**UNITEDSTATES SECURITIES AND EXCHANGE 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, 2004**                                                  |
|   |                                                                                          |
|   | **Or**                                                                                        |
|   |                                                                                          |
| o      | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |

 

**CommissionFile No. 000-50111**

 

**DAKOTAGROWERS PASTA COMPANY, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

**One PastaAvenue, Carrington, ND 58421**

(Address ofprincipal executive offices including zip code)

 

**(701)652-2855**

(Registrant’stelephone number, including area code)

 

**SecuritiesRegistered Pursuant To Section 12(b) Of The Act:**

None

 

**SecuritiesRegistered Pursuant To Section 12(g) Of The Act:**

Common Stock, $.01 par value per shareSeries D Delivery Preferred Stock, $.01 par value per share

 

 

----

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months, and (2) has been subject to such filing requirements for the past 90days.      Yes ýNo o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).      Yes o  No ý

 

There is no establishedpublic market for the Registrant’s common stock. Although there is a limited,private market for shares of the Registrant’s common stock, the Registrant doesnot obtain information 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 27, 2004, the Registrant had13,169,382 shares of common stock, par value $0.01 per share, outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

None.

 

 

----

 

**PART I.**

 

**Forward-Looking Statements**

 

This report containsforward-looking statements based upon assumptions by the management of DakotaGrowers Pasta Company, Inc. (the “Company”, “Dakota Growers” or “we”), a NorthDakota corporation, as of the date of this Annual Report, including assumptionsabout risks and uncertainties faced by the Company. When used in this report,the words “believe,” “expect,” “anticipate,” “will,” “estimate” and similarverbs or expressions are intended to identify such forward-looking statements.If management’s assumptions prove incorrect or should unanticipatedcircumstances arise, the Company’s actual results could differ materially fromthose anticipated. These differences could be caused by a number of factors orcombination of factors including, but not limited to, those factors describedin the “Risk Factors” section of this report. Readers are strongly urged toconsider such factors when evaluating any forward-looking statement. TheCompany undertakes no obligation to update any forward-looking statements inthis report to reflect future events or developments.

 

**ITEM 1.  BUSINESS**

 

**Introduction**

 

The Company is a NorthDakota corporation that was organized on January 30, 2002. It is the successorto and its operations are a continuance of Dakota Growers Pasta Company, aNorth Dakota cooperative (the “Cooperative”), upon the conversion of theCooperative from a cooperative to a corporation effective July 1, 2002.

 

The ownership limitationsand obligations associated with membership under the Cooperative were removedwith the conversion. Ownership of shares of Common Stock may be transferredsubject only to the requirements of the applicable securities laws. Holders ofSeries D Delivery Preferred Stock have a delivery right, but not a deliveryobligation, to sell durum to the Company. The Company must approve alltransfers of shares of Series D Delivery Preferred Stock.

 

Formore information regarding the Company’s conversion from a North Dakotacooperative to a North Dakota corporation please refer to the Company’sRegistration Statement on Form S-4 (File No. 333-81946) filed with the UnitedStates Securities and Exchange Commission.

 

The Company owns andoperates a vertically integrated, state-of-the-art durum wheat milling andpasta production facility in Carrington, North Dakota. Primo Piatto, Inc. (“PrimoPiatto”), a wholly-owned subsidiary of the Company being operated as theMinnesota Division of the Company, currently operates a pasta production plantin New Hope, Minnesota. The Company currently has annual capacity to grind inexcess of 12 million bushels of grain and to produce approximately 440 millionpounds of pasta.

 

**Pasta Industry and Markets**

 

The Company estimatesNorth American annual dry pasta consumption to be slightly less than 4.0billion pounds. Based on the Company’s analysis of the marketplace and tradeand industry information, the Company believes dry pasta consumption declinedat a 4% rate in the last year due to consumer trends, of which the mostsignificant appears to be the trend toward a reduced carbohydrate lifestyle. Inaddition to the domestic market for dry pasta, much smaller domestic marketsexist for refrigerated and frozen pasta.

 

The Pasta industryidentifies domestic dry pasta into two basic markets: retail and institutional.The Company recognizes the institutional market as being comprised ofingredient and foodservice sales.

 

2

----

 

*Retail Market*

 

TheRetail market includes sales of branded and private label pasta to grocerystores, club stores, mass merchants and other consumer retail operations. Asignificant portion 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. The Company estimates thatthe Retail market declined at an overall 5% annual rate, with the traditionalgrocery channels declining at a rate slightly higher due to losses toalternative channels.

 

InMay 2004, New World Pasta Company filed for Chapter 11 bankruptcy protection.

 

In2004, DNA Dreamfields Company, LLC (“DNA Dreamfields”), of whichthe Company has a 24% economic ownership, launched a low digestiblecarbohydrate pasta under the DreamfieldsTM brand name. Effectively launched in the springof 2004, DreamfieldsTM pastaobtained a 1.2% share of the traditional grocery channel pasta market for theweek ended October 2, 2004 based on data from A.C. Nielsen, making it theleading pasta in the low carbohydrate pasta category. The Company anticipatesincreasing its economic ownership in DNA Dreamfields to 29.5% in November 2004.

 

*Ingredient Market*

 

TheIngredient market of the dry pasta industry consists of pasta used by foodprocessors. Those entities use dry pasta as an ingredient or component in afurther-processed or combination food product. Such food products include drypasta dinners, including macaroni and cheese, frozen entrees, refrigeratedsalads, canned entrees, baby food, and canned and dry soups. The size of the Ingredientmarket is influenced by the number of food processors that choose to producepasta internally rather than outsource. Additionally, the Company estimatesthat the Ingredient market has experienced a percentage decline similar to theRetail market.

 

*Foodservice Market*

 

TheFoodservice market consists of sales of dry pasta to commercial andnon-commercial eating establishments such as restaurants, business and industrycafeterias, managed services, hotels and motels, retail vending, recreation,mobile and other away-from-home eating outlets. Marketing dry pasta to thismarket generally 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. The trendtoward a reduced carbohydrate lifestyle does not appear to have significantlyaffected the Foodservice market.

 

**Co-Pack Arrangements**

 

Aportion of each end-user market is supplied under “co-pack” arrangementsbetween pasta manufacturers. These agreements involve the sale of dry pastaproducts between pasta manufacturers in order to supply short-term volumedeficiencies such manufacturers suffer from time to time in meeting customerrequirements, and to allow a manufacturer to draw upon particular areas ofexpertise of other manufacturers, which may be more cost beneficial thanself-manufacturing.  Co-pack salescomprised approximately 3% and 6% of the Company’s net revenues for the yearsended July 31, 2004 and 2003, respectively.

 

**Production and Products**

 

TheCompany purchases durum wheat from holders of the Company’s Series D DeliveryPreferred Stock and on the open market. The durum wheat is used in theproduction of semolina and durum wheat flours that are then used by the Companyto produce dry pasta products.

 

3

----

 

Pastaproduction is basically a mixing, extrusion and drying process. The primaryingredients are semolina and water, although egg, tomato, spinach or otheringredients may be added to produce certain products. The finished dry pasta ispacked to meet different markets and customer requirements.

 

Thepasta products manufactured by the Company consist of over 80 different shapesand are sold to customers in all markets. In addition to the dry pasta producedby the Company, it purchases additional dry pasta shapes from othermanufacturers and resells them. This practice is widely followed by many pastamanufacturers for efficiency reasons and allows distribution of wider productlines to the Company’s customers. Outside purchases of pasta, excluding imports,comprised approximately 1% of net sales for each of the Company’s last threefiscal years. The Company does not anticipate any significant change in itsoutside purchases of pasta in the foreseeable future.

 

The Company has anagreement with Gruppo Euricom, a large pasta manufacturer in Italy, to be theexclusive distributor of Gruppo Euricom’s Italian pasta and rice products inthe United States and Canada.  Theseproducts are primarily private label retail and foodservice products. Sales ofimported products comprised approximately 1% to 2% of the Company’s netrevenues in each of the last three fiscal years.

 

TheCompany’s identity preservation program provides our customers with foodsafety, traceability and quality from the field to the plate.  The Company’s proximity to the durum growingregions, its milling and production facilities, and its information technologysystems allow the Company to produce products under an identity preservationprogram.

 

TheCompany’s Carrington, North Dakota facilities have been certified by theOrganic Crop Improvement Association and 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.

 

TheCompany’s products are manufactured using a comprehensive Hazard AnalysisCritical Control Point (HACCP) program, which requires strict monitoring in allaspects of the manufacturing process, to ensure food quality and safety. Webelieve that meeting HACCP standards strengthens customer confidence in thequality of our products. The Company undergoes food safety and product qualityaudits at various times throughout the year and consistently receives highscores.

 

Inaddition to its pasta products, the Company markets semolina, durum wheat flourand other flour blends to other manufacturers as market conditions allow. Lowergrade flours and millfeed by-products of the durum milling process are soldprimarily for animal feed.  Non-pastasales represented approximately 10% of the Company’s net revenues in fiscal year2004, and approximately 9% of the Company’s net revenues in fiscal years 2003and 2002.

 

**Sales, Marketing and Customers**

 

The Company markets itsproducts through direct sales, supplemented by the efforts of brokers retainedby the Company. These brokers receive a commission upon sale of the Company’sproducts. The Company’s pasta products are distributed on a broad basisthroughout the United States. The Company does not export significantquantities of its pasta products. One customer, U.S. Foodservice, accounted forapproximately 15%, 17% and 12% of net revenues for the years ended July 31,2004, 2003 and 2002, respectively. The Company’s top 10 customers accounted for57% of revenues in fiscal year 2004, 58% of revenues in fiscal year 2003, and51% of revenues in fiscal year 2002. Pasta revenues consisted of 59% Retail and41% Institutional for fiscal year 2004, 63% Retail and 37% Institutional forfiscal year 2003, and 66% Retail and 34% Institutional for fiscal year 2002.

 

The Company sells most ofits pasta under “purchase orders”, whereby the customer and the Company are notobligated for any pre-determined length of time, or under pricing commitmentsagreed to with terms of one year or less. The Company has entered intolong-term marketing agreements, including volume and pricing commitments, withU.S. Foodservice and Safeway, Inc. through December 31, 2006 and August 31,2006, respectively. The Company has entered into an agreement with GruppoEuricom (“Gruppo”), a large pasta

 

4

----

 

manufacturer in Italy, tobe the exclusive distributor of Gruppo’s Italian pasta and rice products in theUnited States and Canada with an initial term through August 2006. Theseproducts are primarily sold in the private label retail and foodservicemarkets.

 

**Series D Delivery Preferred StockDelivery Rights**

 

Each share of Series DDelivery Preferred Stock of the Company gives its holder the privilege, but notthe obligation, to deliver one bushel of durum wheat to the Company each fiscalyear on a “first-come, first-served” basis. From time to time the Company will post notices to the market on its Website (holders may also telephone the Company for information on market notices)for the purchase of durum wheat. During the 24-hour period following theposting of any market notice and to the extent that the Company’s durum wheatrequirements as set forth in the market notice have not been fulfilled by otherholders of Series D Delivery Preferred Stock, holders of Series D DeliveryPreferred Stock have the right to (i) accept the Company’s offer to purchasedurum wheat and (ii) deliver durum wheat to the Company on such terms andconditions as are set forth in the market notice.  However, in any given fiscal year of theCompany, the first-come, first-served privilege to deliver durum wheat shall beexercisable 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 a certainamount of time (not less than one day), holders of Series D Delivery PreferredStock have not sold to the Company all of the durum wheat requested in thenotice, the Company will fulfill its remaining requirements outside of theSeries D Delivery Preferred Stock delivery privilege.

 

Because the privilege ofa holder of Series D Delivery Preferred Stock to deliver durum wheat to theCompany only arises if the Company actually requires durum, the privilege isnot absolute.  Any and all durum wheat deliveredby a holder of Series D Delivery Preferred Stock to the Company shall conformto quality specifications established by the Company.

 

**Competition**

 

*Overview*

 

The markets for pasta and semolina/durum wheat flour arehighly competitive in most markets and geographic regions. The intensity ofcompetition varies from time to time as a result of a number of factors,including: (1) the degree of industry capacity utilization, (2) comparativeproduct distribution costs, (3) ability to render distinctive service tocustomers, (4) the price of raw materials, primarily durum wheat, and (5) adistinguishing or unique ability to provide consistent product quality in linewith customer specifications.  TheCompany believes that, in a broad sense, the most influential factor on theintensity of competitive conditions is industry capacity utilization.  It should be noted that detailed informationregarding pasta production is somewhat difficult to obtain, as many pastaproducers are closely-held enterprises.

 

*Competitionin the Pasta Market*

 

The pasta market is highly competitive and includesseveral well-established enterprises. Those competitors are primarilyindependent companies and, to a lesser extent, divisions or subsidiaries ofother, larger, food products companies. In addition, the Company competesagainst foreign suppliers, including Italian and Turkish enterprises, that sellpasta in the United States.

 

The Company markets in the Retail market primarily as aprivate label supplier. The Company’s Dakota Growers Pasta Co.® label to datehas slight penetration in local area markets in the Dakotas and Minnesota andits Pasta Sanita® label is sold in small niches ranging from the upper Midwestto select markets in the Northeast United States.

 

5

----

 

The Company’s competition in the private label retailmarket is primarily American Italian Pasta Company and, to a lesser extent, NewWorld Pasta Company. These private label retail sales compete with retailbranded products distributed primarily by American Italian Pasta Company(Muellers, R&F, Anthony’s, Golden Grain/Mission brands et al), New WorldPasta Company (Ronzoni, San Georgio, Skinner, American Beauty, Creamette,Prince brands et al), Barilla and a variety of smaller domestic and importedbrands.

 

In the Foodservice market, the Company also markets itspasta primarily as a private label supplier, including sales to three of thelargest foodservice distributors in the country under their labels. TheCompany’s main competitors in the Foodservice market are American Italian PastaCompany, A. Zerega’sSons, Inc., and Barilla, as well as foreign competitors that sell product inthe United States. The Company’s “DakotaGrowers Pasta Co.®,” “Pasta Sanita®” and “Pasta Growers®” foodservice brandsare sold throughout the United States to independent distributors and nationalchain accounts. In September 2004, the Company signed an exclusive distributionagreement with New World Pasta under which the Company is licensed to use the“Ronzoni,” “Prince” and “San Georgio” brands in the Foodservice market,effectively taking over all of New World Pasta’s foodservice operations.

 

TheCompany focuses a majority of its ingredient marketing efforts on companiesthat do not also manufacture the dry pasta ingredient for their end-products.The Company’s top competitors in the Ingredient market include American ItalianPasta Company, Philadelphia Macaroni Co. Inc., and A. Zerega’s Sons, Inc. Alarge portion of the Ingredient market production capacity is represented byself-suppliers, which include Kraft Foods, Campbell Soup Company, ConAgra,Inc., Luigino’s and Stouffers Corporation.

 

The competitive environment in the pasta industrydepends largely on aggregate industry capacity relative to aggregate demand forpasta products. The pasta manufacturing industry experienced capacity changesand restructuring in 2004 which has significantly reduced the excess pastaproduction capacity. However, future fluctuations in capacity availability arelikely to occur.

 

*Competitionin the Semolina and Durum Wheat Flour Market*

 

Giventhe commodity nature of the market forsemolina and durum flour, sales volume is largely dependent on delivered pricewhen adequate supply conditions exist. Italgrani USA, Inc., Horizon Milling,LLC and Miller Milling collectively are believed to represent approximately 40%of total domestic milling capacity. The Company’s current milling operationrepresents about 15% of total domestic milling capacity. Most of the durummilling capacity in the United States is either part of an integrated pastaproduction facility or in an alliance with pasta manufacturers. The Companybelieves that the integration of its milling and pasta production facilitiesenables it to compete more effectively with those competitors who also haveintegrated facilities.

 

**GovernmentRegulation**

 

*TradePolicies*

 

Governmental policies and regulations, includingthose impacting the amount of durum wheat imported from Canada, may affect theoperations of the Company and the volume of pasta imports. United Statesgovernment farm policies also affect durum plantings and thus can have asignificant impact on the market price of durum.

 

Domesticpasta prices are also influenced by competition from foreign pasta producers,and as such, by the trade policies of both the U.S. government and foreigngovernments. The U.S. Customs Service (Customs) distributes antidumping andcountervailing duties assessed on certain pasta imported from Italy and Turkeyto affected domestic producers pursuant to the Continued Dumping and SubsidyOffset Act of 2000 (the “Act”). The Company received net payments ofapproximately $0.6 million under the Act in its fiscal year 2004 and $1.0million in fiscal year 2003. Although these duties may enable the Company tocompete more favorably against Italian and Turkish producers in the U.S. pastamarket, there is no assurance as to the length of time these duties will bemaintained, or that foreign producers will not sell competing products in theUnited States at prices lower than those of the Company.

 

6

----

 

*Food and Drug AdministrationRegulation*

 

As a producer of productsintended for human consumption, the Company’s operations are subject to certainfederal and state regulations, including regulations promulgated by the UnitedStates Food and Drug Administration. The Company believes that it is inmaterial compliance with the applicable regulatory requirements. The FDA iscurrently reviewing the labeling requirements for products marketed as lowcarbohydrate and disclosures related to the terminology “net carbohydrates.”DNA Dreamfields Company, LLC does not believe that any new rule changes willhave a significant impact on the DreamfieldsTM business.

 

*EnvironmentalRegulation*

 

DakotaGrowers is subject to extensive federal and state environmental laws andregulations with respect to water and air quality, solid waste disposal andodor and noise control. The Company conducts an on-going control programdesigned to meet these environmental laws and regulations. There are no pendingregulatory enforcement actions and the Company believes that it is insubstantial compliance with applicable environmental laws and regulations.

 

TheCompany cannot predict whether future changes in environmental laws orregulations might increase the cost of operating its facilities and conductingits business. Any such changes could have adverse financial consequences forthe Company.

 

**IntellectualProperty Rights**

 

TheCompany relies on a combination of trade secret, trademark law, nondisclosureagreements and technical measures to establish and protect its proprietaryrights to its products and processes. The Company owns the following trademarksthat have been registered with the United States Patent and Trademark Officefor the sale of dry pasta: Pasta Growers®, Pasta Sanita®, Zia Briosa®, PrimoPiatto® and Dakota Growers Pasta Co.®.

 

**Research and Development**

 

The Company supportsresearch and development programs in North Dakota that focus on improvedvarieties of durum wheat. Dakota Growers has an on-staff agronomist and is inthe midst of a long-term project of small plot, replicated variety trialresearch, as well as field-scale fungicide research. In connection with plantbreeders and researchers, the Company is working to develop scab-resistant,high-gluten durum varieties.

 

As a result of thecreation of DNA Dreamfields Company, LLC and the introduction of theDreamfieldsTM

low digestiblecarbohydrate products, the Company is investing and participating in productand manufacturing technique research beyond the scope of traditional dry pasta.

 

The Company, as part ofits operations, maintains a modern, well-equipped laboratory facility designedprimarily to evaluate and maintain high quality standards for incoming rawmaterials, ongoing product manufacturing, and development of new pasta shapes.

 

**Employees**

 

As of September 30, 2004,the Company had 367 employees, 93 of which are covered by collective bargainingagreements at its Primo Piatto, Inc. subsidiary. These collective bargainingagreements expire on December 1, 2004 and September 30, 2005. The Companyconsiders its employee relations to be very good.

 

7

----

 

**RiskFactors**

 

Thefollowing are important factors that could cause actual results to differmaterially from those expressed in any forward-looking statements made by or onbehalf of the Company. Additional risks that we do not yet know of, orcurrently believe are immaterial, may also impair the business operations ofthe Company.

 

***Consumer Trends***

 

As the Company competes exclusively in the drypasta industry, changes in consumer trends that result in lowered demand fordry pasta may have a material adverse effect on the Company’s financialcondition and results of operations. The Company believes the most significantconsumer trend that may lower the overall demand for dry pasta is the move bymany consumers to a low carbohydrate lifestyle.

 

***Competitive Environment***

 

Boththe U.S. pasta industry and world pasta industry are extremely competitive. TheCompany competes in all dry pasta markets – retail store brand, foodservice andingredient, with larger, national and international food companies. Competitionwithin the pasta industry is largely dependent upon the relationship of overallindustry production capacity to overall market demand for pasta. The pastaindustry in the U.S. has, until recently, been faced with excess productioncapacity. Recent developments have significantly reduced this excess capacity,although future fluctuations in capacity availability are sure to occur.  Italy faces an excess capacity situationwhich may influence the availability and price of imported products.  Some competitors may have long-term, highvolume contracts, which guarantee a specified amount of volume over the term ofthe contract. Other competitors have retail brand equity and larger amounts ofmarketing dollars to compete against imported and store brand products. Thecompetitive environment, especially in the retail private label and ingredientmarkets, has in the past, and may in the future, put pressure on the Company’sprofitability and its ability to maintain market share. While the Company hasand will continue to apply, where possible, cost saving measures in an effortto remain competitive, there is no guarantee that the Company can operateprofitably in the future.

 

***No Public Market for Shares of the Company’s CommonStock and Preferred Stock***

 

There is currently no established public trading marketfor the shares of Common Stock and Preferred Stock of the Company, and anactive trading market may never develop. The Company maintains no obligation to seek or to obtain a listing on anational market. As a result, you may notbe able to readily resell your shares in the Company.

 

***Technology***

 

TheCompany believes that its overall commitment to maintaining and upgrading pastamanufacturing, milling and packaging equipment is necessary to keep acompetitive edge in the pasta industry. In addition, it also acknowledges thatongoing computer system upgrades to better service the demands of its customersare important to long-term success and profitability. The Company may benegatively impacted if it is unable to consistently keep pace with the industryin these areas.

 

***Pasta, Semolina, Durum Wheat and By-Product Prices***

 

TheCompany’s profitability is directly related to the market price of dry pasta,semolina, durum wheat and mill feed by-products. The supply and price of durumwheat are subject to market conditions and are influenced by many factorsbeyond the Company’s 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 materialadverse effect on operating profits unless we are able to pass cost increaseson to our customers. Competitive pressures often limit our ability to increaseprices in

 

8

----

 

responseto higher input costs. By-products of the milling process compete with otherfeed products, and fluctuate significantly in price with the availability ofthese competing feed products.

 

***Product Concentration***

 

TheCompany competes almost exclusively in the dry pasta industry and relatedflours and by-product markets, with a significant portion of pasta salesconcentrated in the retail and foodservice private label markets. Any declinein pricing or demand for dry pasta, particularly within the retail andfoodservice private label markets, could have a material adverse effect on theCompany’s financial condition and results of operations.

 

***Product Liability***

 

Thesale of food products for human consumption involves the risk of injury toconsumers. These injuries may result from tampering by unauthorized thirdparties, product contamination or spoilage, including the presence of foreignobjects, substances, chemicals, aflatoxin and other agents, or residuesintroduced during the growing, storage, handling or transportation phases. TheCompany has never been involved in a product liability lawsuit. The Company issubject to U.S. Food and Drug Administration inspection and regulations and webelieve the Company’s facilities comply in all material respects with allapplicable laws and regulations, but we cannot be certain that we will not besubject to claims or lawsuits in the future for injuries relating to theconsumption of the Company’s products. The Company carries insurance forproduct liability claims related to its products and for the costs related toproduct recalls. However, we cannot be certain that the Company will not incurclaims or liabilities for which it is not insured or that exceed the amount ofits insurance coverage.

 

***Government Regulation and Trade Policies***

 

DakotaGrowers is subject to extensive federal and state environmental laws andregulations with respect to water and air quality, solid-waste disposal andodor and noise control. The Company conducts an on-going program designed tocomply with these laws and regulations. There are no pending regulatoryenforcement actions against the Company, and the Company believes that itcurrently is and will continue to be in substantial compliance with allapplicable environmental laws and regulations.

 

Asa producer of products intended for human consumption, the Company’s operationsare subject to certain federal and state regulations, including regulationspromulgated by the U.S. Food and Drug Administration. The Company believes thatit is in material compliance with all applicable regulatory requirementsrelating to food quality and safety.

 

Theoperations of the Company may be affected by governmental trade policies andregulations, including those impacting the amount of durum wheat imported fromCanada. Domestic pasta prices are also influenced by competition from foreignpasta producers, and as such, by the trade policies of both the U.S. governmentand foreign governments.

 

***Restrictive Loan Covenants***

 

TheCompany’s loan agreements with CoBank and institutional investors obligate theCompany to maintain or achieve certain amounts of equity and working capitaland achieve certain financial ratios. To the extent that the Company is unablein the future to satisfy the various conditions specified in the loanagreements, the Company’s ability to distribute dividends to its shareholdersmay be restricted. The failure to comply with the various loan covenants mayresult in interest rate penalties, restrict the Company’s corporate activitiesor result in a default by the Company which may have a material adverse effecton the Company’s liquidity.

 

***Board of Directors Discretion Regarding Dividends***

 

TheBoard of Directors of the Company has absolute discretion to determine themanner and amount of payment of dividends on shares of Common Stock and,subject to certain exceptions, Preferred Stock.

 

9

----

 

**AvailableInformation**

 

TheCompany’s Internet website address is *www.dakotagrowers.com*.We make available, free of charge through the “Investors” portion of ourwebsite, the Company’s annual reports on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K, and amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of1934 (the “1934 Act”) as soon as reasonably practicable after we electronicallyfile such materials with, or furnish such materials to, the Securities andExchange Commission. Reports of beneficial ownership filed pursuant to Section16(a) of the 1934 Act are also available through our website.

 

TheSecurities and Exchange Commission maintains an Internet site that containsreports, proxy, and information statements and other information regardingissuers that file electronically with the Securities and Exchange Commission.The address of that site is http://www.sec.gov.

 

**ITEM2.  PROPERTIES AND PROCESSING FACILITIES**

 

DakotaGrowers owns and operates a milling facility in North Dakota, and pasta plantsin North Dakota and Minnesota. The Company owns the warehouse facilities at thepasta plants. These facilities are supplemented by public warehouses inCalifornia, Kansas, Minnesota, New York, North Dakota, Oregon and Washingtonwhere inventory is maintained and redistributed for the needs of specificcustomers.

 

DakotaGrowers continues to invest in information technology to provide enterprisevisibility to all facilities and activities within the supply chain. Thesesystems encompass communications, data collection, data storage, processmanagement and record management to ensure the Company is providing a superiorlevel of service to our customers while reducing operating and administrativeexpenses.

 

**ITEM 3.  LEGAL PROCEEDINGS**

 

From time to time and inthe ordinary course of its business, the Company is named as a defendant inlegal proceedings related to various issues, including worker’s compensationclaims, tort claims and contractual disputes. Other than such routinelitigation, the Company is not currently involved in any material legalproceedings. In addition, the Company is not aware of other potential claimsthat could result in the commencement of legal proceedings. The Company carriesinsurance that provides protection against certain types of claims, up to thepolicy limits of the Company’s insurance.

 

10

----

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

Nomatters were submitted to a vote of our security holders during the fourthquarter of fiscal year 2004.

 

**PART II.**

 

**ITEM 5.  MARKET FOR THE REGISTRANT’S COMMON STOCK ANDRELATED STOCKHOLDER MATTERS**

 

There is no establishedpublic trading market for the Company’s Common Stock or Preferred Stock. As of October 13, 2004 there were 1,318holders of the Company’s Common Stock.

 

Twounrelated companies, Variable Investment Advisers, Inc. (VIA) and AlerusSecurities have established Alternative Trading Systems (ATS) to facilitatetrading of the Company’s Common Stock. We do not implicitly or explicitlyendorse VIA, Alerus Securities or their respective web sites, and we are notresponsible for products and services that VIA or Alerus Securities provide. Wedo not stand behind VIA or Alerus Securities or receive any fees from either ofthem in connection with the services offered on their respective web sites.Links to the respective web sites of VIA and Alerus Securities are availablethrough the “Investors” portion of the Company’s website at *www.dakotagrowers.com*.

 

As a cooperative,qualified patronage dividends had been declared and paid in prior years. Nocorporate dividends on Common Stock have been declared within the last twofiscal years. We anticipate that dividends paid by the Company will be lowerthan the patronage distributions previously declared and paid by 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 distributions as the Board of Directorsreinvests a larger portion of the entity’s earnings to fund debt repayments,working capital requirements, equipment acquisitions, market share retentionand expansion, and cost-saving projects.

 

For information on theCompany’s equity compensation plans, refer to “Item 12. Security Ownership ofCertain Beneficial Owners and Management”.

 

11

----

 

**ITEM 6.  SELECTED FINANCIAL DATA**

 

The selected financialdata presented below for the fiscal years ended July 31, 2004, 2003, 2002, 2001and 2000 has been derived from the audited consolidated financial statements ofthe Company (and the Cooperative for periods presented prior to the conversionfrom a cooperative to a corporation). The conversion of Dakota Growers PastaCompany from a cooperative to a corporation was completed effective July 1,2002. The conversion 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 suchdeferred tax assets and liabilities upon conversion to a corporation, theCompany recorded a nonrecurring, non-cash income tax charge of $6.1 million.The selected 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.

 

**SELECTED FINANCIAL DATA**

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

** **
| ** **                                                                                | ** ** | **Fiscal year ended July 31** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **INCOME STATEMENT DATA**                                                                 |       |                          |       |   |   |   |   |   |   |   |   |
| Net  revenues                                                                             |       | $                             | 144,679    |   | $ | 136,806 |   | $ | 152,465 |   | $ | 135,921 |   | $ | 136,862 |   |
| Cost  of goods sold                                                                       |       | 132,245                       |       | 125,160 |   | 130,502 |   | 124,811 |   | 116,890 |   |
| Gross  profit                                                                             |       | 12,434                        |       | 11,646 |   | 21,963 |   | 11,110 |   | 19,972 |   |
| Marketing,  general and administrative expenses                                           |       | 8,345                         |       | 9,816 |   | 9,382 |   | 9,631 |   | 9,713 |   |
| Loss  on asset impairment                                                                 |       | 704                           |       | — |   | — |   | — |   | — |   |
| Operating  income                                                                         |       | 3,385                         |       | 1,830 |   | 12,581 |   | 1,479 |   | 10,259 |   |
| Other  expense - net                                                                      |       | (2,835                        | )          | (2,364 | ) | (3,365 | ) | (3,574 | ) | (3,929 | ) |
| Income  (loss) before income taxes                                                        |       | 550                           |       | (534 | ) | 9,216 |   | (2,095 | ) | 6,330 |   |
| Charge  to record deferred taxes upon conversion from a cooperative to a corporation  (2) |       | —                        |       | — |   | 6,105 |   | — |   | — |   |
| Income  tax expense (benefit)                                                             |       | 214                           |       | (105 | ) | 1,277 |   | (311 | ) | (1,298 | ) |
| Net  income (loss)                                                                        |       | 336                           |       | (429 | ) | 1,834 |   | (1,784 | ) | 7,628 |   |
| Dividends  on preferred stock                                                             |       | —                        |       | 3 |   | 10 |   | 15 |   | 4 |   |
| Net  earnings (loss) on common/equity stock                                               |       | $                             | 336        |   | $ | (432 | ) | $ | 1,824 |   | $ | (1,799 | ) | $ | 7,624 |   |
|                                                                                      |       |                          |       |   |   |   |   |   |   |   |   |
| Net  earnings (loss) per common/equity share - Basic                                      |       | $                             | 0.03       |   | $ | (0.03 | ) | $ | 0.16 |   | $ | (0.16 | ) | $ | 0.68 |   |
|                                                                                      |       |                          |       |   |   |   |   |   |   |   |   |
| Weighted  average common/equity shares outstanding - Basic                                |       | 12,265                        |       | 12,355 |   | 11,382 |   | 11,253 |   | 11,166 |   |
|                                                                                      |       |                          |       |   |   |   |   |   |   |   |   |
| Patronage  and other dividends per average common/equity share outstanding                |       |                          |       |   |   |   |   |   |   |   |   |
| Declared  (1)                                                                             |       | $                             | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 0.40 |   |
| Distributed  (1)                                                                          |       | —                        |       | — |   | — |   | — |   | 0.40 |   |

 

12

----

 
| ** **                                            | ** ** | **As of July 31** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|
| ** **                                            | ** ** | **2004**          | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **BALANCE SHEET DATA**                                |       |              |       |   |   |   |   |   |   |   |   |
| Cash                                                  |       | $                 | 589        |   | $ | 5 |   | $ | 2,866 |   | $ | 3 |   | $ | 1,725 |   |
| Working  capital                                      |       | 16,586            |       | 13,429 |   | 23,013 |   | 14,420 |   | 25,089 |   |
| Total  assets                                         |       | 119,415           |       | 122,390 |   | 125,541 |   | 128,658 |   | 131,857 |   |
| Long-term  debt (excluding current maturities)        |       | 21,087            |       | 28,263 |   | 38,274 |   | 47,594 |   | 51,626 |   |
| Redeemable  preferred stock                           |       | 20                |       | 33 |   | 54 |   | 113 |   | 126 |   |
| Stockholders’  equity                            |       | 58,619            |       | 53,818 |   | 56,090 |   | 54,267 |   | 60,533 |   |
|                                                  |       |              |       |   |   |   |   |   |   |   |   |
| **OPERATING DATA**                                    |       |              |       |   |   |   |   |   |   |   |   |
| Ratio  of long-term debt to stockholders’ equity |       | .36x              |       | .53x |   | .68x |   | .88x |   | .85x |   |
|                                                       |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                      As acooperative, qualified patronage declarations were made in October of each yearbased on the patronage earnings and average shares for the prior fiscal yearending July 31. Amounts shown for each fiscal year were declared and paid inthe following fiscal year. Amounts reflected above include only dividends onequity stock and qualified patronage declarations, and exclude Non-QualifiedWritten Notices of Allocation to each member’s account as a cooperative.

 

(2)                      Uponconversion from a cooperative to a corporation effective July 1, 2002, theCompany recorded 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-Looking Statements**

 

The following discussioncontains forward-looking statements. Such statements are based on assumptionsby the Company’s management, as of the date of this report, and are subject torisks and uncertainties, including those discussed under “Risk Factors” in thisreport, that could cause actual results to differ materially from thoseanticipated. The Company cautions readers not to place undue reliance on suchforward-looking statements.

 

**Summary**

 

Dakota Growers is thethird largest pasta manufacturer in North America. The Company generates amajority of its revenues from manufacturing pasta for the retail store brandand foodservice markets, although we serve and continually look for opportunitiesin the entire dry pasta industry. Our identity preservation program providesour customers food safety, traceability and quality from the field to theplate. The Company also has a certified organic program and markets organicpasta through its Dakota Growers Pasta Co.® retail label, as well asinto the private label retail, foodservice, and ingredient markets. Importedpasta is distributed via an exclusive agreement with Gruppo Euricom, a largepasta manufacturer in Italy. In September 2004, the Company signed an exclusivedistribution agreement with New World Pasta under which the Company is licensedto use the “Ronzoni,” “Prince” and “San Georgio” brands in the foodservicemarket, effectively taking over all of New World Pasta’s foodservice operations.

 

13

----

 

The Company hastwo production plants, located in Carrington, North Dakota and New Hope,Minnesota. The cost of production of dry pasta is significantly impacted bychanges in durum wheat prices, which have varied widely in recent years. Duringfiscal year 2004, the cost of durum wheat represented approximately one-thirdof the Company’s cost of goods sold. The Company attempts to manage the riskassociated with durum wheat cost fluctuations through cost pass-throughmechanisms with our customers and forward purchase contracts for durum wheat.Volatility with respect to the price of the basic raw material for theCompany’s products leaves it subject to wide variation in its costs from yearto year. As a result, factors which impact the size and quality of the durumwheat crop and the availability of such wheat in the United States and Canadacan have a material adverse impact on the Company. 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.

 

Freight costsrepresent approximately 15% of cost of goods sold.  In calendar year 2004, new regulations in thetrucking industry and significant increases in fuel costs have dramaticallyimpacted the Company’s costs.  TheCompany utilizes its forward warehousing and rail programs to reduce theeffects of these increases. Additionally, packaging material costs, whichtraditionally represent 15% of cost of goods sold, have increased significantlydue to oil and other raw material price increases, fuel costs and other inputcosts passed on by our packaging suppliers.

 

Due to the intensecompetition present in the market for pasta products over the last severalyears, pasta manufacturers have, at times, been unable to fully implement priceincreases for their dry pasta products in periods when higher durum wheatprices or other input costs impacted the cost of pasta production. The Companybelieves that the competitive environment results primarily from excessproduction capacity in the domestic pasta industry in relation to total marketdemand and from strategic actions relating to market share. The industryexperienced some capacity rationalization within the past year, with both NewWorld Pasta Company and American Italian Pasta Company announcing permanent ortemporary shutdowns of certain pasta production facilities. In May 2004, NewWorld Pasta Company filed for Chapter 11 bankruptcy protection.

 

Net income for the yearended July 31, 2004 totaled $0.3 million compared to a $0.4 million net lossfor the year ended July 31, 2003. The increase in net earnings was largely due to higher pasta salesvolumes in the foodservice market.

 

TheCompany has secured new business in its first fiscal quarter 2005 and expectsto begin realizing increased revenues as a result of these new customerrollouts in its second fiscal quarter 2005. As a result of a supply/demandimbalance in the Company’s fourth fiscal quarter of 2004, the Company reducedproduction to keep its inventories at proper levels, resulting in higher perunit conversion costs.  A significant portionof these increased per unit costs will flow through cost of goods sold in theCompany’s first fiscal quarter of 2005.

 

TheCompany acquired a 24% ownership interest in DNA Dreamfields during fiscal year2004. DNA Dreamfields was formed by the Company and other food technology,manufacturing and consumer products marketing enterprises to develop,manufacture and sell low digestible carbohydrate pasta, rice and potatoes underthe DreamfieldsTM brand name. The Company has entered into amanufacturing agreement with DNA Dreamfields whereby Dakota Growers is theexclusive manufacturer of DreamfieldsTM low digestible carbohydratepasta. The Company has also entered into a services agreement with DNADreamfields under which it provides administrative, accounting, informationtechnology, sales, customer service and distribution services to DNA Dreamfields.

 

TheCompany believes that the DreamfieldsTM line of products is well suited for consumersseeking healthy low carbohydrate alternatives. The DreamfieldsTM low digestiblecarbohydrate pasta productscarry a higher selling price and higher profit margins than traditional pasta.DreamfieldsTM low digestible carbohydrate pasta has been acceptedfor distribution into over 20,000 grocery outlets nationwide. Initial shipmentsto customer distribution centers began in February 2004.

 

14

----

 

**Conversion**

 

The Company is a NorthDakota corporation that was organized on January 30, 2002 for the specificpurpose of consummating the conversion of the Cooperative into a corporation.The conversion of the Cooperative from a cooperative to a corporation wascompleted effective July 1, 2002, with the Company being the ultimate survivingentity in the conversion. The Company operates as the Cooperative’s successorand its operations are a continuance of the operations of the Cooperative.

 

The conversion wasaccounted for as an exchange between related parties. Therefore, no gain orloss was recognized at the time of conversion and the book value of the assetsand 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 suchdeferred tax assets and liabilities upon conversion to a corporation, theCompany recorded a nonrecurring, non-cash income tax charge of $6.1 million infiscal year 2002.

 

The comparability ofresults after the conversion versus those in prior periods was affected by theincome tax status change associated with the conversion from a cooperative to acorporation.

 

**CriticalAccounting Policies**

 

Theaccompanying discussion and analysis of the Company’s results of operations andfinancial condition are based upon its consolidated financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requiresmanagement to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. These estimates form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. We base our estimates and judgments onhistorical experience and on various other assumptions that we believe arereasonable under the circumstances. However, future events are subject tochange and the best estimates and judgments may require adjustment. For acomplete description of the Company’s significant accounting policies, pleasesee Note 1 to the consolidated financial statements. Our critical accountingpolicies are those that have meaningful impact on the reporting of ourfinancial condition and results, and that require significant managementjudgment and estimates. These policies include our accounting for (a) allowancefor doubtful accounts, (b) inventory valuation, (c) asset impairment, and (d)income taxes.

 

*Allowance for Doubtful Accounts*

 

Weevaluate the collectibility of our accounts receivable based on a combinationof factors. In cases where we are aware of circumstances that may impair aspecific customer’s ability to meet its financial obligations to us, we recorda specific allowance against amounts due to us, and thereby reduce the netrecognized receivable to the amount we reasonably believe will be collected.For all other customers, we recognize allowances for doubtful accounts based onthe length of time the receivables are past due and our historical experience.If the financial condition of our customers would deteriorate, additionalallowances may be required in the future which could have an adverse impact onour future operating results.

 

*InventoryValuation*

 

Inventories are stated atthe lower of cost or market, determined on a first-in, first-out (FIFO) basis,using product specific standard costs. The Company analyzes variances betweenactual manufacturing costs incurred and amounts absorbed at inventory standardcosts. Inventory valuations are adjusted for these variances as applicable. TheCompany regularly evaluates its inventories and recognizes inventory allowancesfor discontinued and slow-moving inventories based upon these evaluations.

 

15

----

 

*AssetImpairment*

 

We are required toevaluate our long-lived assets for impairment whenever indicators of impairmentexist, and write down the value of any assets if they are determined to beimpaired. Evaluating the impairment of long-lived assets involves managementjudgment in estimating the future cash flows and fair values related to theseassets. The Company recognized a loss on asset impairment totaling $704,000during the year ended July 31, 2004. Future events could cause management toconclude that impairment indicators exist and that the value of certainlong-lived assets is impaired.

 

*IncomeTaxes*

 

Indetermining income (loss) for financial statement purposes, management mustmake certain estimates and judgments in calculating tax liabilities and indetermining the recoverability of certain deferred tax assets. Deferred taxassets must be reduced by a valuation allowance, if based on the weight ofavailable evidence, it is more likely than not that some portion or all of therecorded deferred tax assets will not be realized in future periods. Managementbelieves it is likely that the deferred tax assets as of July 31, 2004 will berealized through the generation of future taxable income and tax planningstrategies.

 

**Results of Operations**

 

*Comparison of Fiscal Years endedJuly 31, 2004 and 2003*

 

***Net Revenues.*** Net revenues increased $7.9 million, or 5.8%, to $144.7 millionfor the year ended July 31, 2004, from $136.8 million for the year ended July31, 2003. The increase was primarily due higher sales volumes in thefoodservice market and sales related to the introduction of DreamfieldsTM pastaproducts into the marketplace.

 

Revenuesfrom the retail market, a portion of which includes co-pack and governmentalsales, decreased $2.2 million, or 2.7%, as a result of a 6.8% decrease in salesvolume offset by higher per unit selling prices. The volume declines weremainly in co-pack and governmental sales. Sales of DreamfieldsTM lowdigestible carbohydrate pasta, which have significantly higher per unit salesprices than the Company’s other products, accounted for a majority of theaverage sales price increase in the retail market. Foodservice revenuesincreased $5.7 million, or 16.2%, primarily driven by a 13.7% increase in salesvolumes. Ingredient revenues increased $2.3 million, or 21.3%, resulting mainly from a 14.1%increase in sales volumes combined with higher per unit sales prices.

 

The Company markets semolina production in excess of itsown requirements as well as durumwheat flour, other flour blends and by-products of the durum milling process. Revenues from mill product sales for the year ended July 31, 2004,increased $2.0 million from the prior year. The increase resulted primarilyfrom higher mill product sales volumes.

 

***Costof Goods Sold.***Cost of goods sold totaled $132.2 millionfor the year ended July 31, 2004, an increase of $7.0 million or 5.7% comparedto the $125.2 million reported for the year ended July 31, 2003. This increasewas primarily due to revenue growth. Gross profit as a percentage of netrevenues remained relatively constant at 8.6% in fiscal year 2004 compared to8.5% in fiscal year 2003. Durum cost decreases were offset by increases in eggingredients and the higher ingredient costs associated with DreamfieldsTM pastaproducts. The Company utilized its forward warehousing and rail programs toreduce the effects of freight industry cost increases resulting from higherfuel prices and regulation changes.

 

***Marketing,General and Administrative (“MG&A”) Expenses.*** MG&A expenses decreased $1.5 million, or15.0%, to $8.3 million for the year ended July 31, 2004, from $9.8 million forthe year ended July 31, 2003.  MG&Aexpenses as a percentage of net revenues decreased from 7.2% to 5.8%. The decrease in MG&A expenses wasprimarily due to lower incentive compensation costs. A portion of the incentivecompensation for the year

 

16

----

 

endedJuly 31, 2003 related to a compensatory transaction in conjunction with theunwinding of previous stock option exercises and related officer loans inresponse to the Sarbanes-Oxley Act of 2002.

 

***Losson Asset Impairment. ***TheCompany recorded a loss on asset impairment of $0.7 million during the yearended July 31, 2004. The impairment loss related to certain pasta productionequipment which was under a purchase option agreement that expired in July2004. Upon review, the Company determined the asset was impaired and adjustedto fair value which was estimated based on the current market conditions forsimilar equipment.

 

***NetLoss Allocated from Joint Venture. ***Thenet loss allocated from joint venture totaled $0.6 million for the year endedJuly 31, 2004, and represents the Company’s allocable share of net losses fromDNA Dreamfields Company, LLC based upon its 24% ownership interest.

 

***InterestExpense.***Interest expense for the year ended July 31,2004, totaled $2.8 million, down $0.6 million from $3.4 million for the yearended July 31, 2003. The decrease was mainly due to lower average outstandingdebt levels. Cash and equity patronage refunds received from CoBank totaling$103,000 and $126,000 have been netted against interest expense for the yearsended July 31, 2004 and 2003, respectively.

 

***Interestand Other Income.*** Interest and other income totaled $0.5 millionfor the year ended July 31, 2004 compared to $1.1 million for the year endedJuly 31, 2003. The U.S. Customs Service(“Customs”) has distributed antidumping and countervailing duties assessed oncertain pasta imported from Italy and Turkey to affected domestic producerspursuant to the Continued Dumping and Subsidy Offset Act of 2000 (the “OffsetAct”), which was enacted in October 2000. The Company received paymentsin the amount of $0.9 million and $1.0 million in December 2003 and 2002,respectively, under the Offset Act, based on duties assessed from October 1,2001 to September 30, 2003. The Companyrepaid $0.3 million to Customs in April 2004 pursuant to a reclamation requestfrom Customs. The reclamation request noted Customs had inadvertently left outan affected domestic producer that had timely filed a valid claim in theallocation calculation, resulting in the initial overpayment to the Company. TheCompany cannot reasonably estimate the potential amount, if any, that it mayreceive under the Offset Act in future periods as any such amount will be basedupon future events over which the Company has little or no control, including,but not limited to, the amount of expenditures by domestic pasta producers andthe amount of antidumping and countervailing duties collected by Customs.

 

***IncomeTaxes. ***Income tax expense for the year ended July31, 2004 was $0.2 million, reflecting an effective corporate income tax rate ofapproximately 39%. The income tax benefit for the year ended July 31, 2003 was$0.1 million.

 

***NetIncome (Loss). ***Netincome for the year ended July 31, 2004 totaled $0.3 million, an increase of$0.7 million compared to the net loss of $0.4 million incurred for the year ended July31, 2003.

 

*Comparison of Fiscal Years endedJuly 31, 2003 and 2002*

 

***Net Revenues.*** Net revenues totaled $136.8 million for the year ended July 31,2003, a decrease of $15.7 million, or 10.3%, compared to $152.5 million for theyear ended July 31, 2002. The decrease was primarily due to lower pasta salesvolumes offset partially by higher per unit selling prices related mainly to thepass through of durum cost increases.

 

Revenuesfrom the retail market, a portion of which includes co-pack and governmentalsales, decreased $13.6 million, or 14.7%, primarily as a result of a 15.6%decrease in sales volume. The loss of two larger retail customers from theprior year combined with a decrease in co-pack sales accounted for much of theretail sales volume decrease. Foodservice revenues increased $2.4 million, or7.5%, primarily driven by a 6.1% increase in per unit selling prices. Ingredientrevenuesdecreased $2.7 million, or 20.3%, resulting mainly from a 26.4% decrease insales volumes offset partially by higher per unit sales prices. Thedecline in ingredient sales resulted primarily from the loss of one customer inthis market due to competitive pricing issues.

 

17

----

 

The Company markets semolina production in excess of itsown requirements as well as by-products of the durum milling process. Revenues from semolina and by-product sales for the year ended July 31,2003, decreased $1.8 million from the prior year. The decrease resultedprimarily from lower sales volumes.

 

***Costof Goods Sold.***Cost of goods sold totaled $125.2 millionfor the year ended July 31, 2003, a decrease of 4.1% compared to the $130.5million reported for the year ended July 31, 2002. The $5.3 million decreaseresulted mainly from lower sales volumes offset by higher durum wheat costs,higher per unit manufacturing costs,increased inventory carrying costs associated with higher inventory levelsduring the second half of fiscal 2003, and costs associated with therestructuring of certain forward warehouse arrangements. Gross profit asa percentage of net revenues decreased from 14.4% to 8.5% primarily as a resultof these factors.

 

***Marketing,General and Administrative (“MG&A”) Expenses.***MG&Aexpenses for the year ended July 31, 2003 totaled $9.8 million compared to $9.4million for the year ended July 31, 2002. The $0.4 million increase wasprimarily the result of costs associated with compliance under theSarbanes-Oxley Act of 2002. MG&A expenses as a percentage of net revenuesincreased from 6.2% to 7.2% primarily due to the decrease in net revenues.

 

***InterestExpense.***Interest expense for the year ended July 31,2003, totaled $3.4 million, down slightly from $3.9 million for the year endedJuly 31, 2002. The decrease was due to lower average outstanding debt levelscombined with lower interest rates. Cash and equity patronage refunds receivedfrom CoBank totaling $126,000 and $228,000 have been netted against interestexpense for the years ended July 31, 2003 and 2002, respectively.

 

***Interestand Other Income.*** Interest and other income totaled $1.1million for the year ended July 31, 2003 compared to $0.5 million for year endedJuly 31, 2002. The increase resulted primarily from a net payment ofapproximately $1.0 million received by the Company during fiscal year 2003 fromCustoms pursuant to the Offset Act. The payment was received in conjunctionwith the distribution by Customs of antidumping and countervailing dutiesassessed on certain pasta imported from Italy and Turkey from October 1, 2001to September 30, 2002, to affected domestic producers pursuant to the OffsetAct. The Company cannotreasonably estimate the potential amount, if any, that may be received infuture periods as these receipts are based upon future events over which wehave little or no control, including, but not limited to, the amount ofexpenditures by domestic pasta producers and the amount of antidumping andcountervailing duties collected by Customs

 

***IncomeTaxes.***The income tax benefit for the year ended July 31,2003 was $0.1 million. Upon conversion to a corporation in fiscal year 2002,the Company recorded deferred tax assets and liabilities for the tax effects ofany temporary differences existing between income tax and financial reportingon the date of the change. Prior to conversion, the Cooperative had notrecorded deferred taxes for temporary differences that were likely to beeliminated through patronage allocations. In recording such deferred tax assetsand liabilities upon conversion to a corporation, the Company recorded anonrecurring, non-cash income tax charge of $6.1 million for the year endedJuly 31, 2002. Income tax expense for the year ending July 31, 2002, excludingthe charge to record deferred taxes upon conversion noted above, was $1.3million. Such expense related to income taxes on nonpatronage net earningswhile a cooperative and corporate net income.

 

***NetIncome (Loss).*** The Company incurred a net loss of $0.4million for the year ended July 31, 2003 compared to net income of $1.8 millionfor the year ended July 31, 2002. The decrease in earnings resultedprimarily from lower sales volumes combined with manufacturing and distributioncost increases as noted above.

 

**Liquidity and Capital Resources**

 

The Company’s primarysources of liquidity are cash provided by operations and borrowings under itsrevolving credit facility. Net working capital as of July 31, 2004 was $16.6million compared to $13.4 million as of July 31, 2003.

 

The Company secured a $25million revolving credit facility with CoBank in February 2004, which extendsthrough February 21, 2005. The revolving line has a variable interest rateestablished by CoBank based on

 

18

----

 

CoBank’s cost of fundsand is secured by property, equipment, and current assets of the Company. Thebalance outstanding on the revolving line of credit was $12.2 million and $9.7million as of July 31, 2004 and 2003, respectively.

 

The Company’s long-termfinancing is provided through various secured term loans and secured notes withCoBank and institutional investors. A majority of the Company’s long-term debtis fixed-rate with a small portion being variable. Variable interest rates onterm loans are based on CoBank’s cost of funds.

 

The Company’s debtagreements with CoBank and certain institutional investors obligate the Companyto maintain or achieve certain amounts of equity and certain financial ratiosand impose restrictions on the Company. The Master Loan Agreement (as amended)with CoBank requires the Company to maintain the following ratios: (a) acurrent ratio of 1.10 to 1.0 through July 31, 2004 and of not less than 1.25 to1.0 thereafter, (b) a long term debt to net worth ratio of 1.10 to 1.0, and (c)a consolidated funded debt to consolidated cash flow ratio of not more than 3.0to 1.0. The Company cannot pay dividends on capital stock in excess of minimumrequirements if such action will cause noncompliance with any financialcondition, without the prior written consent of CoBank. The Note PurchaseAgreement (as amended) with the institutional investors requires the Company tomaintain the following: (a) consolidated net worth of not less than the sum of(1) $27,000,000 plus (2) an aggregate amount equal to 30% of consolidated netincome for each completed fiscal year beginning with the fiscal year ended July31, 1998, (b) a trailing twelve month ratio of consolidated cash flow to consolidatedfixed charges of not less than 2.0 to 1.0 at the end of each fiscal quarter,and (c) a ratio of consolidated funded debt to consolidated cash flow ratio notto exceed 3.0 to 1.0 determined at the end of each fiscal quarter for theimmediately preceding four fiscal quarters. The Notes (as amended) require therate of interest on the unpaid balance be increased by one percent at any timethat either (a) the ratio of the Company’s consolidated funded debt toconsolidated cash flow is greater than 3.0 to 1.0 as of the end of each fiscalquarter 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 Company was in compliance with all debt covenants (as amended) as ofJuly 31, 2004 and the date of this filing.

 

Netcash from operations totaled $10.6 million and $11.8 for the years ended July31, 2004 and 2002, respectively. Net cash used for operations totaled $3.2million for the year ended July 31, 2003. The $13.8 million increase fromfiscal 2003 to fiscal year 2004 was mainly driven by reductions in inventoryand lower payments for long-term marketing costs offset by increases in tradereceivables. The $15.0 million decrease from fiscal year 2002 to 2003 was primarily due to the decrease in netincome, increases in payments made under long-term marketing agreements andhigher working capital requirements mainly related to inventory.

 

Net cash used forinvesting activities totaled $4.8 and $0.4 million for the years ended July 31,2004 and 2003, respectively. The Company made aggregate investments in DNADreamfields Company, LLC totaling $2.5 million during fiscal year 2004. The Company redeemed short-term investmentsof $2.0 million during fiscal 2003 which were previously restricted (See Note14 — Related Party Transactions to the consolidated financial statements). Netcash from investing activities totaled $2.9 million for the year endedJuly 31, 2002, and resulted primarily from proceeds received on the sale ofcertain pasta production equipment under a sale-leaseback transaction. Thesale-leaseback transaction generated $5.0 million in available funds, whichwere used at the time to secure and expand the Company’s sales efforts.Purchases of milling and pasta equipment totaled $2.2 million, $2.0 million and$1.1 million for the years ended July 31, 2004, 2003 and 2002, respectively.

 

The$5.3 million of net cash used for financing activities for the year ended July31, 2004 related primarily to principal payments on long-term debt offset bynet proceeds of $4.5 million received upon the issuance of common stock to MVCCapital, Inc.  Net cash from financing activitiestotaled $0.7 million for the year ended July 31, 2003. The Company paid $1.8 million for therepurchase of stock during the year ended July 31, 2003 (See Note 14 – RelatedParty Transactions to the consolidated financial statements). The remainingcash used for the fiscal year 2003 related to debt principal payments offset bynet borrowings under the Company’s revolving credit facility. Net cash used for financing activities totaled$11.9 million for the year ended July 31, 2002, mainly related topayments made on the Company’s revolving credit facility and long-term debt.

 

19

----

 

The Company forwardcontracts for a certain portion of its future durum wheat requirements. At July31, 2004, the Company had outstanding commitments for grain purchases totaling$12.8 million related to forward purchase contracts. These contracts are setprice contracts to deliver grain to the Company’s mill, and are not derivativein nature as they have no net settlement provision and are not transferable.

 

The Company madeaggregate investments in DNA Dreamfields totaling $2.5 million through July 31,2004. Under the terms of the DNA Dreamfields operating agreement, the Companyagreed to contribute, when and as needed, additional funds up to an aggregateof $4.0 million, to DNA Dreamfields to pay for the development of supply chain,product package development, consumer research, test market launch and regionalroll out, advertising and merchandising. The Company reached this $4.0 millionaggregate funding commitment to DNA Dreamfields in the Company’s first quarterof fiscal year 2005. In addition, the Company is currently engaged indiscussions with the other members of DNA Dreamfields regarding additionalcapital contributions to DNA Dreamfields for use in the on-going activities ofDNA Dreamfields. At the present time, the Company expects to invest anadditional $1.5 million in DNA Dreamfields during the second quarter of fiscalyear 2005, which would increase its economic ownership in DNA Dreamfields to29.5%.

 

Thefollowing table summarizes the Company’s contractual obligations as of July 31,2004 (in thousands):

 
| **Contractual Obligations** | ** ** | **Total** | ** ** | **Payments  Due in Less  Than 1 Year** | ** ** | **Payments  Due in  1-3 Years** | ** ** | **Payments  Due in  4-5 Years** | ** ** | **Payments  Due After  5 Years** | ** ** |
|-----------------------------|------------|-----------|------------|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
|                        |       |      |       |                                   |       |                            |       |                            |       |                             |       |
| Long-term  debt             |       | $         | 28,263     |                                   | $          | 7,176                           |       | $                               | 14,313     |                             | $          | 6,774 |   | $ | — |   |
| Durum  purchase obligations |       | 12,848    |       | 12,848                                 |       | —                          |       | —                          |       | —                           |       |
| Operating  leases           |       | 2,909     |       | 1,113                                  |       | 1,752                           |       | 44                              |       | —                           |       |
|                        |       |      |       |                                   |       |                            |       |                            |       |                             |       |
|                        |       | $         | 44,020     |                                   | $          | 21,137                          |       | $                               | 16,065     |                             | $          | 6,818 |   | $ | — |   |

 

Management believes thatnet cash to be provided by operating activities, along with its available lineof credit, will be sufficient to meet the Company’s expected capital andliquidity requirements for the foreseeable future.

 

**Recently Issued Accounting Standards**

 

InDecember 2003, the Financial Accounting Standards Board (FASB) issued FASBInterpretation No. 46(R), “Consolidation of Variable Interest Entities,” (FIN46(R)). This Interpretation of Accounting Research Bulletin No. 51,“Consolidated Financial Statements”, which replaces FASB Interpretation No. 46,addresses consolidation by business enterprises of variable interest entities.FIN 46(R) was implemented during fiscal year 2004 and did not have a materialimpact on the Company’s consolidated financial statements.

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

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

 

The Company forwardcontracts for a certain portion of its future durum wheat requirements. Thesecontracts are set price contracts to deliver grain to the Company’s mill, andare not derivative in nature as they have no net settlement provision and arenot transferable. The Company does not believe it is subject to any materialmarket risk exposure with respect to interest rates, commodity prices, exchangerates, equity prices, or other market changes that would require disclosureunder this item.

 

20

----

 

**ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS OFDAKOTA GROWERS PASTA COMPANY, INC.**

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

 

21

----

 

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

The Audit Committee

DakotaGrowers Pasta Company, Inc.

Carrington, North Dakota

 

We have audited theaccompanying consolidated balance sheets of Dakota Growers Pasta Company, Inc. (a North Dakota corporation) asof July 31, 2004 and 2003, and the related consolidated statements ofoperations, changes in stockholders’ equity and cash flows for the years endedJuly 31, 2004, 2003 and 2002. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the consolidated financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall consolidated financial statement presentation. Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Dakota Growers Pasta Company, Inc.****asof July 31, 2004 and 2003, and the results of their operations and their cashflows for the years ended July 31, 2004, 2003 and 2002, in conformity withaccounting principles generally accepted in the United States of America.

 

 
| /s/ Eide Bailly LLP |   |
|---------------------|--------|
|                |
| Fargo, North Dakota |
| October 20, 2004    |

 

22

----

 

**DAKOTA GROWERS PASTA COMPANY,INC.**

**CONSOLIDATED BALANCE SHEETS**

**JULY 31, 2004 AND 2003**

**(In Thousands, Except ShareInformation)**

 
| ** **                                                                                                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                    |       |     |       |     |       |
| **ASSETS**                                                                                                              |       |     |       |     |       |
|                                                                                                                    |       |     |       |     |       |
| CURRENT ASSETS                                                                                                          |       |     |       |     |       |
| Cash and cash  equivalents                                                                                              |       | $        | 589        |     | $          | 5 |   |
|                                                                                                                    |       |     |       |     |       |
| Trade accounts  receivable, less allowance for cash discounts and doubtful accounts of $1,209  and $1,012, respectively |       | 14,043   |       | 9,852    |       |
|                                                                                                                    |       |     |       |     |       |
| Other  receivables                                                                                                      |       | 1,002    |       | 1,225    |       |
|                                                                                                                    |       |     |       |     |       |
| Inventories                                                                                                             |       | 25,211   |       | 28,082   |       |
|                                                                                                                    |       |     |       |     |       |
| Prepaid expenses                                                                                                        |       | 3,994    |       | 3,940    |       |
|                                                                                                                    |       |     |       |     |       |
| Deferred income  taxes                                                                                                  |       | 937      |       | 569      |       |
|                                                                                                                    |       |     |       |     |       |
| Total current  assets                                                                                                   |       | 45,776   |       | 43,673   |       |
|                                                                                                                    |       |     |       |     |       |
| PROPERTY AND EQUIPMENT                                                                                                  |       |     |       |     |       |
| In service                                                                                                              |       | 109,987  |       | 108,263  |       |
| Construction in  process                                                                                                |       | 18       |       | 868      |       |
|                                                                                                                    |       | 110,005  |       | 109,131  |       |
| Less accumulated  depreciation                                                                                          |       | (46,980  | )          | (41,799  | )          |
|                                                                                                                    |       |     |       |     |       |
| Net property and  equipment                                                                                             |       | 63,025   |       | 67,332   |       |
|                                                                                                                    |       |     |       |     |       |
| INVESTMENT IN  JOINT VENTURE                                                                                            |       | 1,746    |       | —   |       |
|                                                                                                                    |       |     |       |     |       |
| INVESTMENT IN  COOPERATIVE BANK                                                                                         |       | 2,343    |       | 2,413    |       |
|                                                                                                                    |       |     |       |     |       |
| INTANGIBLE  ASSETS                                                                                                      |       | 392      |       | 539      |       |
|                                                                                                                    |       |     |       |     |       |
| OTHER ASSETS                                                                                                            |       | 6,133    |       | 8,433    |       |
|                                                                                                                    |       |     |       |     |       |
|                                                                                                                    |       | $        | 119,415    |     | $          | 122,390 |   |

 

23

----

 
| ** **                                                                                                                                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                   |       |     |       |     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                         |       |     |       |     |       |
|                                                                                                                                                   |       |     |       |     |       |
| CURRENT  LIABILITIES                                                                                                                                   |       |     |       |     |       |
| Notes payable                                                                                                                                          |       | $        | 12,200     |     | $          | 9,705 |   |
| Current portion  of long-term debt                                                                                                                     |       | 7,176    |       | 10,011   |       |
| Accounts payable                                                                                                                                       |       | 4,969    |       | 3,793    |       |
| Excess  outstanding checks over cash on deposit                                                                                                        |       | —   |       | 2,219    |       |
| Accrued  liabilities                                                                                                                                   |       | 4,845    |       | 4,516    |       |
|                                                                                                                                                   |       |     |       |     |       |
| Total current  liabilities                                                                                                                             |       | 29,190   |       | 30,244   |       |
|                                                                                                                                                   |       |     |       |     |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                         |       | —   |       | —   |       |
| LONG-TERM DEBT,  net of current portion                                                                                                                |       | 21,087   |       | 28,263   |       |
| DEFERRED INCOME  TAXES                                                                                                                                 |       | 10,363   |       | 9,845    |       |
| OTHER  LIABILITIES                                                                                                                                     |       | 136      |       | 187      |       |
| MANDATORILY  REDEEMABLE PREFERRED STOCK                                                                                                                |       |     |       |     |       |
| Series A, 6%  cumulative, $100 par value, 533 shares authorized, 200 and 333 shares issued  and outstanding as of July 31, 2004 and 2003, respectively |       | 20       |       | 33       |       |
|                                                                                                                                                   |       |     |       |     |       |
| Total  liabilities                                                                                                                                     |       | 60,796   |       | 68,572   |       |
|                                                                                                                                                   |       |     |       |     |       |
| STOCKHOLDERS’  EQUITY                                                                                                                             |       |     |       |     |       |
|                                                                                                                                                   |       |     |       |     |       |
| Series D  delivery preferred stock, non-cumulative, $.01 par value, 11,340,841  authorized, 11,275,297 shares issued and outstanding                   |       | 113      |       | 113      |       |
| Common stock,  $.01 par value, 75,000,000 shares authorized, 13,169,382 and 12,554,747  shares issued as of July 31, 2004 and 2003, respectively       |       | 132      |       | 126      |       |
| Additional  paid-in capital                                                                                                                            |       | 62,807   |       | 60,188   |       |
| Treasury stock  at cost, 0 and 294,456 shares as of July 31, 2004 and 2003, respectively                                                               |       | —   |       | (1,840   | )          |
| Accumulated  deficit                                                                                                                                   |       | (4,433   | )          | (4,769   | )          |
|                                                                                                                                                   |       |     |       |     |       |
| Total  stockholders’ equity                                                                                                                       |       | 58,619   |       | 53,818   |       |
|                                                                                                                                                   |       |     |       |     |       |
| Total  liabilities and stockholders’ equity                                                                                                       |       | $        | 119,415    |     | $          | 122,390 |   |

 

See Notes to ConsolidatedFinancial Statements

 

24

----

 

**DAKOTA GROWERS PASTA COMPANY,INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**YEARS ENDED JULY 31, 2004, 2003,AND 2002**

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

 
| ** **                                                                                                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                                                   |       |     |       |     |       |     |       |
| Net revenues  (net of discounts and allowances of $21,188, $16,706 and $17,056 for 2004,  2003 and 2002, respectively) |       | $        | 144,679    |     | $          | 136,806  |       | $ | 152,465 |   |
|                                                                                                                   |       |     |       |     |       |     |       |
| Cost of goods  sold                                                                                                    |       | 132,245  |       | 125,160  |       | 130,502  |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Gross profit                                                                                                           |       | 12,434   |       | 11,646   |       | 21,963   |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Marketing,  general and administrative expenses                                                                        |       | 8,345    |       | 9,816    |       | 9,382    |       |
| Loss on asset  impairment                                                                                              |       | 704      |       | —   |       | —   |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Operating income                                                                                                       |       | 3,385    |       | 1,830    |       | 12,581   |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Other income  (expense)                                                                                                |       |     |       |     |       |     |       |
| Interest and  other income                                                                                             |       | 509      |       | 1,063    |       | 477      |       |
| Gain (loss) on  disposition of property, equipment and other assets                                                    |       | 40       |       | (13      | )          | 23       |       |
| Net loss  allocated from joint venture                                                                                 |       | (622     | )          | —   |       | —   |       |
| Interest  expense, net                                                                                                 |       | (2,762   | )          | (3,414   | )          | (3,865   | )          |
|                                                                                                                   |       |     |       |     |       |     |       |
| Income (loss)  before income taxes                                                                                     |       | 550      |       | (534     | )          | 9,216    |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Charge to record  deferred taxes upon conversion from a cooperative to a corporation                                   |       | —   |       | —   |       | 6,105    |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Income tax  expense (benefit)                                                                                          |       | 214      |       | (105     | )          | 1,277    |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Net income  (loss)                                                                                                     |       | 336      |       | (429     | )          | 1,834    |       |
| Dividends on  preferred stock                                                                                          |       | —   |       | 3        |       | 10       |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Net earnings  (loss) on common/equity stock                                                                            |       | $        | 336        |     | $          | (432     | )          | $ | 1,824 |   |
|                                                                                                                   |       |     |       |     |       |     |       |
| Net earnings  (loss) per common/equity share                                                                           |       |     |       |     |       |     |       |
| Basic                                                                                                                  |       | $        | 0.03       |     | $          | (0.03    | )          | $ | 0.16 |   |
|                                                                                                                   |       |     |       |     |       |     |       |
| Diluted                                                                                                                |       | $        | 0.03       |     | $          | (0.03    | )          | $ | 0.16 |   |
|                                                                                                                   |       |     |       |     |       |     |       |
| Weighted average  common/equity shares outstanding                                                                     |       |     |       |     |       |     |       |
| Basic                                                                                                                  |       | 12,265   |       | 12,355   |       | 11,382   |       |
|                                                                                                                   |       |     |       |     |       |     |       |
| Diluted                                                                                                                |       | 12,625   |       | 12,609   |       | 11,415   |       |

 

See Notes to ConsolidatedFinancial Statements

 

25

----

 

**DAKOTA GROWERS PASTA COMPANY,INC.**

**CONSOLIDATED STATEMENTS OF CHANGES INSTOCKHOLDERS’ EQUITY**

**YEARS ENDED JULY 31, 2004, 2003AND 2002**

**(In Thousands, Except ShareInformation)**

 
| ** **                                                             | ** ** | **Number of Shares**                        | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                             | ** ** | **Series C  Convertible  Preferred  Stock** | ** ** | **Series D  Delivery  Preferred  Stock** | ** ** | **Membership  Stock** | ** ** | **Equity  Stock** | ** ** | **Common  Stock** | ** ** | **Treasury  Stock** | ** ** |
|                                                                   |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY  31, 2001                                                |       | 924                                         |       | — |   | 1,156 |   | 11,253,121 |   | — |   | — |   |
| Net membership  stock retired                                          |       | —                                      |       | — |   | (9 | ) | — |   | — |   | — |   |
| Series C preferred  stock converted to equity stock                    |       | (924                                        | )          | — |   | — |   | 22,176 |   | — |   | — |   |
| Equity  adjustments for conversion from a cooperative to a corporation |       | —                                      |       | 11,275,297 |   | (1,147 | ) | (11,275,297 | ) | 12,554,747 |   | — |   |
|                                                                   |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY  31, 2002                                                |       | —                                      |       | 11,275,297 |   | — |   | — |   | 12,554,747 |   | — |   |
| Purchase of  treasury stock                                            |       | —                                      |       | — |   | — |   | — |   | — |   | 294,456 |   |
|                                                                   |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY  31, 2003                                                |       | —                                      |       | 11,275,297 |   | — |   | — |   | 12,554,747 |   | 294,456 |   |
| Issuance of  common stock                                              |       | —                                      |       | — |   | — |   | — |   | 614,635 |   | (294,456 | ) |
|                                                                   |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| BALANCE, JULY  31, 2004                                                |       | —                                      |       | 11,275,297 |   | — |   | — |   | 13,169,382 |   | — |   |

 

26

----

 

**DAKOTA GROWERS PASTA COMPANY,INC.**

**CONSOLIDATED STATEMENTS OF****CHANGES IN STOCKHOLDERS' EQUITY**

**YEARS ENDED JULY 31, 2004, 2003AND 2002**

**(In Thousands, Except ShareInformation)**

 
| ** ** | ** **                | **Series C**

**Convertible**

**Preferred  Stock** | ** **              | **Series D**

**Delivery**

**Preferred  Stock** | ** **    | **Membership**

**Stock** | ** **     | **Equity**

**Stock** | ** ** | **Common**

**Stock** | ** ** | **Additional**

**Paid-in**

**Capital** | ** ** | **Treasury**

**Stock** | ** ** | **Accumulated**

**Deficit** | ** ** | **Allocated** | ** ** | **Unallocated  Accumulated** | ** ** | ** ** | ** ** |
|------------|---------------------------|-----------------------------------------------------|-------------------------|--------------------------------------------------|---------------|---------------------------|----------------|-----------------------|------------|-----------------------|------------|------------------------------------------|------------|-------------------------|------------|------------------------------|------------|---------------|------------|------------------------------|------------|------------|------------|
| ** ** | **Accumulated  Earnings** | ** **                                          | **Earnings  (Deficit)** | ** **                                       | ** **    | ** **                |
| ** ** | **Qualified**             | ** **                                          | **Non-Qualified**       | ** **                                       | **Patronage** | ** **                | **Non-member** | ** **            | **Total**  | ** **            |
|       |                      |                                                |                    |                                             |          |                      |           |                  |       |                  |       |                                     |       |                    |       |                         |       |          |       |                         |       |       |       |   |   |   |   |
| **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 loss 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 |   |
| Preferred  dividends declared                                                                                                                                   |   | — |         | — |   | —    |   | —  |         | — |   | —       |   | — |         | (3     | )      | —       |   | — |         | — |   | —       |   | (3     | )            |
| Purchase of  treasury stock                                                                                                                                     |   | — |         | — |   | —    |   | —  |         | — |   | —       |   | (1,840 | )            | — |   | —       |   | — |         | — |   | —       |   | (1,840 | )            |
| Net loss for the  year ended July 31, 2003                                                                                                                      |   | — |         | — |   | —    |   | —  |         | — |   | —       |   | — |         | (429   | )      | —       |   | — |         | — |   | —       |   | (429   | )            |
| **BALANCE,  JULY 31, 2003**                                                                                                                                     |   | $      |  — |   | $      |  113 |   | $       |  — |   | $      |  — |   | $      |  126    |   | $      |  60,188 |   | $      |  (1,840 | )      | $      |  (4,769 | )      | $      |  — |   | $ |  — |   | $ |  — |   | $ |  — |   | $ |  53,818 |   |
| Issuance of  common stock                                                                                                                                       |   | — |         | — |   | —    |   | —  |         | 6      |   | 3,154        |   | 1,840  |         | — |   | —       |   | — |         | — |   | —       |   | 5,000  |         |
| Costs associated  with issuing common stock                                                                                                                     |   |   |         |   |   |      |   |    |         |   |   | (535         | )      |   |         |   |   |         |   |   |         |   |   |         |   | (535   | )            |
| Net income for  the year ended July 31, 2004                                                                                                                    |   | — |         | — |   | —    |   | —  |         | — |   | —       |   | — |         | 336    |   | —       |   | — |         | — |   | —       |   | 336    |         |
| **BALANCE,  JULY 31, 2004**                                                                                                                                     |   | $      |  — |   | $      |  113 |   | $       |  — |   | $      |  — |   | $      |  132    |   | $      |  62,807 |   | $      |  — |   | $      |  (4,433 | )      | $      |  — |   | $ |  — |   | $ |  — |   | $ |  — |   | $ |  58,619 |   |
|                                                                                                                                                                 |        |        |              |        |        |           |        |         |              |        |        |              |        |        |              |        |        |              |        |        |              |        |        |              |        |        |              |        |   |              |        |   |              |        |   |              |        |   |              |        |  |  |

** **

See Notes to ConsolidatedFinancial Statements

 

27

----

 

**DAKOTA GROWERS PASTA COMPANY,INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARS ENDED JULY 31, 2004, 2003AND 2002**

**(In Thousands)**

 
| ** **                                                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                          |       |     |       |     |       |     |       |
| OPERATING  ACTIVITIES                                                                         |       |     |       |     |       |     |       |
| Net income  (loss)                                                                            |       | $        | 336        |     | $          | (429     | )          | $ | 1,834 |   |
| Adjustments to  reconcile net income (loss) to net cash from (used for) operating activities: |       |     |       |     |       |     |       |
| Depreciation and  amortization                                                                |       | 8,350    |       | 9,249    |       | 8,813    |       |
| Undistributed  patronage capital from cooperatives                                            |       | (51      | )          | (63      | )          | (139     | )          |
| (Gain) loss on  disposition of property, equipment and other assets                           |       | (40      | )          | 13       |       | (23      | )          |
| Loss on asset  impairment                                                                     |       | 704      |       | —   |       | —   |       |
| Net loss allocated  from joint venture                                                        |       | 622      |       | —   |       | —   |       |
| Deferred income  taxes                                                                        |       | 150      |       | (91      | )          | 5,590    |       |
| Payments for  long-term marketing costs                                                       |       | (125     | )          | (5,000   | )          | (2,250   | )          |
| Changes in  assets and liabilities                                                            |       |     |       |     |       |     |       |
| Trade  receivables                                                                            |       | (4,191   | )          | 6,652    |       | (4,944   | )          |
| Other receivables                                                                             |       | 223      |       | (865     | )          | 778      |       |
| Inventories                                                                                   |       | 2,871    |       | (8,446   | )          | 1,414    |       |
| Prepaid expenses                                                                              |       | 156      |       | (790     | )          | 71       |       |
| Other assets                                                                                  |       | 110      |       | 10       |       | 49       |       |
| Accounts payable                                                                              |       | 1,176    |       | (2,678   | )          | 2,071    |       |
| Grower payables                                                                               |       | —   |       | —   |       | (969     | )          |
| Other accrued  liabilities                                                                    |       | 329      |       | (744     | )          | (449     | )          |
|                                                                                          |       |     |       |     |       |     |       |
| NET CASH FROM  (USED FOR) OPERATING ACTIVITIES                                                |       | 10,620   |       | (3,182   | )          | 11,846   |       |
|                                                                                          |       |     |       |     |       |     |       |
| INVESTING  ACTIVITIES                                                                         |       |     |       |     |       |     |       |
| Purchases of  property and equipment                                                          |       | (2,169   | )          | (2,006   | )          | (1,085   | )          |
| Proceeds from  sale of property, equipment                                                    |       |     |       |     |       |     |       |
| and other assets                                                                              |       | 8        |       | 3        |       | 5,079    |       |
| Purchases of  intangible assets                                                               |       | —   |       | —   |       | (735     | )          |
| Redemption of  short term investments                                                         |       | —   |       | 1,974    |       | —   |       |
| Proceeds from  cooperative bank equity retirements                                            |       | 121      |       | —   |       | —   |       |
| Investments in  joint venture                                                                 |       | (2,492   | )          | —   |       | —   |       |
| Distributions  from joint venture                                                             |       | 124      |       | —   |       | —   |       |
| Payments for  package design costs                                                            |       | (345     | )          | (390     | )          | (343     | )          |
|                                                                                          |       |     |       |     |       |     |       |
| NET CASH FROM  (USED FOR) INVESTING ACTIVITIES                                                |       | (4,753   | )          | (419     | )          | 2,916    |       |
|                                                                                               |            |          |            |          |            |          |            |  |  |  |

 

28

----

 
| ** **                                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                    |       |     |       |     |       |     |       |
| FINANCING  ACTIVITIES                                                   |       |     |       |     |       |     |       |
| Net change in  excess outstanding checks over cash on deposit           |       | (2,219   | )          | 2,219    |       | (1,072   | )          |
| Net change in  short-term notes payable                                 |       | 2,495    |       | 9,705    |       | (8,100   | )          |
| Payments on  long-term debt                                             |       | (10,011  | )          | (9,320   | )          | (2,657   | )          |
| Preferred stock  retirements                                            |       | (13      | )          | (21      | )          | (59      | )          |
| Dividends paid  on preferred stock                                      |       | —   |       | (3       | )          | (10      | )          |
| Memberships  issued                                                     |       | —   |       | —   |       | 1        |       |
| Memberships  retired                                                    |       | —   |       | —   |       | (2       | )          |
| Issuance of  common stock                                               |       | 5,000    |       | —   |       | —   |       |
| Costs associated  with issuing common stock                             |       | (535     | )          | —   |       | —   |       |
| Purchase of  treasury stock                                             |       | —   |       | (1,840   | )          | —   |       |
|                                                                    |       |     |       |     |       |     |       |
| NET CASH FROM  (USED FOR) FINANCING ACTIVITIES                          |       | (5,283   | )          | 740      |       | (11,899  | )          |
|                                                                    |       |     |       |     |       |     |       |
| NET CHANGE IN  CASH AND CASH EQUIVALENTS                                |       | 584      |       | (2,861   | )          | 2,863    |       |
|                                                                    |       |     |       |     |       |     |       |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF YEAR                           |       | 5        |       | 2,866    |       | 3        |       |
|                                                                    |       |     |       |     |       |     |       |
| CASH AND CASH  EQUIVALENTS, END OF YEAR                                 |       | $        | 589        |     | $          | 5        |       | $ | 2,866 |   |
|                                                                    |       |     |       |     |       |     |       |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                      |       |     |       |     |       |     |       |
| Cash payments  for                                                      |       |     |       |     |       |     |       |
| Interest (net of  amounts capitalized)                                  |       | $        | 2,932      |     | $          | 3,544    |       | $ | 3,742 |   |
|                                                                    |       |     |       |     |       |     |       |
| Income taxes  (refunded)                                                |       | $        | (842       | )        | $          | 1,193    |       | $ | 1,720 |   |
|                                                                    |       |     |       |     |       |     |       |
| SUPPLEMENTAL  DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES |       |     |       |     |       |     |       |
| Deferred gain on  sale-leaseback transaction                            |       | $        | —     |     | $          | —   |       | $ | 256 |   |

 

See Notes to ConsolidatedFinancial Statements

 

29

----

 

**DAKOTA GROWERS PASTA COMPANY,INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARS ENDED JULY 31, 2004, 2003AND 2002**

 

**NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

*Conversionand Nature of Business*

 

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

 

Dakota Growers PastaCompany, Inc. was organized on January 30, 2002 for the purpose of consummatingthe conversion of Dakota Growers Pasta Company, a North Dakota cooperative (the“Cooperative”), into a corporation. The conversion of the Cooperative from acooperative to a corporation was completed by means of a series of mergers, thelast of which was effective July 1, 2002, with the Company being the ultimatesurviving entity in the conversion. The conversion 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. The Company operates as theCooperative’s successor and its operations are a continuance of the operationsof the Cooperative.

 

*Principlesof Consolidation*

 

The consolidatedfinancial statements include the accounts of the Company and Primo Piatto,Inc., its wholly owned subsidiary. All significant inter-company accounts andtransactions have been eliminated in the preparation of the consolidated financialstatements. The Company’s investment in and share of net earnings or losses ofits 24% ownership interest in DNA Dreamfields Company, LLC are recorded on anequity basis.

 

*Estimates*

 

The preparation ofconsolidated financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities at the date of theconsolidated financial statements and reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

*Reclassifications*

 

Reclassifications havebeen made to the financial statements as of July 31, 2003 and for the yearsended July 31, 2003 and 2002 to facilitate comparability with the statements asof and for the year ended July 31, 2004. Such reclassifications have no effecton the net result of operations.

 

*Risks and Uncertainties*

 

The Company attempts tominimize the effects of durum wheat cost fluctuations mainly through forwardcontracting and through agreements with certain customers that provide forprice adjustments based on raw material cost changes. Such efforts, whileundertaken to attempt to minimize the risks associated with increasing durumcosts on profitability, may temporarily prevent the Company from recognizingthe benefits of declining durum prices.

 

Most of the Company’scurrently outstanding debt instruments have fixed interest rates to maturity.If the Company’s operations require additional debt issuance, any changes ininterest rates may have an impact on future results.

 

30

----

 

The Company’s cashbalances are maintained in various bank deposit accounts. The deposit accountsmay exceed federally insured limits at various times throughout the year.

 

##### *Impairment and Disposal ofLong-Lived Assets*

 

TheCompany accounts for impairment or disposal of long-lived assets in accordancewith the provisions of Statement of Financial Accounting Standards (SFAS) No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No.144 requires that long-lived assets be reviewed for impairment whenever eventsor changes in circumstances indicate that the carrying amount of an asset maynot be recoverable. Recoverability of long-lived assets to be held and used ismeasured by a comparison of the carrying amount of an asset to future net cashflows expected to be generated by the asset. If such assets are considered tobe impaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceeds the fair value of the assets.Long-lived assets to be disposed of by sale are reported at the lower of thecarrying amount or fair value less costs to sell, and will cease to be depreciated.SFAS No. 144 also requires long-lived assets to be disposed of other than bysale to be considered as held and used until disposed of, requiring thedepreciable life to be adjusted as an accounting change.

 

The Company recorded aloss on asset impairment of $704,000 during the year ended July 31, 2004. Theimpairment loss related to certain pasta production equipment which was under apurchase option agreement that expired in July 2004. Upon review, the Companydetermined the asset was impaired and adjusted to fair value which wasestimated based on the current market conditions for similar equipment.

 

*RevenueRecognition*

 

Revenues are recognizedwhen risk of loss transfers, which occurs when goods are shipped. Pricingterms, including promotions and rebates, are final at that time. Revenuesinclude amounts billed for products as well as any associated shipping costsbilled to deliver such products.

 

The Company providesallowances for annual promotional programs based upon annual sales volumes.Revenues are presented net of discounts and allowances of $21,188,000,$16,706,000 and $17,056,000 for the years ended July 31, 2004, 2003 and 2002,respectively.

 

*Cash andCash Equivalents*

 

Cash and cash equivalentsinclude cash on hand and in financial institutions, and investments withmaturities of less than 90 days.

 

*TradeAccounts Receivable and Major Customers*

 

The Company grantsunsecured credit to certain customers who meet the Company’s creditrequirements. Trade accounts receivable are uncollateralized customerobligations due under normal terms and are generally non-interest bearing.Payments on trade receivables are allocated to specific invoices identified ona customer’s remittance advice or, if unspecified, are generally applied to theearliest unpaid invoices. The carrying amount of the receivables is reduced byan amount that reflects management’s best estimate of amounts that will not becollected. Trade accounts receivable are presented net of allowances for cashdiscounts and doubtful accounts, which totaled $1,209,000 and $1,012,000 as ofJuly 31, 2004 and 2003, respectively.

 

One customer accountedfor 18% and 17% of accounts receivable as of July 31, 2004 and 2003,respectively. Sales toone customer represented 15%, 17% and 12% of net revenues for the years endedJuly 31, 2004, 2003 and 2002, respectively.

 

31

----

 

Thefollowing summarizes balance and activity information related to the allowancefor cash discounts and doubtful accounts (in thousands):

 
| ** **                                           | ** ** | **Balance  at Beginning  of Year** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions  from  Allowance** | ** ** | **Balance  at End  of Year** | ** ** |
|------------------------------------------------------|------------|------------------------------------|------------|-------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
|                                                 |       |                               |       |                                |       |                            |       |                         |       |
| Allowance for  cash discounts:                       |       |                               |       |                                |       |                            |       |                         |       |
| Year ended July  31, 2004                            |       | $                                  | 126        |                                | $          | 2,334                           |       | $                            | (2,301     | ) | $ | 159 |   |
| Year ended July  31, 2003                            |       | 185                                |       | 2,089                               |       | (2,148                          | )          | 126                          |       |
| Year ended July  31, 2002                            |       | 150                                |       | 2,365                               |       | (2,330                          | )          | 185                          |       |
|                                                 |       |                               |       |                                |       |                            |       |                         |       |
| Allowance for  doubtful accounts:                    |       |                               |       |                                |       |                            |       |                         |       |
| Year ended July  31, 2004                            |       | $                                  | 886        |                                | $          | 283                             |       | $                            | (119       | ) | $ | 1,050 |   |
| Year ended July  31, 2003                            |       | 607                                |       | 281                                 |       | (2                              | )          | 886                          |       |
| Year ended July  31, 2002                            |       | 460                                |       | 405                                 |       | (258                            | )          | 607                          |       |
|                                                 |       |                               |       |                                |       |                            |       |                         |       |
| Allowance for  cash discounts and doubtful accounts: |       |                               |       |                                |       |                            |       |                         |       |
| Year ended July  31, 2004                            |       | $                                  | 1,012      |                                | $          | 2,617                           |       | $                            | (2,420     | ) | $ | 1,209 |   |
| Year ended July  31, 2003                            |       | 792                                |       | 2,370                               |       | (2,150                          | )          | 1,012                        |       |
| Year ended July  31, 2002                            |       | 610                                |       | 2,770                               |       | (2,588                          | )          | 792                          |       |
|                                                 |       |                               |       |                                |       |                            |       |                         |       |

 

##### *Inventories*

 

Inventories are stated atthe lower of cost or market, determined on a first-in, first-out (FIFO) basis,using product specific standard costs. The major components of inventories asof July 31, 2004 and 2003 are as follows (in thousands):

 
| ** **                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Finished goods               |       | $        | 18,815     |     | $          | 22,549 |   |
| Raw materials  and packaging |       | 6,396    |       | 5,533    |       |
|                         |       |     |       |     |       |
|                         |       | $        | 25,211     |     | $          | 28,082 |   |

 

*Propertyand Equipment*

 

Property and equipmentare stated at cost. Expenditures for renewals and improvements thatsignificantly add to the productive capacity or extend the useful life of anasset are capitalized. Expenditures for maintenance and repairs are charged toexpense as incurred. When depreciable properties are retired or sold, the costand related accumulated depreciation are eliminated from the accounts and theresultant gain or loss is reflected in income. Interest is capitalized onconstruction projects of higher cost and longer duration.

 

The initial acquisitionof land by the Company is stated at the estimated fair value of the land atacquisition. Subsequent land acquisitions are recorded at cost.

 

32

----

 

Depreciation is providedfor over the estimated useful lives of the individual assets using thestraight-line method. The estimated useful lives used in the computation ofdepreciation expense range from 3 to 40 years. Depreciation expense totaled$5,759,000, $6,100,000 and $6,572,000 for the years ended July 31, 2004, 2003and 2002, respectively.

 

Details relative toproperty and equipment are as follows (in thousands):

* *
| ** **                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
|                               |       |     |       |     |       |
| Land and  improvements             |       | $        | 2,934      |     | $          | 2,893 |   |
| Buildings                          |       | 22,713   |       | 22,213   |       |
| Equipment                          |       | 84,340   |       | 83,157   |       |
|                               |       |     |       |     |       |
| Property and  equipment in service |       | 109,987  |       | 108,263  |       |
| Construction in  progress          |       | 18       |       | 868      |       |
| Less accumulated  depreciation     |       | (46,980  | )          | (41,799  | )          |
|                               |       |     |       |     |       |
|                               |       | $        | 63,025     |     | $          | 67,332 |   |

 

* Investment in Cooperative Bank*

 

Investment in cooperativebank is stated at cost, plus unredeemed patronage refunds received in the formof capital stock.

 

*IntangibleAssets*

 

The Company acquiredintangible assets totaling $735,000 in 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 years ended July 31, 2004, 2003 and 2002 totaled $147,000,$147,000 and $49,000, respectively.

 

Details relative tointangible assets are as follows (in thousands):

 
| ** **                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
|                        |       |     |       |     |       |
| Customer-based  intangibles |       | $        | 405        |     | $          | 405 |   |
| Covenants not to  compete   |       | 330      |       | 330      |       |
|                        |       | 735      |       | 735      |       |
| Accumulated  amortization   |       | (343     | )          | (196     | )          |
|                        |       |     |       |     |       |
|                        |       | $        | 392        |     | $          | 539 |   |

 

33

----

 

The estimatedamortization expense for each of the fiscal years ending July 31 is as follows(in thousands):

 
| 2005   |   | 147    |   |
|--------|--------|--------|--------|
| 2006   |   | 147    |   |
| 2007   |   | 98     |   |
|   |   |   |   |
|   |   | $      | 392    |   |
|        |        |        |        |  |

 

*OtherAssets*

 

The Company capitalizespackage design costs, which relate to certain third party costs to designartwork and to produce die plates and negatives necessary to manufacture andprint packaging materials according to Company and customer specifications.These costs are amortized ratably over three to five year periods based onestimated useful life. Minor revisions are expensed as incurred. If a productdesign is discontinued or replaced prior to the end of the amortization period,the remaining unamortized balance is charged to expense. Package design costs are presented net ofaccumulated amortization totaling $3,949,000 and $3,536,000 as of July 31, 2004and 2003, respectively.

 

Prepaid marketing costsrelate to payments made to certain customers covering contract terms andpricing for varying periods extending beyond one year. These costs areamortized in proportion to sales volumes over the term of the agreement.

 

The debt issuance costsrelate to expenditures incurred in obtaining long-term debt. These costs arebeing amortized over the term of the related debt based on the effectiveinterest rate.

 

The breakdown of otherassets, net of accumulated amortization, is as follows (in thousands):

 
| ** **               | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
|                     |       |     |       |     |       |
| Package design  costs    |       | $        | 522        |     | $          | 597 |   |
| Prepaid  marketing costs |       | 5,521    |       | 7,606    |       |
| Debt issuance  costs     |       | 61       |       | 91       |       |
| Other                    |       | 29       |       | 139      |       |
|                     |       |     |       |     |       |
|                     |       | $        | 6,133      |     | $          | 8,433 |   |

 

*AccruedLiabilities*

 

Accrued liabilitiesconsist of the following (in thousands):

 
| ** **                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |
| Accrued  promotional costs |       | $        | 1,741      |     | $          | 1,217 |   |
| Accrued interest           |       | 891      |       | 1,091    |       |
| Accrued freight            |       | 709      |       | 706      |       |
| Other                      |       | 1,504    |       | 1,502    |       |
|                       |       |     |       |     |       |
|                       |       | $        | 4,845      |     | $          | 4,516 |   |

 

34

----

*Shippingand Handling Costs*

 

Shippingand handling costs are included in cost of goods sold upon shipment ofthe Company’s product to its customers.

 

*Advertising*

 

Costs of advertising areimmaterial and expensed as incurred.

 

*InterestExpense, Net*

 

The Company earnspatronage refunds from its patronage-based debt issued through cooperativebanks based on its share of the net interest income earned by the banks. Thesepatronage refunds received are applied against interest expense.

 

*IncomeTaxes*

 

Income taxes are providedfor the tax effects of transactions reported in the financial statements andconsist of taxes currently due plus deferred taxes. Deferred tax assets andliabilities are determined based on differences between the financial reportingand tax bases of assets and liabilities, and are measured using the enacted taxrates expected to apply when the differences are expected to reverse. Deferredtax assets and liabilities represent the future tax return consequences ofthose differences, which will either be taxable or deductible when the assetsand liabilities are recovered or settled.

 

Prior to the conversionfrom a cooperative to a corporation, the Company was taxed as a non-exemptcooperative for federal income tax purposes. Business conducted with theCooperative’s members constituted patronage business as defined by the InternalRevenue Code. The Cooperative calculated income from patronage sources based onincome 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 wassubject to income taxes on earnings from non-patronage sources and patronageearnings not qualified to the Cooperative’s members. Cooperative organizationshave 8 1⁄2 months after their fiscal year-end to make qualified patronageallocations in the form of written notices of allocation or cash. As acooperative, the provision for income taxes related to the results ofoperations from non-patronage business, state income taxes and certain otherpermanent and temporary differences between financial and income tax reporting.

 

*Stockholders’Equity/Members’ Investment*

 

Under the cooperativestructure, accumulated unallocated earnings represented cumulative net incomewhich had not been allocated to members, while accumulated non-qualifiedallocated earnings represented earnings which had been allocated to membersbased on patronage but not distributed or qualified for income tax purposes.Patronage allocations are reflected in the financial statements in the periodin which such allocations were declared by the Board of Directors.

 

35

----

 

*StockOptions*

 

The Company has electedto follow Accounting Principles Board Opinion (APB) No. 25, “Accounting forStock Issued to Employees” and related interpretations in accounting for itsemployee stock options and has adopted the pro forma disclosure requirementsunder SFAS No. 123, “Accounting for Stock-Based Compensation.” The Company hasnot recognized any compensation expense under APB No. 25 upon the granting orexercise of stock options because the exercise price is equal to or greaterthan the market price of the underlying stock on the date of grant.

 

*Earningsper Share*

 

Basic Earnings per Share(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.

 

Dilutivesecurities, consisting of stock options and convertible preferred stock,included in the calculation of diluted weighted average common/equity sharestotaled 360,000 shares, 254,000 shares and 33,000 shares for the years endedJuly 31, 2004, 2003 and 2002, respectively. As there is currently noestablished public trading market for the Company’s common stock, the Companyhas assumed the proceeds from the exercise of stock options would reduce debtand, thus, interest expense.

##### * *

##### *Recently Issued AccountingStandards*

##### * *

##### *In December 2003, the*Financial AccountingStandards Board (FASB) issued FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities,”(FIN 46(R)).  This Interpretation of Accounting Research BulletinNo. 51, “Consolidated Financial Statements”, which replaces FASB InterpretationNo. 46,  addresses consolidation bybusiness enterprises of variable interest entities. FIN 46(R) was implemented during fiscal year 2004 and did nothave a material impact on the Company’s consolidated financial statements.

 

**NOTE 2 - INVESTMENT IN JOINTVENTURE**

 

The Company acquired a 24% ownership interest in DNADreamfields Company, LLC, an Ohio limited liability company (“DNA Dreamfields”)during fiscal year 2004. The Company has accounted for the investment using theequity method after reviewing the applicability of FIN 46(R) to the Company’sinterest in DNA Dreamfields. DNA Dreamfields was formed by the Company andother food technology, manufacturing and consumer products marketingenterprises to develop, manufacture and sell low digestible carbohydrate pasta,rice and potatoes under the DreamfieldsTM brand name. The Companymade aggregate investments in DNA Dreamfields of $2,492,000 through July 31,2004. Under the terms of the DNA Dreamfields operating agreement, the Company shall contribute, when and as needed,additional funds up to an aggregate of approximately $4.0 million, to DNADreamfields to pay for the development of supply chain, product packagedevelopment, consumer research, test market launch and regional roll out,advertising and merchandising. Such contributions shall be additional capitalcontributions by the Company without the issuance of any additional ownershipunits in DNA Dreamfields.

 

Subsequent to July 31, 2004, the members of DNADreamfields agreed to an amendment to the DNA Dreamfields operating agreement.This amendment included a provision to retroactively change the method ofallocating net losses to each member from a positive capital account basis to aunit ownership basis. The Company has reflected this change in accounting inits fourth fiscal quarter 2004. The effect of this change was immaterial toprior interim periods, and the change did not effect financial statements foryears prior to fiscal 2004.

 

36

----

 

**NOTE 3 - SHORT-TERM NOTES PAYABLE**

 

TheCompany has a $25 million revolving credit facility with CoBank which matureson February 21, 2005. The revolving line has a variable interest rate (3.72% atJuly 31, 2004) established by CoBank based on CoBank’s cost of funds. Thefacility is secured by property, equipment, and current assets of the Company.The balance outstanding on the revolving line of credit was $12,200,000 and$9,705,000 as of July 31, 2004 and 2003, respectively.

 

Weightedaverage interest rates on short-term borrowings were 3.50%, 3.67% and 5.12% forthe years ended July 31, 2004, 2003 and 2002, respectively.

 

**NOTE 4 - LONG-TERM DEBT**

 

Information regardinglong-term debt at July 31, 2004 and 2003 is as follows (in thousands):

 
| ** **                                                                                                                                                                                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                                                                                                 |       |     |       |     |       |
| Term loans from  CoBank due in quarterly installments of $685,000 plus interest through  December 31, 2004, variable interest on $280,000 (4.17% at July 31, 2004),  remainder at 8.76%, collateralized by all assets of the Company |       | $        | 1,280      |     | $          | 4,020 |   |
|                                                                                                                                                                                                                                 |       |     |       |     |       |
| Term loans from  CoBank due in quarterly installments of $625,000 plus interest through  December 31, 2004, variable interest (4.17% at July 31, 2004), collateralized  by all assets of the Company                                 |       | 1,125    |       | 3,625    |       |
|                                                                                                                                                                                                                                 |       |     |       |     |       |
| Non-patronage  term loan from CoBank due in annual principal installments of $1,200,000  through September 30, 2008, interest at 5.71%, collateralized by all assets  of the Company                                                 |       | 6,000    |       | 7,200    |       |
|                                                                                                                                                                                                                                 |       |     |       |     |       |
| Senior Secured  Guaranteed Notes, Series A, due in annual principal installments of  $2,571,000 through August 1, 2008, interest at 8.04%, collateralized by all  assets of the Company                                              |       | 12,858   |       | 15,429   |       |
|                                                                                                                                                                                                                                 |       |     |       |     |       |
| Senior Secured  Guaranteed Notes, Series B, due in annual principal installments of  $1,000,000 through August 1, 2010, interest at 8.14%, collateralized by all  assets of the Company                                              |       | 7,000    |       | 8,000    |       |
|                                                                                                                                                                                                                                 |       |     |       |     |       |
| Total long-term  debt                                                                                                                                                                                                                |       | 28,263   |       | 38,274   |       |
| Less current  portion                                                                                                                                                                                                                |       | 7,176    |       | 10,011   |       |
|                                                                                                                                                                                                                                 |       |     |       |     |       |
| Net long-term  debt                                                                                                                                                                                                                  |       | $        | 21,087     |     | $          | 28,263 |   |

 

37

----

 

Aggregate futurematurities required on long-term debt are as follows (in thousands):

 
| **Years ending July 31,** | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
|                      |       |       |       |
| 2005                      |       | $          | 7,176      |   |
| 2006                      |       | 4,771      |       |
| 2007                      |       | 4,771      |       |
| 2008                      |       | 4,771      |       |
| 2009                      |       | 4,774      |       |
| Thereafter                |       | 2,000      |       |
|                      |       |       |       |
|                      |       | $          | 28,263     |   |

 

TheCompany has a $6,000,000 letter of credit commitment with CoBank, securing thenon-patronage loan from CoBank. The letter of credit commitment is subject to acommitment fee of 1.0% on an annualized basis and expires December 31, 2008.Advances on the letter of credit commitment are payable on demand.

 

The Company’s debtagreements with CoBank and the institutional note holders obligate the Companyto maintain or achieve certain amounts of equity and financial ratios andimpose restrictions on the Company. The Company was in compliance with these financial covenants as of July31, 2004.

 

The Company incurred$2,879,000, $3,547,000 and $4,099,000 of interest on long and short-term debtand other obligations in fiscal years 2004, 2003 and 2002, respectively, ofwhich $14,000, $7,000 and $6,000 was capitalized in the respective periods.Patronage income from CoBank of $103,000, $126,000 and $228,000 was nettedagainst interest expense on the statement of operations for the years endedJuly 31, 2004, 2003 and 2002, respectively.

 

**NOTE 5 - STOCKHOLDERS’ EQUITY**

 

The Company is authorizedto issue 75,000,000 shares of Common Stock, $.01 par value per share, 2,731shares of Series C Preferred Stock, $100 par value per share, 11,340,841 sharesof Series D Delivery Preferred Stock, $.01 par value per share, 130,000 sharesof Series E Junior Participating Preferred Stock, $.01 par value per share, and13,525,370****shares of undesignated preferredstock, $.01 par value per share.

 

As a result of themergers undertaken to effect the change from a cooperative to a corporation infiscal year 2002, members of the Cooperative received: (i) twenty-five sharesof Common Stock of the Company for each share of the Cooperative’s MembershipStock they held as of the effective date of the conversion; (ii) a number ofshares of Common Stock, $.01 par value per share, of the Company equal to thenumber of shares of the Cooperative’s Equity Stock they held as of the effectivedate of the conversion; (iii) a number of shares of Series D Delivery PreferredStock, $.01 par value per share, of the Company equal to the number of sharesof the Cooperative’s Equity Stock they held as of the effective date of theconversion; and (iv) one share of Common Stock of the Company for each $7.36 ofNon-Qualified Written Notices of Allocation held in the member’s name on therecords of the Cooperative. To the extent that shareholders of the Cooperativeheld Series A Preferred Stock or Series B Preferred Stock of the Cooperative asof the effective date of the conversion, they received a number of shares ofSeries A Preferred Stock or Series B Preferred Stock, as applicable, of theCompany equal to the number of shares of the Cooperative’s Series A PreferredStock or Series B Preferred Stock, as applicable, held as of such effectivedate. Persons who held options to acquire Series C Preferred Stock of theCooperative had those options converted automatically into options containingthe same terms with regard to Series C Preferred Stock of the Company.

 

38

----

 

Prior to the conversion,under the terms of the Cooperative’s bylaws, the Cooperative’s net income,determined in accordance with generally accepted accounting principlesconsistently applied, was distributed annually based on the volume of patronagebusiness (bushels of durum delivered, which approximates one bushel of durumper equity share). The distribution was in the form of cash or credits to eachmember-producer’s patronage credit account, which was established on the booksof the Cooperative as determined by the Board of Directors. Equity requirementsof the Cooperative could be retained as unallocated earnings, or retained fromamounts due to patrons and credited to members’ investments in the form of unitretains or undistributed allocated patronage. In the event of a net loss in anyfiscal year under the cooperative structure, the Cooperative could first offsetthe net loss against any earned unallocated surplus. If the net loss exceededthe earned unallocated surplus, the Cooperative could elect to recover the netloss from prior or subsequent years’ net margins or savings.

 

Prior to conversion to acorporation, the net income allocable to patronage business totaled $6,137,000for the year ended July 31, 2002. In April 2002, the Cooperative’s Board ofDirectors authorized a non-qualified patronage allocation of $4,586,000representing the patronage earnings as a cooperative for fiscal 2002 offset bythe patronage net loss for fiscal year 2001.

 

Holdersof Series C Preferred Stock shall receive payment of a non-cumulative annualdividend at the rate of 6% of the $100 par value on each share of Series CPreferred Stock. Each share of Series C Preferred Stock is convertible into 24shares of Common Stock and 24 shares of Series D Delivery Preferred Stock ofthe Company. The conversion ratio shall be proportionately adjusted at any timethe outstanding shares of Common Stock are increased or decreased withoutpayment by or to the Company or the Company’s shareholders.

 

Each share of Series DDelivery Preferred Stock of the Company gives its holder the privilege, but notthe obligation, to deliver one bushel of durum wheat to the Company each yearon a “first-come, first-served” basis. Because the privilege of a holder ofSeries D Delivery Preferred Stock to deliver durum wheat to the Company onlyarises if the Company requires durum, the privilege is not absolute. Holders of Series D Delivery Preferred Stock willbe entitled to receive, if and when declared by the Board of Directors, anon-cumulative annual dividend of up to $.04 per share on each share of SeriesD Delivery Preferred Stock held by such holder. The Company must pay holders of Series D Delivery Preferred Stock adividend of at least $.01 per share before paying any dividends on CommonStock.

 

The Board of Directors ofthe Company adopted a Rights Plan that became effective upon consummation ofthe conversion. Under the Rights Plan, the Board of Directors of the Companyhas declared a dividend of one purchase right (a “Right”) for each outstandingshare of Common Stock held of record immediately following the conversion.  Each Right will entitle the holder topurchase from the Company one-hundredth of one share of Series E JuniorParticipating Preferred Stock at a specified price, subject to certainadjustments. 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.

 

In November 2002, theBoard of Directors approved the repurchase of 294,456 shares of the Company’sCommon Stock from certain executive officers of the Company. The Companypurchased these shares for $1,840,350 or $6.25 per share (see also Note 14 —Related Party Transactions).These shares were held in treasury as of July 31, 2003.

 

39

----

 

OnJuly 30, 2004, the Company completed the sale of 909,091 shares of Common Stock,which included the 294,456 shares of Common Stock held in treasury at thattime, to MVC Capital, Inc.

 

**NOTE 6 - MANDATORILY REDEEMABLE PREFERRED STOCK**

 

The Company adopted SFASNo. 150, “Accounting for Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity” effective August 1, 2003. SFAS No. 150 establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity. Many of theseinstruments were previously classified as equity. SFAS No. 150 requires that anissuer classify a financial instrument that is within its scope as a liability,or as an asset in some circumstances. This Statement applies to three types offreestanding financial instruments. One type of financial instrument to whichSFAS No. 150 applies is mandatorily redeemable shares, which the issuingcompany is obligated to buy back in exchange for cash or assets.

 

The Company is authorizedto issue 533 shares of Series A Preferred Stock, $100 par value per share. TheCompany had 200 and 333 shares of Series A Preferred Stock outstanding as ofJuly 31, 2004 and 2003 respectively. The Series A Preferred Stock is requiredto be redeemed ratably on a quarterly basis through December 2005. Each shareof Series A Preferred Stock entitles its holder to receive a cumulative annualdividend of 6% of the $100 par value per share. As the shares of Series APreferred Stock are mandatorily redeemable, these shares have been classifiedas a liability in the Company’s consolidated balance sheet and “dividends” paidon the Series A Preferred Stock have been recorded as interest expense uponadoption of SFAS No. 150. “Dividends” paid on Series A Preferred Stock prior tothe adoption of SFAS No. 150 have not been reclassified as interest cost.

 

**NOTE 7 - EMPLOYEE BENEFIT PLANS**

 

Dakota Growers PastaCompany, Inc. and Primo Piatto, Inc. have a 401(k) plan that covers employeeswho have met age and service requirements. The plan covers employees who havereached 21 years of age and who have completed 500 hours of service within sixmonths. Effective January 1, 2003, the 401(k) plan was amended, and the Companymatch was changed to 100% on the first 3% of the employees’ elected deferral and50% on the next 2%.Previously, the Company matched 100% on the first 2% of the employees’ electeddeferral, 50% on the next 1%, and 25% on the next 4%. Employer contributions tothe plan totaled $377,000, $345,000 and $319,000 for the years ended July 31,2004, 2003 and 2002, respectively.

 

Primo Piatto, Inc. isalso required to contribute to a multi-employer pension plan covering certainhourly employees subject to a collective bargaining agreement. Such employeesmay also participate in the 401(k) plan but are excluded from amountscontributed by Primo Piatto. Contributions to the pension plan for the yearsended July 31, 2004, 2003 and 2002 totaled $60,000, $81,000 and $72,000,respectively.

 

**NOTE 8 - INCOME TAXES**

 

The conversion from acooperative to a corporation effectuated via a series of mergers, the last ofwhich was completed July 1, 2002, is treated as a reorganization under CodeSection 368(a)(1)(F). 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 retained the fiscal year, accountingmethods, tax elections and other tax attributes of the Cooperative.  However, because it no longer operates on acooperative basis after the conversion, the Company is taxable as a “Ccorporation.” As such, it will no longer pay deductible patronage dividends andany distributions to the shareholders will be treated as nondeductibledividends.

 

40

----

 

The Cooperative was anon-exempt cooperative as defined by Section 1381(a)(2) of the Internal RevenueCode. Accordingly, net margins from business done with member patrons, whichwere allocated and paid as prescribed in Section 1382 of the Code (hereafterreferred to as “qualified”), were taxable to the members and not to theCooperative. Net margins and member allocations were determined on the basis ofaccounting used for financial reporting purposes. To the extent that netmargins were not qualified as stated above or arose from business done withnon-members, the Cooperative had taxable income subject to corporate income taxrates.

 

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 $6,105,000during the year ended July 31, 2002.

 

Significant components ofthe Company’s deferred tax assets and liabilities as of July 31, 2004 and 2003related to temporary differences are as follows (in thousands):

 
| ** **                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |
| Deferred tax  assets                             |       |     |       |     |       |
| AMT credit and  net operating loss carryforwards |       | $        | 1,331      |     | $          | 1,221 |   |
| Accounts receivable  allowances                  |       | 472      |       | 346      |       |
| Joint venture  net loss allocation               |       | 243      |       | —   |       |
| Accrued expenses  and other reserves             |       | 411      |       | 223      |       |
| Total deferred  tax assets                       |       | 2,457    |       | 1,790    |       |
|                                             |       |     |       |     |       |
| Deferred tax  liabilities                        |       |     |       |     |       |
| Property and  equipment                          |       | (11,883  | )          | (11,066  | )          |
|                                             |       |     |       |     |       |
| Net deferred tax  liabilities                    |       | $        | (9,426     | )        | $          | (9,276 | ) |

 

Classified in theaccompanying balance sheets as follows:

 
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |
| Current assets                |       | $        | 937        |     | $          | 569 |   |
| Noncurrent  liabilities       |       | (10,363  | )          | (9,845   | )          |
|                          |       |     |       |     |       |
| Net deferred tax  liabilities |       | $        | (9,426     | )        | $          | (9,276 | ) |

 

At July 31, 2004, theCompany has an AMT credit carryforward of $1,275,000, which may be carriedforward indefinitely, and a federal net operating loss carryforward of$143,000, which expires in fiscal year 2024. Management believes it is morelikely than not that the deferred tax assets as of July 31, 2004 will berealized through the generation of future taxable income and tax planningstrategies.

 

41

----

 

Income tax expense (benefit)for the years ended July 31, 2004, 2003 and 2002 consists of the following (inthousands):

 
| ** **                                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |     |       |
| Current income  tax expense (benefit)           |       | $        | 64         |     | $          | (78      | )          | $ | 1,792 |   |
| Prior year  underaccrual                        |       | —   |       | 64       |       | —   |       |
| Deferred income  taxes                          |       | 150      |       | (91      | )          | (515     | )          |
|                                            |       | 214      |       | (105     | )          | 1,277    |       |
| Charge to record  deferred taxes upon           |       |     |       |     |       |     |       |
| conversion from  a cooperative to a corporation |       | —   |       | —   |       | 6,105    |       |
|                                            |       |     |       |     |       |     |       |
| Income tax  expense (benefit)                   |       | $        | 214        |     | $          | (105     | )          | $ | 7,382 |   |

 

The reconciliation of thefederal statutory income tax rate to the effective income tax rate for theyears ended July 31, 2004, 2003 and 2002 is as follows:

 
| ** **                                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                 |       |     |       |     |       |     |       |
| Federal  statutory income tax rate                                                   |       | 34.0     | %          | (34.0    | )%         | 34.0     | %          |
| Adjustment of  prior year accrual                                                    |       | —   |       | 12.0     |       | —   |       |
| State income  taxes, net of                                                          |       |     |       |     |       |     |       |
| federal income  tax effect                                                           |       | 5.0      |       | (5.0     | )          | 5.0      |       |
| Patronage  earnings                                                                  |       | —   |       | —   |       | (25.1    | )          |
| Charge to record  deferred taxes upon conversion from a cooperative to a corporation |       | —   |       | —   |       | 66.0     |       |
| Other (net)                                                                          |       | —   |       | 7.0      |       | 0.2      |       |
|                                                                                 |       |     |       |     |       |     |       |
| Effective income  tax rate                                                           |       | 39.0     | %          | (20.0    | )%         | 80.1     | %          |

 

**NOTE 9 - FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The fair value of afinancial instrument is generally defined as the amount at which the instrumentcould be exchanged in a current transaction between willing parties, other thanin a forced liquidation sale. Quoted market prices are generally not availablefor the Company’s financial instruments. Accordingly, fair values are based onjudgments regarding anticipated cash flows, future expected loss experience,current economic conditions, risk characteristics of various financialinstruments and other factors. These estimates involve uncertainties andmatters of judgment, and therefore cannot be determined with precision. Changesin assumptions could significantly affect the estimates.

 

The carrying amount ofcash and cash equivalents, receivables, payables, short-term debt and othercurrent assets and liabilities approximates fair value because of the shortmaturity and/or frequent repricing of those instruments.

 

The Company believes itis not practical to estimate the fair value of the securities of non-subsidiarycooperatives without incurring excessive costs because there is no establishedmarket for these securities and it is inappropriate to estimate future cashflows, which are largely dependent on future patronage earnings of thenon-subsidiary cooperatives.

 

42

----

 

Based upon currentborrowing rates with similar maturities, the fair value of the long-term debtapproximates the carrying value as of July 31, 2004 and 2003.

 

**NOTE 10 - OPERATING LEASES**

 

The Company leasesequipment and office space under operating lease agreements. Future obligationsfor operating leases for fiscal years ended July 31 are as follows (inthousands):

 

| 2005       |   | $     | 1,113  |   |
|------------|--------|-------|--------|--------|
| 2006       |   | 1,003 |   |
| 2007       |   | 686   |   |
| 2008       |   | 63    |   |
| 2009       |   | 36    |   |
| Thereafter |   | 8     |   |
|       |   | $     | 2,909  |   |
|            |        |       |        |        |  |

 

Lease expense totaled$1,402,000, $1,485,000 and $1,014,000 for the years ended July 31, 2004, 2003and 2002, respectively.

 

**NOTE 11 - SALE-LEASEBACK**

 

TheCompany entered into a sale-leaseback transaction effective March 29, 2002, forcertain pasta production equipment. Proceeds from the sale totaled $5 million.The lease, which is classified as operating, sets forth an initial term of fiveyears and calls for lease payments of $72,000 per month. At the end of theinitial lease term, the Company may renew the lease at fair rental value,terminate the lease and surrender the equipment with the payment of a 10% ofequipment cost remarketing fee, or purchase the equipment for $1,750,000.  The Company realized a gain on the sale of$255,000, which was deferred and will be amortized in proportion to the grossrentals charged to expense over the five-year lease term. Minimum rentalsrequired under the lease, which are also included in the future leaseobligations disclosed in Note 10, for fiscal years ending July 31 are asfollows (in thousands):

 

| 2005   |   | 863 |   |
|--------|--------|-----|--------|
| 2006   |   | 863 |   |
| 2007   |   | 576 |   |
|   |   | $   | 2,302  |   |
|        |        |     |        |  |

 

**NOTE 12 - COMMITMENTS AND CONTINGENCIES**

 

The Company forwardcontracts for a certain portion of its future durum wheat requirements. At July31, 2004, the Company had outstanding commitments for grain purchases totaling$12,848,000 related to forward purchase contracts. These contracts are setprice contracts to deliver grain to the Company’s mill, and are not derivativein nature as they have no net settlement provision and are not transferable.

 

Pursuantto a warehouse agreement with Sky Logistics & Distribution, Inc. (Sky), theCompany is obligated to minimum monthly storage and handling volumes totalingapproximately $330,000 for fiscal year 2005. This agreement expires October 31,2004.

 

43

----

 

TheCompany has entered into long-term marketing agreements, which include volumeand pricing commitments, with U.S. Foodservice and Safeway, Inc. throughDecember 31, 2006 and August 31, 2006, respectively. The Company has alsoentered into an agreement with Gruppo Euricom, an Italian pasta manufacturer,to be the exclusive distributor of Gruppo Euricom’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.

 

The Company has acommitment to contribute, when and as needed, additional funds up to anaggregate of approximately $4.0 million to DNA Dreamfields under the terms ofthe DNA Dreamfields operating agreement (See Note  2 - Investment in Joint Venture).

 

The Company is subject tovarious lawsuits and claims which arise in the ordinary course of its business.While the results of such litigation and claims cannot be predicted withcertainty, management believes the disposition of all such proceedings,individually or in aggregate, should not have a material adverse effect on theCompany’s financial position, results of operations or cash flows.

 

**NOTE 13 - STOCK OPTION PLANS**

 

OnJanuary 31, 1997 the Cooperative’s Compensation Committee of the Board ofDirectors (the “Compensation Committee”) adopted the Dakota Growers IncentiveStock Option Plan (the “Plan”). The Plan was ratified by the Cooperativemembers at the annual meeting in January 1998. The Compensation Committee orthe Board of Directors has the power to determine the key management employeesof the Company to receive options and the number of shares to be optioned toeach 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 15,000, all of which have been issued as of July 31, 2004. Each share of Series C Preferred Stock isconvertible into 24 shares of Common Stock and 24 shares of Series D DeliveryPreferred Stock of the Company. The conversion ratio is proportionatelyadjusted if the Company increases the outstanding shares of Common Stock orSeries 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 the Plan must be exercisedwithin ten years from the date such options are granted. In the event of theemployee’s termination with the Company, all exercisable options may beexercised within 90 days of the termination date. If not exercised, suchoptions lapse.

 

TheCompany’s 2002 Stock Option Plan (the “2002 Plan”) was adopted by the Board ofDirectors on November 21, 2002. All options granted under the 2002 Plan arenon-qualified stock options and are for the purchase of the Company’s CommonStock. The maximum number of shares of Common Stock that may be issued pursuantto options granted under the 2002 Plan is 294,456 shares, all of which havebeen issued as of July 31, 2004. Stock options granted under the 2002 Planexpire 10 years from the date of grant.

 

44

----

 

OnNovember 21, 2002 the Board of Directors adopted the Dakota Growers PastaCompany, Inc. 2003 Stock Option Plan (the “2003 Plan”), which was approved bythe Company’s shareholders at the Annual Meeting on January 11, 2003. The 2003Plan covers 500,000 shares of the Company’s Common Stock. Participation in thisPlan shall be limited to officers, directors, employees, vendors or consultantsof the Company or any subsidiary of the Company. Options granted under the 2003Plan may be incentive stock options (as defined under Section 422 of the Code)or non-qualified stock options, as determined by the 2003 Plan administrator atthe time of grant of an option and subject to the applicable provisions ofSection 422 of the Code and the regulations promulgated there under. The stockoptions generally expire 10 years from the date of grant. If the employment ofthe Optionee is terminated by any reason other than his or her death ordisability, all exercisable options may be exercised within 90 days of thetermination date. If not exercised, such options lapse. Options to purchase80,524 shares of Common Stock were granted under the 2003 Plan in fiscal year2004.

 

The following table setsforth information regarding stock options outstanding and exercisable:

 
| ** **                    | ** ** | **Options to purchase Series C Convertible Preferred Stock** | ** ** |
|-------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                    | ** ** | **Number of  Series C  Convertible  Preferred Shares**       | ** ** | **Option  Price  per Share** | ** ** | **Weighted**

**Average  Exercise  Price** | ** ** | **Exercisable** | ** ** |
|                          |       |                                                         |       |   |   |   |   |   |   |
| 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 |   |
| Exercised                     |       | —                                                       |       |   |   |   |   |   |   |
| Granted                       |       | 686                                                          |       | $ | 150 |   | $ | 150.00 |   |   |   |
| Canceled/Expired              |       | —                                                       |       |   |   |   |   |   |   |
|                          |       |                                                         |       |   |   |   |   |   |   |
| Outstanding at  July 31, 2003 |       | 2,731                                                        |       | $ | 100-$150 |   | $ | 112.56 |   | 2,731 |   |
| Exercised                     |       | —                                                       |       |   |   |   |   |   |   |
| Granted                       |       | —                                                       |       |   |   |   |   |   |   |
| Canceled/Expired              |       | —                                                       |       |   |   |   |   |   |   |
|                          |       |                                                         |       |   |   |   |   |   |   |
| Outstanding at  July 31, 2004 |       | 2,731                                                        |       | $ | 100-$150 |   | $ | 112.56 |   | 2,731 |   |

 

45

----

 
| ** **                    | ** ** | **Options to purchase Common Stock** | ** ** |
|-------------------------------|------------|--------------------------------------|------------|
| ** **                    | ** ** | **Number of  Common Shares**         | ** ** | **Option  Price  per Share** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Exercisable** | ** ** |
|                          |       |                                 |       |   |   |   |   |   |   |
| Outstanding at  July 31, 2002 |       | —                               |       |   |   |   |   |   |   |
| Exercised                     |       | —                               |       |   |   |   |   |   |   |
| Granted                       |       | 294,456                              |       | $ | 6.25 |   | $ | 6.25 |   |   |   |
| Canceled/Expired              |       | —                               |       |   |   |   |   |   |   |
|                          |       |                                 |       |   |   |   |   |   |   |
| Outstanding at  July 31, 2003 |       | 294,456                              |       | $ | 6.25 |   | $ | 6.25 |   | 294,456 |   |
| Exercised                     |       | —                               |       |   |   |   |   |   |   |
| Granted                       |       | 80,524                               |       | $ | 4.25 |   | $ | 4.25 |   |   |   |
| Canceled/Expired              |       | —                               |       |   |   |   |   |   |   |
|                          |       |                                 |       |   |   |   |   |   |   |
| Outstanding at  July 31, 2004 |       | 374,980                              |       | $ | 4.25-$6.25 |   | $ | 5.82 |   | 294,456 |   |

 

The Company applies APBNo. 25 in accounting for employee stock options. Accordingly, no compensationexpense was recorded during the years ended July 31, 2004, 2003 and 2002related to the issuance or exercise of stock options. The fair value of the stockoptions granted was estimated at the date of grant using the Black-Scholesoption pricing model with the following weighted average assumptions (excludinga volatility assumption): 2004 - risk free interest rate of 2.3%, expecteddividend yield of zero and an expected life of 3 years; 2003 - risk freeinterest rate of 2.5%, expected dividend yield of zero and an expected life of3 years; 2002 - risk free interest rate of 3.6%, expected dividend yield ofzero and an expected life of 3 years. The pro forma application of Statement ofFinancial Accounting Standard (SFAS) No. 123 “Accounting for Stock-BasedCompensation” would not have had a material impact on net income and earningsper share for the periods presented.

 

**NOTE 14 - RELATED PARTY TRANSACTIONS**

 

*Transactionswith Executive Officers*

 

The Company had pledgedcertificates of deposit as security for loans, totaling approximately$1,974,000, made by a financial institution to Timothy J. Dodd, President andChief Executive Officer, and Thomas P. Friezen, Chief Financial Officer, toexercise stock options. These loans matured December 1, 2002.

 

In accordance with theprovisions of the Sarbanes-Oxley Act of 2002, the Board of Directors approvedthe repurchase of 190,800 and 103,656 shares of the Company’s Common Stock fromMessrs. Dodd and Friezen, respectively. The repurchase was completed inNovember 2002. In conjunction with the repurchase of these shares at $6.25 pershare, Messrs. Dodd and Friezen received proceeds of $1,192,500 and $647,850, respectively. In addition, Mr.Friezen received additional gross proceeds of $229,993 under a compensatorytransaction in conjunction with the unwinding of previous stock optionexercises and related officer loans. Messrs. Dodd and Friezen also received$81,311 and $53,425, respectively, under compensatory transactions for theinterest on the loans made by the financial institution to exercise stockoptions. The proceeds received by Messrs. Dodd and Friezen were used to pay offtheir loans with the financial institution. As a result, the Company’scertificates of deposit were no longer restricted. The Company redeemed thecertificates of deposit in December 2002. Finally, Messrs. Dodd and Friezenwere granted stock options to purchase 190,800 and 103,656 shares, respectively,of the Company’s Common Stock with an exercise price of $6.25 per share. Suchoptions were first exercisable on December 2, 2002.

 

46

----

 

TheCompany had advanced funds to Mr.Dodd and Mr. Friezen under promissory agreements to cover personal (unaudited)alternative minimum taxes and other costs generated as a result of theseofficers exercising stock options. Interest on the advances is charged at theapplicable federal rate as published by the Internal Revenue Service. Certainof these promissory notes became due in conjunction with the repurchase ofCommon Stock from Messrs. Dodd and Friezen noted above. The CompensationCommittee approved forgiving the principal totaling $92,153 and interesttotaling $11,093 on these promissory notes in fiscal year 2003 as well as anadditional compensatory transaction of $63,292 to cover estimated personalincome taxes the officers incurred on the promissory note forgiveness.

 

Amounts due from officers totaled $82,000 as of July 31,2004 and 2003.

 

*DNA Dreamfields Company, LLC*

 

TheCompany has entered into a manufacturing agreement with DNA Dreamfields wherebyDakota Growers is the exclusive manufacturer of DreamfieldsTM lowdigestible carbohydrate pasta. The Company has also entered into a servicesagreement with DNA Dreamfields under which the Company provides administrative,accounting, information technology, sales, customer service and distributionservices to DNA Dreamfields. Shipments of DreamfieldsTM low digestiblecarbohydrate pasta began in February 2004.

 

Pursuantto the services agreement with DNA Dreamfields, to the extent the Companysupplies logistics services for the delivery and billing of DreamfieldsTM product,the title in and to the DreamfieldsTM product shall remain withDakota Growers, and the risk of loss shall pass from Dakota Growers to DakotaGrower’s customers in accordance with terms and conditions set forth inpurchase orders or agreements between Dakota Growers and its customers. Salesof DreamfieldsTM products are included in the Company’s netrevenues. Manufacturing, distribution, and promotional costs incurred by theCompany related to DreamfieldsTM products are included in theapplicable line items of the Company’s income statement. On a monthly basis,the Company calculates a net amount due to DNA Dreamfields based on the totalsales of DreamfieldsTM product less related DreamfieldsTM productcosts, which include cash discounts, promotion and allowances, brokerage fees,bad debt write-offs, freight costs, storage and handling fees, and the transferprice established between the Company and DNA Dreamfields (as outlined in themanufacturing agreement). This net amount due to DNA Dreamfields, which totaled$2,712,000 for the year ended July 31, 2004, is included in the Company’s costof goods sold. Service fee income from DNA Dreamfields totaling $119,000 forthe year ended July 31, 2004 is included in net revenues. The net amount duefrom DNA Dreamfields as of July 31, 2004 was $621,000, which is included inOther Receivables on the Balance Sheet.

 

**NOTE 15 - CONTINUED DUMPING AND SUBSIDY OFFSET ACT OF 2000**

 

TheU.S. Customs Service (“Customs”) has distributed antidumping and countervailingduties assessed on certain pasta imported from Italy and Turkey to affecteddomestic producers pursuant to the Continued Dumping and Subsidy Offset Act of2000 (the “Offset Act”), which was enacted in October 2000. The Companyreceived payments in the amount of $903,000 and $1,000,000 in December 2003 and2002, respectively, under the Offset Act, based on duties assessed from October1, 2001 to September 30, 2003. The Company repaid $34,000 and $305,000 toCustoms in June 2003 and April 2004, respectively, pursuant to reclamationrequests from Customs. The reclamation request related to the April 2004repayment noted Customs had inadvertently left out an affected domesticproducer that had timely filed a valid claim in the allocation calculation,resulting in an initial overpayment to the Company. The net proceeds receivedunder the Offset Act have been classified as Other Income on the IncomeStatement. The Company cannot reasonably estimate the potential amount, if any,that it may receive under the Offset Act in future periods as any such amountwill be based upon future events over which the Company has little or nocontrol, including, but not limited to, the amount of expenditures by domesticpasta producers and the amount of antidumping and countervailing dutiescollected by Customs.

 

47

----

 

**NOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)**

 

Summaryquarterly results are as follows (in thousands, except per share amounts):

 
| ** **                                  | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|---------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
|                                        |       |               |       |                |       |               |       |                |       |
| Year ended July  31, 2004:                  |       |               |       |                |       |               |       |                |       |
|                                        |       |               |       |                |       |               |       |                |       |
| Net revenues                                |       | $                  | 37,649     |                | $          | 35,403             |       | $                   | 37,605     |   | $ | 34,022 |   |
| Gross profit                                |       | 1,911              |       | 3,042               |       | 4,126              |       | 3,355               |       |
| Operating income  (loss)                    |       | (92                | )          | 1,035               |       | 2,139              |       | 303                 |       |
| Net income  (loss)                          |       | (539               | )          | 652                 |       | 803                |       | (580                | )          |
| Basic net earnings  (loss) per common share |       | (0.04              | )          | 0.05                |       | 0.07               |       | (0.05               | )          |
|                                        |       |               |       |                |       |               |       |                |       |
| Year ended July  31, 2003:                  |       |               |       |                |       |               |       |                |       |
|                                        |       |               |       |                |       |               |       |                |       |
| Net revenues                                |       | $                  | 37,331     |                | $          | 40,740             |       | $                   | 29,435     |   | $ | 29,300 |   |
| Gross profit                                |       | 5,207              |       | 4,728               |       | 1,295              |       | 416                 |       |
| Operating income  (loss)                    |       | 2,891              |       | 1,562               |       | (801               | )          | (1,822              | )          |
| Net income  (loss)                          |       | 1,247              |       | 1,045               |       | (928               | )          | (1,793              | )          |
| Basic net  earnings (loss) per common share |       | 0.10               |       | 0.08                |       | (0.08              | )          | (0.15               | )          |

 

Theabove quarterly financial data is unaudited, but in the opinion of management,all adjustments necessary for a fair presentation of the selected data forthese interim periods presented have been included.

 

48

----

 

**ITEM 9.  DISAGREEMENTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

None.

 

**ITEM 9A.  CONTROLS AND PROCEDURES**

 

***Evaluation ofDisclosure Controls and Procedures***

 

The Company’s ChiefExecutive Officer, Timothy Dodd, and Chief Financial Officer, Thomas Friezen,have reviewed the Company’s disclosure controls and procedures within 90 daysprior to the filing of this report. Based upon this review, these officersbelieve that the Company’s disclosure controls and procedures are effective inensuring that material information related to the Company is made known to themby others within the Company.

 

***Changes inInternal Controls***

 

Therewere no significant changes in the Company’s internal controls or in otherfactors that could significantly affect these controls during the Company’sfourth fiscal quarter ended July 31, 2004 or from the end of the period to thedate of this Form 10-K.

 

**ITEM 9B.  OTHER INFORMATION**

 

None.

 

**PART III.**

 

**ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT**

 

**Board of Directors**

 

The Board of Directorscurrently consists of ten members. The Board may consist of a minimum of sevenmembers and a maximum of fifteen members. The Articles of Incorporation andBylaws of the Company require that at least five members of the Board ofDirectors be residents of the State of North Dakota and that at least threemembers be agricultural producers. TheBoard of Directors is divided into three classes: Class I, Class II and ClassIII. Class I, Class II and Class III will consist of an equal number ofdirectors, except that, if the Board of Directors consists of a number ofdirectors such that mathematically there cannot be a equal number of directorsin each of Class I, Class II and Class III, then the one remaining directorshall be made a member of Class I and, if there is more than one remainingdirector, the first remaining director shall be made a member of Class I andthe second remaining director shall be made a member of Class II.  Each director in each of Class I, Class IIand Class III will hold office until the third regular meeting of shareholdersfollowing the regular meeting of the shareholders at which such director orsuch director’s predecessor was elected, until his successor shall have beenelected and shall qualify, or until he resigns or is removed.

 

49

----

 

The table below setsforth certain information concerning the directors of the Company. Thedirectors have been elected to serve three-year terms expiring at the annualmeeting in the calendar years indicated in the table below.

 
| **Name**               | ** ** | **Age** | ** ** | **Term Expires** | ** ** | **Class** | ** ** |
|------------------------|------------|---------|------------|------------------|------------|-----------|------------|
|                   |       |    |       |             |       |      |       |
| John S.  Dalrymple III |       | 56      |       | 2006             |       | I         |       |
| Allyn K. Hart          |       | 65      |       | 2005             |       | III       |       |
| Roger A. Kenner  (1)   |       | 55      |       | 2007             |       | II        |       |
| James F. Link          |       | 77      |       | 2006             |       | I         |       |
| Eugene J.  Nicholas    |       | 59      |       | 2007             |       | II        |       |
| John D. Rice,  Jr. (1) |       | 50      |       | 2006             |       | I         |       |
| Michael T.  Tokarz (2) |       | 54      |       | 2005             |       | I         |       |
| Jeffrey O. Topp        |       | 45      |       | 2007             |       | II        |       |
| Curtis R.  Trulson     |       | 52      |       | 2005             |       | III       |       |
| Michael E.  Warner     |       | 54      |       | 2005             |       | III       |       |

 

----

(1) Mr. Kenner and Mr.Rice are first cousins.

 

(2) Mr. Tokarz wasappointed to the Board of Directors in July 2004.

 

**John S.Dalrymple III.**  Mr. Dalrymple has been Chairman of the Board ofDirectors of the Company since 1991. He became Lieutenant Governor of NorthDakota in 2000. Mr. Dalrymple had been a state representative since 1984 andserved as Chairman of the House Appropriations Committee and of the BudgetSection of the North Dakota House of Representatives. He previously served onthe board of directors of the U.S. Durum Growers Association. He has been afarmer in the Casselton, North Dakota area since 1971.  He serves on the board of directors ofthe U.S. Chamber of Commerce.

 

**Allyn K.Hart.**  Mr. Hart hasbeen a director of the Company since 1991. He has been a farmer in the CavalierCounty, North Dakota area since 1961.

 

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

 

**James F.Link.**  Mr. Link has been a director of the Company since1991. Mr. Link has served on the boards of directors of Farm Credit andMinn-Dak Farmers cooperative, including 15 years as its chairman. He has been afarmer in the Wahpeton, North Dakota area since 1947.

 

**Eugene J.Nicholas.**  Mr. Nicholas has been a director of the Companysince 1991.  Mr. Nicholas has been astate representative since 1974, and serves as chairman of the North DakotaHouse of Representatives Agriculture Committee. Mr. Nicholas also serves on theboard of directors of Country Bank USA, Cando, North Dakota, and the board ofgovernors of Golden Plains Frozen Foods LLC. Mr. Nicholas previously served onthe board of directors of the U.S. Durum Growers Association.

 

**John D.Rice, Jr.**  Mr. Rice is the Vice Chairman of the Board ofDirectors and has been a director of the Company since 1991. He also served onthe boards of directors of the National Pasta Association and U.S. DurumGrowers Association. He has been a farmer in the Maddock, North Dakota areasince 1968.

 

50

----

 

**Michael T. Tokarz. **Mr. Tokarz was appointed tothe Board of Directors in July 2004. Mr. Tokarz is the Chairman of MVC Capital,a registered investment company traded on the New York Stock Exchange (Ticker:MVC) that makes equity and debt investments. In addition, Mr. Tokarz is theManaging Member of The Tokarz Group, which manages Mr. Tokarz’s personalinvestments. From 1985 to 2002, Mr. Tokarz was a senior General Partner andAdministrative Partner at Kohlberg Kravis Roberts & Co., a private equityfirm specializing in management buyouts. Prior to joining KKR, Mr. Tokarz waswith Continental Illinois National Bank and Trust Company of Chicago, joiningthe firm in 1973. He also currently serves on the corporate boards of Conseco,Inc, Walter Industries, Inc., IDEX Corporation, Nexstar Financial, TimberlandMachines & Irrigation, Inc., Vestal Manufacturing Enterprises, Inc., BalticMotors Company, Stonewater Control Systems, Lomonsov, Athleta, Inc. and ApertioLtd. Mr. Tokarz also serves on the Board of the University of IllinoisFoundation and its Investment Committee and as Chairman of its Budget andFinance Committee.  He is a member of theBoard of Managers of Illinois Ventures and Chairman of Illinois EmergingTechnology Fund, both affiliated with the University of Illinois.

 

**JeffreyO. Topp.** Mr. Topp has been a director of the Company since1991. He serves on the board of directors of Farmers Elevator, Inc. in GraceCity, North Dakota. He is a partner in T-T Ranch and has been a farmer in theGrace City area since 1978.

 

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

 

**MichaelE. Warner.**  Mr. Warner has been a director of the Companysince 1992. Mr. Warner has been a farmer in the Hillsboro, North Dakota areasince 1967. He also currently serves on the board of directors of WarnerEquipment Co. and Agriceutical Resources LLC. In 2002, Mr. Warner was awarded afellowship by the University of Missouri. He served on the board of directorsof American Crystal Sugar Company from 1989 through 1996, as part of a 23-yearcareer of service to the sugar industry. He is a past member of the board oftrustees of Meritcare Health Systems of Fargo, North Dakota, the largesthospital/multiple clinic system between Minneapolis, Minnesota and Seattle,Washington.

 

**Committeesof the Board of Directors**

 

The Audit Committee isresponsible for assessing and ensuring the independence of the independentauditor, evaluating audit performance, approving the services to be provided bythe independent auditor, evaluating policies and procedures relating tointernal accounting function and controls, and reviewing and approving theCompany’s annual audited financial statements before issuance, subject to approvalby the Board of Directors. The members of the Audit Committee are Messrs.Trulson, Dalrymple and Warner, each of whom is independent, as they are notemployees of the Company and have no other relationships which would preventthem from being considered independent pursuant to the Company’s policies andapplicable laws and regulations. The Board of Directors has determined that Mr.Trulson qualifies as an “audit committee financial expert” within the meaningof Securities and Exchange Commission regulations.

 

The CompensationCommittee makes recommendations to the Board of Directors of the Companyregarding stock and compensation plans, approves transactions of certainofficers and authorizes the granting of stock options.  Messrs. Dalrymple, Trulson and Warner aremembers of the Compensation Committee.

 

TheNomination Committee is responsible for recommending nominees to the Board ofDirectors of the Company. Under the Company’s current bylaws, the NominationCommittee consists of the Company’s Chairman, Vice Chairman, and ChiefExecutive Officer.

 

The Policy Committeeprovides oversight of the Company’s governance obligations to assure compliancewith all applicable laws, regulations, Articles of Incorporation and By-laws,operating pursuant to a written Policy

 

51

----

 

Committee Charter adopted by the Company’s Board of Directors. Messrs.Hart, Trulson and Link are members of the Policy Committee.

 

**Compensation of Directors**

 

The Company provides its directors with minimalcompensation, consisting of (i) a per diem payment of $200 (except for theChairman who will receive $250 per day) for any day on which a directorundertakes activities on the Company’s behalf, including board meetings andother functions of the Company, (ii) a monthly fee of $450 (except for theChairman who receives $500 per month), and (iii) reimbursement forout-of-pocket expenses incurred on behalf of the Company.

 

**Executive Officers**

 

The table below lists theexecutive officers of the Company. Officers are elected annually by the Boardof Directors.

 
| **Name**          | ** ** | **Age** | ** ** | **Position**                                         | ** ** |
|-------------------|------------|---------|------------|------------------------------------------------------|------------|
|              |       |    |       |                                                 |       |
| Timothy J. Dodd   |       | 49      |       | President and Chief Executive Officer                |       |
| Thomas P. Friezen |       | 45      |       | Chief Financial Officer                              |       |
| Eldon Buschbom    |       | 56      |       | Vice President, Operations (Minnesota)               |       |
| Susan M. Clemens  |       | 43      |       | Vice President, Human Resources and Administration   |       |
| James D. Cochran  |       | 36      |       | Vice President, Supply Chain                         |       |
| Jack B. Hasper    |       | 63      |       | Vice President, Sales and Marketing                  |       |
| Radwan Ibrahim    |       | 60      |       | Vice President, Quality Assurance                    |       |
| Edward O. Irion   |       | 33      |       | Vice President, Finance and Chief Accounting Officer |       |
| David E. Tressler |       | 50      |       | Vice President, Manufacturing and Special Projects   |       |

 

**TimothyJ. Dodd.** Mr. Dodd is the President and Chief ExecutiveOfficer of the Company. Prior to joining the Company in December 1991, he had been the Vice President ofManufacturing for American Italian Pasta Company since 1988. Previously, Mr.Dodd participated in the construction and management of two other grainprocessing facilities, one in Texas and one in Cando, North Dakota. Mr. Doddserves on the board of directors of Country Bank USA, Cando, North Dakota.

 

**Thomas P.Friezen.** Mr. Friezen is the Chief Financial Officer of theCompany. Mr. Friezen joined the Company in April 1995 as Vice President,Finance and became Chief Financial Officer in August 2000. Mr. Friezen is amember of the board of directors of CDT, Inc., a development stage watertechnology company. Mr. Friezen is a certified public accountant.

 

**Eldon F.Buschbom.**  Mr. Buschbom has been Vice President, Operations(Minnesota) since May 30, 2000. He joined Borden Foods in February 1996 asEngineering Manager. Mr. Buschbom served as Vice President of Engineering andManufacturing Technology for Primo Piatto, Inc. from August 1997 to February1998.  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.

 

52

----

 

**James D.Cochran.**  Mr. Cochran has been Vice President, Supply Chainsince February 20, 1998. From 1997 to 1998, he was Vice President of NewBusiness Development at Primo Piatto, Inc. Mr. Cochran held various positionswith Borden Foods from 1990 to 1997, most recently as Materials 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 many 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.

 

**RadwanIbrahim.**  Mr. Ibrahim has been Vice President, QualityControl since February 20, 1998. From August 1997 to February 1998, he servedas Chief Technical Officer and Vice President of Primo Piatto, Inc. Mr. Ibrahimwas Group Quality Control Manager at Borden Foods from 1992 to 1997. Mr.Ibrahim holds a Ph.D. degree in cereal chemistry from North Dakota StateUniversity.

 

**Edward O.Irion.** Mr. Irion is Vice President, Finance and ChiefAccounting Officer of the Company.  Mr. Irion joined the Company inDecember 1999 as Assistant Vice President, Planning and Control and became VicePresident, Finance and Chief Accounting Officer in August 2000. Prior tojoining the Company, he spent six years with the regional accounting firm ofEide Bailly LLP in Fargo, North Dakota. Mr. Irion’s most recent position withEide Bailly LLP prior to joining the Company was Senior Associate. Mr. Irion isa certified public accountant.

 

**David E.Tressler.**  Mr. Tressleris Vice President, Manufacturing and Special Projects. Mr. Tressler waspromoted to his current position from VicePresident, Operations (North Dakota) in May 2004. Mr. Tressler joined the Company in February 1992as a Project Engineer. Prior to joining the Company, Mr. Tressler was adirector of engineering at American Italian Pasta Company, where he wasresponsible for monitoring the completion of the initial pasta plant. From 1977to 1988 he was plant engineer at International Multi-Foods, Inc.

 

**Code of Conduct**

 

TheCompany adopted a Code of Conduct during fiscal 2003 applicable to allemployees. A Code of Ethics certification for senior financial officers, includingthe principal executive officer, principal financial officer and principalaccounting officer, is included within the Code of Conduct.

 

Acopy of the Company’s Code of Conduct will be provided, without charge, uponwritten request to:

 

Investor Relations

Dakota Growers PastaCompany, Inc.

One Pasta Avenue

Carrington, ND 58421

 

53

----

 

**ITEM 11.  EXECUTIVE COMPENSATION**

 

The following tablesummarizes the amount of compensation paid to the Company’s President and ChiefExecutive Officer and each of the four next highest paid officers for thefiscal year ended July 31, 2004 and the two prior fiscal years.

 

**SummaryCompensation Table**

 
| ** **                       | ** ** | ** **       | ** ** | ** ** | ** ** | ** **                             | ** ** | **Long-Term  Compensation Awards**                           | ** ** | ** **                                             | ** ** |
|----------------------------------|------------|------------------|------------|------------|------------|----------------------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **Name and  Principal Position** | ** ** | **Fiscal  Year** | ** ** | ** ** | ** ** | **Other  Annual  Compen-  sation (1)** | ** ** | **Series C  Preferred  Securities  Underlying  Options (#)** | ** ** | **Common  Stock  Securities  Underlying  Options (#)** | ** ** | **All  Other  Compen-  sation (2)** | ** ** |
| ** **                       | ** ** | ** **       |
| ** **                       |
| **Annual Compensation**          |
| **Salary**                       | ** ** | **Bonus**        |
|                             |       |             |       |       |       |                                   |       |                                                         |       |                                                   |       |   |   |   |   |
| Timothy J. Dodd                  |       | 2004             |       | $          | 202,566    |                                   | $          | —                                                       |       | $                                                      | 10,552     |   | — |   | 13,511 |   | $ | — |   |
| President and  Chief             |       | 2003             |       | 202,566    |       | 112,130                                |       | 9,273                                                        |       | 686                                                    |       | 190,800 |   | 221,716 |   |
| Executive  Officer               |       | 2002             |       | 192,920    |       | 63,534                                 |       | 5,936                                                        |       | 1,291                                                  |       | — |   | — |   |
|                             |       |             |       |       |       |                                   |       |                                                         |       |                                                   |       |   |   |   |   |
| Thomas P.  Friezen               |       | 2004             |       | 173,628    |       | —                                 |       | 19,438                                                       |       | —                                                 |       | 11,575 |   | — |   |
| Chief Financial  Officer         |       | 2003             |       | 173,628    |       | 34,540                                 |       | 9,670                                                        |       | —                                                 |       | 103,656 |   | 309,551 |   |
|                             |       | 2002             |       | 172,310    |       | 16,263                                 |       | 5,658                                                        |       | 754                                                    |       | — |   | — |   |
|                             |       |             |       |       |       |                                   |       |                                                         |       |                                                   |       |   |   |   |   |
| Jack B. Hasper  (3)              |       | 2004             |       | 144,288    |       | —                                 |       | 15,919                                                       |       | —                                                 |       | 9,100 |   | — |   |
| Vice President,                  |       | 2003             |       | 136,500    |       | 25,169                                 |       | 14,440                                                       |       | —                                                 |       | — |   | — |   |
| Sales and  Marketing             |       | 2002             |       | 45,000     |       | —                                 |       | 3,736                                                        |       | —                                                 |       | — |   | — |   |
|                             |       |             |       |       |       |                                   |       |                                                         |       |                                                   |       |   |   |   |   |
| David E.  Tressler               |       | 2004             |       | 115,840    |       | —                                 |       | 8,604                                                        |       | —                                                 |       | 7,723 |   | — |   |
| Vice President,  Manufacturing   |       | 2003             |       | 115,840    |       | 22,214                                 |       | 9,203                                                        |       | —                                                 |       | — |   | — |   |
| and Special  Projects            |       | 2002             |       | 110,295    |       | 11,196                                 |       | 4,003                                                        |       | —                                                 |       | — |   | — |   |
|                             |       |             |       |       |       |                                   |       |                                                         |       |                                                   |       |   |   |   |   |
| James D. Cochran                 |       | 2004             |       | 115,840    |       | —                                 |       | 4,832                                                        |       | —                                                 |       | 7,723 |   | — |   |
| Vice President,                  |       | 2003             |       | 115,840    |       | 22,234                                 |       | 4,580                                                        |       | —                                                 |       | — |   | — |   |
| Supply Chain                     |       | 2002             |       | 110,323    |       | 6,790                                  |       | 3,822                                                        |       | —                                                 |       | — |   | — |   |
|                                  |            |                  |            |            |            |                                        |            |                                                              |            |                                                        |            |  |  |  |  |  |  |  |  |

 

----

(1)      Includes the Company’s 401(k) matchingcontribution, excess life insurance, the taxable portion of reimbursable businessexpenses and the taxable portion of other benefits.

(2)          Compensation resultingfrom transactions to effect compliance with the Sarbanes-Oxley Act of 2002. See“Transactions with Executive Officers” under “Item 13. Certain Relationshipsand Related Transactions” for further information.

(3)   Mr. Hasper became an employee of the Companyin March 2002.

 

54

----

 

**Option Grants in Fiscal Year 2004**

 

The following table sets forth certain information withrespect to stock options granted to purchase Common Stock during the fiscalyear ended July 31, 2004.

 
| ** **         | ** ** | **Common**     | ** ** | ** **   | ** ** | ** **   | ** ** | ** **     | ** ** | **Potential Realized Value**    | ** ** |    |
|--------------------|------------|----------------|------------|--------------|------------|--------------|------------|----------------|------------|---------------------------------|------------|---------|
| ** **         | ** ** | **Shares**     | ** ** | **Percent**  | ** ** | ** **   | ** ** | ** **     | ** ** | **at Assumed Annual Rates**     | ** ** |    |
| ** **         | ** ** | **Underlying** | ** ** | **of Total** | ** ** | **Exercise** | ** ** | ** **     | ** ** | **of Stock Price Appreciation** | ** ** |    |
| ** **         | ** ** | **Options**    | ** ** | **Options**  | ** ** | **Price**    | ** ** | **Expiration** | ** ** | **for Option Term (1)**         | ** ** |    |
| **Name**           | ** ** | **Granted**    | ** ** | **Granted**  | ** ** | **($/SH)**   | ** ** | **Date**       | ** ** | **5%**                          | ** ** | **10%** | ** ** |   |
|               |       |           |       |         |       |         |       |           |       |                            |       |    |   |   |
| Timothy J. Dodd    |       | 13,511         |       | 17           | %          | $            | 4.25       |           | 2/1/2014   |                            | $          | 37,152  |   | $ | 98,021 |   |
| Thomas P.  Friezen |       | 11,575         |       | 14           | %          | $            | 4.25       |           | 2/1/2014   |                            | $          | 31,829  |   | $ | 83,976 |   |
| Jack B. Hasper     |       | 9,100          |       | 11           | %          | $            | 4.25       |           | 2/1/2014   |                            | $          | 25,023  |   | $ | 66,020 |   |
| David E.  Tressler |       | 7,723          |       | 10           | %          | $            | 4.25       |           | 2/1/2014   |                            | $          | 21,237  |   | $ | 56,030 |   |
| James D. Cochran   |       | 7,723          |       | 10           | %          | $            | 4.25       |           | 2/1/2014   |                            | $          | 21,237  |   | $ | 56,030 |   |
|                    |            |                |            |              |            |              |            |                |            |                                 |            |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)The amounts shown as potential realizable value illustrate what might berealized upon exercise immediately prior to expiration of the option term usingthe 5% and 10% appreciation rates established in SEC regulations, compoundedannually. The potential realizable value is not intended to predict futureappreciation 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.

 

**OptionsExercised in Fiscal Year 2004 and Unexercised Options at July 31, 2004**

 

The following table summarizes stock optionexercises and total number of options held for Series C Convertible PreferredStock at the end of fiscal year 2004.

** **
| ** **         | ** ** | **Series C**       | ** ** | ** **   | ** ** | **Number of Series C**           | ** ** | ** **                       | ** ** | ** **      | ** ** |
|--------------------|------------|--------------------|------------|--------------|------------|----------------------------------|------------|----------------------------------|------------|-----------------|------------|
| ** **         | ** ** | **Convertible**    | ** ** | ** **   | ** ** | **Convertible Preferred Shares** | ** ** | **Value of Unexercised**         | ** ** |
| ** **         | ** ** | **Preferred**      | ** ** | ** **   | ** ** | **Underlying Unexercised**       | ** ** | **In-the-Money**                 | ** ** |
| ** **         | ** ** | **Stock Acquired** | ** ** | **Value**    | ** ** | **Options at July 31, 2004**     | ** ** | **Options at July 31, 2004 (1)** | ** ** |
| **Name**           | ** ** | **on Exercise**    | ** ** | **Realized** | ** ** | **Exercisable**                  | ** ** | **Unexercisable**                | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|               |       |               |       |         |       |                             |       |                             |       |            |       |   |   |
| Timothy J. Dodd    |       | —             |       | $            | —     |                             | 1,977      |                             | —     |            | $          | — |   | $ | — |   |
| Thomas P.  Friezen |       | —             |       | —       |       | 754                              |       | —                           |       | —          |       | — |   |
|                    |            |                    |            |              |            |                                  |            |                                  |            |                 |            |  |  |  |  |  |

** **

The following table summarizes stock option exercises andtotal number of options held for Common Stock at the end of fiscal year 2004.

 
| ** **         | ** ** | ** **      | ** ** | ** **   | ** ** | **Number of**                | ** ** | ** **                       | ** ** | ** **      | ** ** |
|--------------------|------------|-----------------|------------|--------------|------------|------------------------------|------------|----------------------------------|------------|-----------------|------------|
| ** **         | ** ** | **Common**      | ** ** | ** **   | ** ** | **Common Shares**            | ** ** | **Value of Unexercised**         | ** ** |
| ** **         | ** ** | **Stock**       | ** ** | ** **   | ** ** | **Underlying Unexercised**   | ** ** | **In-the-Money**                 | ** ** |
| ** **         | ** ** | **Acquired**    | ** ** | **Value**    | ** ** | **Options at July 31, 2004** | ** ** | **Options at July 31, 2004 (1)** | ** ** |
| **Name**           | ** ** | **on Exercise** | ** ** | **Realized** | ** ** | **Exercisable**              | ** ** | **Unexercisable**                | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|               |       |            |       |         |       |                         |       |                             |       |            |       |   |   |
| Timothy J. Dodd    |       | —          |       | $            | —     |                         | 190,800    |                             | 13,511     |            | $          | — |   | $ | — |   |
| Thomas P.  Friezen |       | —          |       | —       |       | 103,656                      |       | 11,575                           |       | —          |       | — |   |
| Jack B. Hasper     |       | —          |       | —       |       | —                       |       | 9,100                            |       | —          |       | — |   |
| David E.  Tressler |       | —          |       | —       |       | —                       |       | 7,723                            |       | —          |       | — |   |
| James D. Cochran   |       | —          |       | —       |       | —                       |       | 7,723                            |       | —          |       | — |   |
|                    |            |                 |            |              |            |                              |            |                                  |            |                 |            |  |  |  |  |  |

 

----

(1)There is no established public trading market for the Company’s securities;therefore, the Company is unable to estimate the value of unexercised optionsas of July 31, 2004.

 

55

----

 

**Employment Agreements**

 

The Company entered intoan employment agreement, dated March 25, 2002, with its Vice President of Salesand Marketing, Jack B. Hasper. The agreement provides for Mr. Hasper’semployment for a period of thirty-six months commencing on March 25, 2002. TheCompany will pay him an annual salary of $130,000 under the employmentagreement.  His salary will be reviewedannually and, based upon his performance, may be increased each year by theBoard of Directors. In addition, Mr. Hasper will be entitled to receive bonusesand other fringe benefits consistent with the Company’s bonus and benefit plansthat are in effect during the term of his employment agreement.

 

Mr. Hasper will beentitled to the following compensation and benefits if his employment isterminated under the circumstances noted prior to the expiration of thethirty-six month employment period:

 

•                  Ifthe Company terminates Mr. Hasper with cause, then he will be entitled toreceive any earned but unpaid bonuses, any accrued but unused vacation pay andany then-existing but unreimbursed business expenses.

 

•                  Ifthe Company terminates Mr. Hasper’s employment without cause or Mr. Hasperresigns from his employment for good cause, Mr. Hasper will be entitled toreceive his salary then in effect for a period of six months (or twelve months,in the case of his termination without cause or his resignation for good causefollowing a change of control of the Company) following such termination orsuch resignation, in addition to any earned but unpaid bonuses, any accrued butunused vacation pay and any then-existing but unreimbursed business expenses.However, Mr. Hasper will only receive the compensation and benefits describedin the immediately-preceding sentence if, upon his termination or resignation,he releases any and all claims that he might have against the Company.

 

•                  IfMr. Hasper resigns from his employment for any reason other than for goodcause, he will be entitled to receive his salary earned through the date ofsuch resignation, any earned but unpaid bonuses, any accrued but unusedvacation pay and any then-existing but unreimbursed business expenses. Again,he will only receive the compensation and benefits described in theimmediately-preceding sentence if, upon his resignation, he releases any andall claims he might have against the Company.

 

•                  Inthe event that Mr. Hasper’s employment is terminated due to his death ordisability, he or his estate will receive his salary then in effect accrued upto and including the date of termination, any earned but unpaid bonuses, anyaccrued but unused vacation pay and any then-existing but unreimbursed businessexpenses.

 

The Company may terminateMr. Hasper for “cause” if he: (i) commits an act of fraud, embezzlement ormisappropriation involving the Company; (ii) is convicted of any felony; (iii)commits an act, or fails to commit an act, involving the Company that amountsto willful misconduct or gross negligence; (iv) intentionally engages in anyactivity that is adverse to the interests of the Company; (v) commits an act ofdishonesty in connection with his employment; (vi) breaches his fiduciary dutyto the Company; (vii) commits an act of self-dealing; (viii) materiallybreaches his employment agreement; or (ix) commits an act that brings theCompany into substantial public disgrace or disrespect.

 

Mr. Hasper’s employmentagreement prohibits the disclosure to third parties of information,observations and data obtained while he is employed by the Company concerningthe business and affairs of the Company and its affiliates. It also containsprovisions that prohibit Mr. Hasper, at any time after the termination of hisemployment, from using confidential information to compete with the Company ordisclosing confidential information to third parties that do or will competewith the Company. In addition, at any time after the termination of hisemployment, Mr. Hasper may not solicit or recruit employees or customers of theCompany.

 

 

56

----

** **

**Stock Option Plans**

** **

On January 31, 1997 theCooperative’s Compensation Committee of the Board of Directors (the“Compensation Committee”) adopted the Dakota Growers Incentive Stock OptionPlan (the “Plan”). The Plan was ratified by the Cooperative members at theannual meeting in January 1998. The Compensation Committee or the Board ofDirectors has the power to determine the key management employees of theCompany to receive options and the number of shares to be optioned to each ofthe employees. Options granted under the Plan are for the purchase of Series CConvertible Preferred Stock at fair market value, which were convertible intoEquity Stock as a cooperative, and are now convertible into Common Stock andSeries D Delivery Preferred Stock as a corporation at the option of theemployee, under the applicable conversion ratio. The maximum number ofpreferred shares that may be issued pursuant to options granted under the Planis 15,000, all of which have been issued as of July 31, 2003. Each share ofSeries C Preferred Stock is convertible into 24 shares of Common Stock and 24shares of Series D Delivery Preferred Stock of the Company. The conversionratio is proportionately adjusted if the Company increases the outstandingshares of Common Stock or Series D Delivery Preferred Stock, as applicable,without payment by or to the Company or the Company’s shareholders for suchadditional shares (e.g. stock split, stock dividend or other action). Optionsgranted under the Plan must be exercised within ten years from the date suchoptions are granted. In the event of the employee’s termination with theCompany, all exercisable options may be exercised within 90 days of thetermination date. If not exercised, such options lapse.

 

The Company’s 2002 Stock Option Plan (the “2002 Plan”) was adopted bythe Board of Directors on November 21, 2002. All options granted under the 2002Plan are non-qualified stock options and are for the purchase of the Company’sCommon Stock. The maximum number of shares of Common Stock that may be issuedpursuant to options granted under the 2002 Plan is 294,456 shares, all of whichhave been issued as of July 31, 2003. Stock options granted under the 2002 Planexpire 10 years from the date of grant.

 

On November 21,2002 the Board of Directors adopted the Dakota Growers Pasta Company, Inc. 2003Stock Option Plan (the “2003 Plan”), which was approved by the Company’sshareholders at the Annual Meeting on January 11, 2003. No options have beengranted under the 2003 Plan. The 2003 Plan covers 500,000 shares of theCompany’s Common Stock. Participation in this Plan shall be limited toofficers, directors, employees, vendors or consultants of the Company or any subsidiaryof the Company. Options granted under the 2003 Plan may be incentive stockoptions (as defined under Section 422 of the Code) or non-qualified stockoptions, as determined by the 2003 Plan administrator at the time of grant ofan option and subject to the applicable provisions of Section 422 of the Codeand the regulations promulgated there under. The stock options generally expire10 years from the date of grant. If the employment of the Optionee isterminated by any reason other than his or her death or disability, allexercisable options may be exercised within 90 days of the termination date. Ifnot exercised, such options lapse. Options to purchase 80,524 shares of Common Stock were granted underthe 2003 Plan in fiscal year 2004.

 

**Employee Benefit Plans**

 

The Company and its subsidiary, Primo Piatto, Inc., have a 401(k) planthat covers employees who have met age and service requirements. The plancovers employees who have reached 21 years of age and who have completed 500hours of service within six months. Effective January 1, 2003, the 401(k) planwas amended, and the Company match was changed to 100% on the first 3% of theemployees’ elected deferral and 50% on the next 2%. Previously the Companymatched 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$377,000, $345,000 and $319,000 for the years ended July 31, 2004, 2003 and2002, respectively.

 

PrimoPiatto, Inc. is also required to contribute to a multi-employer pension plancovering certain hourly employees subject to a collective bargaining agreement.Such employees may also participate in the 401(k) plan but are excluded fromamounts contributed by Primo Piatto. Contributions for the years ended July 31,2004, 2003 and 2002 totaled $60,000, $81,000 and $72,000, respectively.

 

 

57

----

 

**Compensation Committee Interlocksand Insider Participation**

 

The members of theCompensation Committee are John S. Dalrymple III, Curtis R. Trulson and MichaelE. Warner. None of these directors are or have been an officer or employee ofthe Company. During fiscal year 2004, no executive officer of the Companyserved as a director or member of the Compensation Committee (or othercommittee serving an equivalent function) of any other entity, one of whoseexecutive officers served as a director of or member of the CompensationCommittee of the Company.

 

**ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT**

 

The following tablefurnishes information as to the beneficial ownership of the Company’s CommonStock, Series C Convertible Preferred Stock and Series D Delivery PreferredStock by (a) each person known by us to beneficially own more than 5% of theissued and outstanding shares of the Company’s voting securities, (b) each ofthe Company’s executive officers, (c) each of the Company’s directors and (d)all of the Company’s directors and executive officers as a group.

 

The address of eachperson listed below is c/o Dakota Growers Pasta Company, Inc., One PastaAvenue, Carrington, North Dakota 58421. Except as otherwise noted, each personlisted below has sole investment discretion and voting power. In accordancewith the Securities and Exchange Commission’s rules, in computing the number ofshares beneficially owned by a person and the percentage ownership of thatperson, securities subject to options held by that person that are currentlyexercisable or exercisable within 60 days of July 31, 2004 are treated asoutstanding. These shares, however, are not treated as outstanding for thepurpose of computing the percentage ownership of any other person.

 
| ** **                                              | ** ** | **Beneficially Owned Securities**      | ** ** |
|---------------------------------------------------------|------------|----------------------------------------|------------|
| **Name of  Beneficial Owner**                           | ** ** | **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                                |       | 2.8 | % | — |   | — |   | 333,000 |   | 3.0 | % |
| 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,  Jr. (5)                                  |       | 22,583                                 |       | 0.2 |   | — |   | — |   | 20,200 |   | 0.2 |   |
| Jeffrey O. Topp (6)                                     |       | 302,172                                |       | 2.3 |   | — |   | — |   | 271,420 |   | 2.4 |   |
| 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)                                    |       | 252,934                                |       | 1.9 |   | 1,977 |   | 72.4 | % | 238,248 |   | 2.1 |   |
| Thomas P.  Friezen (8)                                  |       | 126,959                                |       | 1.0 |   | 754 |   | 27.6 |   | 121,752 |   | 1.1 |   |
| Michael Tokarz  (10)                                    |       | 909,091                                |       | 6.9 |   | — |   | — |   | — |   | — |   |
| MVC Capital,  Inc. (10)                                 |       | 909,091                                |       | 6.9 |   | — |   | — |   | — |   | — |   |
| All directors  and officers as a Group (12 persons) (9) |       | 2,413,672                              |       | 17.8 |   | 2,731 |   | 100.0 |   | 1,371,909 |   | 12.1 |   |

 

----

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

(2)               Includesshares held in the name of Mr. Kenner’s spouse.

(3)               Includesshares held in the names of Link Farms LLP LSB Pasta and Link Farms LLP.

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

(5)               Includesshares held in the name of John Rice Farm.

 

 

58

----

 

(6)               Includesshares held in the names of T-T Ranch and Mr. Topp’s spouse and children.

(7)               Includesshares held in the name of Trulson Brothers.

(8)               Messrs.Dodd and Friezen have been granted options that are currently exercisable orexercisable within 60 days of July 31, 2004, to purchase 1,977 and 754 shares,respectively, of the Company’s Series C Preferred Stock and 190,800 and 103,656shares, respectively, of the Company’s Common Stock. Each share of Series CPreferred Stock is convertible into 24 shares of Common Stock and 24 shares ofSeries D Delivery Preferred Stock of the Company. The number of shares ofCommon Stock presented for Messrs. Dodd and Friezen include 47,448 and 18,096shares, respectively, of Common Stock issuable upon exercise of the options topurchase Series C Preferred Stock of the Company and conversion of each suchshare of Series C Preferred Stock into 24 shares of Common Stock in theCompany. The number of shares of Series D Delivery Preferred Stock presentedfor Messrs. Dodd and Friezen includes 47,448 and 18,096 shares, respectively,of Series D Delivery Preferred Stock issuable upon exercise of the options topurchase Series C Preferred Stock of the Company and conversion of each suchshare of Series C Preferred Stock into 24 shares of Common Stock in theCompany, with one share of Series D Delivery Preferred Stock issuable for eachshare of Common Stock so issued upon conversion. The number of shares of CommonStock presented for Messrs. Dodd and Friezen also include 190,800 and 103,656shares, respectively, of Common Stock issuable upon exercise of options topurchase Common Stock.

(9)               Thenumber of shares of Common Stock and Series D Delivery Preferred Stock and thepercentage of the total number of shares of Common Stock and Series D DeliveryPreferred Stock beneficially owned by all directors and executive officers as agroup are shown on a fully-diluted basis, based upon 13,529,382 shares ofCommon Stock and 11,340,841 shares of Series D Delivery Preferred Stock issuedand outstanding on a fully-diluted basis.

(10)         Theshares are directly owned by MVC Capital, Inc. of which Mr. Tokarz is astockholder, director and Chairman.  Mr.Tokarz disclaims any beneficial ownership of the Company’s securities forpurposes of Section 16(a) under the Securities Exchange Act of 1934, asamended, or otherwise, except to the extent of the Reporting Person’s pecuniaryinterests therein.

 

**EquityCompensation Plan Information**

 

See “Item 11. Executive Compensation” for adiscussion of the material features of the Company’s Stock Option Plans. Thefollowing table provides information regarding the Company’s equitycompensation plan as of July 31, 2004.

 
| ** **                                                  | ** ** | ** **                                                        | ** ** | ** **            | ** ** | **Number of Securities** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|
| ** **                                                  | ** ** | **Number of Securities**                                          | ** ** | **Weighted-Average**  | ** ** | **Remaining Available**  | ** ** |
| ** **                                                  | ** ** | **to be Issued**                                                  | ** ** | **Exercise Price of** | ** ** | **for Future Issuance**  | ** ** |
| ** **                                                  | ** ** | **Upon Exercise of**                                              | ** ** | **Outstanding**       | ** ** | **Under Equity**         | ** ** |
| **Plan Category**                                           | ** ** | **Outstanding Options**                                           | ** ** | **Options**           | ** ** | **Compensation Plans**   | ** ** |
|                                                        |       |                                                              |       |                  |       |                     |       |
|                                                        |       | **Options  to purchase Series C Convertible Preferred Stock (1)** |       |
| Equity  compensation plans approved by security holders     |       | 2,731                                                             |       | $                     | 112.56     |                     | —     |   |
|                                                        |       |                                                              |       |                  |       |                     |       |
|                                                        |       | **Options  to purchase Common Stock**                             |       |
| Equity  compensation plans approved by security holders     |       | 80,524                                                            |       | $                     | 4.25       |                     | 419,476    |   |
|                                                        |       |                                                              |       |                  |       |                     |       |
| Equity  compensation plans not approved by security holders |       | 294,456                                                           |       | $                     | 6.25       |                     | —     |   |

 

----

(1) Each share of Series CConvertible Preferred Stock is convertible into 24 shares of Common Stock and24 shares of Series D Delivery Preferred Stock of the Company.

 

59

----

 

**ITEM13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

**Transactions with Executive Officers**

 

The Company had pledged certificates of deposit as security for loans,totaling approximately $1,974,000, made by a financial institution to TimothyJ. Dodd, President and Chief Executive Officer, and Thomas P. Friezen, ChiefFinancial Officer, to exercise stock options. These loans matured December 1,2002.

 

In accordance with the provisions of the Sarbanes-Oxley Act of 2002,the Board of Directors approved the repurchase of 190,800 and 103,656 shares ofthe Company’s Common Stock from Messrs. Dodd and Friezen, respectively. Therepurchase was completed in November 2002. In conjunction with the repurchaseof these shares at $6.25 per share, Messrs. Dodd and Friezen received proceedsof $1,192,500 and $647,850,respectively. In addition, Mr. Friezen received additional gross proceeds of$229,993 under a compensatory transaction in conjunction with the unwinding ofprevious stock option exercises and related officer loans. Messrs. Dodd andFriezen also received $81,311 and $53,425, respectively, under compensatorytransactions for the interest on the loans made by the financial institution toexercise stock options. The proceeds received by Messrs. Dodd and Friezen wereused to pay off their loans with the financial institution. As a result, theCompany’s certificates of deposit were no longer restricted. The Companyredeemed the certificates of deposit in December 2002. Finally, Messrs. Doddand Friezen were granted stock options to purchase 190,800 and 103,656 shares,respectively, of the Company’s Common Stock with an exercise price of $6.25 pershare. Such options were first exercisable on December 2, 2002.

 

The Company had advanced funds to Mr. Dodd and Mr. Friezenunder promissory agreements to cover personal alternative minimum taxes andother costs generated as a result of these officers exercising stock options.Interest on the advances is charged at the applicable federal rate as publishedby the Internal Revenue Service. Certain of these promissory notes became duein conjunction with the repurchase of Common Stock from Messrs. Dodd andFriezen noted above. The Compensation Committee approved forgiving theprincipal ($92,153) and interest ($11,093) on these promissory notes along withan additional compensatory transaction of $63,292 to cover estimated personalincome taxes the officers incurred on the promissory note forgiveness.

 

The current outstanding principal balance of fundsadvanced to officers and the highest amounts of outstanding advances forindebtedness of management exceeding $60,000 at any time since the beginning offiscal year 2004 are set forth below.

 

| ** **         | ** ** | **Current  Outstanding  Balance** | ** ** | **Highest  Amounts  Outstanding** | ** ** |
|--------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **         | ** ** | ** **                        | ** ** | ** **                        | ** ** |
| Timothy J. Dodd    |       | $                                 | 47,000     |                              | $          | 47,000 |   |
| Thomas P.  Friezen |       | 35,000                            |       | 35,000                            |       |
|                    |            |                                   |            |                                   |            |  |  |

 

The current outstandingbalances of $47,000 and $35,000 for Messrs. Dodd and Friezen, respectively,were advanced subject to promissory notes in effect prior to the enactment ofthe Sarbanes-Oxley Act of 2002. There has been no material modification of theterms or any renewal of these promissory notes.

 

**Purchase of Certain Assets**

 

The Company’s VicePresident of Sales and Marketing is Mr. Jack B. Hasper. Prior to his employmentwith the Company, Mr. Hasper was part-owner of a sales and marketing firm fromwhich the Company purchased certain assets during fiscal year 2002. Inconjunction with the purchase of such assets, Mr. Hasper entered into aCovenant not to Compete with the Company for a period extending through March31, 2007. The Company paid Mr. Hasper $100,000 in consideration for enteringinto the aforementioned Covenant not to Compete.

 

60

----

 

**ITEM14.  PRINCIPAL ACCOUNTING FEES ANDSERVICES**

 

   The following table representsaggregate fees billed (in thousands) to the Company for fiscal years ended July31, 2004 and 2003 by Eide Bailly LLP, the Company’s principal accounting firm.

 

| ** **              | ** ** | **Fiscal Year Ended** | ** ** |
|-------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Audit Fees              |       | $                     | 54         |   | $ | 54 |   |
| Audit-Related  Fees (a) |       | 8                     |       | 10 |   |
| Tax Fees (b)            |       | 19                    |       | 26 |   |
| All Other Fees          |       | —                |       | — |   |
|                    |       |                  |       |   |   |
| Total Fees (c)          |       | $                     | 81         |   | $ | 90 |   |

 

----

(a)           Primarily benefit plan auditservices.

 

(b)           Primarily tax advisory andpreparation services.

 

(c)           The Audit Committee has approved allfees.

 

**Auditor Fees Pre-approval Policy**

 

   The Audit Committee mustapprove all services to be provided by Eide Bailly LLP, the Company’s independentauditor, including audit, audit-related, tax and other services.  The Chair of the Committee has the authorityto pre-approve permitted services that require action between regular Committeemeetings, provided a report of these services is given to the full Committee atthe next regular meeting.  The Committeeapproved all services provided by Eide Bailly LLP during fiscal year 2004.

 

61

----

 

**PART IV**

 

**ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES ANDREPORTS ON FORM 8-K**

 

(a)          The following are filedas part of this report:

 
| **1.  Financial Statements** | ** **                                                                                                         |
|------------------------------|--------------------------------------------------------------------------------------------------------------------|
|                         |                                                                                                               |   |
|                         | Report  of Independent Registered Public Accounting Firm                                                           |   |
|                         |                                                                                                               |   |
|                         | Consolidated Balance Sheets  as of July 31, 2004 and 2003                                                          |   |
|                         |                                                                                                               |   |
|                         | Consolidated  Statements of Operations for the years ended July 31, 2004, 2003 and 2002                            |   |
|                         |                                                                                                               |   |
|                         | Consolidated  Statements of Changes in Stockholders’ Equity for the years ended July 31,  2004, 2003 and 2002 |   |
|                         |                                                                                                               |   |
|                         | Consolidated  Statements of Cash Flows for the years ended July 31, 2004, 2003 and 2002                            |   |
|                         |                                                                                                               |   |
|                         | Notes to  Consolidated Financial Statements                                                                        |   |

 

**2.  Financial Statement Schedules**

 

All schedules are omittedas the required information is inapplicable or the information is presented inthe consolidated financial statements or related notes.

 

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

 

OnAugust 6, 2004, the Company filed a Form 8-K announcing the completion of thesale of nine hundred nine thousand ninety one (909,091) shares of its CommonStock, par value $0.01, to MVC Capital, Inc. effective July 30, 2004.

 

**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 PastaRestructuring Cooperative and Dakota Growers Corporation. (Incorporated byreference to Exhibit 2.2 from the Company’s Pre-Effective Amendment No. 2 toForm S-4 Registration 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).

 

62

----

 

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).

 

4.2                                 Waiverand First 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                                 Waiverand Second 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                           IncentiveStock Option Plan. (Incorporated by reference to Exhibit 10.1 from DakotaGrowers Pasta Company’s Quarterly Report on Form 10-Q, File No. 33-99834, forthe quarter ended April 30, 1998).

 

10.2                           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.

 

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

 

10.4                           MasterLease Agreement dated March 6, 2002 and related Schedule A dated March 29, 2002between Dakota Growers Pasta Company and Farm Credit Leasing ServicesCorporation. (Incorporated by reference to Exhibit 10.2 from the Company’sPre-Effective Amendment No. 2 to Form S-4 Registration Statement, File No.333-81946, dated April 19, 2002).

 

63

----

 

10.5                           Amendedand Restated Share Rights Agreement, dated as of April 19, 2002, by and amongthe Company, formerly Dakota Growers Restructuring Company, Inc., and WellsFargo Bank Minnesota, National Association, as Rights Agent. (Incorporated byreference to Exhibit 10.1 from the Company’s Pre-Effective Amendment No. 2 toForm S-4 Registration Statement, File No. 333-81946, dated April 19, 2002).

 

10.6                           ExecutiveEmployment Agreement, dated March 25, 2002, between Dakota Growers PastaCompany and Jack Hasper. (Incorporated by reference to Exhibit 10.3 from theCompany’s Pre-Effective Amendment No. 2 to Form S-4 Registration Statement,File No. 333-81946, dated April 19, 2002).

 

10.7                           MasterLoan Agreement dated February 24, 2004 between the Company and CoBank, ACB.(Incorporated by reference to Exhibit 10.1 from the Company’s Quarterly Reporton Form 10-Q, File No. 000-50111, for the quarter ended April 30, 2004).

 

10.8                           StatusedRevolving Credit Supplement and Term Supplements dated February 24, 2004between the Company and CoBank, ACB. (Incorporated by reference to Exhibit 10.2from the Company’s Quarterly Report on Form 10-Q, File No. 000-50111, for thequarter ended April 30, 2004).

 

10.9                           SecurityAgreement dated February 11, 2003 between the Company and CoBank, ACB.(Incorporated by reference to Exhibit 10.3 from the Company’s Quarterly Reporton Form 10-Q, File No. 000-50111, for the quarter ended January 31, 2003).

 

10.10                     ContinuingGuarantee Agreement dated February 11, 2003 between Primo Piatto, Inc., awholly-owned subsidiary of the Company, and CoBank, ACB. (Incorporated byreference to Exhibit 10.4 from the Company’s Quarterly Report on Form 10-Q,File No. 000-50111, for the quarter ended January 31, 2003).

 

10.11                     Dakota Growers Pasta Company, Inc. 2002 StockOption Plan. (Incorporated by reference to Exhibit 10.16 from theCompany’s Annual Report on Form 10-K, File No. 000-50111, for the year endedJuly 31, 2003).

 

10.12                     Dakota Growers Pasta Company, Inc. Amended and Restated 2003 StockOption Plan. (Incorporated by reference to Exhibit 10.6 from theCompany’s Quarterly Report on Form 10-Q, File No. 000-50111, for the quarterended January 31, 2004).

 

10.13                     Non-RevolvingCredit Supplement dated February 24, 2004 between the Company and CoBank, ACB.(Incorporated by reference to Exhibit 10.3 from the Company’s Quarterly Reporton Form 10-Q, File No. 000-50111, for the quarter ended April 30, 2004).

 

10.14                     DNA Dreamfields Company, LLC Operating Agreement dated October 31, 2003between the Company, B-New, LLC, TechCom Group, LLC, and Buhler, Inc. (Incorporated by reference to Exhibit10.1 from the Company’s Quarterly Report on Form 10-Q, File No. 000-50111, forthe quarter ended January 31, 2004). Confidential treatment has been grantedwith respect to portions of the Exhibit.

 

10.15                     Manufacturing Agreement dated December 26, 2003 between the Company andDNA Dreamfields Company, LLC. (Incorporated by reference to Exhibit 10.2 fromthe Company’s Quarterly Report on Form 10-Q, File No. 000-50111, for the quarter ended January 31, 2004). Confidentialtreatment has been granted with respect to portions of the Exhibit.

 

10.16                     Services Agreement dated December 26, 2003 between the Company and DNADreamfields Company, LLC. (Incorporated by reference to Exhibit 10.3 from theCompany’s Quarterly Report on Form 10-Q, File No. 000-50111, for the quarterended January 31, 2004). Confidential treatment has been granted with respectto portions of the Exhibit.

 

64

----

 

 

10.17                     Trademark License Agreement dated December 26, 2003 between the Companyand DNA Dreamfields Company, LLC. (Incorporated by reference to Exhibit 10.4from the Company’s Quarterly Report on Form 10-Q, File No. 000-50111, for the quarter ended January 31, 2004).

 

10.18                     Technology Sublicense Agreement dated December 26, 2003 between the Company andDNA Dreamfields Company, LLC. (Incorporated by reference to Exhibit 10.5 fromthe Company’s Quarterly Report on Form 10-Q, File No. 000-50111, for thequarter ended January 31, 2004).

 

10.19                     Stock Purchase Agreement dated July 30, 2004between the Company and MVC Capital, Inc. (Incorporated by reference to Exhibit99.2 from the Company’s Report on Form 8-K, File No. 000-50111, filed August 6,2004).

 

10.20                     Registration Rights Agreement dated July 30,2004 between the Company and MVC Capital, Inc. (Incorporated by reference toExhibit 99.3 from the Company’s Report on Form 8-K, File No. 000-50111, filedAugust 6, 2004).

 

10.21                     Consulting Agreement dated July 30, 2004between the Company and MVC Financial Services, Inc. (Incorporated by referenceto Exhibit 99.4 from the Company’s Report on Form 8-K, File No. 000-50111,filed August 6, 2004).

 

10.22                     Amendment No. 1 to DNA Dreamfields Company, LLC Operating Agreementdated February 9, 2004 between the Company, B-New, LLC, TechCom Group, LLC, andBuhler, Inc. Confidential treatment has been requested with respect to portionsof the Exhibit.

 

10.23                     Amendment No. 2 to DNA Dreamfields Company, LLC Operating Agreementdated October 25, 2004 between the Company, B-New, LLC, TechCom Group, LLC, andBuhler, Inc. Confidential treatment has been requested with respect to portionsof the Exhibit.

 

21                                    Subsidiaryof the registrant.

 

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

 

23                                    Consentof Independent Registered Public Accounting Firm; Eide Bailly LLP.

 

31.1                           Certificationof Chief Executive Officer required by Securities and Exchange Commission Rule13a-14(a) or 15d-14(a).

 

31.2                           Certificationof Chief Financial Officer required by Securities and Exchange Commission Rule13a-14(a) or 15d-14(a).

 

32                                    Certification of Chief Executive Officer and ChiefFinancial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18U.S.C. Section 1350.

 

65

----

 

**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 29, 2004                 |

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, this report has been signed below bythe following persons on behalf of the registrant and in the capacities and onthe dates indicated.

 
| **Signature**              | ** ** | **Title**                              |   | **Date**         |
|----------------------------|------------|----------------------------------------|--------|------------------|
|                       |       |                                   |   |             |
| /s/ Timothy J.  Dodd       |       |                                   |   |             |
|                       |       | President and  Chief Executive Officer |   |             |
| Timothy J. Dodd            |       | (Principal  Executive Officer)         |   | October 29, 2004 |
|                       |       |                                   |   |             |
|                       |       |                                   |   |             |
| /s/ Thomas P.  Friezen     |       | Chief Financial  Officer               |   |             |
|                       |       | (Principal  Financial Officer)         |   | October 29, 2004 |
| Thomas P.  Friezen         |       |                                   |   |             |
|                       |       |                                   |   |             |
| /s/ Edward O.  Irion       |       | Vice President -  Finance and          |   |             |
|                       |       | Chief Accounting  Officer              |   |             |
| Edward O. Irion            |       | (Principal  Accounting Officer)        |   | October 29, 2004 |
|                       |       |                                   |   |             |
|                       |       |                                   |   |             |
| /s/ John S.  Dalrymple III |       |                                   |   |             |
|                       |       |                                   |   |             |
| John S.  Dalrymple III     |       | Director                               |   | October 29, 2004 |
|                       |       |                                   |   |             |
| /s/ John D.  Rice, Jr.     |       |                                   |   |             |
|                       |       |                                   |   |             |
| John D. Rice,  Jr.         |       | Director                               |   | October 29, 2004 |

 

66

----

 

 
| **Signature**           | ** ** | **Title** |   | **Date**         |
|-------------------------|------------|-----------|--------|------------------|
|                    |       |      |   |             |
| /s/ Curt R.  Trulson    |       |      |   |             |
|                    |       |      |   |             |
| Curt R. Trulson         |       | Director  |   | October 29, 2004 |
|                    |       |      |   |             |
| /s/ Allyn K.  Hart      |       |      |   |             |
|                    |       |      |   |             |
| Allyn K. Hart           |       | Director  |   | October 29, 2004 |
|                    |       |      |   |             |
| /s/ Roger A.  Kenner    |       |      |   |             |
|                    |       |      |   |             |
| Roger A. Kenner         |       | Director  |   | October 29, 2004 |
|                    |       |      |   |             |
|                    |       |      |   |             |
| /s/ James F.  Link      |       |      |   |             |
|                    |       |      |   |             |
| James F. Link           |       | Director  |   | October 29, 2004 |
|                    |       |      |   |             |
| /s/ Eugene J.  Nicholas |       |      |   |             |
|                    |       |      |   |             |
| Eugene J.  Nicholas     |       | Director  |   | October 29, 2004 |
|                    |       |      |   |             |
| /s/ Michael T.  Tokarz  |       |      |   |             |
|                    |       |      |   |             |
| Michael T.  Tokarz      |       | Director  |   | October 29, 2004 |
|                    |       |      |   |             |
| /s/ Jeffrey O.  Topp    |       |      |   |             |
|                    |       |      |   |             |
| Jeffrey O. Topp         |       | Director  |   | October 29, 2004 |
|                    |       |      |   |             |
|                    |       |      |   |             |
| /s/ Michael E.  Warner  |       |      |   |             |
|                    |       |      |   |             |
| Michael E.  Warner      |       | Director  |   | October 29, 2004 |

 

 

67

----