**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC  20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterlyperiod ended:  October 31, 2003  Commission FileNumber:  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 Boulevard, Suite 201  Rockville, MD 20850**                       |
| (Address of principal executive offices)                                               |
|                                                                                   |
| Registrant’s telephone number, including area code:  **(301) 309-6161** |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reportsand (2) has been subject to such filing requirement for the past 90 days.

 

Yes ý     No o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

Yes o     No ý

 

The number of sharesoutstanding of the registrant’s Class A Common Stock, $.01 par value per share,as of December 13, 2003 was 3,003,476. The number of shares outstanding of theregistrant’s Class B Common Stock, $.01 par value per share, as December 13,2003 was 1,000,000. The Class B Common Stock is not publicly traded.

 

Transitional Small BusinessDisclosure 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 - October 31, 2003 (unaudited) and July  31, 2003                      |                                                                                        |
|                                                                                               |                                                                                        |
| Consolidated Statements of Operations -  Three months ended October 30, 2003 and  2002 (unaudited) |                                                                                        |
|                                                                                               |                                                                                        |
| Consolidated Statements of Cash Flows -  Three months ended October 31, 2003 and  2002 (unaudited) |                                                                                        |
|                                                                                               |                                                                                        |
| 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.                                                                                            | Controls and Procedures                                                                     |   |
|                                                                                               |                                                                                        |   |
| PART II OTHER INFORMATION                                                                          |                                                                                        |
|                                                                                               |                                                                                        |   |
| Item 1.                                                                                            | Legal Proceedings                                                                           |   |
|                                                                                               |                                                                                        |   |
| Item 6.                                                                                            | Exhibits and Reports on Form 8-K                                                            |   |
|                                                                                               |                                                                                        |   |
| SIGNATURES                                                                                         |                                                                                        |
|                                                                                                    |                                                                                             |        |  |

 

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**SHERWOOD BRANDS, INC.AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                        |   | **October 31,  2003** |       | **July 31,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|------------|-------------------------|--------|
|                                                                                                                        |   | **(unaudited)**            |       |                    |   |
| Assets                                                                                                                      |   |                       |       |                    |   |
|                                                                                                                        |   |                       |       |                    |   |
| Current assets                                                                                                              |   |                       |       |                    |   |
| Cash and cash equivalents                                                                                                   |   | $                          | 121,409    |                    | $      | 227,352 |   |
| Accounts receivable, less allowance of  $167,000 and $186,000                                                               |   | 14,244,748                 |       | 899,230                 |   |
| Inventory                                                                                                                   |   | 16,731,412                 |       | 13,719,294              |   |
| Income taxes receivable                                                                                                     |   | 1,020,428                  |       | 1,020,379               |   |
| Other current assets                                                                                                        |   | 489,277                    |       | 578,155                 |   |
| Deferred taxes on income                                                                                                    |   | 614,000                    |       | 614,000                 |   |
| Total current assets                                                                                                        |   | 33,221,274                 |       | 17,058,410              |   |
| Net property and equipment                                                                                                  |   | 6,850,024                  |       | 7,129,227               |   |
| Goodwill                                                                                                                    |   | 2,001,330                  |       | 2,001,330               |   |
| Other assets                                                                                                                |   | 318,504                    |       | 313,504                 |   |
| TOTAL ASSETS                                                                                                                |   | $                          | 42,391,132 |                    | $      | 26,502,471 |   |
| Liabilities and Stockholders’ Equity                                                                                   |   |                       |       |                    |   |
| Current liabilities                                                                                                         |   |                       |       |                    |   |
| Line of credit                                                                                                              |   | $                          | 16,255,795 |                    | $      | 6,260,264 |   |
| Current portion of long-term debt                                                                                           |   | 530,377                    |       | 530,377                 |   |
| Current portion of subordinated debt                                                                                        |   | 2,000,000                  |       | 2,000,000               |   |
| Current portion of capital lease obligation                                                                                 |   | 15,718                     |       | 15,718                  |   |
| Accounts Payable                                                                                                            |   | 9,134,678                  |       | 6,257,145               |   |
| Accrued expenses                                                                                                            |   | 2,957,755                  |       | 1,325,891               |   |
| Total current liabilities                                                                                                   |   | 30,894,323                 |       | 16,389,395              |   |
| Deferred taxes on income                                                                                                    |   | 464,000                    |       | 464,000                 |   |
| Long-term debt                                                                                                              |   | 1,028,089                  |       | 1,150,513               |   |
| Obligations under capital lease                                                                                             |   | 420,050                    |       | 423,892                 |   |
| TOTAL LIABILITIES                                                                                                           |   | 32,806,462                 |       | 18,427,800              |   |
| 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 and 3,003,476 shares issued and outstanding |   | 30,035                     |       | 30,035                  |   |
| 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                  |       | 9,843,774               |   |
| Retained earnings (deficit)                                                                                                 |   | (299,138                   | )          | (1,809,138              | )      |
|                                                                                                                        |   |                       |       |                    |   |
| TOTAL STOCKHOLDERS’ EQUITY                                                                                             |   | 9,584,670                  |       | 8,074,671               |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                             |   | $                          | 42,391,132 |                    | $      | 26,502,471 |   |

 

See Accompanying summary of accounting policies and notes toconsolidated financial statements

 

1

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**SHERWOOD BRANDS, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONSUNAUDITED**

 
|                                          |   | **Three  Months Ended October 31,** |       |
|-----------------------------------------------|--------|-------------------------------------|------------|
|                                          |   | **2003**                            |       | **2002** |   |
|                                          |   |                                |       |   |   |
| Net sales                                     |   | $                                   | 17,420,813 |   | $ | 18,462,212 |   |
| Cost of sales                                 |   | 12,384,142                          |       | 12,955,743 |   |
| Gross profit                                  |   | 5,036,671                           |       | 5,506,469 |   |
| Selling, general and administrative  expenses |   | 2,231,517                           |       | 2,563,700 |   |
| Salaries and related expenses                 |   | 1,062,982                           |       | 1,175,008 |   |
| Pre production costs                          |   | —                              |       | 503,936 |   |
| Total operating expenses                      |   | 3,294,499                           |       | 4,242,644 |   |
| Income from operations                        |   | 1,742,172                           |       | 1,263,825 |   |
| Other income (expense)                        |   |                                |       |   |   |
| Interest income                               |   | 19                                  |       | 2,259 |   |
| Interest expense                              |   | (236,766                            | )          | (141,057 | ) |
| Other (expense)income                         |   | 4,537                               |       | 1,536 |   |
| Total other (expense)income                   |   | (232,210                            | )          | (137,262 | ) |
| Income before provision for taxes on income   |   | 1,509,962                           |       | 1,126,563 |   |
| Provision for taxes on income                 |   | —                              |       | 417,614 |   |
| Net income                                    |   | $                                   | 1,509,962  |   | $ | 708,949 |   |
| Net income per share-basic                    |   | $                                   | 0.38       |   | $ | 0.18 |   |
| -diluted                                      |   | 0.37                                |       | 0.16 |   |
| Weighted average shares outstanding-basic     |   | 3,996,199                           |       | 3,986,809 |   |
| -diluted                                      |   | 4,136,235                           |       | 4,390,550 |   |

 

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

 

2

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**SHERWOOD BRANDS, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSUNAUDITED**

** **
|                                                                          |   | **Three  months ended October 31,** |      |
|-------------------------------------------------------------------------------|--------|-------------------------------------|-----------|
|                                                                          |   | **2003**                            |      | **2002** |   |
|                                                                          |   |                                |      |   |   |
| Cash flows from operating activities                                          |   |                                |      |   |   |
| Net income                                                                    |   | $                                   | 1,509,962 |   | $ | 708,949 |   |
| Adjustments to reconcile net income to net  Cash used in operating activities |   |                                |      |   |   |
| Depreciation expense                                                          |   | 248,444                             |      | 222,921 |   |
|                                                                          |   |                                |      |   |   |
| Provision for doubtful accounts                                               |   | 75,682                              |      | 95,161 |   |
| (Increase) decrease in assets                                                 |   |                                |      |   |   |
| Accounts receivable                                                           |   | (13,421,200                         | )         | (12,409,297 | ) |
| Income taxes receivable                                                       |   | (49                                 | )         | 451,989 |   |
| Inventory                                                                     |   | (3,012,118                          | )         | (1,859,410 | ) |
| Other current assets                                                          |   | 88,878                              |      | (52,631 | ) |
| Other assets                                                                  |   | (5,000                              | )         | (14,427 | ) |
| Increase (decrease) in liabilities                                            |   |                                |      |   |   |
| Accounts payable                                                              |   | 2,877,533                           |      | 2,844,808 |   |
| Accrued expenses                                                              |   | 1,631,901                           |      | 981,548 |   |
| Income taxes payable                                                          |   | —                              |      | — |   |
| Net cash used in operating activities                                         |   | (10,005,966                         | )         | (9,030,289 | ) |
|                                                                          |   |                                |      |   |   |
| Cash flows from investing activities                                          |   |                                |      |   |   |
| Proceeds from sales of assets                                                 |   | 142,750                             |      | — |   |
| Capital expenditures                                                          |   | (111,992                            | )         | (351,960 | ) |
| Net cash used in investing activities                                         |   | 30,759                              |      | (178,664 | ) |
|                                                                          |   |                                |      |   |   |
| Cash flows from financing activities                                          |   |                                |      |   |   |
| Net borrowings on line of credit                                              |   | 9,995,531                           |      | 9,114,060 |   |
| Proceeds from long-term debt                                                  |   | —                              |      | 350,000 |   |
| Payments on long term debt                                                    |   | (126,266                            | )         | (64,235 | ) |
|                                                                          |   |                                |      |   |   |
| Net cash provided by financing activities                                     |   | 9,869,265                           |      | 9,399,825 |   |
|                                                                          |   |                                |      |   |   |
| Net increase in cash and cash equivalents                                     |   | (105,943                            | )         | 17,576 |   |
|                                                                          |   |                                |      |   |   |
| Cash and cash equivalents, at beginning of  period                            |   | 227,352                             |      | 709,247 |   |
|                                                                          |   |                                |      |   |   |
| Cash and cash equivalents, at end of period                                   |   | $                                   | 121,409   |   | $ | 726,823 |   |

 

See accompanying summary of accounting policies and notes toconsolidated financial statements

 

3

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**SHERWOOD BRANDS, INC.AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED**)

 

**1.             BASIS OF PRESENTATION**

 

The consolidated financialstatements include the accounts of Sherwood Brands, Inc., and its direct andindirect wholly-owned subsidiaries, Sherwood Brands, LLC, a Maryland limitedliability company, Sherwood Brands of RI Inc., a Rhode Island corporation,Sherwood Brands Overseas, Inc., a Bahamas entity (“Overseas”), and Asher Candy,Inc., a Wyoming corporation (collectively referred to herein as, “we”, “our”“us” or, the “Company”). All material inter-company transactions and balanceshave 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 Annual Report and Form 10-K filed on October 29, 2003.

 

**2.             ORGANIZATION AND DESCRIPTION OFBUSINESS**

 

Sherwood Brands, Inc. (the“Company”) 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 lollipops, biscuits and assembles seasonal gift itemsincluding gift baskets for Christmas, Valentines Day and Easter. The Company’sprincipal branded products include COWS(TM) butter toffee candies, DEMITASSE(R)biscuits, RUGER(R) wafers, SMILE POPS(R) lollipops, STRIP-O-POPS(R) lollipopsand ELANA(R) chocolates, SOUR FRUIT BURST(TM) fruit-filled hard candiesand  PIRATE’S GOLD COINS(R) milkchocolates. The Company’s marketing strategy, including its packaging ofproducts, is designed to maximize freshness, taste and visual appeal, andemphasizes highly distinctive, premium quality products that are sold at pricesthat compare favorably to those of competitive products. The Company operates inthe confectionery industry and aligns its operations into three businesssegments for management to measure financial performance by product type.  The Company’s business segments are (i)Manufactured Candy, (ii) Purchased Candy and (iii) Gift Items.

 

Sherwood Brands, Inc. is theowner of Sherwood Brands, LLC, a Maryland limited liability company. SherwoodBrands, LLC markets and distributes its own line of confectionery products inthe United States.

 

Sherwood Overseas, Inc. (awholly-owned subsidiary of Sherwood Brands, LLC) was incorporated in July 1993in the Bahamas to market and distribute the Sherwood lines of confectioneryproducts internationally.

 

4

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Sherwood Brands of RI, Inc. isa wholly owned subsidiary of Sherwood Brands, Inc. that was incorporated inSeptember, 1998 in the state of Rhode Island. Sherwood Brands of RI, Inc. d/b/aE. Rosen Company manufactures hard candies and jelly beans and assembles andmarkets gift items and baskets to chains such as Wal-Mart, Kmart and CVS.

 

Sherwood AcquisitionCorporation, a wholly-owned subsidiary of the Company, was incorporated inApril, 2002 in the state of Wyoming. On May 1, 2002, Sherwood Acquisitionmerged with and into Asher Candy Acquisition Corporation, a Wyomingcorporation. Asher Candy Acquisition Corporation is a manufacturer of candycanes and other hard candies under the “Asher” name. The surviving corporationof the merger is Asher Candy Acquisition Corporation, which has changed itsname to Asher Candy, Inc.

 

**3.             INTERIM FINANCIAL INFORMATION**

 

The financial information as ofOctober 31, 2003 and for the three months ended October 31, 2003 and 2002 isun-audited. In the opinion of management, such information contains alladjustments, consisting only of normal recurring adjustments, necessary for afair presentation of the results for such periods. Results for interim periodsare not necessarily indicative of results to be expected for an entire year.

 

**4.             INVENTORY**

 

Inventory consists of raw materials,packaging materials, components used in assembly, work- in- process andfinished goods and is stated at the lower of cost or market. Cost is determinedby the FIFO (first-in, first-out) method.

Inventory consists of thefollowing:

 
|                                    |   | **October 31  2003** |       | **July 31  2003** |   |
|-----------------------------------------|--------|----------------------|------------|-------------------|--------|
|                                    |   | **(unaudited)**      |       |              |   |
| Raw materials and ingredients           |   | $                    | 504,270    |              | $      | 423,497 |   |
| Components used in assembly             |   | 1,973,424            |       | 1,496,166         |   |
| Packaging materials                     |   | 3,157,273            |       | 2,936,702         |   |
| Work-in-process                         |   | 609,496              |       | 648,539           |   |
| Finished product                        |   | 11,549,745           |       | 9,358,100         |   |
|                                    |   |                 |       |              |   |
|                                    |   | 17,794,208           |       | 14,863,004        |   |
| Less reserve for inventory obsolescence |   | (1,081,792           | )          | (1,143,710        | )      |
|                                    |   |                 |       |              |   |
|                                    |   | $                    | 16,712,416 |              | $      | 13,719,294 |   |

 

**5.             USE OF ESTIMATES**

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosures of contingent assets and liabilitiesat the date of

 

5

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the financial statements andreported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates.

 

**6.             INCOME TAXES**

 

Income taxes are calculatedusing the liability method specified by Statement of Financial AccountingStandards No. 109, “Accounting for Income Taxes (SFAS 109).” Under SFAS 109,deferred taxes are determined using the liability method which requires therecognition of deferred tax assets and liability based on differences betweenthe financial statement and the income tax basis using presently enacted taxrates.

 

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, 2004. TheCompany has a net operating loss carry forward which management believes willoffset all taxable income generated in fiscal year 2004.  Therefore, the Company estimated itseffective tax rate at 0%.

 

**7.             STOCKCOMPENSATION OF STOCK OPTIONS**

 

Wehave adopted the disclosure only provisions of Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS123”), but we continue to measure compensation cost for the stock options usingthe intrinsic value method prescribed by APB Opinion No. 25. As allowable underSFAS 123, we used the Black-Sholes method to measure the compensation cost ofstock options granted .  The Company didnot grant any stock options to employees in the period ended October 31, 2003or 2002.

 

There were no adjustments madein calculating the fair value to account for vesting provisions, fornon-transferability or risk of forfeiture. Because our employee stock optionshave characteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management’s opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of its employeestock options.

 

If we had elected to recognize compensationcost based on the value at the grant dates with the method prescribed by SFAS123, net income and earnings per share would have been changed to the pro formaamounts indicated in the following table:

 
|                                                                                                                                          |   | **For the  three months ended October 31,** |      |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|-----------|
|                                                                                                                                          |   | **2003**                                    |      | **2002** |   |
| Net Income/(loss)                                                                                                                             |   |                                        |      |   |   |
| As Reported                                                                                                                                   |   | $                                           | 1,509,962 |   | $ | 708,949 |   |
|                                                                                                                                          |   |                                        |      |   |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | 26,000                                      |      | 37,000 |   |
|                                                                                                                                          |   |                                        |      |   |   |
| Pro Forma net income (loss)                                                                                                                   |   | 1,483,962                                   |      | 671,949 |   |
| Basic Income/(loss) per Common Share:                                                                                                         |   |                                        |      |   |   |
| As Reported                                                                                                                                   |   | $                                           | 0.38      |   | $ | 0.18 |   |
| Pro Forma                                                                                                                                     |   | 0.37                                        |      | 0.17 |   |
| Diluted income/(loss) per Common Share:                                                                                                       |   |                                        |      |   |   |
| As reported                                                                                                                                   |   | $                                           | 0.37      |   | $ | 0.16 |   |
| Pro Forma                                                                                                                                     |   | 0.36                                        |      | 0.15 |   |

 

6

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**8.             EARNINGS PER SHARE**

 

Earnings per share is based onweighted average number of shares of common stock and dilutive common stockequivalents outstanding.  Basic earningsper share includes no dilution and is computed by dividing income available tocommon shareholders by the weighted average number of common shares outstandingfor the period.  Diluted earnings pershare reflects the potential dilution of securities that could share in theearnings of an entity.  The followingtable presents a reconciliation between the weighted average shares outstandingfor basic and diluted earnings per share for the three months ended October 31,2003 and October 31, 2002:

 
| **For the three months ended October 31, 2003** |   | **Income** |      | **Shares** |      | **Per Share  Amount** |   |
|-------------------------------------------------|--------|------------|-----------|------------|-----------|-----------------------|--------|
|                                            |   |       |      |       |      |                  |   |
| Basic earnings per share                        |   |       |      |       |      |                  |   |
| Income available to common shareholders         |   | $          | 1,509,962 |       | 3,996,199 |                  | $      | 0.38 |   |
| Effect of dilutive stock options                |   |       |      | 140,036    |      |                  |   |
| Dilutive earnings per share                     |   | $          | 1,509,962 |       | 4,136,235 |                  | $      | 0.37 |   |

 
| **For the three months ended October 31, 2002** |   | **Income** |    | **Shares** |      | **Per Share  Amount** |   |
|-------------------------------------------------|--------|------------|---------|------------|-----------|-----------------------|--------|
|                                            |   |       |    |       |      |                  |   |
| Basic earnings per share                        |   |       |    |       |      |                  |   |
| Income available to common shareholders         |   | $          | 708,949 |       | 3,986,809 |                  | $      | 0.18 |   |
| Effect of dilutive stock options                |   |       |    | 403,741    |      |                  |   |
| Dilutive earnings per share                     |   | $          | 708,949 |       | 4,390,550 |                  | $      | 0.16 |   |

 

**9.             CONTINGENCY**

 

The Company is, from time totime, involved in litigation incidental to the conduct of its business. TheCompany is currently involved in several actions.  In particular, the Company’s landlord at its Rhode Islandfacility has named the Company as a defendant in an action seeking security forclaims relating to the lease agreement. The Company deposited $180,000 with theregistry of the court relating to claims for payment of real estate taxes,water and sewer, rent of

 

7

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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.  In November 2003, the company has settledits claims with the landlord.  The accrualreflected in the financial statements is sufficient to cover all outstandingobligations to the landlord.

 

The Company is currentlyinvolved as Plaintiff in a suit brought before the Circuit Court for MontgomeryCounty, Maryland, presenting claims in connection with the merger agreementunder which Sherwood Brands acquired securities of Asher Candy AcquisitionCorporation and agreed to sell securities in Sherwood Brands to priorshareholders of Asher Candy.  Thecomplaint alleges that the Company was fraudulently induced to enter into themerger agreement on the basis of, among other things, materialmisrepresentations and omissions by the shareholders of Asher Candy.  Sherwood Brands is seeking declaratory andinjunctive relief and award of damages against the former shareholders of AsherCandy for violations of the merger agreement and for common law fraud andviolations of applicable securities laws. Pending resolution of the litigation, the Company has refused to honorthe demand of the former shareholders for the Company to repurchase half of theshares issued to them at a price of $4.50 per share. Certain of theshareholders have filed a counterclaim seeking $7.0 million in damages.  The Company believes that it has defenses tothe counterclaim. There can be no assurance that the Company will not be aparty to other litigation in the future.

 

**10.          LICENSING AGREEMENTS**

 

During the quarter endedOctober 31, 2003, the Company entered into one licensing agreements toincorporate products into gift sets. The royalty rates for such licenses arefrom 3% of net sales and expire in range of two to three years.

 

The products to be incorporatedinto the Company’s gift set items is during the Christmas holiday  season and are effective on the sellingseason of January 2004. The Company paid $5,000 in advance fee to have therights to incorporate products into its gift set items. These advance fees willbe offset against any amounts due on royalties. There is a $20,000 minimumguarantee license fee under these agreements. The Company incurred $15,185,royalties related to the quarter ended October 31, 2003. The Company iscurrently pursuing other licenses with similar terms and conditions.

 

**11.          CREDIT FACILITY**

 

During the quarter endedOctober 31, 2003, the Company was in no violation of the certain business andfinancial covenants under its credit facility relating to the fixed chargecoverage ratio.  . Management believesthe Company will comply with the restrictive covenants for the remainder of2004.

 

8

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**12.          CONCENTRATION OF CREDIT RISK ANDEXPORT SALES**

 

The Company has a variety ofcustomers, including mass merchandisers, drug stores and grocery storesthroughout the United States and abroad. For the quarter ended October 31, 2003three customers accounted for approximately 16%, 12% and 10% of the Company’snet sales. For the quarter ended October 31, 2002 the same three customersaccounted for approximately 16%, 8% and 13% of the Company’s total net sales.  The Company had sales to customers in Canadawhich represent 0.23% and 0.44% of net sales for quarter ended October 31, 2003and 2002, respectively.

 

**13.          OPERATINGSEGMENTS**

 

We operate in the confectioneryindustry and align our operations into three business segments for managementreporting purposes. These segments are based on product type. This alignmentallows management to measure financial performance by product type. Ourbusiness segments are (i) Manufactured Candy and Cookies, (ii) Purchased Candyand Cookies and (iii) Purchased Gift Items. We report these as reportablesegments in accordance with SFAS 131, “Disclosures about Segments of anEnterprise and Related Information.” The accounting policies of the operatingsegments are the same as those described in the summary of significantaccounting policies.

 

Our Chief Operating DecisionMaker, who is our Chairman and Chief Executive Officer, evaluates performancebased upon a measure of segment operating profit or loss that includes anallocation of common expenses, but excludes some unallocated expenses.Unallocated expenses represent corporate expenditures that are not specificallyallocated to the segments.

 

Ourreportable segments are strategic business units that offer different productsin different geographic areas.  We haveno assets outside of the United States. There is no concentration of net sales in any one area within the UnitedStates.  Net sales outside of the UnitedStates are minimal.

 
|                          |   |                    |      | **Three  Months ended October 31, 2003** |   |
|-------------------------------|--------|-------------------------|-----------|------------------------------------------|--------|
|                          |   | **Manufactured  Candy** |      | **Purchased  Candy**                     |   | **Gift  Items** |   | **Other** |   | **Consolidated  Total** |   |
| Total revenue                 |   | $                       | 5,605,903 |                                     | $      | 8,302,312 |   | $ | 3,515,126 |   | $ | — |   | $ | 17,420,813 |   |
| Gross margin                  |   | 90,326                  |      | 3,801,575                                |   | 1,147,298 |   | — |   | 5,036,671 |   |
| Interest expense              |   | 113,643                 |      | 86,225                                   |   | 36,893 |   | — |   | 236,766 |   |
| Segment assets                |   | 10,731,663              |      | 17,662,819                               |   | 12,640,937 |   | 1,355,713 |   | 42,391,132 |   |
| Depreciation and amortization |   | 172,919                 |      | —                                   |   | 33,884 |   | 41,868 |   | 248,444 |   |
|                               |        |                         |           |                                          |        |  |  |  |  |  |  |  |  |  |  |  |

 

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|                          |   |                    |       | **Three  Months ended October 31, 2002** |   |
|-------------------------------|--------|-------------------------|------------|------------------------------------------|--------|
|                          |   | **Manufactured  Candy** |       | **Purchased  Candy**                     |   | **Gift  Items** |   | **Other** |   | **Consolidated  Total** |   |
| Total revenue                 |   | $                       | 10,161,103 |                                     | $      | 6,106,501 |   | $ | 2,194,608 |   | $ | — |   | $ | 18,462,212 |   |
| Gross margin                  |   | 2,177,604               |       | 2,626,442                                |   | 702,423 |   | — |   | 5,506,469 |   |
| Interest expense              |   | 67,707                  |       | 51,370                                   |   | 21,980 |   | — |   | 141,057 |   |
| Segment assets                |   | 10,155,339              |       | 18,081,409                               |   | 15,453,418 |   | 1,658,453 |   | 45,348,619 |   |
| Depreciation and amortization |   | 159,782                 |       | —                                   |   | 25,572 |   | 37,567 |   | 222,921 |   |
|                               |        |                         |            |                                          |        |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 2.****    Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

Important Information RegardingForward-Looking Statements

 

This quarterly report on Form10-Q contains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. Those statements include statements regardingthe intent, belief or current expectations of the company and itsmanagement.  Such statements are subjectto a variety of risks and uncertainties, many of which are beyond our control,which could cause actual results to differ materially from those contemplatedin such forward-looking statements, including in particular the risks anduncertainties described under “Risk Factors” in our Form 10-K filed with thecommission on October 29, 2003. 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.

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof certain assets and liabilities at the date of the financial statements.Significant estimates in our financial statements include the accountsreceivable and inventory reserves. We continually evaluate these reserves basedupon historical experience. Although actual results could differ from thosedisclosed, management feels that the estimates used to establish the reservesare conservative in nature. Furthermore, management contends that it would beunlikely that the reserve level would be materially different from any otherindependently prudently established reserve.

 

If any of the following risksoccurs, our business, financial condition or results of operations could beadversely affected.

 

The loss of a significantcustomer could have an adverse effect on our business. We are dependent on alimited number of customers for a significant portion of our revenues. Sam’s

 

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Club and Wal-Mart accounted forapproximately 12% and 8%, respectively, of our sales for the quarter endedOcotber 31, 2003. We do not maintain agreements with our customers and sellproducts pursuant to purchase orders placed from time to time in the ordinarycourse of business. The loss of a significant customer could have an adverseeffect on our business.

 

We face significant competitionin the marketing and sales of our products. Our products compete for consumerrecognition and shelf space with candies, cakes, cookies, chocolates and otherfood products which have achieved international, national, regional and localbrand recognition and consumer loyalty. These products are marketed bycompanies (which may include our suppliers) with significantly greaterfinancial, manufacturing, marketing, distribution, personnel and otherresources than we have. Some of these competitors, such as Hershey FoodCorporation, Masterfoods USA (M&M Mars), Inc., Nestle, S.A., and KraftFoods, dominate the markets for candy and cookie products, and have substantialpromotional budgets which enable them to implement extensive advertisingcampaigns. The food industry is characterized by frequent introductions of newproducts, accompanied by substantial promotional campaigns. If we are unable tocontinue to compete successfully our business could be adversely affected.

 

We face various risks relatingto a recent acquisition. In May 2002 we acquired the business of Asher CandyAcquisition Corporation. Asher Candy Acquisition Corporation manufactured candycanes, a product which we had no prior experience in manufacturing. If we areunable to successfully produce a quality product, and maintain or increase thecustomer base, our profitability could be adversely affected.

 

Our success is highly dependenton consumer preferences and industry factors. The markets for candy and cookieproducts are affected by changes in consumer tastes and preferences andnutritional and health-related concerns. We could be subject to increasedcompetition from companies whose products or marketing strategies address theseconcerns. In addition, the markets for our products may be subject to national,regional and local economic conditions which affect discretionary spending,demographic trends and product life cycles, whereby product sales increase fromtheir introductory stage through their maturity and then reach a stage ofdecline over time.

 

We have limited historicalprofitability and may not be profitable in the future. We have historically,until recently, achieved limited profitability. Our operating expenses haveincreased and can be expected to continue to increase in connection with anyexpansion activities undertaken by us, including those relating to advertisingand product manufacturing. Accordingly, our profitability will depend on ourability to improve our operating margins and increase revenues from operations.Unanticipated expenses, unfavorable currency exchange rates, increased pricecompetition and adverse changes in economic conditions could have a materialadverse effect on our operating results. If we are unable to achievesignificantly increased levels of revenues, our future operations may notcontinue to be profitable.

 

We depend on our trademarks. Wehold United States trademark registrations for the “ELANA,” “RUGER”, “TONGUETATTOO”, “STRIP-O-POP”, “SMILE POPS” and “demitasse” names, and have filedapplications to register certain other names, including “COWS,” and use other

 

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names for which we have notapplied for registration. We believe that our rights to these names are asignificant part of our business and that our ability to create demand for ourproducts is dependent to a large extent on our ability to exploit thesetrademarks. Our failure to protect our trademarks and other intellectualproperty rights could negatively impact the value of our brand names. We arerequested some of our marks in countries other than the U.S. and may apply foradditional registration as appropriate.

 

We are dependent on third partymanufacturers and suppliers. We are dependent on the ability of ourmanufacturers to adhere to our product, price and quality specifications andscheduling requirements. Our operations require us to have production orders inplace in advance of shipment to our warehouses (product deliveries typicallytake 60 days). Any delay by manufacturers in supplying finished products to uswould adversely affect our ability to deliver products on a timely andcompetitive basis. In addition, raw materials necessary for the manufacture ofour products at our facilities, including flour, sugar, shortening, butter andflavorings, are purchased from third-party suppliers. We do not maintainagreements with any such suppliers and we are, therefore, subject to risks ofperiodic price fluctuations, shortages and delays. If there is a materialinterruption in the availability or significant price increases for rawmaterials would have a material adverse effect on our operating margins.

 

We face various risks relatingto foreign manufacturing. During the three months ended October 31, 2003 and2002, approximately 45% and 33% , respectively, of our products weremanufactured in foreign countries. We have been and will continue to be subjectto risks associated with the manufacture of products in foreign countries,primarily in Argentina, Austria, Belgium, China and Holland. These risksinclude material shipping delays, fluctuations in foreign currency exchangerates, customs duties, tariffs and import quotas and international political,regulatory and economic developments. We assume the risk of loss, damage ordestruction of products when shipped by a manufacturer. Because we pay for someof our products manufactured outside the United States in foreign currencies,any weakening of the United States dollar in relation to relevant foreigncurrencies, could result in significantly increased costs to us. In addition,some products manufactured overseas are subject to import duties. Deliveries ofproducts from our foreign manufacturers could also be delayed or restricted bythe future imposition of quotas. If quotas were imposed, it is possible that wewould not be able to obtain quality products at favorable prices from domesticor other suppliers whose quotas have not been exceeded by the supply ofproducts to their existing customers.

 

Our operating results aresubject to fluctuations as a result of new product introductions, the timing ofsignificant operating expenses and customer orders, delays in shipping orders,pricing and seasonality.  We are subjectto government regulation. We are subject to extensive regulation by the UnitedStates Food and Drug Administration, the United States Department ofAgriculture and by other state and local authorities in jurisdictions in whichour products are manufactured or sold. Among other things, such regulationgoverns the importation, manufacturing, packaging, storage, distribution andlabeling of our products, as well as sanitary conditions and public health andsafety. Applicable statutes and regulations governing our products include“standards of identity” for the content of specific types of products,nutritional labeling and serving size requirements and general “GoodManufacturing Practices” with respect to manufacturing processes. Ourfacilities and products are subject to periodic inspection by federal, stateand local

 

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authorities. Our failure tocomply with applicable laws and regulations could subject us to civil remedies,including fines, injunctions, recalls or seizures, as well as potentialcriminal sanctions.

 

We may incur product liabilityclaims that are not fully insured. As a manufacturer and marketer of foodproducts, we are subject to product liability claims from consumers. Wemaintain product liability insurance with limits of $2,000,000 in the aggregateand $1,000,000 per occurrence (with excess coverage of $10,000,000). Theseinsurance amounts may not be sufficient to cover potential claims and adequatelevels of coverage may not be available in the future at a reasonable cost. Inthe event of a partially or completely uninsured successful claim against us,our financial condition and reputation would be materially adversely affected.

 

We aredependent on key personnel and the loss of these key personnel could have amaterial adverse effect on our success. Our success is dependent on thepersonal efforts of Uziel Frydman, our Chairman, President and Chief ExecutiveOfficer, Amir Frydman, our Vice President of Marketing and Christopher Willi,our Chief Financial Officer. The loss or interruption of the services of suchindividuals could have a material adverse effect on our business. We maintain“key-man” insurance in the amount of $1,000,000 on the life of Mr. UzielFrydman. Our success also depends upon our ability to hire and retainadditional qualified management, marketing and other personnel. Employment andretention of qualified personnel is important due to the competitive nature ofthe food industry. Our failure to hire and retain qualified personnel couldadversely affect our success.

 

Our Presidentand Chief Executive Officer controls our company. Mr. Uziel Frydman, Presidentand Chief Executive Officer, owns 400,000 shares of Class A Common Stock (witha right to acquire an additional 202,984 upon the exercise of options) and1,000,000 shares of Class B Common Stock, representing, in the aggregate,approximately 43% of the outstanding Common Stock of our company and 76% of thevoting control of our company, assuming that all of the warrants are exercised.Accordingly, Mr. Frydman will be able to direct the election of all of ourcompany’s directors, increase the authorized capital, dissolve, merge or sellthe assets of our company, and generally direct the affairs of our company. Inaddition, the level of control exercised by Mr. Frydman may discourageinvestors from purchasing our Common Stock.

 

We may issue“blank check” preferred stock that would prevent a change of control. OurArticles of Incorporation, as amended, authorize our board of directors toissue up to 5,000,000 shares of “blank check” preferred stock withoutstockholder approval, in one or more series and to fix the dividend rights,terms, conversion rights, voting rights, redemption rights and terms,liquidation preferences, and any other rights, preferences, privileges, andrestrictions applicable to each new series of preferred stock. The issuance ofshares of preferred stock in the future could, among other things, adverselyaffect the voting power of the holders of common stock and, under certaincircumstances, could make it difficult for a third party to gain control of ourcompany, prevent or substantially delay a change in control, discourage bidsfor the Common Stock at a premium, or otherwise adversely affect the marketprice of the Common Stock.

 

We areprohibited from paying dividends by the terms of our financing agreements. Wehave never paid any cash dividends on our common stock and do not anticipatepaying cash dividends

 

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in the foreseeable future. Thepayment of cash dividends is prohibited by the terms of our financingagreements.

 

For the year ended July 31,2003 and first quarter ended October 31, 2003, we had a total of sixteenlicensing agreements, one signed during first quarter ended October 31, 2003,nine signed during the fiscal year ended July 31 ,2003 and six signed duringthe fiscal year ended July 31 ,2002, to incorporate our products into gift setsand to manufacture candies and wafers. The royalty rates for such licensesrange from 2% to 12% of net sales and expire in range of 2 to 3 years. Theproducts to be incorporated into our gift set items are primarily for the firstquarter and Easter selling season. We entered into a licensing agreement toproduce everyday candies and wafers. We paid $242,000 in advance fees for therights under the licensing agreements. These advance fees were offset againstany amounts due on royalties. There were no other minimum license fees underthese agreements. For the quarter ended October 31 ,2003, we incurred $15,185in royalties. We are currently pursuing other licenses with similar terms andconditions. We expect the greatest impact from the agreements will occur in theyear ending July 31, 2004.

 

Our Rhode Island manufacturingfacility, which occupied five stories in an old building, closed on May 31,2002. All the production equipment, together with the electrical, piping, steamand air-conditioning were disassembled and transferred to our expanded ChaseCity, Virginia facility. This 75,000 square feet facility, with an additional25,000 square feet from a recent expansion, and the 73,000 square foot facilityat Keysville, Virginia (about 20 miles from Chase City, Virginia), would becomethe single manufacturing and distribution facility under one plant managementfor all products produced at the Chase City facility

 

Christmas, Easter gift sets andgift baskets are distributed at the Rhode Island and Massachusetts facilities.We source product primarily from the Pacific Rim. We are continually looking tofurther reduce costs by more efficient sourcing.

 

We did not exercise the optionsto extend the term of the lease on our office and assembly facility in RhodeIsland and we plan to vacate the location on March 31, 2004.  After March 31, 2004, our New Bedford,Massachusetts facility together with a planned West Coast assembly anddistribution facility will be utilized to improve our shipping costs andassembly of our products.

 

**EnvironmentalFactors Affecting the Performance in the Quarter Ended October 31, 2002.**

 

On September 30, 2002, 29 westcoast ports were shut down abruptly and remained closed as contractnegotiations between dock-workers and shipping companies broke off negotiationsfor new contracts. The shut down occurred during our peak inventory shippingperiod for orders for the holiday season. In mid-October 2002, the President ofthe United States of America signed an order under the Taft-Hartley Act toreopen the ports and put a moratorium on the strike for 60 days. The shut downhad an effect on our first quarter of shipments to our customers. A largeportion of containers, which were to be received, remained either at ports oron shipping vessels on the water. In addition, empty containers were notbrought back to ports in the Pacific Rim, which we needed to move some of ourother products.  In mid-October 2002,our inventory

 

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began to be released forshipment to our facility in New Bedford, Massachusetts. A slow down by the longshore-men on shipping products was still prevalent. Our revenues for the threemonths ended October 31 ,2002 were impacted by the shut down and resulted in adelay of approximately $6.0 million in sales. Approximately $3.5 million in inventory was shipped out during thesecond quarter and approximately $2.5 million of the remaining inventory willbe shipped during the first and second quarters of fiscal year 2004. We shipped$0.5 million of this inventory in the quarter ended October 31, 2003.

 

**Resultsof Operations**

 

**ThreeMonths Ended October 31, 2003 and 2002**

 

Net sales for the three monthsended October 31, 2003 and 2002 were $17,420,813 and $18,462,212 respectively,a decrease of 5.6%, or $1,041,399.  Thedecline in net sales was due to lower sales of manufactured candy ofapproximately $4,500,000 offset by increases in sales of purchased candy of$2,200,000 and an increase of $1,250,000 on sales of gift sets. Big Lots, Sam’sClub and Dollar General accounted for approximately 16%, 12% and 10%,respectively, of sales for the three months ended October 31, 2003. Big Lots,Dollar Tree and Sam’s Club accounted for approximately 16%, 13% and 8%,respectively, of sales for the prior year’s comparable period.

 

Net sales for each of ourbusiness segments was as follows:

 

Net sales of Manufactured Candydecreased from $10.1 million for the three months ended October 31, 2002 to$5.6 million for the three months ended October 31, 2003.  The decrease of $4.5 million was primarilydue to a decline of $2.9 million of sales of manufactured candy canes, ofwhich, $1.5 million relates to firm orders scheduled to be shipped in the firstquarter but delayed until the second quarter of 2004, $0.4 million decline inour manufactured items for Halloween, $0.6 million decline in Kastins Christmascandy and $0.6 million decline in Cows sales.

 

Net sales of Purchased Candyincreased from $6.1 million for the three months ended October 31, 2002 to $8.3million for the three months ended October 31, 2003. The increase of $2.2million was primarily due to increases in the sale of purchased candy of $0.6million and $1.6 million of purchased gift items, which had been assembled atour New Bedford, Massachusetts facility in the prior fiscal year.

 

Net sales of Gift Itemsincreased from $2.2 million for the three months ended October 31, 2002 to $3.5million for the period ended October 31, 2003. The $1.3 million increase was primarily a result  of a $2.0 million increase of sales ofChristmas assembled goods, offset by $0.7 million of health and beauty giftitems purchased as a one time item by Wal-Mart.

 

Gross margins decreased to $5.0million for the three months ended October 31, 2003 from $5.5 million for thethree months ended October 31, 2002, and decreased to 28.9% from 29.8% aspercent of sales, respectively.

 

Gross margins for each of ourbusiness segments were as follows:

 

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Gross margins on ourManufactured Candy decreased from $2.7 million to $0.1 million for the threemonths ended October 31, 2003 and 2002, respectively.  The decrease was mainly attributable to increased labor costs andoverhead expenses at our manufacturing plant in New Hyde Park, New York.

 

Gross margins for our PurchasedCandy increased from $2.6 million to $3.8 million for the three months endedOctober 31, 2002 and 2003, respectively. The increase was primarily due to  purchased pre-packed assembled gift itemsthat were not assembled in our New Bedford, Massachusetts facility and betterpricing of purchased candy from our third party overseas suppliers.

 

Gross margins on our Gift Itemsincreased from $0.7 million to $1.1 million for the three months ended October31, 2002 and 2003, respectively.  Theincrease was due primarily to lower labor associated with the assembly of ourproducts.  For the three months endedOctober 31, 2002, we were reliant on contract labor.  For the three months ended October 31, 2003, we shifted back toutilizing hourly employees.

 

During the three months endedOctober 31, 2003 and 2002, selling, general and administrative expensesdecreased to $2.2 million from $2.6 million, respectively, and decreased to12.8% from 13.9% as a percent of sales, respectively. The decrease was largelydue to $98,000 in travel expenses, $131,000 of shipping and carrier costs,$24,000 in building rental costs, $28,000 in bank fees, $16,000 ofpre-employment costs and $35,000 in property insurance expenses.

 

Pre-productions startup costsdecreased to $0 during the three month ended October 31, 2003 compared to$503,936 from the three months ended October 31, 2002 period.  In the fourth quarter of fiscal year endedJuly 31, 2002, we reduced the level of employees and the scope of operationseliminating the need for continued training costs for new employees at ourChase City, Virginia facility.

 

Salaries and related expensesdecreased to $1,062,982 for the three months ended October 31, 2003, from$1,175,008 for the three months ended October 31, 2002, or 6.1% from 6.4%,respectively, as a percent of sales. This decrease resulted from a decline of$112,000 in our overhead due to our reorganization effort in the fourth quarterof the fiscal year ended July 31, 2003.

 

As a result, operating expensesfor the three months ended October 31, 2003 decreased to $3.3 million from $4.2million for the three months ended October 31, 2002 and decreased to 18.9% from23.0%, respectively, as a percent of sales.

 

Income from operations for thethree months ended October 31, 2003 was $1.7 million as compared to income of$1.3 million for the prior year’s comparable period. Most of the increaseresulted from the decrease in pre production start up costs of approximately$0.5 million and other expense explained in results from operating expenses.

 

For the three months endedOctober 31, 2003, interest income decreased to $19 from $2,259 for

 

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the three months ended October31, 2002 as reserves declined. For the three months ended October 31, 2003,interest expenses increased to $236,766 from $141,057 for the three monthsended October 31, 2002 due to an increase in our term debt financing of $1.3million associated with the merger with Asher Candy and interest on thesubordinated debt instrument we entered into during the fiscal year ended July31, 2003.

 

For the three months endedOctober 31, 2003, other income increased to $4,537 from $1,536 for the threemonths ended October 31, 2002 due to $6,000 of realized losses on foreignexchange transactions and $10,349 in gains on sales of assets at the Chase Cityfacility.

 

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, 2004. TheCompany has a net operating loss carry forward which management believes willoffset all taxable income generated in fiscal year 2004.  Therefore, the Company estimated itseffective tax rate at 0%.

 

**Liquidityand Capital Resources**

 

Our primary cash requirementshave been to fund the purchase, manufacture and commercialization of ourproducts. We finance our operation and manufacturing with cash flow fromoperations and bank financing. Our working capital at October 31, 2003 and July31, 2003 was $2,326,951 and $669,015, respectively.

 

Net cash used in operatingactivities for the three months ended October 31, 2003 and 2002,  was $10,005,966 and $9,030,289,respectively. The increase in cash used by operating activities was dueprimarily to increases in accounts receivable and inventory, which where offsetby the increase in net income, accounts payable accrued expenses.

 

Net cash provided in investingactivities for the three months ended October 31, 2003 and 2002, increased to$30,759 from cash used of  $351,960,respectively, primarily due to decreased capital improvements for themanufacturing operations into our Chase City, Virginia facility and theproceeds from the sale of assets.

 

Net cash provided by financingactivities for the three months ended October 31, 2003 and 2002, was $9,869,265and $9,399,825, respectively.  Thisincrease was primarily due to increased reliance on borrowings under our lineof credit to finance working capital needs for seasonal materials.  The borrowings for the period ended October31, 2003 was approximately $9,995,531 as compared to $9,114,060 for the prioryears comparable period.  We have$8,004,469 of our $18,000,000 line of credit available to meet additional seasonalneeds to purchase and manufacture inventory subject to availability of accountsreceivable and inventory.

 

Principal payments for ourlong-term debt for the three months ended October 31, 2003, were $126,266. Webelieve that cash provided by operations will be sufficient to finance our operationsand fund debt service requirements.

 

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**Scheduleof Contractual Obligations**

 
|                         |   |      |      | **Payments  Due by Period** |   |
|------------------------------|--------|-----------|-----------|-----------------------------|--------|
| **Contractual Obligation**   |   | **Total** |      | **Less Than  1 year**       |   | **1-3 years** |   | **After 4  years** |   |
| Long-Term Debt               |   | $         | 1,558,466 |                        | $      | 530,376 |   | $ | 870,992 |   | $ | 157,098 |   |
| Subordinated Debt            |   | 2,000,000 |      | 2,000,000                   |   | — |   | — |   |
| Capital Lease Obligation     |   | 420,050   |      | 15,718                      |   | 125,000 |   | 279,332 |   |
| Operating Leases             |   | 973,926   |      | 380,798                     |   | 358,284 |   | 234,844 |   |
| Total Contractual Obligation |   | $         | 4,952,442 |                        | $      | 2,926,892 |   | $ | 1,354,276 |   | $ | 671,274 |   |

 

**Scheduleof Commercial Commitments**

 
|                         |   |      |       | **Amount of  Commitment expiration per period** |   |
|------------------------------|--------|-----------|------------|-------------------------------------------------|--------|
| **Commercial Commitments**   |   | **Total** |       | **Less Than  1 year**                           |   | **1-3 years** |   | **After 4  years** |   |
| Line of Credit (*)           |   | $         | 18,000,000 |                                            | — |   | $ | 18,000,000 |   | — |   |
| Total Commercial Commitments |   | $         | 18,000,000 |                                            | — |   | $ | 18,000,000 |   | — |   |

 

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(*)         Theline of credit is available for advances to finance working capital and theissuance 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 facility varies fromquarter to quarter based on working capital needs and the level of repayments.

 

**Item 3.****    Quantitativeand Qualitative Disclosures About Market Risk**

 

As a result of its variablerate line of credit, we are exposed to the risk of rising interest rates. Our$18,000,000 line of credit had an interest rate ranging from 4.11% to 4.12% forthe three months ended October 31, 2003. Our long-term debt is at variablemarket tax 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 marketrate.

 

**SignificantAccounting Policies and Estimates**

 

Our preparation of financialstatements in conformity with accounting principals generally accepted withinthe United States requires management to make estimates and assumptions incertain circumstances that effect amounts reported in the accompanyingfinancial statements and related notes. In preparing these financial statement,management has made its best estimates and judgments of certain amountsincluded in the financial statements, giving due consideration to materiality.We do not believe there is a great likelihood that materially different amountswould be reported related to the accounting policies described below; however,application of these accounting policies involves the exercise of judgment andthe use of assumptions as to future uncertainties and, as a result, actualresults could differ from these estimates.

 

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We provide an allowance forun-collectible accounts receivable based on experience. We consider thefollowing factors in developing an estimate of our allowance for non-paymentand the overall economic environment. Although it is reasonably possible thatmanagement’s estimate of un-collectible accounts could change in the nearfuture, management is not aware of any events that would result in a change toits estimates which would be material to our financial position or results fromoperations. For the quarter ended October 31, 2003, we had an allowance fordoubtful accounts of approximately $92,000.

 

We provide an allowance forslow moving inventory based on experience and aging of products. We considerthe following factors in developing an estimate of our allowance for non-movingof inventory and the overall economic environment. Although it is reasonablypossible that management’s estimate of slow moving inventory could change inthe near future, management is not aware of any events that would result inchange to its estimates which would be material to our financial position orresults from operations. For the quarter ended October 31, 2003, we had anallowance for slow moving inventory of approximately $1,081,792.

 

Goodwill represents the excessof consideration over the net assets acquired resulting from acquisitions ofcompanies accounted for by the purchase method. We utilize the annualevaluation as required by SFAS 142. At each Balance Sheet date, managementevaluates the recoverability of the goodwill and reviews goodwill and otherlong-lived assets for impairment. As of October 31, 2003 there was noimpairment loss.

 

In April 2003, the FASB issuedStatement No. 149, Amendment of Statement 133 on Derivative Instruments andHedging Activities. This Statement amends and clarifies financial accountingand reporting for derivative instruments, including certain derivativeinstruments embedded in other contracts (collectively referred to asderivatives) and for hedging activities under FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities. We adopted theuse of this accounting statement in June 2003. Adoption did not have a materialeffect on our financial position or results of operations.

 

In May 2003, the FASB issuedStatement No. 150, Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity. This Statement establishedstandards on how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity and requires anissuer to classify a financial instrument that is within its scope as aliability, or an asset in some circumstances. We adopted the use of thisaccounting statement in May 2003. Adoption did not have a material effect onour financial position or results of operations.

 

**Seasonalityand Cylicality; Fluctuation in Quarterly Operating Results**

 

We have experienced and expectto continue to experience variability in revenues and net income from quarterto quarter as a result of seasonality that may accompany private or publicsector budget cycles. Sales of our products have historically been higher inthe first and second quarters as a result of patterns of capital spending byour customers.

 

We also believe that theconfectionery industry is influenced by general economic conditions andparticularly by the level of change. Increase levels of change can have afavorable impact on our

 

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revenues. We also believe thatthe confectionary industry tends to experience periods of decline and recessionduring economic downturns. The confectionary industry could sustain periods ofdecline in revenues in the future, and any decline may materially adverselyeffect us.

 

We could in the futureexperience quarterly fluctuations in operating results due to the factorsdescribed above and other factors, including short-term nature of certainclient commitments; patterns of capital spending by customers; loss of a majorclient; seasonality that may accompany private or public budget cycles; pricingchanges in response to various competitive factors; market factors affectingavailability of qualified personnel and general economic conditions.

 

**Item 4.****    Controls andProcedures**

 

As of the end of the periodcovered by this report, our Chief Executive Officer and our Chief FinancialOfficer (collectively, the “certifying officers”) have evaluated theeffectiveness of our disclosure controls and procedures (as such term isdefined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act).  These disclosure controls and procedures aredesigned to ensure that the information required to be disclosed by us in ourperiodic reports filed with the Commission is recorded, processed, summarizedand reported within the time periods specified by the Commission’s rules andforms, and that the information is communicated to the certifying officers on atimely basis.

 

The certifying officersconcluded, based on their evaluation, that our disclosure controls andprocedures are effective, taking into consideration the size and nature of ourbusiness and operations.

 

No change in our internalcontrol over financial reporting (as such term is defined in Rules 13a-15(f)and 15d-15(f) of the Exchange Act) occurred during the last fiscal quarter thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II OTHER INFORMATION**

 

**Item 1.****    LegalProceedings**

 

We are from time to timeinvolved in litigation incidental to the conduct of its business. We arecurrently a plaintiff in several actions and currently in particular to thelandlord at its Rhode Island Facility. The landlord sought security for itsclaims relating to the lease agreement. The company deposited $180,000 with the registry of the court onallegation relating to amounts sought for payment of real estate taxes, waterand sewer, rent of other occupied space and repair expenses. On September 2002,the landlord claimed other breaches of the Lease Agreement alleging anobligation of $932,000 under the lease and has demanded $750,000 to settle thedisputes.  We have continued claimsagainst the landlord and continue to occupy space at the leased premises. Wehave accrued amounts to cover current charges. Management does not believe thatthe outcome of these actions, individually or in the Aggregate, would have amaterial adverse effect on our financial statements.  In November 2003, we settled the claims with the landlord.  The accrual in the financial statements issufficient to cover all outstanding obligations to the landlord.

 

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We are currently involved asPlaintiff in a suit brought before the Circuit Court for Montgomery County,Maryland, presenting claims in connection with the  merger agreement under which Sherwood Brands acquired securitiesof Asher Candy Acquisition Corporation and agreed to sell securities inSherwood Brands to prior shareholders of Asher Candy.  The complaint alleges that we were fraudulently induced to enterinto the merger agreement on the basis of, among other things, materialmisrepresentations and omissions by the shareholders of Asher Candy.   We are seeking declaratory and injunctiverelief and award of damages against the former shareholders of Asher Candy forviolations of the merger agreement and for common law fraud and violations ofapplicable securities laws.  Pendingresolution of the litigation, we have refused to honor the demand of the formershareholders for us to repurchase half of the shares issued to them at a priceof $4.50 per share. Some of the shareholders have filed a counterclaim seeking$7.0 million in damages.  We believethat we have defenses to the counterclaim. There can be no assurance that wewill not be a party to other litigation in the future.

 

**Item4.    Submission of Matters to a Vote of SecurityHolders**

 

None.

 

**Item5.    Other Information**

 

None.

 

**Item 6.****    Exhibits andReports on Form 8-K**

 

(a)           Exhibits

 

None.

 

(b)           Reports on Form 8-K

 

None.

 

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**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the Registrant has duly caused thisamended report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                     | SHERWOOD  BRANDS, INC.                            |
|--------------------------|---------------------------------------------------|
|                     |                                              |
| Date:  December 12, 2003 | /s/ Uziel  Frydman                                |   |
|                     | Chairman,  President and Chief Executive  Officer |
|                     |                                              |
| Date:  December 12, 2003 | /s/  Christopher J. Willi                         |   |
|                     | Chief  Financial Officer and Secretary            |

 

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**Exhibit Index**

 
| **Exhibit No.** |   | **Description**                                                                                                          |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                     |
| 31.1            |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|            |   |                                                                                                                     |
| 31.2            |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|            |   |                                                                                                                     |
| 32.1            |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |
|            |   |                                                                                                                     |
| 32.2            |   | 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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