UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

Commission File Number 0-22534-LA

 

 

Indicate by 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  ý                      No  o

 

At November 12, 2002, 14,133,926 shares of common stock, $.001 par value, of the registrant were outstanding.

 

MONTEREY PASTA COMPANY

 

FORM 10-Q

 

Table of Contents

 

 

PART 1.	FINANCIAL INFORMATION
			Item 1.	Financial Statements
				Condensed Consolidated Balance Sheets September 29, 2002 (unaudited) and December 30, 2001
				Condensed Consolidated Statements of  Operations (unaudited) Third quarter ended September 29, 2002 and September 30, 2001 and the nine months ended September 29, 2002 and September 30, 2001
				Condensed Consolidated Statements of Cash Flows (unaudited) Nine months ended September 29, 2002 and September 30, 2001
				Notes to Unaudited Condensed Consolidated Financial Statements
			Item 2.	Management’s Discussion and Analysis of  Financial  Condition and Results of Operations
			Item 3.	Quantitative and Qualitative Disclosures about Market Risk
			Item 4.	Disclosure Controls and Procedure
PART II.		OTHER INFORMATION
			Item 1.	Legal Proceedings
			Item 2.	Changes in Securities
			Item 3.	Defaults Upon Senior Securities
			Item 4.	Submission of Matters to a Vote of Security Holders
			Item 5.	Other Information
			Item 6.	Exhibits and Reports on Forms 8-K and S-8
			Signature Page
			Certifications
			Exhibit Index
			Certification of Chief Executive Officer – Exhibit 99.1
			Certification of Chief Executive Officer – Exhibit 99.2

 

2

 

PART I.  FINANCIAL INFORMATION

 

Item 1.    Financial Statements

 

MONTEREY PASTA COMPANY

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		September 29, 2002			December 30, 2001
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	4,087,252		$	7,232,128
Accounts receivable, net		8,011,552			6,025,323
Inventories		4,102,275			3,113,679
Deferred tax assets-short term		4,620,599			1,021,800
Prepaid expenses		1,464,220			1,139,042
Total current assets		22,285,898			18,531,972
Property and equipment, net		13,373,948			11,036,044
Deferred tax assets-long term		435,700			553,700
Goodwill, net		6,167,886			1,315,932
Intangible assets, net		814,061			56,907
Deposits		123,800			101,270
Total assets		$	43,201,293		$	31,595,825
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	3,758,106		$	1,613,090
Accrued liabilities		1,600,584			1,953,140
Current portion of long-term debt		21,053			32,008
Total current liabilities		5,379,743			3,598,238
Long-term debt		3,988			16,749
Commitments and contingencies
Stockholders’ equity:
Common stock		44,270,180			43,063,750
Accumulated deficit		(6,452,618		)	(15,082,912		)
Total stockholders’ equity		37,817,562			27,980,838
Total liabilities and stockholders’ equity		$	43,201,293		$	31,595,825

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

MONTEREY PASTA  COMPANY

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

		Third quarter ended						Nine months ended
		September 29, 2002			September 30, 2001			September 29, 2002			September 30, 2001
Net revenues		$	16,568,577		$	14,408,439		$	46,424,933		$	41,985,094
Cost of sales		10,385,662			9,382,952			29,236,073			27,279,496
Gross profit		6,182,915			5,025,487			17,188,860			14,705,598
Selling, general and administrative		4,194,117			3,268,077			11,712,906			9,670,967
Operating income		1,988,798			1,757,410			5,475,954			5,034,631
Gain (loss) on disposition of assets		—			2,571			(67,880		)	20,330
Other income (expense), net		(223		)	374			2,467			1,049
Interest income (expense), net		5,598			27,293			91,452			77,282
Income before provisions for income tax benefit (expense)		1,994,173			1,787,648			5,501,993			5,133,292
Provision for income tax benefit (expense)		3,549,238			(688,362		)	3,128,300			(1,976,435		)
Net income		$	5,543,411		$	1,099,286		$	8,630,293		$	3,156,857
Basic income per share		$	0.39		$	0.08		$	0.62		$	0.24
Diluted income per share		$	0.38		$	0.08		$	0.59		$	0.22
Basic shares outstanding		14,106,434			13,583,153			14,002,273			13,424,435
Diluted shares outstanding		14,641,970			14,378,552			14,687,571			14,257,387

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MONTEREY PASTA COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Nine Months Ended
		September 29, 2002			September 30, 2001
Cash flows from operating activities:
Net income		$	8,630,293		$	3,156,857
Adjustments to reconcile net income from operations to net cash provided by operating activities:
Deferred income taxes		(3,480,835		)	1,813,374
Depreciation and amortization		1,231,480			1,234,558
Provisions for allowances for bad debts, returns, adjustments and spoils		108,702			(19,760		)
Tax benefit for disqualifying dispositions		379,400			103,806
Loss (gain) on disposition and writedown of property and equipment		67,880			(20,330		)
Stock based compensation		—			167,746
Changes in assets and liabilities:
Accounts receivable		(2,094,931		)	(1,326,998		)
Inventories		(689,577		)	(720,215		)
Prepaid expenses and other assets		(347,672		)	(654,188		)
Accounts payable		2,145,015			407,962
Accrued expenses		(352,555		)	291,740
Net cash provided by operations		5,597,200			4,434,552
Cash flows from investing activities:
Purchase of property and equipment		(3,465,125		)	(2,088,720		)
Purchase of trademark, recipes, and rights		(149,292		)
Proceeds from sale of property and equipment		—			28,559
Acquisition of business operating assets		(5,930,974		)	—
Net cash used in investing activities		(9,545,391		)	(2,060,161		)
Cash flows from financing activities:
Repayment of long term debt and capital lease obligations		(23,716		)	(27,139		)
Proceeds from issuance of common stock		827,031			770,917
Net cash used in financing activities		803,315			743,778
Net increase in cash and cash equivalents		(3,144,876		)	3,118,169
Cash and cash equivalents, beginning of period		7,232,128			1,457,499
Cash and cash equivalents, end of period		$	4,087,252		$	4,575,668

 

 

		September 29, 2002			September 30, 2001
Cash payments:
Interest		$	4,285		$	3,809
Income Taxes		(12,924		)	211,294
Non-Cash activities:
Purchase of leased equipment		—			10,954

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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MONTEREY PASTA COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.    Basis of Presentation

 

The condensed consolidated financial statements have been prepared by Monterey Pasta Company (the “Company”) and are unaudited.  Certain amounts shown in the 2001 financial statements have been reclassified to conform to the current presentation.  The financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not necessarily include all information and footnotes required by generally accepted accounting principles and should be read in conjunction with the Company’s 2001 Annual Report on Form 10-K.   In the opinion of the Company, all adjustments necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows as of September 29, 2002, and for the nine months then ended, have been recorded.  A description of the Company’s accounting policies and other financial information is included in the audited consolidated financial statements as filed with the Securities and Exchange Commission in the Company’s Form 10-K for the year ended December 30, 2001.  The consolidated results of operations for the interim quarterly periods are not necessarily indicative of the results expected for the full year.

 

For quarterly reporting purposes the Company employs a 4-week, 4-week, 5-week reporting period.  The fiscal year ends on the last Sunday of each calendar year (52/53-week year).  The 1999 fiscal year contained 52 weeks and ended on December 26.  The 2000 fiscal year contained 53 weeks and ended on December 31, while the 2001 fiscal year contained 52 weeks and ended on December 30.  The current fiscal year contains 52 weeks and will end on December 29, 2002.

 

2.    Business Acquisition and Statement of Cash Flows

 

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

 

During the third quarter of 2002 the total consideration of $5,744,000, plus related acquisition costs of $187,000, was allocated to identifiable property and equipment totaling $120,000 and inventories of $299,000.  The balance of $5,512,000 was allocated to trademark ($600,000), recipes ($60,000), and goodwill ($4,852,000).  The trademark, which has been included in intangible assets, will continue to be used for an indefinite period.  Therefore, this asset balance will not be amortized on a monthly basis, but will be tested for impairment annually in keeping with Statement of Financial Accounting Standards (“SFAS”) 142.  Recipes will be amortized over a three-year life.

 

The following unaudited proforma financial data present the combined results of operations of Monterey Pasta Company and Emerald Valley as if the purchase had occurred January 1, 2001.  The proforma information gives effect to certain adjustments, including the amortization of goodwill during 2001, prior to the adoption of new accounting pronouncements discussed in note 3.  This proforma summary does not necessarily reflect the results of operations, as they would have been if Monterey Pasta Company and Emerald Valley had constituted a single entity during such periods, and is not necessarily indicative of results that may be obtained in the future.

 

 

3.    New Accounting Pronouncements

 

In May 2000, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) reached a consensus on Issue 00-14, “Accounting for Certain Sales Incentives.” This issue addresses the recognition, measurement, and income statement classification for sales incentives offered voluntarily by a vendor without charge to customers that can be used in, or are exercisable by a customer as a result of, a single exchange transaction. In April 2001, the EITF reached a consensus on Issue 00-25, “Vendor Income Statement Characterization of Consideration to a Purchaser of the Vendor’s Products

 

6

 

or Services.” This issue addresses the recognition, measurement and income statement classification of consideration, other than that directly addressed by Issue 00-14, from a vendor to a retailer or wholesaler.  Both Issue 00-14 and 00-25 have been codified under Issue 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products.”  The Company adopted this Issue effective first quarter 2002.   EITF 01-09 requires the characterization of certain vendor sales incentives such as promotions, trade ads, slotting fees, and coupons as reductions of revenue.  Certain of these expenses, previously classified as selling, general and administrative costs, are now characterized as offsets to revenue.  Reclassifications have been made to prior period financial statements to conform to the current year presentation.  Total vendor sales incentives now characterized as reductions of revenue that previously would have been classified as selling, general and administrative costs were approximately $2,038,000 and $1,688,000 for the first nine months of 2002 and 2001 respectively.

 

In June 2001, the FASB finalized FASB Statements Statement of Financial Accounting Standard (“SFAS”) 141, “Business Combinations,” and SFAS 142, “Goodwill and Other Intangible Assets.”  SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001.  SFAS 141 also requires the recognition of acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria.  SFAS 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001.  It also requires, upon adoption of SFAS 142 that the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141.

 

SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually.  In addition, SFAS 142 requires that we identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life.  An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142.  SFAS 142 requires completion of a transitional goodwill impairment test six months from the date of adoption.  The Company is also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142.

 

The Company’s previous business combinations were accounted for using the purchase method.  As of September 29, 2002, the net carrying amount of goodwill is $6,168,000 and other intangible assets is $814,000.  Amortization expense for the first nine months of 2002 was $52,000.  Due to the adoption of SFAS 142, and prior to the Emerald Valley acquisition, the Company estimated that amortization expense for 2002 from businesses acquired prior to December 30, 2001 would have declined to $47,000 for the year, a reduction of $171,000 compared with that expected prior to the adoption of SFAS 142.  Impairment testing at year-end 2001, under the provisions of SFAS 121, “Accounting for Impairment of Long-lived Assets and Long-Lived Assets to be Disposed of” (which has been superseded by SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”), indicated no need for writedown of goodwill.  The Company performed transitional impairment testing as required by SFAS 142 at the end of the second quarter of 2002 to determine if any writedowns were necessary, with no impairment adjustments needed.

 

The following table reflects consolidated results of operations as though the adoption of SFAS 141 and 142 occurred as of the beginning of the nine-month period ended September 30, 2001.

 

 

7

 

The following table reflects the components of trademarks and other intangible assets as of September 29, 2002:

 

 

In August 2001 SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets” was issued.  SFAS 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-lived Assets to be Disposed of” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.”  SFAS 144 also amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary.  SFAS 144 retains the fundamental provisions of SFAS 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while resolving significant implementation issues associated with SFAS 121.  Among other things, SFAS 144 provides guidance on how long-lived assets used as part of a group should be evaluated for impairment, establishes criteria for when long-lived assets are held for sale, and prescribes the accounting for long-lived assets that will be disposed of other than by sale.  SFAS 144 is effective for fiscal years beginning after December 15, 2001.  The Company’s financial position and results of operations have not been affected by the adoption of SFAS 144.

 

4.    Inventories

 

Inventories consisted of the following:

 

		September 29, 2002			December 30, 2001
Production – Ingredients		$	1,492,314		$	1,088,763
Production – Finished Goods		1,591,963			1,101,410
Paper Goods and Packaging Materials		1,084,113			907,640
Operating Supplies		31,385			43,366
		4,199,775			3,141,179
Reserve for spoils and obsolescence		(97,500		)	(27,500		)
Net Inventories		$	4,102,275		$	3,113,679

 

5.    Property and Equipment

 

Property, plant and equipment consisted of the following:

 

		September 29, 2002			December 30, 2001
Machinery and equipment		$	12,373,352		$	11,273,229
Leasehold improvements		4,952,576			4,551,297
Computers, office furniture and equipment		797,599			943,987
Vehicles		363,747			295,113
		18,487,274			17,063,626
Less accumulated depreciation and amortization		(7,575,334		)	(6,586,503		)
		10,911,940			10,477,123
Construction in progress		2,462,008			558,921
Property, plant and equipment, net		$	13,373,948		$	11,036,044

 

The majority of construction in progress is related to the plant expansion program to be completed during the fourth quarter of 2002 at a current projected cost of approximately $2.1 million.  Other construction in progress is associated with typical annual projects involving replacement, regulatory, food safety and efficiency projects.

 

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6.    Credit Facility

 

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

 

The terms of the Credit Facility prohibit the payment of cash dividends (except with written approval) on the Company’s capital stock and restricts payments for, among other things, repurchasing shares of its capital stock.  Other terms of the Credit Facility limit the Company with respect to, among other things, (i) incurring additional indebtedness,  (ii) adversely changing the capital structure, and (iii) acquiring assets other than in the normal course of business including specific limits on annual capital expenditures (currently $4.25 million).  As of September 29, 2002, there were no violations of any loan covenants and no loans outstanding.

 

The Company has a verbal commitment from Comerica Bank to renew its credit facility as of its expiration date on terms at least as favorable as the prior year.

 

7.    Income Taxes

 

During the quarter and nine months ended September 29, 2002, the Company completed its evaluation of the likelihood of realizing certain deferred tax assets arising from net operating losses (NOLs) originated in connection with its former restaurant operating subsidiary Upscale Food Outlets, Inc. (UFO). As a result, reserves against these deferred tax assets totaling $5,404,000 were released during the nine months ended September 29, 2002 and offset against income tax expense.  This credit, together with permanent differences and other current tax effects resulted in a net year-to-date income tax benefit of $3,128,000.  Of these amounts, $4,674,000 in reserves released during the third quarter along with permanent differences and other current tax effects, resulted in a net income tax benefit for the quarter of $3,549,000. Utilization of these NOLS and other deferred tax assets will offset substantially all of the federal income taxes otherwise payable for 2002.  As of September 2002, remaining net deferred tax assets available to offset future cash taxes are $4,621,000 short term and $436,000 long term.

 

8.    Litigation, Contingencies and Subsequent Event

 

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

 

9.    Stockholders’ Equity

 

During the first nine months of 2002, employee and director options representing 160,239 shares of common stock were exercised for proceeds of $476,573.  Non-plan options representing 150,411 shares of common stock granted to the shareholders and plant manager of Frescala Foods, Inc. as part of the March 1999 acquisition were also exercised, resulting in proceeds of $314,638.  In addition, warrants with an exercise price of $6.50 and an expiration date of May 1, 2003, representing 47,414 shares of company common stock were exercised as parts of net exercises, with no cash proceeds to the Company.  These warrants were originally issued in connection with a July 1996 private placement in which the Company issued warrants to purchase up to 400,750 shares of common stock. Warrants representing up to 242,171 shares of common stock remain unexercised in connection with the July 1996 private placement.  Additionally, 7,670 employee stock purchase plan shares were issued with proceeds of $35,820.

 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

General

 

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 necessarily indicate the financial results that may be achieved by the Company in any future period.

 

9

 

Other than the historical facts contained herein, this Quarterly Report contains forward-looking statements that involve substantial risks and uncertainties.  For a discussion of such risks and uncertainties, please see the Company’s Annual Report on Form 10-K for the year ended December 30, 2001.  In addition to the risks and uncertainties discussed in the Annual Report, the risks set forth herein, including the Company’s ability to expand distribution of food products to new and existing customers, attract and retain qualified management, and compete in the competitive wholesale food products industry, should be considered.

 

Background

 

Monterey Pasta 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.  The Company has since expanded its operations to provide its products to grocery and club stores throughout the United States.  The Company’s overall strategic plan is to enhance the value of the Monterey Pasta Company brand name by distributing its gourmet food products through multiple channels of distribution.

 

The Company sells its pasta and pasta sauces through leading grocery store chains and club stores.  As of September 29, 2002, approximately 8,400 grocery and club stores offered the Company’s products.  The Company plans to continue expansion of its distribution to grocery and club stores in its current market area and to further its penetration in other geographic regions of the U.S. and other parts of the world.

 

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

 

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

 

•                  Introduce new products on a timely basis to maintain customer interest and to respond to changing consumer tastes.  In order to maximize its margins, the Company will focus its efforts on those new products that can be manufactured and distributed out of its Salinas, California facilities and will supplement its existing line of cut pasta, ravioli, tortelloni, tortellini, sauces, gnocchi, pizzas and calzones, borsellini, polenta, and soups.

 

•                  Use the Company’s Internet presence to create awareness of, and make available, Monterey Pasta products in areas in which they are not currently available, and to support the Company’s existing retail and club store accounts.

 

•                  Reduce operating costs as a percent 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.

 

•                  Create brand awareness by communicating to the consumer that Monterey Pasta Company provides a healthful and nutritious line of products and promote repeat business by reinforcing positive experiences with the Company’s products.

 

•                  Consider the acquisition of other compatible companies or product lines to expand retail distribution, or the range of product offerings, or to accomplish other synergies where the acquisition will create long-term stockholder value.

 

The Company will continue to direct its advertising and promotional activities to specific programs customized to suit its retail grocery and club store accounts.  These will include in-store demonstrations, coupons, scan backs, cross-couponing 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.

 

10

 

Results of Operations

 

Net revenues from operations were $16,569,000 for the third quarter ended September 29, 2002 as compared to $14,408,000 for the third quarter ended September 30, 2001, a 15% increase. These sales reflect the reclassification of certain expenses formerly charged to sales and marketing expense to reflect the adoption of EITF 01-09 (“EITF 01-09”) “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products” (refer to “New Accounting Pronouncements, p. 6).  Net revenues before those reclassifications also increased 15% from $14,929,000 for the quarter ended September 30, 2001 to $17,202,000 for the quarter September 29, 2002.  For the nine months ended September 29, 2002, net revenues after reclassifications increased $4,440,000 to $46,425,000 from $41,985,000 for the nine months ended September 30, 2001, an 11% increase. Net revenues before those adjustments also increased 11% to $48,463,000 from $43,673,000.  The quarterly and year-to-date increases in sales over last year resulted primarily from the Company’s additional retail and club store distribution and an increase in same-store sales in some venues.

 

Gross profit was $6,183,000 or 37.3% of net revenues for the third quarter 2002, compared to $5,025,000 or 34.9% for the third quarter of 2001. The third quarter and first nine months’ 2002 and 2001 gross margins reflect the reclassification of certain expenses formerly charged to sales and marketing expense to reflect the adoption of EITF 01-09.  Third quarter gross margin before those adjustments was 39.6%, an increase of 2.5% compared with the quarter ended September 29, 2002, which was 37.1.  Year-to-date 2002 gross margin after reclassifications was 37.1%, compared with 35.0% for the first nine months of 2001 calculated on the same basis.  First nine months’ gross margin before those adjustments was 39.7%, an increase of over 2% compared with the first nine months unadjusted 2001 results, which were 37.5%.  This compares to a 38.4% gross margin for the year ended December 30, 2001.  The gross margin improvement compared with third quarter 2001 and the year-ended December 30, 2001 was a function of cost savings associated with the 2001 capital and operations cost savings programs, fixed overhead absorption related to the 11% adjusted sales increase, and lower dairy ingredients and energy costs.  Gross margins in the third quarter of 2001 were also adversely affected by increased energy costs, increased dairy ingredient prices, and production inefficiencies associated with rapid national rollout of the calzone and borsellini lines.

 

Selling, general and administrative expenses (“SG&A”) for the third quarter ended September 29, 2002, were $4,194,000 an increase of 28% as compared to $3,268,000 for the same quarter last year.  The increase is net of the reclassification of certain selling expenses in the amount of $633,000 to reflect the adoption of EITF 01-09, while 2001 SG&A reflected $521,000 in reclassified selling expenses.  For the nine months ended September 29, 2002, SG&A, after reclassifications consistent with EITF 01-09, totaled $11,713,000, an increase of 21% as compared to $9,671,000 for the same period last year.  Unadjusted nine months SG&A expenses for 2002 were $13,751,000 or 28.4% of sales, compared with $11,359,000 unadjusted SG&A (26.0% of sales) for the first nine months of 2001, an increase of $2,393,000, or 21%.  For fiscal year-end 2001 unadjusted SG&A expenses were 26.2% of sales.  The quarterly and year-to-date increases compared to 2001 are related to variable selling expenses associated with the 11% sales increase, planned additional product demonstrations associated with club store business and national rollout of stuffed gnocchi, sauces in jars, chunky ravioli, and other new products.  The increased percent of SG&A expenses as a percent of sales is attributable to spending levels geared to a higher sales growth expectation than was achieved in the first nine months, one time expenses approximating $450,000 associated with a union organizing effort, which was overwhelmingly defeated by a vote of Company employees, and the successful search for a new President.  These one-time expenses, and $60,000 of SG&A from the first five weeks of Emerald Valley Kitchen operations, accounted for over 5% of the 21% increase compared with the prior year.  Management believes that the current level of SG&A expenses is consistent with efficient operations, and additional expenses in future months, mainly in the sales and marketing area, will be directly associated with the future growth of profitable sales.

 

EITF 01-09 requires the characterization of certain vendor sales incentives such as promotions, trade ads, slotting fees, and coupons as reductions of revenue.  Certain of these expenses, previously classified as selling, general and administrative costs, are now characterized as offsets to revenue.  The tables on the following page reflect the impact of the adoption of Issue EITF 01-09 on financial statement presentation and are meant to allow the investor to better understand the results of the reclassifications.

 

Impact of the Adoption of EITF 01-09

“Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products”

 

Third Quarters 2002, 2001

 

(000’s)		Q3 2002 After Reclass.			Q3 2001 After Reclass.			Q3 2002 Before Reclass.			Q3 2001 Before Reclass.
Net Revenues		$	17,202		$	14,929		$	17,202		$	14,929
Sales Incentives		(633		)	(521		)	—			—
Adjusted Net Revenues		$	16,569		$	14,408		$	17,202		$	14,929
Revenue Increase Percent		15.0		%	—			15.2		%	—
Cost of Sales		10,386			9,383			10,386			9,383
Gross Margin		$	6,183		$	5,025		$	6,816		$	5,546
Gross Margin Percent		37.3		%	34.9		%	39.6		%	37.1		%
Sales General & Adm.		$	4,828		$	3,789		$	4,828		$	3,789
Sales Incentives		(633		)	(521		)	—			—
Adjusted SG&A		$	4,195		$	3,268		$	4,828		$	3,789
SG&A Increase Percent		28.4		%	—			27.4		%	—
SG&A as a Percent of Sales		25.3		%	22.7		%	28.1		%	25.4		%

 

 

11

 

Year-to-Date 2002, 2001

 

(000’s)		YTD 2002 After Reclass.			YTD 2001 After Reclass.			YTD 2002 Before Reclass.			YTD 2001 Before Reclass.
Net Revenues		$	48,463		$	43,673		$	48,463		$	43,673
Sales Incentives		(2,038		)	(1,688		)	—			—
Adjusted Net Revenues		$	46,425		$	41,985		$	48,463		$	43,673
Revenue Increase Percent		10.6		%	—			11.0		%	—
Cost of Sales		29,236			27,279			29,236			27,279
Gross Margin		$	17,189		$	14,706		$	19,227		$	16,394
Gross Margin Percent		37.0		%	35.0		%	39.7		%	37.5		%
Sales General & Adm.		$	13,752		$	11,359		$	13,752		$	11,359
Sales Incentives		(2,038		)	(1,688		)	—			—
Adjusted SG&A		$	11,714		$	9,671		$	13,752		$	11,359
SG&A Increase Percent		21.1		%	—			21.1		%	—
SG&A as a Percent of Sales		25.2		%	23.0		%	28.4		%	26.0		%

 

Depreciation and amortization expense, included in cost of sales and SG&A, was $412,000 or 2.5% of net revenues for the quarter ended September 29, 2002, compared to $417,000 or 2.9% of net revenues for the quarter ended September 30, 2001.  For the nine months ended September 29, 2002, depreciation and amortization expense was $1,231,000 or 2.6% of net revenues, compared to $1,235,000 for the same period last year, which was 2.9% of net revenues. Expense was flat because of the suspension of goodwill amortization on the Frescala Foods, Inc. and Nate’s Polenta acquisitions of 1999 and 2001, respectively, and the writeoff of over $250,000 of obsolete and abandoned computer hardware, software and furniture and fixtures.

 

There was no gain on disposition of fixed assets for the third quarter ended September 29, 2002 compared with a gain of $3,000 for the third quarter last year.  For the nine months ended September 29, 2002, there was a loss of $68,000 compared to a gain of $20,000 for the nine months ended September 30, 2001.  The loss in 2002 resulted from writeoff of over $250,000 of obsolete and abandoned computer hardware, software and furniture and fixtures.

 

Net interest income was $6,000 for the quarter ended September 29, 2002, compared to net interest income of $27,000 for the same quarter in 2001.   For the nine months ended September 29, 2002, net interest income was $91,000 compared to a net interest income of $77,000 for the nine months ended September 30, 2001. The interest income increase is the result of the additional cash generated from the increased profit level, which was invested in short term money instruments.   The lower total in third quarter 2002 was a result of lower interest rates and the funding of the Emerald Valley acquisition from funds that were formerly interest bearing.

 

The Company’s 2002 income tax expense was adjusted as of September 29, 2002 to reflect the reversal of a deferred tax asset valuation account associated with NOLs originating in connection with the Company’s former restaurant subsidiary, UFO.  This makes it difficult to compare after tax results from 2002 with those from 2001, for which taxes were accrued at an estimated book rate of 38.5%.  If the 2002 tax expense were accrued at the same rate as was used for 2001, the resulting tax expense would be $768,000 for the quarter and $2,118,000 for the year-to-date, respectively.   Below are proforma results if the same rate were applied for both years:

 

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		Third quarter ended						Nine months ended
		September 29, 2002			September 30, 2001			September 29, 2002			September 30, 2001
Net income before tax		$	1,994,000		$	1,787,000		$	5,502,000		$	5,133,000
Tax at 38.5%		(768,000		)	(688,000		)	(2,118,000		)	(1,976,000		)
Income after tax*		$	1,226,000		$	1,099,000		$	3,384,000		$	3,157,000
Primary income /sh.		$	0.09		$	0.08		$	0.24		$	0.24
Diluted income/sh.		$	0.08		$	0.08		$	0.23		$	0.22

 

*2002 numbers are proforma

 

As a result, after 2002, future income tax expense will more closely approach a “normalized” combined tax rate of approximately 38.5%.  Results for the final quarter and full 2002 year will still be impacted by the release of reserves referred to above.

 

Liquidity and Capital Resources

 

We finance our operations and growth primarily with cash flows we generate from our operations. We have available a $10,000,000 credit facility consisting of a $1.5 million accounts receivable and inventory revolver and an $8.5 million non-revolving term facility for major capital expenditures and acquisitions (discussed in further detail on Note 6 to the financial statements on page 9).  This access to capital provides us with flexible working capital which occasionally may be needed in the normal course of business, and the opportunity to grow our business through acquisitions or develop our existing infrastructure through capital investment.

 

Net cash provided by operations was $5,597,000 and $4,435,000 million for the nine months ended September 29, 2002 and September 30, 2001, respectively. The increase in operating cash flows is primarily due to the increase income before provision for income taxes of approximately $369,000 and increases in accounts payable caused principally by the timing of payments to vendors.  Our working capital was $16.9 million, and our current ratio was 4.14 to 1, respectively, at September 29, 2002, compared with $14.9 million and 5.15 to 1 respectively, at December 30, 2001. The change in the working capital and current ratio is mainly due to the August 23^rd acquisition of the operating assets and inventory of Emerald Valley Kitchen with a cash use of $5.9 million.

 

In addition to operating cash flows the Company also received cash proceeds from the exercise of employee stock options and sales of stock under the Company’s stock purchase plan totaling approximately $827,000.

 

The cash from operations combined with the cash proceeds from stock sales and option exercises and accumulated cash balances were used principally to fund $3,465,000 of plant expansion and improvement projects, and to fund the $5,744,000 in cash paid for the acquisition of the operating assets and inventory of Emerald Valley, and acquistion related costs of $187,000.

 

We believe that cash on hand of $4.1 million at September 29, 2002, as well as projected remaining fiscal 2002 and 2003 cash flows from operations, and availability under our Credit Facility are sufficient to fund our working capital needs, anticipated capital expenditures, and any acquisitions the Company may enter into for the remainder of fiscal 2002 and 2003. We currently invest our cash on hand in highly liquid short-term investments yielding approximately 2% interest.

 

 

Summary of Critical Accounting Policies

 

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 loss, return, spoilage, adjustment history, contractual relationships with customers, current economic conditions, and other factors that deserve recognition 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.

 

13

 

Sales incentives and Advertising Costs

 

The Company expenses advertising costs as incurred or when the related campaign commences.  Sales incentives paid or credited to club stores and grocery chains for shelf space allocations are amortized between six and twelve months depending on the nature of the chain program or agreement.

 

Goodwill/Intangible Assets

 

Intangible assets consist of tradenames, goodwill, and other intangibles and are recorded at cost, net of accumulated amortization.  Intangibles other than goodwill are amortized over their respective useful lives, if determinate, ranging from 3 to 10 years.  Goodwill and intangibles with indeterminate useful lives are assessed for impairment at least annually.  The valuation of these intangibles is determined based upon valuations performed by third party specialists and management’s best estimates of fair value.  As a result the ultimate value and recoverability of these assets is subject to the validity of the assumptions used.

 

Income Taxes

 

The Company accounts for corporate income taxes in accordance with 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.

 

Deferred tax asset valuation allowance

 

The Company has significant deferred tax assets comprised principally of NOLs from the Company’s former restaurant operating subsidiary UFO. These NOLs were previously fully reserved based upon management’s best estimate of ultimate realizeability. During the current quarter, based upon new evidence and management’s judgments these reserves were substantially reduced.  The amount of the reserve is significantly dependent 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 of realizability changes. The Company expects to fully utilize all of the remaining NOLs in fiscal 2002 and 2003.

 

Sales and Marketing

 

The Company’s sales and marketing strategy is twofold and targets sustainable growth in distribution of its products and the introduction of innovative new products to keep the Company positioned as the category leader in the marketplace.

 

In keeping with its strategy of generating sustainable sales growth and balancing its sales mix to complement its strong club presence, the third quarter of 2002 saw the expansion of the Company ‘s retail business with the addition of the two new Albertson’s divisions encompassing 196 stores, as well as adding to two items to 260 Publix stores.   The Company was also successful in expanding the distribution of its products to an additional 1,125 Wal-Mart stores, the remainder of the Supercenters and Neighborhood Markets, after its 73 store test market proved successful.

 

Continuing its emphasis on high impact new products, the Company introduced its new “Pezzo Grandi” Chunky Stuffed Ravioli line to club accounts during the Third Quarter.   The Company believes it is the only fresh pasta maker offering this item, which features a deeper filling of large morsels of gourmet ingredients in contrast with traditional offerings, which use a pureed filling.  The Company’s line of premium sauces in jars also gained increased distribution during the quarter

 

Deferred Tax Assets

 

During the quarter and nine months ended September 29, 2002, the Company completed its evaluation of the likelihood of realizing certain deferred tax assets arising from net operating losses (NOLs) originated in connection with its former restaurant operating subsidiary Upscale Food Outlets, Inc. (UFO). As a result, reserves against these deferred tax assets totaling $5,404,000 were released during the nine months ended September 29, 2002 and offset against income tax expense.  This credit, together with permanent differences and other current tax effects resulted in a net year-to-date income tax benefit of $3,128,000.  Of these amounts, $4,674,000 in reserves released during the third quarter along with permanent differences and other current tax effects, resulted in a net income tax benefit for the quarter of $3,549,000. Utilization of these NOLS and other deferred tax assets will offset substantially all of the federal income taxes otherwise payable for 2002.  As of September 2002, remaining net deferred tax assets available to offset future cash taxes are $4,621,000 short term and $436,000 long term.

 

14

 

As a result, future income tax expense for the final quarter of 2002 and thereafter will more closely approach a “normalized” combined tax rate of approximately 38.5%.  Results for the full 2002 fiscal year will still be impacted by the release of reserves referred to above.

 

Business Risks

 

Certain characteristics and dynamics of the Company’s business and of financial markets generally create risks to the Company’s long-term success and to predictable quarterly results.  These risks include:

 

•                  No Assurance of Continued Profitability.  In the second quarter of 1994, the Company reported its first operating loss from continuing operations.   Subsequent to that quarter the Company incurred losses through the first quarter of 1997, after which it regained profitability, which has continued for twenty-one consecutive quarters. At September 29, 2002, the Company had an accumulated deficit of $6,453,000.  There can be no assurance that the Company will maintain its profitability in the long or short term.

 

•                  Liquidity:  Need for Additional Capital.   Management believes that its current cash balances, operations, and existing bank lines of credit will provide adequate liquidity to meet the Company’s planned capital and operating requirements for normal operations and capital expenditures through the next twelve months, assuming that its existing bank lines can be extended when they expire in October, 2003 (refer to footnote 6 to the financial statements for a description of credit facility).  In addition, the disallowance of a significant portion of previously-utilized UFO NOLs might require an unexpected cash outlay.   The tax impact of the use of the UFO NOLs through third quarter of 2002 is approximately $3.4 million.  If the Company’s operations do not provide cash sufficient to fund its operations, and the Company seeks outside financing, 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 would cause the Company’s stockholders to incur dilution in net tangible book value per share of Common Stock.

 

•                  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.  On September 3, 2002 the Company announced the hiring of Jim Williams as the new President to replace Lance Hewitt, who will be retiring from day-to-day operations sometime in early 2003.  The Company currently has key man insurance policies in place, each in the face amount of $500,000, for its Chief Executive Officer, R. Lance Hewitt, and its Chief Financial Officer, Stephen L. Brinkman.  A policy will be added form Mr. Williams in the future.  There can be no assurance that significant management turnover will not occur in the future.

 

•                  Impact of Inflation.  Dairy ingredients and energy prices had a significant impact on its operations during the first six months of 2001.  However, management believes that inflation has not had a material impact on its operations through the first three quarters of 2002.  Substantial increases in labor, employee benefits, freight, ingredients and packaging, rents and other operating expenses, and future increases in cheese and energy prices could adversely affect the operations of the Company’s business in future periods.  The Company cannot predict whether such increases will occur in the future, or their magnitude.

 

•                  Volatility of Stock Price.  The market price of the Company’s common stock has fluctuated substantially since the initial public offering of the Company’s common stock in December 1993.  Such volatility may, in part, be attributable to the Company’s operating results or to changes in the direction of the Company’s expansion efforts.  In addition, changes in general conditions in the economy, the financial markets or the food industry, natural disasters or other developments affecting the Company or its competitors could cause the market price of the Company’s common stock to fluctuate substantially.  In addition, in recent years, the stock market has experienced extreme price and volume fluctuations.  This volatility has had a significant effect on the market prices of securities issued by many companies, including the Company, for reasons sometimes unrelated to the operating performance of these companies.  Any 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 the fiscal quarter. This 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.

 

•                  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 and spoilage, and the associated risks of product liability litigation, which may be associated with even an isolated event.  The Company has a modern production facility, employs what it believes is state-of-the-art thermal processing, temperature-controlled storage, HAACP programs intended to insure food safety, and has obtained USDA approval for its production plant.  However, there can be no assurance that the Company’s procedures will be adequate to prevent the occurrence of such events.

 

15

 

•                  Dependence on Major Customers.  During the first nine months of 2002, two customers, Costco and Sam’s Club stores including Wal-Mart Supercenters, accounted for 44% and 33%, respectively, of the Company’s total revenues.  The Company currently sells its products to seven separate Costco regions (approximately 330 stores) 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 Pasta products in the future or continue to allocate Monterey Pasta the same amount of shelf space.  The Company also supplies its products to approximately 450 Sam’s Club stores, and 1,198 Wal-Mart Supercenters and Neighborhood Markets.  Purchasing decisions are made at the company headquarters with input from the store level.  While the Company is in the fifth year of its relationship with Sam’s, and this relationship is expected to continue, there can be no assurance that Sam’s Club stores will continue to carry its products. Loss of either of these customers, Costco or Sam’s Club, would have a material adverse effect on the Company.

 

•                  Seasonality and Quarterly Results.  The Company’s grocery and club store accounts are expected to experience seasonal fluctuations to some extent.  The Company’s business in general may also be affected by a variety of other factors, including but not limited to general economic trends, competition, marketing programs, and special or unusual events.

 

•                  Competition and Dependence on Common Carriers. The Company’s business continues to be dominated by several very large competitors, that 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.  The Company also continues to be 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.

 

•                  California Energy Crisis. During 2001, California experienced an energy crisis that could have disrupted the Company’s operations and did increase the Company’s energy expenses.  In the event of an acute power shortage, when power reserves for California fall below 1.5%, electricity providers have on some occasions implemented, and may in the future implement, rolling blackouts.  If blackouts interrupt the power supply to the Company’s production facilities, such facilities would temporarily be unable to continue production.  Any such interruption could result in a loss of revenue as a result of reduced production and, in severe cases, spoilage of food products.  In addition, related to the energy crisis, many of the electricity and natural gas suppliers raised their rates substantially during the first six months of 2001. Because the Company has most of its operations in California, its operating costs are affected by an increase in electricity and natural gas prices. As a result, the Company’s operating results could to be affected in some measure by in the future by fluctuations in the price or supply of energy.  Electricity prices remained unchanged from May through March 2002, except for adjustment to a lower wintertime rate schedule, which began in November 2001 and ended in April 2002.  Current rates since April 2002 are similar to the same period a year ago.  Natural gas prices have declined substantially from their levels in the first five months of 2001.  Management cannot predict the level of future energy prices or supply with certainty.

 

•                  Marketing and Sales Risks.  The future success of the Company’s efforts 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.  Should these channels choose to reduce or eliminate products, the Company could experience a significant reduction in its product sales.  As indicated previously, the Company remains dependent on the use of slotting allowances and other incentives to expand retail distribution.  In order to reduce risk, the Company has significantly reduced expansion into new markets requiring such major expenditures.

 

•                  Dairy Ingredients Prices.  During the first ten months of 2001 average price of certain dairy ingredients increased over 40% compared with the average of the prior twelve months, as measured by butterfat prices published by the State of California Department of Food and Agriculture.  Because the Company utilizes various dairy ingredients in many of its products, its operating costs will be affected by an increase in those ingredients. The Company’s operating results were affected in the first eleven months of 2001, and, although dairy ingredient prices have declined significantly in the past eleven months, results could be affected in some measure in future months by renewed price increases, if they occur.  Dairy ingredients historically tend to be cyclical in nature and subject to declines in price as well as increases.  Management cannot predict with certainty the duration or magnitude of the current price cycle.

 

16

 

Item 3.   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.  All sales, operating items and balance sheet data are denominated in U.S. dollars, therefore, the Company has no foreign currency exchange rate risk.

 

In the ordinary course of its business the Company enters into commitments to purchase raw materials over a period of time, generally six months to one year, at contracted prices.  At September 29, 2002 these future commitments were not at prices in excess of current market, or in quantities in excess of normal requirements.  The Company does not utilize derivative contracts either to hedge existing risks or for speculative purposes.

 

Interest Rate Risk

 

We have fixed and variable income investments consisting of cash equivalents, the magnitude of the interest income for which is affected by market interest rates.  We do not use marketable securities nor derivative financial instruments in our investment portfolio.

 

The interest payable on our bank line of credit is based on variable interest rates and therefore affected by changes in market interest rates.  The Company had no bank debt at the end of the third quarter and has not had bank debt since the third quarter of 2000

 

Foreign Currency Risk

 

Our sales to-date have been made to primarily U.S. customers and, as a result, we have not had any significant exposure to factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. However, we are now selling and, in future periods, we expect to sell more in foreign markets. If our sales will be made in U.S. dollars, a strengthening of the U.S. dollar could make our products less competitive in foreign markets.

 

Item 4.   Disclosure Controls and Procedure

 

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

 

There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above.

 

 

PART II.  OTHER  INFORMATION

 

Item 1.    Legal Proceedings

 

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

 

Item 2.    Changes in Securities

 

None

 

Item 3.    Defaults upon Senior Securities

 

None

 

17

 

Item 4.           Submission of Matters to a Vote of Security Holders

 

(a) The Company’s annual Stockholders’ meeting was held July 30, 2002.

 

(b) At the annual meeting the following matters were approved:

 

(i)           the election of the following eight directors to hold office for the ensuing year and until their successors are elected and qualified.  The following directors received the identical vote total listed below

 

		Votes For		Votes Against or abstain
R. Lance Hewitt		11,538,068		46,140
Charles B. Bonner		11,538,068		46,140
Michael P. Schall		11,538,068		46,140
Van Tunstall		11,538,068		46,140
James Wong		11,538,068		46,140
Stephen L. Brinkman		11,538,068		46,140
Walter L. Henning		11,538,068		46,140
F. Christopher Cruger		11,538,068		46,140

 

(ii)        the appointment of  BDO Seidman, LLP as the independent public accountants for the year ending December  29, 2002 was approved with 11,505,138 votes in favor, 25,570 votes against, and 53,500 votes abstaining.

 

(iii)     an increase of the Company’s 1993 Stock Option Plan reserve by 1,500,000 options from 1,740,000 to 3,240,000 was approved with 6,118,359 votes in favor, 1,668,801 votes against , and 79,125 votes abstaining.

 

Item 5.           Other Information

 

None

 

 

Item 6.    Exhibits and Reports on Form s 8-K and S-8

 

The Company filed the following report on Form 8-K during the quarter ended September 29, 2002.

 

•                  Report on Form 8-K filed August 30, 2002 reported the acquisition of the operating assets of Emerald Valley Kitchen (“EVK”) effective August 23, 2002 for a consideration of $5,744,000 in cash.  The shareholders of EVK may receive additional cash consideration pursuant to an earnout provision in the Asset Purchase Agreement if the Company exceeds enumerated levels of Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) from the EVK business segment for the first five years of operation under Company ownership.

 

The Company filed the following report on Form S-8 during the quarter ended September 29, 2002.

 

•                  Report on Form S-8 filed August 30, 2002 to register 1.5 million shares of Company common stock which may be issued as part of the First amended and restated 1993 Stock Option plan

 

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SIGNATURES

 

 

Pursuant to the requirements 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.

 

	MONTEREY PASTA COMPANY
Date: November 12, 2002
	By:	/s/ R. LANCE HEWITT
			R. Lance Hewitt
			Chief Executive Officer
	By:	/s/ STEPHEN L. BRINKMAN
			Stephen L. Brinkman
			Chief Financial Officer

 

 

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CERTIFICATIONS

 

I, R. Lance Hewitt, certify that:

 

1.             I have reviewed this quarterly report on Form 10-Q of Monterey Pasta Company (the “Registrant”);

 

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

 

3.             Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

 

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

 

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

 

(b) evaluated the effectiveness of the Registrant’s disclosure controls and procedures as of October 31, 2002; (the “Evaluation Date”) and

 

(c) presented in this quarterly report our conclusions about the effectiveness of the Registrant’s disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors:

 

(a) all significant deficiencies in the design or operation of disclosure controls and procedures which could adversely affect the Registrant’s ability to record, process, summarize and report financial data and have identified for the Registrant’s auditors any material weaknesses in disclosure controls and procedures; and

 

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

 

6.             The Registrant’s other certifyintg officer and I have indicated in this quarterly report whether or not there were significant changes in disclosure controls and procedures or in other factors that could significantly affect the disclosure controls and procedures subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date: November 12, 2002	/s/	R. Lance Hewitt
			R. Lance Hewitt
			President and Chief Executive Officer

 

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I, Stephen L. Brinkman, certify that:

 

1.             I have reviewed this quarterly report on Form 10-Q of Monterey Pasta Company (the “Registrant”);

 

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

 

3.             Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

 

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

 

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

 

(b) evaluated the effectiveness of the Registrant’s disclosure controls and procedures as of October 31, 2002; (the “Evaluation Date”) and

 

(c) presented in this quarterly report our conclusions about the effectiveness of the Registrant’s disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors:

 

(a) all significant deficiencies in the design or operation of disclosure controls and procedures which could adversely affect the Registrant’s ability to record, process, summarize and report financial data and have identified for the Registrant’s auditors any material weaknesses in disclosure controls and procedures; and

 

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

 

6.             The Registrant’s other certifyintg officer and I have indicated in this quarterly report whether or not there were significant changes in disclosure controls and procedures or in other factors that could significantly affect the disclosure controls and procedures subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date: November 12, 2002	/s/	Stephen L. Brinkman
			Stephen L. Brinkman
			Chief Financial Officer

 

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	Index to Exhibits
3.1	Certificate of Incorporation dated August 1, 1996 (incorporated by reference from Exhibit B to the Company’s 1996 Proxy)
3.2	Bylaws of the Company (incorporated by reference from Exhibit C to the 1996 Proxy)
4.1	Form of Warrant for purchase of the Company’s Common Stock, dated as of July 1, 1996 (incorporated by reference from Exhibit 4.5 filed with the Company’s 1996 Form S-3)
4.2	Form of Registration Rights Agreement dated April 1996, among the Company, Spelman & Co., Inc. and investor (incorporated by reference from Exhibit 10.42 filed with the Company’s Original March 31, 1996 Quarterly Report on Form 10-Q on May 1, 1996 (“1996 Q1 10-Q”))
4.3	Stockholder Rights Agreement dated as of May 15, 1996 between the Company and Corporate Stock Transfer, as rights agent (incorporated by reference from Item 2 of Form 8-A filed with the Securities and  Exchange Commission on May 28, 1996)
4.4	Amendment to Registration Rights Agreement dated as of April 20, 1997 among the Company, Spelman & Co., Inc. and investor, amending the Registration Rights Agreement entered into as of April, 1996 (incorporated by reference from Exhibit 4.9 filed with the Company’s 1996 Form 10-KA)
4.5	Registration Rights Agreement dated as of December 31, 1996 among the Company, Sentra Securities Corporation and investor (incorporated by reference from Exhibit 4.12 filed with the Company’s 1996 Form 10-K/A)
4.6	Form of Warrant (“Sentra Warrant”) for purchase of Company’s Common stock dated March 1997 issued in  connection with the Company’s March 1997 Private Placement (incorporated by reference from Exhibit 4.13  filed with the Company’s Pre-Effective Amendment No. 1 to the Registration Statement on Form S-3 filed on May 6, 1997 (“1997 Amendment No. 1 to Form S-3))
4.7*	Stock Purchase Agreement between the Company and Kenneth A. Steel, Jr. dated April 29, 1997 (incorporated by reference from Exhibit 4.14 filed with the 1997 Amendment No. 1 to Form S-3)
10.1*	Second Amended and Restated 1993 Stock Option Plan (as amended on August 1, 1996) (incorporated by reference to Exhibit 10.1 filed with the Company’s 1996 Form 10-K)
10.2*	1995 Employee Stock Purchase Plan (incorporated by reference from Exhibit 10.15 to the Company’s 1994 Form 10-K)
10.3	Monterey County Production Facility Lease of the Company, as amended (incorporated by reference from Exhibit 10.03 to the SB-2)
10.4	Amendment No. 1 dated February 1, 1995 and Amendment No. 2 dated March 1, 1995 to Monterey County Production Facility Lease of the Company (incorporated by reference from Exhibit 10.6 filed with the 1995 Form 10-K)
10.5	Amendment No. 3 dated September 12, 1997, and Amendment No. 4 dated February 6, 1999 to Monterey County Production Facility Lease of the Company (incorporated by reference from Exhibit 10.5 filed with the Company’s September 27, 1999 Quarterly Report on Form 10-Q dated November 4, 1999 (“1999 Q3 10-Q”))
10.6	Trademark Registration – MONTEREY PASTA COMPANY, under Registration No. 1,664,278, registered on November 12, 1991 with the U.S. Patent and Trademark Office (incorporated by reference from Exhibit 10.09 to the SB-2)
10.7	Trademark Registration – MONTEREY PASTA COMPANY, under Registration No. 1,943,602, registered on December 26, 1995 with the U.S. Patent and trademark Office (incorporated by reference from Exhibit 10.24 to the 1995 Form 10-K)
10.8	Trademark Registration – MONTEREY PASTA COMPANY and Design, under Registration No. 1,945,131, registered on January 2, 1996 with the U.S. Patent and trademark Office (incorporated by reference from Exhibit 10.25 to the 1995 Form 10-K)
10.9	Trademark Registration — MONTEREY PASTA COMPANY and Design, under Registration No. 1,951,624, registered on January 23, 1996 with the U.S. Patent and Trademark Office (incorporated by reference from Exhibit 10.26 to the 1995 Form 10-K)
10.10	Trademark Registration — MONTEREY PASTA COMPANY and Design, under Registration No. 1,953,489, registered on January 30, 1996 with the U.S. Patent and Trademark Office (incorporated by reference from Exhibit 10.27 to the 1995 Form 10-K)
10.11	Registration Rights Agreement dated as of June 15, 1995 with GFL Advantage Fund Limited, as amended on October 13 and 19, 1995, respectively (incorporated by reference from Exhibit 10.2 to the 1995 Q2 10-Q, and Exhibits 10.6 and 10.7 to the Company’s S-3 Registration Statement No. 33-96684, filed on December 12, 1995 (“1995 S-3”))
10.12*	The Company’s 401(k) Plan, established to be effective as of January 1, 1996, adopted by the Board of Directors on June 7, 1996  (incorporated by reference from Exhibit 10.44 to the Company’s Quarterly Report on Form 10-Q on August 13, 1996 (“1996 Q2 10-Q”))
10.13*	Directed Employee Benefit Trust Agreement dated June 17, 1996 between the Company and The Charles Schwab Trust Company, as Trustee of the Company’s 401(k) Plan (incorporated by reference from Exhibit 10.45 to the 1996 Q2 10-Q)
10.14	Security and Loan Agreement (Accounts Receivable and/or Inventory) dated July 24, 1997 between the Company and Imperial Bank (incorporated by reference from Exhibit 10.47 of the Company’s Pre-Effective Amendment No. 3 to Form S-3 filed on October 14, 1997 (“1997 Amendment No. 3 to Form S-3”))
10.15*	Agreement Regarding Employment, Trade Secrets, Inventions, and Competition dated May 26, 1997 with Mr. R. Lance Hewitt (incorporated by reference from Exhibit 10.48 of the 1997 Amendment No. 3 to Form S-3)
10.16*	Employment Agreement dated August 25, 1997 with Mr. Stephen L. Brinkman (incorporated by reference to Exhibit 10.49, in the Company’s September 28, 1997 Quarterly Report on Form 10-Q filed on November 10, 1997)
10.17	First Amendment to Security and Loan Agreement dated July 24, 1997 between the Company and Imperial Bank (incorporated by reference from Exhibit 10.50 in the Company’s 1997 Form 10-K)
10.18	Second Amendment to Security and Loan Agreement dated July 24, 1997 between the Company and Imperial Bank (incorporated by reference from Exhibit 10.18 filed with the Company’s 1998 Q3 10-Q)
10.19	Security and Loan Agreement dated July 23, 1998 between the Company and Imperial Bank (incorporated by reference from Exhibit 10.19 filed with the Company’s 1998 Q3 10-Q)
10.20	Addendum to Security and Loan Agreement dated July 23, 1998 between the Company and Imperial Bank (incorporated by reference from Exhibit 10.20 filed with the Company’s 1998 Q3 10-Q)
10.21	Agreement for Handling and Storage Services between the Company and CS Integrated LLC dated February 5, 1999 (incorporated by reference to Exhibit 10.21 filed with the Company’s 1998 Form 10-K on March 17, 1999 (“1998 Form 10-K”))
10.22	Defined Contribution Administrative Service Agreement between the Company and First Mercantile Trust dated December 15, 1999 (incorporated by reference to Exhibit 10.22 filed with the Company’s 1998 Form 10-K)
10.23	First Amendment to Security and Loan Agreement and Addendum thereto between the Company and Imperial Bank dated July 23, 1999 (incorporated by reference to Exhibit 10.23 filed with the Company’s April 1, 2001 Quarterly Report on Form 10-Q filed on April 28, 1999)
10.24	Agreement for Purchase and Sale of Assets dated as of March 12, 1999, by and among the Company and the shareholders of Frescala Foods, Inc. (incorporated by reference from Exhibit 2.1 filed with the Company’s 8-K on March 17, 1999)
10.25	Royalty agreement dated July 12, 1999 between Company and Chet’s Gourmet Foods, Inc. for soups (incorporated by reference to Exhibit 10.25, in the Company’s September 26, 1999 Quarterly Report on Form 10-Q filed on November 9, 1999 (“1999 Q3 10-Q”))
10.26	Storage Agreement Manufactured Products dated August 3, 1999 between the Company and Salinas Valley Public Warehouse for storage and handling of Company’s product in Monterey County, California storage facility (incorporated by reference to Exhibit 10.26, filed with the Company’s 1999 Q3 10-Q)
10.27	Commercial Lease dated August 10, 1999 between Company and Salinas Valley Public Warehouse for storage space in Monterey County, California (incorporated by reference to Exhibit 10.27, filed with the Company’s 1999 Q3 10-Q)
10.28	Rental Agreement dated September 6, 1999 between Company and Porter Family Trust for storage space in Monterey County, California (incorporated by reference to Exhibit 10.28 filed with the Company’s 1999 Q3 10-Q)
10.29	Royalty agreement dated September 15, 1999 between Company and Chet’s Gourmet Foods, Inc. for meatball and sauce item (incorporated by reference to Exhibit 10.29, filed with the Company’s 1999 Q3 10-Q)
10.30	Credit Agreement between the Company and Imperial Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.30 filed with the Company’s 1999 Form 10-K on February 18, 2001 (“1999 Form 10-K”))
10.31	First Amendment to Credit Agreement between the Company and Imperial Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.21 filed with the Company’s 1999 Form 10-K)
10.32	Commercial lease dated January 1, 2001 between the Company and PTF for Operating Engineers, LLC for storage space in Monterey County, California (incorporated by reference to Exhibit 10.32, in the Company’s June 25, 2001 Quarterly Report on Form 10-Q filed on August 4, 2001)
10.33	Second Amendment to Credit Agreement between the Company and Imperial Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.33 in the Company’s September 25, 2001 Quarterly Report on Form 10-Q filed on November 6, 2001 (“2001 Q3 10-Q”))
10.34	Third Amendment to Credit Agreement between the Company and Imperial Bank dated August 2, 1999  (incorporated by reference to Exhibit 10.34 in the Company’s 2001 Q3 10-Q)
10.35	Royalty agreement dated February 11, 2001 between Company and William Naim for development of pizza and calzone recipes and process (incorporated by reference to Exhibit 10.35 filed with the Company’s 2001 Form 10-K on February 7, 2001 (“2001 Form 10-K”))
10.36	Fourth Amendment to Credit Agreement between the Company and Imperial Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.36 filed with the Company’s 2001 Form 10-K)
10.37	Asset Purchase Agreement dated as of December 8, 2001, by and among the Company and the shareholders of Elena’s Food Specialties, Inc. (incorporated by reference to Exhibit 10.37 filed with the Company’s 2001 Form 10-K)
10.38	Limited License for use of Nate’s brand dated as of December 8, 2001, by and among the Company and the shareholders of Elena’s Food Specialties, Inc. (incorporated by reference to Exhibit 10.38 filed with the Company’s 2001 Form 10-K)
10.39	Fifth Amendment to Credit Agreement between the Company and Imperial Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.39 in the Company’s April 1, 2001 Quarterly Report on  Form 10-Q filed on May 7, 2001)
10.40	Lease Extension and Modification Agreement between the Company and Marco Warehouse d.b.a. Salinas Valley Public Warehouse dated September 1, 2001 (incorporated by reference to Exhibit 10.40 in the Company’s September 30, 2001 Quarterly Report on  Form 10-Q filed on November 7, 2001)
10.41	Royalty Agreement dated January 18, 2002 between Company and Toscana Foods, LLC for ravioli with unique rough chopped filling (incorporated by reference to Exhibit 10.41 in the Company's June 30, 2002 Quarterly Report on Form 10-Q filed on August 9, 2002)
99.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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

 

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