** **

**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON DC  20549**

 

**FORM 10-K**

 

| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|-------------------------------------------------------------------------------------------|
|       |                                                                                      |
|       | **For  the fiscal year ended December 29, 2002**                                          |

 

**OR**

 

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

 

**Commissionfile number 0-22534-LA**

 

**MONTEREY PASTA COMPANY**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                                                                                  |   | **77-0227341**                        |
|-------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State of  incorporation)                                                                                                     |   | (IRS employer  identification number) |
|                                                                                                                          |   |                                  |
| **1528  Moffett Street   Salinas, California 93905   (831) 753-6262**                                                         |
| (Address,  including zip code, and telephone number, including area code,   of Registrant’s principal executive offices) |

 

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

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

 

Indicate by check markwhether registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months,and (2) has been subject to such filing requirements for the past 90 days.

YES  ý   NO  o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K.  o

 

The approximate aggregatemarket value of the voting stock held by non-affiliates of the issuer as ofFebruary 13, 2003****was $32,886,968.  Thenumber of shares outstanding of the issuer’s common stock as of February 14,2003 was 14,202,865.

 

 

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**PART I**

 

**ITEM 1.                  BUSINESS**

 

**Introduction**

 

Monterey Pasta Company(“the Company”) was incorporated in June 1989 as a producer and distributor ofrefrigerated gourmet pasta and sauces to restaurants and grocery stores in theMonterey, California area.  The Companyhas since expanded its operations to include a more diversified range ofgourmet refrigerated food products, which it provides to grocery and clubstores throughout the United States, as well as selected regions in Canada, theCaribbean, Latin America, and Asia Pacific. The Company’s overall strategic plan is to enhance the value of theMonterey Pasta Company brand name by distributing its gourmet food productsthrough multiple channels of distribution, while selectively participating inprivate label partnerships.

 

The Company currentlyproduces and markets premium quality refrigerated gourmet pastas, soups,gnocchi, pasta sauces, stuffed pizzas and calzones, pierogies, salsas, dips,hummus, and polenta emphasizing superior flavors and innovative products.  It seeks to build brand recognition andcustomer loyalty by employing a marketing program that focuses on developingmultiple points of sale for the Company’s products, and increasing consumerawareness of the Company’s offerings. The Company markets and sells its products primarily through grocery andclub stores.

 

###### **The Company offers over 200varieties of contemporary gourmet food products that are produced using theCompany’s proprietary recipes.   Someexamples of the Company’s products are listed under “Products” on pages four,five, and six.  In 2002, the Companyintroduced three new product lines; stuffed potato gnocchi with three flavors,a new line of premium sauces in plastic jars with several selections and PezzoGrandi Chunky Stuffed Ravioli with three flavors initially.  Several extensions of existing lines werealso marketed.  In addition, the Companypurchased the operating assets of Emerald Valley Kitchen (“Emerald Valley”) ofEugene, Oregon, a producer of refrigerated organic salsas, dips, hummus andsauces.  The August 2002 acquisitionmarked the Company’s entrance into the rapidly growing organic food businessand will be used as a platform for additional offerings in the future (see“Liquidity, Capital Resources, and Business Acquisitions” on page 14).**

 

The Company sells itsproducts through leading grocery store chains including Albertson’s, KingSoopers, Safeway, Wal-Mart Supercenters, Fred Meyer, Kroger, Raley’s, TraderJoe’s, A&P, Publix, and QFC; and warehouse club stores including Costco Wholesale,Sam’s Club (a division of Wal-Mart), and BJ’s. As of December 29, 2002, approximately 8,700 grocery and club storesoffered Monterey Pasta’s products.

 

In 1998, the Company added a web site, **www.montereypasta.com,**to further support its brand by providing both consumer and investorinformation, and opened an on-line store offering Monterey Pasta products tothose who do not have access to the Company’s offerings through traditionalchannels.  Shoppers can order items fordelivery within two days.  In 1999, theCompany expanded the site to offer other non-food items as well.  In 2000, the website was updated to improveits speed of access, ease of navigation and technical sophistication related tomulti-media, and links to other websites.  Further “user friendly” improvements were made in 2001 and 2002.  The site provides a comprehensive insightinto the Company’s profile, product offerings, financial strength, as well asconsumer tips for those interested in gourmet food.

 

The success of the Company’s sales efforts will depend in large part onfour key factors: (1) whether grocery and club store chains will continue toincrease the number of their stores offering the Company’s products, (2)whether the Company can continue to increase the number of grocery and clubstore chains offering its products, 3) whether the Company can continue tointroduce new products that meet consumer acceptance and 4) whether the Companycan diversify into other complementary businesses and leverage its strengths tocontinue to grow revenues and profits at levels attractive to itsinvestors.  Grocery and club storechains continually re-evaluate the products carried in their stores, and noassurances can be given that the chains currently offering the Company’sproducts will continue to do so in the future.

 

This Form 10-K contains forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, and Section 21E of the SecuritiesExchange Act of 1934, that involve substantial risks to the Company, includingstatements about the Company’s past operating losses, the ability to attractand retain qualified management, the impact of inflation, dependence on majorcustomers, and marketing and sales risks. In connection therewith, please see the cautionary statements containedherein in “Business Risks” which identify important factors that could causeactual results to differ materially from those in the forward-lookingstatements.

 

2

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**Industry Overview**

 

The Company believes thatthe U.S. retail market for refrigerated pasta is large and highlyfragmented.  Although refrigerated pastaproducts are not new, fresh pasta and pasta sauce were essentially created as anational specialty food category in 1986 when Nestle Fresh Foods Co., adivision of Nestle S.A. (“Nestle”), introduced its Contadinaâ(now Buitoniâ) brand of fresh pasta.  In 1990, Kraft General Foods, Inc., a division of Philip Morris(“Kraft”), unveiled its DiGiorno brand of fresh pasta nationally.

 

The Company believes thatthe interest in the fresh pasta category was influenced by several factorsincluding heavy advertising and promotion by Nestle and Kraft, the changingconsumer preference for freshly prepared healthy foods, and increasing consumerdemand for convenient, quick meal solutions. The Company is further encouraged by industry research reports, whichshow that spending on refrigerated gourmet, specialty foods by consumers in theCompany’s target market appears to be growing.

 

No assurance can be giventhat the refrigerated industry will expand further.  Nor can there be any assurance that current trends in healthyeating, perception of fresh pasta and pasta sauce as a healthy eating alternative,consumer demand for meal solutions, or consumer spending levels in thespecialty food category will continue in the future.  Additionally, as the Company expands into different geographicregions, it may encounter different consumer perceptions, attitudes andbehavior.  This may adversely impact theCompany’s marketing and expansion strategy and cause it to incur greaterexpenses in the promotion of its products.

 

The market forrefrigerated stuffed pizzas and calzones is made up of many small localproducers, none of whom, to the Company’s knowledge, offer extended shelflife.  The Company also has onecompetitor (San Francisco Foods of San Leandro, CA) claiming a relatively shortshelf life of approximately two weeks compared to the Company’s guarantee of 30days, and offering competition with some of the Company’s current accounts.

 

The refrigerated soupmarket is comprised of many small local producers and two other moresubstantial competitors, StockPotâ(owned by Campbell Soup Company), and Harry’s, an independent headquartered inPortland, Oregon.  The Company believesit benefited by the promotion of StockPot, which increased consumer awarenessof the refrigerated soup category.

 

While the frozen pierogymarket is dominated by one large producer with over 80% of the market, therefrigerated pierogy market is comprised of very small local producers who sellthrough delis and cannot claim extended shelf life.  To its knowledge, the Company possesses the only refrigeratedextended shelf life pierogy with national distribution.

 

The polenta business isalso highly fragmented and comprised of several regional competitors in retailchains with no club store presence.  TheCompany will continue to market under the Nate’s label, with the potential ofalso selling under its own brand name sometime in the future.  During 2001 the company began marketing anorganic polenta, its first organic product.

 

The organic food businesshas been growing at a double-digit rate since the 1960s and has now reachedover $7 billion in retail sales, according to Nutrition Business Journal.  New Federal standards, under the auspices ofthe United States Department of Food and Agriculture (“USDA”), were adopted forthe industry in October 2002.  Thepurpose of the new standards was to provide a framework for organic content ofproduct with the use of the USDA seal for those products meeting the “organic”definition (95% organic content), and set standards for product quality andfood safety so as to improve the overall strength of the organic foods industryand protect the consumer.  EmeraldValley and other credible producers who meet the standards to be labeled USDAorganic will be in an excellent position to participate in the future growth ofthe industry.  The Company believesthat, while nearly all Emerald Valley products now qualify for the USDAdesignation, the remainder will qualify within the next twelve months.  The Company’s future organic offerings willbe produced and formulated with the objective of qualifying for the USDAdesignation.

 

No assurance can be giventhat the market for refrigerated gourmet food products will expand further andthat space will be made available at the store level to house refrigeratedproducts.  Nor can there be anyassurance that current trends in healthy gourmet eating, perception of many ofthe Company’s products as healthy gourmet eating alternatives, consumer demandfor quick meal solutions, or consumer spending levels in the specialty foodcategory will continue in the future. Additionally, as the Company expands into different geographic regions,it may encounter different consumer perceptions, attitudes and behavior.  This may adversely impact the Company’sexpansion strategy and cause it to incur greater expenses in the promotion of itsproducts.

 

3

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**Strategy**

 

Monterey Pasta’sobjective is to become a leading national supplier of refrigerated gourmet foodproducts through distribution of its products to grocery and club stores.  The key elements of the Company’s strategy includethe following:

 

•                  Expandmarket share through same-store revenue growth, addition of new grocery andclub store chains, geographic diversification, and product line expansion,including creation of additional meal occasions using Monterey Pasta products.

 

•                  Introducenew products on a timely basis to maintain customer interest and to respond tochanging consumer tastes.  In order tomaximize its margins, the Company will focus its efforts on those new productsthat can be manufactured and distributed out of its Salinas, California orEugene, Oregon facilities, and will supplement its existing line of cut pasta,ravioli, tortelloni, tortellini, sauces, gnocchi, pizzas and calzones,borsellini, salsas, dips, hummus, polenta, and soups.

 

•                  Reduceoperating costs as a per cent of sales through continual evaluation ofadministrative and production staffing and procedures.  The Company will consider additional capitalimprovements at its manufacturing facility in order to increase productionefficiencies and capacities, and to reduce the Company’s cost of goods on a perunit basis.

 

•                  Createbrand awareness by communicating to the consumer that Monterey Pasta Companyprovides a healthful and nutritious line of products and promote repeatbusiness by reinforcing positive experiences with the Company’s products.

 

•                  Considerthe acquisition of other compatible companies or product lines to expand retaildistribution, or the range of product offerings, or to accomplish othersynergies where the acquisition will create long-term stockholder value, and beaccretive to earnings in the first year.

 

The Company willcontinue to direct its advertising and promotional activities to specificprograms customized to suit its retail grocery and club store accounts.  These will include in-store demonstrations,coupon programs, temporary price reduction promotions, and other relatedactivities. There can be no assurance that the Company will be able to increaseits net revenues from grocery and club stores. Because the Company will continue to make expenditures associated withthe expansion of its business, the Company’s results of operations may beaffected.

 

Thesuccess of the Company’s acquisition strategy is dependent upon its ability togenerate cash from current operations, attract new capital, find suitableacquisition candidates, and successfully integrate new businesses andoperations.  There is no assurance thatacquisitions can be financed from current cash flow, and, if not, that outsidesources of capital will be available to supplement internally-generatedfunds.  There is no assurance thatmanagement can successfully select suitable acquisition candidates and thatthese new businesses can be successfully integrated to create long termstockholder value.

 

**Products**

 

The Companyproduces and markets a variety of gourmet refrigerated cut pasta, borsellini,ravioli, tortelloni, tortellini, soups, gnocchi, pasta sauces, stuffed pizzas,calzones, pierogies, salsas, dips, hummus, and polenta under the Monterey PastaCompany, Arthur’s, Emerald Valley Kitchen and Nate’s labels, as well as privatelabels.  Arthur’s is a mid-priced pastaand sauce label, which was acquired as part of the March 1999 acquisition ofSan Antonio Texas-based Frescala Foods, Inc. (“Frescala”).  The Emerald Valley Kitchen brand wasacquired as part of the Emerald Valley acquisition in August 2002.  The Nate’s label was acquired in December2000 (See “Liquidity, Capital Resources, and Business Acquisitions” on page 15).  Following is a representative list of theCompany’s products with those sold under the Arthur’s, Emerald Valley Kitchenand Nate’s, and labels so noted:

 

4

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|                                         |   | **Year  Introduced or   Acquired** |   |
|----------------------------------------------|--------|------------------------------------|--------|
| **Cut  Pasta:**                              |   |                               |   |
| Garlic  Basil Fettuccine                     |   | 1989                               |   |
| Lemon  Pepper Linguine (Arthur’s)       |   | 1999                               |   |
|                                         |   |                               |   |
| **Ravioli:**                                 |   |                               |   |
| Lobster                                      |   | 1997                               |   |
| Artichoke  & Cheese                      |   | 1998                               |   |
| Spinach  Ricotta                             |   | 1998                               |   |
| Chicken  Rosemary                            |   | 1999                               |   |
| Four  Cheese (Arthur’s)                 |   | 1999                               |   |
| Light  Garden Vegetable (Arthur’s)      |   | 1999                               |   |
| **Pezzo  Grandi   Chunky Stuffed   Ravioli** |   |                               |   |
| Atlantic  Lobster                            |   | 2002                               |   |
| Roasted  Vegetables                          |   | 2002                               |   |
| Chicken  Prosciutto                          |   | 2002                               |   |
| **Tortelloni:**                              |   |                               |   |
| Rainbow  Five Cheese                         |   | 1998                               |   |
| Italian  Sausage (Arthur’s)             |   | 1999                               |   |
|                                         |   |                               |   |
| **Tortellini:**                              |   |                               |   |
| Garlic  Basil Cheese                         |   | 1996                               |   |
| Tri-Color  (Arthur’s)                   |   | 1999                               |   |
| Cheese  Tortellini                           |   | 2001                               |   |
|                                         |   |                               |   |
| **Tortelloni  Grandi:**                      |   |                               |   |
| Spinach  and Cheese                          |   | 1999                               |   |
| Italian  Sausage                             |   | 1999                               |   |
| Five  Cheese and Rainbow Five Cheese         |   | 1999                               |   |
|                                         |   |                               |   |
| **Sauces:**                                  |   |                               |   |
| Roasted  Garlic Artichoke                    |   | 1995                               |   |
| Basil  Cream Sauce with Artichokes           |   | 1998                               |   |
| Garden  Fresh Marinara                       |   | 1999                               |   |
| Fresh  Alfredo with Herbs                    |   | 1999                               |   |
| Sun  Dried Tomato Pesto (Arthur’s)      |   | 1999                               |   |
| Roasted  Garlic Pesto (Arthur’s)        |   | 1999                               |   |
| Sun  Dried Tomato Cream                      |   | 1999                               |   |
| Sezchuan  Stir Fry (Emerald Valley)          |   | 2002                               |   |
| Sesame  Garlic Stir Fry (Emerald Valley)     |   | 2002                               |   |
|                                         |   |                               |   |
| **Italian  Classics:**                       |   |                               |   |
| Florentine  Marinara                         |   | 2001                               |   |
| Cacciatore                                   |   | 2001                               |   |
| Sicilian  Tomato with Pesto                  |   | 2001                               |   |
|                                         |   |                               |   |
| **Premium  Sauces in Jars:**                 |   |                               |   |
| Roasted  Garlic Pesto                        |   | 2002                               |   |
| All  Natural Fresh Pesto                     |   | 2002                               |   |
| Roma  Tomato with Basil                      |   | 2002                               |   |

 

5

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|                                            |   | **Year Introduced or  Acquired** |   |
|-------------------------------------------------|--------|----------------------------------|--------|
| **Soups:**                                      |   |                             |   |
| Tuscan  Minestrone                              |   | 1999                             |   |
| Monterey  Clam Chowder                          |   | 1999                             |   |
| Autumn  Classic Butternut Squash                |   | 1999                             |   |
|                                            |   |                             |   |
| **Gnocchi:**                                    |   |                             |   |
| Potato  Parmesan                                |   | 1999                             |   |
|                                            |   |                             |   |
| **Stuffed  Gnocchi:**                           |   |                             |   |
| Italian  Four Cheeses                           |   | 2002                             |   |
| Italian  Sausage with Cheese                    |   | 2002                             |   |
|                                            |   |                             |   |
| **Stuffed  Pizzas:**                            |   |                             |   |
| Spicy  Chicken with Sun-dried Tomatoes          |   | 2000                             |   |
| Italian  Sausage and Pepperoni                  |   | 2000                             |   |
| Pepperoni                                       |   | 2000                             |   |
|                                            |   |                             |   |
| **Calzones:**                                   |   |                             |   |
| Spinach,  Feta Cheese and Pesto with Red Onions |   | 2000                             |   |
| Black  Forest Ham and Swiss Cheese              |   | 2000                             |   |
| Meatball                                        |   | 2000                             |   |
| Italian  Sausage, Pepper, and Onion             |   | 2000                             |   |
| Philly  Cheese Steak                            |   | 2001                             |   |
| Portobello  Mushroom and Artichoke              |   | 2001                             |   |
| Florentine  Chicken with Spinach and Cheese     |   | 2001                             |   |
|                                            |   |                             |   |
| **Pierogies:**                                  |   |                             |   |
| Potato  and Cheese                              |   | 2000                             |   |
| Potato  and Onion                               |   | 2000                             |   |
|                                            |   |                             |   |
| **Polenta  (Nate’s):**                     |   |                             |   |
| Original                                        |   | 2000                             |   |
| Sun  Dried Tomato                               |   | 2000                             |   |
| Italian  Herb                                   |   | 2000                             |   |
|                                            |   |                             |   |
| **Borsellini:**                                 |   |                             |   |
| Grilled  Chicken with Cheese and Dijon          |   | 2001                             |   |
| Feta  Cheese with Spinach                       |   | 2001                             |   |
| Aged  Italian Cheeses                           |   | 2001                             |   |
|                                            |   |                             |   |
| **Salsas  (Emerald Valley):**                   |   |                             |   |
| Green  Salsa with Organic Tomatillos            |   | 2002                             |   |
| Organic  Fiesta Salsa                           |   | 2002                             |   |
| Red  Salsa with Organic Tomatoes                |   | 2002                             |   |
|                                            |   |                             |   |
| **Dips  (Emerald Valley):**                     |   |                             |   |
| Organic  3 Bean                                 |   | 2002                             |   |
| Organic  Savory Black Bean                      |   | 2002                             |   |
|                                            |   |                             |   |
| **Hummus  (Emerald Valley):**                   |   |                             |   |
| Organic  Garbanzo Bean                          |   | 2002                             |   |
| Organic  Sun Dried Tomato                       |   | 2002                             |   |
| Organic  Greek Olive and Roasted Garlic         |   | 2002                             |   |

 

6

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

 

The Company’srefrigerated products are packaged predominantly in clear lightweightcontainers, which reveal the fresh appearance of its products.  Monterey Pasta presents its products with acolorful logo, distinctive packaging styles, ingredient information and cookinginstructions to communicate the gourmet, fresh and healthful qualities of itsproducts.  Its pizza, borsellini, andsauce products feature new packaging to maximize shelf impact and generateincreased consumer interest in the products, with increased emphasis on foodphotography.  The Company will continueto emphasize innovative packaging and labeling techniques to maximize appeal onthe shelf.

 

The goal of theCompany is to introduce new products on a timely and regular basis to maintaincustomer interest and to respond to changing consumer tastes.  There can be no assurance that the Company’sefforts to achieve such a goal will result in successful new products orproduct lines or that new products can be developed and introduced on a timelyand regular basis.  If the Company’s newproducts are not successful, the Company’s grocery and club store sales may beadversely affected as customers seek new products.

 

**Production**

 

The Companycurrently produces its products in a 43,680 square foot Monterey County,California facility.  In  2003 it will also be producing products at anew 41,318 square foot facility (8,000 square feet will be used for productioninitially), which is adjacent to its 19,845 square foot refrigerateddistribution center.   These facilities,along with 25,978 square feet of ambient storage, and 2,070 square feet ofoffice space on the same premises (a total of 89,211 square feet), are locatedapproximately three miles from its principal production facility.  In addition, it produces organic salsas,dips, and hummus at its 19,000 square foot organically certified facility inEugene, Oregon, which was integrated into the business as part of the EmeraldValley acquisition. Organic grilling sauces are produced at an organicallycertified co-packer in Forest Grove, Oregon. The California facilities are strategically located in one of thelargest produce-growing regions in the United States and are near several majorvendors and food service distributors. Both California facilities are certified by the United States Departmentof Agriculture (USDA) and utilize state of the art thermal processing, chillingand packaging processes.  There areapproximately 310 employees working at its headquarters facility or at outsidesales locations.  Approximately 19people are employed at the distribution center, including shipping personnel,customer service and traffic personnel, and the logistics manager.  The Company expects to add approximately 40production and sanitation employees at its new California production facility,while 18 were added in Oregon as part of the Emerald Valley acquisition (see“Employees” on page 9).

 

Refrigerated pastais manufactured at the California facility using high quality ingredients suchas Extra Fancy Durham wheat, whole eggs or egg whites, fresh herbs and IQF(Individually Quick Frozen) herbs and spices, and local cheeses and milkproducts.  The ingredients are mixed inaccordance with the Company’s proprietary recipes.  After filling with fresh and unusual ingredients such as snowcrab, spinach and feta cheese, lobster, and Vermont cheddar cheese, the pastaproducts receive a prescribed thermal process (pasteurization) to insureproduct safety and to preserve flavor, quality and shelf life.  The products are then chilled immediatelyand packaged in controlled atmosphere trays. Pasta sauces are mixed and processed in individual batches in accordancewith the Company’s proprietary processes and recipes and then directly packedand sealed in plastic containers.  Pizzaand calzone products are baked in continuous process ovens before beingchilled, packed, and sealed using the same process as is used for pastaproducts.  After preparation,processing, chilling and packaging, all pasta, baked products, and sauces arekept in cold storage to preserve quality and shelf life.

 

The Companycontinuously reviews a variety of capital projects for the productiondepartment and in the past three years has spent approximately $10.7 million oncapital improvements. These included three pasta lines, two packaging lines,capacity for chunky ravioli, a new jar sauce filling line, two clean rooms,increased sauce capacity and efficiency, a pizza/calzone line, and boiler andutility upgrades to accommodate capacity increases. The 2000 additions createda 100% increase in sauce capacity, a 200% increase in filling and mixingcapacity, and a 25% increase in packline capacity compared with 1999levels.  Significant 2001 expendituresincluded $1.2 million to double the capacity of the pizza/calzone line and improvethe overall process, an improved sauce labeling machine, two machines and diesto produce borsellini, and an upgraded ingredients blending area.  The new production facility, which will beutilized during 2003, added approximately 30 percent of additional pastamanufacturing capacity at a cost, including leasehold improvements, ofapproximately $2.1 million.  Futureadditions of assets will be evaluated for increased efficiency, flexibility andcapacity needs.

 

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###### **RawMaterials**

###### ** **

###### **The Company purchases its rawmaterials from vendors throughout the United States and the world, althoughover 90% by dollar volume come from domestic sources, and over 50% of thedomestic ingredients come from California.  Vendor selection is based on ability to meet specifications and pricing,in that order.  Because the ingredientsare agricultural products the Company uses a combination of contracts, all ofwhich are one year or less in duration, as well as open market purchases tominimize the pricing risks and uncertainty of supply.**

###### ** **

###### **The most important ingredients usedare dairy-based ingredients, flour, spinach, basil, and spices.  Management is unaware of any currentrestrictions or other factors that would have a material adverse effect on theavailability of these raw materials. The Company’s purchasing policies are designed to provide more than onecredible source for all ingredients.**

 

###### **Distribution**

 

The Company’ssuccess depends upon an effective system of distribution for its products.   In Northern California, the Companymaintains four direct store delivery (“DSD”) routes to deliver its products toapproximately 140 stores. The Company also delivers product directly towarehouses for several Northern California chains.  To distribute its products to other customers and parts of thecountry (over 90% of its business), the Company uses common carriers.  The dependence on other companies fordelivery of its products poses a risk to the Company.  While the common carrier method of delivery has been reliable andavailable at acceptable rates thus far, there can be no assurance that theCompany will continue to be able to negotiate acceptable freight rates in thefuture and that delivery will not be disrupted for reasons including, but notlimited to, adverse weather, natural disasters or labor disputes in thetrucking industry.

 

**Grocery Chain and Club Store Sales**

 

Monterey Pastasells its products to chain grocery and club stores with approximate number ofstores listed below:

 
|                   |   | **Number of  Stores Carrying Monterey Pasta Products** |   |
|------------------------|--------|--------------------------------------------------------|--------|
|                   |   | **2000**                                               |   | **2001** |   | **2002** | ** ** |
| Retail  Grocery Stores |   | 5,330                                                  |   | 5,640 |   | 7,780 |   |
| Club  Stores           |   | 670                                                    |   | 780 |   | 920 |   |
| **Total**              |   | 6,000                                                  |   | 6,420 |   | 8,700 |   |

 

For the years2000, 2001, and 2002 Costco accounted for 50%, 48%, and 43% of total netrevenues, while Sam’s Club stores, including Wal-Mart Supercenters, accountedfor 30%, 31% and 31% of revenues for the same years.  The Company currently sells its products to eight separate Costcoregions which make purchasing decisions independently of one another.  These regions re-evaluate, on a regularbasis, the products carried in their stores. There can be no assurance that these Costco regions will continue tooffer Monterey Pasta products in the future or continue to allocate MontereyPasta the same amount of shelf space. The Company currently supplies its products to approximately 450 Sam’sClub stores, which feature expanded delis, and approximately 1,100 Wal-MartSupercenters.  Purchasing decisions forthese affiliates are made at the company headquarters with input from the storelevel.  While the Company is in thesixth year of its relationship with Sam’s, there can be no assurance that Sam’sClub stores will continue to carry its products or allocate Monterey Pasta thesame amount of shelf space.  The Companyobtained the Wal-Mart Supercenter business during 2002, so the relationship isrelatively new. The loss of either Costco or Sam’s could materially adverselyaffect the Company’s business operations.

 

In 2002, theaverage grocery store carried 12 individual Monterey Pasta products, or StockKeeping Units  (“SKUs”), and the averageclub store carried 11 SKUs.

 

During the pasttwelve months less than 3.5% of sales were to foreign customers, with Canadaand Mexico accounting for over 95% of those sales, and the remainder going toAsia Pacific.  On the following page isa table depicting sales by country of origin for the last three fiscal years:

 

| **(000’s $)** |   | **Sales by Foreign Country** |   |
|--------------------|--------|------------------------------|--------|
|               |   | **2000**                     |   | **2001** |   | **2002** |   |
| Canada             |   | 256                          |   | 896 |   | 1,032 |   |
| Mexico             |   | —                       |   | 527 |   | 768 |   |
| Taiwan             |   | —                       |   | 85 |   | 59 |   |
| Japan              |   | —                       |   | 16 |   | 7 |   |
| Singapore          |   | —                       |   | 20 |   | — |   |
| **Total**          |   | 256                          |   | 1,544 |   | 1,866 |   |

 

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**Marketing**

 

The Company’smarketing strategy is to create brand awareness by communicating to theconsumer that Monterey Pasta Company provides a gourmet quality nutritious lineof products and to promote repeat business by reinforcing positive experienceswith the Company’s products.  TheCompany’s approach includes the introduction of new products on a timely basisto maintain customer interest and to respond to changing consumer tastes.  Additionally, the Company will continue toexpand its sales into those geographic regions that will best support thepurchase of the Company’s upscale premium grade products.

 

**Competition**

 

The Company’sbusiness is subject to significant competition.  The fresh pasta and pasta sauce industry is highly competitiveand is dominated by two very large multinational companies, Nestle, with itsContadinaâ and Buitoniâbrands, and Kraft, with its DiGiornoâ brand.   There are also a number of smaller regionalcompetitors, such as Mallardsâ (owned by MichaelAngelo’s), Olivieriâ (owned by MapleLeaf Foods of Toronto, Ontario Canada) and Triosâ,(owned by ConAgra) which focuses mostly on the food service trade.  Multinational competitors have significantlymore brand name recognition, marketing personnel, and cash resources than theCompany.  Moreover, competition forshelf space in grocery stores is intense and poses great difficulty for smallerfood companies.

 

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

 

The pizza andcalzone products produced by the Company are believed to be the only nationallydistributed extended shelf life product in the refrigerated section of thesupermarket.  The Company is unaware ofa significant competitor offering these products that can guarantee at least a30-day shelf life, which is the minimum committed to by the Company.

 

The Company hasdeveloped several products for which there is no material competition currentlyin the refrigerated sector including borsellini, gnocchi, stuffed gnocchi, andpierogies.  It will continue to try toproduce distinctive products, which fill specific niches where there is littleor no national competition.

 

Competitivefactors in the refrigerated food market include brand awareness, productquality and taste, perceived healthfulness, price and availability of groceryand club store shelf space. The Company’s suggested retail prices are slightlyhigher than its competitors’ prices for many of its items to emphasize thepremium quality of its product line. The Company believes the excellent quality, taste and perceivedhealthfulness of its products are superior to that of its competitors, althoughits brand name recognition and access to grocery shelf space is significantlyless than some of its competitors.  TheCompany also believes that the quality of its products and the variety of itsproduct lines provide a competitive advantage over many companies which marketmore traditional products.

 

**Management**

 

Informationrelating to directors and executive officers of the Company is set forth inPart III of this report.

 

9

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**ManagementInformation Systems**

 

The Company purchased anew integrated management information system in 1996 with the objective toimplement an electronic link between the Company’s sales operations, productionfacilities and the corporate offices. The Expandable MRP system (“Expandable”) is central to the Company’sefforts to automate, centralize and streamline many of the Company’s keyfunctions including accounting and finance, human resources, and production andinventory control.  During the fall of1998, the Company successfully installed a new version of Expandable to ensurecompliance with year 2000 needs.  Allother systems were successfully updated to comply with year 2000 needs during1999.  The Company installed a newWindowsâ version ofExpandable in the second quarter of 2002. Improvements will also be made in 2003 to its client server system toaugment redundancy and increase capacity.

 

**GovernmentRegulation**

 

The Company issubject to the regulations of the U.S. Food and Drug Administration (“FDA”),the U.S. Department of Agriculture (“USDA”), and state, local and organicindustry regulations relating to cleanliness, maintenance of food productionequipment, food storage, cooking and cooling temperatures, food handling, andorganic ingredient content of products, and is subject to unannounced on-siteinspections of production facilities. Regulations in new markets, new regulations in existing markets, andfuture changes in existing regulations may adversely impact the Company byraising the cost of production and delivery of its products and/or by affectingthe perceived healthfulness of the Company’s products.  A failure to comply with one or more regulatoryrequirements could result in a variety of sanctions, including fines and thewithdrawal of the Company’s products from store shelves.  The Company is not aware of any currentlyexisting facts or circumstances that it is not addressing which would cause itto fail to comply with any of the regulations to which it is currently subject.

 

**Employees**

 

As of December 29,2002, the Company employed a total of approximately 347 persons at alllocations, including 48 administrative personnel, 9 sales personnel, 6 drivers,and 284 distribution and production personnel. None of the Company’s employees are represented by a labor union and theCompany believes its relations with its employees are good.

 

**Trademarksand Service Marks**

 

The Company hasregistered the “Monterey Pasta Company” name and “postage stamp” logo designwith the United States Patent and Trademark Office.  There can be no assurance that competitors will not adopt similarnames 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” labelwith its acquisition of the Frescala Foods, Inc. business.  In December 2000, it acquired the right touse the “Nate’s” label through its acquisition of the Nate’s polenta business(See “Liquidity, Capital Resources, and Business Acquisitions,” page 13). InJanuary 2001 the Company applied for registration with the United States Patentand Trademark Office for the “Borsellini” trademark name currently used for itsfilled pasta of the same name. Additionally, In November 2001, the United States Patent and TrademarkOffice approved the “Homestyle-Fresh” trademark currently used in its soupline.  During 2002 the Company acquiredthe rights to two unregistered trademarks, Isabella’s Kitchen, and EmeraldValley Kitchen as part of acquisitions of businesses of the same names.

 

**ITEM 2.                  PROPERTIES**

 

During the first quarter of 2002, the Company leasedan additional 41,318 square feet of space at its offsite distribution complex toaccommodate plant expansion and to provide for future growth.  The added space has been only partiallydeveloped with two new production lines to be used in the first quarter of2003, thereby leaving the space and flexibility for future expansion.  The Company now leases approximately 133,000square feet in Salinas, California, comprised of 43,680 at its headquartersfacility and 89,211 at its distribution facility three miles from itsheadquarters. The headquarters facility is dedicated to manufacturing operations,offices and its test kitchen.  Thedistribution complex is comprised of 19,845 feet of refrigerated cold storage,2,070 of office space, 25,978 of ambient storage, and the new lease (41,318 sq.ft.), which will be dedicated to production space and storage, withapproximately 8,000 square feet initially earmarked for production space. Thecurrent production facilities/headquarters lease expires in October 2004 withtwo ten-year options for renewal.  Thelease for the distribution center and adjacent production and storagefacilities expires in June 2007 with two five-year renewal options.

 

On January 2, 2003 the Company entered into athree-year lease for an additional 1,190 square feet of office space next doorto its headquarters facility in Salinas, California.  The lease commences March 1, 2003 and expires February 28, 2006.

 

The Company acquired a lease for the 19,000 squarefoot production facility and offices as part of its acquisition of EmeraldValley.  The lease expires December 31,2007, with three five-year renewal options.

 

10

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Management feels that its facilities are adequate tosupport sales growth for at least 24 months unless an acquisition is made.  After that time production and office spacecould be expanded at its distribution complex or additional space could beleased in California to support its Salinas operations or in Eugene, Oregon tosupport its Oregon operations.

 

**ITEM 3.                  LEGALPROCEEDINGS**

 

On February 2, 2000, theUnited States District Court for the District of Delaware denied a motion todismiss a lawsuit against Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLC,stockholders of the Company, (collectively, “Clearwater”), Mark Levy v.Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLC and Monterey PastaCompany, United States District Court for the District of Delaware, Case No.99-004-SLR.  The lawsuit alleged aviolation of Section 16(b) of the Securities Exchange Act of 1934, as amended,in connection with alleged purchases and sales of the Company’s stock within asix-month period.  The Company was namedas a nominal defendant in the lawsuit. The Plaintiff sought the return ofapproximately $1,064,000 in alleged profit and Clearwater contested theclaim.  During the week of July 10,2000, the parties signed a settlement agreement whereby Clearwater agreed topay $700,000 to the Company in settlement of the claim asserted by theplaintiff.  Plaintiff’s counsel appliedto the court for attorney’s fees and expenses of approximately $230,000 fromthe settlement.  As part of thesettlement, Clearwater and the Company exchanged mutual releases.  The settlement was approved by the Board ofDirectors of the Company.

 

On October 27,2000 the Company received a check in the amount of $472,406 including thesettlement amount of $470,000, and interest of $2,406.  The stockholders’ equity account wasincreased to reflect the disgorged profit settlement amount, net of the related$180,000 tax effect and attorney’s fees of $18,000.

 

On February 14, 2003, theCompany became aware that a press release had been issued by the law firm ofBull & Lifshitz, LLP.  The pressrelease stated that a securities class action lawsuit had been filed againstthe Company in the United States Court for the Northern District of Californiaon behalf of purchasers of the Company’s common stock between the period July11, 2002 and December 16, 2002, inclusive ( the “class period”).  The press release stated that the complaintalleges that the defendant violated sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 and SEC Rule 10b-5 promulgated thereunder by allegedlyissuing a series of materially misleading statements to the market during theclass period, thereby artificially inflating the price of the Company’s stock,and that plaintiff, who is not identified in the press release, seeks torecover damages on behalf of all acquirers of the Company’s stock during theclass period.  The Company has not beenserved with, nor seen the complaint as of the time of this filing.

 

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

 

**ITEM 4.                  SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters weresubmitted to vote during the fourth quarter of 2002.

 

**PART II**

 

**ITEM 5.****     MARKETFOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

**PriceRange of Common Stock**

 

The Company wentpublic on December 7, 1993 at a price to the public of $6.00 per share.  Since that date, the Company’s Common Stockhas traded on the NASDAQ National Market System under the symbol “PSTA.”  The table on the following page sets forthin decimals for the period indicated, the high and low sales prices of sharesof the Common Stock on the NASDAQ National Market System.

 
|               |   | **High** |   | **Low** |   |
|--------------------|--------|----------|--------|---------|--------|
| Fiscal  year 2001: |   |     |   |    |   |
| First  quarter     |   | $        | 7.0625 |    | $      | 4.6875 |   |
| Second  quarter    |   | 8.2000   |   | 5.6250  |   |
| Third  quarter     |   | 7.9700   |   | 5.0500  |   |
| Fourth  quarter    |   | 7.5000   |   | 5.1000  |   |
|               |   |     |   |    |   |
| Fiscal  year 2002: |   |     |   |    |   |
| First  quarter     |   | $        | 9.0000 |    | $      | 6.5000 |   |
| Second  quarter    |   | 10.4200  |   | 7.7500  |   |
| Third  quarter     |   | 9.4400   |   | 4.2500  |   |
| Fourth  quarter    |   | 7.2800   |   | 3.6500  |   |

 

11

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As of February 11,2003, there were 230 stockholders of record of the Common Stock andapproximately 4,600****investors with shares in street name.

 

**DividendPolicy**

 

The Company hasnot paid any cash dividends to Common stockholders, except to certain holdersof private placement common stock in 1997, which represented guaranteed yieldfor the period from stock issuance in April, 1997 until the RegistrationStatement on Form S-3 was effective on October 24, 1997.  The Company intends to retain futureearnings in its business and does not anticipate paying cash dividends on theoutstanding Common stock in the near future.

 

**ITEM 6.                  SELECTEDFINANCIAL DATA**

 

The table on the following page sets forthconsolidated financial data for the Company. These data should be read in conjunction with the consolidated financialstatements and related notes included elsewhere in Form 10-K.

 
|                                         |   | **Years  Ended**                                         |   |
|----------------------------------------------|--------|----------------------------------------------------------|--------|
|                                         |   | **1998**                                                 |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|                                         |   | **(dollar  amounts in thousands except per share data)** |   |
| **Consolidated  Statements of Income Data:** |   |                                                     |   |   |   |   |   |   |   |   |   |
| Net  revenues                                |   | $                                                        | 24,348 |   | $ | 34,898 |   | $ | 46,090 |   | $ | 56,987 |   | $ | 61,679 |   |
| Net  income                                  |   | $                                                        | 2,037  |   | $ | 7,027 |   | $ | 6,141 |   | $ | 4,429 |   | $ | 9,491 |   |
| Basic  net income per common share           |   | $                                                        | 0.16   |   | $ | 0.55 |   | $ | 0.46 |   | $ | 0.33 |   | $ | 0.68 |   |
| Diluted  income per common share             |   | $                                                        | 0.16   |   | $ | 0.54 |   | $ | 0.44 |   | $ | 0.31 |   | $ | 0.65 |   |
|                                         |   |                                                     |   |   |   |   |   |   |   |   |   |
| Weighted  average basic shares outstanding   |   | 12,979,055                                               |   | 12,711,801 |   | 13,222,062 |   | 13,491,177 |   | 14,039,902 |   |
| Weighted  average diluted shares outstanding |   | 12,979,055                                               |   | 13,074,776 |   | 13,835,384 |   | 14,254,248 |   | 14,664,762 |   |
|                                         |   |                                                     |   |   |   |   |   |   |   |   |   |
| **Consolidated  Balance Sheet Data:**        |   |                                                     |   |   |   |   |   |   |   |   |   |
| Working  capital                             |   | $                                                        | 1,601  |   | $ | 4,128 |   | $ | 9,799 |   | $ | 14,934 |   | $ | 16,880 |   |
| Total  assets                                |   | $                                                        | 10,835 |   | $ | 18,666 |   | $ | 25,189 |   | $ | 31,596 |   | $ | 43,799 |   |
| Total  debt and capital lease obligations    |   | $                                                        | 2,277  |   | $ | 761 |   | $ | 73 |   | $ | 49 |   | $ | 17 |   |
| Stockholders’  equity                   |   | $                                                        | 6,709  |   | $ | 14,610 |   | $ | 21,663 |   | $ | 27,981 |   | $ | 38,941 |   |

 

Comparability of netrevenues and income from continuing operations over the past five years hasbeen affected by the acquisition of Frescala in 1999, Nate’s in 2000 andEmerald Valley in 2002.  In addition,comparability of net income numbers has been significantly affected by theCompany’s tax position as influenced by the release of reserves againstdeferred tax assets relating to Net Operating Loss carryforwards (“NOLs”),which occurred in 1998, 1999, 2000, and 2002. The following proforma net income results were developed by utilizing anassumed tax rate of 40% for each year:

 
|                                                 |   | **Years  Ended** |   |
|------------------------------------------------------|--------|------------------|--------|
|                                                 |   | **1998**         |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
| Proforma:                                            |   |             |   |   |   |   |   |   |   |   |   |
| Net  income (as reported)                            |   | $                | 2,037  |   | $ | 7,027 |   | $ | 6,141 |   | $ | 4,429 |   | $ | 9,491 |   |
| Addback:  income tax (benefit)/expense (as reported) |   | 31               |   | (3,261 | ) | (109 | ) | 2,936 |   | (2,838 | ) |
| Proforma  net income before taxes                    |   | 2,068            |   | 3,766 |   | 6,032 |   | 7,365 |   | 6,653 |   |
| Less:  proforma income tax (benefit/expense) at 40%* |   | (827             | )      | (1,506 | ) | (2,413 | ) | (2,946 | ) | (2,661 | ) |
| Proforma  net income                                 |   | $                | 1,241  |   | $ | 2,260 |   | $ | 3,619 |   | $ | 4,419 |   | $ | 3,992 |   |
| Basic  net income per common share                   |   | $                | 0.10   |   | $ | 0.18 |   | $ | 0.27 |   | $ | 0.33 |   | $ | 0.28 | ** ** |
| Diluted  income per common share                     |   | $                | 0.10   |   | $ | 0.17 |   | $ | 0.26 |   | $ | 0.31 |   | $ | 0.27 |   |
|                                                 |   |             |   |   |   |   |   |   |   |   |   |
| Weighted  average basic shares outstanding           |   | 12,979,055       |   | 12,711,801 |   | 13,222,062 |   | 13,491,177 |   | 14,039,902 |   |
| Weighted  average diluted shares outstanding         |   | 12,979,055       |   | 13,074,776 |   | 13,835,384 |   | 14,254,248 |   | 14,664,762 |   |
|                                                      |        |                  |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.****     MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

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

 

**Background**

 

Monterey PastaCompany was incorporated in June 1989 as a producer and wholesaler ofrefrigerated gourmet pasta and sauces to restaurants and grocery stores in theMonterey, California area.  The Companyhas since expanded its operations to provide a variety of gourmet refrigeratedfood products to grocery and club stores throughout the United States, selectedregions in Canada, the Caribbean, Latin America, and Asia Pacific.  The Company’s overall strategic plan is toenhance the value of the Monterey Pasta Company brand name by distributing itsgourmet products through multiple channels of distribution.

 

The Company’s product distribution to grocery and clubstores increased from approximately 25 stores as of December 1989, to approximately8,700 stores by December 29, 2002.  During 1994, 1995 and 1996, significant costs were incurred to promotethe rapid expansion that occurred, including product demonstration,advertising, warehousing, and distribution costs and the hiring of additionalpersonnel.  In 1997, the focus waschanged to developing a profitable distribution base.  Hence, the reduction in store totals, and the return toprofitability.  During 1998 through2002, the Company added profitable retail and club distribution includingapproximately 410 additional club stores, 550 retail stores as part of theMarch, 1999 Frescala Foods acquisition, several new retail chains, additionalstores in existing chains, and added stores as part of the Nate’s and EmeraldValley acquisitions comprising approximately 4,300 stores.

 

The success of theCompany’s efforts to increase revenue will depend on five key factors: (1)whether grocery and club store chains will continue to increase the number oftheir stores offering the Company’s products, (2) whether the Company cancontinue to increase the number of grocery and club store chains offering itsproducts, (3) continued introduction of new products that meet consumeracceptance and 4) whether the Company can diversify into other complementarybusinesses through new product offerings or acquisitions and leverage itsstrengths to continue to grow revenues at levels attractive to itsinvestors..  Grocery and club storechains continually re-evaluate the products carried in their stores, and noassurances can be given that the chains currently offering the Company’sproducts will continue to do so in the future or that such chains will notreduce the number of stores carrying the Company’s products.

 

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

 

**Operationsfor 2000, 2001 and 2002**

 

In 2001, theEmerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board(“FASB”) adopted Issue 01-09, “Accounting for Consideration Given by a Vendorto a Customer or a Reseller of the Vendor’s Products.” This Issue requiredreclassification of certain expenses which were formerly classified sellingexpense as reductions in sales (see “Recently Issued Accounting Standards page21 for a complete analysis of pre and post EITF 01-09 net revenue and sales andselling, general and Adminstrative “SG&A” accounting).  Post EITF 01-09 net revenues were$46,090,000, $56,987,000 and 61,679,000 for 2000, 2001 and 2002, respectively,reflecting an annual increase in sales of 24% for 2001, when compared to 2000,and an 8% increase for 2002 when compared to 2001. The 2001 and 2002 increasesresulted from same store sales growth, increased store numbers fromapproximately 4,500 at the end of 2000 to approximately 6,400 individualgrocery and club stores by year-end of 2001, and approximately 8,700 atyear-end 2002. The acquisition of Emerald Valley Kitchen in late August 2002contributed approximately 

 

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2% of the overall 2002 sales growth of 8% from its eighteen weeks ofsales through 2002 fiscal year end. The 2002 sales level represents a compoundannual average growth since 1999, when sales were $36,902,000, of over 20%.

 

Gross margin for2000, 2001, and 2002 based on post EITF 01-09 sales accounting was 36.0%, 36.0%and 36.1%, respectively.  The slightincrease in 2002 was due to lower ingredients prices, especially dairyingredients.

 

Post EITF 01-09SG&A increased to $15,654,000, up $2,372,000 or 18% from $13,282,000 in2001, which had increased $2,787,000****or 26% from 2000.  In addition to variable selling expenseincreases associated with the 8% sales growth, the 2002 increase resulted fromapproximately $650,000 in one-time expenses associated with a union organizingeffort, which was overwhelmingly defeated by a vote of Company employees, andthe successful search for a new President. The 2002 numbers also included SG&A expenses of $307,000 added withthe acquisition of Emerald Valley for the eighteen week period following acquisition.  The 2002 increase also reflected anincreased investment in marketing expenditures, most notably productdemonstrations, without a commensurate increase in sales volume.  Management is examining the level of productdemonstration expenses to determine the most cost-effective level relative tosales revenue.  SG&A expense was25.8%, 26.2%, and 28.0% in 2000, 2001, and 2002, respectively.  Additional expenses in future periods,mainly in the sales and marketing area, will be directly associated withincreased levels of sales.

 

Depreciation andamortization expense, included in cost of sales and SG&A (approximately 85%is in cost of sales), increased to $1,721,000, or 3% of net revenues in 2002,compared to $1,661,000 or 3% of net revenues in 2001, and $1,394,000 or 3% in2000.  The increases over the past twoyears relate primarily to capital expenditures in the Salinas, Californiaproduction facility and the addition of the Nate’s Polenta, and Emerald Valleykitchen businesses.  (See “Liquidity,Capital Resources and Business Acquisitions”, page 15). The Company anticipatesfurther increase in depreciation expense in future periods as additionalequipment is purchased and placed in service. However, because of the changes associated with Statement of FinancialAccounting Standards 142 (see “New Accounting Pronouncements” on page 41, and“Recently issued Accounting Standards” on page 21), amortization of existingintangibles on the books in 2001 declined from $218,000 in 2001 to $47,000 in2002.

 

Net interestincome of $110,000 was recognized in 2002 compared to income of $108,000 in2001 and $40,000 of interest expense in 2000. The 2002 and 2001 interest income was generated from investment inshort-term money funds from operating cash flow in the absence of bankdebt.   At year-end 2002, the Companyhad no bank debt and the net interest income for the year included $5,000 ofinterest expense from financing leases. (See “Consolidated Balance Sheets” page 33).

###### ** **

Income tax benefit (expense) for 2000, 2001, and 2002was $109,100, ($2,936,000) and $2,838,000, respectively.  The 2000 benefit resulted primarily from theutilization of certain tax credits including California Manufacturer’s TaxCredit, combined with the release of reserves against deferred tax assetsrelating to prior net operating losses (“NOLs”).   The 2001 expense resulted from a more normalized tax rate, sinceNOLs utilized in 2001 were not reserved. Thus, during 2001, deferred tax assets were utilized to offset State andFederal income tax with only $231,000 in cash taxes paid.  During 2002, another $5,196,000 of theremaining reserves against deferred tax assets were released and offset againstincome tax since, after a comprehensive study of the nature of the NOLs andtheir likelihood of being utilized, management concluded that it was morelikely than not that they would be utilized. This benefit, together with permanent differences and other current taxeffects, resulted in a net income tax benefit of $2,838,000 for 2002.  Utilization of these NOLS and other deferredtax assets offset substantially all of the cash federal income taxes otherwisepayable for 2002.  As of December 29,2002, remaining net deferred tax assets on the balance sheet available tooffset future taxes are $4,068,000 short term and $765,000 long term.  Additionally, in all three years, werealized additional tax benefits as a result of the exercise of non-qualifiedstock options and the exercise and subsequent sale of certain incentive stockoptions (“disqualifying dispositions”). For financial reporting purposes, anyresulting reduction in actual income tax obligations as a result of thesedisqualifying dispositions is credited to additional paid-in capital (See“Liquidity, Capital Resources and Business Acquisition: Deferred Tax Assets” onpage 15, and Note 8 to the consolidated financial statements****onpages 46-47).

 

The change in treatmentof the deferred tax valuation allowances made it difficult to compare after taxresults for the last three fiscal years. Applying the same assumed level of taxation for all three years of 40%yields the following proforma results:

### ** **

|                                                       |   | **Twelve  months ended** |          |
|------------------------------------------------------------|--------|--------------------------|---------------|
|                                                       |   | **December  31, 2000**   |          | **December  30, 2001** |   | **December  29, 2002** |   |
|                                                       |   |                     | ** **    |   | ** ** |   | ** ** |
| **Net income (as reported)**                               |   | **$**                    | **6,141,000** |   | **$** | **4,429,000** |   | **$** | **9,491,000** |   |
| **Addback: income tax (benefit)/expense  as reported**     |   | **(109,000**             | **)**         | **2,936,000** |   | **(2,838,000** | **)** |
| **Proforma net income before taxes**                       |   | **$**                    | **6,032,000** |   | **$** | **7,365,000** |   | **$** | **6,653,000** |   |
| **Less: Proforma income tax  (benefit/expense) at 40.0%*** |   | **(2,413,000**           | **)**         | **(2,946,000** | **)** | **(2,661,000** | **)** |
| **Proforma net income**                                    |   | **$**                    | **3,619,000** |   | **$** | **4,419,000** |   | **$** | **3,992,000** |   |
|                                                       |   |                     |          |   |   |   |   |
| Basic income  /sh.                                         |   | $                        | 0.27          |   | $ | 0.33 |   | $ | 0.28 |   |
| **Diluted income/sh.**                                     |   | **$**                    | **0.26**      | ** ** | **$** | **0.31** | ** ** | **$** | **0.27** | ** ** |

 

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*Estimatednormalized tax rate

 

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

 

During the twelvemonths ended December 29, 2002, $9,494,000 of cash was provided by theCompany’s operations, compared to $7,416,000 provided in 2001.  The increase in 2002 net income of$5,062,000 was offset by a $5,442,000 increase in deferred tax assets, leavinga net decrease of $380,000 attributable to profit performance associated withoperations.  The Company paid only$228,000 in cash taxes for year 2001 and had a cash credit of $120,000 in 2002,due primarily to utilization of NOLs as discussed above.  A change in working capital componentscontributed $.7 million in cash during 2002, largely a result of the $1.3million increase in accounts payable and accrued liabilities offset by increasein accounts receivable, inventory and prepaids of $.6 million.  The 2002 improvement in cash flow fromoperations followed a $1.4 million improvement of 2001 over 2000, most of whichwas contributed by an increased net cash income, partially offset by a netincrease in working capital components.

 

The Companycurrently has a credit facility, which was renegotiated in August, 2001 for$10.0 million in aggregate borrowings which has been unused since September2000, and has a zero balance outstanding at December 29, 2002 (See Note 4 tothe financial statements).  The $1.5million working capital portion of the facility is priced at either prime rateor LIBOR, plus 185 basis points for a debt/tangible net worth ratio of .50:1,with LIBOR premiums increasing in 25 basis point increments based on increaseddebt/tangible net worth increments of .25:1. The working capital commitment expires October 31, 2003.  The $8.5 million non-revolving term portionof the facility pricing is at either prime rate or LIBOR plus premiums for thesame debt/tangible net worth ratios beginning at 200 basis points over LIBORand increasing 25 basis points for successive debt/tangible net worthincrements.  The term loan facility issubject to annual review if unused.  Ifused, it converts to an 84-month term loan. This access to capital provides uswith flexible working capital, which occasionally may be needed in the normalcourse of business, and the opportunity to grow our business throughacquisitions or develop our existing infrastructure through capital investment.  A Letter of Credit in the amount of $500,000was negotiated during January 2003 in favor of an insurance company to supporta deductible worker’s compensation program initiated by the Company on January1, 2003.

 

In addition to operatingcash flows, the Company also received cash proceeds of $168,000, $989,000, and$985,000 from the exercise of employee stock options and sales of stock underthe Company’s stock purchase Plan during 2000, 2001, and 2002, respectively.During 2000 the Company also received cash proceeds of $261,000 from theexercise of warrants issued as part of a 1997 private placement.

 

The cash from operations in 2002, combined with thecash proceeds from stock sales and option exercises and accumulated cashbalances, was used principally to fund $4.8 million of plant expansion andimprovement projects, and to fund the $5,744,000 in cash paid for theacquisition of the operating assets and inventory of Emerald Valley, andacquisition related costs of $188,000.

 

The Company invested $4.8million in capital assets in 2002. Major projects included approximately $2.1 million for a plant expansionat its distribution center.  Othersignificant projects included a new jar line for sauce packing, a new chunkyravioli line, a new pasta packing line and labeler, a spiral chiller, and anelectrical upgrade improved packaging equipment.  Many other smaller projects were completed to support growth,improve processes, support administrative systems, or assist in complianceissues.

 

TheCompany invested $2.6 million in capital assets in 2001.  Major projects included approximately$900,000 for expansion of and improvements in the pizza/calzone line,approximately $300,000 for ingredients blending upgrade, and over $250,000 forthe borsellini dies and pasta machines. The Company also invested over $500,000 in facility improvements toenhance sanitation and support growth, and $150,000 in new or improvedpackaging equipment, as well as many other capital projects designed to supportgrowth, improve processes, or assist in compliance issues.

 

Atotal of $500,000 in cash was used in 2000 in connection with the Nate’spolenta acquisition, including costs associated with the transaction.  In addition, $4,308,000 in cash was used topurchase equipment and leasehold improvements in 2000. Approximately $2.2million of the 2000 capital expenditures were part of a $3.5 million capitalplan approved by the Company’s Board of Directors in October 1999 for theperiod of October 1999 through December 2000. The Company made additional capital expenditures in 2000 ofapproximately $1.5 million to expand production capability, improve packagingefficiency and maintain quality and upgrade utilities including boiler capacityand waste water treatment, as well as another $.6 million for a stuffedpizza/calzone line.

 

TheCompany anticipates capital expenditures in 2003 to be approximately $2.9million.  All future capitalexpenditures are expected to be funded with a combination of cash flow fromoperations and use of the Company’s credit facility.

 

15

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**Business Acquisitions**

 

OnMarch 12, 1999, the Company purchased the operating assets and inventory ofFrescala Foods, Inc. (“Frescala”), a San Antonio, Texas based fresh pasta andsauce producer with an emphasis on private label production. The Companybenefited in two ways from this acquisition: 1) it acquired several signaturegrocery chains in which it had no previous presence, and 2) it was able toimprove profitability through the closure of the San Antonio facility, therebyeliminating the fixed overhead layer associated with running the facility.  The consideration to the Frescalashareholders consisted of $1,345,000 in cash plus fully vested options topurchase 300,000 shares of the Company’s common stock.  The options had an approximate fair marketvalue of $145,000, an exercise price of $2.33 per share, and a three-yearexpiration.  Additionally, Frescalaowners received an earn-out of $97,000 as of October 31, 1999 based uponFrescala sales above a predetermined level. Funding for the transaction came from a new $750,000 two-year term loan,since repaid, use of existing accounts receivable and inventory line, and cashflow from operations.

 

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

 

On December 8,2000, the Company purchased the Nate’s polenta business of South San Francisco,California for a total consideration of $469,000, plus related acquisitioncosts of $31,000.  Approximately $19,000was allocated to inventory.  Theremaining $481,000 was classified as goodwill. Funding for the Nate’s purchase came from existing bank balances.   The Nate’s acquisition provided the Companyanother gourmet niche item to complement its product lines and addedapproximately 700 stores which the Company did not formerly serve.

 

On August 23,2002, the Company purchased the operating assets and inventory of EmeraldValley Kitchen, Inc. a Eugene, Oregon based producer of organic fresh salsas,dips, hummus, and sauces with over 90% retail chain distribution. The Companyconsidered this purchase an opportunity to enter the rapidly growing organicfood market.  The consideration to thesellers consisted of $5,744,000 in cash. Additionally, the Emerald Valley owners are eligible to receive anearn-out based upon Emerald Valley Earnings before Interest, Taxes,Depreciation, and Amortization (“EBITDA”) above predetermined levels startingat $979,000 for the first five years after the acquisition date.  The earn-out will be calculated annually atthe end of successive twelve-month periods following acquisition.  Funding for the transaction came fromexisting cash balances.

 

The total considerationof $5,744,000, plus related acquisition costs of $188,000, was allocated toidentifiable property and equipment totaling $120,000 and inventories of$299,000.  The balance of $5,513,000 wasallocated to trademark ($600,000), recipes ($60,000), customer lists($1,500,000), and goodwill ($3,353,000). The trademark, which has been included in intangible assets, willcontinue to be used for an indefinite period. Therefore, this asset balance will not be amortized on a monthly basis,but will be tested for impairment annually in keeping with SFAS 142.  Recipes will be amortized over a three-yearlife. Customer list will be amortized over a ten-year life.

 

The following unauditedproforma financial data present the combined results of operations of MontereyPasta Company and Emerald Valley as if the purchase had occurred December 31,2001.  The proforma information giveseffect to certain adjustments, including eliminating the amortization ofgoodwill for 2001, which was expensed prior to the adoption of “Recently IssuedAccounting Standards” on page 21.  Thisproforma summary does not necessarily reflect the results of operations, asthey would have been if Monterey Pasta Company and Emerald Valley hadconstituted a single entity during such periods, and is not necessarilyindicative of results that may be obtained in the future.

 

|                      |   | **Twelve  months ended** |       |
|---------------------------|--------|--------------------------|------------|
|                      |   | **December  30, 2001**   |       | **December  29, 2002** |   |
| Proforma:                 |   |                     | ** ** |   | ** ** |
| Net  Sales                |   | $                        | 60,811     |   | $ | 64,350 |   |
| Net  Income               |   | $                        | 4,926      |   | $ | 9,968 |   |
|                      |   |                     |       |   |   |
| Basic  income per share   |   | $                        | 0.38       |   | $ | 0.71 |   |
| Diluted  Income per share |   | $                        | 0.36       |   | $ | 0.68 |   |

 

Management believes thatcash on hand of $6.8 million at December 29, 2002, as well as projected 2003cash flows from operations, and availability under our Credit Facility, issufficient to fund our working capital needs, anticipated capital expenditures,and any acquisitions the Company may enter into for 2003. We currently investour cash on hand in highly liquid short-term investments yielding approximately2% interest.

 

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**DeferredTax Assets**

 

Due to the prior history of losses, a 100% valuationallowance against deferred tax assets was provided in 1998 and earlier years,as we could not determine that it was more likely than not that we could usethem. As of December 26, 1999, however, we had experienced three consecutiveyears of increasingly profitable operations.  Accordingly, we reversed aportion of the valuation allowance totaling $3,430,000 at year-end 1999, sincewe believed it was more likely than not that at least this portion of deferredtax assets would be realized.  Additional reserves totaling $2.4 millionwere reversed in 2000, as operations remained profitable.

 

During 2002, we completed a comprehensive study of thenature of certain net operating losses (NOLs) arising in connection with ourpreviously owned subsidiary Upscale Food Outlets, Inc. (UFO) and theirlikelihood of their being utilized.   Weconcluded that it was more likely than not that they would be utilized.  As a result, reserves against these specificdeferred tax assets totaling $5,196,000 were released during 2002 and offsetagainst income tax expense.  Thiscredit, together with permanent differences and other current tax effectsresulted in a net year-to-date income tax benefit of $2,838,000.  Utilization of these NOLS and other deferredtax assets offset substantially all of the federal income taxes otherwisepayable for 2002.  As of December 29,2002, remaining net deferred tax assets available to offset future cash taxesare $4,068,000 short term and $765,000 long term.

### ** **

As a result of this evaluation and resulting releaseof reserves, the Company expects that future income tax expense will be accruedat a more “normalized” combined Federal and State rate approaching statutoryrates less certain tax credits and timing differences.

 

The future disallowance of any previous UFO NOL usage,if it occurs, would increase both income tax expense and amounts actuallypayable.

 

**Salesand Marketing**

 

The Company’ssales and marketing strategy is twofold, and targets sustainable growth indistribution of its products and the introduction of innovative new products tokeep the Company positioned as the gourmet refrigerated category leader in themarketplace.  Its focus is on increasingsales through expansion of its club store and retail grocery business.

 

During 2000, theCompany continued its emphasis on bringing innovative new products to themarket place with the introduction of refrigerated stuffed pizzas, calzones,pierogies, a tortilla soup, and a vodka sauce.   The refrigerated pizzas and calzones were introduced late in thethird quarter with a guaranteed shelf life of 30 days, and, to the Company’sknowledge, are the only extended shelf life refrigerated pizzas andcalzones.  The pierogies, introduced inthe first quarter of 2000, are also the only extended shelf life refrigeratedpierogy the Company is aware of, have been accepted nationally at Sam’s Clubstores, and have regional distribution elsewhere.  These introductions are part of an ongoing effort to rapidly introducenew products in the refrigerated section, which further enhance the Company’sgourmet image.

 

Expansion of theCompany’s club store business took on an international flavor during 2001 withthe introduction of the Company’s products into the Eastern Canada division ofCostco, as well as Costco locations in Mexico, and locations in AsiaPacific.  The Company’s products are nowfound in approximately 330 Costco Wholesale locations.  Distribution of the Company’s products alsocontinues to grow with the national expansion of Sam’s Club, and theintroduction of the Company’s products into Sam’s Club locations inMexico.  Monterey Pasta’s products arenow found in approximately 450 Sam’s Club locations.

 

During 2001, theCompany’s retail business increased significantly with an additional 279 Albertson’sstores including 75 in the metro Phoenix market, and 204 in NorthernCalifornia, over 50 Dominick’s stores in the metro Chicago market, and 14Jerry’s Enterprises stores in the upper Midwest, which average 75,000 squarefeet in size. The Company also acquired significant retail business with itspurchase of the Nate’s Polenta brand in late 2000.  The Nate’s Polenta business added distribution to over 700 retailoutlets.  At end of 2001, the Companyhad distribution in over 5,600 retail outlets.

 

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

 

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During 2002 theCompany launched three new product lines: stuffed potato gnocchi with threeflavors, a new line of premium sauces in plastic jars with several selectionsand Pezzo Grandi Chunky Stuffed Ravioli with three flavors initially.  Several extensions of existing lines werealso marketed.

 

The Company madesignificant distribution gains during 2002 with over 600 Albertson’s stores,1,100 Wal-Mart Supercenters, 140 BJ’s club stores and 260 Publix Super Marketsadded to its distribution base.  TheEmerald Valley acquisition also added over 100 stores not formerly served bythe Company.

 

In addition, theCompany purchased the operating assets of Emerald Valley Kitchen of Eugene,Oregon, a producer of refrigerated organic salsas, dips, hummus andsauces.  The August 2002 acquisitionmarked the Company’s formal expansion into the rapidly growing organic foodbusiness (the Nate’s Polenta product is organic also) and will be used as aplatform for additional offerings in the future.

 

**BusinessRisks**

 

Certain characteristicsand dynamics of the Company’s business and of financial markets generallycreate risks to the Company’s long-term success and to predictable quarterlyresults.  These risks include:

 

•                  No Assuranceof Continued Profitability.  In thesecond quarter of 1994, the Company reported its first operating loss fromcontinuing operations.  Subsequent tothat quarter the Company incurred losses through the first quarter of 1997,after which it regained profitability, which has continued for twenty-oneconsecutive quarters. At December 29, 2002, the Company had an accumulateddeficit of $5,592,000.  There can be noassurance that the Company will maintain its profitability in the long or shortterm.

 

•                  Liquidity:  Need for Additional Capital.  Management believes that its current cashbalances, operations, and existing bank lines of credit will provide adequateliquidity to meet the Company’s planned capital and operating requirements fornormal operations and capital expenditures through the next twelve months(refer to Note 6 to the financial statements for a description of creditfacility).  In addition, thedisallowance of a significant portion of previously-utilized UFO NOLs mightrequire an unexpected cash outlay.  Thetax impact of the use of the UFO NOLs through 2002 is approximately $10million.  If the Company’s operations donot provide cash sufficient to fund its operations, and the Company seeksoutside financing, there can be no assurance that the Company will be able toobtain such financing when needed, on acceptable terms, or at all.  In addition, any future equity financing orconvertible debt financing would cause the Company’s stockholders to incurdilution in net tangible book value per share of Common Stock.

 

•                  Hiring andRetention of Key Personnel.  Thesuccess of the Company depends on its ability to retain key executives, and tomotivate and retain other key employees and officers.  On September 3, 2002 the Company announced the hiring of James M.Williams as the new President to replace R. Lance Hewitt, who will be retiringfrom day-to-day operations sometime in early 2003.  The Company currently has key man insurance policies in place,each in the face amount of $500,000, for its Chief Executive Officer, R. LanceHewitt, and its Chief Financial Officer, Stephen L. Brinkman.  A policy will be added for Mr. Williams inthe future.  There can be no assurancethat significant management turnover will not occur in the future.

 

•                  Impact ofInflation.  Dairy ingredients andenergy prices had a significant impact on its operations during the first sixmonths of 2001.  However, managementbelieves that inflation has not had a material impact on its operations during2002.  Substantial increases in labor,employee benefits, freight, ingredients and packaging, rents and otheroperating expenses, and future increases in cheese and energy prices couldadversely affect the operations of the Company’s business in futureperiods.  The Company cannot predictwhether such increases will occur in the future, or their magnitude.

 

•                  RisksInherent in Food Production.  TheCompany faces all of the risks inherent in the production and distribution ofrefrigerated food products, including contamination, adulteration for which itis insured, and spoilage, and the associated risks of product liabilitylitigation, which may be associated with even an isolated event.  The Company has modern productionfacilities, employs what it believes is state-of-the-art thermal processing,temperature-controlled storage, HAACP programs intended to insure food safety,and has obtained USDA approval for its California production facilities.  Quality assurance programs and food safetyprograms similar to those employed in the Salinas, California facilities willbe established for the Eugene, Oregon facility. However, there can be noassurance that the Company’s procedures will be adequate to prevent theoccurrence of such events.

 

•                  Dependence onMajor Customers.  During 2002, twocustomers, Costco and Sam’s Club stores including Wal-Mart Supercenters,accounted for 43% and 31%, respectively, of the Company’s total revenues.  The Company currently sells its 

 

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products to eight separate Costco regions(approximately 330 stores) which make purchasing decisions independently of oneanother.  These regions re-evaluate, ona regular basis, the products carried in their stores. There can be noassurance that these Costco regions will continue to offer Monterey Pasta productsin the future or continue to allocate Monterey Pasta the same amount of shelfspace.  The Company also supplies itsproducts to approximately 450 Sam’s Club stores, and 1,100 Wal-MartSupercenters and Neighborhood Markets. Purchasing decisions are made at the respective company’s headquarterswith input from the store level.  Whilethe Company is in the fifth year of its relationship with Sam’s, and thisrelationship is expected to continue, there can be no assurance that Sam’s Clubstores will continue to carry its products. Loss of either of these customers,Costco or Sam’s Club, to either would have a material adverse effect on theCompany.  Additionally, liberalizedpricing or allowance terms would create downward pressure on gross margins.

 

•                  Seasonalityand Quarterly Results.  The Company’sgrocery and club store accounts are expected to experience seasonalfluctuations to some extent.  TheCompany’s business in general may also be affected by a variety of otherfactors, including but not limited to general economic trends, competition,marketing programs, and special or unusual events.

 

•                  Competitionand Dependence on Common Carriers. The Company’s business continues to bedominated by several very large competitors, which have significantly greaterresources than the Company; such competitors can outspend the Company andnegatively affect the Company’s market share and results of operations.  The Company also continues to be dependenton common carriers to distribute its products. Any disruption in its distribution system or increase in the coststhereof could have a material adverse impact on the Company’s business.

 

•                  CaliforniaEnergy Crisis. During 2001, California experienced an energy crisis thatcould have disrupted the Company’s operations and did increase the Company’senergy expenses.  In the event of anacute power shortage, when power reserves for California fall below 1.5%,electricity providers have on some occasions implemented, and may in the futureimplement, rolling blackouts.  Ifblackouts interrupt the power supply to the Company’s production facilities,such facilities would temporarily be unable to continue production.  Any such interruption could result in a lossof revenue as a result of reduced production and, in severe cases, spoilage offood products.  In addition, related tothe energy crisis, many of the electricity and natural gas suppliers raisedtheir rates substantially during the first six months of 2001. Because theCompany has most of its operations in California, its operating costs areaffected by an increase in electricity and natural gas prices. As a result, theCompany’s operating results could to be affected in some measure by in thefuture by fluctuations in the price or supply of energy.  Electricity prices remained unchanged fromMay through March 2002, except for adjustment to a lower wintertime rateschedule, which began in November 2001 and ended in April****2002.  Current rates since April 2002 are similarto the same period a year ago.  Naturalgas prices have declined substantially from their levels in the first fivemonths of 2001 and continued at much lower levels for all of 2002.  Management cannot predict the level offuture energy prices or supply with certainty.

 

•                  Marketing andSales Risks.  The future success ofthe Company’s efforts will depend on a number of factors, including whethergrocery and club store chains will continue to expand the number of theirindividual stores offering the Company’s products and whether allowances andother incentives will expand retail distribution.  Expansion into new markets increases the risk of significantproduct returns resulting from the Company’s supply of slower selling items toits customers.  In addition, grocery andclub store chains continually re-evaluate the products carried in their storesand no assurances can be given that the chains currently offering the Company’sproducts will continue to do so in the future. Should these channels choose to reduce or eliminate products, theCompany could experience a significant reduction in its product sales.  As indicated previously, the Company remainsdependent on the use of slotting allowances and other incentives to expandretail distribution.  In order to reducerisk, the Company has significantly reduced expansion into new marketsrequiring such major expenditures.

 

•                  DairyIngredients Prices.  During thefirst ten months of 2001 average price of certain dairy ingredients increasedover 40% compared with the average of the prior twelve months, as measured bybutterfat prices published by the State of California Department of Food andAgriculture.  Because the Companyutilizes various dairy ingredients in many of its products, its operating costswill be affected by an increase in those ingredients. The Company’s operatingresults were affected in the first eleven months of 2001. Although dairyingredient prices have declined significantly in the past fourteen months sinceNovember 2001, results could be affected in some measure in future months byrenewed price increases, if they occur. Dairy ingredients historically tend to be cyclical in nature and subjectto declines in price as well as increases. Management cannot predict with certainty the duration or magnitude ofthe current price cycle.

 

•                  DeductibleWorker’s Compensation Program.  The Companyentered into a deductible worker’s compensation program for fiscal year2003.  This program which features afixed annual payment, a deductible of $250,000 per occurrence, and a $500,000letter of credit in favor of the insurance company with an annual cost of$7,500, creates a maximum exposure of approximately $2.1 million for claimsoccurring in 2003.  A competitive“guaranteed cost” program would have cost the 

 

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Company approximately $1.5 million.  Management believes that its current safetyprogram, and its safety record over the last six months of 2002 will providethe foundation to enable the Company to realize the premium savings deductibleprograms are designed to achieve.  TheCompany’s maximum exposure in the event of adverse experience is approximately$600,000.  The maximum potential gain asmuch as $1.1 million.

 

**CriticalAccounting Policies and Management Judgements**

 

***Accounts Receivable and Allowances***

 

The Company providesallowances for estimated credit losses, product returns, spoilage, andadjustments at a level deemed appropriate to adequately provide for known andinherent risks related to such amounts. The allowances are based on reviews of loss, return, spoilage,adjustment history, contractual relationships with customers, current economicconditions, and other factors that deserve recognition in estimating potentiallosses.  While management uses the bestinformation available in making its determination, the ultimate recovery ofrecorded accounts, notes, and other receivables is also dependent on futureeconomic and other conditions that may be beyond management’s control.

 

***Sales incentives and Advertising Costs***

 

The Company expensesadvertising costs as incurred or when the related campaign commences.  Sales incentives paid or credited to clubstores and grocery chains for shelf space allocations are amortized between sixand twelve months depending on the nature of the chain program or agreement.  Loss of a major account could create theneed to expense the remaining prepaid asset relating to that account in aspecific quarter, thereby potentially affecting the results of thatquarter.  In, addition sales incentivescould increase thereby adversely affecting gross margins.

 

***Goodwill/Intangible Assets***

 

Intangible assets otherthan goodwill consist of tradenames, goodwill, and other intangibles and arerecorded at cost, net of accumulated amortization.  These intangibles are amortized over their respective useful lives,if determinate, ranging from 3 to 10 years. Goodwill and intangibles with indeterminate useful lives are assessedfor impairment at least annually. The valuation of these intangibles isgenerally determined based upon valuations performed by third party specialistsand management’s best estimates of fair value. As a result, the ultimate value and recoverability of these assets issubject to the validity of the assumptions used.  The Company cannot predict the occurrence of events that mightadversely affect the reported value of goodwill that totaled $4.7 million atDecember 29, 2002.  However, the currentfair market value of our acquired assets are in excess of carrying values and,accordingly, management believes that only significant changes in cash flowassumptions would result in impairment.

 

***Income Taxes Deferred Tax Asset Valuation Allowance***

 

The Company accounts forcorporate 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 consequencesof temporary timing differences between the book carrying amounts and the taxbasis of assets and liabilities.  Futuretax benefits are subject to a valuation allowance to the extent of thelikelihood that the deferred tax assets may not be realized.

 

The Company has significant deferred tax assetscomprised principally of NOLs from the Company’s former restaurant operatingsubsidiary UFO. These NOLs were previously fully reserved based uponmanagement’s best estimate of ultimate realizeability. During 2002, based uponnew evidence and management’s judgments these reserves were substantiallyreduced.  The amount of the reserve is significantly dependent onmanagement’s assumptions regarding future taxable income and the availabilityof these NOLs to offset future taxable income. The effect on the Company’s netincome is significant whenever the estimate of realizability changes, as it didin 2002 (See Note 8 to the financial statements). The Company expects to fullyutilize all of the remaining NOLs in fiscal 2002 and 2003.

 

**ContractualObligations**

 

The Company has no rawmaterial contracts exceeding one year in duration.  However, it does have one long-term contract with its liquidnitrogen provider, which expires November 30, 2007.   This contract features a 5% price increase cap per year.   The vendor must provide writtendocumentation supporting the price increase before Company will agree to acceptit.  The following table summarizes theestimated annual obligation of that contract through 2007.

 

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| **Year**             |   | **Contractual   Obligation** |      |
|----------------------|--------|------------------------------|-----------|
| 2003                 |   | $                            | 910,000   |   |
| 2004                 |   | 955,000                      |      |
| 2005                 |   | 1,003,000                    |      |
| 2006                 |   | 1,053,000                    |      |
| 2007 and  thereafter |   | 1,014,000                    |      |
|                 |   | $                            | 4,935,000 |   |

 

In addition, the Company has a standby letter ofcredit in favor of an insurance company in the amount of $500,000, whichexpires December 31, 2003.

 

**RecentlyIssued Accounting Standards**

 

In May 2000, Emerging Issues Task Force (EITF) of theFinancial Accounting Standards Board reached a consensus on Issue 00-14,“Accounting for Certain Sales Incentives.” In April 2001, the EITF reached a consensus on Issue 00-25, “VendorIncome Statement Characterization of Consideration to a Purchaser of theVendor’s Products or Services.”  BothIssue 00-14 and 00-25 have been codified under Issue 01-09, “Accounting forConsideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products.”  The Company adopted this Issue effectivefirst quarter 2002.   EITF 01-09requires the characterization of certain vendor sales incentives such aspromotions, trade ads, slotting fees, and coupons as reductions ofrevenue.  Certain of these expenses,previously classified as selling, general and administrative costs, are nowcharacterized as offsets to revenue. Reclassifications have been made to prior period financial statements toconform to the current year presentation. Total vendor sales incentives now characterized as reductions of revenuethat previously would have been classified as SG&A costs were approximately$1,872,000, $2,233,000 and $2,290,000 for 2000, 2001, and 2002, respectively.

 

The table on thefollowing page depicts the proforma impact of reclassifications due to EITF01-09 on the Company’s operating results for 2001, and 2002 and the actualimpact for 2002:

 

**Proformaand Actual Impact on Income Statement of Adoption of EITF 01-09**

**“Accountingfor Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’sProducts”**

 
|                            |   | **—2000—**      |   | **—2001—** |   | **—2002—**      |   |
|---------------------------------|--------|---------------------------|--------|----------------------|--------|---------------------------|--------|
| **(000’s)**                |   | **As  Originally Stated** |   | **Reclassified**     |   | **As  Originally Stated** |   | **Reclassified** |   | **As Stated** |   |
| Net Revenues                    |   | $                         | 47,962 |                 | $      | 47,962                    |   | $ | 59,220 |   | $ | 59,220 |   | $ | 63,969 |   |
| Coupon Expense                  |   | —                    |   | (167                 | )      | —                    |   | (66 | ) | (112 | ) |
| Slotting Expense                |   | —                    |   | (1,478               | )      | —                    |   | (1,990 | ) | (1,865 | ) |
| Promos, Trade  Ads              |   | —                    |   | (227                 | )      | —                    |   | (177 | ) | (313 | ) |
| Adjusted Net Revenues           |   | $                         | 47,962 |                 | $      | 46,090                    |   | $ | 59,220 |   | $ | 56,987 |   | $ | 61,679 |   |
|                            |   |                      |   |                 |   |                      |   |   |   |   |   |
| Cost of Sales                   |   | 29,475                    |   | 29,475               |   | 36,469                    |   | 36,469 |   | 39,417 |   |
|                            |   |                      |   |                 |   |                      |   |   |   |   |   |
| Gross Profit                    |   | $                         | 18,487 |                 | $      | 16,615                    |   | $ | 22,751 |   | $ | 20,518 |   | $ | 22,262 |   |
| Gross Profit%                   |   | 38.5                      |   | 36.0                 |   | 38.4                      |   | 36.0 |   | 36.1 |   |
|                            |   |                      |   |                 |   |                      |   |   |   |   |   |
| Sales, Gen’l  & Admin. |   | $                         | 12,366 |                 | $      | 12,366                    |   | $ | 15,515 |   | $ | 15,515 |   | $ | 17,944 |   |
| Coupon Expense                  |   | —                    |   | (167                 | )      | —                    |   | (66 | ) | (112 | ) |
| Slotting Expense                |   | —                    |   | (1,478               | )      | —                    |   | (1,990 | ) | (1,865 | ) |
| Promos, Trade  Ads              |   | —                    |   | (227                 | )      | —                    |   | (177 | ) | (313 | ) |
| Adjusted SG&A               |   | $                         | 12,366 |                 | $      | 10,494                    |   | $ | 15,515 |   | $ | 13,282 |   | $ | 15,654 |   |
|                            |   |                      |   |                 |   |                      |   |   |   |   |   |
| SG&A%                       |   | 25.8                      |   | 22.8                 |   | 26.2                      |   | 23.3 |   | 25.4 |   |
| Operating Profit                |   | $                         | 6,121  |                 | $      | 6,121                     |   | $ | 7,236 |   | $ | 7,236 |   | $ | 6,608 |   |
| Operating  Profit%              |   | 12.8                      |   | 13.3                 |   | 12.2                      |   | 12.7 |   | 10.7 |   |

 

21

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In June 2001, the FASBfinalized SFAS 141, “Business Combinations,” and SFAS 142, “Goodwill and OtherIntangible Assets.”  SFAS 141 requiresthe use of the purchase method of accounting and prohibits the use of thepooling-of-interests method of accounting for business combinations initiatedafter June 30, 2001.  SFAS 141 alsorequires the recognition of acquired intangible assets apart from goodwill ifthe acquired intangible assets meet certain criteria. SFAS 142 changes the waycompanies account for goodwill in that goodwill is no longer amortized, but itis tested along with any other unamortized intangible assets at least annuallyfor impairment.

 

In March 2002, the EITFreached a consensus on Issue 02-7, “Unit of Accounting for Testing Impairmentof Indefinite-Lived Intangible Assets.” This issue addresses recording indefinite-lived intangible assets in asingle unit of accounting for purposes of testing impairment if they areoperated as a single asset.  Thisguidance became applicable immediately upon the initial application of SFAS 142in the first quarter of 2002. Management does not****expect the adoption of this Statement tohave a material impact on the Company’s financial condition or results ofoperations.

 

In August 2001, the FASBissued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-lived Assets” was issued, superseding SFAS 121,“Accounting for Long-lived Assets to be Disposed of.”  Among other things,SFAS 144 provides guidance on how long-lived assets used as part of a groupshould be evaluated for impairment, establishes criteria for when long-livedassets are held for sale, and prescribes the accounting for long-lived assetsthat will be disposed of other than by sale.  SFAS 144 is effective forfiscal years beginning after December 15, 2001.  The Company’s financialposition and results of operations have not been affected by the adoption ofSFAS 144.

 

In July 2002 the FASB issued SFAS 146, “Accounting forCosts Associated with Exit or Disposal Activities,” which addresses financialaccounting and reporting for costs associated with exit or disposal activities.SFAS 146 requires that a liability for a cost associated with an exit ordisposal activity be recognized when the liability is incurred. This Statementalso establishes that fair value is the objective for initial measurement ofthe liability.  Severance pay under SFAS146, in many cases, would be recognized over time rather than up front. Theprovisions of this Statement are effective for exit or disposal activities thatare initiated after December 31, 2002. Management does not expect the adoption of this Statement to have amaterial impact on the Company’s financial condition or results of operations.

 

In December 2002, the FASB issued SFAS 148,“Accounting for Stock-Based Compensation-Transition and Disclosure,” whichprovides alternative methods of transition for a voluntary change to fair valuebased method of accounting for stock-based employee compensation as prescribedin SFAS 123 “Accounting for Stock Based Compensation.” Additionally, SFAS 148requires more prominent and more frequent disclosures in financial statementsabout the effects of stock-based compensation. The provisions of this Statementare effective for fiscal years ending after December 15, 2002. Management doesnot expect the adoption of this Statement to have a material impact on theCompany’s financial condition or results of operations.

 

In November 2002, the FASB issued FASB interpretation(FIN) No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others.”  FIN No. 45 requires a guarantor torecognize, at the inception of a qualified guarantee, a liability for the fairvalue of the obligation undertaken in issuing the guarantee. FIN No. 45 iseffective on a prospective basis for qualified guarantees issued or modifiedafter December 31, 2002. Management does not expect adoption of thisInterpretation to have a material impact on the Company’s financial conditionor results of operations.

 

**ITEM7A.               QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

*Market RiskDisclosure*

 

The Company does not hold market risk-sensitivetrading instruments, nor does it use financial instruments for tradingpurposes.  All sales, operating itemsand balance sheet data are denominated in U.S. dollars; therefore, the Companyhas no foreign currency exchange rate risk.

 

In the ordinary course of its business the Companyenters into commitments to purchase raw materials over a period of time,generally six months to one year, at contracted prices.  At December 29, 2002 these futurecommitments were not at prices in excess of current market, or in quantities inexcess of normal requirements.  The Companydoes not utilize derivative contracts either to hedge existing risks or forspeculative purposes.

 

22

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*Interest Rate Risk*

 

TheCompany has fixed and variable income investments consisting of cashequivalents.  The magnitude of theinterest income generated by these cash equivalents is affected by marketinterest rates.  We do not usemarketable securities nor derivative financial instruments in our investmentportfolio.

 

The interest payable on the Company’s bank lineof credit is based on variable interest rates and therefore affected by changesin market interest rates.  The Companyhad no bank debt at the end of 2002 and has not had bank debt since the thirdquarter of 2000.

 

**ITEM8.                  FINANCIAL STATEMENTSAND SUPPLEMENTARY DATA**

 

The financial statementsand supplementary data of the Company required by this item are set forth atthe pages indicated at Item 14(a).

 

**ITEM 9.****     CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE**

 

None

 

##### **PART III**

 

**ITEM10.               DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT**

 

As of February 14, 2003,the directors, executive officers, and other significant employees of theCompany are as follows:

 

**Directors and Executive Officers:**

** **
| **Name**              |   | **Age** |   | **Position**                                                         |
|-----------------------|--------|---------|--------|----------------------------------------------------------------------|
| Charles B. Bonner     |   | 60      |   | Director                                                             |
|                  |   |    |   |                                                                 |
| F. Christopher Cruger |   | 68      |   | Director                                                             |
|                  |   |    |   |                                                                 |
| James M. Williams     |   | 53      |   | Chief Executive Officer, President officer President  and Director   |
|                  |   |    |   |                                                                 |
| R. Lance Hewitt       |   | 63      |   | Chairman of the Board  and Director                                  |
|                  |   |    |   |                                                                 |
| Michael P. Schall     |   | 49      |   | Director                                                             |
|                  |   |    |   |                                                                 |
| Van Tunstall          |   | 56      |   | Director                                                             |
|                  |   |    |   |                                                                 |
| James Wong            |   | 55      |   | Director                                                             |
|                  |   |    |   |                                                                 |
| Walter L Henning      |   | 58      |   | Director                                                             |
|                  |   |    |   |                                                                 |
| Stephen L. Brinkman   |   | 54      |   | Chief Financial Officer, Corporate Secretary  Secretary and Director |

 

23

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**Other significant employees:**

 
| **Name**         |   | **Age** |   | **Position**                                   |
|------------------|--------|---------|--------|------------------------------------------------|
| Lynn Port        |   | 58      |   | Plant Controller                               |
|             |   |    |   |                                           |
| Roy Scotton      |   | 43      |   | Director-Logistics                             |
|             |   |    |   |                                           |
| Dan Brown        |   | 43      |   | Plant Manager                                  |
|             |   |    |   |                                           |
| Ron Hendershott  |   | 52      |   | Director-Technical Services                    |
|             |   |    |   |                                           |
| Dan Engle        |   | 51      |   | Sales Manager-Central/Southeast Central Region |
|             |   |    |   |                                           |
| Rick Falkenberg  |   | 50      |   | Director-Quality Assurance                     |
|             |   |    |   |                                           |
| Clifford Farmer  |   | 46      |   | Natural Foods/DSD Sales Manager                |
|             |   |    |   |                                           |
| Lisa Player      |   | 42      |   | Sales Manager-East                             |
|             |   |    |   |                                           |
| Joseph Stirlacci |   | 42      |   | National Sales Manager                         |
|             |   |    |   |                                           |
| Philip Costello  |   | 43      |   | Sales Manager-West                             |
|             |   |    |   |                                           |
| Mary Howard      |   | 45      |   | Costco Account Manager                         |

 

Normally each director iselected for a period of one year and serves until the stockholders duly electhis or her successor.  Directors may beelected by the Board to fill a vacancy between annual stockholder meetingelections.  The principal occupations ofeach director and executive officer of the Company, for at least the past fiveyears, are as follows:

 

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

 

**F. Christopher Cruger, Director.**  Mr. Cruger was elected to the Board ofDirectors in December of 2001.  He is aretired investor and former senior manager or executive of several consumerproduct or food companies including Procter and Gamble, Quaker Oats, Sara Lee,Mrs. Smith’s Pies, Tone Brothers, Inc, and McCormick and Company.  He was President and CEO of Tone Brothersfrom 1985 to 1995.  Mr. Cruger joinedMcCormick and Company in 1995 and served for four years as Manger of the FoodService Division before retiring.  He isa Director of Kemin Industries, Inc, and The Graham Group, Inc.

 

**James M. Williams**, **President,Chief Executive Officer and Director. ** Mr. Williams joined the Company as PresidentOctober 1, 2002 and elected to the Board of Directors on October 29, 2002.  On January 3, 2002 he was promoted to ChiefExecutive Officer. Prior to his employment with the Company Mr. Williams servedthe prior 12 years as President and CEO of Bongrain Cheese-USA, a division ofthe French company Bongrain SA. Previously he held executive positions with the Hillshire Farms divisionof Sara Lee Corporation for twelve years.

 

**R. Lance Hewitt, President, ChiefExecutive Officer and Director.**  Mr. Hewitt joined the Company in June 1997 as President andDirector.  He was named Chief ExecutiveOfficer in August 1997.  He retired fromday-to-day activities and assumed the position of Chairman of the Board ofDirectors effective January 2, 2003. Mr. Hewitt was President of Carriage House Fruit Company from 1995 to1997.  He was Chief Operating Officer ofIngro Mexican Foods from 1988 to 1995. Hewitt also served as Vice President of Marketing and Sales for theLawry’s Foods division of Thomas J. Lipton, Inc., a subsidiary of Unilever, andspent fifteen years with McCormick Schilling, Inc., in various executivecapacities.

 

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

 

**Van Tunstall, Director. **Mr. Tunstall was electedto the Board of Directors****in February 1997.  Since 1997, he has served as President ofthe Central Coast Group, a strategic consulting and business servicesfirm.  He has been an independentconsultant

 

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with a variety of companies since 1997.  Mr. Tunstall was a senior executive with Gilroy Foods, Inc., aninternational manufacturer of various food product ingredients, from 1977 to1995.  He served as President andChairman of the Board from 1991 through 1995.  Previously, Mr. Tunstall held several executive positions with McCormick& Company, Inc.

 

**James Wong, Director.**  Mr. Wong was elected to the Board ofDirectors in March 1997.  Since March2000 Mr. Wong has served as CEO of Service Interactive, Inc., a service,maintenance, and consulting company for the food and hospitality industry. Heis also Chairman and Chief Executive Officer of Restaurant ConnectionsInternational, Inc., a company he co-founded in September 1998, which owns andoperates a chain of restaurants in Brazil. Since 1988 he has worked on five continents facilitating strategicalliances with suppliers and joint venture partners to improve global marketshare and profitability, as Chairman and CEO of Directions International, aU.S. based management consulting firm. Mr. Wong also serves as a Director of Nevada Gold and Casinos.

 

**Walter L. Henning, Director. **Mr. Henning was elected tothe 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 McCormickand Company in 1971 as Manager, Technical Services.  He subsequently was promoted several times to other positions intechnical and plant management before leaving the company in 1983 to accept theposition of Vice President of Operations with Tone Spices.  Following the sale of Tone, Mr. Henningreturned to a subsidiary of McCormick and Company, Gilroy Foods, Inc. in 1995as Vice President of Operations.  Mr.Henning remained with Gilroy Foods, Inc. in the same capacity after it waspurchased by ConAgra in 1996, before ultimately returning to McCormick &Company in 1999.

 

**Stephen L. Brinkman, Chief FinancialOfficer, Corporate Secretary, and Director. **Mr. Brinkman joined the Company in August, 1997 aftera 17 year career with Gilroy Foods, Inc., where he was Controller from 1984through 1988 and Vice President, Finance and Administration from 1989 through1996.   Previously, he was Controllerfor a large California-based farming company, and worked for Security PacificBank in agricultural banking.  Mr.Brinkman was elected to the Board in October 1999.

 

Below are principaloccupations of certain other significant employees of the Company, for at leastthe past five years.

 

**Lynn Port, Plant Controller. **Mr. Port came to theCompany in January 1998.  He has over 24years experience as a controller in agribusiness, retail, government and healthcare concerns, most recently with Country Home Care from 1995 through1997.  From 1989 to 1995 Mr. Port wasDirector of Finance for the Monterey County Housing Authority.  Prior to 1989, Mr. Port served for four yearsas Controller for Gilroy Canning, Inc., a large tomato processing company.

 

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

 

**Dan Brown, Director ofOperations. **Mr. Brownjoined the Company as Director of Operations in May 2001.  Prior to that, Mr. Brown was with GilroyFoods, Inc, and its successor Gilroy Foods (under new ownership) from 1986until 2001 where he served in a variety of technical and operations positions,ultimately being promoted to Manager of Plant Operations in 1997.  He also served as a Logistics Supervisorwith Frito Lay from 1984-86.

 

**Ron Hendershott, Director-TechnicalServices**.  Mr.Hendershott joined the Company in May 1995 as Quality Control Manager.  He was promoted to his current position inMarch 1998. Mr. Hendershott has over 25 years of managerial experience inQuality Control/Quality Assurance, technical services, and regulatoryaffairs.  Prior to joining Monterey Pastahe was with La Victoria Foods as Director of Quality Control from 1993 through1995 after spending two years with Weight Watchers as Manager of TechnicalSupport Services.   He also servedAmerican Home Foods for seven years as Regulatory Affairs Manager.

 

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

 

**Rick Falkenberg, Director-Quality Assurance. **Dr. Falkenberg joined the Company in December 2000 to further strengthenthe Quality Assurance efforts of the Company with 25 years of food processingbackground.  During his career, he

 

25

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worked his way up the chain of responsibilitiesfrom plant sanitarian, QA lab manager, QA divisional manager and then Directorof Quality and Technical Services.  From1998 to 2000, Dr. Falkenberg was the Director of Quality and Technical Servicesfor Basic Vegetable Products, a large industrial ingredient supplier.  Prior to that he ran his own InternationalBusiness Development Company for three years. From 1993-1996 he was the Corporate Manager of Regulatory Affairs forCadbury Beverages, following a three-year stay with Gilroy Foods, Inc. as QualityAssurance Manager.

 

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

 

**Lisa Player, Sales Manager-East. **Ms. Player joined theCompany in the capacity of Eastern Zone Sales Manager and Sam’s Club storesAccount Manager in March 1998 after spending a year as Corporate Sales AccountExecutive with FTP Travel Management Group, a large regional corporate travelmanagement company.  Prior to that shewas employed for over five years by Trio’s Pasta Products of Chelsea,Massachusetts, a competitor of the Company, ultimately as National AccountSales Manager.  During her tenure withTrio’s, Ms. Player was responsible for the Sam’s Club account (which, after hertenure with Trio’s, was acquired by the Company in September, 1997).

 

**Philip Costello, SalesManager-West.  **Mr.Costello joined the Company in February 2001 as Sales Manager-West. After 23years food sales experience with retail grocery chains, and brokeragefirms.  He also held a variety of salespositions with General Mills from 1985-1996. From 1996 to 2001 he worked with brokerage firms as Business Manager orTeam Manager for the Minute Maid Company account.  His retail grocery experience included five years with Save-Mart,and two years with Safeway Stores working at the store level.

 

**Joseph Stirlacci, National SalesManager.**  Mr.Stirlacci served as Western Zone Manager since December 1995 until December1999 when he was promoted to Senior Sales Manager-West.  In January 2001 he was promoted to NationalSales Manger.  His primaryresponsibility is to manage, maintain and secure club store and retail accounts.  Mr. Stirlacci has been in the food andbeverage industry since 1981, serving seven years with Young’s Market managingwholesale liquor and wine from 1988 to 1995, after six years as the accountexecutive for four large grocery chains.

 

**Mary Howard, Costco AccountManager. **Ms. Howardjoined theCompany in July 2002**. **Previously,for the past ten years, she was Costco Account Manager for Tyson Foods.  She also served for nearly five years asMerchandising/Marketing Coodinator for the Shanghai/Contessa product linesmarketed by ZB Industries with a specialty in food service and club sales.

 

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

 

Section 16(a) of theSecurities Exchange Act of 1934, as amended, requires the Company’s directorsand executive officers, and persons who own more than 10% of a registered classof the Company’s equity securities, to file with the SEC initial reports ofownership and reports of changes in ownership of Common Stock and other equitysecurities of the Company.  Officers,directors and greater than 10% beneficial owners are required by SECregulations to furnish the Company with copies of all reports they file underSection 16(a).  To the Company’sknowledge, based solely on its review of the copies of such reports furnishedto the Company and written representations that no other reports were required,all Section 16(a) filing requirements applicable to its officers, directors andgreater than 10% beneficial owners were complied with during the fiscal yearended December 29, 2002, with the exception that there was one incident of latefiling of Forms 4 for Messrs. Bonner, Cruger, Schall, Henning, andBrinkman.  Mr. William’s Form 3 was alsofiled tardy.

 

**ITEM11.               EXECUTIVE COMPENSATION**

** **

**SUMMARY COMPENSATION TABLE**

** **
|                              |   | **Annual  Compensation** |   | **Long Term  Compensation** |    |
|-----------------------------------|--------|--------------------------|--------|-----------------------------|---------|
| **Name and   Principal Position** |   | **Year**                 |   | **Salary $**                |    | **Bonus $** |   | **Other $** |   | **Securities  Underlying  Options (#)** |   | **All  Other $** |   |
| **R. Lance Hewitt**               |   | 2002                     |   | $                           | 215,513 | (1) | $ | 49,785 |   | $ | 9,375 | (1) | — | (1) | $ | — |   |
| President and  Chief              |   | 2001                     |   | $                           | 200,477 | (1) | $ | 94,949 |   | $ | 9,000 | (1) | 80,000 | (1) | $ | — |   |
| Executive  Officer                |   | 2000                     |   | $                           | 189,899 | (1) | $ | 89,923 |   | $ | 9,000 | (1) | 160,000 | (1) | $ | — |   |
|                              |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
| **James M. Williams**             |   | 2002                     |   | $                           | 60,231  | (2) | $ | — |   | $ | 2,250 | (2) | 50,000 | (2) | $ | 67,030 | (2) |
| President and  CEO                |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
|                              |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
| **Stephen L. Brinkman**           |   | 2002                     |   | $                           | 154,699 | (3) | $ | 41,371 |   | $ | — |   | 30,000 | (2) | $ | — |   |
| Chief Financial  Officer          |   | 2001                     |   | $                           | 140,884 | (3) | $ | 39,700 |   | $ | — |   | 60,000 | (2) | $ | — |   |
|                              |   | 2000                     |   | $                           | 132,333 | (3) | $ | 23,319 |   | $ | — |   | 60,000 | (2) | $ | — |   |

 

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

 

(1)           Mr. Hewitt wasappointed President in June 1997 and Chief Executive Officer in August 1997. Heretired from day-to-day activities and assumed the position of Chairman of theBoard of Directors effective January 2, 2003. Mr. Hewitt was eligible for a 35% bonus upon completing his first fullyear of employment in 1998.  For everyyear thereafter he was eligible for a bonus of up to a maximum of 35% of hissalary annually for achieving agreed-upon income targets, as approved by theBoard of Directors, and an additional 25% of his salary for achieving certainspecific objectives for each fiscal period. He was eligible to vest and vested 50,000 options in each of 1998 and1999, because he was still employed by the Company on both the first and secondanniversaries of his May 26, 1997 employment agreement.  Mr. Hewitt was also eligible to receive, atthe discretion of the Board of Directors, an additional 200,000 options duringthe first two years of employment split as follows: 120,000 for achievingagreed-upon business goals in the first year and 80,000 for achieving businessgoals in the second year. The cycle for measurement of Mr. Hewitt’s eligibilityfor bonus, and those options tied to performance, was converted to a fiscalyear basis during the fourth quarter of 1998 by resolution of the board ofDirectors at its October 22, 1998 meeting. At its February 9, 1999 Board of Directors meeting, the directorsawarded 32,000 options to Mr. Hewitt for performance in his first full year ofemployment through fiscal year-end 1998, based on the new measurementcycle.  The determination for theremainder of the options was made subsequent to 1999 fiscal year-end when Mr.Hewitt was awarded an additional 80,000 options which vested as of February 10,2000.  In May 1999 Mr. Hewitt wasgranted an additional 80,000 options based on milestones for the year 2000;27,000 vested since he was still employed by the Company on December 30, 2000,and 53,000 vested in 2001 based on achievement of performance objectivesmutually agreed upon with the Board. During its February 2000 Board of Directors meeting the Board awardedMr. Hewitt a 50% bonus for his 1999 performance.  On February 29, 2000, Mr. Hewitt was granted an additional 80,000options based on milestones for the year 2001; 27,000 vested because he wasstill employed by the Company on December 30, 2001.  Of the remaining 53,000 options, 48,300 vested in 2002 based onachievement of performance objectives for 2001, mutually agreed upon with theBoard, while 5,700 were forfeit.  OnOctober 29, 2001 Mr. Hewitt was granted 80,000 options which vested December29, 2002 because he was still employed by the Company.  Mr. Hewitt also received an auto allowanceof $750 per month, which is included in “Other $.”

 

(2)           Mr. Williams wasappointed President October 1, 2002.  OnDecember 28, 2002 has was promoted to Chief Executive Officer to succeed Mr.Hewitt who retired from day-today activities and accepted the position andaccepted the non-operating executive position of Chairman of the Board ofDirectors.  Mr. Williams was granted50,000 options which will vest if he is still employed by the Company October1, 2003.  He was eligible to receive aprorated quarterly bonus of up to one-fourth of 50% of his base salary based onthe achievement of certain sales and net income goals for the fourth quarter of2002.  He received no bonus, as thefourth quarter results did not meet the criteria for bonus award.  He is also eligible to receive a bonus of upto 50% of his annual salary based on the achievement of certain sales growthand net income goals for 2003.  Theportion of Mr. Williams’ compensation listed as “All Other $” was relocationexpense reimbursement. Mr. Hewitt also received an auto allowance of $750 permonth, which is included in “Other $.”

 

(3)           Mr. Brinkman wasappointed Chief Financial Officer in September 1997.  He was eligible for, and received, a 20% bonus based uponperformance upon completion of his first full year of employment in 1998.  For every year thereafter he is eligible fora bonus of up to 20% based upon the achievement of performance criteria agreedupon with the Chief Executive Officer. Mr. Brinkman was granted 60,000 options in 1997.  He vested 10,000 options upon his initialemployment date, 10,000 options on his first anniversary and 10,000 options forachieving certain performance criteria in his first full year ofemployment.  In addition, he waseligible to vest and vested 10,000 options on his second anniversary ofemployment, 10,000 options for achieving certain performance criteria in hissecond full year of employment, 5,000 options on his third anniversary ofemployment and 5,000 options for achieving certain performance criteria in histhird full year of employment.  Thecycle for measurement of Mr. Brinkman’s eligibility for bonus, and thoseoptions tied to performance, was converted to a fiscal year basis during thefourth quarter of 1998 at the direction of the Chief Executive Officer.  He vested 3,000 options for performancethrough fiscal year-end 1998, based on the new measurement cycle.  The vesting determination for the remainderof the options was made subsequent to 1999 fiscal year-end, at which time Mr.Brinkman vested an additional 6,666 options, with 334 forfeited based on 1998performance criteria.  In February 2000Mr. Brinkman was awarded an 18.8% bonus for his 1999 performance.  In May 1999, Mr. Brinkman was granted anadditional 60,000 options based on

 

27

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milestones for the year 2000; 20,000 vested since he was still employedby the Company on August 25, 2000, and 40,000 vested in 2001 based onachievement of performance objectives mutually agreed upon with the CEO.  On February 29, 2000, Mr. Brinkman wasgranted an additional 60,000 options based on milestones for the year 2001;20,000 vested because he was still employed by the Company on August 25, 2001.Of the remaining 53,000 options, 36,000 vested in 2002 based on achievement ofperformance objectives for 2001, mutually agreed upon with the Board, while4,000 were forfeit. On October 29, 2001 Mr. Brinkman was granted 60,000 optionswhich vested December 29, 2002 because he was still employed by theCompany.  On October 29, 2002 Mr.Brinkman was granted 30,000 options which will vest December 28, 2003 if he isstill employed by the Company.

 

**Option Grantsin Last fiscal Year**

 

The Board granted 30,000options to Mr. Brinkman and 50,000 options to Mr. Williams for the year 2002which will vest based on employment status (see Notes 1 and 2 under “ExecutiveCompensation”).  Mr. Hewitt exercisedand sold the underlying shares for 110,215 options during 2001.  Mr. Brinkman exercised and sold theunderlying shares for 15,000 options during 2001.

** **

**Individual Grants**

** **
| **Name**             |   | **Number of  Securities  Underlying  Options  Granted** |   | **% of Total  Options  Granted to  Employees  In 2002** |   | **Exercise  Or Base  Price** |   | **Expiration  Date** |               | **Potential  Realizable Value  On 12/29/02  Alternative Grant Date  Value** |   |
|----------------------|--------|---------------------------------------------------------|--------|---------------------------------------------------------|--------|------------------------------|--------|----------------------|--------------------|-----------------------------------------------------------------------------|--------|
|                 |   |                                                    |   |                                                    |   |                         |   |                 |               |                                                                        |   |
| James M.  Williams   |   | 50,000                                                  |   | 12.48                                                   |   | $                            | 5.20   |                 | September 30, 2012 |                                                                        | $      | 130,005 |   |
|                 |   |                                                    |   |                                                    |   |                         |   |                 |               |                                                                        |   |
| Stephen L.  Brinkman |   | 30,000                                                  |   | 7.48                                                    |   | $                            | 6.05   |                 | October 28, 2012   |                                                                        | $      | 91,782 |   |

 

The AlternativeGrant-Date Value of Mr. Williams and Mr. Brinkman’s options was calculatedusing a Black-Scholes option pricing model assuming no dividends, a weightedaverage risk-free interest rate of 5.69% and a weighted-average volatility of54.80%.

 

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

 
|                |   | **# of  Securities  Underlying  Options Exercised During 2001** |            | **Number of  Securities Underlying  Unexercised Options at  December 29, 2002** |              | **Value of  Unexercised  In-the-Money Options at  December 30, 2001** |            |
|---------------------|--------|-----------------------------------------------------------------|-----------------|---------------------------------------------------------------------------------|-------------------|-----------------------------------------------------------------------|-----------------|
| **Name**            |   |                                                            | **Exercisable** |                                                                            | **Unexercisable** |                                                                  | **Exercisable** |   | **Unexercisable** |   |
|                |   |                                                            |            |                                                                            |              |                                                                  |            |   |   |   |   |
| R. Lance Hewitt     |   | 110,215                                                         |            | 216,485                                                                         |              | —                                                                |            | $ | 120,328 |   | — |   |
|                |   |                                                            |            |                                                                            |              |                                                                  |            |   |   |   |   |
| Stephen L. Brinkman |   | 15,000                                                          |            | 220,666                                                                         |              | 30,000                                                                |            | $ | 206,474 |   | — |   |

 

**EmploymentContracts**

 

Mr. Brinkman has anemployment agreement, the terms of which are outlined under “ExecutiveCompensation.”

 

**ITEM 12.****                                              SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The****table below sets forth as ofFebruary 10, 2003 (except as noted in the footnotes to the table), certaininformation with respect to the beneficial ownership of the Company’s CommonStock by (i) all persons known by the Company to be the beneficial owners ofmore than 5% of the outstanding Common Stock of the Company, (ii) each directorand director-nominee of the Company, (iii) the Chief Executive Officer as ofFebruary 10, 2003, and (iv) all executive officers and directors of the Companyfor fiscal year 2001 through****February 8, 2003, as a group.

 

28

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|                                                                                        |   | **Shares  Owned**     |   |
|---------------------------------------------------------------------------------------------|--------|-----------------------|--------|
| **Name and  Address of Beneficial Owner (1)**                                               |   | **Number of  Shares** |   | **Percentage  of Class** |   |
| Gruber  and McBaine Capital Management(2)  Osgood Place, Penthouse  San Francisco, CA 94133 |   | 2,472,400             |   | 16.0 | % |
| Fidelity  Investments(3)  82 Devonshire Street  Boston, MA 02109                            |   | 1,377,300             |   | 8.9 | % |
| T Rowe Price  Associates, Inc.(4)   100 East Pratt Street   Baltimore, MD 21202             |   | 949,700               |   | 6.1 | % |
| Wellington  Management Company, LLP(5)   75 State Street 19th Floor   Boston, MA 02109      |   | 1,035,000             |   | 6.7 | % |
| F. Christopher  Cruger(6)                                                                   |   | 12,500                |   |   | * |
| Van Tunstall(7)                                                                             |   | 83,740                |   |   | * |
| Michael P.  Schall(8)                                                                       |   | 10,500                |   |   | * |
| James Wong(9)                                                                               |   | 42,500                |   |   | * |
| R. Lance  Hewitt(10)                                                                        |   | 231,485               |   | 1.5 | % |
| Charles B.  Bonner(11)                                                                      |   | 126,227               |   |   | * |
| Stephen L.  Brinkman(12)                                                                    |   | 238,666               |   | 1.5 | % |
| Walter L.  Henning(13)                                                                      |   | 61,200                |   |   | * |
| All Officers and  Directors as a group (8 persons)(14)                                      |   | 806,818               |   | 5.2 | % |

 

----

* Represents less than 1%

 

(1)               Beneficialownership is determined in accordance with the rules of the Securities andExchange Commission.  In computing thenumber of shares beneficially owned by a person and the percentage ownership ofthat person, shares of Common Stock subject to options or warrants held by thatperson that are currently exercisable or will become exercisable within sixty(60) days after February 10, 2003 are deemed outstanding, while such shares arenot deemed outstanding for purposes of computing percentage ownership of anyother person.  Options granted under theCompany’s First Amended and Restated 1993 Stock Option Plan (the “1993 StockOption Plan”) generally become exercisable as the underlying shares vest.  Unless otherwise indicated in the footnotesbelow, the persons and entities named in the table have sole voting andinvestment power with respect to all shares beneficially owned, subject tocommunity property laws where applicable. Unless otherwise indicated, the address of each of the individualslisted in the table is: c/o Monterey Pasta Company, 1528 Moffett Street,Salinas, CA  93905.

 

(2)              Jon D. Gruber and J.Patterson McBaine are the only directors of, and hold all executive offices of,Gruber and McBaine Capital Management (“GMCM”), an investment advisor.  GMCM, together with Messrs. Gruber, McBaine,and Eric B. Swergold are the general partners of Lagunitas Partners, L.P.(“Lag”), a California investment limited partnership.  As of February 10, 2003, GMCM had shared voting and investmentpower over 1,928,800 shares; Mr. Gruber has sole voting and investment powerover 272,000 shares and shared voting and investment power over 1,928,800shares; Mr. McBaine has sole voting and investment power over 271,600 sharesand shared voting and investment power over 1,928,800 shares; Lag has solevoting and investment power over 1,000,600 shares; and Mr. Butler and Mr.Swergold have shared voting and investment power over 1,928,800 shares.

 

(3)              As of February 10,2003, FMR Corp. on behalf of certain of its direct and indirect subsidiaries,and Fidelity International Limited on behalf of certain of its direct andindirect subsidiaries (collectively “Fidelity”), indirectly held 1,377,300shares of Company stock. The beneficial ownership of PSTA shares arises in thecontext of passive investment activities only by the various investmentaccounts managed by Fidelity on a discretionary basis (the “FidelityAccounts”). Neither Fidelity nor the Fidelity Accounts participate in theManagement of the Company, direct the policies of the company, or serve on theBoard of Directors of the Company. In addition, no Fidelity officer serves asan executive officer of the Company.

 

(4)              T. Rowe PriceAssociates, Inc (“Price Associates”) has sole dispositive power for the entireholding of 949,700 shares and sole voting power over 220,200 shares.  These securities are owned by variousindividual and institutional investors for which Price Associates serves asinvestment advisor with power to direct investments and/or sole power to votethe securities.  For purposes of thereporting requirements of the Securities Exchange Act of 1934, Price Associatesexpressly disclaims that it is, in fact, the beneficial owner of suchsecurities.

 

29

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(5)              As of December 31,2002, Wellington Management  Company,LLP (“WMC”), in its capacity of investment advisor, may be deemed to havebeneficial ownership of 1,035,000 shares of the common stock of theCompany.  Such shares are owned bynumerous investment advisory clients of WMC, none of which is known to havebeneficial ownership of more than 5% of that class of securities of theCompany.  As of December 31, 2003, WMChad voting power and/or dispositive power over such shares as follows:

| Sole voting power:        | — 0 — |   | shares |
|---------------------------|-----------------|--------|--------|
| Shared voting power:      | 635,000         |   | shares |
| Sole dispositive power:   | — 0 — |   | shares |
| Shared dispositive power: | 1,035,000       |   | shares |

 

(6)              Includes 7,500shares subject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

(7)              Includes 67,500shares subject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

(8)              Includes 7,500shares subject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

(9)              Includes 37,500shares subject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

(10)        Includes 216,485 sharessubject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

(11)        Includes 72,500 sharessubject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

(12)        Includes 220,666 sharessubject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

(13)        Includes 6,200 shares heldin an IRA account in the name of Teresa A. Henning to which Mr. Henning claimsbeneficial ownership, and 32,500 shares subject to options granted under the1993 Stock Option Plan which are exercisable within sixty (60) days of February10, 2003.

 

(14)        Includes 662,151 sharessubject to options granted under the 1993 Stock Option Plan which areexercisable within sixty (60) days of February 10, 2003.

 

**ITEM13.               CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS**

 

During the first quarter of2002 the Company acquired certain recipes and a non-registered trademark from aformer director, shareholder and plant manager for a $100,000 cashconsideration and an ongoing royalty agreement.

##### ** **

##### **PART IV**

 

**ITEM14.               EXHIBITS, FINANCIALSTATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

 
| (a)(1) | Consolidated Financial Statements of Monterey Pasta  Company:                                                                                                            |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                     |
|   | Report  of Independent Certified Public Accountants                                                                                                                      |
|   | Consolidated Balance  Sheets: Year-End 2001 and 2002                                                                                                                     |
|   | Consolidated Income  Statements: Years Ended 2000, 2001 and 2002                                                                                                         |
|   | Consolidated  Statements of Stockholders’ Equity: Years Ended 2000, 2001 and 2002                                                                                   |
|   | Consolidated  Statements of Cash Flows:  Years Ended  2000, 2001 and 2002                                                                                           |
|   | Summary of  Significant Accounting Policies                                                                                                                              |
|   | Notes to  Consolidated Financial Statements                                                                                                                              |
|   | Schedule II - Valuation and Qualifying  Accounts                                                                                                                         |
|   |                                                                                                                                                                     |
|   | All other schedules have been omitted since the  required information is contained in the  Consolidated Financial Statements or because such schedules are not required. |

 

30

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(a)(2)       Exhibits:  See Index to Exhibits on page 56.  The Exhibits listed in the accompanyingIndex of Exhibits are filed or incorporated by reference as part of thisreport.  Exhibit Nos. 4.7, 10.1, 10.2,10.12, 10.13, 10.15, and 10.16**** are management contracts or compensatory plans or arrangements.

 

(b)           Reports on Form 8-Kfiled in the fourth quarter of 2002:

 

None

 

**DISCLOSURE CONTROLS AND PROCEDURES**

 

Under the supervision and with the participation ofour management, including our principal executive officer and principalfinancial officer, we conducted an evaluation of our disclosure controls andprocedures, as such term is defined under Rule 13a-14(c) promulgated under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), within 90days of the filing date of this report. Based on their evaluation, ourprincipal executive officer and principal financial officer concluded that ourdisclosure controls and procedures are effective.

 

There have been nosignificant changes (including corrective actions with regard to significantdeficiencies or material weaknesses) in our internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof the evaluation referenced in the paragraph above.

 

31

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**REPORTOF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS**

 

 

To the Stockholders and Board of Directors of

Monterey Pasta Company

 

 

We have audited the accompanying consolidated balance sheets ofMonterey Pasta Company and subsidiary as of December 30, 2001 and December 29,2002 and the related consolidated statements of income, stockholders’ equityand cash flows for each of the three years in the period ended December 29,2002. We have also audited the schedule listed in the accompanying index atItem 14(a).  These financial statementsand the schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements and the schedule based on our audits.

 

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

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of MontereyPasta Company and subsidiary at December 30, 2001 and December 29, 2002, andthe results of its operations and its cash flows for each of the three years inthe period ended December 29, 2002, in conformity with accounting principlesgenerally accepted in the United States of America.

 

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

 

 

BDO Seidman, LLP

San Francisco, California

January 31, 2003

 

32

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**MONTEREY PASTA COMPANY**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                                               |   | **December  30, 2001** |       | **December  29, 2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|------------|------------------------|--------|
| **ASSETS**                                                                                                                                         |   |                   |       |                   |   |
| Current assets:                                                                                                                                    |   |                   |       |                   |   |
| Cash and cash  equivalents (Note 1)                                                                                                                |   | $                      | 7,232,128  |                   | $      | 6,838,244 |   |
| Accounts  receivable, less allowances of $305,483 and $527,349 (Notes 1, 4 and 11)                                                                 |   | 6,025,323              |       | 6,058,710              |   |
| Inventories  (Notes 2 and 4)                                                                                                                       |   | 3,113,679              |       | 3,723,072              |   |
| Deferred tax  assets – short term (Note 8)                                                                                                    |   | 1,021,800              |       | 4,068,400              |   |
| Prepaid expenses  and other (Note 10)                                                                                                              |   | 1,139,042              |       | 1,048,120              |   |
| Total current  assets                                                                                                                              |   | 18,531,972             |       | 21,736,546             |   |
|                                                                                                                                               |   |                   |       |                   |   |
| Property and  equipment, net  (Notes 3 and 4)                                                                                                 |   | 11,036,044             |       | 14,254,574             |   |
| Deferred tax  assets – long term (Note 8)                                                                                                     |   | 553,700                |       | 765,300                |   |
| Goodwill, net  (Note 15)                                                                                                                           |   | 1,315,931              |       | 4,669,254              |   |
| Other intangible  assets, net (Note 15)                                                                                                            |   | 56,908                 |       | 2,239,113              |   |
| Deposits and  other                                                                                                                                |   | 101,270                |       | 134,694                |   |
| Total assets                                                                                                                                       |   | $                      | 31,595,825 |                   | $      | 43,799,481 |   |
|                                                                                                                                               |   |                   |       |                   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                     |   |                   |       |                   |   |
| Current  liabilities:                                                                                                                              |   |                   |       |                   |   |
| Accounts payable                                                                                                                                   |   | $                      | 1,613,090  |                   | $      | 3,201,470 |   |
| Accrued payroll  and related benefits                                                                                                              |   | 610,086                |       | 843,422                |   |
| Accrued  liabilities (Note 13)                                                                                                                     |   | 1,343,054              |       | 796,496                |   |
| Current portion  of notes, loans, and capitalized leases payable (Notes 3 and 4)                                                                   |   | 32,008                 |       | 14,964                 |   |
| Total current  liabilities                                                                                                                         |   | 3,598,238              |       | 4,856,352              |   |
|                                                                                                                                               |   |                   |       |                   |   |
| Notes, loans,  and capitalized leases payable, less current portion (Notes 3 and 4)                                                                |   | 16,749                 |       | 1,785                  |   |
| Total  liabilities                                                                                                                                 |   | 3,614,987              |       | 4,858,137              |   |
|                                                                                                                                               |   |                   |       |                   |   |
| Commitments and  contingencies (Notes 5, 9, 11, 13, and 16)                                                                                        |   |                   |       |                   |   |
|                                                                                                                                               |   |                   |       |                   |   |
| Stockholders’  equity (Notes 6, 7, 8 and 15):  Common stock, $.001 par value, 70,000,000 shares authorized, 13,766,692 and  14,196,391 issued |   | 13,767                 |       | 14,196                 |   |
| Additional paid-in  capital                                                                                                                        |   | 43,049,983             |       | 44,518,855             |   |
| Accumulated  deficit                                                                                                                               |   | (15,082,912            | )          | (5,591,707             | )      |
|                                                                                                                                               |   |                   |       |                   |   |
| Total  stockholders’ equity                                                                                                                   |   | 27,980,838             |       | 38,941,344             |   |
|                                                                                                                                               |   |                   |       |                   |   |
| Total  liabilities and stockholders’ equity                                                                                                   |   | $                      | 31,595,825 |                   | $      | 43,799,481 |   |

 

See accompanyingsummary of significant accounting policies and notes to consolidated financialstatements

 

33

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**MONTEREY PASTA COMPANY**

**CONSOLIDATEDSTATEMENTS OF INCOME**

 
|                                                      |   | **Years  Ended** |       |
|-----------------------------------------------------------|--------|------------------|------------|
|                                                      |   | **2000**         |       | **2001** |   | **2002** |   |
|                                                      |   |             |       |   |   |   |   |
| Net revenues  (Notes 10 and 11)                           |   | $                | 46,089,355 |   | $ | 56,986,912 |   | $ | 61,678,747 |   |
|                                                      |   |             |       |   |   |   |   |
| Cost of sales                                             |   | 29,474,723       |       | 36,469,186 |   | 39,417,027 |   |
|                                                      |   |             | ** ** |   | ** ** |   | ** ** |
| Gross profit                                              |   | 16,614,632       |       | 20,517,726 |   | 22,261,720 |   |
|                                                      |   |             | ** ** |   | ** ** |   | ** ** |
| Selling, general  and administrative (Notes 5, 10 and 13) |   | 10,493,612       |       | 13,281,791 |   | 15,653,711 |   |
| Operating income                                          |   | 6,121,020        |       | 7,235,935 |   | 6,608,009 |   |
|                                                      |   |             | ** ** |   | ** ** |   | ** ** |
| Gain (loss) on  disposition of assets                     |   | (37,421          | )          | 20,330 |   | (67,880 | ) |
| Other income  (expense), net                              |   | (11,260          | )          | 1,278 |   | 2,566 |   |
| Interest income  (expense), net (Note 4)                  |   | (40,338          | )          | 107,779 |   | 110,190 |   |
|                                                      |   |             | ** ** |   | ** ** |   | ** ** |
| Income before  provision for income taxes                 |   | 6,032,001        |       | 7,365,322 |   | 6,652,885 |   |
|                                                      |   |             | ** ** |   | ** ** |   | ** ** |
| Income tax  benefit (provision)  (Note 8)            |   | 109,100          |       | (2,936,332 | ) | 2,838,320 |   |
|                                                      |   |             | ** ** |   | ** ** |   | ** ** |
| Net income                                                |   | $                | 6,141,101  |   | $ | 4,428,990 |   | $ | 9,491,205 |   |
|                                                      |   |             |       |   |   |   |   |
| Net income per  common share (Notes 6 and 14):            |   |             | ** ** |   | ** ** |   | ** ** |
| Basic income per  common share                            |   | $                | 0.46       |   | $ | 0.33 |   | $ | 0.68 |   |
|                                                      |   |             |       |   |   |   |   |
| Diluted income  per common share                          |   | $                | 0.44       |   | $ | 0.31 |   | $ | 0.65 |   |
|                                                      |   |             | ** ** |   | ** ** |   | ** ** |
| Basic shares  outstanding                                 |   | 13,222,062       |       | 13,491,177 |   | 14,039,902 |   |
| Diluted shares  outstanding                               |   | 13,835,384       |       | 14,254,248 |   | 14,664,762 |   |

 

See accompanyingsummary of significant accounting policies and notes to consolidated financialstatements

 

34

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**MONTEREY PASTA COMPANY**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**FOR THE YEARS ENDED 2000, 2001, and 2002**

 
|                                                         |   | **Common  Stock** |   | **Additional  Paid-in Capital** |   | **Accumulated  Deficit** |   | **Total**   |   |
|--------------------------------------------------------------|--------|-------------------|--------|---------------------------------|--------|--------------------------|--------|-------------|--------|
| **Shares**                                                   |   | **Amount**        |
| See Notes 6, 7, 8 and 15                                     |   |              |   |                            |   |                     |   |        |   |   |   |
| Balance, end of  1999                                        |   | 12,938,922        |   | $                               | 12,939 |                     | $      | 40,249,640  |   | $ | (25,653,003 | ) | $ | 14,609,576 |   |
| Issuance of  common stock under Employee Stock Purchase Plan |   | 3,006             |   | 3                               |   | 4,138                    |   | —      |   | 4,141 |   |
| Issuance of common  stock in net warrant exercise            |   | 152,839           |   | 153                             |   | (153                     | )      | —      |   | — |   |
| Exercise of  warrants for cash                               |   | 115,950           |   | 116                             |   | 260,772                  |   | —      |   | 260,888 |   |
| Exercise of  stock options for cash                          |   | 102,304           |   | 102                             |   | 163,301                  |   | —      |   | 163,403 |   |
| Net settlement  from investor 16(b) violation                |   | —            |   | —                          |   | 274,453                  |   | —      |   | 274,453 |   |
| Tax benefit of  disqualifying dispositions                   |   | —            |   | —                          |   | 117,400                  |   | —      |   | 117,400 |   |
| Stock-based  compensation                                    |   | —            |   | —                          |   | 92,480                   |   | —      |   | 92,480 |   |
| Net income for  the year                                     |   | —            |   | —                          |   | —                   |   | 6,141,101   |   | 6,141,101 |   |
| Balance, end of  2000                                        |   | 13,313,021        |   | 13,313                          |   | 41,162,031               |   | (19,511,902 | )      | 21,663,442 |   |
| Issuance of  common stock under Employee Stock Purchase Plan |   | 5,875             |   | 6                               |   | 19,824                   |   | —      |   | 19,830 |   |
| Issuance of  common stock in net warrant exercise            |   | 523               |   | 1                               |   | (1                       | )      | —      |   | — |   |
| Exercise of  stock options for cash                          |   | 447,273           |   | 447                             |   | 968,862                  |   | —      |   | 969,309 |   |
| Net settlement  from investor 16(b) violation                |   | —            |   | —                          |   | 14,299                   |   | —      |   | 14,299 |   |
| Tax benefit of  disqualifying dispositions                   |   | —            |   | —                          |   | 562,200                  |   | —      |   | 562,200 |   |
| Stock-based  compensation                                    |   | —            |   | —                          |   | 322,768                  |   | —      |   | 322,768 |   |
| Net income for  the year                                     |   | —            |   | —                          |   | —                   |   | 4,428,990   |   | 4,428,990 |   |
| Balance, end of  2001                                        |   | 13,766,692        |   | 13,767                          |   | 43,049,983               |   | (15,082,912 | )      | 27,980,838 |   |
| Issuance of  common stock under Employee Stock Purchase Plan |   | 7,670             |   | 8                               |   | 35,812                   |   | —      |   | 35,820 |   |
| Issuance of  common stock in net warrant exercise            |   | 47,414            |   | 47                              |   | (47                      | )      | —      |   | — |   |
| Exercise of  stock options for cash                          |   | 374,615           |   | 375                             |   | 953,180                  |   | —      |   | 953,555 |   |
| Net settlement  from investor 16(b) violation                |   | —            |   | —                          |   | (4,154                   | )      | —      |   | (4,154 | ) |
| Tax benefit of  disqualifying dispositions                   |   | —            |   | —                          |   | 484,080                  |   | —      |   | 484,080 |   |
| Net income for  the year                                     |   | —            |   | —                          |   | —                   |   | 9,491,205   |   | 9,491,205 |   |
| Balance, end of  2002                                        |   | 14,196,391        |   | $                               | 14,196 |                     | $      | 44,518,855  |   | $ | (5,591,707 | ) | $ | 38,941,344 |   |

 

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

 

35

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**MONTEREY PASTA COMPANY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                               |   | **Years Ended** |      |
|------------------------------------------------------------------------------------|--------|-----------------|-----------|
|                                                                               |   | **2000**        |      | **2001** |   | **2002** |   |
| See  Note 12 - Supplemental Cash Flow Information                                  |   |            |      |   |   |   |   |
| Cash flows from operating  activities:                                             |   |            |      |   |   |   |   |
| Net Income                                                                         |   | $               | 6,141,101 |   | $ | 4,428,990 |   | $ | 9,491,205 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |   |            |      |   |   |   |   |
| Deferred income taxes                                                              |   | (509,000        | )         | 2,183,500 |   | (3,258,236 | ) |
| Depreciation and  amortization                                                     |   | 1,394,204       |      | 1,661,327 |   | 1,720,433 |   |
| Provisions for allowances  for bad debt, returns,                                  |   |            |      |   |   |   |   |
| adjustments and spoils                                                             |   | 476,341         |      | 63,182 |   | 221,866 |   |
| Tax benefit of  disqualifying dispositions                                         |   | 117,400         |      | 562,200 |   | 484,080 |   |
| Provision for inventory  reserves                                                  |   | —          |      | — |   | (42,000 | ) |
| Loss (gain) on disposition  and writedown of property and equipment                |   | 37,421          |      | (20,330 | ) | 67,880 |   |
| Stock based compensation                                                           |   | 92,480          |      | 322,768 |   | — |   |
| Changes in assets and  liabilities:                                                |   |            |      |   |   |   |   |
| Accounts receivable                                                                |   | (1,606,739      | )         | (1,144,496 | ) | (255,253 | ) |
| Inventories                                                                        |   | (365,713        | )         | (25,582 | ) | (268,374 | ) |
| Prepaid expenses and other  assets                                                 |   | 65,395          |      | (728,558 | ) | 57,534 |   |
| Accounts payable                                                                   |   | (613,200        | )         | (526,676 | ) | 1,588,379 |   |
| Accrued expenses                                                                   |   | 770,516         |      | 639,914 |   | (313,221 | ) |
| Net cash provided by  operations                                                   |   | 6,000,206       |      | 7,416,239 |   | 9,494,293 |   |
|                                                                               |   |            |      |   |   |   |   |
| Cash flows from investing  activities:                                             |   |            |      |   |   |   |   |
| Purchase of property and  equipment                                                |   | (4,308,418      | )         | (2,638,833 | ) | (4,759,756 | ) |
| Proceeds from sale of  property and equipment                                      |   | —          |      | 28,559 |   | — |   |
| Acquisition of business  operating assets                                          |   | (500,388        | )         | — |   | (6,081,634 | ) |
| Net cash used in investing  activities                                             |   | (4,808,806      | )         | (2,610,274 | ) | (10,841,390 | ) |
|                                                                               |   |            |      |   |   |   |   |
| Cash flows from financing  activities:                                             |   |            |      |   |   |   |   |
| Proceeds from revolving  line of credit                                            |   | 11,682,598      |      | — |   | — |   |
| Repayments on revolving  line of credit                                            |   | (12,287,483     | )         | — |   | — |   |
| Repayment of long-term debt  and capital lease obligations                         |   | (83,301         | )         | (34,774 | ) | (32,008 | ) |
| Section 16(b) settlement  less legal fees                                          |   | 454,453         |      | 14,299 |   | (4,154 | ) |
| Proceeds from issuance of  common stock                                            |   | 428,433         |      | 989,139 |   | 989,375 |   |
| Net cash provided by  financing activities                                         |   | 194,700         |      | 968,664 |   | 953,213 |   |
| Net increase (decrease) in  cash and cash equivalents                              |   | 1,386,100       |      | 5,774,629 |   | (393,884 | ) |
| Cash and cash equivalents,  beginning of year                                      |   | 71,399          |      | 1,457,499 |   | 7,232,128 |   |
| Cash and cash equivalents,  end of year                                            |   | $               | 1,457,499 |   | $ | 7,232,128 |   | $ | 6,838,244 |   |

 

See accompanying summary ofsignificant accounting policies and notes to consolidated financial statements

 

36

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**MONTEREYPASTA COMPANY**

**SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

***Principles of Consolidation and Nature of Operations***

 

The consolidatedfinancial statements include the accounts of Monterey Pasta Company (a producerand distributor of pasta, pasta sauces, soups, salsa, dips, hummus, and relateditems), together with its wholly owned subsidiary, Monterey Pasta DevelopmentCompany  (a franchiser of restaurants -inactive).  All significant intercompanyaccounts and transactions have been eliminated in consolidation.  Collectively, Monterey Pasta Company andMonterey Pasta Development Company are referred to as the “Company.”

 

The Company’s productionfacilities and distribution center are located in Salinas (Monterey County),California, and Eugene, Oregon.  Itsproducts are available throughout the United States as well as selecteddistribution areas in Canada, the Caribbean, Latin America, and Asia Pacific.  The principal customers are retail groceriesand club stores.  The Company offerscredit and payment terms to its customers in line with industry practices,generally calling for unsecured trade accounts receivable.

 

***Accounting Periods***

 

For quarterly reportingpurposes the Company employs a 4-week, 4-week, 5-week reporting period.  The fiscal year ends on the last Sunday ofeach calendar year (52/53-week year). The 2000 fiscal year contained 53 weeksand ended on December 31, while the 2001 fiscal year contained 52 weeks andended on December 30. The 2002 fiscal year contained 52 weeks and ended onDecember 29.

 

***Reclassification****s*

 

Certain of the prior yearfinancial statement amounts have been reclassified to conform to the currentyear presentation.  Thesereclassifications had no impact on previously reported income or accumulateddeficit.

 

***Cash and Cash Equivalents***

 

The Company considers allhighly liquid investments purchased with an original maturity of three monthsor less to be cash equivalents.  TheCompany’s cash equivalents consist primarily of money market accounts.

 

***Accounts Receivable and Allowances***

 

The Company providesallowances for estimated credit losses, product returns, spoilage, andadjustments at a level deemed appropriate to adequately provide for known andinherent risks related to such amounts. The allowances are based on reviews of loss, return, spoilage,adjustment history, contractual relationships with customers, current economicconditions, and other factors that deserve recognition in estimating potentiallosses.  While management uses the bestinformation available in making its determination, the ultimate recovery ofrecorded accounts, notes, and other receivables is also dependent on futureeconomic and other conditions that may be beyond management’s control.

 

***Inventories***

 

Inventories are stated atthe lower of cost (using the first-in, first-out method) or market and consistprincipally of component ingredients to the Company’s refrigerated pasta andsauces, finished goods, and packaging materials.

 

***Sales Incentives and Advertising Costs***

 

The Company expensesadvertising costs as incurred or when the related campaign commences.  Sales incentives paid or credited to clubstores and grocery chains for shelf space allocations are amortized between sixand twelve months depending on the nature of the chain program or agreement,and are netted against revenues.

 

37

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***Property and Equipment***

 

Property and equipmentare recorded at cost.  Depreciation isprovided for on the straight-line method over the estimated useful lives of theassets (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 intangible assets, are assessed for possible impairment wheneverevents or changes in circumstances indicate that the carrying amounts may notbe recoverable, or whenever management has committed to a plan to dispose ofthe assets.  Assets to be held and usedaffected by such an impairment loss are depreciated or amortized at their newcarrying amount over the remaining estimated life; assets to be sold orotherwise disposed of are not subject to further depreciation or amortization.

 

***Goodwill and Intangible Assets***

 

Intangible assets otherthan goodwill consist of tradenames, customer lists, and non-competes and otherintangibles and are recorded at cost, net of accumulated amortization.  Intangibles are amortized over theirrespective useful lives, if determinate, ranging from 3 to 10 years.  Goodwill and certain trademarks withindeterminate useful lives are assessed for impairment at least annually. Thevaluation of these intangibles is determined based upon valuations performed bythird party specialists and management’s best estimates of fair value.  As a result the ultimate value andrecoverability of these assets is subject to the validity of the assumptionsused.

 

***Income Taxes and Deferred Tax Asset Valuation Allowance***

 

The Company accounts forcorporate income taxes in accordance with Statement of Financial AccountingStandards (SFAS) 109, *Accounting for Income Taxes*, whichrequires an asset and liability approach. This approach results in the recognition of deferred tax assets (futuretax benefits) and liabilities for the expected future tax consequences oftemporary timing differences between the book carrying amounts and the taxbasis of assets and liabilities.  Futuretax benefits are subject to a valuation allowance to the extent of thelikelihood that the deferred tax assets may not be realized.

 

TheCompany has significant deferred tax assets comprised principally of NOLs fromthe Company’s former restaurant operating subsidiary UFO. These NOLs werepreviously fully reserved based upon management’s best estimate of ultimaterealizeability. During 2002, based upon new evidence and management’s judgmentsthese reserves were substantially reduced.  The amount of the reserve issignificantly dependent on management’s assumptions regarding future taxableincome and the availability of these NOLs to offset future taxable income. Theeffect on the Company’s net income can be significant whenever the estimate ofrealizability changes. The Company expects to fully utilize all of theremaining NOLs in fiscal 2003 and 2004.

 

***Revenue Recognition***

 

The Company recognizes revenues through sales of pasta and sauceproducts primarily to grocery and club store chains.  Revenues are recognized once there is evidence of an arrangement(such as a customer purchase order), delivery has occurred, the price and termsare finalized, and collectibility is reasonably assured.  Accordingly, sales are recorded when goodsare shipped, at which time title and risk of loss have passed to the customer,consistent with the freight terms for most customers.  Title and risk of loss pass upon delivery to retail locations forthe Direct Store Delivery program, as that product is transported in the Company’sown vehicles.  Consignment shipments toclub store warehouses are recognized upon shipment to individual club storelocations.  Potential returns,adjustments and spoilage allowances are provided for in accounts receivableallowances and accruals.

 

The Company records shipping cost for product delivered to customers inselling expense.  These costs wereapproximately $1,908,000, $2,211,000 and $2,609,000 for 2000, 2001, and 2002respectively.  Any amounts charged tocustomers for freight and delivery are included in revenues.

 

38

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***Stock-based Compensation***

 

As permitted under the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Companycontinues to account for employee stock-based transactions under AccountingPrinciples Board Opinion (APB) No. 25, “Accounting for Stock Issued toEmployees.”  However, SFAS No. 123requires the Company to disclose pro forma net income and earnings per share asif the fair value method had been adopted. Under the fair value method, compensation cost is measured at the grantdate based on the fair value of the award and is recognized over the serviceperiod, which is usually the vesting period. For non-employees, cost is also measured at the grant date, using thefair value method, but is actually recognized in the financial statements overthe vesting period, or immediately if no further services are required.

 

If the Company hadelected the fair value method of accounting for stock-based compensation,compensation cost would be accrued at the estimated fair value of stock optiongrants over the service period, regardless of later changes in stock prices andprice volatility.  The fair value atdate of grant for options granted in 2000, 2001, 2002 have been estimated basedon a modified Black-Scholes pricing model with the following assumptions: nodividend yield for any year; expected volatility for 2000, 2001 and 2002 grantsof approximately 55%, 48%, and 75**%**based on historical results; risk-freeinterest rates of 6.37**%,**4.18**%**and 3.81**%**; and expected lives ofapproximately five years for all grants. The table below shows net income per share for 2000, 2001, and 2002 asif the Company had elected the fair value method of accounting for stockoptions.

 
|                                                                                                                            |   | **2000** |      | **2001** |   | **2002**  |       |
|---------------------------------------------------------------------------------------------------------------------------------|--------|----------|-----------|----------|--------|-----------|------------|
| Net income as  reported                                                                                                         |   | $        | 6,141,101 |     | $      | 4,428,990 |       | $ | 9,491,205 |   |
|                                                                                                                            |   |     |      |     |   |      |       |
| Add: stock-based  employee compensation included in reported net income, net of related tax  effects                            |   | 55,488   |      | 193,661  |   | —    |       |
| Deduct: total  stock-based employee compensation determined under fair value method for all  awards, net of related tax effects |   | (257,108 | )         | (174,564 | )      | (830,285  | )          |
|                                                                                                                            |   |     |      |     |   |      | ** ** |
| Proforma net  income, as adjusted                                                                                               |   | $        | 5,939,481 |     | $      | 4,448,087 |       | $ | 8,660,920 |   |
|                                                                                                                            |   |     |      |     |   |      |       |
| Earnings per  share:                                                                                                            |   |     |      |     |   |      | ** ** |
| Basic, as  reported                                                                                                             |   | $        | 0.46      |     | $      | 0.33      |       | $ | 0.68 |   |
| Basic, as  adjusted                                                                                                             |   | $        | 0.45      |     | $      | 0.33      |       | $ | 0.62 | ** ** |
|                                                                                                                            |   |     |      |     |   |      |       |
| Diluted, as  reported                                                                                                           |   | $        | 0.44      |     | $      | 0.31      |       | $ | 0.65 |   |
| Diluted, as  adjusted                                                                                                           |   | $        | 0.44      |     | $      | 0.31      |       | $ | 0.59 | ** ** |

 

***Use of Estimates***

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amount of assets and liabilities, disclosure of contingent assetsand liabilities at the date of the financial statements, and the reportedamounts of revenues and expenses during the period.  Actual results could differ from those estimates.  The most significant estimates made by theCompany are those related to accounts receivable and deferred tax allowances,allocation of purchase price of acquired businesses, amortization of acquiredintangible assets, and impairment judgments made for intangibles.

 

***New Accounting Pronouncements***

 

In May 2000, the Emerging Issues Task Force (“EITF”)of the Financial Accounting Standards Board (“FASB”) reached a consensus onIssue 00-14, “Accounting for Certain Sales Incentives.”  In April 2001, the EITF reached a consensuson Issue 00-25, “Vendor Income Statement Characterization of Consideration to aPurchaser of the Vendor’s Products or Services.” Both Issue 00-14 and 00-25have been codified under Issue 01-09, “Accounting for Consideration Given by aVendor to a Customer or a Reseller of the Vendor’s Products.”  The Company adopted this Issue effectivefirst quarter 2002.  EITF 01-09 requiresthe characterization of certain vendor sales incentives such as promotions,trade ads, slotting fees, and coupons as reductions of revenue.  Certain of these expenses, previously classifiedas selling, general and administrative costs, are now characterized as offsetsto revenue.  Reclassifications have beenmade to prior period financial statements to conform to the current yearpresentation.  Total vendor salesincentives now characterized as reductions of revenue that previously wouldhave been classified as selling, general and administrative costs wereapproximately $1,872,000 and $2,233,000, and $2,290,000 for 2000, 2001, and2002, respectively.

 

In June 2001, the FASBfinalized SFAS 141, “Business Combinations,” and SFAS 142, “Goodwill and OtherIntangible Assets.”  SFAS 141 requiresthe use of the purchase method

 

39

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of accounting and prohibits the use of the pooling-of-interests methodof accounting for business combinations initiated after June 30, 2001.  SFAS 141 also requires the recognition ofacquired intangible assets apart from goodwill if the acquired intangibleassets meet certain criteria.  SFAS 141applies to all business combinations initiated after June 30, 2001 and forpurchase business combinations completed on or after July 1, 2001.

 

SFAS 142 changes the waythat companies account for goodwill, in that goodwill is no longer amortizedbut instead is tested (along with any other unamortized intangible assets) forimpairment at least annually.

 

In March 2002, the EITFreached a consensus on Issue 02-7, “Unit of Accounting for Testing Impairmentof Indefinite-Lived Intangible Assets.” This issue addresses recording indefinite-lived intangible assets in asingle unit of accounting for purposes of testing impairment if they areoperated as a single asset.    Thisguidance became applicable immediately upon the initial application of SFAS 142in the first quarter of 2002. Management does not****expect the adoption of this Statement tohave a material impact on the Company’s financial condition or results ofoperations.

 

In August 2001 SFAS 144,“Accounting for the Impairment or Disposal of Long-lived Assets” was issued,superseding SFAS 121, “Accounting for the Impairment of Long-lived Assets to beDisposed of.”  Among other things, SFAS 144 provides guidance on howlong-lived assets used as part of a group should be evaluated for impairment,establishes criteria for when long-lived assets are held for sale, andprescribes the accounting for long-lived assets that will be disposed of otherthan by sale.  SFAS 144 is effective for fiscal years beginning afterDecember 15, 2001.  The Company’s financial position and results of operationshave not been affected by the adoption of SFAS 144.

 

In July 2002 the FASBissued SFAS 146, “Accounting for Costs Associated with Exit or DisposalActivities,” which addresses financial accounting and reporting for costsassociated with exit or disposal activities. SFAS 146 requires that a liabilityfor a cost associated with an exit or disposal activity be recognized when theliability is incurred. This Statement also establishes that fair value is theobjective for initial measurement of the liability.  Severance pay under SFAS 146, in many cases, would be recognizedover time rather than up front. The provisions of this Statement are effectivefor exit or disposal activities that are initiated after December 31, 2002,with early application encouraged. Management does not expect the adoption ofthis Statement to have a material impact on the Company’s financial conditionor results of operations.

 

In December 2002, theFASB issued SFAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,”which provides alternative methods of transition for a voluntary change to fairvalue based method of accounting for stock-based employee compensation asprescribed in SFAS 123, “Accounting for Stock-Based Compensation.”  Additionally, SFAS 148 requires moreprominent and more frequent disclosures in financial statements about theeffects of stock-based compensation. The provisions of this Statement areeffective for fiscal years ending after December 15, 2002, with earlyapplication permitted in certain circumstances.  Management does not expect the adoption of this Statement to havea material impact on our the Company’s financial condition or results ofoperations.

 

In November 2002, theFASB Issued FASB interpretation (FIN) No. 45. “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others.”  FIN No. 45requires a guarantor to recognize, at the inception of a qualified guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. FIN No. 45 is effective on a prospective basis for qualifiedguarantees issued or modified after December 31, 2002. Management does notexpect adoption of this Interpretation to have a material impact on theCompany’s financial condition or results of operations.

 

**MONTEREY PASTA COMPANY**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

Financial instruments,which potentially subject the Company to concentration of credit risk, includecash, cash equivalents and accounts receivable.   The Company maintains its cash accounts in Comerica Bank inFresno, California.  The bank cashbalances are insured by the Federal Deposit Insurance Corporation (FDIC) up to$100,000.   At December 29, 2002 uninsuredcash balances totaled $6,582,000.  As ofDecember 29, 2002, approximately 68% of the Company’s accounts receivable areconcentrated with two major customers (See Note 11).

 

**2.**             **Inventories**

 
|                                     |   | **2001**  |      | **2002**  |   |
|------------------------------------------|--------|-----------|-----------|-----------|--------|
| Inventories  consisted of the following: |   |      |      |      |   |
|                                     |   |      |      |      |   |
| Production –  Ingredients           |   | $         | 1,088,763 |      | $      | 1,280,970 |   |
| Production –  Finished goods        |   | 1,101,410 |      | 1,538,465 |   |
| Paper goods and  packaging materials     |   | 907,640   |      | 940,960   |   |
| Operating  supplies                      |   | 43,366    |      | 32,177    |   |
|                                     |   | 3,141,179 |      | 3,950,572 |   |
| Allowances for spoils  and obsolescence  |   | (27,500   | )         | (69,500   | )      |
|                                     |   | $         | 3,113,679 |      | $      | 3,723,072 |   |

 

40

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**3.             Propertyand Equipment**

 
|                                                |   | **2001**   |       | **2002**   |   |
|-----------------------------------------------------|--------|------------|------------|------------|--------|
|                                                |   |       |       |       |   |
| Property and  equipment consisted of the following: |   |       |       |       |   |
|                                                |   |       |       |       |   |
| Leasehold  improvements                             |   | $          | 4,551,297  |       | $      | 4,970,075 |   |
| Machinery and  equipment                            |   | 11,273,229 |       | 15,965,796 |   |
| Computers,  office furniture and equipment          |   | 943,987    |       | 724,198    |   |
| Vehicles                                            |   | 295,113    |       | 363,747    |   |
|                                                |   | 17,063,626 |       | 22,023,816 |   |
| Less accumulated  depreciation and amortization     |   | (6,586,503 | )          | (7,989,339 | )      |
|                                                |   | 10,477,123 |       | 14,034,477 |   |
| Construction in  progress                           |   | 558,921    |       | 220,097    |   |
|                                                |   | $          | 11,036,044 |       | $      | 14,254,574 |   |

 

Construction in progressat December 29, 2002 includes deposits for equipment on order or yet to beinstalled.  At year-end 2002 the Companyhad purchase commitments for approximately $86,000.

 

**4.**             **Notes,Loans, and Capitalized Leases Payable**

 

***Capitalized Leases***

 

The Company leasescertain equipment under capitalized leases, including office equipment, a vanand truck with book values of  $44,042and $15,919 in 2001, and 2002, respectively. Future minimum lease payments consist of:

 

| **Year**                            |   | **Total** |   |
|-------------------------------------|--------|-----------|--------|
| 2003                                |   | $         | 19,015 |   |
| 2004                                |   | 1,814     |   |
|                                |   | 20,829    |   |
|                                |   |      |   |
| Less amounts  representing interest |   | 4,080     |   |
|                                |   |      |   |
| Capitalized  leases payable         |   | 16,749    |   |
| Less current  portion               |   | 14,964    |   |
| Long term  portion                  |   | $         | 1,785  |   |

 

***Credit Facility***

 

On August 1, 2001Imperial Bank (now Comerica Bank) provided a new multi-year credit facility tothe Company.  The existing accountsreceivable and inventory revolver was amended to expire October 31, 2003 with acommitment of $1.5 million and interest at either prime rate or LIBOR plus 185basis points for a debt/tangible net worth ratio of less than 1.0:1.  LIBOR premium increases 25 basis points fordebt/tangible net worth ratios from 1.0 to 1.25:1, with another 25 basis pointincrease for debt/tangible net worth ratios above 1.25:1.  In addition, the Company’s lender approved a$8.5 million non-revolving term facility in the event of a need for major capitalexpenditures and acquisitions, which expires October 31, 2009.  The term loan facility is subject to annualreview if unused.  If used, it convertsto an 84-month term loan.  Pricing is ateither prime rate or LIBOR plus premiums for the same debt/tangible net worthratios beginning at 200 basis points over LIBOR and increasing 25 basis pointsfor successive debt/tangible net worth increments.  The total credit facility is $10.0 million.

 

The terms of the Credit Facility prohibit the paymentof cash dividends (except with written approval) on the Company’s capital stockand restricts payments for, among other things, repurchasing shares of itscapital stock.  Other terms of theCredit Facility limit the Company with respect to, among other things, (i) incurringadditional indebtedness, (ii) adversely changing the capital structure, and(iii) acquiring assets other than in the normal course of business includingspecific limits on annual capital

 

41

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expenditures (currently $4.25 million).  As of September 29, 2002, there were no violations of any loancovenants and no loans outstanding.

### ** **

The Company has a verbalcommitment from Comerica Bank to continue its term credit facility as of itsexpiration date on terms at least as favorable as the prior year.

 

Effective January 1,2003, the Company initiated a $500,000 Letter of Credit in favor of SentryInsurance as required collateral for a deductible worker’s compensationprogram.  The Letter of Credit has anannual cost of $7,500 and expires December 31, 2003 coincident with theexpiration of the worker’s compensation program.

 

**5**.             **OperatingLeases**

 

The Company currentlyleases production, warehouse and corporate office space as well as certainequipment in Monterey County, California under both month-to-month andnon-cancelable operating lease agreements, expiring through December 2004.  The terms of the leases generally requirethe Company to pay common area maintenance, taxes, insurance, and certain othercosts.  All building leases have renewaloptions (see Item 2 “Properties” on page 10) and all include cost of livingadjustments.

 

Future minimum annuallease payments due under non-cancelable operating leases with terms of morethan one year are as follows:

 
| **Year**               |   | **Lease Amount** |      |
|------------------------|--------|------------------|-----------|
| 2003                   |   | $                | 818,368   |   |
| 2004                   |   | 817,469          |      |
| 2005                   |   | 485,872          |      |
| 2006                   |   | 459,576          |      |
| 2007 and  thereafter 6 |   | 238,523          |      |
|                   |   | $                | 2,819,808 |   |

 

Gross rent expense under the leases for 2000, 2001, and 2002 was$714,809, $584,451, and $711,010, respectively.

 

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

 

***Preferred Stock***

 

In December 1997,$3,000,000 of Series A-1 Convertible Preferred Stock, originally issued inAugust 1996, was converted into 4,108,108 shares of common stock.  On February 13, 1998, the Company wasnotified by the NASDAQ Stock Market, Inc. (“NASDAQ”) that the Company’s SeriesA Convertible Preferred stock offering, as amended by the Series A-1 Agreementin March of 1997, had violated Rule 4460(i)(l)(D)(ii) which requiresstockholder approval prior to the issuance of securities convertible intocommon stock equal to, or in excess of, 20% of outstanding shares at the timeof issuance.  The NASDAQ required theCompany to repurchase 2,365,066 shares, held by Clearwater Fund IV, Ltd., orface delisting from the National NASDAQ market.

 

After reviewing itsoptions, Company management, in concert with the Company’s Board of Directorsand its legal advisors, began negotiations with Clearwater Fund IV, Ltd. torepurchase 2,365,066 shares. Negotiations were completed****March 5, 1998 and the Company repurchasedthe shares for a total consideration of $2,690,263 or $1.1375/share.

 

On February 2, 2000, theUnited States District Court for the District of Delaware denied a motion todismiss a lawsuit against Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLC,stockholders of the Company, (collectively, “Clearwater”), Mark Levy v.Clearwater Fund IV, Ltd. and Clearwater Fund IV, LLC and Monterey PastaCompany, United States District Court for the District of Delaware, Case No.99-004-SLR.  The lawsuit alleged aviolation of Section 16(b) of the Securities Exchange Act of 1934, as amended,in connection with alleged purchases and sales of the Company’s stock within asix-month period following the conversion of Clearwater’s convertible preferredstock to the Company’s common stock in 1997. The Company was named as a nominal defendant in the lawsuit.  The Plaintiff sought the return ofapproximately $1,064,000 in alleged profit and Clearwater contested theclaim.  In July 2000, the parties signeda settlement agreement whereby Clearwater agreed to pay $700,000 to the Companyin settlement of the claim asserted by the plaintiff.  Plaintiff’s counsel applied to the court for attorney’s fees andexpenses of approximately $230,000 from the settlement.  As part of the settlement, Clearwater andthe Company  exchanged mutualreleases.  The settlement was approvedby the Board of Directors of the Company.

 

42

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On October 27, 2000 theCompany received a check in the amount of $472,406 including the settlementamount of $470,000, and interest of $2,406. The stockholders’ equity account was increased to reflect the disgorgedprofit settlement amount, net of the related $180,000 tax effect.

 

***Common Stock***

 

During the first threemonths of 2000, warrants with an exercise price of $2.25 and an expiration dateof March 27, 2000, representing a potential of 445,813 shares of Company commonstock, were exercised.  These warrantsrepresented the remainder of those originally issued in connection with a March1997 private placement in which the Company issued warrants to purchase up to532,800 shares of common stock.  Sincecertain of the warrants were converted into stock as a net exercise, only268,789 shares of common stock were issued during 2000, with 52,789 issued in1999, for a total of 321,578 issued as a result of the private placementwarrants.

 

During 2000, employee anddirector options representing 102,304 shares of common stock were exercised.

 

In 2001, employee anddirector options representing 297,684 shares of common stock wereexercised.  Non-plan optionsrepresenting 149,589 shares of common stock granted to the shareholders andplant manager of Frescala Foods, Inc. as part of the March 1999 acquisitionwere also exercised at $2.33 per share resulting in proceeds of $348,542.  In addition, warrants representing 3,786potential shares with an exercise price of $6.50 and an expiration date of May1, 2003, were exercised.  Since thewarrants were converted into stock as a net exercise, only 523 shares of commonstock were issued.  These warrants wereoriginally issued in connection with a July 1996 private placement in which theCompany issued warrants to purchase up to 400,750 shares of common stock. Warrantsrepresenting up to 396,964 shares of common stock remain unexercised inconnection with the July 1996 private placement.  Additionally during 2001, 5,875 employee stock purchase planshares were issued.

 

During 2002, employee anddirector options representing 224,204 shares of common stock were exercised forproceeds of $603,099.  Non-plan optionsrepresenting 150,411 shares of common stock granted to the shareholders andplant manager of Frescala Foods, Inc. as part of the March 1999 acquisition werealso exercised, resulting in proceeds of $350,458.  In addition, warrants with an exercise price of $6.50 and anexpiration date of May 1, 2003, representing 47,414 shares of Company commonstock were exercised as parts of net exercises, with no cash proceeds to theCompany.  These warrants were originallyissued in connection with a July 1996 private placement in which the Companyissued warrants to purchase up to 400,750 shares of common stock. Warrantsrepresenting up to 242,171 shares of common stock remain unexercised inconnection with the July 1996 private placement.  Additionally, 7,670 employee stock purchase plan shares wereissued with proceeds of $35,820.

 

***Employee Stock Purchase Plan***

 

In October 1994, theCompany’s Board of Directors adopted a qualified employee stock purchaseplan.  Under the purchase plan, eligibleemployees (those who have completed one year of continuous employment with theCompany) may purchase shares of the Company’s common stock through payrolldeductions not to exceed 10% of gross wages. The Company has reserved 200,000 shares of its common stock for issuanceunder the purchase plan, which remains in effect until terminated by theCompany’s Board of Directors, or until all of the shares reserved for under thepurchase plan have been issued.  Unlessthe Board has otherwise provided a higher amount prior to the commencement ofan offering period, the offering exercise price for each purchase period is 85%of the lesser of (a) the fair market value of the shares on the offering dateof such offering period or (b) the fair market value of the shares on the givenpurchase date.  There were 3,006, 5,875and 7,670 shares of common stock issued under the plan in 2000, 2001 and 2002,respectively.  At December 29, 2002,there were 177,391 available shares remaining under the plan.

 

***Earnings per Share***

 

Basic earnings per shareare based on earnings available to common stockholders divided by theweighted-average number of common shares actually outstanding during theperiod.  Diluted earnings per share alsoinclude the incremental effect of any dilutive common stock equivalents assumedto be outstanding during the period. Because of equivalent shares includable in different periods or at differentamounts, per-share amounts for the four quarters do not necessarily equalper-share amounts for the entire year.

 

Options to purchase1,500,890, 1,527,250 and 1,528,385 shares of common stock were outstanding atyear-end 2000, 2001, and 2002, respectively (see Note 7).  A total of 1,465,590 options were includedin the 2000 computation of diluted earnings per share, with 35,300 excluded,because exercise prices were greater than the average market price of thecommon shares.  During 2001, a total of 1,465,250options were included in the computation of diluted earnings per share, with62,000 excluded, because of exercise prices. At 2002 year-end a total of 1,423,885 options were included in thecomputation of diluted earnings per share, with 104,500 excluded, because ofexercise prices. Warrants to purchase 400,750, 396,964, and 242,171 shares wereoutstanding at

 

43

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year-end 2000, 2001, and2002, respectively (see Note 7).  During2000, no warrants representing shares on common stock were included, withwarrants representing 400,750 shares of common stock excluded, because ofexercise prices.  At year-end 2001 nowarrants representing shares on common stock were included, with warrantsrepresenting 396,964 shares of common stock excluded, because of exerciseprices.  At year-end 2002 no warrantsrepresenting shares on common stock were included, with warrants representing242,171 shares of common stock excluded, because of exercise prices.

 

**7.****                                      Warrantsand Stock Options**

 

***Warrants***

 

In April 1996, theCompany issued warrants to purchase 400,750 shares of its common stock at $6.50per share in connection with a placement of 916,000 shares of commonstock.  The warrants, with an estimatedoriginal value of $137,400, are valid for seven years, expire in April 2003,and include registration rights for the related shares, which were registeredeffective October 24, 1997.  During2001, warrants representing 3,786 potential shares of common stock wereexercised, leaving warrants representing 396,964 potential shares of commonstock outstanding at year-end 2001.

 

During 2002, additionalwarrants representing 47,414 shares of company common stock from 154,793warrants were exercised as parts of net exercises, with no cash proceeds to theCompany. Through 2002 a total of 47,937 shares of common stock had been issuedas a result of the exercise of 158,579 warrants. Warrants representing up to242,171 shares of common stock remain unexercised at December 29, 2002 inconnection with the July 1996 private placement.

 

In March 1997, theCompany issued warrants for 532,800 shares of its common stock at $2.25 pershare in connection with a private placement of 1,600,000 shares of commonstock.  The warrants, with an estimatedoriginal value of $271,700, were valid for three years, expired in March, 2000,and included registration rights for the related shares which were part of theCompany’s S-3 which was effective October 24, 1997.  Warrants representing a total of 86,987 and 445,813 potentialshares were exercised in 1999 and 2000, respectively (See Note 6).  Some of the warrants exercised were part ofnet exercises.  Therefore, only 321,578shares resulted from the exercise of the 532,800 warrants.  As of December 31, 2000, none of the March1997 warrants remained outstanding.

 

***Stock Option Plan***

 

Effective August 31,1993, the Company’s Board of Directors adopted a stock option plan,subsequently amended and restated, which provides for the granting of incentivestock options or non-qualified stock options to eligible employees, consultantsand outside directors.  The Companyinitially reserved 1,200,000 shares of its common stock for issuance under theplan.  The plan provides that the optionprice shall not be less than the fair market value of the shares on the date ofgrant; therefore, no compensation expense is recorded for employees, unless themarket price exceeds the strike price on the day of grant.  Compensation or other expense is recordedfor any non-employee grants at fair value of the option award.  Options generally vest over a period of oneto three years and may be exercised for a period of up to ten years.  In January of 1998, the Company filed a FormS-8 to register up to 540,000 additional shares of common stock eligible to beissued pursuant to the Plan to increase the total number of registered sharesto 1,740,000. The Plan was amended in July 1998 to allow two years from date ofa transfer of control for the exercise of options for those employees anddirectors not retained after the transfer of control.  On April 23, 1999, the Company filed an S-8 to register 300,000shares of common stock associated with options issued outside of the Plan, inconjunction with the March 12, 1999 purchase of the operating assets ofFrescala Foods, Inc.  During 2001, theCompany issued additional options to purchase up to 155,200 shares outside ofthe Plan.  Management registered theseshares in 2002 as part of an S-8 for 180,000 potential shares (the“Nonstatutory Plan”). An additional 1,500,000 shares was reserved by a vote ofthe Company’s stockholders at its July 30, 2002 annual meeting and the plan wasamended to expire April 30, 2012.  As ofDecember 29, 2002, the Company had 1,468,937 shares available under the Plan,and 33,800 available as part of the Nonstatutory Plan.

 

The following table showsactivity in outstanding options during 2000, 2001, and 2002:

 
|                                                            |   | **2000**   |       | **2001**                            |       | **2002**   |       |
|-----------------------------------------------------------------|--------|------------|------------|-------------------------------------|------------|------------|------------|
|                                                            |   | **Shares** |       | **Weighted  AverageExercise Price** |       | **Shares** |       | **Weighted  AverageExercise Price** |   | **Shares** |   | **Weighted  AverageExercise** |   |
|                                                            |   |       |       |                                |       |       |       |   |   |   |   |   |   |
| Outstanding at  beginning of year                               |   | 1,222,395  |       | $                                   | 2.29       |       | 1,500,890  |   | $ | 2.54 |   | 1,527,250 |   | $ | 3.91 |   |
| Granted                                                         |   | 437,300    |       | 3.30                                |       | 532,200    |       | 6.41 |   | 400,800 |   | 6.47 |   |
| Exercised                                                       |   | (102,304   | )          | 1.60                                |       | (447,273   | )          | 2.17 |   | (374,615 | ) | 2 54 |   |
| Canceled or  expired                                            |   | (56,501    | )          | 4.81                                |       | (58,567    | )          | 4.67 |   | (25,050 | ) | 5.30 |   |
| Outstanding at  end of year                                     |   | 1,500,890  |       | $                                   | 2.54       |       | 1,527,250  |   | $ | 3.91 |   | 1,528,385 |   | $ | 4.90 |   |
|                                                            |   |       | ** ** |                                | ** ** |       | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Options  exercisable at year end                                |   | 1,008,589  |       | $                                   | 2.15       |       | 847,634    |   | $ | 2.47 |   | 951,485 |   | $ | 3.96 |   |
|                                                            |   |       | ** ** |                                | ** ** |       | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Weighted average  fair value of options granted during the year |   |       |       | $                                   | 1.98       |       |       |   | $ | 3.00 |   |   |   | $ | 4.26 |   |

 

44

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The following table showsinformation for options outstanding or exercisable as of December 29, 2002

 
|                           |   | **Options  Outstanding** |   | **Options  Exercisable**                            |   |
|--------------------------------|--------|--------------------------|--------|-----------------------------------------------------|--------|
| **Range of  Exercise  Prices** |   | **Number of  Shares**    |   | **Weighted  Average  Remaining  Contractual  Life** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares** |   | **Weighted  Average  Remaining  Contractual  Life** |   | **Weighted  Average  Exercise  Price** |   |
| $1.13 - 2.63                   |   | 237,400                  |   | 4.4 years                                           |   | $ | 1.77/share |   | 237,400 |   | 4.4 years |   | $ | 1.77/share |   |
| $2.94 - 4.94                   |   | 309,735                  |   | 6.8 years                                           |   | $ | 3.00/share |   | 309,735 |   | 6.8 years |   | $ | 3.00/share |   |
| $5.00 - 6.05                   |   | 263,750                  |   | 8.3 years                                           |   | $ | 5.16/share |   | 130,750 |   | 7.4 years |   | $ | 4.70/share |   |
| $6.20 - 6.45                   |   | 228,050                  |   | 9.6 years                                           |   | $ | 6.07/share |   | 15,000 |   | 8.3 years |   | $ | 6.18/share |   |
| $6.45 - 6.45                   |   | 1,500                    |   | 9.8 years                                           |   | $ | 6.45/share |   | — |   | — |   | — |   |
| $6.55 - 6.55                   |   | 284,700                  |   | 8.8 years                                           |   | $ | 6.55/share |   | 212,350 |   | 8.8 years |   | $ | 6.55/share |   |
| $6.63 - 9.42                   |   | 203,250                  |   | 8.9 years                                           |   | $ | 7.48/share |   | 46,250 |   | 7.4 years |   | $ | 6.94/share |   |
| Total                          |   | 1,528,385                |   | 7.8 years                                           |   | $ | 4.90/share |   | 951,485 |   | 6.8 years |   | $ | 3.96/share |   |

 

The table on the following page provides information about our commonstock that may be issued upon the exercise of options, warrants and rightsunder all of our existing equity compensation plans as of December 29, 2002,including the Monterey Pasta Company 1993 Stock Option Plan, the Monterey PastaCompany 1995 Employee Stock Purchase Plan (See Note 6) and the Monterey PastaCompany 2001 Nonstatutory Stock Option Plan.

 
| **Plan category**                                           |   | **Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights  (a)** |   | **Weighted-average exercise  price of outstanding  options, warrants and  rights  (b)** |   | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))  (c)** |      |
|-------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
| Equity  compensation plans approved by security holders     |   | 1,378,685                                                                                               | (1)    | $                                                                                       | 4.72   |                                                                                                                                                      | 1,646,328 |   |
| Equity  compensation plans not approved by security holders |   | 149,700                                                                                                 | (2)    | $                                                                                       | 6.65   |                                                                                                                                                      | 33,800    |   |
| Total                                                       |   | 1,528,385                                                                                               |   | $                                                                                       | 4.90   |                                                                                                                                                      | 1,680,128 |   |

 

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(1)                                  Issuedunder the Monterey Pasta Company 1993 Stock Option Plan and the Monterey PastaCompany 1995 employee Stock Purchase Plan

 

(2)                                  Issuedto Company employees under the Monterey Pasta Company 2001 Nonstatutory StockOption Plan (154,200 at $6.55)

 

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

 

The Company’s income tax benefit (provision) consistsof:

 

|                       |   | **2000** |     | **2001**   |   | **2002**   |   |
|----------------------------|--------|----------|----------|------------|--------|------------|--------|
| Current:                   |   |     |     |       |   |       |   |
|                       |   |     |     |       |   |       |   |
| Federal                    |   | $        | (244,500 | )          | $      | (618,100   | )      | $ | (263,088 | ) |
| State                      |   | (155,400 | )        | (134,732   | )      | (156,828   | )      |
| Total                      |   | (399,900 | )        | (752,832   | )      | (419,916   | )      |
|                       |   |     |     |       |   |       |   |
| Deferred:                  |   |     |     |       |   |       |   |
|                       |   |     |     |       |   |       |   |
| Federal                    |   | (221,100 | )        | (1,919,400 | )      | 3,366,239  |   |
| State                      |   | 730,100  |     | (264,100   | )      | (108,003   | )      |
| Total                      |   | 509,000  |     | (2,183,500 | )      | 3,258,236  |   |
|                       |   |     |     |       |   |       |   |
| Net tax benefit  (expense) |   | $        | 109,100  |       | $      | (2,936,332 | )      | $ | 2,838,320 |   |

 

45

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A reconciliation between the Company’s effective taxrate and U.S. Federal income tax rate on loss from continuing operationsfollows:

 

|                                                       |   | **2000** |   | **2001** |   | **2002** |   |
|------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Federal  statutory rate                                    |   | 34.0     | %      | 34.0     | %      | 34.0     | %      |
|                                                       |   |     |   |     |   |     |   |
| State income  taxes, net of effect on Federal income taxes |   | 4.3      |   | 2.8      |   | 1.5      |   |
|                                                       |   |     |   |     |   |     |   |
| Reversal of  Federal and State valuation allowances        |   | (40.3    | )      | —   |   | (78.6    | )      |
|                                                       |   |     |   |     |   |     |   |
| Other                                                      |   | .2       |   | 3.1      |   | .4       |   |
|                                                       |   |     |   |     |   |     |   |
| Effective income  tax rate                                 |   | (1.8     | )%     | 39.9     | %      | (42.7    | )%     |

 

The valuation allowance for 2000, 2001, and 2002 wasincreased (reduced) by ($7,512,000), $6,008,000, and ($5,196,000),respectively.  During 2000, reservesagainst certain deferred tax assets totaling $2,400,000 were removed asoperations continued to be profitable following losses in earlier years.  During 2001, the Company restored certaindeferred tax assets totaling $7.4 million, which had been removed from the 2000schedule in error, along with related valuation allowances in the sameamounts.  These changes had no neteffect on tax expense or deferred tax assets. During 2002, the Company completed its evaluation of the likelihood ofrealizing certain net operating losses (NOLs) arising in connection with itspreviously-owned subsidiary Upscale Food Outlets, Inc. (UFO).  As a result, reserves against these deferredtax assets totaling $5,196,000 were released and offset against income taxexpense.  This benefit, together withpermanent differences and other current tax effects, resulted in a netyear-to-date income tax benefit of $2,838,000. Utilization of these NOLs and other deferred tax assets offsetsubstantially all of the federal taxes otherwise payable for 2002.  As of December 29, 2002, remaining netdeferred tax assets available to offset future cash taxes are $4,068,000 shortterm and $765,000 long term.

 

As a result of this evaluation and resulting releaseof reserves, future income tax expense will be accrued at a more “normalized”combined Federal and State statutory rate less certain tax credits and timingdifferences.

 

The future disallowance of any previous UFO NOL usage,if it occurs, would increase both income tax expense and amounts actuallypayable.

 

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

 
|                                       |   | **2001**   |      | **2002**  |   |
|--------------------------------------------|--------|------------|-----------|-----------|--------|
| Federal loss  carryforwards                |   | $          | 6,008,000 |      | $      | 4,209,700 |   |
| Accumulated  depreciation and Amortization |   | 322,600    |      | 194,300   |   |
| Alternative  minimum tax credit carryovers |   | 384,000    |      | 252,000   |   |
| State income and  franchise taxes, net of  |   |       |      |      |   |
| effect on  Federal income taxes            |   | 499,100    |      | 444,200   |   |
| Reserves against  receivables              |   | 103,900    |      | 179,300   |   |
| Other                                      |   | 266,400    |      | 295,800   |   |
|                                       |   | 7,584,000  |      | 5,575,300 |   |
| Less valuation  allowance                  |   | (6,008,500 | )         | (741,600  | )      |
|                                       |   |       |      |      |   |
| Net deferred tax  assets                   |   | $          | 1,575,500 |      | $      | 4,833,700 |   |

 

46

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As of December 29, 2002, the Company has Federal NOLstotaling $12.3 million, which expire in varying amounts through 2012. Should more than a 50% change in Company ownership occur within a three-yearperiod, utilization of these losses to reduce future years’ taxable incomewould be further limited. State income and franchise deferred tax assetsinclude approximately $228,000 in California Manufacturer’s Tax Creditsavailable to offset future California income taxes, expiring in varying amountsthrough 2012.

 

The Company realizes tax benefits as a result of theexercise of non-qualified stock options and the exercise and subsequent sale ofcertain incentive stock options (disqualifying dispositions). For financialreporting purposes, any reduction in income tax obligations as a result ofthese tax benefits is credited to additional paid-in capital. In the years2000, 2001, and 2002 tax benefits of disqualifying dispositions totaling$117,400, $562,200, and $494,080 respectively have been credited tostockholders’ equity.

 

**9**.                                      **Litigationand Contingencies**

 

As of December 29, 2002,there are no other material pending legal proceedings, other than ordinary,routine litigation incidental to the Company’s business, to which the Companyis a party or to which any of its property is subject (see Note 17 forsubsequent event).

 

**10**.                               **Slotting andAdvertising Costs**

 

These expenses relateprimarily to slotting fees paid or credited to grocery chains for shelf spaceallocations.  In accordance with EITF01-09 “Accounting for Consideration Given by a Vendor to a Customer or a Resellerof the Vendor’s Products,” these expenses were reclassified from SG&A in2001 and 2000 to conform with the 2002 treatment where they are offset againstrevenues.  These expenses totaled$1,705,000, $2,168,000, and $2,178,000, in 2000, 2001, and 2002, respectively.

 

**11**.                               **SignificantCustomers**

 

Costco and Sam’s Club(including Wal-Mart Supercenters) stores each accounted for portions of totalrevenues as follows:

** **
|                    |   | **2000** |   | **2001** |   | **2002** |   |
|-------------------------|--------|----------|--------|----------|--------|----------|--------|
| Costco                  |   | 50       | %      | 48       | %      | 43       | %      |
| Sam’s Club  stores |   | 30       | %      | 31       | %      | 31       | %      |

 

At December 30, 2001, andDecember 29, 2002, Costco and Sam’s Club stores accounted for the followingconcentration of accounts receivable:

 
|                    |   | **2001** |   | **2002** |   |
|-------------------------|--------|----------|--------|----------|--------|
| Costco                  |   | 35       | %      | 35       | %      |
| Sam’s Club  stores |   | 41       | %      | 33       | %      |

 

The Company currentlysells its products to eight separate Costco regions which make purchasingdecisions independently of one another. On a regular basis, these regions re-evaluate the products carried intheir stores.  There can be no assurancethat these Costco regions will continue to offer Monterey Pasta’s products inthe future or continue to allocate Monterey Pasta the same amount of shelfspace.  Purchasing decisions for Sam’sClub stores (“Sam’s”) and Wal-Mart Supercenters, the Company’s second largestcustomer, are made at their respective head offices with input from thestores.  While the Company is in thesixth year of its relationship with Sam’s, it is in the first year of itsrelationship with Wal-Mart.  There canbe no assurance that Sam’s or Wal-Mart will continue to carry the Company’sproducts.  Currently, the loss of eitherCostco or Sam’s would materially adversely affect the Company’s businessoperations.  The loss of Wal-Martseparate from Sam’s would have a much less material adverse impact on theCompany.

 

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

 

**12.****                               SupplementalCash Flow information**

 
|                                               |   | **2000** |   | **2001** |   | **2002** |   |
|----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| ***Cash payments:***                               |   |     |   |     |   |     |   |
| Interest                                           |   | $        | 43,954 |     | $      | 4,719    |   | $ | 5,134 |   |
| Income Taxes                                       |   | 265,786  |   | 230,975  |   | (119,763 | )      |
|                                               |   |     |   |     |   |     |   |
| ***Non-cash Financing and Investing Activities:*** |   |     |   |     |   |     |   |
| Purchase of  leased equipment                      |   | —   |   | 10,954   |   | —   |   |
|                                                    |        |          |        |          |        |          |        |  |  |  |

 

47

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**13.****                               EmployeeBenefit Plan**

 

In 1996, the Companyinstituted a 401(k) Plan covering substantially all full-time employees withsix months of service.  Under the Plan,employees may elect to defer up to 15% of compensation (subject to certainlimitations).  Prior to 2003 the Companymatched one-half of employee contributions up to 6% of compensation.  Beginning in January 2003 the Companyadopted a Safe Harbor Plan and will match employee contributions up to 4% ofcompensation.  In addition, the Companymay make an annual discretionary profit-sharing contribution.  Employee contributions, Company matchingcontributions and related earnings are always 100% vested.  Company profit-sharing contributions andrelated earnings vest 20% a year, with 100% vesting after five years ofservice.  During 1999, 2000 and 2001,the Company’s expense for matching contributions was $91,806, $109,619 and$121,507, respectively; there were no profit-sharing contributions for 2000,2001, or 2002.

 

**14.****                               QuarterlyInformation (unaudited)**

 

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

 
|                               |   | **First  Quarter** |       | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |       | **2001**   |   |
|------------------------------------|--------|--------------------|------------|---------------------|--------|--------------------|--------|---------------------|------------|------------|--------|
| **Year  Ended 2001**               |   |               |       |                |   |               |   |                |       |       |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Net revenue                        |   | $                  | 14,180,192 |                | $      | 13,396,464         |   | $                   | 14,408,439 |       | $      | 15,001,817 |   | $ | 56,986,912 |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Gross profit                       |   | 5,165,744          |       | 4,514,368           |   | 5,025,487          |   | 5,812,127           |       | 20,517,726 |   |
| Operating income                   |   | 1,950,354          |       | 1,326,867           |   | 1,757,410          |   | 2,201,304           |       | 7,235,935  |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Net income                         |   | $                  | 1,225,036  |                | $      | 832,535            |   | $                   | 1,099,286  |       | $      | 1,272,133 |   | $ | 4,428,990 |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Basic earnings  per common share   |   | $                  | 0.09       |                | $      | 0.06               |   | $                   | 0.08       |       | $      | 0.09 |   | $ | 0.33 |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Diluted earnings  per common share |   | $                  | 0.09       |                | $      | 0.06               |   | $                   | 0.08       |       | $      | 0.09 |   | $ | 0.31 |   |

 
|                               |   | **First  Quarter** |       | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |       | **2002**   |   |
|------------------------------------|--------|--------------------|------------|---------------------|--------|--------------------|--------|---------------------|------------|------------|--------|
| **Year  Ended 2002**               |   |               |       |                |   |               |   |                |       |       |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Net revenue                        |   | $                  | 16,062,327 |                | $      | 13,794,029         |   | $                   | 16,568,577 |       | $      | 15,253,814 |   | $ | 61,678,747 |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Gross profit                       |   | 6,087,142          |       | 4,918,803           |   | 6,182,915          |   | 5,072,860           |       | 22,261,720 |   |
| Operating income                   |   | 2,274,967          |       | 1,212,189           |   | 1,988,798          |   | 1,132,055           |       | 6,608,009  |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Net income                         |   | $                  | 1,986,472  |                | $      | 1,100,410          |   | $                   | 5,543,411  |       | $      | 860,912 |   | $ | 9,491,205 |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Primary earnings  per common share |   | $                  | 0.14       |                | $      | 0.08               |   | $                   | 0.39       |       | $      | 0.06 |   | $ | 0.68 |   |
|                               |   |               |       |                |   |               |   |                |       |       |   |
| Diluted earnings  per common share |   | $                  | 0.14       |                | $      | 0.07               |   | $                   | 0.38       |       | $      | 0.06 |   | $ | 0.65 |   |

 

48

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**15.****                               Goodwilland Other Intangible Assets**

 

Goodwill and otherintangible assets consist of:

 
|                                                        |   | **Year-end  2001** |      | **2002  Additions** |      | **Year-end  2002** |   |
|-------------------------------------------------------------|--------|--------------------|-----------|---------------------|-----------|--------------------|--------|
| Trademark  and****Tradenames                                |   | $                  | 204,376   |                | $         | 615,000            |   | $ | 819,376 |   |
| Customer  list                                              |   | —             |      | 1,500,000           |      | 1,500,000          |   |
| Other  intangibles                                          |   | 262,684            |      | 194,293             |      | 456,977            |   |
| Goodwill  and other intangibles not separately quantifiable |   | 1,709,784          |      | 3,353,322           |      | 5,063,106          |   |
|                                                        |   | $                  | 2,176,844 |                | 5,662,615 |               | $      | 7,839,459 |   |
| Less  accumulated amortization                              |   | 804,005            |      | 127,087             |      | 931,092            |   |
| Net  intangible assets                                      |   | $                  | 1,372,839 |                | $         | 5,535,528          |   | $ | 6,908,367 |   |

 

All of the Company’sbusiness combinations were accounted for using the purchase method.  As of December 29, 2002, the net carryingamount of goodwill was $4,669,000 and other intangible assets was $2,239,000.  Amortization expense for 2002 was$127,000.  Due to the adoption of SFAS142, and prior to the Emerald Valley acquisition (See Note 16), the Companyestimated that amortization expense for 2002 from businesses acquired prior toDecember 30, 2001 would have declined to approximately $47,000 for the year, areduction of approximately $171,000 compared with amortization expected priorto the adoption of SFAS 142.  TheCompany performed transitional impairment testing as required by SFAS 142 atthe end of the second quarter of 2002 to determine if any writedowns werenecessary, with no impairment adjustments needed.

 

Thefollowing table reflects consolidated results of operations as though theadoption of SFAS 141 and 142 occurred as of the beginning of the twelve-monthperiods ended December 31, 2000, December 30, 2001, and December 29, 2002

 
|                                                           |   | **For the Years-ended** |      |
|----------------------------------------------------------------|--------|-------------------------|-----------|
|                                                           |   | **12-31-2000**          |      | **12-30-2001** |   | **12-29-2002** |   |
| Net income as reported                                         |   | $                       | 6,141,100 |   | $ | 4,429,000 |   | $ | 9,491,200 |   |
| Add back goodwill and indefinite-life intangibles amortization |   | 171,100                 |      | 170,300 |   | — |   |
| Net earnings as adjusted                                       |   | $                       | 6,312,200 |   | $ | 4,599,300 |   | $ | 9,491,200 |   |
|                                                           |   |                    |      |   |   |   |   |
| Basic income per common share:                                 |   |                    |      |   |   |   |   |
| As reported                                                    |   | $                       | 0.46      |   | $ | 0.33 |   | $ | 0.68 |   |
| As adjusted                                                    |   | $                       | 0.47      |   | $ | 0.34 |   | $ | 0.68 |   |
| Diluted income per common share:                               |   |                    |      |   |   |   |   |
| As reported                                                    |   | $                       | 0.44      |   | $ | 0.31 |   | $ | 0.65 |   |
| As adjusted                                                    |   | $                       | 0.45      |   | $ | 0.32 |   | $ | 0.65 |   |

 

The following table reflects thecomponents of trademarks and other intangible assets as of December 29,2002.  Total amortization expense forthe year-ended December 29, 2002 was $127,000.

 
|                                           |   | **Gross Carrying  Amount** |      | **Accumulated  Amortization** |   | **Net Carrying  Amount** |   |
|------------------------------------------------|--------|----------------------------|-----------|-------------------------------|--------|--------------------------|--------|
| Amortized intangible assets:                   |   |                       |      |                          |   |                     |   |
| License agreements, recipes, and customer list |   | $                          | 2,176,353 |                          | $      | 537,240                  |   | $ | 1,639,113 |   |
| Non-amortized intangible assets:               |   |                       |      |                          |   |                     |   |
| Trademark                                      |   | 600,000                    |      | —                        |   | 600,000                  |   |
| Total gross and net carrying amounts           |   | $                          | 2,776,353 |                          | $      | 537,240                  |   | $ | 2,239,113 |   |

 

Followingis table of estimated amortization expense for the next five years:

 
| **Year** |   | **Estimated Amortization Expense** |    |
|----------|--------|------------------------------------|---------|
| 2003     |   | $                                  | 207,000 |   |
| 2004     |   | 198,400                            |    |
| 2005     |   | 191,500                            |    |
| 2006     |   | 178,400                            |    |
| 2007     |   | 170,200                            |    |
|          |        |                                    |         |  |

 

49

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**16.****                            Business Acquisitions**

 

***The Nate’s Purchase***

 

On December 8, 2000, theCompany purchased the Nate’s polenta business of South San Francisco,California for consideration of $469,000, of which $19,000 was allocated toinventory, plus related acquisition costs of $31,000.  The remaining $481,000 was charged to goodwill.  The addition of Nate’s provided up to sixmore refrigerated SKUs in over 700 stores.

 

***The Emerald Valley Purchase***

 

On August 23, 2002 theCompany purchased the operating assets and inventory of Emerald Valley Kitchen,Inc. (“Emerald Valley”), a Eugene, Oregon based producer of organic freshsalsas, dips, hummus, and sauces with over 90% retail chain distribution. TheCompany considered this purchase an opportunity to enter the rapidly growingorganic food market.  The considerationto the sellers consisted of $5,744,000 in cash.  Additionally, the Emerald Valley owners are eligible to receivean earn-out based upon Emerald Valley Earnings before Interest, Taxes,Depreciation, and Amortization (“EBITDA”) above a predetermined level for thefirst five years after the acquisition date. The earn-out will be calculated annually at the end of successivetwelve-month periods following acquisition and any amounts due will be treatedas additional purchase price.  Fundingfor the transaction came from existing cash balances.

 

The total considerationof $5,744,000, plus related acquisition costs of $188,000, was allocated asfollows: The trademark, which has been included in intangible assets, willcontinue to be used for an indefinite period. Therefore, this asset will not be amortized on a monthly basis, but willbe tested for impairment annually in keeping with SFAS 142.  Recipes will be amortized over a three-yearlife.  The customer list will beamortized over a ten-year life.

 
| Inventories             |   | $         | 299,000   |   |
|-------------------------|--------|-----------|-----------|--------|
| Fixed  assets           |   | 120,000   |      |
| Customer  List          |   | 1,500,000 |      |
| Trademark               |   | 600,000   |      |
| Recipes                 |   | 60,000    |      |
| Goodwill                |   | 3,353,000 |      |
| Total  acquisition cost |   | $         | 5,932,000 |   |

 

 

**17.****                            Subsequent Event**

 

On February 14, 2003, theCompany became aware that a press release had been issued by the law firm ofBull & Lifshitz, LLP.  The pressrelease stated that a securities class action lawsuit had been filed againstthe Company in the United States Court for the Northern District of Californiaon behalf of purchasers of the Company’s common stock between the period July11, 2002 and December 16, 2002, inclusive ( the “class period”).  The press release stated that the complaintalleges that the defendant violated sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 and SEC Rule 10b-5 promulgated thereunder by allegedlyissuing a series of materially misleading statements to the market during theclass period, thereby artificially inflating the price of the Company’s stock,and that plaintiff, who is not identified in the press release, seeks torecover damages on behalf of all acquirers of the Company’s stock during theclass period.  The Company has not beenserved with, nor seen the complaint as of the time of this filing.

 

50

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**SCHEDULEII****MONTEREY PASTA COMPANYVALUATION AND QUALIFYING ACCOUNTS**

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

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

 
|                                                                               |   | **Balance,  Beginning  of 2002** |    | **Additions  -  Charged to  Costs and  Expense** |   | **Deductions  -  Write-offs  Charged to  Reserves** |   | **Balance,  End of  2002** |      |
|------------------------------------------------------------------------------------|--------|----------------------------------|---------|--------------------------------------------------|--------|-----------------------------------------------------|--------|----------------------------|-----------|
|                                                                               |   |                             |    |                                             |   |                                                |   |                       |      |
| Allowances  against Receivables —  Spoils, Returns, Adjustments and Bad Debts |   | $                                | 305,483 |                                             | $      | 2,564,897                                           |   | $                          | 2,343,031 |   | $ | 527,349 |   |
|                                                                               |   |                             |    |                                             |   |                                                |   |                       |      |
| Inventory  Reserves —  Spoils and Obsolescence                                |   | 27,500                           |    | 42,000                                           |   | —                                              |   | 69,500                     |      |
|                                                                                    |        |                                  |         |                                                  |        |                                                     |        |                            |           |  |  |  |  |

 

51

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**SIGNATURES**

 

Pursuant to the requirementsof Section 13 of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized, in the city of San Francisco, State of California, on the 14thday of February,****2002

 
|   | MONTEREY PASTA COMPANY |
|--------|------------------------|
|   |                   |   |
|   |                   |   |
|   | By:                    | /s/ James. M. Williams |   |
|   |                   | James M. Williams |
|   |                   | President and Chief  Executive Officer |
|   |                   |   |
|   |                   |   |
|   | By:                    | /s/ STEPHEN L. BRINKMAN |   |
|   |                   | Stephen L. Brinkman |
|   |                   | Chief Financial Officer |
|        |                        |  |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons in the capacities indicated and on thedates indicated.

 
| **Name**                 |   | **Title**                |   | **Date**          |
|--------------------------|--------|--------------------------|--------|-------------------|
|                     |   |                     |   |              |
| /s/R. LANCE HEWITT       |   | Chairman and Director    |   | February 12, 2003 |
| R. Lance Hewitt          |   |                     |   |              |
|                     |   |                     |   |              |
| /s/CHARLES B. BONNER     |   | Director                 |   | February 12, 2003 |
| Charles B. Bonner        |   |                     |   |              |
|                     |   |                     |   |              |
| /s/F. CHRISTOPHER CRUGER |   | Director                 |   | February 12, 2003 |
| F. Christopher Cruger    |   |                     |   |              |
|                     |   |                     |   |              |
| /s/MICHAEL P. SCHALL     |   | Director                 |   | February 12, 2003 |
| Michael P. Schall        |   |                     |   |              |
|                     |   |                     |   |              |
| /s/VAN TUNSTALL          |   | Director                 |   | February 12, 2003 |
| Van Tunstall             |   |                     |   |              |
|                     |   |                     |   |              |
| /s/JAMES WONG            |   | Director                 |   | February 12, 2003 |
| James Wong               |   |                     |   |              |
|                     |   |                     |   |              |
| /s/WALTER L. HENNING     |   | Director                 |   | February 12, 2003 |
| Walter L. Henning        |   |                     |   |              |
|                     |   |                     |   |              |
| /s/R. LANCE HEWITT       |   | Chairman of the Board    |   | February 12, 2003 |
| R. Lance Hewitt          |   |                     |   |              |
|                     |   |                     |   |              |
| /s/STEPHEN L. BRINKMAN   |   | Chief Financial Officer, |   | February 12, 2003 |
| Stephen L. Brinkman      |   | Secretary, and Director  |   |              |

 

52

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**CERTIFICATIONS**

 

I, James M. Williams certify that:

 

1.                                       Ihave reviewed this annual report on Form 10-K of Monterey Pasta Company (the“Registrant”);

 

2.                                       Basedon my knowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report; and

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report.

 

4.                                       Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a) designed such disclosure controls and proceduresto ensure that material information relating to the Registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

(b) evaluated the effectiveness of the Registrant’sdisclosure controls and procedures as of February 6, 2003; (the “EvaluationDate”) and

 

(c) presented in this annual report our conclusionsabout the effectiveness of the Registrant’s disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the Registrant’s auditors and the audit committee of theRegistrant’s board of directors:

 

(a) all significant deficiencies in the design oroperation of disclosure controls and procedures which could adversely affectthe Registrant’s ability to record, process, summarize and report financialdata and have identified for the Registrant’s auditors any material weaknesses indisclosure controls and procedures; and

 

(b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the Registrant’sdisclosure controls and procedures; and

 

6.                                       TheRegistrant’s other certifying officer and I have indicated in this annualreport whether or not there were significant changes in disclosure controls andprocedures or in other factors that could significantly affect the disclosurecontrols and procedures subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: February 12, 2003 | /s/ James M. Williams                    |   |
|-------------------------|------------------------------------------|--------|
|                    | James M. Williams                        |
|                    | *President  and Chief Executive Officer* |

 

53

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I, Stephen L. Brinkman, certify that:

 

1.                                       Ihave reviewed this annual report on Form 10-K of Monterey Pasta Company (the“Registrant”);

 

2.                                       Basedon my knowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report; and

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report.

 

4.                                       Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a) designed such disclosure controls and proceduresto ensure that material information relating to the Registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

(b) evaluated the effectiveness of the Registrant’sdisclosure controls and procedures as of February 6, 2003; (the “EvaluationDate”) and

 

(c) presented in this annual report our conclusionsabout the effectiveness of the Registrant’s disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the Registrant’s auditors and the audit committee of theRegistrant’s board of directors:

 

(a) all significant deficiencies in the design oroperation of disclosure controls and procedures which could adversely affectthe Registrant’s ability to record, process, summarize and report financialdata and have identified for the Registrant’s auditors any material weaknessesin disclosure controls and procedures; and

 

(b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the Registrant’sdisclosure controls and procedures; and

 

6.                                       TheRegistrant’s other certifying officer and I have indicated in this annualreport whether or not there were significant changes in disclosure controls andprocedures or in other factors that could significantly affect the disclosurecontrols and procedures subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: February 12, 2003 | /s/ Stephen L. Brinkman    |   |
|-------------------------|----------------------------|--------|
|                    | Stephen L. Brinkman        |
|                    | *Chief  Financial Officer* |

 

54

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|   | **Index to Exhibits**                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1    | Certificate  of Incorporation dated August 1, 1996 (incorporated by reference from Exhibit  B to the Company’s 1996 Proxy)                                                                                                                                                                                                                                                                                   |
| 3.2    | Bylaws  of the Company (incorporated by reference from Exhibit C to the 1996 Proxy)                                                                                                                                                                                                                                                                                                                               |
| 4.1    | Form  of Warrant for purchase of the Company’s Common Stock, dated as of July 1,  1996 (incorporated by reference from Exhibit 4.5 filed with the Company’s  1996 Form S-3)                                                                                                                                                                                                                             |
| 4.2    | Form  of Registration Rights Agreement dated April 1996, among the Company, Spelman  & Co., Inc. and investor (incorporated by reference from Exhibit 10.42  filed with the Company’s Original March 31, 1996 Quarterly Report on Form  10-Q on May 1, 1996 (“1996 Q1 10-Q”))                                                                                                                  |
| 4.3    | Stockholder  Rights Agreement dated as of May 15, 1996 between the Company and Corporate  Stock Transfer, as rights agent (incorporated by reference from Item 2 of  Form 8-A filed with the Securities and Exchange Commission on May 28, 1996)                                                                                                                                                                  |
| 4.4    | Amendment  to Registration Rights Agreement dated as of April 20, 1997 among the  Company, Spelman & Co., Inc. and investor, amending the Registration  Rights Agreement entered into as of April, 1996 (incorporated by reference  from Exhibit 4.9 filed with the Company’s 1996 Form 10-KA)                                                                                                           |
| 4.5    | Registration  Rights Agreement dated as of December 31, 1996 among the Company, Sentra  Securities Corporation and investor (incorporated by reference from Exhibit  4.12 filed with the Company’s 1996 Form 10-K/A)                                                                                                                                                                                         |
| 4.6    | Form  of Warrant (“Sentra Warrant”) for purchase of Company’s Common stock dated  March 1997 issued in connection with the Company’s March 1997 Private  Placement  (incorporated by reference  from Exhibit 4.13 filed with the Company’s Pre-Effective Amendment No. 1 to  the Registration Statement on Form S-3 filed on May 6, 1997 (“1997 Amendment  No. 1 to Form S-3)) |
| 4.7*   | Stock  Purchase Agreement between the Company and Kenneth A. Steel, Jr. dated April  29, 1997 (incorporated by reference from Exhibit 4.14 filed with the 1997  Amendment No. 1 to Form S-3)                                                                                                                                                                                                                      |
| 10.1*  | Second  Amended and Restated 1993 Stock Option Plan (as amended on August 1, 1996)  (incorporated by reference to Exhibit 10.1 filed with the Company’s 1996 Form  10-K)                                                                                                                                                                                                                                     |
| 10.2*  | 1995  Employee Stock Purchase Plan (incorporated by reference from Exhibit 10.15 to  the Company’s 1994 Form 10-K)                                                                                                                                                                                                                                                                                           |
| 10.3   | Monterey  County Production Facility Lease of the Company, as amended (incorporated by  reference from Exhibit 10.03 to the SB-2)                                                                                                                                                                                                                                                                                 |
| 10.4   | Amendment  No. 1 dated February 1, 1995 and Amendment No. 2 dated March 1, 1995 to  Monterey County Production Facility Lease of the Company (incorporated by  reference from Exhibit 10.6 filed with the 1995 Form 10-K)                                                                                                                                                                                         |
| 10.5   | Amendment  No. 3 dated September 12, 1997, and Amendment No. 4 dated February 6, 1999 to  Monterey County Production Facility Lease of the Company (incorporated by  reference from Exhibit 10.5 filed with the Company’s September 27, 1999  Quarterly Report on Form 10-Q dated November 4, 1999 (“1999 Q3 10-Q”))                                                                          |
| 10.6   | Trademark  Registration — MONTEREY PASTA COMPANY, under Registration No. 1,664,278,  registered on November 12, 1991 with the U.S. Patent and Trademark Office  (incorporated by reference from Exhibit 10.09 to the SB-2)                                                                                                                                                                                   |
| 10.7   | Trademark  Registration — MONTEREY PASTA COMPANY, under Registration No. 1,943,602,  registered on December 26, 1995 with the U.S. Patent and trademark Office  (incorporated by reference from Exhibit 10.24 to the 1995 Form 10-K)                                                                                                                                                                         |
| 10.8   | Trademark  Registration — MONTEREY PASTA COMPANY and Design, under Registration No.  1,945,131, registered on January 2, 1996 with the U.S. Patent and trademark  Office (incorporated by reference from Exhibit 10.25 to the 1995 Form 10-K)                                                                                                                                                                |
| 10.9   | Trademark  Registration-MONTEREY PASTA COMPANY and Design, under Registration No.  1,951,624, registered on January 23, 1996 with the U.S. Patent and Trademark  Office (incorporated by reference from Exhibit 10.26 to the 1995 Form 10-K)                                                                                                                                                                      |
| 10.10  | Trademark  Registration-MONTEREY PASTA COMPANY and Design, under Registration No.  1,953,489, registered on January 30, 1996 with the U.S. Patent and Trademark  Office (incorporated by reference from Exhibit 10.27 to the 1995 Form 10-K)                                                                                                                                                                      |
| 10.11  | Registration  Rights Agreement dated as of June 15, 1995 with GFL Advantage Fund Limited,  as amended on October 13 and 19, 1995, respectively (incorporated by reference  from Exhibit 10.2 to the 1995 Q2 10-Q, and Exhibits 10.6 and 10.7 to the  Company’s S-3 Registration Statement No. 33-96684, filed on December 12, 1995  (“1995 S-3”))                                                  |

 

55

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| 10.12* | The Company’s 401(k) Plan,  established to be effective as of January 1, 1996, adopted by the Board of  Directors on June 7, 1996 (incorporated by reference from Exhibit 10.44 to  the Company’s Quarterly Report on Form 10-Q on August 13, 1996 (“1996 Q2  10-Q”))                                |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.13* | Directed Employee  Benefit Trust Agreement dated June 17, 1996 between the Company and The  Charles Schwab Trust Company, as Trustee of the Company’s 401(k) Plan  (incorporated by reference from Exhibit 10.45 to the 1996 Q2 10-Q)                                                                               |
| 10.14  | Security and Loan  Agreement (Accounts Receivable and/or Inventory) dated July 24, 1997 between  the Company and Imperial Bank (incorporated by reference from Exhibit 10.47  of the Company’s Pre-Effective Amendment No. 3 to Form S-3 filed on October  14, 1997 (“1997 Amendment No. 3 to Form S-3”)) |
| 10.15* | Agreement Regarding  Employment, Trade Secrets, Inventions, and Competition dated May 26, 1997  with Mr. R. Lance Hewitt (incorporated by reference from Exhibit 10.48 of the  1997 Amendment No. 3 to Form S-3)                                                                                                         |
| 10.16* | Employment Agreement  dated August 25, 1997 with Mr. Stephen L. Brinkman (incorporated by reference  to Exhibit 10.49, in the Company’s September 28, 1997 Quarterly Report on  Form 10-Q filed on November 10, 1997)                                                                                               |
| 10.17  | First Amendment to  Security and Loan Agreement dated July 24, 1997 between the Company and  Imperial Bank (incorporated by reference from Exhibit 10.50 in the Company’s  1997 Form 10-K)                                                                                                                          |
| 10.18  | Second Amendment to  Security and Loan Agreement dated July 24, 1997 between the Company and  Imperial Bank (incorporated by reference from Exhibit 10.18 filed with the  Company’s 1998 Q3 10-Q)                                                                                                                   |
| 10.19  | Security and Loan  Agreement dated July 23, 1998 between the Company and Imperial Bank  (incorporated by reference from Exhibit 10.19 filed with the Company’s 1998  Q3 10-Q)                                                                                                                                       |
| 10.20  | Addendum to Security  and Loan Agreement dated July 23, 1998 between the Company and Imperial Bank  (incorporated by reference from Exhibit 10.20 filed with the Company’s 1998  Q3 10-Q)                                                                                                                           |
| 10.21  | Agreement for Handling  and Storage Services between the Company and CS Integrated LLC dated February  5, 1999 (incorporated by reference to Exhibit 10.21 filed with the Company’s  1998 Form 10-K on March 17, 1999 (“1998 Form 10-K”))                                                                 |
| 10.22  | Defined Contribution  Administrative Service Agreement between the Company and First Mercantile Trust  dated December 15, 1999 (incorporated by reference to Exhibit 10.22 filed  with the Company’s 1998 Form 10-K)                                                                                                |
| 10.23  | First Amendment to  Security and Loan Agreement and Addendum thereto between the Company and  Imperial Bank dated July 23, 1999 (incorporated by reference to Exhibit 10.23  filed with the Company’s April 1, 2001 Quarterly Report on Form 10-Q filed on  April 28, 1999)                                         |
| 10.24  | Agreement for Purchase  and Sale of Assets dated as of March 12, 1999, by and among the Company and  the shareholders of Frescala Foods, Inc. (incorporated by reference from  Exhibit 2.1 filed with the Company’s 8-K on March 17, 1999)                                                                          |
| 10.25  | Royalty agreement dated  July 12, 1999 between Company and Chet’s Gourmet Foods, Inc. for soups  (incorporated by reference to Exhibit 10.25, in the Company’s September 26,  1999 Quarterly Report on Form 10-Q filed on November 9, 1999 (“1999 Q3  10-Q”))                                        |
| 10.26  | Storage Agreement  Manufactured Products dated August 3, 1999 between the Company and Salinas  Valley Public Warehouse for storage and handling of Company’s product in  Monterey County, California storage facility (incorporated by reference to  Exhibit 10.26, filed with the Company’s 1999 Q3 10-Q)     |
| 10.27  | Commercial Lease dated  August 10, 1999 between Company and Salinas Valley Public Warehouse for  storage space in Monterey County, California (incorporated by reference to  Exhibit 10.27, filed with the Company’s 1999 Q3 10-Q)                                                                                  |
| 10.28  | Rental Agreement dated  September 6, 1999 between Company and Porter Family Trust for storage space  in Monterey County, California (incorporated by reference to Exhibit 10.28  filed with the Company’s 1999 Q3 10-Q)                                                                                             |
| 10.29  | Royalty agreement dated  September 15, 1999 between Company and Chet’s Gourmet Foods, Inc. for  meatball and sauce item (incorporated by reference to Exhibit 10.29, filed  with the Company’s 1999 Q3 10-Q)                                                                                                   |
| 10.30  | Credit Agreement  between the Company and Imperial Bank dated August 2, 1999 (incorporated by  reference to Exhibit 10.30 filed with the Company’s 1999 Form 10-K on  February 18, 2001 (“1999 Form 10-K”))                                                                                               |
| 10.31  | First Amendment to  Credit Agreement between the Company and Imperial Bank dated August 2, 1999  (incorporated by reference to Exhibit 10.21 filed with the Company’s 1999  Form 10-K)                                                                                                                              |

 

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| 10.32 | Commercial lease dated  January 1, 2001 between the Company and PTF for Operating Engineers, LLC for  storage space in Monterey County, California (incorporated by reference to  Exhibit 10.32, in the Company’s June 25, 2001 Quarterly Report on Form 10-Q  filed on August 4, 2001)        |
|-------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.33 | Second Amendment to  Credit Agreement between the Company and Imperial Bank dated August 2, 1999  (incorporated by reference to Exhibit 10.33 in the Company’s September 25,  2001 Quarterly Report on Form 10-Q filed on November 6, 2001 (“2001 Q3  10-Q”))                        |
| 10.34 | Third Amendment to  Credit Agreement between the Company and Imperial Bank dated August 2, 1999  (incorporated by reference to Exhibit 10.34 in the Company’s 2001 Q3 10-Q)                                                                                                                    |
| 10.35 | Royalty agreement dated  February 11, 2001 between Company and William Naim for development of pizza  and calzone recipes and process (incorporated by reference to Exhibit 10.35  filed with the Company’s 2001 Form 10-K on February 7, 2001 (“2001 Form  10-K”))                  |
| 10.36 | Fourth Amendment to  Credit Agreement between the Company and Imperial Bank dated August 2, 1999  (incorporated by reference to Exhibit 10.36 filed with the Company’s 2001  Form 10-K)                                                                                                        |
| 10.37 | Asset Purchase  Agreement dated as of December 8, 2001, by and among the Company and the  shareholders of Elena’s Food Specialties, Inc. (incorporated by reference to  Exhibit 10.37 filed with the Company’s 2001 Form 10-K)                                                            |
| 10.38 | Limited License for use  of Nate’s brand dated as of December 8, 2001, by and among the Company and  the shareholders of Elena’s Food Specialties, Inc. (incorporated by reference  to Exhibit 10.38 filed with the Company’s 2001 Form 10-K)                                        |
| 10.39 | Fifth Amendment to  Credit Agreement between the Company and Imperial Bank dated August 2, 1999  (incorporated by reference to Exhibit 10.39 in the Company’s April 1, 2001  Quarterly Report on Form 10-Q filed on May 7, 2001)                                                          |
| 10.40 | Lease Extension and  Modification Agreement between the Company and Marco Warehouse d.b.a. Salinas  Valley Public Warehouse dated September 1, 2001 (incorporated by reference to  Exhibit 10.40 in the Company’s September 30, 2001 Quarterly Report on Form  10-Q filed on November 7, 2001) |
| 10.41 | Royalty Agreement dated  January 18, 2002 between Company and Toscana Foods, LLC for ravioli with  unique rough chopped filling (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)                            |
| 10.42 | Asset Purchase  Agreement dated August 23, 2002 by and among the Company and the shareholders  of Emerald Valley Kitchen, Inc. (incorporated by reference from Exhibit 10.42  filed with the Company’s 8-K on August 30, 2002)                                                                 |
| 10.43 | Commercial lease dated  August 23, 2002 between the Company and Mel Bankoff for plant, warehouse and  office space in Eugene, Oregon (incorporated by reference from Exhibit 10.43  filed with the Company’s 8-K on August 30, 2002)                                                           |
| 10.44 | Commercial lease dated  January 3, 2003 between the Company and Conrad Family Trust for office space  in Salinas, Monterey County, California                                                                                                                                                       |
| 23.1  | Consent of BDO Seidman,  LLP                                                                                                                                                                                                                                                                        |
| 99.1  | 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                                                                                                                                                 |
| 99.2  | 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                                                                                                                                                 |

 

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

 

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