`================================================================================

                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON DC 20549

                                    FORM 10-K

(Mark one)
----------
[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934
      For the fiscal year ended December 31, 2007

                                       OR

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934
      FOR THE TRANSITION PERIOD FROM _________ TO _________

                        Commission file number 001-11777

                          MONTEREY GOURMET FOODS, INC.
             (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
   -------------------------------------------         -----------------
    (Address of Principal Executive Offices)              (Zip Code)

                                 (831) 753-6262
--------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

     Title of each class               Name of each exchange on which registered
 Common Stock, $.001 par value                 NASDAQ Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act:

                          Common Stock, $.001 par value
                          -----------------------------
                               Title of each class
                               -------------------

Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ]  No [X]

Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act. Yes [ ]  No [X]

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

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein and
will not be contained, to the best of the Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in PART III of this
Form 10-K, or any amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a small reporting company. See
definition of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

  Large accelerated filer [ ]  Accelerated Filer [ ]  Non-accelerated filer [X]
                         Smaller reporting company [ ]

Indicate by a check mark whether the Registrant is a shell company (as defined
in Exchange Act Rule 12b-2). Yes [ ]  No [X]

The approximate aggregate market value of the voting and non-voting common
equity held by non-affiliates of the issuer as of June 30, 2007 was $38,102,000.
The number of shares outstanding of the issuer's common stock as of March 12,
2008 was 16,991,005.

                       DOCUMENTS INCORPORATED BY REFERENCE

Parts III of this Annual Report on Form 10-K incorporates by reference
information from the Registrant's Proxy Statement for its Annual Meeting of
Shareholders to be held on June 28, 2008 ("2008 Proxy Statement") to be filed
with the SEC within 120 days of the end of the calendar year covered by this
report.`

---

`MONTEREY GOURMET FOODS, INC.
                                TABLE OF CONTENTS`

|Page
                                                                                                 ----
PART I.
       Item 1.  Business                                                                           3
       Item 1A. Risk Factors                                                                       9
       Item 1B. Unresolved Staff Comments                                                         11
       Item 2.  Properties                                                                        12
       Item 3.  Legal Proceedings                                                                 12
       Item 4.  Submission of Matters to a Vote of Securities Holders                             12

PART II.
       Item 5.  Market for Registrant's Common Equity, Related
                Stockholder Matters and Issuer Purchases of Equity Securities                     12
       Item 6.  Selected Financial Data                                                           15
       Item 7.  Management's Discussion and Analysis of Financial
                Condition and Results of Operations                                               15
       Item 7A. Quantitative and Qualitative Disclosures about Market Risk                        27
       Item 8.  Financial Statements and Supplementary Data                                       28
       Item 9.  Changes In and Disagreements with Accountants on
                Accounting and Financial Disclosure                                               28
       Item 9A. Controls and Procedures                                                           28
       Item 9B. Other Information                                                                 29

PART III.
       Item 10. Directors, Executive Officers and Corporate Governance                            29
       Item 11. Executive Compensation                                                            29
       Item 12. Security Ownership of Certain Beneficial Owners and
                Management and Related Stockholder Matters                                        29
       Item 13. Certain Relationships and Related Transactions and
                Director Independence                                                             30
       Item 14. Principal Accounting Fees and Services                                            30

PART IV.
       Item 15. Exhibits, Financial Statement Schedules                                           31

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                                           32

SIGNATURES                                                                                        63

EXHIBIT 23.1                                                                                      66
EXHIBIT 31.1                                                                                      67
EXHIBIT 31.2                                                                                      68
EXHIBIT 32.1                                                                                      69
EXHIBIT 32.2                                                                                      70
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`2`

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`PART I

ITEM 1.  BUSINESS

Information Concerning Forward-Looking Statements

      Certain of the statements contained in this report (other than the
historical financial data and other statements of historical fact), including,
without limitation, statements as to management's expectations and beliefs, are
forward-looking statements. Forward-looking statements are made based upon
management's good faith expectations and beliefs concerning future developments
and their potential effect upon the Company. There can be no assurance that
future developments will be in accordance with such expectations or that the
effect of future developments on the Company will be those anticipated by
management. Forward-looking statements can be identified by the use of words
such as "believe," "expect," "plans," "strategy," "prospects," "estimate,"
"project," "anticipate," "intends" and other words of similar meaning in
connection with a discussion of future operating results or financial
performance. This Report on Form 10-K includes important information as to risk
factors in "Item 1. Business", "Item 1A. Risk Factors", and "Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations." Many important factors could cause actual results to differ
materially from management's expectations, including:

  -   Weather could impact the price of raw materials the Company purchases.

  -   The extent to which the Company can reduce costs.

  -   Unpredictable difficulties or delays in the development of new products or
      the Company's ability to forecast consumer trends.

  -   Changes in U.S. economic conditions such as inflation, recession, or
      interest rate fluctuations.

  -   Pricing changes of raw materials, freight, or impacts for competitive
      pricing.

  -   Competitive products from international sources.

  -   Inherent risks of food production.

  -   Labor relations.

  -   Integration of acquired businesses and the impact from minority interests.

  -   Difficulties in obtaining or retaining the management and other human
      resource competencies that the Company needs to achieve its business
      objectives.

  -   The impact on the Company from the loss of a significant customer or a few
      customers.

  -   Changes in the regulatory environment.

  -   Capital spending requirements.

  -   Adoption of new accounting pronouncements promulgated by the Financial
      Accounting Standards Board or other accounting standard setting agencies
      such as the Public Company Accounting Oversight Board.

Introduction

      Monterey Gourmet Foods, Inc. ("the Company" or "Monterey") began its
business in 1989 as a producer and distributor of refrigerated gourmet pasta and
sauces to restaurants and grocery stores in the Monterey, California area. The
Company has since expanded its operations to include a more diversified range of
gourmet refrigerated food products, which it provides to grocery and club stores
throughout the United States, as well as selected regions in Canada, the
Caribbean, Latin America, and Asia Pacific. The Company's overall strategy is to
enhance the value of the Monterey Gourmet Foods brands by distributing its
gourmet food products through multiple channels of distribution, while
selectively participating in private label partnerships.

      The Company currently produces and/or markets premium quality refrigerated
gourmet pastas, gnocchi, pasta sauces, prepared entrees, salsas, tamales, dips,
hummus, polenta, cheeses, spreadable cheeses, gourmet chicken sausages, and
gourmet chicken meatballs emphasizing superior flavors and innovative products.
The Company seeks to build brand recognition and customer loyalty by employing a
marketing program that focuses on developing multiple points of sale for the
Company's products, and increasing consumer awareness of the Company's offerings
primarily through in-store sampling and advertising and cooperative advertising
with its customers. The Company markets and sells its products primarily through
grocery and club stores with limited distribution to a select few foodservice
accounts.

      The Company offers seven core brands in ten key categories over 250
varieties of contemporary gourmet food products that are produced using the
Company's proprietary recipes. In 2007, the Company introduced an organic or
made with organic line of pastas, three Organic Edamame Spreads, an Organic
Mango Salsa, three Tuscan Bean Spreads, and two gourmet chicken meatballs. In
2006, the Company continued to expand its line and distribution of whole wheat
pasta as well as entered the frozen category with its "OneStep Gourmet" product
which offers consumers a complete meal in less than 13 minutes. It also
introduced several Hispanic products including two flavors of premium tamales.

                                        3`

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`During 2007, Company CEO Eric Eddings implemented significant changes in
the Company's culture and management structure, with the goals of upgrading
management talent within the Company, uniting all functions of the Company and
its subsidiaries under one corporate umbrella, and putting in place a single
company-wide bonus program and performance review process. During 2007, the
Company returned to profitability after three years of losses.

      The Company's web site, www.montereygourmetfoods.com, supports its brands
by providing both consumer and investor information. The site provides insight
into the Company's profile, product offerings, and financial strength, as well
as consumer tips for those interested in gourmet food and links to its various
brands.

      The success of the Company's sales efforts will depend in large part on
four key factors: (1) whether grocery and club store chains will continue to
increase the number of their stores offering the Company's products, (2) whether
the Company can continue to increase the number of grocery and club store chains
offering its products, (3) whether the Company continues to introduce new
products that meet consumer acceptance and (4) whether the Company can continue
to diversify into other complementary businesses and leverage its strengths to
continue to grow revenues and profits at levels attractive to its investors.
Grocery and club store chains continually re-evaluate the products carried in
their stores, and no assurances can be given that the chains currently offering
the Company's products will continue to do so in the future.

      Monterey Gourmet Foods was originally incorporated in California in June
1989 and was reincorporated in Delaware in August 1996. The Company's executive
offices and principal facilities are located at 1528 Moffett Street, Salinas,
California 93905. The Company's telephone number is (831) 753-6262. Investors
and other interested parties can obtain copies of the Company's periodic reports
and proxy material from the Company's website free of charge, as well as from
the SEC's website at www.sec.gov.

Industry Overview

      The Company believes that the U.S. retail market for refrigerated
specialty foods is fragmented and growing with a number of national, regional
and local competitors. The Company believes that it can be successful in this
market by offering high quality, upscale products with superior flavor profiles.
The Company also believes that it can leverage its existing presence in club
stores and retail grocery chain stores to gain distribution of its other gourmet
food products.

      The organic food business has been growing at a double-digit rate since
the 1960s and has reached over $13 billion in retail sales, according to Organic
Trade Associations 2006 Manufacturing Survey. New Federal standards, under the
auspices of the United States Department of Agriculture ("USDA"), were adopted
for the industry in October 2002. The purpose of the new standards was to
provide a framework for organic content of product with the use of the USDA seal
for those products meeting the "organic" definition (95% organic content), and
set standards for product quality and food safety so as to improve the overall
strength of the organic foods industry and protect the consumer. Emerald Valley
Kitchen and other credible producers who meet the standards to be labeled "USDA
organic" are in an excellent position to participate in the future growth of the
industry. Currently all Emerald Valley products qualify for the USDA
designation. The Company's California facility is now certified to produce
organic products as well as its Washington facility. The Company's future
organic offerings will be produced and formulated with the objective of
qualifying for the USDA designation.

      The California Milk Advisory Board stated that Americans consumed 9.3
billion pounds of cheese in 2005. Cheese consumption has increased from 11.1
pounds per person in 1987 to 31.4 pounds in 2005. The specialty cheese category
in which the Company competes has grown from 420 million pounds consumed in 1994
to 930 million pounds in 2005. Specialty cheeses represent almost 10% of all
cheese consumed in the United States. Although the Company has seen recent
setbacks in its cheese sales, the Company believes this category has long-term
growth potential and that Sonoma Cheese will have long-term growth as well.

      Starting in 2005, consumers have increased consumption of refrigerated
pasta products following two years of decline due to in-part to low-carbohydrate
diets. The refrigerated pasta category continued to grow in 2007 because of the
gourmet quality of these products and their quick preparation. Monterey Gourmet
Foods believes its products are well positioned to take advantage of the growing
trend to more gourmet food products.

      No assurance can be given that the market for refrigerated gourmet food
products will expand further and that space will be made available at the store
level to house refrigerated products. Nor can there be any assurance that
current trends in healthy gourmet eating or consumer demand for quick meal
solutions, or consumer spending levels in the specialty food category will
continue in the future. Additionally, as the Company expands into different
geographic regions and new product categories, it may encounter different
consumer perceptions, diet trends, attitudes, behavior and competition. This may
adversely impact the Company's expansion strategy and cause it to incur greater
expenses than anticipated in the promotion of its products.

                                        4`

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`Strategy

      Monterey Gourmet Foods' overall objective is to become a leading national
marketer of refrigerated gourmet food products through distribution of its
products to grocery and club stores and through key acquisitions. The principal
elements of the Company's strategy include the following:

-     Expand the Company's market share through same-store revenue growth,
      addition of new grocery and club stores, geographic and product line
      diversification, including creation of additional meal solutions using
      Monterey Gourmet Foods products.

-     Introduce new products on a timely basis to maintain customer interest and
      to respond to changing consumer tastes. In order to maximize its margins,
      the Company will focus most of its efforts on those new products that can
      be manufactured and distributed out of its Salinas, California, Eugene,
      Oregon or Seattle, Washington facilities, and may supplement this effort
      by selected co-packing arrangements that complement its existing product
      lines.

-     Reduce operating costs as a percentage of sales through continual
      evaluation of administrative and production staffing and procedures. The
      Company will consider additional capital improvements at its manufacturing
      facilities in order to increase production efficiencies and capacities,
      and to reduce the Company's cost of goods on a per unit basis. The Company
      continues to rationalize its production capabilities and may consolidate
      facilities as management deems necessary.

-     Create brand awareness by communicating to the consumer that Monterey
      Gourmet Foods and its sister brands provide a healthy and nutritious line
      of products, and therefore, promote repeat business by reinforcing
      positive experiences with the Company's products.

-     Utilize the current national sales force of the Company to expand
      distribution and sales of the newly acquired brands without adding
      additional sales overhead.

-     Consider the acquisition of other compatible companies or product lines to
      expand distribution, or the range of product offerings, or to accomplish
      other synergies where the acquisition is expected to create long-term
      stockholder value, and be accretive to earnings in the first year.

      The Company will continue to direct its advertising and promotional
activities to specific programs customized to suit its grocery and club store
accounts as well as to reach target consumers. These will include in-store
demonstrations, coupon programs, temporary price reduction promotions, cross
promoting of products, and other related activities. There can be no assurance
that the Company will be able to increase its net revenues from grocery and club
stores. Because the Company will continue 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 acquisition strategy is dependent upon its
ability to generate cash from current operations, attract new capital, find
suitable acquisition candidates, and successfully integrate new businesses and
operations. There is no assurance that acquisitions can be financed from current
cash flow, and, if not, that outside sources of capital will be available to
supplement internally-generated funds. There is no assurance that management can
successfully select suitable acquisition candidates and that these new
businesses can be successfully integrated to create long term stockholder value.

Products

      The Company produces and markets a variety of gourmet refrigerated pastas;
including borsellini, ravioli, tortelloni, tortellini, pasta sauces, salsas,
dips, hummus, edamame spreads, Tuscan bean spreads, Sonoma Jack cheeses, chicken
sausages, chicken meatballs, and polenta under the Monterey Gourmet Foods,
Monterey Pasta, Arthur's, CIBO Naturals, Emerald Valley Kitchen, Isabella's
Kitchen, Sonoma Cheese, and Casual Gourmet brands, as well as private labels.
The Emerald Valley Kitchen brand was acquired as part of the Emerald Valley
acquisition in August 2002. The CIBO Naturals brand was acquired as part of the
CIBO Naturals LLC acquisition in 2004. The Sonoma Cheese brand was acquired as
part of the Sonoma Foods acquisition in 2005. The Casual Gourmet brand was
acquired as part of the Casual Gourmet Foods acquisition in 2005. For further
information, see "Liquidity, Capital Resources, and Business Acquisitions".

                                        5`

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`The Company is committed to diversifying its offerings with innovative new
product line extensions, complementary products, and other gourmet food
products. The Company's product development chefs and product development
consultants focus on creating new products that innovatively blend complementary
tastes, food textures and ingredients while strictly adhering to the Company's
emphasis on freshness, healthfulness and quality. The Company will spend its
product development resources to meet market and customer demands, utilize
current production expertise, and to fill the capacity of the Company's plants.
The Company has increased it spending on product development as the Company
increases its focus on product quality and product innovation. As new products
are introduced, selected items will be discontinued to help ensure that the
product line is focused on consumer demand, to maximize the Company's return on
its shelf space in grocery and club stores, and to respond to changing trends
and consumer preferences.

      The Company's refrigerated products are packaged predominantly in clear
lightweight containers, which reveal the fresh appearance of its products.
Monterey Gourmet Foods presents its products with a colorful logo, distinctive
graphics, ingredient information and cooking instructions to communicate the
gourmet, fresh and healthful qualities of its products. All of the Company's
products feature innovative packaging graphics to maximize shelf impact and
generate increased consumer interest in the products, with increased emphasis on
quickly informing the consumer about the products. The Company will continue to
emphasize packaging and presentation to maximize appeal on the shelf.

      The goal of the Company is to introduce new products on a timely and
regular basis, to increase customer interest and to respond to changing consumer
tastes. There can be no assurance that the Company's efforts to achieve such
goals will result in successful new products or that new products can be
developed and introduced on a timely and regular basis. If the Company's new
products are not successful, the Company's grocery and club store sales may be
adversely affected as customers seek new products.

Production

      The Company currently produces pasta, pasta sauce and tamales in a 43,700
square foot Monterey County, California facility. The Company also leases 87,141
square feet of space three miles from the main production facility. Within this
87,141 square foot facility, the Company has its refrigerated distribution
center and ambient storage. In addition, the Company produces organic salsas,
dips, and hummus at its 19,000 square foot organically certified facility in
Eugene, Oregon, which was integrated into the business as part of the Emerald
Valley acquisition. CIBO Naturals LLC operates out of several different
facilities comprising of a total of 47,500 square feet in Seattle, WA. The
Company has recently signed a new lease in Kent, Washington for 93,306 square
feet for occupancy starting March 1, 2008. During 2008, the Company will close
its current Seattle facility and relocate to the new facility in Kent,
Washington. The California facilities are strategically located in one of the
largest produce-growing regions in the United States and are near several major
vendors and food distributors. The California facility is certified by the USDA,
is certified to produce organic products, and utilizes state of the art thermal
processing, chilling and packaging processes.

      Refrigerated pasta is manufactured at the California facilities using high
quality ingredients such as Extra Fancy Durham Wheat Flour, whole eggs, fresh
and dry herbs and spices, Individually Quick Frozen ("IQF") vegetables, chicken
and other proteins, various fresh cheeses, and milk products. The ingredients
are mixed in accordance with the Company's proprietary recipes. After filling
with fresh and unusual ingredients such as snow crab, spinach, feta cheese,
lobster, chicken, and other types of specialty cheeses, the pasta products
receive a prescribed thermal process, or pasteurization to insure product safety
and to preserve flavor, quality and shelf life. The products are then chilled
immediately and packaged in controlled atmosphere trays. Pasta sauces, salsas,
dips, and spreadable cheeses are mixed and processed in individual batches in
accordance with the Company's proprietary processes and recipes and then
directly packed and sealed in plastic containers. The new "quick preparation"
baked entrees are baked in new rotary tray ovens. After preparation, processing,
chilling and packaging, all pasta, baked entrees, and sauces are kept in cold
storage to preserve quality and shelf life. Cheeses and sausages are produced
and packaged by outside companies under agreements to protect recipes and
provide the quality that the Company requires.

      The Company's salsas, hummus, dips, and sauces are designed, processed and
monitored under strict quality assurance plans in order to insure that the
finished products deliver on customer expectations for these products.

      The Company regularly reviews a variety of potential capital projects for
the production department and in the past three years has spent approximately
$5.4 million on capital improvements. These included significant upgrades and
improvements to the pasta production lines, two packaging lines, capacity for
chunky ravioli, clean rooms, increased sauce capacity and efficiency, and boiler
and utility upgrades to accommodate capacity increases. Capital resources were
used to improve borsellini pasta production capability, increase tamale
production capacity, and combine the two Salinas production facilities. In 2006,
the Company increased capacity on its tamale production line, consolidated the
two manufacturing plants in Salinas, added new pasta packaging equipment. In
2007 the Company added new cup filling equipment in Eugene, Oregon and Seattle,
Washington, increased capacity in the Seattle facility to manufacture sauces and
finish the consolidation of facilities in Salinas, California. Future additions
of assets will be evaluated for increased efficiency, flexibility and capacity
needs.

                                        6`

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`Raw Materials

      The Company purchases its raw materials from vendors throughout the United
States and the world, although the majority of its raw materials come from
domestic sources. All raw material purchases are transacted in U.S. dollars.
Vendor selection is based on ability to meet specifications and pricing. Because
the ingredients are agricultural products, the Company uses a combination of
contracts which are for one year or less in duration, as well as open market
purchases to minimize the pricing risks and uncertainty of supply.

      The most significant ingredients used are dairy-based ingredients, eggs,
flour, olive oil, pine nuts, seafood, chicken and other meats, spinach, basil,
tomatoes, and spices. Management is unaware of any current restrictions or other
factors that would have a material adverse effect on the availability of these
raw materials. The Company's purchasing policies are designed to provide more
than one credible source for all ingredients.

Distribution

      The Company's success depends upon an effective system of distribution for
its products. The Company delivers products directly to warehouses for several
Northern California chains. Sonoma Cheese delivers certain cheese products to
local wineries on Company trucks and these deliveries arrive the same day they
leave our warehouse. The Company distributes its products to other customers and
other parts of the country using common carriers. While common carrier method of
delivery has been reliable, there can be no assurance that the Company's
delivery system will not be disrupted for reasons including, but not limited to,
adverse weather, natural disasters, increasing fuel oil, or labor disputes in
the trucking industry. During 2005, 2006, and 2007 fuel costs increased compared
to previous years, which impacted the Company's operating margins.

Grocery Chain and Club Store Sales

Monterey Gourmet Foods sells its products to supermarket chains and club stores.
The Company has two customers that represent more than ten percent of net
revenues. Combined these two customers represent over 60% of the Company's
revenues for the past three years. Net revenues are detailed as follows:

                                              Years Ended
                              --------------------------------------------
                                       2007            2006           2005
                              --------------------------------------------
     Costco                             48%             48%            45%

     Sam's Club Stores                  17%             17%            17%

     All other customers                35%             35%            38%
                              --------------------------------------------

        Total                          100%            100%           100%
                              ============================================

      The increase in the percent of sales to Costco comes from additional sales
to Costco from the recently acquired companies and the increase in the number of
items being sold to Costco. The Company currently sells its products to eight
separate US Costco regions, Mexico, and Canada which make purchasing decisions
independently of one another. These regions re-evaluate, on a regular basis, the
products carried in their stores. There can be no assurance that these Costco
regions will continue to offer Monterey Gourmet Foods products in the future or
continue to allocate Monterey Gourmet the same amount of shelf space.

      The Company currently supplies its products to Sam's Club stores where the
purchasing decisions are made at the company headquarters with input from the
store level. During 2005, the Company spent significant resources increasing
sales to Sam's Club. While the Company is in the tenth year of its relationship
with Sam's Club, there can be no assurance that Sam's Club stores will continue
to carry its products. During 2007, the Company changed its broker
representation to Sam's Club and Wal-Mart Stores. The Company believes this
change will improve its relationships and sales to Sam's club. The loss of
either Costco or Sam's Club as customers could materially and adversely affects
the Company's business operations.

      During 2007, 2006 and 2005 net revenues to foreign customers represented
0.8%, 1.4%, and 2.2% of total net revenues, with Canada and Mexico accounting
for over 90% of those sales, and the remainder going to Asia Pacific.

Marketing

      The Company's marketing strategy is to create and sell innovative premium
quality products in the categories in which it competes, to communicate to
consumers that Monterey Gourmet Foods provides a gourmet-quality nutritious line
of products and to promote repeat business by reinforcing positive experiences
with the Company's products. The Company's approach includes the introduction of
new products on a timely basis to increase customer interest and to respond to
changing consumer tastes. Additionally, the Company will continue to expand its
sales into those geographic regions that will best support the purchase of the
Company's upscale premium grade products.

                                        7`

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`Competition

      The Company's business is subject to significant competition. The
refrigerated food industry is highly competitive and is dominated by large
multinational companies including among others Nestle and Kraft. There are also
a number of regional competitors especially in the sauce and cheese product
lines. Multinational competitors have significantly more brand name recognition,
marketing personnel, and cash resources than the Company. In addition, large
competitors from Canada and Italy continue to introduce products in the United
States. Moreover, competition for shelf space in club and grocery stores is
intense and poses great difficulty for smaller food companies.

      The Company has developed several products which the Company is using to
increase market share in the refrigerated sector, including whole wheat pasta,
organic pasta, edamame spreads, Tuscan bean spreads, tamales, spreadable
cheeses, flavored jack cheese, gourmet sausages, gourmet chicken meatballs, and
quick preparation gourmet fresh and frozen entrees. Management will continue to
try to produce distinctive products, which fill specific consumer needs.

      Competitive factors in the refrigerated food market include brand
awareness, product quality and taste, perceived healthfulness, price and
availability of grocery and club store shelf space. The Company's prices are
higher than most of its competitors' prices on most items due to higher quality
ingredients and the overall premium quality of its product line. The Company
believes the excellent quality, taste and perceived healthfulness of its
products are superior to that of most of its competitors. The Company also
believes that the quality of its products and the variety of its product lines
provide a competitive advantage over many companies which market more
traditional products.

Management

      Information relating to directors and executive officers of the Company is
set forth in Part III of this report.

Government Regulation

      The Company is subject to the regulations of the U.S. Food and Drug
Administration ("FDA"), USDA, state, local, and organic industry regulations
relating to cleanliness, maintenance of food production equipment, food storage,
cooking and cooling temperatures, food handling, and organic ingredient content
of products, and is subject to unannounced on-site inspections of production
facilities. Regulations in new markets, new regulations in existing markets, and
future changes in existing regulations may adversely impact the Company by
raising the cost of production and delivery of its products and/or by affecting
the perceived healthfulness of the Company's products. Effective January 2006,
all food products were required to declare the content of "trans fatty acids" on
individual labels. The Company has complied with this requirement and has
declared that its products contain no trans fatty acids. A failure to comply
with one or more regulatory requirements could result in a variety of sanctions,
including fines and the withdrawal of the Company's products from store shelves.
The Company is not aware of any currently existing facts or circumstances that
it is not addressing which would cause it to fail to comply with any of the
regulations to which it is currently subject.

Seasonality of Revenues

      During 2007, 25% of the Company's revenues were generated in the first
quarter, 24% were generated in the second quarter, 24% in the third quarter and
27% in the fourth quarter. The seasonality of the Company's revenues continues
to change as different product lines have different seasonality profiles. In the
fourth quarter of 2007, the Company had increased revenues of tamales, dips, and
cheese trays which sell well during the holiday season when consumers entertain.
Pasta items sell less during the summer and more during winter months.
Conversely, chicken sausages have higher revenues during the summer months.

Employees

      As of December 31, 2007, the Company employed a total of 337 persons at
all locations, including 59 administrative personnel, 13 sales personnel, 5
drivers, and 260 distribution and production personnel. None of the Company's
employees are represented by a labor union and the Company believes its
relations with its employees are good.

Trademarks and Service Marks

      The Company or its subsidiaries has registered the "Monterey Gourmet
Foods", "Monterey Pasta Company", "CIBO Naturals", "Sonoma", "Sonoma Jack",
"Casual Gourmet", "Emerald Valley Kitchen", "Borsellini", "Homestyle Fresh
Soups" and "Chef's Finest" names and, in the case of Monterey Pasta Company,
corresponding logo design with the United States Patent and Trademark Office. As
a result of various business acquisitions, the Company also has acquired the
rights to use the "Arthur's" and "Nate's" labels and rights to the unregistered
trademark "La Frescala". The Company is currently in the process of registering
"One Step Gourmet", and "Isabella's Kitchen". A customer of the Company is
currently challenging the Company's ownership of the Sonoma tradename/trademark
in class 29 for cheese. There can be no assurance that competitors will not
adopt similar names or logo designs outside the protection of the Company's
trademark registration.

                                        8`

---

`ITEM 1A. RISK FACTORS

      Any of the following factors could materially adversely affect the
Company's future operating results. Certain characteristics and dynamics of the
Company's business and financial markets generally create risks to the Company's
long-term success and to predictable quarterly results. Other factors are
included in "Management's Discussion and Analysis of Financial Condition and
Results of Operations." These risks include:

-     Lack of Recent Profitability. The Company reported losses for the years
      2005 and 2006, but returned to profitability for 2007. As of December 31,
      2007, the Company had an accumulated deficit of $7,868,000. There can be
      no assurance that the Company will generate profits in the short or long
      term.

-     Liquidity; Access to Capital. Management believes that the Company's
      current cash balances, and future operating projections will provide
      adequate liquidity to meet the Company's planned capital and operating
      requirements for normal operations and capital expenditures through the
      2008 calendar year. See Note 7 to the consolidated financial statements
      (Item 15) for a description of the credit facility. The Company generated
      $4.2 million in cash from operating activities during 2007. In addition,
      the Company generated $7.0 million in cash from operating activities
      during 2006 and raised $11.6 million through a private equity transaction.
      There can be no assurance that the Company will continue to generate cash
      in the future. If the Company's operations do not provide cash sufficient
      to fund its operations and capital requirements; the Company may be
      required to seek outside financing and there can be no assurance that the
      Company will be able to obtain such financing when needed, on acceptable
      terms, or at all. In addition, any future equity financing or convertible
      debt financing could cause the Company's stockholders to incur dilution in
      net tangible book value per share of the Company's Common Stock.

-     Acquisitions; Potential Impairment of Intangible Assets. The Company has
      acquired four companies since 2003. In 2006, the Company as part of its
      assessment of its intangible assets impaired its intangible assets of
      Casual Gourmet Foods in the third quarter of 2006 by $3.1 million. The
      Company also recorded an impairment of $58,000 in 2007 related to the
      Sonoma Foods' tradenames. There are no guarantees that additional
      investments may need to be written down in the future. The Company has
      recorded net intangible assets of $6.3 million and goodwill of $13.2
      million as part of the acquisitions. Some of these intangible assets are
      amortized over a certain amount of time. If these assets become impaired,
      the assets will be expensed in the periods they become impaired which will
      impact profitability. The Company's stock is currently trading near its
      net book value. If the stock trades below its net book value for a
      significant amount of time, the Company may need to impair certain
      intangible assets.

-     Hiring and Retention of Key Personnel. The success of the Company depends
      on its ability to retain key executives, and to motivate and retain other
      key employees and officers. Eric Eddings was named the Company's new CEO
      effective September 5, 2006. Scott Wheeler, the Company's CFO joined the
      Company in April 2003. Part of the Company's acquisition strategy is to
      maintain the current management of each acquired company and motivate them
      appropriately to help garner synergies and grow their respective brands.
      The Company's CEO and the management of Sonoma Foods have employment
      contracts to help ensure the Company's future growth. There can be no
      assurance that key management will remain stable; significant management
      turnover could disrupt the Company's operations with consequent adverse
      effect on the business.

-     Material Weakness in Internal Controls. The Company's management evaluated
      the effectiveness of the Company's disclosure controls and procedures
      pursuant to Rule 13a-15(b) of the Exchange Act as of December 31, 2007.
      During 2006 and 2007, the Company improved its internal controls and
      procedures and management has concluded that as of December 31, 2007 its
      internal controls over financial reporting are adequate. (See Item 9A,
      which is incorporated here by reference.) If weaknesses are identified,
      financial statement accuracy may be at risk.

-     Impact of Inflation. Freight rate increases related to fuel surcharges
      have impacted the Company's financial performance as it ships and sources
      raw ingredients from across the country. Medical benefits continued to
      increase at rates higher than the consumer price index. Increases in
      labor, minimum wage, employee benefits, freight, ingredients, commodities,
      packaging materials, rents and other operating expenses have adversely
      affected the Company's profitability and may continue to impact the
      Company in future periods. The Company cannot predict whether such
      increases will occur in the future or their magnitude if they do occur.
      Also, the Company cannot predict if it can pass these higher costs along
      to its customers.

-     Risks Inherent in Food Production. The Company faces all of the risks
      inherent in the production and distribution of refrigerated food products,
      including contamination, adulteration, spoilage, and the associated risks
      of product liability litigation, which may occur even with an isolated
      event. Although the Company has modern production facilities, has obtained
      USDA approval, organic certification for them, and employs what it
      believes are the necessary processes and equipment in order to insure food
      safety, there can be no assurance that the Company's procedures will be
      adequate to prevent the occurrence of such events.

                                        9`

---

`-     Dependence on Major Customers. During 2007, two of the Company's
      customers, Costco and Wal-Mart (including its subsidiary, Sam's Club),
      accounted for 48% and 17%, respectively, of the Company's total revenues.
      The Company currently sells its products to eight separate US Costco
      regions and its international regions which currently make purchasing
      decisions independently of one another. These regions re-evaluate, on a
      regular basis, the products carried in their stores. There can be no
      assurance that these Costco regions will continue to offer the Company's
      products in the future or continue to allocate Monterey Gourmet Foods the
      same amount of shelf space. There can be no assurance that Sam's Club will
      continue to carry the Company's products. Loss of either of these
      customers, Costco or Sam's Club, or a significant reduction in sales to
      either, would have a material adverse effect on the Company. Additionally,
      liberalized pricing or allowance terms would create downward pressure on
      gross margins.

-     Diversification of Product Line. Over the last five years, the Company has
      acquired four new subsidiaries. A major reason for the acquisitions is the
      diversification of the Company's gourmet food product line. Each
      acquisition brings new product lines, management talents and skills,
      customs and traditions, and customers. Two of the acquisitions did not
      meet projected revenues for 2007. There can be no assurance that the
      acquisition strategy will be profitable in the near or long term or that
      the Company can integrate the acquisitions given the restrictions
      negotiated under the terms of the purchase agreements.

-     Changing Consumer Preferences. Consumer preferences change, sometimes
      quickly, and the success of the Company's food products depends on the
      Company's ability to identify the tastes and dietary habits of consumers
      and offer products that appeal to their preferences. The Company
      introduces new products and improved products, and incurs development and
      marketing costs associated with new products. If the Company's products
      fail to meet consumer preferences, then the Company's strategy to grow
      sales and profits with new products will be less successful.

-     Seasonality and Quarterly Results. The Company's grocery and club store
      accounts are expected to experience seasonal fluctuations to some extent
      with the corresponding impact upon quarterly results.

-     Competition. The Company's business is dominated by several very large
      competitors some of which are international competitors, who have
      significantly greater resources than the Company; such competitors can
      outspend the Company and negatively affect the Company's market share and
      results of operations.

-     Dependence on Common Carriers. The Company also is dependent on common
      carriers to distribute its products. Any disruption in its distribution
      system or increase in the costs thereof could have a material adverse
      impact on the Company's business.

-     Energy Supply and Pricing. Because the majority of the Company's
      operations are in California, its operating costs are affected by regional
      increases in electricity and natural gas prices. As a result, the
      Company's operating results have been affected by the increased cost of
      energy and in addition, natural disasters can impact the availability and
      pricing of energy.

-     Capacity. The plant in Salinas, California is currently operating below
      planned capacity for certain products, which increases unit costs of
      production at the plant. If sales of products produced at this plant do
      not increase or additional costs cannot be reduced, these products will
      remain below targeted profitability which will impact future earnings of
      the Company. Conversely, the plants in Seattle, WA and Eugene, OR are
      seeing increased costs in order to keep up with the demand for their
      products.

-     Seattle facility move. In 2008, the Company will be relocating its
      Seattle, Washington facility to a new facility in Kent, Washington. The
      new facility will be larger than the current facility and will take
      significant financial and human resources to make the transition. If the
      transition costs more than expected, the Company's financial statements
      could be impacted.

-     Volatility of Stock Price. The market price of the Company's common stock
      has fluctuated substantially since the initial public offering of the
      Company's common stock in 1993. Such volatility may, in part, be
      attributable to the Company's operating results or to changes in the
      direction of the Company's expansion efforts. In addition, changes in
      general conditions in the economy, the financial markets or the food
      industry, natural disasters or other developments affecting the Company or
      its competitors could cause the market price of the Company's common stock
      to fluctuate substantially. In addition, in recent years, the stock market
      has experienced extreme price and volume fluctuations. This volatility has
      had a significant effect on the market prices of securities issued by many
      companies, including the Company, for reasons sometimes unrelated to the
      operating performance of these companies. Moreover, any announced
      shortfall in the Company's net sales or earnings from levels expected by
      securities analysts or the market could have an immediate and significant
      adverse effect on the trading price of the Company's common stock in any
      given period. Additionally, the Company may not learn of such shortfalls
      until late in any fiscal quarter, shortly before operating results are due
      to be announced. The announcement, together or in succession, of such a
      shortfall and of lower than expected quarterly operating results, could
      result in an even more immediate and significant adverse impact on the
      trading price of the Company's common stock upon announcement of the
      shortfall or quarterly operating results.

                                       10`

---

`-     Marketing and Sales Risks. The future success of the Company will depend
      on a number of factors, including whether grocery and club store chains
      will continue to expand the number of their individual stores offering the
      Company's products and whether allowances and other incentives will expand
      retail distribution. Expansion into new markets increases the risk of
      significant product returns resulting from the Company's supply of slower
      selling items to its customers. In addition, grocery and club store chains
      continually re-evaluate the products carried in their stores and no
      assurances can be given that the chains currently offering the Company's
      products will continue to do so in the future, either in the same measure
      or at all. Should these channels choose to reduce or eliminate products,
      the Company could experience a significant reduction in its product sales.
      The Company remains dependent on the use of slotting allowances and other
      incentives to expand retail distribution.

-     Compliance with laws applicable to its business. The company's facilities
      and products are subject to many laws and regulations administered by the
      United States Department of Agriculture, the Federal Food and Drug
      Administration, and other federal, state, local, and foreign governmental
      agencies relating to the processing, packaging, storage, distribution,
      advertising, labeling, quality, and safety of food products. The company's
      failure to comply with applicable laws and regulations could subject it to
      administrative penalties and injunctive relief, civil remedies, including
      fines, injunctions and recalls of its products, and negative publicity.

-     Sarbanes Oxley Act: The Company is also subject to the rules and
      regulations of the Securities and Exchange Commission and recently passed
      laws regarding publicly traded companies including the Sarbanes Oxley Act
      of 2002. The Company is not an accelerated filer and therefore is not yet
      required to comply with Section 404 of this Act which requires publication
      of an annual report by management, attested by the Company's registered
      public accounting firm assessing the effectiveness of the Company's
      internal controls and procedures for financial reporting. The Company
      spent $236,000 on consultants' fees during 2007 plus a significant amount
      of internal resources documenting its internal controls in its efforts to
      become compliant with Sarbanes-Oxley Section 404. Because of this
      spending, the management of the Company is able to report that the
      Company's internal controls over financial reporting were effective as of
      December 31, 2007. The Company believes that it will need to spend
      resources each year to remain compliant with this Act and to prepare for
      its registered public accounting firm to give its attestation of
      management's report, currently required to be provided in connection wtth
      the filing of the Company's Annual Report on Form 10-K for the year ending
      December 31, 2009.

-     Deductible Worker's Compensation Program. The Company's California and
      Oregon locations entered into a partially self-insured worker's
      compensation program for fiscal year 2003 and have continued the program
      through 2007. This program features a fixed annual payment, with a
      deductible on a per occurrence basis. The annual expense consists of a
      base fee paid to an insurance company to administer the program, direct
      cash expenses to pay for injuries, an estimate for potential injuries that
      may have occurred but have not been reported, and an estimate by the
      insurance company of costs to close out each injury, and an estimate for
      injury development. The Company has been on this partially self-insured
      program for five years and has limited history of claim resolution
      available to support the Company's specific actuarial projections. The
      Company still has claims from 2003 that have not been closed. Therefore,
      the Company is using published industry actuarial data from an insurance
      carrier and reviewing each claim individually to determine the amount of
      reserves that should be established. Management believes that its current
      safety program and its good safety record will provide the foundation to
      enable the Company to realize the premium savings partially self-insured
      programs are designed to achieve; however, estimated reserves may vary
      from future cash outlays.

-     Fluctuations in revenues due to natural disasters or other causes. The
      Company may experience sales fluctuations for many reasons, including
      variations in the mix of products sold, competitive factors, price
      changes, supply changes, weather-related disruptions, and other natural
      disasters. The Company's main operating facility is located where
      earthquakes are common and the Company lacks a viable plan to continue
      producing if a major natural disaster were to damage its operating plant.
      Sales may also fluctuate because of delays in introducing new products or
      customer delays in issuing purchase orders for new or current products.

ITEM 1B. UNRESOLVED STAFF COMMENTS

      Inapplicable

                                       11`

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`ITEM 2.  PROPERTIES

      The Company leases approximately 130,800 square feet in Salinas,
California, comprised of 43,700 square feet at its headquarters facility and
87,100 square feet at its distribution facility three miles from its
headquarters. The headquarters facility is dedicated to manufacturing
operations, offices and its test kitchen. The distribution complex is comprised
of refrigerated and ambient storage. The current Monterey County production
facility/headquarters lease was renewed until October 2014 and the distribution
facility's lease was renewed until May 2012.

      In 2004, the Company purchased CIBO Naturals LLC which operates out of
three separate leased facilities comprising 47,540 square feet in Seattle, WA
part of which expires in May 2008. The facilities represent 20,300 square feet
of manufacturing space, 4,900 office space and 22,340 of warehousing space. The
Company recently leased 93,306 of new space in Kent, Washington and will be
consolidating these locations into one new location. The new lease begins March
1, 2008 and expires on February 28, 2018.

      The Company acquired a lease for the 19,000 square foot production
facility and offices as part of its acquisition of Emerald Valley in Eugene,
Oregon. The lease expired December 31, 2007, with three five-year renewal
options. The lease was renewed for an additional five years and now expires
December 31, 2012. As part of the Sonoma Cheese acquisition, the Company leases
5,800 square feet of office space and refrigerated storage to operate its
delivery service. This lease expires in December 2015.

      Management feels that its facilities are adequate to support sales growth
for at least 24 months.

ITEM 3.  LEGAL PROCEEDINGS

      The Company is involved in various claims arising in the ordinary course
of business. While management currently believes that the chances these claims
against the Company, individually or in aggregate, will have a material adverse
impact on its financial position, results of operations or statement of cash
flows is remote, these matters are subject to inherent uncertainties and
management's view of these matters may change in the future. Were an unfavorable
final outcome to occur, there exists the possibility of a material adverse
impact on the Company's financial position, results of operations or statement
of cash flows.

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

      No matters were submitted to vote of the security holders during the
fourth quarter of 2007.

                                     PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
         AND ISSUER PURCHASES OF EQUITY SECURITIES

Price Range of Common Stock

      The Company's Common Stock is traded on the NASDAQ Global Market under the
symbol "PSTA." The following table sets forth for the periods indicated the high
and low sales prices of shares of the Common Stock on the NASDAQ Global Market.

            Calendar year 2006:               High             Low
                                              -----           -----

               First quarter                  $4.40           $3.76

               Second quarter                  7.14            4.31

               Third quarter                   5.60            3.68

               Fourth quarter                  4.38            3.69

                                       12`

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`Calendar year 2007:               High             Low
                                              -----           -----

               First quarter                  $4.56           $4.15

               Second quarter                  4.48            3.84

               Third quarter                   4.38            3.44

               Fourth quarter                  4.12            2.77

      As of February 1, 2008, there were approximately 200 stockholders of
record of the Common Stock and approximately 3,000 investors with shares in
street name.

Dividend Policy

      The Company has not paid any cash dividends to Common stockholders since
1997. The Company's line of credit currently prohibits the payment of dividends.
In addition, the Company intends to retain future earnings in its business and
does not anticipate paying cash dividends on the outstanding Common stock in the
near future.

Stock Repurchase Plan

      On December 10, 2007 the Company announced that its Board of Directors has
authorized the Company to institute a stock repurchase program whereby up to
750,000 shares of its Common Stock may be repurchased. The duration of the
repurchase program is open-ended. Under the program, the Company is able to
purchase shares of common stock through open market transactions at prices
deemed appropriate by management. The timing and amount of repurchase
transactions under this program will depend on market conditions and corporate
and regulatory considerations. The program may be discontinued at any time by
the Board of Directors. In announcing the repurchase program, the Board of
Directors' expressed its continued confidence in the Company's near- and
long-term financial and operating performance and its commitment to enhancing
shareholder value. As of December 31, 2007, the Company has repurchased 215,000
shares of the Company's common stock.`

|Total number of          Maximum
                                                                       shares             number of
                                                                   repurchased as      shares that may
                                      Total                       part of publicly          yet be
                                    number of        Average         announced           repurchased
                                      shares       price paid         plans or         under the plans
              Period               repurchased      per share         programs           or programs
-------------------------------    -----------     ----------     ----------------     ---------------
December 10 - December 31, 2007      215,000          $3.06            215,000              535,000
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`Equity Compensation Plan

      The information regarding stock plans approved by Shareholders and not
approved by Shareholders required by this Item is incorporated by reference from
Notes 9 to the consolidated financial statements (Item 15) included in this
document.

                                       13`

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`Comparison of Stockholder Return

      Set forth below is a line graph comparing the annual percentage change in
the cumulative total return on the Company's Common Stock with the cumulative
total return of the NASDAQ Global Market Index (U.S. Companies) and peer issuers
for the period commencing on December 31, 2002 and ending on December 31, 2007.

Comparison of Cumulative Total Return from December 31, 2002 through December
31, 2007:

      Monterey Gourmet Foods, NASDAQ Global Index (U.S. Companies) and Peer
Issuers`

|Dec. 31,   Dec. 31,  Dec. 31,  Dec. 31,  Dec. 31,   Dec. 31,
                                 2002       2003      2004      2005      2006       2007
                               ------------------------------------------------------------
Monterey Gourmet Foods           100.0      99.5      90.4     107.5      116.8      84.9
NASDAQ Stock Market (U.S.)       100.0     149.5     162.7     166.2      182.6     198.0
Peer Issuers                     100.0     117.6     118.6     127.8      150.8     112.9
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The index level for all series was set to $100.00 on 12/31/2002, and it was
assumed that all dividends were reinvested. No dividends have been declared on
the Company's Common Stock. Stockholder returns over the indicated period should
not be considered indicative of future stockholder returns.

                                       14`

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`ITEM 6.  SELECTED FINANCIAL DATA

      The following table sets forth consolidated financial data for the
Company. These data should be read in conjunction with the Consolidated
Financial Statements and related Notes included in Item 15.`

|Years Ended
                                 ---------------------------------------------------------------------
                                 2007(1)(2)    2006(1)(2)        2005            2004         2003
                                 ---------------------------------------------------------------------
                                           (dollar amounts in thousands except per share data)
Consolidated Statements of
   Operations Data:
Net revenues                     $   100,527   $    94,297    $    85,248    $    62,491   $    60,490
Gross profit                          27,519        27,439         23,232         16,468        18,569
SG&A                                  25,304        26,754         23,590         18,224        17,161
Operating income (loss)                2,107        (2,462)          (358)        (1,761)        1,408
Net income (loss)                      1,682        (3,112)          (537)        (1,344)        1,035

Basic net income per common
   share                         $      0.10  ($      0.19)  ($      0.04)  ($      0.09)  $      0.07
Diluted income per common share  $      0.10  ($      0.19)  ($      0.04)  ($      0.09)  $      0.07

Weighted average basic shares
   outstanding                    17,329,365    16,100,250     14,450,251     14,343,386    14,206,627
Weighted average diluted shares
   outstanding                    17,435,201    16,100,250     14,450,251     14,343,386    14,414,931

                                                              Years Ended
                                 ---------------------------------------------------------------------
                                      2007         2006           2005            2004         2003
                                 ---------------------------------------------------------------------
                                                      (dollar amounts in thousands)
Consolidated Statements of
   Income Data as Percent of
   Net Revenues
Net revenues                           100.0%        100.0%         100.0%         100.0%        100.0%
Gross profit                            27.4%         29.1%          27.3%          26.4%         30.7%
SG&A                                    25.2%         28.4%          27.7%          29.2%         28.4%
Operating income (loss)                  2.1%         (2.6)%         (0.4)%         (2.8)%         2.3%
Net income (loss)                        1.7%         (3.3)%         (0.6)%         (2.2)%         1.7%

Consolidated Balance Sheet Data:
Working capital                  $    15,416  $     11,496    $     5,019     $    7,753   $    16,704
Total assets                     $    60,506  $     62,468    $    62,205     $   46,873   $    44,204
Total debt and capital lease
   obligations                   $        79  $      1,147    $    13,654     $    2,459   $         3
Stockholders' equity             $    51,954  $     50,263    $    39,110     $   39,216   $    40,035
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`(1) For 2007, includes a loss on impairment of Sonoma Foods assets of $58,
          and for 2006 includes a loss on impairment of Casual Gourmet
          intangible assets of $3,160.

      (2) For the year ended December 31, 2007 and 2006, includes stock-based
          compensation expense related to the adoption of SFAS No. 123(R).

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

      The following discussion should be read in conjunction with the financial
statements and related notes and other information included in this report. The
financial results reported herein do not indicate the financial results that may
be achieved by the Company in any future period.

                                       15`

---

`Background

      Monterey Gourmet Foods was incorporated in June 1989 as a producer and
wholesaler of refrigerated gourmet pasta and sauces to restaurants and grocery
stores in the Monterey, CA area. The Company has since expanded its operations
to provide a variety of gourmet refrigerated food products to grocery and club
stores throughout the United States, selected regions in Canada, the Caribbean,
Latin America and Asia Pacific. The Company's overall strategic plan is to
enhance the value of the Monterey Gourmet Foods brands by distributing its
gourmet products through multiple channels of distribution.

      The Company's product distribution to grocery and club stores increased
from approximately 25 stores as of December 1989, to over 10,200 stores by
December 31, 2007. During recent years the Company added retail and club
distribution through internal growth and through the Frescala Foods, Nate's,
Isabella's Kitchen, Emerald Valley Kitchen, CIBO Naturals, Sonoma Foods, and
Casual Gourmet acquisitions. In 2004, the Company's shareholders approved the
change of the name of the Company to Monterey Gourmet Foods, Inc. The name
change was made to define the Company's strategic direction more accurately. The
name change also announces to the investor community, our customers and
consumers, our strategic direction to become a complete supplier of gourmet
refrigerated foods.

      In 2004 the Company began a diversification strategy to expand its product
line beyond refrigerated pasta and pasta sauce. The diversification strategy was
a combination of both internal product development and external acquisitions. In
January 2004, the Company acquired CIBO Naturals, a maker of sauces, dips and
spreads.

      In 2005 the Company launched new products such as Chicken Penne Gratin,
Chicken and Mozzarella Ravioli, and Pork and Chicken Tamales. Additionally the
Company was able to increase distribution by introducing whole wheat pastas
which are high in dietary fiber, have a favorable glycemic index, and are made
from whole grains. In 2005 the Company acquired two additional Companies. The
Company markets under the Casual Gourmet brand (acquired January 11, 2005)
flavorful low-fat, low-calorie chicken sausages, chicken burgers and soups, and
under the Sonoma Cheese brand (acquired April 7, 2005) an outstanding line of
refrigerated specialty cheese products that features its flagship line of Sonoma
Jack Cheeses. Sonoma Cheese has earned numerous awards over the years for its
traditional and flavored jack cheeses. Monterey Gourmet Foods believes that the
convenient gourmet food segment is growing rapidly as time-starved consumers
seek high quality quick-meal solutions and the Company, with its staff of senior
chefs and its flexible manufacturing facilities, is well positioned to bring new
products to these consumers.

      In 2006, the Company focused on expanding distribution of its current
products, consolidating production facilities in Salinas, improving the quality
of its current products, hiring experts in product development and creativity to
better utilize the Company's production equipment, improving the synergies
between the different brands, and reorganizing the Company into one operating
unit with one centralized sales force and one marketing department. Also during
2006, the Board of Directors of the Company appointed Eric Eddings as President
and Chief Executive Officer of Monterey Gourmet Foods following the resignation
of James M. Williams effective September 5, 2006.

      In the fourth quarter of 2005, Casual Gourmet saw a significant reduction
in its sales to its two largest customers, Costco and Sam's Club. The Company
took many steps to restore the sales to these two major customers, including the
introduction of such items as Anti-Biotic free ("ABF") all white meat chicken
sausages, nitrite free chicken sausages, sausages made with organic chicken,
flavored pork sausages, and other products that fit under the Casual Gourmet
label. These new products initially sold well, but were mostly discontinued
after the summer grilling season. Therefore, due to the lost business during the
third quarter of 2006, the Company tested for the potential impairment of
goodwill as the loss of business was considered a triggering event under SFAS
142 and SFAS 144 as well as for amortized intangibles. As a result of the
impairment test, the Company recorded a pre-tax, non-cash charge of $3.2 million
in the third quarter of 2006 related to the impairment of intangible assets
associated with the Casual Gourmet Foods acquisition on January 11, 2005.

      In 2007, the Company focused on process improvement, management
discipline, cost reduction, and consolidated all the different acquisitions into
one centralized company. The Company also hired outside culinary consultants to
create new products, many of which were introduced during the fourth quarter of
2007. The Company is focusing on strategic growth, improving the synergies that
are possible with one sales force for all brands, one marketing department, one
finance department, one information systems department, one manager in charge of
all the Company's plants, and one unified goal to improve the profitability of
the Company. The Company also focuses on brand building with an emphasis on
expanding its product offerings of organic or made with organic ingredients,
since such products are especially desired by consumers in the current market
place.

                                       16`

---

`The success of the Company's efforts to increase revenue will depend on
several key factors: (1) whether grocery and club store chains will continue to
increase the number of their stores offering the Company's products, (2) whether
the Company can continue to increase the number of grocery and club store chains
offering its products, (3) whether the Company can continue to introduce new
products that meet consumer acceptance, (4) whether the Company, by diversifying
into other complementary businesses through new product offerings or
acquisitions can leverage its strengths and continue to grow revenues at levels
attractive to its investors, (5) whether the various acquired brands perform as
planned when purchased, and (6) whether the Company can maintain and increase
the number of items it is selling to its two largest customers. Grocery and club
store chains continually re-evaluate the products carried in their stores, and
no assurances can be given that the chains currently offering the Company's
product will continue to do so in the future.

      The Company believes that access to capital resources and increasing sales
to offset higher fixed overhead, coupled with continued reduction of its
administrative and production costs as a percent of sales revenue, will be key
requirements in the Company's efforts to enhance its competitive position and
increase its market penetration. In order to support its expansion program, the
Company continues to develop new products for consumers and revise advertising
and promotional activities for its retail grocery and club store accounts. There
can be no assurance that the Company will be able to increase its net revenues
from grocery and club stores. Because the Company will continue to make
expenditures associated with the expansion of its business, the Company's
results of operations may be affected.

Operations for 2007, 2006 and 2005

      Net revenues were as follows for the years 2005 through 2007 (in '000s):`

|Years Ended
                                                     -------------------------------------------
                                                        2007            2006            2005
                                                     -------------------------------------------
Net Revenues                                         $  100,527      $   94,297      $   85,248
Percent change in net revenues from prior year                7%             11%             36%
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The 2007 increase of $6,230,000 over 2006 was due to an increase in sales
of Monterey Pasta branded refrigerated pasta products which grew $8.1 million or
24 percent when comparing 2007 with 2006 due mainly to the sale of pastas made
with organic ingredients, whole wheat pasta items, and new innovations coming
from the culinary experts hired by the Company. Additional sources of the
increase in net revenue were an increase in chicken sausage revenues which grew
$1.4 million or 31 percent when comparing 2007 with 2006. These increases were
offset by a $2.5 million or 23% reduction in net sales of Sonoma Foods.
Excluding the decline in Sonoma cheese sales, revenues grew $8.7 million or 10%
for 2007 compared to 2006.

      The 2006 increase in sales of $9,049,000 over 2005 was due to the
increased volume at our all natural brands of CIBO Naturals and Emerald Valley
Organics which increased 32% or $6.7 million over 2005, the introduction of
fresh tamales which sold heavily in the fourth quarter of 2006, and increases
from the core pasta business. Additionally, Sonoma Foods recorded twelve months
of sales in 2006 compared to only nine months in 2005, an increase of $2.8
million, because Sonoma Foods was acquired in April 2005. The Casual Gourmet
product lines recorded a revenue decline of $3.1 million when comparing the
twelve months ended December 31, 2006 with the twelve months ended December 31,
2005.

      During 2007, 2006 and 2005 the Company's net revenues were reduced by
$109,000, $363,000, and $351,000, respectively, for costs associated with
placement of product in new stores in various locations.

      Gross profit and gross margin were as follows for the years 2005 through
2007:`

|Years Ended
                                                     -------------------------------------------
                                                        2007            2006            2005
                                                     -------------------------------------------
Gross profit                                         $   27,519      $   27,439      $   23,232
Gross margin percent                                       27.4%           29.1%           27.3%
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`For 2007, the Company's gross profit dollars increased by $80,000. Gross
margin percentage decreased by 1.7% due to a number of factors. The Company was
required to change supplier for its Sonoma Cheese product which increased the
cost of production and the cost of distribution of the Sonoma Cheese products.
In addition, increases in commodity prices such as dairy, eggs, flour, cheese,
pine nuts, and olive oil increased the Company's cost of goods sold. In
addition, total stock based compensation recorded in cost of goods sold for 2007
was $150,000 compared to $55,000 for 2006 primarily because of a onetime
issuance of 20,000 unregistered shares of common stock valued at $77,000 to a
culinary consultant for his work helping the Company develop new products.

                                       17`

---

`The gross profit dollars for 2006 increased $4,207,000 compared to 2005
due to increased sales volume. The improvement in gross margin percent for 2006
compared to the 2005 is a function of cost savings obtained by running more
efficiently and an improvement in product mix. However, in the fourth quarter of
2006, the Company experienced high labor costs associated with overtime related
to cyclical demand in tamales and certain sauces (see Seasonality of Revenues,
Item 1, page 8). Also in 2006, the Company experienced certain write-off costs
associated with a failed frozen ravioli appetizer product. In addition, the
Company announced on September 29, 2006 a reduction in its salaried work force.
Part of the severances paid reduced the Company's gross margin. In 2006, the
Company consolidated its two Salinas, CA plants in an effort to improve margins.

      The Company charged $213,000, $629,000, and $499,000 to cost of sales for
2007, 2006, and 2005 respectively, for obsolete packaging and raw material
inventory. The decrease in obsolete inventory reflects management's goal to
reduce expenses during 2007.

      Selling, General and Administrative expenses ("SG&A") were as follows
for the years 2005 through 2007:`

|Years Ended
                                                     -------------------------------------------
                                                        2007            2006            2005
                                                     -------------------------------------------
SG&A Expense                                         $   25,304      $    26,754     $   23,590
SG&A Expense as a percent of net revenues                  25.2%            28.4%          27.7%
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`SG&A costs for 2007 were $1,450,000 lower that SG&A costs for 2006
which is a 5% reduction in total SG&A dollars. SG&A as a percent of
revenues decreased from 28.4% of net revenues to 25.2% of revenues when
comparing 2007 with 2006 which represents an 11% reduction in the percentage.
The decrease in SG&A is related to the reduction in salaried work force
announced in September 2006 of $480,000, a reduction in promotional activities
of $852,000, a reduction in amortization expense due to the 2006 write-down of
the Company's investment in Casual Gourmet Foods of $268,000, and a reduction in
freight costs from management's initiative to reduce outbound freight of
$361,000. Freight costs would have been reduced even more, had it not been for
the quick rise in fuel costs. These decreases are offset by the Company
incurring legal fees of $661,000 during 2007 which is an increase of $401,000
over legal fees incurred in 2006. The increased legal fees mainly relate to the
defense of several tradenames with the most spending on defending the Sonoma
Cheese tradename. In addition, the Company incurred $236,000 of costs with
outside consultants to insure that its management could give attestation to its
internal controls as required by regulatory agencies.

      The 2006 SG&A increase of $3,164,000 compared to 2005 is related to
increased freight costs due to higher fuel costs of $1,403,000 or 1.5% of net
revenues, non-cash expenses related to the expensing of stock options of
$454,000 or 0.5% of net revenues, accrued severance and other costs associated
with the workforce reduction that occurred during the month of September of
$647,000 or 0.7% of net revenues, and increased costs of $227,000 or 0.2% of net
revenues associated with being a public company in the form of higher audit and
compliance fees.

      Demonstration costs paid to outside vendors were 4.9%, 6.1%, and 6.8% of
net revenues for the years, 2007, 2006, and 2005, respectively.

      Depreciation and amortization expense, included in cost of sales and
SG&A, was $2,948,000 or 2.9% of net revenues compared to $2,926,000 or 3.1%
of net revenues in 2006 and $3,033,000 or 3.6% of net revenues in 2005. The
percentage decrease from 2006 to 2007 is related to the increase in net
revenues. The decrease from 2005 to 2006 relates to the impairment of intangible
assets of Casual Gourmet Foods and some fixed assets becoming fully depreciated
during the year. See "Liquidity, Capital Resources and Business Acquisitions",
page 19.

      During 2007, the Sonoma Foods brand recorded a decline in net revenues of
23%. Due to the lost business during 2007, the Company tested for potential
impairment as the loss of business was considered a triggering event under SFAS
142 and SFAS 144. As a result of the impairment test, the Company recorded a
pre-tax, non-cash impairment charge of $58,000 in the fourth quarter of 2007
related to the impairment of the Sonoma Foods tradename.

      Due to the lost business for Casual Gourmet during the third quarter of
2006, the Company tested for the potential impairment of goodwill as the loss of
business was considered a triggering event under SFAS 142 and SFAS 144. As a
result of the impairment test, the Company recorded a pre-tax, non-cash charge
of $3.2 million in the third quarter of 2006 related to the impairment of
intangible assets associated with the Casual Gourmet Foods acquisition on
January 11, 2005.

      Net interest income for 2007 was $163,000 compared to net interest expense
for 2006 which was $355,000 and net interest expense for 2005 of $628,000. The
net interest income for 2007 is attributable to the Company's excess cash which
generated interest income for the Company. The excess cash came from the
Company's operating activities and the raising of additional capital through a
private placement in 2006. The interest expense in 2006 and 2005 is attributable
to the bank loans needed for the CIBO Naturals, Casual Gourmet Foods and Sonoma
Foods acquisitions and the subordinated debt remaining on the CIBO Naturals
balance sheet.

                                       18`

---

`Income tax benefit (expense) for 2007, 2006, and 2005 was ($600,000),
($295,000), and $431,000, respectively. The 2007 income tax expense reflects a
tax rate of 48% and a reduction of $625,000 in the valuation allowance for
deferred tax assets. The Company's return to profitability in 2007 plus
projections of profitability for 2008 through 2010 allowed the Company to reduce
the valuation allowance. The 2006 income tax expense is mainly impacted by the
$1.2 million increase in the valuation allowance for deferred tax assets as the
Company had recorded consecutive years of losses. The 2005 income tax benefit of
$431,000 represented 45% of pretax loss. The Company's deferred tax assets are
comprised primarily of net operating losses that can offset future taxable
income. Management has established an $847,000 valuation allowance at December
31, 2007 against future deferred tax assets based on its assessment of the
sources of future taxable income and the likelihood of realization of such
deferred tax assets.

      Additionally, the Company realized additional tax benefits as a result of
the exercise of non-qualified stock options and the exercise and subsequent sale
of certain incentive stock options or disqualifying dispositions in 2006. For
financial reporting purposes, when a deduction exceeds the deferred tax assets,
the resulting reduction in actual income tax obligations as a result of these
disqualifying dispositions is credited to additional paid in capital. See
Liquidity, Capital Resources, and Business Acquisitions immediately below and
Note 10 to the consolidated financial statements in Item 15.

Liquidity, Capital Resources, and Business Acquisitions

      During the twelve months ended December 31, 2007, $4,246,000 of cash was
provided by the Company's operating activities compared to $6,980,000 for cash
being provided by the Company's operating activities in 2006 and $1,104,000 of
cash being used in the Company's operations in 2005. The cash provided by
operations during 2007 reflects the Company's net income from operations (a)
with the following items, not representing cash flows, added back: depreciation,
amortization, deferred income taxes, loss on the disposition of fixed assets,
impairment of intangible assets, and stock-based compensation totaling
$6,097,000 in generated cash, (b) with the following items also added back: the
provisions for allowances for bad debts, returns, adjustments, spoils, and
inventory of $5,083,000, and (c) offset by the net increase in working capital
due to timing differences of terms offered by the Company to its customers and
the terms offered to the Company by its suppliers, which working capital changes
reduced the Company cash balances by $6,934,000.

      Funds used for the repurchase of common stock totaled $657,000 for the
year ended December 31, 2007. 215,000 shares were repurchased at an average
price of $3.06. The Company expects to continue to purchase common stock under
its share repurchase plan.

      The Company finances its operations and growth primarily with cash flows
generated from operations. The Company has a $5 million working capital line of
credit which was unused as of December 31, 2007, and a letter of credit in the
amount of $800,000 which is issued in favor of an insurance company to support a
self-funded worker's compensation program. The interest rate on the credit line
will be calculated at the bank's prime lending rate or LIBOR plus 2.00%
whichever the Company chooses. The maturity date of the line of credit is June
30, 2008 and the covenants have been adjusted to accommodate any borrowing.

      Some product lines such as specialty cheeses require more working capital
than other products. Cheese requires a certain amount of time to age before it
can be sold. Other products, such as the gourmet sausages, are produced when
orders are received and then shipped directly to customers. The Company had
$15,416,000 of working capital as of December 31, 2007 compared to $11,496,000
in working capital as of December 31, 2006, an increase of $3,920,000 or 34%.
The Company believes that its existing credit facilities, along with cash flows
from operations, are sufficient to meet its cash needs for normal operations
including all anticipated capital expenditures for the calendar year 2008.

      In addition to operating cash flows, the Company also received cash
proceeds of $66,000, $926,000, and $153,000 from the exercise of employee stock
options and sales of stock under the Company's Employee Stock Purchase Plan
during 2007, 2006, and 2005, respectively.

      Effective January 1, 2006, the Company adopted SFAS 123R. See note 9 to
the Financial Statements (Item 15) which is incorporated here by reference.

      Cash balance at the end of 2007 was $5,541,000 compared with $4,281,000 in
2006. Purchases of equipment in 2007 were $1,345,000 with the majority of
capital spending going towards upgrading the production plants. In addition, in
2007, the Company paid down debt of $1,068,000 and repurchased 215,000 shares of
the Company's stock under the Board of Directors approved stock repurchase
program at a total price of $657,000.

                                       19`

---

`Cash balance at the end of 2006 was 4,281,000 and $330,000 in 2005. The
cash from operations in 2006 and proceeds from a private equity placement were
used to pay down liabilities of $12,524,000 and for capital spending of
$3,010,000 going towards upgrading the plants in Eugene, Oregon, Salinas,
California, and Seattle, Washington.

      In January 2006, as part of the final purchase of CIBO Naturals, LLC,
300,000 shares of the Company's common stock were issued to the previous owners
of CIBO Naturals with a computed value of $1,186,000. The Company now owns 100%
of CIBO Naturals, LLC.

      Management believes that cash on hand at December 31, 2007 and projected
2008 cash flows from operations will be sufficient to fund working capital
needs, expected Company growth, and anticipated capital expenditures during
2008.

Contractual Obligations

      The Company has no raw material contracts exceeding one year in duration.
The Company leases production, warehouse and corporate office space as well as
certain equipment under both month-to-month and non-cancelable operating lease
agreements. Most building leases have renewal options and all include cost of
living adjustments. The Company's President and Chief Executive Officer Eric
Eddings, accepted employment with the Company commencing January 28, 2004, and
became the Company's CEO on September 5, 2006. A copy of his employment contract
with the Company was filed as an exhibit to the Company 8-K report filed on
September 13, 2006 and is incorporated here by reference.

      The following table summarizes the Company's estimated annual obligations
under existing contracts.`

|Payments due by period
                           ---------------------------------------------------------------------------
 Contractual Obligations                    Less than                                       More than
    (in Thousands)             Total         1 year        1 - 3 years     3 - 5 years       5 years
                           ------------    ------------    ------------    ------------    -----------
Long-term debt             $         44    $         27    $         17    $          -    $         -

Capital lease obligations            35              23              12               -              -

Operating leases                 12,124           1,441           3,187           3,050          4,446
                           ---------------------------------------------------------------------------
Total                      $     12,203    $      1,491    $      3,216    $      3,050    $     4,446
                           ===========================================================================
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The Company has commitments for leased manufacturing, warehouse and office
space that range from one year to ten years. See discussion in Item 2
"Properties".

      The Company has an $800,000 standby letter of credit in favor of an
insurance company for the Company's self-funded workers compensation program
which will expire on January 2, 2009.

Stock Repurchase Program

      The Company commenced a public repurchase program of its common stock in
December 2007. During the month of December 2007, the Company purchased a total
of 215,000 shares of common stock at an average price of $3.06. The Company
utilized $657,000 in cash to purchase these common shares. The Company may
choose to continue purchases of its common stock in the future.

Off-Balance Sheet Arrangements

      The Company does not have any off-balance sheet arrangements that are
material to its financial position or results of operations. See Notes to the
consolidated financial statements (Item 15) for information regarding
capitalized leases and operating leases.

Business Acquisitions

      On January 12, 2006, the Company, Suekat LLC ("Suekat") and CIBO Naturals,
LLC ("CIBO"), amended their previous agreement for the purchase and sale of
limited liability company units; as a result, the Company acquired the remaining
15.5% of CIBO from Suekat in exchange for 300,000 unregistered shares of the
Company's common stock with a market value of $1,186,000. The purchase price was
all allocated to goodwill.

                                       20`

---

`CIBO produces a variety of refrigerated gourmet sauces and spreads
including fresh pesto sauces, flavored cheeses, bruschetta toppings and tapenade
spreads. CIBO's products are sold nationally through club stores, specialty food
stores, and regionally in supermarket delis. CIBO fits well with the Company's
growth strategy in premium refrigerated foods. CIBO through its "CIBO Naturals"
brand sells unique, high quality products and has developed a strong market
position which the Company believes has growth potential in both expanded
distribution and new products.

      On January 11, 2005, the Company entered into a definitive agreement with
Casual Gourmet Foods, Inc. and the shareholders of Casual ("Shareholders") for
the purchase by Monterey of 100% of Casual's outstanding shares. The acquisition
was structured to provide that Monterey acquired 60% of Casual's outstanding
shares immediately and the remaining 40% over the next three years. Prior to
entering into the Stock Purchase Agreement, there were no existing material
relationships between or among Monterey and Casual or its Shareholders. Monterey
acquired Casual in order to expand and diversify its product line in the
specialty foods category in which it competes.

      On March 31, 2006, the Company purchased an additional 10% interest in
Casual Gourmet Foods, Inc. ("Casual") pursuant to the Company's January 11, 2005
agreement with Casual and its shareholders. The purchase price for the
additional 10% ownership was $1,600 which increased the Company's ownership of
Casual to 70%. The purchase price was all allocated to goodwill. Casual, which
produces branded gourmet sausages, prepared soups and other food products, is a
Florida corporation.

      On September 29, 2006, the Company, Casual, and the shareholders of Casual
entered into an agreement to amend the Purchase Agreement dated January 11,
2005, to accelerate the Third Closing and Final Closing and to set the amount of
the Third Payment and Final Payment. The amendment calls for the purchase by the
Company of the remaining 30% of Casual's outstanding shares for $23,000. A copy
of the Amendment to the Stock Purchase Agreement was filed on Form 8-K filed
with the SEC on October 5, 2006, and is incorporated here by reference.

      For its initial acquisition, Monterey paid $6.0 million in cash plus
acquisition costs of $159,000. The initial purchase accounting reflects the
transaction as if Monterey purchased 100% of Casual. No liability was
established at that time for the remaining payments to Casual's shareholders
because the liability is not quantifiable. On November 3, 2006, the Company
completed the agreement to amend the Purchase Agreement dated January 11, 2005,
pursuant to which the Company agreed to acquire all of the outstanding shares of
Casual. The Amendment accelerated the Company's purchase of the remaining 30% of
Casual's outstanding shares and established a revised purchase price of $23,000.
After the agreement, the Company owns 100% of the outstanding stock of Casual
Gourmet Foods, Inc. Casual markets a wide range of refrigerated branded
specialty items, including chicken sausages, chicken burgers, and gourmet soups.
Products are sold in club stores and retail food stores under this important
brand. Some of their most popular sausage items include red bell pepper with
basil, and spinach with Asiago cheese.

      On April 7, 2005, the Company entered into a definitive agreement with
Sonoma Foods, Inc. ("Sonoma"), and the shareholders of Sonoma ("Shareholders")
for the purchase by Monterey of 80% of Sonoma's outstanding shares ("Stock
Purchase Agreement"). The Stock Purchase Agreement provides options for Sonoma's
two other shareholders to sell their remaining 20% interest after four years
and, if that option is not exercised, there is an option for Monterey to acquire
the interest after seven years.

      Sonoma markets a variety of refrigerated branded specialty cheese items,
including their flagship products, Sonoma Jack Cheeses in a variety of flavors.
Sonoma's products are sold in retail supermarkets, club stores, and specialty
food stores across the US with the greatest penetration in the Western US
markets. Some of the most popular cheese flavors include Hot Pepper Jack Cheese,
Garlic Jack Cheese, Mediterranean Jack Cheese and Pesto Jack Cheese. Sonoma
maintains its headquarters in Sonoma, CA. Monterey acquired Sonoma in order to
expand and diversify its product line in the specialty foods category in which
it competes.

      For its initial acquisition of 80% of Sonoma's outstanding shares,
Monterey paid $3.3 million in cash and issued 61,250 shares of Monterey Gourmet
Foods common stock valued at $198,000 plus acquisition costs of $127,000.
Purchase of the remaining shares will be at a price derived from a predetermined
calculation based upon a percentage of earnings before taxes, interest, bonuses,
depreciation and amortization during the interim periods. Sonoma has been fully
integrated into the Company's systems using its sales force and distribution
network

      All of the Company's acquisitions pursue the Company's growth strategy in
the specialty premium refrigerated food category. The Company envisions
expanding the existing brands, developing new products, and increasing
distribution in club, retail, and potentially other channels as it pursues
growth, expands its product lines and diversifies its customer base.

                                       21`

---

`Critical Accounting Policies and Management Judgments

      The discussion and analysis of the financial condition and results of
operations are based on the consolidated financial statements included in Item
15. The preparation of these financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make a number of estimates and assumptions relating to the
reporting of assets and liabilities, revenues and expenses, and the disclosure
of contingent assets and liabilities. On an ongoing basis, management evaluates
and discusses with its audit committee these estimates and assumptions,
including those related to accounts receivable and allowances, goodwill and
intangible assets, income taxes, inventory valuation, workers compensation
reserves and revenue recognition. Management bases its estimates on historical
experience and on various other assumptions believed to be reasonable under the
circumstances, which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results could differ from those estimates under different
assumptions or conditions.

      Management believes the following critical accounting policies affect the
more significant judgments and estimates used in the preparation of the
consolidated financial statements

      Accounts Receivable and Allowances

      The Company provides allowances for estimated credit losses, product
returns, spoilage, and adjustments at a level deemed appropriate to adequately
provide for known and inherent risks related to such amounts. The allowances are
based on reviews of the history of losses, returns, spoilage, contractual
relationships with customers, current economic conditions, and other factors
which warrant consideration in estimating potential losses. While management
uses the best information available in making its determination, the ultimate
recovery of recorded accounts, notes, and other receivables is also dependent on
future economic and other conditions that may be beyond management's control.

      Income Taxes

      The Company accounts for corporate income taxes in accordance with the
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") 109, "Accounting for Income Taxes" which requires an asset
and liability approach. This approach results in the recognition of deferred tax
assets (future tax benefits) and liabilities for the expected future tax
consequences of temporary timing differences between the book carrying amounts
and the tax basis of assets and liabilities. Future tax benefits are subject to
a valuation allowance to the extent of the likelihood that the deferred tax
assets may not be realized. The Company's deferred tax assets include
significant amounts of net operating losses ("NOLs"). During 2006, the valuation
allowance was increased based on the management's judgment that it is not
more-likely-than-not that all of the deferred tax assets can be realized partly
due to the intangible asset impairment of Casual Gourmet Foods which affected
the Company's assessment of the realization of our NOLs. In 2007 the Company
again assessed its valuation allowance based on its evaluation of the sources of
future taxable income and the likelihood of realization of such deferred tax
assets and partially reduced the valuation allowance because of the Company's
2007 income position and projected future taxable income. The amount of the
valuation allowance is significantly dependant on management's assumptions
regarding future taxable income and the availability of these NOLs to offset
future taxable income. The effect on the Company's net income is significant
whenever the estimate changes. For business combinations, the Company must
record deferred taxes and liabilities relating to the book versus tax basis
differences of acquired assets and liabilities. Generally, such business
combinations result in deferred tax liabilities as the book values are reflected
at fair value whereas the tax basis is carried over from the acquired company.
Such deferred taxes initially are estimated based on preliminary information and
are subject to change as valuations and tax returns are finalized.

      The Company adopted the provisions of FASB Interpretation No. 48
"Accounting for Uncertainty of Income Taxes - An Interpretation of FASB
Statement No. 109" ("FIN 48") on January 1, 2007. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). This
interpretation prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition of tax benefits, classification on the balance sheet, interest and
penalties, accounting in interim periods, disclosure, and transition. The total
amount of unrecognized tax benefits as of the date of adoption was not material.
As a result of the implementation of FIN 48, the Company recorded no increase in
the liability for unrecognized tax benefits and the balance of unrecognized tax
benefits was zero at January 1, 2007.

      Inventory Valuation

      Inventories are stated at the lower of cost (using the first-in, first-out
method) or market and consist principally of component ingredients to the
Company's refrigerated pasta and sauces, finished goods, and packaging
materials. Many of the ingredients used in the Company's products have a short
shelf life and if not used in a certain amount of time may spoil. Management
estimates that the raw material will be used in a timely manner; however,
management has established certain reserves for the potential of inventory
obsolescence, especially for slow moving inventory. As of December 31, 2007, the
Company reduced the carrying value of its inventory by $153,000. This write-down
was made to cover certain refrigerated raw material inventory that is nearing
its shelf-life, and certain packaging labels for products that may be rotated
out of the Club Store accounts, and products that have already been rotated out
of the Club Store accounts that may or may not be rotated back into the Club
Store accounts. The allowance is established based on management's estimate of
alternative usage or salvage value of obsolete inventory. Management believes
its estimates for spoiled and obsolete inventory is adequate given the current
volume of business to its current customers.

                                       22`

---

`Workers Compensation Reserve

      The Company's California and Oregon locations entered into a partially
self-insured worker's compensation program for fiscal year 2003 and have
continued the program through December 31, 2007. This program features a fixed
annual payment, with a deductible on a per occurrence basis. The annual expense
consists of a base fee paid to an insurance company to administer the program,
direct cash expenses to pay for injuries, an estimate for potential injuries
that may have occurred but have not been reported, an estimate by the insurance
company of costs to close out each injury and an estimate for injury
development. The Company has been on this partially self-insured program for
just over five years and therefore has limited history of claim resolution
available to support the Company's projected liabilities. Therefore the Company
is using published industry actuarial data from an insurance carrier and
reviewing each claim individually to determine the amount of reserves that
should be established. Starting with calendar year 2008, the Company has
switched to a guaranteed fixed cost for worker's compensation insurance because
the premiums for the guaranteed fixed costs insurance are now competitively
priced and eliminate the risk of a partially self-insured program.

      Revenue Recognition

      The Company recognizes revenues through sales of its products primarily to
grocery and club store chains. Revenues are recognized once there is evidence of
an arrangement (such as a customer purchase order), product has been shipped or
delivered to the customer depending on the customer's sales order and invoice
documentation, the price and terms are fixed, and collectibility is reasonably
assured. Accordingly, sales are recorded when goods are shipped or delivered, at
which time title and risk of loss have passed to the customer, consistent with
the freight terms for most customers. For new customers, all revenue is
recognized based on FOB shipping point. Potential returns, adjustments and
spoilage allowances are considered as a reduction in revenues and are provided
for in accounts receivable allowances and accruals. The Company also uses
co-packers to process some of its purchase orders. The Company records the
revenues from these sales on a gross basis as we have inventory risk and are the
primary obligors. The Company records its shipping cost for product delivered to
customers in selling, general, and administrative expense. Any amounts charged
to customers for freight and deliveries are included in revenues. Certain
incentives granted to customers such as promotions, trade ads, slotting fees,
terms discounts, and coupons are recorded as offsets to revenues.

      Valuation of Goodwill/Indefinite-lived Intangible Assets

      Under SFAS 142, "Goodwill and Other Intangible Assets" goodwill and
intangible assets with indefinite useful lives are to be tested for impairment
at least annually. The primary identifiable intangible assets of the Company's
reporting unit with indefinite lives are trademarks, tradenames and goodwill
acquired in business acquisitions. As of December 31, 2007, the net book value
of tradename and trademarks and other identifiable indefinite-lived intangible
assets was $1.8 million.

      The Company defines a reporting unit as a unit one level below its
operating segment. A reporting unit exists if the component constitutes a
business for which discrete financial information is available and segment
managers regularly review the operating results of the component. As of December
31, 2007, the Company determined that it had one reporting unit based on the
Company's internal reorganization which integrated the Company's brands to a
more functional reporting structure. Prior to the fourth quarter of 2006, the
Company had four reporting units as its acquirees' operations were not
integrated.

      Identifiable indefinite-lived intangible assets are not subject to
amortization and are assessed for impairment at least as often as annually and
as triggering events may occur. The impairment test for identifiable intangible
assets not subject to amortization consists of a comparison of the fair value of
the intangible asset with its carrying amount. If the carrying amount exceeds
the fair value, then a second step of assessment is performed to measure the
impairment loss, if any. To determine fair value, the Company relies on a number
of factors to discount anticipated future cash flows including operating
results, business plans and present value techniques. Rates used to discount
cash flows are dependent upon interest rates and the cost of capital at the
relevant point in time. There are inherent uncertainties related to these
factors and management's judgment in applying them to the analysis of intangible
asset impairment. It is possible that assumptions underlying the impairment
analysis will change in such a manner that impairment in value may occur in the
future.

      Goodwill is not amortized but is subject to periodic assessments of
impairment. At December 31, 2007, the Company had $13.2 million of goodwill on
its books. Goodwill is assessed for impairment at least as often as annually and
as triggering events may occur. The Company performs its annual review in the
fourth quarter of each year. Recoverability of goodwill is evaluated using a
comparison of the fair value of a reporting unit with its carrying value.

                                       23`

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`Given the Company's internal reorganization in which the Company operates
under one reporting unit, management primarily relies on the Company's market
capitalization to determine fair value of its reporting unit. In making this
assessment, management relies on a number of factors to discount anticipated
future cash flows including operating results, business plans and present value
techniques. Rates used to discount cash flows are dependent upon interest rates
and the cost of capital at the relevant point in time. There are inherent
uncertainties related to these factors and management's judgment in applying
them to the analysis of goodwill impairment. It is possible that assumptions
underlying the impairment analysis will change in such a manner that impairment
may occur in the future.

      Valuation of Plant and Equipment and finite-lived Intangible Assets

      In accordance with Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-lived Assets ("SFAS
144"), management reviews finite-lived long-lived assets, primarily consisting
of plant and equipment and amortized intangible assets such as acquired recipes,
customer lists and non-compete agreements, whenever events or changes in
circumstances indicate that the carrying amount of an asset group may not be
recoverable. Intangible assets with finite useful lives continue to be amortized
over their respective estimated useful lives. The estimated useful life of an
identifiable intangible asset is based upon a number of factors, including the
effects of demand, competition, and future cash flows. For these assets, if the
total expected future undiscounted cash flows from the asset group are less than
the carrying amount of the asset group, an impairment loss is recognized for the
difference between the fair value and the carrying value of the asset group. The
impairment tests require management to estimate the undiscounted cash flows and
fair value of the asset groups. As of December 31, 2007, the net book value of
finite-lived intangible assets was $4.6 million.

      When analyzing finite, long-lived assets for potential impairment,
significant assumptions are used in determining the undiscounted cash flows of
the asset group, including the cash flows attributed to the asset group; future
cash flows of the asset group, including estimates of future growth rates; and
the period of time in which the assets will be held and used. The Company
primarily determines fair values of the asset group using discounted cash flow
models. In addition, to estimate fair value management is required to estimate
the discount rate that incorporates the time value of money and risk inherent in
future cash flows.

      Impairment of finite-lived and indefinite-lived Intangible Assets

      In the fourth quarter of 2007, it was determined that the intangible
tradename assets of Sonoma Foods were impaired as their discounted cash flows
were insufficient to recover the carrying value. Accordingly, the impairment
charge was measured in accordance with SFAS 142 as the excess of the carrying
value over the fair value of the respective assets.

      The fair value of the Sonoma Foods intangible assets was estimated
primarily using a discounted cash flow model based on the Company's internal
plans related to the future cash flows of Sonoma Foods' primary assets. The
evaluation used a discount rate of 14.0% and future cash flows over the life of
the related intangible asset. Upon completion of the impairment test, the
Company recorded an impairment loss of $58,000 related to tradenames which was
reflected in impairment of intangible assets on the Company's statement of
operations. The decline in the fair value of Sonoma Foods was principally due to
reductions in sales to its customers.

      In the third quarter of 2006, it was determined that the identifiable
intangible assets of Casual Gourmet Foods (including customer relationships,
recipes and processes, non-competition agreements, and tradename) were impaired
as their undiscounted cash flows were insufficient to recover the carrying
value. Accordingly, the impairment charge was measured in accordance with SFAS
144 as the excess of the carrying value over the fair value of the respective
assets.

      The Company's impairment evaluations of both goodwill and other intangible
assets included reasonable and supportable assumptions and projections and were
based on estimates of projected future cash flows. Casual Gourmet Foods
experienced lower than anticipated sales during the third quarter of 2006, due
to a significant reduction in sales to its two largest customers. These
estimates assume that Casual will be able to maintain its current, but reduced
distribution. These estimates of future cash flows are based upon the Company's
experience, historical trends, estimates of future profitability and economic
conditions. Future estimates of profitability and economic conditions require
estimating such factors as sales growth, employment rates and the overall
economics of the retail food industry for five to ten years in the future, and
are therefore subject to variability, are difficult to predict and in certain
cases, beyond the Company's control. The assumptions utilized by management were
consistent with those developed in conjunction with the Company's long-range
planning process. If the assumptions and projections underlying these
evaluations are not achieved, or should the Company ultimately adopt and pursue
different long-range plans, the amount of the impairment could be adversely
affected. Accordingly, there can be no assurance that there will not be
additional impairment charges in the future based on future events and that the
additional charges would not have a materially adverse impact on the Company's
financial position or results of operations.

                                       24`

---

`The fair value of Casual Gourmet Foods for purposes of the intangible
assets impairment test was estimated primarily using a discounted cash flow
model based on the Company's internal plans related to the future cash flows of
Casual Gourmet Foods' primary assets. The evaluation used a discount rate of
18.0% and future cash flows over the life of the related intangible asset.

      Upon completion of step two of the impairment test, the Company recorded
an impairment loss of $3.2 million related to customer relationships,
non-competition agreements, tradenames, and recipes and processes, which was
reflected in impairment of intangible assets on the Company's statement of
operations. The decline in the fair value of Casual Gourmet Foods was
principally due to reductions in sales to its two largest customers. As a result
of this impairment charge to the intangible assets, when testing goodwill
impairment for the reporting unit under SFAS 142, the fair value of the
reporting unit exceeded the carrying value. Accordingly Step 1 of the goodwill
impairment test passed and there was no goodwill impairment.

      Accounting for Stock-Based Awards

      On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123R, "Share-Based Payment." Prior to January 1, 2006, the Company
had applied the intrinsic value method of accounting for stock options granted
to our employees and directors under the provisions of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, as permitted by SFAS No. 123, "Accounting for Stock-Based
Compensation." Accordingly, employee and director compensation expense was
recognized only for those options whose exercise price was less than the market
value of our common stock at the measurement date.

      The Company adopted the fair value recognition provisions of SFAS No.
123R, using the modified prospective transition method. Under the modified
prospective method, (i) compensation expense for share-based awards granted
prior to January 1, 2006 are recognized over the remaining service period using
the compensation cost calculated for pro forma disclosure purposes under SFAS
No. 123 and (ii) compensation expense for all share-based awards granted
subsequent to December 31, 2005 are based on the grant date fair value estimated
in accordance with the provisions of SFAS No. 123R. Results for periods prior to
January 1, 2006 have not been restated. As a result of adopting SFAS No. 123R,
the Company recorded a pre-tax expense of $523,000 and $516,000 for stock-based
compensation for the years ended December 31, 2007 and December 31, 2006
respectively.

      The determination of fair value of share-based payment awards to employees
and directors on the date of grant using the Black-Scholes model is affected by
the Company's stock price as well as assumptions regarding a number of highly
complex and subjective variables. These variables include, but are not limited
to the expected stock price volatility over the term of the awards, and actual
and projected employee stock option exercise behaviors. Prior to 2006, the
Company estimated expected terms based on historical Company data and compared
to a peer group of public companies. For new grants after December 31, 2005
through June 30, 2007, management estimated expected term using the simplified
method provided in SAB 107. Starting July 1, 2007, management estimated the
expected term using the last eleven years of history and computed the expected
term based on the weighted average term of options that were exercised and
expired and the expected weighted average term of options outstanding.
Management has used historical data to estimate forfeitures. The risk-free rate
is based on U.S. Treasury rates in effect during the corresponding period of
grant. The expected volatility is based on the historical volatility of the
Company's stock price.

      Stock options issued prior to November 1, 2005 vested over a two year
period while stock options issued after November 1, 2005 vest over a three year
period. In addition, the Company has significantly reduced the number of
employees who previously would have been eligible to receive stock options.

      The total compensation cost related to nonvested awards not yet recognized
totaled $411,000 as of December 31, 2007 with a weighted average period over
which it is expected to be recognized of one year.

      Business Combinations

      The consolidated financial statements include the Company's accounts and
the accounts of wholly- and majority-owned subsidiaries. The Company
consolidates all of the majority-owned subsidiaries and reflects minority
interest of Sonoma Foods on the consolidated balance sheet because of the
uncertainty that Monterey will purchase the remaining shares from the minority
shareholders. Monterey is the sole source of any financing needed by its
majority-owned subsidiaries.

      In accordance with business combination accounting, the Company allocates
the purchase price of acquired companies to the tangible and intangible assets
acquired, and liabilities assumed based on their estimated fair values.
Management makes estimates of fair value based upon assumptions believed to be
reasonable. These estimates are based on historical experience and information
obtained from the management of the acquired companies and these estimates are
inherently uncertain. Critical estimates in valuing certain of the intangible
assets include but are not limited to: future expected cash flows from product
sales, customer lists, recipes and processes, the acquired company's brand
awareness and market position, as well as assumptions about growth rates, gross
margins, market penetration, and discount rates. Unanticipated events and
circumstances may occur which may affect the accuracy or validity of such
assumptions, estimates or actual results.

                                       25`

---

`For business combinations, the Company must record deferred taxes relating
to the book versus tax basis differences of acquired assets and liabilities.
Generally, such business combinations result in deferred tax liabilities as the
book values are reflected at fair value whereas the tax basis is carried over
from the acquired company. Such deferred taxes are initially estimated based on
preliminary information and are subject to change as valuations and tax returns
are finalized.

Recently Issued Accounting Standards

      In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests
in Consolidated Financial Statements (An Amendment of Account Research Bulletin
("ARB 51")). SFAS 160 amends ARB 51 to establish accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. The statement requires consolidated net income
to be reported at amounts that include the amounts attributable to both the
parent and the noncontrolling interest. It also requires disclosure on the face
of the consolidated statement of income, of the amounts of consolidated net
income attributable to the parent and to the noncontrolling interest. In
addition, this statement establishes a single method of accounting for changes
in a parent's ownership interest in a subsidiary that do not result in a
deconsolidation and requires that a parent recognize a gain or loss in net
income when a subsidiary is deconsolidated. SFAS 160 becomes effective for
fiscal periods beginning after December 15, 2008. The company is currently
assessing the impact of SFAS 160.

      In December 2007, the FASB issued SFAS No. 141(R), Business Combinations
("SFAS 141R"). This standard retains the fundamental acquisition method of
accounting established in Statement 141; however among other things, FAS 141R
requires recognition of assets and liabilities of noncontrolling interests
acquired, fair value measurement of consideration and contingent consideration,
expense recognition for transaction costs and certain integration costs,
recognition of the fair value of contingencies and the adjustments to income tax
expense for the changes in an acquirer's existing valuation allowances or
uncertain tax positions that result from the business combination. The standard
is effective for annual reporting periods beginning after December 15, 2008 and
shall be applied prospectively. The Company is currently assessing the impact of
SFAS 141R.

      In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities ("SFAS 159"). SFAS 159 provides
companies with an option to report selected financial assets and liabilities at
fair value. SFAS 159 also establishes presentation and disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities and to
provide additional information that will help investors and other financial
statement users to more easily understand the effect of the company's choice to
use fair value on its earnings. Finally, SFAS 159 requires entities to display
the fair value of those assets and liabilities for which the company has chosen
to use fair value on the face of the balance sheet. SFAS 159 is effective as of
the beginning of an entity's first fiscal year beginning after November 15,
2007. The Company is currently assessing the impact of SFAS 159 which it will be
required to adopt.

      In December 2006, the FASB issued FASB Staff Position EITF 00-19-2,
Accounting for Registration Payment Arrangements ("FSP 00-19-2") which addresses
accounting for registration payment arrangements. FSP 00-19-2 specifies that the
contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement, whether issued as a
separate agreement or included as a provision of a financial instrument or other
agreement, should be separately recognized and measured in accordance with FASB
Statement No. 5, Accounting for Contingencies. ESP 00-19-2 further clarifies
that a financial instrument subject to a registration payment arrangement should
be accounted for in accordance with other applicable generally accepted
accounting principles without regard to the contingent obligation to transfer
consideration pursuant to the registration payment arrangement. For registration
payment arrangements and financial instruments subject to those arrangements
that were entered into prior to the issuance of EITF 00-19-2, this guidance is
effective for financial statement issued for fiscal years beginning after
December 15, 2006 and interim period within those fiscal years. This
pronouncement had no impact on the Company's consolidated 2007 financial
statements.

      In September 2006, the FASB issued SFAS 157 Fair Value Measurements, which
provides enhanced guidance for using fair value to measure assets and
liabilities and also expands information about the extent to which companies
measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. SFAS 157
applies whenever other accounting standards require or permit assets and
liabilities to be measured at fair value and does not expand the use of fair
value in any new circumstances. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and interim periods
within those fiscal years. On November 14, 2007, the FASB agreed to partially
defer the effective date of the standard for certain nonfinancial assets and
liabilities. The Company is currently assessing the impact of SFAS 157.

                                       26`

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`In September 2006, the Securities and Exchange Commission (SEC) issued SAB
No. 108, Materiality. The interpretations in SAB 108 are being issued to address
diversity in practice in quantifying financial statement misstatements and the
potential under current practice for the buildup of improper amounts on the
balance sheet. SAB 108 is effective for the first interim period of the first
fiscal year ending after November 15, 2006. The Company's adoption of the
provisions of SAB 108 did not impact its financial condition or results of
operations.

      In July, 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" ("FIN
48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in any entity's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes" and prescribes a recognition threshold and
measurement attributes for financial statement disclosure of tax positions taken
or expected to be taken on a tax return. Under FIN 48, the impact of an
uncertain income tax position on the income tax return must be recognized at the
largest amount that is more-likely-than-not to be sustained upon audit by the
relevant taxing authority. An uncertain income tax position will not be
recognized if it has less than a 50% likelihood of being sustained.
Additionally, FIN 48 provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. The Company adopted the provisions of FIN 48 effective January 1,
2007. See discussion at Note 10.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   Market Risk Disclosure

      The Company does not hold market risk-sensitive trading instruments, nor
does it use financial instruments for trading purposes. Except as disclosed
below in this item, all sales, operating items and balance sheet data are
denominated in U.S. dollars; therefore, the Company has no significant foreign
currency exchange rate risk.

      The Company uses many different commodities such as wheat, corn, pork,
poultry, and energy. Commodities are subject to price volatility caused by
commodity market fluctuations, supply and demand, currency fluctuations, and
changes in governmental agricultural programs. Commodity price increases will
result in increases in raw material costs and operating costs. The Company may
not be able to increase its product prices to offset these increased costs; and
increasing prices may result in reduced sales volume and profitability.

      In the ordinary course of its business the Company enters into commitments
to purchase raw materials over a period of time, generally six months to one
year, at contracted prices. At December 31, 2007 these future commitments were
not at prices in excess of current market, or in quantities in excess of normal
requirements. The Company does not utilize derivative contracts either to hedge
existing risks or for speculative purposes.

   Interest Rate Risk

      The Company invests excess cash in variable income investments consisting
of cash equivalents. The magnitude of the interest income generated by these
cash equivalents is affected by market interest rates. Management does not use
marketable securities or derivative financial instruments in its investment
portfolio.

      The interest payable on the Company's bank line of credit is based on
variable interest rates and therefore affected by changes in market interest
rates. During the second quarter of 2006, the Company repaid all of its loans
with variable interest rates.

   Currency Risk

      During 2007, the Company did not sell any product for payment in currency
other than US dollars.

                                       27`

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`ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

      The financial statements and supplementary data of the Company required by
this item are set forth at the pages indicated at Item 15(a) and are
incorporated here by reference.

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

      None

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

      As required by Rule 13a-15(b) under the Exchange Act, we conducted an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer (together the
"Certifying Officers"), of the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2007, the end of the
period covered by this report. Based upon that evaluation, the Certifying
Officers concluded that our disclosure controls and procedures were effective as
of December 31, 2007 to provide reasonable assurance that information required
to be disclosed in our Exchange Act reports is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms and
that such information is accumulated and communicated to our management,
including our Certifying Officers, as appropriate, to allow for timely decisions
regarding required disclosure.

Inherent Limitations on Effectiveness of Controls

      Management is responsible for establishing and maintaining adequate
internal control over financial reporting to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with U.S. generally
accepted accounting principles. Internal control over financial reporting
includes those policies and procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of assets; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with U.S. generally accepted accounting principles, and
that receipts and expenditures are being made only in accordance with
authorizations of the management and the Board; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of Company assets that could have a material effect on the
financial statements.

      Management personnel, including the Certifying Officers, recognize that
our internal control over financial reporting cannot prevent or detect all error
and all fraud. A control system, no matter how well designed and operated, can
provide only reasonable, not absolute, assurance that the control system's
objectives will be met. The design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Further, because of the inherent limitations
in all control systems, no evaluation of controls can provide absolute assurance
that misstatements due to error or fraud will not occur or that all control
issues and instances of fraud, if any, have been detected. The design of any
system of controls is based in part on certain assumptions about the likelihood
of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions.

Management's report on internal control over financial reporting

The following report is provided by management in respect of Monterey Gourmet
Foods' internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Securities Exchange Act of 1934):

      1.    Monterey Gourmet Foods' management is responsible for establishing
            and maintaining adequate internal control over financial reporting.

      2.    Monterey Gourmet Foods management has used the Committee of
            Sponsoring Organizations of the Treadway Commission (COSO) framework
            to evaluate the effectiveness of internal control over financial
            reporting. Management believes that the COSO framework is a suitable
            framework for its evaluation of financial reporting because it is
            free from bias, permits reasonably consistent qualitative and
            quantitative measurements of Monterey Gourmet Foods' internal
            control over financial reporting, is sufficiently complete so that
            those relevant factors that would alter a conclusion about the
            effectiveness of Monterey Gourmet Foods' internal control over
            financial reporting are not omitted and is relevant to an evaluation
            of internal control over financial reporting.

                                       28`

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`3.    Management has assessed the effectiveness of Monterey Gourmet Foods'
            internal control over financial reporting as of December 31, 2007
            and has concluded that such internal control over financial
            reporting was effective. There were no material weaknesses in
            internal control over financial reporting identified by management.

      4.    This annual report does not include an attestation report of the
            Company's registered public accounting firm regarding internal
            controls over financial reporting. Management's report was not
            subject to attestation by the Company's registered public accounting
            firm pursuant to temporary rules of the Securities and Exchange
            Commission that permit the Company to provide only management's
            report in this annual report.

Changes in Internal Control over Financial Reporting

      There have been no changes in our internal control over financial
reporting during the fourth quarter of 2007 that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.

ITEM 9B. OTHER INFORMATION

      None

                                    PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

      The information required by this item relating to the Company's directors
and nominees and disclosure relating to compliance with Section 16(a) of the
Securities Exchange Act of 1934 is included under the captions "Election of
Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of
1934" in the Company's Proxy Statement for the 2008 Annual Meeting of
Stockholders and is incorporated herein by reference.

      The information required by this item relating to the Company's Executive
Officers under the caption "Executive Officers" in the Company's 2008 Proxy
Statement is incorporated herein by reference.

Code of Ethics

      The Company has adopted a Code of Ethics as defined in Item 406 of
Regulation S-K that applies to its principal executive and financial officers
and the persons performing similar functions. Monterey Gourmet Foods will
provide a copy of its Code of Ethics, without charge, to any investor that
requests it. Requests should be addressed in writing to Mr. Scott Wheeler,
Corporate Secretary, 1528 Moffett Street, Salinas, CA 93905.

ITEM 11. EXECUTIVE COMPENSATION

      The information under the captions "Executive Compensation," "Compensation
of Directors," and "Report of Compensation Committee on Executive Compensation,"
in the Company's 2008 Proxy Statement is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
         RELATED STOCKHOLDER MATTERS

      The information under the captions "Security Ownership of Certain
Beneficial Owners and Management" and "Equity Compensation Plan Information" in
the Company's 2008 Proxy Statement is incorporated herein by reference.

                                       29`

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`ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
         INDEPENDENCE

      The Company's policy is to forbid all related party transactions; hence
there is no separate policy to govern Board of Directors review or approval of
such matters. During the year ended December 31, 2007, there were no related
party transactions.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

      The Audit Committee of the Board of Directors of Monterey Gourmet Foods
has selected BDO Seidman, LLP as independent registered public accounting firm
to audit the consolidated financial statements of Monterey Gourmet Foods for the
calendar year ending December 31, 2007. BDO Seidman, LLP has acted in such
capacity since its appointment in fiscal year 1997. The following table sets
forth the aggregate fees billed to Monterey Gourmet Foods for the years ended
December 31, 2007 and December 31, 2006 by BDO Seidman, LLP:

                                                          2007          2006
                                                       ----------    ----------
      Audit Fees (1)................................   $  335,000    $  337,000

      Audit-Related Fees (2)........................   $   26,000    $   30,000

      Tax Fees (3)..................................   $   56,000    $   56,000

      All Other Fees ...............................   $        0    $        0

      (1)    Audit Fees consist of fees billed for professional services
      rendered for the audit of the Company's consolidated annual financial
      statements and review of the interim consolidated financial statements
      included in quarterly reports and services that are normally provided by
      BDO Seidman, LLP in connection with statutory and regulatory filings or
      engagements. Fiscal 2006 fees have been revised from the original 2006
      filing to include additional fees billed in 2007 in relation to the 2006
      audit.

      (2)    Audit-Related Fees consist of fees billed for assurance and
      related services that are reasonably related to the performance of the
      audit or review of the Company's consolidated financial statements and are
      not reported under "Audit Fees." These services generally include fees for
      due diligence related to business acquisitions and equity awards,
      consulting fees related to the implementation of FIN 48 and 404 consulting
      fees.

      (3)    Tax Fees consist of fees billed for professional services
      rendered for annual compliance filings, ongoing tax planning, and
      consultation regarding the tax implication of proposed or pending
      transactions.

      The Audit Committee must pre-approve audit and non-audit services provided
to the Company by the independent registered public accounting firm (or
subsequently approve non-audit services in those circumstances where a
subsequent approval is necessary and permissible); in this regard, the Audit
Committee has the sole authority to approve the hiring and firing of the
independent registered public accounting firm, all audit engagement fees, terms
and all non-audit engagements, as may be permissible, with the independent
registered public accounting firm. Pre-approval was obtained from the audit
committee for all fees incurred by the independent registered public accounting
firm.

                                       30`

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`PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)(1) - (2) Consolidated Financial Statements of Monterey Gourmet Foods:`

|Page Number(s)
                                                                                   --------------
Report of Independent Registered Public Accounting Firm                                  32
Consolidated Balance Sheets: Year-End 2007 and 2006                                      33
Consolidated Statements of Operations: Years Ended 2007, 2006 and 2005                   34
Consolidated Statements of Stockholders' Equity: Years Ended 2007, 2006 and 2005         35
Consolidated Statements of Cash Flows: Years Ended 2007, 2006 and 2005                   36
Summary of Significant Accounting Policies                                               37-43
Notes to Consolidated Financial Statements                                               37-61
Schedule II - Valuation and Qualifying Accounts                                          62
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`All other schedules have been omitted since the required information is
contained in the Consolidated Financial Statements or because such schedules are
not required.

(a)(3) Exhibits: See Index to Exhibits on page 63. The Exhibits listed in the
accompanying Index of Exhibits are filed or incorporated by reference as part of
this report. Exhibit Nos. 10.1, 10.2, and 10.7, are management contracts or
compensatory plans or arrangements.

                                       31`

---

`REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of Monterey Gourmet Foods, Inc.

We have audited the accompanying consolidated balance sheets of Monterey Gourmet
Foods, Inc. as of December 31, 2007 and December 31, 2006 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2007. We have also
audited the schedule listed in the accompanying index at Item 15(a). These
consolidated financial statements and the schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). These standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and schedule are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and schedule, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedule. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Monterey Gourmet
Foods, Inc. at December 31, 2007 and December 31, 2006, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2007, in conformity with accounting principles generally accepted
in the United States of America.

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

As discussed in Note 9 to the Consolidated Financial Statements, effective
January 1, 2006 the Company adopted the provisions of Statement of Financial
Accounting No. 123 (Revised 2004), Share-Based Payment.

BDO Seidman, LLP
San Francisco, California
March 12, 2008

                                       32`

---

`MONTEREY GOURMET FOODS, INC.
                           CONSOLIDATED BALANCE SHEETS
                      (in thousands, except share amounts)`

|December 31, 2007   December 31, 2006
                                                                 -----------------   -----------------
ASSETS
Current assets:
   Cash and cash equivalents                                     $           5,541   $           4,281
   Accounts receivable less allowances of $981 and $722                      8,587               9,958
   Inventories                                                               7,865               7,574
   Deferred tax assets-current                                                 703                 793
   Prepaid expenses and other                                                1,084                 807
                                                                 -----------------   -----------------

      Total current assets                                                  23,780              23,413

   Property and equipment, net                                              14,280              15,303
   Deferred tax assets-long term                                             2,646               3,315
   Deposits and other                                                          243                 174
   Intangible assets, net                                                    6,346               7,052
   Goodwill                                                                 13,211              13,211
                                                                 -----------------   -----------------

      Total assets                                               $          60,506   $          62,468
                                                                 =================   =================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                              $           6,160   $           7,835
   Accrued payroll and related benefits                                      1,192               1,487
   Accrued and other current liabilities                                       962               1,577
   Current portion of notes, loans, and capital leases payable                  50               1,018
                                                                 -----------------   -----------------

      Total current liabilities                                              8,364              11,917

Notes, loans, and capital leases payable, less current portion                  29                 129

Minority interest                                                              159                 159

Stockholders' equity:
   Preferred stock, $.001 par value,
   1,000,000 shares authorized, none outstanding                                 -                   -
   Common stock, $.001 par value,
      50,000,000 shares authorized, 17,356,976 and 17,307,647
      issued and 17,141,976 and 17,307,647 outstanding                          17                  17
   Additional paid-in capital                                               60,462              59,796
   Treasury stock 215,000 and 0 shares, respectively, at cost                 (657)                  -
   Accumulated deficit                                                      (7,868)             (9,550)
                                                                 -----------------   -----------------
   Total stockholders' equity                                               51,954              50,263
                                                                 -----------------   -----------------

      Total liabilities and stockholders' equity                 $          60,506   $          62,468
                                                                 =================   =================
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

                                       33`

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`MONTEREY GOURMET FOODS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
               (in thousands, except share and per share amounts)`

|Years Ended
                                                          --------------------------------------------
                                                              2007            2006            2005
                                                          ------------    ------------    ------------
Net revenues                                              $    100,527     $    94,297     $    85,248

Cost of sales                                                   73,008          66,858          62,016
                                                          ------------    ------------    ------------

Gross profit                                                    27,519          27,439          23,232

Selling, general and administrative expenses                    25,304          26,754          23,590

Impairment of intangible assets                                     58           3,160               -

Gain (loss) on disposition of assets                               (50)             13               -
                                                          ------------    ------------    ------------
Operating income (loss)                                          2,107          (2,462)           (358)

Other income, net                                                   12               -              18
Interest income (expense), net                                     163            (355)           (628)
                                                          ------------    ------------    ------------

Income (loss) before provision for income taxes                  2,282          (2,817)           (968)

Income tax benefit (provision)                                    (600)           (295)            431
                                                          ------------    ------------    ------------

   Net income (loss)                                      $      1,682     $    (3,112)    $      (537)
                                                          ============    ============    ============

Basic income (loss) per common share                      $       0.10    ($      0.19)   ($      0.04)

Diluted income (loss) per common share                    $       0.10    ($      0.19)   ($      0.04)

Weighted average basic shares outstanding                   17,329,365      16,100,250      14,450,251
Weighted average diluted shares outstanding                 17,435,201      16,100,250      14,450,251
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

                                       34`

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`MONTEREY GOURMET FOODS, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                    FOR THE YEARS ENDED 2005, 2006, and 2007
                      (in thousands, except share amounts)`

|Common Stock
                            --------------------     Additional     Treasury   Accumulated
                              Shares      Amount  Paid-in Capital     Stock      Deficit       Total
                            ----------   -------  ---------------   --------   -----------   ---------
Balance, end of 2004        14,392,574   $    14  $        45,103   $      -   $    (5,901)  $  39,216

Issuance of common stock
under Employee Stock
Purchase Plan                    8,198         -               25          -             -          25

Exercise of stock options
for cash                        51,116         -              128          -             -         128

Stock-based compensation             -         -               80          -             -          80

Issuances of stock as part
of an acquisition               62,150         -              198          -             -         198

Net loss for the year                -         -                -          -          (537)       (537)
                            ----------   -------  ---------------   --------   -----------   ---------

Balance, end of 2005        14,514,038   $    14  $        45,534   $      -   $    (6,438)  $  39,110

Issuance of common stock
under Employee Stock
Purchase Plan                   10,900         -               32          -             -          32

Exercise of stock options
for cash                       308,709         -              894          -             -         894

Issuance of stock as part
of an acquisition              300,000         -            1,186          -             -       1,186

Stock issued as part of
PIPE Financing               2,174,000         3           11,632          -             -      11,635

Tax benefit of
disqualifying dispositions           -         -                2          -             -           2

Stock-based compensation             -         -              516          -             -         516

Net loss for the year                -         -                -          -        (3,112)     (3,112)
                            ----------   -------  ---------------   --------   -----------   ---------
Balance, end of 2006        17,307,647   $    17  $        59,796   $      -   $    (9,550)  $  50,263

Issuance of common stock
under Employee Stock
Purchase Plan                    8,579         -               26          -             -          26

Exercise of stock options
for cash                        20,750         -               40          -             -          40

Stock issued to consultant      20,000         -               77          -             -          77

Purchase of treasury stock    (215,000)        -                        (657)            -        (657)

Stock-based compensation             -         -              523          -             -         523

Net income for the year              -         -                -          -         1,682       1,682
                            ----------   -------  ---------------   --------   -----------   ---------

Balance, end of 2007        17,141,976   $    17  $        60,462   $   (657)  $    (7,868)  $  51,954
                            ==========   =======  ===============   ========   ===========   =========
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

                                       35`

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`MONTEREY GOURMET FOODS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                      (in thousands, except share amounts)`

|Years Ended
                                                                      --------------------------------
                                                                        2007        2006        2005
                                                                      --------    --------    --------
Cash flows from operating activities:
Net income (loss)                                                     $  1,682    $ (3,112)   $   (537)
Adjustments to reconcile net  loss to net cash provided by (used in)
   operating activities net of acquisition:
      Deferred income taxes                                                759         282        (379)
      Depreciation and amortization                                      2,948       2,926       3,033
      Impairment of intangibles                                             58       3,160           -
      Provisions for allowances for bad debts, returns,
         adjustments and spoils                                          4,870       4,876       4,792
      Provisions for inventory allowances                                  213         629         499
      Stock-based compensation                                             600         516          80
      (Gain) Loss on disposition of assets                                  50         (13)          -
      Changes in assets and liabilities:
         Accounts receivable                                            (3,499)     (5,492)     (6,554)
         Inventories                                                      (504)     (1,254)     (2,473)
         Prepaid expenses and other                                       (346)         33         205
         Accounts payable                                               (1,675)      3,664         972
         Accrued and other current liabilities                            (910)        765        (742)
                                                                      --------    --------    --------
Net cash provided by (used in) operating activities                      4,246       6,980      (1,104)
                                                                      --------    --------    --------

Cash flows from investing activities:
      Purchase of property and equipment                                (1,345)     (3,010)     (1,071)
      Proceeds from sale of fixed assets                                    18          13           -
      Acquisition of business net of cash and minority interest              -         (69)     (9,062)
                                                                      --------    --------    --------
Net cash used in investing activities                                   (1,327)     (3,066)    (10,133)
                                                                      --------    --------    --------

Cash flows from financing activities:
      Proceeds from bank borrowing                                           -           -       7,500
      Bank overdraft                                                         -      (1,507)      1,507
      Line of credit                                                         -      (3,000)      3,000
      Repayment of debt                                                 (1,036)     (7,992)     (1,143)
      Tax benefit of disqualifying dispositions                              -           2           -
      Repayment of capital lease obligations                               (32)        (27)        (19)
      Purchase of treasury stock                                          (657)          -           -
      Proceeds from issuance of common stock                                66      12,561         153
                                                                      --------    --------    --------
Net cash (used in) provided by financing activities                     (1,659)         37      10,998
                                                                      --------    --------    --------

Net increase (decrease) in cash and cash equivalents                     1,260       3,951        (239)

Cash and cash equivalents, beginning of period                           4,281         330         569
                                                                      --------    --------    --------
Cash and cash equivalents, end of period                              $  5,541    $  4,281    $    330
                                                                      ========    ========    ========

Cash payments:
      Interest                                                        $     58    $    501    $    634
      Income taxes                                                          39           6           7

Non-cash investing and financing activities:
      Capital lease obligations                                       $      -    $     19    $     86
      Issuance of stock for acquisition of business                          -       1,186         198
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

                                       36`

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`MONTEREY GOURMET FOODS, INC

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

   1. Summary of Significant Accounting Policies

      Principles of Consolidation and Nature of Operations

      The consolidated financial statements include the accounts of Monterey
Gourmet Foods, Inc. (a producer, distributor, and marketer of refrigerated
gourmet food products), together with its wholly owned subsidiaries, Monterey
Pasta Development Company (a franchiser of restaurants - inactive), CIBO
Naturals, LLC (100% owned as of January 12, 2006), Casual Gourmet Foods, Inc.
(100% owned as of September 29, 2006) and 80% owned Sonoma Foods, Inc. All
significant intercompany accounts and transactions have been eliminated in
consolidation. Collectively, Monterey Gourmet Foods, CIBO Naturals, LLC,
Monterey Pasta Development Company, Casual Gourmet Foods, and Sonoma Foods are
referred to as the "Company."

      The consolidated financial statements include the Company's accounts and
the accounts of wholly- and majority-owned subsidiaries. The Company
consolidates all of the majority-owned subsidiaries and reflects minority
interest of Sonoma Foods on the consolidated balance sheet because of the
uncertainty that Monterey will purchase the remaining shares from the minority
shareholders. Monterey is the sole source of any financing needed by its
majority-owned subsidiaries.

      The Company's production facilities and distribution center are located in
Salinas (Monterey County), California, Seattle, Washington, and Eugene, Oregon.
Its products are available throughout the United States as well as selected
distribution areas in Canada, the Caribbean, Latin America, and Asia Pacific.
The principal customers are retail grocery and club stores. The Company offers
credit and payment terms to its customers in line with industry practices,
generally calling for unsecured trade accounts receivable.

      The Company reported losses for the years 2005 and 2006 and returned to
profitability during 2007. Nevertheless as of December 31, 2007 the company had
an accumulated deficit of $7,868,000. For 2007, the Company generated $4.2
million in cash from operating activities and has $15.4 million in working
capital. Management believes that the Company's current cash balances and future
operating projections will provide adequate liquidity to meet the Company's
planned capital and operating requirements for normal operations and capital
expenditures through the 2008 calendar year. See Note 7 for a description of the
Company's credit facility.

      Accounting Periods

      The Company operates and reports results on a calendar year. The calendar
year ended on December 31, 2007.

      Cash and Cash Equivalents

      The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. The Company's
cash consists primarily of cash in the Company's bank account.

      Accounts Receivable and Allowances

      The Company provides allowances for estimated credit losses, product
returns, spoilage, and adjustments at a level deemed appropriate to adequately
provide for known and inherent risks related to such amounts. The allowances are
based on reviews of history of losses, returns, spoilages, adjustments,
contractual relationships with customers, current economic conditions, and other
factors that warrant consideration in estimating potential losses. The Company
has a policy that estimates potential returns, spoilages, and adjustments to
revenues; then management adjusts these amounts for known information specific
to each customer. After all attempts to collect a receivable have failed, the
receivable is written off against the allowance.

      While management uses the best information available in making its
determination, the ultimate recovery of recorded accounts and other receivables
is also dependent on future economic and other conditions that may be beyond
management's control.

      Inventory Valuation

      Inventories are stated at the lower of cost (using the first-in, first-out
method) or market and consist principally of component ingredients to the
Company's refrigerated pasta and sauces, finished goods, and packaging
materials. Many of the ingredients used in the Company's products are short
shelf-lived products and if not used in a certain amount of time may spoil.
Management estimates that the raw material will be used in a timely manner;
however, management has established certain reserves for the potential of
inventory obsolescence, especially for slow moving inventory. As of December 31,
2007 and December 31, 2006, the Company reduced the carrying value of its
inventory by $153,000 and $273,000 respectively. This write-down was made to
cover certain refrigerated raw material inventory that is nearing its
shelf-life, certain packaging labels for products that may be rotated out of the
Club Store accounts and for products that have already been rotated out of the
Club Store accounts that may or may not be rotated back into the Club Store
accounts. The allowance is established based on management's estimate of
alternative usage or salvage value of obsolete inventory. Management believes
its estimates for spoiled and obsolete inventory are adequate given the current
volume of business to current customers.

                                       37`

---

`Advertising Costs

      The Company expenses advertising costs as incurred or when the related
campaign commences. The Company spent $88,000, $107,000, and $253,000 on
advertising during, 2007, 2006, and 2005, respectively.

      Property and Equipment

      Property and equipment are recorded at cost. Depreciation is provided for
on the straight-line method over the estimated useful lives of the assets (or
lease term for leasehold improvements if shorter):

         Leasehold improvements                              7 to 12 years
         Machinery and equipment                             7 to 12 years
         Office furniture and equipment                      5 to 15 years
         Computer and software                               3 to 5 years
         Vehicles                                            5 to 7 years

      Long-lived assets, including plant and equipment, are assessed for
possible impairment whenever events or changes in circumstances indicate that
the carrying amounts may not be recoverable, or whenever management has
committed to a plan to dispose of the assets. Assets to be held and used,
affected by such an impairment loss, are depreciated or amortized at their new
carrying amount over the remaining estimated life; assets to be sold or
otherwise disposed of are not subject to further depreciation or amortization.

      Valuation of Goodwill/Indefinite-lived Intangible Assets

      Under SFAS 142, "Goodwill and Other Intangible Assets" goodwill and
intangible assets with indefinite useful lives are to be tested for impairment
at least annually. The primary identifiable intangible assets of the Company's
reporting unit with indefinite lives are trademarks, tradenames and goodwill
acquired in business acquisitions. As of December 31, 2007, the net book value
of trademarks and other identifiable indefinite-lived intangible assets was $1.8
million.

      The Company defines a reporting unit as a unit one level below its
operating segment. A reporting unit exists if the component constitutes a
business for which discrete financial information is available and senior
managers regularly review the operating results of the component. As of December
31, 2007 the Company determined that it had one reporting unit based on the
Company's internal reorganization which integrated the Company's brands to a
more functional reporting structure. Prior to the fourth quarter of 2006, the
Company had four reporting units as its acquirees' operations were not
integrated.

      Identifiable indefinite-lived intangible assets are not subject to
amortization and are assessed for impairment at least as often as annually and
as triggering events may occur. The impairment test for identifiable intangible
assets not subject to amortization consists of a comparison of the fair value of
the intangible asset with its carrying amount. If the carrying amount exceeds
the fair value, then a second step of assessment is performed to measure the
impairment loss, if any. To determine fair value, the Company relies on a number
of factors to discount anticipated future cash flows including operating
results, business plans and present value techniques. Rates used to discount
cash flows are dependent upon interest rates and the cost of capital at the
relevant point in time. There are inherent uncertainties related to these
factors and management's judgment in applying them to the analysis of intangible
asset impairment. It is possible that assumptions underlying the impairment
analysis will change in such a manner that impairment in value may occur in the
future.

      Goodwill is not amortized but is subject to periodic assessments of
impairment. At December 31, 2007, the Company had $13.2 million of goodwill on
its books. Goodwill is assessed for impairment at least as often as annually and
as triggering events may occur. The Company performs its annual review in the
fourth quarter of each year. Recoverability of goodwill is evaluated using a
comparison of the fair value of a reporting unit with its carrying value.

      Given the Company's internal reorganization in which the Company operates
under one reporting unit, management primarily relies on the Company's market
capitalization to determine fair value of its reporting unit. In making this
assessment, management relies on a number of factors to discount anticipated
future cash flows including operating results, business plans and present value
techniques. Rates used to discount cash flows are dependent upon interest rates
and the cost of capital at the relevant point in time. There are inherent
uncertainties related to these factors and management's judgment in applying
them to the analysis of goodwill impairment. It is possible that assumptions
underlying the impairment analysis will change in such a manner that impairment
may occur in the future.

                                       38`

---

`Valuation of Plant and Equipment and finite-lived Intangible Assets

      In accordance with Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-lived Assets ("SFAS
144"), management reviews finite-lived long-lived assets, primarily consisting
of plant and equipment and amortized intangible assets such as acquired recipes,
customer lists and non-compete agreements, whenever events or changes in
circumstances indicate that the carrying amount of an asset group may not be
recoverable. Intangible assets with finite useful lives continue to be amortized
over their respective estimated useful lives. The estimated useful life of an
identifiable intangible asset is based upon a number of factors, including the
effects of demand, competition, and future cash flows. For these assets, if the
total expected future undiscounted cash flows from the asset group are less than
the carrying amount of the asset group, an impairment loss is recognized for the
difference between the fair value and the carrying value of the asset group. The
impairment tests require management to estimate the undiscounted cash flows and
fair value of the asset groups. As of December 31, 2007, the net book value of
finite-lived intangible assets was $4.6 million.

      When analyzing finite, long-lived assets for potential impairment,
significant assumptions are used in determining the undiscounted cash flows of
the asset group, including the cash flows attributed to the asset group; future
cash flows of the asset group, including estimates of future growth rates; and
the period of time in which the assets will be held and used. The Company
primarily determines fair values of the asset group using discounted cash flow
models. In addition, to estimate fair value management is required to estimate
the discount rate that incorporates the time value of money and risk inherent in
future cash flows.

      Impairment of finite-lived and indefinite-lived Intangible Assets

      In the fourth quarter of 2007, it was determined that the intangible
tradename assets of Sonoma Foods were impaired as their discounted cash flows
were insufficient to recover the carrying value. Accordingly, the impairment
charge was measured in accordance with SFAS 142 as the excess of the carrying
value over the fair value of the respective assets.

      The fair value of Sonoma Foods for purposes of the intangible assets
impairment test was estimated primarily using a discounted cash flow model based
on the Company's internal plans related to the future cash flows of Sonoma
Foods' primary assets. The evaluation used a discount rate of 14.0% and future
cash flows over the life of the related intangible asset. Upon completion of the
impairment test, the Company recorded an impairment loss of $58,000 related to
tradenames which was reflected in impairment of intangible assets on the
Company's statement of operations. The decline in the fair value of Sonoma
Foods' tradename was principally due to reductions in sales to its customers.

      In the third quarter of 2006, it was determined that the identifiable
intangible assets of Casual Gourmet Foods (including customer relationships,
recipes and processes, non-competition agreements, and tradename) were impaired
as their undiscounted cash flows were insufficient to recover the carrying
value. Accordingly, the impairment charge was measured in accordance with SFAS
144 as the excess of the carrying value over the fair value of the respective
assets.

      The Company's impairment evaluations included reasonable and supportable
assumptions and projections and were based on estimates of projected future cash
flows. Casual Gourmet Foods experienced lower than anticipated sales during the
third quarter of 2006, due to a significant reduction in sales to its two
largest customers. These estimates assumed that Casual would be able to maintain
its then current, but reduced distribution. These estimates of future cash flows
are based upon the Company's experience, historical trends, estimates of future
profitability and economic conditions. Future estimates of profitability and
economic conditions require estimating such factors as sales growth, employment
rates and the overall economics of the retail food industry for five to ten
years in the future, and are therefore subject to variability, are difficult to
predict and in certain cases, beyond the Company's control. The assumptions
utilized by management were consistent with those developed in conjunction with
the Company's long-range planning process. If the assumptions and projections
underlying these evaluations are not achieved, or should the Company ultimately
adopt and pursue different long-range plans, the amount of the impairment could
be adversely affected. Accordingly, there can be no assurance that there will
not be additional impairment charges in the future based on future events and
that the additional charges would not have a materially adverse impact of the
Company's financial position or results of operations.

      The fair value of Casual Gourmet Foods for purposes of the intangible
assets impairment test was estimated primarily using a discounted cash flow
model based on the Company's internal plans related to the future cash flows of
Casual Gourmet Foods' primary assets. The evaluation used a discount rate of
18.0% and future cash flows over the life of the related intangible asset.

      Upon completion of step two of the impairment test, the Company recorded
an impairment loss of $3.2 million related to customer relationships,
non-competition agreements, tradenames, and recipes and processes, which was
reflected in impairment of intangible assets on the Company's statement of
operations. The decline in the fair value of Casual Gourmet Foods was
principally due to reductions in sales to its two largest customers. As a result
of this impairment charge to the intangible assets, when testing goodwill
impairment for the reporting unit under SFAS 142, the fair value of the
reporting unit exceeded the carrying value. Accordingly Step 1 of the goodwill
impairment test passed and there was no goodwill impairment.

                                       39`

---

`Income Taxes and Deferred Tax Asset Valuation Allowance

      The Company accounts for corporate income taxes in accordance with SFAS
109, "Accounting for Income Taxes" which requires an asset and liability
approach. This approach results in the recognition of deferred tax assets
(future tax benefits) and liabilities for the expected future tax consequences
of temporary timing differences between the book carrying amounts and the tax
basis of assets and liabilities. Future tax benefits are subject to a valuation
allowance to the extent of the likelihood that the deferred tax assets may not
be realized. The Company's deferred tax assets include significant amounts of
net operating losses ("NOLs"). During 2007, the valuation allowance was
decreased, but not eliminated based on management's judgment that it is not
more-likely-than-not that all of its deferred tax assets could be realized due
to the Company's assessment of the realization of our NOLs. The amount of the
valuation allowance is significantly dependant on management's assumptions
regarding future taxable income and the availability of these NOLs to offset
future taxable income. The effect on the Company's net income is significant
whenever the estimate changes. The Company has a valuation allowance against
deferred tax assets of $847,000 as of December 31, 2007.

      Revenue Recognition

      The Company recognizes revenues through sales of its products primarily to
grocery and club store chains. Revenues are recognized once there is evidence of
an arrangement (such as a customer purchase order), product has been shipped or
delivered to the customer depending on the customer's sales order and invoice
documentation, the price and terms are fixed, and collectibility is reasonably
assured. Accordingly, sales are recorded when goods are shipped or delivered, at
which time title and risk of loss have passed to the customer, consistent with
the freight terms for most customers. For new customers, all revenue is
recognized based on FOB shipping point. Potential returns, adjustments and
spoilage allowances are considered as a reduction in revenues and are provided
for in accounts receivable allowances and accruals. The Company also uses
co-packers to process some of its purchase orders. The Company records the
revenues from these sales on a gross basis as we have inventory risk and are the
primary obligors.

      The Company records shipping cost for product delivered to customers in
selling general and administrative expense. These costs were approximately
$5,403,000, $5,764,000, and $ 4,361,000 for 2007, 2006, and 2005 respectively.
Any amounts charged to customers for freight and deliveries are included in
revenues and approximate the amount recorded in SG&A. Certain incentives
granted to customers such as promotions, trade ads, slotting fees, terms
discounts, and coupons are recorded as offsets to revenues.

      Workers Compensation Reserve

      The Company's California and Oregon locations entered into a partially
self-insured worker's compensation program for fiscal year 2003 and have
continued the program through 2007. This program features a fixed annual
payment, with a deductible on a per occurrence basis. The annual expense
consists of a base fee paid to an insurance company to administer the program,
direct cash expenses to pay for injuries, an estimate for potential injuries
that may have occurred but have not been reported, an estimate by the insurance
company of costs to close out each injury and an estimate for injury
development. The Company has been on this partially self-insured program for
five years and therefore has limited history of claim resolution available to
support the Company's projected liabilities. Therefore the Company is using
published industry actuarial data from an insurance carrier and reviewing each
claim individually to determine the amount of reserves that should be
established. Management believes that its current safety program and its safety
record will provide the foundation to enable the Company to realize the premium
savings partially self-insured programs are designed to achieve; however,
estimated reserves may vary from future cash outlays. The remaining locations
are on a fixed premium insurance contract that covers all costs including
claims. Starting with calendar year 2008, the Company has switched to a
guaranteed fixed cost for workers compensation insurance.

      Stock-based Compensation

      On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors based on estimated
fair values. SFAS 123(R) supersedes previous accounting under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") for periods beginning before calendar year 2006. In March 2005, the
Securities and Exchange Commission issued Staff Accounting Bulletin No. 107
("SAB 107") relating to SFAS 123(R). The Company has applied the provisions of
SAB 107 in its adoption of SFAS 123(R).

                                       40`

---

`The Company adopted SFAS 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006, the first day of the Company's fiscal year 2006. Consolidated financial
statements as of December 31, 2007 and December 31, 2006 reflect the impact of
SFAS 123(R). In accordance with the modified prospective transition method, the
consolidated financial statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R). There was no stock-based
compensation expense related to employee or director stock options recognized
during 2005. During 2007 and 2006, the Company recognized $523,000 and $516,000,
respectively in stock-based compensation expense. Since the Company adopted SFAS
123(R) the Company has valued options as low as $1.29 for each option and as
high as $4.02.

      Stock options issued prior to November 1, 2005 vested over a two year
period while stock options issued after November 1, 2005 vest over a three year
period. In addition, the Company has significantly reduced the number of
employees who previously would have been eligible to receive stock options.

      Segment and Enterprise-Wide Reporting

      The Company discloses segment enterprise-wide information in accordance
with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." Based upon definitions contained within SFAS No. 131, management
has determined that the Company operates in one segment. In addition, virtually
all revenues are in the United States, and all of the long-lived assets are
located within the United States.

      Use of Estimates

      The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the period.
Actual results could differ from those estimates. The most significant estimates
made by the Company are those related to accounts receivable and deferred tax
allowances, allocation of purchase price of acquired businesses, workers
compensation reserves, assumptions regarding the expense of stock-based
compensation, depreciation of fixed assets, amortization of acquired intangible
assets, and impairment assessments made for intangible assets and goodwill.

      Indemnifications

      The Company follows FASB Interpretation No. ("FIN") 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". FIN 45 requires a guarantor to recognize,
at the inception of a qualified guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee.

      Pursuant to its bylaws, the Company has agreed to indemnify its officers
and directors for certain events or occurrences arising as a result of the
officer or director serving in such capacity. The term of the indemnification
period is for the officer's or director's lifetime. The Company has no
liabilities recorded for these agreements as of December 31, 2007.

      The Company enters into indemnification provisions under (i) its
agreements with other companies both in extraordinary transactions (such as
acquisitions of a material amount of assets or other investment in other
companies) and in its ordinary course of business, typically with business
partners, contractors and customers, and its sublandlord and (ii) its agreements
with investors. Under these provisions the Company has agreed to generally
indemnify and hold harmless the indemnified party for losses suffered or
incurred by the indemnified party as a result of the Company's activities or, in
some cases, as a result of the indemnified party's activities under the
agreement. These indemnification provisions often include indemnifications
relating to representations made by the Company with regard to intellectual
property and other rights. These indemnification provisions generally survive
termination of the underlying agreement. The maximum potential amount of future
payments the Company could be required to make under these indemnification
provisions is unlimited. To date, the Company has not incurred any costs as
there have been no lawsuits or claims related to these indemnification
agreements. Accordingly, the Company has no liabilities recorded for these
agreements as of December 31, 2007.

                                       41`

---

`New Accounting Pronouncements

      In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests
in Consolidated Financial Statements (An Amendment of Account Research Bulletin
("ARB 51")). SFAS 160 amends ARB 51 to establish accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. The statement requires consolidated net income
to be reported at amounts that include the amounts attributable to both the
parent and the noncontrolling interest. It also requires disclosure on the face
of the consolidated statement of income, of the amounts of consolidated net
income attributable to the parent and to the noncontrolling interest. In
addition, this statement establishes a single method of accounting for changes
in a parent's ownership interest in a subsidiary that do not result in a
deconsolidation and requires that a parent recognize a gain or loss in net
income when a subsidiary is deconsolidated. SFAS 160 becomes effective for
fiscal periods beginning after December 15, 2008. The company is currently
assessing the impact of SFAS 160.

      In December 2007, the FASB issued SFAS No. 141(R), Business Combinations
("SFAS 141R"). This standard retains the fundamental acquisition method of
accounting established in Statement 141; however among other things, FAS 141R
requires recognition of assets and liabilities of noncontrolling interests
acquired, fair value measurement of consideration and contingent consideration,
expense recognition for transaction costs and certain integration costs,
recognition of the fair value of contingencies and the adjustments to income tax
expense for the changes in an acquirer's existing valuation allowances or
uncertain tax positions that result from the business combination. The standard
is effective for annual reporting periods beginning after December 15, 2008 and
shall be applied prospectively. The Company is currently assessing the impact of
SFAS 141R.

      In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities ("SFAS 159"). SFAS 159 provides
companies with an option to report selected financial assets and liabilities at
fair value. SFAS 159 also establishes presentation and disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities and to
provide additional information that will help investors and other financial
statement users to more easily understand the effect of the company's choice to
use fair value on its earnings. Finally, SFAS 159 requires entities to display
the fair value of those assets and liabilities for which the company has chosen
to use fair value on the face of the balance sheet. SFAS 159 is effective as of
the beginning of an entity's first fiscal year beginning after November 15,
2007. The Company is currently assessing the impact of SFAS 159 which it will be
required to adopt.

      In December 2006, the FASB issued FASB Staff Position EITF 00-19-2,
Accounting for Registration Payment Arrangements ("FSP 00-19-2") which addresses
accounting for registration payment arrangements. FSP 00-19-2 specifies that the
contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement, whether issued as a
separate agreement or included as a provision of a financial instrument or other
agreement, should be separately recognized and measured in accordance with FASB
Statement No. 5, Accounting for Contingencies. ESP 00-19-2 further clarifies
that a financial instrument subject to a registration payment arrangement should
be accounted for in accordance with other applicable generally accepted
accounting principles without regard to the contingent obligation to transfer
consideration pursuant to the registration payment arrangement. For registration
payment arrangements and financial instruments subject to those arrangements
that were entered into prior to the issuance of EITF 00-19-2, this guidance is
effective for financial statement issued for fiscal years beginning after
December 15, 2006 and interim period within those fiscal years. This
pronouncement had no impact on the Company's consolidated 2007 financial
statements.

      In September 2006, the FASB issued SFAS 157 Fair Value Measurements, which
provides enhanced guidance for using fair value to measure assets and
liabilities and also expands information about the extent to which companies
measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. SFAS 157
applies whenever other accounting standards require or permit assets and
liabilities to be measured at fair value and does not expand the use of fair
value in any new circumstances. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and interim periods
within those fiscal years. On November 14, 2007, the FASB agreed to partially
defer the effective date of the standard for certain nonfinancial assets and
liabilities. The Company is currently assessing the impact of SFAS 157.

      In September 2006, the Securities and Exchange Commission (SEC) issued SAB
No. 108, Materiality. The interpretations in SAB 108 are being issued to address
diversity in practice in quantifying financial statement misstatements and the
potential under current practice for the buildup of improper amounts on the
balance sheet. SAB 108 is effective for the first interim period of the first
fiscal year ending after November 15, 2006. The Company's adoption of the
provisions of SAB 108 did not impact its financial condition or results of
operations.

                                       42`

---

`In July, 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" ("FIN
48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in any entity's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes" and prescribes a recognition threshold and
measurement attributes for financial statement disclosure of tax positions taken
or expected to be taken on a tax return. Under FIN 48, the impact of an
uncertain income tax position on the income tax return must be recognized at the
largest amount that is more-likely-than-not to be sustained upon audit by the
relevant taxing authority. An uncertain income tax position will not be
recognized if it has less than a 50% likelihood of being sustained.
Additionally, FIN 48 provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. The Company adopted the provisions of FIN 48 effective January 1,
2007. See discussion at Note 10.

      Earnings per Share

      Basic earnings per share are based on the weighted average number of
common shares outstanding during the calendar period. Diluted earnings per share
are based on the weighted average number of common shares outstanding plus,
where applicable, the additional common shares that would have been outstanding
as a result of the conversion of dilutive options and warrants.

   2. Business Acquisitions

      2006 Activities

      On January 12, 2006, the Company, Suekat LLC ("Suekat") and CIBO Naturals,
LLC ("CIBO"), amended their previous agreement for the purchase and sale of
limited liability company units: as a result, the Company acquired the remaining
15.5% of CIBO from Suekat in exchange for 300,000 unregistered shares of the
Company's common stock with a market value of $1,186,000. The purchase price was
all allocated to goodwill. The shares were later registered as part of the
registration statement filed with the SEC on Form S-3 on July 19, 2006.

      On March 31, 2006, the Company purchased an additional 10% interest in
Casual Gourmet Foods, Inc. ("Casual") pursuant to the Company's January 11, 2005
agreement with Casual and its shareholders. The purchase price for the
additional 10% ownership was $1,600 which increased the Company's ownership of
Casual to 70%. The purchase price was all allocated to goodwill. Casual, which
produces branded gourmet sausages and other food products, is a Florida
corporation.

      On September 29, 2006, the Company, Casual, and the shareholders of Casual
entered into an agreement to amend the Purchase Agreement dated January 11,
2005, to accelerate the Third Closing and Final Closing to set the amount of the
Third Payment and Final Payment, and to accelerate the purchase by the Company
of the remaining 30% of Casual's outstanding shares for $23,000. A copy of the
Amendment to the Stock Purchase Agreement was filed on Form 8-K filed with the
SEC on October 5, 2006, and is incorporated here by reference.

      The Casual Gourmet Foods Purchase in 2005

      On January 11, 2005, the Company entered into a definitive agreement with
Casual Gourmet Foods, Inc. ("Casual"), and the shareholders of Casual
("Shareholders") for the purchase by the Company of 100% of Casual's outstanding
shares. The acquisition was structured to provide that the Company acquired 60%
of Casual's outstanding shares immediately and the remaining 40% over the next
three years. Casual, which produces branded gourmet sausages and other food
products, is a Florida corporation. Prior to entering into the Stock Purchase
Agreement, there were no existing material relationships between or among the
Company and Casual or its Shareholders. The Company acquired Casual in order to
expand and diversify its product line in the specialty foods category in which
it competes.

      For its initial acquisition, the Company paid $6.0 million in cash plus
acquisition costs of $159,000. The Company purchased the remaining 40% of Casual
Gourmet Foods, Inc. in 2006. The details of the 40% purchase are described in
the 2006 activities above.

      Casual markets a wide range of refrigerated branded specialty items,
including chicken sausages, chicken burgers, and gourmet soups. Their products
are sold in club stores and retail food stores. Some of their most popular
sausage items include red bell pepper with basil, and spinach with Asiago
cheese.

                                       43`

---

`As part of the acquisition, Monterey Gourmet Foods determined the
components that represent the intangible assets and goodwill purchased as part
of the initial purchase price. Under the purchase method of accounting, the
total purchase price is allocated to Casual's tangible and intangible assets
based upon their estimated fair value as of the date of completion of the
acquisition. Based upon the purchase price, the purchase price allocation is as
follows (in thousands of dollars):`

|Cash paid directly to owners of Casual                                    $     6,000
Acquisition costs incurred                                                        159
                                                                          -----------
   Total cost of acquisition                                                    6,159
                                                                          -----------

Liabilities assumed:
   Accounts payable                                                               325
   Income taxes payable                                                           159
   Other accrued liabilities                                                      504
   Long-term notes payable                                                        266
   Deferred tax liability created at time of acquisition                        1,069

Tangible assets acquired:
   Cash on hand                                                                  (524)
   Accounts receivable, net                                                      (524)
   Income tax refund recievable                                                  (264)
   Inventory                                                                     (315)
   Prepaid expenses and other                                                     (30)
   Fixed assets                                                                  (183)
Computed interest on non-interest bearing notes                                     8

Intangible assets acquired:
   Customer Relations                                                          (2,500)
   Non Compete                                                                   (800)
   Trademarks                                                                    (840)
   Recipes                                                                       (400)

                                                                          -----------
Goodwill acquired in transaction                                          $     2,110
                                                                          ===========
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`As a result of a significant reduction in sales at Casual Gourmet Foods,
the Company determined that indicators of impairment existed for the Casual
Gourmet Foods intangible assets and potentially the reporting unit as a whole
during the third quarter of 2006. Accordingly, in accordance with Statement of
Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible
Assets" and SFAS No. 144 "Accounting for the Impairment of Disposal of
Long-Lived Assets," the Company applied impairment tests to its intangible
assets, including goodwill. As a result of this testing and in accordance with
SFAS No. 142, the Company recorded a pre-tax, non-cash charge of approximately
$3.2 million in the third quarter of 2006 related to the impairment of
intangible assets associated with the acquisition of Casual Gourmet Foods in
January 2005. The values of the intangible assets and goodwill recorded as
assets on the Company's balance sheet at December 31, 2006 are:`

|Current values of intangible assets (in thousands)

   Customer Relations                                                     $        67
   Non Compete                                                                    128
   Trademarks                                                                     440
   Recipes                                                                         38
   Goodwill                                                                     2,135
                                                                          -----------
Total                                                                     $     2,808
                                                                          ===========
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The Sonoma Foods Purchase in 2005

      On April 7, 2005, the Company entered into a definitive agreement with
Sonoma Foods, Inc. ("Sonoma") and the shareholders of Sonoma ("Shareholders")
for the purchase by the Company of 80% of Sonoma's outstanding shares ("Stock
Purchase Agreement"). The Stock Purchase Agreement provides options for Sonoma's
two other shareholders to sell their remaining 20% interest after four years
and, if that option is not exercised, there is an option for the Company to
acquire the interest after seven years. This option has a $0 fair value since
the option does not offer the holder any material economic advantage. Sonoma
will continue to operate under its current management with its Board of
Directors controlled by the Company.

                                       44`

---

`Sonoma markets a variety of refrigerated branded specialty cheese items,
including its flagship products, Sonoma Jack Cheeses in a variety of flavors.
Sonoma's products are sold in retail supermarkets, club stores, and specialty
food stores across the US with the greatest penetration in the Western US
markets. Some of the most popular cheese flavors include Hot Pepper Jack Cheese,
Garlic Jack Cheese, Mediterranean Jack Cheese and Pesto Jack Cheese. Sonoma
maintains its headquarters in Sonoma, CA. The Company acquired Sonoma in order
to expand and diversify its product line in the specialty foods category in
which it competes.

      For its initial acquisition of 80% of Sonoma's outstanding shares, the
Company paid $3.3 million in cash and issued 62,150 shares of the Company's
common stock valued at $198,000 plus acquisition costs of $129,000. Purchase of
the remaining shares will be at a price derived from a predetermined calculation
based upon a percentage of earnings before taxes, interest, bonuses,
depreciation and amortization during the interim periods. Initially, Sonoma
operated as an independent operating unit, however, effective September 2006,
all operations including sales, marketing, logistics, warehousing, product
development, and all overhead departments, have been fully integrated into
Monterey Gourmet Foods' consolidated operations. The Company controls a majority
of the Board of Directors and will be entitled to all future profits and is at
risk for all future losses, if any.

      As part of the acquisition, the Company commissioned a valuation study to
determine the components that represent the intangible assets and goodwill
purchased as part of the initial purchase price. Under the purchase method of
accounting, the total purchase price was allocated to Sonoma's tangible and
intangible assets based upon their estimated fair value as of the date of
completion of the acquisition. Based upon the purchase price, the purchase price
allocation was as follows (in thousands of dollars):`

|Cash paid directly to Sonoma for debt payment                             $     3,000
Cash paid directly to owners of Sonoma                                            300
Value of 61,250 shares of Monterey Gourmet Foods
   common stock issued to owners of Sonoma                                        198
Acquisition costs incurred                                                        129
                                                                          -----------
   Total cost of acquisition                                                    3,627
                                                                          -----------

Accounts payable assumed                                                          577
Notes, loans, and capital leases payable                                          287
Minority interest                                                                 159
Cash acquired at time of acquisition                                                -
Inventory valuation adjustment to market                                           (8)
Tangible assets acquired:
   Accounts receivable less allowances                                           (580)
   Inventories                                                                   (330)
   Deferred tax assets-current                                                     (1)
   Prepaid expenses and other                                                      (2)
   Property and equipment                                                        (529)
   Deposits and other                                                            (104)
Intangible assets assumed:
   Non-compete agreements                                                         (56)
   Customers                                                                     (762)
   Tradenames                                                                    (574)
                                                                          -----------
Goodwill acquired in transaction                                          $     1,704
                                                                          ===========
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The following unaudited pro forma financial information presents a summary
of our consolidated results of operations for the year ended December 31, 2005
assuming Casual Gourmet Foods, Inc. (see the Company's current reports on Form
8-K and 8-K/A dated January 18 and March 28, 2005, respectively), and Sonoma
Foods, Inc. (see the Company's current reports on Form 8-K and 8-K/A dated April
13 and June 22, 2005, respectively) acquisitions had taken place as of January
1, 2005 (in thousands except per share data).

                                       45`

---

``

|December 31, 2005
                                                                         -----------------
                                                                            (unaudited)

Net revenues                                                             $          87,815

Net loss                                                                 $            (660)
                                                                         =================

Net loss per common share:
Basic loss per common share                                              $           (0.05)
                                                                         =================

Diluted loss per common share                                            $           (0.05)
                                                                         =================

Basic shares outstanding                                                        14,450,251
Diluted shares outstanding                                                      14,450,251
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The unaudited condensed pro forma financial information has been prepared
for comparative purposes only and reflects the historical audited results of
Casual Gourmet Foods and Sonoma Foods. The pro forma financial information
includes adjustments to reflect interest expense generated from cash that was
used for the acquisition and related income tax adjustments. The pro forma
information also includes an estimate of amortization of identifiable intangible
assets. The pro forma information does not purport to be indicative of operating
results that would have been achieved had the acquisition taken place on the
dates indicated or the results that may be obtained in the future.

   3. Concentration of Credit Risk

      Financial instruments, which potentially subject the Company to
concentration of credit risk, include cash, cash equivalents, and accounts
receivable. The Company maintains its cash accounts in Comerica Bank in Fresno,
California. The bank cash balances are insured by the Federal Deposit Insurance
Corporation up to $100,000. In addition, as of December 31, 2007, approximately
57% of the Company's accounts receivables are concentrated with two major
customers (See Note 11).

   4. Inventories

      Inventories consisted of the following:`

|2007               2006
                                                              -----------------    --------------
                                                                        (in thousands)

Production - Ingredients                                       $          3,266    $        3,178
Production - Finished goods                                               3,561             3,174
Paper goods and packaging materials                                       1,115             1,382
Operating supplies                                                           76               113
                                                              -----------------    --------------
                                                                          8,018             7,847

Allowances for spoils and obsolescence                                     (153)             (273)
                                                              -----------------    --------------
                                                              $           7,865    $        7,574
                                                              =================    ==============
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`46`

---

`5. Property and Equipment

      Property and equipment consisted of the following:`

|2007            2006
                                                                  ------------    ------------
                                                                          (in thousands)

Leasehold improvements                                            $      6,141    $      5,508
Machinery and equipment                                                 22,699          21,215
Computers, office furniture and equipment                                1,420           1,393
Vehicles                                                                   420             454
                                                                  ------------    ------------
                                                                        30,680          28,570

Less accumulated depreciation and amortization                         (16,692)        (14,754)
                                                                  ------------    ------------
                                                                        13,988          13,816
Construction in progress                                                   292           1,487
                                                                  ------------    ------------
                                                                  $     14,280    $     15,303
                                                                  ============    ============
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`Construction in progress at December 31, 2007 includes deposits for
equipment on order or yet to be installed or in the process of being installed.
The Company believes it will cost approximately $390,000 to complete projects
that have already been started.

      Depreciation expense for 2007, 2006, and 2005 was $2,300,000, $2,052,000,
and $2,075,000 respectively.

   6. Goodwill and Other Intangible Assets

      Goodwill and other intangible assets consisted of (in thousands of
dollars):`

|Gross goodwill and
                                    intangible assets
                            --------------------------------                      Net
                            Year-end    2006     Impairments                  Accumulated   Carrying
                              2005    Additions      2006      Year-end 2006  Amortization   Amount
                            --------  ---------  -----------   --------------------------------------
Trademarks and tradenames   $    220  $       -  $         -   $         220  $        220  $       -
Customer lists                 8,002          -       (2,020)          5,982         2,031      3,951
Other intangibles              1,982          -         (740)          1,242           845        397
                            --------  ---------  -----------   --------------------------------------
   Total amortized
      intangible assets       10,204          -       (2,760)          7,444         3,096      4,348

Intangible assets with
   indefinite lives            3,104          -         (400)          2,704             -      2,704
                            --------  ---------  -----------   --------------------------------------

   Total intangible assets    13,308          -       (3,160)         10,148         3,096      7,052

Goodwill                      11,956      1,255            -          13,211             -     13,211
                            --------  ---------  -----------   --------------------------------------

   Total goodwill and
      intangible assets     $ 25,264  $   1,255  $    (3,160)  $      23,359  $      3,096  $  20,263
                            ========  =========  ===========   ======================================
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`47`

---

``

|Gross goodwill and
                                    intangible assets
                            --------------------------------                       Net
                            Year-end     2007    Impairments                   Accumulated  Carrying
                              2006    Additions     2007       Year-end 2007  Amortization   Amount
                            --------  ---------  -----------   --------------------------------------
Trademarks and tradenames   $    220  $       -  $         -   $         220  $        220  $       -
Customer lists                 5,982          -            -           5,982         2,546      3,436
Other intangibles              2,112          -            -           2,112           978      1,134
                            --------  ---------  -----------   --------------------------------------
   Total amortized
      intangible assets        8,314          -            -           8,314         3,744      4,570

Intangible assets with
   indefinite lives            1,834          -          (58)          1,776             -      1,776
                            --------  ---------  -----------   --------------------------------------

   Total intangible assets    10,148          -          (58)         10,090         3,744      6,346

Goodwill                      13,211          -            -          13,211             -     13,211
                            --------  ---------  -----------   --------------------------------------

   Total goodwill and
      intangible assets     $ 23,359  $       -  $       (58)  $      23,301  $      3,744  $  19,557
                            ========  =========  ===========   ======================================
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`Amortization expense was $648,000, $876,000, and $958,000 for 2007, 2006
and 2005 respectively.

      As part of the Company's ongoing review of the useful lives of its
intangible assets, the Company determined during the quarter ended June 30, 2007
that a change was warranted in the useful life of its recipes acquired as part
of the Company's purchase of CIBO Naturals LLC in 2004. Prior to June 30, 2007,
the CIBO recipes had been considered to have an indefinite life and not been
subject to amortization. Based on recent interactions with customers, however,
the Company began amortizing the recipes over a ten year useful life which is
comparable to the useful lives of the CIBO customer lists. As a result, the
Company recorded amortization on the CIBO recipes of $50,800 for the year ended
December 31, 2007.

      As a result of a reduction in sales with the Sonoma Foods brand during
2007, the Company determined that indicators of impairment existed for Sonoma
Foods intangible assets. Accordingly, in accordance with Statement of Financial
Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets" and
SFAS No. 144 "Accounting for the Impairment of Disposal of Long-Lived Assets,"
the Company applied impairment tests. As a result of this testing and in
accordance with SFAS No. 142, the Company recorded a pre-tax, non-cash charge of
$58,000 in the fourth quarter of 2007 related to the impairment of intangible
assets associated with the acquisition of Sonoma Foods in April 2005, which is
reflected in the table above.

      As a result of a significant reduction in sales with the Casual Gourmet
Foods brand during the third quarter of 2006 the Company determined that
indicators of impairment existed for the Casual Gourmet Foods intangible assets
and potentially the reporting unit as a whole. Accordingly, in accordance with
Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" and SFAS No. 144 "Accounting for the Impairment of Disposal
of Long-Lived Assets," the Company applied impairment tests to its intangible
assets, including goodwill. As a result of this testing and in accordance with
SFAS No. 142, the Company recorded a pre-tax, non-cash charge of $3.2 million in
the third quarter of 2006 related to the impairment of intangible assets
associated with the acquisition of Casual Gourmet Foods in January 2005, which
is reflected in the table above.

      The Company performed annual impairment testing as required by SFAS 142
during the fourth quarter of 2007 to determine if any additional writedowns were
necessary, with no impairment adjustments needed except as noted above.

      Following is table of estimated amortization expense for the next five
years:

                                          Estimated Amortization
                           Year                   Expense
                           ----           ----------------------
                                              (In thousands)

                           2008                  $   680
                           2009                      678
                           2010                      665
                           2011                      643
                           2012                      563
            2013 and thereafter                    1,341
                                                 -------
                          Total                  $ 4,570
                                                 =======

                                       48`

---

`7. Notes, Loans, and Capitalized Leases Payable

      Notes, loans and capital leases payable consist of (in thousands):`

|2007       2006
                                                                                   --------    -------

Subordinated note payable to OBIC Inc.; assumed from CIBO Naturals stock purchase  $      -    $   944
   Monthly principal payments of $8,000 starting April 1, 2006
   Matures in July 2007
Notes assumed from Casual Gourmet stock purchase                                         15         92
   Interest rate at 0.0%; payable in monthly payments of $725
   Maturing September 2009
Note payable assumed from Sonoma Foods stock purchase                                    29         44
   Payable in monthly payments of $3,857 including interest of 15.88% and 17.6%
   Matures in June 2009
Capital leases payable                                                                   35         67
                                                                                   --------    -------

Total notes, loans, and capital leases payable                                      $    79    $ 1,147

Less current portion of notes, loans, and capital leases payable                        (50)    (1,018)
                                                                                   --------    -------

Notes, loans, and capital leases payable, less current portion                     $     29    $   129
                                                                                   ========    =======
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The weighted average interest rate on notes payable with outstanding
balances at December 31, 2007 was 14%.

      Credit Facility

      The Company has a $5.0 million working capital line of credit which was
not utilized as of December 31, 2007 and a letter of credit in the amount of
$800,000 which is issued in favor of an insurance company to support a
self-funded worker's compensation program. No additional loans are available to
the Company without bank approval. The working capital commitment in place at
December 31, 2007 expires June 30, 2008. The interest rate on this entire credit
line will be calculated at the bank's prime lending rate or LIBOR plus 2.00%,
which ever the Company chooses.

      The terms of the Credit Facility prohibit the payment of cash dividends
(except with written approval) on the Company's capital stock and restrict
payments for, among other things, repurchasing shares of Company's capital
stock. Other terms of the Credit Facility limit the Company with respect to,
among other things, (i) incurring additional indebtedness, (ii) adversely
changing the capital structure, and (iii) acquiring assets other than in the
normal course of business, and (iv) meeting certain financial covenants. The
Company's assets are held as collateral for the working capital line of credit.
The Company began with the bank's approval a program to repurchase its own stock
which was a violation of the Company's debt covenants with the bank. As of
December 31, 2007, excluding the waiver from the bank, the Company was not in
violation of any bank covenant.

      Effective January 1, 2008, the Company initiated an $800,000 Letter of
Credit in favor of Sentry Insurance as required collateral for a deductible
worker's compensation program. The new letter of credit expires January 2, 2009.

      Future principal payments due under notes, loans, and capital leases
payable are as follows (in thousands):

                         Year                      Principal Amount
                    --------------                 ----------------
                         2008                      $             50

                         2009                                    29
                                                   ----------------
                                                   $             79
                                                   ================

      Employment Contracts

      On September 5, 2006, the Board of Directors of the Company appointed Eric
Eddings as President and Chief Executive Officer of Monterey Gourmet Foods. As
part of the employment contract with Mr. Eddings which was signed on September
15, 2006, the Company will pay Mr. Eddings a base salary of $285,000 per year.
Mr. Eddings is eligible for an annual cash bonus based on performance and
achieving certain goals. In addition, Mr. Eddings received an incentive stock
option to purchase 150,000 shares of the Company's common stock, to be vested
and exercisable in installments of 50,000 shares on each of the first, second,
and third anniversaries of his employment agreement. As part of the agreement,
if Mr. Eddings is terminated by the Board of Directors without cause, Mr.
Eddings will be eligible for severance compensation equal to twelve months of
his then applicable base annual salary.

                                       49`

---

`In addition, the management team of Sonoma Foods has employment contracts
that extend through April 2009.

      Capitalized Leases

      The Company leases certain equipment under capitalized leases, including
office equipment, and a forklift, with a liability of $35,000 and $67,000 in
2007 and 2006, respectively.

   8. Operating Leases

      The Company currently leases production, warehouse and corporate office
space as well as certain equipment in Monterey County, California under both
month-to-month and non-cancelable operating lease agreements, expiring at
various times through 2014. The terms of the leases generally require the
Company to pay common area maintenance, taxes, insurance, and certain other
costs. All building leases have renewal options (see Item 2 "Properties" on page
12) and all include cost of living adjustments. The Company records rent expense
on a straight-line basis over the lease term.

      Future minimum annual lease payments due under non-cancelable operating
leases with terms of more than one year are as follows (in thousands):

                   Year                            Lease Amount
                   ----                            ------------
                   2008                            $      1,441
                   2009                                   1,581
                   2010                                   1,606
                   2011                                   1,633
                   2012                                   1,417
                   2013 and Thereafter                    4,446
                                                   ------------
                                                   $     12,124
                                                   ============

      Gross rent expense under the leases for 2007, 2006, and 2005 was
$1,515,000, $1,338,000, and $1,286,000 respectively. The Company's three
production facilities are leased. The Company leases approximately 130,000
square feet at two locations in Salinas, California. The current production
facilities/headquarters lease expires in October 2014. The lease for the
distribution center and storage facilities expires in May 2012.

      The Company acquired a lease for the 19,000 square foot production
facility and offices in Eugene, Oregon, as part of its acquisition of Emerald
Valley. The lease expires December 31, 2012, with two five-year renewal options.
In 2004, in connection with its CIBO Naturals acquisition, the Company assumed
an operating lease of 47,500 square feet in Seattle, Washington under a lease
which expires in May 2008. The Company has recently signed a new 10 year lease
in Kent, Washington for 93,306 square feet for occupancy starting March 1, 2008
and the lease will expire on February 28, 2018.

   9. Stockholders' Equity

      Preferred Stock

      The Company has 1,000,000 Preferred Shares at $.001 par value authorized;
however none are issued.

      Common Stock

      During 2007 employee and director options representing 20,750 shares of
common stock were exercised for proceeds of $40,000 and 8,579 employee stock
purchase plan shares were issued for proceeds of $26,000. In addition, 20,000
shares of unregistered common stock valued at $77,000 were issued to a culinary
consultant as a onetime payment for his work.

      On December 10, 2007 the Company announced that its Board of Directors had
authorized the Company to institute a stock repurchase program whereby up to
750,000 shares of its Common Stock may be repurchased. The duration of the
repurchase program is open-ended. Under the program, the Company is able to
purchase shares of common stock through open market transactions at prices
deemed appropriate by management. The timing and amount of repurchase
transactions under this program will depend on market conditions and corporate
and regulatory considerations. The program may be discontinued at any time by
the Board of Directors. As of December 31, 2007, the Company has repurchased
215,000 shares of the Company's common stock at an average price of $3.06 per
share.

                                       50`

---

`During 2006 employee and director options representing 308,709 shares of
common stock were exercised for proceeds of $894,000 and 10,900 employee stock
purchase plan shares were issued for proceeds of $32,000.

      On January 12, 2006, the Company, Suekat LLC ("Suekat") and CIBO Naturals,
LLC ("CIBO"), amended their previous agreement for the purchase and sale of
limited liability company units. As a result, the Company acquired the remaining
15.5% of CIBO from Suekat in exchange for 300,000 unregistered shares of the
Company's common stock with a market value of $1,186,000.

      On June 28, 2006 the Company announced the completion of a private
placement of 2,174,000 shares of Monterey Gourmet Foods common stock at a price
of $5.75 per share for net proceeds of $11.6 million. In addition, the Company
issued fully vested warrants to investors to purchase a total 652,200 shares of
common stock of the Company at an exercise price of $7.50 per share. Part of the
proceeds was used to pay down the Company's bank debt. Monterey Gourmet Foods
filed a registration statement with the SEC to register the resale of the shares
of common stock issued in the private placement, as well as the shares of common
stock issuable upon the exercise of the warrants issued in the private
placement. The registration statement was declared effective by the SEC on
August 4, 2006. Stock offering costs of $868,000 have been reflected as a
reduction of the gross proceeds received.

      During 2005 employee and director options representing 51,116 shares of
common stock were exercised for proceeds of $128,000 and 8,198 employee stock
purchase plan shares were issued for proceeds of $25,000. In addition, as part
of the Sonoma Foods acquisition, 62,150 shares of common stock were issued with
a value of $198,000.

      Employee Stock Purchase Plan

      In October 1994, the Company's Board of Directors adopted a qualified
employee stock purchase plan. Under the purchase plan, eligible employees (those
who have completed one year of continuous employment with the Company) may
purchase shares of the Company's common stock through payroll deductions not to
exceed 10% of gross wages. The Company has reserved 200,000 shares of its common
stock for issuance under the purchase plan, which remains in effect until
terminated by the Company's Board of Directors, or until all of the shares
reserved for under the purchase plan have been issued. Unless the Board has
otherwise provided a higher amount prior to the commencement of an 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 date of such
offering period or (b) the fair market value of the shares on the given purchase
date. There were 8,597 shares 10,900 shares, and 8,198 shares of common stock
issued under the plan in 2007, 2006, and 2005 respectively. At December 31,
2007, there were 119,037 shares remaining available for purchase under the plan.

      Income per Share Calculation

      The Company has reported its earnings/ (loss) in accordance with Statement
of Financial Accounting Standard ("SFAS") No. 128, "Earnings per Share." Basic
net income/ (loss) per common share is based on the weighted average number of
shares outstanding during the period. Diluted net income/ (loss) per common
share is based on the weighted average number of shares outstanding during the
period, including common stock equivalents. The reconciliation of the share
denominator used in the basic and diluted net income per share computations is
as follows:`

|2007              2006               2005
                                                   ----------        ----------         ----------

Weighted average common shares
   outstanding used in basic
   net income per share computation                17,329,365        16,100,250         14,450,251

Dilutive effect of common stock equivalents,
   using the treasury stock method                    105,836                 -                  -
                                                   ----------        ----------         ----------

Shares used in dilutive net income per share
   computation                                     17,435,201        16,100,250         14,450,251
                                                   ==========        ==========         ==========
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`Basic earnings per share are based on earnings available to common
stockholders divided by the weighted-average number of common shares actually
outstanding during the period. Diluted earnings per share also include the
incremental effect of any dilutive common stock equivalents assumed to be
outstanding during the period. Because of equivalent shares includable in
different periods or at different amounts, per-share amounts for the four
quarters do not necessarily equal per-share amounts for the entire year.

                                       51`

---

`Outstanding options to purchase 1,031,982, 1,687,435, and 1,807,194 shares
of common stock for 2007, 2006, and 2005, respectively were excluded from the
computation of diluted earnings per share because they were anti-dilutive.

      The Company repurchased 215,000 shares at an average price of $3.06 during
the calendar year 2007 under the Company's stock repurchase program.

      Stock-Based Compensation Expense

      On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors based on estimated
fair values. SFAS 123(R) supersedes previous accounting under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") for periods beginning before calendar year 2006. In March 2005, the
Securities and Exchange Commission issued Staff Accounting Bulletin No. 107
("SAB 107") relating to SFAS 123(R). The Company has applied the provisions of
SAB 107 in its adoption of SFAS 123(R).

      SFAS 123(R) requires companies to estimate the fair value of share-based
payment awards to employees and directors on the date of grant using an
option-pricing model. The value of the portion of the award that is ultimately
expected to vest is recognized as expense over the requisite service periods in
our Consolidated Statements of Operations. Prior to the adoption of SFAS 123(R),
the Company accounted for stock-based awards to employees and directors using
the intrinsic value method in accordance with APB 25 as allowed under Statements
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). Under the intrinsic value method, no stock-based
compensation expense had been recognized in the Consolidated Statements of
Operations for awards to employees and directors because the exercise price of
stock options equaled the fair market value of the underlying stock at the date
of grant.

      Stock-based compensation expense recognized in the Consolidated Statements
of Operations for the year ended December 31, 2007 and December 31, 2006
included compensation expense for share-based payment awards granted prior to,
but not yet vested as of January 1, 2006 based on the grant date fair value
estimated in accordance with the pro-forma provisions of SFAS 123 and
compensation expense for the share-based payment awards granted subsequent to
January 1, 2006 based on the grant date fair value estimated in accordance with
the provisions of SFAS 123(R). For stock-based awards issued to employees and
directors, stock-based compensation is expensed ratably over the vesting period,
which is consistent with how the prior-period proformas were provided. As
stock-based compensation expense recognized in the Consolidated Statements of
Operations for the year ended December 31, 2007 and December 31, 2006 is based
on awards ultimately expected to vest, it has been reduced for estimated
forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates.

      The determination of fair value of share-based payment awards to employees
and directors on the date of grant using the Black-Scholes model is affected by
the Company's stock price as well as assumptions regarding a number of highly
complex and subjective variables. These variables include, but are not limited
to the expected stock price volatility over the term of the awards, and actual
and projected employee stock option exercise behaviors. Prior to 2006, the
Company estimated expected terms based on historical Company data and compared
to a peer group of public companies. For grants issued between January 1, 2000
and June 30, 2007, management estimated expected term using the simplified
method provided in SAB 107. For grants issued after July 1, 2007, management
estimated expected term based on 11 years of exercise history. Management has
used six years of historical data to estimate forfeitures. The risk-free rate is
based on U.S. Treasury rates in effect during the corresponding period of grant.
The expected volatility is based on the historical volatility of the Company's
stock price.

                                       52`

---

`The Company accounts for stock option grants in accordance with Statement
of Financial Accounting Standards No. 123 (revised 2004), "Share Based Payment"
"SFAS 123(R)". Stock-based compensation expense recognized under SFAS 123(R) for
employees, directors, and outside consultants is as follows:`

|2007             2006                2005
                                                    ----------       -----------         ----------

Stock based compensation expense:
   Recorded in cost of sales                        $  150,000       $    55,000         $        -
   Recorded in selling, general and administrative     450,000           461,000             80,000
                                                    ----------       -----------         ----------
Total stock based compensation                      $  600,000       $   516,000         $   80,000
                                                    ==========       ===========         ==========

Estimated fair value of options granted to
   employees and directors                          $  523,000       $ 1,005,000         $  436,000
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The main reason for the increase in stock-based compensation in 2007
compared to 2006 is that in 2005 the Company elected to vest all stock options
that had a strike price higher than the stock price at the time the stock
options were vested and the Company issued 20,000 restricted shares of the
Company's common stock valued at $77,000 to a culinary consultant.

      Assumptions used to value the options were as follows:`

|2007              2006               2005
                                                    ----------        ----------         ----------

Dividend yield                                               -                 -                  -

Volatility                                                41.4%             52.3%              53.7%

Risk-free interest rates                                  4.73%             4.75%              3.58%

Expected lives in years                                   5.94                 6                  6

Forfeiture rate                                           13.5%              7.0%                 -
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The following table illustrates the effect on net loss and loss per share
if the Company had applied the fair value recognition provisions of SFAS 123 to
stock-based awards granted under the Company's stock option plans for 2005.
Proforma disclosures for 2007 and 2006 are not presented because the amounts are
recognized in the Consolidated Statement of Operations. For purposes of this
pro-forma disclosure, the fair value of the options is estimated using the
Black-Scholes-Merton option-pricing formula ("Black-Scholes model") and
amortized to expense over the options' contractual term (in thousands except
share data).`

|2005
                                                                           ------------
Net income (loss) as reported                                              $      (537)

Add: stock-based employee compensation expense
   included in reported net loss, net of related tax effects                        80

Deduct: total stock-based employee compensation
   determined under fair value method for all awards,
   net of related tax effects                                                     (619)
                                                                           -----------

Proforma net loss, as adjusted                                                  (1,076)
                                                                           ===========

Earnings per share:
Basic, as reported                                                         $     (0.04)
Basic, as adjusted                                                         $     (0.07)
                                                                           ===========

Diluted, as reported                                                       $     (0.04)
Diluted, as adjusted                                                       $     (0.07)
                                                                           ===========

Basic shares                                                                14,450,251
Diluted Shares                                                              14,450,251
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`53`

---

`Warrants

      On June 28, 2006 the Company announced the completion of a private
placement of 2,174,000 shares of Monterey Gourmet Foods common stock. In
connection with this private placement the Company also issued warrants for
652,200 shares of common stock with a conversion price of $7.50 per share. The
warrants remain exercisable for a period of five years from June 28, 2006. The
warrants are subject to call at the option of the Company after 18 months, if
among other things, the registration statement filed by the Company to register
the resale of the shares (including the warrant shares) issued in the June 28,
2006 private placement is effective and the volume weighted average trading
price of the Company's common stock is $15 or higher for 20 consecutive trading
days. The warrants meet the requirements of and are being accounted for as
equity in accordance with EITF 00-19 "Accounting for Derivative Financial
Instruments Indexed to or Potentially Settled in a Company's Own Stock." All of
the 2,174,000 warrants remain outstanding as of December 31, 2007.

      Stock Options

      The Company's 2002 Stock Option Plan, originally established in 1993 (the
"Plan"), provides for the granting of incentive stock options or non-qualified
stock options to eligible employees, consultants and outside directors. The
Company initially reserved 1,200,000 shares of its common stock for issuance
under the Plan and in subsequent years increased the total shares reserved to
3,240,000. The Plan provides that the option price shall not be less than the
fair market value of the shares on the date of grant. Options generally vest
over a period of one to three years and may be exercised for a period of up to
ten years. During 2001, the Company issued additional options to purchase up to
155,200 shares outside of the Plan (the "Nonstatutory Plan"). The Plan expires
April 30, 2012. As of December 31, 2007, the Company had 304,387 shares
available for new grants under the Plan, and 129,300 shares available for new
grants under the Nonstatutory Plan.

      In 2005, the Board of Directors amended the 2002 stock option plan and
forms of option agreement (1) to allow retiring or deceased or disabled
directors who satisfy the board's age and service requirements to exercise their
vested options at any time prior to the end of their stated term and (2) to make
certain necessary technical changes. Prior to this change, a retiring director
would have been required to exercise his options within 90 days of retirement.
This requirement may have made it difficult or impossible for retiring directors
to exercise their options in a manner which would not conflict with the
Company's insider trading policy. The board also determined that the proposed
changes would not adversely affect any outstanding option under the plan and
therefore directed that each outstanding option granted to a current director
shall be deemed to have been modified to permit extended exercise in accordance
with the approved revised form of agreement for such option. This amendment
caused the Company to incur a non-cash compensation expense in 2005 of $80,000
due to the death of its Chairman Mr. Lance Hewitt.

                                       54`

---

`The following table summarizes option activity:`

|Weighted
                                                            Weighted         Average        Aggregate
                                                             Average        Remaining       Intrinsic
                                               Shares    Exercise Price  Contractual Life     Value
                                             ---------   --------------  ----------------  -----------

                                                      2005
                                             --------------------------
Outstanding at beginning of year             1,763,810   $         4.44
Granted                                        258,000             3.72
Exercised                                      (51,116)            2.44
Canceled or expired                           (163,500)            6.30
                                             ---------   --------------
Outstanding at end of year                   1,807,194   $         4.24
                                             =========   ==============

                                                      2006
                                             --------------------------
Outstanding at beginning of year             1,807,194   $         4.24
Granted                                        470,000             4.42
Exercised                                     (308,709)            2.90
Canceled or expired                           (281,050)            4.40
                                             ---------   --------------
Outstanding at end of year                   1,687,435   $         4.51        6.34        $   919,978
                                             =========   ==============  =============================

Vested/expected to vest at end of year       1,644,161   $         4.51        6.34        $   905,959
                                             =========================================================

Options exercisable at year end              1,269,855   $         4.51        5.31        $   772,266
                                             =========   ==============  =============================

                                                      2007
                                             --------------------------
Outstanding at beginning of year             1,687,435   $         4.51
Granted                                        258,600             4.30
Exercised                                      (20,750)            1.92
Canceled or expired                           (151,249)            4.28
                                             ---------   --------------
Outstanding at end of year                   1,774,036   $         4.53        5.47        $    72,891
                                             =========   ==============  =============================

Vested/expected to vest at end of year       1,665,571   $         4.53        5.25        $    72,891
                                             =========================================================

Options exercisable at year end              1,383,111   $         4.53        4.50        $    72,891
                                             =========   ==============  =============================
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The aggregate intrinsic value in the preceding table represents the total
intrinsic value based on the closing stock price of $3.19 as of December 31,
2007, which would have been received by the option holders had all option
holders exercised as of that date. The aggregate intrinsic value of options
exercised during the calendar year 2007 was $42,000.

      The weighted average grant-date fair value of options granted was $2.02,
$2.14 and $1.69 for the years ended December 31, 2007, 2006, and 2005.

                                       55`

---

`The following table shows information for options outstanding or exercisable as
of December 31, 2007:`

|OPTIONS OUTSTANDING                         OPTIONS EXERCISABLE
                  --------------------------------------------------   ------------------------------
                                       Weighted
                      Number           Average           Weighted          Number         Weighted
   Range of         Outstanding       Remaining           Average        Exercisable       Average
Exercise Prices   As of 12/31/07   Contractual life   Exercise Price   As of 12/31/07  Exercise Price
----------------  --------------   ----------------   --------------   --------------  --------------
$  1.19  $  3.34         234,735         3.31 Years   $         2.95          224,735  $         2.94
$  3.35  $  3.44         237,100         5.66 Years   $         3.41          224,500  $         3.41
$  3.45  $  3.76         193,200         5.02 Years   $         3.70          193,200  $         3.70
$  3.77  $  3.89         196,500         7.94 Years   $         3.88           93,167  $         3.87
$  3.90  $  4.26         205,501         5.32 Years   $         4.01          159,505  $         3.98
$  4.30  $  4.81         184,000         8.73 Years   $         4.42           15,000  $         4.81
$  4.99  $  6.05         185,800         3.96 Years   $         5.82          185,800  $         5.82
$  6.43  $  6.94         203,200         3.69 Years   $         6.64          203,200  $         6.64
$  7.14  $  9.20         133,000         6.54 Years   $         7.37           83,004  $         7.50
$  9.25  $  9.25           1,000         4.28 Years   $         9.25            1,000  $         9.25
                  --------------                                       --------------
$  1.19  $  9.25       1,774,036         5.47 Years   $         4.53        1,383,111  $         4.53
                  ==============                                       ==============
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`The following table provides information about our common stock that may
be issued upon the exercise of options, warrants or rights under all of our
existing equity compensation plans as of December 31, 2007, including the
Monterey Gourmet Foods 2002 Stock Option Plan and the Monterey Gourmet Foods
2001 Nonstatutory Stock Option Plan.`

|Number of securities
                                                                               remaining available for
                    Number of securities to be                                  future issuance under
                     issued upon exercise of     Weighted-average exercise    equity compensation plans
                       outstanding options,         price of outstanding        (excluding securities
                       warrants and rights      options, warrants and rights   reflected in column (a))
   Plan category               (a)                          (b)                          (c)
-------------------------------------------------------------------------------------------------------
Equity compensation
  plans approved
  by security
  holders                  1,723,336(1)                    $4.47                       304,387
-------------------------------------------------------------------------------------------------------
Equity compensation
  plans not
  approved by
  security holders            50,700(2)                    $6.55                       129,300
-------------------------------------------------------------------------------------------------------
Total                      1,774,036                       $4.53                       433,687
-------------------------------------------------------------------------------------------------------
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`(1)   Issued under the Monterey Gourmet Foods 2002 Stock Option Plan.

(2)   Issued to Company employees under the Monterey Gourmet Foods 2001
      Nonstatutory Stock Option Plan.

                                       56`

---

`10. Income Taxes

      The Company's income tax benefit (provision) consists of (in thousands):

                                             2007        2006          2005
                                           --------     ------        ------
         Current:

            Federal                        $    176     $   (2)       $   25
            State                               (17)       (11)           27
                                           --------     ------        ------
               Total                            159        (13)           52
                                           --------     ------        ------

         Deferred:

            Federal                            (613)      (375)          334
            State                              (146)        93            45
                                           --------     ------        ------
               Total                           (759)      (282)          379
                                           --------     ------        ------

            Net tax benefit (expense)      $   (600)    $ (295)       $  431
                                           ========     ======        ======

      The reason the Company recorded a current tax benefit for federal in 2007
is due to a loss carryback claim made during 2007. Without the loss carryback
claim, the Company would have reported a federal alternative minimum tax of
approximately $36,000.

      Reconciliation between the Company's effective tax rate and U.S. Federal
income tax rate on loss from continuing operations follows:

                                              2007        2006         2005
                                            -------     -------       ------

         Federal statutory rate                34.0%     (34.0)%        34.0%

         State income taxes, net of effect
            on federal income taxes             6.9%      (3.0)%         3.4%

         Federal and State valuation
            allowances                        (22.3)%     44.0%          0.0%

         Manufacturing investment credits       0.0%       0.0%          4.3%

         Stock-based compensation               5.0%       2.0%          0.0%

         Other                                  2.7%       2.0%          2.8%
                                            -------     ------        ------

         Effective income tax rate             26.3%      11.0%         44.5%
                                            =======     ======        ======

      The valuation allowance for 2007, 2006 and 2005 was (reduced) increased by
($625,000), $1,222,000 and ($689,000) respectively. During 2007, the valuation
allowance decreased due to the Company's reassessment of the likelihood of
utilization of its NOLs and other deferred tax assets. This assessment was
largely based upon the Company's future projections of income, which was
impacted positively by the income generated in 2007 but offset by the losses
incurred in 2006 and 2005.

                                       57`

---

`Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets are as follows:

                                                           2007      2006
                                                         -------   -------
                                                           (in thousands)
      Deferred tax assets:

         Federal NOLs and tax credit carryovers           5,584      6,385
         Allowances against receivables and other         1,120      1,120
                                                         ------    -------
                                                          6,704      7,505

         Less valuation allowance                          (847)    (1,472)
                                                         ------    -------
      Total deferred tax assets:                          5,857      6,033

      Deferred tax liabilities:
         Accumulated depreciation and  amortization      (2,508)    (1,925)
                                                         ------    -------

      Net deferred tax assets                             3,349      4,108
                                                         ======    =======

      We have elected to track the portion of our federal and state net
operating loss carry forwards attributable to stock option benefits, in a
separate memo account pursuant to SFAS No. 123(R). Therefore, these amounts are
no longer included in our gross or net deferred tax assets. Pursuant to SFAS No.
123(R), footnote 82, the benefit of these net operating loss carry forwards will
only be recorded to equity when they reduce cash taxes payable.

      While we do not expect any impact to the effective tax rate for US
non-qualified stock option or restricted stock expense due to the adoption of
SFAS No. 123(R), the effective tax rate may be negatively impacted by incentive
stock option expense that may not be deductible for tax. Also, SFAS No. 123(R)
requires that the tax benefit of stock option deductions relating to Incentive
Stock Options (ISO's) be recorded in the period of disqualifying disposition.
This could result in fluctuations in our effective tax rate between accounting
periods.

      On November 10, 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position No. FAS 123(R)-3 "Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards." The Company has
elected to adopt the alternative transition method provided in the FASB Staff
Position for calculating the tax effects of stock-based compensation pursuant to
SFAS 123(R). The alternative transition method includes simplified methods to
establish the beginning balance of the additional paid-in capital pool ("APIC
pool") related to the tax effects of employee stock-based compensation and to
determine the subsequent impact on the APIC pool and Consolidated Statements of
Cash Flows of the tax effects of employee stock-based compensation awards that
are outstanding upon adoption of SFAS 123(R).

      As of December 31, 2007, the Company had federal NOLs totaling $14.0
million, which expire in varying amounts beginning in 2012. Should more than a
50% change in Company ownership occur within a three-year period, utilization of
these losses to reduce future taxable income would be further limited. Federal
deferred tax credits include a minimum tax credit of $290,000 and a targeted
jobs credit of $22,000. The targeted jobs credit will expire in 2020 and the
minimum tax credit will not expire. State deferred tax assets include
approximately $231,000 in California Manufacturing Tax Credits available to
offset future California income taxes, expiring in varying amounts through 2011.
In addition, the Company has some California minimum tax credits of immaterial
amount which will not expire.

      The Company realizes tax benefits as a result of non-qualified stock
options and the exercise and subsequent early resale of certain incentive stock
options (disqualifying disposition). For financial reporting purposes, any
reduction in income tax obligations as a result of these tax benefits is
credited to additional paid in capital. For the years, 2007, 2006, and 2005, tax
benefits of disqualifying dispositions totaling $0, $2,000, and $0, were
credited to stockholders' equity.

      The Company adopted the provisions of FASB Interpretation No. 48
"Accounting for Uncertainty of Income Taxes - An Interpretation of FASB
Statement No. 109" ("FIN 48") on January 1, 2007. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). This
interpretation prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition of tax benefits, classification on the balance sheet, interest and
penalties, accounting in interim periods, disclosure, and transition. The total
amount of unrecognized tax benefits as of the date of adoption was not material.
As a result of the implementation of FIN 48, the Company recorded no increase in
the liability for unrecognized tax benefits and the balance of unrecognized tax
benefits was zero at December 31, 2007.

                                       58`

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`11. Significant Customers

      Costco and Sam's Club (including Wal-Mart Supercenters) stores each
accounted for percentages of total net revenues as follows:

                                             2007        2006       2005
                                            ------      ------     ------
         Costco                               48%         48%        45%

         Sam's Club Stores                    17%         17%        17%

      At December 31, 2007 and December 31, 2006, Costco and Sam's Club stores
accounted for the following concentration of accounts receivable:

                                                2007            2006
                                               ------          ------

         Costco                                  50%              38%

         Sam's Club Stores                        7%              20%

      The Company currently sells its products to eight separate US Costco
regions, Mexico and Canada which make purchasing decisions independently of one
another. On a regular basis, these regions re-evaluate the products carried in
their stores. There can be no assurance that these Costco regions will continue
to offer the Company's products in the future or continue to allocate the
Company the same amount of shelf space. Purchasing decisions for Sam's Club
stores, the Company's second largest customer, are made at their respective head
offices with input from the stores. The Company is in the tenth year of its
relationship with Sam's Club. There can be no assurance that Sam's Club will
continue to carry the Company's products. Currently, the loss of either Costco
or Sam's Club or the significant reduction in sales to either of these customers
would materially adversely affect the Company's business operations.

      No other single customer accounted for more than 10% of revenues or
accounts receivable during 2007 and 2006.

      The Company operates in the refrigerated specialty foods segment. During
2007, 2006 and 2005 net revenues to foreign customers represented 0.8%, 1.4%,
and 2.2% of total net revenues, with Canada and Mexico accounting for over 90%
of those sales, and the remainder going to Asia Pacific. Most of the foreign
sales are invoiced in US dollars.

      The Company discloses segment enterprise-wide information in accordance
with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." Based upon definitions contained within SFAS No. 131, management
has determined that the Company operates in one segment. In addition, virtually
all revenues are in the United States, and all of the long-lived assets are
located within the United States.

      The Company's revenues by product category are as follows:

                                             2007            2006        2005
                                        -----------      ----------   ---------
      Entrees (1)                       $    59,303      $   51,087   $  48,683
      Condiments and appetizers (2)          41,224          43,210      36,565
                                        -----------      ----------   ---------
                                        $   100,527      $   94,297   $  85,248
                                        ===========      ==========   =========

(1)   Entrees include pasta, wrap sandwiches, sausages, meatballs, lasagnas,
      fresh entree meals, tamales, frozen meal solutions and similar items.

(2)   Condiments and appetizers include salsas, sauces, dips, flavored cheeses
      and cheese spreads, soups, bruschetta toppings and similar items.

   12. Litigation and Contingencies

      The Company is involved in various claims arising in the ordinary course
of business. While management currently believes that the chances these claims
against the Company, individually or in aggregate, will have a material adverse
impact on its financial position, results of operations or statement of cash
flows is remote, these matters are subject to inherent uncertainties and
management's view of these matters may change in the future. Were an unfavorable
final outcome to occur, there exists the possibility of a material adverse
impact on the Company's financial position, results of operations or statement
of cash flows.

                                       59`

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`13. Employee Benefit Plan

      In 1996, the Company instituted a 401(k) Plan covering substantially all
full-time employees with six months of service. Under the Plan, employees may
elect to defer up to 15% of compensation (subject to certain limitations).
Beginning in January 2003 the Company adopted a Safe Harbor Plan and currently
matches employee contributions up to 4% of compensation. In addition, the
Company may make an annual discretionary profit-sharing contribution. Employee
contributions, Company matching contributions and related earnings are always
100% vested. The Company offers its employees multiple investment options with
varying degrees of risk. The Company also provides its employees with outside
investment advice annually. Company profit-sharing contributions and related
earnings vest 20% a year, with 100% vesting after five years of service. During
2007, 2006, and 2005 the Company's expense for matching contributions was
$277,000, $270,000, and $228,000 respectively; there were no discretionary
profit-sharing contributions for 2007, 2006, or 2005.

                                       60`

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`14. Quarterly Information (unaudited)

      The summarized quarterly financial data presented below reflect all
adjustments which, in the opinion of management, are of a normal and recurring
nature necessary to present fairly the results of operations for the periods
presented (in thousands of dollars).`

|First          Second           Third        Fourth
Year Ended 2006                    Quarter        Quarter          Quarter       Quarter        2006
                                   --------       --------        --------       --------    ---------
   Net revenue                     $ 22,478       $ 23,081        $ 22,090       $ 26,648    $  94,297

   Gross profit                       6,780          6,963           6,379          7,317       27,439

   Operating income (loss)              404            400          (3,955)           689       (2,462)

   Net income (loss)                    100            146          (3,872)           514       (3,112)

Primary earnings per common share  $   0.01       $   0.01        $  (0.22)      $   0.03    $   (0.19)

Diluted earnings per common share  $   0.01       $   0.01        $  (0.22)      $   0.03    $   (0.19)

                                    First          Second           Third        Fourth
Year Ended 2007                    Quarter        Quarter          Quarter       Quarter        2007
                                   --------       --------        --------       --------    ---------
   Net revenue                     $ 24,715       $ 24,529        $ 24,458       $ 26,825    $ 100,527

   Gross profit                       6,931          6,739           6,623          7,226       27,519

   Operating income (loss)              467            734             413            493        2,107

   Net income (loss)                    298            464             279            641        1,682

Primary earnings per common share  $   0.02       $   0.03        $   0.02       $   0.04    $    0.10

Diluted earnings per common share  $   0.02       $   0.03        $   0.02       $   0.04    $    0.10
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`61`

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`SCHEDULE II
                             MONTEREY PASTA COMPANY
                        VALUATION AND QUALIFYING ACCOUNTS
                                   (in '000s)`

|Additions -       Deductions -
                                       Balance,       Charged to         Write-offs       Balance,
                                      Beginning        Costs and         Charged to        End of
                                       of 2005          Expense           Reserves          2005
                                      ---------       -----------       ------------      --------
Allowances against receivables --
   Spoils, returns, adjustments
   and bad debts                      $     240       $     4,792       $      4,040      $    992

Inventory reserves --
   Spoils and obsolescence            $     213       $       499       $        589      $    123

                                                      Additions -       Deductions -
                                       Balance,       Charged to         Write-offs       Balance,
                                      Beginning        Costs and         Charged to        End of
                                       of 2006          Expense           Reserves          2006
                                      ---------       -----------       ------------      --------
Allowances against receivables --
   Spoils, returns, adjustments
   and bad debts                      $     992       $     4,876       $      5,146      $    722

Inventory reserves --
   Spoils and obsolescence            $     123       $       629       $        479      $    273

                                                      Additions -       Deductions -
                                       Balance,       Charged to         Write-offs       Balance,
                                      Beginning        Costs and         Charged to        End of
                                       of 2007          Expense           Reserves          2007
                                      ---------       -----------       ------------      --------
Allowances against receivables --
   Spoils, returns, adjustments
   and bad debts                      $     722       $     4,870       $      4,611      $    981

Inventory reserves --
   Spoils and obsolescence            $     273       $       213       $        333      $    153
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`62`

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`SIGNATURES

      Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the city of San Francisco,
State of California, on the 7th day of March, 2008

                                      MONTEREY GOURMET FOODS

                                      By: /s/ ERIC C. EDDINGS
                                          --------------------------------------
                                           Eric C. Eddings
                                           President and Chief Executive Officer

                                      By: /s/ SCOTT S. WHEELER
                                          --------------------------------------
                                           Scott S. Wheeler
                                           Chief Financial Officer

      Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities
indicated and on the dates indicated.`

|Name                         Title                                Date
----                         -----                                ----
/s/ ERIC C. EDDINGS          Chief Executive Officer,             March 12, 2008
-------------------------    President, and Director
Eric C. Eddings

/s/ VAN TUNSTALL             Chairman of the Board                March 12, 2008
-------------------------
Van Tunstall

/s/ CHARLES B. BONNER        Director                             March 12, 2008
-------------------------
Charles B. Bonner

/s/ VIJI SAMPATH             Director                             March 12, 2008
-------------------------
Viji Sampath

/s/ JAMES WONG               Director                             March 12, 2008
-------------------------
James Wong

/s/ JOHN H. McGARVEY         Director                             March 12, 2008
-------------------------
John H. McGarvey

/s/ WALTER L. HENNING        Director                             March 12, 2008
-------------------------
Walter L. Henning

/s/ SCOTT S. WHEELER         Chief Financial Officer              March 12, 2008
-------------------------    Corporate Secretary and Director
Scott S. Wheeler
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

`63`

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`Index to Exhibits

            (Unless otherwise indicated, all exhibits incorporated by reference
            are filed under SEC file number 001-11177.)

3.1         Certificate of Incorporation dated August 1, 1996 (incorporated by
            reference from Exhibit B to the Company's Definitive Proxy Statement
            for its August 1, 1996 Special Meeting of Shareholders filed June
            27, 1996 )

3.2         Amendments of Articles I and IV of Delaware Certificate of
            Incorporation (incorporated by reference from Exhibits 3 and 4 to
            the Company's Definitive Proxy Statement for its 2004 Annual Meeting
            of Shareholders filed June 21, 2004)

3.3         Bylaws of the Company, as amended. Incorporated by reference from
            Exhibit 3.3 filed with the Company's Form 10-Q for the quarter ended
            June 30, 2005 filed with the Commission.

4.1         Form of Investor Warrant, issued by Monterey Gourmet Foods, Inc. to
            the investors in connection with the June 28, 2006 private offering.
            (incorporated by reference from Exhibit 10.31 filed with the
            Company's Form 8-K on June 13, 2006)

4.2         Registration Rights Agreement (incorporated by reference from
            Exhibit 10.29 filed with the Company's Form 8-K on June 13, 2006)

10.1*       2002 Stock Option Plan, as amended on March 3, 2006. Incorporated by
            reference from Exhibit 10.1 to the Company's Form 10-Q for the
            quarter ended March 31, 2006

10.2*       1995 Employee Stock Purchase Plan (incorporated by reference from
            Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended
            January 1, 1995

10.3        Monterey County Production Facility Lease of the Company, as amended
            (incorporated by reference from Exhibit 10.03 to the Company's
            Registration Statement on Form SB-2 filed with the Commission (the
            "SB-2)) on August 29, 1993

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
            Company's Form 10-K for the fiscal year ended December 31, 1995)
            filed April 1, 1996(the "1995 Form 10-K")

10.5        Amendment No. 3 dated September 12, 1997, and Amendment No. 4 dated
            February 6, 1998 to Monterey County Production Facility Lease of the
            Company (incorporated by reference from Exhibit 10.5 filed with the
            Company's September 27, 1998 Quarterly Report on Form 10-Q filed
            November 4, 1998 ("1998 Q3 10-Q"))

10.6        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)

10.7*       Employment letter dated September 15, 2006 to Chief Executive
            Officer Eric C. Eddings (incorporated by reference from Exhibit 10.1
            filed with the Company's Form 8-K filed September 20, 2006)

10.8        Agreement for Handling and Storage Services between the Company and
            CS Integrated LLC dated February 5, 1999 (incorporated by reference
            to Exhibit 10.21 to the Company's 1998 Form 10-K for the fiscal year
            ended December 27, 1998, filed March 17, 1999

10.9        Royalty agreement dated July 12, 1999 between Company and Chet's
            Gourmet Foods, Inc. (incorporated by reference to Exhibit 10.25, in
            the Company's September 26, 1999 Quarterly Report on Form 10-Q filed
            November 9, 1999 ("1999 Q3 10-Q"))

10.10       Storage Agreement Manufactured Products dated August 3, 1999 between
            the Company and Salinas Valley Public Warehouse (incorporated by
            reference to Exhibit 10.26, filed with the Company's 1999 Q3 10-Q)

10.11       Commercial Lease dated August 10, 1999 between Company and Salinas
            Valley Public Warehouse (incorporated by reference to Exhibit 10.27,
            filed with the Company's 1999 Q3 10-Q)

10.12       Commercial lease dated January 1, 2000 between the Company and PTF
            for Operating Engineers, LLC (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)

10.13       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)

10.14       Commercial lease dated August 23, 2002 between the Company and Mel
            Bankoff (incorporated by reference from Exhibit 10.43 filed with the
            Company's Report on Form 8-K on August 30, 2002)

10.15       Commercial lease dated January 3, 2003 between the Company and
            Conrad Family Trust (incorporated by reference from Exhibit 10.44
            filed with the Company's Form 10-K for the fiscal year ended
            December 29, 2002, filed on February 14, 2003)

10.16       Third Lease modification to Commercial lease dated August 8, 2006
            between the Company and PTF for Operating Engineers, LLC for storage
            space in Monterey County, California

                                       64`

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`10.17       Lease Extension and Modification Agreement between the Company and
            Kenneth Salma and Pattie Salma dated August 24, 2005 (incorporated
            by reference from Exhibit 10.18 filed with the Company's September
            30, 2005 Quarterly Report of Form 10-Q filed on November 14, 2005.)

10.18       Stock Purchase Agreement by and among Monterey Gourmet Foods, Inc.,
            Sonoma Foods, Inc., and Its Shareholders dated April 7, 2005
            (incorporated by reference from Exhibit 2.01 filed with the
            Company's 8-K on April 13, 2005)

10.19       Third Modification to Business Loan Agreement between the Company
            and Comerica Bank dated January 5, 2005.(incorporated by reference
            to Exhibit 10.33 filed with the Company's Form 10-K for the fiscal
            year ended December 26, 2004, filed on March 25, 2005

10.20       Fourth Modification to Business Loan Agreement between the Company
            and Comerica Bank dated April 11, 2005 (incorporated by reference
            from Exhibit 10.24 to the Company's Form 10-Q for the quarter ended
            June 30, 2005 filed with the Commission).

10.21       Securities Purchase Agreement, dated as of June 12, 2006,
            (incorporated by reference from Exhibit 10.28 filed with the
            Company's 8-K on June 13, 2006)

10.22       Employment Agreement dated September 15, 2006 with Company Chief
            Executive officer Eric Eddings (incorporated by reference from
            Exhibit 10.1 filed with the Company's Current Report on Form 8-K/A
            filed September 21, 2006)

10.23*      Employment agreement dated April 7, 2005 to Chief Executive Officer
            - Sonoma Foods, Inc. A. Martin Adams (incorporated by reference from
            Exhibit 10.25 filed with the Company's Quarterly Report on Form 10-Q
            filed May 14, 2007)

10.24*      Employment agreement dated April 7, 2005 to Chief Operating Officer
            - Sonoma Foods, Inc. C. David Viviani (incorporated by reference
            from Exhibit 10.26 filed with the Company's Quarterly Report on Form
            10-Q filed May 14, 2007)

10.25       Commercial Lease dated November 15, 2007 between the Company and
            RREEF America REIT II Corp II (incorporated by reference from
            Exhibit 10.27 filed with the Company's report on Form 8-K on
            November 21, 2007.

10.26**     Commercial lease extension dated December 24, 2007 between the
            Company and the McCabe Trust filed herewith.

23.1**      Consent of Independent Registered Public Accounting Firm

31.1**      Certification of Chief Executive Officer pursuant to Section 302 of
            the Sarbanes-Oxley Act of 2002

31.2**      Certification of Chief Financial Officer pursuant to Section 302 of
            the Sarbanes-Oxley Act of 2002

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

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

* Management contract or compensatory plan or arrangement covering executive
  officers or directors of the Company and its former subsidiary, Upscale Food
  Outlets, Inc.

** filed herewith

                                       65`

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