** **

**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-K**

 

| x      | ** ** | **Annual Report Pursuant to Section  13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended  July 31, 2006** |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                               |
|   |       | **or**                                                                                                                             |
|   |       |                                                                                                                               |
| **o**  | ** ** | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**                                      |

 

**Commission File No. 000-50111**

 

**DAKOTAGROWERS PASTA COMPANY, INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

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

(Address of principal executive officesincluding zip code)

 

**(701) 652-2855**

(Registrant’s telephone number, includingarea code)

 

**Securities Registered Pursuant To Section12(b) Of The Act:**

None

 

**Securities Registered Pursuant To Section12(g) Of The Act:**

Common Stock, $.01 par value per share

Series D Delivery Preferred Stock, $.01 parvalue per share

 

----

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act.

Yeso  No x

 

Indicateby check mark if the Registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act.

Yeso  No x

 

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months, and (2) has been subject to such filing requirements forthe past 90 days.

Yesx No o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer’ in Rule 12b-2 of the Exchange Act. (Checkone):

LargeAccelerated Filer    o               Accelerated Filer   o           Non-AcceleratedFiler    x

 

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

 

Thereis no established public market for the Registrant’s common stock. Althoughthere is a limited, private market for shares of the Registrant’s common stock,the Registrant does not obtain information regarding the transfer price intransactions between its shareholders and therefore is unable to estimate theaggregate market value of the Registrant’s common shares held bynon-affiliates. As of October 30, 2006, the Registrant had 13,169,382 shares ofcommon stock, par value $0.01 per share, outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

None.

 

 

----

 

**PART I.**

 

**Forward-Looking Statements**

 

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

 

**ITEM1.****      BUSINESS**

 

**Introduction**

 

The Company is a North Dakota corporation that was organized on January30, 2002. It is the successor to and its operations are a continuance of DakotaGrowers Pasta Company, a North Dakota cooperative (the “Cooperative”), upon theconversion to a corporation effective July 1, 2002.

 

The Company owns and operates a vertically integrated, state-of-the-artdurum wheat milling and pasta production facility in Carrington, North Dakota.Primo Piatto, Inc. (“Primo Piatto”), a wholly-owned subsidiary of the Companybeing operated as the Minnesota Division of the Company, currently operates apasta production plant in New Hope, Minnesota. The Company currently has annualcapacity to grind in excess of 12 million bushels of grain and to produceapproximately 500 million pounds of pasta.

 

**Pasta Industry and Markets**

 

The Company estimates North American annual dry pasta demand to beroughly 4.0 billion pounds, including pasta used in dinners, side dishes andmeal solutions. Based on the Company’s analysis of the marketplace and tradeand industry information, the Company believes dry pasta consumption has increasedslightly over the last two years after declining in the previous two years. Whilethere seems to be a relatively stable level of consumers continuing to followreduced carbohydrate lifestyles, the negative pasta consumption trendassociated with low carbohydrate dieting appears to have subsided. The Companyis anticipating growth in domestic dry pasta consumption between 1% and 2% inthe upcoming year. In addition to the domestic market for dry pasta, muchsmaller domestic markets exist for refrigerated and frozen pasta.

 

The Pasta industry identifies domestic dry pasta into two basicmarkets: retail and institutional. The Company recognizes the institutionalmarket as being comprised of ingredient and foodservice sales.

 

*Retail Market*

 

The Retail market includes sales of branded and private label pasta togrocery stores, club stores, mass merchants and other consumer retailoperations. A significant portion of the Retail market is represented byestablished national or regional pasta brands. Barilla, New World Pasta Companyand American Italian Pasta Company account for over 70% of the branded retailmarket. The Company focuses almost all of its Retail marketing efforts onprivate label sales. The market leaders in private label sales are AmericanItalian Pasta Company and Dakota Growers, together representing nearly 80% ofprivate label sales. A small portion of the Retail market consists of sales tofederal and state government entities. The Company estimates that the Retail

 

2

----

 

market declined almost 9% from2002 to 2004 before rebounding slightly over 1% in 2005 and 2006, with thetraditional grocery channels declining at a rate slightly higher due to lossesto alternative channels.

 

In 2004, DNA Dreamfields Company, LLC (“DNA Dreamfields”), of which theCompany currently has a 47% economic ownership, launched a low digestiblecarbohydrate pasta under the DreamfieldsTM brandname. Effectively launched in the spring of 2004, DreamfieldsTM pastahas maintained a 1.1% dollar share of the traditional grocery channel pastamarket during the last two years based on data from A.C. Nielsen, making it theleading pasta in the low carbohydrate pasta category. DreamfieldsTM pastaalso has a 65% lower glycemic index than regular pasta. The Company increasedits economic ownership in DNA Dreamfields from 24% to 47% in fiscal year 2005.

 

In 2005, a new trend toward high fiber products developed, displacingsome of the low carbohydrate consumption. While still small relative to thetotal pasta category, the consumption of these whole wheat/whole grain productscontinues to grow. DreamfieldsTM pasta offers fiber benefits similar to thelevels of other whole wheat/whole grain pastas while maintaining the integrityof the taste and low carbohydrate traits. Dakota Growers also manufactures andsells traditional whole wheat/whole grain pastas.

 

*Institutional Market*

 

Ingredient sales consist of pasta used by food processors as aningredient or component in a further-processed or combination food product.Such food products include dry pasta dinners, including macaroni and cheese,frozen entrees, refrigerated salads, canned entrees, baby food, and canned anddry soups. The size of the Ingredient market is influenced by the number offood processors that choose to produce pasta internally rather than outsource. TheCompany estimates that the Ingredient market had experienced consumption lossessimilar to the Retail market over the last several years, and experiencedsimilar growth in 2005 and 2006.

 

Foodservice sales are to commercial and non-commercial eatingestablishments such as restaurants, business and industry cafeterias, managedservices, hotels and motels, retail vending, recreation, mobile and otheraway-from-home eating outlets. Marketing dry pasta to this market generallyconsists of selling to a network of competitive distribution organizations andbuying groups, and selling dry pasta to individual restaurant chains and otheroperator organizations. A small portion of the Foodservice market consists ofsales to federal and state government entities. The trend toward a reducedcarbohydrate lifestyle did not have a significant impact on the Foodservicemarket, which the Company believes is stable or experiencing slight growth.

 

**Co-Pack Arrangements**

 

A portion of each end-user market is supplied under “co-pack”arrangements between pasta manufacturers. These agreements involve the sale ofdry pasta products between pasta manufacturers in order to supply short-termvolume deficiencies such manufacturers suffer from time to time in meetingcustomer requirements, and to allow a manufacturer to draw upon particularareas of expertise of other manufacturers, which may be more cost beneficialthan self-manufacturing. Co-pack sales comprised approximately 3%, 1% and 3% ofthe Company’s net revenues for the years ended July 31, 2006, 2005 and 2004,respectively.

 

**Production and Products**

 

The Company purchases durum wheat which is processed through itsmilling facility into semolina and durum wheat flours that are then used by theCompany to produce dry pasta products.

 

Pasta production is basically a mixing, extrusion and drying process.The primary ingredients are semolina and water, although egg, tomato, spinachor other ingredients may be added to produce certain products. The finished drypasta is packed to meet different markets and customer requirements.

 

The pasta products manufactured by the Company consist of over 80different shapes and are sold to customers in all markets. In addition to thedry pasta produced by the Company, it purchases additional dry pasta shapesfrom other manufacturers and resells them. This practice is widely followed bymany pasta manufacturers

 

3

----

 

for efficiency and productioncapacity reasons, and allows distribution of wider product lines to the Company’scustomers. Outside purchases of pasta, excluding imports, comprisedapproximately 2%, 2% and 1% of net sales for the years ended July 31, 2006,2005 and 2004, respectively.

 

The Company has an agreement with Gruppo Euricom, an Italian pastamanufacturer, to be the exclusive distributor of Gruppo Euricom’s Italian pastaand rice products in the United States and Canada. These products are primarilyprivate label retail and foodservice products. Sales of imported productscomprised approximately 1% to 2% of the Company’s net revenues in each of thelast three fiscal years.

 

The Company’s identity preservation program provides our customers withfood safety, traceability and quality from the field to the plate. The Company’sproximity to the durum growing regions, its milling and production facilities,and its information technology systems allow the Company to produce productsunder an identity preservation program.

 

The Company’s Carrington, North Dakota facilities are certified by theOrganic Crop Improvement Association, which allows the Company to offer 100%organic pasta and semolina. The Company’s facilities allow for the isolation ofthe durum, semolina and pasta to enable this certification.

 

The Company’s products are manufactured using a comprehensive HazardAnalysis Critical Control Point (HACCP) program, which requires strictmonitoring in all aspects of the manufacturing process, to ensure food qualityand safety. We believe that meeting HACCP standards strengthens customerconfidence in the quality of our products. The Company undergoes food safetyand product quality audits at various times throughout the year and has consistentlyreceived high scores.

 

In addition to its pasta products, the Company markets semolina, durumwheat flour and other flour blends to other food product manufacturers asmarket conditions allow. Lower grade second clear flours and millfeedby-products of the durum milling process are sold primarily for animal feed. Non-pastasales represented approximately 7%, 7% and 10% of the Company’s net revenuesfor the years ended July 31, 2006, 2005 and 2004, respectively.

 

**Sales, Marketing and Customers**

 

The Company markets its products through direct sales, supplemented bythe efforts of third party brokers retained by the Company. These brokersreceive commissions based upon sales of the Company’s products. The Company’spasta products are distributed on a broad basis throughout the United States.The Company does not export significant quantities of its pasta products. Onecustomer, U.S. Foodservice, accounted for approximately 12%, 13% and 15% of netrevenues for the years ended July 31, 2006, 2005 and 2004, respectively. TheCompany’s top 10 customers accounted for 50% of revenues in fiscal year 2006,52% of revenues in fiscal year 2005 and 51% of revenues in fiscal year 2004. Pastarevenues consisted of 51% Retail and 49% Institutional for fiscal year 2006,53% Retail and 47% Institutional for fiscal year 2005, and 59% Retail and 41%Institutional for fiscal year 2004.

 

The Company sells most of its pasta under “purchase orders”, wherebythe customer and the Company are not obligated for any pre-determined length oftime, or under pricing commitments agreed to with terms of one year or less. Pastaproducts imported from Italy under the Company’s agreement with Gruppo Euricomare primarily sold in the private label retail and foodservice markets.

 

4

----

 

**Series D Delivery Preferred Stock DeliveryRights**

 

Each share of Series D Delivery Preferred Stock of the Company givesits holder the privilege, but not the obligation, to deliver one bushel ofdurum wheat to the Company each fiscal year 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 fiscalyear of the Company, the first-come, first-served privilege to deliver durumwheat shall be exercisable to deliver one bushel of durum wheat****only once with respect to each share ofSeries D Delivery Preferred Stock. During the 24-hour period following theposting of any market notice, the Company will not purchase durum wheat fromnon-holders of Series D Delivery Preferred Stock to fulfill the Company’s durumwheat requirements as set forth in the market notice. If, after the lapse of acertain amount of time (not less than one day), holders of Series D DeliveryPreferred Stock have not sold to the Company all of the durum wheat requestedin the notice, the Company will fulfill its remaining requirements outside ofthe Series D Delivery Preferred Stock delivery privilege.

 

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

 

The Company purchases durum wheat primarily on the open market. Durumwheat purchases from holders of the Company’s Series D Delivery Preferred Stockhave been negligible.

 

**Competition**

 

*Overview*

 

The markets for pasta and semolina/durum wheat flour are highlycompetitive 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) comparative productdistribution costs, (3) ability to render distinctive service to customers, (4)the price of raw materials, primarily durum wheat, and (5) a distinguishing orunique ability to provide consistent product quality in line with customerspecifications. The Company believes that, in a broad sense, the mostinfluential factor on the intensity of competitive conditions is industrycapacity utilization. It should be noted that detailed information regardingpasta production is somewhat difficult to obtain, as many pasta producers areclosely-held enterprises.

 

*Competition in the Pasta Market*

 

The pasta market is highly competitive and includes severalwell-established enterprises. Those competitors are primarily independentcompanies and, to a lesser extent, divisions or subsidiaries of other, larger,food products companies. In addition, the Company competes against foreignsuppliers, including Italian and Turkish enterprises, that sell pasta in theUnited States.

 

The Company markets its products 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. DreamfieldsTM pasta has maintained a 1.1% dollar share ofthe traditional grocery channel pasta market during the last year based on datafrom A.C. Nielsen, making it the leading pasta in the low carbohydrate pastacategory.

 

5

----

 

The Company’s competition in the private label retail market isprimarily American Italian Pasta Company and, to a lesser extent, New WorldPasta Company. These private label retail sales compete with retail brandedproducts distributed primarily by Barilla, New World Pasta Company (*Ronzoni, San Giorgio, Skinner, American Beauty, Creamette, Prince*brands et al), American Italian Pasta Company (*Muellers,R&F, Anthony’s, Golden Grain/Mission* brands et al) and a varietyof smaller domestic and imported brands.

 

In the Foodservice market, the Company also markets its pasta primarilyas a private label supplier, including sales to three of the largestfoodservice distributors in the country under their labels. The Company’s maincompetitors in the Foodservice market are American Italian Pasta Company, A.Zerega’s Sons, Inc., and Barilla, as well as foreign competitors that sellproduct in the United States. The Company’s Dakota Growers Pasta Co.®, PastaSanita® and Pasta Growers® foodservice brands are sold throughout the UnitedStates to independent distributors and national chain accounts. In September2004, the Company signed an exclusive distribution agreement with New WorldPasta under which the Company is licensed to use the *Ronzoni,**Prince,**San Giorgio*and *Mrs. Weiss* brands in the Foodservicemarket, effectively taking over all of New World Pasta’s foodserviceoperations.

 

The Company’s ingredient sales have significantly increased as ingredientpurchasers of dry pasta have sought out more reliable low cost suppliers. TheCompany’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 industry depends largely onaggregate industry capacity relative to aggregate demand for pasta products.The pasta manufacturing industry experienced restructuring over the past fewyears which reduced the excess pasta production capacity to what the Companybelieves is roughly 15% - 20%. Barilla has announced construction of a plant inAvon, NY that is expected to be operational in mid-2007.

 

*Competition in the Semolina and Durum WheatFlour Market*

 

Given the commodity nature of the market for semolina and durum flour,sales volume is largely dependent on delivered price when adequate supplyconditions exist. Italgrani USA, Inc., Horizon Milling, LLC and Miller Millingcollectively are believed to represent approximately 40% of total domestic durummilling capacity, while the Company’s current milling operation representsabout 15%. Most of the durum milling capacity in the United States is eitherpart of an integrated pasta production facility or in an alliance with pastamanufacturers. The Company believes that the integration of its milling andpasta production facilities enables it to compete more effectively with thosecompetitors who also have integrated facilities.

 

**Government Regulation**

 

*Trade Policies*

 

Governmental policies and regulations, including those impacting theamount of durum wheat imported from Canada, may affect the operations of theCompany and the volume of pasta imports. United States government farm policiesalso affect durum plantings and thus can have a significant impact on themarket price of durum.

 

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. U.S. Customs and Border Protection (Customs)distributes antidumping and countervailing duties assessed on certain pastaimported from Italy and Turkey to affected domestic producers pursuant to theContinued Dumping and Subsidy Offset Act of 2000 (the “ Offset Act”). TheCompany received net payments of $1.1 million, $0.4 million and $0.6 million infiscal years 2006, 2005 and 2004, respectively, under the Offset Act. Althoughthese duties may enable the Company to compete more favorably against Italianand Turkish producers in the U.S. pasta market, there is no assurance as to

 

6

----

 

the length of time these dutieswill be maintained, or that foreign producers will not sell competing productsin the United States at prices lower than those of the Company.

 

*Food and Drug Administration Regulation*

 

As a producer of products intended for human consumption, the Company’soperations are subject to certain federal and state regulations, includingregulations promulgated by the United States Food and Drug Administration. TheCompany believes that it is in material compliance with the applicableregulatory requirements.

 

*Environmental Regulation*

 

Dakota Growers is subject to extensive federal and state environmentallaws and regulations with respect to water and air quality, solid wastedisposal and odor and noise control. The Company conducts an on-going controlprogram designed to meet these environmental laws and regulations. There are nopending regulatory enforcement actions and the Company believes that it is insubstantial compliance with applicable environmental laws and regulations.

 

The Company cannot predict whether future changes in environmental lawsor regulations might increase the cost of operating its facilities andconducting its business. Any such changes could have adverse financialconsequences for the Company.

 

**Intellectual Property Rights**

 

The Company relies on a combination of trade secret, trademark law,nondisclosure agreements and technical measures to establish and protect itsproprietary rights to its products and processes. The Company owns thefollowing trademarks that have been registered with the United States Patentand Trademark Office for the sale of dry pasta: Pasta Growers®, Pasta Sanita®,Zia Briosa®, Primo Piatto® and Dakota Growers Pasta Co.®.

 

**Research and Development**

 

The Company supports research and development programs in North Dakotathat focus on improved varieties of durum wheat. Dakota Growers has an on-staffagronomist and is in the midst of a long-term project of small plot, replicatedvariety trial research, as well as field-scale fungicide research. Inconnection with plant breeders and researchers, the Company is working todevelop scab-resistant, high-gluten durum varieties.

 

As a result of the creation of DNA Dreamfields Company, LLC and theintroduction of the DreamfieldsTM pastaproducts, the Company is investing and participating in product andmanufacturing technique research beyond the scope of traditional dry pasta.

 

The Company, as part of its operations, maintains a modern,well-equipped laboratory facility designed primarily to evaluate and maintainhigh quality standards for incoming raw materials, ongoing productmanufacturing, and development of new pasta shapes.

 

**Employees**

 

As of October 5, 2006, the Company had 416 employees, 132 of which arecovered by collective bargaining agreements at its Primo Piatto, Inc.subsidiary. These collective bargaining agreements expire on December 1, 2007and September 30, 2008. The Company considers its employee relations to be verygood.

 

7

----

 

**Available Information**

 

*SEC Filings*

 

The Company’s Internet website address is *www.dakotagrowers.com*. We make available, free of chargethrough the “Investors” portion of our website, the Company’s annual reports onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, andamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934 (the “1934 Act”) as soon asreasonably practicable after we electronically file such materials with, orfurnish such materials to, the Securities and Exchange Commission. Reports ofbeneficial ownership filed pursuant to Section 16(a) of the 1934 Act are alsoavailable through our website.

 

The Securities and Exchange Commission maintains an Internet site thatcontains reports, proxy, and information statements and other informationregarding issuers that file electronically with the Securities and ExchangeCommission. The address of that site is *www.sec.gov*.

 

*Corporate Governance*

 

The Company’s Code of Conduct, which is applicable to all of ouremployees, and the Charters of the Committees of our Board of Directors areavailable under the “Investors” portion of the Company’s website at *www.dakotagrowers.com*. Any of these items or any of theCompany’s filings with the Securities and Exchange Commission will be provided,without charge, upon written request to:

 

InvestorRelations

Dakota GrowersPasta Company, Inc.

One PastaAvenue

Carrington, ND58421

 

**ITEM1A.****   RISKFACTORS**

 

The following are important factors that could cause actual results todiffer materially from those expressed in any forward-looking statements madeby or on behalf 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 dry pasta industry, changesin consumer trends that result in lowered demand for dry pasta may have amaterial adverse effect on the Company’s financial condition and results ofoperations.

 

***CompetitiveEnvironment***

 

Both the U.S. pasta industry and global pasta industry are extremelycompetitive. The Company competes in all dry pasta markets – retail storebrand, foodservice and ingredient, with larger, national and international foodcompanies. Competition within the pasta industry is largely dependent upon therelationship of overall industry production capacity to overall market demandfor pasta. Developments over the last few years have reduced the level ofexcess capacity in the domestic pasta industry, although future fluctuations incapacity availability are sure to occur. Some competitors may have long-term,high volume contracts, which guarantee a specified amount of volume over theterm of the contract. Other competitors have retail brand equity and largeramounts of marketing dollars to compete against imported and store brandproducts. The competitive environment, especially in the retail private labeland ingredient markets, has in the past, and may in the future, put pressure onthe Company’s profitability and its ability to maintain market share. While theCompany has and will continue to apply, where possible, cost saving measures inan effort to remain competitive, there is no guarantee that the Company canoperate profitably in the future.

 

***No Public Market forShares of the Company’s Common Stock and Preferred Stock***

 

There is currently no established public trading market for the sharesof Common Stock and Preferred Stock of the Company, and an active tradingmarket may never develop. The Company maintains no obligation to seek or toobtain a listing on a national market. As a result, you may not be able toreadily resell your shares in the Company.

 

8

----

 

***Technology***

 

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

 

***Pasta, Semolina,Mill By-Product Prices; Durum Wheat and Other Input Costs***

 

The Company’s profitability is directly related to the market price ofdry pasta, semolina, durum wheat and mill feed by-products. The supply andprice of durum wheat are subject to market conditions and are influenced bymany factors beyond the Company’s control including weather patterns affectingdurum wheat production, governmental programs and regulations, insects, andplant diseases. Such volatility with respect to the price of the basic rawmaterial for the Company’s products leaves the Company subject to widevariation in its costs from year to year. Future increases in durum costs couldhave a material adverse effect on operating profits unless we are able to passcost increases on to our customers. By-products of the milling process competewith other feed products, and fluctuate significantly in price with theavailability of these competing feed products.

 

Increases in other input costs, such as packaging materials, ingredientsand fuel costs, could adversely affect us. The costs of packaging materials,ingredients and fuel have varied widely in recent years, and future changes insuch costs may cause our results of operations and our operating margins tofluctuate significantly. Fuel costs, which represent the most significantfactor affecting our transportation costs, were at very high levels duringfiscal year 2006.

 

Changes in sales prices of our products often lag behind changes ininput costs. Competitive pressures may also limit our ability to quickly increaseprices in response to higher input costs. If the Company is unable to increasesales prices to offset increases in raw materials, packaging and fuel costs,operating margins and profits could be materially adversely affected.

 

***ProductConcentration***

 

The Company competes almost exclusively in the dry pasta industry andrelated flours and by-product markets. Any decline in pricing or demand for drypasta could have a material adverse effect on the Company’s financial conditionand results of operations.

 

***Product Liability***

 

The sale of food products for human consumption involves the risk ofinjury to consumers. These injuries may result from tampering by unauthorizedthird parties, product contamination or spoilage, including the presence offoreign objects, 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.

 

***GovernmentRegulation and Trade Policies***

 

Dakota Growers is subject to extensive federal and state environmentallaws and regulations with respect to water and air quality, solid-wastedisposal and odor and noise control. The Company conducts an on-going programdesigned to comply with these laws and regulations. There are no pendingregulatory enforcement actions against the Company, and the Company believesthat it currently is and will continue to be in substantial compliance with allapplicable environmental laws and regulations.

 

9

----

 

As a producer of products intended for human consumption, the Company’soperations are subject to certain federal and state regulations, includingregulations promulgated by the U.S. Food and Drug Administration. The Companybelieves that it is in material compliance with all applicable regulatory requirementsrelating to food quality and safety.

 

The operations of the Company may be affected by governmental tradepolicies and regulations, including those impacting the amount of durum wheatimported from Canada. Domestic pasta prices are also influenced by competitionfrom foreign pasta producers, and as such, by the trade policies of both theU.S. government and foreign governments.

 

***Restrictive LoanCovenants***

 

The Company’s loan agreements with CoBank and institutional investorsobligate the Company to maintain or achieve certain amounts of equity andworking capital and achieve certain financial ratios. The failure to complywith the various loan covenants may result in interest rate penalties, restrictthe Company’s corporate activities or result in a default by the Company whichmay have a material adverse effect on the Company’s liquidity.

 

***Board of DirectorsDiscretion Regarding Dividends***

 

The Board of Directors of the Company has absolute discretion todetermine the manner and amount of payment of dividends on shares of CommonStock and, subject to certain exceptions, Preferred Stock.

 

**ITEM2.****      PROPERTIESAND PROCESSING FACILITIES**

 

Dakota Growers owns and operates a milling facility in North Dakota,and pasta plants in North Dakota and Minnesota. The Company owns the warehousefacilities at the pasta plants. These facilities are supplemented by publicwarehouses in California, Kansas, Minnesota, New York, North Carolina, NorthDakota, Oregon, Ohio and Washington where inventory is maintained and redistributedfor the needs of specific customers.

 

Dakota Growerscontinues to invest in technologies to improve operational efficiencies, andinformation technology to provide enterprise visibility to all facilities andactivities within the supply chain. These information systems encompasscommunications, data collection, data storage, process management and recordmanagement to ensure the Company is providing a superior level of service toour customers while reducing operating and administrative expenses.

 

**ITEM3.****      LEGALPROCEEDINGS**

 

From time to time and in the ordinary course of its business, theCompany is named as a defendant in legal proceedings related to various issues,including worker’s compensation claims, tort claims and contractual disputes. Otherthan such routine litigation, the Company is not currently involved in anymaterial legal proceedings. In addition, the Company is not aware of otherpotential claims that could result in the commencement of legal proceedings.The Company carries insurance that provides protection against certain types ofclaims, up to the policy limits of the Company’s insurance.

 

**ITEM4.****      SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matterswere submitted to a vote of our security holders during the fourth quarter offiscal year 2006.

 

10

----

 

**PART II.**

 

**ITEM5.****      MARKETFOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS**

 

There is no established public trading market for the Company’s CommonStock or Preferred Stock. As of October 16, 2006 there were 1,312 holders ofthe Company’s Common Stock.

 

Ownership of shares of Common Stock may be transferred subject only tothe requirements of the applicable securities laws. Holders of Series DDelivery Preferred Stock have a delivery right, but not a delivery obligation,to sell durum to the Company. The Company must approve all transfers of sharesof Series D Delivery Preferred Stock.

 

Two unrelated companies, Variable Investment Advisers, Inc. (VIA) andAlerus Securities have established Alternative Trading Systems (ATS) tofacilitate trading of the Company’s Common Stock. We do not implicitly orexplicitly endorse VIA, Alerus Securities or their respective web sites, and weare not responsible for products and services that VIA or Alerus Securitiesprovide. We do not stand behind VIA or Alerus Securities or receive any feesfrom either of them in connection with the services offered on their respectiveweb sites. Links to the respective web sites of VIA and Alerus Securities areavailable through the “Investors” portion of the Company’s website at *www.dakotagrowers.com*.

 

Trading volumes of the Company’s Common Stock have been minimal todate.

 

On December 15, 2005, the Company’s Board of Directors authorized the paymentof $0.04 per share dividend on its Series D Delivery Preferred Stock and anon-periodic dividend payment of $0.04 per share on its common stock, payableon January 10, 2006 to shareholders of record as of December 19, 2005. TheCompany did not declare or pay any dividends in fiscal year 2005.

 

11

----

 

**ITEM6.****      SELECTEDFINANCIAL DATA**

 

The selected financial data presented below for the fiscal years endedJuly 31, 2002 through 2006 has been derived from the audited consolidatedfinancial statements of the Company (and the Cooperative for the periodpresented prior to the Cooperative's conversion to a corporation). Theconversion of Dakota Growers Pasta Company from a cooperative to a corporation,completed effective July 1, 2002, was accounted for as an exchange betweenrelated parties; therefore, no gain or loss was recognized at the time ofconversion and the book value of the assets and liabilities of the Cooperativecarried over to the Company. The comparability of results after the conversionversus those in prior periods is affected by the income tax status changeassociated with the conversion.

 

Effective May 1, 2005, the Company began to include DNADreamfields Company, LLC in its consolidated financial statements.  Thefinancial statements for prior fiscal years have not been restated andtherefore do not include consolidated data pertaining to DNA Dreamfields. TheCompany has included consolidated amounts for DNA Dreamfields in the incomestatement for the years ending July 31, 2005 and 2006. See Note 2 of theconsolidated financial statements for additional information.

 

The selected financial data set forth in this section should be read inconjunction with the Company’s consolidated financial statements and relatednotes and “Management’s Discussion and Analysis of Financial Condition andResults of Operations” included elsewhere in this report.

 

**SELECTEDFINANCIAL DATA**

**(Inthousands, except per share data and ratios)**

 
| ** **                                                                               | ** ** | **Fiscal year ended July 31** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **INCOME STATEMENT DATA**                                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Net revenues                                                                             |       | $                                                 | 171,509    |   | $ | 155,619 |   | $ | 144,679 |   | $ | 136,806 |   | $ | 152,465 |   |
| Cost of goods sold                                                                       |       | 148,904                                           |       | 136,179 |   | 132,245 |   | 125,160 |   | 130,502 |   |
| Gross profit                                                                             |       | 22,605                                            |       | 19,440 |   | 12,434 |   | 11,646 |   | 21,963 |   |
| Marketing, general and administrative  expenses                                          |       | 14,190                                            |       | 16,507 |   | 8,345 |   | 9,816 |   | 9,382 |   |
| Loss on asset impairment                                                                 |       | —                                            |       | — |   | 704 |   | — |   | — |   |
| Operating income                                                                         |       | 8,415                                             |       | 2,933 |   | 3,385 |   | 1,830 |   | 12,581 |   |
| Other expense - net                                                                      |       | (2,143                                            | )          | (1,817 | ) | (2,835 | ) | (2,364 | ) | (3,365 | ) |
| Noncontrolling interests                                                                 |       | 894                                               |       | 3,003 |   | — |   | — |   | — |   |
| Income (loss) before income taxes                                                        |       | 7,166                                             |       | 4,119 |   | 550 |   | (534 | ) | 9,216 |   |
| Charge to record deferred taxes upon  conversion from a cooperative to a corporation (1) |       | —                                            |       | — |   | — |   | — |   | 6,105 |   |
| Income tax expense (benefit)                                                             |       | 2,793                                             |       | 1,606 |   | 214 |   | (105 | ) | 1,277 |   |
| Net income (loss)                                                                        |       | 4,373                                             |       | 2,513 |   | 336 |   | (429 | ) | 1,834 |   |
| Dividends on preferred stock                                                             |       | 451                                               |       | — |   | — |   | 3 |   | 10 |   |
|                                                                                     |       |                                              |       |   |   |   |   |   |   |   |   |
| Net earnings (loss) on common stock                                                      |       | $                                                 | 3,922      |   | $ | 2,513 |   | $ | 336 |   | $ | (432 | ) | $ | 1,824 |   |
|                                                                                     |       |                                              |       |   |   |   |   |   |   |   |   |
| Net earnings (loss) per common share -  Basic                                            |       | $                                                 | 0.30       |   | $ | 0.19 |   | $ | 0.03 |   | $ | (0.03 | ) | $ | 0.16 |   |
|                                                                                     |       |                                              |       |   |   |   |   |   |   |   |   |
| Weighted average common shares outstanding  - Basic                                      |       | 13,169                                            |       | 13,169 |   | 12,265 |   | 12,355 |   | 11,382 |   |
|                                                                                     |       |                                              |       |   |   |   |   |   |   |   |   |
| Cash dividends declared per common share                                                 |       | $                                                 | 0.04       |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |

 

12

----

 
| ** **                                            | ** ** | **As of July 31** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **2006**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **BALANCE SHEET DATA**                                |       |                             |       |   |   |   |   |   |   |   |   |
| Cash                                                  |       | $                                | 343        |   | $ | 229 |   | $ | 589 |   | $ | 5 |   | $ | 2,866 |   |
| Working capital                                       |       | 23,273                           |       | 20,156 |   | 16,586 |   | 13,429 |   | 23,013 |   |
| Total assets                                          |       | 134,249                          |       | 135,130 |   | 119,415 |   | 122,390 |   | 125,541 |   |
| Long-term debt (excluding current  maturities)        |       | 28,545                           |       | 25,385 |   | 21,087 |   | 28,263 |   | 38,274 |   |
| Redeemable preferred stock                            |       | —                           |       | 7 |   | 20 |   | 33 |   | 54 |   |
| Stockholders’ equity                             |       | 64,592                           |       | 61,132 |   | 58,619 |   | 53,818 |   | 56,090 |   |
|                                                  |       |                             |       |   |   |   |   |   |   |   |   |
| **OPERATING DATA**                                    |       |                             |       |   |   |   |   |   |   |   |   |
| Ratio of long-term debt to stockholders’  equity |       | .44                              | x          | .42 | x | .36 | x | .53 | x | .68 | x |
|                                                       |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)       Prior to conversion, the Cooperative had notrecorded deferred taxes for temporary differences that were likely to beeliminated through patronage allocations. Upon conversion to a corporationeffective July 1, 2002, the Company recorded deferred tax assets andliabilities for the tax effects of any temporary differences existing betweenincome tax and financial reporting on the date of the change. 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.

 

13

----

 

**ITEM7.****                   MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Forward-Looking Statements**

 

The following discussion contains forward-looking statements. Suchstatements are based on assumptions by the Company’s management, as of the dateof this report, and are subject to risks and uncertainties, including thosediscussed under “Risk Factors” in this report, that could cause actual resultsto differ materially from those anticipated. The Company cautions readers notto place undue reliance on such forward-looking statements.

 

**Summary**

 

Dakota Growers is the third largest pasta manufacturer in NorthAmerica. The Company has two production plants, located in Carrington, NorthDakota and New Hope, Minnesota and generates a majority of its revenues frommanufacturing pasta for the retail store brand and institutional markets,although we serve and continually look for opportunities in the entire drypasta industry. Our identity preservation program provides our customers foodsafety, traceability and quality from the field to the plate. The Company alsohas a certified organic program and markets organic pasta through its DakotaGrowers Pasta Co.® retail label, as well as into the privatelabel retail, foodservice, and ingredient markets. The Company competes throughlow cost production, high product quality, flexibility and customer service.

 

Net income for the year ended July 31, 2006 totaled $4.4 millioncompared to net income of $2.5 million for the year ended July 31, 2005. Netearnings per basic common share, after the effect of dividends paid on theCompany’s Series D Delivery Preferred Stock, were $0.30 per share for the yearended July 31, 2006 compared to $0.19 for the year ended July 31, 2005. Thecompany paid dividends of $451,000 ($0.04 per share) on its Series D DeliveryPreferred Stock and $527,000 ($0.04 per share) on its common stock during thesecond quarter of fiscal year 2006.

 

The Company’s net revenues increased 10.2% for the year ended July 31,2006 when compared to the year ended July 31, 2005. The revenue increase wasprimarily due to higher pasta sales volumes. Benefits derived from increased salesand lower durum costs were partially offset by continued high transportationcosts. Freight cost increases during fiscal year 2006 were driven by acombination of higher diesel fuel prices and reduced rail and truckavailability. However, diesel fuel prices have declined in the first quarter offiscal year 2007 when compared to the fiscal year 2006 levels. Theeffectiveness of the Company’s rail programs was diminished in fiscal year 2006as lower finished goods inventory levels limited the Company’s ability toutilize rail programs to forward warehouses.

 

During fiscal year 2006, the Company undertook a $15 million capitalproject at its New Hope, Minnesota facility to better balance its pastaproduction capabilities and improve operating costs. A main component of thisproject was the installation of a new, state-of-the-art short goods productionline. The new short goods line, which became operational during the Company’ssecond quarter of fiscal 2006, increased the New Hope plant’s capacity by 35%to approximately 230 million pounds annually. However, higher conversion costsper unit at the New Hope facility during the installation and start-up of thenew production line negatively impacted the Company’s results for fiscal year2006. The Company also recorded a $598,000 loss on disposal during the yearended July 31, 2006 related to the retirement of certain equipment inconjunction with the capital project at the New Hope facility.

 

The Company increased its economic ownership in DNA Dreamfields to 47%effective May 2005. DNA Dreamfields was formed by the Company and other foodtechnology, manufacturing and consumer products marketing enterprises todevelop, manufacture and sell low digestible carbohydrate pasta, rice andpotatoes under the DreamfieldsTM brandname. In conjunction with the Company’s increase in ownership in DNADreamfields, the DNA Dreamfields operating agreement was amended whereby DakotaGrowers was named the managing member of DNA Dreamfields. The Company is theexclusive manufacturer of DreamfieldsTM 

 

14

----

 

pasta, and providesadministrative, accounting, information technology, sales, customer service anddistribution services to DNA Dreamfields.

 

The Company believes that the DreamfieldsTM line of products is well suited for consumersseeking healthy eating alternatives. DreamfieldsTM pasta has a 65% lower glycemic index thanregular pasta as well as 5 grams of digestible carbs and 5 grams of fiber perserving. The DreamfieldsTM pasta products carry a higher selling priceand higher profit margins than traditional pasta. Initial shipments ofDreamfieldsTM pasta to customer distribution centers beganin February 2004.

 

In 2005, a new trend toward high fiber products developed, displacing someof the low carbohydrate consumption. While still small relative to the totalpasta category, the consumption of these whole wheat/whole grain productscontinues to grow. DreamfieldsTM pasta offers fiber benefits similar to thelevels of other whole wheat/whole grain pastas while maintaining the integrityof the taste and low carbohydrate traits. Dakota Growers also manufactures andsells traditional whole wheat/whole grain pastas.

 

The cost of production of dry pasta is significantly impacted bychanges in durum wheat prices, which have varied widely in recent years. TheCompany attempts to manage the risk associated with durum wheat costfluctuations through cost pass-through mechanisms with our customers andforward purchase contracts for durum wheat. Volatility with respect to theprice of the basic raw material for the Company’s products leaves it subject towide variation in its costs from year to year. As a result, factors whichimpact the size and quality of the durum wheat crop and the availability ofsuch wheat in the United States and Canada can have a material adverse impacton the Company. Those factors include such variables as producer strategies,the weather in durum wheat production areas in the United States, Canada andother parts of the world, and import and export policies and regulations. Durumprices have significantly escalated in the first quarter of fiscal year 2007compared to fiscal year 2006. The Company has generally been successful in obtainingprice increases to offset the higher cost of durum. However, the effectivedates of the price increases generally lag the increase in durum costs whichmay have a negative impact on the Company’s first and second quarters of fiscalyear 2007.

 

Freight costs represent approximately 15% of cost of goods sold. Beginningin calendar year 2004, new regulations in the trucking industry and significantincreases in fuel costs, which accelerated in 2005 and 2006, have dramaticallyimpacted the Company’s costs. Additionally, packaging material costs, whichtraditionally represent 15% of cost of goods sold, continue to increase.

 

**Critical Accounting Policies**

 

The accompanying discussion and analysis of the Company’s results ofoperations and financial condition are based upon its consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires management to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities. These estimates form the basisfor making judgments about the carrying values of assets and liabilities thatare not readily apparent from other sources. We base our estimates andjudgments on historical experience and on various other assumptions that webelieve are reasonable under the circumstances. However, future events aresubject to change and the best estimates and

 

15

----

 

judgments may requireadjustment. For a complete description of the Company’s significant accountingpolicies, please see Note 1 to the consolidated financial statements. Ourcritical accounting policies are those that have meaningful impact on thereporting of our financial condition and results, and that require significantmanagement judgment and estimates. These policies include our accounting for(a) allowance for doubtful accounts, (b) inventory valuation, (c) assetimpairment, and (d) income taxes.

 

*Allowance for Doubtful Accounts*

 

We evaluate the collectibility of our accounts receivable based on acombination of factors. In cases where we are aware of circumstances that mayimpair a specific customer’s ability to meet its financial obligations to us,we record a specific allowance against amounts due to us, and thereby reducethe net recognized receivable to the amount we reasonably believe will becollected. For all other customers, we recognize allowances for doubtful accountsbased on the length of time the receivables are past due and our historicalexperience. If the financial condition of our customers would deteriorate,additional allowances may be required in the future which could have an adverseimpact on our future operating results.

 

*Inventory Valuation*

 

Inventories are stated at the lower of cost or market, determined on afirst-in, first-out (FIFO) basis, using product specific standard costs. TheCompany analyzes variances between actual manufacturing costs incurred andamounts absorbed at inventory standard costs. Inventory valuations are adjustedfor these variances as applicable. The Company regularly evaluates itsinventories and recognizes inventory allowances for discontinued andslow-moving inventories based upon these evaluations.

 

*Asset Impairment*

 

We are required to evaluate our long-lived assets, including goodwill,for impairment and write down the value of any assets if they are determined tobe impaired. Evaluating the impairment of long-lived assets involves managementjudgment in estimating the fair values and future cash flows related to theseassets. The Company recognized a loss on asset impairment related to certainpasta production equipment totaling $704,000 during the year ended July 31,2004. Future events could cause management to conclude that impairmentindicators exist and that the value of certain long-lived assets is impaired.

 

*Income Taxes*

 

In determining income (loss) for financial statement purposes,management must make certain estimates and judgments in calculating taxliabilities and in determining the recoverability of certain deferred taxassets. Deferred tax assets must be reduced by a valuation allowance, if basedon the weight of available evidence, it is more likely than not that someportion or all of the recorded deferred tax assets will not be realized infuture periods. Management believes it is likely that the deferred tax assetsas of July 31, 2006 will be realized through the generation of future taxableincome and tax planning strategies.

 

**Basis of Presentation**

 

Effective May 1, 2005, the Company began to include DNADreamfields in its consolidated financial statements.  The financialstatements for prior fiscal years have not been restated and therefore do notinclude consolidated data pertaining to DNA Dreamfields. The Company hasincluded consolidated amounts for DNA Dreamfields in the income statement forthe years ending July 31, 2006 and 2005. See Note 2 of the consolidatedfinancial statements for additional information.

 

16

----

 

**Results of Operations**

 

*Comparison of Fiscal Years ended July 31,2006 and 2005*

 

***Net Revenues.***Net revenues increased $15.9 million, or 10.2%, to $171.5 million for the yearended July 31, 2006, from $155.6 million for the year ended July 31, 2005. Theincrease resulted from higher pasta sales volumes, particularly in theingredient market.

 

Revenues from the retail market, a portion of which includes co-packand governmental sales, increased $5.0 million, or 6.6%, for the year endedJuly 31, 2006 due to a 3.7% increase in average selling prices and a 2.8%increase in volume. Foodservice revenues increased $3.1 million, or 6.5%, forthe year ended July 31, 2006 due to a 2.5% increase in average selling pricesand a 4.0% increase in volume. Ingredient revenues increased $6.6 million, or30.7%, due to increased sales volumes to new and existing customers.

 

The Company markets semolina production in excess of its ownrequirements as well as durum wheat flour, other flour blends and by-productsof the durum milling process. Revenues from mill product sales for the yearended July 31, 2006 totaled $11.7 million, an increase of $1.2 million from theprior year. The increase was primarily due to higher semolina sales volumes.

 

***Cost of Goods Sold.***Costof goods sold totaled $148.9 million for the year ended July 31, 2006, anincrease of 9.3% compared to the $136.2 million reported for the year endedJuly 31, 2005. The increase was mainly due to higher sales volumes relative tothe prior year. Gross profit as a percentage of net revenues increased to 13.2%in fiscal year 2006 compared to 12.5% in fiscal year 2005, largely due tobenefits derived from lower durum costs, which were partially offset by thenegative impacts of higher freight costs.

 

***Marketing, Generaland Administrative (“MG&A”) Expenses.***MG&Aexpenses decreased $2.3 million, or 14.0%, to $14.2 million for the year endedJuly 31, 2006, from $16.5 million for the year ended July 31, 2005. Thedecrease is primarily due to the reduction in consumer advertising forDreamfieldsTM pasta products. MG&A expenses as apercentage of net revenues decreased from 10.6% to 8.3%.

 

***Interest Expense.***Interestexpense for the year ended July 31, 2006, totaled $2.6 million, up $0.3 millionfrom $2.3 million for the year ended July 31, 2005. The increase was mainly dueto higher interest rates. Cash and equity patronage refunds received fromCoBank totaling $144,000 and $114,000 have been netted against interest expensefor the years ended July 31, 2006 and 2005, respectively.

 

***Gain (Loss) onDisposition of Property, Equipment and Other Assets.***TheCompany incurred a Loss on Disposition of $0.5 million during fiscal year 2006.Virtually all of this loss was related to the retirement of certain equipmentin conjunction with the capital project at the New Hope, Minnesota facility.

 

***Other Income, net.***Otherincome totaled $1.0 million for the year ended July 31, 2006 and $0.4 millionfor the year ended July 31, 2005. U.S. Customs and Border Protection (“Customs”)has distributed antidumping and countervailing duties assessed on certain pastaimported from Italy and Turkey to affected domestic producers pursuant to theContinued Dumping and Subsidy Offset Act of 2000 (the “Offset Act”), which wasenacted in October 2000. The Company received net payments in the amount of$1.1 million and $0.4 million in fiscal years 2006 and 2005, respectively,under the Offset Act. These amounts have been classified as other income. 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.

 

***NoncontrollingInterests.***Noncontrolling interests reflects theportion of the DNA Dreamfields net loss allocable to the other members of DNADreamfields. The loss allocated to those other members totaled $0.9 million and$3.0 million for the years ended July 31, 2006 and 2005, respectively. The $2.1million decrease was

 

17

----

 

due to a reduction in the netloss reported by DNA Dreamfields for the year ended July 31, 2006, whencompared to the prior year, partially offset by the Company’s increasedownership interest in DNA Dreamfields.

 

***Income Taxes.***Incometax expense for the years ended July 31, 2006 and 2005 totaled $2.8 million and$1.6 million, respectively, reflecting an effective corporate income tax rateof approximately 39%.

 

***Net Income.***Netincome for the year ended July 31, 2006 totaled $4.4 million, an increase of$1.9 million compared to net income of $2.5 million for the year ended July 31,2005. Net earnings available to common shareholders for the year ended July 31,2006 totaled $3.9 million after reducing net income for dividends declared onpreferred stock.

 

*Comparison of Fiscal Years ended July 31,2005 and 2004*

 

***Net Revenues.***Net revenues increased $10.9 million, or 7.6%, to $155.6 million for the yearended July 31, 2005, from $144.7 million for the year ended July 31, 2004. Theincrease resulted from higher pasta sales volumes, particularly in thefoodservice and ingredient markets.

 

Revenues from the retail market, a portion of which includes co-packand governmental sales, increased $0.2 million, or 0.3%, for the year endedJuly 31, 2005 due to a 7.7% increase in average selling prices offset by volumedeclines. A significant factor contributing to retail volume declines was adecrease in co-pack sales, primarily to New World Pasta Company. Foodservicerevenues increased $6.1 million, or 14.9%, primarily due to sales volume growthassociated with sales under the New World Pasta license agreement combined withnew customer sales. The Company entered into a license agreement with New WorldPasta Company in September 2004, which gave the Company the exclusive right toproduce and market pasta products bearing the *Ronzoni*,*Prince*, *San Giorgio* and *Mrs. Weiss*brands in the foodservice market. Ingredientrevenues increased $8.7 million, or 67.4%, due to sales volume increasesprimarily associated with the addition of one customer in this market.

 

The Company markets semolina production in excess of its ownrequirements as well as durum wheat flour, other flour blends and by-productsof the durum milling process. Revenues from mill product sales for the yearended July 31, 2005 totaled $10.6 million, down $3.9 million from the prioryear. The decrease resulted from lower semolina sales volumes as the Companyutilized a larger portion of its semolina production for internal pastaproduction purposes.

 

The consolidation of DNA Dreamfields in the Company’s consolidatedfinancial statements for fiscal year 2005 did not have a material impact on netrevenues when compared to fiscal year 2004.

 

***Cost of Goods Sold.***Costof goods sold totaled $136.2 million for the year ended July 31, 2005, anincrease of 3.0% compared to the $132.2 million reported for the year endedJuly 31, 2004, mainly due to higher sales volumes relative to the prior year.Gross profit as a percentage of net revenues increased to 12.5% in fiscal year2005 compared to 8.6% in fiscal year 2004 due to various factors includinglower per unit manufacturing costs resulting from increased factoryutilization. These positive factors were partially offset by the negativeimpacts of higher freight costs. The impact of including DNA Dreamfields in theCompany’s consolidated financial statements for fiscal year 2005 accounted forapproximately one-half of the 3.9% change in gross profit percentageimprovement.

 

***Marketing, Generaland Administrative (“MG&A”) Expenses.***MG&Aexpenses increased $8.2 million, or 97.8%, to $16.5 million for the year endedJuly 31, 2005, from $8.3 million for the year ended July 31, 2004. The impactof including DNA Dreamfields in the Company’s consolidated financial statementsfor the year ended July 31, 2005 accounted for 75% of the increase in MG&Aexpenses, and related primarily to consumer advertising. The remainder of theincrease in MG&A resulted from a variety of factors, the most significantof which were increased customer marketing support associated with DreamfieldsTM pasta products and increased research anddevelopment costs. MG&A expenses as a percentage of net revenues increasedfrom 5.8% to 10.6%.

 

18

----

 

***Loss on AssetImpairment.***The Company recorded a loss on assetimpairment of $0.7 million during the year ended July 31, 2004. The impairmentloss related to certain pasta production equipment which was under a purchaseoption agreement that expired in July 2004. Upon review, the Company determinedthe asset was impaired and adjusted to fair value which was estimated based onthe current market conditions for similar equipment.

 

***Net Loss Allocatedfrom Joint Venture***. The Company did not report anet loss allocation from joint venture for the year ended July 31, 2005 as theCompany included DNA Dreamfields in the consolidated financial statements forfiscal year 2005 (See also Note 2 – DNA Dreamfields Company, LLC of theconsolidated financial statements).**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 during thatperiod.

 

***Interest Expense.***Interestexpense for the year ended July 31, 2005, totaled $2.3 million, down $0.5million from $2.8 million for the year ended July 31, 2004. The decrease wasmainly due to lower average outstanding debt levels. Cash and equity patronagerefunds received from CoBank totaling $114,000 and $103,000 have been nettedagainst interest expense for the years ended July 31, 2005 and 2004,respectively.

 

***Other Income, net.***Otherincome totaled $0.4 million and $0.5 million for the years ended July 31, 2005and 2004, respectively. The Company received net payments in the amount of $0.4million and $0.6 million in fiscal years 2005 and 2004, respectively, under theOffset Act. These amounts have been classified as other income. The Companycannot reasonably estimate the potential amount, if any, that it may receiveunder the Offset Act in future periods as any such amount will be based uponfuture events over which the Company has little or no control, including, butnot limited to, the amount of expenditures by domestic pasta producers and theamount of antidumping and countervailing duties collected by Customs.

 

***NoncontrollingInterests.***Noncontrolling interests reflect theportion of the DNA Dreamfields net loss allocable to the other members of DNADreamfields for the year ended July 31, 2005.

 

***Income Taxes.***Incometax expense for the years ended July 31, 2005 and 2004 totaled $1.6 million and$0.2 million, respectively, reflecting an effective corporate income tax rateof approximately 39%.

 

***Net Income.***Netincome for the year ended July 31, 2005 totaled $2.5 million, an increase of$2.2 million compared to net income of $0.3 million for the year ended July 31,2004.

 

**Liquidity and Capital Resources**

 

The Company’s primary sources of liquidity are cash provided byoperations and borrowings under its revolving credit facility. Net workingcapital as of July 31, 2006 was $23.3 million compared to $20.2 million as ofJuly 31, 2005.

 

Effective June 1, 2006, the Company secured a $25 million revolvingcredit facility with CoBank that extends through May 30, 2007. Interest on therevolving line is currently charged at a variable rate established by CoBankbased on CoBank’s cost of funds, although the facility also allows for a fixedrate option. The Company had $25 million available for borrowings under theline of credit as of July 31, 2006.

 

The Company also has a $19.0 million term loan facility with CoBank.The balance outstanding under the term loan was $19.0 million as of July 31,2006 and no further borrowings are available under the term loan facility.

 

The Master Loan Agreement with CoBank contains certain restrictivecovenants including, but not limited to, financial covenants which require theCompany to maintain, at the end of each of the Company’s fiscal quarters, aminimum current ratio of 1.20 to 1.0, a maximum total debt to earnings beforeinterest, taxes, depreciation and amortization (“EBITDA”)  of 4.25 to 1.0, a minimum fixed charge ratioof 1.15 to 1.0, and a minimum tangible

 

19

----

 

net worth level of at least $40million adjusted for subsequent earnings and capital contributions.

 

The Company’s long-term financing is also provided through securednotes held by institutional investors. The Note Purchase Agreement (as amended)with the institutional investors requires the Company to maintain thefollowing: (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 toconsolidated fixed charges of not less than 2.0 to 1.0 at the end of eachfiscal quarter, and (c) a ratio of consolidated funded debt to consolidatedcash flow ratio not to exceed 3.0 to 1.0 determined at the end of each fiscalquarter for the immediately preceding four fiscal quarters. The Notes (asamended) require the rate of interest on the unpaid balance be increased by onepercent at any time that either (a) the ratio of the Company’s consolidatedfunded debt to consolidated cash flow is greater than 3.0 to 1.0 as of the endof each fiscal quarter for the immediately preceding four fiscal quarters or(b) the Securities 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 of July 31,2006 and the date of this filing.

 

Net cash from operations totaled $19.1 million and $12.7 million forthe years ended July 31, 2006 and 2005, respectively. The $6.4 million netincrease from fiscal year 2005 to 2006 was attributable to a $1.9 millionincrease in net income, a decrease in receivables and inventories, and anincrease in accounts payable. The decrease in inventories from the year endedJuly 31, 2005 to the year ended July 31, 2006 related to the Company’sutilization of inventories built-up over the latter portion of fiscal year 2005to compensate for the reduced pasta production volumes resulting from theproduction upgrade project at the New Hope manufacturing facility. The $2.1million net increase from fiscal year 2004 to 2005 was attributable to a $2.2million increase in net income and $5.4 million of accrued promotional costs appliedto marketing prepayments related to U.S. Foodservice, offset partially by anincrease in inventories. In March 2005, the Company entered into an agreementwith U.S. Foodservice which finalized the economic terms and conditionsgoverning the purchase of dry pasta products by U.S. Foodservice from theCompany. The agreement included provisions to apply accrued promotional amountsto marketing prepayments which reduced the time to recover the unamortizedportion of these marketing prepayments made to U.S. Foodservice. The agreementalso eliminated the Company’s right to be the exclusive supplier of dry pastaproducts to U.S. Foodservice and does not provide for minimum purchasecommitments by U.S. Foodservice. The increase in inventories from July 31, 2004to July 31, 2005 primarily related to inventory build-up in conjunction withthe production upgrade project at the New Hope, Minnesota manufacturingfacility.

 

Net cash used for investing activities totaled $10.8 million, $16.0million, and $4.8 million for the years ended July 31, 2006, 2005 and 2004,respectively. A majority of the net cash used for investing activities for theyear ended July 31, 2006 related to capital expenditures for the New Hopeupgrade project. The $11.2 million increase in net cash used for investingactivities for fiscal year 2005 when compared to fiscal year 2004 related toincreased fixed asset expenditures in conjunction with the New Hope productionupgrade project and increased investments in DNA Dreamfields. The Company madeaggregate investments in DNA Dreamfields Company, LLC totaling $7.0 million and$2.5 million during fiscal years 2005 and 2004, respectively.

 

Net cash used for financing activities totaled $8.2 million and $5.3million for the years ended July 31, 2006 and 2004. Net cash from financingactivities totaled $2.9 million for the year ended July 31, 2005. The $8.2million of net cash used for financing activies for the year ended July 31,2006 related primarily to principal payments on short-term and long-term debt.The $2.9 million of net cash from financing activities for the year ended July31, 2005 included $9.1 million in borrowings under the CoBank secured term loanfacility to finance the New Hope production upgrade project and investments inDNA Dreamfields and $7.2 million for scheduled debt principal payments. 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.

 

The Company increased its economic ownership in DNA Dreamfields from24% to 30% effective November 2004, and to 47% effective May 2005. Inconnection with the latest investment in DNA Dreamfields, the

 

20

----

 

Company and the othermember/owners of DNA Dreamfields also entered into an Amended and Restated DNADreamfields Company, LLC Operating Agreement, under which the Company was namedas the “Managing Member” of DNA Dreamfields.  As such, the Company hasauthority to make all decisions with respect to DNA Dreamfields, its business,assets and operations that do not expressly require either a unanimous vote ofthe member/owners of DNA Dreamfields or a “Super Majority” vote of the holdersof 75% of the outstanding Membership Units in DNA Dreamfields.

 

The Company also entered into a “2005 Line of Credit Loan Agreement”with DNA Dreamfields in the fourth quarter of fiscal year 2005.  Underthat Agreement, the Company has agreed to loan up to $5.0 million to DNADreamfields, with DNA Dreamfields able to repay and reborrow amounts under theLine of Credit Loan Agreement from time to time.  Interest on amountsoutstanding under the Line of Credit Loan Agreement will accrue from the dateof any advance at a variable rate ranging from a high of the then-current LIBORthirty day rate plus 8.0% per annum to a low of the then-current LIBOR thirtyday rate plus 5.0% per annum based on the adjusted income of DNA Dreamfields. Interest is payable on a monthly basis. Principal payments due to the Companyon a monthly basis will equal DNA Dreamfields monthly net income (as determinedin accordance with generally accepted accounting principles) reduced by anycash or other reserves established by DNA upon the decision of the Company asthe managing member of DNA Dreamfields.  The Line of Credit Loan Agreementmatures on May 31, 2010.  DNA Dreamfields is also required to complywith certain financial covenants under the Line of Credit Loan Agreement. Tosecure DNA Dreamfield’s obligations under the 2005 Line of Credit LoanAgreement, the member/owners of DNA Dreamfields other than the Company havepledged their Membership Units in DNA Dreamfields to the Company pursuant to a “LLCUnit Pledge Agreement”.

 

The following table summarizes the Company’s contractual obligations asof July 31, 2006 (in thousands):

 
| ** **                       | ** ** | ** ** | ** ** | **Payments**              | ** ** | **Payments**       | ** ** | **Payments**       | ** ** | **Payments**       | ** ** |
|----------------------------------|------------|------------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Due in Less** | ** ** | **Due in**    | ** ** | **Due in**    | ** ** | **Due After** | ** ** |
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Than 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **5 Years**   | ** ** |
|                             |       |       |       |                      |       |               |       |               |       |               |       |
| Long-term debt                   |       | $          | 35,316     |                      | $          | 6,771              |       | $                  | 23,745     |               | $          | 4,800 |   | $ | — |   |
| Durum purchase obligations       |       | 15,873     |       | 15,873                    |       | —             |       | —             |       | —             |       |
| Warehouse obligations            |       | 3,425      |       | 1,888                     |       | 1,537              |       | —             |       | —             |       |
| Operating leases                 |       | 1,423      |       | 954                       |       | 455                |       | 14                 |       | —             |       |
|                             |       |       |       |                      |       |               |       |               |       |               |       |
|                             |       | $          | 56,037     |                      | $          | 25,486             |       | $                  | 25,737     |               | $          | 4,814 |   | $ | — |   |

 

The Company forward contracts for a certain portion of its future durumwheat requirements. At July 31, 2006, the Company had outstanding commitments forgrain purchases totaling $15.9 million related to forward purchase contracts.These contracts are set price contracts to deliver grain to the Company’s mill,and are not derivative in nature as they have no net settlement provision andare not transferable.

 

Management believes that net cash to be provided by operatingactivities, along with amounts available under its line of credit will besufficient to meet the Company’s expected capital and liquidity requirementsfor the foreseeable future.

 

##### ***Recently IssuedAccounting Standards***

 

The FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB 43,Chapter 4” in November 2004. This Statement amends the guidance in ARB No. 43,Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amountsof idle facility expense, freight, handling costs, and wasted material(spoilage) so as to require such costs to be treated as current period charges.Further, this Statement requires that the allocation of fixed overhead costs tothe inventoriable production costs be based on the normal capacity of theproduction facilities. The provisions of this Statement are effective forinventory costs incurred during fiscal

 

21

----

 

years beginning after June 15,2005. The Company adopted SFAS No. 151 in the quarter ended October 31, 2005.The adoption of this Statement did not have a material impact on its financialstatements. However, future changes in the Company’s production or logisticscould have a material impact on the Company’s financial statements as a resultof SFAS No. 151.

 

In June 2006, the FASB issued FASB Interpretation No. 48 (FINNo. 48), “Accounting for Uncertainty in Income Taxes – an Interpretationof FASB Statement No. 109”, which clarifies the accounting for uncertaintyin income taxes recognized in accordance with SFAS No. 109, “Accountingfor Income Taxes.” FIN No. 48 clarifies the application of SFASNo. 109 by defining criteria that an individual tax position must meet forany part of the benefit of that position to be recognized in the financialstatements. Additionally, FIN No. 48 provides guidance on the measurement,de-recognition, classification and disclosure of tax positions along with theaccounting for the related interest and penalties. The provisions of FINNo. 48 are effective for the fiscal years beginning afterDecember 15, 2006, with the cumulative effect of the change in accountingprinciple recorded as an adjustment to opening retained earnings. The Companywill be required to adopt FIN No. 48 for its fiscal year beginningAugust 1, 2007. The Company does not expect this Statement to have amaterial impact on its financial statements upon adoption. However, futurechanges in the Company’s income tax situation may have a material impact on theCompany’s financial statements as a result of this Statement.

 

**ITEM 7A.****   QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Market risk is the risk of loss to future earnings, to fair values orto future cash flows that may result from changes in the price of a financialinstrument. The value of a financial instrument may change as a result ofchanges in interest rates, commodity prices, exchange rates, equity prices andother market changes. Market risk is attributed to all market-risk sensitivefinancial instruments, including long-term debt.

 

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

 

22

----

 

**ITEM8.      FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF**

**DAKOTA 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                       |   |

 

23

----

 

 

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

To the Audit Committee, Boardof Directors and Stockholders

Dakota Growers Pasta Company,Inc.

Carrington, North Dakota

 

We have audited theaccompanying consolidated balance sheets of Dakota Growers Pasta Company, Inc.and Subsidiary as of July 31, 2006 and 2005, and the related consolidatedstatements of operations, changes in stockholders’ equity and cash flows foreach of the years ended July 31, 2006, 2005, and 2004. These financialstatements are the responsibility of the company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we do not express such an opinion. An audit alsoincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidatedfinancial statements referred to above present fairly, in all materialrespects, the financial position of Dakota Growers Pasta Company, Inc. andSubsidiary as of July 31, 2006 and 2005, and the results of its operations andits cash flows for each of the years ended July 31, 2006, 2005, and 2004, inconformity with accounting principles generally accepted in the United Statesof America.

 

 

Minneapolis, Minnesota

October 24, 2006

 

PEOPLE. PRINCIPLES. POSSIBILITIES.

www.eidebailly.com

5601 Green Valley Dr., Ste. 700 • Minneapolis,Minnesota 55437-1145 • Phone 952.944.6166 • Fax 952.944.8496 •EOE

 

24

----

 

**DAKOTAGROWERS PASTA COMPANY, INC.**

**CONSOLIDATED BALANCE SHEETS**

**JULY 31,2006 AND 2005**

**(InThousands, Except Share Information)**

 
| ** **                                                                                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                   |       |     |       |     |       |
| **ASSETS**                                                                                                             |       |     |       |     |       |
|                                                                                                                   |       |     |       |     |       |
| CURRENT ASSETS                                                                                                         |       |     |       |     |       |
| Cash and cash equivalents                                                                                              |       | $        | 343        |     | $          | 229 |   |
|                                                                                                                   |       |     |       |     |       |
| Trade accounts receivable, less allowance  for cash discounts and doubtful accounts of $1,080 and $1,507, respectively |       | 14,441   |       | 16,188   |       |
|                                                                                                                   |       |     |       |     |       |
| Other receivables                                                                                                      |       | 91       |       | 411      |       |
|                                                                                                                   |       |     |       |     |       |
| Inventories                                                                                                            |       | 26,118   |       | 28,102   |       |
|                                                                                                                   |       |     |       |     |       |
| Prepaid expenses                                                                                                       |       | 2,007    |       | 2,578    |       |
|                                                                                                                   |       |     |       |     |       |
| Deferred income taxes                                                                                                  |       | 955      |       | 955      |       |
|                                                                                                                   |       |     |       |     |       |
| Total current assets                                                                                                   |       | 43,955   |       | 48,463   |       |
|                                                                                                                   |       |     |       |     |       |
| PROPERTY AND EQUIPMENT                                                                                                 |       |     |       |     |       |
| In service                                                                                                             |       | 124,035  |       | 111,394  |       |
| Construction in progress                                                                                               |       | 4,093    |       | 7,350    |       |
|                                                                                                                   |       | 128,128  |       | 118,744  |       |
| Less accumulated depreciation                                                                                          |       | (57,198  | )          | (52,286  | )          |
|                                                                                                                   |       |     |       |     |       |
| Net property and equipment                                                                                             |       | 70,930   |       | 66,458   |       |
|                                                                                                                   |       |     |       |     |       |
| INVESTMENT IN COOPERATIVE BANK                                                                                         |       | 1,515    |       | 2,054    |       |
|                                                                                                                   |       |     |       |     |       |
| GOODWILL                                                                                                               |       | 16,654   |       | 16,654   |       |
|                                                                                                                   |       |     |       |     |       |
| OTHER ASSETS                                                                                                           |       | 1,195    |       | 1,501    |       |
|                                                                                                                   |       |     |       |     |       |
|                                                                                                                   |       | $        | 134,249    |     | $          | 135,130 |   |

 

25

----

 
| ** **                                                                                                                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                |       |     |       |     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                       |       |     |       |     |       |
|                                                                                                                                                |       |     |       |     |       |
| CURRENT LIABILITIES                                                                                                                                 |       |     |       |     |       |
| Notes payable                                                                                                                                       |       | $        | —     |     | $          | 10,000 |   |
| Current portion of long-term debt                                                                                                                   |       | 6,771    |       | 4,771    |       |
| Accounts payable                                                                                                                                    |       | 7,250    |       | 4,197    |       |
| Excess outstanding checks over cash on  deposit                                                                                                     |       | 704      |       | 3,110    |       |
| Accrued liabilities                                                                                                                                 |       | 5,957    |       | 6,229    |       |
|                                                                                                                                                |       |     |       |     |       |
| Total current liabilities                                                                                                                           |       | 20,682   |       | 28,307   |       |
|                                                                                                                                                |       |     |       |     |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                       |       | —   |       | —   |       |
| LONG-TERM DEBT, net of current portion                                                                                                              |       | 28,545   |       | 25,385   |       |
| DEFERRED INCOME TAXES                                                                                                                               |       | 12,417   |       | 11,419   |       |
| OTHER LIABILITIES                                                                                                                                   |       | 34       |       | 85       |       |
| MANDATORILY REDEEMABLE PREFERRED STOCK                                                                                                              |       |     |       |     |       |
| Series A, 6% cumulative, $100 par value,  533 shares authorized, 0 and 67 shares issued and outstanding as of July 31, 2006  and 2005, respectively |       | —   |       | 7        |       |
|                                                                                                                                                |       |     |       |     |       |
| Total liabilities                                                                                                                                   |       | 61,678   |       | 65,203   |       |
|                                                                                                                                                |       |     |       |     |       |
| NONCONTROLLING INTERESTS                                                                                                                            |       | 7,979    |       | 8,795    |       |
|                                                                                                                                                |       |     |       |     |       |
| 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 shares issued and outstanding                                               |       | 132      |       | 132      |       |
| Additional paid-in capital                                                                                                                          |       | 62,872   |       | 62,807   |       |
| Accumulated earnings (deficit)                                                                                                                      |       | 1,475    |       | (1,920   | )          |
|                                                                                                                                                |       |     |       |     |       |
| Total stockholders’ equity                                                                                                                     |       | 64,592   |       | 61,132   |       |
|                                                                                                                                                |       |     |       |     |       |
| Total liabilities and stockholders’ equity                                                                                                     |       | $        | 134,249    |     | $          | 135,130 |   |

 

See Notes to ConsolidatedFinancial Statements

 

26

----

 

**DAKOTAGROWERS PASTA COMPANY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**YEARSENDED JULY 31, 2006, 2005 AND 2004**

**(InThousands, Except per Share Amounts)**

 
| ** **                                                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                                                    |       |     |       |     |       |     |       |
| Net revenues (net of discounts and  allowances of $26,474, $24,184, and $21,188 for 2006, 2005 and 2004,  respectively) |       | $        | 171,509    |     | $          | 155,619  |       | $ | 144,679 |   |
|                                                                                                                    |       |     |       |     |       |     |       |
| Cost of goods sold                                                                                                      |       | 148,904  |       | 136,179  |       | 132,245  |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Gross profit                                                                                                            |       | 22,605   |       | 19,440   |       | 12,434   |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Marketing, general and administrative  expenses                                                                         |       | 14,190   |       | 16,507   |       | 8,345    |       |
| Loss on asset impairment                                                                                                |       | —   |       | —   |       | 704      |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Operating income                                                                                                        |       | 8,415    |       | 2,933    |       | 3,385    |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Other income (expense)                                                                                                  |       |     |       |     |       |     |       |
| Interest expense, net                                                                                                   |       | (2,573   | )          | (2,283   | )          | (2,762   | )          |
| Net loss allocated from joint venture                                                                                   |       | —   |       | —   |       | (622     | )          |
| Gain (loss) on disposition of property,  equipment and other assets                                                     |       | (546     | )          | 38       |       | 40       |       |
| Other income, net                                                                                                       |       | 976      |       | 428      |       | 509      |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Income before noncontrolling interests and  income taxes                                                                |       | 6,272    |       | 1,116    |       | 550      |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Noncontrolling interests                                                                                                |       | 894      |       | 3,003    |       | —   |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Income before income taxes                                                                                              |       | 7,166    |       | 4,119    |       | 550      |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Income tax expense                                                                                                      |       | 2,793    |       | 1,606    |       | 214      |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Net income                                                                                                              |       | 4,373    |       | 2,513    |       | 336      |       |
| Dividends on preferred stock                                                                                            |       | 451      |       | —   |       | —   |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Net earnings on common stock                                                                                            |       | $        | 3,922      |     | $          | 2,513    |       | $ | 336 |   |
|                                                                                                                    |       |     |       |     |       |     |       |
| Net earnings  per common share                                                                                          |       |     |       |     |       |     |       |
| Basic                                                                                                                   |       | $        | 0.30       |     | $          | 0.19     |       | $ | 0.03 |   |
|                                                                                                                    |       |     |       |     |       |     |       |
| Diluted                                                                                                                 |       | $        | 0.30       |     | $          | 0.19     |       | $ | 0.03 |   |
|                                                                                                                    |       |     |       |     |       |     |       |
| Weighted average common shares outstanding                                                                              |       |     |       |     |       |     |       |
| Basic                                                                                                                   |       | 13,169   |       | 13,169   |       | 12,265   |       |
|                                                                                                                    |       |     |       |     |       |     |       |
| Diluted                                                                                                                 |       | 13,555   |       | 13,549   |       | 12,625   |       |

 

See Notes to Consolidated Financial Statements

 

27

----

 

**DAKOTAGROWERS PASTA COMPANY, INC.**

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

**YEARSENDED JULY 31, 2006, 2005 AND 2004**

**(InThousands)**

 
| ** **                                   | ** ** | **Series D Delivery** | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**          | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                  | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|-----------------------|------------|-------------|------------|-------------------------|------------|-----------------|------------|------------|------------|------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **Preferred Stock**        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Treasury Stock** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Shares**                      | ** ** | **Amount**            | ** ** | **Shares**  | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Earnings (Deficit)** | ** ** | **Total** | ** ** |
| ** **                                   | ** ** | ** **                      | ** ** | ** **            | ** ** | ** **  | ** ** | ** **              | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                  | ** ** | ** ** | ** ** |
| BALANCE, JULY 31,  2003                      |       | 11,275                          |       | $                     | 113        |        | 12,555     |                    | $          | 126             |       | $          | 60,188     |       | 294        |                        | $          | (1,840 | ) | $ | (4,769 | ) | $ | 53,818 |   |
| Issuance of  common stock                    |       | —                          |       | —                |       | 614         |       | 6                       |       | 3,154           |       | (294       | )          | 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                      |       | 11,275                          |       | $                     | 113        |        | 13,169     |                    | $          | 132             |       | $          | 62,807     |       | —     |                        | $          | — |   | $ | (4,433 | ) | $ | 58,619 |   |
| Net income for  the year ended July 31, 2005 |       | —                          |       | —                |       | —      |       | —                  |       | —          |       | —     |       | —     |       | 2,513                       |       | 2,513 |   |
| BALANCE, JULY 31,  2005                      |       | 11,275                          |       | $                     | 113        |        | 13,169     |                    | $          | 132             |       | $          | 62,807     |       | —     |                        | $          | — |   | $ | (1,920 | ) | $ | 61,132 |   |
| Dividends on  common stock                   |       | —                          |       | —                |       | —      |       | —                  |       | —          |       | —     |       | —     |       | (527                        | )          | (527 | ) |
| Dividends on  preferred stock                |       | —                          |       | —                |       | —      |       | —                  |       | —          |       | —     |       | —     |       | (451                        | )          | (451 | ) |
| Stock-based  employee compensation           |       | —                          |       | —                |       | —      |       | —                  |       | 65              |       | —     |       | —     |       | —                      |       | 65 |   |
| Net income for  the year ended July 31, 2006 |       | —                          |       | —                |       | —      |       | —                  |       | —          |       | —     |       | —     |       | 4,373                       |       | 4,373 |   |
| BALANCE, JULY 31,  2006                      |       | 11,275                          |       | $                     | 113        |        | 13,169     |                    | $          | 132             |       | $          | 62,872     |       | —     |                        | $          | — |   | $ | 1,475 |   | $ | 64,592 |   |

 

See Notes to Consolidated Financial Statements

 

28

----

 

**DAKOTAGROWERS PASTA COMPANY, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARSENDED JULY 31, 2006, 2005 AND 2004**

**(InThousands)**

 
| ** **                                                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                        |       |     |       |     |       |     |       |
| OPERATING ACTIVITIES                                                        |       |     |       |     |       |     |       |
| Net income                                                                  |       | $        | 4,373      |     | $          | 2,513    |       | $ | 336 |   |
| Adjustments to reconcile net income to net  cash from operating activities: |       |     |       |     |       |     |       |
| Depreciation and amortization                                               |       | 7,234    |       | 7,675    |       | 8,350    |       |
| Undistributed patronage capital from cooperatives                           |       | (29      | )          | (46      | )          | (51      | )          |
| (Gain) loss on disposition of property, equipment  and other assets         |       | 546      |       | (38      | )          | (40      | )          |
| Loss on asset impairment                                                    |       | —   |       | —   |       | 704      |       |
| Net loss allocated from joint venture under  equity method                  |       | —   |       | 914      |       | 622      |       |
| Deferred income taxes                                                       |       | 998      |       | 1,038    |       | 150      |       |
| Stock-based employee compensation                                           |       | 65       |       | —   |       | —   |       |
| Payments for long-term marketing costs                                      |       | —   |       | —   |       | (125     | )          |
| Accrued promotional costs applied to marketing  prepayments                 |       | —   |       | 5,442    |       | —   |       |
| Noncontrolling interests                                                    |       | (894     | )          | (219     | )          | —   |       |
| Changes in assets and liabilities                                           |       |     |       |     |       |     |       |
| Trade receivables                                                           |       | 1,747    |       | (2,145   | )          | (4,191   | )          |
| Other receivables                                                           |       | 320      |       | 626      |       | 223      |       |
| Inventories                                                                 |       | 1,984    |       | (2,891   | )          | 2,871    |       |
| Prepaid expenses                                                            |       | (63      | )          | (508     | )          | 156      |       |
| Other assets                                                                |       | 48       |       | (36      | )          | 110      |       |
| Accounts payable                                                            |       | 3,053    |       | (899     | )          | 1,176    |       |
| Other accrued liabilities                                                   |       | (272     | )          | 1,273    |       | 329      |       |
|                                                                        |       |     |       |     |       |     |       |
| NET CASH FROM OPERATING ACTIVITIES                                          |       | 19,110   |       | 12,699   |       | 10,620   |       |
|                                                                        |       |     |       |     |       |     |       |
| INVESTING ACTIVITIES                                                        |       |     |       |     |       |     |       |
| Purchases of property and equipment                                         |       | (10,755  | )          | (8,803   | )          | (2,169   | )          |
| Proceeds from sale of property, equipment and  other assets                 |       | —   |       | —   |       | 8        |       |
| Investments in joint venture                                                |       | —   |       | (2,970   | )          | (2,492   | )          |
| Other investments                                                           |       | (476     | )          | —   |       | —   |       |
| Distributions from joint venture                                            |       | —   |       | —   |       | 124      |       |
| Proceeds from cooperative bank equity  retirements                          |       | 568      |       | 335      |       | 121      |       |
| Acquisition of controlling interest in  joint venture, net of cash acquired |       | —   |       | (3,771   | )          | —   |       |
| Payments for package design costs                                           |       | (180     | )          | (773     | )          | (345     | )          |
|                                                                        |       |     |       |     |       |     |       |
| NET CASH USED FOR INVESTING ACTIVITIES                                      |       | (10,843  | )          | (15,982  | )          | (4,753   | )          |
|                                                                             |            |          |            |          |            |          |            |  |  |  |

 

29

----

 
| ** **                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                    |       |     |       |     |       |     |       |
| FINANCING ACTIVITIES                                                    |       |     |       |     |       |     |       |
| Net change in excess outstanding checks  over cash on deposit           |       | (2,406   | )          | 3,110    |       | (2,219   | )          |
| Net change in short-term notes payable                                  |       | (10,000  | )          | (2,200   | )          | 2,495    |       |
| Payments on long-term debt                                              |       | (4,771   | )          | (7,176   | )          | (10,011  | )          |
| Proceeds from long-term debt                                            |       | 9,931    |       | 9,069    |       | —   |       |
| Preferred stock retirements                                             |       | (7       | )          | (13      | )          | (13      | )          |
| Investments by noncontrolling interests                                 |       | 78       |       | 133      |       | —   |       |
| Dividends paid on common stock                                          |       | (527     | )          | —   |       | —   |       |
| Dividends paid on preferred stock                                       |       | (451     | )          | —   |       | —   |       |
| Issuance of common stock                                                |       | —   |       | —   |       | 5,000    |       |
| Costs associated with issuing common stock                              |       | —   |       | —   |       | (535     | )          |
|                                                                    |       |     |       |     |       |     |       |
| NET CASH FROM (USED FOR) FINANCING  ACTIVITIES                          |       | (8,153   | )          | 2,923    |       | (5,283   | )          |
|                                                                    |       |     |       |     |       |     |       |
| NET CHANGE IN CASH AND CASH EQUIVALENTS                                 |       | 114      |       | (360     | )          | 584      |       |
|                                                                    |       |     |       |     |       |     |       |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  YEAR                           |       | 229      |       | 589      |       | 5        |       |
|                                                                    |       |     |       |     |       |     |       |
| CASH AND CASH EQUIVALENTS, END OF YEAR                                  |       | $        | 343        |     | $          | 229      |       | $ | 589 |   |
|                                                                    |       |     |       |     |       |     |       |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION                      |       |     |       |     |       |     |       |
|                                                                    |       |     |       |     |       |     |       |
| Cash payments for                                                       |       |     |       |     |       |     |       |
| Interest (net of amounts capitalized)                                   |       | $        | 2,649      |     | $          | 2,363    |       | $ | 2,932 |   |
|                                                                    |       |     |       |     |       |     |       |
| Income taxes (refunded)                                                 |       | $        | 1,451      |     | $          | 79       |       | $ | (842 | ) |
|                                                                    |       |     |       |     |       |     |       |
| SUPPLEMENTAL DISCLOSURES OF NONCASH  INVESTING AND FINANCING ACTIVITIES |       |     |       |     |       |     |       |
|                                                                    |       |     |       |     |       |     |       |
| Acquisition of controlling interest in  joint venture:                  |       |     |       |     |       |     |       |
| Current assets less cash                                                |       |     |       | $        | 38         |     |       |   |
| Current liabilities                                                     |       |     |       | (238     | )          |     |       |
| Goodwill                                                                |       |     |       | 16,654   |       |     |       |
| Reported amount of previously held interests  in joint venture          |       |     |       | (3,802   | )          |     |       |
| Noncontrolling interests                                                |       |     |       | (8,881   | )          |     |       |
|                                                                    |       |     |       |     |       |     |       |
|                                                                    |       |     |       | $        | 3,771      |     |       |   |
|                                                                         |            |          |            |          |            |          |            |  |  |  |  |

 

See Notes to Consolidated Financial Statements

 

30

----

 

**DAKOTAGROWERS PASTA COMPANY, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARSENDED JULY 31, 2006, 2005 AND 2004**

 

**NOTE 1 - NATURE OFBUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

*Nature of Business*

 

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

 

*Principles of Consolidation*

 

The consolidated financial statements are comprised of the Company, itswholly-owned subsidiary Primo Piatto, Inc., and DNA Dreamfields Company, LLC (“DNADreamfields”), which the Company began to consolidate in fiscal year 2005. Allmaterial inter-company accounts and transactions have been eliminated in thepreparation of the consolidated financial statements.

 

The Company acquired an additional 17.25% ownership interest in DNADreamfields, effective May 1, 2005, resulting in an increase in theCompany’s ownership in DNA Dreamfields to 46.7%. As a result of the ownershipincrease and changes in the DNA Dreamfields operating agreement and othercontractual agreements, the Company reevaluated whether DNA Dreamfields was avariable interest entity under FASB Interpretation No. 46(R), “Consolidation ofVariable Interest Entities,” (FIN 46(R)). The Company determined that DNADreamfields was a variable interest entity and that the Company was the primarybeneficiary. Therefore, effective May 1, 2005, the Company began toinclude DNA Dreamfields in its consolidated financial statements.  Thefinancial statements for prior fiscal years have not been restated andtherefore do not include consolidated data pertaining to DNA Dreamfields. TheCompany has included consolidated amounts for DNA Dreamfields in the incomestatement for the years ending July 31, 2005 and 2006. The Company hadpreviously accounted for its investment in and share of net earnings or lossesof its ownership interest in DNA Dreamfields Company, LLC under the equitymethod.

 

*Estimates*

 

The preparation of consolidated financial statements in conformity withgenerally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities atthe date of the consolidated financial statements and reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

 

*Reclassifications*

 

Reclassifications have been made to the financial statements as of July31, 2005 and for the years ended July 31, 2005 and 2004 to facilitatecomparability with the statements as of and for the years ended July 31, 2006.Such reclassifications have no effect on the net result of operations.

 

*Risks and Uncertainties*

 

The Company attempts to minimize the effects of durum wheat costfluctuations mainly through forward contracting and through agreements withcertain customers that provide for price adjustments based on raw material costchanges. Such efforts, while undertaken to attempt to minimize the risksassociated with increasing durum costs on profitability, may temporarilyprevent the Company from recognizing the benefits of declining durum prices.

 

31

----

 

Some of the Company’s currently outstanding debt instruments have fixedinterest rates to maturity. If the Company’s operations require additional debtissuance, any changes in interest rates may have an impact on future results.

 

The Company’s cash balances are maintained in various bank depositaccounts. The deposit accounts may exceed federally insured limits at varioustimes throughout the year.

 

*Impairmentand Disposal of Long-Lived Assets*

##### * *

The Company accounts for impairment or disposal of long-lived assets inaccordance with the provisions of Statement of Financial Accounting Standards(SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.” SFAS No. 144 requires that long-lived assets be reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Recoverability oflong-lived assets to be held and used is measured by a comparison of thecarrying amount of an asset to future net cash flows expected to be generatedby the asset. If such assets are considered to be impaired, the impairment tobe recognized is measured by the amount by which the carrying amount of theassets exceeds the fair value of the assets. Long-lived assets to be disposedof by sale are reported at the lower of the carrying amount or fair value lesscosts to sell, and will cease to be depreciated. SFAS No. 144 also requireslong-lived assets to be disposed of other than by sale to be considered as heldand used until disposed of, requiring the depreciable life to be adjusted as anaccounting change.

 

The Company recorded a loss on asset impairment of $704,000 during theyear ended 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.

 

##### *Goodwill*

 

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,”the Company does not amortize goodwill. SFAS No. 142 requires that goodwill beevaluated for impairment at least annually or whenever events or changes incircumstances indicate that the carrying amount of an asset may not be fullyrecoverable. The Company used a discounted cash flow analysis in evaluatinggoodwill for impairment in fiscal years 2005 and 2006 and determined that noimpairment charges were necessary.

 

*Revenue Recognition*

 

Revenues are recognized when risk of loss transfers, which occurs whengoods are shipped. Pricing terms, including promotions and rebates, are finalat that time. Revenues include amounts billed for products as well as anyassociated shipping costs billed to deliver such products.

 

The Company provides allowances for annual promotional programs basedupon annual sales volumes. Revenues are presented net of discounts andallowances of $26,474,000, $24,184,000 and $21,188,000 for the years ended July31, 2006, 2005 and 2004, respectively.

 

*Cash and Cash Equivalents*

 

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

 

32

----

 

*Trade Accounts Receivable and Major Customers*

 

The Company grants unsecured credit to certain customers who meet theCompany’s credit requirements. Trade accounts receivable are uncollateralizedcustomer obligations due under normal terms and are generally non-interestbearing. Payments on trade receivables are allocated to specific invoicesidentified on a customer’s remittance advice or, if unspecified, are generallyapplied to the earliest unpaid invoices. The carrying amount of the receivablesis reduced by an amount that reflects management’s best estimate of amountsthat will not be collected. Trade accounts receivable are presented net ofallowances for cash discounts and doubtful accounts, which totaled $1,080,000and $1,507,000 as of July 31, 2006 and 2005, respectively.

 

One customer accounted for 15% and 17% of accounts receivable as ofJuly 31, 2006 and 2005, respectively and 12%, 13% and 15% of net revenues forthe years ended July 31, 2006, 2005 and 2004, respectively.

 

The following summarizes balance and activity information related tothe allowance for cash discounts and doubtful accounts (in thousands):

 
| ** **                                           | ** ** | **Balance**           | ** ** | **Charged to** | ** ** | **Deductions** | ** ** | **Balance**      | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|---------------------|------------|----------------|------------|------------------|------------|
| ** **                                           | ** ** | **at Beginning** | ** ** | **Costs and**  | ** ** | **from**       | ** ** | **at End**  | ** ** |
| ** **                                           | ** ** | **of Year**      | ** ** | **Expenses**        | ** ** | **Allowance**  | ** ** | **of Year** | ** ** |
|                                                 |       |                  |       |                |       |           |       |             |       |
| Allowance for cash discounts:                        |       |                  |       |                |       |           |       |             |       |
| Year ended July 31, 2006                             |       | $                     | 157        |                | $          | 2,695          |       | $                | (2,672     | ) | $ | 180 |   |
| Year ended July 31, 2005                             |       | 159                   |       | 2,560               |       | (2,562         | )          | 157              |       |
| Year ended July 31, 2004                             |       | 126                   |       | 2,334               |       | (2,301         | )          | 159              |       |
|                                                 |       |                  |       |                |       |           |       |             |       |
| Allowance for doubtful accounts:                     |       |                  |       |                |       |           |       |             |       |
| Year ended July 31, 2006                             |       | $                     | 1,350      |                | $          | 640            |       | $                | (1,090     | ) | $ | 900 |   |
| Year ended July 31, 2005                             |       | 1,050                 |       | 399                 |       | (99            | )          | 1,350            |       |
| Year ended July 31, 2004                             |       | 886                   |       | 283                 |       | (119           | )          | 1,050            |       |
|                                                 |       |                  |       |                |       |           |       |             |       |
| Allowance for cash discounts and doubtful  accounts: |       |                  |       |                |       |           |       |             |       |
| Year ended July 31, 2006                             |       | $                     | 1,507      |                | $          | 3,335          |       | $                | (3,762     | ) | $ | 1,080 |   |
| Year ended July 31, 2005                             |       | 1,209                 |       | 2,959               |       | (2,661         | )          | 1,507            |       |
| Year ended July 31, 2004                             |       | 1,012                 |       | 2,617               |       | (2,420         | )          | 1,209            |       |

 

*Inventories*

 

Inventories are stated at the lower of cost or market, determined on afirst-in, first-out (FIFO) basis, using product specific standard costs. Themajor components of inventories as of July 31, 2006 and 2005 are as follows (inthousands):

 
| ** **                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
|                        |       |     |       |     |       |
| Finished goods              |       | $        | 19,589     |     | $          | 20,840 |   |
| Raw materials and packaging |       | 6,529    |       | 7,262    |       |
|                        |       |     |       |     |       |
|                        |       | $        | 26,118     |     | $          | 28,102 |   |

 

33

----

 

*Concentration of Sources of Labor*

 

The Company’s total hourly and salaried workforce consists ofapproximately 416 employees, of which 32% are covered by collective bargainingagreements. The expiration dates of the union contracts are December 1, 2007and September 30, 2008.

 

*Property and Equipment*

 

Property and equipment are stated at cost. Expenditures for renewalsand improvements that significantly add to the productive capacity or extendthe useful life of an asset are capitalized. Expenditures for maintenance andrepairs are charged to expense as incurred. When depreciable properties are retiredor sold, the cost and related accumulated depreciation are eliminated from theaccounts and the resultant gain or loss is reflected in income. Interest iscapitalized on construction projects of higher cost and longer duration.

 

The initial acquisition of land by the Company was stated at theestimated fair value of the land at acquisition. Subsequent land acquisitionsare recorded at cost.

 

Depreciation is provided for over the estimated useful lives of theindividual assets using the straight-line method. The estimated useful livesused in the computation of depreciation expense range from 3 to 40 years.Depreciation expense totaled $5,686,000, $5,357,000 and $5,759,000 for theyears ended July 31, 2006, 2005 and 2004, respectively.

 

Details relative to property and equipmentare as follows (in thousands):

 
| ** **                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
|                              |       |     |       |     |       |
| Land and improvements             |       | $        | 2,934      |     | $          | 2,934 |   |
| Buildings                         |       | 22,899   |       | 22,713   |       |
| Equipment                         |       | 98,202   |       | 85,747   |       |
|                              |       |     |       |     |       |
| Property and equipment in service |       | 124,035  |       | 111,394  |       |
| Construction in progress          |       | 4,093    |       | 7,350    |       |
| Less accumulated depreciation     |       | (57,198  | )          | (52,286  | )          |
|                              |       |     |       |     |       |
|                              |       | $        | 70,930     |     | $          | 66,458 |   |

 

*Investmentin Cooperative Bank*

 

Investment in cooperative bank is stated at cost, plus unredeemedpatronage refunds received in the form of capital stock.

 

*Other Assets*

 

The Company capitalizes package design costs,which relate to certain third party costs to design artwork and to produce dieplates and negatives necessary to manufacture and print packaging materialsaccording to Company and customer specifications. These costs are amortizedratably over three to five year periods based on estimated useful life. Minorrevisions are expensed as incurred. If a product design is discontinued orreplaced prior to the end of the amortization period, the remaining unamortizedbalance is charged to expense. Package design costs are presented net ofaccumulated amortization totaling $4,849,000 and $4,381,000 as of July 31, 2006and 2005, respectively.

 

34

----

 

Prepaid marketing costs relate to paymentsmade to certain customers covering contract terms and pricing for varyingperiods extending beyond one year. These costs are amortized in proportion tosales volumes over the term of the agreement.

 

The breakdown of other assets, net of accumulated amortization, is asfollows (in thousands):

 
| ** **              | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
|                    |       |     |       |     |       |
| Package design costs    |       | $        | 555        |     | $          | 862 |   |
| Prepaid marketing costs |       | —   |       | 300      |       |
| Other                   |       | 640      |       | 339      |       |
|                    |       |     |       |     |       |
|                    |       | $        | 1,195      |     | $          | 1,501 |   |

 

*Accrued Liabilities*

 

Accrued liabilities consist of the following(in thousands):

 
| ** **                | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |
| Accrued promotional costs |       | $        | 2,213      |     | $          | 2,752 |   |
| Accrued interest          |       | 664      |       | 778      |       |
| Accrued freight           |       | 418      |       | 527      |       |
| Other                     |       | 2,662    |       | 2,172    |       |
|                      |       |     |       |     |       |
|                      |       | $        | 5,957      |     | $          | 6,229 |   |

 

*Shipping and Handling Costs*

 

Shipping and handling costs are included incost of goods sold upon shipment of the Company’s product to itscustomers.

 

*Advertising*

 

Costs of advertising are expensed as incurred. Advertising expensesincluded in the consolidated income statement totaled $2,808,000 and $5,062,000(primarily related to consumer advertising for DreamfieldsTM pasta products) for the year ended July 31,2006 and July 31, 2005, respectively, and were immaterial for the fiscal yearended July 31, 2004.

 

*Research and Development*

 

Research and development costs are expensed as incurred. Research anddevelopment expenses included in the consolidated income statement for theyears ended July 31, 2006 and July 31, 2005 totaled $730,000 and $1,059,000, respectively,including $229,000 and $551,000, respectively, incurred by DNA Dreamfieldswhich the Company began to consolidate in fiscal year 2005. Research anddevelopment expenses totaled $152,000 for the year ended July 31, 2004.

 

35

----

 

*Interest Expense, Net*

 

The Company earns patronage refunds from its patronage-based debtissued through CoBank based on its share of the net interest income earned byCoBank. These patronage refunds received are applied against interest expense.

 

*Income Taxes*

 

Income taxes are provided for the tax effects of transactions reportedin the financial statements and consist of taxes currently due plus deferredtaxes. Deferred tax assets and liabilities are determined based on differencesbetween the financial reporting and tax bases of assets and liabilities, andare measured using the enacted tax rates expected to apply when the differencesare expected to reverse. Deferred tax assets and liabilities represent thefuture tax return consequences of those differences, which will either betaxable or deductible when the assets and liabilities are recovered or settled.

 

*Stock Options*

 

Effective August 1, 2005, the Companyadopted Statement of Financial Accounting Standard No. 123 (revised 2004),“Share Based Payment” (SFAS No. 123R). Under SFAS No. 123R, theCompany is required to recognize, as expense, the estimated fair value of allshare based payments to employees. In accordance with this standard, theCompany has elected to recognize the compensation cost of all service basedawards on a straight-line basis over the vesting period of the award.Performance based awards are recognized ratably for each vesting tranche.

 

Prior to adopting SFAS No. 123R, the Companyhad elected to follow Accounting Principles Board Opinion (APB) No. 25,“Accounting for Stock Issued to Employees” and related interpretations inaccounting for its employee stock options and had adopted the pro formadisclosure requirements under SFAS No. 123, “Accounting for Stock-BasedCompensation.” Prior to August 1, 2005, the Company had not recognized anycompensation expense under APB No. 25 upon the granting or exercise of stockoptions because the exercise price was equal to or greater than the marketprice of the underlying stock on the date of grant.

 

*Earnings per Share*

 

Basic Earnings per Share (EPS) is calculatedby dividing net earnings on common stock by the weighted average number ofcommon shares effective and outstanding during the period. Diluted EPS includesthe effect of all potentially dilutive securities, such as options andconvertible preferred stock.

 

Dilutive securities, consisting of stockoptions and convertible preferred stock, included in the calculation of dilutedweighted average common shares totaled 386,000 shares, 380,000 shares and360,000 shares for the years ended July 31, 2006, 2005 and 2004, respectively.As there is currently no established public trading market for the Company’scommon stock, the Company has assumed the proceeds from the exercise of stockoptions would reduce debt and, thus, interest expense for purposes ofcalculating diluted EPS.

 

##### *RecentlyIssued Accounting Standards*

##### * *

The FASB issued SFAS No. 151, “InventoryCosts, an amendment of ARB 43, Chapter 4” in November 2004. This Statementamends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarifythe accounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage) so as to require such costs to be treatedas current period charges. Further, this Statement requires that the allocationof fixed overhead costs to the inventoriable production costs be based on thenormal capacity of the production facilities. The provisions of this Statementare effective for inventory costs incurred during fiscal years beginning afterJune 15, 2005. The Company adopted SFAS No. 151 in the quarter ended October31, 2005. The adoption of this

 

36

----

 

statement did not have a material impact onthe Company’s financial statements. However, future changes in the Company’sproduction or logistics could have a material impact on the Company’s financialstatements as a result of this statement.

 

In June 2006, the FASBissued FASB Interpretation No. 48 (FIN No. 48), “Accounting forUncertainty in Income Taxes – an Interpretation of FASB Statement No. 109”,which clarifies the accounting for uncertainty in income taxes recognized inaccordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48clarifies the application of SFAS No. 109 by defining criteria that anindividual tax position must meet for any part of the benefit of that positionto be recognized in the financial statements. Additionally, FIN No. 48provides guidance on the measurement, de-recognition, classification anddisclosure of tax positions along with the accounting for the related interestand penalties. The provisions of FIN No. 48 are effective for the fiscalyears beginning after December 15, 2006, with the cumulative effect of thechange in accounting principle recorded as an adjustment to opening retainedearnings. The Company will be required to adopt FIN No. 48 for its fiscalyear beginning August 1, 2007. The Company does not expect this Statementto have a material impact on its financial statements upon adoption. However,future changes in the Company’s income tax situation may have a material impacton the Company’s financial statements as a result of this Statement.

 

**NOTE 2 - DNA DREAMFIELDS COMPANY, LLC**

 

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 DreamfieldsTMbrand name. The Company initially acquired a 24% ownershipinterest in DNA Dreamfields during fiscal year 2004. At that time, the Companyaccounted for the investment using the equity method after reviewing theapplicability of FIN 46(R) to the Company’s interest in DNA Dreamfields. TheCompany increased it economic ownership in DNA Dreamfields to 29.5% in November2004.

 

The Company acquired an additional 17.25% ownership interest in DNADreamfields effective May 1, 2005, resulting in an increase in the Company’sownership in DNA Dreamfields to 46.7%. Inconjunction with the Company’s increase in ownership in DNA Dreamfields, theDNA Dreamfields operating agreement was amended whereby Dakota Growers wasnamed the managing member of DNA Dreamfields. As a result of theownership increase and changes in the DNA Dreamfields operating agreement andother contractual agreements, the Company reevaluated whether DNA Dreamfieldswas a variable interest entity under FIN 46(R). The Company determined that DNADreamfields was a variable interest entity and that the Company was the primarybeneficiary. Therefore, effective May 1, 2005, the Company began toinclude DNA Dreamfields in its consolidated financial statements. Goodwilltotaling $16,654,000 was recorded in conjunction with the Company’s consolidationof DNA Dreamfields. The financial statements for prior fiscal years have notbeen restated and therefore do not include consolidated data pertaining to DNADreamfields. The Company has included consolidated amounts for DNA Dreamfieldsin the income statements for the years ending July 31, 2006 and July 31, 2005.The Company had previously accounted for its investment in and share of netearnings or losses of its ownership interest in DNA Dreamfields Company, LLCunder the equity method. The net loss allocated from joint venture on theincome statement for the year ended July 31, 2004 represent amounts reportedunder the equity method.

 

37

----

 

Following is summary balance sheet information for DNA Dreamfields asof April 30, 2005 prior to consolidation (in thousands):

 
| Current assets                        |   | $      |  267 |   |
|--------------------------------------------|--------|--------|-----------|--------|
|                                       |   |   |      |
| Current liabilities                        |   | $      | 239       |   |
| Members’ equity                       |   | 28     |      |
|                                       |   |   |      |
| Total liabilities and members’ equity |   | $      | 267       |   |

 

Following are summary pro forma consolidated results of operations asif DNA Dreamfields were consolidated for the year ended July 31, 2004 (inthousands except earnings per share):

 
| Net revenues                        |   | $      | 144,560 |   |
|-------------------------------------|--------|--------|---------|--------|
| Gross profit                        |   | 14,879 |    |
| Operating income                    |   | 806    |    |
| Net income                          |   | 336    |    |
| Basic net earnings per common share |   | 0.03   |    |

 

The Company has entered into amanufacturing agreement with DNA Dreamfields whereby Dakota Growers is theexclusive manufacturer of DreamfieldsTM pasta. The Company has also entered intoa services agreement with DNA Dreamfields under which the Company providesadministrative, accounting, information technology, sales, customer service anddistribution services to DNA Dreamfields. Shipments of DreamfieldsTM pasta began in February 2004.

 

Pursuant to the terms of theservices agreement with DNA Dreamfields, sales of DreamfieldsTM products are included in theCompany’s net revenues. Manufacturing, distribution, and promotional costsincurred by the Company related to DreamfieldsTM products are included in the applicableline items of the Company’s income statement. The Company calculates a netamount due to DNA Dreamfields based on the total sales of DreamfieldsTM product less relatedDreamfieldsTM product andselling costs, as outlined in the manufacturing agreement. Prior toconsolidating DNA Dreamfields in its financial statements, the Companypresented this net amount due to DNA Dreamfields, which totaled $2,712,000 forthe year ended July 31, 2004, in the Company’s cost of goods sold. Service feeincome from DNA Dreamfields totaling $119,000 for the year ended July 31, 2004is included in net revenues. All material inter-company accounts andtransactions have been eliminated in the preparation of the consolidatedfinancial statements as of and for the years ended July 31, 2006 and 2005.

 

The Company entered into a “2005Line of Credit Loan Agreement” with DNA Dreamfields in the fourth quarter offiscal year 2005. Under that Agreement, the Company has agreed to loan upto $5,000,000 to DNA Dreamfields, with DNA Dreamfields able to repay andreborrow amounts under the Line of Credit Loan Agreement from time totime. The Line of Credit Loan Agreement matures on May 31,2010. The balance outstanding related to advances to DNA Dreamfields underthe Line of Credit Loan Agreement totaled $2,184,000 and $465,000 as of July31, 2006 and July 31, 2005, respectively. These amounts have been eliminated inthe preparation of the consolidated financial statements. To secure theobligations of DNA Dreamfields under the 2005 Line of Credit Loan Agreement, theother member/owners of DNA Dreamfields have pledged their Membership Units inDNA Dreamfields to the Company.

 

38

----

 

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

** **

Effective June 1, 2006, the Company secured a $25 million revolvingcredit facility with CoBank that extends through May 30, 2007. Interest on therevolving line is currently charged at a variable rate established by CoBankbased on CoBank’s cost of funds, although the facility also allows for a fixedrate option. There was no balance outstanding under this revolving line ofcredit arrangement as of July 31, 2006. However, the balance outstanding was$10.0 million as of July 31, 2005. The Company had $25.0 million availablefor borrowings under the line of credit as of July 31, 2006. Weighted averageinterest rates on short-term borrowings were 6.40%, 4.84% and 3.50% for theyears ended July 31, 2006, 2005 and 2004, respectively.

 

**NOTE 4 - LONG-TERM DEBT**

 

Information regarding long-term debt at July 31, 2006 and 2005 is asfollows (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| 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                                                                                                         |       | 3,600    |       | 4,800    |       |
|                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| 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                                                                                                      |       | 7,716    |       | 10,287   |       |
|                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| 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                                                                                                      |       | 5,000    |       | 6,000    |       |
|                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Term loan from CoBank due in quarterly  installments of $500,000 for four quarters starting August 20, 2006 and of $1,100,000  quarterly thereafter through May 20, 2011, variable interest (5.59% at July  31, 2005; 7.59% at July 31, 2006), collateralized by all assets of the  Company |       | 19,000   |       | 9,069    |       |
|                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Total long-term debt                                                                                                                                                                                                                                                                        |       | 35,316   |       | 30,156   |       |
| Less current portion                                                                                                                                                                                                                                                                        |       | 6,771    |       | 4,771    |       |
|                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Net long-term debt                                                                                                                                                                                                                                                                          |       | $        | 28,545     |     | $          | 25,385 |   |
|                                                                                                                                                                                                                                                                                             |            |          |            |          |            |  |  |

 

39

----

 

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

 
| **Years ending July 31,** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|------------|------------|------------|
|                                     |       |       |       |
| 2007                                     |       | 6,771      |       |
| 2008                                     |       | 9,171      |       |
| 2009                                     |       | 9,174      |       |
| 2010                                     |       | 5,400      |       |
| 2011                                     |       | 4,800      |       |
| Thereafter                               |       | —     |       |
|                                     |       |       |       |
|                                     |       | $          | 35,316     |       |
|                                          |            |            |            |            |  |

 

The Company has a $3,600,000 letter of creditcommitment with CoBank, securing the non-patronage loan from CoBank. The letterof credit commitment is subject to a commitment fee of 1.0% on an annualizedbasis and expires December 31, 2008. Advances on the letter of creditcommitment are payable on demand.

 

The Company’s debt agreementswith CoBank and the institutional note holders obligate the Company to maintainor achieve certain amounts of equity and financial ratios and imposerestrictions on the Company. The Company was in compliance with these financialcovenants as of July 31, 2006.

 

The Company incurred $2,960,000, $2,518,000and $2,879,000 of interest on long and short-term debt and other obligations infiscal years 2006, 2005 and 2004, respectively, of which $243,000, $121,000 and$14,000 was capitalized in the respective periods. Patronage income from CoBankof $144,000, $114,000 and $103,000 was netted against interest expense on thestatement of operations for the years ended July 31, 2006, 2005 and 2004,respectively.

 

**NOTE 5 - STOCKHOLDERS’ EQUITY**

 

The Company is authorized to issue 75,000,000shares of Common Stock, $.01 par value per share, 2,731 shares of Series CPreferred Stock, $100 par value per share, 11,340,841 shares of Series DDelivery Preferred Stock, $.01 par value per share, 130,000 shares of Series EJunior Participating Preferred Stock, $.01 par value per share, and 13,525,370****shares of undesignated preferred stock, $.01 par value pershare.

 

Holders of Series C Preferred Stock shall receive payment of anon-cumulative annual dividend at the rate of 6% of the $100 par value on eachshare of Series C Preferred Stock. 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 shall be proportionatelyadjusted at any time the outstanding shares of Common Stock are increased ordecreased without payment by or to the Company or the Company’s shareholders.

 

Each share of Series D Delivery Preferred Stock of the Company givesits holder the privilege, but not the obligation, to deliver one bushel of durumwheat to the Company each year on a “first-come, first-served” basis. Becausethe privilege of a holder of Series D Delivery Preferred Stock to deliver durumwheat to the Company only arises if the Company requires durum, the privilegeis not absolute. Holders of Series DDelivery Preferred Stock will be entitled to receive, if and when declared bythe Board of Directors, a non-cumulative annual dividend of up to $.04 pershare on each share of Series D Delivery Preferred Stock held by such holder. TheCompany must pay holders of Series D Delivery Preferred Stock a dividend of atleast $.01 per share before paying any dividends on Common Stock.

 

40

----

 

The Board of Directors of the Company adopted a Rights Plan that becameeffective July 1, 2002. Under the Rights Plan, the Board of Directors of theCompany has declared a dividend of one purchase right (a “Right”) for eachoutstanding share of Common Stock held. 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. Inthose events, each Right will entitle the holder (other than the acquiring personor group) to receive, upon exercise, common shares of either the Company or theacquiring company having value equal to two times the exercise price of theRight. The Rights issued under the Rights Plan will be redeemable by theCompany’s Board of Directors in certain circumstances and will expire ten yearsfrom the date of adoption.

 

On July 30, 2004, the Company completed the sale of 909,091 shares ofCommon Stock, which included 294,456 shares of Common Stock held in treasury atthat time, to MVC Capital, Inc.

 

On December 15, 2005, the Company’s Board of Directors authorized thepayment of $0.04 per share dividend on its Series D Delivery Preferred Stockand a non-periodic dividend payment of $0.04 per share on its common stock,payable on January 10, 2006 to shareholders of record as of December 19, 2005.

 

**NOTE 6 - MANDATORILY REDEEMABLE PREFERRED STOCK**

 

The Company adopted SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity” effective August1, 2003. SFAS No. 150 establishes standards for how an issuer classifies andmeasures certain financial instruments with characteristics of both liabilitiesand equity. Many of these instruments were previously classified as equity.SFAS No. 150 requires that an issuer classify a financial instrument that iswithin its scope as a liability, or as an asset in some circumstances. ThisStatement applies to three types of freestanding financial instruments. Onetype of financial instrument to which SFAS No. 150 applies is mandatorilyredeemable shares, which the issuing company is obligated to buy back inexchange for cash or assets.

 

The Company is authorized to issue 533 shares of Series A PreferredStock, $100 par value per share. The Company had 0 and 67 shares of Series APreferred Stock outstanding as of July 31, 2006 and 2005 respectively. TheSeries A Preferred Stock was required to be redeemed ratably on a quarterlybasis through December 2005. Each share of Series A Preferred Stock entitledits holder to receive a cumulative annual dividend of 6% of the $100 par valueper share. As the shares of Series A Preferred Stock were mandatorilyredeemable, these shares were classified as a liability in the Company’sconsolidated balance sheet and “dividends” paid on the Series A Preferred Stockwere recorded as interest expense upon adoption of SFAS No. 150. “Dividends”paid on Series A Preferred Stock prior to the adoption of SFAS No. 150 were notreclassified as interest cost.

 

**NOTE 7 - EMPLOYEE BENEFIT PLANS**

 

Dakota Growers Pasta Company, Inc. and Primo Piatto, Inc. have a 401(k)plan that covers employees who have met age and service requirements. The plancovers employees who have reached 18 years of age and who have completed 500hours of service within six months. The Company matches 100% on the first 3% ofthe employees’ elected deferral and 50% on the next 2%. Employer contributionsto the plan totaled $499,000, $437,000 and $377,000 for the years ended July31, 2006, 2005 and 2004, respectively.

 

Primo Piatto, Inc. is also required tocontribute to a multi-employer pension plan covering certain hourly employeessubject to a collective bargaining agreement. Such employees may alsoparticipate in the 401(k) plan

 

41

----

 

but are excluded from amounts contributed byPrimo Piatto. Contributions to the pension plan for the years ended July 31,2006, 2005 and 2004 totaled $83,000, $51,000 and $60,000, respectively.

 

**NOTE 8 - INCOME TAXES**

 

Significant components of the Company’sdeferred tax assets and liabilities as of July 31, 2006 and 2005 related totemporary differences are as follows (in thousands):

 
| ** **                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
|                                |       |     |       |     |       |
| Deferred tax assets                 |       |     |       |     |       |
| AMT credit carryforward             |       | $        | —     |     | $          | 851 |   |
| Accounts receivable allowances      |       | 421      |       | 588      |       |
| Accrued expenses and other reserves |       | 534      |       | 367      |       |
| Other                               |       | 68       |       | 138      |       |
| Total deferred tax assets           |       | 1,023    |       | 1,944    |       |
|                                |       |     |       |     |       |
| Deferred tax liabilities            |       |     |       |     |       |
| Property and equipment              |       | (12,485  | )          | (12,408  | )          |
|                                |       |     |       |     |       |
| Net deferred tax liabilities        |       | $        | (11,462    | )        | $          | (10,464 | ) |

 

Classified in theaccompanying balance sheets as follows:

 
| ** **                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Current assets               |       | $        | 955        |     | $          | 955 |   |
| Noncurrent liabilities       |       | (12,417  | )          | (11,419  | )          |
|                         |       |     |       |     |       |
| Net deferred tax liabilities |       | $        | (11,462    | )        | $          | (10,464 | ) |

 

At July 31, 2005, the Company had an AMT credit carryforward of$851,000, which is being utilized in the year ended July 31, 2006. Managementbelieves it is more likely than not that the deferred tax assets as of July 31,2006 will be realized through the generation of future taxable income and taxplanning strategies.

 

Income tax expense for the years ended July 31, 2006, 2005 and 2004consists of the following (in thousands):

 
| ** **                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |     |       |
| Current income tax expense |       | $        | 1,795      |     | $          | 568      |       | $ | 64 |   |
| Deferred income taxes      |       | 998      |       | 1,038    |       | 150      |       |
|                       |       |     |       |     |       |     |       |
| Income tax expense         |       | $        | 2,793      |     | $          | 1,606    |       | $ | 214 |   |

 

42

----

 

The reconciliation ofthe federal statutory income tax rate to the effective income tax rate for theyears ended July 31, 2006, 2005 and 2004 is as follows:

 
| ** **                                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal statutory income tax rate                     |       | 34.0     | %          | 34.0     | %          | 34.0     | %          |
| State income taxes, net of federal income  tax effect |       | 5.0      |       | 5.0      |       | 5.0      |       |
|                                                  |       |     |       |     |       |     |       |
| Effective income tax rate                             |       | 39.0     | %          | 39.0     | %          | 39.0     | %          |

 

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

 

The fair value of a financial instrument is generally defined as theamount at which the instrument could be exchanged in a current transactionbetween willing parties, other than in a forced liquidation sale. Quoted marketprices are generally not available for the Company’s financial instruments.Accordingly, fair values are based on judgments regarding anticipated cashflows, future expected loss experience, current economic conditions, riskcharacteristics of various financial instruments and other factors. Theseestimates involve uncertainties and matters of judgment, and therefore cannotbe determined with precision. Changes in assumptions could significantly affectthe estimates.

 

The carrying amount of cash and cashequivalents, receivables, payables, short-term debt and other current assetsand liabilities approximates fair value because of the short maturity and/orfrequent repricing of those instruments.

 

The Company believes it is not practical to estimate the fair value ofthe securities of non-subsidiary cooperatives without incurring excessive costsbecause there is no established market for these securities and it isinappropriate to estimate future cash flows, which are largely dependent onfuture patronage earnings of the non-subsidiary cooperatives.

 

Based upon current borrowing rates with similar maturities, the fairvalue of the long-term debt approximates the carrying value as of July 31, 2006and 2005.

 

**NOTE 10 - OPERATING LEASES**

** **

The Company leases equipment and office space under operating leaseagreements. Future obligations for operating leases for fiscal years ended July31 are as follows (in thousands):

 
| 2007       |   | $      |  954 |   |
|------------|--------|--------|-----------|--------|
| 2008       |   | 229    |      |
| 2009       |   | 153    |      |
| 2010       |   | 73     |      |
| 2011       |   | 14     |      |
| Thereafter |   | — |      |
|       |   |   |      |
|       |   | $      | 1,423     |   |

 

Lease expense totaled $1,462,000, $1,413,000 and $1,402,000 for theyears ended July 31, 2006, 2005 and 2004, respectively.

 

43

----

 

**NOTE 11 - SALE-LEASEBACK**

** **

The Company entered into a sale-leaseback transaction effective March 29,2002, for certain pasta production equipment. Proceeds from the sale totaled $5million. The lease, which is classified as operating, sets forth an initialterm of five years and calls for lease payments of $72,000 per month. At theend of the initial lease term, the Company may renew the lease at fair rentalvalue, terminate the lease and surrender the equipment with the payment of a10% of equipment 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 isbeing amortized in proportion to the gross rentals charged to expense over thefive-year lease term. Minimum rentals required under the lease, which are alsoincluded in the future lease obligations disclosed in Note 10, for fiscal yearending July 31, 2007 total $576,000.

 

**NOTE 12 - COMMITMENTS AND CONTINGENCIES**

 

The Company forward contracts for a certainportion of its future durum wheat requirements. At July 31, 2006, the Companyhad outstanding commitments for grain purchases totaling $15,873,000 related toforward purchase contracts. These contracts are set price contracts to delivergrain to the Company’s mill, and are not derivative in nature as they have nonet settlement provision and are not transferable.

 

Pursuant to certain warehouse agreements, theCompany is obligated to minimum monthly storage and handling amounts totaling$1,888,000, and $1,537,000  for the yearsending July 31, 2007, and 2008 respectively.

 

The Company has entered into a long-termmarketing agreement, which includes volume commitments, with Safeway, Inc.through August 31, 2006. The Company has also entered into an agreement withGruppo Euricom, an Italian pasta manufacturer, to be the exclusive distributorof Gruppo Euricom’s Italian pasta and rice products in the United States andCanada with an initial term through August 2006. These products are primarilysold in the private label retail and foodservice markets.

 

The Company is subject to various lawsuits and claims which arise inthe ordinary course of its business. While the results of such litigation andclaims cannot be predicted with certainty, management believes the dispositionof all such proceedings, individually or in aggregate, should not have amaterial adverse effect on the Company’s financial position, results ofoperations or cash flows.

 

**NOTE 13 - STOCK OPTION PLANS**

** **

On January 31, 1997 the Cooperative’s Compensation Committee of theBoard of Directors (the “Compensation Committee”) adopted the Dakota GrowersIncentive Stock Option Plan (the “Plan”). The Plan was ratified by theCooperative members at the annual meeting in January 1998. The CompensationCommittee or the Board of Directors has the power to determine the keymanagement employees of the Company to receive options and the number of sharesto be optioned to each of the employees. Options granted under the Plan are forthe purchase of Series C Convertible Preferred Stock at fair market value,which were convertible into Equity Stock as a cooperative, and are nowconvertible into Common Stock and Series D Delivery Preferred Stock as acorporation at the option of the employee, under the applicable conversionratio. The maximum number of preferred shares that may be issued pursuant tooptions granted under the Plan is 15,000, all of which have been issued. Eachshare of Series C Preferred Stock is convertible into 24 shares of Common Stockand 24 shares of Series D Delivery Preferred Stock of the Company. Theconversion ratio is proportionately adjusted if the Company increases theoutstanding shares of Common Stock or Series D Delivery Preferred Stock, asapplicable, without payment by or to the Company or the Company’s shareholdersfor such additional shares (e.g. stock split, stock dividend or other action).Options granted under the Plan must be exercised within ten years from the datesuch

 

44

----

 

options are granted. In the event of the employee’s termination withthe Company, 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 “2002Plan”) was adopted by the Board of Directors on November 21, 2002. All optionsgranted under the 2002 Plan are non-qualified stock options and are for thepurchase of the Company’s Common Stock. The maximum number of shares of CommonStock that may be issued pursuant to options granted under the 2002 Plan is294,456 shares, all of which have been issued. Stock options granted under the2002 Plan expire 10 years from the date of grant.

 

On November 21, 2002 the Board of Directors adopted the Dakota GrowersPasta Company, Inc. 2003 Stock Option Plan (the “2003 Plan”), which wasapproved by the Company’s shareholders at the Annual Meeting on January 11,2003. The 2003 Plan covers 500,000 shares of the Company’s Common Stock.Participation in this Plan shall be limited to officers, directors, employees,vendors or consultants of the Company or any subsidiary of the Company. Optionsgranted under the 2003 Plan may be incentive stock options (as defined underSection 422 of the Code) or non-qualified stock options, as determined by the2003 Plan administrator at the time of grant of an option and subject to theapplicable provisions of Section 422 of the Code and the regulationspromulgated there under. The stock options generally expire 10 years from thedate of grant. If the employment of the Optionee is terminated by any reasonother than his or her death or disability, all exercisable options may beexercised within 90 days of the termination date. If not exercised, suchoptions lapse.

 

45

----

 

The followingtables set forth information regarding stock options outstanding andexercisable:

 
| ** **                   | ** ** | **Options to purchase Series C Convertible Preferred Stock** | ** ** |
|------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **Number of**                                                                              | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Series C**                                                                               | ** ** | **Option** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Convertible**                                                                                 | ** ** | **Price** | ** ** | **Exercise** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Preferred Shares**                                                                       | ** ** | **per Share** | ** ** | **Price** | ** ** | **Exercisable** | ** ** |
|                         |       |                                                                                            |       |   |   |   |   |   |   |
| Outstanding at July 31, 2003 |       | 2,731                                                                                           |       | $100-$150 |   | $ | 112.56 |   | 2,731 |   |
| Exercised                    |       | —                                                                                          |       |   |   |   |   |   |   |
| Granted                      |       | —                                                                                          |       |   |   |   |   |   |   |
| Forfeited/Expired            |       | —                                                                                          |       |   |   |   |   |   |   |
| Outstanding at July 31, 2004 |       | 2,731                                                                                           |       | $100-$150 |   | $ | 112.56 |   | 2,731 |   |
| Exercised                    |       | —                                                                                          |       |   |   |   |   |   |   |
| Granted                      |       | —                                                                                          |       |   |   |   |   |   |   |
| Forfeited/Expired            |       | —                                                                                          |       |   |   |   |   |   |   |
| Outstanding at July 31, 2005 |       | 2,731                                                                                           |       | $100-$150 |   | $ | 112.56 |   | 2,731 |   |
| Exercised                    |       | —                                                                                          |       |   |   |   |   |   |   |
| Granted                      |       | —                                                                                          |       |   |   |   |   |   |   |
| Forfeited/Expired            |       | (754                                                                                            | )          | $100 |   | $ | 100 |   |   |   |
| Outstanding at July 31, 2006 |       | 1,977                                                                                           |       | $100-$150 |   | $ | 117.35 |   | 1,977 |   |

 
| ** **                   | ** ** | **Options to purchase Common Stock** | ** ** |
|------------------------------|------------|----------------------------------------------------------|------------|
| ** **                   | ** ** | ** **                                               | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                                               | ** ** | **Option** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Number of**                                       | ** ** | **Price** | ** ** | **Exercise** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Common Shares**                                   | ** ** | **per Share** | ** ** | **Price** | ** ** | **Exercisable** | ** ** |
|                         |       |                                                     |       |   |   |   |   |   |   |
| Outstanding at July 31, 2003 |       | 294,456                                                  |       | $6.25 |   | $ | 6.25 |   | 294,456 |   |
| Exercised                    |       | —                                                   |       |   |   |   |   |   |   |
| Granted                      |       | 80,524                                                   |       | $4.25 |   | $ | 4.25 |   |   |   |
| Forfeited/Expired            |       | —                                                   |       |   |   |   |   |   |   |
| Outstanding at July 31, 2004 |       | 374,980                                                  |       | $4.25-$6.25 |   | $ | 5.82 |   | 294,456 |   |
| Exercised                    |       | —                                                   |       |   |   |   |   |   |   |
| Granted                      |       | —                                                   |       |   |   |   |   |   |   |
| Forfeited/Expired            |       | —                                                   |       |   |   |   |   |   |   |
| Outstanding at July 31, 2005 |       | 374,980                                                  |       | $4.25-$6.25 |   | $ | 5.82 |   | 334,722 |   |
| Exercised                    |       | —                                                   |       |   |   |   |   |   |   |
| Granted                      |       | 141,256                                                  |       | $4.00 |   | $ | 4.00 |   |   |   |
| Forfeited/Expired            |       | (130,399                                                 | )          | $4.00-$6.25 |   | $ | 5.81 |   |   |   |
| Outstanding at July 31, 2006 |       | 385,837                                                  |       | $4.00-$6.25 |   | $ | 5.16 |   | 242,517 |   |

 

Effective August 1, 2005, the Companyadopted Statement of Financial Accounting Standard No. 123 (revised 2004),“Share Based Payment” (SFAS No. 123R). Under SFAS No. 123R, theCompany is required to recognize, as expense, the estimated fair value of allshare based payments to employees. In accordance with this standard, theCompany has elected to recognize the compensation cost of all service basedawards on a straight-line basis over the vesting period of the award.Performance based awards are recognized ratably for each vesting tranche. Forthe year ended July 31, 2006, the Company recorded stock-based employeecompensation expense of $65,000.

 

46

----

 

Prior to adopting SFAS No.123R, the Company had elected to follow Accounting Principles Board Opinion(APB) No. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations in accounting for its employee stock options and had adoptedthe pro forma disclosure requirements under SFAS No. 123, “Accounting forStock-Based Compensation.” Prior to August 1, 2005, the Company had notrecognized any compensation expense under APB No. 25 upon the granting orexercise of stock options because the exercise price was equal to or greaterthan the market price of the underlying stock on the date of grant.

 

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: 2006 -risk free interest rate of 4.4%, expected dividend yield of 1.0%, expected lifeof 5 years and volatility of 30%; 2004 - risk free interest rate of 2.3%,expected dividend yield of zero and an expected life of 3 years. The pro formaapplication of Statement of Financial Accounting Standard (SFAS) No. 123“Accounting for Stock-Based Compensation” would not have had a material impacton net income and earnings per share for the years ended July 31, 2005 and2004.

 

A summary of the status of the Company’s issuedbut nonvested stock options as of July 31, 2006, and changes during the yearended July 31, 2006, is presented below:

 
| ** **                       | ** ** | ** ** | ** ** | **Weighted-Average** | ** ** |
|----------------------------------|------------|------------|------------|----------------------|------------|
| ** **                       | ** ** | **Common** | ** ** | **Grant-Date**       | ** ** |
| **Nonvested Stock Options** | ** ** | **Shares** | ** ** | **Fair Value**  | ** ** |
|                             |       |       |       |                 |       |
| Nonvested at August 1, 2005      |       | 40,258     |       | $                    | 4.25       |   |
| Granted                          |       | 141,256    |       | $                    | 4.00       |   |
| Vested                           |       | (20,132    | )          | $                    | 4.25       |   |
| Forfeited/Expired                |       | (18,062    | )          | $                    | 4.04       |   |
| Nonvested at July 31, 2006       |       | 143,320    |       | $                    | 4.03       |   |

 

As of July 31, 2006, there was approximately $120,000 of totalunrecognized compensation cost related to nonvested employee stockoptions.  That cost is expected to be recognized over a period of 2.9years.

 

**NOTE 14 - RELATED PARTY TRANSACTIONS**

 

Amounts due from executive officers totaled$47,000 and $82,000 as of July 31, 2006 and 2005, respectively.

 

**NOTE 15 - CONTINUED DUMPING AND SUBSIDY OFFSET ACTOF 2000**

 

U.S. Customs and Border Protection (“Customs”) has distributedantidumping and countervailing duties assessed on certain pasta imported fromItaly and Turkey to affected domestic producers pursuant to the ContinuedDumping and Subsidy Offset Act of 2000 (the “Offset Act”), which was enacted inOctober 2000. The Company received payments in the amount of $1,103,000,$425,000 and $903,000 in December 2005, 2004 and 2003, respectively, under theOffset Act. The Company repaid $305,000 to Customs in April 2004, pursuant to areclamation request from Customs. The net proceeds received under the OffsetAct have been classified as Other Income on the Income Statement. The Companycannot reasonably estimate the potential amount, if any, that it may receiveunder the Offset Act in future periods as any such amount will be based uponfuture events over which the Company has little or no control, including, butnot limited to, the amount of expenditures by domestic pasta producers and theamount of antidumping and countervailing duties collected by Customs.

 

47

----

 

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

 

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

 
| ** **                                 | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|--------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                 | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
|                                       |       |        |       |        |       |        |       |        |       |
| Year ended July 31, 2006:                  |       |        |       |        |       |        |       |        |       |
|                                       |       |        |       |        |       |        |       |        |       |
| Net revenues                               |       | $           | 44,072     |        | $          | 42,490      |       | $           | 41,968     |   | $ | 42,979 |   |
| Gross profit                               |       | 5,240       |       | 4,366       |       | 6,403       |       | 6,596       |       |
| Operating income                           |       | 1,372       |       | 120         |       | 3,047       |       | 3,876       |       |
| Net income                                 |       | 399         |       | 617         |       | 1,487       |       | 1,870       |       |
| Basic net earnings per common share        |       | 0.03        |       | 0.01        |       | 0.11        |       | 0.15        |       |
|                                       |       |        |       |        |       |        |       |        |       |
| Year ended July 31, 2005:                  |       |        |       |        |       |        |       |        |       |
|                                       |       |        |       |        |       |        |       |        |       |
| Net revenues                               |       | $           | 35,877     |        | $          | 40,698      |       | $           | 39,122     |   | $ | 39,922 |   |
| Gross profit                               |       | 3,980       |       | 4,915       |       | 5,117       |       | 5,428       |       |
| Operating income (loss)                    |       | (1,704      | )          | 824         |       | 1,948       |       | 1,865       |       |
| Net income (loss)                          |       | (185        | )          | 764         |       | 1,004       |       | 930         |       |
| Basic net earnings (loss) per common share |       | (0.01       | )          | 0.06        |       | 0.08        |       | 0.07        |       |

 

The quarterly results for the year ended July31, 2005 are presented on a proforma basis to include the results of operationsof DNA Dreamfields in the consolidated income statement for the entire year.

 

The above quarterly financial data isunaudited, but in the opinion of management, all adjustments necessary for afair presentation of the selected data for these interim periods presented havebeen included.

 

48

----

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

**a) Evaluationof Disclosure Controls and Procedures.**

 

The Company’sChief Executive Officer, Timothy J. Dodd, and Chief Financial Officer, EdwardO. Irion, have evaluated the Company’s disclosure controls and procedures as ofthe end of the period covered by this report. Based upon the review, they haveconcluded that these controls and procedures are effective.

 

**b) Changes inInternal Controls over Financial Reporting.**

 

In conjunction with the resignation of ThomasP. Friezen as the Company’s Chief Financial Officer and the appointment ofEdward O. Irion to the position of Chief Financial Officer on February 21,2006, applicable internal controls over financial reporting were reviewed andchanged as necessary. Mr. Irion most recently served as the Company’s VicePresident – Finance and Chief Accounting Officer. There were no other changesin the Company’s internal controls over financial reporting during the Company’sfiscal year ended July 31, 2006 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**ITEM 9B. OTHER INFORMATION**

 

None.

 

**PART III.**

 

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

**Board of Directors**

 

The Board of Directors currently consists often members. The Board may consist of a minimum of seven members and a maximumof fifteen members. The Articles of Incorporation and Bylaws of the Companyrequire that at least five members of the Board of Directors be residents ofthe State of North Dakota and that at least three members be agriculturalproducers. The Board of Directors isdivided into three classes: Class I, Class II and Class III. Class I,Class II and Class III are to consist of an equal number of directors, exceptthat, if the Board of Directors consists of a number of directors such thatmathematically there cannot be an equal number of directors in each of Class I,Class II and Class III, then the one remaining director shall be made a memberof Class I and, if there is more than one remaining director, the firstremaining director shall be made a member of Class I and the second remainingdirector shall be made a member of Class II. Each director in each of Class I,Class II and Class III will hold office until the third regular meeting ofshareholders following the regular meeting of the shareholders at which suchdirector or such director’s predecessor was elected, until his successor shallhave been elected and shall qualify, or until he resigns or is removed.

 

49

----

 

The table below sets forth certaininformation concerning the directors of the Company. The directors have beenelected to serve three-year terms expiring at the annual meeting in thecalendar years indicated in the table below.

 
| **Name**              | ** ** | **Age** | ** ** | **Term Expires** | ** ** | **Class** | ** ** |
|-----------------------|------------|---------|------------|-----------------------|------------|-----------|------------|
|                  |       |    |       |                  |       |      |       |
| John S. Dalrymple III |       | 58      |       | 2009                  |       | I         |       |
| Allyn K. Hart         |       | 67      |       | 2008                  |       | III       |       |
| Roger A. Kenner (1)   |       | 57      |       | 2007                  |       | II        |       |
| James F. Link         |       | 79      |       | 2009                  |       | I         |       |
| Eugene J. Nicholas    |       | 61      |       | 2007                  |       | II        |       |
| John D. Rice, Jr. (1) |       | 52      |       | 2009                  |       | I         |       |
| Michael T. Tokarz     |       | 56      |       | 2009                  |       | I         |       |
| Jeffrey O. Topp       |       | 47      |       | 2007                  |       | II        |       |
| Curtis R. Trulson     |       | 54      |       | 2008                  |       | III       |       |
| Michael E. Warner     |       | 56      |       | 2008                  |       | III       |       |

 

----

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

 

**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.

 

**Allyn K. Hart.**Mr.Hart has been a director of the Company since 1991. Mr. Hart has served on theboard of directors of Cavalier County Job Development Authority and U.S. Durum Growers Association. He hasbeen a farmer in the Cavalier County, 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 a state representative since 1974, and servesas chairman of the North Dakota House of Representatives Agriculture Committee.Mr. Nicholas also serves on the board of directors of Country Bank USA, Cando,North Dakota, and the board of governors of Golden Plains Frozen Foods LLC. Mr.Nicholas previously served on the board of directors of the U.S. Durum GrowersAssociation.

 

**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 has beena director of the Company since 2004. Mr. Tokarz is the Chairman of MVC Capital, a registered investmentcompany traded on the New York Stock Exchange (Ticker: MVC) that makes equityand debt investments. In addition, Mr. Tokarz is the Managing Member of TheTokarz Group, which manages Mr. Tokarz’s personal investments. From 1985 to2002, Mr. Tokarz was a senior General Partner and Administrative Partner atKohlberg Kravis Roberts & Co., a private equity firm specializing inmanagement buyouts. Prior to joining KKR, Mr. Tokarz was with ContinentalIllinois National Bank and Trust Company of Chicago, joining the firm in 1973.He serves or has served on the Board of Directors of numerous companies,including: Conseco, Inc., Walter Industries, Inc., Mueller Water Products,Inc., Safeway, Inc., IDEX Corporation, PRIMEDIA, Inc., Neway AnchorlokInternational, Inc., Flagstar Corporation, ConAgra Food Corporation, KSLRecreation Corporation, RJR Nabisco Corp, Evenflo & Spalding HoldingsCorporation, Beatrice Foods Corporation, Nexstar Financial Corporation, ApertioLimited (UK), United Fixtures Company, Stonewater Controls, Lomonosov Porcelain(Russia), Kamaz A.O. (Russia). Mr. Tokarz also serves on the Board of theUniversity of Illinois Foundation and its Investment Committee and as Chairmanof its Budget and Finance Committee.  Heis a member of the Board of Managers of Illinois Ventures and Chairman ofIllinois Emerging Technology Fund, both affiliated with the University ofIllinois.

 

**Jeffrey O. Topp.** Mr. Topphas been a director of the Company since 1991. He serves on the board ofdirectors of Farmers Elevator, Inc. in Grace City, North Dakota. He is apartner in T-T Ranch and has been a farmer in the Grace City area since 1978.

 

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

 

**Michael E. Warner.**  Mr.Warner has been a director of the Company since 1992. Mr. Warner has been afarmer in the Hillsboro, North Dakota area since 1967. He also currently serveson the board of directors of Warner Equipment Co. and Agriceutical ResourcesLLC. In 2002, Mr. Warner was awarded a fellowship by the University ofMissouri. He served on the board of directors of American Crystal Sugar Companyfrom 1989 through 1996, as part of a 23-year career of service to the sugarindustry. He is a past member of the board of trustees of Meritcare HealthSystems of Fargo, North Dakota, the largest hospital/multiple clinic systembetween Minneapolis, Minnesota and Seattle, Washington.

 

**Committees of the Board of Directors**

** **

*Audit Committee*. The AuditCommittee is responsible for overseeing the accounting and financial reportingprocesses of the Company and audits of the Company’s financial statements,including assessing and ensuring the independence of the independent auditor,evaluating audit performance, approving the services to be provided by theindependent audit, evaluating policies and procedures relating to internalstatements before issuance, subject to approval by the Board of Directors. TheAudit Committee has the sole authority to retain, compensate, oversee andterminate the independent auditors. The Audit Committee reviews the Company’sannual audited financial statements, quarterly financial statements and filingswith the Securities and Exchange Commission. The Audit Committee reviewsreports on various matters, including critical accounting policies of theCompany, significant changes in the Company’s selection or application ofaccounting principles and the Company’s internal control processes. The AuditCommittee also pre-approves all audit and non-audit services performed by theindependent auditor.

 

The Audit Committee operates under a writtencharter adopted by the Board of Directors. The Company’s Audit Committee presentlyconsists of Messrs. Curtis R. Trulson (Chair), Michael E. Warner and John S.Dalrymple III.  Under the Company’sbylaws, the Audit Committee of the Board of Directors must be composed of atleast three directors who are not employees of the Company. The charter of theAudit Committee requires that members of the Audit Committee must beindependent, and the Board of Directors has determined that all members of theAudit Committee are independent directors. The Board of Directors has alsodetermined that Mr. Trulson meets the Securities and Exchange Commissiondefinition of an “audit committee financial expert.”

 

51

----

 

*Compensation Committee.* TheCompensation Committee operates under a written charter and reviews andapproves the compensation and other terms of employment of the Company’s ChiefExecutive Officer and other senior management of the Company. Among its otherduties, the Compensation Committee is responsible for overseeing the Company’sstock-based compensation plans for executive officers and, in consultation withthe Nomination Committee, making recommendations on succession plans for theChief Executive Officer. The Compensation Committee is to annually review theChief Executive Officer’s compensation and evaluate the Chief Executive Officer’sperformance. The current members of the Compensation Committee are Messrs. JohnS. Dalrymple III (Chair), Curtis R. Trulson and Michael E. Warner.

 

The charter of the Compensation Committeerequires that the Committee consist of independent directors. Each member ofthe Compensation Committee must also be an “outside director” for purposes ofSection 162(m) of the Internal Revenue Code. Each member of the Company’sCompensation Committee meets these requirements.

 

*Nomination Committee*.The Nomination Committee operates under a written charter and is charged withthe responsibilities of nominating and evaluating Board member candidates andestablishing criteria for nomination, developing and recommending governanceguidelines and reviewing them periodically, facilitating annual evaluations ofthe performance of the Board and its members, reviewing the structure andmembership of the Company’s Board and committees, and reviewing Boardcompensation policies.  Additionally, theNomination Committee, in consultation with the Compensation Committee,facilitates development of the mission and objectives of the Chief ExecutiveOfficer, succession for the Chief Executive Officer and annual evaluation ofthe performance of the Chief Executive Officer.

 

The Company’s bylaws require that theNomination Committee be comprised of the Chairman of the Board, theVice-Chairman and the Chief Executive Officer, except that if one individualholds two of the designated offices, the Board of Directors shall appoint athird member to the Nomination committee, who need not be a director of theCompany. Additionally, as required by its charter, the Nomination Committee iscomposed of a majority of independent directors. The current members of theNomination Committee are Messrs. John S. Dalrymple III (Chair), John D. Rice,Jr. and Timothy J. Dodd. The Board of Directors has determined that Messrs.Dalrymple and Rice are independent directors.

 

*Policy Committee.* The Policy Committeeoperates pursuant to a written Policy Committee Charter. The Policy Committeeis to provide oversight of the Company’s governance obligations to assurecompliance with all applicable laws, regulations, Articles of Incorporation andBy-laws by adoption and periodic review of a governance policy. The members ofthe Policy Committee are Allyn K. Hart (Chair), Curtis R. Trulson and James F.Link. Each member of the committee is a non-employee director and the Board ofDirectors has determined that there are no relationships that would interferewith a Policy Committee member’s exercise of independent judgment in carryingout his responsibilities as a member of the policy committee.

 

**Compensation of Directors**

** **

The Companyprovides its directors with compensation consisting of (i) a per diem paymentof $500 (except for the Chairman of the Board and Chairman of the AuditCommittee who will each receive $600 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 $1,000 (except for theChairman of the Board and Chairman of the Audit Committee who each receive$1,200 per month), and (iii) reimbursement for out-of-pocket expenses incurredon behalf of the Company.

 

52

----

 

**Executive Officers**

 

The table below lists the executive officersof the Company. Officers are elected annually by the Board of Directors.

 
| **Name**        | ** ** | **Age** | ** ** | **Position**                           | ** ** |
|-----------------|------------|---------|------------|----------------------------------------|------------|
|            |       |    |       |                                   |       |
| Timothy J. Dodd |       | 51      |       | President  and Chief Executive officer |       |
| Edward O. Irion |       | 35      |       | Chief  Financial Officer               |       |

 

**Timothy J. Dodd.** Mr. Doddis the President and Chief Executive Officer of the Company. Prior to joiningthe Company in December 1991, he had been the Vice President of Manufacturingfor American Italian Pasta Company since 1988. Previously, Mr. Doddparticipated in the construction and management of two other grain processingfacilities, one in Texas and one in Cando, North Dakota. Mr. Dodd serves on theboard of directors of Country Bank USA, Cando, North Dakota.

 

**Edward O. Irion.** Mr.Irion was appointed as the Company’s Chief Financial Officer effectiveFebruary 21, 2006.  Mr. Irion joinedthe Company in December 1999 and served as the Company’s Assistant VicePresident – Planning and Control until August 2000.  FromAugust 2000 until his appointment as Chief Financial Officer,Mr. Irion served as the Company’s Vice President – Finance and ChiefAccounting Officer.  He received aBachelor of Science degree in accounting from Minnesota StateUniversity-Moorhead and is a certified public accountant.

 

**Code of Conduct**

** **

The Company has adopted a Code of Conduct applicable to all employees.A Code of Ethics certification for senior financial officers, including theprincipal executive officer, principal financial officer and principalaccounting officer, is included within the Code of Conduct.

 

A copy of the Code of Conduct is availableunder the “Investors” portion of the Company’s website at *www.dakotagrowers.com*. A copy of the Company’s Code ofConduct will also be provided, without charge, upon written request to:

 

Investor Relations

Dakota Growers Pasta Company, Inc.

One Pasta Avenue

Carrington, ND 58421

 

53

----

 

**ITEM 11.  EXECUTIVE COMPENSATION**

 

The following table summarizes the amount ofcompensation paid to the Company’s President and Chief Executive Officer andChief Financial Officer for the fiscal year ended July 31, 2006 and the twoprior fiscal years.

 

**Summary Compensation Table**

 
| ** **                  | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **        | ** ** | ** **                | ** ** | **Long-Term**                | ** ** | ** **           | ** ** |             |
|-----------------------------|------------|------------|------------|------------------------------|------------|-------------------|------------|---------------------------|------------|------------------------------|------------|----------------------|------------|------------------|
| ** **                  | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **        | ** ** | ** **                | ** ** | **Compensation Awards** | ** ** | ** **           | ** ** |             |
| ** **                  | ** ** | ** ** | ** ** | ** **                   | ** ** | **Series C** | ** ** | **Common**                | ** ** | ** **                   | ** ** |                 |
| ** **                  | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Preferred**     | ** ** | **Stock**                 | ** ** | ** **                   | ** ** |                 |
| ** **                  | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **        | ** ** | **Other**                 | ** ** | **Securities**               | ** ** | **Securities**       | ** ** | **All**          | ** ** |   |
| **Name and**           | ** ** | **Fiscal** | ** ** | ** **                   | ** ** | ** **        | ** ** | **Annual**                | ** ** | **Underlying**               | ** ** | **Underlying**       | ** ** | **Other**        | ** ** |   |
| **Principal Position** | ** ** | **Year**   | ** ** | **Salary**                   | ** ** | **Bonus**         | ** ** | **Compensation (1)** | ** ** | **Options (#)**         | ** ** | **Options (#)** | ** ** | **Compensation** | ** ** |   |
|                        |       |       |       |                         |       |              |       |                      |       |                         |       |                 |       |             |   |   |
| Timothy J. Dodd             |       | 2006       |       | $                            | 229,690    |              | $          | 42,539                    |       | $                            | 11,819     |                 | —     |             | 35,392 |   | $ | — |   |   |
| President and Chief         |       | 2005       |       | 212,500                      |       | 21,413            |       | 21,290                    |       | —                       |       | —               |       | —           |   |   |
| Executive Officer           |       | 2004       |       | 202,566                      |       | —            |       | 10,552                    |       | —                       |       | 13,511               |       | —           |   |   |
|                        |       |       |       |                         |       |              |       |                      |       |                         |       |                 |       |             |   |   |
| Edward O. Irion             |       | 2006       |       | $                            | 163,628    |              | $          | 13,000                    |       | $                            | 13,357     |                 | —     |             | 10,816 |   | $ | — |   |   |
| Chief Financial             |       | 2005       |       | 129,859                      |       | 13,000            |       | 8,808                     |       | —                       |       | —               |       | —           |   |   |
| Officer                     |       | 2004       |       | 115,985                      |       | —            |       | 4,808                     |       | —                       |       | 7,723                |       | —           |   |   |   |

 

----

(1)   Includes the Company’s 401(k) matching contribution,excess life insurance, the taxable portion of reimbursable business expensesand the taxable portion of other benefits.

 

**Option Grants in Fiscal Year 2006**

 

The following table sets forth certaininformation with respect to stock options granted to purchase Common Stockduring the fiscal year ended July 31, 2006.

 
| ** **      | ** ** | **Common**     | ** ** | ** **   | ** ** | ** **   | ** ** | ** **     | ** ** | **Potential Realizable 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 |       | 35,392         |       | 25%          |       | $            | 4.00       |           | 12/22/2015 |                            | $          | 89,031 |   | $ | 225,623 |   |
| Edward O. Irion |       | 10,816         |       | 8%           |       | $            | 4.00       |           | 12/22/2015 |                            | $          | 27,209 |   | $ | 68,952 |   |

 

----

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

 

**Options Exercised in Fiscal Year 2006 and Unexercised Options at July31, 2006**

 

The following tablesummarizes stock option exercises and total number of options held for Series CConvertible Preferred Stock at the end of fiscal year 2006.

 
| ** **      | ** ** | **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, 2006** | ** ** | **Options at July 31, 2006 (1)** | ** ** |
| **Name**        | ** ** | **on Exercise**    | ** ** | **Realized** | ** ** | **Exercisable**                                  | ** ** | **Unexercisable**                                         | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|            |       |                    |       |         |       |                                             |       |                                                      |       |   |   |   |   |
| Timothy J. Dodd |       | —                  |       | $            | —     |                                             | 1,977      |                                                      | —     |   | $ | — |   | $ | — |   |
|                 |            |                         |            |              |            |                                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

The following table summarizes stockoption exercises and total number of options held for Common Stock at the endof fiscal year 2006.

 
| ** **      | ** ** | **Common**           | ** ** | ** **   | ** ** | **Common Shares**                           | ** ** | **Value of Unexercised**                        | ** ** |
|-----------------|------------|----------------------|------------|--------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **      | ** ** | **Stock**            | ** ** | ** **   | ** ** | **Underlying Unexercised**                  | ** ** | **In-the-Money**                                          | ** ** |
| ** **      | ** ** | **Acquired**         | ** ** | **Value**    | ** ** | **Options at July 31, 2006** | ** ** | **Options at July 31, 2006 (1)** | ** ** |
| **Name**        | ** ** | **on Exercise** | ** ** | **Realized** | ** ** | **Exercisable**                                  | ** ** | **Unexercisable**                                         | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|            |       |                 |       |         |       |                                             |       |                                                      |       |   |   |   |   |
| Timothy J. Dodd |       | —               |       | $            | —     |                                             | 200,933    |                                                      | 38,770     |   | $ | — |   | $ | — |   |
| Edward O. Irion |       | —               |       | —       |       | 5,792                                            |       | 12,747                                                    |       | — |   | — |   |
|                 |            |                      |            |              |            |                                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

----

(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, 2006.

 

**Employment Agreements**

 

The Company does not have any employment agreements in place at thecurrent time.

 

54

----

 

**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. 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 conversion ratio isproportionately adjusted if the Company increases the outstanding shares ofCommon Stock or Series D Delivery Preferred Stock, as applicable, withoutpayment by or to the Company or the Company’s shareholders for such additionalshares (e.g. stock split, stock dividend or other action). Options grantedunder the Plan must be exercised within ten years from the date such optionsare granted. In the event of the employee’s termination with the Company, allexercisable options may be exercised within 90 days of the termination date. Ifnot exercised, such options lapse.

 

The Company’s 2002 StockOption Plan (the “2002 Plan”) was adopted by the Board of Directors on November21, 2002. All options granted under the 2002 Plan are non-qualified stockoptions and are for the purchase of the Company’s Common Stock. The maximumnumber of shares of Common Stock that may be issued pursuant to options grantedunder the 2002 Plan is 294,456 shares, all of which have been issued. Stockoptions granted under the 2002 Plan expire 10 years from the date of grant.

 

On November 21, 2002 theBoard of Directors adopted the Dakota Growers Pasta Company, Inc. 2003 StockOption Plan (the “2003 Plan”), which was approved by the Company’s shareholdersat the Annual Meeting on January 11, 2003. The 2003 Plan covers 500,000 shares of the Company’s Common Stock.Participation in this Plan shall be limited to officers, directors, employees,vendors or consultants of the Company or any subsidiary of the Company. Optionsgranted under the 2003 Plan may be incentive stock options (as defined underSection 422 of the Code) or non-qualified stock options, as determined by the2003 Plan administrator at the time of grant of an option and subject to theapplicable provisions of Section 422 of the Code and the regulationspromulgated there under. The stock options generally expire 10 years from thedate of grant. If the employment of the Optionee is terminated by any reasonother than his or her death or disability, all exercisable options may beexercised within 90 days of the termination date. If not exercised, suchoptions lapse.

 

**Compensation Committee Interlocks and Insider Participation**

** **

The members of the Compensation Committee areJohn S. Dalrymple III, Curtis R. Trulson and Michael E. Warner. None of thesedirectors are or have been an officer or employee of the Company. During fiscalyear 2006, no executive officer of the Company served as a director or memberof the Compensation Committee (or other committee serving an equivalentfunction) of any other entity, one of whose executive officers served as adirector of or member of the Compensation Committee of the Company.

 

55

----

 

**ITEM 12.  SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

** **

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

 

The address of each person listed below isc/o Dakota Growers Pasta Company, Inc., One Pasta Avenue, Carrington, NorthDakota 58421. Except as otherwise noted, each person listed below has soleinvestment discretion and voting power. In accordance with the Securities andExchange Commission’s rules, in computing the number of shares beneficiallyowned by a person and the percentage ownership of that person, securitiessubject to options held by that person that are currently exercisable orexercisable within 60 days of July 31, 2006 are treated as outstanding. Theseshares, however, are not treated as outstanding for the purpose of computingthe 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)                                     |       | 394,569                                               |       | 3.0 |   | — |   | — |   | 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)                                      |       | 263,067                                               |       | 2.0 |   | 1,977 |   | 100 | % | 238,248 |   | 2.1 |   |
|                                                     |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Edward O. Irion (9)                                      |       | 5,792                                                 |       | .0 |   | — |   | — |   | — |   | — |   |
|                                                     |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Michael Tokarz (10)                                      |       | 1,081,195                                             |       | 8.2 |   | — |   | — |   | — |   | — |   |
|                                                     |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| MVC Capital, Inc. (10)                                   |       | 1,081,195                                             |       | 8.2 |   | — |   | — |   | — |   | — |   |
|                                                     |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| All directors and officers as a Group (12  persons) (11) |       | 2,567,139                                             |       | 19.1 |   | 1,977 |   | 100 |   | 1,250,157 |   | 11.0 |   |

 

----

(1)   Includes 40,058 shares of Common Stock and 36,000 shares of SeriesD Delivery Preferred Stock held in the name of Mr. Dalrymple’s spouse, 20,035shares of Common Stock and 18,000 shares of Series D Delivery Preferred Stockheld in the name of Mr. Dalrymple’s daughter and 190,159 shares of Common Stockand 171,000 shares of Series D Delivery Preferred Stock held in the name of theJohn S. Dalrymple III Trust, of which Mr. Dalrymple is a trustee.

(2)   Includes 77,798 shares of Common Stock and 70,000 shares of SeriesD Delivery Preferred Stock held in the name of Mr. Kenner’s spouse.

(3)   Includes 55,472 shares of Common Stock and 53,050 shares of SeriesD Delivery Preferred Stock held in the names of Link Farms LLP LSB Pasta and1,551 shares of Common Stock held in the name of Link Farms LLP.  

(4)   Includes 26,548 shares of Common Stock and 23,850 shares of SeriesD Delivery Preferred Stock held in the name of Mr. Nicholas’ spouse.

(5)   Includes 15,298 shares of Common Stock and 13,750 shares of SeriesD Delivery Preferred Stock held in the name of John Rice Farm.

(6)   Includes 143,734 shares of Common Stock and 129,000 shares ofSeries D Delivery Preferred Stock held in the name of T-T Ranch and 18,010shares of Common Stock and 16,125 shares of Series D Delivery Preferred Stockheld in the name of Mr. Topp’s spouse and children.

(7)   Includes 7,537 shares of Common Stock and 6,750 shares of Series DDelivery Preferred Stock held in the name of Trulson Brothers.

(8)   Mr. Dodd has been granted options that are currently exercisableor exercisable within 60 days of July 31, 2006, to purchase 1,977 shares of theCompany’s Series C Preferred Stock and 200,933 shares of the Company’s CommonStock. Each share of Series C Preferred Stock is convertible into 24 shares ofCommon Stock and 24 shares of Series D Delivery Preferred Stock of the Company.The number of shares of Common Stock presented for Mr. Dodd includes 47,448shares of Common Stock issuable upon exercise of the options to purchase SeriesC Preferred Stock of the Company and conversion of each such share of Series CPreferred Stock into 24 shares of Common Stock in the Company. The number ofshares of Series D Delivery Preferred Stock presented for Mr. Dodd includes47,448 of Series D Delivery Preferred Stock issuable upon exercise of theoptions to purchase Series C Preferred Stock of the Company and conversion ofeach such share of Series C Preferred Stock into 24 shares of Common Stock inthe Company, with one share of Series D Delivery Preferred Stock issuable foreach share of Common Stock so issued upon conversion. The number of shares ofCommon Stock presented for Mr. Dodd includes 200,933 shares of Common Stockissuable upon exercise of the options to purchase Common Stock.

 

56

----

 

(9)   Mr.Irion has been granted options that are currently exercisable or exercisablewithin 60 days of July 31, 2006. The number of shares presented for Mr. Irionrelate to Common Stock shares issuable upon the exercise of the options topurchase Common Stock.

(10) Includes1,081,195 shares of Common Stock held by MVC Capital, Inc. of which Mr. Tokarzis a stockholder and Chairman.  Mr.Tokarz shares voting and dispositive control over all shares held by MVCCapital, Inc. Mr. Tokarz disclaims any beneficial ownership of the Company’ssecurities for purposes of Section 16(a) under the Securities Exchange Act of1934, as amended, or otherwise, except to the extent of Mr. Tokarz’s pecuniaryinterests therein.  

(11) Includes 206,725 shares of Common Stock and 1,977 shares of Series CPreferred Stock issuable upon exercise of options exercisable within 60 days ofJuly 31, 2006, and includes an additional 47,448 shares of Common Stock and47,448 shares of Series D Delivery Preferred Stock issuable upon conversion ofthe Series C Preferred Stock underlying such options.

 

**Equity Compensation Plan Information**

 

See “Item 11. ExecutiveCompensation” for a discussion of the material features of the Company’s StockOption Plans. The following table provides information regarding the Company’sequity compensation plans as of July 31, 2006.

 
| ** **                                                  | ** ** | ** **                                                        | ** ** | ** **                      | ** ** | **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     |       | 1,977                                                             |       | $                               | 117.35     |                               | —     |   |
|                                                        |       |                                                              |       |                            |       |                               |       |
| ** **                                                  | ** ** | **Options  to purchase Common Stock**                             | ** ** |
| Equity compensation plans approved by security  holders     |       | 195,037                                                           |       | $                               | 4.09       |                               | 304,963    |   |
|                                                        |       |                                                              |       |                            |       |                               |       |
| Equity compensation plans not approved by  security holders |       | 190,800                                                           |       | $                               | 6.25       |                               | —     |   |

 

----

(1) Eachshare of Series C Convertible Preferred Stock is convertible into 24 shares ofCommon Stock and 24 shares of Series D Delivery Preferred Stock of the Company.

 

57

----

 

**ITEM 13.  CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS**

 

**Transactions with Executive Officers**

 

Amounts due from officers totaled $47,000 and$82,000 as of July 31, 2006 and 2005, respectively.

 

**Consulting Services**

** **

In July 2004, the Company and MVC FinancialServices, Inc. (“MVC Financial”) entered into a consulting agreement pursuantto which MVC Financial will provide certain business consulting services to theCompany for annual compensation of $75,000 per year and the reimbursement ofexpenses. MVC Financial Services, Inc. is an affiliate of MVC Capital, Inc., aholder of 5% or greater of the Company’s Common Stock. Michael T. Tokarz, adirector of the Company, is a stockholder and Chairman of MVC Capital, Inc. Theterm of the consulting agreement shall continue until the earlier of (a) theoccurrence of a Liquidity Event or (b) the termination by written notice fromMVC Financial to the Company. For purposes of this consulting agreement, a“Liquidity Event” shall have occurred on such date that MVC Capital, Inc. nolonger beneficially owns at least fifty percent (50%) of the shares of theCompany’s Common Stock acquired by MVC Capital Inc. pursuant to the StockPurchase Agreement dated July 30, 2004 (as adjusted for stock splits, stockdividends, share contributions and the like) or the earlier sale ofsubstantially all of the assets of the Company and the distribution ofsubstantially all of the net proceeds thereof.

 

58

----

**ITEM 14.  PRINCIPAL ACCOUNTINGFEES AND SERVICES**

 

The following table represents aggregate feesbilled (in thousands) to the Company for fiscal years ended July 31, 2006 and2005 by Eide Bailly LLP, the Company’s principal accounting firm.

 
| ** **             | ** ** | **Fiscal Year Ended** | ** ** |
|------------------------|------------|---------------------------------|------------|
| ** **             | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **             | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Audit Fees             |       | $                               | 64         |   | $ | 61 |   |
| Audit-Related Fees (a) |       | 9                               |       | 9 |   |
| Tax Fees (b)           |       | 15                              |       | 22 |   |
| All Other Fees         |       | —                          |       | — |   |
|                   |       |                            |       |   |   |
| Total Fees (c)         |       | $                               | 88         |   | $ | 92 |   |

 

----

(a)   Primarily benefit plan audit services.

 

(b)   Primarily tax advisory and preparation services.

 

(c)   The Audit Committee has approved all fees.

 

**Auditor Services Pre-approval Policy**

** **

The Audit Committee has a formalpolicy concerning pre-approval of all services to be provided by Eide BaillyLLP, the Company’s independent auditor, including audit, audit-related, tax andother services. The Chair of the Committee has the authority to pre-approvepermitted services that require action between regular Committee meetings,provided a report of these services is given to the full Committee at the nextregular meeting. The Committee approved all services provided by Eide BaillyLLP during fiscal year 2006.

 

59

----

 

**PART IV**

** **

**ITEM 15.  EXHIBITS, FINANCIALSTATEMENT SCHEDULES**

** **

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

 

**1.****     Financial Statements**

** **
|   | Report of  Independent Registered Public Accounting Firm                                                          |   |
|--------|-------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                              |   |
|   | Consolidated Balance Sheets as of July 31,  2006 and 2005                                                         |   |
|   |                                                                                                              |   |
|   | Consolidated Statements of Operations for  the years ended July 31, 2006, 2005 and 2004                           |   |
|   |                                                                                                              |   |
|   | Consolidated Statements of Changes in  Stockholders’ Equity for the years ended July 31, 2006, 2005 and 2004 |   |
|   |                                                                                                              |   |
|   | Consolidated Statements of Cash Flows for  the years ended July 31, 2006, 2005 and 2004                           |   |
|   |                                                                                                              |   |
|   | Notes to Consolidated Financial Statements                                                                        |   |

 

**2.****     Financial Statement Schedules**

** **

All schedules are omitted as the requiredinformation is inapplicable or the information is presented in the consolidatedfinancial statements or related notes.

 

**3.**     **Exhibits**

 

2.1          Second Amended and Restated Plan of Mergerbetween Dakota Growers Pasta Company and Dakota Growers Pasta RestructuringCooperative. (Incorporated by reference to Exhibit 2.1 from the Company’sPre-Effective Amendment No. 2 to Form S-4 Registration Statement, File No.333-81946, dated April 19, 2002).

 

2.2          Second Amended and Restated Merger Agreementbetween Dakota Growers Pasta Restructuring Cooperative and Dakota GrowersCorporation. (Incorporated by reference to Exhibit 2.2 from the Company’sPre-Effective Amendment No. 2 to Form S-4 Registration Statement, File No.333-81946, dated April 19, 2002).

 

2.3          Second Amended and Restated Merger Agreementbetween Dakota Growers Corporation and the Company, formerly Dakota GrowersRestructuring Company, Inc. (Incorporated by reference to Exhibit 2.3 from theCompany’s Pre-Effective Amendment No. 2 to Form S-4 Registration Statement,File No. 333-81946, dated April 19, 2002).

 

2.4          Second Amended and Restated TransactionAgreement between Dakota Growers Pasta Company, Dakota Growers PastaRestructuring Cooperative, Dakota Growers Corporation and the Company, formerlyDakota Growers Restructuring Company, Inc. (Incorporated by reference toExhibit 2.4 from the Company’s Pre-Effective Amendment No. 2 to Form S-4Registration Statement, File No. 333-81946, dated April 19, 2002).

 

3.1          Second Amended and Restated Articles ofIncorporation of the Company, formerly Dakota Growers Restructuring Company,Inc. (Incorporated by reference to Exhibit 3.1 from the Company’s Pre-EffectiveAmendment No. 2 to Form S-4 Registration Statement, File No. 333-81946, datedApril 19, 2002).

 

60

----

 

3.2          Second Amended and Restated Bylaws of theCompany, formerly Dakota Growers Restructuring Company, Inc. (Incorporated byreference to Exhibit 3.3 from the Company’s Pre-Effective Amendment No. 2 toForm S-4 Registration Statement, File No. 333-81946, dated April 19, 2002).

 

3.3          Certificate of Designation of Series E JuniorParticipating Preferred Stock of the Company, formerly Dakota GrowersRestructuring Company, Inc. (Incorporated by reference to Exhibit 3.2 from theCompany’s Pre-Effective Amendment No. 2 to Form S-4 Registration Statement,File No. 333-81946, dated April 19, 2002).

 

4.1          Note Purchase Agreement dated July 15, 1998.(Incorporated by reference to Exhibit 4.1 from Dakota Growers Pasta Company’sAmendment No. 1 to Form S-1 Registration Statement on Form S-1/A, File No.333-65071, declared effective October 21, 1998).

 

4.2          Waiver and First Amendment to Note PurchaseAgreements dated November 28, 2000. (Incorporated by reference to Exhibit 4.1from Dakota Growers Pasta Company’s Quarterly Report on Form 10-Q, File No.33-99834, for the quarter ended October 31, 2000).

 

4.3          Waiver and Second Amendment to Note PurchaseAgreement and Notes dated June 1, 2001. (Incorporated by reference to Exhibit4.3 from Dakota Growers Pasta Company’s Annual Report on Form 10-K for thefiscal year ended July 31, 2001, File No. 33-99834).

 

10.1        Incentive Stock Option Plan. (Incorporated byreference to Exhibit 10.1 from Dakota Growers Pasta Company’s Quarterly Reporton Form 10-Q, File No. 33-99834, for the quarter ended April 30, 1998).

 

10.2        Master Lease Agreement dated March 6, 2002 andrelated Schedule A dated March 29, 2002 between Dakota Growers Pasta Companyand Farm Credit Leasing Services Corporation. (Incorporated by reference toExhibit 10.2 from the Company’s Pre-Effective Amendment No. 2 to Form S-4Registration Statement, File No. 333-81946, dated April 19, 2002).

 

10.3        Amended and Restated Share Rights Agreement,dated as of April 19, 2002, by and among the Company, formerly Dakota GrowersRestructuring Company, Inc., and Wells Fargo Bank Minnesota, NationalAssociation, as Rights Agent. (Incorporated by reference to Exhibit 10.1 fromthe Company’s Pre-Effective Amendment No. 2 to Form S-4 Registration Statement,File No. 333-81946, dated April 19, 2002).

 

10.4        Dakota Growers Pasta Company, Inc. 2002 StockOption Plan. (Incorporated by reference to Exhibit 10.16 from the Company’sAnnual Report on Form 10-K, File No. 000-50111, for the year ended July 31,2003).

 

10.5        Dakota Growers Pasta Company, Inc. Amended andRestated 2003 Stock Option Plan. (Incorporated by reference to Exhibit 10.6from the Company’s Quarterly Report on Form 10-Q, File No. 000-50111, for thequarter ended January 31, 2004).

 

10.6        Manufacturing Agreement dated December 26, 2003between the Company and DNA Dreamfields Company, LLC. (Incorporated byreference to Exhibit 10.2 from the 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.

 

10.7        Services Agreement dated December 26, 2003between the Company and DNA Dreamfields Company, LLC. (Incorporated byreference to Exhibit 10.3 from the 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.

 

61

----

 

10.8        Trademark License Agreement dated December 26,2003 between the Company and DNA Dreamfields Company, LLC. (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, 2004).

 

10.9        Technology Sublicense Agreement dated December26, 2003 between the Company and DNA Dreamfields Company, LLC. (Incorporated byreference to Exhibit 10.5 from the Company’s Quarterly Report on Form 10-Q,File No. 000-50111, for the quarter ended January 31, 2004).

 

10.10      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).

 

10.11      Registration Rights Agreement dated July 30, 2004between the Company and MVC Capital, Inc. (Incorporated by reference to Exhibit99.3 from the Company’s Report on Form 8-K, File No. 000-50111, filed August 6,2004).

 

10.12      Consulting Agreement dated July 30, 2004 betweenthe Company and MVC Financial Services, Inc. (Incorporated by reference toExhibit 99.4 from the Company’s Report on Form 8-K, File No. 000-50111, filedAugust 6, 2004).

 

10.13      Membership Unit Purchase Agreement effective May1, 2005 between and among Dakota Growers Pasta Company, Inc., B-New, LLC,TechCom Group, LLC and Buhler, Inc. (Incorporated by reference to Exhibit 10.1 from the Company’s Report onForm 8-K, File No. 000-50111, filed July 1, 2005).

 

10.14      Amended and Restated DNA Dreamfields Company, LLCOperating Agreement effective May 1, 2005 between the Company, B-New, LLC,TechCom Group, LLC and Buhler, Inc. (Incorporated by reference to Exhibit 10.2 from the Company’s Report onForm 8-K, File No. 000-50111, filed July 1, 2005).

 

10.15      2005 Line of Credit Loan Agreement effective May31, 2005 by and between the Company (“Lender”) and DNA Dreamfields Company, LLC(“Borrower”).  (Incorporated by referenceto Exhibit 10.3 from the Company’s Report on Form 8-K, File No. 000-50111,filed July 1, 2005).

 

10.16      Promissory Note effective May 31, 2005 executedby DNA Dreamfields Company, LLC.   (Incorporatedby reference to Exhibit 10.4 from the Company’s Report on Form 8-K, File No.000-50111, filed July 1, 2005).

 

10.17      LLC Unit Pledge Agreement effective May 31, 2005between and among B-New, LLC, TechCom Group, LLC, Buhler, Inc.(collectively the “Pledgors”) and the Company (“Lender”).  (Incorporated by reference to Exhibit 10.5from the Company’s Report on Form 8-K, File No. 000-50111, filed July 1, 2005).

 

10.18      Master Loan Agreement dated May 23, 2005 betweenthe Company and CoBank, ACB.  (Incorporatedby reference to Exhibit 10.1 from the Company’s Report on Form 8-K, File No.000-50111, filed July 7, 2005).

 

10.19      Statused Revolving Credit Supplement dated May26, 2006 between the Company and CoBank, ACB. (Incorporated by reference to Exhibit 10.1 from the Company’s Report onForm 8-K, File No. 000-50111, filed June 1, 2006).

 

10.20      Non-Revolving Credit Supplement dated May 26,2006 between the Company and CoBank, ACB. (Incorporated by reference to Exhibit 10.2 from the Company’s Report onForm 8-K, File No. 000-50111, filed June 1, 2006).

 

62

----

 

10.21      Multiple Advance Term Loan Supplement dated May23, 2005 between the Company and CoBank, ACB. (Incorporated by reference to Exhibit 10.4 from the Company’s Report onForm 8-K, File No. 000-50111, filed July 7, 2005).

 

10.22      Continuing Guarantee Agreement dated May 23, 2005between Primo Piatto, Inc., a wholly-owned subsidiary of the Company, andCoBank, ACB.  (Incorporated by referenceto Exhibit 10.5 from the Company’s Report on Form 8-K, File No. 000-50111,filed July 7, 2005).

 

10.23      Security Agreement dated May 23, 2005 betweenPrimo Piatto, Inc. and CoBank, ACB. (Incorporated by reference to Exhibit 10.6 from the Company’s Report onForm 8-K, File No. 000-50111, filed July 7, 2005).

 

21           Subsidiary of the registrant.

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

 

23           Consent of Independent Registered PublicAccounting Firm; Eide Bailly LLP.

 

31.1        Certification of Chief Executive Officerrequired by Securities and Exchange Commission Rule 13a-14(a) or 15d-14(a).

 

31.2        Certification of Chief Financial Officerrequired by Securities and Exchange Commission Rule 13a-14(a) or 15d-14(a).

 

32.1        Certification of Chief Executive Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section1350.

 

32.2        Certification of Chief Financial Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section1350.

 

63

----

 

**SIGNATURES**

** **

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|   | DAKOTA GROWERS PASTA COMPANY, INC.     |
|--------|----------------------------------------|
|   |                                   |
|   |                                   |
|   | By:                                    | /s/ Timothy J. Dodd |   |
|   |                                   |
|   | Timothy J. Dodd,                       |
|   | PRESIDENT AND CHIEF EXECUTIVE OFFICER, |
|   | AND PRINCIPAL EXECUTIVE OFFICER        |
|   |                                   |
|   | Dated: October 30, 2006                |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 
| **Signature**             | ** ** | **Title**                                    | ** ** | **Date**         |
|---------------------------|------------|----------------------------------------------|------------|------------------|
| ** **                | ** ** | ** **                                   | ** ** | ** **       |
| /s/ Timothy J. Dodd       |       | President and Chief Executive Officer        |       |             |
| Timothy J. Dodd           |       | (Principal Executive Officer)                |       | October 30, 2006 |
|                      |       |                                         |       |             |
|                      |       |                                         |       |             |
| /s/ Edward O. Irion       |       | Chief Financial Officer                      |       |             |
| Edward O. Irion           |       | (Principal Financial and Accounting Officer) |       | October 30, 2006 |
|                      |       |                                         |       |             |
|                      |       |                                         |       |             |
| /s/ John S. Dalrymple III |       |                                         |       |             |
| John S. Dalrymple III     |       | Director                                     |       | October 30, 2006 |
|                      |       |                                         |       |             |
|                      |       |                                         |       |             |
| /s/ John D. Rice, Jr.     |       |                                         |       |             |
| John D. Rice, Jr.         |       | Director                                     |       | October 30, 2006 |

 

 

64

----

 
| **Signature**          | ** ** | **Title**  | ** ** | **Date**         |
|------------------------|------------|------------|------------|------------------|
| ** **             | ** ** | ** ** | ** ** | ** **       |
| /s/ Curtis R. Trulson  |       |       |       |             |
| Curtis R. Trulson      |       | Director   |       | October 30, 2006 |
|                   |       |       |       |             |
|                   |       |       |       |             |
| /s/ Allyn K. Hart      |       |       |       |             |
| Allyn K. Hart          |       | Director   |       | October 30, 2006 |
|                   |       |       |       |             |
|                   |       |       |       |             |
| /s/ Roger A. Kenner    |       |       |       |             |
| Roger A. Kenner        |       | Director   |       | October 30, 2006 |
|                   |       |       |       |             |
|                   |       |       |       |             |
| /s/ James F. Link      |       |       |       |             |
| James F. Link          |       | Director   |       | October 30, 2006 |
|                   |       |       |       |             |
|                   |       |       |       |             |
| /s/ Eugene J. Nicholas |       |       |       |             |
| Eugene J. Nicholas     |       | Director   |       | October 30, 2006 |
|                   |       |       |       |             |
|                   |       |       |       |             |
| /s/ Michael T. Tokarz  |       |       |       |             |
| Michael T. Tokarz      |       | Director   |       | October 30, 2006 |
|                   |       |       |       |             |
|                   |       |       |       |             |
| /s/ Jeffrey O. Topp    |       |       |       |             |
| Jeffrey O. Topp        |       | Director   |       | October 30, 2006 |
|                   |       |       |       |             |
|                   |       |       |       |             |
| /s/ Michael E. Warner  |       |       |       |             |
| Michael E. Warner      |       | Director   |       | October 30, 2006 |

 

65

----