UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

 

Commission File No. 000-50111

 

 

DAKOTA GROWERS PASTA COMPANY, INC.

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                 Yes ý No o

 

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

 

As of March 16, 2004, the Registrant had 12,260,291 shares of common stock, par value $0.01 per share, outstanding.

 

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

DAKOTA GROWERS PASTA COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Information)

 

		(Unaudited) January 31, 2004			July 31, 2003
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	6		$	5
Trade accounts receivable, less allowance for cash discounts and doubtful accounts of $1,198 and $1,012, respectively		13,969			9,852
Other receivables		341			1,225
Inventories		20,954			28,082
Prepaid expenses		3,830			3,940
Deferred income taxes		569			569
Total current assets		39,669			43,673
PROPERTY AND EQUIPMENT
In service		109,297			108,263
Construction in process		425			868
		109,722			109,131
Less accumulated depreciation		(44,794		)	(41,799		)
Net property and equipment		64,928			67,332
INVESTMENT IN COOPERATIVE BANKS		2,413			2,413
INTANGIBLE ASSETS		466			539
OTHER ASSETS		7,402			8,433
		$	114,878		$	122,390

 

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DAKOTA GROWERS PASTA COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Information)

 

		(Unaudited) January 31, 2004			July 31, 2003
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Notes payable		$	8,400		$	9,705
Current portion of long-term debt		9,796			10,011
Accounts payable		3,614			3,793
Excess outstanding checks over cash on deposit		2,805			2,219
Accrued liabilities		5,139			4,516
Total current liabilities		29,754			30,244
COMMITMENTS AND CONTINGENCIES		—			—
LONG-TERM DEBT, net of current portion		21,087			28,263
DEFERRED INCOME TAXES		9,917			9,845
OTHER LIABILITIES		162			187
MANDATORILY REDEEMABLE PREFERRED STOCK
Series A, 6% cumulative, $100 par value, 533 shares authorized, 267 and 333 shares issued and outstanding as of January 31, 2004 and July 31, 2003, respectively		27			33
Total liabilities		60,947			68,572
STOCKHOLDERS’ EQUITY
Series D delivery preferred stock, non-cumulative, $.01 par value, 11,324,377 shares authorized, 11,275,297 shares issued and outstanding		113			113
Common stock, $.01 par value, 75,000,000 shares authorized, 12,554,747 shares issued		126			126
Additional paid-in capital		60,188			60,188
Treasury stock at cost, 294,456 shares		(1,840		)	(1,840		)
Accumulated deficit		(4,656		)	(4,769		)
Total stockholders’ equity		53,931			53,818
Total liabilities and stockholders’ equity		$	114,878		$	122,390

 

See Notes to Consolidated Financial Statements

 

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DAKOTA GROWERS PASTA COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)(Unaudited)

 

		Three Months Ended January 31,
		2004			2003
Net revenues (net of discounts and allowances of $4,563 and $5,034, respectively)		$	35,403		$	40,740
Cost of goods sold		32,361			36,012
Gross profit		3,042			4,728
Marketing, general and administrative expenses		2,007			3,166
Operating income		1,035			1,562
Other income (expense)
Interest and other income		903			1,035
Gain on disposition of property, equipment and other assets		—			11
Net loss allocated from joint venture		(144		)	—
Interest expense, net		(725		)	(895		)
Income before income taxes		1,069			1,713
Income tax expense		417			668
Net income		652			1,045
Dividends on preferred stock		—			1
Net earnings on common stock		$	652		$	1,044
Net earnings per common share
Basic		$	0.05		$	0.08
Diluted		$	0.05		$	0.08
Weighted average common shares outstanding
Basic		12,260			12,340
Diluted		12,620			12,593

 

See Notes to Consolidated Financial Statements

 

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DAKOTA GROWERS PASTA COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)(Unaudited)

 

		Six Months Ended January 31,
		2004			2003
Net revenues (net of discounts and allowances of $9,305 and $9,894, respectively)		$	73,051		$	78,071
Cost of goods sold		68,099			68,136
Gross profit		4,952			9,935
Marketing, general and administrative expenses		4,009			5,482
Operating income		943			4,453
Other income (expense)
Interest and other income		904			1,076
Gain on disposition of property, equipment and other assets		13			24
Net loss allocated from joint venture		(144		)	—
Interest expense, net		(1,531		)	(1,796		)
Income before income taxes		185			3,757
Income tax expense		72			1,465
Net income		113			2,292
Dividends on preferred stock		—			2
Net earnings on common stock		$	113		$	2,290
Net earnings per common share
Basic		$	0.01		$	0.18
Diluted		$	0.01		$	0.18
Weighted average common shares outstanding
Basic		12,260			12,448
Diluted		12,620			12,599

 

See Notes to Consolidated Financial Statements

 

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DAKOTA GROWERS PASTA COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)(Unaudited)

 

		Six Months Ended January 31,
		2004			2003
OPERATING ACTIVITIES
Net income		$	113		$	2,292
Adjustments to reconcile net income to net cash from (used for) operating activities:
Depreciation and amortization		4,354			5,093
Gain on disposition of property, equipment and other assets		(13		)	(24		)
Net loss allocated from joint venture		144			—
Deferred income taxes		72			478
Payments for long-term marketing costs		(125		)	(5,000		)
Changes in assets and liabilities
Trade receivables		(4,117		)	(204		)
Other receivables		884			(33		)
Inventories		7,128			(4,634		)
Prepaid expenses		234			(1,076		)
Other assets		5			5
Accounts payable		(179		)	(1,481		)
Excess outstanding checks over cash on deposit		586			2,971
Other accrued liabilities		623			(750		)
NET CASH FROM (USED FOR) OPERATING ACTIVITIES		9,709			(2,363		)
INVESTING ACTIVITIES
Purchases of property and equipment		(619		)	(949		)
Proceeds on sale of property, equipment, and other assets		—			3
Redemption of short-term investments		—			1,974
Payments for package design costs		(242		)	(236		)
Investments in joint venture		(145		)	—
NET CASH FROM (USED FOR) INVESTING ACTIVITIES		(1,006		)	792
FINANCING ACTIVITIES
Net change in short-term notes payable		(1,305		)	7,250
Principal payments on long-term debt		(7,391		)	(6,684		)
Preferred stock retirements		(6		)	(14		)
Dividends paid on preferred stock		—			(2		)
Purchase of treasury stock		—			(1,840		)
NET CASH USED FOR FINANCING ACTIVITIES		(8,702		)	(1,290		)
NET CHANGE IN CASH AND CASH EQUIVALENTS		1			(2,861		)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		5			2,866
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	6		$	5
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments (refunds) for
Interest (net of amounts capitalized)		$	1,693		$	1,945
Income taxes		$	(972	)	$	1,160

 

See Notes to Consolidated Financial Statements

 

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DAKOTA GROWERS PASTA COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

The following notes should be read in conjunction with the notes to the financial statements for the year ended July 31, 2003 as filed in the Company’s Form 10-K.

 

NOTE 1 - ORGANIZATION

 

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

 

NOTE 2 – FINANCIAL STATEMENT PRESENTATION

 

The unaudited consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended January 31, 2004 are not necessarily indicative of the results that may be expected for the year ended July 31, 2004. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis and the consolidated financial statements and footnotes included in the Company’s Form 10-K for the year ended July 31, 2003. The information contained in the balance sheet as of July 31, 2003 was derived from the Company’s audited annual report for fiscal year 2003. Reclassifications have been made to facilitate comparability with current presentation. Such reclassifications have no effect on the net results of operations.

 

The financial information presented herein includes the consolidated balance sheets and results of operations of Dakota Growers Pasta Company, Inc. and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated.

 

NOTE 3 – INVENTORIES

 

Inventories are valued at lower of cost or market. Inventories as of January 31, 2004 include raw materials and packaging of $4,324,000 and finished goods of $16,630,000. Inventories at July 31, 2003 include raw materials and packaging of $5,533,000 and finished goods of $22,549,000.

 

NOTE 4 – LOAN AGREEMENTS

 

The Company extended its $19 million revolving credit facility with CoBank through March 31, 2004. The revolving line has a variable interest rate established by CoBank based on CoBank’s cost of funds. The balance outstanding under the revolving line of credit totaled $8,400,000 and $9,705,000 as of January 31, 2004 and July 31, 2003, respectively.

 

The Company’s various debt agreements with CoBank and certain institutional investors obligate the Company to maintain or achieve certain amounts of equity and certain financial ratios and impose certain restrictions on the Company. The Company was not in compliance with certain ratios set forth in its debt agreements with CoBank and such institutional investors as of January 31, 2004. The Company is currently in discussions with CoBank and such institutional investors regarding the terms of a waiver and amendment to resolve the noncompliance situation.

 

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NOTE 5 – EARNINGS PER SHARE

 

Basic earnings per share (EPS) is calculated by dividing net earnings on common stock by the weighted average number of common shares effective and outstanding during the period. Diluted EPS includes the effect of all potentially dilutive securities, such as stock options and convertible preferred stock.

 

Dilutive securities, consisting of stock options and convertible preferred stock, included in the calculation of diluted weighted average common shares totaled 360,000 and 253,000 for the three months ended January 31, 2004 and 2003, respectively. Dilutive securities included in the calculation of diluted weighted average common shares totaled 360,000 and 151,000 for the six months ended January 31, 2004 and 2003, respectively. As there is currently no established public trading market for the Company’s common stock, the Company has assumed the proceeds from the exercise of stock options would reduce debt and, thus, interest expense.

 

NOTE 6 – STOCK OPTIONS

 

The Compensation Committee of the Board of Directors granted, effective February 1, 2004, incentive stock options to purchase 80,524 shares of the Company’s common stock at a per share exercise price of $4.25. The vesting of these options is subject to certain qualifications, including but not limited to, the continued employment of the optionee with the Company. Subject to the foregoing qualifications and such other certain qualifications, fifty percent of these options vest on February 1, 2005, twenty-five percent vest on February 1, 2006, and twenty-five percent vest on February 1, 2007.

 

NOTE 7 – CONTINUED DUMPING AND SUBSIDY OFFSET ACT OF 2000

 

The U.S. Customs Service (“Customs”) has distributed antidumping and countervailing duties assessed on certain pasta imported from Italy and Turkey to affected domestic producers pursuant to the Continued Dumping and Subsidy Offset Act of 2000 (the “Offset Act”), which was enacted in October 2000. The Company received payments in the amount of $903,000 and $1,000,000 in December 2003 and 2002, respectively, under the Offset Act, based on duties assessed from October 1, 2001 to September 30, 2003. These amounts have been classified as other income. Under certain circumstances, the Company may be obligated to return certain amounts previously received by the Company under the Offset Act. The Company cannot reasonably estimate the potential amount, if any, that it may receive under the Offset Act in future periods as any such amount will be based upon future events over which the Company has little or no control, including, but not limited to, the amount of expenditures by domestic pasta producers and the amount of antidumping and countervailing duties collected by Customs.

 

NOTE 8 – MANDATORILY REDEEEMABLE PREFERRED STOCK

 

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

 

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The Company had 267 shares of Series A Preferred Stock, $100 par value, outstanding as of January 31, 2004. The Series A Preferred Stock is required to be redeemed ratably on a quarterly basis through December 2005. As the shares of Series A Preferred Stock are mandatorily redeemable, these shares have been classified as a liability in the Company’s consolidated balance sheet and “dividends” paid on the Series A Preferred Stock have been 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 have not been reclassified as interest cost.

 

NOTE 9 – INVESTMENT IN JOINT VENTURE

 

The Company has a 24% ownership interest in DNA Dreamfields Company, LLC, an Ohio limited liability company (“DNA Dreamfields”). The investment is accounted for using the equity method. 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 under the Dreamfields^TM brand name. The Company made aggregate investments in DNA Dreamfields of $145,000 through January 31, 2004. Under the terms of the DNA Dreamfields operating agreement, the Company shall contribute, when and as needed, additional funds up to an aggregate of approximately $4.0 million, to DNA Dreamfields to pay for the development of supply chain, product package development, consumer research, test market launch and regional roll out, advertising and merchandising. Such contributions shall be additional capital contributions by the Company without the issuance of any additional ownership units in DNA Dreamfields.

 

The Company has entered into a manufacturing agreement with DNA Dreamfields whereby Dakota Growers is the exclusive manufacturer of Dreamfields^TM low digestible carbohydrate pasta. The Company has also entered into a services agreement with DNA Dreamfields under which it provides administrative, accounting, information technology, sales and distribution services to DNA Dreamfields. Shipments of Dreamfields^TM low digestible carbohydrate pasta began in February 2004.

 

NOTE 10 – COMMITMENTS

 

The Company forward contracts for a certain portion of its future durum wheat requirements. The Company had outstanding commitments for grain purchases totaling $10,502,000 related to forward purchase contracts as of January 31, 2004. 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 and are not transferable.

 

The Company has a commitment to contribute, when and as needed, additional funds up to an aggregate of approximately $4.0 million, to DNA Dreamfields under the terms of the DNA Dreamfields operating agreement (See Note 9 – Investment in Joint Venture).

 

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

 

Forward-Looking Statements

 

The following discussion contains forward-looking statements. Such forward-looking statements include, among others, those statements including the words “expect”, “anticipate”, “believe”, “may” and similar expressions. Such statements are based on assumptions by the Company’s management, as of the date of this Quarterly Report, and are subject to risks and uncertainties, including those discussed in the Company’s Form 10-K for the year ended July 31, 2003 under “Risk Factors”, that could cause actual results to differ materially from those anticipated. The Company cautions readers not to place undue reliance on such forward-looking statements. The Company will not update any forward-looking statements in this Quarterly Report to reflect future events or developments.

 

Summary

 

Dakota Growers is the third largest producer of dry pasta products in North America. The pasta industry identifies domestic dry pasta into two basic markets: retail and institutional. The Company recognizes the institutional market as being comprised of foodservice and ingredient sales. We participate in each of the retail, foodservice and ingredient markets. The Company has two production plants, located in Carrington, North Dakota and New Hope, Minnesota. The Company’s cost of goods sold consists mainly of raw materials (primarily durum wheat), packaging, and manufacturing and distribution costs.

 

Net income for the six months ended January 31, 2004 totaled $0.1 million compared to $2.3 million for the six months ended January 31, 2003. Lower sales volumes along with higher raw material costs and higher per unit manufacturing costs, primarily resulting from lower production volumes, were the major factors contributing to the decrease in net earnings for the six months ended January 31, 2004 when compared to the corresponding period of the prior year. The Company was able to increase sales prices to pass through a portion of the increase in raw material costs. The Company was unable to fully recover higher costs incurred due to the continued competitive pricing environment in the dry pasta industry.

 

The Company has a 24% ownership interest in 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 under the Dreamfields^TM brand name. The Company has entered into a manufacturing agreement with DNA Dreamfields whereby Dakota Growers is the exclusive manufacturer of Dreamfields^TM low digestible carbohydrate pasta. The Company has also entered into a services agreement with DNA Dreamfields under which it provides administrative, accounting, information technology, sales and distribution services to DNA Dreamfields. The Company believes that the Dreamfields^TM line of products is well suited for what the Company views as an increased demand for low carbohydrate products, and that the increased sales and shift from lower margin customers and products will ultimately provide greater profit margins. The Company expects to incur significant expenses associated with its commitments to DNA Dreamfields relating to the new product roll-out in its third fiscal quarter 2004. Dreamfields^TM low digestible carbohydrate pasta has been accepted for distribution into nearly 10,000 grocery outlets nationwide, with shipments beginning in February 2004.

 

Critical Accounting Policies

 

The accompanying discussion and analysis of our results of operations and financial condition are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the

 

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circumstances. However, future events are subject to change and the best estimates and judgments may require adjustment. For a complete description of the Company’s significant accounting policies, please see Note 1 to the consolidated financial statements included in the Company’s Form 10-K for the year ended July 31, 2003. Our critical accounting policies are those that have meaningful impact on the reporting of our financial condition and results, and that require significant management judgment and estimates. These policies include our accounting for (a) allowance for doubtful accounts, (b) asset impairment, and (c) income taxes.

 

Allowance for Doubtful Accounts

 

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

 

Asset Impairment

 

We are required to evaluate our long-lived assets for impairment whenever indicators of impairment exist, and write down the value of any assets if they are determined to be impaired. Evaluating the impairment of long-lived assets involves management judgment in estimating the future cash flows and fair values related to these assets. Future events could cause management to conclude that impairment indicators exist and that the value of certain long-lived assets is impaired.

 

Income Taxes

 

In determining income for financial statement purposes, management must make certain estimates and judgments in calculating tax liabilities and in determining the recoverability of certain deferred tax assets. Deferred tax assets must be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Management believes it is more likely than not that the deferred tax assets as of January 31, 2004 will be realized through the generation of future taxable income and tax planning strategies.

 

Results of Operations

 

Comparison of the Three Months Ended January 31, 2004 and 2003

 

Net Revenues. Net revenues decreased $5.3 million, or 13.1%, to $35.4 million for the three months ended January 31, 2004, from $40.7 million for the three months ended January 31, 2003. The decrease for the three months ended January 31, 2004 primarily resulted from lower pasta sales volumes.

 

Revenues from the retail market, a portion of which includes co-pack and governmental sales, decreased $2.6 million, or 12.0%, primarily as a result of a 9.1% decrease in sales volumes. A significant factor relating to the decrease in retail sales volumes was a decline in co-pack sales, primarily to New World Pasta Company. Co-pack sales comprised only 2.2% of net revenues for the quarter ended January 31, 2004 compared to 8.9% of net revenues for the quarter ended January 31, 2003. Foodservice revenues decreased $4.0 million, or 30.0%, as a result of a 32.8% decrease in sales volumes. The large decrease in foodservice volumes primarily resulted from a 54% decrease in sales to U.S. Foodservice, the Company’s largest customer. As noted in previous public filings with the Securities and Exchange Commission, sales volumes to U.S. Foodservice fell off dramatically after the second fiscal quarter 2003, down 67% in the second half of fiscal 2003 compared to first half of fiscal 2003. The Company was led to believe the increased sales to U.S. Foodservice in October through December 2002 were being fueled by increased demand by U.S. Foodservice customers for dry pasta products. In addition, the Company had received information suggesting that its third fiscal quarter 2003 sales to U.S. Foodservice, while

 

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below second fiscal quarter 2003 levels, would be relatively consistent with historical third quarter U.S. Foodservice sales. While the Company had no reason to question the reliability of this information at that time, it subsequently learned the information was inaccurate. U.S. Foodservice sales volumes did not return to normalized historical levels until the end of fiscal year 2003. Based on published news reports, certain management personnel at U.S. Foodservice were investigated for alleged accounting improprieties. Ingredient revenues increased $0.4 million, or 20.0%, mainly as a result of a 17.3% increase in sales volumes.

 

The Company markets semolina production in excess of its own requirements as well as by-products of the durum milling process. Revenues from semolina and by-product sales increased $0.9 million to $4.6 million for the three months ended January 31, 2004, compared to $3.7 million for the three months ended January 31, 2003. The change primarily resulted from higher semolina sales volumes.

 

Cost of Goods Sold. Cost of goods sold totaled $32.4 million for the three months ended January 31, 2004, a decrease of $3.7 million, or 10.1%, compared to the three months ended January 31, 2003. The decrease resulted mainly from lower sales volumes. Gross profit as a percentage of net revenues decreased from 11.6% to 8.6% primarily due to higher per unit manufacturing costs resulting from lower production volumes during the quarter ended January 31, 2004 compared to the corresponding quarter of the prior year.

 

Marketing, General, and Administrative (“MG&A”) Expenses. MG&A expenses totaled $2.0 million for the three months ended January 31, 2004, down 36.6% from $3.2 million for the three months ended January 31, 2003. MG&A expenses as a percentage of net revenues decreased from 7.8% to 5.7%. The decrease in MG&A expenses was primarily due to lower incentive compensation costs. A portion of incentive compensation for the second fiscal quarter 2003 related to a compensatory transaction in conjunction with the unwinding of previous stock option exercises and related officer loans in response to the Sarbanes-Oxley Act of 2002.

 

Interest Expense. Interest expense for the three months ended January 31, 2004 totaled $0.7 million, down $0.2 million from $0.9 million for the three months ended January 31, 2003. The decrease was primarily due to lower average outstanding debt levels.

 

Interest and Other Income. Interest and other income totaled $0.9 million for the three months ended January 31, 2004 compared to $1.0 million for the three months ended January 31, 2003. The U.S. Customs Service (“Customs”) has distributed antidumping and countervailing duties assessed on certain pasta imported from Italy and Turkey to affected domestic producers pursuant to the Continued Dumping and Subsidy Offset Act of 2000 (the “Offset Act”), which was enacted in October 2000. The Company received payments in the amount of $903,000 and $1,000,000 in December 2003 and 2002, respectively, under the Offset Act, based on duties assessed from October 1, 2001 to September 30, 2003. These amounts have been classified as other income. Under certain circumstances, the Company may be obligated to return certain amounts previously received by the Company under the Offset Act. The Company cannot reasonably estimate the potential amount, if any, that it may receive under the Offset Act in future periods as any such amount will be based upon future events over which the Company has little or no control, including, but not limited to, the amount of expenditures by domestic pasta producers and the amount of antidumping and countervailing duties collected by Customs.

 

Income Taxes. Income tax expense for the three months ending January 31, 2004, was $0.4 million, compared to $0.7 million for the three months ending January 31, 2003.  The income tax expense reflects an effective corporate income tax rate of approximately 39%.

 

Net Income. Net income for the three months ending January 31, 2004 totaled $0.7 million compared to $1.0 million for the three months ending January 31, 2003. The decrease in net income resulted primarily from lower pasta sales volumes and cost increases as noted above.

 

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Comparison of the Six Months Ended January 31, 2004 and 2003

 

Net Revenues. Net revenues decreased $5.0 million, or 6.4%, to $73.1 million for the six months ended January 31, 2004, from $78.1 million for the six months ended January 31, 2003. The decrease primarily resulted from lower pasta sales volumes.

 

Revenues from the retail market, a portion of which includes co-pack and governmental sales, decreased $3.0 million, or 6.9%, primarily due to a 6.5% decrease in sales volumes. A significant factor relating to the decrease in retail sales volumes was a decline in co-pack sales, primarily to New World Pasta Company. Co-pack sales comprised 5.5% of net revenues for the six months ended January 31, 2004 compared to 9.2% of net revenues for the six months ended January 31, 2003.  Foodservice revenues decreased $3.4 million, or 14.9%, primarily due to a volume decrease of 19.6% offset partially by higher per unit selling prices. The volume decrease related primarily to U.S. Foodservice. Ingredient revenues increased $0.9 million, or 21.8%, mainly as a result of a 22.1% increase in sales volumes.

 

Revenues from semolina and by-product sales for the six months ended January 31, 2004 totaled $7.7 million, up $0.5 million from $7.2 million for the six months ended January 31, 2003. The change primarily resulted from an increase in semolina sales volumes.

 

Cost of Goods Sold. Cost of goods sold totaled $68.1 million for the six months ended January 31, 2004, and January 31, 2003. Gross profit as a percentage of net revenues decreased from 12.7% to 6.8% due to higher raw material costs and higher per unit manufacturing costs, primarily resulting from lower production volumes, for the six months ended January 31, 2004 compared to the corresponding period of the prior year.

 

Marketing, General, and Administrative (“MG&A”) Expenses. MG&A expenses totaled $4.0 million for the six months ended January 31, 2004, down 26.9% from $5.5 million for the six months ended January 31, 2003. MG&A expenses as a percentage of net revenues decreased from 7.0% to 5.5%. The decrease in MG&A expenses was primarily due to lower incentive compensation costs. A portion of incentive compensation for the six months ended January 31, 2003 related to a compensatory transaction in conjunction with the unwinding of previous stock option exercises and related officer loans in response to the Sarbanes-Oxley Act of 2002.

 

Interest Expense. Interest expense for the six months ended January 31, 2004 totaled $1.5 million, down $0.3 million from $1.8 million for the six months ended January 31, 2003. The decrease was primarily due to lower average outstanding debt levels.

 

Interest and Other Income. Interest and other income totaled $0.9 million for the six months ended January 31, 2004 compared to $1.1 million for the six months ended January 31, 2003. The Company received payments in the amount of $0.9 million and $1.0 million in December 2003 and 2002, respectively, under the Offset Act, based on duties assessed from October 1, 2001 to September 30, 2003. Under certain circumstances, the Company may be obligated to return certain amounts previously received by the Company under the Offset Act. The Company cannot reasonably estimate the potential amount, if any, that it may receive under the Offset Act in future periods as any such amount will be based upon future events over which the Company has little or no control, including, but not limited to, the amount of expenditures by domestic pasta producers and the amount of antidumping and countervailing duties collected by Customs.

 

Income Taxes. Income tax expense for the six months ending January 31, 2004, was $72,000, compared to $1.5 million for the six months ending January 31, 2003.  The income tax expense reflects an effective corporate income tax rate of approximately 39%.

 

Net Income.  Net income for the six months ended January 31, 2004 totaled $0.1 million compared to $2.3 million for the six months ended January 31, 2003. The decrease resulted primarily from lower pasta sales volumes and cost increases as noted above.

 

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Liquidity and Capital Resources

 

Our primary sources of liquidity are cash provided by operations and borrowings under our credit facility. Working capital as of January 31, 2004 totaled $9.9 million compared to $13.4 million as of July 31, 2003.

 

The Company extended its $19 million revolving credit facility with CoBank through March 31, 2004. The Company plans to increase its line of credit to $25 million upon entering into a new revolving credit agreement on or before the March 31, 2004 maturity date. The revolving line has a variable interest rate established by CoBank based on CoBank’s cost of funds. The balance outstanding under the revolving line of credit totaled $8.4 million as of January 31, 2004.

 

The various debt agreements with CoBank and certain institutional investors obligate the Company to maintain or achieve certain amounts of equity and certain financial ratios and impose certain restrictions on the Company. The Company was not in compliance with certain ratios set forth in its debt agreements with CoBank and such institutional investors as of January 31, 2004. The Company is currently in discussions with CoBank and such institutional investors regarding the terms of a waiver and amendment to resolve the noncompliance situation. As noted above, sales volumes to the Company’s largest customer, U.S. Foodservice, increased significantly in October through December of 2002 when compared to historical levels and then fell off dramatically. U.S. Foodservice sales volumes did not return to normalized historical levels until the end of fiscal year 2003. The Company believes that if U.S. Foodservice had not shifted their purchasing pattern from normalized historical quarterly levels, the Company would have remained in compliance with all financial covenants as of January 31, 2004.

 

Net cash from operating activities totaled $9.7 million for the six months ended January 31, 2004 compared to net cash used for operating activities of $2.4 million for the six months ended January 31, 2003. The increase was primarily due to the reduction in inventory and lower payments for long-term marketing costs offset by an increase in trade receivables and the reduction in net income.  Because of the actions of U.S. Foodservice, as well as an unexpected decline in co-pack sales, the Company increased its finished goods inventories by $6.2 million through May 2003.  Changes in production schedules and improved sales volumes enabled the Company to reduce its finished goods by $6.2 million as of January 31, 2004.  The reduced factory utilization, as well as carrying costs associated with the higher inventory levels, have negatively impacted the Company’s earnings over the last four fiscal quarters.

 

Net cash used for investing activities totaled $1.0 million for the six months ended January 31, 2004, compared to net cash from investing activities of $0.8 million for the six months ended January 31, 2003. Cash used for investing activities related primarily to the purchase of milling and pasta equipment and payments for package design costs. The Company redeemed short-term investments of $2.0 million during the six months ended January 31, 2003, accounting for a majority of the change.

 

Net cash used for financing activities totaled $8.7 million and $1.3 million for the six months ended January 31, 2004 and 2003, respectively.  Substantially all of the net cash used for financing activities for the six months ended January 31, 2004 related to debt principal payments. The net cash used for financing activities for the six months ended January 31, 2003 consisted primarily of debt principal payments and the repurchase of stock offset by net borrowings under the revolving credit facility.

 

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The following table summarizes the Company’s contractual obligations as of January 31, 2004 (in thousands):

 

Contractual Obligations		Total			Payments Due in Less Than 1 Year			Payments Due in 1-3 Years			Payments Due in 4-5 Years			Payments Due After 5 Years
Long-term debt		$	30,883		$	9,796		$	14,313		$	5,774		$	1,000
Durum purchase obligations		10,502			10,502			—			—			—
Operating leases		3,565			1,261			2,242			62			—
		$	44,950		$	21,559		$	16,555		$	5,836		$	1,000

 

The Company forward contracts for a certain portion of its future durum wheat requirements. The Company had outstanding commitments for grain purchases totaling $10.5 million as of January 31, 2004 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 and are not transferable.

 

The Company made aggregate investments in DNA Dreamfields of $145,000 through January 31, 2004. Under the terms of the DNA Dreamfields operating agreement, the Company shall contribute, when and as needed, additional funds up to an aggregate of approximately $4.0 million, to DNA Dreamfields to pay for the development of supply chain, product package development, consumer research, test market launch and regional roll out, advertising and merchandising. Such contributions shall be additional capital contributions by the Company without the issuance of any additional ownership units in DNA Dreamfields.

 

Management believes that net cash to be provided by operating activities, along with its available line of credit, will be sufficient to meet the Company’s expected capital and liquidity requirements for the foreseeable future.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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

 

The Company does not believe it is subject to any material market risk exposure with respect to interest rates, commodity prices, exchange rates, equity prices, or other market changes that would require disclosure under this item.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed the Company’s disclosure controls and procedures within 90 days prior to the filing of this quarterly report. Based upon this review, these officers believe that the Company’s disclosure controls and procedures are effective in ensuring that material information related to the Company is made known to them by others within the Company.

 

Changes in Internal Controls

 

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the most recent evaluation.

 

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PART II – OTHER INFORMATION

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

The Annual Meeting of Stockholders of the Company was held on January 10, 2004. The following proposals were presented for stockholder consideration at the Annual Meeting:

 

•                  The election of three directors to serve as “Class II” directors.

•                  Approval of the appointment of Eide Bailly LLP as the Company’s independent auditors for fiscal year 2004.

 

At the Annual Meeting, the Company’s stockholders elected each of the Company’s nominees named in its Proxy Statement, dated December 8, 2003, to serve as “Class II” directors on the Board of Directors of the Company.  The Company’s nominees were Roger A. Kenner, Eugene J. Nicholas and Jeffrey O. Topp.  As newly-elected “Class II” directors, each of these individuals will serve on the Board of Directors for three-year terms ending in 2007. Following are the results for the election of directors:

 

		Shares Voted For		Shares Withheld
Roger A. Kenner		5,970,749		545,297
Eugene J. Nicholas		6,080,996		435,050
Jeffrey O. Topp		6,232,766		283,280

 

Allyn K. Hart, Curtis R. Trulson and Michael E. Warner will continue serving as directors until the annual meeting held in 2005. John S. Dalrymple III, James F. Link and John D. Rice, Jr. will continue serving as directors until the annual meeting held in 2006.

 

In addition, the stockholders approved the appointment of Eide Bailly LLP as the Company’s independent auditors for fiscal year 2004, as follows:

 

Shares Voted For		6,341,010
Shares Voted Against		90,341
Shares Abstained		84,695

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

Exhibits

 

10.1                 DNA Dreamfields Company, LLC Operating Agreement dated October 31, 2003 between the Company, B-New, LLC, TechCom Group, LLC, and Buhler, Inc. Confidential treatment has been requested with respect to portions of the Exhibit.

 

10.2                 Manufacturing Agreement dated December 26, 2003 between the Company and DNA Dreamfields Company, LLC. Confidential treatment has been requested with respect to portions of the Exhibit.

 

10.3                 Services Agreement dated December 26, 2003 between the Company and DNA Dreamfields Company, LLC. Confidential treatment has been requested with respect to portions of the Exhibit.

 

10.4                 Trademark License Agreement dated December 26, 2003 between the Company and DNA Dreamfields Company, LLC.

 

10.5                 Technology Sublicense Agreement dated December 26, 2003 between the Company and DNA Dreamfields Company, LLC.

 

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10.6                 Dakota Growers Pasta Company, Inc. Amended and Restated 2003 Stock Option Plan.

 

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

 

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

 

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

 

32.2                 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.

 

Reports on Form 8-K

 

The Company filed a Form 8-K on January 12, 2004 announcing it had communicated to stockholders at the Company’s Annual Meeting of Stockholders held on January 10, 2004, that it has been continuing its previously-disclosed efforts, working with other food technology organizations, to develop a low digestible carbohydrate pasta product. The Company announced that it plans to commence production and sale of a line of low digestible carbohydrate pasta products in the early part of calendar year 2004.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	DAKOTA GROWERS PASTA COMPANY, INC.
	(Registrant)

 

 

Signature			Title		Date
/s/ Timothy J. Dodd			President and Chief Executive Officer
Timothy J. Dodd			(Principal Executive		March 16, 2004
			Officer)
/s/ Thomas P. Friezen			Chief Financial Officer
Thomas P. Friezen			(Principal Financial		March 16, 2004
			Officer)
/s/ Edward O. Irion			Vice President – Finance and
Edward O. Irion			Chief Accounting Officer		March 16, 2004
			(Principal Accounting Officer)

 

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