** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON DC  20549**

 

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**FORM 10-K**

 

| **ý** |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|-------------------------------------------------------------------------------------------|
|       |   | **For  the fiscal year ended December 30, 2001**                                          |

** **

**OR**

| **o**  |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                           |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | **FOR  THE TRANSITION PERIOD FROM                         TO                       ** |

 

**Commissionfile number 0-22534-LA**

 

**MONTEREY PASTA COMPANY**

(Exact name of registrant as specified in its charter)

 

| **Delaware**              |   | **77-0227341**                        |
|---------------------------|--------|---------------------------------------|
| (State of  incorporation) |   | (IRS employer  identification number) |

 

**1528 Moffett Street**

**Salinas, California 93905**

**(831) 753-6262**

(Address, including zip code, and telephone number, including areacode,

of Registrant’s principal executive offices)

 

Securities registeredpursuant to Section 12(b) of the Act: None

Securities registeredpursuant to Section 12(g) of the Act: Common Stock, $.001 par value

 

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

 

                Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K.  o

 

                Theapproximate aggregate market value of the voting stock held by non-affiliatesof the issuer as of February 11, 2002 was $64,689,240.  The number of shares outstanding of theissuer’s common stock as of February 11, 2002 was 13,807,100.

 

 

 

**PART I**

 

**ITEM 1.  BUSINESS**

 

**Introduction**

 

**               **Monterey Pasta Company (“the Company”) wasincorporated in June 1989 as a producer and distributor of refrigerated gourmetpasta and sauces to restaurants and grocery stores in the Monterey, Californiaarea.  The Company has since expandedits operations to include a more diversified range of gourmet refrigerated foodproducts, which it provides to grocery and club stores throughout the UnitedStates, as well as selected regions in Canada, the Caribbean, Latin America,and Asia Pacific.  The Company’s overallstrategic plan is to enhance the value of the Monterey Pasta Company brand nameby distributing its gourmet food products through multiple channels ofdistribution, while selectively participating in private label partnerships.

 

**               **The Company currently produces andmarkets premium quality refrigerated gourmet pastas, soups, gnocchi, pastasauces, stuffed pizzas and calzones, pierogies, and polenta emphasizingsuperior flavors and innovative products. It seeks to build brand recognition and customer loyalty by employing amarketing program that focuses on developing multiple points of sale for theCompany’s products, and increasing consumer awareness of the Company’sofferings.  The Company markets andsells its products primarily through grocery and club stores.

 

The Company offers over185 varieties of contemporary gourmet food products that are produced using theCompany’s proprietary recipes.  Examples of the Company’s products are listed under “Products” on pagesfour, five, and six.  In 2001, theCompany introduced two new product lines, veil thin pasta in the borsellinishape with five flavors, and a new line of sauces called “Italian Classics”with three selections.  Severalextensions of existing lines were also marketed.

 

                The Company sellsits products through leading grocery store chains including Albertson’s, KingSoopers, Safeway, Dominick’s, Ralphs, Fred Meyer, Kroger, Raley’s, and QFC; andwarehouse club stores including Costco Wholesale and Sam’s Club (a division ofWal-Mart).  As of December 30, 2001,approximately 6,400 grocery and club stores offered Monterey Pasta’s products.

 

In 1998, the Company added a web site, **www.montereypasta.com,**to further support its brand by providing both consumer and investorinformation, and opened an on-line store offering Monterey Pasta products tothe rapidly growing number of Internet shoppers.  Shoppers can now order items for delivery within two days.  In 1999, the Company expanded the site tooffer other non-food items as well.  In2000, the website was updated to improve its speed of access, ease ofnavigation and technical sophistication related to multi-media, and links toother websites.   Further “userfriendly” improvements were made in 2001.

 

                The success of the Company’s sales efforts willdepend in large part on three key factors: (1) whether grocery and club storechains will continue to increase the number of their stores offering theCompany’s products, (2) whether the Company can continue to increase the numberof grocery and club store chains offering its products, and 3) whether theCompany can continue to introduce new products that meet consumeracceptance.  Grocery and club storechains continually re-evaluate the products carried in their stores, and noassurances can be given that the chains currently offering the Company’sproducts will continue to do so in the future.

 

                This Form 10-K contains forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, and Section21E of the Securities Exchange Act of 1934, that involve substantial risks tothe Company, including statements about the Company’s past operating losses,the ability to attract and retain qualified management, the impact ofinflation, dependence on major customers, and marketing and sales risks.  In connection therewith, please see thecautionary statements contained herein in “Business Risks” which identifyimportant factors that could cause actual results to differ materially fromthose in the forward-looking statements.

 

**Industry Overview**

 

**               **The Company believes that the U.S. retailmarket for refrigerated pasta is large and highly fragmented.  Although refrigerated pasta products are notnew, fresh pasta and pasta sauce were essentially created as a nationalspecialty food category in 1986 when Nestle Fresh Foods Co., a division ofNestle S.A. (“Nestle”), introduced its Contadinaâ (nowBuitoniâ) brand of fresh pasta.  In 1990, Kraft General Foods, Inc., adivision of Philip Morris (“Kraft”), unveiled its DiGiornoâbrand of fresh pasta nationally.

 

The Company believes thatthe interest in the fresh pasta category was influenced by several factorsincluding heavy advertising and promotion by Nestle and Kraft, the changingconsumer preference for freshly prepared healthy foods, and increasing 

 

 

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consumer demandfor convenient, quick meal solutions. The Company is further encouraged by industry research reports, whichshow that spending on refrigerated gourmet, specialty foods by consumers in theCompany’s target market appears to be growing.

 

                No assurance can be given that the refrigeratedindustry will expand further.  Nor canthere be any assurance that current trends in healthy eating, perception offresh pasta and pasta sauce as a healthy eating alternative, consumer demandfor meal solutions, or consumer spending levels in the specialty food categorywill continue in the future. Additionally, as the Company expands into different geographic regions,it may encounter different consumer perceptions, attitudes and behavior.  This may adversely impact the Company’smarketing and expansion strategy and cause it to incur greater expenses in thepromotion of its products.

 

                The market for refrigerated stuffed pizzas andcalzones is made up of many small local producers, none of whom, to theCompany’s knowledge, offer extended shelf life.  The Company also has one larger competitor (San Francisco Foodsof San Leandro, CA) claiming a relatively short shelf life compared to theCompany’s guarantee of 30 days, and offering competition with some of theCompany’s current accounts.

 

                The refrigerated soup market is comprised of manysmall local producers and two other more substantial competitors, Stock Pot (ownedby Campbell Soup Company), and Harry’s, an independent headquartered inPortland, Oregon.  The Company believesit benefited by the promotion of Stock Pot, which increased consumer awarenessof the refrigerated soup category.

 

                While the frozen pierogy market is dominated by onelarge producer with over 80% of sales revenue, the refrigerated pierogy marketis comprised of very small local producers who sell through delis and cannotclaim extended shelf life.  To itsknowledge, the Company possesses the only refrigerated extended shelf lifepierogy with national distribution.

 

                The polenta business is also highly fragmented andcomprised of several regional competitors in retail chains with no club storepresence.  The Company will initiallymarket under the Nate’s label, with the potential of also selling under its ownbrand sometime in the future.  During2001 the company began marketing an organic polenta, its first organic product.

 

                No assurance can be given that the market forrefrigerated gourmet food products will expand further and that space will bemade available at the store level to house refrigerated products.  Nor can there be any assurance that currenttrends in healthy gourmet eating, perception of many of the Company’s productsas healthy gourmet eating alternatives, consumer demand for quick mealsolutions, or consumer spending levels in the specialty food category willcontinue in the future.  Additionally,as the Company expands into different geographic regions, it may encounterdifferent consumer perceptions, attitudes and behavior.  This may adversely impact the Company’smarketing and expansion strategy and cause it to incur greater expenses in thepromotion of its products.

 

**Strategy**

 

                Monterey Pasta’s objective is to become a leadingnational supplier of refrigerated gourmet food products through distribution ofits products to grocery and club stores. The key elements of the Company’s strategy include the following:

 

•                    Expand market share through same-storerevenue growth, addition of new grocery and club store chains, geographicdiversification, and product line expansion, including creation of additionalmeal occasions using Monterey Pasta products.

 

•                    Introduce new products on a timely basisto maintain customer interest and to respond to changing consumer tastes.  In order to maximize its margins, theCompany will focus its efforts on those new products that can be manufacturedand distributed out of its Salinas, California facility and will supplement itsexisting line of cut pasta, ravioli, tortelloni, tortellini, sauces, gnocchi,pizzas and calzones, borsellini, polenta, and soups.

 

•                    Use the Company’s Internet presence tocreate awareness of, and make available, Monterey Pasta products in areas inwhich they are not currently available, and to support the Company’s existingretail and club store accounts.

 

•                    Reduce operating costs as a per cent ofsales through continual evaluation of administrative and production staffingand procedures.  The Company willconsider additional capital improvements at its manufacturing facility in orderto increase production efficiencies and capacities, and to reduce the Company’scost of goods on a per unit basis.

 

•                    Create brand awareness by communicatingto the consumer that Monterey Pasta Company provides a healthful and nutritiousline of products and promote repeat business by reinforcing positiveexperiences with the Company’s products.

 

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•                    Consider the acquisition of othercompatible companies or product lines to expand retail distribution, or therange of product offerings, or to accomplish other synergies where theacquisition will create long-term stockholder value.

 

                TheCompany will continue to direct its advertising and promotional activities tospecific programs customized to suit its retail grocery and club storeaccounts.  These will include in-storedemonstrations, coupons, scan backs, cross-couponing and other 

 

related activities. There can be no assurance that theCompany will be able to increase its net revenues from grocery and clubstores.  Because the Company willcontinue to make expenditures associated with the expansion of its business,the Company’s results of operations may be affected.

 

                The success of the Company’s acquisitionstrategy is dependent upon its ability to generate cash from currentoperations, attract new capital, find suitable acquisition candidates, andsuccessfully integrate new businesses and operations.  There is no assurance that acquisitions can be financed fromcurrent cash flow, and, if not, that outside sources of capital will beavailable to supplement internally-generated funds.  There is no assurance that management can successfully selectsuitable acquisition candidates and that these new businesses can besuccessfully integrated to create long term stockholder value.

 

**Products**

 

                The Company produces and marketsa variety of gourmet refrigerated cut pasta, borsellini, ravioli, tortelloni,tortellini, soups, gnocchi, pasta sauces, stuffed pizzas, calzones, pierogies,and polenta under the Monterey Pasta Company, Arthur’s and Nate’s labels, aswell as private labels.  Arthur’s is amid-priced pasta and sauce label which was acquired as part of the March 1999acquisition of San Antonio Texas-based Frescala Foods, Inc. and the Nate’slabel was acquired in December 2000 (See “Liquidity, Capital Resources, andBusiness Acquisitions”, page 13). Following is a representative list of the Company’s products with thosesold under the Arthur’s label so noted:

 

| **Cut Pasta:**                          |   | **Year  Introduced or Acquired** |   |
|-----------------------------------------|--------|----------------------------------|--------|
| Garlic Basil Fettuccine                 |   | 1989                             |   |
| Angel  Hair                             |   | 1989                             |   |
| Spinach  Fettuccine (Arthur’s)     |   | 1999                             |   |
| Lemon  Pepper Linguine (Arthur’s)  |   | 1999                             |   |
|                                    |   |                             |   |
| **Ravioli:**                            |   |                             |   |
| Lobster                                 |   | 1997                             |   |
| Fire  Roasted Vegetable                 |   | 1997                             |   |
| Artichoke  & Cheese                 |   | 1998                             |   |
| Chicken  Piccata                        |   | 1998                             |   |
| Gorgonzola  Cheese                      |   | 1998                             |   |
| Snow  Crab                              |   | 1998                             |   |
| Roasted  Garlic, Herb, and Cheese       |   | 1998                             |   |
| Spinach  Ricotta                        |   | 1998                             |   |
| Shrimp  Scampi                          |   | 1998                             |   |
| Chicken  Rosemary                       |   | 1999                             |   |
| Four  Cheese (Arthur’s)            |   | 1999                             |   |
| Light  Garden Vegetable (Arthur’s) |   | 1999                             |   |
| Spinach  and Cheese                     |   | 2000                             |   |
| Italian  Sausage                        |   | 2001                             |   |

 

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| **Tortelloni:**                                   |   | **Year  Introduced or Acquired** |   |
|---------------------------------------------------|--------|----------------------------------|--------|
| Spinach  Mushroom                                 |   | 1994                             |   |
| Sundried  Tomato and Asiago Cheese                |   | 1994                             |   |
| Rainbow  Five Cheese                              |   | 1998                             |   |
| Italian  Sausage (Arthur’s)                  |   | 1999                             |   |
| Proscuitto,  Spinach & Cheese (Arthur’s) |   | 1999                             |   |
|                                              |   |                             |   |
| **Tortellini:**                                   |   |                             |   |
| Garlic  Basil Cheese                              |   | 1996                             |   |
| Tri-Color  (Arthur’s)                        |   | 1999                             |   |
| Cheese  (Arthur’s)                           |   | 1999                             |   |
| Cheese  Tortellini                                |   | 2001                             |   |
|                                              |   |                             |   |
| **Sauces:**                                       |   |                             |   |
| Roasted  Garlic Artichoke                         |   | 1995                             |   |
| Thick  and Chunky Tomato Basil                    |   | 1996                             |   |
| Roasted  Garlic and Parmesan                      |   | 1998                             |   |
| Basil  Cream Sauce with Artichokes                |   | 1998                             |   |
| Pesto  Sauce with Garlic and Basil                |   | 1998                             |   |
| Garden  Fresh Marinara                            |   | 1999                             |   |
| Fresh  Alfredo with Herbs                         |   | 1999                             |   |
| Sun  Dried Tomato Pesto (Arthur’s)           |   | 1999                             |   |
| Alfredo  (Arthur’s)                          |   | 1999                             |   |
| Roasted  Garlic Pesto (Arthur’s)             |   | 1999                             |   |
| Sun  dried Tomato Cream                           |   | 1999                             |   |
| Italian  Classics:                                |   |                             |   |
| Florentine  Marinara                              |   | 2001                             |   |
| Cacciatore                                        |   | 2001                             |   |
| Sicilian  Tomato with Pesto                       |   | 2001                             |   |
|                                              |   |                             |   |
| **Soups:**                                        |   |                             |   |
| Tuscan  Minestrone                                |   | 1999                             |   |
| Monterey  Clam Chowder                            |   | 1999                             |   |
| Autumn  Classic Butternut Squash                  |   | 1999                             |   |
| Old  Fashioned Chicken Noodle                     |   | 1999                             |   |
| Red  Ripe Tomato with Basil                       |   | 1999                             |   |
| Southwest  Style Tortilla                         |   | 2000                             |   |
|                                              |   |                             |   |
| **Tortelloni Grandi:**                            |   |                             |   |
| Spinach  and Cheese                               |   | 1999                             |   |
| Italian  Sausage                                  |   | 1999                             |   |
| Five  Cheese and Rainbow Five Cheese              |   | 1999                             |   |
|                                              |   |                             |   |
| **Gnocchi:**                                      |   |                             |   |
| Potato  Parmesan                                  |   | 1999                             |   |
|                                              |   |                             |   |
| **Stuffed Pizzas:**                               |   |                             |   |
| Spicy  Chicken with Sun-dried Tomatoes            |   | 2000                             |   |
| 6  Italian Cheeses                                |   | 2000                             |   |
| Italian  Sausage and Pepperoni                    |   | 2000                             |   |
| Pepperoni                                         |   | 2000                             |   |

 

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| **Calzones:**                                        |   | **Year  Introduced or Acquired** |   |
|------------------------------------------------------|--------|----------------------------------|--------|
| Spinach,  Feta Cheese and Pesto with Red Onions      |   | 2000                             |   |
| Black  Forest Ham and Swiss Cheese                   |   | 2000                             |   |
| Scrambled  Eggs with Country Sausage and Two Cheeses |   | 2000                             |   |
| Meatball                                             |   | 2000                             |   |
| Italian  Sausage, Pepper, and Onion                  |   | 2000                             |   |
| Philly  Cheese Steak                                 |   | 2001                             |   |
| Portobello  Mushroom and Artichoke                   |   | 2001                             |   |
| Fajita                                               |   | 2001                             |   |
| Florentine  Chicken with spinach And Cheese          |   | 2001                             |   |
|                                                 |   |                             |   |
| **Pierogies:**                                       |   |                             |   |
| Potato  and Cheese                                   |   | 2000                             |   |
| Potato  and Onion                                    |   | 2000                             |   |
|                                                 |   |                             |   |
| **Polenta (Nate’s):**                           |   |                             |   |
| Original                                             |   | 2000                             |   |
| Sun  Dried Tomato                                    |   | 2000                             |   |
| Mexican  Pepper                                      |   | 2000                             |   |
| Italian  Herb                                        |   | 2000                             |   |
| Wild  Mushroom                                       |   | 2000                             |   |
|                                                 |   |                             |   |
| **Borsellini:**                                      |   |                             |   |
| Grilled  Chicken with Cheese and Dijon               |   | 2001                             |   |
| Feta  Cheese with Spinach                            |   | 2001                             |   |
| Aged  Italian Cheeses                                |   | 2001                             |   |
| Italian  Herb                                        |   | 2001                             |   |
| Wild  Mushroom                                       |   | 2001                             |   |

 

                The Company is committed todiversifying its product offerings with innovative new pasta products and othergourmet product lines.  The Company’sproduct development team and product development consultants focus on creatingnew products that innovatively blend complementary tastes, food textures andingredients while strictly adhering to the Company’s emphasis on freshness,healthfulness and quality.  As newproducts are introduced, selected items will be discontinued to help ensurethat the product line is focused on consumer demand, to maximize the Company’sreturn on its shelf space in grocery and club stores, and to respond tochanging trends and consumer preferences.

 

                The Company’s refrigeratedproducts are packaged in clear lightweight containers, which reveal the freshappearance of its products.  MontereyPasta presents its products with a colorful logo, distinctive packaging styles,ingredient information and cooking instructions to communicate the gourmet,fresh and healthful qualities of its products. Its pizza, borsellini, and sauce products feature new packaging tomaximize shelf impact and generate increased consumer interest in the products,with increased emphasis on food photography.

 

                The goal of the Company is tointroduce new products on a timely and regular basis to maintain customerinterest and to respond to changing consumer tastes.  There can be no assurance that the Company’s efforts to achievesuch a goal will result in successful new products or product lines or that newproducts can be developed and introduced on a timely and regular basis.  If the Company’s new products are notsuccessful, the Company’s grocery and club store sales may be adversely affectedas customers seek new products.

 

                **Production**

 

**               **The Company produces its products in a43,680 square foot Monterey County, California facility.  It is strategically located in one of thelargest produce-growing regions in the United States and is near several majorvendors and food service distributors. The 

 

 

 

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facility iscertified by the United States Department of Agriculture (USDA) and utilizesstate of the art thermal processing, chilling and packaging processes.   The Company added a new 20,000 square footrefrigerated distribution center in December 1999, which is also located inMonterey County, approximately three miles from its production facility.  During 2001 the distribution center was furtherexpanded with the addition of 25,000 square feet of ambient storage to augmentexisting storage and replace storage lost at the  production facility which was converted to production space.  Further expansion is contemplated at thedistribution center location for 2002 to included an unspecified amount ofproduction space and additional storage. Approximately 19 people are employed at the distribution center,including shipping personnel, customer service and traffic personnel, and thelogistics manager.

 

                The currentproduction/headquarters facility is staffed by approximately 330 employees,including plant management, a purchasing agent, quality control, accountingpersonnel, sales staff, drivers, and production line workers.  Refrigerated pasta is manufactured at thefacility using high quality ingredients such as Extra Fancy Durham wheat, wholeeggs or egg whites, fresh herbs and IQF (Individually Quick Frozen) herbs andspices, and local cheeses and milk products. The ingredients are mixed in accordance with the Company’s proprietaryrecipes.  After filling with fresh andunusual ingredients such as snow crab, spinach and feta cheese, lobster, andVermont cheddar cheese, the pasta products receive a prescribed thermal process(pasteurization) to insure product safety and to preserve flavor, quality andshelf life.  The products are thenchilled immediately and packaged in controlled atmosphere trays.  Pasta sauces are mixed and processed inindividual batches in accordance with the Company’s proprietary processes andrecipes and then directly packed and sealed in plastic containers.  Pizza and calzone products are baked incontinuous process ovens before being chilled, packed, and sealed using thesame process as is used for pasta products. After preparation, processing, chilling and packaging, all pasta, bakedproducts, and sauces are kept in cold storage to preserve quality and shelflife.

 

                The Company continuously reviewsa variety of capital projects for the production department and in the past twoyears has spent approximately $9.4 million on capital improvements. Theseincluded a new tortelloni line, a new packaging line and clean room, increasedsauce capacity and efficiency, a new pasteurizer, a pizza/calzone line, andboiler and utility upgrades to accommodate capacity increases.   Approximately $900,000 was invested in a new state-of-the-art20,000 square foot refrigerated distribution center, which materially improvedefficiencies and customer service in 2000 when compared with 1999.  The 2000 additions created a 100% increasein sauce capacity, a 200% increase in filling and mixing capacity, and a 25%increase in packline capacity compared with 1999 levels.  Significant 2001 expenditures included $1.2million to double the capacity of the pizza/calzone line and improve theoverall process, an improved sauce labeling machine, two machines and dies toproduce borsellini, and an upgraded ingredients blending area.  Future additions of assets will be evaluatedfor increased efficiency, flexibility and need.

 

###### **Distribution**

 

**               **The Company’s success depends upon aneffective system of distribution for its products.   In Northern California, the Company maintains three direct storedelivery (“DSD”) routes to deliver its products to approximately 140 stores.  The Company also delivers product directlyto warehouses for Safeway, its largest Northern California customer. Todistribute its products to other customers and parts of the country (over 90%of its business), the Company uses common carriers.  The dependence on other companies for delivery of its productsposes a risk to the Company.  While thecommon carrier method of delivery has been reliable and available at acceptablerates thus far, there can be no assurance that the Company will continue to beable to negotiate acceptable freight rates in the future and that delivery willnot be disrupted for reasons including, but not limited to, adverse weather,natural disasters or labor disputes in the trucking industry.

 

**Grocery Chain and Club Store Sales**

 

                Monterey Pasta sells itsproducts to chain grocery and club stores.

 
|                   |   | **Number of  Stores Carrying Monterey Pasta Products** |   |
|------------------------|--------|--------------------------------------------------------|--------|
|                   |   | **1999**                                               |   | **2000** |   | **2001** |   |
| Retail  Grocery Stores |   | 3,900                                                  |   | 5,330 |   | 5,640 |   |
| Club  Stores           |   | 640                                                    |   | 670 |   | 780 |   |
| **Total**              |   | 4,540                                                  |   | 6,000 |   | 6,420 |   |

 

                For the years 1999, 2000 and2001, Costco accounted for 49%**,** 50% and 48% of total net revenues, whileSam’s Club stores accounted for 31%, 30%, and 31% of revenues for the sameyears.  The Company currently sells itsproducts to eight separate Costco regions which make purchasing decisionsindependently of one another.  Theseregions re-evaluate, on a regular basis, the products carried in theirstores.  There can be no assurance thatthese Costco regions will continue to offer Monterey Pasta products in thefuture 

 

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or continue toallocate Monterey Pasta the same amount of shelf space.  The Company currently supplies its productsto approximately 450 Sam’s Club stores which feature expanded delis.  Purchasing decisions are made at the companyheadquarters with input from the store level. While the Company is in the fifth year of its relationship with Sam’s,there can be no assurance that Sam’s Club stores will continue to carry itsproducts or allocate Monterey Pasta the same amount of shelf space.  The loss of either of these major customerscould materially adversely affect the Company’s business operations.

 

                In 2001, the average grocerystore carried 12 individual Monterey Pasta products, or Stock KeepingUnits  (“SKUs”), and the average clubstore carried 11 SKUs.

 

**Marketing**

 

**               **The Company’s marketing strategy is tocreate brand awareness by communicating to the consumer that Monterey PastaCompany provides a gourmet quality nutritious line of products and to promoterepeat business by reinforcing positive experiences with the Company’sproducts.  The Company’s approachincludes the introduction of new products on a timely basis to maintaincustomer interest and to respond to changing consumer tastes.  Additionally, the Company will continue toexpand its sales into those geographic regions that will best support thepurchase of the Company’s upscale, premium grade products.

 

**Competition**

 

**               **The Company’s business is subject tosignificant competition.  The freshpasta and pasta sauce industry is highly competitive and is dominated by a twovery large multinational companies, Nestle, with its Contadinaâ andBuitoniâ brands, and Kraft, with its DiGiornoâbrand.   There are also a number ofsmaller regional competitors, such as Mallardsâ(owned by Tyson), Romance, and Triosâ, (owned by ConAgra) which focuses mostlyon the food service trade. Multinational competitors have significantly more brand namerecognition, marketing personnel, and cash resources than the Company.  Moreover, competition for shelf space ingrocery stores is intense and poses great difficulty for smaller foodcompanies.

 

                To date, the Company hasbenefited indirectly from the marketing efforts of Nestle and Kraft in thepasta and sauce business, and Stockpot (Campbell Soup Company) in the soupbusiness.  These companies committedsignificant financial resources towards advertisement, promotion anddevelopment of the fresh pasta, sauce and soup industries, which havecontributed to the rapid expansion of these markets and to the increasedconsumer attention to the categories. No assurance, however, can be given thatthese companies will continue to expend such resources in the future or thatthe Company will continue to enjoy such benefits. In the future, the Companymay be required to incur significantly greater expenses for promotion,advertisement and marketing, which could adversely affect profitability.  There can be no assurance that the Companywill be able to continue to commit sufficient funds to promotion, advertisementand marketing while operating profitably.

 

**               **The pizza and calzone products producedby the Company are believed to be the only nationally distributed extendedshelf life product in the refrigerated section of the supermarket.  The Company is unaware of a significantcompetitor offering these products that can guarantee at least a 30-day shelflife, which is the minimum committed to by the Company.

 

**               **Competitive factors in the refrigeratedfood market include brand awareness, product quality and taste, healthfulness,price and availability of grocery and club store shelf space. The Company’ssuggested retail prices are slightly higher than its competitors’ prices formany of its items to emphasize the premium quality of its product line.  The Company believes the excellent quality,taste and healthfulness of its products are superior to that of itscompetitors, although its brand name recognition and access to grocery shelfspace is significantly less than some of its competitors.  The Company also believes that the qualityof its products and the variety of its product lines provide a competitiveadvantage over many companies which market more traditional products.

 

**Management**

 

                Information relating todirectors and executive officers of the Company is set forth in Part III ofthis report.

 

**ManagementInformation Systems**

 

The Company purchased anew integrated management information system in 1996 with the objective toimplement an electronic link between the Company’s retail sales operations,production facilities and the corporate offices.  The Expandable MRP system (“Expandable”) is central to theCompany’s efforts to automate, centralize and streamline many of the Company’skey functions including accounting and finance, human resources, and productionand inventory control.  During the fallof 1998, the Company successfully installed a new version of Expandable toensure compliance with year 2000 needs. All other systems were 

 

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successfully updated to comply with year 2000 needsduring 1999.  The Company is scheduledto install a new Windowsâ version of Expandable in the first orsecond quarter of 2002.  Improvementswill also be made to its client server system to augment redundancy andincrease capacity.

 

**GovernmentRegulation**

 

**               **The Company is subject to the regulations of the U.S.Food and Drug Administration (FDA), the U.S. Department of Agriculture (USDA),and state and local regulations relating to cleanliness, maintenance of foodproduction equipment, food storage, cooking and cooling temperatures and foodhandling, and is subject to unannounced on-site inspections of productionfacilities.  Regulations in new markets,new regulations in existing markets, and future changes in existing regulationsmay adversely impact the 

 

Company by raising the cost of production and deliveryof pasta and sauces and/or by affecting the perceived healthfulness of theCompany’s products.  A failure to complywith one or more regulatory requirements could result in a variety ofsanctions, including fines and the withdrawal of the Company’s products fromstore shelves.  The Company is not awareof any currently existing facts or circumstances that it is not addressingwhich would cause it to fail to comply with any of the regulations to which itis currently subject.

 

**Employees**

 

**               **As of December 30, 2001, the Company employed a totalof approximately 350 persons, including 40 administrative personnel, 6 salespersonnel, 5 drivers, and 299 distribution and production personnel.  None of the Company’s employees arerepresented by a labor union and the Company believes its relations with itsemployees are good.

 

**Trademarksand Service Marks**

 

                TheCompany has registered the “Monterey Pasta Company” name and “postage stamp”logo design with the United States Patent and Trademark Office.  There can be no assurance that competitorswill not adopt similar names or logo designs outside the protection of theCompany’s trademark registration. In March of 1999, the Company acquired theright to use the “Arthur’s” label with its acquisition of the Frescala Foods,Inc. business.  In December 2000, itacquired the right to use the “Nate’s” label through its acquisition of theNate’s polenta business (See “Liquidity, Capital Resources, and Business Acquisitions,”page 13). In January 2001 the Company applied for registration with the UnitedStates Patent and Trademark Office for the “Borsellini” trademark namecurrently used for its filled pasta of the same name.  Additionally, In November 2001, the United States Patent andTrademark Office approved the “Homestyle-Fresh” trademark currently used in itssoup line.

 

**ITEM2.  PROPERTIES**

 

                Thetotal square footage California leased by the Company at 1528 Moffett Street inSalinas (Monterey County), California for its production facility and corporateoffices is 43,680, or approximately one acre of building space, and comprisesthe entire building.  Company managementis in the process of leasing an additional 40,000 square feet adjacent to itsdistribution facility (see following paragraph) to provide additionalproduction, ambient and refrigerated storage space and to provide for futuregrowth.  The current productionfacilities/headquarters lease expires in October 2004 with two ten-year optionsfor renewal.

 

                The Company currently leases twooutside warehouse facilities in Salinas, California adjacent to each otherwithin the same warehouse complex, approximately three-miles from itsproduction facility.  One, comprised ofapproximately 25,000 square feet, is used to store raw materials, packagingmaterials, excess coolers and display racks, idle equipment and companyrecords, and is a month-to-month lease.  The second is for 20,000 square feet of refrigerated storage, from whichthe Company distributes its finished products. The term is for five years and expires January 2005.

 

During February 1996, the Company leased 9,160 squarefeet of executive office and training space facilities in downtown SanFrancisco.  The Company vacated thisspace in January 1997 following a staff reduction and consolidation of alloperations in the Company’s factory in Monterey County.  The Company subleased the San Franciscoproperty at a small premium, as of April 1, 1997, to a large publishinginterest for the remaining term of the lease, which expired February 14,2001.  Following its expiration thelease was relinquished.

 

**ITEM3.  LEGAL PROCEEDINGS**

 

On February 2, 2000, theUnited States District Court for the District of Delaware denied a motion todismiss a lawsuit against Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLC,stockholders of the Company, (collectively, “Clearwater”), Mark Levy v. 

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Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLCand Monterey Pasta Company, United States District Court for the District ofDelaware, Case No. 99-004-SLR.  Thelawsuit alleged a violation of Section 16(b) of the Securities Exchange Act of1934, as amended, in connection with alleged purchases and sales of theCompany’s stock within a six-month period. The Company was named as a nominal defendant in the lawsuit. Plaintiffsought the return of approximately $1,064,000 in alleged profit and Clearwatercontested the claim.  During the week ofJuly 10, 2000, the parties signed a settlement agreement whereby Clearwateragreed to pay $700,000 to the Company in settlement of the claim asserted bythe plaintiff.  Plaintiff’s counselapplied to the court for attorney’s fees and expenses of approximately $230,000from the settlement.  As part of thesettlement, Clearwater and the Company exchanged mutual releases.  Thesettlement was approved by the Board of Directors of the Company.

 

                On October 27, 2000 the Companyreceived a check in the amount of $472,406 including the settlement amount of$470,000, and interest of $2,406.  Thestockholders’ equity account was increased to reflect the disgorged profitsettlement amount, net of the related $180,000 tax effect.

 

There are no othermaterial pending legal proceedings, other than ordinary, routine litigationincidental to the Company’s business, to which the Company is a party or towhich any of its property is subject.

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

                Nomatters were submitted to vote during the fourth quarter of 2001.

 

**PART II**

 

**ITEM 5.****    ****MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS**

 

**PriceRange of Common Stock**

 

                TheCompany effected its initial public offering on December 7, 1993 at a price tothe public of $6.00 per share.  Sincethat date, the Company’s Common Stock has traded on the NASDAQ National MarketSystem under the symbol “PSTA.”   Thetable on the following page sets forth in decimals for the period indicated,the high and low sales prices of shares of the Common Stock on the NASDAQNational Market System.

 

|               |   | **High** |   | **Low** |   |
|--------------------|--------|----------|--------|---------|--------|
| Fiscal  year 2000: |   |     |   |    |   |
| First  quarter     |   | $        | 4.8125 |    | $      | 3.3750 |   |
| Second  quarter    |   | 4.3125   |   | 3.2500  |   |
| Third  quarter     |   | 5.2500   |   | 3.6250  |   |
| Fourth  quarter    |   | 5.8750   |   | 4 .3125 |   |
|               |   |     |   |    |   |
| Fiscal  year 2001: |   |     |   |    |   |
| First  quarter     |   | $        | 7.0625 |    | 4.6875 |   |
| Second  quarter    |   | 8.2000   |   | 5.6250  |   |
| Third  quarter     |   | 7.9700   |   | 5.0500  |   |
| Fourth  quarter    |   | 7.5000   |   | 5.1000  |   |
|                    |        |          |        |         |        |  |  |

 

                As of February 11,2002, there were 231 stockholders of record of the Common Stock andapproximately 4,600 investors with shares in street name.

 

**DividendPolicy**

 

                TheCompany has not paid any cash dividends to Common stockholders, except tocertain holders of private placement common stock in 1997, which representedguaranteed yield for the period from stock issuance in April, 1997 until theRegistration Statement on Form S-3 was effective on October 24, 1997.  The Company intends to retain futureearnings in its business and does not anticipate paying cash dividends on the outstandingCommon stock in the near future.

 

 

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**ITEM6.  SELECTED FINANCIAL DATA**

 

The following table sets forth selected consolidatedfinancial data for the Company.  Thesedata should be read in conjunction with the consolidated financial statementsand related notes included elsewhere in Form 10-K.

 

|                                             |   | **Years  Ended**                                         |   |
|--------------------------------------------------|--------|----------------------------------------------------------|--------|
|                                             |   | **1997**                                                 |   | **1998** |   | **1999** |   | **2000** |   | **2001** |   |
|                                             |   | **(dollar  amounts in thousands except per share data)** |   |
| **Consolidated  Statements of Operations Data:** |   |                                                     |   |   |   |   |   |   |   |   |   |
| Net  revenues from continuing operations         |   | $                                                        | 23,447 |   | $ | 26,217 |   | $ | 36,902 |   | $ | 47,962 |   | $ | 59,220 |   |
| Income  from continuing operations               |   | $                                                        | 474    |   | $ | 2,037 |   | $ | 7,027 |   | $ | 6,141 |   | $ | 4,429 |   |
| Income  from discontinued operations             |   | $                                                        | 37     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Basic  net income per common share               |   | $                                                        | 0.02   |   | $ | 0.16 |   | $ | 0.55 |   | $ | 0.46 |   | $ | 0.33 |   |
| Diluted  income per common share                 |   | $                                                        | 0.02   |   | $ | 0.16 |   | $ | 0.54 |   | $ | 0.44 |   | $ | 0.31 |   |
|                                             |   |                                                     |   |   |   |   |   |   |   |   |   |
| Weighted  average primary shares outstanding     |   | 10,458,451                                               |   | 12,979,055 |   | 12,711,801 |   | 13,222,062 |   | 13,491,177 |   |
| Weighted  average diluted shares outstanding     |   | 10,458,451                                               |   | 12,979,055 |   | 13,074,776 |   | 13,835,384 |   | 14,254,248 |   |
|                                             |   |                                                     |   |   |   |   |   |   |   |   |   |
| **Consolidated  Balance Sheet Data:**            |   |                                                     |   |   |   |   |   |   |   |   |   |
| Working  capital                                 |   | $                                                        | 2,444  |   | $ | 1,601 |   | $ | 4,128 |   | $ | 9,799 |   | $ | 14,934 |   |
| Total  assets                                    |   | $                                                        | 11,029 |   | $ | 10,835 |   | $ | 18,666 |   | $ | 25,189 |   | $ | 31,596 |   |
| Total  debt and capital lease obligations        |   | $                                                        | 1,797  |   | $ | 2,277 |   | $ | 761 |   | $ | 73 |   | $ | 49 |   |
| Stockholders’  equity                       |   | $                                                        | 7,360  |   | $ | 6,709 |   | $ | 14,610 |   | $ | 21,663 |   | $ | 27,981 |   |

 

 

**ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL                 CONDITION AND RESULTS OFOPERATIONS**

 

**               **The following discussion should be read in conjunctionwith the financial statements and related notes and other information includedin this report.  The financial resultsreported herein do not indicate the financial results that may be achieved bythe Company in any future period.

 

**Background**

 

**               **Monterey Pasta Company was incorporated in June 1989as a producer and wholesaler of refrigerated gourmet pasta and sauces torestaurants and grocery stores in the Monterey, California area.  The Company has since expanded its operationsto provide a variety of gourmet refrigerated food products to grocery and clubstores throughout the United States, selected regions in Canada, the Caribbean,Latin America, and Asia Pacific.  TheCompany’s overall strategic plan is to enhance the value of the Monterey PastaCompany brand name by distributing its gourmet products through multiplechannels of distribution.

 

                TheCompany’s product distribution to grocery and club stores increased fromapproximately 25 stores as of December 1989, to approximately 4,300 by December1995, declined to approximately 3,100 as of December 28, 1997 and increased,once again, to approximately 6,400 stores by December 30, 2001.   During 1994, 1995 and 1996, significantcosts were incurred to promote the expansion that occurred, including productdemonstration, advertising, warehousing, and distribution costs and the hiringof additional personnel.  In 1997, thefocus was changed to developing a profitable distribution base.  Hence, the reduction in store totals, andthe return to profitability.  During1998 through 2001, the Company added profitable retail and club distributionincluding approximately 250 additional club stores, 550 retail stores as partof the March, 1999 Frescala Foods acquisition, and several new retail chainscomprising approximately 2,200 stores.

 

                The success of the Company’sefforts to increase revenue will depend on three key factors: (1) whethergrocery and club store chains will continue to increase the number of theirstores offering the Company’s products, (2) whether the Company can continue toincrease the number of grocery and club store chains offering its products, and(3) continued introduction of new products that meet consumer acceptance.  Grocery and club store chains continuallyre-evaluate the products carried in their stores, and no assurances can 

 

 

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be given that thechains currently offering the Company’s products will continue to do so in thefuture or that such chains will not reduce the number of stores carrying theCompany’s products.

 

                TheCompany believes that access to substantially greater capital resources,coupled with continued reduction of its administrative and production costs asa percent of sales revenue, will be key requirements in the Company’s effortsto enhance its competitive position and increase its market penetration.  In order to support its expansion program,the Company has developed, and is continuing to develop new products forconsumers and revised advertising and promotional activities for its retailgrocery and club store accounts. There can be no assurance that the Companywill be able to increase its net revenues from grocery and club stores.  Because the Company will continue to makeexpenditures associated with the expansion of its business, the Company’sresults of operations may be affected.

 

**Operationsfor 1999, 2000 and 2001**

 

**               **Net revenues from were $36,902,000, $47,962,000, and$59,220,000 for 1999, 2000, and 2001, respectively, reflecting an annualincrease in sales of 30% for 2000, when compared to 1999, and a 23% increasefor 2001 when compared to 2000. The 2000 

 

and 2001 increases resulted from same store salesgrowth as well as increased store numbers from approximately 4,500 at the endof 1999 to approximately 6,000 individual grocery and club stores by year-endof 2000, and approximately 6,400 at year end 2001.  The 2001 sales level represents a compound annual average growthsince 1998, when sales were $26,217,000, of over 31%.

 

                Grossmargin for 2001 remained close to the 2000 level at 38.4% compared with 38.5%,although the last quarter of 2001 evidenced an increase in gross margin at40.9%, when compared to the first three quarters, which averaged 37.5%.  Gross margin in 1999 was 38.5%.  The 2001 decline was influenced bysignificant energy cost increases in the first two quarters, substantialincreases in dairy ingredients affecting the first ten months of 2001 invarying degrees, and production inefficiencies associated with the rapidnational rollout of the successful borsellini and calzone product lines.  Electricity prices at year-end were 65%higher than they were in January of 2001. Natural gas prices increased in excess of 160% compared with averageyear 2000 levels by March of 2001.  Byyear-end 2001 they were approximately 12% below year average 2000 levels.  The production inefficiencies related to theborsellini and calzone lines were completely resolved by the middle of quarterthree.  Dairy ingredients at year-end2001 were tracking at or below levels originally budgeted for 2001, althoughthe decline did not begin influencing margins until the middle of the fourthquarter.

 

                Selling,general and administrative expenses (“SG&A”) increased to $15,515,000, up$3,149,000 or 26% from $12,366,000 in 2000, which had increased $2,146,000 or21% from 1999. The 2001 increase resulted from variable expense increaseassociated with the 23% sales increase. It also reflected an increased investment in marketing expenditures, mostnotably product demonstrations, the addition of several salaried positions tofurther support growth, and $323,000 in non-cash compensation expense relatedto performance-based stock options granted to executives in year 2000.  Eliminating the one-time option compensationexpense would reduce the SG&A increase from 26% to 23%   The 21% increase in 2000 over 1999 resultedprimarily from variable costs associated with the 30% sales increase.  SG&A expenses as a percent of sales were27.7%, 25.8%, and 26.2% for 1999, 2000, and 2001, respectively.  Adjusting for the one time optioncompensation expense would reduce SG&A expense as a percent of sales for2001 to 25.6%.  Management believes thecurrent level of SG&A expenses is consistent with efficient operations, andadditional expenses in future periods, mainly in the sales and marketing area,will be directly associated with increased levels of sales.

 

Depreciation andamortization expense, included in cost of sales and SG&A, increased to$1,661,000, or 3% of net revenues in 2001, compared to $1,394,000 or 3% of netrevenues in 2000, and $1,183,000 or 3% in 1999.  The increases over the past two years relate primarily to capitalexpenditures in the Salinas, California production facility and the addition ofthe Frescala Foods business that added $94,000 amortization expense during1999, $126,000 in 2000, and 124,000 in 2001. The acquisition of the Nate’spolenta business in December 2000 (See “Liquidity, Capital Resources andBusiness Acquisitions”, page 13) added $55,000 in amortization expense in2001.  The Company anticipates furtherincrease in depreciation expense in future periods as additional equipment ispurchased and placed in service. Because of the changes associated with Statement of Financial AccountingStandards 142 (see “New Accounting Pronouncements” on page 36), however,amortization of existing intangibles is expected to decline from $218,000 in2001 to $47,000 in 2002.

 

                Netinterest income of $108,000 was recognized in 2001 compared to net interestexpense of $40,000 in 2000 and $156,000 in 1999. The 2001 interest income wasgenerated from investment in short-term money funds, pending the need forinvestment in capital assets or a potential acquisition.  At year-end 2001, the Company had no bankdebt and the net interest income for the year included $5,000 of interestexpense from financing leases.  The 2000decrease in interest expense compared with 1999 resulted from the reduction of,and by the end of quarter three, the elimination of debt resulting fromincreased profitability. (See “Consolidated Balance Sheets” page 28).

 

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Income tax benefit (expense) for 1999, 2000, and 2001 was $3,261,2000,$109,100 and $(2,936,000), respectively. The 1999 benefit resulted primarily from the reversal of prior valuationallowances against deferred tax assets.   As of December 26, 1999, we had experienced three consecutive years ofincreasingly profitable operations.  Accordingly, a portion of the valuationallowance totaling $3,430,000 was reversed in 1999, since we believed it wasmore likely than not that at least this portion of deferred tax assets,relating to net operating loss carryforwards (“NOLs”), CaliforniaManufacturer’s Tax credits, and various timing differences, would berealized.  Additional reserves were reversed in 2000.    In 2000, we realized additional actual taxbenefits as a result of the exercise of non-qualified stock options and the exerciseand subsequent sale of certain incentive stock options (“disqualifyingdispositions”). For financial reporting purposes, any resulting reduction inincome tax obligations is credited to additional paid-in capital.

 

In 2001, estimated incometax expense of $2,936,000 was offset for actual cash liability purposes by useof NOLs, the tax credits, and the effect of current year disqualifyingdispositions.  Accordingly, estimatedincome tax liability for 2001 is only $217,000 towards which $228,000 has been paidas of December 31, 2001, leaving a prepayment of $11,000, associated with2001.  Future income tax expense mayfluctuate significantly depending upon the outcome of a Tax Court caseinvolving a similar tax situation which may result in our ability to useapproximately $17.7 million in additional NOLs relating to our previously-ownedsubsidiary Upscale Food Outlets, Inc. (“UFO”), currently covered with avaluation reserve as we cannot yet determine that utilization of these NOLs isprobable. Alternatively, it is at least possible that approximately $4.0million in UFO NOLs already utilized might be disallowed.  See also “Liquidity, Capital Resources andBusiness Acquisition: Deferred Tax Assets” and Note 8 to the consolidatedfinancial statements.

###### ** **

###### **Liquidity, CapitalResources, and Business Acquisitions**

 

**               **During the twelve months ended December 30, 2001,$7,416,000 of cash was provided by the Company’s operations, compared to$6,000,000 provided in 2000.  Thedecline in 2001 net income of $1,712,000 was offset by a $2,184,000 decrease indeferred tax assets, leaving a net increase of $472,000 attributable to profitperformance associated with operations. The Company accrued $2,936,000 in tax expense for book purposes but paidonly $228,000 in cash taxes for year 2001 due primarily to utilization of NOLsas discussed above.  The $1.5 millionincrease in net cash income over 2000 (net income plus depreciation andamortization, deferred income taxes and non-cash compensation expense) waspartially offset by growth in the working capital components to support the 23%sales growth.  The $724,000 increase inprepaid expenses was a result of a $325,000 reclassification of operatingsupplies inventory from the production inventory account, increased prepaidinsurance and taxes of $172,000, and other prepaid expense increases of$227,000 mainly associated with customer programs.  The 2001improvement in cash flow from operations followed a $1.3improvement of 2000 over 1999, most of which was contributed by an increasednet cash income, partially offset by a decrease in accounts payable.  The 1999 accounts payable balance includednearly $800,000 in accrued fixed asset expenditures associated with thesignificant plant expansion program completed in 2000.  The 2000 accounts payable balance was$613,000 lower because of a much lower level of capital commitments atyear-end.

 

                TheCompany currently has a credit facility, which was renegotiated in August, 2001for $10.0 million in aggregate borrowings, of which zero was outstanding atDecember 30, 2001 (See Note 4 to the financial statements).  The $1.5 million working capital portion ofthe facility is priced at either prime rate or LIBOR, plus 185 basis points fora debt/tangible net worth ratio of .50:1, with LIBOR premiums increasing in 25basis point increments based on increased debt/tangible net worth increments of .25:1.   The $8.5 million non-revolvingterm portion of the facility pricing is ateither prime rate or LIBOR plus premiums for the same debt/tangible net worthratios beginning at 200 basis points over LIBOR and increasing 25 basis pointsfor successive debt/tangible net worth increments.  The termloan facility is subject to annual review if unused.  If used it converts to an 84-month term loan.  A term note from the same institution, inthe amount of $750,000, was obtained in March 1999 to assist with the FrescalaFoods acquisition discussed below, and was repaid in September 1999.

 

A total of $500,000 incash was used in 2000 in connection with the Nate’s polenta acquisition,including costs associated with the transaction, compared with $1,516,000 in1999 associated with the March 1999 acquisition of Frescala Foods, Inc.discussed below.  In addition,$4,308,000 in cash was used to purchase equipment and leasehold improvements in2000, compared to $2,415,000 in 1999. Approximately $1.3 million of the 1999 capital expenditures were part ofa $3.5 million capital plan approved by the Company’s Board of Directors inOctober 1999 for the period of October 1999 through December 2000.  The Company made additional capitalexpenditures in 2000 of approximately $1.7 million to expand productioncapability, improve packaging efficiency and maintain quality and upgradeutilities including boiler capacity and waste water treatment, as well asanother $.6 million for a stuffed pizza/calzone line.

 

The Company invested$2.6 million in capital assets in 2001. Major projects included approximately $900,000 for expansion of andimprovements in the pizza/calzone line, approximately $300,000 for ingredientsblending upgrade, and over $250,000 for the 

 

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borsellini dies and pasta machines.  The Company also invested over $500,000 infacility improvements to enhance sanitation and support growth, and $150,000 innew or improved packaging equipment, as well as many other capital projectsdesigned to support growth, improve processes, or assist in compliance issues.The Company anticipates capital expenditures in 2002 to be approximately $2.7million.  All future capitalexpenditures are expected to be funded with a combination of cash flow fromoperations and use of the Company’s credit facility.

 

OnMarch 12, 1999, the Company purchased the operating assets and inventory ofFrescala Foods, Inc. (“Frescala”), a San Antonio, Texas based fresh pasta andsauce producer with an emphasis on private label production. The considerationto Frescala consisted of $1,345,000 in cash plus fully vested options topurchase 300,000 shares of the Company’s common stock.  The options had an approximate fair marketvalue of $145,000, an exercise price of $2.33 per share, and a three-yearexpiration.  Additionally, Frescalaowners received an earn-out of $97,000 as of October 31, 1999 based upon Frescalasales above a predetermined level.  Fundingfor the transaction came from a new $750,000 two-year term loan, since repaid,use of existing accounts receivable and inventory line, and cash flow fromoperations.

 

                Thetotal consideration for Frescala of $1,587,000 plus related acquisition costsof $73,000 was allocated to identifiable fixed assets totaling $200,000 andinventories of $217,000.  The balance of$1,243,000, which includes trademarks and recipes not specificallyquantifiable, was charged to goodwill.

 

                OnDecember 8, 2000, the Company purchased the Nate’s polenta business of SouthSan Francisco, California for a total consideration of $469,000, plus relatedacquisition costs of $31,000. Approximately $19,000 was allocated to inventory.  The remaining $481,000, which includedrecipes, a licensing agreement, and customer list was charged to goodwill.Additionally, Nate’s former owners could have received an earn-out of a maximumof $100,000 to be paid as of August 8, 2001 based upon Nate’s sales above apredetermined level.  However, sales didnot reach the predetermined level so no additional payment was made.

 

Management believes thatthe Company’s $10 million credit facility, cash generated from operations, andits current cash balance will provide adequate funding to meet its needs fornormal operations and capital purchases through 2002.

 

**DeferredTax Assets**

 

Due to the prior history of losses, a 100% valuationallowance against deferred tax assets was provided in 1998 and earlier years,as we could not determine that it was more likely than not that we could usethem. As of December 26, 1999, however, we had experienced three consecutiveyears of increasingly profitable operations.  Accordingly, we reversed aportion of the valuation allowance totaling $3,430,000 at year-end 1999, sincewe believed it was more likely than not that at least this portion of deferredtax assets would be realized.  Additional reserves, other than thosereferred to below, were reversed in 2000.

 

 The findingsin a 2000 Federal Court case for an unrelated party involving some similarissues and fact patterns indicated that we would probably not be able to usecertain net operating losses (NOLs) arising in connection with ourpreviously-owned subsidiary Upscale Food Outlets, Inc. (UFO).  Accordingly, beginning of year Federal NOLs in 2000 were reduced, as were therelated deferred tax assets.   The resulting reduction in relatedgross deferred tax assets had no income statement effect in 2000 since they hadbeen fully reserved in prior years.  Inlate 2001, however, this Federal Court case was reversed on appeal.  The Internal Revenue Service has issued anotice indicating it does not agree with the Federal Court’s decision. The IRShas recommended, and the government has filed, a petition for rehearing and reconsiderationwith the Federal Circuit Court.  Thus, although the deferred tax assetsrelated to the NOLs have been restored, amounts potentially available forfuture usage are substantially all reserved, as it cannot currently bedetermined that their utilization is probable. We believe that the UFO NOLs utilized to date of approximately $4.0million will probably not be disallowed, as it is more likely that any negativedetermination through the Tax Court or legislatively would be prospective innature.

 

As this case progresses, we will continue tore-evaluate whether we can utilize any portion of the NOLs relating toUFO.  Any such positive determinationwould reduce both income tax expense for book purposes and the amounts actuallypayable to the Federal taxing authorities. The disallowance of any previous UFO NOL usage would increase bothincome tax expense and amounts actually payable.

 

**Salesand Marketing**

 

                TheCompany’s sales and marketing strategy is twofold and targets sustainablegrowth in distribution of its products and the introduction of innovative newproducts to keep the Company positioned as the gourmet refrigerated categoryleader in the marketplace.  Its focus ison increasing sales through expansion of its club store and retail grocerybusiness.

 

 

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                Aftergaining over 300 new club stores during 1997 and 1998, expansion of theCompany’s club store business continued in 1999 with the rollout of theCompany’s products in Costco’s Los Angeles and San Diego divisions with 72total warehouses.  The Company’spresence in Costco was approximately 230 stores at year-end 2000.  Distribution of the Company’s products alsocontinues to grow with the national expansion of Sam’s Club.  Monterey Pasta’s products are now found inapproximately 430 Sam’s Club locations, an increase of approximately 100 storesover 1998.

 

                During1999, the Company’s retail grocery distribution increased significantly withthe addition of over 200 Ralph’s stores in California, 79 stores ofDenver-based King Soopers, 44 stores of Norfolk, VA-based Farm Fresh, Inc., 150Smart and Final Stores throughout the western United States, as well as a thirdDirect Store Delivery route in Northern California.  It also acquired 750 new stores with the March 1999 Frescalaacquisition, of which it retained approximately 550.  During 2000, the net retail store increase was approximately1,430 with the addition of 24 Whole Foods and Wild Oats stores, 147 Raley’s, 30Super Targets, 77 Vons, 35 Furr’s, and the balance, over 1,100 stores from anincreased presence with a large private label customer, to whom the Companyformerly sold its branded product.

 

                MontereyPasta’s products typically are made with no preservatives or artificialingredients.  Capitalizing on thisstrength, the Company continues to pursue increased distribution throughnatural and organic food retailers, whose growth has exceeded 20% in recentyears.  The Company estimates there are450 potential natural and organic retail grocery stores available, as potentialmarkets for its products.

 

                During2000, the Company continued its emphasis on bringing innovative new products tothe market place with the introduction of refrigerated stuffed pizzas,calzones, pierogies, a tortilla soup, and a vodka sauce.   The refrigerated pizzas and calzones wereintroduced late in the third quarter with a guaranteed shelf life of 30 days,and, to the company’s knowledge, are the only extended shelf life refrigeratedpizzas and calzones.  The pierogies,introduced in the first quarter of 2000, are also the only extended shelf liferefrigerated pierogy the Company is aware of, have been accepted nationally atSam’s Club stores, and have regional distribution elsewhere.  These introductions are part of an ongoingeffort to rapidly introduce new products in the refrigerated section, whichfurther enhance the Company’s gourmet image.

 

Expansion of theCompany’s club store business took on an international flavor during 2001 withthe introduction of the Company’s products into the Eastern Canada division ofCostco, as well as Costco locations in Mexico, and  locations in Asia Pacific. The Company’s products are now found in approximately 330 CostcoWholesale locations.  Distribution ofthe Company’s products also continues to grow with the national expansion ofSam’s Club, and the introduction of the Company’s products into Sam’s Clublocations in Mexico.  Monterey Pasta’sproducts are now found in approximately 450 Sam’s Club locations.

 

During 2001 the Company’sretail business increased significantly with an additional 279 Albertson’sstores including 75 in the metro Phoenix market, and 204 in NorthernCalifornia, over 50 Dominick’s stores in the metro Chicago market, and 14Jerry’s Enterprises stores in the upper Midwest, which average 75,00 squarefeet in size. The Company also acquired significant retail business with itspurchase of the Nate’s Polenta brand in late 2000.  The Nate’s Polenta business added distribution to over 700 retailoutlets.  At end of 2001, the Companyhad distribution in over 5,600 retail outlets.

 

In 2001, the Companycontinued its emphasis on bringing innovative new products to the marketplacewith the introduction of two new product lines: Veil-thin pasta and ItalianClassic sauces.  Veil-thin pastafeatures a delicate dough that is significantly thinner than traditionalrefrigerated pasta doughs.  TheCompany’s first offering in the Veil-thin line is its Borsellini, which wrapsgourmet fillings in small pouches of veil-thin dough.  The product line has enjoyed considerable success in both retailand club store accounts.  The ItalianClassics sauce line expands the Company’s sauce offerings, and features threevarieties of Traditional-style Italian sauces. Italian Classics sauces can be found in both retail and club storeaccounts.  In addition, the Company alsoadded significantly to its existing line of refrigerated, fresh calzones duringthe year, and was successful in introducing them to both retail and club storeaccounts.

 

**BusinessRisks**

 

                Certaincharacteristics and dynamics of the Company’s business and of financial marketsgenerally create risks to the Company’s long-term success and to predictablequarterly results.  These risks include:

 

•                    No Assurance of Continued Profitability. In the second quarter of 1994, the Company reported its first operatingloss from continuing operations.  Subsequent to that quarter the Company incurred losses through the firstquarter of 1997, after which it regained profitability, which has continued fornineteen consecutive quarters.   AtDecember 30, 2001, the Company had an 

 

15

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accumulated deficit of $15,083,000. There can be no assurance that the Company will maintain its recent profitabilityin the long or short term.

 

•                    Liquidity:  Need for Additional Capital.   Managementbelieves that its current cash balances, operations and existing bank lines ofcredit will provide adequate liquidity to meet the Company’s planned capitaland operating requirements for normal operations and capital expendituresthrough the next twelve months, assuming that its existing bank lines can beextended when they expire in October, 2003. In addition, the disallowance of a significant portion of previously-utilizedUFO NOLs might require an unexpected cash outlay.   If the Company’s operations do not provide cash sufficient tofund its operations, and the Company seeks outside financing, there can be noassurance that the Company will be able to obtain such financing when needed,on acceptable terms, or at all.  Inaddition, any future equity financing or convertible debt financing would causethe Company’s stockholders to incur dilution in net tangible book value pershare of Common Stock.

 

•                    Hiring and Retention of Key Personnel. The success of the Company depends on its ability to retain keyexecutives, and to motivate and retain other key employees and officers.  The Company has key man insurance policiesin place, each in the face amount of $500,000, for its Chief Executive Officer,R. Lance Hewitt, and its Chief Financial Officer, Stephen L. Brinkman.  There can be no assurance that significantmanagement turnover will not occur in the future.

 

•                    Impact of Inflation. Except for dairy ingredients and energyprice increases, (see “California Energy Crisis” and “Dairy Ingredients Prices”risks on page 17), the Company believes that inflation has not had a materialimpact on its operations through 2001. Substantial increases in labor, employee benefits, freight, ingredientsand packaging, rents and other operating expenses, and

 

                        further increases in cheese and energyprices could adversely affect the operations of the Company’s business infuture periods.  The Company cannotpredict whether such increases will occur in the future, or their magnitude.

 

•                    Volatility of Stock Price. The market price of the Company’s common stock has fluctuatedsubstantially since the initial public offering of the Company’s common stockin December 1993.  Such volatility may,in part, be attributable to the Company’s operating results or to changes inthe direction of the Company’s expansion efforts.  In addition, changes in general conditions in the economy, thefinancial markets or the food industry, natural disasters or other developmentsaffecting the Company or its competitors could cause the market price of theCompany’s common stock to fluctuate substantially.  In addition, in recent years, the stock market has experiencedextreme price and volume fluctuations. This volatility has had a significant effect on the market prices ofsecurities issued by many companies, including the Company, for reasonssometimes unrelated to the operating performance of these companies.  Any shortfall in the Company’s net sales orearnings from levels expected by securities analysts or the market could havean immediate and significant adverse effect on the trading price of theCompany’s common stock in any given period. Additionally, the Company may not learn of such shortfalls until late inthe fiscal quarter. This could result in an even more immediate and significantadverse impact on the trading price of the Company’s common stock uponannouncement of the shortfall or quarterly operating results.

 

•                    Risks Inherent in Food Production.  The Company faces all of the risks inherent in the production anddistribution of refrigerated food products, including contamination,adulteration and spoilage, and the associated risks of product liability litigation,which may be associated with even an isolated event.  The Company has a modern production facility, employs what itbelieves is state-of-the-art thermal processing, temperature-controlledstorage, HAACP programs intended to insure food safety, and has obtained USDAapproval for its production plant. However, there can be no assurance that the Company’s procedures will beadequate to prevent the occurrence of such events.

 

•                    Dependence on Major Customers. During 2001, two customers, Costco and Sam’s Club stores, accounted for48% and 31%, respectively, of the Company’s total revenues.  The Company currently sells its products toseven separate Costco regions (approximately 330 stores) which make purchasingdecisions independently of one another. These regions re-evaluate, on a regular basis, the products carried intheir stores. There can be no assurance that these Costco regions will continueto offer Monterey Pasta products in the future or continue to allocate MontereyPasta the same amount of shelf space. The Company also supplies its products to approximately 450 Sam’s Clubstores.  Purchasing decisions are madeat the company headquarters with input from the store level.  While the Company is in the fifth year ofits relationship with Sam’s, and this relationship is expected to continue,there can be no assurance that Sam’s Club stores will continue to carry itsproducts. Loss of either of these customers, Costco or Sam’s Club, would have amaterial adverse effect on the Company.

 

•                    Seasonality and Quarterly Results. The Company’s grocery and club store accounts are expected to experienceseasonal fluctuations to some extent. The Company’s business in general may also be affected by a variety ofother factors, including but not limited to general economic trends,competition, marketing programs, and special or unusual events.

 

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•                    Competition and Dependence on CommonCarriers. TheCompany’s business continues to be dominated by several very large competitors,which have significantly greater resources than the Company; such competitorscan outspend the Company and negatively affect the Company’s market share andresults of operations.  The Company alsocontinues to be dependent on common carriers to distribute its products.  Any disruption in its distribution system orincrease in the costs thereof could have a material adverse impact on theCompany’s business.

 

•                    California Energy Crisis. During 2001, California experienced anenergy crisis that could have disrupted the Company’s operations and didincrease the Company’s energy expenses. In the event of an acute power shortage, when power reserves forCalifornia fall below 1.5%, electricity providers have on some occasionsimplemented, and may in the future implement, rolling blackouts. If blackoutsinterrupt the power supply to the Company’s production facilities, suchfacilities would temporarily be unable to continue production.  Any such interruption could result in a lossof revenue as a result of reduced production and, in severe cases, spoilage offood products.  In addition, related tothe energy crisis, many of the electricity and natural gas suppliers raisedtheir rates substantially during the first six months of 2001. Because theCompany has most of its operations in California, its operating costs areaffected by an increase in electricity and natural gas prices. As a result, theCompany’s operating results are likely to be affected in some measure by thecurrent California energy crisis. Electricity prices have remained unchanged from May through December2001, while natural gas prices have declined substantially from their levels inthe first five months of 2001. Management cannot predict the level of future energy prices with certainty.

 

•                    Marketing and Sales Risks. The future success of the Company’s efforts will depend on a number offactors, including whether grocery and club store chains will continue toexpand the number of their individual stores offering the Company’s productsand whether allowances and other incentives will expand retaildistribution.  Expansion into newmarkets increases the risk of 

 

                        significant product returns resultingfrom the Company’s supply of slower selling items to its customers.  In addition, grocery and club store chainscontinually re-evaluate the products carried in their stores and no assurancescan be given that the chains currently offering the Company’s products willcontinue to do so in the future.  Shouldthese channels choose to reduce or eliminate products, the Company could experiencea significant reduction in its product sales. As indicated previously, the Company remains dependent on the use ofslotting allowances and other incentives to expand retail distribution.  In order to reduce risk, the Company hassignificantly reduced expansion into new markets requiring such majorexpenditures.

 

•                    Dairy Ingredients Prices. During the first ten months of 2001 average price of certain dairyingredients increased over 40% compared with the average of the prior twelvemonths, as measured by butterfat prices published by the State of CaliforniaDepartment of Food and Agriculture. Because the Company utilizes various dairy ingredients in many of itsproducts, its operating costs will be affected by an increase in thoseingredients. The Company’s operating results were affected in the first elevenmonths of 2001, and could be affected in some measure in future months by priceincreases.  Dairy ingredientshistorically tend to be cyclical in nature and subject to declines in price aswell as increases.  Management cannotpredict with certainty the duration or magnitude of the current price cycle.

 

**RecentlyIssued Accounting Standards**

 

              In May 2000, the EITF reached a consensus on Issue 00-14, “Accountingfor Certain Sales Incentives.” This issue addresses the recognition,measurement, and income statement classification for sales incentives offeredvoluntarily by a vendor without charge to customers that can be used in, or areexercisable by a customer as a result of, a single exchange transaction.   In April 2001, the EITF reached a consensuson Issue 00-25, “Vendor Income Statement Characterization of Consideration to aPurchaser of the Vendor’s Products or Services.” This issue addresses the recognition,measurement and income statement classification of consideration, other thanthat directly addressed by Issue 00-14, from a vendor to a retailer orwholesaler. Issue 00-25 will be effective for the Company’s 2002 fiscal year.Both Issue 00-14 and 00-25 have been codified under issue 01-09, “Accountingfor Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’sProducts.”  We are currently analyzingIssue 01-09.   Issue 00-25 is not expectedto have a material impact on the Company’s financial position or results of operations,except that certain reclassifications will occur. The consenses reached inIssue 00-25 and Issue 00-14 (codified by Issue 01-09) are effective for fiscalquarters beginning after December 15, 2001. The Company analyzed the impact of reclassifications on its operatingresults for the last three fiscal years, if EITF 01-09 had been adopted withthe following proforma results shown on page 18:

 

17

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|                            |   | **—1999—** |   | **—2000—** |   | **—2001—** |   |
|---------------------------------|--------|----------------------|--------|----------------------|--------|----------------------|--------|
| **(000’s)**                |   | **As Stated**        |   | **Reclassified**     |   | **As Stated**        |   | **Reclassified** |   | **As Stated** |   | **Reclassified** |   |
| Net Revenues                    |   | $                    | 36,902 |                 | $      | 36,902               |   | $ | 47,962 |   | $ | 47,962 |   | $ | 59,220 |   | $ | 59,220 |   |
| Coupon Expense                  |   | —               |   | (153                 | )      | —               |   | (167 | ) | — |   | (66 | ) |
| Slotting Expense                |   | —               |   | (1,568               | )      | —               |   | (1,478 | ) | — |   | (1,990 | ) |
| Promos, Trade  Ads              |   | —               |   | (283                 | )      | —               |   | (227 | ) | — |   | (178 | ) |
| Adjusted Net Revenues           |   | $                    | 36,902 |                 | $      | 34,898               |   | $ | 47,962 |   | $ | 46,090 |   | $ | 59,220 |   | $ | 56,986 |   |
|                            |   |                 |   |                 |   |                 |   |   |   |   |   |   |   |
| Cost of Sales                   |   | 22,748               |   | 22,748               |   | 29,475               |   | 29,475 |   | 36,469 |   | 36,469 |   |
|                            |   |                 |   |                 |   |                 |   |   |   |   |   |   |   |
| Gross Profit                    |   | $                    | 14,154 |                 | $      | 12,150               |   | $ | 18,487 |   | $ | 16,615 |   | $ | 22,751 |   | $ | 20,517 |   |
| Gross Profit%                   |   | 38.4                 |   | 34.8                 |   | 38.5                 |   | 36.0 |   | 38.4 |   | 36.0 |   |
|                            |   |                 |   |                 |   |                 |   |   |   |   |   |   |   |
| Sales, Gen’l  & Admin. |   | $                    | 10,220 |                 | $      | 10,220               |   | $ | 12,366 |   | $ | 12,366 |   | $ | 15,515 |   | $ | 15,515 |   |
| Coupon Expense                  |   | —               |   | (153                 | )      | —               |   | (167 | ) | — |   | (66 | ) |
| Slotting Expense                |   | —               |   | (1,568               | )      | —               |   | (1,478 | ) | — |   | (1,990 | ) |
| Promos, Trade  Ads              |   | —               |   | (283                 | )      | —               |   | (227 | ) | — |   | (178 | ) |
| Adjusted SG&A               |   | $                    | 10,220 |                 | $      | 8,216                |   | $ | 12,366 |   | $ | 10,494 |   | $ | 15,515 |   | $ | 13,281 |   |
|                            |   |                 |   |                 |   |                 |   |   |   |   |   |   |   |
| SG&A%                       |   | 27.7                 |   | 23.5                 |   | 25.8                 |   | 22.8 |   | 26.2 |   | 23.3 |   |
| Operating Profit                |   | $                    | 3,934  |                 | $      | 3,934                |   | $ | 6,121 |   | $ | 6,121 |   | $ | 7,236 |   | $ | 7,236 |   |
| Operating  Profit%              |   | 10.7                 |   | 11.3                 |   | 12.8                 |   | 13.3 |   | 12.2 |   | 12.7 |   |

 

                In June 2001, theFinancial Accounting Standards Board finalized FASB Statements 141, BusinessCombinations (SFAS 141), and 142, Goodwill and Other Intangible Assets (SFAS142).  SFAS 141 requires the use of thepurchase method of accounting and prohibits the use of the pooling-of-interestsmethod of accounting for business combinations initiated after June 30,2001.  SFAS 141 also requires that werecognize acquired intangible assets apart from goodwill if the acquiredintangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after June 30,2001 and for purchase business combinations completed on or after July 1,2001.  It also requires, upon adoptionof SFAS 142 that we reclassify the carrying amounts of intangible assets andgoodwill based on the criteria in SFAS 141.

 

SFAS 142 requires, among other things, that companiesno longer amortize goodwill, but instead test goodwill for impairment at leastannually.  In addition, SFAS 142requires that we identify reporting units for the purposes of assessingpotential future impairments of goodwill, reassess the useful lives of otherexisting recognized intangible assets, and cease amortization of intangibleassets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested forimpairment in accordance with the guidance in SFAS 142.  SFAS 142 is required to be applied in fiscalyears beginning after December 15, 2001 to all goodwill and other intangibleassets recognized at that date, regardless of when those assets were initiallyrecognized.  SFAS 142 requires us tocomplete a transitional goodwill impairment test six months from the date ofadoption.  We are also required toreassess the useful lives of other intangible assets within the first interimquarter after adoption of SFAS 142.

 

The Company’s previous business combinations wereaccounted for using the purchase method. As of December 30, 2001, the net carrying of amount of goodwill is$1,316,000 and other intangible assets is $57,000.  Amortization expense for the fiscal year ended December 30, 2001was $218,000. Due to the adoption of SFAS 142 the Company estimates thatamortization expense for 2002 is expected to decline to $47,000, a decline of$171,000 compared with that expected prior to the adoption of SFAS 142.  Impairment testing at year-end 2001, underthe provisions of SFAS 121 “Accounting for Impairment of Long-lived Assets andLong-Lived Assets to be Disposed of (which will be superseded by SFAS 144“Accounting for the Impairment or Disposal of Lone-Lived Assets”) indicated noneed for writedown of goodwill.  TheCompany will perform impairment testing again at the end of the second quarterof 2002 to determine if any writedowns are necessary.

 

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In August 2001, Statement of Financial Standards No.144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“FAS144”) was issued. FAS 144 supersedes Statement of Financial AccountingStandards No. 121, “Accounting for the Impairment of Long-lived Assets to beDisposed of,” and the accounting and reporting provisions of APB Opinion No.30, “Reporting the Results of Operations-Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently occurringEvents and Transactions.” FAS 144 also amends ARB (“Accounting ResearchBulletins”) No. 51, Consolidated Financial Statements, to eliminate theexception to consolidation for a subsidiary for which control is likely to betemporary. FAS 144 retains the fundamental provisions of FAS 121 for recognizingand measuring impairment losses on long-lived assets held for use andlong-lived assets to be disposed of by sale, while resolving significantimplementation issues associated with FAS 121. Among other things, FAS 144provides guidance on how long-lived assets used as part of a group should beevaluated for impairment, establishes criteria for when long-lived assets areheld for sale, and prescribes the accounting for long-lived assets that will bedisposed of other than by sale. FAS 144 is effective for fiscal years beginningafter December 15, 2001. While the Company has not yet completed the process ofdetermining the effect of this new accounting pronouncement on its consolidatedfinancial statements, the Company currently expects that the effect of SFAS No.144 on the Company’s consolidated financial statements, when it becomeseffective, will not be significant.

 

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

 

**               **The financial statements and supplementary data of theCompany required by this item are set forth at the pages indicated at Item14(a).

 

**ITEM 9.****    ****CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTINGAND FINANCIAL DISCLOSURE**

 

**               **None

 

##### **PART III**

 

**ITEM10.       DIRECTORS AND EXECUTIVE OFFICERSOF THE REGISTRANT**

 

                As of February 11, 2002, the directors, executiveofficers, and other significant employees of the Company are as follows:

 

                **Directors and Executive Officers:**

** **
| **Name**               |   | **Age** |   | **Position**                                                         |   |
|------------------------|--------|---------|--------|----------------------------------------------------------------------|--------|
| Charles B.  Bonner     |   | 59      |   | Director                                                             |   |
|                   |   |    |   |                                                                 |   |
| F. Christopher  Cruger |   | 67      |   | Director                                                             |   |
|                   |   |    |   |                                                                 |   |
| R. Lance Hewitt        |   | 62      |   | Chief Executive Officer,  President and Director                |   |
|                   |   |    |   |                                                                 |   |
| Michael P.  Schall     |   | 48      |   | Director                                                             |   |
|                   |   |    |   |                                                                 |   |
| Van Tunstall           |   | 55      |   | Director                                                             |   |
|                   |   |    |   |                                                                 |   |
| James Wong             |   | 54      |   | Director                                                             |   |
|                   |   |    |   |                                                                 |   |
| Walter L Henning       |   | 57      |   | Director                                                             |   |
|                   |   |    |   |                                                                 |   |
| Stephen L.  Brinkman   |   | 53      |   | Chief Financial Officer, Corporate Secretary  Secretary and Director |   |

 

 

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**Other significant employees:**

 
| **Name**               |   | **Age** |   | **Position**                                   |   |
|------------------------|--------|---------|--------|------------------------------------------------|--------|
| Lynn Port              |   | 57      |   | Plant Controller                               |   |
|                   |   |    |   |                                           |   |
| Roy Scotton            |   | 42      |   | Director-Logistics                             |   |
|                   |   |    |   |                                           |   |
| Dan Brown              |   | 42      |   | Plant Manager                                  |   |
|                   |   |    |   |                                           |   |
| Ron Hendershott        |   | 51      |   | Director-Technical Services                    |   |
|                   |   |    |   |                                           |   |
| Dan Engle              |   | 50      |   | Sales Manager-Central/Southeast Central Region |   |
|                   |   |    |   |                                           |   |
| Rick Falkenberg        |   | 49      |   | Director-Quality Assurance                     |   |
|                   |   |    |   |                                           |   |
| Clifford Farmer        |   | 45      |   | Natural Foods/DSD Sales Manager                |   |
|                   |   |    |   |                                           |   |
| Lisa Player            |   | 41      |   | Sales Manager— East                       |   |
|                   |   |    |   |                                           |   |
| Joseph  Stirlacci |   | 41      |   | National Sales Manager                         |   |

 

                Normally each director is elected for a period of oneyear and serves until the stockholders duly elect his or her successor.  Directors may be elected by the Board tofill a vacancy between annual stockholder meeting elections.

 

                The principal occupations of each director andexecutive officer of the Company, for at least the past five years, are asfollows:

 

**                CharlesB. Bonner, Director.**  Mr. Bonner served as a Director of theCompany from 1993 through January 1995, and was reappointed as a Directoreffective September 1995.  Mr. Bonner isPresident of Pacific Resources, Inc., a mergers and acquisitions advisory firm,a position he has held since September 1989. Mr. Bonner also serves as a director for the following entities:  Everything Metal Imaginable, Inc., ScripAdvantage, Inc., Vision One Worldwide, Northwest Log Homes and Daystar VentureFund, LP.

 

                **F.Christopher Cruger, Director.** Mr. Cruger was elected to the Board of Directors in December of2001.  He is a retired investor andformer senior manager or executive of several consumer product or food companiesincluding Proctor and Gamble, Quaker Oats, Sara Lee, Mrs. Smith’s Pies, ToneBrothers, Inc, and McCormick and Company. He was President and CEO of Tone Brothers from 1985 to 1995.  Mr. Cruger joined McCormick and Company in1995 and served for four years as Manger of the Food Service Division beforeretiring.  He is a Director of KeminIndustries, Inc, The Graham Group, Inc. and Chairman and Director of Dominex,LC.

 

                **R. Lance Hewitt, President, Chief Executive Officerand Director.**  Mr. Hewittjoined the Company in June 1997 as President and Director.  He was named Chief Executive Officer inAugust 1997.  Mr. Hewitt was mostrecently President of Carriage House Fruit Company from 1995 to 1997.  He was Chief Operating Officer of IngroMexican Foods from 1988 to 1995.  Hewittalso served as Vice President of Marketing and Sales for the Lawry’s Foodsdivision of Thomas J. Lipton, Inc., a subsidiary of Unilever, and spent fifteenyears with McCormick Schilling, Inc., in various executive capacities.

 

                **Michael P. Schall, Director. **Mr. Schall was elected to the Board of Directors inDecember of 2001.   He is Senior VicePresident of Sales, Marketing, and DSD with Wise Foods.  He was President and CEO of The B.Manischewitz Company, LLC from 2000 until 2002.  Prior to that he was President and CEO of Guiltless Gourmet from1994 to 2000.  In addition to holdingexecutive or senior positions with Carnation , Lawry’s and Prepared Foods, Mr.Schall founded his own strategic consulting firm called Strategic MarketingMethods, Inc. which he ran for six years.

 

                **VanTunstall, Director. **Mr.Tunstall was elected to the Board of Directorsin February 1997.  Since 1997, he has served as President ofthe Central Coast Group, a strategic consulting and business servicesfirm.  He has been an independentconsultant with a variety of companies since 1997.  Mr. Tunstall was a senior executive with Gilroy Foods, Inc., aninternational manufacturer of various food product ingredients, from 1977 to1995.  He served as President andChairman of the Board from 1991 through 1995.  Previously, Mr. Tunstall held several executive positions with McCormick& Company, Inc.

 

 

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                **James Wong,Director.**  Mr. Wong waselected to the Board of Directors in March 1997.  Since March 2000 Mr. Wong has served as CEO of ServiceInteractive, Inc., a service, maintenance, and consulting company for the foodand hospitality industry. He is also Chairman and Chief Executive Officer ofRestaurant Connections International, Inc., a company he co-founded inSeptember 1998, which owns and operates a chain of restaurants in Brazil.  Since 1988 he has worked on five continentsfacilitating strategic alliances with suppliers and joint venture partners toimprove global market share and profitability, as Chairman and CEO ofDirections International, a U.S. based management consulting firm.  Mr. Wong also serves as a Director of NevadaGold and Casinos.

 

                **Walter L. Henning, Director. **Mr. Henning was elected to the Board of Directors inDecember 1999.  He is currently PlantManager of the Salinas Plant, McCormick & Company, Inc., a position he hasheld since early 1999.  Mr. Henningbegan his career with McCormick and Company in 1971 as Manager, TechnicalServices.  He subsequently was promotedseveral times to other positions in technical and plant management beforeleaving the company in 1983 to accept the position of Vice President ofOperations with Tone Spices.  Followingthe sale of Tone, Mr. Henning returned to a subsidiary of McCormick andCompany, Gilroy Foods, Inc. in 1995 as Vice President of Operations.  Mr. Henning remained with Gilroy Foods, Inc.in the same capacity after it was purchased by ConAgra in 1996, beforeultimately returning to McCormick & Company in 1999.

 

                **Stephen L.Brinkman, Chief Financial Officer, Corporate Secretary, and Director. **Mr. Brinkman joined the Companyin August, 1997 after a 17 year career with Gilroy Foods, Inc., where he wasController from 1984 through 1988 and Vice President, Finance andAdministration from 1989 through 1996.  Previously, he was Controller for a large California-based farmingcompany, and worked for Security Pacific Bank in agricultural banking.  Mr. Brinkman was elected to the Board inOctober 1999.

 

                The principal occupations of certain other significantemployees of the Company, for at least the past five years, are as follows:

 

                **Lynn Port, Plant Controller. **Mr. Port came to the Company in January 1998.  He has over 24 years experience as acontroller in agribusiness, retail, government and health care concerns, mostrecently with Country Home Care from 1995 through 1997.  From 1989 to 1995 Mr. Port was Director ofFinance for the Monterey County Housing Authority.  Prior to 1989, Mr. Port served for four years as Controller forGilroy Canning, Inc., a large tomato processing company.

 

                 **Roy G.Scotton, Director-Logistics. **Mr.Scotton joined the Company in June 1996 as Production Manager and wassubsequently promoted to Plant Manager. Mr. Scotton served at Nestle Food Company from 1987 to 1996, mostrecently as Organizational Development Manager.  In March 1998, Mr. Scotton was reassigned to the responsibilitiesformerly held by Mr. Klein, with the exception of plant maintenance.  He is now head of Logistics and responsiblefor the Company’s new distribution center.

 

                **Dan Brown, Director of Operations. **Mr. Brown joined the Company asDirector of Operations in May 2001. Prior to that, Mr. Brown was with Gilroy Foods, Inc, and its successorGilroy Foods (under new ownership) from 1986 until 2001 where he served in avariety of technical and operations positions, ultimately being promoted toManager of Plant Operations in 1997.  Healso served  as a Logistics Supervisorwith Frito Lay from 1984-86.

 

                **Ron Hendershott, Director-Technical Services**.  Mr. Hendershott joined the Company in May1995 as Quality Control Manager.  He waspromoted to his current position in March 1998. Mr. Hendershott has over 25years of managerial experience in Quality Control/Quality Assurance,  technical services, and regulatoryaffairs.  Prior to joining MontereyPasta he was with La Victoria Foods as Director of Quality Control from 1993through 1995 after spending two years with Weight Watchers as Manager ofTechnical Support Services.   He alsoserved American Home Foods for seven years as Regulatory Affairs Manager.

 

                **Dan Engle, Sales Manager-Central/Southeast.**  Mr. Engle joined the Company in June 2000 toreplace Don Anspaugh who  left theCompany.  Mr. Engle has over 25 yearsfood related sales and management experience, most recently with Benzel’sBretzels, where he served as Private Label Manager from 1998 to 2000.  He was National Sales Manager withNutritional Medical from 1997 to 1998, and Vice President of Sales andMarketing for Freedom Foods from 1996 to 1998. Prior to that he worked in private label development and sales over aperiod of 13 years with several companies, after concluding a seven-year stintas Account Manager with Oscar Mayer.

 

                **Rick Falkenberg, Director-Quality Assurance.**  Dr. Falkenberg joined the Company inDecember 2000 to further strengthen the Quality Assurance efforts of theCompany with 25 years of food processing background.  During his career, he worked his way up the chain ofresponsibilities from plant sanitarian, QA lab manager, QA divisional managerand then Director of Quality and Technical Services.  From 1998 to 2000, Dr. Falkenberg was the Director of Quality andTechnical Services for Basic Vegetable Products, a large industrial ingredientsupplier.  Prior to that he ran his ownInternational Business Development Company for three 

 

 

21

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years. From 1993-1996 he was the Corporate Manager of Regulatory Affairs forCadbury Beverages, following a three-year stay with Gilroy Foods, Inc. asQuality Assurance Manager.

 

**                CliffordM. (Rick) Farmer, Natural Foods/DSD Sales Manager. **Mr.Farmer joined Monterey Pasta Company in April 1991 and was responsible fordeveloping the Company’s Direct Store Delivery operation.   After the successful startup of the DSDsystem, he was promoted in 1992 to Plant Operations/Distribution Manager.  Her moved back to the DSD operation in June1993 in the capacity of Northern California Division Manager and was ultimatelypromoted to Western Regional Operations Manager.  He has been responsible for the Company’s DSD operations since1993 and in 1999 added natural food and specialty stores to hisresponsibilities.  Mr. Farmer has over15 years of food sales and distribution experience including as four-year stintas Executive Vice President of Golden Yolk Egg Company in San Francisco.

 

**                LisaPlayer, Sales Manager-East. **Ms. Player joined the Company in thecapacity of Eastern Zone Sales Manager and Sam’s Club stores Account Manager inMarch 1998 after spending a year as Corporate Sales Account Executive with FTPTravel Management Group, a large regional corporate travel managementcompany.  Prior to that she was employedfor over five years by Trio’s Pasta Products of Chelsea, Massachusetts, acompetitor of the Company, ultimately as National Account Sales Manager.  During her tenure with Trio’s, Ms. Playerwas responsible for the Sam’s Club account (which, after her tenure withTrio’s, was acquired by the Company in September, 1997).

 

                **Philip Costello, Sales Manager-West.  **Mr. Costello joined the Companyin February 2001 as Sales Manager-West. After 23 years food sales experiencewith retail grocery chains, and brokerage firms.  He also held a variety of sales positions with General Mills from1985-1996.  From 1996 to 2001 he workedwith brokerage firms as Business Manager or Team Manager for the Minute MaidCompany account.  His retail groceryexperience included five years with Save-Mart, and two years with SafewayStores working at the store level.

 

**                JosephStirlacci, National Sales Manager.**  Mr. Stirlacciserved as Western Zone Manager since December 1995 until December 1999 when hewas promoted to Senior Sales Manager-West. In January 2001 he was promoted to National Sales Manger.  His primary responsibility is to manage,maintain and secure club store and retail accounts.  Mr. Stirlacci has been in the food and beverage industry since1981, serving seven years with Young’s Market managing wholesale liquor andwine from 1988 to 1995, after six years as the account executive for four largegrocery chains.

 

**Compliance with Section 16(a) of the Securities Exchange Act of 1934**

 

**               **Section 16(a) of the Securities Exchange Act of 1934,as amended, requires the Company’s directors and executive officers, andpersons who own more than 10% of a registered class of the Company’s equitysecurities, to file with the SEC initial reports of ownership and reports ofchanges in ownership of Common Stock and other equity securities of theCompany.  Officers, directors andgreater than 10% beneficial owners are required by SEC regulations to furnishthe Company with copies of all reports they file under Section 16(a).  To the Company’s knowledge, based solely onits review of the copies of such reports furnished to the Company and writtenrepresentations that no other reports were required, all Section 16(a) filingrequirements applicable to its officers, directors and greater than 10%beneficial owners were complied with during the fiscal year ended December 30,2001, with the exception that the Forms 3 for Messrs. Cruger and Schall werefiled late.

 

**ITEM 11.               EXECUTIVE COMPENSATION**

** **

**SUMMARY COMPENSATION  TABLE**

** **
|                             |   | **Annual  Compensation** |   |         | **Long Term  Compensation** |        |
|----------------------------------|--------|--------------------------|--------|--------------|-----------------------------|-------------|
| **Name and  Principal Position** |   | **Year**                 |   | **Salary $** |                        | **Bonus $** |   | **Other** |   |   | **Securities  Underlying  $Options (#)** |   |   | **All  Other $** |   |   |
| **R. Lance Hewitt**              |   | 2001                     |   | $            | 200,477                     | (1)         | $ | 94,949 |   | $ | 9,000 | (1) |   | 80,000 | (1) |   | $ | — |   |   |
| President and  Chief             |   | 2000                     |   | $            | 189,899                     | (1)         | $ | 89,923 |   | $ | 9,000 | (1) |   | 160,000 | (1) |   | $ | — |   |   |
| Executive  Officer               |   | 1999                     |   | $            | 179,846                     | (1)         | $ | — |   | $ | 9,000 | (1) |   | 112,000 | (1) |   | $ | — |   |   |
|                             |   |                     |   |         |                        |        |   |   |   |   |   |   |   |   |   |   |
| **Stephen L. Brinkman**          |   | 2001                     |   | $            | 140,884                     | (2)         | $ | 39,700 |   | $ | — |   |   | 60,000 | (2) |   | $ | — |   |   |
| Chief Financial  Officer         |   | 2000                     |   | $            | 132,333                     | (2)         | $ | 23,319 |   | $ | — |   |   | 60,000 | (2) |   | $ | — |   |   |
|                             |   | 1999                     |   | $            | 124,038                     | (2)         | $ | 3,923 |   | $ | — |   |   | 60,000 | (2) |   | $ | — |   |   |
|                                  |        |                          |        |              |                             |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

22

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Notes:  (“options” in all casesrefer to an option to purchase one share of common stock for each optiongranted)

 

(1)           Mr. Hewitt wasappointed President in June 1997 and Chief Executive Officer in August1997.   He was eligible for a 35% bonus upon completing his first fullyear of employment in 1998.  For everyyear thereafter he is eligible for a bonus of up to a maximum of 35% of hissalary annually for achieving agreed-upon income targets, as approved by the Boardof Directors, and an additional 25% of his salary for achieving certainspecific objectives for each fiscal period. He was eligible to vest and vested 50,000 options in each of 1998 and1999, because he was still employed by the Company on both the first and secondanniversaries of his May 26, 1997 employment agreement.  Mr. Hewitt was also eligible to receive, atthe discretion of the Board of Directors, an additional 200,000 options duringthe first two years of employment split as follows: 120,000 for achievingagreed-upon business goals in the first year and 80,000 for achieving businessgoals in the second year. The cycle for measurement of Mr. Hewitt’s eligibilityfor bonus, and those options tied to performance, was converted to a fiscalyear basis during the fourth quarter of 1998 by resolution of the board ofDirectors at its October 22, 1998 meeting. At its February 9, 1999 Board of Directors meeting, the directorsawarded 32,000 options to Mr. Hewitt for performance in his first full year ofemployment through fiscal year-end 1998, based on the new measurementcycle.  The determination for theremainder of the options was made subsequent to 1999 fiscal year-end when Mr.Hewitt was awarded an additional 80,000 options which vested as of February 10,2000.  In May 1999 Mr. Hewitt wasgranted an additional 80,000 options based on milestones for the year 2000;27,000 vested since he was still employed by the Company on December 30, 2000,and 53,000 vested in 2001 based on achievement of performance objectivesmutually agreed upon with the Board. During its February 2000 Board of Directors meeting the Board awardedMr. Hewitt a 50% bonus for his 1999 performance.  On February 29, 2000, Mr. Hewitt was granted an additional 80,000options based on milestones for the year 2001; 27,000 vested because he wasstill employed by the Company on December 30, 2001, and 53,000 could vest in2002 based on achievement of performance objectives for 2001, mutually agreedupon with the Board.  On October 29,2001 Mr. Hewitt was granted 80,000 options which will vest if he is stillemployed by the Company December 29, 2002. Mr. Hewitt also receives an auto allowance of $750 per month.

 

(2)           Mr. Brinkman wasappointed Chief Financial Officer in September 1997.  He was eligible for, and received, a 20% bonus based uponperformance upon completion of his first full year of employment in 1998.  For every year thereafter he is eligible fora bonus of up to 20% based upon the achievement of performance criteria agreedupon with the Chief Executive Officer. Mr. Brinkman was granted 60,000 options in 1997.  He vested 10,000 options upon his initialemployment date, 10,000 options on his first anniversary and 10,000 options forachieving certain performance criteria in his first full year ofemployment.  In addition, he waseligible to vest and vested 10,000 options on his second anniversary ofemployment, 10,000 options for achieving certain performance criteria in hissecond full year of employment, 5,000 options on his third anniversary ofemployment and 5,000 options for achieving certain performance criteria in histhird full year of employment.  Thecycle for measurement of Mr. Brinkman’s eligibility for bonus, and thoseoptions tied to performance, was converted to a fiscal year basis during thefourth quarter of 1998 at the direction of the Chief 

 

Executive Officer.  He vested3,000 options for performance through fiscal year-end 1998, based on the newmeasurement cycle.  The vestingdetermination for the remainder of the options was made subsequent to 1999fiscal year-end, at which time Mr. Brinkman vested an additional 6,666 options,with 334 forfeited based on 1998 performance criteria.  In February 2000 Mr. Brinkman was awarded an18.8% bonus for his 1999 performance. In May 1999, Mr. Brinkman was granted an additional 60,000 options basedon milestones for the year 2000; 20,000 vested since he was still employed bythe Company on August 25, 2000, and 40,000 vested in 2001 based on achievementof performance objectives mutually agreed upon with the CEO.  On February 29, 2000, Mr. Brinkman wasgranted an additional 60,000 options based on milestones for the year 2001;20,000 vested because he was still employed by the Company on August 25, 2001,and 40,000 could vest in 2002 based on achievement of 2001 performanceobjectives mutually agreed upon with the CEO. On October 29, 2001 Mr. Brinkman was granted 60,000 options which willvest if he is still employed by the Company December 29, 2002.

 

                **OptionGrants in Last fiscal Year**

 

**               **The Board granted 80,000 options to Mr. Hewitt and60,000 options to Mr. Brinkman for the year 2002 which will vest based onemployment status (see Notes 1 and 2 under “Executive Compensation”).  Mr. Hewitt exercised and sold the underlyingshares for 120,000 options during 2001.

** **
|                 |   |                                                    |   | **Individual  Grants**                                  |   |                         |   |                 |             |
|----------------------|--------|---------------------------------------------------------|--------|---------------------------------------------------------|--------|------------------------------|--------|----------------------|------------------|
| **Name**             |   | **Number of  Securities  Underlying  Options  Granted** |   | **% of Total  Options  Granted to  Employees  In 2001** |   | **Exercise  Or Base  Price** |   | **Expiration  Date** |             | **Potential  Realizable Value  On 12/30/01  Alternative Grant Date**

**Value** |   |
|                 |   |                                                    |   |                                                    |   |                         |   |                 |             |   |   |
| R. Lance Hewitt      |   | 80,000                                                  |   | 15.03                                                   |   | $                            | 6.55   |                 | October 28, 2011 |   | $ | 232,800 |   |
|                 |   |                                                    |   |                                                    |   |                         |   |                 |             |   |   |
| Stephen L.  Brinkman |   | 60,000                                                  |   | 11.27                                                   |   | $                            | 6.55   |                 | October 28, 2011 |   | $ | 174,600 |   |

 

 

23

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                The AlternativeGrant-Date Value of Mr. Hewitt’s and Mr. Brinkman’s options was calculatedusing a Black-Scholes option pricing model assuming no dividends, a weightedaverage risk-free interest rate of 3.91% and a weighted-average volatility of44.93%.

** **

**AggregatedOption Exercises in Last Fiscal Year and Fiscal Year-End Option Values**

 
|                |   | **# of  Securities Underlying Options Exercised** |   | **Number of  Securities Underlying Unexercised Options at December 30, 2001** |   | **Value of  Unexercised In-the-Money Options at December 30, 2001** |   |
|---------------------|--------|---------------------------------------------------|--------|-------------------------------------------------------------------------------|--------|---------------------------------------------------------------------|--------|
| **Name**            |   | **During  2001**                                  |   | **Exercisable**                                                               |   | **Unexercisable**                                                   |   | **Exercisable** |   | **Unexercisable** |   |
|                |   |                                              |   |                                                                          |   |                                                                |   |   |   |   |   |
| R. Lance Hewitt     |   | 120,000                                           |   | 199,000                                                                       |   | 133,000                                                             |   | $ | 937,019 |   | $ | 256,381 |   |
|                |   |                                              |   |                                                                          |   |                                                                |   |   |   |   |   |
| Stephen L  Brinkman |   | —                                            |   | 139,666                                                                       |   | 100,000                                                             |   | $ | 680,534 |   | $ | 193,250 |   |

 

**EmploymentContracts**

 

                Mr. Hewitt and Mr.Brinkman have employment agreements, the terms of which are outlined under“Executive Compensation.”

 

**ITEM 12.****                                             ****SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT**

 

**               **Thetablebelow sets forth as of February 8, 2002 (except as noted in the footnotes to the table), certain informationwith respect to the beneficial ownership of the Company’s Common Stock by  (i) all persons known by the Company to bethe beneficial owners of more than 5% of the outstanding Common Stock of theCompany,  (ii) each director anddirector-nominee of the Company,  (iii)the Chief Executive Officer as of February 8, 2002, and  (iv) all executive officers and directors ofthe Company for fiscal year 2001 throughFebruary 8, 2002,  as a group.

 
|                                                                                             |   | **Shares  Owned**     |   |
|--------------------------------------------------------------------------------------------------|--------|-----------------------|--------|
| **Name and  Address of Beneficial Owner (1)**                                                    |   | **Number of  Shares** |   | **Percentage  of Class** |   |
| Gruber and McBaine Capital Management (2)   50 Osgood Place, Penthouse   San Francisco, CA 94133 |   | 2,529,900             |   | 16.7 | % |
| RS Investment Management Co, LLC (3)  388 Market Street  San Francisco, CA 94111                 |   | 1,114,050             |   | 7.4 | % |
| T Rowe Price Associates, Inc. (4)  100 East Pratt Street  Baltimore, MD 21202                    |   | 885,100               |   | 5.9 | % |
| Kern Capital Management LLC (5)  114 West 47th Street, Suite 1926  New York, New York 10036      |   | 767,600               |   | 5.1 | % |
| F. Christopher Cruger                                                                            |   | —                |   | * |   |
| Van Tunstall (6)                                                                                 |   | 82,740                |   | * |   |
| Michael P. Schall                                                                                |   | 2,000                 |   | * |   |
| James Wong (7)                                                                                   |   | 20,000                |   | * |   |
| R. Lance Hewitt (8)                                                                              |   | 214,000               |   | 1.4 | % |
| Charles B. Bonner (9)                                                                            |   | 111,227               |   | * |   |
| Stephen L. Brinkman (10)                                                                         |   | 157,666               |   | 1.0 | % |
| Walter L. Henning (11)                                                                           |   | 46,200                |   | * |   |
| All Officers and Directors as a group (8 persons)  (12)                                          |   | 633,833               |   | 4.2 | % |

----

* Represents less than 1%

 

 

24

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(1)              Beneficial ownership is determined in accordance withthe rules of the Securities and Exchange Commission.  In computing the number of shares beneficially owned by a personand the percentage ownership of that person, shares of Common Stock subject tooptions or warrants held by that person that are currently exercisable or willbecome exercisable within sixty (60) days after February 8, 2002 are deemedoutstanding, while such shares are not deemed outstanding for purposes ofcomputing percentage ownership of any other person.  Options granted under the Company’s First Amended and Restated1993 Stock Option Plan (the “1993 Stock Option Plan”) generally becomeexercisable as the underlying shares vest. Unless otherwise indicated in the footnotes below, the persons andentities named in the table have sole voting and investment power with respectto all shares beneficially owned, subject to community property laws whereapplicable.  Unless otherwise indicated,the address of each of the individuals listed in the table is: c/o MontereyPasta Company, 1528 Moffett Street, Salinas, CA  93905.

 

(2)              Jon D. Gruber and J. Patterson McBaine are the onlydirectors of, and hold all executive offices of, Gruber and McBaine CapitalManagement (“GMCM”), an investment advisor. GMCM, together with Messrs. Gruber, McBaine, Thomas O. Lloyd-Butler, andEric B. Swergold are the general partners of Lagunitas Partners, L.P. (“Lag”),a California investment limited partnership. As of February 06, 2001, GMCM had shared voting and investment powerover 1,931,300 shares; Mr. Gruber has sole voting and investment power over294,000 shares and shared voting and investment power over 1,931,300 shares;Mr. McBaine has sole voting and investment power over 304,600 shares and sharedvoting and investment power over 1,931,300 shares; Lag has sole voting andinvestment power over 1,045,600 shares; and Mr. Butler and Mr. Swergold haveshared voting and investment power over 1,931,300 shares.

 

(3)              RS Investment Management Co. LLC (“RSIM Co. LLC”) isthe General Partner of RS investment Management L.P. (“RSIM, L.P.”) and thesole member of RS Regulated I, LLC, the sole shareholder of RS InvestmentManagement, Inc. (“RSIM, Inc”). RSIM, L.P. has sole investment dispositive andvoting power over 1,087,400 shares. RSIM, Inc. has sole investment, dispositive and voting power over 26,650shares.  These securities are owned byinstitutional investors for which RSIM. L.P. and RSIM, Inc. serve as investmentadvisor.  For purposes of reportingrequirements of the Securities and Exchange Act of 1934, RSIM, L.P.  and RSIM, Inc. disclaim beneficial ownershipof such securities.

 

(4)              T. Rowe Price Associates, Inc (“Price Associates”) hassole dispositive power for the entire holding of 885,100 shares and sole votingpower over 219,800 shares.  These securitiesare owned by various individual and institutional investors for which PriceAssociates serves as investment advisor with power to direct investments and/orsole power to vote the securities.  Forpurposes of the reporting requirements of the Securities Exchange Act of 1934,Price Associates expressly disclaims that it is, in fact, the beneficial ownerof such securities.

 

(5)              Kern Capital Management LLC (“Kern Capital”) is thebeneficial owner of the shares.  RobertE. Kern Jr. and David Kern are Controlling Members of Kern Capital and may bedeemed the beneficial owner of the securities in that they may be deemed toshare the power as to the voting or disposition of the securities.  This does not constitute an admission thateither Robert Kern or David Kern is, for any purpose, the beneficial owner ofthe securities and such beneficial ownership is expressly denied.

 

(6)              Includes 52,500 shares subject to options grantedunder the 1993 Stock Option Plan which are exercisable within sixty (60) daysof February 8, 2002.

 

(7)              Includes 15,000 shares subject to options grantedunder the 1993 Stock Option Plan which are exercisable within sixty (60) daysof February 8, 2002.

 

(8)              Includes 199,000 shares subject to options grantedunder the 1993 Stock Option Plan which are exercisable within sixty (60) daysof February 8, 2002.

 

(9)              Includes 57,500 shares subject to options grantedunder the 1993 Stock Option Plan which are exercisable within sixty (60) daysof February 8, 2002.

 

(10)        Includes 139,666 shares subject to options grantedunder the 1993 Stock Option Plan which are exercisable within sixty (60) daysof February 8, 2002.

 

(11)        Includes 6,200 shares held in an IRA account in thename of Teresa A. Henning to which Mr. Henning claims beneficial ownership, and17,500 shares subject to options granted under the 1993 Stock Option Plan whichare exercisable within sixty (60) days of February 8, 2002.

 

 

25

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(12)        Includes 481,666 shares subject to options grantedunder the 1993 Stock Option Plan which are exercisable within sixty (60) daysof February 8, 2002.

 

**ITEM 13.               CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

**               **None

## ** **

##### **PARTIV**

 

**ITEM 14.               EXHIBITS, FINANCIAL STATEMENTSCHEDULES AND REPORTS ON FORM 8-K**

 
| (a)(1) | Consolidated Financial Statements of Monterey Pasta  Company:                          |
|--------|----------------------------------------------------------------------------------------|
|   |                                                                                   |
|   | Report  of Independent Certified Public Accountants                                    |
|   | Consolidated Balance  Sheets: Year-End 2000 and 2001                                   |
|   | Consolidated Statements of Operations: Years Ended  1999, 2000 and 2001                |
|   | Consolidated  Statements of Stockholders’ Equity: Years Ended 1999, 2000 and 2001 |
|   | Consolidated  Statements of Cash Flows:  Years Ended  1999, 2000 and 2001         |
|   | Summary of  Significant Accounting Policies                                            |
|   | Notes to  Consolidated Financial Statements                                            |
|   | Schedule II - Valuation and Qualifying  Accounts                                       |

 

                All otherschedules have been omitted since the required information is contained in the

                ConsolidatedFinancial Statements or because such schedules are not required.

 

(a)(2)       Exhibits:  See Index to Exhibits on page 49.  The Exhibits listed in the accompanyingIndex of Exhibits are filed or incorporated by reference as part of thisreport.  Exhibit Nos. 4.7, 10.1, 10.2,10.12, 10.13, 10.15, and 10.16 are management contracts or compensatory plans or arrangements.

 

(b)           Reports on Form 8-Kfiled in the fourth quarter of 2001:

 

                None

 

26

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**REPORTOF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS**

 

 

 

To the Stockholders and Board of Directors of

Monterey Pasta Company

 

 

We have audited the accompanying consolidated balance sheets ofMonterey Pasta Company and subsidiary as of December 31, 2000 and December 30,2001 and the related consolidated statements of income, stockholders’ equityand cash flows for each of the three years in the period ended December 30,2001. We have also audited the schedule listed in the accompanying index atItem 14(a).  These financial statementsand the schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements and the schedule based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. These standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements and schedule arefree of material misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements and schedule.  An audit also includes assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overallpresentation of the financial statements and schedule.  We believe that our audits provide a reasonablebasis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of MontereyPasta Company and subsidiary at December 31, 2000 and December 30, 2001, andthe results of its operations and its cash flows for each of the three years inthe period ended December 30, 2001, in conformity with accounting principlesgenerally accepted in the United States of America.

 

Also, in our opinion, the schedule presents fairly in all materialrespects, the information set forth therein.

 

 

 

BDO Seidman, LLP

San Francisco, California

February 1, 2002

 

27

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**MONTEREY PASTA COMPANY**

**CONSOLIDATEDBALANCE SHEETS**

 
| **ASSETS**                                                                                                            |   | **December  31, 2000** |       | **December  30, 2001** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|------------------------|------------|------------------------|--------|
| Current assets:                                                                                                       |   |                   |       |                   |   |
| Cash and cash  equivalents  (Note 1)                                                                             |   | $                      | 1,457,499  |                   | $      | 7,232,128 |   |
| Accounts  receivable, less allowances of $242,301 and $305,483  (Notes 1, 4  and 11)                        |   | 4,944,009              |       | 6,025,323              |   |
| Inventories  (Notes 2 and 4)                                                                                     |   | 3,088,097              |       | 3,113,679              |   |
| Deferred tax  assets — short term (Note 8)                                                                       |   | 3,379,200              |       | 1,021,800              |   |
| Prepaid expenses  and other  (Note 10)                                                                           |   | 415,438                |       | 1,139,042              |   |
| Total current  assets                                                                                                 |   | 13,284,243             |       | 18,531,972             |   |
|                                                                                                                  |   |                   |       |                   |   |
| Property and  equipment, net  (Notes 3 and 4)                                                                    |   | 9,838,097              |       | 11,036,044             |   |
| Deferred tax  assets — long term (Note 8)                                                                        |   | 379,800                |       | 553,700                |   |
| Intangible  assets, net (Note 15)                                                                                     |   | 1,590,555              |       | 1,372,839              |   |
| Deposits and  other                                                                                                   |   | 96,316                 |       | 101,270                |   |
| Total assets                                                                                                          |   | $                      | 25,189,011 |                   | $      | 31,595,825 |   |
|                                                                                                                  |   |                   |       |                   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                        |   |                   |       |                   |   |
| Current  liabilities:                                                                                                 |   |                   |       |                   |   |
| Accounts payable                                                                                                      |   | $                      | 2,139,767  |                   | $      | 1,613,090 |   |
| Accrued payroll  and related  benefits                                                                           |   | 440,155                |       | 610,086                |   |
| Accrued  liabilities  (Note 13)                                                                                  |   | 873,070                |       | 1,343,054              |   |
| Current portion  of notes, loans, and capitalized leases payable  (Notes  3  and 4)                    |   | 32,398                 |       | 32,008                 |   |
| Total current  liabilities                                                                                            |   | 3,485,390              |       | 3,598,238              |   |
|                                                                                                                  |   |                   |       |                   |   |
| Notes, loans,  and capitalized leases payable, less current portion  (Notes 3 and 4)                             |   | 40,179                 |       | 16,749                 |   |
| Total  liabilities                                                                                                    |   | 3,525,569              |       | 3,614,987              |   |
|                                                                                                                  |   |                   |       |                   |   |
| Commitments and  contingencies  (Notes 5, 9, 11, 13, and  15)                                                    |   |                   |       |                   |   |
|                                                                                                                  |   |                   |       |                   |   |
| Stockholders’  equity  (Notes  6, 7, and 15):                                                          |   |                   |       |                   |   |
| Common stock,  $.001 par  value, 70,000,000 shares  authorized, 13,313,021 and 13,766,692 issued and outstanding |   | 41,175,344             |       | 43,063,750             |   |
| Accumulated  deficit                                                                                                  |   | (19,511,902            | )          | (15,082,912            | )      |
| Total  stockholders’ equity                                                                                      |   | 21,663,442             |       | 27,980,838             |   |
|                                                                                                                  |   |                   |       |                   |   |
| Total  liabilities and stockholders’ equity                                                                      |   | $                      | 25,189,011 |                   | $      | 31,595,825 |   |

 

See accompanying summaryof significant accounting policies and notes to consolidated financialstatements

 

28

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** **

**MONTEREY PASTA COMPANY**

**CONSOLIDATED STATEMENTS OF INCOME**

 
|                                                             |   | **Years  Ended** |       |
|------------------------------------------------------------------|--------|------------------|------------|
|                                                             |   | **1999**         |       | **2000** |   | **2001** |   |
| Net  revenues(Note 11)                                           |   | $                | 36,901,772 |   | $ | 47,961,799 |   | $ | 59,220,134 |   |
|                                                             |   |             |       |   |   |   |   |
| Cost of sales                                                    |   | 22,748,471       |       | 29,474,723 |   | 36,469,186 |   |
|                                                             |   |             |       |   |   |   |   |
| Gross profit                                                     |   | 14,153,301       |       | 18,487,076 |   | 22,750,948 |   |
|                                                             |   |             |       |   |   |   |   |
| Selling, general  and administrative  (Notes 5, 10 and  13) |   | 10,219,615       |       | 12,366,056 |   | 15,515,013 |   |
| Operating income                                                 |   | 3,933,686        |       | 6,121,020 |   | 7,235,935 |   |
|                                                             |   |             |       |   |   |   |   |
| Gain/(loss) on  disposition of assets                            |   | (13,004          | )          | (37,421 | ) | 20,330 |   |
| Other income  (expense), net                                     |   | 1,736            |       | (11,260 | ) | 1,278 |   |
| Interest income  (expense), net  (Note 4)                   |   | (156,233         | )          | (40,338 | ) | 107,779 |   |
|                                                             |   |             |       |   |   |   |   |
| Income before  provision for income taxes                        |   | 3,766,185        |       | 6,032,001 |   | 7,365,322 |   |
|                                                             |   |             |       |   |   |   |   |
| Income tax  benefit (provision)  (Note 8)                   |   | 3,261,245        |       | 109,100 |   | (2,936,332 | ) |
|                                                             |   |             |       |   |   |   |   |
| Net income                                                       |   | $                | 7,027,430  |   | $ | 6,141,101 |   | $ | 4,428,990 |   |
|                                                             |   |             |       |   |   |   |   |
| Net income per  common share (Note 6):                           |   |             |       |   |   |   |   |
| Basic income per  common share                                   |   | $                | 0.55       |   | $ | 0.46 |   | $ | 0.33 |   |
|                                                             |   |             |       |   |   |   |   |
| Diluted income  per common share                                 |   | $                | 0.54       |   | $ | 0.44 |   | $ | 0.31 |   |
|                                                             |   |             |       |   |   |   |   |
| Basic shares  outstanding                                        |   | 12,711,801       |       | 13,222,062 |   | 13,491,177 |   |
| Diluted shares  outstanding                                      |   | 13,074,776       |       | 13,835,384 |   | 14,254,248 |   |

 

See accompanying summary of significant accounting policies and notesto consolidated financial statements

 

29

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**MONTEREY PASTA COMPANY**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**FOR THE YEARS ENDED 1999, 2000, and 2001**

 
|                                                                                                            |   | **Common  Stock** |   | **Accumulated** |       |        |   |
|-----------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|-----------------|------------|-------------|--------|
| **See Notes 6 and 7**                                                                                           |   | **Shares**        |   | **Amount**      |       | **Deficit** |   | **Total** |   |
| Balance, end of  1998                                                                                           |   | 12,542,613        |   | 39,389,656      |       | (32,680,433 | )      | 6,709,223 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common   stock under Employee Stock Purchase Plan, at an average net price per  share of $1.47 |   | 1,534             |   | 2,257           |       | —      |   | 2,257 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of net warrant  exercised  with an exercise price of  $2.25 per share     |   | 12,489            |   | (5              | )          | —      |   | (5 | ) |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of cash warrant  exercise with an exercise price of $2.25 per share            |   | 40,300            |   | 90,675          |       | —      |   | 90,675 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of cash stock  option exercises                                                |   | 41,986            |   | 72,496          |       | —      |   | 72,496 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock to former CEO upon  repayment of  non-recourse stock loan                         |   | 300,000           |   | 562,500         |       | —      |   | 562,500 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Fair market value of options issued as part of  acquisition of business                                    |   | —            |   | 145,000         |       | —      |   | 145,000 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Net income for  the year                                                                                        |   | —            |   | —          |       | 7,027,430   |   | 7,027,430 |   |
| Balance, end of  1999                                                                                           |   | 12,938,922        |   | $               | 40,262,579 |        | $      | (25,653,003 | ) | $ | 14,609,576 |   |
|                                                                                                                 |        |                   |        |                 |            |             |        |  |  |  |  |  |

 

See accompanying summary of significant accounting policies and notesto consolidated financial statements.

 

30

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**MONTEREY PASTA COMPANY**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**FOR THE YEARS ENDED 1999, 2000, and 2001**

 
|                                                                                                            |   | **Common  Stock** |   | **Accumulated** |       |        |   |
|-----------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|-----------------|------------|-------------|--------|
| **See Notes 6 and 7**                                                                                           |   | **Shares**        |   | **Amount**      |       | **Deficit** |   | **Total** |   |
| Balance, end of  1999                                                                                           |   | 12,938,922        |   | $               | 40,262,579 |        | $      | (25,653,003 | ) | $ | 14,609,576 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common   stock under Employee Stock Purchase Plan, at an average net price per  share of $1.47 |   | 3,006             |   | 4,141           |       | —      |   | 4,141 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of net warrant  exercised  with an exercise price of  $2.25 per share     |   | 152,839           |   | —          |       | —      |   | — |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of cash warrant  exercise with an exercise price of $2.25 per share            |   | 115,950           |   | 260,888         |       | —      |   | 260,888 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of cash stock  option exercises                                                |   | 102,304           |   | 163,403    |       | —      |   | 163,403 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Net settlement less legal expenses and tax effect  from Clearwater Fund IV LLC (Note 6)                         |   | —            |   | 274,453         |       | —      |   | 274,453 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Tax benefit of  disqualifying dispositions (Note 8)                                                             |   | —            |   | 117,400         |       | —      |   | 117,400 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Stock based  compensation                                                                                       |   | —            |   | 92,480          |       | —      |   | 92,480 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Net income for  the year                                                                                        |   | —            |   | —          |       | 6,141,101   |   | 6,141,101 |   |
| Balance, end of  2000                                                                                           |   | 13,313,021        |   | $               | 41,175,344 |        | $      | (19,511,902 | ) | $ | 21,663,442 |   |

 

See accompanying summary of significant accounting policies and notesto consolidated financial statements.

 

31

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**MONTEREY PASTA COMPANY**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**FOR THE YEARS ENDED 1999, 2000, and  2001**

 
|                                                                                                            |   | **Common  Stock** |   | **Accumulated** |       |        |   |
|-----------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|-----------------|------------|-------------|--------|
| **See Notes 6 and 7**                                                                                           |   | **Shares**        |   | **Amount**      |       | **Deficit** |   | **Total** |   |
| Balance, end of  2000                                                                                           |   | 13,313,021        |   | $               | 41,175,344 |        | $      | (19,511,902 | ) | $ | 21,663,442 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common   stock under Employee Stock Purchase Plan, at an average net price per  share of $3.37 |   | 5,875             |   | 19,830          |       | —      |   | 19,830 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of net warrant  exercised  with an exercise price of  $6.50 per share     |   | 523               |   | —          |       | —      |   | — |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Issuance of common stock as part of cash stock option  exercises                                                |   | 447,273           |   | 969,309    |       | —      |   | 969,309 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Net settlement less legal expenses and tax effect  from investor 16b violation                                  |   | —            |   | 14,299          |       | —      |   | 14,299 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Tax benefit of  disqualifying dispositions  (Note 8)                                                       |   | —            |   | 562,200         |       | —      |   | 562,200 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Stock based  compensation                                                                                       |   | —            |   | 322,768         |       | —      |   | 322,768 |   |
|                                                                                                            |   |              |   |            |       |        |   |   |   |
| Net income for  the year                                                                                        |   | —            |   | —          |       | 4,428,990   |   | 4,428,990 |   |
| Balance, end of  2001                                                                                           |   | 13,766,692        |   | $               | 43,063,750 |        | $      | (15,082,912 | ) | $ | 27,980,838 |   |

 

See accompanying summary of significant accounting policies and notesto consolidated financial statements.

 

32

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| **MONTEREY PASTA COMPANY**                 |
|--------------------------------------------|
| **CONSOLIDATED STATEMENTS OF CASH  FLOWS** |

 
|                                                                               |   | **Years Ended** |      |
|------------------------------------------------------------------------------------|--------|-----------------|-----------|
| See  Note 12 — Supplemental Cash Flow Information                             |   | **1999**        |      | **2000** |   | **2001** |   |
| Cash flows from operating activities:                                              |   |            |      |   |   |   |   |
| Net Income                                                                         |   | $               | 7,027,430 |   | $ | 6,141,101 |   | $ | 4,428,990 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |            |      |   |   |   |   |
| Deferred income taxes                                                              |   | (3,430,000      | )         | (509,000 | ) | 2,183,500 |   |
| Depreciation and amortization                                                      |   | 1,182,883       |      | 1,394,204 |   | 1,661,327 |   |
| Provisions for allowances for bad debt, returns,  adjustments and spoils           |   | 693,727         |      | 476,341 |   | 63,182 |   |
| Tax benefit of disqualifying dispositions                                          |   | —          |      | 117,400 |   | 562,200 |   |
| Provision for inventory reserves                                                   |   | 149,500         |      | — |   | — |   |
| Loss (gain) on disposition and writedown of property  and equipment                |   | 13,004          |      | 37,421 |   | (20,330 | ) |
| Stock based compensation                                                           |   | —          |      | 92,480 |   | 322,768 |   |
| Changes in assets and liabilities:                                                 |   |            |      |   |   |   |   |
| Accounts receivable                                                                |   | (2,444,773      | )         | (1,606,739 | ) | (1,144,496 | ) |
| Inventories                                                                        |   | (821,886        | )         | (365,713 | ) | (25,582 | ) |
| Prepaid expenses and other assets                                                  |   | 884,243         |      | 65,395 |   | (728,558 | ) |
| Accounts payable                                                                   |   | 1,422,318       |      | (613,200 | ) | (526,676 | ) |
| Accrued expenses                                                                   |   | 24,289          |      | 770,516 |   | 639,914 |   |
| Net cash provided by operations                                                    |   | 4,700,735       |      | 6,000,206 |   | 7,416,239 |   |
|                                                                               |   |            |      |   |   |   |   |
| Cash flows from investing activities:                                              |   |            |      |   |   |   |   |
| Purchase of property and equipment                                                 |   | (2,414,538      | )         | (4,308,418 | ) | (2,638,833 | ) |
| Proceeds from sale of property and equipment                                       |   | 27,600          |      | — |   | 28,559 |   |
| Acquisition of business operating assets                                           |   | (1,515,741      | )         | (500,388 | ) | — |   |
| Net cash used in investing activities                                              |   | (3,902,679      | )         | (4,808,806 | ) | (2,610,274 | ) |
|                                                                               |   |            |      |   |   |   |   |
| Cash flows from financing activities:                                              |   |            |      |   |   |   |   |
| Proceeds from revolving line of credit                                             |   | 16,393,424      |      | 11,682,598 |   | — |   |
| Repayments on revolving line of credit                                             |   | (16,311,796     | )         | (12,287,483 | ) | — |   |
| Proceeds from long-term debt                                                       |   | 750,000         |      | — |   | — |   |
| Repayment of long-term debt and capital lease  obligations                         |   | (2,347,853      | )         | (83,301 | ) | (34,774 | ) |
| Section 16(b) settlement                                                           |   | —          |      | 454,453 |   | 14,299 |   |
| Proceeds from issuance of common stock                                             |   | 727,923         |      | 428,433 |   | 989,139 |   |
| Net cash provided by (used in) financing activities                                |   | (788,302        | )         | 194,700 |   | 968,664 |   |
| Net increase in cash and cash equivalents                                          |   | 9,754           |      | 1,386,100 |   | 5,774,629 |   |
| Cash and cash equivalents, beginning of year                                       |   | 61,645          |      | 71,399 |   | 1,457,499 |   |
| Cash and cash equivalents, end of year                                             |   | $               | 71,399    |   | $ | 1,457,499 |   | $ | 7,232,128 |   |

 
| See accompanying  summary of significant accounting policies and notes to consolidated  financial statements. |   |
|---------------------------------------------------------------------------------------------------------------|--------|

 

 

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**MONTEREY PASTA COMPANY**

**SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

*                **Principlesof Consolidation and Nature of Operations***

 

                The consolidated financial statements include theaccounts of Monterey Pasta Company (a producer and distributor of pasta, pastasauces, soups, and related items), together with its wholly-owned subsidiary,Monterey Pasta Development Company  (afranchiser of restaurants - inactive). All significant intercompany accounts and transactions have beeneliminated in consolidation. Collectively, Monterey Pasta Company and Monterey Pasta DevelopmentCompany are referred to as the “Company.”

 

                The Company’s production facility and distributioncenter are both located in Monterey County, California.  Its products are available throughout theUnited States as well as selected distribution areas in Canada, the Caribbean,Latin America, and Asia Pacific.  Theprincipal customers are retail groceries and club stores.  The Company offers credit and payment termsto its customers in line with industry practices, generally calling forunsecured trade accounts receivable.

 

                ***Accounting Periods***

 

                For quarterly reporting purposes the Company employsa 4-week, 4-week, 5-week reporting period. The fiscal year ends on the last Sunday of each calendar year(52/53-week year).  The 1999 fiscal yearcontained 52 weeks and ended on December 26. The 2000 fiscal year contained 53 weeks and ended on December 31, whilethe 2001 fiscal year contained 52 weeks and ended on December 30.

 

                ***Reclassification****s*

 

*               *Certain of the prior year financialstatement amounts have been reclassified to conform to the current yearpresentation.

 

                ***Cash and Cash Equivalents***

 

                The Company considers all highly liquid investmentspurchased with an original maturity of three months or less to be cashequivalents.

 

                ***Accounts Receivable and Allowances***

 

                The Company provides allowances for estimated creditlosses, product returns, spoilage, and adjustments at a level deemedappropriate to adequately provide for known and inherent risks related to suchamounts.  The allowances are based onreviews of loss, return, spoilage, adjustment history, contractualrelationships with customers, current economic conditions, and other factorsthat deserve recognition in estimating potential losses.  While management uses the best informationavailable in making its determination, the ultimate recovery of recordedaccounts, notes, and other receivables is also dependent on future economic andother conditions that may be beyond management’s control.

 

                ***Inventories***

 

***               ***Inventories are stated at the lower ofcost (using the first-in, first-out method) or market and consist principallyof component ingredients to the Company’s refrigerated pasta and sauces,finished goods, and packaging materials.

 

***                Slottingand Advertising Costs***

 

                The Company expenses advertising costs as incurred orwhen the related campaign commences. Slotting fees paid or credited to club stores and grocery chains forshelf space allocations are amortized between six and twelve months dependingon the nature of the chain program or agreement.

 

34

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                ***Property and Equipment***

 

                Property and equipment are recorded at cost.  Depreciation is provided for on thestraight-line method  over the estimateduseful lives of the assets (or lease term for leasehold improvements ifshorter):

 
| Leasehold improvements          |   | 7 to 12 years |
|---------------------------------|--------|---------------|
| Machinery and equipment         |   | 7 to 12 years |
| Office furniture and  equipment |   | 5 to 15 years |
| Vehicles                        |   | 5 to 7 years  |

 

                Long-lived assets, including intangible assets, areassessed for possible impairment whenever events or changes in circumstancesindicate that the carrying amounts may not be recoverable, or whenevermanagement has committed to a plan to dispose of the assets.  Assets to be held and used affected by suchan impairment loss are depreciated or amortized at their new carrying amountover the remaining estimated life; assets to be sold or otherwise disposed ofare not subject to further depreciation or amortization.

 

                ***Intangible Assets***

 

                Intangible assets consist of tradenames, goodwill,and other intangibles and are recorded at cost, net of accumulated amortization.  Intangibles are amortized over theirrespective useful lives, ranging from 3 to 10 years.

 

                ***Income Taxes***

 

                The Company accounts for corporate income taxes inaccordance with Statement of Financial Accounting Standards (SFAS) 109, *Accountingfor Income Taxes*, which requires an asset and liabilityapproach.  This approach results in therecognition of deferred tax assets (future tax benefits) and liabilities forthe expected future tax consequences of temporary timing differences betweenthe book carrying amounts and the tax basis of assets and liabilities.  Future tax benefits are subject to avaluation allowance to the extent of the likelihood that the deferred taxassets may not be realized.

 

*                **RevenueRecognition***

 

                The Company recognizes revenues through sales ofpasta and sauce products primarily to grocery and club store chains.  Sales are recorded when goods are shippedfor most customers and upon delivery to retail locations for the Direct StoreDelivery program.  Consignment shipmentsto club store warehouses are recognized upon shipment to individual club storelocations.  Potential returns,adjustments and spoilage allowances are provided for in accounts receivableallowances and accruals.

 

                ***Stock-based Compensation***

 

                As permitted under the provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation*,the Company continues to account for employee stock-based transactions underAccounting Principles Board Opinion (APB) No. 25, *Accounting for Stock Issued toEmployees*.  However, SFAS No.123 requires the Company to disclose pro forma net income and earnings pershare as if the fair value method had been adopted.  Under the fair value method, compensation cost is measured at thegrant date based on the fair value of the award and is recognized over theservice period, which is usually the vesting period.  For non-employees, cost is also measured at the grant date, usingthe fair value method, but is actually recognized in the financial statements overthe vesting period, or immediately if no further services are required.

 

                ***Use of Estimates***

 

                The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amount of assets andliabilities, disclosure of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenues and expenses duringthe period.  Actual results could differfrom those estimates.  The mostsignificant estimates made by the Company are those related to accountsreceivable and deferred tax allowances.

 

***                NewAccounting Pronouncements***

 

                In May 2000, theEITF reached a consensus on Issue 00-14, “Accounting for Certain Sales Incentives.”This issue addresses the recognition, measurement, and income statementclassification for sales incentives offered voluntarily by a vendor withoutcharge 

 

 

35

----

 

to customers that can be used in, or are exercisable by a customer as aresult of, a single exchange transaction.  In April 2001, the EITF reached a consensus on Issue 00-25, “VendorIncome Statement Characterization of Consideration to a Purchaser of theVendor’s Products or Services.” This issue addresses the recognition,measurement and income statement classification of consideration, other thanthat directly addressed by Issue 00-14, from a vendor to a retailer orwholesaler. Issue 00-25 will be effective for the Company’s 2002 fiscal year.  Both Issue 00-14 and 00-25 have beencodified under issue 01-09, “Accounting for Consideration Given by a Vendor toa Customer or a Reseller of the Vendor’s Products.”  We are currently analyzing Issue 01-09.  Issue 01-09 is not expected to have a material impact on theCompany’s financial position or results of operations, except that certainreclassifications may occur. The consenses reached in Issue 00-25 and Issue00-14 (codified by Issue 01-09) are effective for fiscal quarters beginningafter December 15, 2001.

 

                InJune 2001, the Financial Accounting Standards Board finalized SFAS 141,“Business Combinations,” and SFAS 142, “Goodwill and Other IntangibleAssets.”  SFAS 141 requires the use ofthe purchase method of accounting and prohibits the use of thepooling-of-interests method of accounting for business combinations initiatedafter June 30, 2001.  SFAS 141 alsorequires recognition of acquired intangible assets apart from goodwill if theacquired intangible assets meet certain criteria.  SFAS 141 applies to all business combinations initiated afterJune 30, 2001 and for purchase business combinations completed on or after July1, 2001.  It also requires, uponadoption of SFAS 142, the reclassification of the carrying amounts ofintangible assets and goodwill based on the criteria in SFAS 141.

 

SFAS 142 requires, among other things, that companiesno longer amortize goodwill, but instead test goodwill for impairment at leastannually.  In addition, SFAS 142requires that the Company identify reporting units for the purposes ofassessing potential future impairments of goodwill, reassess the useful livesof other existing recognized intangible assets, and cease amortization ofintangible assets with an indefinite useful life.  An intangible asset with an indefinite useful life should betested for impairment in accordance with the guidance in SFAS 142.  SFAS 142 is required to be applied in fiscalyears beginning after December 15, 2001 to all goodwill and other intangibleassets recognized at that date, regardless of when those assets were initiallyrecognized.  SFAS 142 requires theCompany to complete a transitional goodwill impairment test six months from thedate of adoption.  The Company is alsorequired to reassess the useful lives of other intangible assets within thefirst interim quarter after adoption of SFAS 142.

 

The Company’s previous business combinations wereaccounted for using the purchase method. As of December 30, 2001, the net carrying of amount of goodwill is$1,316,000 and other intangible assets is $57,000. Amortization expense for thefiscal year ended December 30, 2001 was $218,000.  Due to the adoption of SFAS 142 the Company estimates thatamortization expense for 2002 is expected to decline to $47,000, a decline of$171,000 compared with that expected prior to the adoption of SFAS 142.  Impairment testing at year-end 2001, underthe provisions of SFAS 121 “Accounting for Impairment of Long-lived Assets andLong-Lived Assets to be Disposed of (which will be superseded by SFAS 144“Accounting for the Impairment or Disposal of Lone-Lived Assets”) indicated noneed for writedown of goodwill.  TheCompany will perform impairment testing again at the end of the second quarterof 2002 to determine if any writedowns are necessary.

 

                In August 2001, Statement of Financial Standards No.144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“FAS144”) was issued. FAS 144 supersedes Statement of Financial AccountingStandards No. 121, “Accounting for the Impairment of Long-lived Assets to beDisposed of,” and the accounting and reporting provisions of APB Opinion No.30, “Reporting the Results of Operations-Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently occurringEvents and Transactions.” FAS 144 also amends ARB (“Accounting ResearchBulletins”) No. 51, Consolidated Financial Statements, to eliminate theexception to consolidation for a subsidiary for which control is likely to betemporary. FAS 144 retains the fundamental provisions of FAS 121 forrecognizing and measuring impairment losses on long-lived assets held for useand long-lived assets to be disposed of by sale, while resolving significantimplementation issues associated with FAS 121. Among other things, FAS 144provides guidance on how long-lived assets used as part of a group should beevaluated for impairment, establishes criteria for when long-lived assets areheld for sale, and prescribes the accounting for long-lived assets that will bedisposed of other than by sale. FAS 144 is effective for fiscal years beginningafter December 15, 2001. While the Company has not yet completed the process ofdetermining the effect of this new accounting pronouncement on its consolidatedfinancial statements, the Company currently expects that the effect of SFAS No.144 on the Company’s consolidated financial statements, when it becomeseffective, will not be significant.

 

36

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**MONTEREYPASTA COMPANY**

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.**             **Concentrationof Credit Risk**

 

                Financial instruments, which potentially subject theCompany to concentration of credit risk, include cash and accountsreceivable.   The Company maintains itscash accounts in Comerica, Fresno, California. The bank cash balances are insured by the Federal Deposit InsuranceCorporation (FDIC) up to $100,000.   AtDecember 30, 2001 uninsured cash balances totaled $7,132,000.  As of December 30, 2001, approximately 76%of the Company’s accounts receivable are concentrated with two major customers(See Note 11).

 

**2.             Inventories**
|                                     |   | **2000**  |      | **2001**  |   |
|------------------------------------------|--------|-----------|-----------|-----------|--------|
| Inventories  consisted of the following: |   |      |      |      |   |
|                                     |   |      |      |      |   |
| Production —  Ingredients           |   | $         | 1,168,907 |      | $      | 1,088,763 |   |
| Production —  Finished goods        |   | 1,089,653 |      | 1,101,410 |   |
| Paper goods and  packaging materials     |   | 606,349   |      | 907,640   |   |
| Operating  supplies                      |   | 250,688   |      | 43,366    |   |
|                                     |   | 3,115,597 |      | 3,141,179 |   |
| Allowances for  spoils and obsolescence  |   | (27,500   | )         | (27,500   | )      |
|                                     |   | $         | 3,088,097 |      | $      | 3,113,679 |   |

 

**       **The Company records shipping costfor product delivered to customers. These costs were approximately $1,279,000, $1,908,000, 2,211,000 for1999, 2000, and 2001, respectively.

 

**3.             Property and Equipment**

** **
|                                                |   | **2000**   |      | **2001**   |      |
|-----------------------------------------------------|--------|------------|-----------|------------|-----------|
| Property and  equipment consisted of the following: |   |       |      |       |      |
|                                                |   |       |      |       |      |
| Leasehold  improvements                             |   | $          | 3,592,696 |       | 4,551,297 |   |
| Machinery and  equipment                            |   | 8,269,797  |      | 11,273,229 |      |
| Computers,  office furniture and equipment          |   | 879,575    |      | 943,987    |      |
| Vehicles                                            |   | 391,302    |      | 295,113    |      |
|                                                |   | 13,133,370 |      | 17,063,626 |      |
| Less accumulated  depreciation and amortization     |   | (5,297,906 | )         | (6,586,503 | )         |
|                                                |   | 7,835,464  |      | 10,477,123 |      |
| Construction in  progress                           |   | 2,002,633  |      | 558,921    |      |
|                                                |   | $          | 9,838,097 |       | $         | 11,036,044 |   |
|                                                     |        |            |           |            |           |  |  |

 

        Construction in progress atDecember 30, 2001 includes deposits for equipment on order or yet to be installed.

 

37

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**4.**             **Notes, Loans, and Capitalized LeasesPayable**

 

**        *Capitalized Leases***

 

The Company leases certain equipment under capitalized leases, includingoffice equipment, a van and truck with book values of  $60,603 and $51,681 in 2000, and 2001, respectively.  Future minimum lease payments consist of:

 
| **Year**                            |   | **Total** |   |
|-------------------------------------|--------|-----------|--------|
| 2002                                |   | $         | 35,442 |   |
| 2003                                |   | 19,015    |   |
| 2004                                |   | 1,814     |   |
|                                |   | 56,271    |   |
|                                |   |      |   |
| Less amounts  representing interest |   | 7,514     |   |
|                                |   |      |   |
| Capitalized  leases payable         |   | $         | 48,757 |   |
| Less current  portion               |   | 32,008    |   |
| Long term  portion                  |   | $         | 16,749 |   |

 

**        *Credit Facility***

 

                On August 1, 2001Imperial Bank provided a new multi-year credit facility to the Company.  The existing accounts receivable andinventory revolver was renewed to expire October 31, 2003 with a commitment of$1.5 million and interest at either prime rate or LIBOR plus 185 basis pointsfor a debt/tangible net worth ratio of less than 1.0:1.  LIBOR premium increases 25 basis pointsfor  debt/tangible net worth ratios from1.0 to 1.25:1, with another 25 basis point increase for debt/tangible net worthratios above 1.25:1.  In addition, theCompany’s lender approved a $8.5 million non-revolving term facility in theevent of a need for major capital expenditures and acquisitions to expireOctober 31, 2009.   Pricing is at eitherprime rate or LIBOR plus premiums for the same debt/tangible net worth ratiosbeginning at 200 basis points over LIBOR and increasing 25 basis points forsuccessive debt/tangible net worth increments. The total credit facility is $10.0 million.  The term loan facility is subject to annual review ifunused.  If used it converts to an84-month term loan.

 

                The terms of theCredit Facility prohibit the payment of cash dividends (except with writtenapproval) on the Company’s capital stock and restricts payments for, amongother things, repurchasing shares of its capital stock.  Other terms of the Credit Facility limit theCompany with respect to, among other things, (i) incurring additional indebtedness,  (ii) adversely changing the capitalstructure, and (iii) acquiring assets other than in the normal course ofbusiness including specific limits on annual capital expenditures (currently$4.25 million).  As of December 30,2001, there were no violations of any loan covenants and no loans outstanding.

 

 **5**.            **Operating Leases**

 

                The Companycurrently leases production, warehouse and corporate office space as well ascertain equipment in Monterey County, California under both month-to-month andnon-cancelable operating lease agreements, expiring through December 2004.  The terms of the leases generally requirethe Company to pay common area maintenance, taxes, insurance, and certain othercosts.

 

                Future minimumannual lease payments due under non-cancelable operating leases with terms ofmore than one year are as follows:

 
| **Year** |   | **Lease Amount** |      |
|----------|--------|------------------|-----------|
| 2002     |   | $                | 487,368   |   |
| 2003     |   | 487,505          |      |
| 2004     |   | 469,787          |      |
| 2005     |   | 35,062           |      |
|     |   | $                | 1,479,722 |   |

 

                Gross rent expenseunder the leases for 1999, 2000, and 2001 was $578,179, $714,809 and $594,454respectively.  During 1997, the Companysubleased its former San Francisco premises at a slight premium to the rent forwhich it had a contractual liability. The 

 

 

38

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sublease expired in 2001 on the same date as the underlying lease.   Sublease income for the San Franciscoproperty for 1999, 2000 and 2001 was $230,700, $247,865, and $31,108respectively.

 

**6**.             **Stockholders’ Equity**

 

**                *Preferred Stock***

 

                In December 1997, $3,000,000 ofSeries A-1 Convertible Preferred Stock, originally issued in August 1996, wasconverted into 4,108,108 shares of common stock.  OnFebruary 13, 1998, the Company was notified by the NASDAQ Stock Market, Inc.(“NASDAQ”) that the Company’s Series A Convertible Preferred stock offering, asamended by the Series A-1 Agreement in March of 1997, had violated Rule4460(i)(l)(D)(ii) which requires stockholder approval prior to the issuance ofsecurities convertible into common stock equal to, or in excess of, 20% ofoutstanding shares at the time of issuance. The NASDAQ required the Company to repurchase 2,365,066 shares, held byClearwater Fund IV, Ltd., or face delisting from the National NASDAQ market.

 

                After reviewing its options, Company management, inconcert with the Company’s Board of Directors and its legal advisors, begannegotiations with Clearwater Fund IV, Ltd. to repurchase 2,365,066 shares.  Negotiations were completedMarch5, 1998 and the Company repurchased the shares for a total consideration of$2,690,263 or $1.1375/share.

 

On February 2, 2000, theUnited States District Court for the District of Delaware denied a motion todismiss a lawsuit against Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLC,stockholders of the Company, (collectively, “Clearwater”), Mark Levy v.Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLC and Monterey PastaCompany, United States District Court for the District of Delaware, Case No.99-004-SLR.  The lawsuit alleged a violationof Section 16(b) of the Securities Exchange Act of 1934, as amended, inconnection with alleged purchases and sales of the Company’s stock within asix-month period following the conversion of Clearwater’s convertible preferredstock to the Company’s common stock. The Company was named as a nominal defendant in the lawsuit.  Plaintiff sought the return of approximately$1,064,000 in alleged profit and Clearwater contested the claim.  In July 2000, the parties signed asettlement agreement whereby Clearwater agreed to pay $700,000 to the Companyin settlement of the claim asserted by the plaintiff.  Plaintiff’s counsel applied to the court for attorney’s fees andexpenses of approximately $230,000 from the settlement.  As part of the settlement, Clearwater andthe Company  exchanged mutualreleases.  The settlement was approvedby the Board of Directors of the Company.

 

                On October 27, 2000 the Companyreceived a check in the amount of $472,406 including the settlement amount of$470,000, and interest of $2,406.  Thestockholders’ equity account was increased to reflect the disgorged profitsettlement amount, net of the related $180,000 tax effect.

 

                ***Common Stock***

 

The Company includes itsadditional paid-in capital under the heading common stock on its consolidatedbalance sheets.  The additional paid incapital portion amounted to $13,313 and $13,767 at December 31, 2000 andDecember 31, 2001, respectively.

 

                In April 1997, theCompany’s then current Chief Executive Officer agreed to purchase 550,000shares of common stock based on an agreement containing various time-served andperformance restrictions with a full recourse note due December 31, 1997.  Certain of the performance restrictions werenot met and 250,000 shares were forfeited during 1997, leaving 300,000 sharesoutstanding at December 28, 1997.  Thenote, with a remaining balance of $562,500, was converted to non-interestbearing, non-recourse status effective December 31, 1997 with an expirationdate of December 31, 1999.   Because thenew note was non-recourse, the shares and related note were treated foraccounting purposes as canceled and replaced with an option to purchase suchshares.  The $51,000 fair value of theresulting option grant was recorded as an expense during the first quarter of1998.  During 1999, the former ChiefExecutive Officer of the Company sold the shares and repaid the note entirely.

 

                During 1999, warrants representing 86,987potential shares of Company common stock were exercised at $2.25 per share (SeeNote 7).  Certain of the warrants wereconverted into stock as a “net exercise.” In this case, no actual cash exercise proceeds were received by theCompany.  Instead, shares were issuedfor only the difference between the average of the NASDAQ closing bid and askon the day preceding exercise, and the exercise price, multiplied by the numberof shares represented by warrants.  Thispotential gain was then divided by the average of the closing bid and ask todetermine the number of shares to issue. As a result, while warrants potentially representing 86,987 commonshares were exercised, only 52,789 shares of common stock were issued.

 

                In addition, employee optionsrepresenting 10,219 shares of common stock were exercised in 1999 with anaverage exercise price of $1.125.  Aformer employee also exercised options during the third quarter of 1999representing 24,000 shares of common 

 

 

39

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stock with anexercise price of $1.875.  A consultantexercised options representing 7,767 shares of common stock during the fourthquarter of 1999 with an exercise price of $2.06.

 

                During the first three months of 2000,warrants, with an exercise price of $2.25 and an expiration date of March 27,2000, representing a potential of 445,813 shares of company common stock, wereexercised.  These warrants representedthe remainder of those originally issued in connection with a March 1997private placement in which the Company issued warrants to purchase up to 

532,800 shares ofcommon stock.  Since certain of thewarrants were converted into stock as a net exercise, only 268,789 shares ofcommon stock were issued.

 

         During 2000, employee and directoroptions representing 102,304 shares of common stock were exercised.

 

         In 2001, employee and director optionsrepresenting 297,684 shares of common stock were exercised.  Non-plan options representing 149,589 sharesof common stock granted to the shareholders and plant manager of FrescalaFoods, Inc. as part of the March 1999 acquisition were also exercised.  In addition, warrants representing 3,786potential shares with an exercise price of $6.50 and an expiration date of May1, 2003, were exercised.  Since thewarrants were converted into stock as a net exercise, only 523 shares of commonstock were issued.  These warrants wereoriginally issued in connection with a July 1996 private placement in which theCompany issued warrants to purchase up to 400,750 shares of common stock.Warrants representing up to 396,964 shares of common stock remain unexercisedin connection with the July 1996 private placement.  Additionally during 2001, 5,875 employee stock purchase planshares were issued.

 

         ***Employee Stock Purchase Plan***

 

                In October 1994,the Company’s Board of Directors adopted a qualified employee stock purchaseplan.  Under the purchase plan, eligibleemployees (those who have completed one year of continuous employment with theCompany) may purchase shares of the Company’s common stock through payrolldeductions not to exceed 10% of gross wages. The Company has reserved 200,000 shares of its common stock for issuanceunder the purchase plan, which remains in effect until terminated by theCompany’s Board of Directors, or until all of the shares reserved for under thepurchase plan have been issued.  Unlessthe Board has otherwise provided a higher amount prior to the commencement ofan offering period, the offering exercise price for each purchase period is 85%of the lesser of (a) the fair market value of the shares on the offering dateof such offering period or (b) the fair market value of the shares on the givenpurchase date.  There were 1,534, 3,006,and 5,875 shares of common stock issued under the plan in 1999, 2000 and 2001,respectively.  At December 30, 2001,there were 185,061 available shares remaining under the plan.

 

**                *Earnings perShare***

 

                Basic earnings per share are based on earningsavailable to common stockholders divided by the weighted-average number ofcommon shares actually outstanding during the period.  Diluted earnings per share also include the incremental effect ofany dilutive common stock equivalents assumed to be outstanding during theperiod.  Because of equivalent sharesincludable in different periods or at different amounts, per-share amounts forthe four quarters do not necessarily equal per-share amounts for the entireyear.

 

                Options to purchase 1,222,395, 1,500,890, and1,527,250 shares of common stock were outstanding at year-end 1999, 2000, and2001, respectively (see Note 7).  Atotal of 1,152,395 options were included in the 1999 computation of dilutedearnings per share, with 70,000 excluded, because exercise prices were greaterthan the average market price of the common shares.  During 2000, a total of 1,465,590 options were included in thecomputation of diluted earnings per share, with 35,300 excluded, because ofexercise prices.  At 2001 year-end atotal of 1,465,250 options were included in the computation of diluted earningsper share, with 62,000 excluded, because of exercise prices. Warrants to purchase846,563, 400,750, and 396,964 shares were outstanding at year-end 1999, 2000,and 2001, respectively (see Note 7).  In1999, warrants representing 445,813 shares of common stock were included in thecalculation of diluted earnings per share, leaving warrants representing400,750 shares excluded, because of exercise prices.  During 2000, no warrants representing shares on common stock wereincluded, with warrants representing 400,750 shares of common stock excluded,because of exercise prices.  At year-end2001 no warrants representing shares on common stock were included, withwarrants representing 396,964 shares of common stock excluded, because ofexercise prices.

 

**7.             Warrants and Stock Options**

 

***                Warrants***

 

                In April 1996, theCompany issued warrants to purchase 400,750 shares of its common stock at $6.50per share in connection with a placement of 916,000 shares of commonstock.  The warrants, with an estimatedoriginal value of $137,400, are valid for seven 

 

 

40

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years, expire in April 2003, and include registration rights for therelated shares, which were registered effective October 24, 1997.  During 2001 warrants representing 3,786potential shares of common stock were exercised, leaving warrants representing396,964 potential shares of common stock outstanding at year-end.

 

                In March 1997, theCompany issued warrants for 532,800 shares of its common stock at $2.25 pershare in connection with a private placement of 1,600,000 shares of commonstock.  The warrants, with an estimatedoriginal value of $271,700, were valid for three years, expired in March, 2000,and included registration rights for the related shares which were part of theCompany’s S-3 which was 

effective October 24, 1997. Warrants representing a total of 86,987 and 445,813 potential shareswere exercised in 1999 and 2000, respectively (See Note 6).  Therefore, as of December 31, 2000 none ofthe March 1997 warrants remained outstanding.

 

                ***Stock Option Plan***

 

                                EffectiveAugust 31, 1993, the Company’s Board of Directors adopted a stock option plan,subsequently amended and restated, which provides for the granting of incentivestock options or non-qualified stock options to eligible employees, consultantsand outside directors.  The Companyinitially reserved 1,200,000 shares of its common stock for issuance under theplan.  The plan provides that the optionprice shall not be less than the fair market value of the shares on the date ofgrant; therefore, no compensation expense is recorded for employees, unless themarket price exceeds the strike price on the day of grant.  Compensation or other expense is recordedfor any non-employee grants at fair value of the option award.  Options generally vest over a period of oneto three years and may be exercised for a period of up to ten years.  In January of 1998, the Company filed a FormS-8 to register up to 540,000 additional shares of common stock eligible to beissued pursuant to the Plan to increase the total number of registered sharesto 1,740,000.  As of December 30, 2001,the Company had 60,654 shares available under the Plan.  The Plan was amended in July 1998 to allow two yearsfrom date of a transfer of control for the exercise of options for thoseemployees and directors not retained after the transfer of control.  On April 23, 1999, the Company filed an S-8to register 300,000 shares of common stock associated with options issuedoutside of the plan, in conjunction with the March 12, 1999 purchase of theoperating assets of Frescala Foods, Inc. During 2001, the Company issuedadditional options to purchase up to 155,200 shares outside of the Plan.  Management expects to register these sharesin 2002.

 

        The following table showsactivity in outstanding options during 1999, 2000, and 2001.

 
|                                                            |   | **1999**   |       |                |       | **2000**   |       |                |       | **2001**   |       |                |       |
|-----------------------------------------------------------------|--------|------------|------------|---------------------|------------|------------|------------|---------------------|------------|------------|------------|---------------------|------------|
|                                                            |   |       |       | **Weighted**        |       |       |       | **Weighted**        |       |       |       | **Weighted**        |       |
|                                                            |   |       |       | **Average**         |       |       |       | **Average**         |       |       |       | **Average**         |       |
|                                                            |   | **Shares** |       | **Exercise  Price** |       | **Shares** |       | **Exercise  Price** |       | **Shares** |       | **Exercise  Price** |       |
| Outstanding at  beginning of year                               |   | 1,002,581  |       | $                   | 2.24       |       | 1,222,395  |                | $          | 2.29       |       | 1,500,890           |       | $ | 2.54 |   |
| Granted                                                         |   | 616,000    |       | 2.44                |       | 437,300    |       | 3.30                |       | 532,200    |       | 6.41                |       |
| Exercised                                                       |   | (341,986   | )          | 1.86                |       | (102,304   | )          | 1.60                |       | (447,273   | )          | 2.17                |       |
| Canceled or  expired                                            |   | (54,200    | )          | 5.86                |       | (56,501    | )          | 4.81                |       | (58,567    | )          | 4.67                |       |
| Outstanding at  end of year                                     |   | 1,222,395  |       | $                   | 2.29       |       | 1,500,890  |                | $          | 2.54       |       | 1,527,250           |       | $ | 3.91 |   |
|                                                            |   |       | ** ** |                | ** ** |       | ** ** |                | ** ** |       | ** ** |                | ** ** |
| Options  exercisable at year end                                |   | 880,645    |       | $                   | 2.26       |       | 1,008,589  |                | $          | 2.15       |       | 847,634             |       | $ | 2.47 |   |
|                                                            |   |       | ** ** |                | ** ** |       | ** ** |                | ** ** |       | ** ** |                | ** ** |
| Weighted average  fair value of Options granted during the year |   |       |       | $                   | 0.88       |       |       |                | $          | 1.98       |       |                |       | $ | 3.00 |   |

 

 

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        The following table showsinformation for options outstanding or exercisable as of December 30, 2001

 
|              |   | **Options  Outstanding** |   | **Options  Exercisable** |   |
|-------------------|--------|--------------------------|--------|--------------------------|--------|
|              |   |                     |   | **Weighted**             |   |   |   |   |   | **Weighted** |   |   |   |
|              |   |                     |   | **Average**              |   | **Weighted** |   |   |   | **Average** |   | **Weighted** |   |
| **Range of**      |   |                     |   | **Remaining**            |   | **Average** |   |   |   | **Remaining** |   | **Average** |   |
| **Exercise**      |   | **Number of**            |   | **Contractual**          |   | **Exercise** |   | **Number of** |   | **Contractual** |   | **Exercise** |   |
| **Prices**        |   | **Shares**               |   | **Life**                 |   | **Price** |   | **Shares** |   | **Life** |   | **Price** |   |
| $1.13 — 2.99 |   | 705,550                  |   | 4.9 years                |   | $ | 2.17/share |   | 702,884 |   | 4.9 years |   | $ | 2.16/share |   |
| $3.00 — 4.99 |   | 291,000                  |   | 8.1 years                |   | $ | 3.58/share |   | 126,750 |   | 7.9 years |   | $ | 3.61/share |   |
| $5.00 — 6.99 |   | 499,200                  |   | 9.6 years                |   | $ | 6.38/share |   | 8,000 |   | 8.9 years |   | $ | 5.23/share |   |
| $7.00 — 8.00 |   | 31,500                   |   | 8.0 years                |   | $ | 7.11/share |   | 10,000 |   | 3.7 years |   | $ | 7.00/share |   |
|              |   |                     |   |                     |   |   |   |   |   |   |   |   |   |
| Total             |   | 1,527,250                |   | 7.1 years                |   | $ | 3.91/share |   | 847,634 |   | 5.4 years |   | $ | 2.47/share |   |

 

                If the Company hadelected the fair value method of accounting for stock-based compensation, compensationcost would be accrued at the estimated fair value of stock option grants overthe service period, regardless of later changes in stock prices and pricevolatility.  The fair value at date ofgrant for options granted in 1999, 2000, and 2001 has been estimated based on amodified Black-Scholes pricing model with the following assumptions: nodividend yield for any year; expected volatility for 1999, 2000 and 2001 grantsof approximately 49%, 55%, and 48**%**based on historical results; risk-freeinterest rates of 7.37**%,**6.37**%**and 4.18**%**; and expected lives ofapproximately five years for all grants. The table on the following page shows net income per share for 1999,2000, and 2001 as if the Company had elected the fair value method ofaccounting for stock options.

 
|                                                       |   | **1999** |      | **2000** |   | **2001**  |   |
|------------------------------------------------------------|--------|----------|-----------|----------|--------|-----------|--------|
| Net income as  reported                                    |   | $        | 7,027,430 |     | $      | 6,141,101 |   | $ | 4,428,990 |   |
|                                                       |   |     |      |     |   |      |   |
| Additional  compensation expense, net of tax effect        |   | (164,211 | )         | (257,108 | )      | (174,564  | )      |
|                                                       |   |     |      |     |   |      |   |
| Proforma net  income, as adjusted                          |   | $        | 6,863,219 |     | $      | 5,883,993 |   | $ | 4,254,426 |   |
|                                                       |   |     |      |     |   |      |   |
| Basic net income  per share                                |   | $        | 0.55      |     | $      | 0.46      |   | $ | 0.33 |   |
| Additional  compensation expense                           |   | (0.01    | )         | (0.02    | )      | (0.01     | )      |
| Basic Proforma  net income per share, as adjusted          |   | $        | 0.54      |     | $      | 0.44      |   | $ | 0.32 |   |
|                                                       |   |     |      |     |   |      |   |
| Diluted net  income per share                              |   | $        | 0.54      |     | $      | 0.44      |   | $ | 0.31 |   |
| Additional  compensation expense                           |   | (.01     | )         | (.01     | )      | (0.01     | )      |
| Diluted Proforma  net income (loss) per share, as adjusted |   | $        | 0.53      |     | $      | 0.43      |   | $ | 0.30 |   |
|                                                            |        |          |           |          |        |           |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

**8.**             **Income Taxes**

 

         The Company’s income taxbenefit (provision) consists of:
|                       |   | **1999**  |      | **2000** |   | **2001**   |   |
|----------------------------|--------|-----------|-----------|----------|--------|------------|--------|
| Current:                   |   |      |      |     |   |       |   |
|                       |   |      |      |     |   |       |   |
| Federal                    |   | $         | 105,051   | )        | $      | (244,500   | )      | $ | (618,100 | ) |
| State                      |   | (63,704   | )         | (155,400 | )      | (134,732   | )      |
| Total                      |   | (168,755  | )         | (399,900 | )      | (752,832   | )      |
|                       |   |      |      |     |   |       |   |
| Deferred:                  |   |      |      |     |   |       |   |
|                       |   |      |      |     |   |       |   |
| Federal                    |   | 3,250,000 |      | (221,100 | )      | (1,919,400 | )      |
| State                      |   | 180,000   |      | 730,100  |   | (264,100   | )      |
| Total                      |   | 3,430,000 |      | 509,000  |   | (2,183,500 | )      |
|                       |   |      |      |     |   |       |   |
| Net tax benefit  (expense) |   | $         | 3,261,245 |     | $      | 109,100    |   | $ | (2,936,332 | ) |

 

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                A reconciliationbetween the Company’s effective tax rate and U.S. Federal income tax rate onloss from continuing operations follows:
|                                                                                                                |   | **1999** |   | **2000** |   | **2001** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Federal  statutory rate                                                                                             |   | 34.0     | %      | 34.0     | %      | 34.0     | %      |
|                                                                                                                |   |     |   |     |   |     |   |
| State income  taxes, net of effect on Federal income taxes                                                          |   | 1.7      |   | 4.3      |   | 2.8      |   |
|                                                                                                                |   |     |   |     |   |     |   |
| Utilization of  net operating losses for which deferred income tax assets had been reduced by  valuation allowances |   | (37.8    | )      | —   |   | —   |   |
|                                                                                                                |   |     |   |     |   |     |   |
| Reversal of  Federal and State valuation allowances                                                                 |   | (91.1    | )      | (40.3    | )      | —   |   |
|                                                                                                                |   |     |   |     |   |     |   |
| Other                                                                                                               |   | 7.0      |   | .2       |   | 3.1      |   |
|                                                                                                                |   |     |   |     |   |     |   |
| Effective income  tax rate                                                                                          |   | (86.2    | )%     | (1.8     | )%     | 39.9     | %      |

 

Due to the prior history of losses, a 100% valuationallowance against deferred tax assets was provided in 1998 and earlier years,as management could not determine that it was more likely than not that theywould be realized. As of December 26, 1999, however, the Company hadexperienced three consecutive years of increasingly profitableoperations.  Accordingly, a portion of the valuation allowance totaling$3,430,000 was reversed in 1999, since the Company believed it was more likelythan not that at least this portion of deferred tax assets would berealized.  Additional reserves, other than those referred to below, werereversed in 2000.

 

The valuation allowance for 1999, 2000 and 2001 wasincreased (reduced) by ($4,563,000), ($7,512,000), and $6,008,000,respectively.  The findings in a 2000 Federal Court case for an unrelatedparty involving some similar issues and fact patterns indicated that the Companywould probably not be able to use certain net operating losses (NOLs) arisingin connection with its previously-owned subsidiary Upscale Food Outlets, Inc.(UFO).   Accordingly, beginning of year Federal NOLs in 2000 werereduced, as were the related deferred tax assets.   The resultingreduction in related gross deferred tax assets had no income statement effectin 2000 since they had been fully reserved in prior years.  In late 2001, however, this Federal Courtcase was reversed on appeal.  The InternalRevenue Service has issued a notice indicating it does not agree with theFederal Court’s decision. The IRS has recommended, and the government hasfiled, a petition for rehearing and reconsideration with the Federal CircuitCourt.  Thus, although the deferred tax assets related to the NOLs havebeen restored, amounts potentially available for future usage are substantiallyall reserved, as it cannot currently be determined that their utilization isprobable.  There is no reserve oraccrual for the tax effect of UFO NOLs utilized through December 30, 2001, asmanagement believes it is more likely that any negative determination throughthe Tax Courts of legislatively would be prospective in nature.

 

                Deferred income taxes reflect the net tax effectsof temporary differences between the carrying amounts of assets and liabilitiesfor financial reporting purposes and the amounts used for income taxpurposes.  Significant components of theCompany’s deferred tax assets are as follows:

 
|                                       |   | **2000**  |      | **2001**   |   |
|--------------------------------------------|--------|-----------|-----------|------------|--------|
| Federal loss  carryforwards                |   | $         | 2,356,000 |       | $      | 6,008,000 |   |
| Accumulated  depreciation and Amortization |   | 305,800   |      | 322,600    |   |
| Alternative  minimum tax credit carryovers |   | 248,000   |      | 384,000    |   |
| State income and  franchise taxes, net of  |   |      |      |       |   |
| effect on  Federal income taxes            |   | 519,000   |      | 499,100    |   |
| Other                                      |   | 236,100   |      | 370,300    |   |
|                                       |   | 3,759,000 |      | 7,584,000  |   |
| Less valuation  allowance                  |   | —    |      | (6,008,500 | )      |
|                                       |   |      |      |       |   |
| Net deferred tax  assets                   |   | $         | 3,759,000 |       | $      | 1,575,500 |   |

 

 

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                As of December 31, 2001, the Company hasrestored Federal NOLs totaling $17.7, which expire in varying amounts through2012, respectively.  Should more than a 50% change in Company ownershipoccur within a three-year period, utilization of these losses to reduce futureyears’ taxable income would be further limited. State income and franchisedeferred tax assets include approximately $489,000 in California Manufacturer’sTax Credits available to offset future California income taxes, expiring invarying amounts through 2010.

 

                The Companyrealizes tax benefits as a result of the exercise of non-qualified stockoptions and the exercise and subsequent sale of certain incentive stock options(disqualifying dispositions). For financial reporting purposes, any reductionin income tax obligations as a result of these tax benefits is credited toadditional paid-in capital. In the years 2000 and 2001, tax benefits ofdisqualifying dispositions totaling $117,400 and $562,200 have been credited tostockholders’ equity.

 

**9**.             **Litigation and Contingencies**

 

                InNovember 2000, the Company received $472,406 in settlement of a Section 16(b)lawsuit against a former significant stockholder (see Note 6).

 

                As of December 30, 2001, thereare no other material pending legal proceedings, other than ordinary, routinelitigation incidental to the Company’s business, to which the Company is aparty or to which any of its property is subject.

 

**10**.          **Slotting and Advertising Costs**

 

                Included in thebalance sheet under “Prepaid Expenses and Other” was slotting and advertisingcosts of $37,177 at December 31, 2000, with no prepaid balance at December 30,2001,  These expenses relate primarilyto slotting fees paid or credited to grocery chains for shelf space allocations.  Total advertising expenses and slotting feesincluded in Selling, General and Administrative expenses in the accompanyingstatements of operations for 1999, 2000 and 2001 were $1,977,333, $1,847,292,and $2,444,056 respectively.  Inaccordance with EITF  01-09 “Accounting for Consideration Given by aVendor to a Customer or a Reseller of the Vendor’s Products,” certain of theseexpenses will be reclassified and offset against revenues in 2002.

 

**11**.          **Significant Customers**

 

                Costco and Sam’sClub stores each accounted for portions of total revenues as follows:

** **
|                    |   | **1999** |   | **2000** |   | **2001** |   |
|-------------------------|--------|----------|--------|----------|--------|----------|--------|
| Costco                  |   | 49       | %      | 50       | %      | 48       | %      |
| Sam’s Club  stores |   | 31       | %      | 30       | %      | 31       | %      |

 

                At December 26, 1999, December 31, 2000, and December30, 2001 Costco and Sam’s Club stores accounted for the following concentrationof accounts receivable.

 
|                    |   | **1999** |   | **2000** |   | **2001** |   |
|-------------------------|--------|----------|--------|----------|--------|----------|--------|
| Costco                  |   | 49       | %      | 42       | %      | 35       | %      |
| Sam’s Club  stores |   | 27       | %      | 32       | %      | 41       | %      |

 

                The Company currently sells its products to eightseparate Costco regions which make purchasing decisions independently of oneanother.  On a regular basis, theseregions re-evaluate the products carried in their stores.  There can be no assurance that these Costcoregions will continue to offer Monterey Pasta’s products in the future orcontinue to allocate Monterey Pasta the same amount of shelf space.  Purchasing decisions for Sam’s Club stores(“Sam’s”), the Company’s second largest customer, are made at the head officelevel with input from the stores.  Whilethe Company is in the fifth year of its relationship with Sam’s, there can beno assurance that Sam’s will continue to carry the Company’s products.  Currently, the loss of either Costco orSam’s would materially adversely affect the Company’s business operations.

 

                No other single customer accounted for more than 10%of revenues or accounts receivable.

 

44

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**12.          SupplementalCash Flow information**

** **
| ***Cash payments:***                                |   | **1999** |    | **2000** |   | **2001** |   |
|-----------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Interest                                            |   | $        | 171,212 |     | $      | 43,954   |   | $ | 4,719 |   |
| Income Taxes                                        |   | 177,958  |    | 265,786  |   | 230,975  |   |
|                                                |   |     |    |     |   |     |   |
| ***Non-cash Financing and Investing  Activities:*** |   |     |    |     |   |     |   |
| Issuance of  common stock in payment of assets      |   | 145,000  |    | —   |   | —   |   |
| Purchase of  leased equipment                       |   | 19,099   |    | —   |   | 10,954   |   |
|                                                     |        |          |         |          |        |          |        |  |  |  |

 

**13.          EmployeeBenefit Plan**

 

                In 1996, the Company instituted a 401(k) Plancovering substantially all full-time employees with six months of service.  Under the Plan, employees may elect to deferup to 15% of compensation (subject to certain limitations).  The Company matches one-half of employeecontributions up to 6% of compensation. In addition, the Company may make an annual discretionary profit-sharingcontribution.   Employee contributions,Company matching contributions and related earnings are always 100%vested.  Company profit-sharingcontributions and related earnings vest 20% a year, with 100% vesting afterfive years of service.  During 1999,2000 and 2001, the Company’s expense for matching contributions was $73,326,$91,806, and $109,619 respectively; there were no profit-sharing contributionsfor 1999, 2000, or 2001.

 

**14.          QuarterlyInformation (unaudited)**

 

                The summarized quarterly financial data presented onthe following page and on the following page reflect all adjustments which, inthe opinion of management, are of a normal and recurring nature necessary topresent fairly the results of operations for the periods presented.

 
|                               |   | **First**   |       | **Second**  |   | **Third**   |   | **Fourth**  |       |       |   |
|------------------------------------|--------|-------------|------------|-------------|--------|-------------|--------|-------------|------------|------------|--------|
|                               |   | **Quarter** |       | **Quarter** |   | **Quarter** |   | **Quarter** |       | **2000**   |   |
| **Year Ended 2000**                |   |        |       |        |   |        |   |        |       |       |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Net revenue                        |   | $           | 11,155,539 |        | $      | 11,045,842  |   | $           | 12,160,813 |       | $      | 13,599,605 |   | $ | 47,961,799 |   |
| Gross profit                       |   | 4,124,081   |       | 4,260,230   |   | 4,796,379   |   | 5,306,386   |       | 18,487,076 |   |
| Operating income                   |   | 1,192,526   |       | 1,444,428   |   | 1,611,672   |   | 1,872,394   |       | 6,121,020  |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Net income                         |   | $           | 1,094,434  |        | $      | 1,311,563   |   | $           | 1,825,411  |       | $      | 1,909,693 |   | $ | 6,141,101 |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Basic earnings  per common share   |   | $           | 0.08       |        | $      | 0.10        |   | $           | 0.14       |       | $      | 0.14 |   | $ | 0.46 |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Diluted earnings  per common share |   | $           | 0.08       |        | $      | 0.09        |   | $           | 0.13       |       | $      | 0.14 |   | $ | 0.44 |   |

 

 

45

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|                               |   | **First**   |       | **Second**  |   | **Third**   |   | **Fourth**  |       |       |   |
|------------------------------------|--------|-------------|------------|-------------|--------|-------------|--------|-------------|------------|------------|--------|
|                               |   | **Quarter** |       | **Quarter** |   | **Quarter** |   | **Quarter** |       | **2001**   |   |
| **Year Ended 2001**                |   |        |       |        |   |        |   |        |       |       |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Net revenue                        |   | $           | 14,732,461 |        | $      | 14,011,656  |   | $           | 14,929,347 |       | $      | 15,546,670 |   | $ | 59,220,134 |   |
| Gross profit                       |   | 5,718,013   |       | 5,129,560   |   | 5,546,395   |   | 6,356,980   |       | 22,750,948 |   |
| Operating income                   |   | 1,950,354   |       | 1,326,867   |   | 1,757,410   |   | 2,201,304   |       | 7,235,935  |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Net income                         |   | $           | 1,225,036  |        | $      | 832,535     |   | $           | 1,099,286  |       | $      | 1,272,133 |   | $ | 4,428,990 |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Primary earnings  per common share |   | $           | 0.09       |        | $      | 0.06        |   | $           | 0.08       |       | $      | 0.11 |   | $ | 0.33 |   |
|                               |   |        |       |        |   |        |   |        |       |       |   |
| Diluted earnings  per common share |   | $           | 0.09       |        | $      | 0.06        |   | $           | 0.08       |       | $      | 0.11 |   | $ | 0.31 |   |

** **

**15.          IntangibleAssets and Business Acquisition**

 

**               **Intangible assets consist of:

 
|                                                        |   | **2000**  |      | **2001**  |   |
|-------------------------------------------------------------|--------|-----------|-----------|-----------|--------|
| Tradenames                                                  |   | $         | 204,376   |      | $      | 204,376 |   |
| Other  intangibles                                          |   | 262,684   |      | 262,684   |   |
| Goodwill  and other intangibles not separately quantifiable |   | 1,709,784 |      | 1,709,784 |   |
|                                                        |   | $         | 2,176,844 |      | $      | 2,176,844 |   |
| Less  accumulated amortization                              |   | 586,289   |      | 804,005   |   |
| Net  intangible assets                                      |   | $         | 1,590,555 |      | $      | 1,372,839 |   |

 

***The Frescala Purchase***

 

On March 12, 1999, theCompany purchased the operating assets and inventory of Frescala Foods, Inc.(“Frescala”), a San Antonio, Texas based fresh pasta and sauce producer with anemphasis on private label production. The consideration to Frescala consistedof $1,345,000 in cash plus fully vested options to purchase 300,000 shares ofthe Company’s common stock.  The optionshave an approximate fair market value of $145,000, an exercise price of $2.33per share, and a three-year expiration. Additionally, Frescala owners received an earn-out of $97,000 as ofOctober 31, 1999 (treated as additional purchase price) based upon Frescalasales above a predetermined level. The entire $1,660,000 cost of theacquisition (including acquisition costs of $73,000) was recorded as follows:

 
| Inventories                                                                                |   | $         | 217,000   |   |
|--------------------------------------------------------------------------------------------|--------|-----------|-----------|--------|
| Fixed  assets                                                                              |   | 200,000   |      |
| Goodwill  including trademarks, customer list, and recipes, not specifically  quantifiable |   | 1,243,000 |      |
| Total  acquisition cost                                                                    |   | $         | 1,660,000 |   |

 

                Results of operations would not be materiallydifferent if Frescala would have been acquired as of January 1999.

 

***TheNate’s Purchase***

 

On December 8, 2000, theCompany purchased the Nate’s polenta business of South San Francisco,California for consideration of $469,000, of which $19,000 was allocated toinventory, plus related acquisition costs of $31,000.  The remaining $481,000, which included recipes, a licensingagreement, and customer list, not specifically quantifiable, was charged togoodwill. Additionally, Nate’s former owners could have received an earn-out ofa maximum of $100,000 to be paid as of August 8, 2001 based upon sales above apredetermined level.  However, sales didnot reach the predetermined level so no additional payment was made.

 

                Results of operations would not be materiallydifferent if Nate’s would have been acquired as of January 1999. 

 

46

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**SCHEDULEII**

**MONTEREY PASTA COMPANY**

**VALUATION AND QUALIFYING ACCOUNTS**

 
|                                                                                |   |          |    | **Additions  —** |   | **Deductions  —** |   |         |    |
|-------------------------------------------------------------------------------------|--------|---------------|---------|-----------------------|--------|------------------------|--------|--------------|---------|
|                                                                                |   | **Balance,**  |    | **Charged to**        |   | **Write-offs**         |   | **Balance,** |    |
|                                                                                |   | **Beginning** |    | **Costs and**         |   | **Charged to**         |   | **End of**   |    |
|                                                                                |   | **of 1999**   |    | **Expense**           |   | **Reserves**           |   | **1999**     |    |
| Allowances  against Receivables —   Spoils, Returns, Adjustments And Bad Debts |   | $             | 312,408 |                  | $      | 693,727                |   | $            | 870,008 |   | $ | 136,127 |   |
|                                                                                |   |          |    |                  |   |                   |   |         |    |
| Inventory  Reserves —  Spoils and Obsolescence                                 |   | 30,000        |    | 149,500               |   | 152,000                |   | 27,500       |    |
|                                                                                     |        |               |         |                       |        |                        |        |              |         |  |  |  |  |

 

 
|                                                                                |   |          |    | **Additions  —** |   | **Deductions  —** |   |         |    |
|-------------------------------------------------------------------------------------|--------|---------------|---------|-----------------------|--------|------------------------|--------|--------------|---------|
|                                                                                |   | **Balance,**  |    | **Charged to**        |   | **Write-offs**         |   | **Balance,** |    |
|                                                                                |   | **Beginning** |    | **Costs and**         |   | **Charged to**         |   | **End of**   |    |
|                                                                                |   | **of 2000**   |    | **Expense**           |   | **Reserves**           |   | **2000**     |    |
| Allowances  against Receivables —   Spoils, Returns, Adjustments And Bad Debts |   | $             | 136,127 |                  | $      | 476,341                |   | $            | 370,167 |   | $ | 242,301 |   |
|                                                                                |   |          |    |                  |   |                   |   |         |    |
| Inventory  Reserves —  Spoils and Obsolescence                                 |   | 27,500        |    | —                |   | —                 |   | 27,500       |    |
|                                                                                     |        |               |         |                       |        |                        |        |              |         |  |  |  |  |

 

 
|                                                                                |   |          |    | **Additions  —** |   | **Deductions  —** |   |         |      |
|-------------------------------------------------------------------------------------|--------|---------------|---------|-----------------------|--------|------------------------|--------|--------------|-----------|
|                                                                                |   | **Balance,**  |    | **Charged to**        |   | **Write-offs**         |   | **Balance,** |      |
|                                                                                |   | **Beginning** |    | **Costs and**         |   | **Charged to**         |   | **End of**   |      |
|                                                                                |   | **of 2001**   |    | **Expense**           |   | **Reserves**           |   | **2001**     |      |
| Allowances  against Receivables —   Spoils, Returns, Adjustments and Bad Debts |   | $             | 242,301 |                  | $      | 1,331,337              |   | $            | 1,268,155 |   | $ | 305,483 |   |
|                                                                                |   |          |    |                  |   |                   |   |         |      |
| Inventory  Reserves —  Spoils and Obsolescence                                 |   | 27,500        |    | 111,000               |   | 111,000                |   | 27,500       |      |
|                                                                                     |        |               |         |                       |        |                        |        |              |           |  |  |  |  |

 

 

47

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**SIGNATURES**

 

                Pursuant to the requirements of Section 13 of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized, in thecity of San Francisco, State of California, on the 8th day of February, 2002

 
|   |   |   | MONTEREY PASTA COMPANY |
|--------|--------|--------|------------------------|
|   |   |   |                   |   |   |   |   |   |
|   |   |   |                   |   |   |   |   |   |
|   |   |   | By:                    | /s/ R. LANCE HEWITT |
|   |   |   |                   | R. Lance Hewitt |
|   |   |   |                   | President and Chief  Executive Officer |
|   |   |   |                   |   |   |   |   |   |
|   |   |   |                   |   |   |   |   |   |
|   |   |   | By:                    | /s/STEPHEN L. BRINKMAN |
|   |   |   |                   | Stephen L. Brinkman |
|   |   |   |                   | Chief Financial Officer |

 

                Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons in the capacities indicated and on the dates indicated.

 
| **Name**                         |   | **Title**                  |   | **Date**          |
|----------------------------------|--------|----------------------------|--------|-------------------|
|                             |   |                       |   |              |
| /s/  CHARLES  B. BONNER     |   | Director                   |   | February 08, 2002 |
| Charles B. Bonner                |   |                       |   |              |
|                             |   |                       |   |              |
| /s/  F.  CHRISTOPHER CRUGER |   | Director                   |   | February 08, 2002 |
| F. Christopher Cruger            |   |                       |   |              |
|                             |   |                       |   |              |
| /s/  MICHAEL  P. SCHALL     |   | Director                   |   | February 08, 2002 |
| Michael P. Schall                |   |                       |   |              |
|                             |   |                       |   |              |
| /s/  VAN  TUNSTALL          |   | Director                   |   | February 08, 2002 |
| Van Tunstall                     |   |                       |   |              |
|                             |   |                       |   |              |
| /s/  JAMES  WONG            |   | Director                   |   | February 08, 2002 |
| James Wong                       |   |                       |   |              |
|                             |   |                       |   |              |
| /s/  WALTER  L. HENNING     |   | Director                   |   | February 08, 2002 |
| Walter L. Henning                |   |                       |   |              |
|                             |   |                       |   |              |
| /s/  R. LANCE  HEWITT       |   | President, Chief Executive |   | February 08, 2002 |
| R. Lance Hewitt                  |   | Officer and Director       |   |              |
|                             |   |                       |   |              |
| /s/  STEPHEN  L. BRINKMAN   |   | Chief Financial Officer,   |   | February 08, 2002 |
| Stephen L. Brinkman              |   | Secretary, and Director    |   |              |
|                             |   |                       |   |              |

### ** **

 

48

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|   |   | **Index  to Exhibits**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1    |   | Certificate  of Incorporation dated August 1, 1996 (incorporated by reference from Exhibit  B to the Company’s 1996 Proxy)                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.2    |   | Bylaws  of the Company (incorporated by reference from Exhibit C to the 1996 Proxy)                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.1    |   | Form  of Warrant for purchase of the Company’s Common Stock, dated as of July 1,  1996 (incorporated by reference from Exhibit 4.5 filed with the Company’s  1996 Form S-3)                                                                                                                                                                                                                                                                                                                                                                           |
| 4.2    |   | Form  of Registration Rights Agreement dated April 1996, among the Company, Spelman  & Co., Inc. and investor (incorporated by reference from Exhibit 10.42  filed with the Company’s Original March 31, 1996 Quarterly Report on Form  10-Q on May 1, 1996 (“1996 Q1 10-Q”))                                                                                                                                                                                                                                                                |
| 4.3    |   | Stockholder  Rights Agreement dated as of May 15, 1996 between the Company and Corporate  Stock Transfer, as rights agent (incorporated by reference from Item 2 of  Form 8-A filed with the Securities and   Exchange Commission on May 28, 1996)                                                                                                                                                                                                                                                                                                         |
| 4.4    |   | Amendment  to Registration Rights Agreement dated as of April 20, 1997 among the  Company, Spelman & Co., Inc. and investor, amending the Registration  Rights Agreement entered into as of April, 1996 (incorporated by reference  from Exhibit 4.9 filed with the Company’s 1996 Form 10-KA)                                                                                                                                                                                                                                                         |
| 4.5    |   | Registration  Rights Agreement dated as of December 31, 1996 among the Company, Sentra  Securities Corporation and investor (incorporated by reference from Exhibit  4.12 filed with the Company’s 1996 Form 10-K/A)                                                                                                                                                                                                                                                                                                                                       |
| 4.6    |   | Form  of   Warrant  (“Sentra  Warrant”)  for purchase of  Company’s Common stock dated  March 1997 issued  in   connection  with  the   Company’s  March  1997   Private   Placement(incorporated  by  reference  from  Exhibit   4.13  filed  with   the  Company’s  Pre-Effective Amendment No. 1 to the  Registration Statement on Form S-3 filed on May 6, 1997 (“1997 Amendment No.  1 to Form S-3)) |
| 4.7*   |   | Stock  Purchase Agreement between the Company and   Kenneth A.  Steel, Jr.  dated April 29, 1997 (incorporated by  reference from Exhibit 4.14 filed with the 1997 Amendment No. 1 to Form S-3)                                                                                                                                                                                                                                                                                                                                                  |
| 10.1*  |   | Second  Amended and Restated 1993 Stock Option Plan (as amended on August 1, 1996)  (incorporated by reference to Exhibit 10.1 filed with the Company’s 1996 Form  10-K)                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.2*  |   | 1995  Employee Stock Purchase Plan (incorporated by reference from  Exhibit 10.15 to the Company’s 1994 Form  10-K)                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.3   |   | Monterey  County Production Facility Lease of the Company, as amended  (incorporated by reference from Exhibit  10.03 to the SB-2)                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.4   |   | Amendment  No. 1 dated February 1, 1995 and Amendment No. 2 dated March 1, 1995 to  Monterey County Production Facility Lease of the Company  (incorporated by reference from Exhibit  10.6 filed with the 1995 Form 10-K)                                                                                                                                                                                                                                                                                                                                 |
| 10.5   |   | Amendment  No. 3 dated September 12, 1997, and Amendment No. 4 dated February 6, 1999 to  Monterey County Production Facility Lease of the Company (incorporated by  reference from Exhibit 10.5 filed with the Company’s September 27, 1999  Quarterly Report on Form 10-Q dated November 4, 1999 (“1999 Q3 10-Q”))                                                                                                                                                                                                                             |
| 10.6   |   | Trademark  Registration — MONTEREY PASTA COMPANY, under Registration No. 1,664,278,  registered on November 12, 1991 with the U.S. Patent and Trademark Office  (incorporated by reference from Exhibit 10.09 to the SB-2)                                                                                                                                                                                                                                                                                                                                 |
| 10.7   |   | Trademark  Registration — MONTEREY PASTA COMPANY, under Registration No. 1,943,602,  registered on December 26, 1995 with the U.S. Patent and trademark Office  (incorporated by reference from Exhibit 10.24 to the 1995 Form 10-K)                                                                                                                                                                                                                                                                                                                       |
| 10.8   |   | Trademark  Registration — MONTEREY PASTA COMPANY and Design, under Registration No.  1,945,131, registered on January 2, 1996 with the U.S. Patent and trademark  Office (incorporated by reference from Exhibit 10.25 to the 1995 Form 10-K)                                                                                                                                                                                                                                                                                                              |
| 10.9   |   | Trademark  Registration-MONTEREY PASTA COMPANY and Design, under Registration No.  1,951,624, registered on January 23, 1996 with the U.S. Patent and Trademark  Office (incorporated by reference from Exhibit 10.26 to the 1995 Form 10-K)                                                                                                                                                                                                                                                                                                                    |
| 10.10  |   | Trademark  Registration-MONTEREY PASTA COMPANY and Design, under Registration No.  1,953,489, registered on January 30, 1996 with the U.S. Patent and Trademark  Office (incorporated by reference from Exhibit 10.27 to the 1995 Form 10-K)                                                                                                                                                                                                                                                                                                                    |

 

49

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| 10.11  |   | Registration  Rights Agreement dated as of June 15, 1995 with GFL Advantage Fund Limited,  as amended on October 13 and 19, 1995, respectively  (incorporated by reference from Exhibit 10.2 to the 1995 Q2  10-Q, and Exhibits 10.6 and 10.7 to the Company’s S-3 Registration Statement  No. 33-96684, filed on December 12, 1995 (“1995 S-3”)) |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.12* |   | The Company’s  401(k) Plan, established to be effective as of January 1, 1996, adopted  by the Board of Directors on June 7,  1996  (incorporated by reference from  Exhibit 10.44 to the Company’s Quarterly Report on Form 10-Q on August 13,  1996 (“1996 Q2 10-Q”))                                                                 |
| 10.13* |   | Directed  Employee Benefit Trust Agreement dated June 17, 1996 between the Company and  The Charles Schwab Trust Company, as Trustee of the Company’s 401(k) Plan  (incorporated by reference from Exhibit 10.45 to the 1996 Q2 10–Q)                                                                                                                       |
| 10.14  |   | Security and  Loan Agreement (Accounts Receivable and/or Inventory) dated July 24, 1997  between the Company and Imperial Bank (incorporated by reference from  Exhibit 10.47 of the Company’s  Pre-Effective Amendment No. 3 to Form S-3 filed on October 14, 1997 (“1997  Amendment No. 3 to Form S-3”))                                        |
| 10.15* |   | Agreement  Regarding   Employment,  Trade  Secrets,   Inventions,  and  Competition  dated  May 26, 1997 with  Mr. R. Lance Hewitt (incorporated by reference from Exhibit 10.48 of the 1997  Amendment No. 3 to Form S-3)                                                                                               |
| 10.16* |   | Employment  Agreement dated August 25, 1997 with Mr. Stephen L. Brinkman (incorporated by  reference to Exhibit 10.49, in the Company’s September 28, 1997 Quarterly  Report on Form 10-Q filed on November 10, 1997)                                                                                                                                            |
| 10.17  |   | First Amendment  to Security and Loan Agreement dated July 24, 1997 between the Company and  Imperial Bank (incorporated by reference from Exhibit 10.50  in the Company’s 1997 Form 10-K)                                                                                                                                                                  |
| 10.18  |   | Second Amendment  to Security and Loan Agreement dated   July  24,  1997   between  the  Company   and Imperial Bank (incorporated by reference from Exhibit 10.18 filed  with the Company’s 1998 Q3 10-Q)                                                                                                                    |
| 10.19  |   | Security and  Loan Agreement dated July 23, 1998 between the Company and Imperial Bank  (incorporated by reference from Exhibit 10.19 filed with the Company’s 1998  Q3 10-Q)                                                                                                                                                                                    |
| 10.20  |   | Addendum to  Security and Loan Agreement dated July 23, 1998 between the Company and  Imperial Bank (incorporated by reference from Exhibit 10.20 filed with the  Company’s 1998 Q3 10-Q)                                                                                                                                                                        |
| 10.21  |   | Agreement for  Handling and Storage Services between the Company and CS Integrated LLC dated  February 5, 1999 (incorporated by reference to Exhibit 10.21 filed with the  Company’s 1998 Form 10-K on March 17, 1999 (“1998 Form 10-K”))                                                                                                              |
| 10.22  |   | Defined  Contribution Administrative Service Agreement between the Company and First  Mercantile Trust dated December 15, 1999 (incorporated by reference to  Exhibit 10.22 filed with the Company’s 1998 Form 10-K)                                                                                                                                             |
| 10.23  |   | First Amendment  to Security and Loan Agreement and Addendum thereto between the Company and  Imperial Bank dated July 23, 1999 (incorporated by reference to Exhibit 10.23  filed with the Company’s March 28, 1999 Quarterly Report on Form 10-Q filed  on April 28, 1999)                                                                                     |
| 10.24  |   | Agreement for  Purchase and Sale of Assets dated as of March 12, 1999, by and among the  Company and  the shareholders of  Frescala Foods, Inc. (incorporated by reference from Exhibit 2.1 filed with  the Company’s 8-K on March 17, 1999)                                                                                                                |
| 10.25  |   | Royalty  agreement dated July 12, 1999 between Company and Chet’s Gourmet Foods, Inc.  for soups (incorporated by reference to Exhibit 10.25, in the Company’s  September 26, 1999 Quarterly Report on Form 10-Q filed on November 9, 1999  (“1999 Q3 10-Q”))                                                                                     |
| 10.26  |   | Storage  Agreement Manufactured Products dated August 3, 1999 between the Company and  Salinas Valley Public Warehouse for storage and handling of Company’s product  in Monterey County, California storage facility (incorporated by reference to  Exhibit 10.26, filed with the Company’s 1999 Q3 10-Q)                                                  |
| 10.27  |   | Commercial Lease  dated August 10, 1999 between Company and Salinas Valley Public Warehouse for  storage space in Monterey County, California (incorporated by reference to  Exhibit 10.27, filed with the Company’s 1999 Q3 10-Q)                                                                                                                               |
| 10.28  |   | Rental Agreement  dated September 6, 1999 between Company and Porter Family Trust for storage  space in Monterey County, California (incorporated by reference to Exhibit  10.28 filed with the Company’s 1999 Q3 10-Q)                                                                                                                                          |
| 10.29  |   | Royalty  agreement dated September 15, 1999 between Company and Chet’s Gourmet Foods,  Inc. for meatball and sauce item (incorporated by reference to Exhibit 10.29,  filed with the Company’s 1999 Q3 10-Q)                                                                                                                                                |

 

 

50

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| 10.30 |   | Credit Agreement  between the Company and Imperial Bank dated August 2, 1999 (incorporated by  reference to Exhibit 10.30 filed with the Company’s 1999 Form 10-K on  February 18, 2000 (“1999 Form 10-K”))                                                                                 |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.31 |   | First Amendment  to Credit Agreement between the Company and Imperial Bank dated August 2,  1999 (incorporated by reference to Exhibit 10.21 filed with the Company’s  1999 Form 10-K)                                                                                                                |
| 10.32 |   | Commercial lease  dated January 1, 2000 between the Company and PTF for Operating Engineers,  LLC for storage space in Monterey County, California (incorporated by  reference to Exhibit 10.32, in the Company’s June 25, 2000 Quarterly Report  on Form 10-Q filed on August 4, 2000)               |
| 10.33 |   | Second Amendment  to Credit Agreement between the Company and Imperial Bank dated August 2,  1999 (incorporated by reference to Exhibit 10.33 in the Company’s September  25, 2000 Quarterly Report on Form 10-Q filed on November 6, 2000 (“2000 Q3  10-Q”))                               |
| 10.34 |   | Third Amendment  to Credit Agreement between the Company and Imperial Bank dated August 2,  1999  (incorporated by reference to  Exhibit 10.34 in the Company’s 2000 Q3 10-Q)                                                                                                                    |
| 10.35 |   | Royalty  agreement dated February 11, 2000 between Company and William Naim for  development of pizza and calzone recipes and process (incorporated by  reference to Exhibit 10.35 filed with the Company’s 2000 Form 10-K on  February 7, 2001 (“2000 Form 10-K”))                         |
| 10.36 |   | Fourth Amendment  to Credit Agreement between the Company and Imperial Bank dated August 2,  1999 (incorporated by reference to Exhibit 10.36 filed with the Company’s  2000 Form 10-K)                                                                                                               |
| 10.37 |   | Asset Purchase  Agreement dated as of December 8, 2000, by and among the Company and the  shareholders of Elena’s Food Specialties, Inc. (incorporated by reference to  Exhibit 10.37 filed with the Company’s 2000 Form 10-K)                                                                   |
| 10.38 |   | Limited License  for use of Nate’s brand dated as of December 8, 2000, by and among the  Company and the shareholders of Elena’s Food Specialties, Inc. (incorporated by  reference to Exhibit 10.38 filed with the Company’s 2000 Form 10–K)                                          |
| 10.39 |   | Fifth Amendment  to Credit Agreement between the Company and Imperial Bank dated August 2,  1999 (incorporated by reference to Exhibit 10.39 in the Company’s April 1,  2001 Quarterly Report on  Form 10-Q  filed on May 7, 2001)                                                               |
| 10.40 |   | Lease Extension  and Modification Agreement between the Company and Marco Warehouse d.b.a.  Salinas Valley Public Warehouse dated September 1, 2001 (incorporated by  reference to Exhibit 10.40 in the Company’s September 30, 2001 Quarterly  Report on  Form 10-Q filed on November  7, 2001) |
| 10.41 |   | Consent of BDO  Seidman, LLP                                                                                                                                                                                                                                                                               |

 

 

### ***  Management contract or compensatory plan orarrangement covering executive officers or directors of the Company and itsformer subsidiary, Upscale Food Outlets, Inc.**

 

 

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