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 management in any future period.

Our Company was incorporated in June 1989 as a producer and wholesaler of refrigerated gourmet pasta and sauces to restaurants and grocery stores in the Monterey, California area. We have since expanded our 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. Our overall strategic plan is to enhance the value of our brands by distributing our gourmet products through multiple channels of distribution.

Our products are distributed to grocery and club stores. Our distribution increased from approximately 25 stores as of December 1989, to over 10,000 stores by December 31, 2008. During recent years we added retail, foodservice, and club distribution through internal growth and through the Frescala Foods, Nate's, Isabella's Kitchen, Emerald Valley Kitchen, CIBO Naturals, and Sonoma Foods acquisitions. In 2004, our shareholders approved the change of the name of our Company to Monterey Gourmet Foods, Inc. The name change was made to define the Company's strategic direction more accurately. The name change also announces to the investor community, our customers and consumers, our strategic direction to become a complete supplier of gourmet refrigerated foods.

In 2004 and 2005, we began a diversification strategy to expand our 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, we acquired CIBO Naturals, a maker of sauces, dips and spreads. In 2005 we acquired two additional Companies - Casual Gourmet Foods (acquired January 11, 2005), a marketer of flavorful low-fat, low-calorie chicken sausages, chicken burgers and soups, and Sonoma Foods (acquired April 7, 2005), a purveyor of an outstanding line of refrigerated specialty cheese products that features its flagship line of Sonoma Jack Cheeses.

In 2006, we focused on expanding distribution of our current products, consolidating production facilities in Salinas, improving the quality of our current products, hiring experts in product development and creativity to better utilize our production equipment, improving the synergies between the different brands, and reorganizing operations into one operating unit with one centralized sales force and one marketing department.

In 2007, we focused on process improvement, management discipline, cost reduction, and consolidation of our different acquisitions into one centralized company. We also hired outside culinary consultants to create new products, many of which were introduced during the fourth quarter of 2007. We focused on strategic growth, improving the synergies that are possible with one sales force for all brands, one marketing department, one finance department, one information systems department, one manager in charge of all our plants, and one unified goal to improve our profitability. We also focused and we continue to focus on brand building with an emphasis on expanding our product offerings of organic or made with organic ingredients, which are especially desired by consumers in the current marketplace.

In 2008, we addressed the capacity and efficiency constraints of our fragmented Seattle Washington facility by securing a ten year lease on a new facility in Kent, Washington, approximately 20 miles from the former location. We spent approximately $4.5 million preparing this new facility and moving equipment into it before occupancy in December 2008. The improvements added capacity to our sauce production and made other important changes in our production processes. In addition, we saw increases in the prices of many of our raw ingredients such as cheese, eggs, corn, flour, oil, pine nuts, and dairy products, and in our transportation costs, but we were not able to increase our prices sufficiently to offset these increased costs during the year.

Also during 2008, we launched new items across all product lines, with the main focus on organic and made with organic products. Our goal is to gain incremental distribution points as soon as possible using promotional and sampling programs as vehicles. We also focused on Sonoma Foods and Casual Gourmet Foods because these two brands have lost significant amounts of money during the last two years. In March 2008, we reviewed the low margins and decreasing revenues being generated from the Sonoma Cheese products and determined, among other things, to buy out the minority interest and the employment contracts of the minority shareholders.

In addition, at the December 4, 2008 Board meeting, management presented to the Board discrete financial information for the further processed protein items currently being sold under the Casual Gourmet brand. The Board agreed with management to separate out these products for future Board meetings as these products were no longer considered our "core competency". The Board also agreed with management to sell this segment and if we could not sell this segment, then we would by year end proceed to wind down and close all operations associated with it. We made a concerted but unsuccessful effort to sell this unit, and in December 2008, we announced to our employees that we would shut it down. We laid off all employees associated with the further processed protein product line and notified all customers and suppliers of these products that we were discontinuing them. We were still obligated to fulfill further processed protein product orders through the end of January 2009 and did not fully abandon all assets relating to the further processed protein products by the end of December 31, 2008. In early 2009 we negotiated a licensing agreement pursuant to which Aidells Sausage Company will pay a royalty for all sausage sold under the Casual Gourmet brand.

The success of our 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 our products, (2) whether we can continue to increase the number of grocery and club store chains offering our products, (3) whether we can continue to introduce new products that meet consumer acceptance,
(4) whether, by diversifying into other complementary businesses through new product offerings or acquisitions, we can leverage our strengths and continue to grow revenues at levels attractive to our investors, (5) whether the various acquired brands perform as planned when purchased, (6) whether we can maintain and increase the number of items we are selling to our two largest customers and
(7) whether we can sell products to foodservice operators. Grocery and club store chains continually re-evaluate the products carried in their stores, and we have no assurance that the chains currently offering our products will continue to do so in the future.

We believe that access to capital resources and increasing sales to offset higher fixed overhead, coupled with continued reduction of our administrative and production costs as a percent of sales revenue, will be key requirements in our efforts to enhance our competitive position and increase our market penetration. In order to support our expansion program, we will continue to develop new products for consumers and revise advertising and promotional activities for our retail grocery and club store accounts. We have no assurance that we will be able to increase our net revenues from grocery and club stores.

Operations for 2008, 2007 and 2006

       Net revenues were as follows for the years 2006 through 2008 (in '000s):


                                                               Years Ended

                                                       2008       2007        2006


    Net Revenues                                     $ 97,188   $ 100,527   $ 94,297
    Percent change in net revenues from prior year         -3 %         7 %       11 %

The 2008 decrease in net revenues of $3,339,000 is due to a $3.1 million decline in tamale revenues as a result of additional competition, together with a $2.1 million decline in Sonoma Cheese sales as a result of discontinuing certain processed cheese spreads under the Sonoma Cheese brand, an $2.7 million decrease in revenues for our frozen items, and a $5.0 million decline in sales to our second largest customer. Net sales were also reduced when we increased our allowances to our customers during the year to help facilitate the transition to higher prices and when we partnered with our largest customer by issuing a coupon for their members. We spent $620,000 on coupons to promote our products in 2008 compared to $80,000 in 2007.

Offsetting these reductions we saw a 10% increase in revenues to our largest customer as a result of the introduction of new flavors and new products. We also experienced a 19% increase in our refrigerated pasta revenues.

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

During 2008, 2007 and 2006 our net revenues were reduced by $264,000, $109,000, and $363,000, respectively, for costs associated with placement of product in new stores in various locations.

                                                 Years Ended

                                          2008       2007       2006

                 Gross profit           $ 24,177   $ 27,519   $ 27,439
                 Gross margin percent       24.9 %     27.4 %     29.1 %

The gross profit dollars and the gross margin percentage for 2008 decreased compared to 2007 due mainly to the increased costs of commodities and increased promotional activities. In addition, as part of our restructuring of Sonoma Cheese, we discontinued the Sonoma processed cheeses product line and established inventory reserves of Sonoma products and other products totaling $1,470,000. The Sonoma Cheese segment reported a gross profit percentage of 5.1% for 2008 compared to gross profit percentage of 17.5% for 2007. In addition, we paid $264,000 in slotting costs to introduce our new organic pasta line and family pack sizes which also reduced overall gross margins compared to $109,000 spent in 2007. We also spent $620,000 in coupon promotions during 2008 compared to $80,000 spent on coupons in 2007. We also experienced record high commodity prices in flour, eggs, corn, protein, olive and other types of oil, pine nuts, and dairy products including all types of cheese, cream, and milk, which have impacted our gross margins.

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

We charged $1,470,000, $213,000, and $629,000 to cost of sales for 2008, 2007, and 2006 respectively, for obsolete packaging and raw material inventory. The increase in 2008 for obsolete inventory is mainly due to discontinuing certain product lines in Sonoma Cheese, frozen products, and protein items.

Selling, General and Administrative expenses ("SG&A") were as follows for the years 2006 through 2008:

                                                            Years Ended

                                                     2008       2007       2006

       SG&A Expense                                $ 26,797   $ 25,304   $ 26,754
       SG&A Expense as a percent of net revenues       27.6 %     25.2 %     28.4 %

SG&A costs for 2008 were $1,493,000 higher than for 2007. The increase for 2008 was due to (1) higher legal fees of $56,000, (2) an increase in variable selling costs, such as demonstration costs, brokerage fees of $858,000, and (3) severance costs not included in impairment and restructuring cost of $421,000. In addition, freight costs as a percent of net revenues increased by 0.1% resulting in an increase of $74,000. We continue to make changes to our management and selling organizations to improve the quality and productivity of our people.

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

Demonstration costs paid to outside vendors were 5.4%, 4.9%, and 6.1%, of net revenues for the years, 2008, 2007, and 2006, respectively.

Depreciation and amortization expense, included in cost of sales and SG&A, was $3,026,000 or 3.1% of net revenues compared to $2,948,000 or 2.9% of net revenues in 2007, and $2,926,000 or 3.1% of net revenues in 2006. The percentage increase from 2007 to 2008 is related to the decrease in net revenues and additional spending for capital equipment. The decrease in 2007 from 2006 is related to increased revenues which reduced the costs as a percent of revenues.

                                                                    Years Ended

                                                               2008     2007     2006

 Impairment and restructuring                                $ 14,791   $  58   $ 3,160
 Impairment and restructuring as a percent of net revenues       15.2 %   0.1 %     3.4 %

We performed our annual test of goodwill impairment under SFAS 142 "Goodwill and Other Intangible Assets" and SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" in the fourth quarter of 2008. Due principally to the significant decline in the market price of our common stock, we failed the impairment test. As a result, we impaired all of the goodwill and part of our other intangible assets from prior acquisitions. As a result we recorded a pretax, non-cash charge of $13,185,000 related to the impairment of goodwill and intangibles assets associated with all of our brands. In addition, in the first quarter of 2008, we experienced a reduction in sales at Sonoma Foods and we determined that indicators of impairment existed for Sonoma Foods' intangible assets. Accordingly, in accordance with SFAS 142 and SFAS 144 we applied impairment tests to Sonoma Foods' intangible assets, including goodwill during the first quarter of 2008. We determined its reporting units to be the same as its operating segments. As a result of this testing and in accordance with SFAS 142, we recorded a pre-tax, non-cash charge of approximately $1,140,000 in the first quarter of 2008 related to the impairment of intangible assets and goodwill associated with the acquisition of Sonoma Foods in April 2005. Also included in the 2008 impairment and restructuring is $466,000 of severance payments.

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

Due to the lost business for Casual Gourmet during the third quarter of 2006, we 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, we 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.

Gain or (loss) on the disposal of fixed assets for 2008, 2007, and 2006 was ($1,987,000), ($50,000) and $13,000. The 2008 disposal of fixed assets relates to the disposal of assets associated with our pizza line. As part of our focus on our core business, we determined that we would no longer put efforts toward selling these products and we removed the assets from our production facility.

Net interest income for 2008 was $66,000 compared to $163,000 for 2007 and net interest expense for 2006 which was $355,000. The net interest income for 2008 is attributable to our excess cash which generated interest income for us. The excess cash came from our operating activities and the raising of additional capital through a private placement in 2006. The interest expense in 2006 is attributable to the bank loans needed for the CIBO Naturals, Casual Gourmet Foods and Sonoma Foods acquisitions.

Income tax expense for 2008, 2007, and 2006 was $3,351,000, $600,000, and $295,000, respectively. The 2008 income tax expense reflects a charge associated with establishing a full valuation allowance for all deferred tax assets. The 2007 income tax expense reflects a tax rate of 48% and a reduction of $625,000 in the valuation allowance for deferred tax assets. The 2006 income tax expense is mainly impacted by the $1.2 million increase in the valuation allowance for deferred tax assets as we recorded consecutive years of losses. We have established a $10,834,000 valuation allowance at December 31, 2008 against future deferred tax assets based on our cumulative losses over the past four years. If we are able to generate profits in the future, our valuation reserve will reduce our income tax expense in future years.

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

Through 2007, based upon definitions contained within SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", management determined that we operated as one segment due to the lack of discrete financial information reviewed by Eric Eddings, our Chief Operating Decision Maker. In addition, virtually all revenues are in the United States, and all of the long-lived assets are located within the United States.

On March 20, 2008, we reviewed the low margins and dwindling revenues being generated from the Sonoma Cheese products and determined, among other strategic actions, to dedicate sales resources specifically to Sonoma Cheese products, and to buy out the minority interest and the employment contracts of the minority shareholders. In order to make this decision, we reviewed discrete financial information for the Sonoma Cheese Products. As a result, we concluded that Sonoma Foods constitutes an operating segment and reporting unit and therefore, we are reporting Sonoma Cheese products as a separate reporting segment.

During the December 4, 2008 meeting of the Board of Directors, the Board agreed with management to look for a buyer for the further processed protein products sold under the Casual Gourmet Brand. In addition, we reviewed with our Board discrete financial information for the further processed protein products currently being sold under the Casual Gourmet Brand. The Board agreed with us to separate out these products for future Board meetings as these products were no longer considered a "core competency" for us. The Board also agreed with us to sell this segment and if we could not sell this segment, then we would by year end proceed to wind down and close all operations associated with this segment. As a result, certain trademark rights were transferred to the parent company from Casual Gourmet Foods, Inc. and procedures to dissolve Casual Gourmet voluntarily were commenced. We still were obligated to fulfill further processed protein product orders through the end of January 2009 and did not fully abandon all assets relating to the further processed protein products by the end of December 31, 2008.

Accordingly, for the calendar year 2008, we are operating in three segments, Gourmet Food Products, Sonoma Cheese Products and Further Processed Protein Products. We use operating income as the profit measure for our reporting segments.

Gourmet Foods Products: These products are developed from sophisticated recipes designed to enhance the eating experience. These products include ravioli, tortelloni, borsellini, pasta sauces, dips, hummus, salsa and other like products. The products are sold in various forms, flavors and sizes, are marketed to domestic food retailers, and are mostly produced in one of our three plant locations at Salinas, California, Kent, Washington, or Eugene, Oregon.

Sonoma Cheese Products: Packaged cheese operations include all products sold under the Sonoma Cheese brand. These products are co-packed by cheese producers mostly in California, are sold to consumers as slices, shredded, or as six or eight ounce blocks, and are marketed to domestic food retailers.

Further Processed Protein Products: The products are developed from recipes designed to use high quality chicken to make sausages and meatballs. The products are sold in various flavors and sizes. The products are manufactured on our behalf by other manufactures to our specifications. The products are marketed to domestic food retailers.

Information on segments and reconciliation to operating income are as follows (in thousands):

                                              2008        2007       2006

             Gourmet Foods Products
             Net revenues                   $  84,947   $ 86,564   $ 79,268
             Gross profit                   $  22,104   $ 24,534   $ 22,738
             Impairment and restructuring   $  (9,372 ) $      -   $      -
             Operating profit (loss)        $ (11,970 ) $  3,906   $    819

             Gross profit percentage             26.0 %     28.3 %     28.7 %
             SGA percentage                      29.1 %     23.8 %     27.7 %

Highlights for 2008 compared to 2007:

† Pasta branded products revenues grew 19%
† Tamale revenue declined 32% as our Costco distribution declined
† Products sold in a frozen state declined 81% as rotational items were ended without any replacement item.
† The gross margin percentage of 26.0% compared to 28.3% reflects higher commodity prices and higher allowances which our price increases did not fully offset.

† SG&A as a percent of net revenues was 29.1% compared to 23.8%. The increase in SG&A for 2008 compared to 2007 is due to higher selling expenses, higher legal fees, and higher wages and salaries consisting mostly of severance accruals.
† The impairment charge relates mainly to the goodwill associated with the Nate's acquisition, the Frescala acquisition, the Emerald Valley Kitchen acquisition, and the CIBO Naturals acquisition.

Highlights for 2007 compared to 2006:

† The 2007 increase over 2006 was due in part to an increase in sales of Monterey Pasta branded refrigerated pasta products which grew $8.1 million or 24 percent.
† The increase is also attributable to new sales of pastas made with organic ingredients, whole wheat pasta items, and new innovations coming from the culinary experts hired by our management.
† Gross margin percentage decreased because of increases in commodity prices for ingredients such as dairy, eggs, flour, cheese, pine nuts, and olive oil.
† Total stock based compensation recorded in cost of goods sold for 2007 was $150,000 compared to $55,000 for 2006 primarily because of a one-time issuance of 20,000 unregistered shares of common stock valued at $77,000 to a culinary consultant for his work helping us develop new products.
† The decrease in SG&A as a percentage of revenues is related to the reduction in salaried work force announced in September 2006, a reduction in promotional activities, and a reduction in freight costs from management's initiative to reduce outbound freight.
† We incurred $236,000 of costs with outside consultants to assure that we could give attestation on our internal controls as required by regulatory agencies.

                                              2008       2007       2006

             Sonoma Cheese Products
             Net revenues                   $  6,189   $  8,265   $ 10,761
             Gross profit                   $    317   $  1,395   $  3,637
             Impairment and restructuring   $ (2,708 ) $    (58 ) $      -
             Operating profit (loss)        $ (4,247 ) $ (1,019 ) $  1,068

. . .