**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC  20549**

 

**FORM 10-Q**

 

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

 

For the quarterly periodended:  **April 30,2004**

 

Commission File Number:  **1-14091**

 

**SHERWOODBRANDS, INC.**

(Exact name of Registrant as specified in itscharter)

 

| **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 checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports and (2) has been subject to such filingrequirement for the past 90 days.

 

Yes ý        Noo

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

 

Yes o        No ý

 

The number ofshares outstanding of the registrant’s Class A Common Stock, $.01 par value pershare, as of  June 11, 2004 was3,033,476. The number of shares outstanding of the registrant’s Class B CommonStock, $.01 par value per share, as June 11 , 2004 was 1,000,000. TheClass B Common Stock is not publicly traded.

 

 

----

 

**SHERWOODBRANDS, INC.**

 

**INDEX**

 
| PART I                                                                                                         | FINANCIAL INFORMATION                                                                       |   |
|----------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|--------|
|                                                                                                           |                                                                                        |   |
| Item 1.                                                                                                        | FINANCIAL STATEMENTS                                                                        |   |
|                                                                                                           |                                                                                        |   |
| Consolidated Balance Sheets  - April 30, 2004 (unaudited) and July 31, 2003                          |                                                                                        |
| Consolidated  Statements of Operations - Three and nine months ended April 30, 2004  and 2003 (unaudited) |                                                                                        |
| Consolidated  Statements of Cash Flows - Nine months ended April 30, 2004 and 2003  (unaudited)           |                                                                                        |
| Consolidated  Statements of Stockholders Equity - Nine months ended April 30, 2004  (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                                                                                                     |                                                                                        |

 

----

 

**SHERWOODBRANDS, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                         |   | **April 30,  2004** |       | **July 31,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|--------|
|                                                                                                                         |   | **(unaudited)**          |       | **(audited)**           |   |
| Assets                                                                                                                       |   |                     |       |                    |   |
| Current assets                                                                                                               |   |                     |       |                    |   |
| Cash and cash equivalents                                                                                                    |   | $                        | 91,879     |                    | $      | 227,352 |   |
| Accounts receivable, less allowance of  $232,000 and $92,000                                                                 |   | 3,279,174                |       | 899,230                 |   |
| Inventory                                                                                                                    |   | 10,036,966               |       | 13,719,294              |   |
| Income taxes receivable                                                                                                      |   | 1,502,489                |       | 1,020,379               |   |
| Other current assets                                                                                                         |   | 593,128                  |       | 578,155                 |   |
| Deferred taxes on income                                                                                                     |   | 346,000                  |       | 614,000                 |   |
| Total current assets                                                                                                         |   | 15,849,636               |       | 17,058,410              |   |
| Net property and equipment                                                                                                   |   | 6,435,684                |       | 7,129,227               |   |
| Goodwill                                                                                                                     |   | 2,001,330                |       | 2,001,330               |   |
| Other assets                                                                                                                 |   | 155,952                  |       | 313,504                 |   |
| TOTAL ASSETS                                                                                                                 |   | $                        | 24,442,602 |                    | $      | 26,502,471 |   |
| Liabilities and Stockholders’ Equity                                                                                    |   |                     |       |                    |   |
| Current liabilities                                                                                                          |   |                     |       |                    |   |
| Line of credit                                                                                                               |   | $                        | 6,400,321  |                    | $      | 6,260,264 |   |
| Current portion of long-term debt                                                                                            |   | 515,377                  |       | 530,377                 |   |
| Current portion of subordinated debt                                                                                         |   | 3,397,140                |       | 2,000,000               |   |
| Current portion of capital lease obligation                                                                                  |   | 15,718                   |       | 15,718                  |   |
| Accounts payable                                                                                                             |   | 1,828,011                |       | 6,257,145               |   |
| Accrued expenses                                                                                                             |   | 1,467,179                |       | 1,325,891               |   |
| Total current liabilities                                                                                                    |   | 13,623,746               |       | 16,389,395              |   |
| Deferred taxes on income                                                                                                     |   | 464,000                  |       | 464,000                 |   |
| Long-term debt                                                                                                               |   | 730,402                  |       | 1,150,513               |   |
| Obligations under capital lease                                                                                              |   | 412,192                  |       | 423,892                 |   |
| TOTAL LIABILITIES                                                                                                            |   | 15,230,340               |       | 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, 3,033,476 and 3,003,476 shares issued and  outstanding |   | 30,335                   |       | 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                                                                                                   |   | 9,893,380                |       | 9,843,774               |   |
| Retained earnings (deficit)                                                                                                  |   | (721,453                 | )          | (1,809,138              | )      |
|                                                                                                                         |   |                     |       |                    |   |
| TOTAL STOCKHOLDERS’ EQUITY                                                                                              |   | 9,212,262                |       | 8,074,671               |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                              |   | $                        | 24,442,602 |                    | $      | 26,502,471 |   |

 

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

 

1

----

 

**SHERWOODBRANDS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONSUNAUDITED**

 
|                                                |   | **Three  Months Ended** |       | **Nine  Months Ended April 30,** |   |
|-----------------------------------------------------|--------|-------------------------|------------|---------------------------------------|--------|
|                                                |   | **2004**                |       | **2003**                              |   | **2004** |   | **2003** |   |
|                                                |   |                    |       |                                  |   |   |   |   |   |
| Net sales                                           |   | $                       | 9,344,200  |                                  | $      | 9,482,412 |   | $ | 44,178,172 |   | $ | 47,335,225 |   |
| Cost of sales                                       |   | 7,687,056               |       | 7,919,775                             |   | 32,228,128 |   | 35,218,817 |   |
| Write-down obsolescence inventory                   |   | —                  |       | 2,192,005                             |   | — |   | 2,192,005 |   |
|                                                |   |                    |       |                                  |   |   |   |   |   |
| Gross profit (loss)                                 |   | 1,657,144               |       | (629,368                              | )      | 11,950,044 |   | 9,924,403 |   |
| Selling, general and administrative  expenses       |   | 2,230,507               |       | 1,632,931                             |   | 6,956,341 |   | 6,945,440 |   |
| Salaries and related expenses                       |   | 1,060,698               |       | 1,249,423                             |   | 3,179,866 |   | 3,707,832 |   |
| Pre production costs                                |   | —                  |       | 405,838                               |   | — |   | 1,790,214 |   |
| Total operating expenses                            |   | 3,291,205               |       | 3,288,192                             |   | 10,136,207 |   | 12,443,486 |   |
| (Loss) income from operations                       |   | (1,634,061              | )          | (3,917,560                            | )      | 1,813,837 |   | (2,519,083 | ) |
| Other income (expense)                              |   |                    |       |                                  |   |   |   |   |   |
| Interest income                                     |   | 23                      |       | 116                                   |   | 120 |   | 2,608 |   |
| Interest expense                                    |   | (246,049                | )          | (126,893                              | )      | (776,778 | ) | (463,965 | ) |
| Other (expense)income                               |   | (28,727                 | )          | 379,673                               |   | (154,918 | ) | 317,498 |   |
| Total other (expense)income                         |   | (274,753                | )          | 252,896                               |   | (931,576 | ) | (143,859 | ) |
| (Loss) income before provision for taxes on  income |   | (1,908,814              | )          | (3,664,664                            | )      | 882,261 |   | (2,662,942 | ) |
| Provision for taxes on income                       |   | (205,424                | )          | (914,637                              | )      | (205,424 | ) | (544,000 | ) |
| Net income                                          |   | $                       | (1,703,390 | )                                     | $      | (2,750,027 | ) | $ | 1,087,685 |   | $ | (2,118,942 | ) |
| Net income per share-basic                          |   | $                       | (0.42      | )                                     | $      | (0.69 | ) | $ | 0.27 |   | $ | (0.53 | ) |
| -diluted                                            |   | (0.42                   | )          | (0.69                                 | )      | 0.25 |   | (0.53 | ) |
| Weighted average shares outstanding-basic           |   | 4,030,254               |       | 4,001,454                             |   | 4,015,100 |   | 3,993,476 |   |
| -diluted                                            |   | 4,030,254               |       | 4,001,454                             |   | 4,352,607 |   | 3,993,476 |   |

 

See accompanying summary of accounting policies andnotes to consolidated financial statements.

 

2

----

 

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

 
|                                                 |   | **Nine  months ended April 30,** |      |
|------------------------------------------------------|--------|---------------------------------------|-----------|
|                                                 |   | **2004**                              |      | **2003** |   |
|                                                 |   |                                  |      |   |   |
| Cash flows from operating activities                 |   |                                  |      |   |   |
| Net income                                           |   | $                                     | 1,087,685 |   | $ | (2,118,941 | ) |
| Adjustments to reconcile net income to net           |   |                                  |      |   |   |
| Cash used in operating activities                    |   |                                  |      |   |   |
| Depreciation expense                                 |   | 768,227                               |      | 719,377 |   |
| Gain on disposal of assets                           |   | (14,609                               | )         | — |   |
| Provision for inventory obsolescence                 |   | 38,185                                |      | 146,390 |   |
| Provision for doubtful accounts                      |   | 303,515                               |      | 157,275 |   |
| Deferred income taxes                                |   | 268,000                               |      | — |   |
| (Increase) decrease in assets                        |   |                                  |      |   |   |
| Accounts receivable                                  |   | (2,683,458                            | )         | (2,237,837 | ) |
| Inventory                                            |   | 3,644,143                             |      | 4,843,496 |   |
| Other current assets                                 |   | (14,973                               | )         | 628,153 |   |
| Income tax receivable                                |   | (482,110                              | )         | (544,000 | ) |
| Other assets                                         |   | 157,513                               |      | (30,671 | ) |
| Increase (decrease) in liabilities                   |   |                                  |      |   |   |
| Accounts payable                                     |   | (4,429,133                            | )         | (714,693 | ) |
| Accrued expenses                                     |   | 141,325                               |      | 91,576 |   |
| Income taxes payable                                 |   | —                                |      | — |   |
| Net cash provided by (used in) operating  activities |   | (1,215,690                            | )         | 940,125 |   |
|                                                 |   |                                  |      |   |   |
| Cash flows from investing activities                 |   |                                  |      |   |   |
| Proceeds from sales of assets                        |   | 142,750                               |      | — |   |
| Capital expenditures                                 |   | (202,825                              | )         | (693,857 | ) |
| Net cash used in investing activities                |   | (60,075                               | )         | (693,857 | ) |
|                                                 |   |                                  |      |   |   |
| Cash flows from financing activities                 |   |                                  |      |   |   |
| Net borrowings (repayments) on line of  credit       |   | 140,057                               |      | (996,390 | ) |
| Proceeds from exercise of options                    |   | 49,906                                |      | 27,084 |   |
| Borrowing on debt                                    |   | —                                |      | 350,000 |   |
| Borrowing on subordinated debt                       |   | 1,397,140                             |      | — |   |
| Payments on long term debt                           |   | (446,811                              | )         | (279,819 | ) |
| Net cash (used in) provided by financing  activities |   | 1,140,292                             |      | (899,125 | ) |
| Net decrease in cash and cash equivalents            |   | (135,473                              | )         | (652,857 | ) |
| Cash and cash equivalents, at beginning of  period   |   | 227,352                               |      | 709,247 |   |
| Cash and cash equivalents, at end of period          |   | $                                     | 91,879    |   | $ | 56,390 |   |

 

See accompanying summary of accounting policies andnotes to consolidated financial statements

 

3

----

 

**SHERWOODBRANDS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFSTOCKHOLDERS EQUITY**

 
|                        |   | **Common Stock** |   | **Accumulated** |   | **Other**             |      |         |   |              |   |
|-----------------------------|--------|------------------|--------|-----------------|--------|-----------------------|-----------|--------------|--------|-------------------|--------|
|                        |   | **Class A**      |   | **Class B**     |   | **Additional  Paid-** |      | **Retained** |   | **Comprehensive** |   |   |   |
|                        |   | **Shares**       |   | **Amount**      |   | **Shares**            |      | **Amount**   |   | **In Capital**    |   | **Earnings** |   | **Income  (Loss)** |   | **Total** |   |
|                        |   |             |   |            |   |                  |      |         |   |              |   |   |   |   |   |   |   |
| Balance, July 31, 2004 |   | 3,003,476        |   | $               | 30,035 |                  | 1,000,000 |         | $      | 10,000            |   | $ | 9,843,774 |   | $ | (1,809,138) |   | $ | — |   | $ | 8,074,671 |   |
|                        |   |             |   |            |   |                  |      |         |   |              |   |   |   |   |   |   |   |
| Exercise of stock options   |   | 30,000           |   | 300             |   | —                |      | —       |   | 49,606            |   | — |   | — |   | 49,906 |   |
|                        |   |             |   |            |   |                  |      |         |   |              |   |   |   |   |   |   |   |
| Net income (loss)           |   | —           |   | —          |   | —                |      | —       |   | —            |   | 1,087,685 |   |   |   | 1,087,685 |   |
|                        |   |             |   |            |   |                  |      |         |   |              |   |   |   |   |   |   |   |
| Balance April 30, 2004 |   | 3,033,476        |   | $               | 30,335 |                  | 1,000,000 |         | $      | 10,000            |   | $ | 9,893,380 |   | $ | (721,453 | ) | $ | — |   | $ | 9,212,262 |   |

 

See accompanying summary of accounting policies andnotes to consolidated financial statements

 

4

----

 

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

 

**1.****                                      BASISOF PRESENTATION**

 

The consolidatedfinancial statements include the accounts of Sherwood Brands, Inc., and itswholly-owned subsidiaries, Sherwood Brands, LLC, a Maryland limited liabilitycompany, Sherwood Brands of RI Inc., a Rhode Island corporation, Sherwood BrandsOverseas, Inc., a Bahamas entity, and Asher Candy, Inc., a Wyoming corporation(collectively referred to herein as, “we”, “our” “us” or, the “Company”). Allmaterial inter-company transactions and balances have been eliminated inconsolidation.

 

The accompanyingconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles for interim financial information andwith the instructions to Form 10-Q and Article 10 of Regulation S-X.Certain information and footnote disclosures normally included in theconsolidated financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations. These consolidated financial statements should be readin conjunction with the consolidated financial statements, and the notesthereto, included in the Company’s Annual Report and Form 10-K filed onOctober 29, 2003.

 

**2.****                                      ORGANIZATIONAND DESCRIPTION OF BUSINESS**

 

Sherwood Brands, Inc. (the “Company”) was incorporated inDecember 1982 in the state of North Carolina. Sherwood Brands, Inc. isengaged in the manufacture, marketing and distribution of a diverse line ofbrand name candies, cookies, chocolates and gifts. The Company manufactures andpurchases; lollipops, biscuits and assembles seasonal gift items including giftbaskets for Christmas, Valentines Day and Easter. The Company’s principalbranded products include COWS(TM) butter toffee candies, DEMITASSE(R) biscuits,RUGER(R) wafers, SMILE POPS(R) lollipops, STRIP-O-POPS(R) lollipops andELANA(R) chocolates, SOUR FRUIT BURST(TM) fruit-filled hard candies andPIRATE’S GOLD COINS(R) milk chocolates. The Company’s marketing strategy,including its packaging of products, is designed to maximize freshness, tasteand visual appeal, and emphasizes highly distinctive, premium quality productsthat are sold at prices that compare favorably to those of competitiveproducts. The Company operates in the confectionery industry and aligns itsoperations into three business segments for management to measure financialperformance by product type.  TheCompany’s business segments are (i) Manufactured Candy, (ii) Purchased Candyand (iii) Gift Items.

 

Sherwood Brands, Inc. is the owner of Sherwood Brands, LLC, a Marylandlimited liability company. Sherwood Brands, LLC markets and distributes its ownline of confectionery products in the United States.

 

Sherwood Overseas, Inc. (a wholly-owned subsidiary of Sherwood Brands,LLC) was incorporated in July 1993 in the Bahamas to market and distributethe Sherwood lines of confectionery products internationally.

 

5

----

 

Sherwood Brands of RI, Inc. is a wholly owned subsidiary of SherwoodBrands, Inc. that 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.

 

Sherwood Acquisition Corporation, a wholly-owned subsidiary of theCompany, was incorporated in April 2002 in the state of Wyoming. On May 1,2002, Sherwood Acquisition merged with and into Asher Candy AcquisitionCorporation, a Wyoming corporation. Asher Candy Acquisition Corporation is amanufacturer of candy canes and other hard candies under the “Asher” name. Thesurviving corporation of the merger is Asher Candy Acquisition Corporation,which has changed its name to Asher Candy, Inc.

 

**3.****                                      INTERIMFINANCIAL INFORMATION**

 

The financialinformation as of April 30, 2004 and for the three and nine months endedApril 30, 2004 and 2003 is un-audited. In the opinion of management, suchinformation 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 an entire year.

 

**4.****                                      INVENTORY**

 

Inventory consists of raw materials, packaging materials, componentsused in assembly, work- in- process and finished goods and is stated at thelower of cost or market. Cost is determined by the FIFO (first-in, first-out)method.  The decrease in the reserveswas attributable to decreasing the obsolescence inventory during the nine monthsended April 30, 2004.

 

Inventory consists of the following:

 
|                                    |   | **April 30,  2004** |       | **July 31,  2003** |   |
|-----------------------------------------|--------|--------------------------|------------|-------------------------|--------|
|                                    |   | **(unaudited)**          |       | **(audited)**           |   |
| Raw materials and ingredients           |   | $                        | 445,832    |                    | $      | 423,497 |   |
| Components used in assembly             |   | 927,873                  |       | 1,496,166               |   |
| Packaging materials                     |   | 2,843,675                |       | 2,936,702               |   |
| Work-in-process                         |   | 297,303                  |       | 648,539                 |   |
| Finished product                        |   | 5,824,383                |       | 9,358,100               |   |
|                                    |   |                     |       |                    |   |
|                                    |   | 10,339,066               |       | 14,863,004              |   |
| Less reserve for inventory obsolescence |   | (302,100                 | )          | (1,143,710              | )      |
|                                    |   |                     |       |                    |   |
|                                    |   | $                        | 10,036,966 |                    | $      | 13,719,294 |   |

 

6

----

 

**5.**                                      USEOF ESTIMATES

** **

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financialstatements and reported amounts of revenues and expenses during the reportingperiod. Actual results could differ from those estimates.

 

**6.**                                      INCOMETAXES

** **

Income taxes are calculated using the liability method specified byStatement of Financial Accounting Standards No. 109, “Accounting for IncomeTaxes (SFAS 109).” Under SFAS 109, deferred taxes are determined using the liabilitymethod which requires the recognition of deferred tax assets and liabilitybased on differences between the financial statement and the income tax basisusing presently enacted tax rates.

 

The income tax rate utilized on an interim basis is based on theCompany’s estimate of the effective income tax rate for the fiscal year endingJuly 31, 2004. The Company has a net operating loss carry forward whichmanagement believes will offset all taxable income generated in fiscal year2004.  Therefore, the Company estimatedits effective tax rate at 0%. During the quarter ended April 30, 2004, theCompany had $473,424 of additional benefits as a result of amended returnsfiled with the Internal Revenue Service and State income tax. These refunds arepartially offset by a change in deferred taxes of $268,000.

 

**7.****                                      STOCKCOMPENSATION OF STOCK OPTIONS**

 

**TheCompany has adopted the disclosure only provisions of Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS123”), but it continues to measure compensation cost for the stock optionsusing the intrinsic value method prescribed by APB Opinion No. 25. As allowableunder SFAS 123, the Company used the Black-Scholes method to measure thecompensation cost of stock options granted . The Company did not grant any stock options to employees in the quartersended April 30, 2004 or April 30, 2003.**

** **

There were no adjustments made in calculating the fair value to accountfor vesting provisions, for non-transferability or risk of forfeiture. Becausethe Company’s employee stock options have characteristics significantlydifferent from those of traded options, and because changes in the subjectiveinput assumptions can materially affect the fair value estimate, inmanagement’s opinion, the existing models do not necessarily provide a reliablesingle measure of the fair value of its employee stock options.

 

If the Company had elected to recognize compensation cost based on thevalue at the grant dates with the method prescribed by SFAS 123, net income(loss) and earnings per share would have been changed to the pro forma amountsindicated in the following table:

 

7

----

 
|                                                                                                                                          |   | **For the  three months ended April 30,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|------------|
|                                                                                                                                          |   | **2004**                                       |       | **2003** |   |
| Net income/(loss)                                                                                                                             |   |                                           |       |   |   |
| As reported                                                                                                                                   |   | $                                              | (1,703,390 | ) | $ | (2,750,027 | ) |
|                                                                                                                                          |   |                                           |       |   |   |
| 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)                                                                                                                   |   | (1,729,390                                     | )          | (2,787,027 | ) |
| Basic income/(loss) per common share:                                                                                                         |   |                                           |       |   |   |
| As reported                                                                                                                                   |   | $                                              | (0.42      | ) | $ | (0.69 | ) |
| Pro forma                                                                                                                                     |   | (0.43                                          | )          | (0.70 | ) |
| Diluted income/(loss) per common share:                                                                                                       |   |                                           |       |   |   |
| As reported                                                                                                                                   |   | $                                              | (0.42      | ) | $ | (0.69 | ) |
| Pro forma                                                                                                                                     |   | (0.43                                          | )          | (0.70 | ) |

 
|                                                                                                                                          |   | **For the  nine months ended April 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|
|                                                                                                                                          |   | **2004**                                      | ** ** | **2003** | ** ** |
| Net income/(loss)                                                                                                                             |   |                                          |       |   |   |
| As reported                                                                                                                                   |   | $                                             | 1,087,685  |   | $ | (2,118,942 | ) |
|                                                                                                                                          |   |                                          |       |   |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | 78,000                                        |       | 112,000 |   |
|                                                                                                                                          |   |                                          |       |   |   |
| Pro forma net income (loss)                                                                                                                   |   | 1,009,685                                     |       | (2,230,942 | ) |
| Basic income/(loss) per common share:                                                                                                         |   |                                          |       |   |   |
| As reported                                                                                                                                   |   | $                                             | 0.27       |   | $ | (0.53 | ) |
| Pro forma                                                                                                                                     |   | 0.25                                          |       | (0.56 | ) |
| Diluted income/(loss) per common share:                                                                                                       |   |                                          |       |   |   |
| As reported                                                                                                                                   |   | $                                             | 0.25       |   | $ | (0.53 | ) |
| Pro forma                                                                                                                                     |   | 0.23                                          |       | (0.56 | ) |

** **

**8.**                                      EARNINGSPER SHARE

** **

Earnings per shareis based on weighted average number of shares of common stock and dilutivecommon stock equivalents outstanding. Basic earnings per share includes no dilution and is computed bydividing income available to common shareholders by the weighted average numberof common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securitiesthat could share in the earnings of an entity. The following table presents a reconciliation between the weightedaverage shares outstanding for basic and diluted earnings per share for thethree and nine months ended April 30, 2004 and April 30, 2003, except

 

8

----

 

for the threemonths ended April 30, 2003 and April 30, 2004 and the nine monthsended April 30, 2003, where the common stock equivalents outstanding wereanti-dilutive:

 
| **For the nine months ended April 30, 2004** |   | **Income** |      | **Shares** |      | **Per Share  Amount** |   |
|---------------------------------------------------|--------|------------|-----------|------------|-----------|-----------------------|--------|
|                                              |   |       |      |       |      |                  |   |
| Basic earnings per share                          |   |       |      |       |      |                  |   |
| Income available to common shareholders           |   | $          | 1,087,685 |       | 4,015,100 |                  | $      | 0.27 |   |
| Effect of dilutive stock options                  |   |       |      | 337,507    |      |                  |   |
| Dilutive earnings per share                       |   | $          | 1,087,685 |       | 4,352,607 |                  | $      | 0.25 |   |

 

**9.**                                      CONTINGENCIES

 

The Company is, from time to time, involved in litigation incidental tothe conduct of its business. The Company is currently involved in severalactions.  In particular, the Company’slandlord at its Rhode Island facility named the Company as a defendant in anaction seeking security for claims relating to the lease agreement. The Companydeposited $180,000 with the registry of the court relating to claims forpayment of real estate taxes, water and sewer, rent of other occupied space andrepair expenses. In September 2002, the landlord claimed other breaches ofthe lease agreement, alleging an obligation of $932,000 under the lease anddemanded $750,000 to settle the disputes. The Company had claims against thelandlord it is pursuing. The Company had accrued amounts to cover currentcharges.  In November 2003, theCompany settled its claims with the landlord. The accrual reflected in the financial statements was sufficient tocover all outstanding obligations to the landlord.  The Company vacated the space on March 31, 2004.

 

The Company is currently involved as Plaintiff in a suit brought beforethe Circuit Court for Montgomery County, Maryland, presenting claims inconnection with the merger agreement

 

under which Sherwood Brands acquired securities of Asher CandyAcquisition Corporation and agreed to sell securities in Sherwood Brands toprior shareholders of Asher Candy.  Thecomplaint alleges that the Company was fraudulently induced to enter into themerger agreement on the basis of, among other things, 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.**                               LICENSINGAGREEMENTS

** **

During the ninemonths ended April 30, 2004, the Company entered into three licensingagreements to incorporate products into gift sets. The Company now has a totalof eighteen 

 

9

----

 

licensingagreements. The royalty rates for such licenses are from 2% to 15% of net salesand expire in two to three years.

 

The products to be incorporated into the Company’s gift set items areproducts to be sold during the Easter holiday season and become effective onthe selling season of January 2005. The Company paid $12,500 in advancefees for the rights to incorporate products into its gift set items. Theseadvance fees will be offset against any amounts due on royalties. There areminimum guaranteed license fees under these agreements. The Company incurred$150,000 in royalty expense for the three months ended April 30, 2004 and$926,000 for the nine months ended April 30, 2004. There were no royaltyexpenses for the three and nine months ended April 30, 2003. The Companyis currently pursuing other licenses with similar terms and conditions.

 

**11.          CREDIT FACILITY**

** **

During the quarter ended April 30, 2004, the Company was not incompliance with it’s business and financial covenants under its credit facilityrelating to the fixed charge coverage ratio. Management believes the Companywill not continue to be in compliance with its covenants for the remainder of2004.  The Company is currently indiscussions with its lender regarding the extension of the term of the creditfacility. Currently the Company’s $18.0 million credit facility expires onJune 13, 2004. Management believes it will have the renewed creditfacility in place during the fourth quarter ending July 31, 2004.

 

**12.          CONCENTRATIONOF CREDIT RISK AND EXPORT SALES**

 

The Company has a variety of customers, including mass merchandisers,drug stores and grocery stores throughout the United States and abroad. For thenine months ended April 30, 2004, three customers accounted forapproximately 28%, 9% and 7% of the Company’s net sales. For the nine monthsended April 30, 2003, the same three customers accounted for approximately10%, 16% and 8% of the Company’s total net sales.  The Company had sales to customers in Canada which represent0.82% and 0.32% of net sales for the nine months ended April 30, 2004 and2003, respectively.

 

**13.****                               OPERATINGSEGMENTS**

 

The Company operates in the confectionery industry and aligns itsoperations into three business segments for management reporting purposes.These segments are based on product type. This alignment allows management tomeasure financial performance by product type. The Company’s business segmentsare (i) Manufactured Candy and Cookies, (ii) Purchased Candy and Cookies and(iii) Purchased Gift Items. The Company reports these as reportable segments inaccordance with SFAS 131, “Disclosures about Segments of an Enterprise andRelated Information.” The accounting policies of the operating segments are thesame as those described in the summary of significant accounting policies.

 

The Company’s Chief Operating Decision Maker, who is its Chairman andChief Executive Officer, evaluates performance based upon a measure of segmentoperating profit or loss that includes an allocation of common expenses, butexcludes some unallocated expenses. 

 

10

----

 

Unallocated expenses represent corporate expenditures that are notspecifically allocated to the segments.

 

**TheCompany’s reportable segments are strategic business units that offer differentproducts in different geographic areas. The Company has no assets outside of the United States.  There is no concentration of net sales inany one area within the United States. Net sales outside of the United States are minimal.**

** **
|                          |   |                    |                  | **Three  Months ended April 30, 2004** |   |
|-------------------------------|--------|-------------------------|-----------------------|---------------------------------------------|--------|
|                          |   | **Manufactured  Candy** |                  | **Purchased  Candy**                        |   | **Gift  Items** |   | **Other** |   | **Consolidated  Total** |   |
| Total revenue                 |   | $                       | 364,409               |                                        | $      | 1,979,001 |   | $ | 7,000,790 |   | $ | — |   | $ | 9,344,200 |   |
| Gross margin                  |   | (994,112                | )                     | 774,815                                     |   | 1,876,441 |   | — |   | 1,657,144 |   |
| Interest expense              |   | 118,104                 |                  | 89,605                                      |   | 38,340 |   | — |   | 246,049 |   |
| Segment assets                |   | 11,529,033              |                  | 5,233,023                                   |   | 6,286,391 |   | 1,394,155 |   | 24,442,602 |   |
| Depreciation and amortization |   | 202,558                 |                  | —                                      |   | 45,131 |   | 25,865 |   | 273,554 |   |
|                          |   |                    |                  |                                        |   |   |   |   |   |   |   |
|                          |   |                    |                  | **Three Months ended April 30, 2003**  |   |
|                          |   | **Manufactured  Candy** |                  | **Purchased  Candy**                        |   | **Gift  Items** |   | **Other** |   | **Consolidated  Total** |   |
| Total revenue                 |   | $                       | 1,013,178   |                                        | $      | 1,604,823 |   | $ | 6,864,411 |   | $ | — |   | $ | 9,482,412 |   |
| Gross margin                  |   | (1,820,410              | )                     | 273,048                                     |   | 917,994 |   | — |   | (629,368 | ) |
| Interest expense              |   | 60,909                  |                  | 46,212                                      |   | 19,772 |   | — |   | 126,893 |   |
| Segment assets                |   | 13,299,204              |                  | 7,327,918                                   |   | 5,672,987 |   | 1,449,661 |   | 27,749,770 |   |
| Depreciation and amortization |   | 237,794                 |                  | —                                      |   | 25,747 |   | 9,584 |   | 273,125 |   |
|                          |   |                    |                  |                                        |   |   |   |   |   |   |   |
|                          |   |                    |                  | **Nine Months ended April 30, 2004**   |   |
|                          |   | **Manufactured  Candy** |                  | **Purchased  Candy**                        |   | **Gift  Items** |   | **Other** |   | **Consolidated  Total** |   |
| Total revenue                 |   | $                       | 7,471,729             |                                        | $      | 21,762,197 |   | $ | 14,944,246 |   | $ | — |   | $ | 44,178,172 |   |
| Gross margin                  |   | (1,927,916              | )                     | 9,318,163                                   |   | 4,559,797 |   | — |   | 11,950,044 |   |
| Interest expense              |   | 372,854                 |                  | 282,885                                     |   | 121,039 |   | — |   | 776,778 |   |
| Segment assets                |   | 11,529,033              |                  | 5,233,023                                   |   | 6,286,391 |   | 1,394,155 |   | 24,442,602 |   |
| Depreciation and amortization |   | 578,660                 |                  | —                                      |   | 113,187 |   | 76,380 |   | 768,227 |   |

 

11

----

 
|                          |   |                    |       | **Nine  Months ended April 30, 2003** |   |
|-------------------------------|--------|-------------------------|------------|--------------------------------------------|--------|
|                          |   | **Manufactured  Candy** |       | **Purchased  Candy**                       |   | **Gift  Items** |   | **Other** |   | **Consolidated  Total** |   |
| Total revenue                 |   | $                       | 16,676,078 |                                       | $      | 14,655,623 |   | $ | 16,003,524 |   | $ | — |   | $ | 47,335,225 |   |
| Gross margin                  |   | (674,407                | )          | 6,351,053                                  |   | 4,247,757 |   | — |   | 9,924,403 |   |
| Interest expense              |   | 222,704                 |       | 168,966                                    |   | 72,295 |   | — |   | 463,965 |   |
| Segment assets                |   | 13,299,204              |       | 7,327,918                                  |   | 5,672,987 |   | 1,449,661 |   | 27,749,770 |   |
| Depreciation and amortization |   | 584,923                 |       | —                                     |   | 76,879 |   | 57,575 |   | 719,377 |   |
|                               |        |                         |            |                                            |        |  |  |  |  |  |  |  |  |  |  |  |

 

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

** **

ImportantInformation Regarding Forward-Looking Statements

 

This quarterlyreport on Form 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended. Thosestatements include statements regarding the intent, belief or currentexpectations of the Company and its management.  Such statements are subject to a variety of risks anduncertainties, many of which are beyond our control, which could cause actualresults to differ materially from those contemplated in such forward-lookingstatements, including in particular the risks and uncertainties described under“Risk Factors” in our Form 10-K filed with the commission on October 29,2003. Existing and prospective investors are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the datehereof. We undertake no obligation to update or revise the informationcontained in this quarterly report on Form 10-Q, whether as a result of newinformation, future events or circumstances or otherwise.

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of certain assets and liabilities at the date of thefinancial statements. Significant estimates in our financial statements includethe accounts receivable and inventory reserves. We continually evaluate thesereserves based upon historical experience. Although actual results could differfrom those disclosed, management feels that the estimates used to establish thereserves are conservative in nature. Furthermore, management contends that itwould be unlikely that the reserve level would be materially different from anyother independently prudently established reserve.

 

If any of the following risks occurs, our business, financial conditionor results of operations could be adversely affected.

 

The loss of a significant customer could have an adverse effect on ourbusiness. We are dependent on a limited number of customers for a significantportion of our revenues. Wal-Mart, Sam’s Club and Dollar General accounted forapproximately 28%, 9% and 7%, respectively, of our sales for the nine monthsended April 30, 2004 and for the nine months ended April 30, 2003 

 

12

----

 

Wal-Mart, Sam’s Club, and Dollar General accounted for approximately10%, 16% and 8%, respectively. We do not maintain agreements with our customersand sell products pursuant to purchase orders placed from time to time in theordinary course of business. The loss of a significant customer could have anadverse effect on our business.

 

We face significant competition in the marketing and sales of ourproducts. Our products compete for consumer recognition and shelf space withcandies, cakes, cookies, chocolates and other food products which have achievedinternational, national, regional and local brand recognition and consumerloyalty. These products are marketed by companies (which may include oursuppliers) with significantly greater financial, manufacturing, marketing,distribution, personnel and other resources than we have. Some of thesecompetitors, such as Hershey Food Corporation, Masterfoods USA (M&M Mars),Inc., Nestle, S.A., and Kraft Foods, dominate the markets for candy and cookieproducts, and have substantial promotional budgets which enable them toimplement extensive advertising campaigns. The food industry is characterizedby frequent introductions of new products, accompanied by substantialpromotional campaigns. If we are unable to continue to compete successfully ourbusiness could be adversely affected.

 

We face various risks relating to a recent acquisition. In May 2002, weacquired the business of Asher Candy Acquisition Corporation. Asher CandyAcquisition Corporation manufactured candy canes, a product which we had noprior experience in manufacturing. If we cannot continue to successfullyproduce a quality product, and maintain or increase the customer base, ourprofitability could be adversely affected.

 

Our success is highly dependent on consumer preferences and industryfactors. The markets for candy and cookie products are affected by changes inconsumer tastes and preferences and nutritional and health-related concerns. Wecould be subject to increased competition from companies whose products ormarketing strategies address these concerns. In addition, the markets for ourproducts may be subject to national, regional and local economic conditionswhich affect discretionary spending, demographic trends and product lifecycles, whereby product sales increase from their introductory stage throughtheir maturity and then reach a stage of decline over time.

 

We have limited historical profitability and may not be profitable inthe future. Our operating expenses have decreased for the nine months endedApril 30, 2004 and can be expected to continue to increase in connectionwith any expansion activities undertaken by us, including those relating toadvertising and product manufacturing. Accordingly, our profitability willdepend on our ability to improve our operating margins and increase revenuesfrom operations. Unanticipated expenses, unfavorable currency exchange rates,increased price competition and adverse changes in economic conditions couldhave a material adverse effect on our operating results. If we are unable toachieve significantly increased levels of revenues, our future operations maynot continue to be profitable.

 

We depend on our trademarks. We hold United States trademarkregistrations for the “ELANA,” “RUGER”, “TONGUE TATTOO”, “STRIP-O-POP”, “SMILEPOPS” and “demitasse” names, and have filed applications to register certainother names, including “COWS,” and use other

 

13

----

 

names for which we have not applied for registration. We believe thatour rights to these names are a significant part of our business and that ourability to create demand for our products is dependent to a large extent on ourability to exploit these trademarks. Our failure to protect our trademarks andother intellectual property rights could negatively impact the value of ourbrand names. We have requested some of our marks in countries other than theU.S. and may apply for additional registration as appropriate.

 

We are dependent on third party manufacturers and suppliers. We are dependenton the ability of our manufacturers to adhere to our product, price and qualityspecifications and scheduling requirements. Our operations require us to haveproduction orders in place in advance of shipment to our warehouses (productdeliveries typically take 60 days). Any delay by manufacturers in supplyingfinished products to us would adversely affect our ability to deliver productson a timely and competitive basis. In addition, raw materials necessary for themanufacture of our products at our facilities, including flour, sugar,shortening, butter and flavorings, are purchased from third-party suppliers. Wedo not maintain agreements with any such suppliers and we are, therefore,subject to risks of periodic price fluctuations, shortages and delays. If thereis a material interruption in the availability or significant price increasesfor raw materials would have a material adverse effect on our operatingmargins.

 

We face various risks relating to foreign manufacturing. During thethree months ended April 30, 2004 and 2003, approximately 22% and 17%,respectively, of our products were manufactured in foreign countries. Duringthe nine months ended April 30, 2004 and 2003, approximately 49% and 31%,respectively, of our products were manufactured in foreign countries. We havebeen and will continue to be subject to risks associated with the manufactureof products in foreign countries, primarily in Argentina, Austria, Belgium,China and Holland. These risks include material shipping delays, fluctuationsin foreign currency exchange rates, customs duties, tariffs and import quotasand international political, regulatory and economic developments. We assumethe risk of loss, damage or destruction of products when shipped by amanufacturer. Because we pay for some of our products manufactured outside theUnited States in foreign currencies, any weakening of the United States dollarin relation to relevant foreign currencies, could result in significantlyincreased costs to us. In addition, some products manufactured overseas aresubject to import duties. Deliveries of products from our foreign manufacturerscould also be delayed or restricted by the future imposition of quotas. Ifquotas were imposed, it is possible that we would not be able to obtain qualityproducts at favorable prices from domestic or other suppliers whose quotas havenot been exceeded by the supply of products to their existing customers.

 

We are subject to government regulation. We are subject to extensiveregulation by the United States Food and Drug Administration, the United StatesDepartment of Agriculture and by other state and local authorities injurisdictions in which our products are manufactured or sold. Among otherthings,  these regulations govern theimportation, manufacturing, packaging, storage, distribution and labeling ofour products, as well as sanitary conditions and public health and safety.Applicable statutes and regulations governing our products include “standardsof identity” for the content of specific types of products, nutritionallabeling and serving size requirements and general “Good ManufacturingPractices” with respect to manufacturing processes. Our facilities and productsare subject to periodic inspection by federal, state and local

 

14

----

 

authorities. Our failure to comply with applicable laws and regulationscould subject us to civil remedies, including fines, injunctions, recalls orseizures, as well as potential criminal sanctions.

 

We may incur product liability claims that are not fully insured. As amanufacturer and marketer of food products, we are subject to product liabilityclaims from consumers. We maintain product liability insurance with limits of$2,000,000 in the aggregate and $1,000,000 per occurrence (with excess coverageof $10,000,000). These insurance amounts may not be sufficient to coverpotential claims and adequate levels of coverage may not be available in thefuture at a reasonable cost. In the event of a partially or completely uninsuredsuccessful claim against us, our financial condition and reputation would bematerially adversely affected.

 

We are dependent on key personnel and the loss of these key personnelcould have a material adverse effect on our success. Our success is dependenton the personal efforts of Uziel Frydman, our Chairman, President and ChiefExecutive Officer, Amir Frydman, our Vice President of Marketing andChristopher Willi, our Chief Financial Officer. The loss or interruption of theservices of such individuals could have a material adverse effect on ourbusiness. We maintain “key-man” insurance in the amount of $1,000,000 on thelife of Mr. Uziel Frydman. Our success also depends upon our ability to hireand retain additional qualified management, marketing and other personnel.Employment and retention of qualified personnel is important due to thecompetitive nature of the food industry. Our failure to hire and retainqualified personnel could adversely affect our success.

 

Our President and Chief Executive Officer controls our company. Mr.Uziel Frydman, President and Chief Executive Officer, owns 400,000 shares ofClass A Common Stock (with a right to acquire an additional 202,984 upon theexercise of options) and 1,000,000 shares of Class B Common Stock,representing, in the aggregate, approximately 38% of the outstanding CommonStock of our company and 76% of the voting control of our company, assumingthat all of the warrants are exercised. Accordingly, Mr. Frydman will be ableto direct the election of all of our company’s directors, increase theauthorized capital, dissolve, merge or sell the assets of our company, andgenerally direct the affairs of our company. In addition, the level of controlexercised by Mr. Frydman may discourage investors from purchasing our CommonStock.

 

We may issue “blank check” preferred stock that would prevent a changeof control. Our Articles of Incorporation, as amended, authorize our board ofdirectors to issue 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 are prohibited from paying dividends by the terms of our financingagreements. We have never paid any cash dividends on our common stock and donot anticipate paying cash dividends

 

15

----

 

in the foreseeable future. The payment of cash dividends is prohibitedby the terms of our financing agreements.

 

For the nine months ended April 30, 2004 and for the year endedJuly 31, 2003, we had a total of eighteen licensing agreements toincorporate our products into gift sets and to manufacture candies and wafers. Three of these agreements were signed during the nine months endedApril 30, 2004, nine of these agreements were signed during the fiscalyear ended July 31 ,2003 and six of these agreements were signed duringthe fiscal year ended July 31, 2002. The royalty rates for these licensingagreements range from 2% to 15% of net sales and expire in two to three years.The products licensed are primarily incorporated into our gift set items andare recognized in the first quarter and Easter selling season net sales. Wehave also entered into a licensing agreement to produce everyday candies andwafers. We paid an aggregate of $275,000 in advance fees for the rights underthe licensing agreements. These advance fees were offset against any amountsdue on royalties. There were no other minimum license fees under theselicensing agreements. For the three months ended April 30, 2004, weincurred $150,000 in royalties and for the nine months ended April 30,2004, we incurred $926,000 in royalties. We are currently pursuing otherlicensing agreements with similar terms and conditions. We expect the greatestimpact from these agreements will occur in the fiscal year ending July 31,2004.

 

Our Rhode Islandmanufacturing facility, which occupied five stories in an old building, closedon May 31, 2002. All the production equipment, together with the electrical,piping, steam and air-conditioning were disassembled and transferred to ourexpanded Chase City, Virginia facility. This 75,000 square feet facility, withan additional 25,000 square feet from a recent expansion, and the 73,000 squarefoot facility at Keysville, Virginia (about 20 miles from Chase City,Virginia), is now the single manufacturing and distribution facility operatingunder one plant management for all products produced at the Chase Cityfacility.

 

Christmas andEaster gift sets and baskets are distributed at the Rhode Island andMassachusetts facilities. We source product for these gift sets and basketsprimarily from the Pacific Rim. We are continually looking to further reducecosts by more efficient sourcing on our gift set and baskets items throughother overseas suppliers.

 

We did not exercise the option to extend the term of the lease on ouroffice and assembly facility in Rhode Island and we vacated the location onMarch 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.  There is nofacility or commitments at this time relating to the planned West Coastfacility.

 

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

** **

On September 30, 2002, 29 west coast ports were shut down abruptlyand remained closed as contract negotiations between dock-workers and shippingcompanies broke off negotiations for new contracts. The shut down occurredduring our peak inventory shipping period for orders for the holiday season. Inmid-October 2002, the President of the United States of America signed anorder under the Taft-Hartley Act to reopen the ports and put a moratorium onthe strike for 60 days. The shut down had an effect on our first quarter ofshipments to our customers. A large

 

16

----

 

portion of containers, which were to be received, remained either atports or on shipping vessels on the water. In addition, empty containers werenot brought back to ports in the Pacific Rim, which we needed to move some ofour other products.  In mid-October 2002,our inventory began to be released for shipment to our facility in New Bedford,Massachusetts. A slow down by the long shore-men on shipping products was stillprevalent. Our revenues for the three months ended October 31, 2002 wereimpacted by the shut down and resulted in a delay of approximately $6.0 millionin sales.  Approximately $3.5 million ininventory was shipped out during the second quarter and approximately $1.5million of the inventory was shipped during the first and second quarters offiscal year 2004. We shipped $0.5 million of this inventory in the quarterended October 31, 2003 and $1.0 million of this inventory was shipped inthe quarter ended January 31, 2004.

 

**Results ofOperations**

** **

**Three Months EndedApril 30, 2004 and 2003**

** **

Net sales for thethree months ended April 30, 2004 and 2003 were $9.3 million and $9.5million respectively, a decrease of 2.1%, or $200,000.  The decline in net sales was due to lowersales of manufactured candy of approximately $600,000 which were offset byincreased sales of purchased candy of $400,000. Wal-Mart, Sam’s Club and Kmartaccounted for approximately 27%, 18% and 10%, respectively, of sales for thethree months ended April 30, 2004. Sam’s Club, Wal-Mart and Kmartaccounted for approximately 23%, 21% and 9%, respectively, of sales for theprior year’s comparable period.

 

Net sales for each of our business segments was as follows:

 

Net sales of Manufactured Candy decreased  to $360,000 for the three months ended April 30, 2004 from$1.0 million for the three months ended April 30, 2003.  The $540,000 decrease was attributable to a$411,000 decline in sales of our manufactured Easter candies,  a $104,000 decline in sales of ourmanufactured Kastins filled candy items and a $25,000 decline in sales of ourCows products.   The decline is due to ashift in our focus towards purchasing products rather than manufacturing.  Therefore, there will continue to be adecline in sales of Manufactured Candy.

 

Net sales of Purchased Candy increased to $1.98 million for the threemonths ended April 30, 2004 from $1.6 million for the three months endedApril 30, 2003. The $0.38 million increase was attributable to $0.3million increase in sales of purchased candies and  a $0.3 million increase in sales of purchased Cows products and a$0.2 million increase in sales of purchased gold coins. These increases werepartially offset by decreased sales of purchased health and beauty itemsof  $0.19 million , which represented aone time sale of these items to Sam’s Club during the quarter endedApril 30, 2003.

 

Net sales of Gift Items increased to $7.0 million for the three monthsended April 30, 2004 from $6.9 million for the three months endedApril 30, 2003.  The $0.1 millionincrease was attributable to a $0.1 million increase in sales of Easterassembled goods.

 

We had no write-down of obsolescence inventory  costs during the three months endedApril 30,

 

17

----

 

2004 for our change in operations compared to $2,192,000 during thethree months ended April 31, 2003. In the fourth quarter of the fiscal year ended July 31, 2003, wereduced the scope of operations at our Chase City, Virginia facilityeliminating the need for continued packaging inventory relating to variousproducts that we had shifted to our overseas suppliers.

 

Gross margins increased to $1.7 million for the three months endedApril 30, 2004 from ($0.6) million for the three months endedApril 30, 2003, and increased to 17.7% from (6.6%) as percent of sales,respectively.

 

Gross margins for each of our business segments were as follows:

 

Gross margins on our Manufactured Candy decreased to ($994,000) from($1.82 million) for the three months ended April 30, 2004 and 2003, andfrom (272.8%) to (179.67%) as a percent of sales, respectively.  The decrease was attributable to theshifting of our hard and soft candy manufacturing and production to ouroverseas suppliers.

 

Gross margins for our Purchased Candy increased to $0.8 million from$0.3 million for the three months ended April 30, 2004 and 2003, and to39.1% from 17.0% as a percent of sales, respectively. The $0.4 million increasewas primarily due to better pricing of purchased candy from our third partyoverseas suppliers.

 

Gross margins on our Gift Items increased to $1.9 million from $0.9million for the three months ended April 30, 2004 and 2003, and to 26.8%from 13.4% as a percent of sales, respectively.  The $1.0 million increase was primarily due to the shipmentdelays on orders for our Easter gift baskets from the second quarter endedJanuary 31, 2004 into our third quarter ended April 30, 2004.

 

During the three months ended April 30, 2004 and 2003, selling,general and administrative expenses increased to $2.2 million from $1.6million, respectively, and increased to 23.8% from 17.2% as a percent of sales,respectively. The $0.6 million increase was attributable to a $344,000 increasein commission expense due to more concentration of brokers and buyers, a$282,000 increase in advertising and promotional expenses, a $18,000 increasein moving expenses, a $37,000 increase in cash management expenses, and a$19,000 increase in  business licenseexpense.

 

We had no pre-productions startup costs during the three months endedApril 30, 2004 as compared to $405,838 during the three months endedApril 31, 2003.  In the fourthquarter of the fiscal year ended July 31, 2003, we reduced the number ofemployees and changed the scope of operations at our Chase City, Virginiafacility eliminating the need for continued training costs for new employees atthe facility.

 

Salaries and related expenses decreased to $1.1 million for the threemonths ended April 30, 2004, from $1.25 million for the three months endedApril 30, 2003, or 11.3% from 13.2%, respectively, as a percent of sales.The $150,000 decrease was a result of a decline in our overhead due to ourreorganization effort in the fourth quarter of the fiscal year endedJuly 31, 2003.

 

18

----

 

As a result of the foregoing, operating expenses  remained at $3.29 million for the threemonths ended April 30, 2004 from $3.29 million for the three months endedApril 30, 2003 and increased to 35.2% from 34.6%, respectively, as a percentof sales.

 

 Loss from operations for thethree months ended April 30, 2004 was $1.6 million as compared to a lossof $3.9 million for the prior year’s comparable period. The decrease wasattributable to a $0.4 million decrease in pre production start up costs, a$2.2 million write-down of inventory  and the other expenses explained in results from operatingexpenses above.

 

Interest income decreased to $23 for the three months endedApril 30, 2004 from $116 for the three months ended April 30, 2003 asreserves declined. For the three months ended April 30, 2004, interestexpense increased to $246,049 from $126,893 for the three months endedApril 30, 2003 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 endedJuly 31, 2003.

 

Other expenses increased to $28,727 for the three months endedApril 30, 2004 from income of $379,673 for the three months endedApril 30, 2003.  The increase wasdue to $28,000 of realized loss on foreign exchange transactions which wasoffset by $580,000 settlement of a trade mark infringement less $149,000 oflegal costs associated with the settlement.

 

The income tax rate utilized onan interim basis is based on our estimate of the effective income tax rate forthe fiscal year ending July 31, 2004. We have a net operating loss carryforward which management believes will offset all taxable income generated infiscal year 2004.  Therefore, we estimatedour effective tax rate at 0%.  Duringthe quarter ended April 30, 2004, we have $473,424 in additional refundsdue from the Internal Revenue Service and local state jurisdictions for amendedincome tax returns from prior years. These amounts are partially offset by achange in deferred taxes of $268,000.

 

**Nine Months EndedApril 30, 2004 and 2003**

** **

Net sales for thenine months ended April 30, 2004 and 2003 were $44.2 million and $47.3million respectively, a decrease of 6.6%, or $3.1 million.  The decline in net sales was due to lowersales of manufactured candy of approximately $9.2 million offset by increasesin sales of purchased candy of $7.1 million and a decrease of $1.0 million onsales of gift items. Wal-Mart, Sam’s Club and Dollar General accounted forapproximately 28%, 9% and 7%, respectively, of sales for the nine months endedApril 30, 2004. Sam’s Club, Big Lots and Wal-Mart accounted forapproximately 16%, 10.3% and 10%, respectively, of sales for the prior year’scomparable period.

 

Net sales for each of our business segments was as follows:

 

Net sales of Manufactured Candy decreased to $7.5 million for the ninemonths ended April 30, 2004 from $16.7 million for the nine months endedApril 30, 2003.  The $9.2 milliondecrease was primarily due to a decline of $3.6 million of sales ofmanufactured candy canes, a $1.1 million decline in sales of our manufactureditems for Valentine’s Day, a $0.6 million decline in

 

19

----

 

sales of our manufactured items for Halloween, a $0.6 million declinein sales of our manufactured items for Easter, a $0.3 million decline in salesof our manufactured items for Christmas, a $1.4 million decline in sale ofKastins Christmas  and Easter candy anda $1.6 million decline in sales of our Cows products.   The decline in sales of Manufacturing Candy is due to a shift inour focus towards purchasing products rather than manufacturing.  Therefore, there will be a continuingdecline in sales of Manufactured Candy.

 

Net sales of Purchased Candy increased to $21.8 million for the ninemonths ended April 30, 2004 from $14.7 million for the nine months endedApril 31, 2003. The $7.1 million increase was primarily due to a $1.7million increase in the sale of purchased candy canes, a $0.9 million increasein the sales of purchased Cows products and a $4.5 million increase in thesales of purchased gift items, which gift items were assembled at our NewBedford, Massachusetts facility during the prior fiscal year.

 

Net sales of Gift Items decreased to $14.9 million for the nine monthsended April 30, 2004 from $16.0 million for the nine months endedApril 30, 2003.  The $1.1 milliondecrease was primarily a result  of a$0.9 million decrease in sales of Easter assembled gift items and a $0.2million decrease in sales of Valentines gift items.

 

We had no write-down of obsolescence inventory  costs during the nine months endedApril 30, 2004 compared to a write-down of $2.192 million during the ninemonths ended April 31, 2003.  Inthe fourth quarter of the fiscal year ended July 31, 2003, we reduced thescope of operations at our Chase City, Virginia facility eliminating the needfor continued packaging inventory relating to various products that we hadshifted to our overseas suppliers.

 

Gross margins increased to $11.9 million for the nine months endedApril 30, 2004 from $9.9 million for the nine months ended April 30,2003, and increased to 27.0% from 20.9% as percent of sales, respectively.

 

Gross margins for each of our business segments were as follows:

 

Gross margin losses on our Manufactured Candy decreased from $0.7million to $1.9 million for the nine months ended April 30, 2003 and 2004,respectively.  The decrease was mainlyattributable to increased labor costs and overhead expenses at ourmanufacturing plant in New Hyde Park, New York and decreased sales of candycanes and continued losses at our Chase City facility. We expect that therewill be a continuing decline in sales of manufactured candy until we completethe shift of our operations and equipment to our overseas suppliers sometime inthe fiscal year ending July 31, 2005.

 

Gross margins for our Purchased Candy increased from $6.3 million to$9.3 million for the nine months ended April 30, 2003 and 2004,respectively or 43.3% and 42.8% as a percent of sales, respectively. Theincrease was primarily due to  purchasedpre-packed assembled gift items that were not assembled in our New Bedford,Massachusetts facility and better pricing of purchased candy from our thirdparty overseas suppliers.

 

Gross margins on our Gift Items increased from $4.2 million to $4.6million for the nine months

 

20

----

 

ended April 30, 2003 and 2004, respectively or 26.5% and 30.5% asa percent of sales, respectively.  Theincrease was due primarily to the Christmas assembled gift items and Valentinecards and pops assembled in China.

 

During the nine months ended April 30, 2004 and 2003, selling,general and administrative expenses increased to $6.96 million from $6.95million, respectively, and increased from 14.7% to 15.7% as a percent of sales,respectively. The increase was largely due to a $816,000 increase in commissionexpense, a $379,000 increase in advertising and promotional costs, a $18,000increase in moving expense. These were offset by a $438,000 decrease in travelexpenses, a $116,000 decrease of carrier costs, a $27,000 decrease incommunication and telephone expenses, a $88,000 decrease in professional feesand a $534,000 decrease in shipping and freight costs.

 

Pre-productions startup costs decreased to $0 during the nine monthended April 30, 2004 compared to $1,790,214 from the nine months endedApril 30, 2003.  During the fourthquarter of the fiscal year ended July 31, 2003, we reduced the level ofemployees and the scope of our operations thereby eliminating the need forcontinued training costs for new employees at our Chase City, Virginiafacility.

 

Salaries and related expenses decreased to $3.2 million for the ninemonths ended April 30, 2004, from $3.7 million for the nine months endedApril 30, 2003, or 7.2% from 7.8%, respectively, as a percent of sales.This decrease resulted from a approximate decline of $0.5 million in ouroverhead due to our reorganization effort in the fourth quarter of the fiscalyear ended July 31, 2003.

 

As a result, operating expenses for the nine months endedApril 30, 2004 decreased to $10.1 million from $12.4 million for the ninemonths ended April 30, 2003 and decreased to 22.9% from 26.3%,respectively, as a percent of sales.

 

Income from operations for the nine months ended April 30, 2004was $1.8 million as compared to a loss of $2.5 million for the prior year’scomparable period. Most of the increase resulted from the $1.8 million decreasein pre-production start up costs and the other expenses explained in resultsfrom operating expenses above.

 

For the nine months ended April 30, 2004, interest incomedecreased to $83 from $2,608 for the nine months ended April 30, 2003 asreserves declined. For the nine months ended April 30, 2004, interestexpenses increased to $776,778 from $463,965 for the nine months endedApril 30, 2003 due to an $1.3 million increase in our term debt financingassociated with the merger with Asher Candy and interest on the subordinateddebt instrument we entered into during the fiscal year ended July 31,2003.

 

For the nine months ended April 30, 2004, other expenses increasedto $154,918 from income of $317,498 for the nine months ended April 30,2003 due to $1,762 of realized losses on foreign exchange transactions and$14,000 in gains on sales of assets at the Chase City facility and the $580,000proceeds of a legal settlement of a trade mark infringement less $149,000 oflegal costs during the nine months ended April 30, 2003.

 

21

----

 

The income tax rate utilized onan interim basis is based on our estimate of the effective income tax rate forthe fiscal year ending July 31, 2004. We have a net operating loss carryforward which management believes will offset all taxable income generated infiscal year 2004.  Therefore, we haveestimated our effective tax rate at 0%. During the quarter ended April 30, 2004, we have $473,424 in additionalrefunds due from the Internal Revenue Service and local state jurisdictions foramended income tax returns from prior years. These amounts are partially offsetby a change in deferred taxes of $268,000.

** **

**Liquidity andCapital Resources**

** **

Our primary cashrequirements have been to fund the purchase, manufacture and commercializationof our products. Our working capital at April 30, 2004 and July 31,2003 was $2,225,891 and $669,015, respectively.

 

Net cash used inoperating activities for the nine months ended April 30, 2004 was($1,215,690) and for the nine months ended April 30, 2003 net cashprovided was $940,125. The increase in cash used in operating activities wasdue primarily to increases in accounts receivable and decreases in inventory,accrued expenses and accounts payable, which were offset by increases in netincome,  and other assets.

 

Net cash used ininvesting activities for the nine months ended April 30, 2004 and 2003,decreased to $60,075 from $693,857, respectively, primarily due to decreasedcapital improvements for the manufacturing operations in our Chase City, Virginiafacility and the proceeds from the sale of assets at the Chase City facility.

 

Net cash provided by and (used in) financing activities for the ninemonths ended April 30, 2004 and 2003, was $1,140,292 and  ($899,125), respectively.  The increase was primarily due to increasedreliance on borrowings under our line of credit and subordinated debt facilityto finance working capital needs for seasonal materials.  The borrowings for the period endedApril 30, 2004 were approximately $6,400,321 as compared to $7,207,580 forthe prior year’s comparable period.  Wehave $11,599,679 of our $18,000,000 line of credit available to meet additionalseasonal needs to purchase and manufacture inventory subject to availability ofaccounts receivable and inventory. We were in violation of a covenant duringthe quarter ended April 30, 2004 and are renegotiating our line of creditwhich expires on June 13, 2004.

 

Principal paymentsfor our long-term debt for the nine months ended April 30, 2004 were$446,811.

 

**Schedule ofContractual Obligations**

 
|                         |   |      |       | **Payments  Due by Period** |       |
|------------------------------|--------|-----------|------------|-----------------------------|------------|
| **Contractual Obligation**   |   | **Total** | ** ** | **Less Than  1 year**       | ** ** | **1-3 years** | ** ** | **After 4  years** | ** ** |
| Long-Term Debt               |   | $         | 1,245,779  |                        | $          | 582,877 |   | $ | 392,902 |   | $ | 270,000 |   |
| Subordinated Debt            |   | 3,637,857 |       | 3,637,857                   |       | — |   | — |   |
| Capital Lease Obligation     |   | 427,910   |       | 15,718                      |       | 53,215 |   | 358,977 |   |
| Operating Leases             |   | 1,182,544 |       | 260,025                     |       | 597,189 |   | 325,330 |   |
| Total Contractual Obligation |   | $         | 6,494,090  |                        | $          | 4,496,477 |   | $ | 1,043,306 |   | $ | 954,307 |   |

 

22

----

 

**Schedule ofCommercial 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 |   | — |   | — |   |

 

----

(*)         The line of credit is available foradvances to finance working capital and the issuance of letter of credits.  Advances under the line of credit are basedon a borrowing formula equal to 85% of eligible domestic accounts receivableplus 60% of eligible finished goods and 30% of eligible components inventory.The line of credit facility varies from quarter to quarter based on workingcapital needs and the level of repayments.

 

During the quarter ended April 30, 2004, we were not in compliancewith our business and financial covenants under our credit facility relating tothe fixed charge coverage ratio. Management believes we will not continue to bein compliance with our covenants for the remainder of 2004.  We are currently in discussions with ourlender regarding the extension of the term of the credit facility. Currently,our $18.0 million credit facility expires on June 13, 2004.  Management believes it will have the renewedcredit facility in place during the fourth quarter ending July 31, 2004.

 

**Item 3**.           Quantitative and Qualitative DisclosuresAbout Market Risk

** **

As a result of ourvariable rate line of credit, we are exposed to the risk of rising interestrates. Our $18.0 million line of credit had an interest rate ranging from 4.09%to 4.10% for the nine months ended April 30, 2004. 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.

 

Our preparation offinancial statements in conformity with accounting principals generallyaccepted within the United States requires management to make estimates andassumptions in certain circumstances that effect amounts reported in theaccompanying financial statements and related notes. In preparing thesefinancial statement, 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.

 

We provide anallowance for un-collectible accounts receivable based on experience. Weconsider the following factors in developing an estimate of our allowance fornon-payment and the overall economic environment. Although it is reasonablypossible that management’s

 

23

----

 

estimate ofun-collectible accounts could change in the near future, management is notaware of any events that would result in a change to its estimates which wouldbe material to our financial position or results from operations. For thequarter ended April 30, 2004, we had an allowance for doubtful accounts ofapproximately $232,000.

 

We provide anallowance for slow moving inventory based on experience and aging of products.We consider the following factors in developing an estimate of our allowancefor non-moving of inventory and the overall economic environment. Although itis reasonably possible that management’s estimate of slow moving inventorycould change in the near future, management is not aware of any events thatwould result in change to its estimates which would be material to ourfinancial position or results from operations. For the quarter endedApril 30, 2004, we had an allowance for slow moving inventory ofapproximately $302,100.

 

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. Management evaluates therecoverability of the goodwill annually and reviews goodwill and otherlong-lived assets for impairment. As of April 30, 2004 there was noimpairment loss.

 

In April 2003, the FASB issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. We adopted the use of this accounting statement in June 2003. The adoption of the statement did not have a material effect on our financial position or results of operations.

 

In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement established standards on how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires an issuer to classify a financial instrument that is within its scope as a liability, or an asset in some circumstances. We adopted the use of this accounting statement in May 2003. The adoption of the statement did not have a material effect on our financial position or results of operations.

 

**Seasonality andCylicality; Fluctuation in Quarterly Operating Results**

** **

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

 

We also believethat the confectionery industry is influenced by general economic conditionsand particularly by the level of change. Increase levels of change can have afavorable impact on our revenues. We also believe that the confectionaryindustry tends to experience periods of decline and recession during economicdownturns. The confectionary industry could sustain periods of decline inrevenues in the future, and any decline may materially adversely effect us.

 

24

----

 

We could in thefuture experience quarterly fluctuations in operating results due to thefactors described above and other factors, including short-term nature ofcertain client commitments; patterns of capital spending by customers; loss ofa major client; seasonality that may accompany private or public budget cycles;pricing changes in response to various competitive factors; market factorsaffecting availability of qualified personnel and general economic conditions.

 

**Item 4**.           Controls and Procedures

** **

As of the end ofthe period covered by this report, our Chief Executive Officer and our ChiefFinancial Officer have evaluated the effectiveness of our disclosure controlsand procedures (as such term is defined in Rule 13a-15(e) and 15d-15(e) underthe Exchange Act).  Based upon thatevaluation, our Chief Executive Officer and our Chief Financial Officerconcluded that, as of the end of the period covered by this report, ourdisclosure controls and procedures are effective in the timely recording,processing, summarizing and reporting of material financial and non-financialinformation.

 

No change in our internal control over financial reporting (as suchterm is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) occurredduring the last fiscal quarter that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART II** OTHER INFORMATION

** **

**Item 1**.           Legal Proceedings

** **

We are from time to time involved in litigation incidental to theconduct of our business. We were a plaintiff in an action with the landlord atour Rhode Island facility. The landlord sought security for its claims relatingto the lease agreement.  We deposited$180,000 with the registry of the court on allegation relating to amountssought for payment of real estate taxes, water and sewer, rent of otheroccupied space and repair expenses. On September 2002, the landlordclaimed other breaches of the lease agreement alleging an obligation of$932,000 under the lease and has demanded $750,000 to settle the disputes.  We had claims against the landlord it ispursuing. We had accrued amounts to cover current charges.  In November 2003, We settled our claimswith the landlord.  The accrual in thefinancial statements was sufficient to cover all outstanding obligations to thelandlord.  The settlement was paid bybooth parties. We vacated the space on March 31, 2004.

 

We are currently involved as Plaintiff in a suit brought before theCircuit Court for Montgomery County, Maryland, presenting claims in connectionwith the  merger agreement under whichSherwood Brands acquired securities of Asher Candy Acquisition Corporation andagreed to sell securities in Sherwood Brands to prior shareholders of AsherCandy.  The complaint alleges that wewere fraudulently induced to enter into the merger agreement on the basis of,among other things, material misrepresentations and omissions by theshareholders of Asher Candy.   We areseeking declaratory and injunctive relief and award of damages against theformer shareholders of Asher Candy for violations of the merger agreement andfor common law fraud and violations of applicable securities laws.  Pending resolution of the litigation, wehave refused to honor the demand of the former shareholders for us torepurchase half of the shares issued to them at a

 

25

----

 

price of $4.50 per share. Some of the shareholders have filed acounterclaim seeking $7.0 million in damages. We believe that we have defenses to the counterclaim. There can be noassurance that we will not be a party to other litigation in the future.

 

**Item 4.**           Submissionof Matters to a Vote of Security Holders

** **

None

 

**Item 6.**           Exhibits and Reports on Form 8-K

** **
| (a)    |   | Exhibits                                                                                                             |
|--------|--------|----------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                 |
| 31.1   |   | Certification of  the Chief Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.       |
|   |   |                                                                                                                 |
| 31.2   |   | Certification of  the  Chief Financial Officer Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                 |
| 32.1   |   | Certification of  the Chief Executive Officer Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.       |
|   |   |                                                                                                                 |
| 32.2   |   | Certification of  the Chief Financial Officer Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.       |
|   |   |                                                                                                                 |
| (b)    |   | Reports on Form  8-K                                                                                                 |
|   |   |                                                                                                                 |
| None.  |   |                                                                                                                 |

 

26

----

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                      |   | SHERWOOD BRANDS,  INC.                           |
|---------------------------|--------|--------------------------------------------------|
|                      |   |                                             |
| Date:  June 11, 2004 |   | /s/ Uziel  Frydman                               |
|                      |   | Chairman,  President and Chief Executive Officer |
|                      |   |                                             |
| Date:  June 11, 2004 |   | /s/ Christopher  J. Willi                        |
|                      |   | Chief Financial  Officer and Secretary           |

 

27

----

 

**Exhibit Index**

 
| **Exhibit No.** |   | **Description**                                                                                                    |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                               |
| **31.1**        |   | **Certification  of the Chief Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.** |
|            |   |                                                                                                               |
| **31.2**        |   | **Certification  of the Chief Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.** |
|            |   |                                                                                                               |
| **32.1**        |   | **Certification  of the Chief Executive Officer Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.** |
|            |   |                                                                                                               |
| **32.2**        |   | **Certification  of the Chief Financial Officer Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.** |

 

28

----