UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON DC 20549

                                    FORM 10-K
(Mark one)
----------
[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934
        For the fiscal year ended December 31, 2006
                                       OR
[ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934
        FOR THE TRANSITION PERIOD FROM _____________ TO _____________

                        Commission file number 001-11777

                          MONTEREY GOURMET FOODS, INC.
             (Exact name of registrant as specified in its charter)

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


       1528 Moffett Street , Salinas, California                93905
       -----------------------------------------              ----------
        (Address of Principal Executive Offices)              (Zip Code)

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

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

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


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

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

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

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

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

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

     Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ]   Accelerated Filer [ ]   Non-accelerated filer [X]

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

The approximate aggregate market value of the voting and non-voting common
equity held by non-affiliates of the issuer as of June 30, 2006 was $37,346,000.
The number of shares outstanding of the issuer's common stock as of March 21,
2007 was 17,323,025.
<PAGE>

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<CAPTION>
TABLE OF CONTENTS


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PART I.                                                                                                 Page
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<S>               <C>                                                                                    <C>
         Item 1.  Business                                                                               3
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         Item 1A. Risk Factors                                                                           9
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         Item 1B. Unresolved Staff Comments                                                              12
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         Item 2.  Properties                                                                             12
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         Item 3.  Legal Proceedings                                                                      12
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         Item 4.  Submission of Matters to a Vote of Securities Holders                                  12
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PART II.
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         Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer          12
                  Purchases of Equity Securities
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         Item 6.  Selected Financial Data                                                                14
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         Item 7.  Management's Discussion and Analysis of Financial Condition and Results of             15
                  Operations
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         Item 7A. Quantitative and Qualitative Disclosures about Market Risk                             26
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         Item 8.  Financial Statements and Supplementary Data                                            27
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         Item 9.  Changes In and Disagreements with Accountants on Accounting and Financial              27
                  Disclosure
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         Item 9A. Controls and Procedures                                                                27
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         Item 9B. Other Information                                                                      28
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PART III.
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         Item 10. Directors and Executive Officers of the Registrant                                     28
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         Item 11. Executive Compensation                                                                 30
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         Item 12. Security Ownership of Certain Beneficial Owners and Management and Related             37
                  Stockholder Matters
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         Item 13. Certain Relationships and Related Transactions                                         39
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         Item 14. Principal Accountant Fees and Services                                                 39
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PART IV.
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         Item 15. Exhibits, Financial Statement Schedules                                                40
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                                                  41
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SIGNATURES                                                                                               71
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EXHIBIT 23.1                                                                                             74
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EXHIBIT 31.1                                                                                             75
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EXHIBIT 31.2                                                                                             76
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EXHIBIT 32.1                                                                                             77
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EXHIBIT 32.2                                                                                             78
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                                       2
<PAGE>

                                     PART I

ITEM 1.           BUSINESS

Information Concerning Forward-Looking Statements

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

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

Introduction

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

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

         The Company offers seven core brands in ten key categories over 250
varieties of contemporary gourmet food products that are produced using the
Company's proprietary recipes. In 2006, the Company continued to expand its line
and distribution of whole wheat pasta. The Company entered the frozen category
with its "OneStep Gourmet" product which offers consumers a complete meal in
less than 13 minutes. It also introduced several Hispanic products including two
flavors of premium tamales.

         On September 5, 2006, the Board of Directors of the Company appointed
Eric Eddings as President and Chief Executive Officer of Monterey Gourmet Foods
following the resignation of James M. Williams effective September 5, 2006. Mr.

                                       3
<PAGE>

Eddings has been the President of the Natural Foods Division of Monterey Gourmet
Foods; previously Mr. Eddings was the Chief Operating Officer and minority
shareholder of CIBO Naturals, LLC which he and his associates purchased in June
2002. CIBO Naturals was acquired by Monterey Gourmet Foods in January 2004 and
later became part of the Natural Foods Division of Monterey Gourmet Foods. Prior
to his employment with CIBO Naturals, Mr. Eddings was the Vice President
Wholesale/Plant operations of Tully's Coffee Corporation in Seattle, Washington.
Mr. Eddings has also previously worked for Dreyers Grand Ice Cream, Haagen -
Dazs Company and Frito Lay, Inc. Mr. Eddings has a Masters of Business
Administration degree from the University of Redlands and a Bachelors of Arts
degree in Business Administration from California State University at Fullerton.

         On January 12, 2006, Monterey Gourmet Foods, Inc. ("Monterey"), Suekat
LLC ("Suekat") and CIBO Naturals, LLC ("CIBO"), amended their previous agreement
for the purchase and sale of limited liability company units, as a result of
which Monterey acquired the remaining 15.5% of CIBO from Suekat in exchange for
300,000 unregistered shares of Monterey common stock with a market value of $1.2
million. CIBO Naturals LLC ("CIBO"), a leading manufacturer of premium sauces
and spreads located in Seattle, Washington, produces a variety of refrigerated
gourmet sauces and spreads including fresh pesto sauces, flavored cheeses,
bruschetta toppings and tapenade spreads. Their products are sold nationally
through club stores, supermarket delis and specialty food stores. The CIBO
acquisition continues to meet the Company's strategy for growth in the premium
refrigerated foods category. CIBO, through its "CIBO Naturals" brand, sells
unique, high quality products and has developed a strong position in its markets
which has great growth potential in both expanded distribution and in new
products. The brand has been fully integrated into Monterey Gourmet Foods.

         On November 3, 2006, Monterey Gourmet Foods, Inc., Casual Gourmet
Foods, Inc. ("Casual"), and the shareholders of Casual ("Shareholders")
completed the agreement entered into on September 29, 2006 (the "Amendment") to
amend the Purchase Agreement dated January 11, 2005, pursuant to which the
Company agreed to acquire all of the outstanding shares of Casual. Prior to
entry into the Amendment, the Company owned 70% of the outstanding shares of
Casual. The Amendment accelerated the Company's purchase of the remaining 30% of
Casual's outstanding shares and established a revised purchase price of $23,000.
The Company sells a line of refrigerated gourmet chicken sausages under the
Casual Gourmet Foods brand. The Company is also utilizing the Casual Gourmet
Foods brand to market other refrigerated and frozen products to its customers.

         On April 7, 2005, the Company purchased 80% of Sonoma Foods, Inc.
("Sonoma") outstanding shares. Sonoma markets a variety of refrigerated branded
specialty cheese items, including their flagship products, Sonoma Jack Cheeses
in a variety of flavors. Sonoma's products are sold in retail supermarkets, club
stores, and specialty food stores across the US with the greatest penetration in
the Western US markets. Some of the most popular cheese flavors include Hot
Pepper Jack Cheese, Garlic Jack Cheese, Mediterranean Jack Cheese and Pesto Jack
Cheese. Sonoma maintains its headquarters in Sonoma, CA.

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

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

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


Industry Overview

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

                                       4
<PAGE>

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

         The California Milk Advisory Board stated that Americans consumed 9.3
billion pounds of cheese in 2005. Cheese consumption has increased from 11.1
pounds per person in 1987 to 31.4 pounds in 2005. The specialty cheese category
in which the Company competes has grown from 420 million pounds consumed in 1994
to 930 million pounds in 2005. Specialty cheeses represent almost 10% of all
cheese consumed in the United States. The Company believes this is a growing
category and that Sonoma Cheese is well positioned to grow with this category
and also expand market share.

         Starting in 2005, consumers have increased consumption of refrigerated
pasta products following two years of decline due to in-part to low-carbohydrate
diets. The refrigerated pasta category continued to grow in 2006 because of the
gourmet quality of these products and their quick preparation. Monterey Gourmet
Foods believes its products are well positioned to take advantage of the growing
trend to more gourmet food products.

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


Strategy

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

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

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

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

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

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

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

                                       5
<PAGE>

         The Company will continue to direct its advertising and promotional
activities to specific programs customized to suit its grocery and club store
accounts as well as to reach target consumers. These will include in-store
demonstrations, coupon programs, temporary price reduction promotions, cross
promoting of products, and other related activities. There can be no assurance
that the Company will be able to increase its net revenues from grocery and club
stores. Because the Company will continue to make expenditures associated with
the expansion of its business, the Company's results of operations may be
affected.

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


Products

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

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

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

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


Production

         The Company currently produces pasta, pasta sauce and tamales in a
43,700 square foot Monterey County, California facility. The Company also leases
87,100 square feet of space three miles from the main production facility.
Within this 87,100 square foot facility, the Company has its refrigerated
distribution center and ambient storage. In addition, the Company produces
organic salsas, dips, and hummus at its 19,000 square foot organically certified
facility in Eugene, Oregon, which was integrated into the business as part of
the Emerald Valley acquisition. CIBO Naturals LLC operates out of three
different facilities comprising of a total of 47,500 square feet in Seattle, WA.
The California facilities are strategically located in one of the largest
produce-growing regions in the United States and are near several major vendors
and food distributors. The California facility is certified by the USDA and
utilizes state of the art thermal processing, chilling and packaging processes.

         Refrigerated pasta is manufactured at the California facilities using
high quality ingredients such as Extra Fancy Durham Wheat Flour, whole eggs,
fresh and dry herbs and spices, Individually Quick Frozen ("IQF") vegetables,
chicken and other proteins, various fresh cheeses, and milk products. The
ingredients are mixed in accordance with the Company's proprietary recipes.
After filling with fresh and unusual ingredients such as snow crab, spinach,
feta cheese, lobster, chicken, and other types of specialty cheeses, the pasta

                                       6
<PAGE>

products receive a prescribed thermal process, or pasteurization to insure
product safety and to preserve flavor, quality and shelf life. The products are
then chilled immediately and packaged in controlled atmosphere trays. Pasta
sauces, salsas, dips, and spreadable cheeses are mixed and processed in
individual batches in accordance with the Company's proprietary processes and
recipes and then directly packed and sealed in plastic containers. The new
"quick preparation" baked entrees are baked in new rotary tray ovens. After
preparation, processing, chilling and packaging, all pasta, baked entrees, and
sauces are kept in cold storage to preserve quality and shelf life. Cheeses and
sausages are produced and packaged by outside companies under agreements to
protect recipes and provide the quality that the Company requires.

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

         The Company regularly reviews a variety of potential capital projects
for the production department and in the past three years has spent
approximately $4.9 million on capital improvements. These included significant
upgrades and improvements to the pasta production lines, two packaging lines,
capacity for chunky ravioli, clean rooms, increased sauce capacity and
efficiency, and boiler and utility upgrades to accommodate capacity increases.
Capital resources were used to improve borsellini pasta production capability,
increase tamale production capacity, and combine the two Salinas production
facilities. In 2006, the Company increased capacity on its tamale production
line, consolidated the two manufacturing plants in Salinas, added new pasta
packaging equipment, added new cup filling equipment in Eugene, OR and Seattle,
WA, and increased capacity in the Seattle facility to manufacture cooked/chilled
sauces. Future additions of assets will be evaluated for increased efficiency,
flexibility and capacity needs.

Raw Materials

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

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

Distribution

         The Company's success depends upon an effective system of distribution
for its products. The Company delivers products directly to warehouses for
several Northern California chains. Sonoma Cheese delivers certain cheese
products to local wineries on Company trucks and these deliveries arrive the
same day they leave our warehouse. The Company distributes its products to other
customers and other parts of the country using common carriers. While common
carrier method of delivery has been reliable, there can be no assurance that the
Company's delivery system will not be disrupted for reasons including, but not
limited to, adverse weather, natural disasters, increasing fuel oil, or labor
disputes in the trucking industry. During 2004, 2005, and 2006 fuel costs
increased compared to previous years, which impacted the Company's operating
margins.

Grocery Chain and Club Store Sales

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

                                                     Years Ended
                                     ------------------------------------------
                                         2006            2005             2004
                                     ------------------------------------------

         Costco                           48%             45%              36%

         Sam's Club Stores                17%             17%              24%

         All other customers              35%             38%              40%
                                     ------------------------------------------

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

                                       7
<PAGE>

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

         The Company currently supplies its products to Sam's Club stores where
the purchasing decisions are made at the company headquarters with input from
the store level. During the 4th quarter of 2004 Sam's Club implemented an item
reduction program which reduced the number of items that the Company sells to
Sam's Club and correspondingly has reduced the amount of shelf space for the
Company's products. During 2005, the Company spent significant resources
increasing sales to Sam's Club. While the Company is in the ninth year of its
relationship with Sam's Club, there can be no assurance that Sam's Club stores
will continue to carry its products. The loss of either Costco or Sam's Club as
customers could materially and adversely affect the Company's business
operations.

         During 2006, 2005 and 2004 net revenues to foreign customers
represented 1.4%, 2.2% and 3.4% of total net revenues, with Canada and Mexico
accounting for over 90% of those sales, and the remainder going to Asia Pacific.

Marketing

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

Competition

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

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

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

Management

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

Government Regulation

         The Company is subject to the regulations of the U.S. Food and Drug
Administration ("FDA"), USDA, state, local, and organic industry regulations
relating to cleanliness, maintenance of food production equipment, food storage,
cooking and cooling temperatures, food handling, and organic ingredient content
of products, and is subject to unannounced on-site inspections of production
facilities. Regulations in new markets, new regulations in existing markets, and
future changes in existing regulations may adversely impact the Company by
raising the cost of production and delivery of its products and/or by affecting
the perceived healthfulness of the Company's products. Effective January 2006,
all food products were required to declare the content of "trans fatty acids" on
individual labels. The Company has complied with this requirement and has
declared that its products contain no trans fatty acids. A failure to comply
with one or more regulatory requirements could result in a variety of sanctions,
including fines and the withdrawal of the Company's products from store shelves.

                                       8
<PAGE>

The Company is not aware of any currently existing facts or circumstances that
it is not addressing which would cause it to fail to comply with any of the
regulations to which it is currently subject.

Seasonality of Revenues

         During 2006, 24% of the Company's revenues were generated in the first
quarter, 25% were generated in the second quarter, 23% in the third quarter and
28% in the fourth quarter. The seasonality of the Company's revenues continues
to change as different product lines have different seasonality profiles. In the
fourth quarter of 2006, the Company had increased revenues of tamales, dips, and
cheese trays which sell well during the holiday season when consumers entertain.
Pasta items sell less during the summer and more during winter months.
Conversely, chicken sausages have higher revenues during the summer months.


Employees

         As of December 31, 2006, the Company employed a total of 299 persons at
all locations, including 57 administrative personnel, 13 sales personnel, 4
drivers, and 225 distribution and production personnel. None of the Company's
employees are represented by a labor union and the Company believes its
relations with its employees are good.

Trademarks and Service Marks

         The Company or its subsidiaries has registered the "Monterey Pasta
Company", "CIBO Naturals", "Sonoma", "Sonoma Jack", "Casual Gourmet",
"Borsellini", and "Homestyle Fresh Soups" names and, in the case of Monterey
Pasta Company, corresponding logo design with the United States Patent and
Trademark Office. The Company is currently in the process of registering "One
Step gourmet", "Isabella's Kitchen", "Emerald Valley Kitchen" and "Chef's
Finest". There can be no assurance that competitors will not adopt similar names
or logo designs outside the protection of the Company's trademark registration.
In March of 1999, the Company acquired the right to use the "Arthur's" label
with its acquisition of the Frescala Foods, Inc. business. In December 2000, it
acquired the right to use the "Nate's" label through its acquisition of the
Nate's polenta business. Also the Company acquired the rights to the
unregistered trademarks, "La Frescala" as part of acquisitions of businesses.


ITEM 1A           RISK FACTORS

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

o    Lack of Recent Profitability. The Company reported losses for the years
     2005 and 2006 and at December 31, 2006, the Company had an accumulated
     deficit of $9,550,000. There can be no assurance that the Company will
     generate profits in the short or long term.

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

o    Acquisitions; Potential Impairment of Intangible Assets. The Company has
     acquired four companies since 2003. The Company as part of its assessment
     of its intangible assets impaired its intangible investment in Casual
     Gourmet Foods in the third quarter of 2006 by $3.1 million. There are no
     guarantees that additional investments may need to be written down in the
     future. The Company has recorded net intangible assets of $7.1 million and
     goodwill of $13.2 million as part of the acquisitions. Some of these
     intangible assets are amortized over a certain amount of time. If these
     assets become impaired, the assets will be expensed in the periods they
     become impaired which will impact profitability.

o    Hiring and Retention of Key Personnel. The success of the Company depends
     on its ability to retain key executives, and to motivate and retain other
     key employees and officers. Former CEO James Williams joined the Company in
     October 2002 and resigned his position in September 2006. Mr. Eric Eddings
     was named the Company's new CEO effective September 5, 2006. Scott Wheeler,
     the Company's CFO joined the Company in April 2003. Part of the Company's
     acquisition strategy is to maintain the current management of each acquired
     company and motivate them appropriately to help garner synergies and grow

                                       9
<PAGE>

     their respective brands. The Company's CEO and the management of Casual
     Gourmet and Sonoma Foods have employment contracts to help ensure the
     Company's future growth. There can be no assurance that key management will
     remain stable; significant management turnover could disrupt the Company's
     operations with consequent adverse effect on the business.

o    Material Weakness in Internal Controls. The Company's management evaluated
     the effectiveness of the Company's disclosure controls and procedures
     pursuant to Rule 13a-15(b) of the Exchange Act as of December 31, 2005. In
     its form 10-K for 2005, the Company reported a material weakness in
     internal control and stated that its controls and procedures were not fully
     effective. During 2006, the Company took steps to improve its internal
     controls and procedures and management has concluded that as of December
     31, 2006, these improvements were effective to eliminate the material
     weakness. (See Item 9A, which is incorporated here by reference.) If the
     weaknesses return or other weaknesses are identified, financial statement
     accuracy may be at risk.

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

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

o    Dependence on Major Customers. During 2006, two of the Company's customers,
     Costco and Wal-Mart (including its subsidiary, Sam's Club), accounted for
     48% and 17%, respectively, of the Company's total revenues. The Company
     currently sells its products to eight separate US Costco regions and its
     international regions which currently make purchasing decisions
     independently of one another. These regions re-evaluate, on a regular
     basis, the products carried in their stores. There can be no assurance that
     these Costco regions will continue to offer the Company's products in the
     future or continue to allocate Monterey Pasta the same amount of shelf
     space. There can be no assurance that Sam's Club will continue to carry the
     Company's products. Loss of either of these customers, Costco or Sam's
     Club, or a significant reduction in sales to either, would have a material
     adverse effect on the Company. Additionally, liberalized pricing or
     allowance terms would create downward pressure on gross margins.

o    Diversification of Product Line. Over the last four years, the Company has
     acquired four new subsidiaries. A major reason for the acquisitions is the
     diversification of the Company's gourmet food product line. Each
     acquisition brings new product lines, management talents and skills, and
     customers. There can be no assurance that the acquisition strategy will be
     profitable in the near or long term.

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

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

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

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

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

                                       10
<PAGE>

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

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

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

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

o    Sarbanes Oxley Act: The Company is also subject to the rules and
     regulations of the Securities and Exchange Commission and recently passed
     laws regarding publicly traded companies including the Sarbanes Oxley Act
     of 2002. The Company is not an accelerated filer and therefore is not yet
     required to comply with Section 404 of this Act which requires publication
     of an annual report by management, attested by the Company's registered
     public accounting firm assessing the effectiveness of the Company's
     internal controls and procedures for financial reporting. The Company spent
     $82,000 on consultants' fees plus a significant amount of internal
     resources documenting its internal controls in its efforts to become
     compliant with Sarbanes-Oxley Section 404. The Company believes that it
     will need to spend additional significant resources to become compliant
     with this Act.

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

o    Fluctuations in revenues due to natural disasters or other causes. The
     Company may experience sales fluctuations for many reasons, including
     variations in the mix of products sold, competitive factors, price changes,
     supply changes, weather-related disruptions, and other natural disasters.
     The Company's main operating facility is located where earthquakes are

                                       11
<PAGE>

     common and the Company lacks a viable plan to continue producing if a major
     natural disaster were to damage its operating plant. Sales may also
     fluctuate because of delays in introducing new products or customer delays
     in issuing purchase orders for new or current products.


ITEM 1B.          UNRESOLVED STAFF COMMENTS

                  Inapplicable


ITEM 2.           PROPERTIES

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

         In 2004, the Company purchased CIBO Naturals LLC which operates out of
three separate leased facilities comprising 47,540 square feet in Seattle, WA
part of which expires in May 2008. The facilities represent 20,300 square feet
of manufacturing space, 4,900 office space and 22,340 of warehousing space.

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

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


ITEM 3.           LEGAL PROCEEDINGS

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


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

         No matters were submitted to vote of the security holders during the
fourth quarter of 2006.


                                     PART II

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

Price Range of Common Stock

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

                                       12
<PAGE>

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

                        First quarter                   $3.93            $3.13

                        Second quarter                   3.38             2.87

                        Third quarter                    4.37             3.13

                        Fourth quarter                   4.80             3.84

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

                        First quarter                    4.40             3.76

                        Second quarter                   7.14             4.31

                        Third quarter                    5.60             3.68

                        Fourth quarter                   4.38             3.69

         As of February 1, 2007, there were 193 stockholders of record of the
Common Stock and approximately 3,600 investors with shares in street name.

Dividend Policy

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

Equity Compensation Plan

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

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

         The primary purpose of the accelerated vesting was to eliminate future
compensation expense the Company would otherwise recognize in its statement of
operations with respect to these accelerated options upon the adoption of SFAS
123R ("Share-Based Payment"). The acceleration of the vesting of these options
did not impact the Company's financial statements in 2005.

         The Company has also changed the vesting period of all stock options
issued after November 1, 2005 from a two year vesting period to a three year
vesting period. In addition, the Company has reduced the size of the pool of
employees eligible to receive stock options in order to reduce the overall
Company's stock-based compensation expense.

Comparison of Stockholder Return

         Set forth below is a line graph comparing the annual percentage change
in the cumulative total return on the Company's Common Stock with the cumulative
total return of the NASDAQ Global Market Index (U.S. Companies) and peer issuers
for the period commencing on December 31, 2001 (1) and ending on December 31,
2006.

Comparison of Cumulative Total Return from December 31, 2001 through December
31, 2006:

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

                                       13
<PAGE>



                               [GRAPHIC OMITTED]



<TABLE>
<CAPTION>

                              Dec. 31,   Dec. 31,   Dec. 26,   Dec. 23,   Dec. 30,   Dec. 30,
                              --------   --------   --------   --------   --------   --------
                                2001       2002       2003       2004       2005       2006
                                ----       ----       ----       ----       ----       ----
<S>                               <C>         <C>       <C>        <C>        <C>        <C>
Monterey Gourmet Foods            100.0       50.3       46.9       43.2       54.0       58.7
NASDAQ Stock Market (U.S.)        100.0       69.1      101.9      111.7      114.9      126.2
Peer Issuers                      100.0       80.0       90.3       83.4      100.5      118.5
</TABLE>


ITEM 6.           SELECTED FINANCIAL DATA

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

                                       14
<PAGE>

<TABLE>
<CAPTION>
                                                                                          Years Ended
                                                       ---------------------------------------------------------------------------
                                                            2006                  2005          2004          2003          2002
                                                       ---------------------------------------------------------------------------
                                                                    (dollar amounts in thousands except per share data)
<S>                                                    <C>                   <C>           <C>           <C>           <C>
Consolidated Statements of Operations Data:
Net revenues                                           $    94,297           $    85,248   $    62,491   $    60,490   $    61,679
Gross profit                                                27,439  (b)           23,232        16,468        18,569        22,262
SG&A                                                        26,754  (b)           23,590        18,224        17,161        15,654
Operating income (loss)                                     (2,462)   (a) (b)       (358)       (1,761)        1,408         6,540
Net income (loss)                                           (3,112)   (a) (b)       (537)       (1,344)        1,035         9,491

Basic net income per common share                           ($0.19) (b)           ($0.04)       ($0.09)        $0.07         $0.68
Diluted income per common share                             ($0.19) (b)           ($0.04)       ($0.09)        $0.07         $0.65

Weighted average basic shares outstanding               16,100,250            14,450,251    14,343,386    14,206,627    14,039,902
Weighted average diluted shares outstanding             16,100,250            14,450,251    14,343,386    14,414,931    14,664,762


                                                                                          Years Ended
                                                       ---------------------------------------------------------------------------
                                                            2006                  2005          2004          2003          2002
                                                       ---------------------------------------------------------------------------
                                                                                (dollar amounts in thousands)

Consolidated Statements of Income Data as Percent of Net Revenues
Net revenues                                                 100.0%                100.0%        100.0%        100.0%        100.0%
Gross profit                                                  29.1%                 27.3%         26.4%         30.7%         36.1%
SG&A                                                          28.4%                 27.7%         29.2%         28.4%         25.4%
Operating income (loss)                                       (2.6)%                (0.4)%        (2.8)%         2.3%         10.6%
Net income (loss)                                             (3.3)%                (0.6)%        (2.2)%         1.7%         15.4%

Consolidated Balance Sheet Data:
Working capital                                             $11,496                $5,019        $7,753       $16,704       $16,880
Total assets                                                $62,468               $62,205       $46,873       $44,204       $43,799
Total debt and capital lease obligations                     $1,147               $13,654        $2,459            $3           $17
Stockholders' equity                                        $50,263  (b)          $39,110       $39,216       $40,035       $38,941
</TABLE>

     (a)  Includes a loss on impairment of Casual Gourmet intangible assets of
          $3,160.
     (b)  For the year ended December 31, 2006, includes stock-based
          compensation expense related to the adoption of SFAS No. 123(R).

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

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

Background

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

         The Company's product distribution to grocery and club stores increased
from approximately 25 stores as of December 1989, to over 10,200 stores by
December 31, 2006. During recent years the Company added retail and club
distribution through internal growth and through the Frescala Foods, Nate's,
Isabella's Kitchen, Emerald Valley Kitchen, CIBO, Sonoma Cheese, and Casual
Gourmet acquisitions. In 2004, the Company's shareholders approved the change of
the name of the Company to Monterey Gourmet Foods, Inc. The name change was made

                                       15
<PAGE>

to define the Company's strategic direction more accurately. The name change
also announces to the investor community, our customers and consumers, our
strategic direction to become a complete supplier of gourmet refrigerated foods.

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

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

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

         In the fourth quarter of 2005, Casual Gourmet saw a significant
reduction in its sales to its two largest customers, Costco and Sam's Club. The
Company took many steps to restore the sales to these two major customers,
including the introduction of such items as Anti-Biotic free ("ABF") all white
meat chicken sausages, nitrite free chicken sausages, sausages made with organic
chicken, flavored pork sausages, and other products that fit under the Casual
Gourmet label. The Company also introduced these products into the retail market
place through Monterey Gourmet Foods' retail sales force. In the spring of 2006,
these new items restored Casual's sales to its level of sales of the prior year
and therefore the Company did not impair its intangible assets. However, between
the dates of August 15, 2006 and September 9, 2006, the Company was informed
that these new items would be discontinued in select divisions of Costco.

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

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

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

Operations for 2006, 2005 and 2004

         Net revenues were as follows (in `000s):

                                       16
<PAGE>

<TABLE>
<CAPTION>
                                                                                      Years Ended
                                                                     ---------------------------------------------
                                                                           2006            2005            2004
                                                                     ---------------------------------------------
<S>                                                                      <C>             <C>             <C>
         Net Revenues                                                    $ 94,297        $ 85,248        $ 62,491

         Percent change in net revenues from prior year                        11%             36%              3%
</TABLE>

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

         During 2006, 2005 and 2004 the Company reduced net revenues by
$363,000, $351,000 and $226,000 respectively for costs associated with placement
of product in new stores in various locations.

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

         In addition, Casual Gourmet, the specialty poultry sausage and soup
marketer experienced several setbacks of product distribution and sales with its
two largest customers during the fourth quarter of 2005. In both cases, losses
were related to the customer's change in merchandising strategy and increased
competition within the poultry sausage category. Casual Gourmet management
responded quickly with innovative new products, including products in the much
larger pork sausage category. Casual regained several product placements with
key club customers during the first quarter of 2006, however these items were
subsequently discontinued in the third quarter of 2006.

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


<TABLE>
<CAPTION>
                                                                                  Years Ended
                                                                 ---------------------------------------------
                                                                      2006            2005            2004
                                                                 ---------------------------------------------
<S>                                                                <C>             <C>             <C>
         Percent of net revenues from recent acquisitions             45.1%           41.4%           18.2%

         All other net revenues                                       54.9%           58.6%           81.8%
                                                                 ---------------------------------------------
             Total                                                   100.0%          100.0%          100.0%
                                                                 =============================================

         Gross profit and gross margin were as follows:

                                                                                  Years Ended
                                                                 ---------------------------------------------
                                                                      2006            2005            2004
                                                                 ---------------------------------------------
         Gross profit                                              $ 27,439        $ 23,232        $ 16,468

         Gross margin percent                                         29.1%           27.3%           26.4%
</TABLE>

         The gross profit dollars for 2006 increased $4,207,000 compared to 2005
due to increased sales volume. The improvement in gross margin percent for 2006
compared to the 2005 is a function of cost savings obtained by running more
efficiently and an improvement in product mix. However, in the fourth quarter of
2006, the Company experienced high labor costs associated with overtime related
to cyclical demand in tamales and certain sauces (see Seasonality of Revenues,
Item 1, page 9). Also in 2006, the Company experienced certain write-off costs
associated with a failed frozen ravioli appetizer product. In addition, the
Company announced on September 29, 2006 a reduction in its salaried work force.
Part of the severances paid reduced the Company's gross margin. In 2006, the
Company consolidated its two Salinas, CA plants which the Company believes will
improve margins. The impact of future change on the Company's gross profit is
difficult to quantify because of its sensitivity to volume through the plant.

                                       17
<PAGE>

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

         The Company charged $629,000, $499,000 and $550,000 to cost of sales
for 2006, 2005, and 2004 respectively, for obsolete packaging and raw material
inventory.

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

<TABLE>
<CAPTION>
                                                                            Years Ended
                                                           ---------------------------------------------
                                                                2006            2005            2004
                                                           ---------------------------------------------
<S>                                                          <C>             <C>             <C>
         SG&A Expense                                        $ 26,754        $ 23,590        $ 18,224

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

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

         SG&A as a percent of net revenues decreased by 1.5% for 2005 compared
to 2004. This decrease was due to higher revenues in 2005 compared to 2004 which
spread the fixed portion of SG&A over more revenue. The Company also spent
$82,000 on consultants' fees plus a significant amount of internal resources
documenting its internal controls in its efforts to become compliant with
Sarbanes-Oxley Section 404. Also the Company saw its audit and audit related
fees increase in 2005 compared to the same period in 2004. Amortization
associated with the 2005 acquisitions increased 89% when comparing 2005 to 2004.

         Demonstration costs paid to outside vendors were 6.1%, 6.8% and 8.1% of
net revenues for the years, 2006, 2005, and 2004, respectively.

         Depreciation and amortization expense, included in cost of sales and
SG&A, decreased to $2,926,000 or 3.1% of net revenues in 2006 compared to
$3,033,000 or 3.6% of net revenues in 2005 and $2,510,000 or 4.0% of net
revenues in 2004. The decrease from 2005 to 2006 is related to the impairment of
intangible assets of Casual Gourmet Foods and some fixed assets becoming fully
depreciated during the year. The increase in 2005 compared to 2004 relates to
the recent acquisitions and to capacity expansion and equipment upgrades in the
Salinas, California, Seattle, Washington and Eugene, Oregon production
facilities. Amortization of intangible assets as a result of acquisitions was
$875,000 in 2006 compared to $958,000 in 2005 and $482,000 in 2004. See
"Liquidity, Capital Resources and Business Acquisitions", page 19.

         Net interest expense for 2006 was $355,000 compared to $628,000 for
2005, and $130,000 in 2004. The interest expense in 2006, 2005 and 2004 is
attributable to the bank loans needed for the CIBO Naturals, Casual Gourmet
Foods and Sonoma Foods acquisitions and the subordinated debt remaining on the
CIBO Naturals balance sheet. The loans from Comerica Bank were paid off in July
2006 after the Company raised additional capital through a private placement.

         Income tax benefit (expense) for 2006, 2005, and 2004 was ($295,000),
$431,000, and $505,000, respectively. The 2006 income tax expense is mainly
impacted by the $1.2 million increase in the of valuation allowance for deferred
tax assets. The 2005 and 2004 income tax benefits of $431,000 and $505,000
represented 45% and 27% of pretax loss respectively. The Company's deferred tax
assets are comprised primarily of net operating losses that can offset future
taxable income. Management has established a $1.5 million valuation allowance
against future deferred tax assets based on its assessment of the sources of
future taxable income and the likelihood of realization of such deferred tax
assets.

         Additionally, the Company realized additional tax benefits as a result
of the exercise of non-qualified stock options and the exercise and subsequent
sale of certain incentive stock options or disqualifying dispositions in 2006,
2005, and 2004. For financial reporting purposes, when a deduction exceeds the
deferred tax assets, the resulting reduction in actual income tax obligations as
a result of these disqualifying dispositions is credited to additional paid in
capital. See Liquidity, Capital Resources, and Business Acquisitions immediately
below and Note 7 to the consolidated financial statements in Item 15.

                                       18
<PAGE>

Impairment Charge

         In the fourth quarter of 2005, Casual Gourmet saw a significant
reduction in its sales to its two largest customers, Costco and Sam's Club. The
Company took many steps to restore the sales to these two major customers,
including the introduction of such items as Anti-Biotic free ("ABF") all white
meat chicken sausages, nitrite free chicken sausages, sausages made with organic
chicken, flavored pork sausages, and other products that fit under the Casual
Gourmet label. The Company also introduced these products into the retail market
place through Monterey Gourmet Foods' retail sales force. In the spring of 2006,
these new items restored Casual's sales to its level of sales of the prior year
and therefore the Company did not impair its intangible assets. However, between
the dates of August 15, 2006 and September 9, 2006, the Company was informed
that these new items would be discontinued in select divisions of Costco.

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


Liquidity, Capital Resources, and Business Acquisitions

         During the twelve months ended December 31, 2006, $6,981,000 of cash
was provide by the Company's operating activities compared to $1,104,000 of cash
being used in the Company's operations in 2005, and $1,898,000 of cash provided
by the Company's operations in 2004. The 2006 net loss of $3,112,000 plus the
depreciation and amortization of $2,926,000, the non-cash impairment of
intangible assets of $3,160,000, plus non-cash income tax expense of $282,000,
plus non-cash stock compensation of $516,000, and the increase in accounts
payable and other accrued current liabilities of $4,429,000 accounted for most
of the increase in cash from operations which was reduced by the increase in net
accounts receivable and inventories. The increase in accounts payable and other
accrued current liabilities of $4.4 million is a function of the timing of
payments to the Company's vendors according to the terms offered by the Company.

         The increase in net accounts receivable and the increase in inventory
were a direct result of the increase in net revenues for December 2006. Net
revenues for December were $9.8 million compared to $8.7 million in December
2005, a 16% increase. Accounts receivable, net of allowances, increased only 7%.
Inventory increased 9%, which also used cash.

         The Company finances its operations and growth primarily with cash
flows generated from operations. The Company has a $5 million working capital
line of credit which was unused as of December 31, 2006, and a letter of credit
in the amount of $1,100,000 which is issued in favor of an insurance company to
support a self-funded worker's compensation program which decreased to $800,000
in January 2007. The interest rate on the credit line will be calculated at the
bank's prime lending rate or LIBOR plus 2.00% whichever the Company chooses. The
maturity date of the line of credit has been extended to June 1, 2007 and the
covenants have been adjustment to accommodate the additional borrowing.

         Some product lines such as specialty cheeses require more working
capital than other products. Cheese requires a certain amount of time to age
before it can be sold. Other products such as the gourmet sausages are produced
when orders are received and then shipped directly to customers. The Company
currently has $11,496,000 of working capital as of December 31, 2006 compared to
$5,019,000 in working capital as of December 31, 2005. The Company believes that
its existing credit facilities, along with cash flows from operations, are
sufficient to meet its cash needs for normal operations including all
anticipated capital expenditures for the calendar year 2007.

         In addition to operating cash flows, the Company also received cash
proceeds of $926,000, $153,000 and $470,000 from the exercise of employee stock
options and sales of stock under the Company's Employee Stock Purchase Plan
during 2006, 2005, and 2004, respectively.

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

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

         Cash balance at the end of 2006 was $4,281,000 compared with $330,000
in 2005. Purchases of equipment in 2006 were $3,010,000 with the majority of
capital spending going towards upgrading the production plants.

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

                                       19
<PAGE>

         Management believes that cash on hand at December 31, 2006 and
projected 2007 cash flows from operations will be sufficient to fund working
capital needs, expected Company growth, and anticipated capital expenditures
during 2007. Alternative financing arrangements will need to be found if the
Company makes further acquisitions.

Contractual Obligations

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


         The following table summarizes the estimated annual obligations.

<TABLE>
<CAPTION>
                                                              Payments due by period
                                     ------------------------------------------------------------------------
           Contractual Obligations                  Less than 1                                    More than
             (in Thousands)              Total          year        1 - 3 years    3 - 5 years      5 years
                                     ------------   ------------   ------------   ------------   ------------
<S>                                  <C>            <C>            <C>            <C>            <C>
         Long-term debt              $      1,079   $        988   $         89   $          2   $         --

         Capital lease obligations             68             30             38             --             --

         Operating leases                  10,706          1,773          4,396          2,664          1,873
                                     ------------------------------------------------------------------------
         Total                       $     11,853   $      2,791   $      4,523   $      2,666   $      1,873
                                     ========================================================================
</TABLE>

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

         The Company has an $800,000 standby letter of credit in favor of an
insurance company for the Company's self-funded workers compensation program
which will expire on December 31, 2007.


Off-Balance Sheet Arrangements

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

Business Acquisitions

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

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

         On March 31, 2006, the Company purchased an additional 10% interest in
Casual Gourmet Foods, Inc. ("Casual") pursuant to the Company's January 11, 2005
agreement with Casual and its shareholders. The purchase price for the

                                       20
<PAGE>

additional 10% ownership was $1,600 which increased the Company's ownership of
Casual to 70%. The purchase price was all allocated to goodwill. Casual, which
produces branded gourmet sausages, prepared soups and other food products, is a
Florida corporation.

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

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

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

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

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

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

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


Critical Accounting Policies and Management Judgments

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

                                       21
<PAGE>

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

         Business Combinations

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

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

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

         Accounts Receivable and Allowances

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

         Income Taxes

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

         Inventory Valuation

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

                                       22
<PAGE>

alternative usage or salvage value of obsolete inventory. Management believes
its estimates for spoiled and obsolete inventory is adequate given the current
volume of business to its current customers.

         Workers Compensation Reserve

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

         Revenue Recognition

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

         The Company records its shipping cost for product delivered to
customers in selling, general, and administrative expense. Any amounts charged
to customers for freight and deliveries are included in revenues. Certain
incentives granted to customers such as promotions, trade ads, slotting fees,
terms discounts, and coupons are recorded as offsets to revenues.

         Valuation of Goodwill/Indefinite-lived Intangible Assets

         Under SFAS 142, "Goodwill and Other Intangible Assets" goodwill and
intangible assets with indefinite useful lives are to be tested for impairment
at least annually. The primary identifiable intangible assets of the Company's
reporting unit with indefinite lives are trademarks, tradenames and goodwill
acquired in business acquisitions. As of December 31, 2006, the net book value
of trademarks and other identifiable indefinite-lived intangible assets was $2.7
million.

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

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

         Goodwill is not amortized but is subject to periodic assessments of
impairment. At December 31, 2006, the Company had $13.2 million of goodwill on
its books. Goodwill is assessed for impairment at least as often as annually and
as triggering events may occur. The Company performs its annual review in the
fourth quarter of each year. Recoverability of goodwill is evaluated using a
comparison of the fair value of a reporting unit with its carrying value.

                                       23
<PAGE>

         In evaluating the recoverability of goodwill, it is necessary to
estimate the fair value of the reporting unit. In making this assessment,
management relies on a number of factors to discount anticipated future cash
flows including operating results, business plans and present value techniques.
Rates used to discount cash flows are dependent upon interest rates and the cost
of capital at the relevant point in time. There are inherent uncertainties
related to these factors and management's judgment in applying them to the
analysis of goodwill impairment. It is possible that assumptions underlying the
impairment analysis will change in such a manner that impairment may occur in
the future.

         Valuation of Plant and Equipment and finite-lived Intangible Assets

         In accordance with Statement of Financial Accounting Standards (SFAS)
No. 144, Accounting for the Impairment or Disposal of Long-lived Assets ("SFAS
144"), management reviews finite-lived long-lived assets, primarily consisting
of plant and equipment and amortized intangible assets such as acquired recipes,
customer lists and non-compete agreements, whenever events or changes in
circumstances indicate that the carrying amount of an asset group may not be
recoverable. Intangible assets with finite useful lives continue to be amortized
over their respective estimated useful lives. The estimated useful life of an
identifiable intangible asset is based upon a number of factors, including the
effects of demand, competition, and future cash flows. For these assets, if the
total expected future undiscounted cash flows from the asset group are less than
the carrying amount of the asset group, an impairment loss is recognized for the
difference between the fair value of the carrying value of the asset group. The
impairment tests require management to estimate the undiscounted cash flows and
fair value of the asset groups. As of December 31, 2006, the net book value
finite-lived intangible assets were $4.3 million.

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

         Impairment of finite-lived and indefinite-lived Intangible Assets

         In the third quarter of 2006, it was determined that the identifiable
intangible assets of Casual Gourmet Foods (including customer relationships,
recipes and processes, non-competition agreements, and trade name) were impaired
as their undiscounted cash flows were insufficient to recover the carrying
value. Accordingly, the impairment charge was measured in accordance with SFAS
144 as the excess of the carrying value over the fair value of the respective
assets. The Company's impairment evaluations were performed with the assistance
of an independent valuation firm. The evaluations of both goodwill and other
intangible assets included reasonable and supportable assumptions and
projections and were based on estimates of projected future cash flows. Casual
Gourmet Foods experienced lower than anticipated sales during the third quarter
of 2006, due to a significant reduction in sales to its two largest customers.
These estimates assume that Casual will be able to maintain its current, but
reduced distribution. These estimates of future cash flows are based upon the
Company's experience, historical trends, estimates of future profitability and
economic conditions. Future estimates of profitability and economic conditions
require estimating such factors as sales growth, employment rates and the
overall economics of the retail food industry for five to ten years in the
future, and are therefore subject to variability, are difficult to predict and
in certain cases, beyond the Company's control. The assumptions utilized by
management were consistent with those developed in conjunction with the
Company's long-range planning process. If the assumptions and projections
underlying these evaluations are not achieved, or should the Company ultimately
adopt and pursue different long-range plans, the amount of the impairment could
be adversely affected. Accordingly, there can be no assurance that there will
not be additional impairment charges in the future based on future events and
that the additional charges would not have a materially adverse impact on the
Company's financial position or results of operations.

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

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

                                       24
<PAGE>

Accounting for Stock-Based Awards

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

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

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

         On June 23, 2005 the Company accelerated the vesting of all stock
options outstanding under the Company's 2002 Stock Option Plan (formerly the
1993 Stock Option Plan) that have exercise prices per share higher than the
closing price of the Company's common stock on June 23, 2005, which was $3.07.
Options to purchase 422,600 shares of the Company's common stock became
exercisable immediately. No other changes to these options were made. These
options range in price from a low of $3.25 to a high of $4.99 with an average of
$3.53. The primary purpose of the accelerated vesting was to eliminate future
compensation expense the Company would otherwise recognize in its statement of
operations with respect to these accelerated options upon the adoption of SFAS
123R "Share-Based Payment". The acceleration of the vesting of these options did
not impact the Company's financial statements.

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

         The total compensation cost related to nonvested awards not yet
recognized total $673,000 with a weighted average period over which it is
expected to be recognized of one year.


Recently Issued Accounting Standards

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

         In September 2006, the FASB issued SFAS 157 "Fair Value Measurements",
which provides enhanced guidance for using fair value to measure assets and
liabilities and also expands information about the extent to which companies
measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. SFAS 157

                                       25
<PAGE>

applies whenever other accounting standards require or permit assets and
liabilities to be measured at fair value and does not expand the use of fair
value in any new circumstances. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and interim periods
within those fiscal years. The Company is currently assessing the impact of SFAS
157.

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

         In July 2006, the FASB issued Interpretation No. 48, ("FIN 48")
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109." FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in a company's financial statements in accordance with SFAS
109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold
and measurement attribute for the financial statement recognition and measure of
a tax position taken or expected to be taken in a tax return. It also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company is currently evaluating the
impact that adoption of FIN 48 may have on its results of operations or
financial position.

         In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections." This new standard replaces APB Opinion No. 20, "Accounting
Changes in Interim Financial Statements," and SFAS No. 3, "Reporting Accounting
Changes in Interim Financial Statements," and represents another step in the
FASB's goal to converge its standards with those issued by the International
Accounting Standards Board ("IASB"). Among other changes, SFAS 154 requires that
a voluntary change in accounting principle be applied retrospectively with all
prior period financial statements presented on the new accounting principle,
unless it is impractical to do so. SFAS 154 also provides that (1) a change in
method of depreciating or amortizing a long-lived nonfinancial asset be
accounted for as a change in estimate (prospectively) that was effected by a
change in accounting principle, and (2) correction of errors in previously
issued financial statements should be termed a "restatement." The new standard
was effective for accounting changes and correction of errors made in fiscal
years beginning after December 15, 2005. As of December 31, 2006 this
pronouncement had no impact on the Company's consolidated financial statements.

         In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities ("SFAS 159"). SFAS 159 provides
companies with an option to report selected financial assets and liabilities at
fair value. SFAS 159 also establishes presentation and disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities and to
provide additional information that will help investors and other financial
statement users to more easily understand the effect of the company's choice to
use fair value on its earnings. Finally, SFAS 159 requires entities to display
the fair value of those assets and liabilities for which the company has chosen
to use fair value on the face of the balance sheet. SFAS 159 is effective as of
the beginning of an entity's first fiscal year beginning after November 15,
2007. Early adoption is permitted as of the beginning of the previous fiscal
year provided that the entity makes that choice in the first 120 days of that
fiscal year and also elects to apply the provisions of SFAS 157 (see above). The
Company is currently assessing the impact of SFAS 159 which it will be required
to adopt.



ITEM 7A.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Market Risk Disclosure

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

         In the ordinary course of its business the Company enters into
commitments to purchase raw materials over a period of time, generally six
months to one year, at contracted prices. At December 31, 2006 these future
commitments were not at prices in excess of current market, or in quantities in
excess of normal requirements. The Company does not utilize derivative contracts
either to hedge existing risks or for speculative purposes.

                                       26
<PAGE>

      Interest Rate Risk

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

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

      Currency Risk

         During 2006, the Company sold $86,000 of product in currency other than
US dollars. These sales have terms of net 30 days from shipment. The Company
believes that its currency exposure is not material and has chosen not to hedge
these sales.


ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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


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

         None


ITEM  9A.         CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

         As required by Rule 13a-15(b) under the Exchange Act, we conducted an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer (together the
"Certifying Officers"), of the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2006, the end of the
period covered by this report. Based upon that evaluation, the Certifying
Officers concluded that our disclosure controls and procedures were effective as
of December 31, 2006 to provide reasonable assurance that information required
to be disclosed in our Exchange Act reports is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms and
that such information is accumulated and communicated to our management,
including our Certifying Officers, as appropriate, to allow for timely decisions
regarding required disclosure.


Inherent Limitations on Effectiveness of Controls

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

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

                                       27
<PAGE>

system of controls is based in part on certain assumptions about the likelihood
of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions.

Changes in Internal Control over Financial Reporting

         The Company reported a material weakness in conjunction with its 2005
audited financial statements. During 2006, the Company implemented the following
remediation actions in order to conclude that the Company had effective internal
controls as of December 31, 2006. All of the changes described below were
implemented as of March 31, 2006 and remained through 2006.

          (a)  Expanding accounting professionals. As of December 31, 2005, due
               to medical disability and unanticipated departure of personnel,
               the Company employed only two full-time and one part-time
               accountants. As of December 31, 2006, the Company had replaced or
               hired additional qualified accountants to bring its accounting
               staff to five full-time accountants and one part-time accountant.
          (b)  Implementation of certain enhanced control processes over
               accounting for subsidiaries.
          (c)  Enhanced internal reporting from its financial systems including
               general ledger reporting and consolidating entries.
          (d)  Engagement of third party tax specialists to provide quality
               assurance and tax expertise outside of the firm that currently
               prepares the Company's tax return.
          (e)  Engaging other specialists to provide support for reporting of
               technical areas.
          (f)  Reviewing the process by which its tax provision is prepared.

         Other than these improvements, there has been no change during the
company's fiscal quarter ended December 31, 2006 in the company's internal
control over financial reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) that has materially affected, or is reasonably
likely to materially affect, the company's internal control over financial
reporting.


ITEM  9B.         OTHER INFORMATION

            None

                                    PART III


ITEM 10.          DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

         As of March 30, 2007, the directors, executive officers, and other
significant employees of the Company are as follows:

         Directors and Executive Officers:
<TABLE>
<CAPTION>

           Name                                         Age           Position
           ----                                         ---           --------
<S>                                                      <C>          <C>
           Charles B. Bonner (1) (4) (5)                 64           Director

           F. Christopher Cruger (2) (3) (4)             72           Director

           Eric C. Eddings                               46           Chief Executive Officer, President
                                                                      and Director

           Michael P. Schall (1) (4)                     53           Director

           Van Tunstall  (4) (5)                         60           Chairman of the Board

           James Wong (2) (3) (4) (5)                    59           Director

           Walter L Henning  (2) (3) (4)                 62           Vice Chairman of the Board

           John H. McGarvey (1) (4)                      62           Director

           Scott Wheeler                                 52           Chief Financial Officer,
                                                                      Corporate Secretary and Director
</TABLE>

     (1)   Member of Audit Committee
     (2)   Member of Compensation Committee
     (3)   Member of Nominating Committee
     (4)   Independent Director
     (5)   Member of the Governance Committee

                                       28
<PAGE>

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

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

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

         Eric C. Eddings, Mr. Eddings was appointed by the Board of Directors as
President and Chief Executive Officer of Monterey Gourmet Foods in September
2006. Prior to his appointment, he was the President of the Natural Foods
Division of Monterey Gourmet Foods. Previously Mr. Eddings was the Chief
Operating Officer and minority shareholder of CIBO Naturals, LLC which he and
his associates purchased in June, 2002. CIBO Naturals was acquired by Monterey
Gourmet Foods in January 2004 and later became part of the Natural Foods
Division of Monterey Gourmet Foods. Prior to his employment with CIBO Naturals,
Mr. Eddings was the Vice President of Wholesale/Plant Operations of Tully's
Coffee Corporation in Seattle Washington. Mr. Eddings also has previously worked
for Dreyers Grand Ice Cream, Haagen - Dazs Company and Frito Lay, Inc. Mr.
Eddings has a Masters of Business Administration degree from the University of
Redlands and a Bachelors of Arts degree in Business Administration from
California State University at Fullerton.

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

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

         James Wong. Mr. Wong was elected to the Board of Directors in March
1997. Following a career in the U.S. Marine Corps, he worked as a turnaround
manager and productivity consultant at General Motors and subsequently at
PepsiCo, working in the U.S. and overseas. Since leaving employment with PepsiCo
in 1988, Mr. Wong has worked on five continents as an entrepreneur and
management consultant facilitating business turnarounds, strategic alliances and
technology transfers for PepsiCo and other companies. Mr. Wong is currently
Chairman and a Director of FRSI, Inc., a technology exploration, development and
integration company.

         Walter L. Henning. Mr. Henning was elected to the Board of Directors in
December 1999 and elected as Vice-Chairman in 2006. He has over 35 years
experience in the production and distribution of a multitude of food products,
including spices, extracts, seasoning mixes, and dehydrated onion, garlic and
capsicums. He has been responsible for 12 plants in 5 different companies,
including Rykoff- Sexton, Burns- Philp, ConAgra, and McCormick & Co, Inc., and
has served as Vice- President Operations for each company. He was responsible
for world- wide supply chain operations for Tone Spices in Des Moines, IA, and
while there was instrumental in establishing a joint- venture manufacturing
plant in Cochin, India. He also served as Chairman of the State of Iowa's
Manufacturing Council from 1990 - 1995. His responsibilities with both McCormick
and ConAgra included managing an extensive farming operation as well as the
largest onion/garlic dehydration facilities in the world. Mr. Henning has B.S.
and M.S. degrees in Food Science and Technology from the University of
California, and currently holds an APICS Certification in Production and

                                       29
<PAGE>

Inventory Management. He retired from his daily activities at McCormick and Co.
in January, 2007 after eight years in operations management and now devotes his
primary effort to teaching at Cal State University- Monterey Bay. He is a
faculty member in the School of Business where he teaches upper division courses
in Operations Management.

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

         Scott S. Wheeler. Mr. Wheeler joined the company in April 2003 as
Corporate Controller, and was promoted to Chief Financial Officer, effective
October 27, 2003 and was elected as a Board member in June 2004. His most recent
position was Vice President and Financial Officer of KBC Edible Beans Division
of ConAgra Foods, where he worked for three years. Prior to that he worked for
Mallard's Food Products both when it was an independent company and after it was
sold to Tyson Foods. He began his career at Mallard's Food Products in 1994 as
Chief Financial Officer until 1999 when he was promoted to General Manager until
joining KBC in April of 2000. Prior to joining Mallard's, Mr. Wheeler held a
variety of positions with Basic American Foods over a thirteen-year period. He
is a CPA with an MBA in finance from Golden Gate University in San Francisco,
CA.

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

         Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's directors and executive officers, and persons who own
more than 10% of a registered class of the Company's equity securities, to file
with the SEC initial reports of ownership and reports of changes in ownership of
Common Stock and other equity securities of the Company. Officers, directors and
greater than 10% beneficial owners are required by SEC regulations to furnish
the Company with copies of all reports they file under Section 16(a). To the
Company's knowledge, based solely on its review of the copies of such reports
furnished to the Company and written representations that no other reports were
required, all Section 16(a) filing requirements applicable to its officers,
directors and greater than 10% beneficial owners were complied with during the
fiscal year ended December 31, 2006.

Audit Committee Composition

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

Audit Committee Expert

         The Company's Board of Directors has determined that Mr. Charles B.
Bonner and Mr. John H. McGarvey are the Board's designated financial experts.

Code of Ethics

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


ITEM 11.          EXECUTIVE COMPENSATION


                      Compensation Discussion and Analysis


Overview of Compensation Policy

         The Company's Compensation Committee is empowered to review and
approve, or in some cases recommend for the approval of the full Board of
Directors the annual compensation for the executive officers of the Company.
This Committee has the responsibility for establishing, implementing, and
monitoring the Company's compensation strategy and policy. Among its principal
duties, the Committee ensures that the total compensation of the executive
officers is fair, reasonable and competitive.

                                       30
<PAGE>

Objectives and Philosophies of Compensation

         The primary objective of the Company's compensation policy, including
the executive compensation policy, is to help attract and retain qualified,
energetic managers who are enthusiastic about the Company's mission and
products. The policy is designed to reward the achievement of specific annual
and long-term strategic goals aligning executive performance with company growth
and shareholder value. In addition, the Board of Directors strives to promote an
ownership mentality among key leaders and the Board of Directors. The Corporate
Governance Principles provide that it is the policy of the Board of Directors to
encourage all directors to maintain an outright investment in the Company of a
minimum of 5,000 shares of the company stock.

Setting Executive Compensation

         The compensation policy is designed to reward performance. In measuring
executive officers' contribution to the Company, the Compensation Committee
considers numerous factors including the Company's growth and financial
performance as measured by revenue, gross margin and net income before taxes
among other key performance indicators.

         Regarding most compensation matters, including executive and director
compensation, management provides recommendations to the Compensation Committee;
however, the Compensation Committee does not delegate any of its functions to
others in setting compensation. The Compensation Committee does not currently
engage any consultant related to executive and/or director compensation matters.

         Stock price performance has not been a factor in determining annual
compensation because the price of the Company's common stock is subject to a
variety of factors outside of management's control. The Company does not
subscribe to an exact formula for allocating cash and non-cash compensation.
However, a significant percentage of total executive compensation is
performance-based. Historically, the majority of the incentives to executives
have been in the form of non-cash incentives in order to better align the goals
of executives with the goals of stockholders.

Elements of Company's Compensation Plan

         The principal components of compensation for the Company's executive
officers are:
            o    base salary
            o    performance-based incentive cash compensation
            o    right to purchase the company's stock at a preset price
                 (stock options)
            o    retirement and other benefits

         Base Salary

         The Company provides named executive officers and other employees with
base salary to compensate them for services rendered during the fiscal year.
Base salary ranges for named executive officers are determined for each
executive based on his or her position and responsibility.

         During its review of base salaries for executives, the Committee
primarily considers:
            o    market data;
            o    internal review of the executives' compensation, both
                 individually and relative to other officers; and
            o    individual performance of the executive.

         Salary levels are typically evaluated annually as part of the Company's
performance review process as well as upon a promotion or other change in job
responsibility.

         Performance-Based Incentive Compensation

         The management incentive plan gives the Committee the latitude to
design cash and stock-based incentive compensation programs to promote high
performance and achievement of corporate goals, encourage the growth of
stockholder value and allow key employees to participate in the long-term growth
and profitability of the Company.

         For stock-based programs, the Committee may grant participants stock
options which are the only non-cash incentive currently approved by the
stockholders of the Company. In granting these awards, the Committee establishes
parameters such as vesting schedules and terms of the grants.

                                       31
<PAGE>

         All awards of shares of the Company's stock options are made at the
market price at the time of the award. Annual awards of stock options to
executives are made at the Committee's regularly scheduled meeting while the
stock options awarded to outside Board members are automatically granted at the
regularly scheduled annual shareholders meeting.

         Newly hired or promoted executives receive their award of stock options
on the first business day of their hire or promotion or at the time the
Committee meets and approves such grants.

         Ownership Guidelines

         To directly align the interests of the Board of Directors with the
interests of the stockholders, the Committee recommends that each Board member
maintain a minimum ownership interest in the Company. Currently, the
Compensation Committee recommends that each Board member own a minimum of 5,000
shares of the Company's common stock with such stock to be acquired within a
reasonable time following election to the Board.

         Stock Option Program

         The Stock Option Program assists the Company to:

         o    enhance the link between the creation of stockholder value and
              long-term executive incentive compensation;
         o    provide an opportunity for increased equity ownership by
              executives; and
         o    maintain competitive levels of total compensation.

         Stock option award levels are determined based on market data, vary
among participants based on their positions within the Company and are granted
at the Committee's regularly scheduled meeting. Options are awarded at the
NASDAQ's closing price of the Company's Common Stock on the date of the grant.
The Committee has never granted options with an exercise price that is less than
the closing price of the Company's Common Stock on the grant date, nor has it
granted options which are priced on a date other than the grant date.

         The majority of the options granted by the Committee vest at a rate of
33% per year over the first three years of the ten-year option term. Vesting and
exercise rights cease upon termination of employment for executives and upon
expiration of the vested options for independent Board members. Prior to the
exercise of an option, the holder has no rights as a stockholder with respect to
the shares subject to such option, including voting rights.

         Beginning on January 1, 2006, the Company began accounting for
stock-based payments including its Stock Option Program and its Employee Stock
Purchase Plan in accordance with the requirements of FASB Statement 123(R).

         Retirement and Other Benefits

         All employees in the United States are eligible to participate in the
Company's 401-k Retirement Plan. In addition, employees are entitled to
participate in the Company's Employee Stock Purchase Plan.

         401-k Retirement Plan

         In 1996, the Company instituted a 401(k) Plan covering substantially
all full-time employees with six months of service. Under the Plan, employees
may elect to defer up to 15% of compensation (subject to certain limitations).
Beginning in January 2003 the Company adopted a Safe Harbor Plan and currently
matches employee contributions up to 4% of compensation. In addition, the
Company may make an annual discretionary profit-sharing contribution. Employee
contributions, Company matching contributions and related earnings are always
100% vested.

         Employee Stock Purchase Plan

         In October 1994, the Company's Board of Directors adopted a qualified
employee stock purchase plan. Under the purchase plan, eligible employees (those
who have completed one year of continuous employment with the Company) may
purchase shares of the Company's common stock through payroll deductions not to
exceed 10% of gross wages. The Company has reserved 200,000 shares of its common
stock for issuance under the purchase plan, which remains in effect until
terminated by the Company's Board of Directors, or until all of the shares
reserved for under the purchase plan have been issued. Unless the Board has
otherwise provided a higher amount prior to the commencement of an offering

                                       32
<PAGE>

period, the offering exercise price for each purchase period is 85% of the
lesser of (a) the fair market value of the shares on the offering date of such
offering period or (b) the fair market value of the shares on the given purchase
date.

         Perquisites and Other Personal Benefits

         The Company provides some executive officers with perquisites and other
personal benefits that the Company and the Committee believe are reasonable and
consistent with its overall compensation program to better enable the Company to
attract and retain superior employees for key positions. The Committee
periodically reviews the levels of perquisites and other personal benefits
provided to named executive officers.

         Some executive officers are provided use of company automobiles and all
employees can participate in the plans and programs described above.

         Each employee of the Company is entitled to term life insurance,
premiums for which are paid by the Company in the amount of one-times annual
base salary. In addition, each employee is entitled to receive certain medical
and dental benefits and part of the cost is funded by the employee.


         Accounting and Tax Considerations

         The Company's stock option grant policy has been impacted by the
implementation of SFAS No. 123R, which was adopted in the first quarter of
fiscal year 2006. Under this accounting pronouncement, the Company is required
to value unvested stock options granted prior to the adoption of SFAS 123 under
the fair value method and expense those amounts in the income statement over the
stock option's remaining vesting period.

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

Summary Compensation Table (2006)

         The following table includes information concerning compensation for
the one year period ended December 31, 2006 in reference to the five most highly
compensated employees of the Company which includes required disclosure related
to the CEO and CFO.

<TABLE>
<CAPTION>
                                                                                           Change in Pension
                                                                                               Value and
                                                                                             Nonqualified
                                                                               Non-Equity      Deferred
     Name and                                            Stock     Option    Incentive Plan  Compensation   All Other
 Principal Position     Year  Salary $ (4)  Bonus $ (5)  Awards   Awards (8)  Compensation     Earnings   Compensation (9)   Total
 ------------------     ----  ------------  -----------  ------   ----------  ------------     --------   ----------------   -----
<S>                     <C>    <C>           <C>         <C>      <C>            <C>            <C>         <C>            <C>
James M.                2006   $ 335,000     $ 41,959    $   --   $ 193,515      $    --        $    --     $ 295,786 (6)  $ 866,260
Williams (1)
Former President
and CEO

Eric C.                 2006   $ 227,950     $155,622    $   --   $  74,631      $    --        $    --     $  16,431      $ 474,634
Eddings (3)
Current President
and CEO

Scott S.                2006   $ 177,308     $ 15,000             $  24,549      $    --        $    --     $   7,092      $ 223,949
Wheeler (2)
Chief Financial
Officer

A. Martin Adams         2006   $ 181,125     $ 82,883 (7)         $      --      $    --        $    --     $  14,294      $ 278,302
Chief Executive
Officer -
Sonoma Foods, Inc.

C. David Viviani        2006   $ 181,125     $ 82,883 (7)         $      --      $    --        $    --     $  14,294      $ 278,302
Chief Operating
Officer -
Sonoma Foods, Inc.
</TABLE>

(1)  Mr. Williams joined the Company in October 2002 as President. On December
     28, 2002, Mr. Williams was promoted to President and Chief Executive
     Officer. On September 5, 2006 Mr. Williams resigned as an officer and Board
     member of the Company.
(2)  Mr. Wheeler joined the Company in April 2003 and was promoted to Chief
     financial Officer in October 2003.

                                       33
<PAGE>

(3)  Mr. Eddings joined the Company in January 2004 as part of the acquisition
     of CIBO Naturals LLC. Mr. Eddings became President and Chief Executive
     Officer on September 5, 2006.
(4)  Includes amounts (if any) deferred at the named executive officer's option
     under the Company's 401(k) plan.
(5)  Bonuses were based on the Company's performance and other objectives
     obtained.
(6)  Represents payments made in accordance with the separation agreement
     between Mr. Williams and the Company.
(7)  Amount paid as part of the purchase agreement for Sonoma Foods, Inc. and
     deemed compensation according to GAAP.
(8)  Amounts calculated utilized the provisions of SFAS No. 123R "Share-based
     Payments" of the consolidated financial statements and reconciled to the
     amounts expensed in the Company's 2006 financial statements. Since the
     vesting of the option awards are over three years, this amount represents
     only a portion of the fair value of the options granted during 2005 and
     2006. The fair value of the options granted in 2006 are: Mr. Williams
     $132,143; Mr. Eddings $317,085; Mr. Wheeler $0; Mr. Adams $0; and Mr.
     Viviani $0.
(9)  The Company matches 100% of the employee contributions to the Company's
     401-k plan up to 4% of individual compensation. All of the participates
     contributed a minimum of 4% of base salary to the 401-k plan and the
     Company matched that contribution. Also, Mr. Williams, Mr. Eddings, Mr.
     Adams, and Mr. Viviani received a car allowance.

Grants of Plan-Based Awards for 2006

         The following table sets forth certain information with respect to the
options granted during or for the calendar year ended December 31, 2006 to each
of the executive officers listed in the summary Compensation Table as shown
under the caption "Executive Compensation."

<TABLE>
<CAPTION>

                                                             Estimated Future                            Estimated Future
                                                            Payouts Under Non-                            Payouts Under
                                                             Equity Incentive                            Equity Incentive
                                                                Plan Awards                                 Plan Awards
    Name and                                       -------------------------------------     ---------------------------------------
Principal Position               Grant Date        Threshold      Target         Maximum     Threshold        Target        Maximum
--------------------------------------------       ---------      ------         -------     ---------        ------        --------

<S>                                <C>                  <C>          <C>            <C>          <C>             <C>           <C>
James M. Williams                  9/5/2006             --           --             --           --              --            --
Former President and CEO

Eric C. Eddings                    9/13/2006            --           --             --           --              --            --
Current President and CEO

Scott S. Wheeler                                        --           --             --           --              --            --
Chief Financial Officer

A. Martin Adams
Chief Executive Officer - Sonoma Foods, Inc.            --           --             --           --              --            --

C. David Viviani
Chief Operating Officer - Sonoma Foods, Inc.            --           --             --           --              --            --


<CAPTION>
                                                     All Other        All Other
                                                      Stock           Option
                                                      Awards:         Awards:                       Grant Date
                                                     Number of       Number of      Exercise or     Fair Value
                                                     Shares of      Securities      Base Price       of Stock
    Name and                                        Stock or        Underlying       of Option       and Option
Principal Position                                    Units           Options         Awards          Awards
--------------------------------------------        ----------      -----------      ----------     -----------

<S>                                                     <C>           <C>              <C>            <C>
James M. Williams                                       --            150,000          3.72           $ 132,143
Former President and CEO

Eric C. Eddings                                         --            150,000          3.89           $ 317,085
Current President and CEO

Scott S. Wheeler                                        --                 --            --                  --
Chief Financial Officer

A. Martin Adams
Chief Executive Officer - Sonoma Foods, Inc.            --                 --            --                  --

C. David Viviani
Chief Operating Officer - Sonoma Foods, Inc.            --                 --            --                  --
</TABLE>

Outstanding Equity Awards at December 31, 2006

         The following table includes certain information with respect to the
value at the calendar year end December 31, 2006 of all unexercised options
previously awarded to the executive officers named above.

                                       34
<PAGE>

<TABLE>
<CAPTION>
                                                                                    Option Awards
                                                   --------------------------------------------------------------------------------




                                                                                     Equity
                                                                                    Incentive
                                                                                      Plan
                                                                    Number of        Awards:
                                                     Number of     Securities       Number of
                                                     Securities    Underlying      Securities
                                                     Underlying    Unexercised     Underlying
                                                    Unexercised      Options       Unexercised          Option          Option
Name and Principal                                    Options     Unexercisable     Unearned           Exercise       Expiration
Position                                            Exercisable        (1)           Options            Price            Date
----------------------------------------------------------------  --------------  --------------    --------------- ---------------

<S>                                                      <C>            <C>                <C>            <C>          <C>
James M. Williams                                        50,000              --            --             $ 3.76         9/5/2009
Former President and CEO                                 50,000              --            --             $ 3.44         9/5/2009
                                                         50,000              --            --             $ 3.95         9/5/2009

Eric C. Eddings                                           5,000          10,000            --             $ 3.95        12/9/2015
Current President and CEO                                    --         150,000            --             $ 3.89        9/13/2016

Scott S. Wheeler                                         10,000              --            --             $ 3.39        4/26/2013
Chief Financial Officer                                  15,000              --            --             $ 3.76       10/29/2013
                                                         15,000              --            --             $ 3.44       11/11/2014
                                                          6,667          13,333            --             $ 3.95        12/9/2015

A. Martin Adams                                              --              --            --                 --               --
Chief Executive Officer - Sonoma Foods, Inc.

C. David Viviani                                             --              --            --                 --               --
Chief Operating Officer - Sonoma Foods, Inc.


<CAPTION>
                                                                              Stock Awards
                                                   ----------------------------------------------------------------------
                                                                                                            Equity
                                                                                                           Incentive
                                                                                         Equity              Plan
                                                                                        Incentive           Awards:
                                                                                          Plan              Market
                                                                                         Awards:           or Payout
                                                                                        Number of          Value of
                                                                       Market           Unearned           Unearned
                                                      Number          Value of           Shares,            Shares,
                                                     of Shares        Shares or         Units or           Units or
                                                    or Units of       Units of            Other              Other
                                                    Stock That       Stock That          Rights             Rights
Name and Principal                                   Have Not         Have Not          That Have          That Have
Position                                              Vested           Vested          Not Vested         Not Vested
-----------------------------------------------------------------  ----------------  ----------------  ------------------

<S>                                                       <C>               <C>               <C>                 <C>
James M. Williams                                         --                --                --                  --
Former President and CEO                                  --                --                --                  --
                                                          --                --                --                  --

Eric C. Eddings                                           --                --                --                  --
Current President and CEO                                 --                --                --                  --

Scott S. Wheeler                                          --                --                --                  --
Chief Financial Officer                                   --                --                --                  --
                                                          --                --                --                  --
                                                          --                --                --                  --

A. Martin Adams                                           --                --                --                  --
Chief Executive Officer - Sonoma Foods, Inc.

C. David Viviani                                          --                --                --                  --
Chief Operating Officer - Sonoma Foods, Inc.
</TABLE>


Option Exercises and Stock Vested in 2006

         The following table includes certain information with respect to the
options exercised by the executive officers named above during the calendar year
ended December 31, 2006.

<TABLE>
<CAPTION>
                                                               Option Awards                           Stock Awards
                                                     -----------------------------------    ----------------------------------
                                                        Number of                            Number of
                                                          Shares                              Shares
                                                         Acquired       Value Realized        Acquired         Value Realized
Name and Principal Position                            on Exercise       on Exercise         on Vesting          on Vesting
---------------------------------------------------------------------- -----------------    --------------     ---------------

<S>                                                        <C>              <C>                      <C>                  <C>
James M. Williams                                              --                 --                 --                   --
Former President and CEO

Eric C. Eddings                                            15,000           $ 44,228                 --                   --
Current President and CEO                                  15,000           $ 36,855                 --                   --

Scott S. Wheeler                                               --                 --                 --                   --
Chief Financial Officer

A. Martin Adams                                                --                 --                 --                   --
Chief Executive Officer - Sonoma Foods, Inc.

C. David Viviani                                               --                 --                 --                   --
Chief Operating Officer - Sonoma Foods, Inc.
</TABLE>

(1) All options listed above vest at a rate of 33% per year over the first three
years of the ten-year option term.

                                       35
<PAGE>

Board of Directors Compensation Table for 2006

         The following table provides compensation information for the one year
period ended December 31, 2006 for each non-employee member of the Board of
Directors.

<TABLE>
<CAPTION>
                                                                                         Change in
                                                                                          Pension
                                                                                         Value and
                            Fees                                                        Nonqualified
                           Earned                                      Non-Equity         Deferred        All Other
                         or Paid in        Stock         Option      Incentive Plan     Compensation      Compen-
Name                      Cash (1)         Awards       Awards (2)    Compensation        Earnings         sation        Total
-------------------------------------     --------     -----------   ---------------   ---------------   ------------   --------
<S>                         <C>            <C>          <C>                    <C>               <C>            <C>     <C>
Charles B. Bonner           $ 14,800       $    --      $  24,327              --                --             --      $ 39,127

F. Christopher Cruger       $ 12,000       $    --      $  24,327              --                --             --      $ 36,327

Michael P. Schall           $ 12,000       $    --      $  24,327              --                --             --      $ 36,327

Van Tunstall                $ 19,000       $    --      $  33,774              --                --             --      $ 52,774

James Wong                  $ 14,000       $    --      $  24,327              --                --             --      $ 38,327

Walter L Henning            $ 12,000       $    --      $  24,327              --                --             --      $ 36,327

John H. McGarvey            $ 12,688       $    --      $  18,488              --                --             --      $ 31,176
</TABLE>


1.       Independent directors are reimbursed for out-of-pocket travel expenses
which are not included in this table. Each Board member receives a stipend of
$3,000 for each Board meeting attended. The Board Chairman receives $4,500 for
each Board meeting attended. The Audit Committee Chairperson receives a stipend
of $700 for each Audit Committee meeting chaired, the Compensation Committee
chairperson receives a stipend of $500 for each committee meeting chaired, and
the Board Chairman receives a stipend of $1,000 for each meeting chaired.
2.       Since the vesting of the option awards are over three years, this
amount represents only a portion of the fair value of the options granted during
2006. The fair value of the options granted in 2006 is: Mr. Bonner $40,211; Mr.
Cruger $40,211; Mr. Schall $40,211; Mr. Tunstall $60,933; Mr. Wong $40,211; Mr.
Henning $40,211; Mr. McGarvey $50,263. Each Board member is granted 10,000 stock
options each year with a grant date on the annual shareholder's meeting. The
Board Chairman receives 15,000 stock options each year.

Certain Relationships and Related Transactions

         The Compensation Committee is charged with monitoring and reviewing
issues involving potential conflicts of interest, and reviewing and approving
all related party transactions. As of December 31, 2006, there were no related
party transactions.

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

         On September 4, 2006, the Board of Directors of the Company appointed
Eric Eddings as President and Chief Executive Officer of Monterey Gourmet Foods
effective September 5, 2006, pursuant to an employment contract which was signed
on September 15, 2006 and filed on Form 8-K on September 21, 2006 and is
incorporate here by reference.

         As part of the agreement, the Company will pay Mr. Eddings a base
salary of $285,000 per year. Mr. Eddings will be eligible for an annual cash
bonus based on performance and achieving certain goals. In addition, Mr. Eddings
received an incentive stock option to purchase 150,000 shares of the Company's
common stock vesting and exercisable in installments of 50,000 shares on each of
the first, second, and third anniversaries of his employment agreement. As part
of the agreement, if Mr. Eddings is terminated by the Board of Directors without
cause, Mr. Eddings will be eligible for severance compensation equal to twelve
months of his then applicable base annual salary.

                                       36
<PAGE>

Compensation Committee Interlocks and Insider Participation

         During the fiscal year ended December 31, 2006, executive compensation
was administered by the Compensation Committee comprised of three independent
members of the Board of Directors, James Wong, Walter L. Henning, and F.
Christopher Cruger.

Compensation Committee Report

         We have reviewed and discussed with management certain Compensation
Discussion and Analysis provisions to be included in the Company's SEC Form 10-K
and 2007 Shareholder Meeting Schedule 14A Proxy Statement. Based on the reviews
and discussions referred to above, we recommend to the Board of Directors that
the Compensation Discussion and Analysis referred to above be included in the
Company's Annual Report on Form 10-K.


Compensation Committee

James Wong, Chairman
Walter Henning
F. Christopher Cruger


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

         The table below sets forth (except as noted in the footnotes to the
table), certain information with respect to the beneficial ownership of the
Company's Common Stock by (i) all persons known by the Company to be the
beneficial owners of more than 5% of the outstanding Common Stock of the Company
as of December 31, 2006, (ii) each director of the Company as of December 31,
2006, (iii) the executive officers named in the Summary Compensation Table in
Item 11, and (iv) all such executive officers and directors of the Company as of
December 31, 2006, as a group. No shares reported on this report are pledged.

<TABLE>
<CAPTION>
                                                                            Shares Owned
                                                             --------------------------------------------
Name and Address of Beneficial Owner (1)                     Number of Shares         Percentage of Class
-------------------------------------------------------      ----------------         -------------------
<S>                                                               <C>                         <C>
Gruber and McBaine Capital Management (2)                         2,528,055                   14.6%
50 Osgood Place, Penthouse
San Francisco, CA 94133

T. Rowe Price Associates, Inc. (3)                                1,267,400                    7.3%
100 East Pratt Street
Baltimore, MD 21202

Dimensional Fund Advisors (4)                                     1,410,462                    8.1%
1299 Ocean Ave
Santa Monica, CA 90401

AWM Investment Co., Inc. (5)                                      1,105,041                    6.4%
153 East 53rd Street
New York, NY  10022

F. Christopher Cruger (6)                                            61,317                    *

Van Tunstall (7)                                                    135,807                    *

Michael P. Schall (8)                                                65,350                    *

James Wong (9)                                                       86,000                    *

Charles B. Bonner (10)                                              181,906                    1.0%

Scott Wheeler (11)                                                   50,667                    *

Walter L. Henning (12)                                              108,700                    *

Eric C. Eddings (13)                                                 74,000                    *

John H. McGarvey (14)                                                    --                    *

James M. Williams (15)                                              156,650                    *

A. Martin Adams                                                       6,215                    *

C. David Viviani                                                     24,860                    *

All Executive Officers and Directors as a group (12 persons)(16)    951,472                    5.1%
</TABLE>

                                       37
<PAGE>

_____________________
* Represents less than 1%

(1)  Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission. In computing the number of shares
     beneficially owned by a person and the percentage ownership of that person,
     shares of Common Stock subject to options or warrants held by that person
     that are currently exercisable or will become exercisable within sixty (60)
     days after December 31, 2006 are deemed outstanding, while such shares are
     not deemed outstanding for purposes of computing percentage ownership of
     any other person. Options granted under the Company's 2002 Stock Option
     Plan (the "2002 Stock Option Plan") generally become exercisable as the
     underlying shares vest. Unless otherwise indicated in the footnotes below,
     the persons and entities named in the table have sole voting and investment
     power with respect to all shares beneficially owned, subject to community
     property laws where applicable. Unless otherwise indicated, the address of
     each of the individuals listed in the table is: c/o Monterey Gourmet Foods,
     Inc., 1528 Moffett Street, Salinas, CA 93905.

(2)  Jon D. Gruber and J. Patterson McBaine are the only managers of, and hold
     all executive offices of, Gruber and McBaine Capital Management LLC
     ("GMCM"), an investment advisor. GMCM is the general partner of Lagunitas
     Partners, L.P. ("Lag"), a California investment limited partnership. As of
     December 31, 2006, GMCM had shared voting and investment power over
     2,528,055 shares; Mr. Gruber had sole voting and investment power over
     322,820 shares and shared voting and investment power over 2,528,055
     shares; Mr. McBaine had sole voting and investment power over 351,750
     shares and shared voting and investment power over 2,528,055 shares; Lag
     has shared voting and investment power over 1,249,885 shares. Neither Mr.
     Gruber nor Mr. McBaine participate in the Management of the Company, direct
     the policies of the company, or serve on the Board of Directors of the
     Company.

(3)  As of December 31, 2006, T. Rowe Price Associates, Inc ("Price Associates")
     had sole dispositive power for an entire holding of 1,267,400 shares and
     sole voting power over 267,400 shares. These securities are owned by
     various individual and institutional investors for whom Price Associates
     serves as investment advisor with power to direct investments and/or sole
     power to vote the securities. For purposes of the reporting requirements of
     the Securities Exchange Act of 1934, Price Associates expressly disclaims
     that it is, in fact, the beneficial owner of such securities.

(4)  As of December 31, 2006, Dimensional Fund Advisors Inc ("Dimensional") an
     investment advisor registered under Section 203 of the Investment Advisors
     Act of 1940 which furnishes investment advice to four investment companies
     registered under the Investment Company Act of 1940 and serves as
     investment manager to certain other commingled groups trusts and separate
     accounts directly or indirectly held 1,410,462 shares of Company stock. In
     its role as investment advisor or manager, Dimensional possesses investment
     and/or voting power over 1,410,462 shares. However, Dimensional disclaims
     beneficial ownership of these securities. In addition, no Dimensional
     officer serves as an executive officer or director of the Company.

(5)  As of December 31, 2006, AWM Investment Co., Inc. ("AWM"), in its capacity
     of investment advisor, may be deemed to have beneficial ownership of
     1,105,041shares of the common stock of the Company. Mr. Austin W. Marxe and
     Mr. David M. Greenhouse are the controlling principals of AWM Investment
     Company, Inc. AWM had voting power and/or dispositive power over 1,105,041
     shares.

(6)  Includes 56,250 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

(7)  Includes 111,667 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

(8)  Includes 56,250 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

(9)  Includes 80,000 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

(10) Includes 103,750 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

(11) Includes 46,667 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

                                       38
<PAGE>

(12) Includes 6,200 shares held in an IRA account in the name of Teresa A.
     Henning to which Mr. Henning claims beneficial ownership, and 80,000 shares
     subject to options granted under the 2002 Stock Option Plan which are
     exercisable within sixty (60) days of December 31, 2006.

(13) Includes 5,000 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

(14) Mr. McGarvey was elected to the Board of Directors in February 2006 and
     does not own any of the Company's stock and has not been issued any options
     under the 2002 Stock Option Plan which are exercisable within sixty (60)
     days of December 31, 2006.

(15) Includes 150,000 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

(16) Includes 689,584 shares subject to options granted under the 2002 Stock
     Option Plan which are exercisable within sixty (60) days of December 31,
     2006.

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


ITEM 13.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
                  INDEPENDENCE

         The Company's policy is to forbid all related party transactions; hence
there is no separate policy to govern Board of Directors review or approval of
such matters. During the year ended December 31, 2006, there were no related
party transactions.


ITEM 14.          PRINCIPAL ACCOUNTING FEES AND SERVICES

         The Audit Committee of the Board of Directors of Monterey Gourmet Foods
has selected BDO Seidman, LLP as independent registered public accounting firm
to audit the consolidated financial statements of Monterey Gourmet Foods for the
calendar year ending December 31, 2006. BDO Seidman, LLP has acted in such
capacity since its appointment in fiscal year 1997. The following table sets
forth the aggregate fees billed to Monterey Gourmet Foods for the years ended
December 31, 2006 and December 31, 2005 by BDO Seidman, LLP:

                                                   Fiscal 2006    Fiscal 2005
                                                   -----------    -----------

      Audit Fees (1)...........................      $318,000       $288,000

      Audit-Related Fees (2)...................       $30,000        $40,000

      Tax Fees (3).............................       $56,000        $55,000

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

         (1)      Audit Fees consist of fees billed for professional services
         rendered for the audit of the Company's consolidated annual financial
         statements and review of the interim consolidated financial statements
         included in quarterly reports and services that are normally provided
         by BDO Seidman, LLP in connection with statutory and regulatory filings
         or engagements. Fiscal 2005 fees have been revised from the original
         2005 filing to include additional fees billed in 2006 in relation to
         the 2005 audit.
         (2)      Audit-Related Fees consist of fees billed for assurance and
         related services that are reasonably related to the performance of the
         audit or review of the Company's consolidated financial statements and
         are not reported under "Audit Fees." These services generally include
         fees for due diligence related to business acquisitions and equity
         awards.
         (3)      Tax Fees consist of fees billed for professional services
         rendered for annual compliance filings, ongoing tax planning, and
         consultation regarding the tax implication of proposed or pending
         transactions.

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

                                       39
<PAGE>

                                     PART IV


ITEM 15.          EXHIBITS, FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
(a)(1) - (2)      Consolidated Financial Statements of Monterey Gourmet Foods:                  Page Number (s)
                                                                                                ---------------
<S>                                                                                                 <C>
          Report of Independent Registered Public Accounting Firm                                      41
          Consolidated Balance Sheets: Year-End 2006 and 2005                                          42
          Consolidated Statements of Operations: Years Ended 2006, 2005 and 2004                       43
          Consolidated Statements of Stockholders' Equity: Years Ended 2006, 2005 and 2004             44
          Consolidated Statements of Cash Flows:  Years Ended 2006, 2005 and 2004                      45
          Summary of Significant Accounting Policies                                                46-51
          Notes to Consolidated Financial Statements                                                52-69
          Schedule II - Valuation and Qualifying Accounts                                              70
</TABLE>

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

(a)(3)   Exhibits: See Index to Exhibits on page 72. The Exhibits listed in the
accompanying Index of Exhibits are filed or incorporated by reference as part of
this report. Exhibit Nos. 10.1, 10.2, and 10.7, are management contracts or
compensatory plans or arrangements.

                                       40
<PAGE>

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



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


We have audited the accompanying consolidated balance sheets of Monterey Gourmet
Foods, Inc. as of December 31, 2006 and December 31, 2005 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2006. We have also
audited the schedule listed in the accompanying index at Item 15(a). These
consolidated financial statements and the schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Monterey Gourmet
Foods, Inc. at December 31, 2006 and December 31, 2005, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2006, in conformity with accounting principles generally accepted
in the United States of America.

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

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

BDO Seidman, LLP
San Francisco, California
March 21, 2007

                                       41
<PAGE>

<TABLE>
<CAPTION>
                                               MONTEREY GOURMET FOODS, INC.
                                               CONSOLIDATED BALANCE SHEETS
                                           (in thousands, except share amounts)

                                                                                   December 31, 2006    December 31, 2005
                                                                                   -----------------    -----------------
<S>                                                                                <C>                  <C>
ASSETS
Current assets:
  Cash and cash equivalents                                                        $           4,281    $             330
  Accounts receivable less allowances of $722 and $992                                         9,958                9,342
  Inventories                                                                                  7,574                6,949
  Deferred tax assets-current                                                                    793                1,030
  Prepaid expenses and other                                                                     807                  866
                                                                                   -----------------    -----------------

   Total current assets                                                                       23,413               18,517

  Property and equipment, net                                                                 15,303               14,324
  Deferred tax assets-long term                                                                3,315                6,172
  Deposits and other                                                                             174                  148
  Intangible assets, net                                                                       7,052               11,088
  Goodwill                                                                                    13,211               11,956
                                                                                   -----------------    -----------------

   Total assets                                                                    $          62,468    $          62,205
                                                                                   =================    =================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Bank overdraft                                                                  $              --    $           1,507
   Line of credit                                                                                 --                3,000
  Accounts payable                                                                             7,835                4,171
  Accrued payroll and related benefits                                                         1,487                1,246
  Accrued and other current liabilities                                                        1,577                1,053
  Current portion of notes, loans, and capital leases payable                                  1,018                2,521
                                                                                   -----------------    -----------------

   Total current liabilities                                                                  11,917               13,498

Notes, loans, and capital leases payable, less current portion                                   129                6,626

Deferred tax liability-long term                                                                  --                2,812

Minority interest                                                                                159                  159

Stockholders' equity:
  Preferred stock, $.001 par value,
  1,000,000 shares authorized, none outstanding
  Common stock, $.001 par value,
  50,000,000 shares authorized, 17,307,647 and 14,514,038 issued and outstanding                  17                   14
  Additional paid-in capital                                                                  59,796               45,534
  Accumulated deficit                                                                         (9,550)              (6,438)
                                                                                   -----------------    -----------------
  Total stockholders' equity                                                                  50,263               39,110
                                                                                   -----------------    -----------------

   Total liabilities and stockholders' equity                                      $          62,468    $          62,205
                                                                                   =================    =================
</TABLE>

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

                                       42
<PAGE>

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

                                                               Years Ended
                                               --------------------------------------------
                                                   2006            2005            2004
                                               ------------    ------------    ------------
<S>                                            <C>             <C>             <C>
Net revenues                                   $     94,297    $     85,248    $     62,491

Cost of sales                                        66,858          62,016          46,023
                                               ------------    ------------    ------------

Gross profit                                         27,439          23,232          16,468

Selling, general and administrative expenses         26,754          23,590          18,224
Impairment of intangible assets                       3,160              --              --
Gain (loss) on disposition of assets                     13              --              (5)
                                               ------------    ------------    ------------
Operating loss                                       (2,462)           (358)         (1,761)

Other income, net                                        --              18              42
Interest expense, net                                  (355)           (628)           (130)
                                               ------------    ------------    ------------

Loss before provision for income taxes               (2,817)           (968)         (1,849)

Income tax benefit (provision)                         (295)            431             505
                                               ------------    ------------    ------------

 Net  loss                                     $     (3,112)   $       (537)   $     (1,344)
                                               ============    ============    ============


Basic loss per common share                    ($      0.19)   ($      0.04)   ($      0.09)

Diluted loss per common share                  ($      0.19)   ($      0.04)   ($      0.09)

Weighted average basic shares outstanding        16,100,250      14,450,251      14,343,386
Weighted average diluted shares outstanding      16,100,250      14,450,251      14,343,386
</TABLE>

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

                                       43
<PAGE>

<TABLE>
<CAPTION>
                                                    MONTEREY GOURMET FOODS, INC.
                                           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                              FOR THE YEARS ENDED 2004, 2005, and 2006
                                                (in thousands, except share amounts)

                                                     Common Stock
                                           ---------------------------------     Additional        Accumulated
                                                Shares           Amount        Paid-in Capital       Deficit             Total
                                           ---------------   ---------------   ---------------   ---------------    ---------------
<S>                                             <C>          <C>               <C>               <C>                <C>
Balance, end of 2003                            14,213,682   $            14   $        44,578   $        (4,557)   $        40,035

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

Exercise of stock options for cash                 163,928                --               427                --                427
Tax benefit of disqualifying dispositions               --                --                55                --                 55

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

Balance, end of 2004                            14,392,574   $            14   $        45,103   $        (5,901)   $        39,216

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

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

Stock-based compensation                                --                --                80                --                 80

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

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

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

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

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

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

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

Tax benefit of disqualifying
dispositions                                            --                --                 2                --                  2

Stock-based compensation                                --                --               516                --                516

Net loss for the year                                   --                --                --            (3,112)            (3,112)
                                           ---------------   ---------------   ---------------   ---------------    ---------------

Balance, end of 2006                            17,307,647   $            17   $        59,796   $        (9,550)   $        50,263
                                           ===============   ===============   ===============   ===============    ===============
</TABLE>

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

                                       44
<PAGE>

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

                                                                                        Years Ended
                                                                       --------------------------------------------
                                                                           2006            2005            2004
                                                                       ------------    ------------    ------------
<S>                                                                    <C>             <C>             <C>
Cash flows from operating activities:
Net loss                                                               $     (3,112)   $       (537)   $     (1,344)
Adjustments to reconcile net  loss to net cash provided by (used in)
   operating activities net of acquisition:
           Deferred income taxes                                                282            (379)           (557)
           Depreciation and amortization                                      2,926           3,033           2,510
           Impairment of intangibles                                          3,160              --              --
           Provisions for allowances for bad debts, returns,
              adjustments and spoils                                          4,876           4,792           3,646
           Provisions for inventory allowances                                  629             499             550
           Tax benefit of disqualifying dispositions                             --              --              55
           Stock-based compensation                                             516              80              --
           (Gain) Loss on disposition of assets                                 (13)             --               5
           Changes in assets and liabilities:
               Accounts receivable                                           (5,492)         (6,554)         (2,924)
               Inventories                                                   (1,254)         (2,473)           (267)
               Prepaid expenses and other                                        33             205             538
               Accounts payable                                               3,664             972              (3)
               Accrued and other current liabilities                            765            (742)           (311)
                                                                       ------------    ------------    ------------
Net cash provided by (used in) operating activities                           6,980          (1,104)          1,898
                                                                       ------------    ------------    ------------

Cash flows from investing activities:
           Purchase of property and equipment                                (3,010)         (1,071)           (777)
           Proceeds from sale of fixed assets                                    13              --              --
           Acquisition of business net of cash and minority interest            (69)         (9,062)         (7,689)
                                                                       ------------    ------------    ------------
Net cash used in investing activities                                        (3,066)        (10,133)         (8,466)
                                                                       ------------    ------------    ------------

Cash flows from financing activities:
           Proceeds from bank borrowing                                          --           7,500           2,000
           Bank overdraft                                                    (1,507)          1,507              --
           Line of credit                                                    (3,000)          3,000              --
           Repayment of debt                                                 (7,992)         (1,143)           (610)
           Tax benefit of disqualifying dispositions                              2              --              --
           Repayment of capital lease obligations                               (27)            (19)             (8)
           Proceeds from issuance of common stock                            12,561             153             470
                                                                       ------------    ------------    ------------
Net cash provided by financing activities                                        37          10,998           1,852
                                                                       ------------    ------------    ------------

Net increase (decrease) in cash and cash equivalents                          3,951            (239)         (4,716)

Cash and cash equivalents, beginning of period                                  330             569           5,285
                                                                       ------------    ------------    ------------
Cash and cash equivalents, end of period                               $      4,281    $        330    $        569
                                                                       ============    ============    ============

Cash payments:
             Interest                                                  $        501    $        634    $        131
             Income taxes                                                         6               7              89

Non-cash investing and financing activities:
             Note issued to seller in acquisition of business          $         --    $         --    $      1,000
             Capital lease obligations                                           19              86               5
             Issuance of stock for acquisition of business                    1,186             198              --
</TABLE>

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

                                       45
<PAGE>

                           MONTEREY GOURMET FOODS, INC
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     1.  Summary of Significant Accounting Policies

         Principles of Consolidation and Nature of Operations

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

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

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

         The Company reported losses for the years 2004, 2005, and 2006 and at
December 31, 2006 the company had an accumulated deficit of $9,550,000. The
Company generated $7 million in cash from operating activities during 2006 and
raised $11.6 million through a private equity transaction. Management believes
that the Company's current cash balances and future operating projections will
provide adequate liquidity to meet the Company's planned capital and operating
requirements for normal operations and capital expenditures through the 2007
calendar year. See Note 7 for a description of the Company's credit facility.

         Accounting Periods

         The Company operates and reports results on a calendar year. The
calendar year ended on December 31, 2006.

         Cash and Cash Equivalents

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

         Accounts Receivable and Allowances

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

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

         Inventory Valuation

         Inventories are stated at the lower of cost (using the first-in,
first-out method) or market and consist principally of component ingredients to
the Company's refrigerated pasta and sauces, finished goods, and packaging
materials. Many of the ingredients used in the Company's products are short
shelf-lived products and if not used in a certain amount of time may spoil.
Management estimates that the raw material will be used in a timely manner;
however, management has established certain reserves for the potential of
inventory obsolescence, especially for slow moving inventory. As of December 31,
2006 and December 31, 2005, the Company reduced the carrying value of its
inventory by $273,000 and $123,000 respectively. This write-down was made to
cover certain refrigerated raw material inventory that is nearing its
shelf-life, certain packaging labels for products that may be rotated out of the
Club Store accounts and for products that have already been rotated out of the
Club Store accounts that may or may not be rotated back into the Club Store
accounts. The allowance is established based on management's estimate of

                                       46
<PAGE>

alternative usage or salvage value of obsolete inventory. Management believes
its estimates for spoiled and obsolete inventory are adequate given the current
volume of business to current customers.

         Advertising Costs

         The Company expenses advertising costs as incurred or when the related
campaign commences. The Company spent $107,000, $253,000 and $149,000 on
advertising during, 2006, 2005, and 2004, respectively.

         Property and Equipment

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

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

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

         Valuation of Goodwill/Indefinite-lived Intangible Assets

         Under SFAS 142, "Goodwill and Other Intangible Assets" goodwill and
intangible assets with indefinite useful lives are to be tested for impairment
at least annually. The primary identifiable intangible assets of the Company's
reporting unit with indefinite lives are trademarks, tradenames and goodwill
acquired in business acquisitions. As of December 31, 2006, the net book value
of trademarks and other identifiable indefinite-lived intangible assets was $2.7
million.

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

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

         Goodwill is not amortized but is subject to periodic assessments of
impairment. At December 31, 2006, the Company had $13.2 million of goodwill on
its books. Goodwill is assessed for impairment at least as often as annually and
as triggering events may occur. The Company performs its annual review in the
fourth quarter of each year. Recoverability of goodwill is evaluated using a
comparison of the fair value of a reporting unit with its carrying value.

         In evaluating the recoverability of goodwill, it is necessary to
estimate the fair value of the reporting unit. In making this assessment,
management relies on a number of factors to discount anticipated future cash
flows including operating results, business plans and present value techniques.
Rates used to discount cash flows are dependent upon interest rates and the cost
of capital at the relevant point in time. There are inherent uncertainties
related to these factors and management's judgment in applying them to the
analysis of goodwill impairment. It is possible that assumptions underlying the
impairment analysis will change in such a manner that impairment may occur in
the future.

                                       47
<PAGE>

         Valuation of Plant and Equipment and finite-lived Intangible Assets

         In accordance with Statement of Financial Accounting Standards (SFAS)
No. 144, Accounting for the Impairment or Disposal of Long-lived Assets ("SFAS
144"), management reviews finite-lived long-lived assets, primarily consisting
of plant and equipment and amortized intangible assets such as acquired recipes,
customer lists and non-compete agreements, whenever events or changes in
circumstances indicate that the carrying amount of an asset group may not be
recoverable. Intangible assets with finite useful lives continue to be amortized
over their respective estimated useful lives. The estimated useful life of an
identifiable intangible asset is based upon a number of factors, including the
effects of demand, competition, and future cash flows. For these assets, if the
total expected future undiscounted cash flows from the asset group is less than
the carrying amount of the asset group, an impairment loss is recognized for the
difference between the fair value of the carrying value of the asset group. The
impairment tests require management to estimate the undiscounted cash flows and
fair value of the asset groups. As of December 31, 2006, the net book value of
finite-lived intangible assets was $4.3 million.

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


         Impairment of finite-lived and indefinite-lived Intangible Assets

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

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

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

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


         Income Taxes and Deferred Tax Asset Valuation Allowance

         The Company accounts for corporate income taxes in accordance with SFAS
109, "Accounting for Income Taxes" which requires an asset and liability
approach. This approach results in the recognition of deferred tax assets
(future tax benefits) and liabilities for the expected future tax consequences
of temporary timing differences between the book carrying amounts and the tax

                                       48
<PAGE>

basis of assets and liabilities. Future tax benefits are subject to a valuation
allowance to the extent of the likelihood that the deferred tax assets may not
be realized. The Company's deferred tax assets include significant amounts of
net operating losses (`NOLs"). During 2006, the valuation allowance was
increased based on the management's judgment that it is not more-likely-than-not
that all of its deferred tax assets could be realized due to the intangible
asset impairment of the Casual Gourmet Foods which affected the Company's
assessment of the realization of our NOLs. The amount of the valuation allowance
is significantly dependant on management's assumptions regarding future taxable
income and the availability of these NOLs to offset future taxable income. The
effect on the Company's net income is significant whenever the estimate changes.
The Company has a valuation allowance against deferred tax assets of $1.5
million as of December 31, 2006.

         Revenue Recognition

         The Company recognizes revenues through sales of its products primarily
to grocery and club store chains. Revenues are recognized once there is evidence
of an arrangement (such as a customer purchase order), product has been shipped
to the customer or (in the case of Costco wholesales) when the product has been
delivered to the customer, the price and terms are fixed, and collectibility is
reasonably assured. Accordingly, sales are recorded when goods are shipped or
delivered, at which time title and risk of loss have passed to the customer,
consistent with the freight terms for the customer. Potential returns,
adjustments and spoilage allowances which reduce net revenues are provided for
in accounts receivable allowances and accruals. All pricing is quoted FOB
shipping point to customers with freight included in the price for the
convenience of the customer.

         The Company records shipping cost for product delivered to customers in
selling general and administrative expense. These costs were approximately
$5,764,000, $ 4,361,000 and $3,201,000 for 2006, 2005, and 2004 respectively.
Any amounts charged to customers for freight and deliveries are included in
revenues and approximate the amount recorded in SG&A. Certain incentives granted
to customers such as promotions, trade ads, slotting fees, terms discounts, and
coupons are recorded as offsets to revenues.

         Workers Compensation Reserve

         The Company's California and Oregon locations entered into a partially
self-insured worker's compensation program for fiscal year 2003 and have
continued the program through 2006 and into 2007. This program features a fixed
annual payment, with a deductible on a per occurrence basis. The annual expense
consists of a base fee paid to an insurance company to administer the program,
direct cash expenses to pay for injuries, an estimate for potential injuries
that may have occurred but have not been reported, an estimate by the insurance
company of costs to close out each injury and an estimate for injury
development. The Company has been on this partially self-insured program for
four years and therefore has limited history of claim resolution available to
support the Company's projected liabilities. Therefore the Company is using
published industry actuarial data from an insurance carrier and reviewing each
claim individually to determine the amount of reserves that should be
established. Management believes that its current safety program and its safety
record will provide the foundation to enable the Company to realize the premium
savings partially self-insured programs are designed to achieve; however,
estimated reserves may vary from future cash outlays. The remaining locations
are on a fixed premium insurance contract that covers all costs including
claims.

         Stock-based Compensation

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

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

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

                                       49
<PAGE>

compensation expense the Company would otherwise recognize in its statement of
operations with respect to these accelerated options upon the adoption of SFAS
123R "Share-Based Payment". The acceleration of the vesting of these options did
not impact the Company's financial statements.

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

         Segment and Enterprise-Wide Reporting

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

         Use of Estimates

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

         Indemnifications

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

         Pursuant to its bylaws, the Company has agreed to indemnify its
officers and directors for certain events or occurrences arising as a result of
the officer or director serving in such capacity. The term of the
indemnification period is for the officer's or director's lifetime. The Company
has no liabilities recorded for these agreements as of December 31, 2006.

         The Company enters into indemnification provisions under (i) its
agreements with other companies both in extraordinary transactions (such as
acquisitions of a material amount of assets or other investment in other
companies) and in its ordinary course of business, typically with business
partners, contractors and customers, and its sublandlord and (ii) its agreements
with investors. Under these provisions the Company has agreed to generally
indemnify and hold harmless the indemnified party for losses suffered or
incurred by the indemnified party as a result of the Company's activities or, in
some cases, as a result of the indemnified party's activities under the
agreement. These indemnification provisions often include indemnifications
relating to representations made by the Company with regard to intellectual
property and other rights. These indemnification provisions generally survive
termination of the underlying agreement. The maximum potential amount of future
payments the Company could be required to make under these indemnification
provisions is unlimited. To date, the Company has not incurred any costs as
there have been no lawsuits or claims related to these indemnification
agreements. Accordingly, the Company has no liabilities recorded for these
agreements as of December 31, 2006.

         New Accounting Pronouncements

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

         In September 2006, the FASB issued SFAS 157 "Fair Value Measurements",
which provides enhanced guidance for using fair value to measure assets and
liabilities and also expands information about the extent to which companies

                                       50
<PAGE>

measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. SFAS 157
applies whenever other accounting standards require or permit assets and
liabilities to be measured at fair value and does not expand the use of fair
value in any new circumstances. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and interim periods
within those fiscal years. The Company is currently assessing the impact of SFAS
157.

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

         In July 2006, the FASB issued Interpretation No. 48, ("FIN 48")
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109." FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in a company's financial statements in accordance with SFAS
109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold
and measurement attribute for the financial statement recognition and measure of
a tax position taken or expected to be taken in a tax return. It also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company is currently evaluating the
impact that adoption of FIN 48 may have on its results of operations or
financial position.

         In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections." This new standard replaces APB Opinion No. 20, "Accounting
Changes in Interim Financial Statements," and SFAS No. 3, "Reporting Accounting
Changes in Interim Financial Statements," and represents another step in the
FASB's goal to converge its standards with those issued by the International
Accounting Standards Board ("IASB"). Among other changes, SFAS 154 requires that
a voluntary change in accounting principle be applied retrospectively with all
prior period financial statements presented on the new accounting principle,
unless it is impractical to do so. SFAS 154 also provides that (1) a change in
method of depreciating or amortizing a long-lived nonfinancial asset be
accounted for as a change in estimate (prospectively) that was effected by a
change in accounting principle, and (2) correction of errors in previously
issued financial statements should be termed a "restatement." The new standard
was effective for accounting changes and correction of errors made in fiscal
years beginning after December 15, 2005. As of December 31, 2006 this
pronouncement had no impact on the Company's consolidated financial statements.

         In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities ("SFAS 159"). SFAS 159 provides
companies with an option to report selected financial assets and liabilities at
fair value. SFAS 159 also establishes presentation and disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities and to
provide additional information that will help investors and other financial
statement users to more easily understand the effect of the company's choice to
use fair value on its earnings. Finally, SFAS 159 requires entities to display
the fair value of those assets and liabilities for which the company has chosen
to use fair value on the face of the balance sheet. SFAS 159 is effective as of
the beginning of an entity's first fiscal year beginning after November 15,
2007. Early adoption is permitted as of the beginning of the previous fiscal
year provided that the entity makes that choice in the first 120 days of that
fiscal year and also elects to apply the provisions of SFAS 157 (see above). The
Company is currently assessing the impact of SFAS 159 which it will be required
to adopt.

         Reclassifications

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

         Earnings per Share

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

                                       51
<PAGE>

     2.  Business Acquisitions

         2006 Activities

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

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

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

         The Casual Gourmet Foods Purchase in 2005

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

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

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

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

                                       52
<PAGE>

<TABLE>
<CAPTION>

<S>                                                                     <C>
            Cash paid directly to owners of Casual                      $    6,000
            Acquisition costs incurred                                         159
                                                                        ----------
               Total cost of acquisition                                     6,159
                                                                        ----------
            Liabilities assumed:
                Accounts payable                                               325
                Income taxes payable                                           159
                Other accrued liabilities                                      504
                Long-term notes payable                                        266
                Deferred tax liability created at time of acquisition        1,069

            Tangible assets acquired:
                 Cash on hand                                                 (524)
                Accounts receivable, net                                      (524)
                Income tax refund recievable                                  (264)
                Inventory                                                     (315)
                Prepaid expenses and other                                     (30)
                Fixed assets                                                  (183)
            Computed interest on non-interest bearing notes                      8
            Intangible assets acquired:
                Customer Relations                                          (2,500)
                Non Compete                                                   (800)
                Trademarks                                                    (840)
                Recipes                                                       (400)

                                                                        ----------
            Goodwill acquired in transaction                            $    2,110
                                                                        ==========
</TABLE>

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

            Current values of intangible assets (in thousands)

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


         The Sonoma Foods Purchase in 2005

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

         Sonoma markets a variety of refrigerated branded specialty cheese
items, including its flagship products, Sonoma Jack Cheeses in a variety of
flavors. Sonoma's products are sold in retail supermarkets, club stores, and
specialty food stores across the US with the greatest penetration in the Western
US markets. Some of the most popular cheese flavors include Hot Pepper Jack

                                       53
<PAGE>

Cheese, Garlic Jack Cheese, Mediterranean Jack Cheese and Pesto Jack Cheese.
Sonoma maintains its headquarters in Sonoma, CA. The Company acquired Sonoma in
order to expand and diversify its product line in the specialty foods category
in which it competes.

         For its initial acquisition of 80% of Sonoma's outstanding shares, the
Company paid $3.3 million in cash and issued 62,150 shares of the Company's
common stock valued at $198,000 plus acquisition costs of $129,000. Purchase of
the remaining shares will be at a price derived from a predetermined calculation
based upon a percentage of earnings before taxes, interest, bonuses,
depreciation and amortization during the interim periods. Sonoma will remain a
separate entity and, under additional agreement between the Company, Sonoma and
the Shareholders, Sonoma's day-to-day operations until the acquisition is
completed are managed by Sonoma's existing management; The Company controls a
majority of the Board of Directors and will be entitled to all future profits
and is at risk for all future losses, if any.

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

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

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


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

                                       54
<PAGE>

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

 Net revenues                                        $          87,815

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

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

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

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


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


     3.  Concentration of Credit Risk

         Financial instruments, which potentially subject the Company to
concentration of credit risk, include cash, cash equivalents, and accounts
receivable. The Company maintains its cash accounts in Comerica Bank in Fresno,
California. The bank cash balances are insured by the Federal Deposit Insurance
Corporation up to $100,000. In addition, as of December 31, 2006, approximately
58% of the Company's accounts receivables are concentrated with two major
customers (See Note 11).

     4.  Inventories

            Inventories consisted of the following:
<TABLE>
<CAPTION>
                                                           2006             2005
                                                        ------------    ------------
                                                              (in thousands)
<S>                                                     <C>             <C>
               Production - Ingredients                 $      3,178    $      2,510
               Production - Finished goods                     3,174           2,742
               Paper goods and packaging materials             1,382           1,784
               Operating supplies                                113              36
                                                        ------------    ------------
                                                               7,847           7,072
               Allowances for spoils and obsolescence           (273)           (123)
                                                        ------------    ------------
                                                        $      7,574    $      6,949
                                                        ============    ============
</TABLE>

                                       55
<PAGE>

     5.  Property and Equipment

            Property and equipment consisted of the following:
<TABLE>
<CAPTION>
                                                                    2006            2005
                                                                ------------    ------------
                                                                      (in thousands)
<S>                                                             <C>             <C>
               Leasehold improvements                           $      5,508    $      5,142
               Machinery and equipment                                21,215          19,941
               Computers, office furniture and equipment               1,393           1,240
               Vehicles                                                  454             454
                                                                ------------    ------------
                                                                      28,570          26,777
               Less accumulated depreciation and amortization        (14,754)        (12,703)
                                                                ------------    ------------
                                                                      13,816          14,074
               Construction in progress                                1,487             250
                                                                ------------    ------------
                                                                $     15,303    $     14,324
                                                                ============    ============


         Construction in progress at December 31, 2006 includes deposits for
equipment on order or yet to be installed. The Company believes it will cost
approximately $200,000 to complete projects that have already been started.

         Depreciation expense for 2006, 2005, and 2004 was $2,052,000,
$2,075,000, and $2,029,000 respectively.


     6.  Goodwill and Other Intangible Assets

         Goodwill and other intangible assets consisted of (in thousands of
dollars):
<CAPTION>

                                              Gross goodwill and intangible assets
                                            ------------------------------------------                       Net
                                             Year-end         2005        Impairments                    Accumulated      Carrying
                                                2004        Additions         2005        Year-end 2005  Amortization      Amount
                                            ------------   ------------   ------------    ------------------------------------------
<S>                                         <C>            <C>            <C>             <C>            <C>            <C>
Trademarks and tradenames                   $        220   $         --   $         --    $        220   $        215   $          5
Customer lists                                     4,740          3,262             --           8,002          1,361          6,641
Other intangibles                                    725          1,257             --           1,982            644          1,338
                                            ------------   ------------   ------------    ------------------------------------------
     Total amortized intangible assets             5,685          4,519             --          10,204          2,220          7,984

Intangible assets with indefinite lives            1,690          1,414             --           3,104             --          3,104
                                            ------------   ------------   ------------    ------------------------------------------

     Total intangible assets                       7,375          5,933             --          13,308          2,220         11,088

Goodwill                                           8,143          3,813             --          11,956             --         11,956
                                            ------------   ------------   ------------    ------------------------------------------

     Total goodwill and intangible assets   $     15,518   $      9,746   $         --    $     25,264   $      2,220   $     23,044
                                            ============   ============   ============    ==========================================



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

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

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

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

     Total goodwill and intangible assets   $     25,264   $      1,255   $     (3,160)   $     23,359   $      3,096   $     20,263
                                            ============   ============   ============    ==========================================
</TABLE>

                                       56
<PAGE>

         All of the Company's business combinations were accounted for using the
purchase method. Amortization expense was $876,000, $958,000 and $481,000 for
2006, 2005 and 2004 respectively.

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

         The Company performed annual impairment testing as required by SFAS 142
during the fourth quarter of 2006 to determine if any additional writedowns were
necessary, with no impairment adjustments needed.

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

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

                                  2007            $  597
                                  2008               593
                                  2009               591
                                  2010               591
                                  2011               591
                   2012 and thereafter             1,385
                                                  ------
                                 Total            $4,348
                                                  ======

                                       57
<PAGE>

     7.  Notes, Loans, and Capitalized Leases Payable

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

<TABLE>
<CAPTION>
                                                                                              2006            2005
                                                                                          ------------    ------------
<S>                                                                                       <C>             <C>
Subordinated note payable to OBIC Inc.; assumed from CIBO Naturals stock purchase         $        944    $      1,000
           Monthly principal payments of $8,000 starting April 1, 2006
           Matures in July 2007
Note payable to Comerica Bank to partially purchase CIBO Naturals                                   --             625
           Variable rate interest at LIBOR plus 200 basis points
           Monthly principal payments of $62,500 plus interest of approximately 7%
           Matures in October 2006; Paid off in July 2006
Note payable to Comerica Bank to partially purchase Sonoma Foods                                    --           2,208
           Variable rate interest at LIBOR plus 275 basis points
           Monthly principal payments of $41,667 plus interest of approximately 7%
           Matures in May 2010; Paid off in July 2006
Note payable to Comerica Bank to partially purchase Casual Gourmet Foods                            --           5,000
           Variable rate interest at LIBOR plus 275 basis points
           Monthly principal payments of $104,167 plus interest of approximately 7%
           Matures in February 2009; Paid off in July 2006
Notes assumed from Casual Gourmet stock purchase                                                    92             180
           Interest ranges from 0.0% to 9.35%; payable in monthly payments of $7,367
           Maturing from January 2007 through March 2011
Note payable assumed from Sonoma Foods stock purchase                                               94             121
           Payable in monthly payments of $3,857 including interest of 15.88% and 17.6%
           Matures in June 2009
Capital leases payable                                                                              17              13
                                                                                          ------------    ------------
Total notes, loans, and capital leases payable                                            $      1,147    $      9,147
Less current portion of notes, loans, and capital leases payable                                (1,018)         (2,521)
                                                                                          ------------    ------------
Notes, loans, and capital leases payable, less current portion                            $        129    $      6,626
                                                                                          ============    ============
</TABLE>

         The weighted average interest rate on notes payable with outstanding
balances at December 31, 2006 was 8%.

         Credit Facility

         The Company has a $5.0 million working capital line of credit which was
not utilized as of December 31, 2006 and a letter of credit in the amount of
$1,100,000 which is issued in favor of an insurance company to support a
self-funded worker's compensation program and which was decreased to $800,000 on
January 1, 2007. No additional loans are available to the Company without bank
approval. The working capital commitment in place at December 31, 2006 expires
June 1, 2007. The interest rate on this entire credit line will be calculated at
the bank's prime lending rate or LIBOR plus 2.00%, which ever the Company
chooses.

         The terms of the Credit Facility prohibit the payment of cash dividends
(except with written approval) on the Company's capital stock and restrict
payments for, among other things, repurchasing shares of Company's capital
stock. Other terms of the Credit Facility limit the Company with respect to,
among other things, (i) incurring additional indebtedness, (ii) adversely
changing the capital structure, and (iii) acquiring assets other than in the
normal course of business, and (iv) meeting certain financial covenants. As of
December 31, 2006, the Company was not in violation of any bank covenant.

         Effective January 1, 2007, the Company initiated an $800,000 Letter of
Credit in favor of Sentry Insurance as required collateral for a deductible
worker's compensation program. The new letter of credit expires December 31,
2007.

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

                                       58
<PAGE>

                           Year                      Principal Amount
                 --------------------------    ----------------------
                           2007                              $  1,018
                           2008                                    67
                           2009                                    47
                           2010                                    13
                           2011                                     2
                                               ----------------------
                                                             $  1,147
                                               ======================

         Employment Contracts

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

         In addition, the management team of Casual Gourmet Foods has employment
contracts that extend through the calendar year 2007 and the Sonoma Foods
management team has employment contracts that extend through April 2009.


         Capitalized Leases

         The Company leases certain equipment under capitalized leases,
including office equipment, and a forklift, with a liability of $68,000 and
$75,000 in 2006 and 2005, respectively.


     8.  Operating Leases

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

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

                   Year                           Lease Amount
                   ----                           ------------
                   2007                                $ 1,773
                   2008                                  1,528
                   2009                                  1,430
                   2010                                  1,438
                   2011                                  1,449
                   2012 and Thereafter                   3,088
                                                --------------
                                                      $ 10,706
                                                ==============

         Gross rent expense under the leases for 2006, 2005, and 2004 was
$1,338,000, $1,286,000, and $1,080,000 respectively. The Company's four
production facilities are leased. The Company leases approximately 133,000
square feet at two locations in Salinas, California. The current production
facilities/headquarters lease expires in October 2014. The lease for the
distribution center and storage facilities expires in May 2012.

         The Company acquired a lease for the 19,000 square foot production
facility and offices in Eugene, Oregon, as part of its acquisition of Emerald
Valley. The lease expires December 31, 2007, with three five-year renewal
options. In 2004, in connection with its CIBO Naturals acquisition, the Company
assumed an operating lease of 47,500 square feet in Seattle, Washington under a
lease which expires in May 2008.

                                       59
<PAGE>

     9.  Stockholders' Equity

         Preferred Stock

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

         Common Stock

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

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

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

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

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

         Employee Stock Purchase Plan

         In October 1994, the Company's Board of Directors adopted a qualified
employee stock purchase plan. Under the purchase plan, eligible employees (those
who have completed one year of continuous employment with the Company) may
purchase shares of the Company's common stock through payroll deductions not to
exceed 10% of gross wages. The Company has reserved 200,000 shares of its common
stock for issuance under the purchase plan, which remains in effect until
terminated by the Company's Board of Directors, or until all of the shares
reserved for under the purchase plan have been issued. Unless the Board has
otherwise provided a higher amount prior to the commencement of an offering
period, the offering exercise price for each purchase period is 85% of the
lesser of (a) the fair market value of the shares on the offering date of such
offering period or (b) the fair market value of the shares on the given purchase
date. There were 10,900 shares, 8,198 shares, and 14,964 shares of common stock
issued under the plan in 2006, 2005, and 2004 respectively. At December 31,
2006, there were 127,634 shares remaining available for purchase under the plan.

         Income per Share Calculation

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

                                       60
<PAGE>

<TABLE>
<CAPTION>
                                                            2006           2005           2004
                                                        ------------   ------------   ------------
<S>                                                       <C>            <C>            <C>
         Weighted average common shares
              outstanding used in basic
              net income per share computation            16,100,250     14,450,251     14,343,386

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

         Shares used in dilutive net income per share
              computation                                 16,100,250     14,450,251     14,343,386
                                                        ============   ============   ============
</TABLE>

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

         Options to purchase 1,687,435, 1,807,194, and 1,763,810, shares of
common stock were outstanding at year-end 2006, 2005, and 2004, respectively and
were excluded from the computation of diluted earnings per share because they
were anti-dilutive due to the Company's net losses for those years.

     Stock-Based Compensation Expense

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

         The Company adopted SFAS 123(R) using the modified prospective
transition method, which requires the application of the accounting standard as
of January 1, 2006, the first day of the Company's fiscal year 2006.
Consolidated financial statements as of December 31, 2006 reflect the impact of
SFAS 123(R). In accordance with the modified prospective transition method, the
consolidated financial statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R). The Company recorded
stock-based compensation in 2005 of $80,000, and no stock-based compensation
expense related to employee or director stock options recognized during 2004.
Stock-based compensation expense recognized under SFAS 123(R) for employee and
directors for the year ended December 31, 2006 was $516,000. The Company
recorded $55,000 in cost of sales and $461,000 in selling, general and
administrative expenses. Included in the $461,000 stock based compensation
expense is a stock compensation charge of $132,000 recorded in relation to the
modification to extend the exercise period on 150,000 options as part of the
separation agreement with the Company's former CEO. Basic and diluted loss per
share for the year ended December 31, 2006 would have been ($0.16), if the
Company had not adopted SFAS 123(R), compared to reported basic and diluted loss
per share of ($0.19).

The estimated fair value of option grants or modifications to employees and
directors during the years 2006, 2005, and 2004 were $1,005,000, $436,000, and
$534,000. The weighted average fair value per share of the stock options awarded
in 2006, 2005 and 2004 of $2.14, $1.69 and $1.55 was based on the fair market
value of the Company's common stock on the grant dates.

         The following table illustrates the effect on net loss and loss per
share if the Company had applied the fair value recognition provisions of SFAS
123 to stock-based awards granted under the Company's stock option plans for
2005 and 2004. Proforma disclosures for 2006 are not presented because the
amounts are recognized in the Consolidated Statement of Operations. For purposes
of this pro-forma disclosure, the fair value of the options is estimated using
the Black-Scholes-Merton option-pricing formula ("Black-Scholes model") and
amortized to expense over the options' contractual term (in thousands except
share data).

                                       61
<PAGE>

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

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

Deduct: total stock-based employee compensation
   determined under fair value method for all awards,
   net of related tax effects                                          (619)           (715)
                                                               ------------    ------------

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

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

Diluted, as reported                                           $      (0.04)   $      (0.09)
Diluted, as adjusted                                           $      (0.07)   $      (0.14)
                                                               ============    ============
</TABLE>

         The fair value of stock option grants has been estimated at the date of
grant using the Black-Scholes option pricing model with the following weighted
average assumptions:

                                            2006          2005          2004
                                         ----------    ----------    ----------

        Dividend yield                         --            --           --

        Volatility                           52.3%         53.7%        54.9%

        Risk-free interest rates             4.75%         3.58%        3.69%

        Expected lives in years                 6             6            4

        Forfeiture rate                         7%           --           --


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

         Stock-based compensation expense recognized during the period is based
on the value of the portion of share-based payment awards that is ultimately
expected to vest during the period. Stock-based compensation expense recognized
in the Consolidated Statements of Operations for the year ended December 31,
2006 included compensation expense for share-based payment awards granted prior
to, but not yet vested as of January 1, 2006 based on the grant date fair value
estimated in accordance with the pro-forma provisions of SFAS 123 and
compensation expense for the share-based payment awards granted subsequent to
January 1, 2006 based on the grant date fair value estimated in accordance with
the provisions of SFAS 123(R). For stock-based awards issued to employees and
directors, stock-based compensation is expensed ratably over the vesting period,
which is consistent with how the prior-period proformas were provided. As
stock-based compensation expense recognized in the Consolidated Statements of
Operations for the year ended December 31, 2006 is based on awards ultimately
expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R)
requires forfeitures to be estimated at the time of grant and revised, if
necessary, in subsequent periods if actual forfeitures differ from those
estimates. For 2006, forfeitures of unvested stock options were estimated to be
approximately 7%. In the pro-forma information required under SFAS 123 for the
periods prior to fiscal 2006, the Company accounted for forfeitures as they
occurred.

                                       62
<PAGE>

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

         Warrants

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

         Stock Options

         The Company's 2002 Stock Option Plan, originally established in 1993
(the "Plan"), provides for the granting of incentive stock options or
non-qualified stock options to eligible employees, consultants and outside
directors. The Company initially reserved 1,200,000 shares of its common stock
for issuance under the Plan and in subsequent years increased the total shares
reserved to 3,240,000. The Plan provides that the option price shall not be less
than the fair market value of the shares on the date of grant. Options generally
vest over a period of one to three years and may be exercised for a period of up
to ten years. During 2001, the Company issued additional options to purchase up
to 155,200 shares outside of the Plan (the "Nonstatutory Plan"). The Plan
expires April 30, 2012. As of December 31, 2006, the Company had 541,038 shares
available for new grants under the Plan, and 33,800 shares available for new
grants under the Nonstatutory Plan.

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

         The following table summarizes option activity:

                                       63
<PAGE>

<TABLE>
<CAPTION>
                                                         2004
                                         ------------------------------------
                                                                                   Weighted
                                                                Weighted            Average           Aggregate
                                                                 Average           Remaining          Intrinsic
                                              Shares          Exercise Price    Contractual Life        Value
                                         ----------------    ----------------   ----------------   ----------------
<S>                                             <C>          <C>                            <C>    <C>
Outstanding at beginning of year                1,872,739    $           4.63
Granted                                           344,000                3.46
Exercised                                        (163,928)               2.61
Canceled or expired                              (289,001)               5.59
                                         ----------------    ----------------
Outstanding at end of year                      1,763,810    $           4.44
                                         ================    ================


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


                                                         2006
                                         ------------------------------------
Outstanding at beginning of year                1,807,194    $           4.24
Granted                                           470,000                4.42
Exercised                                        (308,709)               2.90
Canceled or expired                              (281,050)               4.40
                                         ----------------    ----------------
Outstanding at end of year                      1,687,435    $           4.51               6.34   $        919,978
                                         ================    ================   ================   ================
Vested/expected to vest at end of year          1,644,161    $           4.51               6.34   $        905,959
                                         ================    ================   ================   ================

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


         The following table shows information for options outstanding or
exercisable as of December 31, 2006:
<CAPTION>

                                           OPTIONS OUTSTANDING                                    OPTIONS EXERCISABLE
                        -----------------------------------------------------------   --------------------------------------------
                                          Weighted
                                           Average      Weighted      Aggregate          Number      Weighted        Aggregate
                           Number         Remaining     Average    Intrinsic Value     Exercisable   Average      Intrinsic Value
       Range of         Outstanding      Contractual    Exercise  Closing price at       As of       Exercise    Closing price at
   Exercise Prices     As of 12/31/06       Life          Price   12/31/06 of $4.38     12/31/06      Price      12/31/06 of $4.38
 --------------------  -----------------------------   ---------  -----------------   -------------  ---------   -----------------
<S>           <C>       <C>               <C>            <C>         <C>               <C>            <C>              <C>
 $ 1.19       $ 3.34      246,235         3.80 Years     $ 2.85      $ 375,705           244,735      $ 2.85           $ 373,943
 $ 3.35       $ 3.44      232,500         6.88 Years     $ 3.41        224,990           202,500      $ 3.42             194,390
 $ 3.45       $ 3.76      193,200         6.35 Years     $ 3.70        131,322           193,200      $ 3.70             131,322
 $ 3.77       $ 3.89      196,500         8.94 Years     $ 3.88         98,015            41,500      $ 3.85              21,865
 $ 3.90       $ 3.95      178,500         6.45 Years     $ 3.94         77,733           113,170      $ 3.94              49,641
 $ 3.97       $ 5.85      190,500         7.55 Years     $ 4.81             --            99,750      $ 5.31                  --
 $ 5.94       $ 6.55      254,000         4.97 Years     $ 6.31             --           254,000      $ 6.31                  --
 $ 6.75       $ 7.92      177,500         6.92 Years     $ 7.12             --           102,500      $ 7.10                  --
 $ 8.08       $ 9.20       17,500         5.21 Years     $ 8.17             --            17,500      $ 8.17                  --
 $ 9.25       $ 9.25        1,000         5.28 Years     $ 9.25             --             1,000      $ 9.25                  --
 $ 1.19       $ 9.25    1,687,435         6.34 Years     $ 4.51      $ 907,764         1,269,855      $ 4.51           $ 771,160
</TABLE>

         The aggregate intrinsic value in the preceding table represents the
total intrinsic value based on the closing stock price of $4.38 as of December
29, 2006, which would have been received by the option holders had all option
holders exercised as of that date. The aggregate intrinsic value of options
exercised during the calendar year 2006 was $872,000.

                                       64
<PAGE>

         The following table provides information about our common stock that
may be issued upon the exercise of options, warrants or rights under all of our
existing equity compensation plans as of December 31, 2006, including the
Monterey Gourmet Foods 2002 Stock Option Plan and the Monterey Gourmet Foods
2001 Nonstatutory Stock Option Plan.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
                                Number of securities to be    Weighted-average exercise      Number of securities
                                  issued upon exercise of       price of outstanding        remaining available for
        Plan category              outstanding options,         options, warrants and        future issuance under
                                    warrants and rights                rights              equity compensation plans
                                                                                             (excluding securities
                                                                                            reflected in column (a))
                                            (a)                          (b)                          (c)
--------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                             <C>                         <C>
Equity compensation plans
approved by security                    1,636,735(1)                    $4.45                       411,738
holders
--------------------------------------------------------------------------------------------------------------------
Equity compensation plans
not approved by security                   50,700(2)                    $6.55                       129,300
holders
--------------------------------------------------------------------------------------------------------------------

Total                                   1,687,435                       $4.51                       541,038
--------------------------------------------------------------------------------------------------------------------

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

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


     10. Income Taxes

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

<CAPTION>
                                                 2006            2005           2004
                                             ------------    ------------   ------------
<S>                                          <C>             <C>            <C>
                Current:

                Federal                      $         (2)   $         25   $        (45)
                State                                 (11)             27             (7)
                                             ------------    ------------   ------------
                  Total                               (13)             52            (52)
                                             ------------    ------------   ------------

               Deferred:

                Federal                              (375)            334            404
                State                                  93              45            153
                                             ------------    ------------   ------------
                  Total                              (282)            379            557
                                             ------------    ------------   ------------

                 Net tax benefit (expense)   $       (295)   $        431   $        505
                                             ============    ============   ============
</TABLE>

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

                                       65
<PAGE>

<TABLE>
<CAPTION>
                                                                 2006           2005           2004
                                                              ----------     ----------     ----------
<S>                                                                <C>             <C>            <C>
               Federal statutory rate                              (34.0)%         34.0%          34.0%

               State income taxes, net of effect on
               federal income taxes                                 (3.0)%          3.4%           5.6%

               Federal and State valuation allowances
                                                                    44.0%           0.0%         (10.7)%

               Manufacturing investment credits                      0.0%           4.3%           2.3%

               Other                                                 4.0%           2.8%          (3.9)%
                                                              ----------     ----------     ----------

               Effective income tax rate                            11.0%          44.5%          27.3%
                                                              ==========     ==========     ==========

         The valuation allowance for 2006, 2005 and 2004 was increased (reduced)
by $1,222,000, ($689,000) and $197,000 respectively. During 2006, the valuation
allowance increased due to the Company's reassessment of the likelihood of
utilization of its NOLs. This assessment was largely based upon the Company's
ability to project future income, which was impacted negatively by the loss
generated in 2006.

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

<CAPTION>
                                                                    2006          2005
                                                                 ----------    ----------
                                                                     (in thousands)
                                                                     --------------
<S>                                                                   <C>           <C>
         Deferred tax assets:

                    Federal NOLs and tax credit carryovers            6,385         6,211
                    State income and franchise taxes, net of
                        effect on federal income taxes                   --            28
                    Allowances against receivables and other          1,120         1,213
                                                                 ----------    ----------
                                                                      7,505         7,452

                    Less valuation allowance                         (1,472)         (250)
                                                                 ----------    ----------
         Total deferred tax assets:                                   6,033         7,202

         Deferred tax liabilities:
                    Accumulated depreciation and  amortization       (1,925)       (2,812)
                                                                 ----------    ----------

         Net deferred tax assets                                      4,108         4,390
                                                                 ==========    ==========
</TABLE>

         We have elected to track the portion of our federal and state net
operating loss carryforwards attributable to stock option benefits, in a
separate memo account pursuant to SFAS No. 123(R). Therefore, these amounts are
no longer included in our gross or net deferred tax assets. Pursuant to SFAS No.
123(R), footnote 82, the benefit of these net operating loss carryforwards will
only be recorded to equity when they reduce cash taxes payable. The amounts
removed from the memo account relating to deductions for stock option benefits
as of December 31, 2006 are $150,000 for federal and $20,000 for state tax
purposes, respectively.

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

         On November 10, 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position No. FAS 123(R)-3 "Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards." The Company has
elected to adopt the alternative transition method provided in the FASB Staff
Position for calculating the tax effects of stock-based compensation pursuant to

                                       66
<PAGE>

SFAS 123(R). The alternative transition method includes simplified methods to
establish the beginning balance of the additional paid-in capital pool ("APIC
pool") related to the tax effects of employee stock-based compensation and to
determine the subsequent impact on the APIC pool and Consolidated Statements of
Cash Flows of the tax effects of employee stock-based compensation awards that
are outstanding upon adoption of SFAS 123(R).

         As of December 31, 2006, the Company had federal NOLs totaling $17.0
million, which expire in varying amounts through 2012. Should more than a 50%
change in Company ownership occur within a three-year period, utilization of
these losses to reduce future taxable income would be further limited. Federal
deferred tax credits include a minimum tax credit of $252,000 and a targeted
jobs credit of $21,000. The targeted jobs credit will expire in 2020 and the
minimum tax credit will not expire. State deferred tax assets include
approximately $350,000 in California Manufacturing Tax Credits available to
offset future California income taxes, expiring in varying amounts through 2012.
As of December 31, 2006, the deferred tax assets available to offset future cash
tax liabilities are $793,000 short-term and $5,240,000 long-term offset by
$1,925,000 of long-term deferred tax liabilities.

         The Company realizes tax benefits as a result of non-qualified stock
options and the exercise and subsequent early resale of certain incentive stock
options (disqualifying disposition). For financial reporting purposes, any
reduction in income tax obligations as a result of these tax benefits is
credited to additional paid in capital. For the years, 2006, 2005 and 2004, tax
benefits of disqualifying dispositions totaling $2,000, $0, and $55,000 were
credited to stockholders' equity.


     11. Significant Customers

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

                                             2006          2005        2004
                                            ------        ------      ------
                Costco                         48%           45%         36%

                Sam's Club Stores              17%           17%         24%


         At December 31, 2006 and December 31, 2005, Costco and Sam's Club
stores accounted for the following concentration of accounts receivable:



                                                2006            2005
                                               ------          ------
                Costco                            38%             42%

                Sam's Club Stores                 20%             15%


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

         No other single customer accounted for more than 10% of revenues or
accounts receivable during 2006 and 2005.

         The Company operates in the refrigerated specialty foods segment.
During 2006, 2005 and 2004 net revenues to foreign customers represented 1.4%,
2.2% and 3.4% of total net revenues, with Canada and Mexico accounting for over
90% of those sales, and the remainder going to Asia Pacific. Most of the foreign
sales are invoiced in US dollars.

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

                                       67
<PAGE>

     12. Litigation and Contingencies

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

     13. Employee Benefit Plan

         In 1996, the Company instituted a 401(k) Plan covering substantially
all full-time employees with six months of service. Under the Plan, employees
may elect to defer up to 15% of compensation (subject to certain limitations).
Beginning in January 2003 the Company adopted a Safe Harbor Plan and currently
matches employee contributions up to 4% of compensation. In addition, the
Company may make an annual discretionary profit-sharing contribution. Employee
contributions, Company matching contributions and related earnings are always
100% vested. The Company offers its employees multiple investment options with
varying degrees of risk. The Company also provides its employees with outside
investment advice annually. Company profit-sharing contributions and related
earnings vest 20% a year, with 100% vesting after five years of service. During
2006, 2005, and 2004 the Company's expense for matching contributions was
$270,000, $228,000 and $201,000 respectively; there were no discretionary
profit-sharing contributions for 2006, 2005, or 2004.

                                       68
<PAGE>

     14. Quarterly Information (unaudited)

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

<TABLE>
<CAPTION>
Year Ended 2005                        First       Second        Third        Fourth
                                      Quarter      Quarter      Quarter       Quarter        2005
                                    ----------   ----------   ----------    ----------    ----------

<S>                                 <C>          <C>          <C>           <C>           <C>
  Net revenue                       $   17,663   $   21,155   $   22,772    $   23,658    $   85,248

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

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

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


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

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



Year Ended 2006                        First       Second        Third        Fourth
                                      Quarter      Quarter      Quarter       Quarter        2005
                                    ----------   ----------   ----------    ----------    ----------

  Net revenue                       $   22,478   $   23,081   $   22,090    $   26,648    $   94,297

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

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

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


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

Diluted earnings per common share   $     0.01   $     0.01   $    (0.22)   $     0.03    $    (0.19)
</TABLE>

                                       69
<PAGE>

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

<TABLE>
<CAPTION>
                                                                Additions -    Deductions -
                                                  Balance,      Charged to     Write-offs     Balance,
                                                 Beginning      Costs and      Charged to      End of
                                                  of 2004        Expense       Reserves         2004
                                                ------------   ------------   ------------   ------------
<S>                                             <C>            <C>            <C>            <C>
Allowances against receivables --
           Spoils, returns, adjustments
           and bad debts                        $        441   $      3,646   $      3,847   $        240


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


                                                                Additions -    Deductions -
                                                  Balance,      Charged to     Write-offs     Balance,
                                                 Beginning      Costs and      Charged to      End of
                                                  of 2005        Expense       Reserves         2005
                                                ------------   ------------   ------------   ------------

Allowances against receivables --
           Spoils, returns, adjustments
           and bad debts                        $        240   $      4,792   $      4,040   $        992


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


                                                                Additions -    Deductions -
                                                  Balance,      Charged to     Write-offs     Balance,
                                                 Beginning      Costs and      Charged to      End of
                                                  of 2006        Expense       Reserves         2006
                                                ------------   ------------   ------------   ------------

Allowances against receivables --
           Spoils, returns, adjustments
           and bad debts                        $        992   $      4,876   $      5,146   $        722


Inventory reserves --                           $        123   $        629   $        479   $        273
           Spoils and obsolescence
</TABLE>

                                       70
<PAGE>

                                   SIGNATURES

         Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the city of San
Francisco, State of California, on the 14th day of March, 2006

                                      MONTEREY GOURMET FOODS


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


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

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

<TABLE>
<CAPTION>
             Name                              Title                              Date
             ----                              -----                              ----
<S>                                            <C>                                <C>
             /s/ ERIC C. EDDINGS               Chief Executive Officer,           March 21, 2007
             ------------------------------    President, and Director
             Eric C. Eddings

             /s/ CHARLES B. BONNER             Director                           March 21, 2007
             ------------------------------
             Charles B. Bonner

             /s/ F. CHRISTOPHER CRUGER         Director                           March 21, 2007
             ------------------------------
             F. Christopher Cruger

             /s/ MICHAEL P. SCHALL             Director                           March 21, 2007
             ------------------------------
             Michael P. Schall

             /s/ VAN TUNSTALL                  Chairman of the Board              March 21, 2007
             ------------------------------
             Van Tunstall

             /s/ JAMES WONG                    Director                           March 21, 2007
             ------------------------------
             James Wong

             /s/ JOHN H. McGARVEY              Director                           March 21, 2007
             ------------------------------
             John H. McGarvey

             /s/ WALTER L. HENNING             Director                           March 21, 2007
             ------------------------------
             Walter L. Henning

             /s/ SCOTT S. WHEELER              Chief Financial Officer            March 21, 2007
             ------------------------------    Corporate Secretary and Director
             Scott S. Wheeler
</TABLE>

                                       71
<PAGE>

         Index to Exhibits

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

3.1      Certificate of Incorporation dated August 1, 1996 (incorporated by
         reference from Exhibit B to the Company's Definitive Proxy Statement
         for its August 1, 1996 Special Meeting of Shareholders filed June 27,
         1996 )
3.2      Amendments of Articles I and IV of Delaware Certificate of
         Incorporation (incorporated by reference from Exhibits 3 and 4 to the
         Company's Definitive Proxy Statement for its 2004 Annual Meeting of
         Shareholders filed June 21, 2004)
3.3      Bylaws of the Company, as amended. Incorporated by reference from
         Exhibit 3.3 filed with the Company's Form 10-Q for the quarter ended
         June 30, 2005 filed with the Commission.
4.1      Form of Investor Warrant, issued by Monterey Gourmet Foods, Inc. to the
         investors in connection with the June 28, 2006 private offering.
         (incorporated by reference from Exhibit 10.31 filed with the Company's
         Form 8-K on June 13, 2006)
4.2      Registration Rights Agreement (incorporated by reference from Exhibit
         10.29 filed with the Company's Form 8-K on June 13, 2006)
10.1*    2002 Stock Option Plan, as amended on March 3, 2006. Incorporated by
         reference from Exhibit 10.1 to the Company's Form 10-Q for the quarter
         ended March 31, 2006
10.2*    1995 Employee Stock Purchase Plan (incorporated by reference from
         Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended
         January 1, 1995
10.3     Monterey County Production Facility Lease of the Company, as amended
         (incorporated by reference from Exhibit 10.03 to the Company's
         Registration Statement on Form SB-2 filed with the Commission (the
         "SB-2)) on August 29, 1993
10.4     Amendment No. 1 dated February 1, 1995 and Amendment No. 2 dated March
         1, 1995 to Monterey County Production Facility Lease of the Company
         (incorporated by reference from Exhibit 10.6 filed with the Company's
         Form 10-K for the fiscal year ended December 31, 1995) filed April 1,
         1996(the "1995 Form 10-K")
10.5     Amendment No. 3 dated September 12, 1997, and Amendment No. 4 dated
         February 6, 1998 to Monterey County Production Facility Lease of the
         Company (incorporated by reference from Exhibit 10.5 filed with the
         Company's September 27, 1998 Quarterly Report on Form 10-Q filed
         November 4, 1998 ("1998 Q3 10-Q"))
10.6     Trademark Registration--MONTEREY PASTA COMPANY and Design, under
         Registration No. 1,953,489, registered on January 30, 1996 with the
         U.S. Patent and Trademark Office (incorporated by reference from
         Exhibit 10.27 to the 1995 Form 10-K)
10.7*    Employment letter dated September 15, 2006 to Chief Executive Officer
         Eric C. Eddings (incorporated by reference from Exhibit 10.1 filed with
         the Company's Form 8-K filed September 20, 2006)
10.8     Agreement for Handling and Storage Services between the Company and CS
         Integrated LLC dated February 5, 1999 (incorporated by reference to
         Exhibit 10.21 to the Company's 1998 Form 10-K for the fiscal year ended
         December 27, 1998, filed March 17, 1999
10.9     Royalty agreement dated July 12, 1999 between Company and Chet's
         Gourmet Foods, Inc. (incorporated by reference to Exhibit 10.25, in the
         Company's September 26, 1999 Quarterly Report on Form 10-Q filed
         November 9, 1999 ("1999 Q3 10-Q"))
10.10    Storage Agreement Manufactured Products dated August 3, 1999 between
         the Company and Salinas Valley Public Warehouse (incorporated by
         reference to Exhibit 10.26, filed with the Company's 1999 Q3 10-Q)
10.11    Commercial Lease dated August 10, 1999 between Company and Salinas
         Valley Public Warehouse (incorporated by reference to Exhibit 10.27,
         filed with the Company's 1999 Q3 10-Q)
10.12    Commercial lease dated January 1, 2000 between the Company and PTF for
         Operating Engineers, LLC (incorporated by reference to Exhibit 10.32,
         in the Company's June 25, 2000 Quarterly Report on Form 10-Q filed on
         August 4, 2000)
10.13    Lease Extension and Modification Agreement between the Company and
         Marco Warehouse d.b.a. Salinas Valley Public Warehouse dated September
         1, 2001 (incorporated by reference to Exhibit 10.40 in the Company's
         September 30, 2001 Quarterly Report on Form 10-Q filed on November 7,
         2001)
10.14    Commercial lease dated August 23, 2002 between the Company and Mel
         Bankoff (incorporated by reference from Exhibit 10.43 filed with the
         Company's Report on Form 8-K on August 30, 2002)

                                       72
<PAGE>

10.15    Commercial lease dated January 3, 2003 between the Company and Conrad
         Family Trust (incorporated by reference from Exhibit 10.44 filed with
         the Company's Form 10-K for the fiscal year ended December 29, 2002,
         filed on February 14, 2003)
10.16**  Third Lease modification to Commercial lease dated August 8, 2006
         between the Company and PTF for Operating Engineers, LLC for storage
         space in Monterey County, California
10.17    Lease Extension and Modification Agreement between the Company and
         Kenneth Salma and Pattie Salma dated August 24, 2005 (incorporated by
         reference from Exhibit 10.18 filed with the Company's September 30,
         2005 Quarterly Report of Form 10-Q filed on November 14, 2005.)
10.18    Second Amendment of Agreement for the Purchase and Sales of Limited
         Liability Company Units dated January 12, 2006. (Incorporated by
         reference from Exhibit 2.1 filed with the Company's current report on
         Form 8-K dated January 12, 2006 filed with the Commission.)
10.19    Stock Purchase Agreement by and among Monterey Gourmet Foods, Inc.,
         Casual Gourmet Foods, Inc., and Certain Shareholders dated January 11,
         2005 (incorporated by reference from Exhibit 2.01 filed with the
         Company's Report on Form 8-K on January 18, 2005)
10.20    Amendment to the Stock Purchase Agreement by and among Monterey Gourmet
         Foods, Inc. Casual Gourmet Foods, Inc. and Certain Shareholders dated
         September 29, 2006 (incorporated by reference from Exhibit 2 filed with
         the Company's Report on Form 8-K on October 5, 2006)
10.21    Stock Purchase Agreement by and among Monterey Gourmet Foods, Inc.,
         Sonoma Foods, Inc., and Its Shareholders dated April 7, 2005
         (incorporated by reference from Exhibit 2.01 filed with the Company's
         8-K on April 13, 2005)
10.22    Third Modification to Business Loan Agreement between the Company and
         Comerica Bank dated January 5, 2005.(incorporated by reference to
         Exhibit 10.33 filed with the Company's Form 10-K for the fiscal year
         ended December 26, 2004, filed on March 25, 2005
10.23    Fourth Modification to Business Loan Agreement between the Company and
         Comerica Bank dated April 11, 2005 (incorporated by reference from
         Exhibit 10.24 to the Company's Form 10-Q for the quarter ended June 30,
         2005 filed with the Commission).
10.24    Securities Purchase Agreement, dated as of June 12, 2006, (incorporated
         by reference from Exhibit 10.28 filed with the Company's 8-K on June
         13, 2006)
10.25    Engagement letter between Roth Capital Partners, LLC and Monterey
         Gourmet Foods, Inc. dated May 26, 2006(incorporated by reference from
         Exhibit 10.30 filed with the Company's 8-K on June 13, 2006)
23.1**   Consent of Independent Registered Public Accounting Firm
31.1**   Certification of Chief Executive Officer pursuant to Section 302 of the
         Sarbanes-Oxley Act of 2002
31.2**   Certification of Chief Financial Officer pursuant to Section 302 of the
         Sarbanes-Oxley Act of 2002
32.1**   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
         1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
         2002
32.2**   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
         1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
         2002



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

**   filed herewith

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