**FORM 10-Q**

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

 

**QuarterlyReport Pursuant to Section 13 or 15(d) ofthe Securities and Exchange Act of 1934**

 

**For the quarterly period ended: 04/30/03Commission file number: 1-14091**

 

| **SHERWOOD BRANDS, INC.**                                                  |
|----------------------------------------------------------------------------|
| (Exact name of Registrant as specified in  its charter)                    |
|                                                                       |   |   |
| **North Carolina**                                                         |   | **56-1349259** |
| (State or other jurisdictions of  incorporation or organization)           |   | (I.R.S. Employer  Identification No.) |
|                                                                       |   |   |
| **1803 Research Blvd. Suite 201, Rockville MD  20850**                     |
| (Address of principal executive offices)                                   |
|                                                                       |   |   |
| Registrant’s telephone number, including  area code: **301-309-6161** |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports and (2) has been subject to suchfiling requirement for the past 90 days. Yes ý    No o

 

The number of shares outstanding of issuer’s Class A Common Stock, $.01par value per share, as of June 10, 2003 was 3,003,476. The number ofshares outstanding of issuer’s Class B Common Stock, $.01 par value per share,as June 10, 2003 was 1,000,000. The Class B Common Stock is not publiclytraded.

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  Yes  o    No ý

 

 

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SHERWOOD BRANDS, INC.

 

INDEX

 
| PART I    FINANCIAL INFORMATION                                                                        |                                                                                                                      |
|----------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                       |                                                                                                                      |
| Item  1.    FINANCIAL STATEMENTS                                                                       |                                                                                                                      |
|                                                                                                                       |
|                                                                                                                       | Consolidated  Balance Sheets – April 30, 2003 (unaudited) and July 31, 2002                                |
|                                                                                                                       |                                                                                                                      |
|                                                                                                                       | Consolidated Statements of Operations –  Three months and nine months ended April 30, 2003 and 2002 (unaudited) |
|                                                                                                                       |                                                                                                                      |
|                                                                                                                       | Consolidated Statements of Cash Flows – Nine  months ended April 30, 2003 and 2002 (unaudited)                  |
|                                                                                                                       |                                                                                                                      |
|                                                                                                                       | Notes to  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.    Control and Procedures                                                                      |
|                                                                                                                       |                                                                                                                      |
| PART  II    OTHER INFORMATION                                                                          |
|                                                                                                                       |                                                                                                                      |
| Item 1.    Legal Proceedings                                                                           |
|                                                                                                                       |                                                                                                                      |
| Item 4.    Submission of Matters to a Vote of  Security Holders                                        |
|                                                                                                                       |                                                                                                                      |
| Item 6.    Exhibits and Reports on form 8-K                                                            |
|                                                                                                                       |                                                                                                                      |
| SIGNATURES                                                                                                                 |
|                                                                                                                            |                                                                                                                           |  |

 

2

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SHERWOOD BRANDS, INC. AND SUBSIDIARIES

CONSOLIDATEDBALANCE SHEETS

Unaudited

 
|                                                                                                          |   | **April 30, 2003** |   | **July 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                                                                                          |   | **(unaudited)**         |   | **(audited)**           |   |
| Assets                                                                                                        |   |                    |   |                    |   |
| Current assets                                                                                                |   |                    |   |                    |   |
| Cash and cash equivalents                                                                                     |   | 56,389                  |   | 709,247                 |   |
| Accounts receivable, less allowance of  $273,000 and $126,000                                                 |   | 4,628,016               |   | 2,547,452               |   |
| Inventory                                                                                                     |   | 10,966,258              |   | 15,956,145              |   |
| Income taxes receivable                                                                                       |   | 1,357,240               |   | 1,555,078               |   |
| Other current assets                                                                                          |   | 564,060                 |   | 450,375                 |   |
| Deferred taxes on income                                                                                      |   | 512,000                 |   | 512,000                 |   |
|                                                                                                          |   |                    |   |                    |   |
| Total current assets                                                                                          |   | 18,083,963              |   | 21,730,297              |   |
|                                                                                                          |   |                    |   |                    |   |
| Net property and equipment                                                                                    |   | 7,324,968               |   | 7,350,488               |   |
|                                                                                                          |   |                    |   |                    |   |
| Goodwill                                                                                                      |   | 2,001,330               |   | 2,001,330               |   |
|                                                                                                          |   |                    |   |                    |   |
| Other assets                                                                                                  |   | 339,509                 |   | 308,839                 |   |
|                                                                                                          |   |                    |   |                    |   |
| TOTAL ASSETS                                                                                                  |   | 27,749,770              |   | 31,390,954              |   |
|                                                                                                          |   |                    |   |                    |   |
| Liabilities  and Stockholders’ Equity                                                                    |   |                    |   |                    |   |
| Current liabilities                                                                                           |   |                    |   |                    |   |
| Line of credit                                                                                                |   | 7,207,580               |   | 8,203,971               |   |
| Current portion of long-term debt                                                                             |   | 481,111                 |   | 90,000                  |   |
| Current portion of capital lease obligation                                                                   |   | 15,718                  |   | 15,718                  |   |
| Accounts payable                                                                                              |   | 5,118,608               |   | 5,833,301               |   |
| Accrued expenses                                                                                              |   | 1,429,328               |   | 1,368,928               |   |
| Income taxes payable                                                                                          |   | —                  |   | —                  |   |
|                                                                                                          |   |                    |   |                    |   |
| Total current liabilities                                                                                     |   | 14,252,345              |   | 15,511,918              |   |
| Deferred taxes on income                                                                                      |   | 331,000                 |   | 331,000                 |   |
| Long-term debt                                                                                                |   | 1,412,090               |   | 1,722,000               |   |
| Obligations under capital lease                                                                               |   | 427,676                 |   | 438,696                 |   |
|                                                                                                          |   |                    |   |                    |   |
| TOTAL LIABILITIES                                                                                             |   | 16,423,111              |   | 18,003,614              |   |
|                                                                                                          |   |                    |   |                    |   |
| Stockholders’ equity                                                                                     |   |                    |   |                    |   |
| Preferred stock, $.01 par value, 5,000,000  shares authorized; no shares issued or outstanding                |   | —                  |   | —                  |   |
| Common stock, Class A, $.01 par value,  30,000,000 shares authorized, 3,003,476 shares issued and outstanding |   | 30,035                  |   | 29,869                  |   |
| Common stock, Class B, $.01 par value,  5,000,000 shares authorized, 1,000,000 shares issued and outstanding  |   | 10,000                  |   | 10,000                  |   |
| Additional paid-in-capital                                                                                    |   | 9,843,774               |   | 9,816,856               |   |
| Retained earnings                                                                                             |   | 1,442,850               |   | 3,561,754               |   |
| Accumulated other comprehensive income  (loss)                                                           |   | —                  |   | (31,139                 | )      |
|                                                                                                          |   |                    |   |                    |   |
| TOTAL STOCKHOLDERS’ EQUITY                                                                               |   | 11,326,659              |   | 13,387,340              |   |
|                                                                                                          |   |                    |   |                    |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                               |   | 27,749,770              |   | 31,390,954              |   |

 

See accompanying summary of accounting policies and notes toconsolidated financial statements

 

3

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SHERWOODBRANDS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSUnaudited

 
|                                                          |     | **THREE  MONTHS ENDED APRIL 30,** | ** ** | **NINE  MONTHS ENDED APRIL 30,** | ** ** |
|---------------------------------------------------------------|----------|----------------------------------------|------------|---------------------------------------|------------|
|                                                          |     | **Unaudited**                          | ** ** | **Unaudited**                         | ** ** |
|                                                          |     | **2003**                               |       | **2002**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                          |     |                                   |       |                                  |       |   |   |   |   |
| Net sales                                                     |     | $                                      | 9,482,412  |                                  | $          | 11,312,184 |   | $ | 47,335,225 |   | $ | 48,290,502 |   |
| Cost of sales                                                 |     | 7,919,775                              |       | 9,063,422                             |       | 35,218,817 |   | 34,402,511 |   |
| Write-down of inventory                                       |     | 2,192,005                              |       | —                                |       | 2,192,005 |   | — |   |
| Gross profit (loss                                            |     | (629,368                               | )          | 2,248,762                             |       | 9,924,403 |   | 13,887,991 |   |
| Selling, general and administrative  expenses                 |     | 1,632,931                              |       | 1,588,005                             |       | 6,945,440 |   | 6,592,152 |   |
| Pre-production costs                                          |     | 405,838                                |       | 393,918                               |       | 1,790,214 |   | 393,918 |   |
| Salaries and related expenses                                 |     | 1,249,423                              |       | 1,102,277                             |       | 3,707,832 |   | 3,777,329 |   |
| Total operating expenses                                      |     | 3,288,192                              |       | 3,084,200                             |       | 12,443,486 |   | 10,763,399 |   |
| (Loss) income from operations                                 |     | (3,917,560                             | )          | (835,438                              | )          | (2,519,083 | ) | 3,124,592 |   |
| Other income (expense)                                        |     |                                   |       |                                  |       |   |   |   |   |
| Interest income                                               |     | 116                                    |       | 460                                   |       | 2,608 |   | 4,340 |   |
| Interest expense                                              |     | (126,893                               | )          | (114,194                              | )          | (463,965 | ) | (402,855 | ) |
| Other income                                                  |     | 379,673                                |       | 33,595                                |       | 317,498 |   | 19,469 |   |
| Total other income (expense)                                  |     | 252,896                                |       | (80,139                               | )          | (143,859 | ) | (379,046 | ) |
| (Loss) income before provision (benefit)  for taxes on income |     | (3,664,664                             | )          | (915,577                              | )          | (2,662,942 | ) | 2,745,546 |   |
| (Benefit) provision for taxes on income                       |     | (914,637                               | )          | (222,072                              | )          | $ | (544,000 | ) | 1,099,341 |   |
| Net (loss) income                                             |     | $                                      | (2,750,026 | )                                     | $          | (693,505 | ) | $ | (2,118,941 | ) | $ | 1,646,205 |   |
|                                                          |     |                                   |       |                                  |       |   |   |   |   |
| Net (loss) income per share                                   | -basic   |                                   | $          | (0.69                                 | )          | $ | (0.19 | ) | $ | (0.53 | ) | $ | 0.44 |   |
|                                                          | -diluted |                                   | (0.69      | )                                     | (0.19      | ) | (0.53 | ) | 0.37 |   |
|                                                          |     |                                   |       |                                  |       |   |   |   |   |
| Weighted average shares outstanding                           |     |                                   |       |                                  |       |   |   |   |   |
|                                                          | -basic   |                                   | 4,001,454  |                                  | 3,716,250  |   | 3,993,756 |   | 3,707,143 |   |
|                                                          | -diluted |                                   | 4,001,454  |                                  | 3,716,250  |   | 3,993,756 |   | 4,390,870 |   |

 

See accompanying summary of accounting policies and notes toconsolidated financial statements.

 

4

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SHERWOOD BRANDS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

 
|                                                                          |   | **Nine  months ended April 30,** |       |
|-------------------------------------------------------------------------------|--------|---------------------------------------|------------|
|                                                                          |   | **Unaudited**                         | ** ** |
|                                                                          |   | **2003**                              |       | **2002** | ** ** |
| Cash flows from operating activities                                          |   |                                  |       |   |   |
| Net (loss) income                                                             |   | $                                     | (2,118,941 | ) | $ | 1,646,205 |   |
| Adjustments to reconcile net income to net  Cash used in operating activities |   |                                  |       |   |   |
| Depreciation expense                                                          |   | 719,377                               |       | 306,566 |   |
| Provision for inventory obsolescence                                          |   | 146,390                               |       | 865 |   |
| Provision for doubtful accounts                                               |   | 157,275                               |       | 245,742 |   |
| (Increase) decrease in assets                                                 |   |                                  |       |   |   |
| Accounts receivable                                                           |   | (2,237,837                            | )          | (2,123,160 | ) |
| Inventory                                                                     |   | 4,843,496                             |       | 4,274,996 |   |
| Other current assets                                                          |   | 628,153                               |       | (142,511 | ) |
| Other assets                                                                  |   | (30,671                               | )          | (907,484 | ) |
| Increase (decrease) in liabilities                                            |   |                                  |       |   |   |
| Accounts payable                                                              |   | (714,693                              | )          | (1,350,139 | ) |
| Accrued expenses                                                              |   | 91,576                                |       | 284,036 |   |
| Income taxes payable                                                          |   | —                                |       | (384,144 | ) |
| Net cash provided by operating activities                                     |   | 940,124                               |       | 1,850,972 |   |
|                                                                          |   |                                  |       |   |   |
| Cash flows from investing activities                                          |   |                                  |       |   |   |
| Capital expenditures                                                          |   | (693,857                              | )          | (1,317,836 | ) |
| Net cash used in investing activities                                         |   | (693,857                              | )          | (1,317,836 | ) |
|                                                                          |   |                                  |       |   |   |
| Cash flows from financing activities                                          |   |                                  |       |   |   |
| Net pay-downs on line of credit                                               |   | (996,390                              | )          | (330,649 | ) |
| Exercise of Stock options                                                     |   | 27,084                                |       | — |   |
| Borrowings on Debt                                                            |   | 350,000                               |       | — |   |
| Payments on Debt                                                              |   | (279,819                              | )          | 42,910 |   |
| Net cash used by financing activities                                         |   | (899,125                              | )          | (287,739 | ) |
|                                                                          |   |                                  |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                         |   | (652,858                              | )          | 245,397 |   |
|                                                                          |   |                                  |       |   |   |
| Cash and cash equivalents, at beginning of  period                            |   | 709,247                               |       | 385,195 |   |
| Cash and cash equivalents, at end of period                                   |   | $                                     | 56,389     |   | $ | 630,592 |   |

 

See accompanying summary of accounting policies and notes toconsolidated financial statements

 

5

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1. BASIS OFPRESENTATION

 

Theconsolidated financial statements include the accounts of Sherwood Brands,Inc., and its direct and indirect wholly-owned subsidiaries, Sherwood Brands,LLC, a Maryland limited liability company, Sherwood Brands of RI Inc., a RhodeIsland corporation, Sherwood Brands Overseas, Inc., a Bahamas entity, and AsherCandy, Inc., a Wyoming corporation (collectively referred to herein as, “we”,“our” “us” or, the “Company”). All material inter-company transactions andbalances have been eliminated in consolidation. The accompanying consolidatedfinancial statements have been prepared in accordance with generally acceptedaccounting principles for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Certain informationand footnote disclosures normally included in the consolidated financialstatements prepared in accordance with generally accepted accounting principleshave been condensed or omitted pursuant to such rules and regulations. Theseconsolidated financial statements should be read in conjunction with theconsolidated financial statements, and the notes thereto, included in theCompany’s amended Annual Report and Form 10-K/A filed on December 20, 2002.

 

2. ORGANIZATION AND DESCRIPTION OF BUSINESS

 

SherwoodBrands, Inc. was incorporated in December 1982 in the State of NorthCarolina. Sherwood Brands, Inc. is engaged in the manufacture, marketing anddistribution of a diverse line of brand name candies, cookies, chocolates andgifts. The Company manufactures jelly beans, lollipops, biscuits and soft andhard candies and assembles seasonal gift items including gift baskets forChristmas and Easter. The Company’s principal branded products are COWS(TM)butter toffee candies, DEMITASSE(R) biscuits, RUGER(R) wafers, SMILE POPS(R)lollipops, STRIP-O-POPS(R) lollipops and ELANA(R) Belgian chocolates. TheCompany also markets SOUR FRUIT BURST(TM) fruit-filled hard candies, as well asholiday specialty products, such as PIRATE’S GOLD COINS(R) milk chocolates forChristmas and TOKENS OF LOVE(TM) milk chocolates for Valentine’s Day. TheCompany’s marketing strategy, including its packaging of products, is designedto maximize freshness, taste and visual appeal, and emphasizes highlydistinctive, premium quality products that are sold at prices that comparefavorably to those of competitive products. The Company believes that all ofits operations are part of the confectionery industry and it currently reportsas a single industry segment.

 

Sherwood Brands, Inc. has the following subsidiaries:

 

•                  SherwoodOverseas, Inc. was incorporated in July 1993 in the Bahamas to market anddistribute the Sherwood lines of confectionery products internationally.

 

•                  Sherwood Brandsof RI, Inc. was incorporated in September, 1998 in the state of Rhode Island.Sherwood Brands of RI, Inc. d/b/a E. Rosen Company manufactures hard candiesand jelly beans and assembles and markets gift items and baskets to chains suchas Wal-Mart, Kmart and CVS.

 

•                  SherwoodAcquisition Corporation was incorporated in April 2002 in the State ofWyoming. On May 1, 2002, Sherwood Acquisition merged with and into AsherCandy Acquisition Corporation, a Wyoming corporation, that manufactured candycanes and other hard candies under the “Asher” name. The surviving corporationof the merger was Asher Candy Acquisition Corporation, which changed its nameto Asher Candy, Inc., and is now a wholly-owned subsidiary of Sherwood Brands.The Company issued an aggregate of 270,559 shares of its Class A common stock,then valued at $1,675,000, to the shareholders of Asher Candy AcquisitionCorporation in consideration for the transaction, subject to claims forindemnification and adjustments based on a final audit. The Company also issuedwarrants exercisable for 38,652 shares of its Class A common stock, valued at$108,000.  The Company is currentlyengaged in litigation with the former shareholders of Asher Candy AcquisitionCorporation.

 

3. INTERIM FINANCIAL INFORMATION

 

The financialinformation as of April 30, 2003 and for the three and nine months endedApril 30, 2003 and 2002 is unaudited. In the opinion of management, suchinformation contains all adjustments, consisting only of normal recurringadjustments, necessary for a fair presentation of the results for such periodsexcept for the 

 

6

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$2,192,005 writedown ofobsolete inventory recognized in the quarter ended April 30, 2003. Resultsfor interim periods are not necessarily indicative of results to be expectedfor the fiscal year.

 

4. ACQUISITION

 

On May 1,2002, the Company acquired all of the outstanding common stock of Asher CandyAcquisition Corporation, a Wyoming corporation with operations located in NewHyde Park, New York, that manufactured candy canes and other hard candies underthe “Asher” name. The purchase price paid to the shareholders of Asher CandyAcquisition Corporation in consideration for the transaction was approximately$1,786,000, consisting of an aggregate of 270,559 shares of the Company’s ClassA common stock, then valued at $6.20 per share, or $1,675,000, subject toclaims for indemnification, and warrants exercisable for 38,652 shares ofSherwood Brands Class A common stock, which warrants were valued at $108,000.The Company valued the common shares at the closing market price onApril 30, 2002 and valued the warrants using the Black-Scholes optionspricing method.  Under the terms of themerger agreement, for a period of 30 days commencing on April 25, 2003,the Asher shareholders had the right to sell to the Company one-half of theshares issued to them at a price of $4.50 per share.    During the quarter ended April 30, 2003, the Ashershareholders notified the Company of their exercise of the put right.  However, because the Company has commencedlitigation against the Asher shareholders alleging fraud, calling into questionthe validity of the put right and seeking damages, the Company determined notto give effect to the put right unless and until the matter is judiciallyresolved. The Company seeks declaratory and injunctive relief and award ofdamages against the prior shareholders for violations of the Merger Agreementand for common law fraud and violations of applicable securities laws.  Certain of the Shareholders have filed acounterclaim seeking $7.0 million in damages. The Company believes that it has defenses to the counterclaim.

 

The followingproforma information sets forth the consolidated results of operations for thethree and nine months ended April 30, 2002, as though the acquisition hadbeen completed on August 1, 2001. The pro forma information for the three months ended April 30, 2002is the same as the Company’s reported results, since Asher’s entire businessrelates to manufacturing of Christmas seasonal items.

 

|                               |   | **Three  Months Ended  April 30, 2002** |       | **Nine  Months Ended  April 30, 2002** |   |
|------------------------------------|--------|----------------------------------------------|------------|---------------------------------------------|--------|
| Net sales                          |   | $                                            | 11,312,184 |                                        | $      | 58,005,438 |   |
| Income (loss) before provision for |   | (1,491,287                                   | )          | 3,797,051                                   |   |
| income taxes                       |   |                                         |       |                                        |   |
| Net (loss) income                  |   | (1,269,755                                   | )          | 2,318,664                                   |   |
| Earnings per share—basic      |   | $                                            | (0.34      | )                                           | $      | 0.58 |   |
| Earnings per share—diluted    |   | $                                            | (0.34      | )                                           | $      | 0.55 |   |

 

5. INVENTORY

 

Inventoryconsists of raw materials, packaging materials; components used in assembly,work-in-process and finished goods and are stated at the lower of cost ormarket. Cost is determined by the FIFO (first-in, first-out) method.

 

Inventoryconsists of the following:

 
|                                 |   | **APRIL 30  2003** |       | **JULY 31  2002** |   |
|--------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                 |   | **(UNAUDITED)**         |       | **(AUDITED)**          |   |
|                                 |   |                    |       |                   |   |
| Raw materials and ingredients        |   | $                       | 582,286    |                   | $      | 868,319 |   |
| Components used in assembly          |   | 1,160,692               |       | 1,200,576              |   |
| Packaging materials                  |   | 2,200,744               |       | 2,850,910              |   |
| Work-in-process                      |   | 599,398                 |       | 667,697                |   |
| Finished product                     |   | 6,744,528               |       | 11,069,470             |   |
|                                 |   | 11,287,648              |       | 16,656,972             |   |
| Less reserve for inventory allowance |   | (321,390                | )          | (700,827               | )      |
|                                 |   | $                       | 10,966,258 |                   | $      | 15,956,145 |   |

 

7

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During the quarter ended April30, 2003, the Company wrote down $1.2 million of packaging materials andinventory resulting from product lines that will no longer be manufactured atthe Company’s Chase City facility and $1.0 million of hard candy product linesthat will no longer be produced at the Chase City, Virginia facility.  These product lines will be manufactured bythe Company’s overseas third party suppliers.

 

6. USE OF ESTIMATES

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosures ofcontingent assets and liabilities at the date of the financial statements andreported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates.

 

7. INCOME TAXES

 

The Companyreversed the provision for income taxes of $370,637 recorded in the firstquarter since it will generate a net loss for fiscal year 2003.  In addition, the Company recognized an$544,000 income tax benefit for the carryback of the net operating loss torecover income taxes previously paid.

 

8. EARNINGS PER SHARE

 

Earnings pershare are based on weighted average number of shares of common stock anddilutive common stock equivalents outstanding. Basic earnings per shareincludes no dilution and is computed by dividing income available to commonshareholders by the weighted average number of common shares outstanding forthe period. Diluted earnings per share reflects the potential dilution ofsecurities that could share in the earnings of an entity. The following tablepresents a reconciliation between the weighted average shares outstanding forbasic and diluted earnings per share for the three and nine months ended April30, 2003 and April 30, 2002

 
| **For the three months  ended April 30,  2003** |   | **Loss** |       | **Shares** |            | **Per Share  Amount** |   |
|-------------------------------------------------|--------|----------|------------|------------|-----------------|-----------------------|--------|
|                                            |   |     |       |       |            |                  |   |
| Basic Earnings per Share                        |   |     |       |       |            |                  |   |
| Income (loss) available to common  shareholders |   | $        | (2,750,026 | )     | 4,001,454  |                  | $      | (0.69 | ) |
| Effect of dilutive stock options                |   |     |       | —     |            |                  |   |
| Dilutive earnings per share                     |   | $        | (2,750,026 | )     | 4,001,454       |                  | $      | (0.69 | ) |

 
| **For the three months  ended April 30,  2002** |   | **Loss** |     | **Shares** |      | **Per Share  Amount** |   |
|-------------------------------------------------|--------|----------|----------|------------|-----------|-----------------------|--------|
|                                            |   |     |     |       |      |                  |   |
| Basic Earnings per Share                        |   |     |     |       |      |                  |   |
| Income (loss) available to common  shareholders |   | $        | (693,505 | )          | 3,716,250 |                  | $      | (0.19 | ) |
| Effect of dilutive stock options                |   |     |     | —     |      |                  |   |
| Dilutive earnings per share                     |   | $        | (693,505 | )          | 3,716,250 |                  | $      | (0.19 | ) |

 
| **For the three months  ended April 30,  2002** |   | **Loss** |       | **Shares** |      | **Per Share  Amount** |   |
|-------------------------------------------------|--------|----------|------------|------------|-----------|-----------------------|--------|
|                                            |   |     |       |       |      |                  |   |
| Basic Earnings per Share                        |   |     |       |       |      |                  |   |
| Income (loss) available to common  shareholders |   | $        | (2,118,941 | )          | 3,993,756 |                  | $      | (0.53 | ) |
| Effect of dilutive stock options                |   |     |       | —     |      |                  |   |
| Dilutive earnings per share                     |   | $        | (2,118,941 | )          | 3,993,756 |                  | $      | (0.53 | ) |

 

8

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| **For the three months  ended April 30,  2002** |   | **Loss** |      | **Shares** |      | **Per Share  Amount** |   |
|-------------------------------------------------|--------|----------|-----------|------------|-----------|-----------------------|--------|
|                                            |   |     |      |       |      |                  |   |
| Basic Earnings per Share                        |   |     |      |       |      |                  |   |
| Income available to common shareholders         |   | $        | 1,646,205 |       | 3,707,143 |                  | $      | 0.44 |   |
| Effect of dilutive stock options                |   |     |      | 536,179    |      |                  |   |
| Dilutive earnings per share                     |   | $        | 1,646,205 |       | 4,243,322 |                  | $      | 0.39 |   |

 

9. CONTINGENCY

 

The Companyis, from time to time, involved in litigation incidental to the conduct of itsbusiness. The Company is currently involved in several actions.  In particular, the Company’s landlord at itsRhode Island facility has named the Company as a defendant in an action seekingsecurity for claims relating to the lease agreement. The Company deposited$180,000 with the registry of the court relating to claims for payment of realestate taxes, water and sewer, rent of other occupied space and repairexpenses. In September 2002, the landlord claimed other breaches of the leaseagreement, alleging an obligation of $932,000 under the lease and demanded$750,000 to settle the disputes. The Company has claims against the landlord itis pursuing and continues to occupy space at the leased premises. The Companyhas accrued amounts to cover current charges. Management does not believe thatthe outcome of these actions, individually or in the aggregate, will have amaterial adverse effect on the financial condition of the Company.

 

The Company iscurrently involved as Plaintiff in a suit brought before the Circuit Court forMontgomery County, Maryland, presenting claims in connection with the mergeragreement under which Sherwood Brands acquired securities of Asher CandyAcquisition Corporation and agreed to sell securities in Sherwood Brands toprior shareholders of Asher Candy.  Thecomplaint alleges that the Company was fraudulently induced to enter into themerger agreement on the basis of, among other things, material misrepresentationsand omissions by the shareholders of Asher Candy.   Sherwood Brands seeks declaratory and injunctive relief andaward of damages against the former shareholders of Asher Candy for violationsof the merger agreement and for common law fraud and violations of applicablesecurities laws.  Pending resolution ofthe litigation, the Company has refused to honor the demand of the formershareholders for the Company to repurchase half of the shares issued to them ata price of $4.50 per share. Certain of the shareholders have filed acounterclaim seeking $7.0 million in damages. The Company believes that it has defenses to the counterclaim.

 

10. LICENSING AGREEMENTS

 

During thequarter ended April 30, 2003, the Company entered into a two year licenseagreement to incorporate products into gift sets and a license agreement tomanufacture candy canes using a licensed brand name. Under this agreement, theCompany pays a royalty of 12% of net sales . The products will be incorporated into the Company’s gift set itemsduring the Christmas and Easter holiday seasons but the agreement is effectiveas of January 2003. The Company paid $35,000 as an advance fee for the license,which is to be offset against any royalties due. The Company incurred $890 inroyalties during the quarter ended April 30, 2003 and $244,654 during the ninemonths ended April 30, 2003 under this and other license agreements. TheCompany is currently pursuing other licenses with similar terms and conditions.

 

11. CREDIT FACILITY

 

During the quarterended April 30, 2003, the Company was in violation of  certain business and financial covenants under its creditfacility relating to the fixed charge coverage ratio and tangible net worth.  As of the filing date of this quarterlyreport, the Company was still in violation of those financial covenants. TheCompany is seeking to amend the credit agreement.  The Company has been in discussions with the bank regarding theamendment of the credit agreement and the modification of some of the financialcovenants to help ensure the Company’s compliance with those covenants on agoing forward basis. The Company believes that the bank will agree to thechanges.

 

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During thequarter ended April 30, 2003, the Company entered into a third  amendment and modification to its Loan andSecurity Agreement allowing for a short term permitted out of formula advanceof $300,000 through May 31, 2003.  Theshort term loan was fully paid during the fourth quarter ending July 31, 2003.

 

The Company is currentlyseeking to obtain third party financing for short-term unsecured orsubordinated debt to fund the Company’s immediate cash needs during the fourthquarter ending July 31, 2003 and part of first quarter ending October 31, 2003.The Company is close to over advance financing from a source other than thebank for its out of formula advances. The new financing will provide net cash to the Company in an amountequal to $2,000,000 and an additional $1,000,000 provided from the bank.  All the proceeds of the new financing shallbe used by the Company for working capital and or to pay a portion of theoutstanding revolving loans.  The newfinancing shall be secured by assets of the Company and the party extending thenew financing will enter into a letter agreement regarding the subordination ofthe new financing only to the bank, but shall be prior to all other debts ofthe Company’s right of the shareholders. The new financing will be in form andcontent as shall be satisfactory to the bank.

 

The additional $3,000,000 willprovide cash needs during the fourth quarter ending July 31, 2003 and part ofthe first quarter ending October 31, 2003 and is expected to be fully paid offby December 31, 2003 or earlier at which time the Company will have excessavailability against its line of credit.

 

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Important Information RegardingForward-Looking Statements

 

This QuarterlyReport on Form 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. Those statements includestatements regarding the intent, belief or current expectations of the Companyand its management. These statements are subject to a variety of risks anduncertainties, many of which are beyond our control, which could cause actualresults to differ materially from those contemplated in such forward-lookingstatements, including in particular the risks and uncertainties described under“Risk Factors” in our amended Annual Report, on Form 10-K/A, filed with theCommission on December 20, 2002. Existing and prospective investors arecautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof. We undertake no obligation to update orrevise the information contained in this Quarterly Report on Form 10-Q, whetheras a result of new information, future events or circumstances or otherwise.

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of certain assets and liabilities at the dateof the financial statements. Significant estimates in our financial statementsinclude the accounts receivable and inventory reserves. We continually evaluatethese reserves based upon historical experience. Although actual results coulddiffer from those disclosed, management feels that the estimates used toestablish the reserves are conservative in nature. Furthermore, managementbelieves that it would be unlikely that the reserve level would be materiallydifferent from any other independently prudently established reserve.

 

On May 1,2002, we acquired all of the outstanding common stock of Asher CandyAcquisition Corporation, a Wyoming corporation with operations located in NewHyde Park, New York, that manufactured candy canes and other hard candies underthe “Asher” name. The purchase price paid to the shareholders of Asher CandyAcquisition Corporation in consideration for the transaction was approximately$1,786,000, consisting of an aggregate of 270,559 shares of our Class A commonstock valued at $6.20 per share, or $1,675,000, subject to claims forindemnification, and warrants exercisable for 38,652 shares of our Class Acommon stock, which warrants were valued at $108,000. We valued the commonshares at the closing market price on April 30, 2002 and valued the warrantsusing the Black-Scholes options pricing method.  Under the terms of the merger agreement, for a period of 30 dayscommencing on April 25, 2003, the Asher Candy shareholders had the right tosell to us one-half of the shares issued to them at a price of $4.50 pershare.  During the quarter ended April30, 2003, the Asher Candy shareholders notified us of their exercise of the putright.  However we are  currently involved as Plaintiff in a suitbrought before the Circuit Court for Montgomery County, Maryland, presentingclaims in connection with the  mergeragreement under which we acquired securities of Asher Candy AcquisitionCorporation and agreed to sell securities in Sherwood Brands to the formershareholders of Asher Candy in reasonable reliance on shareholders materialmisrepresentations and omissions.   Weare seeking declaratory and injunctive relief and award of damages against theformer shareholders of Asher Candy for violations of the merger agreement andfor common law fraud and violations of applicable securities  laws. Pending resolution of the litigation, we have refused to honor thedemand of the former shareholders for us to repurchase half of the shares issuedto them at a price of $4.50 per share. Some of the former Asher Candyshareholders have filed a counterclaim seeking $7.0 million in damages.  We believe that we have defenses to thecounterclaim. During the quarter ended April 30, 2003, we included theoperating results of Asher Candy in our consolidated results. Asher Candygenerated $0.00 net sales during the quarter ended April 30, 2003 and $9.8million of net sales for the nine months ended April 30, 2003.

 

During thetwenty two months ended April 30, 2003, we entered into fourteen licensingagreements to incorporate our products into gift sets and to manufacturecandies and wafers under license from the trademark holders. The royalty ratesfor these licenses range from 2% to 12% of net sales and are for terms of twoto three years. The products to be incorporated into our gift set items areprimarily for the Christmas and Easter selling seasons. We also entered into anagreement to produce everyday candies and wafers under license from thetrademark holder. We paid $230,000 in advance fees for the rights under thelicensing agreements which may be offset

 

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against any royalties due.During the quarter and nine months ended April 30, 2003, we incurred $890 and$244,654, respectively, of royalty expense. We are currently pursuing otherlicenses with similar terms and conditions. We expect to generate sales fromthe license agreements in the fiscal year ending July 31, 2003, but hope thatthe greatest impact will occur beginning in the fiscal year ending July 31,2004.

 

On May 31,2002, we closed our Rhode Island manufacturing facility, which occupied fivestories in an old building. All the production equipment, together with theelectrical, piping, steam and air-conditioning, were disassembled andtransferred to our expanded Chase City, Virginia facility. The Chase Cityfacility occupies 65,000 square feet, including 25,000 square feet of newlyconstructed space. We also maintain a 73,000 square foot facility at Keysville,Virginia (about 20 miles from Chase City, Virginia). We expected to operatethese facilities as a single manufacturing and distribution facility under oneplant management for all products produced at the Chase City facility. Because ofthe Chase City manufacturing facility inefficiencies and production levels running at 45% on a daily basis ,the transition period resulted in decreased sales for seasonal merchandise forthe three months and nine months ended April 30, 2003.  The impact of this transition  resulted in approximately $1.8 million ofpre-production costs, or 4% of net sales and resulted in a write down ofimpaired film and packaging inventory of approximately $2.2 million or 4.6% of netsales. The inventory write-down was a direct result of our decision in thethird quarter to shift certain production to our overseas third partymanufacturing suppliers. We have reduced our work force from 280 employees to68 at the Chase City facility, and are currently in the process of moving hardcandy production to our third party manufacturing suppliers overseas. Weanticipate that additional expenses may arise due to movement from Chase Cityto our overseas suppliers.

 

Our Christmas and Easter giftsets and gift baskets are distributed from our Rhode Island and Massachusettsfacilities. We source product primarily from the Pacific Rim. We arecontinually looking to further reduce costs through more efficientsourcing.  We are currently shifting assemblyand manufacturing to China and South America as a way to reduce overallassembly and manufacturing costs and improve gross margins.

 

We did not exercise the optionson our office and assembly facility in Rhode Island and plan to vacate thelocation on March 31, 2004.  After March31, 2004, our New Bedford, Massachusetts facility together with a planned WestCoast facility will be utilized to improve our shipping costs and assembly ofour products.

 

Factors Affecting Performancein the Quarter Ended April 30, 2003.

 

On September30, 2002, 29 west coast sea ports were shut down and remained closed ascontract negotiations between dockworkers and shipping companies broke offnegotiations for new contracts. The shutdown occurred during our peak inventoryshipping period for orders for the holiday season. In mid-October 2002, thePresident of the United States signed an order under the Taft-Hartley Act toreopen the sea ports and put a moratorium on the strike for 60 days. Theshutdown affected our first quarter shipments to customers. A large amount ofour inventory containers, which were to be received by our customers, remainedeither at sea ports or on shipping vessels. In addition, empty containers,which we needed to move other inventory, were not brought back to ports in thePacific Rim. In mid-October 2002, our inventory began to be released forshipment to our facility in New Bedford, Massachusetts. A slowdown by thelongshoremen involved in shipping inventory was still prevalent. Our firstquarter revenues were impacted by the shut down and resulted in a delay ofapproximately $6.0 million in sales. Approximately $3.5 million was shipped out during the second quarter andapproximately $2.5 million of the remaining inventory will be shipped during thefirst and second quarter of fiscal year 2004.

 

Results of Operations

 

Three Months Ended April 30,2003 and 2002

 

Net sales for the three monthsended April 30, 2003 and 2002 were $9,482,412 and $11,312,184, respectively.Net sales decreased 16.2% due to decreased sales of manufactured hard candy ofapproximately $1.3 million and decreased sales of manufactured soft candy of$0.5 million for the Valentine’s Day and Easter seasons. The decrease wasprimarily the result of production through put and quality inefficiencies atour Chase City, Virginia manufacturing facility, which prevented us fromfilling orders. Sam’s Club, Wal-Mart and Kmart accounted for approximately 23%,21% and 9% of sales during the three months ended April 30, 2003, respectively,and

 

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Wal-Mart, Kmart and Sam’s Club accounted for approximately 32%, 18% and9% of the sales for the prior year’s comparable period, respectively.  The reduction in sales to Sam’s Club andWal-mart was a result of sales in the prior years of specialty gift items aspart of their Easter seasonal items, including shadow boxes, steamer trunks and leather clocks, which were aone time order in fiscal year 2002.

 

Gross profit (loss) for the three months ended April 30, 2003 and 2002were ($629,368) and $2,248,762, respectively. During the three months ended April 30, 2003, gross margins decreased to(6.6%) as percent of net sales from 19.9% during the prior year’s comparableperiod. The decrease in earnings was largely attributable to the production throughput and quality inefficiencies at our manufacturing facility in Chase City,Virginia.  The facility’s operationswere running at a 45% production level during the three months ended April 30,2003.  The decrease in the productionlevels created unfavorable labor costs and material variances in packaging andraw materials which resulted in $0.6 million loss, which was expensed in thecurrent period.  This reduced our grossmargins for the three months ended April 30, 2003 by 6.3%. The inefficiency anddecreased production levels at the facility represented approximately 7.4% ofthe gross margin decrease as a percent of net sales during the quarter endedApril 30, 2003. Write down of inventory of $2,192,005, or 23.1% for the threemonths ended April 30, 2003, resulted from impaired film and packaging materials at our Chase City, Virginiafacility for product lines that will be no longer manufactured at the plant.These lines will be purchased from overseas suppliers which we currentlypurchase from.  We may incur additionalexpenses in the fourth quarter as we reduce and reorganize the plant’soperations.

 

During the three months ended April 30, 2003 and 2002, selling, generaland administrative expenses increased to $1,632,931 from $1,588,005,respectively, and increased to 17.2% from 14.0% as a percent of sales,respectively. The increase as a percent of sales was largely due to a $90,000increase in broker commissions and $47,000 in shipping violations resultingfrom not meeting shipping dates for our customers, and was partially offset bya $92,000 reduction in legal expense.

 

Pre-production costs increased to $405,838 during the three monthsended April 30, 2003 from $393,918 during the three months ended April 30,2003, or 3% as a result of increased training costs and inefficiencies at ourChase City, Virginia facility.  Weanticipate incurring additional costs associated with the Chase City, Virginiafacility in the fourth quarter as we reduce and reorganize the plant’soperations.

 

During the three months ended April 30, 2003 and 2002, salaries andrelated expenses increased to $1,249,423 from $1,102,277, respectively, andincreased to 13.2% from 9.7% as a percent of sales, respectively. This increasewas mainly attributable to  an increaseof $8,000 in contract labor associated with the design and artwork for our 2004Christmas seasonal items, a $12,000 increase resulting from the hiring ofadditional staff in our sales and marketing department, an additional $50,000of workmen’s comp insurance premiums charged to corporate overhead and anadditional $77,000 of health insurance costs.

 

Operating expenses increased to $3,288,192 for the three months endedApril 30, 2003 from $3,084,200 for the three months ended April 30, 2002, anincrease of 6.6% as a percent of sales. The increase as a percentage of saleswas largely due to increased pre-production costs of $406,000 associated withthe Chase City, Virginia facility compared to $394,000 in the prior period,$47,000 in shipping violations resulting from our inability to meet shippingdates for our customers and additional brokers commissions of $90,000,which  was partially offset by a $92,000reduction in legal expenses, an increase in contract labor of $8,000 andadditional overall labor cost of $139,000.

 

Loss from operations for the three months ended April 30, 2003 was($3,917,560), as compared to ($835,438) for the prior year’s comparable period.The increase was primarily the result of the production inefficiencies at ourChase City, Virginia facility, a $600,000 increase in our raw materials andpackaging costs, and an increase of $406,000 in pre-production costs. Weincurred approximately $2.2 million relating to a write down of film andpackaging materials that had become impaired due to the transfer of productproduction to our third party overseas suppliers and a reduction of productlines manufactured at our Chase City, Virginia facility.

 

Interest income decreased to $116 during the three months ended April30, 2003 from $460 during the three months ended April 30, 2002. Interestexpense increased to $126,893 during the three months ended April 30, 2003 from$114,194 during the three

 

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months ended April 30, 2002. Although we had lower interest rates on our working capital line andterm facilities, the increase is due to term debt assumed in connection withthe merger with Asher Candy, which was $1.3 million on May 1, 2002. Otherincome (expense) increased to $379,673 during the three months ended April 30,2003 from $35,595 during the three months ended April 30,2002 due to a $580,000settlement on a trade infringement claim partially offset by $149,000 of legalcosts associated with the settlement, and $87,000 realized losses on foreignexchange transaction.

 

We reversed the provision for income taxes of $370,637 recorded infirst quarter since we will generate a net loss for fiscal year 2003.  In addition, we recognized an $544,000income tax benefit for the carryback of the net operating loss to recoverincome taxes previously paid.

 

As a result of the foregoing, we incurred a net loss of ($2,750,026)for the three months ended April 30, 2003, compared to net loss of ($693,505)for the prior year’s comparable period, or (29.0%) compared to (6.1)% aspercent of sales.

 

Nine months ended April 30, 2003 and 2002

 

Net sales for the nine months ended April 30, 2003 and 2002 were$47,335,225 and $48,290,502 respectively. Net sales decreased 1.98%, primarilydue to decreased sales of manufactured hard and soft candy for the Valentineand Easter seasons of $2.0 million, which was offset by increased sales of $1.0million of our gift baskets. Sam’s Club, Big Lots and Wal-Mart accounted forapproximately 16%, 10.3% and 10% of sales, respectively during the nine monthsended April 30, 2003, and Sam’s Club, Wal-Mart and Big Lots accounted for theperiod approximately 36%, 15% and 9% of sales, respectively, for the prioryear’s comparable period. The reduction in sales to Sam’s Club and Wal-mart wasa result of sales of specialty gift items as part of their Easter seasonalitems,  including shadow boxes, steamertrunks and leather clocks, which were a one time order in fiscal year 2002.

 

For the nine months ended April 30, 2003 and 2002, gross marginsdecreased to $9,924,403 from $13,887,991, respectively, and decreased to 20.9%and 28.8% as percent of sales, respectively. The decrease in margins wasattributable to the low efficiency levels at our Chase City, Virginia facility.  The facility ran at a 38% production levelduring the nine months ended April 30, 2003. The decrease in the production levels created unfavorable labor cots andmaterial variances in packaging and raw materials of approximately $2.2million, or a 4.6% effect to the gross margins for the nine month period endedApril 30, 2003. We have expensed these unfavorable variance as incurred. Weincurred $515,000 of additional freight and duty costs associated with the westcoast dockworkers strike.  The inefficiencyand decreased production levels at the facility and the additional freight andduty costs incurred due to the dockworkers strike amounted to approximately5.7% of the decrease as a percent of sales during the nine months ended April30, 2003. Write down of inventory of $2,192,005, or 4.6%% for the nine monthsended April 30, 2003,  resulted from awrite down of film and packaging materials that became impaired due to thetransfer of product production to our third party overseas suppliers and reductionof product lines manufactured at our Chase City, Virginia facility.

 

We may incur additional expenses in the fourth quarter as we continueto reorganize the plant’s operations.

 

During the nine months ended April 30, 2003 and 2002, selling, generaland administrative expenses increased to $6,945,440 from $6,592,152,respectively, and increased to 14.7% from 13.7% as a percent of sales,respectively. The increase as a percent of sales was largely due to $174,000 intravel expenses, of which approximately $85,000 was for trips to China, $47,00of shipping violation fees resulting from our inability to meeting shippingdates for our customers , $23,000 in building rental costs, $77,000 inaccounting and auditing fees, $32,000 in shipping and carrier cost associatedwith samples, and  $149,000 of warehousetransfer costs, which was partially offset by a decrease of $159,000 of brokerscommissions.

 

Pre-productions costs increased to $1,790,214 during the nine monthsended April 30, 2003 compared to $393,918 from prior year’s comparable period,or increase to 3.8% from 0.8% as percent of sales, respectively, as a result ofthe training required for, and decreased production levels experienced at ourChase City, Virginia facility.

 

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During the nine months ended April 30, 2003, salaries and relatedexpenses decreased to $3,707,832 from $3,777,329 during the nine months endedApril 30, 2002, or 7.8% from 7.8%, respectively, as a percent of sales. Thisdecrease was mainly attributable to a $70,000 decrease in personnel andcorporate overhead.

 

As a result, operating expenses for the nine months ended April 30,2003 increased to $12,443,486 from $10,763,399 for the nine months ended April30, 2002 and increased to 26.3% from 22.3%, respectively, as a percent ofsales. The increase as a percentage of sales was largely due to increasedpre-production costs of $1,396,296 at the Chase City, Virginia facility.  The increase was partially  offset by a $159,000 decrease in brokerscommissions, $215,000 in warehouse transfer costs  and $174,000 of additional travel costs, of which $85,000resulted from trips to China. We incurred $47,000 of shipping violation feesresulting from not meeting shipping dates for our customers , $24,000associated with D&O insurance premiums, $23,000 in building rental costs,$77,000 in accounting and auditing fees, $32,000 of shipping and carrier costsassociated with samples and a decrease of $149,000 in legal expensesattributable to the settlement of a trade infringement claim.

 

Loss from operations for the nine months ended April 30, 2003 was$2,519,083, as compared to income of $3,124,592 for the prior year’s comparableperiod. Most of the loss resulted from the write down of film and packagingmaterials that had become impaired due to production transferring to our thirdparty overseas suppliers and reduction of product lines manufactured at ourChase City, Virginia facility.

 

For the nine months ended April 30, 2003, interest income decreased to$2,608 from $4,340 for the nine months ended April 30, 2002. For the ninemonths ended April 30, 2003, interest expenses increased to $463,965 from$402,855 for the nine months ended April 30, 2002 due to an increase in ourterm debt financing of $1.3 million associated with the merger with AsherCandy.

 

For the nine months ended April 30, 2003, other income increased to$317,498 from $19,469 for the nine months ended April 30, 2002 due to $133,000realized losses on foreign exchange transactions, legal settlement on tradeinfringement of $580,000 offset by $149,000 in legal expenses associated withthe settlement.

 

We reversed the provision for income taxes of $370,637 recorded infirst quarter since we will generate a net loss for fiscal year 2003.  In addition, we recognized an $544,000 incometax benefit for the carryback of the net operating loss to recover income taxespreviously paid.

 

As a result of the foregoing, we incurred a net loss of ($2,118,941)for the nine months ended April 30, 2003, compared to net income of $1,646,205for the prior year’s comparable period, or a decrease of (4.5%) from 3.4% aspercent of sales. The decrease was primarily due to approximately $2.8 millionin production through put and quality inefficiency costs, write-down ofimpaired inventory of approximately $2.2 million at our manufacturing facilityin Chase City, Virginia, $515,000 of increased freight and duty costsassociated with the dockworkers strike and $174,000 of additional travel costs.The increase was partially offset by a $159,000 decrease in brokerscommissions, $215,000 warehouse transfer costs, $47,000 of shipping violationfees resulting from not meeting shipping dates for our customers , $24,000 inpremiums for D&O insurance, $23,000 in building rental costs, $77,000 inaccounting and auditing fees, $32,000 of shipping and carrier costs associatedwith samples, and a reduction of $430,000 attributable to a trade infringementsettlement.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary cash requirements have been to fund the purchase, manufactureand commercialization of our products. We finance our operations andmanufacturing with cash flow from operations and bank financing along withfavorable payment terms from some of our vendors. Our working capital at April30, 2003 and July 31, 2002 was $3,831,619 and $6,218,379, respectively.

 

Net cash provided in operating activities for the nine months endedApril 30, 2003 and 2002, was $940,124 and $1,850,972, respectively. Thedecrease in cash provided by operating activities was due primarily to increasesin  the net loss, other current assetsand accounts receivable, which were partially offset by a decrease in  accrued expenses, as well as decreases ininventory and accounts payable.

 

Net cash used in investing activities for the nine months ended April30, 2003 and 2002 decreased to $693,857 from $1,317,836, respectively,primarily due to the

 

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reduction in purchase of production equipment lines and capitalimprovements for our facility in Chase City, Virginia.

 

Net cash used by financing activities for the nine months ended April30, 2003 and 2002 was $899,125 and $287,739, respectively. This increase wasprimarily due to $996,391 pay-down on our credit facility, $279,819 pay-down onterm debt offset by proceeds of $350,000 on additional term debt. Theborrowings for the nine months ended April 30, 2003, was approximately$7,207,580 as compared to $3,511,648 for the prior years comparable period. Theincrease is mainly a result of our reliance on borrowings under our line ofcredit to finance working capital needs for seasonal purchases.  The impact of higher borrowings was offsetsomewhat by lower interest rates. We have $17,792,420 of our $25,000,000 lineof credit available to meet additional seasonal needs to purchase andmanufacture inventory subject to availability of accounts receivable andinventory.

 

During the quarter ended April 30, 2003, we were in violation of  some of the business and financial covenantsunder our credit facility relating to the fixed charge coverage ratio andtangible net worth.  As of the filingdate of this quarterly report, we are still violation of those covenants. Weare seeking to amend the credit agreement to modify the covenants and to helpensure our compliance going forward. The bank is currently working with us to  amend the credit agreement.

 

During the quarter ended April 30, 2003, we entered into a thirdamendment and modification to our loan and security agreement allowing for ashort term permitted out of formula advance of $300,000 through May 31,2003.  The permitted out of formulaadvance facility was paid in full during the fourth quarter ending July 31,2003.

 

We are currently seeking to obtain third party financing for short-termunsecured or subordinated debt for our immediate cash needs during the fourthquarter ending July 31, 2003 and part of first quarter ending October 31, 2003.We are in the process of finalizing the over advance financing from a sourceother than our bank for out of formula advances.  The new financing will provide us with net cash in an amountequal to $2,000,000 and an additional $1,000,000 provided from our bank .  We will use all the proceeds of the newfinancing for working capital and or to pay a portion of the outstandingrevolving loans.  The new financingshall be secured by our assets and the party extending the new financing willenter into a letter agreement regarding the subordination of the new financingonly to the bank, but shall be prior to all other debts of the right of ourshareholders. The new financing will be in form and content as shall besatisfactory to the bank.

 

The additional $3,000,000 will provide cash needs during the fourthquarter ending July 31, 2003 and part of the first quarter ending October 31,2003 and will be fully paid off by December 31, 2003 or earlier.  At which time we will have excessavailability against our line of credit .

 

Principal payments for our long-term debt for the twelve months endingApril 30, 2004 are $456,061. We believe that cash provided by operations willbe sufficient to finance our operations and fund debt service requirements forthe next twelve months.

 

Schedule of Contractual Obligations

 
|                         |   | **Payments  Due by Period** |      |
|------------------------------|--------|-----------------------------|-----------|
| **ContractualObligation**    |   | **Total**                   |      | **Less Than1 year** |   | **1-3 years** |   | **After 4 years** |   |
|                         |   |                        |      |   |   |   |   |   |   |
| Long-Term Debt               |   | $                           | 1,893,201 |   | $ | 212,312 |   | $ | 1,185,403 |   | $ | 495,486 |   |
| Capital Lease Obligation     |   | 443,395                     |      | 15,718 |   | 46,395 |   | 381,282 |   |
| Licensing Agreements         |   | 694,000                     |      | — |   | 694,000 |   | — |   |
| Operating Leases             |   | 965,687                     |      | 295,677 |   | 435,166 |   | 234,844 |   |
| Total Contractual Obligation |   | $                           | 3,996,283 |   | $ | 523,707 |   | $ | 2,360,964 |   | $ | 1,111,612 |   |

 

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Schedule of Commercial Commitments

 
|                         |   | **Amount of  Commitment expiration  per period** |       |
|------------------------------|--------|--------------------------------------------------|------------|
| **Commercial  Commitments**  |   | **Total**                                        |       | **Less  Than  1 year** |   | **1-3 years** |   | **After  4 years** |   |
|                         |   |                                             |       |   |   |   |   |   |   |
| Line of Credit (*)           |   | $                                                | 25,000,000 |   | — |   | $ | 25,000,000 |   | — |   |
| Total Contractual Obligation |   | $                                                | 25,000,000 |   | — |   | $ | 25,000,000 |   | — |   |

 

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(*)    The line of credit is available for advancesto finance working capital and the issuance of letter of credits. Advancesunder the line of credit are based on a borrowing formula equal to 85% ofeligible domestic accounts receivable plus 60% of eligible finished goods and30% of eligible components inventory. The line of credit varies from quarter toquarter based on working capital needs and pay-downs.

 

INFLATION

 

We do notbelieve that inflation has had a significant impact on our results ofoperations for the periods presented.

 

Item 3.             Quantitative and Qualitative DisclosuresAbout Market Risk

 

As a result ofour variable rate line of credit, we are exposed to the risk of rising interestrates. Our $25,000,000 line of credit had an interest rate ranging from 4.06%to 3.69% for the three months ended April 30, 2003 and 4.7% to 3.69% for thenine months ended April 30, 2003. Our long-term debt is at variable markettax-exempt rates, which exposes us to fluctuations in the market. However,since the rate is based on the tax-exempt rate, it is below the market rate.

 

We previouslyutilized derivative instruments, from time to time, foreign currency forwardcontracts and currency exchange rate contracts to hedge our market price riskexposures. Foreign currency contracts were executed for periods consistent withrelated underlying exposures and do not constitute positions independent ofthose exposures. We do not hold or issue derivative instruments for tradingpurposes and are not a party to any instruments with leverage or prepayment features.In entering into these contracts, we have assumed risk which might arise frompossible inability of counter-parties to meet the terms of their contracts. Forthe quarter ended April 30, 2003, we incurred losses of $58,000 on foreignexchange transactions. For the nine months ended April 30, 2003 we incurredlosses of $178,000 on foreign exchange transactions.

 

Periodicallywe enter into foreign exchange forward contracts to hedge transactionsprimarily related to firm commitments to purchase our contract manufacturedproducts from foreign manufactures under terms that provide for payment ofgoods in foreign currency approximately 60 to 90 days from invoice date.Purchases of COWS butter toffee candies and other candies from manufacturerslocated in Argentina are paid in U.S. Dollars. Purchases of RUGER wafers, ELANABelgian chocolate products and Zed Gum Specialty Gum products are purchasedfrom manufacturers located in Austria, Belgium and Ireland respectively, andare paid for in Euros.

 

We follow theguidance in SFAS 133 and account for these contracts as cash flow hedges. Asof  April 30, 2003, we had no foreignexchange contracts.  We recognizedrealized losses of approximately $31,000 related to these derivativeinstruments in fiscal 2003.

 

Significant Accounting Policies and Estimates

 

Ourpreparation of financial statements in conformity with accounting principalsgenerally accepted within the United States requires management to makeestimates and assumptions in certain circumstances that effect amounts reportedin the accompanying financial statements and related notes. In preparing thesefinancial statements, management has made its best estimates and judgments ofcertain amounts included in the financial statements, giving due considerationto materiality. We do not believe there is a great likelihood that materiallydifferent amounts would be

 

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reported related to theaccounting policies described below; however, application of these accountingpolicies involves the exercise of judgment and the use of assumptions as tofuture uncertainties and, as a result, actual results could differ from theseestimates.

 

We provide anallowance for uncollectible accounts receivable based on experience. We considerthe following factors in developing an estimate of our allowance fornon-payment and the overall economic environment. Although it is reasonablypossible that management’s estimate of uncollectible accounts could change inthe near future, management is not aware of any events that would result in achange to its estimates which would be material to our financial position orresults from operations. For the nine months ended April 30, 2003, we had anallowance for doubtful accounts of approximately $273,000.

 

We provide anallowance for slow moving inventory based on experience and aging of products.We consider the following factors in developing an estimate of our allowancefor non-moving of inventory and the overall economic environment. Although itis reasonably possible that management’s estimate of slow moving inventorycould change in the near future, management is not aware of any events thatwould result in change to its estimates which would be material to ourfinancial position or results from operations. For the nine months ended April30, 2003, we had an allowance for slow moving inventory of approximately$321,000.  During the quarter endedApril 30, 2003, we wrote-down impaired packaging and film inventory ofapproximately $2.2 million, this was in part due to the impaired inventory ofwhich the product lines will be shifted to overseas manufacturers.

 

Goodwillrepresents the excess of consideration over the net assets acquired resultingfrom acquisitions of companies accounted for by the purchase method. We utilizethe annual evaluation as required by SFAS 142. At each balance sheet date,management evaluates the recoverability of the goodwill and reviews goodwilland other long-lived assets for impairment. We will complete our impairmentevaluations with the aid of an independent valuation group, in the fourthquarter.

 

Seasonality and Cylicality; Fluctuation in Quarterly Operating Results

 

We haveexperienced and expect to continue to experience variability in revenues andnet income from quarter to quarter as a result of seasonality that mayaccompany private or public sector budget cycles. Sales of our products havehistorically been higher in the first and second quarters as a result ofpatterns of spending by our customers.

 

We also believethat the confectionery industry is influenced by general economic conditionsand particularly by the level of change in the economy. Increased levels ofconsumer spending change can have a favorable impact on our revenues. We alsobelieve that the confectionery industry tends to experience periods of declineand recession during economic downturns. The confectionery industry couldsustain periods of decline in revenues in the future, and any decline may havea material adverse effect on us.

 

We could inthe future experience quarterly fluctuations in operating results due to thefactors described above and other factors, including short-term nature ofcertain customer commitments; patterns of capital spending by customers; lossof a major customer; seasonality that may accompany private or public budgetcycles; pricing changes in response to various competitive factors; marketfactors affecting availability of qualified personnel and general economicconditions.

 

Item 4.             Controls and Procedures

 

Based on theirevaluation, as of a date within 90 days of the filing date of this form 10-Q,our Chief Executive Officer and Chief Financial Officer have concluded that ourdisclosure c and procedures (as defined in Rules 13a-14(c) and 15d-14(c)

 

under the SecuritiesExchange Act of 1934, as amended) are effective. There have been no significantchanges in internal controls or in other factors that could significantlyaffect these controls subsequent to the date of their evaluation.

 

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PART II                OTHER INFORMATION

 

Item 1.             Legal Proceedings

 

We are from time to time involved in litigation incidental to theconduct of our business. We are currently involved in several actions. Inparticular, the landlord at our Rhode Island facility has named us as adefendant in an action seeking security for claims relating to the leaseagreement. We deposited $180,000 with the registry of the court relating toclaims for payment of real estate taxes, water and sewer, rent of other occupiedspace and repair expenses. In September 2002, the landlord claimed otherbreaches of the lease agreement alleging an obligation of $932,000 under thelease and demanded $750,000 to settle the disputes. We have claims against thelandlord we are pursuing and continue to occupy space at the leased premises.We have accrued amounts to cover current charges. Management does not believethat the outcome of these actions, individually or in the aggregate, will havea material adverse effect on our financial condition .

 

On April 24, 2003, we filed a claim in the Circuit Court for MontgomeryCounty, Maryland, against Robert Davidoff, Howard Davidoff, James Spampinato,Leonard Levie, Elanor Levie, StepCapp LLC and CAMCO, Inc., the formershareholders of Asher Candy Acquisition Corporation. The suit presents claimsin connection with the corporate merger agreement under which we acquired alloutstanding securities of Asher Candy Acquisition Corporation and agreed tosell securities in Sherwood Brands to the former shareholders of Asher Candy inreasonable reliance on the shareholders’ material misrepresentations andomissions.   We are seeking declaratoryand injunctive relief and an award of damages against the former shareholdersof Asher Candy for violations of the Merger Agreement, for common law fraud andfor statutory securities claims.  Someof the former shareholders of Asher Candy filed a counterclaim seeking $7.0million in damages.  We believe that wehave  defenses to the counterclaim.

 

Item 4.             Submission of Matters to a Vote ofSecurity Holders

 

None

 

Item 6.             Exhibits and Reports on Form 8-K

 

(a)                        Exhibits

 

10.1                                          ThirdAmendment and Modification to Loan and Security Agreement dated April 7, 2003,between the Registrant and Wachovia Bank, National Association

 

(b)                       Reportson Form 8-K

 

None.

 

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**SIGN****ATURES**

 

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 theundersigned thereunto duly authorized.

 
|                      | SHERWOOD BRANDS, INC.                                       |
|---------------------------|-------------------------------------------------------------|
| Date:  June 13, 2003 |                                                        |
|                      | /s/ Uziel Frydman                                           |   |
|                      | Uziel Frydman, President and Chief Executive Officer        |
|                      |                                                        |
| Date:  June 13, 2003 |                                                        |
|                      | /s/ Christopher J. Willi                                    |   |
|                      | Christopher J. Willi, Chief Financial Officer and Secretary |

 

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**CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002**

 

I, UzielFrydman, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Sherwood Brands, Inc. (the“Registrant”);

 

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

 

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

 

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

 

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

 

(b)  evaluated the effectiveness of the Registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

(c)  presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.                                       TheRegistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the Registrant’s auditors and the audit committee ofRegistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)  all significant deficiencies in the design or operationof internal controls which could adversely affect the Registrant’s ability torecord, process, summarize and report financial data and have identified forthe Registrant’s auditors any material weaknesses in internal controls; and

 

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

 

6.                                       TheRegistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions with regardto significant deficiencies and material weaknesses.

 
| Date:  June 13, 2003 |                                            |
|---------------------------|-------------------------------------------------|
|                      |                                            |
|                      | /s/ Uziel Frydman                               |
|                      | Uziel Frydman                                   |
|                      | Chairman, President and Chief Executive Officer |

 

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**CERTIFICATIONPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002**

 

I, ChristopherJ. Willi, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Sherwood Brands, Inc. (the“Registrant”);

 

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

 

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

 

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

 

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

 

(b)  evaluated the effectiveness of the Registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

(c)  presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.                                       TheRegistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the Registrant’s auditors and the audit committee ofRegistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)  all significant deficiencies in the design or operationof internal controls which could adversely affect the Registrant’s ability torecord, process, summarize and report financial data and have identified forthe Registrant’s auditors any material weaknesses in internal controls; and

 

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

 

6.                                       TheRegistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  June 13, 2003 |                     |
|---------------------------|--------------------------|
|                      |                     |
|                      | /s/ Christopher J. Willi |
|                      | Christopher J. Willi     |
|                      | Chief Financial Officer  |

 

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**ExhibitIndex**

 
| **Exhibit No.** |   | **Description**                                                                                                          |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------|
| 99.1            |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |
|            |   |                                                                                                                     |
| 99.2            |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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