**FORM 10-Q**

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 
| **Quarterly  Report Pursuant to Section 13 or 15(d) of  the Securities and Exchange Act of 1934** |
|---------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended: 01/31/03**

 

**Commission 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 March 6, 2003 was 2,993,476. The number of sharesoutstanding of issuer’s Class B Common Stock, $.01 par value per share, asMarch 6, 2003 was 1,000,000. The Class B Common Stock is not publicly traded. 

 

Transitional Small Business Disclosure Format (check one):

Yes o   No ý

 

 

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SHERWOOD BRANDS, INC.

 

INDEX

 
| PART  I      FINANCIAL INFORMATION |
|-------------------------------------------------------------|
|                                                        |
| Item 1.                                                     | FINANCIAL STATEMENTS |
|                                                        |
|                                                        | Consolidated Balance Sheets - January 31, 2003 (unaudited) and July  31, 2002 |
|                                                        |   |   |   |
|                                                        | Consolidated Statements of Operations -  Three months and six months ended January 31, 2003 and 2002 (unaudited) |
|                                                        |   |   |   |
|                                                        | Consolidated Statements of Cash Flows - Six  months ended January 31, 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                                                  |   |
|                                                             |  |  |  |  |  |  |

 

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SHERWOOD BRANDS, INC. ANDSUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

Unaudited

 
|                                                                                                                         |   | **January 31, 2003** |   | **July 31, 2002** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|-------------------|--------|
|                                                                                                                         |   | **(unaudited)**      |   | **(audited)**     |   |
|                                                                                                                         |   |                 |   |              |   |
| Assets                                                                                                                       |   |                 |   |              |   |
| Current assets                                                                                                               |   |                 |   |              |   |
| Cash and cash  equivalents                                                                                                   |   | 228,683              |   | 709,247           |   |
| Accounts  receivable, less allowance of $284,000 and $189,000                                                                |   | 6,610,681            |   | 2,547,452         |   |
| Inventory                                                                                                                    |   | 15,979,694           |   | 15,956,145        |   |
| Income taxes  receivable                                                                                                     |   | 126,164              |   | 1,555,078         |   |
| Other current  assets                                                                                                        |   | 631,452              |   | 450,375           |   |
| Deferred taxes  on income                                                                                                    |   | 512,000              |   | 512,000           |   |
|                                                                                                                         |   |                 |   |              |   |
| Total Current  Assets                                                                                                        |   | 24,088,674           |   | 21,730,297        |   |
|                                                                                                                         |   |                 |   |              |   |
| Net property and  equipment                                                                                                  |   | 7,490,784            |   | 7,350,488         |   |
|                                                                                                                         |   |                 |   |              |   |
| Goodwill                                                                                                                     |   | 2,001,330            |   | 2,001,330         |   |
|                                                                                                                         |   |                 |   |              |   |
| Other assets                                                                                                                 |   | 414,938              |   | 308,839           |   |
|                                                                                                                         |   |                 |   |              |   |
| TOTAL ASSETS                                                                                                                 |   | 33,995,726           |   | 31,390,954        |   |
|                                                                                                                         |   |                 |   |              |   |
| Liabilities  and Stockholders’ Equity                                                                                   |   |                 |   |              |   |
| Current  liabilities                                                                                                         |   |                 |   |              |   |
| Line of credit                                                                                                               |   | 10,133,909           |   | 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                                                                                                             |   | 4,991,204            |   | 5,833,301         |   |
| Accrued expenses                                                                                                             |   | 2,016,653            |   | 1,368,928         |   |
| Income taxes  payable                                                                                                        |   | —               |   | —            |   |
|                                                                                                                         |   |                 |   |              |   |
| Total current  liabilities                                                                                                   |   | 17,638,595           |   | 15,511,918        |   |
|                                                                                                                         |   |                 |   |              |   |
| Deferred taxes  on income                                                                                                    |   | 331,000              |   | 331,000           |   |
| Long-term debt                                                                                                               |   | 1,534,291            |   | 1,722,000         |   |
| Obligations  under capital lease                                                                                             |   | 431,405              |   | 438,696           |   |
|                                                                                                                         |   |                 |   |              |   |
| TOTAL LIABILITIES                                                                                                            |   | 19,935,291           |   | 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, 2,993,476 and  1,150,000 shares issued and outstanding |   | 29,935               |   | 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                                                                                                  |   | 9,827,624            |   | 9,816,856         |   |
| Retained earnings                                                                                                            |   | 4,192,876            |   | 3,561,754         |   |
| Accumulated  other comprehensive income / (loss)                                                                             |   | —               |   | (31,139           | )      |
|                                                                                                                         |   |                 |   |              |   |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                             |   | 14,060,435           |   | 13,387,340        |   |
|                                                                                                                         |   |                 |   |              |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                             |   | 33,995,726           |   | 31,390,954        |   |

 

See accompanying summary ofaccounting policies and notes to consolidated financial statements.

 

1

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SHERWOOD BRANDS, INC. ANDSUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

 
|                                                          |   | **THREE MONTHS ENDED JANUARY 31,** |       | **SIX MONTHS ENDED JANUARY 31,** |   |
|---------------------------------------------------------------|--------|------------------------------------|------------|----------------------------------|--------|
|                                                          |   | **Unaudited**                      |       | **Unaudited**                    |   |
|                                                          |   | **2003**                           |       | **2002**                         |   | **2003** |   | **2002** |   |
|                                                          |   |                               |       |                             |   |   |   |   |   |
| Net sales                                                     |   | $                                  | 19,390,601 |                             | $      | 15,931,434 |   | $ | 37,852,813 |   | $ | 36,978,318 |   |
| Cost of sales                                                 |   | 14,343,300                         |       | 11,054,530                       |   | 27,299,042 |   | 25,339,089 |   |
| Gross profit                                                  |   | 5,047,301                          |       | 4,876,904                        |   | 10,553,771 |   | 11,639,229 |   |
|                                                          |   |                               |       |                             |   |   |   |   |   |
| Selling, general  and administrative expenses                 |   | 2,748,809                          |       | 2,548,744                        |   | 5,312,509 |   | 5,003,147 |   |
| Pre-Production  costs                                         |   | 880,440                            |       | —                           |   | 1,384,376 |   | — |   |
| Salaries and  related expenses                                |   | 1,283,401                          |       | 1,305,121                        |   | 2,458,409 |   | 2,675,052 |   |
| Total operating  expenses                                     |   | 4,912,650                          |       | 3,853,865                        |   | 9,155,294 |   | 7,678,199 |   |
| Income (loss)  from operations                                |   | 134,651                            |       | 1,023,039                        |   | 1,398,477 |   | 3,961,030 |   |
|                                                          |   |                               |       |                             |   |   |   |   |   |
| Other income  (expense)                                       |   |                               |       |                             |   |   |   |   |   |
| Interest income                                               |   | 233                                |       | 2,893                            |   | 2,492 |   | 3,880 |   |
| Interest expense                                              |   | (196,015                           | )          | (140,784                         | )      | (337,072 | ) | (288,661 | ) |
| Other (expense)  income                                       |   | (63,711                            | )          | 24,696                           |   | (62,175 | ) | (14,126 | ) |
| Total other  (expense) income                                 |   | (259,493                           | )          | (113,195                         | )      | (396,755 | ) | (298,907 | ) |
| (Loss) income  before provision (benefit) for taxes on income |   | (124,842                           | )          | 909,844                          |   | 1,001,722 |   | 3,662,123 |   |
| Provision  (benefit) for taxes on income                      |   | (46,977                            | )          | 298,354                          |   | 370,637 |   | 1,321,413 |   |
| Net (loss)  income                                            |   | $                                  | (77,865    | )                                | $      | 611,490 |   | $ | 631,085 |   | $ | 2,340,710 |   |
|                                                          |   |                               |       |                             |   |   |   |   |   |
| Net (loss)  income per share-basic                            |   | $                                  | (0.02      | )                                | $      | 0.17 |   | $ | 0.16 |   | $ | 0.63 |   |
| -diluted                                                      |   | (0.02                              | )          | 0.14                             |   | 0.15 |   | 0.53 |   |
|                                                          |   |                               |       |                             |   |   |   |   |   |
| Weighted average  shares outstanding                          |   |                               |       |                             |   |   |   |   |   |
| -basic                                                        |   | 3,993,476                          |       | 3,705,476                        |   | 3,993,476 |   | 3,702,738 |   |
| -diluted                                                      |   | 3,993,476                          |       | 4,433,723                        |   | 4,326,082 |   | 4,389,596 |   |

 

See accompanying summary of accountingpolicies and notes to consolidated financial statements.

 

2

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SHERWOOD BRANDS, INC. ANDSUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

 
|                                                                          |   | **Six  months ended January 31,** |    |
|-------------------------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                                          |   | **Unaudited**                     |    |
|                                                                          |   | **2003**                          |    | **2002** |   |
|                                                                          |   |                              |    |   |   |
| Cash flows from  operating activities                                         |   |                              |    |   |   |
| Net income                                                                    |   | $                                 | 631,085 |   | $ | 2,340,710 |   |
| Adjustments to  reconcile net income to net Cash used in operating activities |   |                              |    |   |   |
| Depreciation  expense                                                         |   | 446,253                           |    | 198,667 |   |
| Provision for  inventory obsolescence                                         |   | 137,376                           |    | 133,834 |   |
| Provision for  doubtful accounts                                              |   | 97,696                            |    | 246,355 |   |
| (Increase)  decrease in assets                                                |   |                              |    |   |   |
| Accounts  receivable                                                          |   | (4,160,925                        | )       | (5,529,065 | ) |
| Inventory                                                                     |   | (160,925                          | )       | 186,984 |   |
| Other current  assets                                                         |   | 1,247,837                         |    | (236,768 | ) |
| Other assets                                                                  |   | (106,099                          | )       | 2,842 |   |
| Increase  (decrease) in liabilities                                           |   |                              |    |   |   |
| Accounts payable                                                              |   | (842,097                          | )       | 884,288 |   |
| Accrued expenses                                                              |   | 678,901                           |    | 253,545 |   |
| Income taxes  payable                                                         |   | —                            |    | (42,517 | ) |
| Net cash used in  operating activities                                        |   | (2,030,898                        | )       | (1,561,125 | ) |
|                                                                          |   |                              |    |   |   |
| Cash flows from  investing activities                                         |   |                              |    |   |   |
| Capital  expenditures                                                         |   | (586,549                          | )       | (272,341 | ) |
| Net cash used in  investing activities                                        |   | (586,549                          | )       | (272,341 | ) |
|                                                                          |   |                              |    |   |   |
| Cash flows from  financing activities                                         |   |                              |    |   |   |
| Net borrowings  on line of credit                                             |   | 1,929,938                         |    | 2,386,749 |   |
| Exercise of  Stock options                                                    |   | 10,834                            |    | — |   |
| Borrowings on  Debt                                                           |   | 350,000                           |    | — |   |
| Payments on Debt                                                              |   | (153,889                          | )       | 42,296 |   |
| Net cash  provided by financing activities                                    |   | 2,136,883                         |    | 2,429,045 |   |
|                                                                          |   |                              |    |   |   |
| Net increase  (decrease) in cash and cash equivalents                         |   | (480,564                          | )       | 595,579 |   |
|                                                                          |   |                              |    |   |   |
| Cash and cash  equivalents, at beginning of period                            |   | 709,247                           |    | 385,195 |   |
| Cash and cash  equivalents, at end of period                                  |   | $                                 | 228,683 |   | $ | 980,774 |   |

 

See accompanying summary of accountingpolicies and notes to consolidated financial statements.

 

3

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1. BASIS OF PRESENTATION

 

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 North Carolina.Sherwood Brands, Inc. is engaged in the manufacture, marketing and distributionof a diverse line of brand name candies, cookies, chocolates and gifts. TheCompany manufactures jelly beans, lollipops, biscuits and soft and hard candiesand assembles seasonal gift items including gift baskets for Christmas andEaster. The Company’s principal branded products are COWS(TM) butter toffeecandies, DEMITASSE(R) biscuits, RUGER(R) wafers, SMILE POPS(R) lollipops,STRIP-O-POPS(R) lollipops and ELANA(R) Belgian chocolates. The Company alsomarkets SOUR FRUIT BURST(TM) fruit-filled hard candies, as well as holidayspecialty 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.

 

SherwoodBrands, 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.

 

•                  SherwoodBrands of RI, Inc. was incorporated in September, 1998 in the state of RhodeIsland. Sherwood Brands of RI, Inc. d/b/a E. Rosen Company manufactures hardcandies and jelly beans and assembles and markets gift items and baskets tochains such as Wal-Mart, Kmart and CVS.

 

•                  SherwoodAcquisition Corporation was incorporated in April 2002 in the State of Wyoming.On May 1, 2002, Sherwood Acquisition merged with and into Asher CandyAcquisition Corporation, a Wyoming corporation, that manufactured candy canesand other hard candies under the “Asher” name. The surviving corporation of themerger is Asher Candy Acquisition Corporation, which changed its name to Asher Candy,Inc. The Company issued an aggregate of 270,559 shares of its Class A commonstock, then valued at $1,675,000, to the shareholders of Asher CandyAcquisition Corporation in consideration for the transaction, subject to claimsfor indemnification and adjustments based on a final audit. The Company alsoissued warrants exercisable for 38,652 shares of its Class A common stock,valued at $108,000.

 

4

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3. INTERIM FINANCIAL INFORMATION

 

Thefinancial information as of January 31, 2003 and for the three and six monthsended January 31, 2003 and 2002 is un-audited. In the opinion of management,such information contains all adjustments, consisting only of normal recurringadjustments, necessary for a fair presentation of the results for such periods.Results for interim periods are not necessarily indicative of results to beexpected for the fiscal year.

 

4. ACQUISITION

 

OnMay 1, 2002, the Company acquired all of the outstanding common stock of AsherCandy Acquisition Corporation, a Wyoming corporation with operations located inNew Hyde Park, New York, that manufactured candy canes and other hard candiesunder the “Asher” name. The purchase price paid to the shareholders of AsherCandy Acquisition Corporation in consideration for the transaction wasapproximately $1,786,000 consisting of an aggregate of 270,559 shares of theCompany’s Class A common stock, then valued at $6.20 per share, or $1,675,000,subject to claims for indemnification and warrants exercisable for 38,652shares of Sherwood Brands Class A common stock valued at $108,000. The Companyvalued the common shares at the closing market price on April 30, 2002 andvalued the warrants using the Black-Scholes options pricing method.  Under the terms of the merger agreement, fora period of 30 days commencing on April 25, 2003, the Asher shareholders havethe right to sell to the Company one-half of the shares issued to them at aprice of $4.50 per share.  This putright is only exercisable if, among other things, the prior day’s closing priceof the Company’s Class A Common Stock on the American Stock Exchange was below$4.50 per share.

 

Thefollowing proforma information sets forth the consolidated results ofoperations for the three months ended January 31, 2002 and six months endedJanuary 31, 2002 assuming that Company had acquired Asher on August 1, 2001:

 
|                                      |   | **Three Months ended  January 31, 2002** |       | **Six Months Ended  January 31, 2002** |   |
|-------------------------------------------|--------|------------------------------------------|------------|----------------------------------------|--------|
|                                      |   |                                     |       |                                   |   |
| Net sales                                 |   | $                                        | 18,201,547 |                                   | $      | 41,841,209 |   |
| Income before  provision for income taxes |   | 1,352,515                                |       | 3,885,978                              |   |
| Net Income                                |   | 909,001                                  |       | 2,448,166                              |   |
| Earnings per  share—basic            |   | $                                        | 0.25       |                                   | $      | 0.61 |   |
| Earnings per  share—diluted          |   | $                                        | 0.21       |                                   | $      | 0.57 |   |

 

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:

 
|                                  |   | **JANUARY 31  2003** |       | **JULY 31  2002** |   |
|---------------------------------------|--------|----------------------|------------|-------------------|--------|
|                                  |   | **(UNAUDITED)**      |       | **(AUDITED)**     |   |
|                                  |   |                 |       |              |   |
| Raw materials  and ingredients        |   | $                    | 1,376,013  |              | $      | 868,319 |   |
| Components used  in assembly          |   | 2,839,751            |       | 1,200,576         |   |
| Packaging  materials                  |   | 3,818,164            |       | 2,850,910         |   |
| Work-in-process                       |   | 704,757              |       | 667,697           |   |
| Finished product                      |   | 8,078,713            |       | 11,069,470        |   |
|                                  |   | 16,817,398           |       | 16,656,972        |   |
| Less reserve for  inventory allowance |   | (837,804             | )          | (700,827          | )      |
|                                  |   | $                    | 15,979,594 |              | $      | 15,956,145 |   |

 

5

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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

 

Theincome tax rate utilized on an interim basis is based on the Company’s estimateof the effective income tax rate for the fiscal year ending July 31, 2003,which approximates 37%.

 

8. EARNINGS PER SHARE

 

Earningsper share 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 six months ended January31, 2003 and January 31, 2002

 
| **For the three months  ended January 31,  2002** |   | **Income** |    | **Shares** |      | **Per Share  Amount** |   |
|---------------------------------------------------|--------|------------|---------|------------|-----------|-----------------------|--------|
| Basic Earnings  per Share                         |   |       |    |       |      |                  |   |
| Income available  to common shareholders          |   | $          | 611,490 |       | 3,705,476 |                  | $      | 0.17 |   |
| Effect of  dilutive stock options                 |   |       |    | 728,248    |      |                  |   |
| Dilutive  earnings per share                      |   | $          | 611,490 |       | 4,433,723 |                  | $      | 0.14 |   |

 

6

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| **For  the six months  ended January 31,  2003** |   | **Income** |      | **Shares** |      | **Per Share  Amount** |   |
|--------------------------------------------------|--------|------------|-----------|------------|-----------|-----------------------|--------|
| Basic Earnings  per Share                        |   |       |      |       |      |                  |   |
| Income available  to common shareholders         |   | $          | 631,085   |       | 3,993,476 |                  | $      | 0.16 |   |
| Effect of  dilutive stock options                |   |       |      | 332,606    |      |                  |   |
| Dilutive  earnings per share                     |   | $          | 631,085   |       | 4,326,082 |                  | $      | 0.15 |   |
|                                             |   |       |      |       |      |                  |   |
| **For the six months  ended January 31,  2002**  |   | **Income** |      | **Shares** |      | **Per ShareAmount**   |   |
| Basic Earnings  per Share                        |   |       |      |       |      |                  |   |
| Income available  to common shareholders         |   | $          | 2,340,710 |       | 3,702,738 |                  | $      | 0.63 |   |
| Effect of  dilutive stock options                |   |       |      | 686,858    |      |                  |   |
| Dilutive  earnings per share                     |   | $          | 2,340,710 |       | 4,389,596 |                  | $      | 0.53 |   |

 

9. CONTINGENCY

 

TheCompany is from time to time, involved in litigation incidental to the conductof its business. 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.

 

10. LICENSING AGREEMENTS

 

Duringthe quarter ended January 31, 2003, the Company entered into a licenseagreement to incorporate products into gift sets and a license agreement tomanufacture candy canes using a licensed brand name. Under these agreements,the Company pays royalty of 2% of net sales and the agreements are for terms oftwo to three years.

 

Theproducts will be incorporated into the Company’s gift set items during theChristmas and Easter holiday seasons but the agreement is effective as ofJanuary 2003. The Company paid $3,500 as an advance fee for the license, whichis to be offset against any royalties due. The Company incurred $177,974 inroyalties during the quarter ended January 31, 2003 and $243,674 during the sixmonths ended January 31, 2003 under these and other license agreements. TheCompany is currently pursuing other licenses with similar terms and conditions.

 

11. CREDIT FACILITY

 

Duringthe quarter ended January 31, 2003, the Company was in violation of itsbusiness and financial covenants with the line of credit agreement.  The Company has been in discussions with theBank in changing the covenants relating to the credit agreement and the Companybelieves that the Bank will support the changes going forward.

 

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ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Important Information RegardingForward-Looking Statements

 

ThisQuarterly Report on Form 10-Q contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended. Those statementsinclude statements regarding the intent, belief or current expectations of theCompany and its management. Such statements are subject to a variety of risksand uncertainties, many of which are beyond our control, which could causeactual results to differ materially from those contemplated in suchforward-looking statements, including in particular the risks and uncertaintiesdescribed under “Risk Factors” in our amended Annual Report, on Form 10-K,filed with the Commission on December 20, 2002. Existing and prospectiveinvestors are cautioned not to place undue reliance on these forward-lookingstatements, which speak only as of the date hereof. We undertake no obligationto update or revise the information contained in this Quarterly Report on Form10-Q, whether as a result of new information, future events or circumstances orotherwise.

 

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.

 

OnMay 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 valued at $108,000. We valued the common shares at the closingmarket price on April 30, 2002 and valued the warrants using the Black-Scholesoptions pricing method.  Under the termsof the merger agreement, fora period of 30 days commencing on April 25, 2003, the Asher shareholders havethe right to sell to us one-half of the shares issued to them at a price of$4.50 per share. This put right is only exercisable if, among other things, theprior day’s closing price for our common stock on the American Stock Exchangewas below $4.50 per share.   During the quarter ended January 31, 2003, weincluded the operating results of Asher Candy in our consolidated results.Asher Candy generated $2.3 million of net sales during the quarter endedJanuary 31, 2003 and $9.8 million of net sales for the six months ended January31, 2003.

 

Duringthe eighteen months ended January 31, 2003, we entered into thirteen 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 10% 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 season. We also entered into anagreement to produce everyday candies and wafers under the license from thetrademark holder. We paid $195,000 in advance fees for the rights under the licensingagreements which may be offset against any royalties due. During the quarterand six months ended January 31, 2003, we incurred $177,974 and $243,674 ofroyalty expense, respectively. We are currently pursuing other licenses withsimilar terms and conditions. We expect to generate sales from the licenseagreements in this fiscal year ending July 31, 2003, but expect that thegreatest impact will occur beginning in the year ending July 31, 2004.

 

OnMay 31, 2002, we closed our Rhode Island manufacturing facility, which occupiedfive stories in an old building. All the production equipment, together with

 

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the electrical, piping, steamand air-conditioning were disassembled and transferred to our expanded ChaseCity, Virginia facility. The Chase City facility occupies 65,000 square feet,including 25,000 square feet of newly constructed space. We also maintain a73,000 square foot facility at Keysville, Virginia (about 20 miles from ChaseCity, Virginia). We expect to operate these facilities as a singlemanufacturing and distribution facility under one plant management for allproducts produced at the Chase City facility. Because the Chase City facilitywas not fully operational, the transition period resulted in decreased salesfor seasonal merchandise for the quarter and six months ended January 31,2003.  The impact of this transitionalso resulted in approximately $1.4 million of pre-production costs or 4% ofnet sales. Christmas and Easter gift sets and gift baskets are distributed atthe Rhode Island and Massachusetts facilities. We source product primarily fromthe Pacific Rim. We are continually looking to further reduce costs by moreefficient sourcing.  We are exploringthe options of using contract manufacturing in China and South America as a wayto reduce overall manufacturing costs and improve gross margins.

 

Factors Affecting the Performance in theQuarter Ended January 31, 2003.

 

AfterSeptember 11, 2001, the total consumer market experienced a major slow down. Asa result, some of our larger customers delayed their shipments of our products,and held their inventory at our facilities. We were forced to hold inventoryfor these customers for a period of up to twelve months. During the quarterended January 31, 2003, approximately $1.0 million of the goods were shippedout to our customers.

 

OnSeptember 30, 2002, 29 west coast sea ports were shut down and remained closedas contract 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 effected 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 slow down by thelongshoremen on shipping inventory is still prevalent. Our first quarterrevenues were impacted by the shut down and resulted in a delay of sales intothe second quarter. During the quarter ended January 31, 2003, approximately$3.5 million of these goods were shipped to our customers.

 

Results of Operations

 

THREE MONTHS ENDED January 31, 2003 and2002

 

Net sales for the three months endedJanuary 31, 2003 and 2002 were $19,390,601 and $15,931,434 respectively. Netsales increased 21.7% due to increased sales of gift items to Wal-Mart ofapproximately $1.4 million, which was a carry over from the first quarter salesand $2.1 million in net sales of gift set items for the Christmas holidaycompared to Sam’s Club, Wal-Mart and Dollar General accounted for approximately20%, 10.5% and 10.3% of sales during the three months ended January 31, 2003,respectively, and Sams Club, Wal-Mart and Dollar General accounted forapproximately 24%, 16% and 8% of the sales for the prior year’s comparableperiod, respectively.  The reduction insales to Sam’s Club and Wal-mart was a result of specialty gift items thatwhere not part of their Christmas seasonal items.

 

Gross profit for the three months endedJanuary 31, 2003 and 2002 were $5,047,301 and $4,876,904, respectively.  During the three months ended January 31,2003, gross margins decreased to 26% as percent of sales from 30.6% during theprior year’s comparable period. The decrease in earnings was attributablelargely to the low efficiency levels at our manufacturing facility in ChaseCity, Virginia.  The facility’soperations were running at a 38% production level during the three months endedJanuary 31, 2003.  The decrease in theproduction levels created unfavorable labor conditions, and material variancesin packaging and raw materials of approximately $1.3 million having a 6.7%effect to the gross margins for the period ended January 31, 2003. We incurred$350,000 of additional freight and duty costs associated with the west coastdockworkers strike.  The inefficiencyand decreased

 

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production levels at the facility and theadditional freight and duty costs due to the dockworkers strike representedapproximately 8.5% of the gross margin decrease as a percent of net salesduring the quarter ended January 31, 2003.

 

During the three months ended January 31,2003 and 2002, selling, general and administrative expenses increased to$2,748,809 from $2,548,744, respectively, but decreased to 14.2% from 16.0% asa percent of sales, respectively. The decrease as a percent of sales waslargely due to $135,000 decrease in broker commissions and a $65,000 decreasein advertising and promotional expense.

 

Pre-productions costs accounted for$880,440, or 4.5% as percent of sales for the three months ended January 31,2003, as a result of the training and decreased production levels at the ChaseCity, Virginia facility.  No comparablecosts or expense were incurred for the three months ended January 31,2003.  We anticipate additional costsassociated with the Chase City, Virginia facility in the third quarter as wereduce and reorganize the plants’ operations.

 

During the three months ended January 31,2003 and 2002, salaries and related expenses decreased to $1,283,401 from $1,305,121,respectively, and decreased to 6.6% from 8.2% as a percent of sales,respectively. This decrease was mainly attributable to a reduction of ouroverhead.

 

Operating expenses increased to $4,912,650for the three months ended January 31, 2003 from $3,853,865 for the threemonths ended January 31, 2002 an increase of 1.1% as a percent of sales. Theincrease as a percentage of sales was largely due to increased pre-productioncosts of $880,440 associated with the Chase City, Virginia facility, increasedfreight and duty costs of $273,000 and additional travel costs of $41,000 fortrips to China.  The increase waspartially offset by decreased brokers commissions of $135,000.

 

Income from operations for the three monthsended January 31, 2003 was $134,651, as compared to $1,023,039 for the prioryear’s comparable period. The reduction was primarily the result of thepre-production costs discussed above.

 

Interest income decreased to $233 duringthe three months ended January 31, 2003 from $2,893 during the three monthsended January 31, 2002. Interest expenses increased to $196,015 during thethree months ended January 31, 2003 from $140,784 during the three months endedJanuary 31, 2002.  Although we had lowerinterest rates on our working capital line and term facilities, the increase isdue to term debt from the merger with Asher Candy, which was $1.3 million onMay 2002. Other income (expense) increased to ($63,711) from a $24,696 due torealized losses on foreign exchange currency purchases.

 

The income tax rate utilized for thethree-month period is based on our estimate of the effective tax rate for thefiscal year ending July 31, 2003, which approximates 37%.

 

As a result of the foregoing, we incurred anet loss of $77,865, for the three months ended January 31, 2003, compared tonet income of $611,490 for the prior year’s comparable period, or (0.4%)compared to 3.8% as percent of sales.

 

SIX MONTHS ENDED January 31, 2003 AND 2002

 

Net sales for the six months ended January31, 2003 and 2002 were $37,852,813 and $36,978,318 respectively. Net salesincreased 2.36% primarily due increased net sales of gift items for theChristmas holiday. Sam’s Club, Big Lots and Dollar Tree accounted forapproximately 14%, 11% and 9% of sales, respectively during the six monthsended January 31, 2003, and Sam’s Club, Wal-Mart and Dollar General accountedfor the period approximately 36%, 10% and 9% of sales, respectively, for theprior year’s comparable period.

 

For the six months ended January 31, 2003and 2002 gross margins decreased to $10,553,771 from $11,639,229, respectively,and decreased to 27.9% and 31.5% as percent of sales, respectively. Thedecrease in earnings was attributable to the low efficiency levels at our ChaseCity, Virginia facility.  The facility ranat a 38% production level during the six months ended January 31, 2003.  The decrease in the production levelscreated unfavorable labor conditions and material variances in

 

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packaging and raw materials ofapproximately $1.6 million, or 4.2% effect to the gross margins for the sixmonth period ended January 31, 2003.  Weincurred $515,000 of additional freight and duty costs associated with the westcoast dockworkers strike.  Theinefficiency and decreased production levels at the facility and the additionalfreight and duty costs incurred due to the dockworkers strike amounted toapproximately 5.6% of the decrease as a percent of sales during the six monthsended January 31, 2003.

 

During the six months ended January 31,2003 and 2002, selling, general and administrative expenses decreased to$5,312,147 from $5,003,147 and increased to 14.0% from 13.5% as a percent ofsales, respectively. The decrease as a percent of sales was largely due toreduction in warehouse freight of $135,000 and a increase of $174,000 in travelexpenses, of which approximately $85,000 was for trips to China.

 

Pre-productions costs accounted for$1,384,376, or 3.7% as percent of sales, for the six months ended January 31,2003, as a result of the training required for, and decreased production levelsexperienced, at the Chase City, Virginia facility.  No comparable costs or expense was incurred for the six monthsended January 31, 2002.

 

During the six months ended January 31, 2003,salaries and related expenses decreased to $2,458,409 from $2,675,052 duringthe six months ended January 31, 2002, or 6.5% from 7.2% as a percent of sales.This decrease was mainly attributable to a decrease in personnel overhead.

 

As a result, operating expenses for the sixmonths ended January 31, 2003 increased to $9,155,294 from $7,678,199 for thesix months ended January 31, 2002 and increased to 24.2% from 20.8%,respectively, as a percent of sales. The increase as a percentage of sales waslargely due to increased pre-production costs of $1,384,376 at the Chase City,Virginia facility and freight costs of $515,000.  the increase was partially offset by $293,000 decrease in brokers commissions, a $172,000 decreasein professional fee and $174,000 of additional travel costs, of which $85,000resulted from trips to China.

 

Income from operations for the six monthsended January 31, 2003 was $1,398,477, as compared to $3,961,030 for the prioryear’s comparable period.

 

For the six months ended January 31, 2003,interest income decreased to $2,492 from $3,880 for the six months endedJanuary 31, 2002. For the six months ended January 31, 2003, interest expensesincreased to $337,072 from $288,661 for the six months ended January 31, 2002due to an increase in our term debt financing associated with the merger withAsher Candy.

 

For the six months ended January 31, 2003,other income (expense) increased to ($62,175) from ($14,126) for the six monthsended January 31, 2002 due to realized losses on foreign exchange currencypurchases.

 

The income tax rate utilized for thesix-month period is based on our estimate of the effective tax rate for thefiscal year ending July 31, 2003, which approximates 37%.

 

As a result of the foregoing, we earned netincome of $631,085 for the six months ended January 31, 2003, compared to netincome of $2,340,710 for the prior year’s comparable period, or a decrease of1.7% from 6.3% as percent of sales. The reduction was primarily due toapproximately $1.4 million in inefficiency in production at our manufacturingfacility in Chase City, Virginia, $515,000 of freight and duty costs associatedwith the dockworkers strike and $174,000 of additional travel costs, of which$85,000 resulted from trips to China.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary cash requirements have been tofund the purchase, manufacture and commercialization of our products. Wefinance our operation and manufacturing with cash flow from operations and bankfinancing. Our working capital at January 31, 2003 and July 31, 2002 were$6,450,079 and $6,218,379, respectively.

 

Net cash used in operating activities forthe six months ended January 31, 2003 and 2002, was $2,030,898 and $1,561,125,respectively. The increase in cash used by

 

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operating activities was due primarily toincreases in inventory allowance, accrued expenses, income taxes payable andinventory, which were partially offset by a decrease in accounts receivable, aswell as decreases in net income and accounts payable.

 

Net cash used in investing activities forthe six months ended January 31, 2003 and 2002 increased to $586,549 from$272,341, respectively, primarily due to the purchase of four candy caneproduction equipment lines and capital improvements for our facility in ChaseCity, Virginia.

 

Net cash provided by financing activitiesfor the six months ended January 31, 2003 and 2002 was $2,136,883 and$2,429,045, respectively. This decrease was primarily due to decreased relianceon borrowings under our line of credit to finance working capital needs forseasonal materials. The borrowings for the period ended January 31, 2003 wasapproximately $10,134,000 as compared to $8,204,000 for the prior yearscomparable period. The impact of higher borrowings was offset somewhat by lowerinterest rates. We have $14,866,000 of our $25,000,000 line of credit availableto meet additional seasonal needs to purchase and manufacture inventory.

 

Principal payments for our long-term debtfor the twelve months ending January 31, 2004 are $496,829. We believe thatcash provided by operations will be sufficient to finance our operations andfund debt service requirements for the next twelve months.

 

Schedule of Contractual Obligations

 
|                          |   |      |      | **Payments Due by Period** |   |
|-------------------------------|--------|-----------|-----------|----------------------------|--------|
| **Contractual  Obligation**   |   | **Total** |      | **Less Than  1 year**      |   | **1-3 years** |   | **After 4 years** |   |
| Long-Term Debt                |   | $         | 2,015,402 |                       | $      | 481,111 |   | $ | 1,204,403 |   | $ | 329,888 |   |
| Capital Lease  Obligation     |   | 447,123   |      | 15,718                     |   | 50,123 |   | 381,282 |   |
| Licensing  Agreements         |   | 481,500   |      | —                     |   | 481,500 |   | — |   |
| Operating Leases              |   | 965,687   |      | 295,677                    |   | 435,166 |   | 234,844 |   |
| Total  Contractual Obligation |   | $         | 3,909,712 |                       | $      | 792,506 |   | $ | 2,171,192 |   | $ | 946,014 |   |

 

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 advances to finance working capitaland the issuance of letter of credits. Advances under the line of credit arebased on a borrowing formula equal to 85% of eligible domestic accountsreceivable plus 60% of eligible finished goods and 30% of eligible componentsinventory. The line of credit facility varies from quarter to quarter based onworking capital needs and pay-downs.

 

INFLATION

 

Wedo not believe that inflation has had a significant impact on our results ofoperations for the periods presented.

 

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Item 3.             Quantitativeand Qualitative Disclosures About Market Risk

 

Asa result of our variable rate line of credit, we are exposed to the risk ofrising interest rates. Our $25,000,000 line of credit had an interest rateranging from 4.04% to 3.69% for the three months ended January 31, 2003 and4.2% to 3.69% for the six months ended January 31, 2003. Our long-term debt isat variable market tax-exempt rates, which exposes us to fluctuations in themarket. However, since the rate is based on the tax-exempt rate, it is belowthe market rate.

 

Weutilize derivative instruments, from time to time, foreign currency forwardcontracts and currency exchange rate contracts to hedge our market price riskexposures. Foreign currency contracts are entered into for periods consistentwith related underlying exposures and do not constitute positions independentof those exposures. We do not hold or issue derivative instruments for tradingpurposes and are not a party to any instruments with leverage or prepaymentfeatures. In entering into these contracts, we have assumed risk which mightarise from possible inability of counter-parties to meet the terms of theircontracts. For the quarter ended January 31, 2003, we incurred losses of$73,000 on foreign exchange purchases due to the weak dollar.

 

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.

 

Wefollow the guidance in SFAS 133 and account for these contracts as cash flowhedges. As of the six months ending January 31, 2003, we had no foreignexchange contracts.  We recognizedrealized losses of approximately $31,000 related to these derivativeinstruments in fiscal 2003.

 

Significant Accounting Policies andEstimates

 

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 reported related to the accounting policiesdescribed below; however, application of these accounting policies involves theexercise of judgment and the use of assumptions as to future uncertainties and,as a result, actual results could differ from these estimates.

 

Weprovide an allowance for uncollectible accounts receivable based on experience.We consider the following factors in developing an estimate of our allowancefor non-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 six months ended January 31, 2003, we had anallowance for doubtful accounts of approximately $284,000.

 

Weprovide an allowance for slow moving inventory based on experience and aging ofproducts. We consider the following factors in developing an estimate of ourallowance for non-moving of inventory and the overall economic environment.Although it is reasonably possible that management’s estimate of slow movinginventory could change in the near future, management is not aware of anyevents that would result in change to its estimates which would be material toour financial position or results from operations. For the six months endedJanuary 31, 2003, we had an allowance for slow moving inventory ofapproximately $837,800.

 

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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. As of July 31, 2002 there was noimpairment loss.

 

Seasonality and Cylicality; Fluctuation inQuarterly Operating Results

 

Wehave experienced and expect to continue to experience variability in revenuesand net 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.

 

Wealso believe that the confectionary industry is influenced by general economicconditions and particularly by the level of change in the economy. Increasedlevels of consumer spending can have a favorable impact on our revenues. Wealso believe that the confectionary industry tends to experience periods ofdecline and recession during economic downturns. The confectionary industrycould sustain periods of decline in revenues in the future, and any decline mayhave a 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.

 

Item4.  Controls and Procedures

 

Within the 90 days prior to the dateof this Quarterly Report, we evaluated the effectiveness of the design andoperation of our “disclosure controls and procedures” (Disclosure Controls),and our “internal controls and procedures for financial reporting” (InternalControls). This evaluation (the Evaluation) was done under the supervision andwith the participation of management, including our Chief Executive Officer(CEO) and Chief Financial Officer (CFO).

 

Disclosure Controls are procedures that aredesigned with the objective of ensuring that information required to bedisclosed in our reports filed under the Securities Exchange Act of 1934, suchas this Quarterly Report, is recorded, processed, summarized and reportedwithin the time periods specified by the Securities and Exchange Commission.Disclosure Controls are also designed with the objective of ensuring that theinformation is accumulated and communicated to our management, including theCEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure. Internal Controls are procedures that are designed with theobjective of providing reasonable assurance that (1) our transactions areproperly authorized; (2) our assets are safeguarded against unauthorizedor improper use; and (3) our transactions are properly recorded andreported, all to permit the preparation of our financial statements inconformity with generally accepted accounting principles.

 

Our management, including the CEO and CFO,does not expect that our Disclosure Controls or our Internal Controls willprevent any error and fraud. A control system, no matter how well operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met. Further, the design of a control system must reflectthe fact that there are resource constraints, and the benefits of controls mustbe considered relative to their costs. Because of the inherent limitations inall control systems, no evaluation of controls can provide absolute assurancethat all control issues and instances of fraud, if any, have been detected. Thedesign of any system of controls also is based in part upon assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions; over time, control may become inadequate because of changes inconditions, or the degree of compliance with the policies or procedures maydeteriorate. Because of the inherent

 

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limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not bedetected.

 

The CEO/CFO evaluation of our DisclosureControls and our Internal Controls included a review of the controls’objectives and design, the controls’ implementation and the effect of thecontrols on the information generated for use in this Quarterly Report. In thecourse of the Evaluation, we sought to identify data errors, controls problemsor acts of fraud and to confirm that appropriate corrective action, includingprocess improvements, were being undertaken. This type of evaluation will bedone on a quarterly basis so that the conclusions concerning controlseffectiveness can be reported in our Quarterly Reports on Form 10-Q andAnnual Report on Form 10-K. Our Internal Controls are also evaluated by our independentauditors in connection with their audit and review activities. The overallgoals of these evaluation activities are to monitor our Disclosure Controls andour Internal Controls and to make modifications as necessary; our intent inthis regard is that the Disclosure Controls and the Internal Controls will bemaintained as dynamic systems that change (including with improvements andcorrections) as conditions warrant.

 

Among other matters, we sought in ourevaluation to determine whether there were any “significant deficiencies” or“material weaknesses” in the Internal Controls. In the professional auditingliterature, “significant deficiencies” are referred to as “reportableconditions”; these are control issues that could have a significant adverse effecton the ability to record, process, summarize and report financial data in thefinancial statements. A “material weakness” is defined in the auditingliterature as a particularly serious reportable condition where the internalcontrol does not reduce to a relatively low level the risk that misstatementscaused by error or fraud may occur in amounts that would be material inrelation to the financial statements and not be detected within a timely periodby employees in the normal course of performing their assigned functions.

 

In accord with SEC requirements, the CEOand CFO note that, since the date of the Evaluation to the date of thisQuarterly Report, there have been no significant changes in Internal Controlsor in other factors that could significantly affect Internal Controls,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Basedupon the Controls Evaluation, our CEO and CFO have concluded that, subject tothe limitations noted above, our Disclosure Controls are effective to ensurethat material information relating to Sherwood Brands and its subsidiaries ismade known to management, including the CEO and CFO, particularly during theperiod when our periodic reports are being prepared, and that our InternalControls are effective to provide reasonable assurance that our financialstatements are fairly presented in conformity with generally acceptedaccounting principles.

 

PARTII OTHER INFORMATION

 

Item1. Legal Proceedings

 

Weare from time to time involved in litigation incidental to the conduct of ourbusiness. We are currently involved in several actions. In particular, thelandlord at our Rhode Island facility has named us as a defendant in an actionseeking security for claims relating to the lease agreement. We 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 lease agreementalleging an obligation of $932,000 under the lease and demanded $750,000 tosettle the disputes. We have claims against the landlord we are pursuing andcontinue to occupy space at the leased premises. We have accrued amounts tocover current charges. Management does not believe that the outcome of theseactions, individually or in the aggregate, will have a material adverse effecton the financial condition of the Company.

 

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Item4.  Submission of Matters to a Vote ofSecurity Holders

 

OurAnnual Meeting of Shareholders (the “Meeting”) was held on January 6th, 2003.

 

Theonly matters voted on at the Meeting consisted of the following;

 

The electionof five members to our Board of Directors. The name of each nominee for theelection and the number of shares voted and withheld for such nominee, as wellas the number of broker non-votes with respect to such matters, are set forthbelow:

 
| **NAME**            |   | **FOR**   |   | **WITHHELD** |   | **NON-VOTES** |
|---------------------|--------|-----------|--------|--------------|--------|---------------|
| Uziel Frydman       |   | 9,600,612 | *      | 101,000      |   | 0             |
| Amir Frydman        |   | 9,600,612 | *      | 102,300      |   | 0             |
| Douglas A. Cummins  |   | 9,600,612 | *      | 99,700       |   | 0             |
| Kenneth J. Lapiejko |   | 9,600,612 | *      | 100,700      |   | 0             |
| Guy M. Bynn         |   | 9,600,612 | *      | 99,700       |   | 0             |

 

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| *       Includes 1 million shares of our Class  B Common Stock which are entitled to seven votes per share. |
|-------------------------------------------------------------------------------------------------------------------------------------------|

 

Item6. Exhibits and Reports on Form 8-K

 

(a)               Exhibits

 

None.

 

(b)              Reports onForm 8-K

 

None.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                       | SHERWOOD  BRANDS, INC.                 |
|----------------------------|----------------------------------------|
|                       |                                   |
| Date:  March 14, 2003 | /s/  Uziel Frydman                     |
|                       | President  and Chief Executive Officer |
|                       |                                   |
|                       |                                   |
| Date:  March 14, 2003 | /s/  Christopher J. Willi              |
|                       | Chief  Financial Officer and Secretary |

 

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**CERTIFICATION PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002**

 

I, Uziel Frydman, certify that:

 

1.                  I have reviewed this quarterly reporton Form 10-Q of Sherwood Brands, Inc. (the “Registrant”);

 

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

 

3.                  Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the Registrant as of, and for, the periodspresented in this quarterly report;

 

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

 

(a) designed such disclosure controls and procedures to ensure that materialinformation relating to the Registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this amended quarterly report is being prepared;

 

(b) evaluated the effectiveness of the Registrant’s disclosure controls andprocedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

 

(c) presented in this amended quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.                  The Registrant’s other certifyingofficer and I have disclosed, based on our most recent evaluation, to theRegistrant’s auditors and the audit committee of Registrant’s board ofdirectors (or persons performing the equivalent function):

 

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

 

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

 

6.                  The Registrant’s other certifyingofficer and I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date:  March 14, 2003

 

 
|   | /s/ Uziel Frydman                                 |   |
|--------|---------------------------------------------------|--------|
|   | Uziel Frydman                                     |
|   | Chairman, President and  Chief Executive Officer, |

 

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

 

I, Christopher J. Willi, certify that:

 

1.                  I have reviewed this quarterly reporton Form 10-Q of Sherwood Brands, Inc. (the “Registrant”);

 

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

 

3.                  Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the Registrant as of, and for, the periodspresented in this quarterly report;

 

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

 

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

 

(b) evaluated the effectiveness of the Registrant’s disclosure controls andprocedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

 

(c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.                  The Registrant’s other certifyingofficer and I have disclosed, based on our most recent evaluation, to theRegistrant’s auditors and the audit committee of Registrant’s board ofdirectors (or persons performing the equivalent function):

 

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

 

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

 

6.                  The Registrant’s other certifyingofficer and I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date:  March 14, 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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