the Company, (ii) a monthly feeof $450, and (iii) reimbursement for out-of-pocket expenses incurred on behalfof the Company.

 

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**ExecutiveOfficers**

 

The table below lists the executive officers of theCompany. Officers are elected annually by the Board of Directors.

 
| **Name**          |   | **Age** |   | **Position**                                         |   |
|-------------------|--------|---------|--------|------------------------------------------------------|--------|
|              |   |    |   |                                                 |   |
| Timothy  J. Dodd  |   | 47      |   | President and Chief Executive Officer                |   |
| Thomas P. Friezen |   | 43      |   | Chief Financial Officer                              |   |
| Eldon Buschbom    |   | 54      |   | Vice President, Operations (Minnesota)               |   |
| Susan M. Clemens  |   | 41      |   | Vice President, Human Resources and Administration   |   |
| James D. Cochran  |   | 34      |   | Vice President, Supply Chain                         |   |
| Jack B. Hasper    |   | 61      |   | Vice President, Sales and Marketing                  |   |
| Radwan Ibrahim    |   | 58      |   | Vice President, Quality Assurance                    |   |
| Edward O. Irion   |   | 31      |   | Vice President, Finance and Chief Accounting Officer |   |
| David E. Tressler |   | 48      |   | Vice President, Operations (North Dakota)            |   |

 

**Timothy J. Dodd.** Mr. Dodd is the President andChief Executive Officer of the Company. Prior to joining the Company inDecember 1991, he had been the vice president of manufacturing for AmericanItalian Pasta Company since 1988. Previously, Mr. Dodd participated inthe construction and management of two other grain processing facilities, onein Texas and one in Cando, North Dakota. Mr.Dodd serves on the board of directors of Country Bank USA, Cando, North Dakota.

 

**Thomas P. Friezen.** Mr.Friezen is the Chief Financial Officer of the Company. Mr. Friezen joined theCompany in April 1995 as Vice President, Finance and became Chief Financial Officer in August 2000. From 1991 to 1995 he was theAccounting Supervisor at Arizona Electric Power cooperative, an electricitygeneration and transmission company. Prior to that Mr. Friezen was theAccounting Manager at Williston Basin Interstate Pipeline, a natural gastransmission company. Mr. Friezen is a member of the board of directors of CDT,Inc., a water technology company. Mr. Friezen is a certified public accountant.

 

**Eldon F. Buschbom.**  Mr.Buschbom has been Vice President, Operations (Minnesota) since May 30, 2000. Hejoined Borden/Creamette in February 1996 as Engineering Manager. Mr. Buschbomserved as Vice President of Engineering and Manufacturing Technology for PrimoPiatto, Inc. from August 1997 to February 1998.  Prior to joining the Company, Mr. Buschbom was Plant Manager forSteel Prep, Inc., and during the previous 14 years, held various engineeringand manufacturing operations management positions with divisions of Pillsburyincluding American Beauty Pasta, Green Giant Frozen Vegetables, Totino’s Pizzaand the International Foods Division.

 

**Susan M. Clemens.** Ms. Clemenshas been Vice President, Human Resources and Administration since February 20,1998. From August 1997 to February 1998, she was Vice President of HumanResources and Administration at Primo Piatto, Inc. Ms. Clemens was Senior HumanResources Manager at Borden Foods from January 1993 to August 1997.

 

**James D. Cochran.**  Mr. Cochran has been VicePresident, Supply Chain since February 20, 1998. From 1997 to 1998, he was VicePresident of New Business Development at Primo Piatto, Inc. Mr. Cochran heldvarious positions with Borden Foods from 1990 to 1997, most recently asMaterials Manager.

 

**Jack B. Hasper. **Mr.Hasper has been Vice President, Sales and Marketing since January 2002. Heserved as Vice President of Retail Private Label Sales of the Company from May1997 until January 2002. Mr. Hasper has 39 years of experience in the foodbusiness and held various marketing and sales positions with Borden Foods,Super Valu, Pillsbury and General Mills prior to joining the Company.

 

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**Radwan Ibrahim.**  Mr. Ibrahim has been VicePresident, Quality Control since February 20, 1998. From August 1997 toFebruary 1998, he served as Chief Technical Officer and Vice President of PrimoPiatto, Inc. Mr. Ibrahim was Group Quality Control Manager at Borden Foods from1992 to 1997. Mr. Ibrahim holds a Ph.D. degree in cereal chemistry from NorthDakota State University.

 

**Edward O. Irion.** Mr. Irion is Vice President,Finance and Chief Accounting Officer of the Company.  Mr. Irion joined the Company in December 1999 as Assistant VicePresident, Planning and Control and became Vice President, Finance and ChiefAccounting Officer in August 2000. Prior to joining the Company, he spent sixyears with the regional accounting firm of Eide Bailly LLP in Fargo, NorthDakota. Mr. Irion’s most recent position with Eide Bailly LLP prior to joiningthe Company was Senior Associate. Mr. Irion is a certified public accountant.

 

**David E. Tressler.**  Mr.Tressler is the Vice President, Operations (North Dakota) of the Company. Mr.Tressler joined the Company in February 1992 as a Project Engineer. Prior tojoining the Company, Mr. Tressler was a director of engineering at AmericanItalian Pasta Company, where he was responsible for monitoring the completionof the initial pasta plant. From 1977 to 1988 he was plant engineer atInternational Multi-Foods, Inc.

 

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**ITEM11.  EXECUTIVE COMPENSATION**

 

The following table summarizes the amount ofcompensation paid to the Company’s President and Chief Executive Officer andeach of the four next highest paid officers for the fiscal year ended July 31,2002 and the two prior fiscal years.

 

**Summary Compensation Table**

 
|                             |   |             |   |                     |          | **Long-Term  Compensation  Awards**  |   |
|----------------------------------|--------|------------------|--------|--------------------------|---------------|--------------------------------------|--------|
|                             |   |             |   | **Annual  Compensation** |          | **Securities  Underlying   Options** |   |
| **Name and Principal  Position** |   | **Fiscal  Year** |   | **Salary**               |          | **Bonus**                            |   | **Other  Annual  Compensation(1)** |   |   |
|                             |   |             |   |                     |          |                                 |   |   |   |   |   |
| Timothy J. Dodd                  |   | 2002             |   | $                        | 192,920  |                                 | $      | 63,534 |   | $ | 5,936 |   | 1,291 |   |
| President and Chief Executive    |   | 2001             |   | 185,652                  |          | —                               |   | 6,234 |   | — |   |
| Officer                          |   | 2000             |   | 175,000                  |          | 102,785                              |   | 3,884 |   | 4,950 |   |
|                             |   |             |   |                     |          |                                 |   |   |   |   |   |
| Thomas P. Friezen                |   | 2002             |   | 172,310                  |          | 16,263                               |   | 5,658 |   | 754 |   |
| Chief Financial Officer          |   | 2001             |   | 137,955                  |          | —                               |   | 4,813 |   | — |   |
|                             |   | 2000             |   | 136,250                  |          | 22,510                               |   | 4,194 |   | 580 |   |
|                             |   |             |   |                     |          |                                 |   |   |   |   |   |
| David E. Tressler                |   | 2002             |   | 110,295                  |          | 11,196                               |   | 4,003 |   | — |   |
| Vice President,                  |   | 2001             |   | 106,152                  |          | —                               |   | 1,378 |   | — |   |
| Operations (North Dakota)        |   | 2000             |   | 100,000                  |          | 50,000                               |   | 4,423 |   | — |   |
|                             |   |             |   |                     |          |                                 |   |   |   |   |   |
| James D. Cochran                 |   | 2002             |   | 110,323                  |          | 6,790                                |   | 3,822 |   | — |   |
| Vice President, Supply Chain     |   | 2001             |   | 106,217                  |          | —                               |   | 3,881 |   | — |   |
|                             |   | 2000             |   | 100,000                  |          | 15,000                               |   | 6,023 |   | — |   |
|                             |   |             |   |                     |          |                                 |   |   |   |   |   |
| Eldon F. Buschbom(2)             |   | 2002             |   | 110,323                  |          | 6,790                                |   | 3,340 |   | — |   |
| Vice President,                  |   | 2001             |   | 105,506                  |          | —                               |   | 3,693 |   | — |   |
| Operations (Minnesota)           |   | 2000             |   | 58,119                   |          | 10,000                               |   | 2,397 |   | — |   |
|                                  |        |                  |        |                          |               |                                      |        |  |  |  |  |  |  |  |

 

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(1) Includes the Company’s 401(k) matching contribution, excess lifeinsurance and with respect to Mr. Dodd, Mr. Friezen, Mr. Tressler and Mr.Cochran the taxable portion of reimbursable business expenses.

 

(2) Mr. Buschbom left the Company in March 2000 and returned in May2000 as Vice President of Operations (Minnesota).

 

**OptionGrants in Fiscal Year 2002**

 

The following table sets forth certain information withrespect to stock options granted to the named executive officers during thefiscal year ended July 31, 2002.

 
| **Name**          |   | **Preferred  Shares  Underlying  Options  Granted** |   | **Percent  of Total  Options  Granted** |   | **Exercise  Price  ($/SH)** |    | **Expiration  Date** |       | **Potential  Realized Value  at Assumed Annual Rates  of Stock Price Appreciation  for Option Term(1)** |   |
|-------------------|--------|-----------------------------------------------------|--------|-----------------------------------------|--------|-----------------------------|---------|----------------------|------------|---------------------------------------------------------------------------------------------------------|--------|
|              |   |                                                |   |                                    | **5%** |                        | **10%** |                 |
|              |   |                                                |   |                                    |   |                        |    |                 |       |                                                                                                    |   |   |   |
| Timothy J. Dodd   |   | 1,291                                               |   | 63                                      | %      | $                           | 100     |                 | 12/01/2011 |                                                                                                    | $      | 81,190 |   | $ | 205,752 |   |
| Thomas P. Friezen |   | 754                                                 |   | 37                                      | %      | 100                         |    | 12/01/2011           |       | 47,419                                                                                                  |   | 120,168 |   |
|                   |        |                                                     |        |                                         |        |                             |         |                      |            |                                                                                                         |        |  |  |  |  |  |

 

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(1) The amounts shown as potential realizable value illustrate whatmight be realized upon exercise immediately prior to expiration of the optionterm using the 5% and 10% appreciation rates established in SEC regulations,compounded annually. The potential realizable value is not intended to predictfuture appreciation of the price of the stock. The values shown do not considernontransferability or termination of the unexercisable options upon terminationof such employee’s service relationship with the Company.

 

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**OptionsExercised in Fiscal Year 2002 and Unexercised Options at July 31, 2002**

 

The following table summarizes stock option exercises andtotal number of options held at the end of fiscal year 2002 by the namedexecutive officers.

 
| **Name**          |   | **Convertible  Preferred  Stock  Acquired on  Exercise** |                                                                        | **Value  Realized** |                                                                 |   |            |   |              |
|-------------------|--------|----------------------------------------------------------|-----------------------------------------------------------------------------|---------------------|----------------------------------------------------------------------|--------|-----------------|--------|-------------------|
|              |   |                                                     | **Number of  Securities  Underlying Unexercised  Options at July 31, 2002** |                | **Value of  Unexercised  In-the-Money  Options at July 31, 2002(1)** |   |
|              |   |                                                     | **Exercisable**                                                             |                | **Unexercisable**                                                    |   | **Exercisable** |   | **Unexercisable** |   |
|              |   |                                                     |                                                                        |                |                                                                 |   |            |   |              |   |   |   |   |
| Timothy J. Dodd   |   | —                                                   |                                                                        | $                   | —                                                               |   | 1,291           |   | —            |   | $ | — |   | $ | — |   |
| Thomas P. Friezen |   | —                                                   |                                                                        | —              |                                                                 | 754    |            | — |              | — |   | — |   |
|                   |        |                                                          |                                                                             |                     |                                                                      |        |                 |        |                   |  |  |  |  |  |  |  |

 

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(1) There is no public trading market for the Company’s securities;therefore, the Company is unable to estimate the value of unexercised optionsas of July 31, 2002.

 

**EmploymentAgreements**

 

The Company entered into an employment agreement,dated March 25, 2002, with its Vice President of Sales and Marketing, Jack B.Hasper. The agreement provides for Mr. Hasper’s employment for a period ofthirty-six months commencing on March 25, 2002. The Company will pay him anannual salary of $130,000 under the employment agreement.  His salary will be reviewed annually and,based upon his performance, may be increased each year by the Board ofDirectors. In addition, Mr. Hasper will be entitled to receive bonuses andother fringe benefits consistent with the Company’s bonus and benefit plansthat are in effect during the term of his employment agreement.

 

Mr. Hasper will be entitled to the followingcompensation and benefits if his employment is terminated under thecircumstances noted prior to the expiration of the thirty-six month employmentperiod:

 

•                  If the Companyterminates Mr. Hasper with cause, then he will be entitled to receive anyearned but unpaid bonuses, any accrued but unused vacation pay and anythen-existing but unreimbursed business expenses.

 

•                  If the Companyterminates Mr. Hasper’s employment without cause or Mr. Hasper resigns from hisemployment for good cause, Mr. Hasper will be entitled to receive his salarythen in effect for a period of six months (or twelve months, in the case of histermination without cause or his resignation for good cause following a changeof control of the Company) following such termination or such resignation, inaddition to any earned but unpaid bonuses, any accrued but unused vacation payand any then-existing but unreimbursed business expenses. However, Mr. Hasperwill only receive the compensation and benefits described in theimmediately-preceding sentence if, upon his termination or resignation, hereleases any and all claims that he might have against the Company.

 

•                  If Mr. Hasperresigns from his employment for any reason other than for good cause, he willbe entitled to receive his salary earned through the date of such resignation,any earned but unpaid bonuses, any accrued but unused vacation pay and anythen-existing but unreimbursed business expenses. Again, he will only receivethe compensation and benefits described in the immediately-preceding sentenceif, upon his resignation, he releases any and all claims he might have againstthe Company.

 

•                  In the eventthat Mr. Hasper’s employment is terminated due to his death or disability, heor his estate will receive his salary then in effect accrued up to andincluding the date of termination, any earned but unpaid bonuses, any accruedbut unused vacation pay and any then-existing but unreimbursed businessexpenses.

 

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The Company may terminate Mr. Hasper for “cause” ifhe: (i) commits an act of fraud, embezzlement or misappropriation involving theCompany; (ii) is convicted of any felony; (iii) commits an act, or fails tocommit an act, involving the Company that amounts to willful misconduct orgross negligence; (iv) intentionally engages in any activity that is adverse tothe interests of the Company; (v) commits an act of dishonesty in connectionwith his employment; (vi) breaches his fiduciary duty to the Company; (vii)commits an act of self-dealing; (viii) materially breaches his employmentagreement; or (ix) commits an act that brings the Company into substantialpublic disgrace or disrespect.

 

Mr. Hasper’s employment agreement prohibits thedisclosure to third parties of information, observations and data obtainedwhile he is employed by the Company concerning the business and affairs of theCompany and its affiliates. It also contains provisions that prohibit Mr.Hasper, at any time after the termination of his employment, from usingconfidential information to compete with the Company or disclosing confidentialinformation to third parties that do or will compete with the Company. Inaddition, at any time after the termination of his employment, Mr. Hasper maynot solicit or recruit employees or customers of the Company.

 

**EmployeeBenefit Plans**

 

On January 31, 1997 the Cooperative’s CompensationCommittee of the Board of Directors (the “Compensation Committee”) adopted theDakota Growers Incentive Stock Option Plan (the “Plan”). The purpose of thePlan is to provide benefits to participants in the form of additionalcompensation for services that have been or will be rendered as an inducementfor continuing as employees of the Company. The Plan was ratified by theCooperative members at the annual meeting in January 1998.

 

The Compensation Committee administers the Plan. TheCompensation Committee or the Board of Directors has the power to determine thekey management employees of the Company to receive options and the number ofshares to be optioned to each of the employees.  At the time of each grant of options, the Compensation Committeeor the Board of Directors determines, in its business judgment, the fair marketvalue of the shares to be covered by the options and establishes the exerciseprice of each option at that fair market value. In determining fair marketvalue, the Board of Directors has considered such factors as any recent salesof shares by the Company and the absence of a liquid and established market forresale of such shares.

 

Options granted under the Plan are for the purchase ofSeries C Convertible Preferred Stock at fair market value, which wereconvertible into Equity Stock as a cooperative and are now convertible intoCommon Stock and Series D Delivery Preferred Stock as a corporation at theoption of the employee, under the applicable conversion ratio. The maximumnumber of preferred shares that may be issued pursuant to options granted underthe Plan is fifteen thousand (15,000), of which 14,314 have been issued as ofJuly 31, 2002. Each share of Series C Preferred Stock carries a non-cumulativedividend of 6% per annum. Under the terms of the Plan, the option price may notbe less than the fair market value of the Series C Preferred Stock at the timethe option is granted. The unexercised options granted to date are scheduled toexpire on December 1, 2011, ten years after the date of grant. All such optionswere immediately vested when granted.

 

Each share of Series C PreferredStock is convertible into 24 shares of Common Stock and 24 shares of Series DDelivery Preferred Stock of the Company. The conversion ratio isproportionately adjusted if the Company increases the outstanding shares ofCommon Stock or Series D Delivery Preferred Stock, as applicable, without payment by or to the Company or the Company’sshareholders for such additional shares (e.g. stock split, stockdividend or other action).

 

The Company and its subsidiary, Primo Piatto, Inc., have a401(k) plan that covers employees who have met age and service requirements.The plan covers employees who have reached 21 years of age and completed six

 

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months of service as defined in the plandocument. The Company matches 100%on the first 2% of the employees’ elected deferral, 50% on the next 1%, and 25%on the next 4%. Employer contributions to the plan totaled $319,000, $342,000and $291,000 for the years ended July 31, 2002, 2001 and 2000, respectively.

 

Primo Piatto, Inc. is alsorequired to contribute to a multi-employer pension plan covering certain hourlyemployees subject to a collective bargaining agreement. Such employees may alsoparticipate in the 401(k) plan but are excluded from amounts contributed byPrimo Piatto. Contributions for the years ended July 31, 2002, 2001 and 2000totaled $72,000, $99,000 and $74,000, respectively.

 

**CompensationCommittee Interlocks and Insider Participation**

 

The members of the Compensation Committee are John S.Dalrymple III, Curtis R. Trulson and Michael E. Warner. None of these directorsare or have been an officer or employee of the Company. During fiscal year2002, no executive officer of the Company served as a director or member of theCompensation Committee (or other committee serving an equivalent function) ofany other entity, one of whose executive officers served as a director of ormember of the Compensation Committee of the Company.

 

**Compensation Committee Report onExecutive Compensation**

 

The Compensation Committee of the Board of Directorshas not adopted formal policies related to designing total executive compensation.In setting executive base salaries, the Compensation Committee considerssalaries for executives in other food processing companies comparable in sizeto the Company. Annual incentives, including cash bonuses and stock optionawards, are not based on a specific formula, although the CompensationCommittee has considered Company performance and shareholder patronage paymentsin determining annual incentive awards in the past.

 

The Compensation Committee is currently in the processof formalizing executive compensation policies for fiscal year 2003.

 

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**ITEM12.  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

The following table furnishes information as to thebeneficial ownership of the Company’s Common Stock, Series C Preferred Stockand Series D Delivery Preferred Stock by (a) each person known by us tobeneficially own more than 5% of the issued and outstanding shares of theCompany’s voting securities, (b) each of the Company’s executive officers, (c)each of the Company’s directors and (d) all of the Company’s directors andexecutive officers as a group.

 

The address of each person listed below is c/o DakotaGrowers Pasta Company, Inc., One Pasta Avenue, Carrington, North Dakota58421.  Each person listed below hassole investment discretion and voting power. In accordance with the Securitiesand Exchange Commission’s rules, in computing the number of shares beneficiallyowned by a person and the percentage ownership of that person, securitiessubject to options held by that person that are currently exercisable orexercisable within 60 days of July 31, 2002 are treated as outstanding. Theseshares, however, are not treated as outstanding for the purpose of computingthe percentage ownership of any other person.

 
| **Name of  Beneficial Owner**                        |                                    | **Beneficially  Owned Securities** |                                 |
|------------------------------------------------------|-----------------------------------------|------------------------------------|--------------------------------------|
|                                                 | **Number  of  Shares of  Common Stock** |                               | **Percent  of  Total Common  Stock** |   | **Number  of  Shares of Series   C Preferred** |   | **Percent  of  Total Series  C Preferred** |   | **Number  of  Shares of****Series  D Preferred** |   | **Percent  of  Total Series  D Preferred** |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| John S. Dalrymple, III(1)                            |                                    | 370,368                            |                                 | 2.9 | % | — |   | — |   | 333,000 |   | 2.9 | % |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Allyn K. Hart                                        |                                    | 16,723                             |                                 | 0.1 |   | — |   | — |   | 15,000 |   | 0.1 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Roger A. Kenner(2)                                   |                                    | 155,596                            |                                 | 1.2 |   | — |   | — |   | 140,000 |   | 1.2 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| James F. Link(3)                                     |                                    | 59,656                             |                                 | 0.5 |   | — |   | — |   | 54,550 |   | 0.5 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Eugene J. Nicholas(4)                                |                                    | 65,525                             |                                 | 0.5 |   | — |   | — |   | 58,951 |   | 0.5 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| John D. Rice(5)                                      |                                    | 22,583                             |                                 | 0.2 |   | — |   | — |   | 20,200 |   | 0.2 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Jeffrey O. Topp(6)                                   |                                    | 218,056                            |                                 | 1.7 |   | — |   | — |   | 196,420 |   | 1.7 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Curtis R. Trulson(7)                                 |                                    | 68,624                             |                                 | 0.5 |   | — |   | — |   | 61,750 |   | 0.5 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Michael E. Warner                                    |                                    | 63,441                             |                                 | 0.5 |   | — |   | — |   | 57,038 |   | 0.5 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Timothy J. Dodd(8)                                   |                                    | 236,470                            |                                 | 1.9 |   | 1,291 |   | 63.1 | % | 221,784 |   | 2.0 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| Thomas P. Friezen(8)                                 |                                    | 126,959                            |                                 | 1.0 |   | 754 |   | 36.9 |   | 121,752 |   | 1.1 |   |
|                                                 |                                    |                               |                                 |   |   |   |   |   |   |   |   |   |   |
| All directors and officers as a Group(11 persons)(9) |                                    | 1,404,001                          |                                 | 11.1 |   | 2,045 |   | 100.0 |   | 1,280,445 |   | 11.3 |   |

 

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(1)                                  Includes shares held in the names of Mr.Dalrymple’s spouse, daughter and the John S. Dalrymple III Trust.

(2)                                  Includes shares held in the name of Mr. Kenner’sspouse.

(3)                                  Includes shares held in the names of Link FarmsLLP LSB Pasta and Link Farms LLP.

(4)                                  Includes shares held in the name of Mr. Nicholas’spouse.

(5)                                  Includes shares held in the name of John RiceFarm.

(6)                                  Includes shares held in the names of T-T Ranchand Mr. Topp’s spouse and children.

(7)                                  Includes shares held in the name of TrulsonBrothers.

(8)                                  Messrs. Dodd and Friezen have been grantedoptions to purchase 1,291 and 754 shares, respectively, of Series C PreferredStock in the Company. Each share of Series C Preferred Stock is convertibleinto 24 shares of Common Stock and 24 shares of Series D Delivery PreferredStock of the Company. The number of shares of Common Stock presented forMessrs. Dodd and Friezen include 30,984 and 18,096 shares, respectively, ofCommon Stock issuable upon exercise of the options to purchase Series CPreferred Stock of the Company and conversion of each such share of Series CPreferred Stock into 24 shares of Common Stock in the Company. The number ofshares of Series D Delivery Preferred Stock presented for Messrs. Dodd andFriezen includes 30,984 and 18,096 shares, respectively, of Series D DeliveryPreferred Stock issuable upon exercise of the options to purchase Series CPreferred Stock of the Company and conversion of each such share of Series CPreferred Stock into 24 shares of Common Stock in the Company, with one shareof Series D Delivery Preferred Stock issuable for each share of Common Stock soissued upon conversion.

(9)                                  The number of shares of Common Stock and Series DDelivery Preferred Stock and the percentage of the total number of shares ofCommon Stock and Series D Delivery Preferred Stock beneficially owned by alldirectors and executive officers as a group are shown on a fully-diluted basis,based upon 12,603,826 shares of Common Stock and 11,324,377 shares of Series DDelivery Preferred Stock issued and outstanding on a fully-diluted basis.

 

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**EquityCompensation Plan Information**

 

The Company has one equitycompensation plan, which is the Dakota Growers Incentive Stock Option Plan. See“Item 11. Executive Compensation” for a discussion of the material features ofthe Plan. The following table provides information regarding the Company’sequity compensation plan as of July 31, 2002.

 
| **Plan Category**                                       |   | **Number of Securities  to be Issued  Upon Exercise of  Outstanding Options** |   | **Weighted-Average  Exercise Price of  Outstanding  Options** | ** ** | **Number of Securities  Remaining Available  for Future Issuance  Under Equity  Compensation Plans** | ** ** |
|---------------------------------------------------------|--------|-------------------------------------------------------------------------------|--------|---------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
|                                                    |   |                                                                          |   |                                                          |       |                                                                                                 |       |
| Equity  compensation plans approved by security holders |   | 2,045                                                                         |   | $                                                             | 100.00     |                                                                                                 | 686        |   |
|                                                         |        |                                                                               |        |                                                               |            |                                                                                                      |            |  |

 

Options granted under the Plan are for the purchase ofSeries C Convertible Preferred Stock. Eachshare of Series C Convertible Preferred Stock is convertible into 24 shares ofCommon Stock and 24 shares of Series D Delivery Preferred Stock of the Company.

 

**ITEM13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

**Advances to Executive Officers**

 

Upon review and approval by theCompensation Committee of the Board of Directors, the Company hasadvanced funds to certain officers to cover personal alternative minimum taxesand other costs generated as a result of these officers exercising stockoptions. The Company has not established apre-determined amount of funds available for advances to officers, and intereston such advances is charged at the applicable federal rate as publishedby the Internal Revenue Service. Thecurrent outstanding balance of funds advanced to officers and the highestamounts of outstanding advances for indebtedness exceeding $60,000 at any timesince the beginning of fiscal year 2002 are set forth below.

 
|              |   | **Current  Outstanding  Balance** |    | **Highest  Amounts  Outstanding** |   |
|-------------------|--------|-----------------------------------|---------|-----------------------------------|--------|
|              |   |                              |    |                              |   |
| Timothy J. Dodd   |   | $                                 | 123,658 |                              | $      | 153,658 |   |
| Thomas P. Friezen |   | 66,495                            |    | 79,995                            |   |
|                   |        |                                   |         |                                   |        |  |  |

 

The Company has also pledged certificates of depositas security for loans, totaling approximately $1,974,000, made by a financialinstitution to officers of the Company. These loans are scheduled to matureDecember 1, 2002.

 

The Compensation Committee of the Board of Directorsis reviewing the above arrangements in response to the Sarbanes-Oxley Act of2002.

 

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**Warehouse Arrangements**

 

Pursuant to a warehouse agreement, effective April 1,1999, with Sky Logistics & Distribution, Inc. (“Sky”), the Company is obligatedto minimum monthly storage and handling volumes totaling approximately $110,000per month. This agreement expires October 31, 2004. The Company has alsotransferred the obligation for a certain building lease to Sky. If Sky wereunable to perform under the existing lease, the Company would be obligated tomake payments under this lease over the remaining term. Current monthlypayments under this lease total approximately $67,000, and the lease expiresApril 30, 2004.

 

No current director or officer of the Company isaffiliated with Sky, which was formed on March 3, 1999. Investors notaffiliated with the Company, together with Maury Hanson, who is the former VicePresident of Logistics of the Cooperative, own Sky. Mr. Hanson, who terminatedhis employment with the Cooperative on April 1, 1999, is a shareholder of theCompany, owning less than 0.05% of the Company’s outstanding Common Stock andSeries D Delivery Preferred Stock. Mr. Hanson did not negotiate the Skywarehouse agreement on behalf of the Cooperative, although he did provide input(notably with respect to pricing) to those persons at the Cooperative who wereresponsible for negotiating the warehouse agreement.

 

Prior to entering into the warehouse agreement withSky, the Cooperative had operated a portion of its warehousing in a leasedfacility. The lease on the facility expires on October 31, 2004. In addition tostoring inventory at the Cooperative’s owned warehouse, it paid a per-palletcharge to maintain inventory in numerous off-site warehouses. In March 1999,the Cooperative decided to outsource all of its logistics operations, exit thecooperative-operated warehouse and terminate all employees who had worked inthose areas. Sky assumed the warehouse lease, with the Company retaining theultimate obligation for the minimum monthly lease payments for the lease termthrough minimum monthly storage and handling volumes. In addition to providingservices for the Company on an arm’s-length basis, Sky provides storage anddistribution services to other customers.

 

**Purchaseof Certain Assets**

 

The Company’s Vice President of Sales and Marketing isMr. Jack B. Hasper. Prior to his employment with the Company, Mr. Hasper waspart-owner of a sales and marketing firm from which the Company purchasedcertain assets. In conjunction with the purchase of such assets, Mr. Hasperentered into a Covenant not to Compete with the Company for a period extendingthrough March 31, 2007. The Company paid Mr. Hasper $100,000 in considerationfor entering into the aforementioned Covenant not to Compete.

** **

**ITEM14.  CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controls and Procedures***

 

The Company’s Chief Executive Officer, Timothy Dodd,and Chief Financial Officer, Thomas Friezen, have reviewed the Company’s disclosurecontrols and procedures within 90 days prior to the filing of this report.Based upon this review, these officers believe that the Company’s disclosurecontrols and procedures are effective in ensuring that material informationrelated to the Company is made known to them by others within the Company.

 

***Changes in Internal Controls***

 

There were no significantchanges in the Company’s internal controls or in other factors that couldsignificantly affect these controls during the fiscal year covered by thisreport or from the end of the period to the date of this Form 10-K.

 

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**PART IV**

 

**ITEM15.  EXHIBITS, FINANCIAL STATEMENTSCHEDULES AND REPORTS ON FORM 8-K**

 

(a)  The following are filed as part of this report:

 

**1. Financial Statements**

 

Independent Auditor’s Report

 

Consolidated Balance Sheets as of July 31, 2002 and2001

 

Consolidated Statements of Operations for the yearsended July 31, 2002, 2001 and 2000

 

Consolidated Statements of Changes in Stockholders’Equity for the years ended July 31, 2002, 2001 and 2000

 

Consolidated Statements of Cash Flows for the yearsended July 31, 2002, 2001 and 2000

 

Notes to Consolidated Financial Statements

 

**2.  Financial Statement Schedules**

 

All schedules are omitted as the required informationis inapplicable or the information is presented in the consolidated financialstatements or related notes.

 

**3.  Reports on Form 8-K**

 

The Company filed a Form 8-K on July 1, 2002announcing the conversion of Dakota Growers Pasta Company, a North Dakotacooperative, from a cooperative to a corporation was completed effective July1, 2002, with Dakota Growers Pasta Company, Inc., a North Dakota corporation,being the ultimate surviving entity in the conversion. The Company operates asthe Cooperative’s successor and its operations are a continuance of theoperations of the Cooperative.

 

**4.**  **Exhibits**

 

2.1                        SecondAmended and Restated Plan of Merger between Dakota Growers Pasta Company andDakota Growers Pasta Restructuring Cooperative. (Incorporated by reference toExhibit 2.1 from the Company’s Pre-Effective Amendment No. 2 to Form S-4Registration Statement, File No. 333-81946, dated April 19, 2002.)

 

2.2                        SecondAmended and Restated Merger Agreement between Dakota Growers Pasta RestructuringCooperative and Dakota Growers Corporation. (Incorporated by reference toExhibit 2.2 from the Company’s Pre-Effective Amendment No. 2 to Form S-4Registration Statement, File No. 333-81946, dated April 19, 2002.)

 

2.3                        SecondAmended and Restated Merger Agreement between Dakota Growers Corporation andthe Company, formerly Dakota Growers Restructuring Company, Inc. (Incorporatedby reference to Exhibit 2.3 from the Company’s Pre-Effective Amendment No. 2 toForm S-4 Registration Statement, File No. 333-81946, dated April 19, 2002.)

 

2.4                        SecondAmended and Restated Transaction Agreement between Dakota Growers PastaCompany, Dakota Growers Pasta Restructuring Cooperative, Dakota GrowersCorporation and the Company, formerly Dakota Growers Restructuring Company,Inc. (Incorporated by reference to Exhibit 2.4 from the Company’s Pre-EffectiveAmendment No. 2 to Form S-4 Registration Statement, File No. 333-81946, datedApril 19, 2002.)

 

3.1                        SecondAmended and Restated Articles of Incorporation of the Company, formerly DakotaGrowers Restructuring Company, Inc. (Incorporated by reference to Exhibit 3.1from the Company’s Pre-Effective Amendment No. 2 to Form S-4 RegistrationStatement, File No. 333-81946, dated April 19, 2002.)

 

3.2                        SecondAmended and Restated Bylaws of the Company, formerly Dakota GrowersRestructuring Company, Inc. (Incorporated by reference to Exhibit 3.3 from theCompany’s Pre-Effective Amendment No. 2 to Form S-4 Registration Statement,File No. 333-81946, dated April 19, 2002.)

 

3.3                        Certificateof Designation of Series E Junior Participating Preferred Stock of the Company,formerly Dakota Growers Restructuring Company, Inc. (Incorporated by referenceto Exhibit 3.2 from the Company’s Pre-Effective Amendment No. 2 to Form S-4Registration Statement, File No. 333-81946, dated April 19, 2002.)

 

4.1                        NotePurchase Agreement dated July 15, 1998. (Incorporated by reference to Exhibit4.1 from Dakota Growers Pasta Company’s Amendment No. 1 to Form S-1Registration Statement on Form S-1/A, File No. 333-65071, declared effectiveOctober 21, 1998.)

 

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4.2                        Waiver andFirst Amendment to Note Purchase Agreements dated November 28, 2000.(Incorporated by reference to Exhibit 4.1 from Dakota Growers Pasta Company’sQuarterly Report on Form 10-Q, File No. 33-99834, for the quarter ended October31, 2000.)

 

4.3                        Waiver andSecond Amendment to Note Purchase Agreement and Notes dated June 1, 2001.(Incorporated by reference to Exhibit 4.3 from Dakota Growers Pasta Company’sAnnual Report on Form 10-K for the fiscal year ended July 31, 2001, File No.33-99834.)

 

10.1                  Indenture ofLease between RLN Leasing, Inc. and Dakota Growers Pasta Company dated May 1,1997. (Incorporated by reference to Exhibit 10.10 from Dakota Growers PastaCompany’s Annual Report on Form 10-K for the fiscal year ended July 31, 1997,as amended on September 30, 1998, File No. 33-99834.) Confidential treatmenthas been granted with respect to portions of this Exhibit.

 

10.2                  Incentive Stock OptionPlan. (Incorporated by reference to Exhibit 10.1 from Dakota Growers PastaCompany’s Quarterly Report on Form 10-Q, File No. 33-99834, for the quarterended April 30, 1998.)

 

10.3                  Distribution andMarketing Alliance Agreement between Dakota Growers Pasta Company and GruppoEuricom dated August 15, 2000. (Incorporated by reference to Exhibit 10.3 fromDakota Growers Pasta Company’s Quarterly Report on Form 10-Q, File No.33-99834, for the quarter ended January 31, 2001.) Confidential treatment has beengranted with respect to portions of this Exhibit.

 

10.4                  Five-YearContract Extension between Dakota Growers Pasta Company and U.S. Foodservicedated December 28, 2000. (Incorporated by reference to Exhibit 10.4 from DakotaGrowers Pasta Company’s Quarterly Report on Form 10-Q, File No. 33-99834, forthe quarter ended January 31, 2001.) Confidential treatment has been grantedwith respect to portions of this Exhibit.

 

10.5                  Master LoanAgreement and Supplements dated June 20, 2001 between Dakota Growers PastaCompany and CoBank, ACB. (Incorporated by reference to Exhibit 10.7 from DakotaGrowers Pasta Company’s Annual Report on Form 10-K, File No. 33-99834, for thefiscal year ended July 31, 2001.)

 

10.6                  Amendment toLoan Agreement dated January 24, 2002 between Dakota Growers Pasta Company andCoBank, ACB. (Incorporated by reference to Exhibit 10.2 from Dakota GrowersPasta Company’s Quarterly Report on Form 10-Q, File No. 33-99834, for thequarter ended January 31, 2002.)

 

10.7                  StatusedRevolving Credit Supplement dated February 15, 2002 between Dakota GrowersPasta Company and CoBank, ACB. (Incorporated by reference to Exhibit 10.1 fromDakota Growers Pasta Company’s Quarterly Report on Form 10-Q, File No.33-99834, for the quarter ended January 31, 2002.)

 

10.8                  First Amendment:Five-Year Contract Extension between Dakota Growers Pasta Company and U.S.Foodservice dated December 20, 2001. (Incorporated by reference to Exhibit 10.3from Dakota Growers Pasta Company’s Quarterly Report on Form 10-Q, File No. 33-99834,for the quarter ended January 31, 2002.) Confidential treatment has beengranted with respect to portions of this Exhibit.

 

10.9                  Co-packingAgreement dated April 30, 2002 between Dakota Growers Pasta Company and NewWorld Pasta Company. (Incorporated by reference to Exhibit 10.2 from DakotaGrowers Pasta Company’s Quarterly Report on Form 10-Q, File No. 33-99834, forthe quarter ended April 30, 2002.) Confidential treatment has been granted withrespect to portions of this Exhibit.

 

10.10            Master Lease Agreementdated March 6, 2002 and related Schedule A dated March 29, 2002 between DakotaGrowers Pasta Company and Farm Credit Leasing Services Corporation.(Incorporated by reference to Exhibit 10.2 from the Company’s Pre-EffectiveAmendment No. 2 to Form S-4 Registration Statement, File No. 333-81946, datedApril 19, 2002.)

 

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10.11            Amended and RestatedShare Rights Agreement, dated as of April 19, 2002, by and among the Company,formerly Dakota Growers Restructuring Company, Inc., and Wells Fargo BankMinnesota, National Association, as Rights Agent. (Incorporated by reference toExhibit 10.1 from the Company’s Pre-Effective Amendment No. 2 to Form S-4Registration Statement, File No. 333-81946, dated April 19, 2002.)

 

10.12            Executive EmploymentAgreement, dated March 25, 2002, between Dakota Growers Pasta Company and JackHasper. (Incorporated by reference to Exhibit 10.3 from the Company’sPre-Effective Amendment No. 2 to Form S-4 Registration Statement, File No.333-81946, dated April 19, 2002.)

 

21                           Subsidiaryof the registrant

 

| **Name of  Subsidiary** |   | **Jurisdiction  of Incorporation** |   |
|-------------------------|--------|------------------------------------|--------|
|                    |   |                               |   |
| Primo Piatto, Inc.      |   | Minnesota                          |   |

 

23.1                  Consent ofIndependent Auditor; Eide Bailly LLP

 

99.1                  Certification ofChief Executive Officer, Timothy J. Dodd, and Chief Financial Officer, ThomasP. Friezen.

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|   | DAKOTA GROWERS PASTA COMPANY, INC.                                       |
|--------|--------------------------------------------------------------------------|
|   |                                                                     |
|   | By:                                                                      | /s/ Timothy J. Dodd |
|   |                                                                     |
|   | Timothy J. Dodd,                                                         |
|   | PRESIDENT AND CHIEF  EXECUTIVE OFFICER,  AND PRINCIPAL EXECUTIVE OFFICER |
|   |                                                                     |
|   | Dated: October 28, 2002                                                  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**              |   | **Title**                              |   | **Date**         |
|----------------------------|--------|----------------------------------------|--------|------------------|
|                       |   |                                   |   |             |
| /s/ Timothy J. Dodd        |   | President and Chief  Executive Officer |   |             |
| Timothy J. Dodd            |   | (Principal Executive  Officer)         |   | October 28, 2002 |
|                       |   |                                   |   |             |
| /s/ Thomas P. Friezen      |   | Chief Financial Officer                |   |             |
| Thomas P. Friezen          |   | (Principal Financial  Officer)         |   | October 28, 2002 |
|                       |   |                                   |   |             |
|                       |   | Vice President -  Finance and          |   |             |
| /s/ Edward O. Irion        |   | Chief Accounting  Officer              |   |             |
| Edward O. Irion            |   | (Principal Accounting  Officer)        |   | October 28, 2002 |
|                       |   |                                   |   |             |
| /s/ John S. Dalrymple  III |   |                                   |   |             |
| John S. Dalrymple III      |   | Director                               |   | October 28, 2002 |
|                       |   |                                   |   |             |
| /s/ John D. Rice, Jr.      |   |                                   |   |             |
| John D. Rice, Jr.          |   | Director                               |   | October 28, 2002 |
|                       |   |                                   |   |             |

 

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|                   |   |     |   |             |
|------------------------|--------|----------|--------|------------------|
| /s/ Curt R. Trulson    |   |     |   |             |
| Curt R. Trulson        |   | Director |   | October 28, 2002 |
|                   |   |     |   |             |
| /s/ Allyn K. Hart      |   |     |   |             |
| Allyn K. Hart          |   | Director |   | October 28, 2002 |
|                   |   |     |   |             |
| /s/ Roger A. Kenner    |   |     |   |             |
| Roger A. Kenner        |   | Director |   | October 28, 2002 |
|                   |   |     |   |             |
| /s/ James F. Link      |   |     |   |             |
| James F. Link          |   | Director |   | October 28, 2002 |
|                   |   |     |   |             |
| /s/ Eugene J. Nicholas |   |     |   |             |
| Eugene J. Nicholas     |   | Director |   | October 28, 2002 |
|                   |   |     |   |             |
| /s/ Jeffrey O. Topp    |   |     |   |             |
| Jeffrey O. Topp        |   | Director |   | October 28, 2002 |
|                   |   |     |   |             |
| /s/ Michael E. Warner  |   |     |   |             |
| Michael E. Warner      |   | Director |   | October 28, 2002 |

 

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**OFFICERCERTIFICATION**

 

I, Timothy J. Dodd, certify that:

 

1. I have reviewed this annual report on Form 10-K of Dakota GrowersPasta Company, Inc.;

 

2. Based on my knowledge, this annual report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisannual report;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officers and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisannual report (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed,based on our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors (or persons performing theequivalent functions):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6. The registrant’s other certifying officers and I have indicated inthis annual report whether there were significant changes in internal controlsor in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 

Date: October 28, 2002

 
|   | /s/ Timothy J. Dodd                   |   |
|--------|---------------------------------------|--------|
|   | Timothy J. Dodd                       |
|   | President and Chief Executive Officer |

 

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**OFFICERCERTIFICATION**

 

I, Thomas P. Friezen, certify that:

 

1. I have reviewed this annual report on Form 10-K of Dakota GrowersPasta Company, Inc.;

 

2. Based on my knowledge, this annual report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisannual report;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officers and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisannual report (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed,based on our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors (or persons performing theequivalent functions):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6. The registrant’s other certifying officers and I have indicated inthis annual report whether there were significant changes in internal controlsor in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 

Date: October 28, 2002

 
|   | /s/ Thomas P. Friezen   |   |
|--------|-------------------------|--------|
|   | Thomas P. Friezen       |
|   | Chief Financial Officer |

 

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