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, 2005
                                             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)
----------------------------------------    ------------------------------------

Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:  Common Stock, $.001
                                                             par value


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 (ss.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 a check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

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, 2005 was $18,561,000.
The number of shares outstanding of the issuer's common stock as of March 30,
2006 was 14,838,044.
<PAGE>

                                     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 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:

     o    Weather could impact the price of raw materials the Company purchases.
     o    The extent to which the Company can reduce costs according to its cost
          reduction initiatives.
     o    Unpredictable difficulties or delays in the development of new
          products or the Company's ability to forecast consumer trends.
     o    Changes in U.S. economic conditions such as inflation, or interest
          rate fluctuations.
     o    Pricing changes of raw materials, freight, or impacts for competitive
          pricing.
     o    Inherent risks of food production.
     o    Labor relations.
     o    Integration of acquired businesses.
     o    Difficulties in obtaining or retaining the management and other human
          resource competencies that the Company needs to achieve its business
          objectives.
     o    The impact on the Company from the loss of a significant customer or a
          few customers.
     o    Changes in the regulatory environment.
     o    Capital spend requirements.
     o    Ability to pay current debt obligations.
     o    Adoption of new accounting pronouncements promulgated by the Financial
          Accounting Standards Board or other accounting standard setting
          agencies.

Introduction

         Monterey Gourmet Foods, Inc. ("the Company") 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,
dips, hummus, polenta, soups, cheeses, spreadable cheeses, and gourmet sausages,
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.

         The Company offers over 250 varieties of contemporary gourmet food
products that are produced using the Company's proprietary recipes. In 2005, the
Company expanded its line and distribution of whole wheat pasta. The Company
entered the frozen category with its "OneStep Gourmet" product which offers
consumers a complete meal in less than 10 minutes. It also introduced several
Hispanic Products including two flavors of premium tamales. Also in 2005, the

                                       2
<PAGE>

Company acquired Sonoma Cheese Company which markets its original Sonoma Jack
Cheese in many flavor varieties, and Casual Gourmet Foods which markets a line
of gourmet soups and sausages. In 2004, the Company introduced new prepared food
items such as the grilled wrapped sandwiches, expanded its line of "quick
preparation" gourmet entrees, expanded its distribution of reduced-carbohydrate
pastas and sauces and began the introduction of a line of whole wheat pastas. In
2003, the Company introduced new prepared food items such as lasagna and stuffed
manicotti along with a line of reduced-carbohydrate pasta products under the
CARB-SMART(TM) Brand, and several extensions of existing lines.

         On January 12, 2006, as a subsequent event, Monterey Gourmet Foods,
Inc. ("Monterey"), 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 of which Monterey acquired the remaining 15.5% of
CIBO from Suekat in exchange for 300,000 unregistered shares of Monterey common
stock with an estimated market value of $1.2 million.

         On June 16, 2005, the Board of Directors of Monterey Gourmet Foods,
Inc. passed a resolution to amend its bylaws changing its fiscal year from a
52/53 week year ending on the Sunday closest to December 31 to that of a
calendar year, effective as of the end of and for the quarter ending June 30,
2005.

         On April 7, 2005, Monterey Gourmet Foods, Inc. ("Monterey"), Sonoma
Foods, Inc. ("Sonoma"), and the shareholders of Sonoma ("Shareholders") entered
into a definitive agreement for the purchase by Monterey of 80% of Sonoma's
outstanding shares ("Stock Purchase Agreement"). 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.

         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 60% of Casual's outstanding
shares with the balance of Casual's shares to be acquired by the Company in
three annual installments at predetermined contractual prices. Casual, which
produces branded gourmet sausages, prepared soups and other food products, is a
Florida corporation with headquarters in Clearwater, Florida.

         In 2004, the Company acquired an 80% interest in CIBO Naturals LLC
("CIBO"), a leading manufacturer of premium sauces and spreads located in
Seattle, Washington. CIBO produces a variety of refrigerated gourmet sauces and
spreads including fresh pesto sauces, flavored cheeses, bruschetta toppings and
tapenade spreads. Their products are sold nationally through club stores,
supermarket delis and specialty food stores. The CIBO acquisition met the
Company's strategy for growth in the premium refrigerated foods category. CIBO,
through its "CIBO Naturals" brand, sells unique, high quality products and has
developed a strong position in its markets which has great growth potential in
both expanded distribution and in new products.

         The Company sells its products through leading grocery store chains
including Albertson's, King Soopers, Safeway, Fred Meyer, Kroger, Raley's,
Trader Joe's, Wegmans, Dominick's, Hannaford Brothers, Shop Rite, Jewel, Publix
and QFC; and warehouse club stores including Costco Wholesale, Sam's Club, a
division of Wal-Mart, and BJ's. As of December 31, 2005, approximately 10,100
grocery and club stores offered Monterey Gourmet Foods' products.

         The Company also has a web site, www.montereygourmetfoods.com, to
further support its brand by providing both consumer and investor information.
The site provides insight into the Company's profile, product offerings,
financial strength, as well as consumer tips for those interested in gourmet
food and links its recently acquired 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 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.

                                       3
<PAGE>

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 higher 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 now reached over $10 billion in retail sales, according to
Organic Trade Associations 2004 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 and other credible producers who meet the standards to be labeled USDA
organic will be 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 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 8.8
billion pounds of cheese in 2003. Cheese consumption has increased from 11.1
pounds per person in 1987 to 30.6 pounds in 2003. The specialty cheeses category
in which the Company competes has grown from 420 million pounds consumed in 1994
to 815 million pounds in 2003. Specialty cheeses represents almost 10% of all
cheese consumed in the United States. The Company believes this is a growing
category and that Sonoma Cheese is well positioned to grow with this category
and also expand market share.

         The refrigerated pasta category, along with all pastas has seen
reductions in sales starting in 2003 as the low-carbohydrate diets became more
popular due to the publicized relationship between reduced carbohydrate
consumption and weight loss. Since 2003, the pasta category declined
approximately 7% each year until 2005. Starting in 2005, this trend has reversed
and the consumption of carbohydrates has been on the rise. The smaller
refrigerated pasta category has grown faster than the overall pasta category
because of the gourmet products it includes. 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.

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:

o    Expand 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.

o    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 compliment its existing product lines.

o    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.

o    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.

                                       4
<PAGE>

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

o    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; Sonoma Jack(TM) cheeses, chicken sausages, soups, and
polenta under the Monterey Gourmet Foods, Monterey Pasta, Arthur's, CIBO
Naturals, La Frescala, Emerald Valley 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".

         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. 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 innovative packaging techniques to maximize appeal on the shelf as an
important sales tool.

         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 product lines 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 wrapped
sandwiches in a 43,700 square foot Monterey County, California facility. The
Company also leases 89,200 square feet of space three miles from the main
production facility. Within this 89,200 square foot facility, the Company has
its refrigerated distribution center, a prepared foods manufacturing line 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 which operates out of a 27,000 square foot
facility in Seattle, WA was acquired in 2004. 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. Both

                                       5
<PAGE>

California facilities are certified by the USDA and utilize state of the art
thermal processing, chilling and packaging processes. The Company employs a
total of approximately 297 persons at all locations, including 44 administrative
personnel, 17 sales personnel, 3 drivers, and 233 distribution and production
personnel. For additional information, see "Employees" on page 8.

         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 Individually Quick Frozen ("IQF") vegetables and spices,
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, 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. The new
grilled wrapped sandwiches and burritos are produced with proprietary recipes,
hand rolled in a special tortilla, grilled and quickly packaged to preserve
flavor, 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 regularly reviews a variety of potential capital projects
for the production department and in the past three years has spent
approximately $4.7 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 sauce labeling, borsellini pasta
production capability, and upgrade the ingredients blending area. The new
production facility, established during 2003, added approximately 30 percent of
additional pasta manufacturing capacity at a cost, including leasehold
improvements, of approximately $2.1 million. Also in 2003, the Company added the
ability to produce items in the rapidly growing prepared foods category, and
corresponding plant improvement to accommodate these new products. Also added
was automated filling equipment that reduced operating costs. In 2004, only $.8
million was spent on capital spending. Of this amount $.25 million was spent at
the newly acquired CIBO facility to upgrade its filling and packaging equipment.
Projects completed in 2004 consisted of improved packaging equipment for the new
"quick preparation" baked line to improve product quality and consistency,
product pouching equipment which allows the company to sell its products in a
pouch and other smaller projects to ensure product safety. In 2005, the Company
completed projects which upgraded its wrap line, upgraded the cooking and
ventilation equipment at its Emerald Valley Organics facility, added capacity to
produce tamales, and added refrigeration storage and additional packaging
equipment at the CIBO Naturals facility. Future additions of assets will be
evaluated for increased efficiency, flexibility and capacity needs.

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, and the many of the domestic ingredients come from
California. Vendor selection is based on ability to meet specifications and
pricing, in that order. Because the ingredients are agricultural products, the
Company uses a combination of contracts which are one year or less in duration,
as well as open market purchases to minimize the pricing risks and uncertainty
of supply. The Company does have one long-term contract with its liquid nitrogen
provider which expires November 30, 2007.

         The most significant ingredients used are dairy-based ingredients,
eggs, flour, cooked seafood, cooked 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. In 2004, the Company experienced
higher than normal raw material costs in protein and dairy based ingredients and
some ingredients have continued at historically high prices into 2005.

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. The Company distributes its
products to other customers and other parts of the country, which is over 90% of
its business using common carriers. The dependence on other companies for
delivery of its products poses a risk to the Company. While the common carrier
method of delivery has been reliable and available at acceptable rates thus far,
there can be no assurance that the Company will continue to be able to negotiate
acceptable freight rates in the future and that delivery will not be disrupted
for reasons including, but not limited to, adverse weather, natural disasters or
labor disputes in the trucking industry. During 2004 and 2005, fuel costs
increased compared to previous years, which impacted the Company's operating
margin in 2004 and 2005.

                                       6
<PAGE>

Grocery Chain and Club Store Sales

         Monterey Gourmet Foods sells its products to supermarket chains and
club stores with the approximate number of stores at each year-end listed below:

                                                 Years Ended
                                     -----------------------------------
                                        2003         2004         2005
                                     -----------------------------------

         Retail grocery stores         7,940        8,500        9,100

         Club stores                   1,060        1,100        1,100
                                     -----------------------------------

            Total                      9,000        9,600       10,200
                                     ===================================


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
                                     -----------------------------------
                                        2003         2004         2005
                                     -----------------------------------

         Costco                           34%          36%          45%

         Sam's Club Stores                32%          24%          17%

         All other customers              34%          40%          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. During 2003, Costco made a decision
to reduce the number of items that it offers to its members, which caused a
reduction in the number of items that the Company sold to Costco during 2003 and
2004. Sales to Costco stabilized and actually increased in 2005. 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 the 4th quarter of 2004 Sam's Club
implemented an item reduction program which reduced the number of items that the
Company sells to Sam's Club and correspondingly has reduced the amount of shelf
space for the Company's products. During 2005, the Company spent significant
resources increasing sales to Sam's Club. While the Company is in the eighth
year of its relationship with Sam's Club, there can be no assurance that Sam's
Club stores will continue to carry its products. On February 2, 2004 the Company
announced that approximately 1,100 Wal-Mart Supercenters discontinued its
private label pasta and sauce program which the Company had been making since
2002. Wal-Mart Supercenter's private label business represented $3,490,000,
$147,000, and $0 of Net Sales in 2003, 2004 and 2005, respectively. The loss of
either Costco or Sam's Club as customers could materially and adversely affect
the Company's business operations.

         During 2003, 2004 and 2005 net revenues to foreign customers
represented 3.4%, 3.4% 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.

                                       7
<PAGE>

Marketing

         The Company's marketing strategy is to create and sell innovative
premium quality products in the categories in which it competes and 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.

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. Multinational competitors have significantly
more brand name recognition, marketing personnel, and cash resources than the
Company. 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 for which there is limited
competition currently in the refrigerated sector including whole wheat pasta,
wrapped sandwiches, burritos, tamales, spreadable cheeses, flavored jack cheese,
gourmet sausages and quick preparation gourmet entrees. Management will continue
to try to produce distinctive products, which fill specific niches where there
is little or no national competition.

         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
slightly 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.

Employees

         As of December 31, 2005, the Company employed a total of 297 persons at
all locations, including 44 administrative personnel, 17 sales personnel, 3
drivers, and 233 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 Pasta
Company", "CIBO Naturals", "Sonoma", "Sonoma Jack", "Casual Gourmet",
"Borsellini", and "Homestyle Fresh Soups" names and, in the case of Monterey
Pasta Company, corresponding logo design with the United States Patent and
Trademark Office. The Company is currently in the process of registering "Maria
Sabellas", One Step gourmet" and "Chef's Finest". There can be no assurance that
competitors will not adopt similar names or logo designs outside the protection
of the Company's trademark registration. In March of 1999, the Company acquired
the right to use the "Arthur's" label with its acquisition of the Frescala
Foods, Inc. business. In December 2000, it acquired the right to use the
"Nate's" label through its acquisition of the Nate's polenta business Also the
Company acquired the rights to two unregistered trademarks, "La Frescala", and
"Emerald Valley Organics", as part of acquisitions of businesses.

                                       8
<PAGE>

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 of 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:

o    Effect on Profitability. The Company reported a loss for the years 2004 and
     2005 and at December 31, 2005, the Company had an accumulated deficit of
     $6,438,000. There can be no assurance that the Company will generate
     profits in the short or long term.

o    Liquidity; Access to Capital. Management believes that its current cash
     balances, operations, and newly negotiated bank lines of credit will
     provide adequate liquidity to meet the Company's planned capital and
     operating requirements for normal operations and capital expenditures
     through the 2006 calendar year. See Note 7 to the consolidated financial
     statements (Item 15) for a description of the credit facility. The Company
     is required to pay $2.5 million in principal on its outstanding loans in
     2006 which is greater than the cash generated from operations in 2005. If
     the Company's operations do not provide cash sufficient to fund its
     operations and make required debt payments; 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.

o    Acquisitions; Potential Goodwill Impairment. The Company has acquired four
     companies since 2003, and is in the process of integrating these
     acquisitions onto one financial platform. Certain other synergies have been
     identified such as selling and distribution opportunities which should
     increase sales and reduce costs. There are no guarantees that any of these
     synergies will be properly completed or improve the profitability of the
     Company. In addition, the Company has recorded net intangible assets of
     $11.1 million and goodwill of $12.0 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. In the fourth
     quarter 2005, Casual Gourmet saw a significant reduction in its sales to
     its two largest customers. If revenues to these two customers do not return
     to historical levels, the Company may need to make a charge against
     earnings in order to record the impairment of the goodwill and or
     intangible assets that have previously been recorded.

o    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. CEO James Williams joined the Company in
     October 2002 and CFO Scott Wheeler joined the Company in April 2003. The
     Company currently has a key man insurance policy with a face amount of
     $500,000 for Mr. Williams. 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 companies.
     The management of CIBO, Casual Gourmet, and Sonoma Foods have employment
     contracts to help insure the growth of these acquisitions. 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.

o    Material Weakness in Internal Controls: The Company's management has
     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, 2005. Based on that evaluation, the Company has concluded that, because
     of a material weakness in internal control, the Company's disclosure
     controls and procedures were not fully effective as of December 31, 2005.
     If this weakness cannot be rectified, financial statement accuracy may be
     at risk. See Item 9A, which is incorporated here by reference.

o    Impact of Inflation. The increased cost of dairy ingredients had a material
     inflationary impact on the Company's operations during 2005. 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. Energy costs such as electricity and natural gas have
     increased significantly and the Company is projecting additional increases
     over the next several months. Increases in labor, employee benefits,
     freight, ingredients and packaging, 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.

o    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, and has

                                       9
<PAGE>

     obtained USDA approval 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.

o    Dependence on Major Customers. During 2005, two of the Company's customers,
     Costco and Wal-Mart (including its subsidiary, Sam's Club), accounted for
     45% 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 Pasta 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.

o    Diversification of Product Line. Over the last three 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, and
     customers. There can be assurances that the acquisition strategy will be
     profitable in the near or long term.

o    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. Recent attention to low
     carbohydrate diets by certain segments of the U.S. population has affected
     the consumption of pasta, and pasta sales have decline as a percentage of
     grocery sales in the U.S. As American consumers seek new ways to reduce
     their intake of carbohydrates, Monterey Gourmet Foods has developed
     products to address these changing preferences. Towards the end of 2004,
     the low-carbohydrate diet trend decreased and the trend has been towards
     whole grains and less refined products. The Company has spent resources to
     develop whole wheat pasta products that meet this new trend. However, there
     can be no assurance that these new products will meet the changing demands
     of the consumer.

o    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.

o    Competition. The Company's business is dominated by several very large
     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.

o    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.

o    California 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, such as hurricane Katrina, can impact the
     availability and pricing of energy.

o    Capacity. The two plants in Salinas, California are currently operating
     below planned capacity, which increases costs of producing products in
     these plants. If sales of products produced at these plants do not increase
     or additional costs cannot be reduced, these products will remain
     unprofitable which will impact future earnings of the Company. In response
     to this lower than required sales volume out of these plants the Company
     announced a plan to close the smaller of these two operating plants. The
     Company will incur costs to close the plant and move equipment to other
     locations.

o    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 December 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

                                       10
<PAGE>

     period. Additionally, the Company may not learn of such shortfalls until
     late in the 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.

o    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.

o    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.

o    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
     required to comply with certain sections of this Act. However, the Company
     has spent some resources complying with Section 404 of this Act and the
     Company believes that it will need to spend additional significant
     resources to become compliant with this Act.

o    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
     into 2005. 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 three years and
     therefore has limited history of claim resolution available to support the
     Company's specific actuarial projections. 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.

ITEM 1B     UNRESOLVED STAFF COMMENTS

            Inapplicable

ITEM 2.     PROPERTIES

         The Company leases approximately 133,000 square feet in Salinas,
California, comprised of 43,700 square feet at its headquarters facility and
89,200 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 19,800 feet of refrigerated cold storage, 2,100 square feet of office space,
26,000 square feet of ambient storage, and 41,300 sq. ft., which is dedicated to
production space and storage. The current Monterey County production
facility/headquarters lease was renewed until October 2014. The lease for the
distribution center and adjacent production and storage facilities expires in
June 2007 with two five-year renewal options.

         In 2004, the Company purchased CIBO Naturals LLC which operates out of
a 27,000 square foot leased facility in Seattle, WA which expires in May 2008.

                                       11
<PAGE>

         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 expires December 31, 2007, with three five-year renewal
options. 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. As part of the Casual Gourmet
Foods acquisition, the Company leases 1,500 square feet of office space.

         Management feels that its facilities are adequate to support sales
growth for at least 24 months unless an acquisition is made. Most of its
facilities are only operating one shift per day and only running five days per
week.

ITEM 3.     LEGAL PROCEEDINGS

         There are no material legal proceedings pending to which the Company or
any of its subsidiaries is a party or to which any of its property is subject.


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 2005.


                                     PART II

ITEM 5.     MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
            MATTERS

Price Range of Common Stock

         The Company's Common Stock is traded on the NASDAQ National Market
System 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 National Market System.

         Fiscal year 2004:                  High             Low
                                            ----             ---

                 First quarter             $4.11           $3.33

                 Second quarter             3.81            3.32

                 Third quarter              3.64            2.90

                 Fourth quarter             3.61            3.08


         Calendar year 2005:                High             Low
                                            ----             ---

                 First quarter              3.93            3.13

                 Second quarter             3.38            2.87

                 Third quarter              4.37            3.13

                 Fourth quarter             4.80            3.84

         As of February 1, 2006, there were 203 stockholders of record of the
Common Stock and approximately 4,600 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.

                                       12
<PAGE>

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
Note 10 to the consolidated financial statements (Item 15) included in this
document.

         On June 23, 2005 the Company accelerated the vesting of all stock
options outstanding under the Company's 2002 Stock Option Plan (formerly the
1993 Stock Option Plan) that have exercise prices per share higher than the
closing price of the Company's stock on June 23, 2005, which was $3.07. Options
to purchase 422,600 shares of the Company's common stock became exercisable
immediately. These options range in price from a low of $3.25 to a high of $4.99
with an average of $3.53.

         The primary purpose of the accelerated vesting was to eliminate future
compensation expense the Company would otherwise recognize in its statement of
operations with respect to these accelerated options upon the adoption of SFAS
123R ("Share-Based Payment"). SFAS 123R is effective for the Company beginning
in the first quarter of 2006, and will require that compensation expense
associated with stock options be recognized in the statement of operations,
rather than as a footnote disclosure in the Company's consolidated financial
statements. The acceleration of the vesting of these options does not impact the
Company's financial statements.

         The Company has also changed the vesting period of all stock options
issued after November 1, 2005 from a two year vesting period to a three year
vesting period. In addition, the Company has reduced by approximately 70%, the
number of employees who previously would have been eligible to receive stock
options.



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.

<TABLE>
<CAPTION>
                                                                             Years Ended
                                              -------------------------------------------------------------------------
                                                   2001           2002           2003           2004            2005
                                              -------------------------------------------------------------------------
                                                          (dollar amounts in thousands except per share data)
<S>                                           <C>            <C>            <C>            <C>             <C>
Consolidated Statements of Operations Data:
Net revenues                                  $     56,987   $     61,679   $     60,490   $     62,491    $     85,248
Gross profit                                        20,518         22,262         18,569         16,468          23,232
SG&A                                                13,282         15,654         17,161         18,224          23,590
Operating income (loss)                              7,236          6,540          1,408         (1,761)           (358)
Net income (loss)                                    4,429          9,491          1,035         (1,344)           (537)

Basic net income per common share             $       0.33   $       0.68   $       0.07   ($      0.09)   ($      0.04)
Diluted income per common share               $       0.31   $       0.65   $       0.07   ($      0.09)   ($      0.04)

Weighted average basic shares outstanding       13,491,177     14,039,902     14,206,627     14,343,386      14,450,251
Weighted average diluted shares outstanding     14,254,248     14,664,762     14,414,931     14,343,386      14,450,251
</TABLE>

                                       13
<PAGE>

<TABLE>
<CAPTION>
                                                                       Years Ended
                                           --------------------------------------------------------------------
                                               2001          2002          2003          2004           2005
                                           --------------------------------------------------------------------
                                                             (dollar amounts in thousands )
<S>                                        <C>           <C>           <C>           <C>            <C>
Consolidated Statements of Income Data as Percent of Net Revenues
Net revenues                                    100.0%        100.0%        100.0%        100.0%         100.0%
Gross profit                                     36.0%         36.1%         30.7%         26.4%          27.3%
SG&A                                             23.3%         25.4%         28.4%         29.2%          27.7%
Operating income (loss)                          12.7%         10.6%          2.3%         (2.8)%         (0.4)%
Net income (loss)                                 7.8%         15.4%          1.7%         (2.2)%         (0.6)%

Consolidated Balance Sheet Data:
Working capital                            $   14,934    $   16,880    $   16,704    $    7,753     $    5,019
Total assets                               $   31,596    $   43,799    $   44,204    $   46,873     $   62,205
Total debt and capital lease obligations   $       49    $       17    $        3    $    2,459     $   13,654
Stockholders' equity                       $   27,981    $   38,941    $   40,035    $   39,216     $   39,110
</TABLE>


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

         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.

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, California 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 approximately 10,200 stores
by December 31, 2005. During recent years the Company added retail and club
distribution through internal growth and through the Frescala Foods, Nate's,
Emerald Valley, CIBO, Sonoma Cheese, 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 launched two new product lines outside its core
pasta/sauce business, including Gourmet Refrigerated Entrees, such as Seafood
Lasagna and Pasta Primavera, and Grilled Wrap Sandwiches, featuring a Garlic
Chicken Wrap and a Chicken Ranchero Burrito. Additional distribution was
obtained in 2004 when the Company introduced low-carbohydrate pastas and sauces.
Also in 2004, the Company acquired CIBO Naturals (January, 2004), 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 higher in dietary fiber, have a favorable glycemic index, and are made
from whole grains. In 2005 the Company acquired two additional Companies. Casual
Gourmet Foods, Inc. (January 2005) is a marketer of flavorful low fat,
low-calorie chicken sausages, chicken burgers and soups, and Sonoma Foods, Inc.
(April 2005) is a producer of 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.

                                       14
<PAGE>

         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 newly acquired acquisitions 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
products will continue to do so in the future or that such chains will not
reduce the number of stores carrying the Company's products. During 2003, Costco
chose to reduce the number of items it carries, which caused a reduction of
sales from the Company to Costco. In late 2004, Sam's Club began an SKU (Stock
Keeping Unit) reduction project which has impacted the Company's sales in 2005.

         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.

         In the fourth quarter of 2005, the Company incurred several exceptional
costs. These costs included a disruption in product flow through a major
customer's warehouse which caused out-of-code issues on one product, a limited
voluntary product withdrawal resulting from a quality issue on a secondary
out-sourced private label product, and costs associated with the rapid start-up
and introduction of a major new product line with our largest customer. This new
product performed well in the fourth quarter; however, significant extra costs
and inefficiencies with this product were incurred in the fourth quarter from
the rapid scale-up in production necessitated by this customer's volume demands.


Operations for 2003, 2004 and 2005

         Net revenues were as follows:

<TABLE>
<CAPTION>
                                                                                  Years Ended
                                                               ---------------------------------------------------
                                                                    2003              2004               2005
                                                               ---------------------------------------------------
<S>                                                                <C>               <C>                <C>
         Net Revenues                                              $ 60,490          $ 62,491           $ 85,248

         Percent Change in Net Revenues from prior year                  -2%                3%                36%
</TABLE>

         On June 16, 2005, the Board of Directors approved a resolution to
change the fiscal year of the Company to a calendar year. Prior to this change
the Company employed a 4-week, 4-week, 5-week reporting period with the fiscal
year ending on the last Sunday of each calendar year (52/53-week year). The 2004
fiscal year ended on December 26, 2004 and the 2005 fiscal year would have ended
on December 25, 2005. The change was made primarily to accommodate the
consolidation process of newly acquired subsidiaries. . The Company recorded
sales of $1.1 million between December 26, 2005 and December 31, 2005

         The 2005 increase compared to 2004 is due to the additional volume
generated from the acquisitions of CIBO, Emerald Valley, Casual Gourmet Foods,
and Sonoma Foods some of which had sales in the previous year. Excluding sales
generated from these four acquisitions, net sales increased 5%. Again excluding
sales generated from these four acquisitions, sales to Costco increased 33%
compared to 2004; however, sales to Sam's Club declined 24% in 2005 compared to
2004. The Company's Monterey Pasta brand retail business, excluding the sales to
the club stores, which has been a focus for the Company, was up 15% when
compared to the previous year and was up 46% in the second half of 2005 when
compared to the second half of 2004. The success of the Company's new whole
wheat pastas is helping fuel this growth. The change in net revenues is mostly a
result of changes in volume sold and only a small portion is a result of price
changes for the Company's products.

         In addition, Casual Gourmet, the specialty poultry sausage and soup
marketer acquired in January, 2004 experienced several set backs of product
distribution and sales with its two largest customers during the fourth quarter.
In both cases, losses were related to the customer's change in merchandising
strategy and increased competition within the poultry sausage category. Casual
Gourmet management has responded quickly with innovative new products, including
products in the much larger pork sausage category. Casual expects to begin

                                       15
<PAGE>

regaining several product placements with key club customers during the first
quarter of 2006. Additionally, Casual Gourmet has developed a line of no-nitrite
chicken sausages targeted at the retail supermarket channel.

         The Company also increased the distribution of its products and spent
limited amounts for slotting new SKUs in the retail supermarket channel. As a
result, the Company saw slotting dollars increase 55% in 2005 compared to 2004.

         In 2004, the Company announced that approximately 1,100 Wal-Mart
Supercenters discontinued its private label refrigerated pasta and pasta sauce
program which the Company was making since 2002. The Company does not sell any
other products to Wal-Mart Supercenters. Wal-Mart Supercenter's private label
business represented $3,490,000, $147,000, and $0 of Net Sales in 2003, 2004 and
2005, respectively. Additionally, popular diet trends in the United States
impacted the overall consumption of pasta which negatively impacted sales. Sales
to Costco continued to be impacted by Costco's SKU reduction and also from
competitor inroads. Sales to Costco were $22.8 million in 2004. During 2004,
Monterey Pasta branded retail sales of pasta items grew by 1% in spite of a
decline in the overall pasta category, reflecting on the Company's increased
focus on this distribution channel.

         The Company has embarked upon a diversification strategy which included
the acquisition in 2002 of Emerald Valley Kitchens in 2004 of CIBO Naturals,
LLC, and in 2005 Casual Gourmet Foods and Sonoma Foods. The table below shows
the percent of net revenues these four acquisitions have represented:

<TABLE>
<CAPTION>
                                                                                       Years Ended
                                                                      ------------------------------------------------
                                                                         2003              2004               2005
                                                                      ------------------------------------------------
<S>                                                                      <C>               <C>                <C>
         Percent of net revenues from recent acquisitions                  6.8%             18.2%              41.4%
         All other net revenues                                           93.2%             81.8%              58.6%
                                                                      ------------------------------------------------

             Total                                                       100.0%            100.0%             100.0%
                                                                      ================================================

<CAPTION>

         Gross profit and gross margin were as follows:

                                                               Years Ended
                                              ------------------------------------------------
                                                   2003             2004              2005
                                              ------------------------------------------------
<S>                                              <C>              <C>               <C>
         Gross profit                            $ 18,569         $ 16,468          $ 23,232

         Gross margin percent                        30.7%            26.4%             27.3%
</TABLE>


         The 2005 gross margin improvement of $6,764,000 compared with 2004 was
a function of higher sales, higher production volume through the Company's
currently operating plants, reduced fixed costs, and reduced labor costs. Gross
margin percent improvement compared to prior year is a function of cost savings
from higher plant volume, lower fixed costs, and also an improvement in product
mix especially from recent acquisitions, offset by higher utility and rent
costs. Management has continued to reorganize and reduce its workforce in
Salinas, where the number of employees has been reduced by approximately 30%
since 2004.

         In 2004, the gross margin declined compared to 2003. The decline was a
result of higher raw material costs which the Company was not fully able to pass
along to its customers, a decline in pasta sales of 22% which increased fixed
costs as a percent of sales, higher workers compensation costs, and new product
introductions start up costs, including label development, USDA approvals, and
product development costs. As a consequence of lower pasta sales and raw
material higher costs, in 2004, management reorganized its production and plant
overhead workforce which reduced the number of employees at the Company by
approximately 15%. Since that time additional reduction in workforce both in the
plant and in general overhead has taken place. Currently, the Company has
reduced its California work force by 33% compared to the same time in 2003.
Other initiatives that have been implemented have reduced the Company's
packaging costs, offset increased freight costs, lowered general and
administrative costs, and minimized the impact of higher raw material costs.
These projects were done in an effort to reduce processing costs and increase
margins. The impact of these changes on the Company's gross profit is difficult
to quantify because of its sensitivity to volume through the plant.

         The Company charged to costs or expense $510,000, $550,000, and
$459,000 in 2003, 2004, and 2005 respectively, of obsolete packaging inventory.
In addition, the rapid rollout of new packaging in 2003 to the Company's second
largest club store customer, where the customer chose to deplete from its
shelves the inventory of the old packaging before ordering product in the new
packaging, caused expenses to exceed expectations. This caused a dramatic
slowdown in production followed by rapid increase in production, causing high
expenditures all of which contributed to the decline in gross margin.

                                       16
<PAGE>

         Selling, General and Administrative expenses ("SG&A") were as follows:

<TABLE>
<CAPTION>
                                                                             Years Ended
                                                            ------------------------------------------------
                                                                 2003             2004              2005
                                                            ------------------------------------------------
<S>                                                            <C>              <C>               <C>
         SG&A Expense                                          $ 17,161         $ 18,224          $ 23,590

         SG&A Expense as a percent of net revenues                 28.4%            29.2%             27.7%
</TABLE>

         SG&A as a percent of net revenues decreased for 2005 compared to 2004
as illustrated in the above table. During 2005, the Company introduced many new
products including "One Step Gourmet" frozen entrees, additional whole wheat
pastas, new flavors of dips and new refrigerated entrees. The Company spent
incrementally higher promotional dollars in order to introduce these new
products. The Company spent 15% more in targeted promotional costs in Sam's Club
and Costco in 2005 compared to 2004. The Company also has spent $82,000 with
consultants plus a significant amount of internal resources documenting its
internal controls in its efforts to become compliant with Sarbanes-Oxley Section
404. Also the company has seen its audit and audit related fees increase in 2005
compared to the same period in 2004. Amortization associated with the 2005
acquisitions increased 89% when comparing 2005 to 2004.

         The Company is also consolidating its sales force, distribution system
and warehousing following its most recent acquisitions. These cost reductions
are partially offset by increased freight cost due to fuel surcharges and also
by adding the SG&A costs associated with Casual Gourmet's and Sonoma Foods'
overhead. Demonstration costs paid to outside vendors were 9.1%, 8.1% and 6.8%
of net revenues for the years 2003, 2004, and 2005, respectively.

         The increases in 2004 compared to 2003 were related to increased
marketing costs related to the introduction of new products, increased freight
costs due to fuel surcharges and reduced volume on each truck due to reduced
club sales and the addition of expenses associated with operating the CIBO
business. These increases were offset by the elimination of approximately 100
employee positions.

         Depreciation and amortization expense, included in cost of sales and
SG&A, increased to $3,033,000 or 3.6% of net revenues, compared to $2,510,000 or
4.0% of net revenues in 2004 and $2,082,000, or 3.4% of net revenues in 2003.
The increases over the past two years relate to the recent acquisitions and to
capacity expansion and equipment upgrades in the Salinas, California, Seattle,
Washington and Eugene, Oregon production facilities. Amortization of intangible
assets as a result of acquisitions was $958,000 in 2005 compared to $482,000 in
2004, and $243,000 in 2003. See "Liquidity, Capital Resources and Business
Acquisitions", page 18.

         Net interest expense for 2005 was $628,000, compared to net interest
expense of $130,000 in 2004 and interest income of $71,000 in 2003. The interest
expense in 2005 and 2004 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. The 2003
interest income was generated from investment in short-term money funds from
operating cash flow in the absence of bank debt.

         Income tax benefit (expense) for 2005, 2004 and 2003 was $431,000,
$505,000 and ($444,000), respectively. The 2005 income tax benefit of $431,000
was 45% of pretax loss. Income taxes for 2004 reflect a deferred tax credit of
$505,000 or 27% of pretax loss. The 2003 tax expense was $444,000 or 30% of
pre-tax income. The higher than expected income tax rate in 2005 is due to
manufacturing tax credits and other permanent book and tax differences. The
Company has recorded deferred tax assets partly because of net operating losses
that can offset future taxable income. Management has concluded that it's more
likely than not that these NOLs would be fully utilized and will offset future
taxable income. This benefit, together with permanent differences and other
current tax effects resulted in a net income tax benefit of $431,000.

         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 2005,
2004 and 2003. For financial reporting purposes, any 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 9 to the consolidated financial
statements in Item 15.

                                       17
<PAGE>

Liquidity, Capital Resources, and Business Acquisitions

         During the twelve months ended December 31. 2005, $1,104,000 of cash
was used by the Company's operations, compared to $1,898,000 of cash provided by
the Company's operations in 2004 and $1,511,000 provided in 2003. The 2005 net
loss of $537,000 plus depreciation and amortization of $3,033,000 plus increased
balances of current liabilities of $208,000 funded the Company's ability to grow
its accounts receivable and inventory. Net accounts receivable and inventory,
adjusted for receivables and inventory purchased as a result of the acquisitions
increased $1,763,000 and $1,980,000 respectively when comparing 2005 balances
with 2004 balances.

         The increase in net accounts receivable and the increase in inventory,
which strained working capital at year end is a direct result of the increase in
net revenues for December 2005. Net revenues for December were $8.7 million
compared to $5.4 million in December 2004, a 61% increase. Accounts receivable,
net of allowances increased only 50% due to the fact that the Company's aged
receivables expressed in days outstanding decreased from 38 days in 2004 to 32
days in 2005. Inventory increased 61%, which is similar to the revenue growth.
The Company's inventory turnover expressed in days was 26 days for 2004 compared
to 25 days for 2005; thus inventory increased at the same rate as revenues.
These increases were partially offset by increases in accounts payable and the
Company's line of credit.

         The Company finances its operations and growth primarily with cash
flows generated from operations. The Company has a $3.0 million working capital
line of credit which was fully utilized as of December 31, 2005 and no
additional line of credit was available to the Company at December 31, 2005, a
letter of credit in the amount of $1,000,000 which is issued in favor of an
insurance company to support a self-funded worker's compensation program, which
was increased to $1,100,000 in January 2006, and non-revolving term loans from
the bank to fund acquisitions. No additional revolving term loan is available to
the Company without bank approval. The Company also had a bank overdraft of
$1,507,000. The Company borrowed $2,000,000 under a non-revolving term loan in
2004 to partially fund the CIBO acquisition, the Company borrowed an additional
$5.0 million in 2005 to partially fund the Casual Gourmet acquisition and on
April 11, 2005 the Company borrowed $2.5 million to partially fund the Sonoma
Foods acquisition. The outstanding principal balance on the non-revolving term
loan was $7,833,000 as of December 31, 2005. The working capital commitment in
place at December 31, 2005 expires October 31, 2006; however, subsequent to
year-end, the Company negotiated an increase to its operating line of credit
because of its need to provide additional working capital which is being
required because of the recent sales growth which the Company expects to
continue. The new line of credit allows for advances up to $5 million based on a
formula calculated on accounts receivable and inventory balances. 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 maturity date of
the line of credit has been extended to March 31, 2007 and the covenants have
been adjustment to accommodate the additional borrowing. The Company was also
out of compliance with its debt coverage ratio covenant with its current bank as
of December 31, 2005, and has obtained a waiver.

         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. Working capital
requirements for the Company are being adjusted to reflect the growth of each
product line.

         The Company believes that its existing credit facilities, along with
the increased credit facility, and cash flows from operations, are sufficient to
meet its cash needs for normal operations including all anticipated capital
expenditures for the next twelve months.

         In addition to operating cash flows, the Company also received cash
proceeds of $58,000, $470,000 and $153,000 from the exercise of employee stock
options and sales of stock under the Company's Employee Stock Purchase Plan
during 2003, 2004, and 2005, respectively.

         Cash balance at the end of 2005 was $330,000 compared with $569,000 in
2004. The cash from operations in 2004 and non-revolving bank loans were used to
purchase a 60% interest in Casual Gourmet Foods, Inc. and 80% of Sonoma Foods,
Inc. Purchases of equipment were kept to a minimum during the year with the
majority of capital spending going towards upgrading the plants in Eugene,
Oregon and Seattle, Washington.

         Cash balance at the end of 2004 was $569,000. The cash from operations
in 2004, cash balances on hand on December 31, 2003, and part of the
non-revolving bank loan was used to purchase an 80% interest in CIBO Naturals
LLC. Purchases of equipment were kept to a minimum during the year. Over half of
the equipment spending in 2004 was to finish projects started in 2003.

         The cash from operations in 2003 and cash balances from the prior year
were used primarily to purchase $3,029,000 of plant and equipment during the
year. In 2003, the Company added the ability to produce items in the rapidly
growing prepared foods category, including a lasagna line and corresponding
plant improvement to accommodate these new products. Also added were automated
filling equipment that reduced operating costs of the Company. Many other
smaller projects were completed to support growth, improve processes, support
administrative systems, or assist in compliance issues.

                                       18
<PAGE>

         The Company anticipates 2006 capital expenditures to be approximately
$1.0 million which is about what was spent in 2005. All future capital
expenditures are expected to be funded with a combination of cash flow from
operations or the use of the Company's line of credit.

         Management believes that cash on hand at December 31, 2005, projected
2006 cash flows from operations, and the increase in its operating line of
credit will be sufficient to fund working capital needs, expected Company
growth, and anticipated capital expenditures during 2006. Alternative financing
arrangements will need to be found if the Company makes further acquisitions.

Contractual Obligations

         The Company has no raw material contracts exceeding one year in
duration. However, it does have one long-term contract with its liquid nitrogen
provider, which expires November 30, 2007. In addition, the Company leases
production, warehouse and corporate office space as well as certain equipment
under both a 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 accepted employment with the
Company commencing October 1, 2002 pursuant to terms set forth in a letter from
the Company, a copy of which is filed as exhibit 10.7 to this Form 10-K and in
incorporated here by reference.

         The following table summarizes the estimated annual obligations.

<TABLE>
<CAPTION>
                                                   Payments due by period
                            -------------------------------------------------------------------

Contractual Obligations                    Less than                                 More than
   (in Thousands)              Total         1 year     1 - 3 years   3 - 5 years     5 years
                            -----------   -----------   -----------   -----------   -----------
<S>                         <C>           <C>           <C>           <C>           <C>
Long-term debt              $     8,903   $     2,462   $     4,483   $     1,958   $        --
Capital lease obligations           243   $        59   $       125   $        57   $         3
Operating leases                  6,054   $     1,205   $     1,552   $     1,089   $     2,208
Purchase obligations              1,332   $       695   $       637   $        --   $        --
                            -------------------------------------------------------------------
Total                       $    16,533   $     4,421   $     6,797   $     3,104   $     2,211
                            ===================================================================
</TABLE>

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

         The Company has a $1,100,000 standby letter of credit in favor of an
insurance company for the Company's self-funded workers compensation program
which will expire on December 31, 2006.

         The Company also has obligations to purchase the remaining interests in
Casual Gourmet Foods, which are not presently quantifiable. See "Business
Acquisitions" below.

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, which is incorporated here by
reference.

Business Acquisitions

         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.
Casual, which produces branded gourmet sausages, prepared soups and other food
products, is a Florida corporation with headquarters in Clearwater, Florida.
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.

         For its initial acquisition, Monterey paid $6.0 million in cash plus
acquisition costs of $159,000. Purchase of the remaining shares over the next
three years will be at a price derived from a predetermined calculation based
upon a multiple of earnings before taxes, interest, depreciation and

                                       19
<PAGE>

amortization during the interim periods. Monterey is also the sole source of any
financing needed by Casual in the interim period. Purchase accounting reflects
the transaction as if Monterey purchased 100% of Casual. No liability has been
established for the remaining payments to Casual's shareholders because the
liability is not quantifiable. When Monterey determines the amount to be paid
for the remaining shares of Casual, the Company's goodwill will increase by the
corresponding amount.

         Casual will remain a separate entity until the acquisition is completed
and, under additional agreement between Monterey, Casual and the Shareholders,
Casual's day-to-day operations until the acquisition is completed are managed by
Casual's existing management under the direction of the board of directors;
Monterey controls a majority of the Board of Directors.

         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 in 38 states. Some of their most
popular sausage items include red bell pepper with basil, and spinach with
Asiago cheese. Additional information about Casual Gourmet Foods, Inc. and its
products can be found on its website at www.cgfoods.com

         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 will remain a
separate entity and, under additional agreement between Monterey, Sonoma and the
Shareholders, Sonoma's day-to-day operations until the acquisition is completed
are managed by Sonoma's existing management; Monterey 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.

         In January 2004, the Company acquired a controlling interest in CIBO
Naturals, LLC ("CIBO"), a leading manufacturer of premium sauces and spreads
located in Seattle, Washington. The Company paid CIBO and its members $6.0
million cash for 80% of CIBO. Additionally, the acquisition agreement provides
for the purchase of the remaining 20% ownership after four years at a
predetermined calculation based on earnings before taxes. The cash to fund the
acquisition came partly from the Company's cash balances and from its credit
facilities. On May 12, 2004, the Company purchased for $316,500 (but without any
earn-out provision) the entire remaining holdings of one of the minority members
of CIBO. This additional acquisition increased the Company's interest in CIBO to
84.5%.

         On January 12, 2006, the Company announced an amendment of the
acquisition agreement to accelerate its purchase of the remaining 15.5% of CIBO
from Suekat in exchange for 300,000 unregistered shares of Monterey common stock
with an estimated market value of $1.2 million. The Company now owns 100% of
CIBO Naturals LLC.

         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.

         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.

                                       20
<PAGE>

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
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


         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 on the consolidated balance sheet of Sonoma Foods because of the
uncertainty that Monterey will purchase the remaining shares from the minority
shareholders. No minority interest has been recorded for the acquisitions of
CIBO and Casual because the purchase of the remaining shares is mandated by the
purchase agreements over the next several years at a price derived from a
predetermined calculation. Monterey is the sole source of any financing needed
by its majority-owned subsidiaries. Accordingly, for the CIBO and Casual
acquisitions, purchase accounting reflects the transaction as if Monterey
purchased 100% of the entities. No liability has been established for the
remaining payments to their shareholders because the liability is not
quantifiable. When Monterey pays for the remaining shares of CIBO and Casual,
the Company's goodwill will increase by the corresponding amount of the payment.
All intercompany transactions and balances have been eliminated.

         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 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.

         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.


         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

                                       21
<PAGE>

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 2005, the valuation
allowance was decreased due to the consideration of the impact of deferred tax
liabilities resulting from acquisitions which affected the Company's assessment
of the realization of such 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 expects to utilize all of the NOLs in future years. 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.


         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, 2005, the
Company reduced the carrying value of its inventory by $123,000. 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 is adequate given the current
volume of business to its current customers.


         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 into 2005. 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 three
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.


         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
to the customer or when the product has been delivered to the customer, 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. Potential returns, adjustments and spoilage
allowances are considered as a reduction in revenues and are provided for in
accounts receivable allowances and accruals. All pricing is quoted FOB shipping
point to customers with freight included in the price for the convenience of the
customer

         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.

                                       22
<PAGE>

         Goodwill/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. Intangible assets with finite useful lives continue to be
amortized over their respective estimated useful lives. The primary identifiable
intangible assets of the Company's reporting units are trademarks, tradenames
and customer relationships acquired in business acquisitions. Identifiable
intangibles with finite lives are amortized and those with indefinite lives are
not amortized. The estimated useful life of an identifiable intangible asset to
the reporting unit is based upon a number of factors, including the effects of
demand, competition, and future cash flows. As of December 31, 2005, the net
book value of trademarks and other identifiable intangible assets was $11.1
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.

         Identifiable intangible assets that are subject to amortization are
evaluated for impairment using a process similar to that used to evaluate
elements of property. Identifiable intangible assets not subject to amortization
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 goodwill impairment is performed to measure
the impairment loss, if any. In making an 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 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, 2005, the Company had $12.0 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.

         In evaluating the recoverability of goodwill, it is necessary to
estimate the fair value of the reporting units. 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.

         In the fourth quarter 2005, Casual Gourmet saw a significant reduction
in its sales to its two largest customers. If revenues to these two customers do
not return to historical levels, the Company may need to impair the goodwill and
or intangible assets that have previously been recorded. The Company has taken
many steps to restore the sales to these two major customers. The Company is
introducing among other items: Anti-Biotic 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. The
Company is also introducing these products into the retail market place through
Monterey Gourmet Foods' retail sales force.

Recently Issued Accounting Standards

         In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections". This new standard replaces Accounting Principles Board
("APB") Opinion No. 20, "Accounting Changes in Interim Financial Statements",
and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements",
and represents another step in the FASB's goal to converge its standards with
those issued by the IASB. Among other changes, SFAS 154 requires that a
voluntary change in accounting principle be applied retrospectively with all
prior period financial statements presented on the new accounting principle,
unless it is impracticable to do so. FAS 154 also provides that (1) a change in
method of depreciating or amortizing a long-lived nonfinancial asset be
accounted for as a change in estimate (prospectively) that was effected by a
change in accounting principle, and (2) correction of errors in previously
issued financial statements should be termed a "restatement." The new standard
is effective for accounting changes and correction of errors made in fiscal
years beginning after December 15, 2005. Early adoption of this standard is
permitted for accounting changes and correction of errors made in fiscal years
beginning after June 1, 2005. Management does not expect the adoption of SFAS
154 to have a material effect on its consolidated financial statements in the
future. As of December 31, 2005 this pronouncement had no impact on its
consolidated financial statements.

                                       23
<PAGE>

         In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment".
SFAS No. 123R is a revision of SFAS No. 123, "Accounting for Stock Based
Compensation", and supersedes APB Opinion No. 25 "Accounting for Stock Issued to
Employees". Among other items, SFAS 123R eliminates the use of APB 25 and the
intrinsic value method of accounting, and requires companies to recognize the
cost of employee services received in exchange for awards of equity instruments,
based on the grant date fair value of those awards, in the financial statements.

         The effective date of SFAS 123R is the first fiscal year beginning
after June 15, 2005, which is the first quarter 2006 for calendar year
companies, although early adoption is allowed. SFAS 123R permits companies to
adopt its requirements using either a "modified prospective" method, or a
"modified retrospective" method. Under the "modified prospective" method,
compensation cost is recognized in the financial statements beginning with the
effective date, based on the requirements of SFAS 123R for all share-based
payments granted after that date, and based on the requirements of SFAS 123 for
all unvested awards granted prior to the effective date of SFAS 123R. Under the
"modified retrospective" method, the requirements are the same as under the
"modified prospective" method, but the "modified retrospective" method also
permits entities to restate financial statements of previous periods based on
proforma disclosures made in accordance with SFAS 123.

         The Company currently utilizes a standard option pricing model (i.e.,
Black-Scholes) to measure the fair value of stock options granted to employees.
While SFAS 123R permits entities to continue to use such a model, the standard
also permits the use of a "lattice" model. The lattice model uses assumptions,
based upon actual historical data, about employee exercise behavior and expected
changes in stock-price volatility which can result in more accurate and often
lower estimates of option value and expense. The Company has not yet determined
which model it will use to measure the fair value of employee stock options upon
the adoption of SFAS 123R. See Note 10 to the consolidated financial statements
in Item 15 for further information regarding the Company's outstanding options.
SFAS 123R also requires that the benefits associated with the tax deductions in
excess of recognized compensation cost be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature. This
requirement will reduce net operating cash flows and increase net financing cash
flows in periods after the effective date. These future amounts cannot be
estimated, because they depend on, among other things, when employees exercise
stock options.

         The Company is required to adopt SFAS 123R effective January 1, 2006.
The Company believes that the amount the Company will expense in future years is
approximately reflected in Note 1 of the notes to consolidated financial
statements in Item 15.

         In November 2004, the FASB issued SFAS No. 151, "Inventory Costs: an
amendment of Accounting Research Bulletin ("ARB") No. 43, Chapter 4" to clarify
the accounting of abnormal amounts of idle facility expense, freight, handling
costs and wasted material. SFAS No. 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. At this time,
management is in the process of reviewing this Statement for its impact on the
Company's cost of goods sold and inventory valuation. Management has not
determined if this statement will impact its financial accounting in the future.


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, all sales, operating items and balance sheet data are denominated in U.S.
dollars; therefore, the Company has no foreign currency exchange rate risk.

         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, 2005, management does
not believe 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 and other
long-term liabilities are based on variable interest rates and therefore
affected by changes in market interest rates. Short-term interest rates have
increased over the last two years. The average interest rate the Company is

                                       24
<PAGE>

paying is 7.2%. Rising interest rates have impacted interest expense. If
interest rates continue to rise, they will further depress the Company's
earnings.


     Currency Risk

         During 2005, the Company sold $95,000 of product in currency other than
US dollars. These sales have terms of net 30 days from shipment. The Company
believes that its currency exposure is not material and has chosen not to hedge
these sales.

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

         The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has 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, 2005. Based on that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that, because of the material weaknesses in internal control discussed below,
the Company's disclosure controls and procedures were not effective as of
December 31, 2005.

         A material weakness in internal control is a significant deficiency, or
combination of significant deficiencies, that results in more than a remote
likelihood that a material misstatement of the financial statements would not be
prevented or detected on a timely basis by the Company. The material weaknesses
as of December 31, 2005 were as follows:

         1.  In connection with the annual audit of our consolidated financial
             statements for the year ended December 31, 2005, there were a
             number of post closing adjustments identified and recorded. These
             adjustments were not detected by the Company's system of internal
             controls and affected several financial statement accounts
             including cash, accounts receivable, inventory and accrued
             liabilities. These deficiencies have resulted partly due to the
             additional workload placed on the existing financial staff to
             address the increasing requirements of regulatory compliance and
             the additional work created from the Company's most recent
             acquisitions. The aggregate size of these adjustments indicates a
             material weakness in the Company's internal controls over financial
             reporting.

         2.  In connection with the annual audit of the Company's consolidated
             financial statements for the year ended December 31, 2005,
             management did not detect an error relating to deferred tax
             liabilities associated with acquisitions in the Company's annual
             income tax provision. This error arose in part due to the
             complexities relating to the deferred tax liabilities associated
             with the acquisitions. This error in the preparation of its income
             tax provision and related deferred tax assets and liabilities
             indicated a material weakness in the Company's internal controls
             over financial reporting.

         Management believes that actions taken since December 31, 2005 and
additional actions to be taken in 2006, correct the material weaknesses in
internal control over financial reporting noted above. Some of these remediation
actions are:

               1.   Expanding accounting professionals. As of December 31, 2005,
                    due to medical disability and unanticipated departure of
                    personnel, the Company employed only two full-time and one
                    part-time accountants. As of March 15, 2006, the Company had
                    replaced or hired additional qualified accountants to bring
                    its accounting staff to five full-time accountants and one
                    part-time accountant.
               2.   Implementation of certain enhanced control processes over
                    accounting for subsidiaries.
               3.   Enhanced internal reporting from its financial systems
                    including general ledger reporting and consolidating
                    entries.
               4.   Engagement of third party tax specialists to provide quality
                    assurance and tax expertise outside of the firm that
                    currently prepares the Company's tax return.

                                       25
<PAGE>

               5.   Engaging other specialists to provide support for reporting
                    of technical areas.
               6.   Reviewing the process by which its tax provision is
                    prepared.

Inherent Limitations on Effectiveness of Controls

         The Company's Chief Executive Officer and Chief Financial Officer do
not expect that the Company's internal controls will prevent all errors. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, 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.

Changes in Internal Control over Financial Reporting

         Except for changes related to the material weaknesses described above,
there has been no change during the company's fiscal quarter ended December 31,
2005 in the company's internal control over financial reporting (as such term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has
materially affected, or is reasonably likely to materially affect, the company's
internal control over financial reporting.


ITEM  9B.   OTHER INFORMATION

         None

                                    PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         As of March 30, 2006, the directors, executive officers, and other
significant employees of the Company are as follows:

Directors and Executive Officers:

           Name                             Age      Position
           ----                             ---      --------
           Charles B. Bonner (1)             63      Director

           F. Christopher Cruger (2) (3)     70      Director

           James M. Williams                 56      Chief Executive Officer,
                                                     President officer President
                                                     And Director

           Michael P. Schall (1)             52      Director

           Van Tunstall                      59      Chairman of the Board

           James Wong (2) (3)                58      Director

           Walter L Henning  (2) (3)         61      Director

           John H. McGarvey (1)              61      Director

           Scott Wheeler                     51      Director, Chief Financial
                                                     Officer
                                                     and Corporate Secretary

   (1)   Member of Audit Committee
   (2)   Member of Compensation Committee
   (3)   Member of Nominating Committee

         Normally each director is elected for a period of one year and serves
until the stockholders duly elect his or her successor. Directors may be elected
by the Board to fill a vacancy between annual stockholder meeting elections. The
principal occupations of each director and executive officer of the Company, for
at least the past five years, are as follows:

                                       26
<PAGE>

         Charles B. Bonner. Mr. Bonner served as a Director of the Company from
1993 through January 1995, and was reappointed as a Director effective September
1995. Mr. Bonner is Principal and Founder of Pacific Resources, Inc., a mergers
and acquisitions advisory firm, a position he has held since September 1989.
From 1975 to 1988 he was president of Bonner Packing Co., an $80MM dried fruit
processing and marketing company which was sold to Dole Food Company in 1988.
Mr. Bonner also serves as a director for Everything Metal Imaginable, Inc., and
Scrip Advantage, Inc.

         F. Christopher Cruger. Mr. Cruger was elected to the Board of Directors
in December of 2001. He is a retired investor and former senior manager or
executive of several consumer product companies. Mr. Cruger joined McCormick and
Company, a maker of spices and seasonings, in 1995 and served until 1999 as
Vice-President and General Manager of the Food Service Group and as Chairman of
McCormick's Global Food Service Council. Mr. Cruger was president and CEO of
Tone Brothers, Inc., a spice producer, from 1985 to 1995. He is a Director of
Kemin Industries, Inc.

         James M. Williams. Mr. Williams joined the Company as President on
October 1, 2002 and was elected to the Board of Directors on October 29, 2002.
On January 3, 2003 Mr. Williams was promoted to Chief Executive Officer. Prior
to his employment with the Company, Mr. Williams served as President and CEO of
Bongrain Cheese-USA, a division of the French company Bongrain SA, a world-wide
public company focusing on specialty cheeses, from 1990 to 2002. Previously he
held executive, sales and marketing positions with the Hillshire Farm division
of Sara Lee Corporation, a global consumer products company.

         Michael P. Schall. Mr. Schall was elected to the Board of Directors in
December of 2001. Mr. Schall is currently President of Strategic Marketing
Methods, a consulting and advisory firm providing sales and marketing, business
development advisory and new product expertise to the food and foodservice
industries. Mr. Schall served as Senior Vice President of Sales, Marketing, and
Direct Store Delivery for Wise Foods, a snack food company, from January 2002
until March 2003. From 2000 until January of 2002 he was President and CEO of
the B. Manischewitz Company, one of the nation's largest kosher food companies.
Prior to that Mr. Schall was President and CEO of Guiltless Gourmet, a food
manufacturing company, from 1994 until it's acquisition by Manischewitz. Mr.
Schall held executive or senior management positions with Carnation Company, now
Nestle S.A., Lawry's Foods Inc., a division of Unilever U.S., and Prepared
Products Co.

         Van Tunstall. Mr. Tunstall was elected to the Board of Directors in
February 1997. Since 1997, he has served as President of the Central Coast
Group, a strategic consulting and business services firm. Mr. Tunstall has been
an independent consultant with a variety of companies since 1997. Mr. Tunstall
was a senior executive with Gilroy Foods, Inc., an international manufacturer of
various food product ingredients, from 1977 to 1995. He served as President and
Chairman of the Board of Gilroy Foods, Inc. from 1991 through 1995. Previously,
Mr. Tunstall held several executive positions with McCormick & Company, Inc. Mr.
Tunstall also serves on the Board of other food companies, including Rudi's
Organic Bakery, Inc. and Cascade Specialties, Inc.

         James Wong. Mr. Wong was elected to the Board of Directors in March
1997. Since 1988, he has worked on five continents as an entrepreneur and
management consultant facilitating strategic alliances and technology transfer
projects. Mr. Wong is currently Chairman and a Director of Restaurant
Connections International, Inc. a company he co-founded in September 1998, which
owns and operates a chain of restaurants in Brazil. Until September 2001, Mr.
Wong was also President and CEO of Restaurant Connections International. From
2000 to 2002, Mr. Wong served as CEO and a Director of Service Interactive,
Inc., a service turnaround manager for PepsiCo and General Motors.

         Walter L. Henning. Mr. Henning was elected to the Board of Directors in
December 1999. He is currently Plant Manager of the Salinas Plant, McCormick &
Company, Inc., a position he has held since early 1999. Mr. Henning began his
career with McCormick and Company in 1971 as Manager, Technical Services. He
subsequently was promoted several times to other positions in technical and
plant management before leaving the company in 1983 to accept the position of
Vice President of Operations with Tone Spices. Following the sale of Tone
Spices, Mr. Henning returned to Gilroy Foods, a subsidiary of McCormick and
Company in 1995 as Vice President of Operations. Mr. Henning remained with
Gilroy Foods, Inc. in the same capacity after it was purchased by ConAgra Foods
Inc., a packaged food company, in 1996, before ultimately returning to McCormick
& Company in 1999.

         John H. McGarvey. Mr. McGarvey was elected to the Board of Directors in
February 2006. He has served since 1990 as an associate and/or partner of Cybus
Capital Markets, LLC, an investment bank specializing in capital placement and
formation services for middle market companies in the food and agribusiness
areas. Mr. McGarvey is an owner and director of McGarvey & Affiliates, a
financial consulting firm. Currently, Mr. McGarvey serves on the boards of Cybus
Capital Markets, LLC, The Jacobson Companies, Dominex LLC and Sioux-Preme
Packaging Company. Mr. McGarvey is a law graduate of Creighton University,
received a Masters degree in Taxation from New York University, and has earned
continuing education credit in finance from the Wharton Business School.

                                       27
<PAGE>

         Scott Wheeler, Chief Financial Officer, Corporate Secretary and
Director. Mr. Wheeler joined the company in April 2003 as Corporate Controller,
and was promoted to Chief Financial Officer, effective October 27, 2003. His
most recent position was Vice President and Financial Officer of KBC Edible
Beans Division of ConAgra Foods, where he worked for three years. Prior to that
he worked for Mallard's Food Products both when it was an independent company
and after it was sold to Tyson Foods, Inc, He began his career at Mallard's Food
Products in 1994 as Chief Financial Officer until 1999 when he was promoted to
General Manager until joining KBC in April of 2000. Prior to joining Mallard's,
Mr. Wheeler held a variety of positions with Basic American Foods over a
thirteen-year period. He is a CPA with an MBA in finance from Golden Gate
University in San Francisco, CA.


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

         Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's directors and executive officers, and persons who own
more than 10% of a registered class of the Company's equity securities, to file
with the SEC initial reports of ownership and reports of changes in ownership of
Common Stock and other equity securities of the Company. Officers, directors and
greater than 10% beneficial owners are required by SEC regulations to furnish
the Company with copies of all reports they file under Section 16(a). To the
Company's knowledge, based solely on its review of the copies of such reports
furnished to the Company and written representations that no other reports were
required, all Section 16(a) filing requirements applicable to its officers,
directors and greater than 10% beneficial owners were complied with during the
fiscal year ended December 31, 2005.

Audit Committee Composition

         Among the committees identified above, the Company has a separately
designated standing audit committee established in accordance with Section
3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. Charles B.
Bonner, Michael P. Schall and Walter L. Henning are members of the audit
committee during the year 2005. At the Board meeting in February 2006, Mr.
Henning was replaced by Mr. McGarvey on the audit committee. The Company's Board
of Directors has determined that all members of the Company's Audit Committee
are "independent" as defined in NASD Marketplace Rule 4200(a)(15).

Audit Committee Expert

         The Company's Board of Directors has determined that Mr. Charles B.
Bonner, because of his experience in mergers and acquisitions, extensive
experience in financial transactions and knowledge of business operations, is
the Board's designated financial expert.

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.

                                       28
<PAGE>

ITEM 11.    EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>

                                               Annual Compensation                                  Long Term Compensation
                                               -------------------                                  ----------------------

                                                                                  Other           Securities           All
          Name and                                                                Annual          Underlying          Other
     Principal Position            Year       Salary $ (1)        Bonus $       Compensation      Options (#)      Compensation
     ------------------            ----       ------------        -------       ------------      -----------      ------------
<S>                                <C>         <C>              <C>                <C>             <C>              <C>
James M. Williams (2)              2005        $ 323,696        $ 124,350 (3)      $9,000 (4)      (50,000)         $     --
President and CEO                  2004        $ 317,681        $  16,000 (3)      $9,000 (4)      (50,000)         $ 20,000 (5)
                                   2003        $ 292,453        $  69,500 (3)      $9,000 (4)      (50,000)         $ 27,708 (5)

Scott S. Wheeler                   2005        $ 160,616        $  15,000 (3)      $   --           20,000          $     --
Chief Financial Officer            2004        $ 146,779        $  20,000 (3)      $   --           15,000          $     --
                                   2003        $  66,635        $      --          $   --           25,000          $ 50,000 (5)
</TABLE>

Note:  ("options" in all cases refer to an option to purchase one share of
common stock for each option granted)

(1)   Includes amounts (if any) deferred at the named executive officer's option
      under the Company's 401(k) plan.

(2)   Mr. Williams joined the Company in October 2002 as President. On December
      28, 2002, Mr. Williams was promoted to President and Chief Executive
      Officer.

(3)   Bonuses were based on the Company's performance and other objectives
      obtained.

(4)   Represents the sum of monthly automobile allowances.

(5)   Represents relocation expenses and housing allowances paid by the Company



Stock Options Granted in Fiscal 2005

The following table provides the specified information concerning grants of
options to purchase our Common Stock made during the fiscal year ended December
31, 2005 to the persons named in the Summary Compensation Table:

<TABLE>
<CAPTION>
                                     OPTION GRANTS IN LAST FISCAL YEAR

                                               Individual Grants
                          ---------------------------------------------------------

                                            % of Total
                             Number of       Options
                              Shares        Granted to
                            Underlying      Employees      Exercise
                              Options       in Fiscal       Price        Expiration      Potential Realizable
       Name                 Granted(1)         Year       Per Share(2)      Date        Value on 12/09/2005 (3)
---------------------     -------------   --------------  ------------   ----------     -----------------------
<S>                           <C>             <C>            <C>          <C>                  <C>
James M. Williams             50,000          19.38%         $3.95        12/9/2015            $ 106,605

Scott S. Wheeler              20,000           7.75%         $3.95        12/9/2015            $  42,642
</TABLE>
----------------

                                       29
<PAGE>

(1)   The option to purchase shares was granted on December 9, 2005 and will
      vest 33% on December 9, 2006, 33% of December 9, 2007 and 34% on December
      9, 2008 conditioned upon continued service with the Company. In 2005 the
      Company changed its vesting schedule for stock options from two years to
      three years.

(2)   All options were granted at market value on the date of grant.

(3)   The Potential Realizable Value of the options was calculated using a
      Black-Scholes option pricing model assuming no dividends, a weighted
      average risk-free interest rate of 3.56%, a weighted-average volatility of
      53.6%, and an expected life of 6 years.

Option Exercises and Fiscal 2005 Year-End Values

         There were no exercises of options by any of the officers named in the
Summary Compensation Table during the fiscal year ended December 31, 2005. The
following table specifies the number and value of unexercised options held as of
December 31, 2005, by the persons named in the Summary Compensation Table above.

<TABLE>
<CAPTION>
                                                AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                                                          AND FISCAL YEAR-END VALUES

                                         Number of Shares
                                 Underlying Unexercised Options at                 Value of Unexercised
                                          Fiscal Year End               In-the-Money Options at Fiscal Year End(1)
                                ----------------------------------      -------------------------------------------

         Name                     Exercisable       Unexercisable         Exercisable $           Unexercisable $
------------------------        ---------------    ---------------      -----------------        ------------------
<S>                                  <C>                <C>                  <C>                      <C>
James M. Williams                    150,000            50,000               $43,000                  $4,000

Scott S. Wheeler                      40,000            20,000               $19,300                  $1,500
</TABLE>

----------------

(1)   Based on a market value of $4.03 per share, the closing price of our
      Common Stock on December 30, 2005, the last trading day of our fiscal
      year, as reported by the NASDAQ National Market.

Employment Contracts and Termination of Employment and Change-in-Control
Arrangements

         The Company's President and Chief Executive Officer accepted employment
with the Company commencing October 1, 2002 pursuant to terms set forth in a
letter from the Company, a copy of which is filed as Exhibit 10.7. Pursuant to
this letter, Mr. Williams is an "at will" employee with (1) salary payable at
the rate of $290,000 per annum and eligibility for an annual bonus up to a
maximum of 50% of gross salary based upon achievement of mutually agreed
performance standards, (2) options for 200,000 shares of Company common stock
vesting over a period of four years, (3) a car allowance of $750 per month, (4)
the right to participate in group medical insurance and similar benefits
available to all employees, and (5) a severance benefit equal to one year's
salary in the event his employment is terminated without cause. Pursuant to the
letter also, the Company provided Mr. Williams with relocation assistance,
including a $20,000 per year housing assistance bonus during the first three
years of employment, reimbursement for moving costs, reimbursement for certain
costs in connection with sale of a previous home and purchase of a new one, and
gross up to alleviate the income tax impact of the additional consideration.

Compensation of Directors

         Outside directors are reimbursed for out-of-pocket travel expenses
related to Board meetings and receive a stipend of $3,000 for each Board meeting
attended. The Audit Committee chairperson receives a stipend of $700 for each
Audit Committee meeting chaired, the Compensation Committee chairperson receives
a stipend of $500 for each committee meeting chaired, and the Board Chairman
receives a stipend of $1,000 for each meeting chaired. Total payments made to
all directors in 2005 were $76,800, plus travel expenses.

         Non-employee directors receive an annual option grant pursuant to the
Company's 2002 Stock Option Plan (the "Plan") to purchase 10,000 shares of the
Company's Common Stock. The Chairman receives an additional option to purchase
5,000 shares of the Company's Common Stock. The exercise price may not be less
than the fair market value of a share of Common Stock on the date of grant and

                                       30
<PAGE>

the grant date will be the stockholder annual meeting date. Each option vests in
three approximately equal annual installments commencing one year after the date
of grant of the option, provided that the director has continuously served as
director or employee from the date of grant.

Compensation Committee Interlocks and Insider Participation

         During the fiscal year ended December 31, 2005, executive compensation
was administered by the Compensation Committee comprised of three independent
members of the Board of Directors, Van Tunstall, James Wong and F. Christopher
Cruger.

Report of the Compensation Committee on Executive Compensation

         The Compensation Committee of the Board of Directors is comprised of
non-employee directors. The members of the Compensation Committee during fiscal
2005 were Van Tunstall, F. Christopher Cruger and James Wong. The Compensation
Committee is responsible for setting and administering the policies governing
annual compensation of the executive officers of Monterey Gourmet Foods. The
Compensation Committee reviews the performance and compensation levels for
executive officers and sets salary levels.

         The goals of Monterey Gourmet Foods' executive officer compensation
policies are to attract, retain and reward executive officers who contribute to
Monterey Gourmet Foods' success, to align executive officer compensation with
performance and to motivate executive officers to achieve Monterey Gourmet
Foods' business objectives. Monterey Gourmet Foods uses salary, bonus
compensation and option grants to attain these goals. The Compensation Committee
reviews compensation surveys to compare Monterey Gourmet Foods' compensation
package with that of similarly-sized food companies. In preparing the
performance graph set forth in the section entitled "Comparison of Stockholder
Return," Monterey Gourmet Foods has selected the Nasdaq National Stock Market
Index as its published industry index; however, the companies included in
Monterey Gourmet Foods salary surveys are not necessarily those included in this
index, because companies in the index may not compete with Monterey Gourmet
Foods for executive talent, and companies which do compete for executive
officers may not be publicly traded.

         Base salaries of executive officers are reviewed annually by the
Compensation Committee and adjustments are made based on (i) salary
recommendations from the Chief Executive Officer, (ii) individual performance of
executive officers for the previous fiscal year, (iii) financial results of
Monterey Gourmet Foods for the previous year and (iv) reports to the
Compensation Committee concerning competitive salaries, scope of
responsibilities of the officer position and levels paid by similarly-sized food
companies.

         The Company believes that employee equity ownership, through stock
options, provides significant additional motivation to executive officers to
maximize value for the Company's stockholders. Because stock options will be
granted at the prevailing market price, they will only have value if the
Company's stock price increases over the exercise price. Therefore, the
Committee believes that stock options will serve to align the interests of
executive officers closely with other stockholders through the direct benefit
executive officers receive through improved stock performance. The Committee
reviews the 2002 Stock Option Plan and the grant of stock options with the
foregoing philosophy. Levels of compensation, particularly bonuses and incentive
compensation are tied to both the overall performance of the Company as well as
the effectiveness of each individual executive in adding to that performance.

         The Committee approved Mr. Williams' compensation as President and
Chief Executive Officer, including his salary and bonus. The Committee reviewed
Mr. Williams's performance based on objectives for net income, large customer
management, new product introductions, product line diversification,
acquisitions, and certain other measures. Mr. Williams was eligible to receive a
bonus of up to 50% of his annual salary based upon the achievement these goals.
A bonus of $124,350 was paid in 2005 and 2006 based on accomplishments during
2005. The Committee also reviewed Mr. Williams' equity compensation in 2004 and
granted Mr. Williams additional options. The size and terms of Mr. Williams'
option grant were based on the responsibilities, expected future contributions
of Mr. Williams, the compensation of CEOs at similarly situated companies and
the retention value of the grant.

         During 2004, Scott S. Wheeler served as Chief Financial Officer. The
Compensation Committee in conjunction with the Audit Committee and the CEO,
reviewed his compensation package to verify that is was commensurate with his
performance, experience and contribution to the Company. A bonus of $15,000 was
paid in 2006 based on accomplishments during 2004.

         During the fiscal year ended December 31, 2005, the Committee granted
options to certain key individuals whom the committee believes can have the most
impact on the current price of the Company's stock. The Committee reduced the
number of employees who are eligible to received options and reviewed the impact
of FAS 123R on Company profitability. The Committee also reviewed, changed and
approved a bonus plan for all salaried employees and plant work leaders to be
paid based on achievement of quarterly and annual net income goals.

                                       31
<PAGE>

         Section 162(m) of the Internal Revenue Code restricts deductibility of
executive compensation paid to Monterey Gourmet Foods' chief executive officer
and each of the four other most highly compensated executive officers holding
office at the end of any year to the extent such compensation exceeds $1,000,000
for any of such officers in any year and does not qualify for an exception under
Section 162(m) or related regulations. The Committee's policy is to qualify its
executive compensation for deductibility under applicable tax laws to the extent
practicable. Income related to stock options granted under the Option Plan
generally qualifies for an exemption from these restrictions imposed by Section
162(m). In the future, the Committee will continue to evaluate the advisability
of qualifying its executive compensation for full deductibility.

                                                 COMPENSATION COMMITTEE

                                                 Van Tunstall, Chairman
                                                 F. Christopher Cruger
                                                 James Wong


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 Stock Market Index (U.S. Companies) and peer issuers
for the period commencing on December 31, 2000 (1) and ending on December 31,
2005.

          Comparison of Cumulative Total Return from December 31, 2000
                           through December 31, 2005:
                Monterey Gourmet Foods, NASDAQ Stock Market Index
                        (U.S. Companies) and Peer Issuers





                               [GRAPHIC OMITTED]




<TABLE>
<CAPTION>
                                    Dec. 29,       Dec. 31,       Dec. 31,       Dec. 26,       Dec. 23,       Dec. 30,
                                    --------       --------       --------       --------       --------       --------
                                      2000           2001           2002           2003           2004           2005
                                      ----           ----           ----           ----           ----           ----
<S>                                  <C>           <C>            <C>            <C>            <C>            <C>
Monterey Gourmet Foods               $100.0        $ 157.1        $  78.9        $  73.7        $  67.8        $  84.8
NASDAQ Stock Market (U.S.)           $100.0        $  79.3        $  54.8        $  80.9        $  88.6        $  91.1
Peer Issuers                         $100.0        $ 121.7        $  92.9        $ 104.4        $  94.5        $ 111.4
</TABLE>

                                       32
<PAGE>

-----------

(1) The index level for all series was set to $100.00 on 12/29/2000, 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.


ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The table below sets forth (except as noted in the footnotes to the
table), certain information with respect to the beneficial ownership of the
Company's Common Stock by (i) all persons known by the Company to be the
beneficial owners of more than 5% of the outstanding Common Stock of the Company
as of December 31, 2005, (ii) each director and director-nominee of the Company,
(iii) the Chief Executive Officer and Chief Financial Officer as of December 31,
2005, and (iv) all executive officers and directors of the Company as of
December 31, 2005, as a group.

<TABLE>
<CAPTION>
                                                                                    Shares Owned
                                                                   --------------------------------------------------
Name and Address of Beneficial Owner (1)                             Number of Shares          Percentage of Class
--------------------------------------------------------------     ------------------------  ------------------------
<S>                                                                      <C>                           <C>
Gruber and McBaine Capital Management (2)                                2,956,625                     18.68%
50 Osgood Place, Penthouse
San Francisco, CA 94133

Fidelity Investments (3)                                                 1,408,700                       8.9%
82 Devonshire Street
Boston, MA 02109

T Rowe Price Associates, Inc. (4)                                        1,111,400                       7.0%
100 East Pratt Street
Baltimore, MD 21202

Dimensional Fund Advisors (5)                                            1,303,492                       8.2%
1299 Ocean Ave
Santa Monica, CA 90401

Heartland Advisors, Inc. (6)                                               745,457                       4.7%
789 North Water Street
Milwaukee, WI  53202

AWM Investment Co., Inc. (7)                                               871,599                       5.5%
153 East 53rd Street
New York, NY  10022

F. Christopher Cruger (8)                                                   56,317                        *

Van Tunstall (9)                                                           126,240                        *

Michael P. Schall (10)                                                      58,350                        *

James Wong (11)                                                             81,000                        *

Charles B. Bonner (12)                                                     177,477                       1.1%

Scott Wheeler (13)                                                          43,000                        *

Walter L. Henning (14)                                                     103,700                        *

James M. Williams (15)                                                     155,950                        *

John H. McGarvey (16)                                                            0                        *

All Officers and Directors as a group (9 persons) (17)                     802,034                       5.0%
</TABLE>

-------------------------
* Represents less than 1%

(1)   Beneficial ownership is determined in accordance with the rules of the
      Securities and Exchange Commission. In computing the number of shares
      beneficially owned by a person and the percentage ownership of that
      person, shares of Common Stock subject to options or warrants held by that

                                       33
<PAGE>

      person that are currently exercisable or will become exercisable within
      sixty (60) days after December 31, 2005 are deemed outstanding, while such
      shares are not deemed outstanding for purposes of computing percentage
      ownership of any other person. Options granted under the Company's 2002
      Stock Option Plan (the "2002 Stock Option Plan") generally becomes
      exercisable as the underlying shares vest. Unless otherwise indicated in
      the footnotes below, the persons and entities named in the table have sole
      voting and investment power with respect to all shares beneficially owned,
      subject to community property laws where applicable. Unless otherwise
      indicated, the address of each of the individuals listed in the table is:
      c/o Monterey Gourmet Foods, Inc., 1528 Moffett Street, Salinas, CA 93905.

(2)   Jon D. Gruber and J. Patterson McBaine are the only managers of, and hold
      all executive offices of, Gruber and McBaine Capital Management LLC
      ("GMCM"), an investment advisor. GMCM is the general partner of Lagunitas
      Partners, L.P. ("Lag"), a California investment limited partnership. As of
      December 31, 2005, GMCM had shared voting and investment power over
      2,330,855 shares; Mr. Gruber had sole voting and investment power over
      298,820 shares and shared voting and investment power over 2330855 shares;
      Mr. McBaine had sole voting and investment power over 326,950 shares and
      shared voting and investment power over 2,330,855 shares; Lag has sole
      voting and investment power over 1,137,085 shares; Mr. Eric Swergold, an
      investment manager, has shared voting and investment power over 2,330,855
      shares. Neither Mr. Gruber nor Mr. McBaine participate in the Management
      of the Company, direct the policies of the company, or serve on the Board
      of Directors of the Company.

(3)   As of December 31, 2005, FMR Corp. on behalf of certain of its direct and
      indirect subsidiaries, and Fidelity International Limited on behalf of
      certain of its direct and indirect subsidiaries (collectively "Fidelity"),
      indirectly held 1,408,700 shares of Company stock. The beneficial
      ownership arises in the context of passive investment activities only by
      the various investment accounts managed by Fidelity on a discretionary
      basis (the "Fidelity Accounts"). Neither Fidelity nor the Fidelity
      Accounts participate in the Management of the Company, direct the policies
      of the company, or serve on the Board of Directors of the Company. No
      Fidelity officer serves as an executive officer of the Company.

(4)   As of December 31, 2005, T. Rowe Price Associates, Inc ("Price
      Associates") had sole dispositive power for an entire holding of 1,111,400
      shares and sole voting power over 256,800 shares. These securities are
      owned by various individual and institutional investors for whom Price
      Associates serves as investment advisor with power to direct investments
      and/or sole power to vote the securities. For purposes of the reporting
      requirements of the Securities Exchange Act of 1934, Price Associates
      expressly disclaims that it is, in fact, the beneficial owner of such
      securities.

(5)   As of December 31, 2005, Dimensional Fund Advisors Inc ("Dimensional") an
      investment advisor registered under Section 203 of the Investment Advisors
      Act of 1940 which furnishes investment advice to four investment companies
      registered under the Investment Company Act of 1940 and serves as
      investment manager to certain other commingled groups trusts and separate
      accounts directly or indirectly held 1,303,492 shares of Company stock. In
      its role as investment advisor or manager, Dimensional possesses
      investment and/or voting power over 1,303,492 shares. However, Dimensional
      disclaims beneficial ownership of these securities. In addition, no
      Dimensional officer serves as an executive officer or director of the
      Company.

(6)   As of December 31, 2005, Heartland Advisors, Inc. ("Heartland"), in its
      capacity of investment advisor, may be deemed to have beneficial ownership
      of 745,457 shares of the common stock of the Company. Heartland had voting
      power and/or dispositive power over 745,457 shares.

(7)   As of December 31, 2005, AWM Investment Co., Inc. ("AWM"), in its capacity
      of investment advisor, may be deemed to have beneficial ownership of
      871,599 shares of the common stock of the Company. Mr. Austin W. Marxe and
      Mr. David M. Greenhouse are the controlling principals of AWM Investment
      Company, Inc. AWM had voting power and/or dispositive power over 871,599
      shares.

(8)   Includes 51,250 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

(9)   Includes 105,000 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

(10)  Includes 51,250 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

                                       34
<PAGE>

(11)  Includes 75,000 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

(12)  Includes 108,750 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

(13)  Includes 40,000 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

(14)  Includes 6,200 shares held in an IRA account in the name of Teresa A.
      Henning to which Mr. Henning claims beneficial ownership, and 75,000
      shares subject to options granted under the 2002 Stock Option Plan which
      are exercisable within sixty (60) days of December 31, 2005.

(15)  Includes 150,000 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

(16)  Mr. McGarvey was elected to the Board of Directors in February 2006 and
      does not own any of the Company's stock and has not been issued any
      options under the 2002 Stock Option Plan.

(17)  Includes 656,250 shares subject to options granted under the 2002 Stock
      Option Plan which are exercisable within sixty (60) days of December 31,
      2005.

         Additional information required by this item covering equity
compensation plans offered by the Company is incorporated by reference from Note
10 to the consolidated financial statements contained in Item 15.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

      None

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, 2005. 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 fiscal year
ended December 26, 2004 and for the calendar year ended December 31, 2005 by BDO
Seidman, LLP:

                                                Fiscal 2004        Fiscal 2005
                                              ---------------    ---------------

         Audit Fees (1)....................       $171,000           $239,000

         Audit-Related Fees (2)............       $  6,900           $ 41,600

         Tax Fees (3)......................       $ 38,000           $ 31,000

         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.
         (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.
         (3)      Tax Fees consist of fees billed for professional services
         rendered for annual compliance filings, ongoing tax planning,
         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

                                       35
<PAGE>

registered public accounting firm. Pre-approval was obtained from the audit
committee for all fees incurred by the independent registered public accounting
firm.

                                     PART IV

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
(a)(1) - (2)   Consolidated Financial Statements of Monterey Gourmet Foods:                  Page Number (s)
                                                                                             ---------------
<S>                                                                                                <C>
         Report of Independent Registered Public Accounting Firm                                    37
         Consolidated Balance Sheets: Year-End 2004 and 2005                                        38
         Consolidated Statements of Operations: Years Ended 2003, 2004 and 2005                     39
         Consolidated Statements of Stockholders' Equity: Years Ended 2003, 2004 and 2005           40
         Consolidated Statements of Cash Flows:  Years Ended 2003, 2004 and 2005                    41
         Summary of Significant Accounting Policies                                                42-47
         Notes to Consolidated Financial Statements                                                47-62
         Schedule II - Valuation and Qualifying Accounts                                            63
</TABLE>

         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 65. 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.

                                       36
<PAGE>

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 as of December 26, 2004 and December 31, 2005 and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2005. We have also audited the
schedule listed in the accompanying index at Item 15(a). These 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. An audit includes
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 at December 26, 2004 and December 31, 2005, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2005, 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.



BDO Seidman, LLP
San Francisco, California
March 1, 2006

                                       37
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                   December 26, 2004    December 31, 2005
                                                                                   -----------------    -----------------
<S>                                                                                <C>                  <C>
ASSETS
Current assets:
  Cash and cash equivalents                                                        $             569    $             330
  Accounts receivable less allowances of $240 and $992                                         6,212                9,342
  Inventories                                                                                  4,325                6,949
  Deferred tax assets-current                                                                  1,126                1,030
  Prepaid expenses and other                                                                     957                  866
                                                                                   -----------------    -----------------

   Total current assets                                                                       13,189               18,517

  Property and equipment, net                                                                 14,768               14,324
  Deferred tax assets-long term                                                                4,519                6,172
  Deposits and other                                                                             126                  148
  Intangible assets, net                                                                       6,114               11,088
  Goodwill                                                                                     8,143               11,956
                                                                                   -----------------    -----------------

   Total assets                                                                    $          46,859    $          62,205
                                                                                   =================    =================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Bank overdraft                                                                  $              --    $           1,507
   Line of credit                                                                                 51                3,000
  Accounts payable                                                                             2,298                4,171
  Accrued payroll and related benefits                                                         1,042                1,246
  Accrued and other current liabilities                                                        1,277                1,053
  Current portion of notes, loans, and capital leases payable                                    757                2,521
                                                                                   -----------------    -----------------

   Total current liabilities                                                                   5,425               13,498

Notes, loans, and capital leases payable, less current portion                                 1,651                6,626

Deferred tax liability-long term                                                                 567                2,812

Minority interest                                                                                 --                  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, 14,392,574 and 14,514,038 issued and outstanding                  14                   14
  Additional paid-in capital                                                                  45,103               45,534
  Accumulated deficit                                                                         (5,901)              (6,438)
                                                                                   -----------------    -----------------
  Total stockholders' equity                                                                  39,216               39,110
                                                                                   -----------------    -----------------

   Total liabilities and stockholders' equity                                      $          46,859    $          62,205
                                                                                   =================    =================
</TABLE>

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

                                       38
<PAGE>

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

<TABLE>
<CAPTION>
                                                                    Years Ended
                                                   --------------------------------------------
                                                       2003            2004            2005
                                                   ------------    ------------    ------------
<S>                                                <C>             <C>             <C>
 Net revenues                                      $     60,490    $     62,491    $     85,248

 Cost of sales                                           41,921          46,023          62,016
                                                   ------------    ------------    ------------

 Gross profit                                            18,569          16,468          23,232

 Selling, general and administrative expenses            17,161          18,224          23,590
 Loss on disposition of assets                               --              (5)             --
                                                   ------------    ------------    ------------
 Operating income (loss)                                  1,408          (1,761)           (358)

 Other income (expense), net                                 (1)             42              18
 Interest income (expense), net                              72            (130)           (628)
                                                   ------------    ------------    ------------

 Income (loss) before provision for income taxes          1,479          (1,849)           (968)

 Income tax benefit (provision)                            (444)            505             431
                                                   ------------    ------------    ------------

  Net income (loss)                                $      1,035    $     (1,344)   $       (537)
                                                   ============    ============    ============


Net income (loss) per common share
 Basic income (loss) per common share              $       0.07    ($      0.09)   ($      0.04)

 Diluted income (loss) per common share            $       0.07    ($      0.09)   ($      0.04)

 Basic shares outstanding                            14,206,627      14,343,386      14,450,251
 Diluted shares outstanding                          14,414,931      14,343,386      14,450,251
</TABLE>

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

                                       39
<PAGE>

                          MONTEREY GOURMET FOODS, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                    FOR THE YEARS ENDED 2003, 2004, and 2005
                      (in thousands, except share amounts)

<TABLE>
<CAPTION>
                                               Common Stock
                                     ---------------------------------      Additional       Accumulated
                                         Shares            Amount        Paid-in Capital       Deficit             Total
                                     ---------------   ---------------   ---------------   ---------------    ---------------
<S>                                       <C>                       <C>           <C>               <C>                <C>
Balance, end of 2002                      14,196,391                14            44,519            (5,592)            38,941

Issuance of common stock under
Employee Stock Purchase Plan                  15,695                --                54                --                 54

Exercise of stock options for cash             1,596                --                 4                --                  4

Tax benefit of disqualifying
dispositions                                      --                --                 1                --                  1

Net income for the year                           --                --                --             1,035              1,035
                                     ---------------   ---------------   ---------------   ---------------    ---------------

Balance, end of 2003                      14,213,682                14            44,578            (4,557)            40,035

Issuance of common stock under
Employee Stock Purchase Plan                  14,964                --                43                --                 43

Exercise of stock options for cash           163,928                --               427                --                427

Tax benefit of disqualifying
dispositions                                      --                --                55                --                 55

Net income (loss) for the year                    --                --                --            (1,344)            (1,344)
                                     ---------------   ---------------   ---------------   ---------------    ---------------

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

Compensation expense due to
modification of stock option                      --                --                80                --                 80

Stock issued as part of an
acquisition                                   62,150                --               198                                  198

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

Balance, end of 2005                      14,514,038   $            14   $        45,534   $        (6,438)   $        39,110
                                     ===============   ===============   ===============   ===============    ===============
</TABLE>

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

                                       40
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                         Years Ended
                                                                            --------------------------------------
                                                                               2003          2004          2005
                                                                            ----------    ----------    ----------
<S>                                                                         <C>           <C>           <C>
Cash flows from operating activities:
Net income (loss)                                                           $    1,035    $   (1,344)   $     (537)
Adjustments to reconcile net income (loss) to net cash provided by
   operating activities net of acquisition:
           Deferred income taxes                                                   313          (557)         (379)
           Depreciation and amortization                                         2,082         2,510         3,033
           Provisions for allowances for bad debts, returns,
              adjustments and spoils                                             3,211         3,646         4,792
           Provisions for inventory allowances                                     510           550           499
           Tax benefit of disqualifying dispositions                                 1            55            --
          Non-cash stock compensation                                               --            --            80
           Loss on disposition of assets                                            --             5            --
           Changes in assets and liabilities:
               Accounts receivable                                              (3,429)       (2,924)       (6,554)
               Inventories                                                      (1,146)         (267)       (2,473)
               Prepaid expenses and other                                         (389)          538           205
               Bank overdraft                                                       --            --            --
               Accounts payable                                                   (353)           (3)          972
               Accrued and other current liabilities                              (324)         (311)         (742)
                                                                            ----------    ----------    ----------
                  Net cash provided by operating activities                      1,511         1,898        (1,104)
                                                                            ----------    ----------    ----------

Cash flows from investing activities:
           Purchase of property and equipment                                   (3,029)         (777)       (1,071)
           Acquisition of business net of cash and minority interest               (79)       (7,689)       (9,062)
                                                                            ----------    ----------    ----------
     Net cash used in investing activities                                      (3,108)       (8,466)      (10,133)
                                                                            ----------    ----------    ----------

Cash flows from financing activities:
           Proceeds from bank borrowing                                             --         2,000         7,500
           Bank overdraft                                                           --            --         1,507
           Line of Credit                                                           --            --         3,000
           Repayment of debt                                                        --          (610)       (1,143)
           Repayment of capital lease obligations                                  (14)           (8)          (19)
           Proceeds from issuance of common stock                                   58           470           153
                                                                            ----------    ----------    ----------
   Net cash provided by financing activities                                        44         1,852        10,998
                                                                            ----------    ----------    ----------

Net decrease in cash and cash equivalents                                       (1,553)       (4,716)         (239)

Cash and cash equivalents, beginning of period                                   6,838         5,285           569
                                                                            ----------    ----------    ----------
Cash and cash equivalents, end of period                                    $    5,285    $      569    $      330
                                                                            ==========    ==========    ==========

Cash payments:
             Interest                                                       $        1    $      131    $      634
             Income taxes                                                          166            89             7

Non-cash investing and financing activities:
             Note issued to seller in acquisition of business               $       --    $    1,000    $       --
             Capital lease obligations assumed in acquisition of business           --             5            86
             Issuance of stock for acquisiton of business                           --            --           198
</TABLE>

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

                                       41
<PAGE>

                           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 subsidiary, Monterey
Pasta Development Company (a franchiser of restaurants - inactive), 84.5% owned
CIBO Naturals, LLC, 60% owned Casual Gourmet Foods, Inc. 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 on the consolidated balance sheet of Sonoma Foods because of the
uncertainty that Monterey will purchase the remaining shares from the minority
shareholders. No minority interest has been recorded for the acquisitions of
CIBO and Casual because the purchase of the remaining shares is mandated by the
purchase agreements over the next several years at a price derived from a
predetermined calculation. 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 groceries 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.

         Accounting Periods

         On June 16, 2005, the Board of Directors approved a resolution to
change the fiscal year of the Company to a calendar year. Prior to this change
the Company employed a 4-week, 4-week, 5-week reporting period with the fiscal
year ending on the last Sunday of each calendar year (52/53-week year). The 2004
fiscal year ended on December 26, 2004 and the 2005 fiscal year would have ended
on December 25, 2005. The change was made primarily to accommodate the
consolidation process of newly acquired subsidiaries. . The Company recorded
sales of $1.1 million between December 26, 2005 and December 31, 2005

         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.

                                       42
<PAGE>

         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,
2005 and December 26, 2004, the Company reduced the carrying value of its
inventory by $123,000 and $213,000 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 is adequate given the current
volume of business to its current customers.

         Advertising Costs

         The Company expenses advertising costs as incurred or when the related
campaign commences. The Company spent $145,000, $149,000 and $253,000 on
advertising during 2003, 2004, 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.

         Goodwill and Intangible Assets

         Intangible assets other than goodwill consist of tradenames, customer
lists, and non-competes and other intangibles and are recorded at cost, net of
accumulated amortization. Non-compete agreements are amortized on a
straight-line basis over the life of the non-compete agreement ranging from six
to nine years. Registered trademarks and tradenames are determined to have
indefinite lives and are not amortized. Other tradenames are amortized over four
years. Customer lists are amortized over a period ranging from nine to twelve
years. Certain customer lists are amortized on an accelerated basis if the
number of customers are many and there is a possibility of customer turnover,
otherwise customer lists are amortized on a straight-line basis. Recipes and
processes are amortized on a straight-line basis over a range of three years to
six years. Certain acquired recipes, because of their strategic nature, are
deemed to have indefinite lives.

         Effective January 1, 2002 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. Intangible assets with finite
useful lives continue to be amortized over their respective estimated useful
lives. The primary identifiable intangible assets of the Company's reporting
units are trademarks, tradenames and customer relationships acquired in business
acquisitions. Identifiable intangibles with finite lives are amortized and those
with indefinite lives are not amortized. The estimated useful life of an
identifiable intangible asset to the reporting unit is based upon a number of
factors, including the effects of demand, competition, and future cash flows. As
of December 31, 2005, the net book value of trademarks and other identifiable
intangible assets was $11.1 million.

         Identifiable intangible assets that are subject to amortization are
evaluated for impairment using a process similar to that used to evaluate
elements of property. Identifiable intangible assets not subject to amortization
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. In making an assessment, management

                                       43
<PAGE>

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, 2005, the Company had $12.0 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.

         In evaluating the recoverability of goodwill, it is necessary to
estimate the fair value of the reporting units. 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.

         In the fourth quarter 2005, Casual Gourmet saw a significant reduction
in its sales to its two largest customers. If revenues to these two customers do
not return to historical levels, the Company may need to impair the goodwill and
or intangible assets that have previously been recorded. The Company has taken
many steps to restore the sales to these two major customers. The Company is
introducing among other items: Anti-Biotic 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. The
Company is also introducing these products into the retail market place through
Monterey Gourmet Foods' retail sales force.


         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 valuations
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
NOLs. During 2005, the valuation allowance was decreased due to the
consideration of the impact of deferred tax liabilities resulting from
acquisitions which affected the Company's assessment of the realization of such
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 expects to
utilize all of the NOLs in future years.


         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
to the customer or (in the case of Costco wholesales) when the product has been
delivered to the customer, 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. Potential returns,
adjustments and spoilage allowances which reduce net revenues are provided for
in accounts receivable allowances and accruals. All pricing is quoted FOB
shipping point to customers with freight included in the price for the
convenience of the customer.

         The Company records shipping cost for product delivered to customers in
selling general and administrative expense. These costs were approximately
$3,158,000, $3,201,000 and $4,361,000 for 2003, 2004 and 2005 respectively. 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.

                                       44
<PAGE>

         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 into 2005. 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 three 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.


         Stock-based Compensation

         As permitted under the provisions of SFAS 123, Accounting for
Stock-Based Compensation, for calendar year 2005, the Company accounted for
employee stock-based transactions under Accounting Principles Board Opinion
("APB") No. 25, Accounting for Stock Issued to Employees. However, SFAS 123
requires the Company to disclose pro forma net income and earnings per share as
if the fair value method had been adopted. Under the fair value method,
compensation cost is measured at the grant date based on the fair value of the
award and is recognized over the service period, which is usually the vesting
period. For non-employees, cost is also measured at the grant date, using the
fair value method, but is actually recognized in the financial statements over
the vesting period, or immediately if no further services are required.

         If the Company had elected the fair value method of accounting for
stock-based compensation, compensation cost would be accrued at the estimated
fair value of stock option grants over the service period, regardless of later
changes in stock prices and price volatility. The fair value at date of grant
for options granted in 2003, 2004, and 2005 have been estimated based on a
modified Black-Scholes pricing model with the assumptions identified in the
following table.

                                           2003          2004          2005
                                        ----------    ----------    ----------

         Dividend Yield                      --            --            --
         Volatility                       66.0%         54.9%         53.7%
         Risk-Free Interest Rates          4.60%         3.69%         3.58%
         Expected Lives in Years             5             4             6

         The table below shows net income per share for 2003, 2004, and 2005 as
if the Company had elected the fair value method of accounting for stock options
(dollars except per share data stated in thousands).

                                       45
<PAGE>

<TABLE>
<CAPTION>
                                                                   2003            2004           2005
                                                               ------------    ------------    ------------
<S>                                                            <C>             <C>             <C>
Net income (loss) as reported                                  $      1,035    $     (1,344)   $       (537)

Add:  stock-based employee compensaiton 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                                        (1,393)           (715)           (619)

Proforma net loss, as adjusted                                         (358)         (2,059)         (1,076)
                                                               ============    ============    ============

Earnings per share:
Basic, as reported                                             $       0.07    $      (0.09)   $      (0.04)
Basic, as adjusted                                             $      (0.03)   $      (0.14)   $      (0.07)
                                                               ============    ============    ============

Diluted, as reported                                           $       0.07    $      (0.09)   $      (0.04)
Diluted, as adjusted                                           $      (0.02)   $      (0.14)   $      (0.07)
                                                               ============    ============    ============


Basic shares                                                     14,206,627      14,343,386      14,450,251
Diluted Shares                                                   14,414,931      14,343,386      14,450,251
</TABLE>

         Beginning with the fourth quarter of fiscal 2005, the Company increased
the estimate of the expected life of new options granted to employees from four
years to six years. This change in expected life assumption is based on
historical experience, change in the amount of options issued, change in the mix
of employees who receive options, as well as increasing the vesting period of
the options granted.

         On June 23, 2005 the Company accelerated the vesting of all stock
options outstanding under the Company's 2002 Stock Option Plan (formerly the
1993 Stock Option Plan) that have exercise prices per share higher than the
closing price of the Company's stock on June 23, 2005, which was $3.07. Options
to purchase 422,600 shares of the Company's common stock became exercisable
immediately. No other changes to these options were made. These options range in
price from a low of $3.25 to a high of $4.99 with an average of $3.53.

         The primary purpose of the accelerated vesting was to eliminate future
compensation expense the Company would otherwise recognize in its statement of
operations with respect to these accelerated options upon the adoption of SFAS
123R "Share-Based Payment". SFAS 123R is effective for the Company beginning in
the first quarter of 2006, and will require that compensation expense associated
with stock options be recognized in the statement of operations, rather than as
a footnote disclosure in the Company's consolidated financial statements. The
acceleration of the vesting of these options does not impact the Company's
financial statements.

         The Company has also changed the vesting period of all stock options
issued after November 1, 2005 from a two year vesting period to a three year
vesting 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 North America, 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.

                                       46
<PAGE>

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, 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, 2005.

         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, 2005.


         New Accounting Pronouncements

         In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections". This new standard replaces APB Opinion No. 20, "Accounting
Changes in Interim Financial Statements", and SFAS No. 3, "Reporting Accounting
Changes in Interim Financial Statements", and represents another step in the
FASB's goal to converge its standards with those issued by the International
Accounting Standards Board ("IASB"). Among other changes, SFAS 154 requires that
a voluntary change in accounting principle be applied retrospectively with all
prior period financial statements presented on the new accounting principle,
unless it is impracticable to do so. SFAS 154 also provides that (1) a change in
method of depreciating or amortizing a long-lived nonfinancial asset be
accounted for as a change in estimate (prospectively) that was effected by a
change in accounting principle, and (2) correction of errors in previously
issued financial statements should be termed a "restatement." The new standard
is effective for accounting changes and correction of errors made in fiscal
years beginning after December 15, 2005. Early adoption of this standard is
permitted for accounting changes and correction of errors made in fiscal years
beginning after June 1, 2005. Management does not expect the adoption of SFAS
154 to have a material effect on the consolidated financial statements. As of
December 31, 2005 this pronouncement had no impact on the consolidated financial
statements.

         In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment".
SFAS No. 123R is a revision of SFAS No. 123, "Accounting for Stock Based
Compensation", and supersedes APB 25. Among other items, SFAS 123R eliminates
the use of APB 25 and the intrinsic value method of accounting, and requires
companies to recognize the cost of employee services received in exchange for
awards of equity instruments, based on the grant date fair value of those
awards, in the financial statements.

         The effective date of SFAS 123R is the first fiscal year beginning
after June 15, 2005, which is the first quarter 2006 for calendar year
companies, although early adoption is allowed. SFAS 123R permits companies to
adopt its requirements using either a "modified prospective" method, or a
"modified retrospective" method. Under the "modified prospective" method,
compensation cost is recognized in the financial statements beginning with the
effective date, based on the requirements of SFAS 123R for all share-based
payments granted after that date, and based on the requirements of SFAS 123 for
all unvested awards granted prior to the effective date of SFAS 123R. Under the
"modified retrospective" method, the requirements are the same as under the
"modified prospective" method, but the "modified retrospective" method also
permits entities to restate financial statements of previous periods based on
proforma disclosures made in accordance with SFAS 123.

         The Company currently utilizes a standard option pricing model (i.e.,
Black-Scholes) to measure the fair value of stock options granted to employees.
While SFAS 123R permits entities to continue to use such a model, the standard
also permits the use of a "lattice" model. The Company has not yet determined

                                       47
<PAGE>

which model it will use to measure the fair value of employee stock options upon
the adoption of SFAS 123R. See Note 10 to the Consolidated Financial Statements
for further information. SFAS 123R also requires that the benefits associated
with the tax deductions in excess of recognized compensation cost be reported as
a financing cash flow, rather than as an operating cash flow as required under
current literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after the effective date. These
future amounts cannot be estimated, because they depend on, among other things,
when employees exercise stock options.

         The Company is required to adopt SFAS 123R effective January 1, 2006.

         In November 2004, the FASB issued SFAS No. 151, "Inventory Costs: an
amendment of ARB No. 43, Chapter 4" to clarify the accounting of abnormal
amounts of idle facility expense, freight, handling costs and wasted material.
SFAS No. 151 is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. At this time, management is in the process of
reviewing this Statement for its impact on the Company's cost of goods sold and
inventory valuation. Management has not determined if this Statement will impact
its statement of operations in the future.


         Reclassifications

         Certain of the prior year financial statement amounts have been
reclassified to conform to the current year presentation. These
reclassifications had no impact on previously reported income or accumulated
deficit.

     2.  Business Acquisitions

                  The CIBO Naturals Purchase

         In 2004, the Company acquired an 80% interest in CIBO Naturals LLC
("CIBO"), a leading manufacturer of premium sauces and spreads located in
Seattle, Washington. The Company paid CIBO and its members $7.0 million cash for
80% interest in CIBO. $3,000,000 went to the owners of CIBO and $4,000,000 went
to pay down debt on the books of CIBO. The acquisition agreement provided for
the purchase of the remaining 20% ownership after four years at a predetermined
calculation based on earnings before taxes. The cash came partly from the
Company's cash balances and from its credit facilities.

         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, supermarket
delis and specialty food stores. 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 great growth potential in both expanded
distribution and in new products.

         As part of the acquisition, Management determined the components that
represent the intangible assets are customer and distributor relationships,
non-competition agreements, recipes and tradenames and goodwill purchased as
part of the purchase price. Under the purchase method of accounting, the total
estimated purchase price is allocated to CIBO'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 and valuation, and based on financial
information at the time of the acquisition the purchase price allocation was as
follows (in thousands of dollars):

                                       48
<PAGE>

          Cash paid directly to CIBO for debt payment      $   4,000
          Cash paid directly to owners of CIBO                 3,000
          Cash paid to buyout OBIC, Inc.'s 4.5% interest         317
          Acquisition costs incurred                             344
          ----------------------------------------------------------
          Total cost of acquisition                            7,661
          ----------------------------------------------------------
          Liabilities assumed:
             Accounts payable                                    485
             Accrued payroll and other related benefits           81
             Other accrued liabilities                           216
             Long term liabilities                             1,023
          Tangible assets acquired:
             Cash                                                (31)
             Accounts receivable, net of allowances             (633)
             Inventory                                          (274)
             Prepaid expenses and other                          (31)
             Fixed assets                                       (562)
          Intangible assets:
            Customer Relations                                (3,240)
            Non-compete                                         (270)
            Trademarks                                          (220)
            Recipes                                             (870)
          ----------------------------------------------------------
          Goodwill acquired in acquisition                 $   3,335
          ==========================================================

         On May 12, 2004, the Company purchased an additional 4.5% ownership in
CIBO from OBIC, Inc. for $316,500 which is noted in the above purchase
allocation. No earn-out was involved with this purchase. This purchase increased
the Company's investment in CIBO to 84.5%.


         The Casual Gourmet Foods Purchase

         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 will acquire the remaining 40%
over the next three years. Casual, which produces branded gourmet sausages,
prepared soups and other food products, is a Florida corporation with
headquarters in Clearwater, Florida. 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. Purchase of the remaining shares over the next
three years will be at a price derived from a predetermined calculation based
upon a multiple of earnings before taxes, interest, depreciation and
amortization during the interim periods. The Company is also the sole source of
any financing needed by Casual in the interim period. Purchase accounting
reflects the transaction as if the Company purchased 100% of Casual, because the
Company, by contract is entitled to 100% of the profits, losses, cash flows, and
supervision of the acquisition. No liability has been established for the
remaining payments to Casual's shareholders because the liability is not
quantifiable. When the Company determines the amount to be paid for the
remaining shares of Casual, the Company's goodwill will increase by the
corresponding amount.

         Casual will remain a separate entity until the acquisition is completed
and, under additional agreement between the Company, Casual and the
Shareholders, Casual's day-to-day operations until the acquisition is completed
are managed by Casual's existing management under the direction of the board of
directors; the Company controls a majority of the Board of Directors.

         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 in 38 states. Some of their most
popular sausage items include red bell pepper with basil, and spinach with
Asiago cheese. Additional information about Casual Gourmet Foods, Inc. and its
products can be found on its website at www.cgfoods.com

                                       49
<PAGE>

         As part of the acquisition, Monterey Gourmet Foods 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 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 preliminary
estimation of deferred tax liability, which may change upon preparing the tax
returns, and the financial information at the time of the acquisition, 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
                                                               =========

         The Sonoma Foods Purchase

         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. Sonoma will continue to operate under
its current management with its Board of Directors controlled by the Company.

         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. 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
Gourmet Foods 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.
Sonoma will remain a separate entity and, under additional agreement between The
Company, Sonoma and the Shareholders, Sonoma's day-to-day operations until the
acquisition is completed are managed by Sonoma's existing management; 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.

                                       50
<PAGE>

         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 is 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 preliminary
estimation of deferred tax liability which may change upon preparing the tax
returns, and the financial information at the time of the acquisition, the
purchase price allocation is 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 three month periods
ended December 26, 2004 and December 31, 2005 assuming CIBO Naturals, LLC (see
the Company's current reports on Forms 8-K and 8-K/A dated January 28, 2004 and
April 12, 2004, respectively), 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, 2004 (in thousands except per share data).

                                         December 26, 2004    December 31, 2005
                                         -----------------    -----------------

Net revenues                             $          84,971    $          87,815

Net income (loss)                        $          (1,828)   $            (660)
                                         =================    =================

Net income (loss) per common share:
Basic income (loss) per common share     $           (0.13)               (0.05)
                                         =================    =================

Diluted income (loss) per common share   $           (0.13)               (0.05)
                                         =================    =================

Basic shares outstanding                        14,343,386           14,450,251
Diluted shares outstanding                      14,343,386           14,450,251

                                       51
<PAGE>

         The unaudited condensed pro forma financial information has been
prepared for comparative purposes only and reflects the historical audited
results of CIBO Naturals LLC, 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 estimation 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, 2005, approximately
57% of the Company's accounts receivables are concentrated with two major
customers (See Note 12).


     4.       Inventories

         Inventories consisted of the following:

                                                     2004          2005
                                                  ----------    ----------
                                                      (in thousands)

         Production - Ingredients                 $    1,971    $    2,510
         Production - Finished goods                   1,341         2,742
         Paper goods and packaging materials           1,190         1,784
         Operating supplies                               36            36
                                                  ----------    ----------
                                                       4,538         7,072
         Allowances for spoils and obsolescence         (213)         (123)
                                                  ----------    ----------
                                                  $    4,325    $    6,949
                                                  ==========    ==========

     5.       Property and Equipment

         Property and equipment consisted of the following:

<TABLE>
<CAPTION>
                                                             2004          2005
                                                          ----------    ----------
                                                               (in thousands)
<S>                                                       <C>           <C>
         Leasehold improvements                           $    5,084    $    5,142
         Machinery and equipment                              19,317        19,941
         Computers, office furniture and equipment             1,195         1,240
         Vehicles                                                298           454
                                                          ----------    ----------
                                                              25,894        26,777
         Less accumulated depreciation and amortization      (11,163)      (12,703)
                                                          ----------    ----------
                                                              14,731        14,074
         Construction in progress                                 37           250
                                                          ----------    ----------
                                                          $   14,768    $   14,324
                                                          ==========    ==========
</TABLE>

         Construction in progress at December 31, 2005 includes deposits for
equipment on order or yet to be installed.

         Depreciation expense for 2003, 2004, and 2005 was $1,593,000,
$2,029,000, and $2,075,000, respectively.

     6.       Goodwill and Other Intangible Assets

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

                                       52
<PAGE>

<TABLE>
<CAPTION>
                                                   Gross goodwill and intangible assets
                                                ------------------------------------------                      Net
                                                  Year-end         2004         Year-end     Accumulated      Carrying
                                                    2003         Additions        2004       Amortization      Amount
                                                ------------   ------------   ------------   ------------   ------------
<S>                                             <C>            <C>            <C>            <C>            <C>
Trademarks and tradenames with definite lives   $        220   $         --   $        220   $        187   $         33
Customer lists                                         1,500          3,240          4,740            632          4,108
Other intangibles                                        455            270            725            442            283
                                                ------------   ------------   ------------   ------------   ------------
     Total amortized intangible assets                 2,175          3,510          5,685          1,261          4,424
Intangible assets with indefinite lives                  600          1,090          1,690             --          1,690
                                                ------------   ------------   ------------   ------------   ------------
     Total intangible assets                           2,775          4,600          7,375          1,261          6,114
Goodwill                                               4,749          3,394          8,143             --          8,143
                                                ------------   ------------   ------------   ------------   ------------
     Total goodwill and intangible assets       $      7,524   $      7,994   $     15,518   $      1,261   $     14,257
                                                ============   ============   ============   ============   ============


                                                   Gross goodwill and intangible assets
                                                ------------------------------------------                      Net
                                                  Year-end         2005         Year-end     Accumulated      Carrying
                                                    2004         Additions        2005       Amortization      Amount
                                                ------------   ------------   ------------   ------------   ------------

Trademarks and tradenames                       $        220   $         --   $        220   $        215   $          5
Customer lists                                         4,740          3,262          8,002          1,361          6,641
Other intangibles                                        725          1,257          1,982            644          1,338
                                                ------------   ------------   ------------   ------------   ------------
     Total amortized intangible assets                 5,685          4,519         10,204          2,220          7,984
Intangible assets with indefinite lives                1,690          1,414          3,104             --          3,104
                                                ------------   ------------   ------------   ------------   ------------
     Total intangible assets                           7,375          5,933         13,308          2,220         11,088
Goodwill                                               8,143          3,813         11,956             --         11,956
                                                ------------   ------------   ------------   ------------   ------------
     Total goodwill and intangible assets       $     15,518   $      9,746   $     25,264   $      2,220   $     23,044
                                                ============   ============   ============   ============   ============
</TABLE>

         All of the Company's business combinations were accounted for using the
purchase method. Amortization expense was $958,000 and $481,000 for 2005 and
2004 respectively. The Company performed annual impairment testing as required
by SFAS 142 during the fourth quarter of 2005 to determine if any writedowns
were necessary, with no impairment adjustments needed.

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

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

                                     2006            $ 1,007
                                     2007              1,001
                                     2008              1,001
                                     2009                998
                      2010 and thereafter              3,977
                                                     -------
                                    Total            $ 7,984
                                                     =======

                                       53
<PAGE>

     7.       Notes, Loans, and Capitalized Leases Payable

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

<TABLE>
<CAPTION>
                                                                                             2004          2005
                                                                                          ----------    ----------
<S>                                                                                       <C>           <C>
Subordinated note payable to OBIC Inc.; assumed from CIBO Naturals stock purchase         $    1,000    $    1,000
      6% interest only  until March 31, 2006
      Monthly principal payments of $8,000 starting April 1, 2006
      Matures in July 2007
Note payable to Comerica Bank to partial purchase CIBO Naturals                                1,390           625
      Variable rate interest at LIBOR plus 200 basis points
      Monthly principal payments of $62,500 plus interest of approximately 7%
      Matures in October 2006
Note payable to Comerica Bank to partially purchase Sonoma Foods                                  --         2,208
      Variable rate interest at LIBOR plus 275 basis points
      Monthly principal payments of $41,667 plus interest of approximately 7%
      Matures in May 2010
Note payable to Comerica Bank to partially purchase Casual Gourmet Foods                          --         5,000
      Variable rate interest at LIBOR plus 275 basis points
      Monthly principal payments of $104,167 plus interest of approximately 7%
      Matures in February 2009
Notes assumed from Casual Gourmet stock purchase                                                  --           180
      interest ranges from 0.0% to 9.35%; payable in monthly payments of $7,367 through
      maturing from January 2007 through March 2011
Note payable assumed from Sonoma Foods stock purchase                                              0           121
      Payable in monthly payments of $3,857 including interest of 15.88% and 17.6%
      Matures in June 2009
Capital leases payable                                                                            18            13
                                                                                          ----------    ----------
Total notes, loans, and capital leases payable                                            $    2,408    $    9,147

Less current portion of notes, loans, and capital leases payable                                (757)       (2,521)
                                                                                          ----------    ----------
Notes, loans, and capital leases payable, less current portion                            $    1,651    $    6,626
                                                                                          ==========    ==========
</TABLE>

     Credit Facility

         The Company has a $3.0 million working capital line of credit which was
fully utilized as of December 31, 2005 and no additional line of credit was
available to the Company at December 31, 2005, a letter of credit in the amount
of $1,000,000 which is issued in favor of an insurance company to support a
self-funded worker's compensation program and which was increased to $1,100,000
in January 2006, and non-revolving term loans from the bank to fund
acquisitions. No additional revolving term loan is available to the Company
without bank approval. The Company also had a bank overdraft of $1,507,000. The
Company borrowed $2,000,000 under a non-revolving term loan in 2004 to partially
fund the CIBO acquisition, the Company borrowed an additional $5.0 million in
2005 to partially fund the Casual Gourmet acquisition and on April 11, 2005 the
Company borrowed $2.5 million to partially fund the Sonoma Foods acquisition.
The outstanding principal balance on the non-revolving term loan was $7,833,000
as of December 31, 2005. No additional loans are available to the Company under
the non-revolving term loan without prior consent from the Bank. The loans are
secured by the assets of the Company. The working capital commitment in place at
December 31, 2005 expires October 31, 2006; however, subsequent to year-end, the
Company negotiated an increase to its operating line of credit because of its
need to provide additional working capital which is being required because of
the recent sales growth which the Company expects to continue. The new line of
credit allows for advances up to $5 million based on a formula calculated on
accounts receivable and inventory balances. The interest rate on this entire

                                       54
<PAGE>

credit line will be calculated at the bank's prime lending rate or LIBOR plus
2.00% which ever the Company chooses. The maturity date of the line of credit
has been extended to March 31, 2007 and the covenants have been adjustment to
accommodate the additional borrowing. The Company was also out of compliance
with its debt coverage ratio covenant with its current bank as of December 31,
2005, and has obtained a waiver. As of December 31, 2005, the Company was paying
an average of 7.2% interest on these loans.

         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 including specific limits on annual capital
expenditures and (iv) certain financial covenants. As of December 31, 2005, the
Company was in violation of the debt coverage ratio bank covenant. The bank has
issued a temporary waiver of the covenant.

         Effective January 1, 2005, the Company initiated a $1,000,000 Letter of
Credit in favor of Sentry Insurance as required collateral for a deductible
worker's compensation program. On January 1, 2006 the Letter of Credit was
increased to $1,100,000 in favor of the same insurance company. The new letter
of credit expires December 31, 2006

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

          Year                                    Principal Amount
          -------------------------------       ---------------------
          2006                                          $       2,521
          2007                                                  2,794
          2008                                                  1,814
          2009                                                  1,796
          2010 and Thereafter                                     222
                                                ---------------------
                                                        $       9,147
                                                =====================

         The Company's President and Chief Executive Officer accepted employment
with the Company commencing October 1, 2002 pursuant to terms set forth in a
letter from the Company, a copy of which is filed as Exhibit 10.7. Pursuant to
this letter, Mr. Williams is an "at will" employee with (1) salary payable at
the rate of $290,000 per annum and eligibility for an annual bonus up to a
maximum of 50% of gross salary based upon achievement of mutually agreed
performance standards, (2) options for 200,000 shares of Company common stock
vesting over a period of four years, (3) a car allowance of $750 per month, (4)
the right to participate in group medical insurance and similar benefits
available to all employees, and (5) a severance benefit equal to one year's
salary in the event his employment is terminated without cause. Pursuant to the
letter also, the Company provided Mr. Williams with relocation assistance,
including a $20,000 per year housing assistance bonus during the first three
years of employment, reimbursement for moving costs, reimbursement for certain
costs in connection with sale of a previous home and purchase of a new one, and
gross up to alleviate the income tax impact of the additional consideration.


     Capitalized Leases

         The Company leases certain equipment under capitalized leases,
including office equipment, and a forklift, with a liability of $18,000 and
$13,000 in 2004 and 2005, 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
10) 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):

                                       55
<PAGE>

               Year                            Lease Amount
               ----                            ------------
               2006                            $      1,205
               2007                                     943
               2008                                     609
               2009                                     546
               2010 and Thereafter                    2,751
                                               ------------
                                               $      6,054
                                               ============

         Gross rent expense under the leases for 2003, 2004, and 2005 was
$805,000, $1,080,000 and $1,286,000 respectively. Each of the Company's four
production facilities are leased. The Company leases approximately 133,000
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 adjacent production and storage facilities expires in
June 2007 with two five-year renewal options.

         The Company acquired a lease for the 19,000 square foot production
facility and offices as part of its acquisition of Emerald Valley. The lease
expires December 31, 2007, with three five-year renewal options. In 2004, the
Company acquired a 27,000 square foot leased facility in Seattle, WA which
expires in May 2007.


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 2003 employee and director options representing 1,596 shares of
common stock were exercised for proceeds of $4,000 and 15,695 employee stock
purchase plan shares were issued for proceeds of $54,000.

         During 2004 employee and director options representing 163,928 shares
of common stock were exercised for proceeds of $427,000 and 14,964 employee
stock purchase plan shares were issued for proceeds of $43,000.

         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 15,696, 14,964 and 8,198 shares of common stock issued under
the plan in 2003, 2004 and 2005, respectively. At December 31, 2005, there were
138,534 available shares remaining under the plan.

         Income per Share

         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.

         Options to purchase 1,872,739, 1,763,810, and 1,807,194 shares of
common stock were outstanding at year-end 2003, 2004, and 2005, respectively. At
2003 year-end a total of 649,739 options were included in the computation of

                                       56
<PAGE>

diluted income per share, with 1,223,000 excluded, because of exercise prices.
At 2004 year-end a total of 1,763,810 options were excluded from the computation
of diluted earnings per share because they were anti-dilutive due to the
Company's net loss for the year. At 2005 year-end a total of 1,807,194 options
were excluded from the computation of diluted earnings per share because they
were anti-dilutive due to the Company's net loss for the year.


10.      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, 2005, the Company had 729,988 shares
available for new grants under the Plan, and 33,800 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
and may have had conflicts 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 noncash
compensation expense of $80,000 due to the death of its Chairman Mr. Lance
Hewitt.

The following table shows activity in outstanding options during 2003, 2004, and
2005:

<TABLE>
<CAPTION>
                                               2003                             2004                             2005
                                   ------------------------------   ------------------------------   ------------------------------
                                                      Weighted                         Weighted                         Weighted
                                                      Average                          Average                          Average
                                      Shares       Exercise Price      Shares       Exercise Price      Shares       Exercise Price
                                   ------------    --------------   ------------    --------------   ------------    --------------
<S>                                   <C>          <C>                 <C>          <C>                 <C>          <C>
Outstanding at beginning of year      1,528,385    $         4.90      1,872,739    $         4.63      1,763,810    $         4.44
Granted                                 391,200              3.82        344,000              3.46        258,000              3.72
Exercised                                (1,596)             2.55       (163,928)             2.61        (51,116)             2.44
Canceled or expired                     (45,250)             6.69       (289,001)             5.59       (163,500)             6.30
                                   ------------    --------------   ------------    --------------   ------------    --------------
Outstanding at end of year            1,872,739    $         4.63      1,763,810    $         4.44      1,807,194    $         4.24
                                   ============    ==============   ============    ==============   ============    ==============

Options exercisable at year end       1,338,639    $         4.65      1,281,210    $         4.76      1,578,194    $         4.31
                                   ============    ==============   ============    ==============   ============    ==============
</TABLE>

         The following table shows information for options outstanding or
exercisable as of December 31, 2005:

                                       57
<PAGE>

<TABLE>
<CAPTION>
                                                  OPTIONS OUTSTANDING                               OPTIONS EXERCISABLE
                                 ------------------------------------------------------     -----------------------------------
                                                       Weighted
                                      Number            Average            Weighted              Number            Weighted
        Range of                   Outstanding         Remaining            Average            Exercisable          Average
     Exercise Prices             As of 12/31/2005   Contractual Life     Exercise Price     As of  12/31/2005    Exercise Price
-----------------------------    ----------------   ----------------     --------------     -----------------    --------------
<S>                                 <C>                   <C>                <C>               <C>                    <C>
     $1.13      $2.63                 229,494             1.98 Years         $2.03               229,494              $2.03
     $2.94      $3.36                 241,450             7.10 Years         $3.30               166,950              $3.28
     $3.39      $3.40                  25,000             7.24 Years         $3.40                25,000              $3.40
     $3.44      $3.44                 227,500             9.16 Years         $3.44               227,500              $3.44
     $3.45      $3.76                 230,700             8.55 Years         $3.71               230,700              $3.71
     $3.77      $3.95                 265,000             8.57 Years         $3.91               112,000              $3.86
     $3.96      $5.94                 197,050             6.45 Years         $5.33               195,550              $5.34
     $5.94      $6.55                 270,000             6.11 Years         $6.34               270,000              $6.34
     $6.75      $9.20                 120,000             6.13 Years         $7.26               120,000              $7.26
     $9.25      $9.25                   1,000             6.29 Years         $9.25                 1,000              $9.25

     $1.13      $9.25               1,807,194             6.83 Years         $4.24             1,578,194              $4.31
</TABLE>

         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, 2005, including the
Monterey Gourmet Foods 2002 Stock Option Plan, the Monterey Gourmet Foods 1995
Employee Stock Purchase Plan and the Monterey Gourmet Foods 2001 Nonstatutory
Stock Option Plan.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
                                Number of securities to be    Weighted-average exercise      Number of securities
                                  issued upon exercise of       price of outstanding        remaining available for
        Plan category              outstanding options,         options, warrants and        future issuance under
                                    warrants and rights                rights              equity compensation plans
                                                                                             (excluding securities
                                                                                           reflected in column (a))
                                            (a)                          (b)                          (c)
--------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                             <C>                         <C>
Equity compensation plans               1,673,244(1)                    $4.06                       729,988
approved by security holders

--------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders              133,950(2)                    $6.55                        33,800

--------------------------------------------------------------------------------------------------------------------
Total                                   1,807,194                       $4.24                       763,788
--------------------------------------------------------------------------------------------------------------------
</TABLE>

(1)  Issued under the Monterey Gourmet Foods 2002 Stock Option Plan and the
     Monterey Gourmet Foods 1995 employee Stock Purchase Plan

(2)  Issued to Company employees under the Monterey Gourmet Foods 2001
     Nonstatutory Stock Option Plan (154,200 at $6.55)

                                       58
<PAGE>

11.      Income Taxes

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

                                          2003          2004          2005
                                       ----------    ----------    ----------
         Current:

          Federal                      $       (1)   $      (45)   $       25
          State                              (130)           (7)           27
                                       ----------    ----------    ----------
            Total                            (131)          (52)           52
                                       ----------    ----------    ----------

         Deferred:

          Federal                            (373)          404           334
          State                                60           153            45
                                       ----------    ----------    ----------
            Total                            (313)          557           379
                                       ----------    ----------    ----------

           Net tax benefit (expense)   $     (444)   $      505    $      431
                                       ==========    ==========    ==========

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

                                         2003         2004         2005
                                       --------     --------     --------

         Federal statutory rate            34.0%        34.0%        34.0%

         State income taxes, net of
         effect on Federal income           1.6%         5.6%         3.4%

         Federal and State valuation
         allowances                         0.0%       (10.7)%        0.0%

         Manufacturing investment
         credits                           (5.3)%        2.3%         4.3%

         Other                             (0.3)%       (3.9)%        2.8%
                                       --------     --------     --------

         Effective income tax rate         30.0%        27.3%        44.5%
                                       ========     ========     ========

         The valuation allowance for 2003, 2004 and 2005 was increased (reduced)
by $0, $197,000 and ($689,000) respectively. During 2004, the valuation
allowance increased due to the Company's assessment of its utilization of NOLs.
This assessment was largely based upon the company's ability to project future
income, which was impacted negatively by the taxable loss generated in 2004.
During 2005, the valuation allowance was decreased due to consideration of the
impact of deferred tax liabilities resulting form acquisitions on the Company's
assessment on the realization of such NOLs.

         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:

                                       59
<PAGE>

<TABLE>
<CAPTION>
                                                                2004          2005
                                                             ----------    ----------
                                                                  (in thousands)
                                                                  --------------
         Deferred tax assets:
<S>                                                          <C>           <C>
                Federal NOLs                                 $    5,861    $    5,706

                Federal and state tax credit carryovers             190           505

                State income and franchise taxes, net of
                    effect on Federal income taxes                 (146)           28

                Allowances against receivables                       94           389

                Other                                               585           824
                                                             ----------    ----------
                                                                  6,584         7,452
                Less valuation allowance                           (939)         (250)
                                                             ----------    ----------
         Total Deferred tax assets:                               5,645         7,202

         Deferred tax liabilities:
                Accumulated depreciation and  amortization         (567)       (2,812)
                                                             ----------    ----------

         Net deferred tax assets                             $    5,078    $    4,390
                                                             ==========    ==========
</TABLE>

         As of December 31, 2005, the Company had federal NOLs totaling $16.1
million, which expire in varying amounts through 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 $252,000 and a targeted
jobs credit of $21,000. The targeted jobs credit will expire in 2020 and the
minimum tax credit will not expire. State deferred tax assets include
approximately $350,000 in California Manufacturing Tax Credits available to
offset future California income taxes, expiring in varying amounts through 2012.
As of December 31, 2005, the net deferred tax assets available to offset future
cash tax liabilities are $1,030,000 short-term and $3,360,000 long-term.

         The Company realizes tax benefits as a result of non-qualified stock
options and the exercise of subsequent sale 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, 2003, 2004 and 2005, tax benefits of
disqualifying dispositions totaling $1,000, $55,000 and $0 were credited to
stockholders' equity.

12.      Significant Customers

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

                                          2003        2004        2005
                                        --------    --------    --------

                Costco                     34%         36%         45%

                Sam's Club Stores          32%         24%         17%


         At December 26, 2004 and December 31, 2005, Costco and Sam's Club
stores accounted for the following concentration of accounts receivable:


                                                 2004            2005
                                               --------        --------

                Costco                            53%             42%

                Sam's Club Stores                 14%             15%

                                       60
<PAGE>

         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 eighth year of its
relationship with Sam's Club. On February 2, 2004 the Company announced that
Wal-Mart Supercenters discontinued its private label program which has impacted
the Company's profitability. 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 2004 and 2005.

         The Company operates in the refrigerated specialty foods segment.
During 2003, 2004 and 2005 net revenues to foreign customers represented 3.4%,
3.4%, 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.


13.      Litigation and Contingencies

         There are no material legal proceedings pending to which the Company is
a party or to which any of its property is subject. The Company is a party to
ordinary routine litigation incidental to the Company's business.


14.      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. Company profit-sharing contributions and related earnings vest 20%
a year, with 100% vesting after five years of service. During 2003, 2004 and
2005, the Company's expense for matching contributions was $191,000, $201,000,
and $228,000 respectively; there were no discretionary profit-sharing
contributions for 2003, 2004, or 2005.


15.      Subsequent Events

         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 under which Monterey acquired the
remaining 15.5% of CIBO from Suekat in exchange for 300,000 unregistered shares
of Monterey common stock with an estimated market value of $1.2 million.

                                       61
<PAGE>

16.      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).

<TABLE>
<CAPTION>
Year Ended 2004                      First      Second       Third     Fourth
                                    Quarter     Quarter     Quarter    Quarter       2004
                                    --------    --------    --------   --------    --------
<S>                                 <C>         <C>         <C>        <C>         <C>
  Net revenue                       $ 16,385    $ 14,988    $ 16,032   $ 15,086    $ 62,491

  Gross profit                         4,375       3,580       4,367      4,146      16,468

  Operating income (loss)               (699)       (900)        129       (291)     (1,761)

  Net income (loss)                     (481)       (543)         75       (395)     (1,344)


Primary earnings per common share   $  (0.03)   $  (0.04)   $   0.01   $  (0.03)   $  (0.09)

Diluted earnings per common share   $  (0.03)   $  (0.04)   $   0.01   $  (0.03)   $  (0.09)



Year Ended 2005                      First      Second       Third     Fourth
                                    Quarter     Quarter     Quarter    Quarter       2005
                                    --------    --------    --------   --------    --------

  Net revenue                       $ 17,663    $ 21,155    $ 22,772   $ 23,658    $ 85,248

  Gross profit                         4,948       5,744       6,591      5,949      23,232

  Operating income (loss)                102         194         306       (960)       (358)

  Net income (loss)                       17          11         132       (697)       (537)


Primary earnings per common share   $     --    $     --    $   0.01   $  (0.05)   $  (0.04)

Diluted earnings per common share   $     --    $     --    $   0.01   $  (0.05)   $  (0.04)
</TABLE>

                                       62
<PAGE>

                                   SCHEDULE II
                             MONTEREY PASTA COMPANY
                        VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                                            Additions -    Deductions -
                                              Balance,      Charged to     Write-offs      Balance,
                                             Beginning      Costs and      Charged to       End of
                                              of 2003        Expense        Reserves         2003
                                            ------------   ------------   ------------   ------------
<S>                                         <C>            <C>            <C>            <C>
Allowances against receivables --
        Spoils, returns, adjustments
        and bad debts                       $        527   $      3,211   $      3,298   $        441


Inventory reserves --                       $         70   $        510   $        528   $         51
        Spoils and obsolescence



                                                            Additions -    Deductions -
                                              Balance,      Charged to     Write-offs      Balance,
                                             Beginning      Costs and      Charged to       End of
                                              of 2004        Expense        Reserves         2004
                                            ------------   ------------   ------------   ------------

Allowances against receivables --
        Spoils, returns, adjustments
        and bad debts                       $        441   $      3,646   $      3,847   $        240


Inventory reserves --                       $         51   $        550   $        388   $        213
        Spoils and obsolescence



                                                            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 --                       $        213   $        499   $        589   $        123
        Spoils and obsolescence
</TABLE>

                                       63
<PAGE>

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 30th day of March, 2006

                                      MONTEREY GOURMET FOODS


                                      By: /s/ JAMES M. WILLIAMS
                                          -------------------------------------
                                          James M. Williams
                                          President and Chief Executive Officer


                                      By: /s/ SCOTT S. WHEELER
                                          -------------------------------------
                                          Scott 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.

<TABLE>
<CAPTION>
             Name                                Title                              Date
             ----                                -----                              ----

<S>                                              <C>                                <C>
             /s/ JAMES  M. WILLIAMS              Chief Executive Officer,           March 30, 2006
             -------------------------------     President, and Director
             James M. Williams

             /s/ CHARLES B. BONNER               Director                           March 30, 2006
             -------------------------------
             Charles B. Bonner

             /s/ F. CHRISTOPHER CRUGER           Director                           March 30, 2006
             -------------------------------
             F. Christopher Cruger

             /s/ MICHAEL P. SCHALL               Director                           March 30, 2006
             -------------------------------
             Michael P. Schall

             /s/ VAN TUNSTALL                    Chairman of the Board              March 30, 2006
             -------------------------------
             Van Tunstall

             /s/ JAMES WONG                      Director                           March 30, 2006
             -------------------------------
             James Wong

                                                 Director                           March 30, 2006
             -------------------------------
             John H. McGarvey

             /s/ WALTER L. HENNING               Director                           March 30, 2006
             -------------------------------
             Walter L. Henning

             /s/ SCOTT S. WHEELER                Chief Financial Officer            March 30, 2006
             -------------------------------     Corporate Secretary and Director
             Scott S. Wheeler
</TABLE>

                                       64
<PAGE>

            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.
10.1**   2002 Stock Option Plan, as amended on March 3, 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 August 20, 2002 to Chief Executive Officer
                James M. Williams (incorporated by reference from Exhibit 10.11
                filed with the Company's Form 10-Q for the quarter ended
                September 26, 2004 filed November 8, 2004)
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    Royalty Agreement dated January 18, 2002 between Company and Toscana
                Foods, LLC (incorporated by reference to Exhibit 10.41 in the
                Company's June 30, 2002 Quarterly Report on Form 10-Q filed on
                August 9, 2002
10.15    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)

                                       65
<PAGE>

10.16    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)
10.17    Second Lease modification to Commercial lease dated January 1, 2000
                between the Company and PTF for Operating Engineers, LLC for
                storage space in Monterey County, California (incorporated by
                reference from Exhibit 10.45 filed with the Company's June 29,
                2003 Quarterly Report of Form 10-Q filed on August 7, 2003
10.18    Lease Extension and Modification Agreement between the Company and
                Kenneth Salma and Pattie Salma dated August 24, 2005. California
                (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
10.19    Agreement for Purchase and Sale of Limited Liability Company Units
                dated January 28, 2004 by and among the Company and the
                Unitholders of CIBO Naturals, LLC. (incorporated by reference
                from Exhibit 2.6 to the Company's Form 8-K filed with the
                omission on February 5, 2004)
10.20    Amendment dated May 12, 2004 to Agreement for Purchase and Sale of
                Limited Liability Company Units dated January 28, 2004
                (incorporated by reference from Exhibit 10.19 to the Company's
                Form 10-Q for the quarter ended June 30, 2005 filed with the
                Commission).
10.21    Second Amendment of Agreement for the Purchase and Sales of Limited
                Liability Company Units dated January 12, 2006. (incorporated by
                reference from Exhibit 2.1 filed with the Company's current
                report on Form 8-K dated January 12, 2006 filed with the
                Commission.
10.22    Agreement for Purchase and Sale of OBIC, Inc.'s Limited Liability
                Company Units dated May 12, 2004 by and among the Company and
                the Unitholders of CIBO Naturals, LLC (incorporated by reference
                from Exhibit 10.20 to the Company's Form 10-Q for the quarter
                ended June 30, 2005 filed with the Commission)
10.23    Stock Purchase Agreement by and among Monterey Gourmet Foods, Inc.,
                Casual Gourmet Foods, Inc., and Certain Shareholders dated
                January 11, 2005 (incorporated by reference from Exhibit 2.01
                filed with the Company's Report on Form 8-K on January 18, 2005)
10.24    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)

10.25    Third Modification to Business Loan Agreement between the Company and
                Comerica Bank dated January 5, 2005.(incorporated by reference
                to Exhibit 1.33 filed with the Company's Form 10-K for the
                fiscal year ended December 26, 2004, filed on March 25, 2005

10.26    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).
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

                                       66