**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-K**

 

**Annual Report Pursuant To Section13 or 15(d) Of The Securities Exchange Act Of 1934For the fiscal year ended July 31, 2004**

 

**Commission File Number: 1-14091**

 

**SHERWOODBRANDS, INC.**

(Exact Name of Registrantas Specified in Its Charter)

 
| **North  Carolina**                            | ** ** | **56-1349259**                       |
|------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of Incorporation) |       | (IRS Employer Identification Number) |

 

**1803Research Blvd., Suite 201**

**Rockville,Maryland 20850**

(Addressof Principal Executive Offices)

 

Registrant’s telephonenumber: **(301) 309-6161**

 

Securities RegisteredPursuant to Section 12(b) of the Act:

 

**None**

Securities RegisteredPursuant to Section 12(g) of the Act:

 

Class A Common Stock,$.01 Par Value

 

Indicate by check mark whether the registrant:(1) hasfiled all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. ý

 

Indicate by check mark whether the Registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2). Yes oNo ý.

 

State the aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was last sold, or the average bid and askedprice of such common equity, as of the last business day of the registrant’smost recently completed second fiscal quarter.

 

Class A Common Stock, $.01 par value per share —$14,724,204 as of January 30, 2004.

 

Class B Common Stock, $.01 par value per share —$4,880,000 as of January 30, 2004.  Noshares of Class B Common Stock are held by non-affiliates of the Company.  While the Class B Common Stock is not listedfor public trading on any exchange or market system, shares of that class areconvertible into shares of Class A Common Stock at any time on ashare-for-share basis.  The market valueindicated is calculated based on the closing price of the Class A Common Stockon the American Stock Exchange on January 30, 2004.

 

Indicate the number of shares outstanding of each ofthe registrant’s classes of common stock as of the latest practicable date.

 

Class A Common Stock, $.01 par value per share —3,017,255 shares, as of October 28, 2004.

 

Class B Common Stock, $.01 par value per share —1,000,000 shares, as of October 28, 2004.

 

DOCUMENTS INCORPORATED BYREFERENCE

 

Certain portions of the registrant’s definitive Proxy Statementpursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,which will be filed with the Commission subsequent to the date hereof, areincorporated by reference into PART III of this form 10-K

 

 

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TABLE OF CONTENTS

 
|      | PART I                                                                                      |   |
|-----------|---------------------------------------------------------------------------------------------|--------|
|      |                                                                                        |   |
| ITEM  1.  | BUSINESS                                                                                    |   |
|      |                                                                                        |   |
| ITEM  2.  | PROPERTIES                                                                                  |   |
|      |                                                                                        |   |
| ITEM  3.  | LEGAL PROCEEDINGS                                                                           |   |
|      |                                                                                        |   |
| ITEM  4.  | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        |   |
|      |                                                                                        |   |
|      | PART II                                                                                     |   |
|      |                                                                                        |   |
| ITEM  5   | MARKET  FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                 |   |
|      |                                                                                        |   |
| ITEM  6   | SELECTED FINANCIAL DATA                                                                     |   |
|      |                                                                                        |   |
| ITEM  7   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |
|      |                                                                                        |   |
| ITEM  7A  | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 |   |
|      |                                                                                        |   |
| ITEM  8   | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                |   |
|      |                                                                                        |   |
| ITEM  9   | CHANGE IN ACCOUNTANTS                                                                       |   |
|      |                                                                                        |   |
| ITEM  9A  | CONTROLS AND PROCEDURES                                                                     |   |
|      |                                                                                        |   |
| ITEM  9B  | OTHER INFORMATION                                                                           |   |
|      |                                                                                        |   |
| ITEM  10  | CODE OF ETHICS                                                                              |   |
|      |                                                                                        |   |
|      | PART III                                                                                    |   |
|      |                                                                                        |   |
| ITEM  10  | DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT                                         |   |
|      |                                                                                        |   |
| ITEM  11  | EXECUTIVE COMPENSATION                                                                      |   |
|      |                                                                                        |   |
| ITEM  12  | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED  STOCKHOLDERS   |   |
|      |                                                                                        |   |
| ITEM  13  | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                             |   |
|      |                                                                                        |   |
| ITEM  14  | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                     |   |
|      |                                                                                        |   |
|      | PART IV                                                                                     |   |
|      |                                                                                        |   |
| ITEM  15. | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                           |   |
|      |                                                                                        |   |
|      | SIGNATURES                                                                                  |   |

 

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**PART I.**

 

**ITEM 1.****                             Business**

 

**(a)           GeneralDevelopment of Business**

 

SherwoodBrands, Inc. was incorporated in December 1982 in the state of NorthCarolina.  Sherwood Brands, Inc. and itsconsolidated subsidiaries (together, the “Company”) manufacture, market anddistribute a diverse line of brand name candies, cookies, chocolates and gifts.The Company also manufactures lollipops and biscuits and assembles seasonalgift items including gift baskets for Christmas, Valentine’s Day and Easter.The Company’s principal branded products include COWS(TM) butter toffeecandies, DEMITASSE(R) biscuits, RUGER(R) wafers, SMILE POPS(R) lollipops,STRIP-O-POPS(R) lollipops, ELANA(R) chocolates, SOUR FRUIT BURST(TM)fruit-filled hard candies and PIRATE’S GOLD COINS(R) milk chocolates. TheCompany’s marketing strategy, including product packaging, is designed tomaximize freshness, taste and visual appeal, and emphasizes highly distinctive,premium quality products that are sold at competitively favorable prices.

 

Many companies in the confectionary industry areshifting manufacturing operations to foreign manufacturers and suppliers totake advantage of lower world sugar prices, which have been selling at $0.08 to$0.10 per pound, as compared to domestic prices of $0.26 to $0.32 per pound andlower labor costs and overhead structures of foreign factories.  For example, Kraft recently closed itsLifeSavers plant in Michigan and Brach’s recently shifted some of its domesticproduction to Argentinean manufacturers and suppliers.  Other confectioners have outsourced theirmanufacturing to the People’s Republic of China to take advantage of highquality, low-cost manufacturing facilities and market opening concessions madeby the Chinese government.  According to Candy Business, for the first tenmonths of last year the value of sugar confectionery items imported into theUnited States from mainland China nearly doubled as compared to the same periodthe previous years, rising from $19.4 million in 2001 to $47.0 million during2003.  During the same 10-month periodthe value of items imported from Hong Kong more than tripled ($2.27 million in2001 to nearly $19 million in 2003), and China outpaces Argentina as theseventh largest importer to the U.S. Management believes that the Company’sexperience in these markets and distribution channels, coupled with itsexpanded manufacturing capabilities with its suppliers overseas, should enablethe Company to capitalize on opportunities in these markets.

 

Following the outsourcing trend, in the Fall of 2003 the Company beganmoving a portion of its hard candy operations and its candy cane line to itsoverseas suppliers.  Sherwood Brandsfinalized a production and manufacturing agreement with one of the largestmanufacturers in Argentina. This agreement includes achieving volumecommitments of 8,000,000 pounds of products. Specializing in the manufacture ofhard candies, chocolates, cookies and butter toffees, the Argentine Company andSherwood had already established a long relationship working successfully overthe years in developing brands. The Argentine company did not have theequipment or the facilities to completely take over the production of all ourproduct lines. Therefore, the Chase City facility continues to be utilized toproduce certain products which the Argentine company could not yet produce or couldnot produce within the time frame Sherwood Brands needed to meet the demandswith its customers.  In addition, theChase City facility is currently being utilized as a warehouse for theChristmas seasonal items that need to be shipped to our southeast regioncustomers.  The Argentine company wasselected initially for its ability to produce the butter toffee as theArgentine company is an expert in this field. Later given the Argentine company’s success and availability of a newfacility, Sherwood and the Argentine company agreed to move Asher Candy CaneProduction to the Argentine company during the third and fourth quarters offiscal 2004.

 

Since the production of candy canes involves very specialized equipmentand technology along with a specialized trained labor force, Sherwood had toevaluate many suppliers to meet the stringent guidelines to produce thisspecialized product. Sherwood selected the largest manufacturer inArgentina.  The Argentine company with operationsin many S. American countries offered many advantages including a highlytalented labor and management force, brand new state of the art facilities, anda willingness to move the equipment and train. The process was done in severalstages to mitigate any disruptions. Between January 2004 and October 2004, boththe Asher facility in New Hyde Park, New York and the Argentine companiesfacility were running concurrently. The Argentine company quickly sped throughthe learning curve achieving similar production output as New Hyde Park, New Yorkbut at lower costs due to the materials and labor structure enjoyed inArgentina. The Argentine company uses Asher equipment exclusively for the candycane production, which was shipped to Argentina during the third and fourthquarters of fiscal 2004.  The Companyanticipates that the complete transition of the Candy Cane lines into theArgentine Company will be by the end of November 2004.

 

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In the Spring of 2004, Sherwood entered into aproduction agreement with a second Argentine company with the objective ofproducing lollipops in South America-again benefiting from lower sugar prices,lower labor costs and state of the art facilities. The move over the lastseveral months is near completion with Sherwood benefiting from the expertiseand technology of the Argentine company in lollipop production. The secondArgentine company is using a combination of Sherwood’s equipment and their ownequipment to help Sherwood increase margins, capacity and marketability ofSherwood’s products.  The completion ofthis transition should likely be completed by October 31, 2004.

 

In September 2004, the Company entered into a JointVenture Agreement with an Israeli company, which is subject to certainconditions, which have yet to be satisfied. The Joint Venture would market and distribute two patented products inthe United States and worldwide.  TheCompany and the Israeli Company each would own 50% of the Joint Venture. TheCompany would invest $800,000 in the Joint Venture, which would be in the formof working capital for its 50% ownership in the Joint Venture.  The working capital investment would be madein four quarterly payments of $200,000. The Joint Venture would use the investment for the marketing and distributionof the products into the United States and then worldwide.  The Company would also have a serviceagreement with the Joint Venture, for the contribution of the Company’smarketing, distribution and general business management knowledge.  For performing such services, the Companywould be reimbursed on a cost basis for all services rendered. Managementbelieves that all conditions to the Joint Venture will be satisfied and a finaljoint venture agreement will be completed by November 15, 2004.

 

**(b)           FinancialInformation About Industry Segments**

 

The Company has three business segments:(i)Manufactured Candy and Cookies, (ii) Purchased Candy and Cookies; and (iii)Purchased Gift Items.

 

Net sales and gross profit attributable to eachsegment for each of the last three years are set forth in Note 19 to theCompany’s consolidated financial statements attached hereto and incorporatedherein by reference.

 

**(c)           NarrativeDescription of the Business**

 

### **Products**

 
| **Manufactured Candy and Cookies:** | ** ** | DEMITASSE(TM) BISCUITS offered in a variety of  flavors including the traditional tea biscuit, “Petit Beurre” (with real  butter), cinnamon honey, coconut, chocolate and several sugar free varieties,  all certified kosher by the Orthodox Union.

 

CANDY CANES in a variety of packages, sizes, colors  and flavors, ranging from traditional peppermint canes to gourmet lines and  flavors, including amaretto, merlot, Irish creme, Dutch chocolate, maraschino  cherry and blueberry cheesecake.                                            |
|-------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                          | ** ** |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| **Purchased Candy and Cookies:**    | ** ** | COWS(TM) and COWPOKES(TM) LOLLIPOPS butter toffee  candies and lollipops, including soft and chewy toffees and a dairy butter  and cream hard candy.

 

SOUR FRUIT BURST(TM) HARD CANDIES fruit-filled hard  candies that are available in a variety of flavors.

 

RUGER(R) WAFERS wafer cookies, including sugar free varieties,  available in four flavors: chocolate, vanilla, lemon and coffee.

 

ELANA(R) BELGIAN CHOCOLATES chocolate bars sold in a  variety of flavors, including mint, caramel, mocha, truffle, crispers, and  almonds. |

 

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| ** **                | ** ** | COUNTDOWN TO CHRISTMAS(TM) CHOCOLATE CALENDARS  chocolate calendars made with 24 milk-chocolate candies behind numbered  doors.

 

PIRATE’S GOLD COINS(TM) FOIL-WRAPPED CHOCOLATE COINS  coin shaped milk chocolates wrapped in embossed gold foil.

 

STRIP O POPS(TM) LOLLIPOPS hard candy lollipops in a  variety of flavors merchandised in hanging strips.

 

SMILE POPS(TM) LOLLIPOPS candy iced lollipops  decorated with smiling faces.

 

TONGUE TATTOO(TM) LOLLIPOPS hard candy lollipops  embossed with candy icing images, which transfers when pressed on the tongue  creating a tongue tattoo.

 

COWSCARAMELS(TM) caramel candy with flavored  fillings

 

including vanilla, cappuccino and butter and cream,  certified kosher by the Orthodox Union and offered in both a soft and chewy  toffee and as a dairy butter and cream hard candy.

 

BUBBLE GUM in various varieties:

•      Blood Balls TM is a line of Bubble Gum  products with super sour taste and a red mouth coloring center.

•      Screechers TM mouth coloring powder  center bubble gum

 

•      Alien Pods TM Super sour bubble gum with  coloring center, bite sized pods

 

•      Big Curl– curled gum that comes in  variety of flavors, fruit, strawberry and apple.

 

•      Spaghetti gum– gum that looks like  spaghetti |
|---------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                | ** ** |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **Purchased Gift Items:** | ** ** | The Company’s gift sets and gift baskets are  typically designed for a particular holiday such as Christmas, Valentine’s  Day or Easter. The gift sets and gift baskets may contain gourmet food  products, candy, novelty items or seasonal merchandise. A significant portion  of the contents of the gift sets and gift baskets are assembled from  components imported from China.

 

Christmas assembled items include Elana Holiday  Gifts, Chocolate Santa Bears, Chocolate Holiday Ornaments, Candy Filled  Votive Candle Holders, Old Fashioned Milk Can and Milk bottles, Candy Filled  Cars, Starry Night, Botanical Mug and Canister Set, Pasta Houses, Share the  Spirit Mug Set, Spice of Life and Just for Him Mugs.

 

Valentines assembled items include Valentine Card  and Pops, Valentine Coin Purses and Valentine Treasure Chests.

 

Easter assembled items include Easter Baskets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

 

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| ** ** | ** ** | with various themes including Playtime assortment,  Fun and Games assortment, Toy Time assortment and Fuzzy Friends plush  assortment. |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|

 

**Distribution,Advertising and Marketing, Competition and Raw Mater**ials

 

Market Overview

 

According to Information Resources, Inc. (IRI), alongwith much of the U.S. economy, the confectionery industry began to see signs ofa recovery in the second half of 2003. Major economic developments have had a significant impact on theconfectionery industry.  While economistsdebate the official dates of this latest recession in the United Stateseconomy, retailers and candy manufacturers have re-energized the confectionerycategory with the introduction of new items and a renewed focus on theconfectionery holidays.  Manufacturingjobs in many categories have left the United States for Mexico’s loweringredient costs and labor rates.  In thecase of candy, a significant level of non-chocolate candy manufacturing hasmoved offshore with Canada and Mexico being the top two producers.

 

United States retailers rebounded in the second halfof 2003 with the general economy.  Thefourth quarter and Christmas selling season saw retail sales grow at a 6.2percent clip over 2002.  One companyposted a 12 percent sales gain in 2003 to lead mass merchants. Consumerscontinued to shop at dollar stores and general merchandise stores.  The retail drugstore industry had a banneryear.  After struggling over the pastfive years with re-organizations and mergers, the retail sector posted salesincreases of 7.2 percent. Supermarket sales grew at a rate of 3.3 percent.  Warehouse club sales grew 13 percent in 2003.

 

Retail candy and gum sales grew 2.2 percent in 2003,significantly higher than the 1.5 percent sales increase posted in 2002.  Sales were led by everyday sales indicatingstrong acceptance of new product offerings by candy manufacturers and retailers.  Gum sales, led by strong increases in thesugar free sector, led overall sales increase with 5.5 percent gain.  The chocolate candy category was led by salesin count goods and everyday bags and boxes with sales increases of 8.7 percentand 6.9 respectively.  Non-chocolatecandy sales grew 1.8 percent in 2003 despite continuing declines in the salesof breath fresheners.  2003 could beremembered as the year of sugar–free candy and gum.  Sugar-free gum, a well-established category,grew more than 13 percent according to IRI, and the sugar-free/diet candycategory grew almost 90 percent.

 

Seasonal candy sales showed mixed results in 2003 perIRI. Halloween candy sales were particularly strong at retail drug storeoutlets, continuing a trend of seasonal candy sales shifting from supermarketsto other trade channels.  This year therewas a very strong early selling season for the Halloween sales period.September sales of Halloween candy increased at a faster rate thanOctober.  Branded give-away candiescontinued to generate a larger share of Halloween business, as product packagedfor Halloween (i.e. packaging with witches and ghosts), saw sales slip.  Christmas candy sales slipped 1.4 percent asa result of the shorter sales period between Thanksgiving and Christmas in2003. A more compact selling season for Christmas candy continues as a trendfor retailers. The four-week December sales period posted stronger sales thanthe early December and November sales period. This is a continued trend of consumers putting off shopping until thelast two weeks before Christmas. Christmas posted even sales as compared to ayear ago.  As expected with Valentine’sDay falling on a Saturday in 2004, candy sales faced difficult competition fromrestaurants and other weekend offerings. Total Valentine’s Day candy sales were down 4.0 percent.  The Saturday effect can be seen withchocolate candy sales decreasing 4.8 percent and non-chocolate sales decreasing1.2 percent.  Easter candy sales in 2004had strong increases across all channels in the mass markets led by a 5.7percent increase in unit sales at retail drug stores.  Across all mass retail outlets, chocolateEaster candy unit sales increased by 6.1 percent but non-chocolate unit salesdeclined 2.5 percent. Seasonal candy sales have been impacted by the recentgeneral retail trend of consumers shopping over a shorter period of time tofulfill their holiday needs.

 

  Candy sales enjoyed a strong four-week sales period endingin December 28, 2003.  During this time period,chocolate candy sales grew nearly 5 percent in drug stores and mass merchants,but sales over the eight-week holiday period were only even.

 

According to an article in USA today, more than 40percent of retail Christmas sales occurred in the final week beforeChristmas.  As recently as two years ago,that figure was only 28 percent. American consumers are not spending time shopping for Christmas early.   This has an impact on the impulsive natureof candy.  If consumers are not in thestores, they are not buying.

 

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Mass merchants suffered their second consecutive yearof sales declines according to IRI. However these declines were reversed in the fourth quarter and totalmass outlets posted a 1.4 percent gain in Christmas candy sales. Supermarketsales posted a 3 percent gain in candy and gum sales and retail drug storesales grew 4.4 percent.  Conveniencestore sales grew an estimated 5.5 percent and warehouse clubs gained anestimated 8 percent.

 

Sales of candy and cookie products in the UnitedStates have increased significantly in recent years. According to the UnitedStates Department of Commerce, manufacturers’ domestic shipments ofconfectionery products (excluding chewing gum) have increased fromapproximately $9 billion in 1990 to $24.8 billion in 2003. The ChocolateManufacturers Association/National Confectioners Association has estimated thattotal retail sales of confectionery products in the United States in 2003 wereapproximately $24.8 billion, comprised of $13.5 billion in chocolate, $7.6billion in non-chocolate products, $3.0 billion in gum products and $700million in other products. Despite the growth, the United States ranks onlyfifth in per capita candy consumption among the industrialized nations.

 

  The Company believes that the expanding candy market in theUnited States presents attractive growth opportunities for its business, and isfocusing on introducing new products in these holiday categories as well asachieving greater brand recognition and market penetration for all of theCompany’s products.

 

The markets for candy and cookie products aredominated by a number of large, well capitalized corporations. In the candymarket, these companies include Hershey Food Corporation, Masterfoods USA(M&M Mars) and Nestle S.A. The cookie and biscuit market is dominated byKraft foods. In addition to domestic manufacturers, foreign candy and cookiecompanies, such as Lindt of Switzerland, Bahlsen KG, and Storck, haveestablished their products in the United States. The Company believes that theremainder of the market is highly fragmented, with numerous manufacturers andhundreds of products and distribution channels, such as mass merchandisers,drug stores, club stores, vending companies and gourmet distributors.

 

Suppliers

 

Some of the Company’s products are manufactured bythird party sources to specific recipe and design specifications developed bythe Company. These third party sources are located in Argentina, Austria,Belgium, Holland, Germany, Italy, and Turkey. The Company’s operations requireit to have production orders in place in advance of shipment to the Company’swarehouses (product deliveries typically take 60 days). Generally, the Company’sforeign suppliers deliver finished products free on board to a freightforwarder, cargo consolidator or directly to a seaport for ocean transport. TheCompany assumes the risk of loss, damage or destruction of products, althoughthe Company maintains cargo insurance. Upon entry into the United States, theproducts are then transported by rail or truck to one of the six regionalwarehouses used by the Company.

 

The Company has long-term relationships with themanufacturers of ELANA(R)Belgian chocolates, RUGER(R) Wafers, and PIRATE’S GOLDCOINS(TM) milk chocolates. Generally, these manufacturers have agreed not toexport into the United States, and in some cases, other countries, any productssimilar to those produced for the Company. The Company has no formal writtenagreements with these manufacturers and has no formal commitment to purchaseminimum volumes of products. However, on an annual basis the Company and itsmanufacturer will agree upon volumes and prices and establish a deliveryschedule based upon the Company’s forecast.

 

The Company requires that its suppliers maintainproduct liability insurance with the Company as an additional named insured.The loss of any one supplier would not have a material adverse effect on theCompany’s business.

 

The Company purchases the necessary ingredients andpackaging materials, which are used in its products that are manufactured atits New Hyde Park, NY and Chase City, VA production facilities from numerousthird-party suppliers. These ingredients and packaging materials include flour,sugar, shortening, flavorings, butter, folding cartons, shipping cartons andwrapping film. The purchases are made on an open account basis with competitivepayment terms.   With the move of ourmanufacturing to our overseas suppliers, the company will be limited to onlypurchases of ingredients and packaging materials for its cookies and biscuitslines, which will be limited in production during the fiscal year 2005.

 

Most of the components used in the Company’s line ofholiday gift sets and gift baskets are assembled at its New Bedford, MAfacility and are purchased from manufacturers located in Asia,

 

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principally China. Inaddition, the Company purchases some components from domestic sources on anopen account basis.

 

Vending companies are one of the Company’s majorcustomer categories. ELANA Belgian chocolates, RUGER wafers, COWS butter toffeecandies and SOUR FRUIT BURST candies are available in vending machines as wellas through traditional outlets. The Company believes that the visibility of itsproducts in vending channels enhances market acceptance and consumer appeal ofthe Company’s products in other distribution channels.

 

The Company also sells its products to numerousgourmet distributors throughout the United States. These distributors in turnsell the Company’s products to a wide base of gourmet stores. The Companybelieves that it has been able to penetrate this customer segment because ofits ability to satisfy consumer demand for premium quality products at pricesthat are attractive to these distributors.

 

Distribution Channels

 

The Company distributes its products throughout theUnited States, Puerto Rico and Canada. Net sales of the Company’s products inthe Canadian market accounted for 1% in fiscal 2004 compared to less than 1% ofthe Company’s total net sales in fiscal 2003.

 

The Company engages independent food and candy brokersin various regions throughout the United States for marketing to retail stores.These brokers account for a majority of the Company’s sales. Food and candybrokers are paid on a commission basis (typically 5% of sales) and aregenerally responsible in their respective geographic markets for identifyingcustomers, soliciting orders and inspecting merchandise on store shelves. As ofJuly 31, 2004, the Company had arrangements with approximately 65 food andcandy broker organizations. These arrangements typically prohibit the brokersfrom selling competing products during their engagement with the Company. TheCompany believes that the use of brokers, enhances the quality and scope of theCompany’s sales operations. In addition, the use of brokers permits the Companyto limit the costs associated with creating and maintaining a directdistribution network. The Company’s executive officers and six regional salesmanagers work with the brokers on an individual basis and are responsible formanaging the broker network, identifying opportunities and developing sales intheir respective territories.

 

The Company uses six regional bonded public warehousesthat specialize in food and confectionery storage. These warehouses areselected based on proximity to the Company’s customers, their ability toprovide prompt customer service and their efficient and economic delivery.Generally, the Company sells its products pursuant to customer purchase ordersand fills these orders from inventory within one to two days of receipt.

 

Because these purchase orders are filled shortly afterreceipt, backlog is not material to the Company’s business. Substantially allof the Company’s products are delivered by common carrier.

 

Marketing, Sales and Advertising

 

The Company believes that product recognition byretail and wholesale customers, consumers and food brokers is an importantfactor in the marketing of its products. Accordingly, the Company promotes itsproducts and brand names through the use of promotional materials, includingfull-color product brochures and newspaper inserts, advertising in trademagazines targeted to the mass merchandisers, vending industry, gourmet tradeand gift basket markets, and participation in trade shows. For the year endedJuly 31, 2004, the Company spent approximately $1,418,000 on advertising andproduct promotion. For the years ended July 31, 2003 and 2002 the Company spentapproximately $928,000 and $1,127,000, respectively, on advertising and productpromotion.

 

The Company also promotes its products through salesdiscounts and advertising allowances. Promotional programs are generally usedmost during the initial introduction of a new product. As distribution of thenew product increases, the Company gradually shifts from promotion to directadvertising in order to reinforce trade and consumer repeat purchasing.Management believes that these promotional programs have shortened the timeperiods necessary to achieve market penetration of its products. The Companyintends to continue to develop and implement marketing and advertising programsto increase brand recognition of its products and to emphasize favorable pricingcompared to competing products.

 

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 Competition

 

The Company faces significant competition in themarketing and sale of its products. The Company’s products compete for consumerrecognition and shelf space with candies, cakes, cookies, chocolates and otherfood products which have achieved international, national, regional and localbrand recognition and consumer loyalty. These products are marketed bycompanies (which may include the Company’s suppliers) with significantlygreater financial, manufacturing, marketing, distribution, personnel and otherresources than the Company. Certain of these competitors, such as Hershey FoodCorporation, Masterfoods USA (M&M Mars), Inc., Nestle, S.A., and KraftFoods, dominate the markets for candy and cookie products, and have substantialpromotional budgets which enable them to implement extensive advertisingcampaigns. The food industry is characterized by frequent introductions of newproducts, accompanied by substantial promotional campaigns. Competitive factorsin these markets include brand identity, product quality, taste and price. TheCompany’s major competitors for holiday gift items and gift baskets are HoustonHarvest Co., Smith Enterprises, Inc. and Wonder Treats. The Company’s majorcompetitors for candy canes are Bob’s Candies, Inc., Spangler Candy Company,and Allan Candy Company.

 

### **GovernmentRegulation**

### ** **

The Company is subject to extensive regulation by theUnited States Food and Drug Administration, the United States Department ofAgriculture and by other state and local authorities in jurisdictions in whichthe Company’s products are manufactured or sold. Among other things, suchregulations govern the importing, manufacturing, packaging, storing, distributionand labeling of the Company’s products, as well as sanitary conditions andpublic health and safety. Applicable statutes and regulations governing theCompany’s products include “standards of identity” for the content of specifictypes of products, nutritional labeling and serving size requirements andgeneral “Good Manufacturing Practices” with respect to manufacturing processes.The Company’s manufacturing facilities and manufactured products are subject toperiodic inspection by federal, state and local authorities. The Companybelieves that it is in compliance with all governmental laws and regulationsand maintains all permits and licenses required for its operations.

 

### **Other**

### ** **

Customers

 

The Company sells its products primarily to massmerchandisers, other retail customers, grocery and drug store chains, clubstores, convenience stores, specialty shops and wholesalers. The Company’s massmerchandise customers include Family Dollar, Target, Dollar General, K-Mart andWal-Mart. For the year ended July 31, 2004, Sam’s Club and Wal-Mart accountedfor 4% and 27% of the Company’s total net sales, respectively. For the yearended July 31, 2003, Sam’s Club and Wal-Mart accounted for 15% and 9%,respectively, of the Company’s total net sales. For the year ended July 31,2002 Sam’s Club and Wal-Mart accounted 29% and 14% of the Company’s total netsales. The loss of either Sam’s Club or Wal-Mart as a customer would result ina significant decrease in the Company’s revenues and profits.

 

Employees

 

As of October 8, 2004, the Company had approximately61 full-time employees and approximately 112 part-time or seasonal employees.Of the Company’s full-time workforce, 16 are located at the Company’s principaloffice in Rockville, MD. The Company has approximately 36 full and part-timeemployees in Virginia, approximately 75 full, part-time and seasonal employeesin Rhode Island and Massachusetts and 46 full, part-time and seasonal employeesin its New Hyde Park, NY facility. Management believes that the Company’s relationshipwith its employees is good. The 40 employees at the Asher Candy facility arethe Company’s only employees represented by labor unions under a collectivebargaining agreement. The closure of the Asher Candy facility in New Hyde Park,New York in November 2004 will have an effect on the entire 40 employees at thefacility. The Company will provide the required state of New York timetable forseverance associated with each remaining employee under the union contract atthe time the facility is closed. The Union Contract stipulates that severancewill be based on seniority of employment at the New Hyde Park, New Yorkfacility. The potential liability to the Company for severance could be up toapproximately $155,000.

 

Trademarks

 

The Company holds United States trademarkregistrations for the “ELANA,” “RUGER”, “TONGUE TATTOO”, “STRIP-O-POP”, “SMILEPOPS” and “demitasse” names, and has filed applications to register for certainother names, including “COWS,” and uses other names for which it has not appliedfor registration. The Company believes that its rights to these names are asignificant part of the Company’s business and that its ability to createdemand for its products is dependent to a large extent on its ability toexploit these trademarks. The Company’s failure to protect its trademarks andother intellectual property rights could negatively impact the value of itsbrand names. The Company is not aware of any other infringement claims or otherchallenges to the Company’s rights to use these marks. The Company is applyingfor the international registration of all its trademarks.

 

9

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Seasonality

 

Our sales are greatest during the first and secondquarters of our fiscal year, due to holidays that occur during those quarters.During the fiscal years ended July 31, 2002, 2003 and 2004, approximately 70%,77% and 76%, respectively, of our annual sales occurred in the first twoquarters of the fiscal year.

 

Insurance

 

The Company maintains product liability insurance withlimits of $2,000,000 in the aggregate and $1,000,000 per occurrence (withexcess coverage of $10,000,000), which it believes is adequate for the types ofproducts currently offered by the Company.

 

**(d) Financial Information AboutForeign and Domestic Operations and Export Sales.**

 

The Company distributes its products throughout theUnited States, Puerto Rico and Canada. Net sales of the Company’s products in the Canadian market accounted for1% in the fiscal year ended July 31, 2004 compared to less than 1% of theCompany’s total net sales in the fiscal year ended July 31, 2003.

 

**(e)           Available Information**

 

The Company is required to file annual, quarterly andspecial reports, proxy statements and other information with the Securities andExchange Commission (“SEC”). Investors may read and copy any document that theCompany files, including this Annual Report on Form 10-K, at the SEC’s PublicReference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Investors mayobtain information on the operation of the Public Reference Room by calling theSEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site atwww.sec.gov that contains reports, proxy and information statements, and otherinformation regarding issuers that file electronically with the SEC, from whichinvestors can electronically access the Company’s SEC filings.

 

The Company maintains a websitewww.sherwoodbrands.com, but does not make available its public filings throughits website currently.   The Companyintends to make such filings available through its website sometime during thesecond quarter ending January 31, 2005. The information on the Company’s website is not, and shall not be deemedto be, a part of this Report or incorporated into any other filings the Companymakes with the SEC.

 

**ITEM 2.**                             **Properties**

 

The following table sets forth, with respect toproperties leased and owned by the Company at July 31, 2004, the location ofthe property, the size of the property, the annual rent, and the year in whichthe lease expires, if applicable, and the business use which the Company makesof such facilities:

 
| **Address**             | ** ** | **Approximate  Square  Feet** | ** ** | **Annual  Rent** | ** ** | **Expiration  of Lease** | ** **       | **Business Use**           | ** **                   | **Segment**     |
|-------------------------|------------|-------------------------------|------------|------------------|------------|--------------------------|------------------|----------------------------|------------------------------|-----------------|
|                    |       |                          |       |             |       |                     |             |                       |                         |            |
| Leased Properties:      |       |                          |       |             |       |                     |             |                       |                         |            |
| 1803 Research Boulevard |       | 5,500                         |       | $                | 116,000    |                     | January 31, 2009 |                       | Executive and General Office |            | — |
| Rockville, MD 20850     |       |                          |       |             |       |                     |             |                       |                         |            |
|                    |       |                          |       |             |       |                     |             |                       |                         |            |
| 275 Ferris Avenue       |       | 10,000                        |       | $                | 51,706     |                     | October 2004     |                       | General Office               |            | — |
| Rumford, RI 02860       |       |                          |       |             |       |                     |             |                       |                         |            |
|                    |       |                          |       |             |       |                     |             |                       |                         |            |
| 1815 Gilford Avenue     |       | 30,000                        |       | $                | 139,588    |                     | October 2004     |                       | Manufacturing Plant          |            | Manufactured |
| New Hyde Park, NY       |       |                          |       |             |       |                     |             |                       |                         | Candy           |
|                    |       |                          |       |             |       |                     |             |                       |                         |            |
| 27 Healy Street         |       | 430,000                       |       | $                | 25,000     |                     | June 2020        |                       | Assembly facility, Storage   |            | Purchase Candy, |
| New Bedford, MA 02745   |       |                          |       | (Yr 1-2          | )          |                     |             | and Distribution           |                         | Gift Items      |
|                    |       |                          |       | 41,667           |       |                     |             |                       |                         |            |
|                    |       |                          |       | (Yr 3-20         | )          |                     |             |                       |                         |            |
|                    |       |                          |       |             |       |                     |             |                       |                         |            |
| Owned Properties:       |       |                          |       |             |       |                     |             |                       |                         |            |
| 807 South Main Street   |       | 100,000                       |       |             |       |                     |             | Manufacturing Plant        |                         | Manufactured    |
| Chase City, VA 23924    |       |                          |       |             |       |                     |             |                       |                         | Candy           |
|                    |       |                          |       |             |       |                     |             |                       |                         |            |
| 350 Sherwood Drive      |       | 73,000                        |       |             |       |                     |             | Assembly facility, Storage |                         | Purchase Candy, |
| Keysville, VA 23947     |       |                          |       |             |       |                     |             | and distribution           |                         | Gift Items      |

 

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Manufacturing and Assembly Facilities

 

The Company currently manufactures Demitasse biscuitsand limited production of its lollipop candies at its Chase City, VA facility.The Chase City facility consists of a brick building with 100,000 square feet(including a 1,750 square foot office) situated on approximately ten acres inSouthern Virginia. The facility had approximately 25,000 square feet added toaccommodate the consolidation of the Company’s Pawtucket, RI facility, whichwas closed in May 2002. The facility is equipped with state-of-the-artequipment for the manufacture and packaging of cookie and candy products and employedapproximately 35 skilled and unskilled workers during the year ended July 31,2004.  Currently, the labor force at theChase City facility has been reduced to 15 employees to better meet currentbiscuit and cookie orders. The facility will be operating at this level throughthe end of July 31, 2005. The facility is certified kosher by the OrthodoxUnion. In the fall of 2003, Sherwood Brands began moving its operations of hardcandy to its overseas suppliers to meet demands for the up coming seasons.  Sherwood Brands finalized a production andmanufacturing agreement with an Argentine company, one of its key suppliersspecializing in the manufacture of hard candies, chocolates, cookies and buttertoffees. The Argentine company did not have the equipment or the facilities yetto completely take over the production of all our product lines.  Therefore, the Chase City facility continuesto be utilized to produce certain products, which the Argentine company could notproduce or could not produce within the time frame Sherwood Brands needed inorder to meet its demands with its customers. Chase City is also being utilized currently as a warehouse facility forit Christmas seasonal items that will be shipped to its southeast regioncustomers. The Company also has a 73,000 square foot packaging and storagefacility located on approximately 15 acres in Keysville, VA. Both the ChaseCity and Keysville facilities have access to a supply of skilled and unskilledlabor. In addition, the Southern Virginia area in which the two plants arelocated, is readily accessible to common carriers, rail lines and a majorseaport (Newport News). Management believes that by limiting its productionlevel to its cookies and biscuits lines in Chase City it is more likely that theCompany will return to profitability during the year ending July 31, 2005.

 

The Company leases approximately 10,000 square feet ofoffice space in Rumford, Rhode Island, which has access to skilled andunskilled labor. The Company did not exercise its option to extend the term ofour lease in Pawtucket, Rhode Island and vacated the location on March 31,2004.  The New Bedford, Massachusettsfacility together with a relationship with its ship line carrier now has variousassembly and distribution facilities which it can utilize to improve ourshipping costs and assembly of our products. The Company’s relationship with our ship line carrier, enables theCompany to distribute orders direct to our customers and minimizes our freightcosts associated with shipping them to the East coast and then shipping themback to our customers in the West coast and to the middle of the United States.

 

The Company leases approximately 30,000 square feet ofimproved real estate in New Hyde Park, NY. The property is used for manufacturingcandy canes. The location has access to both skilled and unskilled labor, andis readily accessible to common carriers and a major seaport (New York).  The current lease expired in March 31, 2004.  The Company requested from the landlord toextend the lease month to month until October 31, 2004 at which time it will nolonger produce candy canes in the US. The Company has decided to move all production to its overseas suppliersand will shift its equipment to the Argentine company for use at their facilityto meet production demand.

 

In May 2000, the Company entered into a capital leaseagreement with the New Bedford Redevelopment Authority to lease a 430,000square foot building in New Bedford, MA. The facility is used for assembly andstorage of components. Under the terms of the lease the Company made an initialpayment of $400,000 and paid rent of $25,000 per annum for years one and twoand is committed to pay $41,666.66 per annum for years three through twenty.The Company has an option to purchase the building at any time during the leaseterm for $1,200,000 less any amounts of rental payments made.

 

The Company currently employs technical and productionpersonnel who have working knowledge of the technical and operational aspectsof the Company’s production equipment. The Company also employs personnel toconduct quality control testing at the facilities through on-site laboratoryanalysis and quality assurance inspections. The inspectors evaluate the Company’sproducts on the basis of subjective factors such as taste and appearance. TheCompany monitors the efficiency of the production equipment continuously andits facilities are climate controlled where required.

 

The Company believes that its existing facilities arewell maintained and in good operating condition.

 

**ITEM 3.****                             LegalProceedings**

 

 The Company is, from time to time, involved inlitigation incidental to the conduct of its

 

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business. The Company is currently involved in several actions.  In particular, the Company’s landlord at itsRhode Island facility has named the Company as a defendant in an action seekingsecurity for claims relating to the lease agreement. The Company deposited$180,000 with the registry of the court relating to claims for payment of realestate taxes, water and sewer, rent of other occupied space and repairexpenses. The Company in November 2003 settled the claims with the landlord,which resulted in a $275,000 settlement of which the $180,000 deposit was offsetagainst the amount agreed in the settlement. The accrual in the financial statements was sufficient to cover alloutstanding obligations to the landlord. We vacated the space on March 31,2004.

 

The Company is currently involved as Plaintiff in asuit brought before the Circuit Court for Montgomery County, Maryland,presenting claims in connection with the merger agreement under which SherwoodBrands acquired securities of Asher Candy Acquisition Corporation and agreed tosell securities in Sherwood Brands to prior shareholders of Asher Candy.  The complaint alleges that the Company wasfraudulently induced to enter into the merger agreement on the basis of, amongother things, material misrepresentations and omissions by the shareholders ofAsher Candy.   The Company seeksdeclaratory and injunctive relief and award of damages against the formershareholders of Asher Candy for violations of the merger agreement, for commonlaw fraud and violations of applicable securities laws.  Pending resolution of the litigation, theCompany has refused to honor the demand of the former shareholders for theCompany to repurchase half of the shares issued to them at a price of $4.50 pershare. Some of the shareholders have filed a counterclaim seeking $7.0 millionin damages.  The Company believes that ithas defenses to the counterclaim. There can be no assurance that the Companywill not be a party to other litigation in the future.

 

#### **ITEM 4.**                             Submissionof Matters to a Vote of Security Holders

#### ** **

No matters were submitted to a vote of securityholders during the fourth quarter of the fiscal year ended July 31, 2004.

 

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**PART II**

 

**ITEM 5****.****                            ****Market for the Company’s Common Equity and RelatedStockholder Matters**

 

**(a) Market Information**

 

The Company’s Class A Common Stock is traded on theAmerican Stock Exchange (“AMEX”) (symbol: SHD). The following table shows thehigh and low sales prices as reported on the AMEX for the Class A Common Stockfor each quarter within the last two fiscal years:

 

| **Price Period**                  | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------------|------------|----------|------------|---------|------------|
|                              |       |     |       |    |       |   |   |
| Fiscal Year  Ended July 31, 2003: |       |     |       |    |       |   |   |
| First Quarter                     |       |     |       | $       | 5.10       |   | $ | 2.90 |   |
| Second Quarter                    |       |     |       | $       | 3.50       |   | $ | 2.46 |   |
| Third Quarter                     |       |     |       | $       | 2.60       |   | $ | 1.57 |   |
| Fourth Quarter                    |       |     |       | $       | 2.33       |   | $ | 1.60 |   |
| Fiscal Year  Ended July 31, 2004: |       |     |       |    |       |   |   |
| First Quarter                     |       |     |       | $       | 2.84       |   | $ | 1.65 |   |
| Second Quarter                    |       |     |       | $       | 5.98       |   | $ | 2.33 |   |
| Third Quarter                     |       |     |       | $       | 6.61       |   | $ | 4.15 |   |
| Fourth Quarter                    |       |     |       | $       | 4.29       |   | $ | 2.05 |   |

 

**(b)  Holders**

 

 As of October 28, 2004, there were 29 holders of record of theClass A Common Stock and one holder of record of the Class B Common Stock. TheCompany believes that there are more than 311 beneficial holders of its Class ACommon Stock.

 

(**c)  Dividends**

 

The Company has never declared or paid any cashdividends on the Class A and Class B Common Stock and has no present intentionto declare or pay cash dividends on the Class A and Class B Common Stock in theforeseeable future. It intends to retain earnings, if any, which it may realizein the foreseeable future to finance its operations. The Company is subject tovarious financial covenants with its lenders that could limit and/or prohibitthe payment of dividends in the future. See “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.” The payment offuture cash dividends on the Class A Common Stock will be at the discretion ofthe Board of Directors and will depend on a number of factors, including futureearnings, capital requirements, the financial condition and prospects of the Companyand any restrictions under credit agreements existing from time to time.

 

**(d)           SecuritiesAuthorized for Issuance under Equity Compensation Plans**

 

EquityCompensation Plan Information

 
| **Plan  Category**                                      | ** ** | **Number of  Securities to be  issued upon  exercise of  outstanding  options,  warrants and  rights** | ** ** | **Weighted-average  exercise price of  outstanding  options,  warrants and  rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities  reflected in the first  column)** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders |       |                                                                                                   |       |                                                                                 |       |                                                                                                                                                         |       |
| 1998 Stock  Option Plan                                 |       | 999,451                                                                                                |       | $                                                                                    | 2.98       |                                                                                                                                                         | 100,549    |   |
|                                                         |            |                                                                                                        |            |                                                                                      |            |                                                                                                                                                              |            |  |

 

#### **ITEM 6**.                             SelectedFinancial Data

#### ** **

The selected financialdata set forth below have been derived from the consolidated financialstatements of the Company and the related notes thereto. The statement ofoperations data for the five years ended July 31, 2004 and the balance sheetdata as of July 31, 2004, 2003, 2002, 2001 and 2000 are derived from theconsolidated financial statements of the Company, which have been audited byBDO Seidman, LLP, independent registered accounting firm. The followingselected financial data should be read in conjunction with the Company’sconsolidated financial statements and the related notes thereto and “ManagementDiscussion and Analysis of Financial Condition and Results from Operations”,which are included elsewhere herein.

 

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| **For  the years ended July 31,**                             | ** ** | **2004**   | ** **       | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** | **2000**   | ** ** |
|---------------------------------------------------------------|------------|------------|------------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                    | ** ** | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                     |       | $          | 45,881,039  |       | $          | 49,162,787 |       | $          | 52,782,341 |       | $          | 58,316,716 |   | $ | 42,104,645 |   |
| Cost of sales                                                 |       | 34,726,872 |             | 37,680,097 |       | 37,714,680 |       | 41,796,184 |       | 32,183,885 |       |
| Write down of  Inventory                                      |       | 1,817,322  |             | 2,192,005  |       | —     |       | —     |       | —     |       |
|                                                          |       |       |             |       |       |       |       |       |       |       |       |
| Gross profit                                                  |       | 9,336,845  |             | 9,290,685  |       | 15,067,661 |       | 16,520,532 |       | 9,920,760  |       |
| Selling, general  and administrative expenses                 |       | 8,420,600  |             | 8,192,774  |       | 8,313,603  |       | 8,006,416  |       | 6,675,177  |       |
| Salaries and  related expenses                                |       | 4,154,036  |             | 5,057,115  |       | 5,100,167  |       | 4,806,061  |       | 3,285,850  |       |
| Non-recurring  costs                                          |       | —     |             | 1,932,075  |       | 707,551    |       | —     |       | —     |       |
| Total operating  expenses                                     |       | 12,574,636 |             | 15,181,964 |       | 14,121,321 |       | 12,812,477 |       | 9,961,027  |       |
| Income (Loss)  from operations                                |       | (3,237,791 | )                | (5,891,279 | )          | 946,340    |       | 3,708,055  |       | (40,267    | )          |
| Other income  (expense)                                       |       |       |             |       |       |       |       |       |       |       |       |
| Interest income                                               |       | 100        |             | 2,636      |       | 4,881      |       | 11,182     |       | 36,016     |       |
| Interest expense                                              |       | (1,032,694 | )                | (623,201   | )          | (468,687   | )          | (539,971   | )          | (434,978   | )          |
| Other income  (expense)                                       |       | (131,534   | )                | 274,728    |       | 90,535     |       | 132,209    |       | 693,413    |       |
| Total other  income (expense)                                 |       | (1,164,128 | )                | (345,837   | )          | (373,271   | )          | (396,580   | )          | 294,451    |       |
| Income (Loss)  before provision (benefit) for taxes on income |       | (4,401,919 | )                | (6,237,116 | )          | 573,069    |       | 3,311,475  |       | 254,184    |       |
| Provision  (Benefit) for taxes on income                      |       | (301,425   | )                | (866,224   | )          | 248,039    |       | 1,093,100  |       | 98,100     |       |
| Net income  (loss)                                            |       | $          | (4,100,674       | )          | $          | (5,370,892 | )          | $          | 325,030    |       | $          | 2,218,375 |   | $ | 156,084 |   |
| Net income  (loss) per share                                  |       |       |             |       |       |       |       |       |       |       |       |
| •basic                                                   |       | $          | (1.02            | )          | $          | (1.34      | )          | $          | 0.09       |       | $          | 0.60 |   | $ | 0.04 |   |
| •diluted                                                 |       | (1.02      | )                | (1.34      | )          | 0.08       |       | 0.56       |       | 0.04       |       |
| Weighted average  common shares outstanding                   |       |       |             |       |       |       |       |       |       |       |       |
| •basic                                                   |       | 4,017,255  |             | 3,996,199  |       | 3,778,375  |       | 3,700,000  |       | 3,700,000  |       |
| •diluted                                                 |       | 4,017,255  |             | 3,996,199  |       | 4,312,762  |       | 3,954,428  |       | 3,700,000  |       |

 
| **For  the years ended July 31,** | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** | **2000**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
|                              |       |       |       |       |       |       |       |       |       |       |       |
| Balance Sheet  Data:              |       |       |       |       |       |       |       |       |       |       |       |
| Working Capital                   |       | $          | (2,353,281 | )          | $          | 669,015    |       | $          | 6,218,382  |       | $          | 7,485,168 |   | $ | 6,020,265 |   |
| Total Assets                      |       | 20,406,453 |       | 26,502,471 |       | 31,390,954 |       | 22,804,112 |       | 20,618,891 |       |
| Total Long Term  Debt             |       | 1,024,978  |       | 1,574,405  |       | 2,266,414  |       | 1,221,162  |       | 1,755,170  |       |
| Total  Liabilities                |       | 16,382,550 |       | 18,427,800 |       | 18,003,614 |       | 11,575,121 |       | 11,590,004 |       |
| Stockholders’  Equity        |       | 4,023,903  |       | 8,074,671  |       | 13,387,340 |       | 11,228,991 |       | 9,028,887  |       |
|                                   |            |            |            |            |            |            |            |            |            |            |            |  |  |  |  |  |

 

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**ITEM 7****.****                             Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report on Form 10-K contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended.Those statements include statements regarding the intent, belief or currentexpectations of the Company and its management. Such statements are subject toa variety of risks and uncertainties, many of which are beyond the Company’scontrol, which could cause actual results to differ materially from thosecontemplated in such forward-looking statements, including in particular therisks and uncertainties described below. Investors are cautioned not to placeundue reliance on those forward-looking statements, which speak only as of thedate hereof. The Company undertakes no obligation to update or revise theinformation contained in this Annual Report on Form 10-K, whether as a resultof new information, future events or circumstances or otherwise.

 

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

 

The loss of a significant customer could have anadverse effect on our business. We are dependent on a limited number ofcustomers for a significant portion of our revenues. Sam’s Club and Wal-Martaccounted for approximately 4% and 27%, respectively, of our sales for the yearended July 31, 2004. We do not maintain agreements with our customers and sellproducts pursuant to purchase orders placed from time to time in the ordinarycourse of business. The loss of a significant customer could have an adverseeffect on our business.

 

We face significant competition in the marketing andsales of our products. Our products compete for consumer recognition and shelfspace with candies, cakes, cookies, chocolates and other food products, whichhave achieved international, national, regional and local brand recognition andconsumer loyalty. These products are marketed by companies (which may includeour suppliers) 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 recentacquisition. We recently acquired the business of Asher Candy AcquisitionCorporation. Asher Candy Acquisition Corporation manufactured candy canes, aproduct which we had no prior experience in manufacturing. If we are unable tosuccessfully produce a quality product, and maintain or increase the customerbase, our profitability could be adversely affected.

 

Our success is highly dependent on consumerpreferences and industry factors. The markets for candy and cookie products areaffected by changes in consumer tastes and preferences and nutritional andhealth-related concerns. We could be subject to increased competition fromcompanies whose products or marketing strategies address these concerns. Inaddition, the markets for our products may be subject to national, regional andlocal economic conditions, which affect discretionary spending, demographictrends and product life cycles, whereby product sales increase from their introductorystage through their maturity and then reach a stage of decline over time.

 

We have limited historical profitability and may notbe profitable in the future. We have historically, until recently, achievedlimited profitability. Our operating expenses have increased and can beexpected to continue to increase in connection with any expansion activitiesundertaken by us, including those relating to advertising and productmanufacturing. Accordingly, our profitability will depend on our ability to improveour operating margins and increase revenues from operations. Unanticipatedexpenses, unfavorable currency exchange rates, increased price competition andadverse changes in economic conditions could have a material adverse effect onour operating results. If we are unable to achieve significantly increasedlevels of revenues, our future operations may not continue to be profitable.

 

We depend on our trademarks. We hold United Statestrademark registrations for the “ELANA,” “RUGER”, “TONGUE TATTOO”, “STRIP-O-POP”,“SMILE POPS” and “demitasse” names, and have filed applications to registercertain other names, including “COWS,” and use other names for which

 

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we have not applied forregistration. We believe that our rights to these names are a significant partof our business and that our ability to create demand for our products isdependent to a large extent on our ability to exploit these trademarks. Ourfailure to protect our trademarks and other intellectual property rights couldnegatively impact the value of our brand names. We have requested some of ourmarks to be registered in countries other than the U.S. and may apply foradditional registration as appropriate, based on our need to register our marksfor worldwide distribution.

 

We are dependent on third party manufacturers andsuppliers. We are dependent on the ability of our manufacturers to adhere toour product, price and quality specifications and scheduling requirements. Ouroperations require us to have production orders in place in advance of shipmentto our warehouses (product deliveries typically take 60 days). Any delay bymanufacturers in supplying finished products to us would adversely affect ourability to deliver products on a timely and competitive basis. In addition, rawmaterials necessary for the manufacture of our products at our facilities,including flour, sugar, shortening, butter and flavorings, are purchased fromthird-party suppliers. We do not maintain agreements with any such suppliersand we are, therefore, subject to risks of periodic price fluctuations,shortages and delays. If there is a material interruption in the availabilityor significant price increases for raw materials, such events would have amaterial adverse effect on our operating margins.

 

We face various risks relating to foreignmanufacturing. During the fiscal years ended July 31, 2002, 2003 and 2004,approximately 23%, 33% and 49%, respectively, of our products were manufacturedin foreign countries. We have been and will continue to be subject to risksassociated with the manufacture of products in foreign countries, primarily inArgentina, Austria, Belgium, China, Holland and Ireland. These risks includematerial shipping delays, fluctuations in foreign currency exchange rates,customs duties, tariffs and import quotas and international political,regulatory and economic developments. We assume the risk of loss, damage ordestruction of products when shipped by a manufacturer. Because we pay for someof our products manufactured outside the United States in foreign currencies,any weakening of the United States dollar in relation to relevant foreigncurrencies, could result in significantly increased costs to us. In addition,some products manufactured overseas are subject to import duties. Deliveries ofproducts from our foreign manufacturers could also be delayed or restricted bythe future imposition of quotas. If quotas were imposed, it is possible that wewould not be able to obtain quality products at favorable prices from domesticor other suppliers whose quotas have not been exceeded by the supply ofproducts to their existing customers.

 

Our operating results fluctuate and we are subject toseasonality. Our operating results are subject to fluctuations as a result ofnew product introductions, the timing of significant operating expenses andcustomer orders, delays in shipping orders, pricing and seasonality. Our salesincrease during the first and second quarters of our fiscal year, due to the holidaysthat occur during those quarters. During the fiscal years ended July 31, 2002,2003 and 2004, approximately 70%, 77% and 76%, respectively, of our annualsales occurred in the first two quarters of the fiscal year. If we are unableto meet the delivery schedules of our customers during the first two quartersof our fiscal year our profitability would be adversely affected during thatfiscal year.    We are subject togovernment regulation. We are subject to extensive regulation by the UnitedStates Food and Drug Administration, the United States Department ofAgriculture and by other state and local authorities in jurisdictions in whichour products are manufactured or sold. Among other things, such regulationgoverns the importation, manufacturing, packaging, storage, distribution andlabeling of our products, as well as sanitary conditions and public health andsafety. Applicable statutes and regulations governing our products include “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 authorities. Ourfailure to comply with applicable laws and regulations could subject us tocivil remedies, including fines, injunctions, recalls or seizures, as well aspotential criminal sanctions.

 

We may incur product liability claims that are notfully insured. As a manufacturer and marketer of food products, we are subjectto product liability claims from consumers. We maintain product liabilityinsurance with limits of $2,000,000 in the aggregate and $1,000,000 peroccurrence (with excess coverage of $10,000,000). These insurance amounts maynot be sufficient to cover potential claims and adequate levels of coverage maynot be available in the future at a reasonable cost. In the event of apartially or completely uninsured successful claim against us, our financialcondition and reputation would be materially affected.

 

We are dependent on key personnel and the loss ofthese key personnel could have a material adverse effect on our success. Oursuccess is dependent on the personal efforts of Uziel

 

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Frydman, our Chairman,President and Chief Executive Officer, Amir Frydman, our Vice President ofMarketing and Christopher Willi, our Chief Financial Officer. The loss orinterruption of the services of such individuals could have a material adverseeffect on our business. We maintain “key-man” insurance in the amount of $1million on the life of Mr. Uziel Frydman. Our success also depends upon ourability to hire and retain additional qualified management, marketing and otherpersonnel. Employment and retention of qualified personnel is important due tothe competitive nature of the food industry. Our failure to hire and retainqualified personnel could adversely affect our success.  During the fiscal year ended July 31, 2004,these executives have no employment agreements.

 

Our President and Chief Executive Officer controls ourcompany. Mr. Uziel Frydman, President and Chief Executive Officer of ourcompany, owns 400,000 shares of Class A Common Stock (with a right to acquirean additional 202,984 upon the exercise of options) and 1,000,000 shares ofClass B Common Stock, representing, in the aggregate, approximately 39% of theoutstanding Common Stock of our company and 76% of the voting control of ourcompany, assuming that all of the warrants are exercised. Accordingly, Mr.Frydman will be able to direct the election of all of our company’s directors,increase the authorized capital, dissolve, merge or sell the assets of ourcompany, and generally direct the affairs of our company. In addition, thelevel of control exercised by Mr. Frydman may discourage investors frompurchasing our Common Stock.

 

We may issue “blank check” preferred stock that wouldprevent a change of control. Our Articles of Incorporation, as amended,authorize our board of directors to issue up to 5,000,000 shares of “blankcheck” preferred stock without stockholder approval, in one or more series andto fix the dividend rights, terms, conversion rights, voting rights, redemptionrights and terms, liquidation preferences, and any other rights, preferences,privileges, and restrictions applicable to each new series of preferred stock.The issuance of shares of preferred stock in the future could, among otherthings, adversely affect the voting power of the holders of common stock and,under certain circumstances, could make it difficult for a third party to gaincontrol of our company, prevent or substantially delay a change in control,discourage bids for the Common Stock at a premium, or otherwise adversely affectthe market price of the Common Stock.

 

We have never paid any cash dividends on our commonstock and do not anticipate paying cash dividends in the foreseeable future.The payment of cash dividends is prohibited by the terms of our financingagreements.

 

CAUTIONARY NOTE REGARDINGFORWARD-LOOKING STATEMENTS

 

This 10-K report contains some forward-lookingstatements, within the meaning of federal securities laws, about our financialcondition, results of operations and business. You can find many of these statementsby looking for words like “will,” “should,” “believes,” “expects,” “project,” “could,”“anticipates,” “estimates,” “intends,” “may,” “pro forma” or similarexpressions used in this 10-K report. These forward-looking statements aresubject to numerous assumptions, risks and uncertainties that may cause ouractual results or performance to be materially different from any futureresults or performance expressed or implied by the forward-looking statements.The risks and uncertainties include those risks and uncertainties identifiedabove. Because these forward-looking statements are subject to risks anduncertainties, we caution you not to place undue reliance on these statements,which speak only as of the date of this 10-K report. We do not undertake anyresponsibility to review or confirm analysts’ expectations or estimates or torelease publicly any revisions to these forward-looking statements to take intoaccount events or circumstances that occur after the date of this 10-K report.Additionally, we do not undertake any responsibility to update you on theoccurrence of unanticipated events which may cause actual results to differfrom those expressed or implied by these forward-looking statements.

 

Overview

 

The Company is engaged in the manufacture, marketingand distribution of a diverse line of brand name candies, cookies, chocolatesand gifts. Through fiscal year ended July 31, 2001, the Company had experiencedcontinued revenue growth. This growth was a direct result of the Company’sintroduction of gift items, gift baskets and new candy products. The new giftproducts enabled the Company to expand its customer base to includemass-merchandisers.

 

With net sales growing from approximately $18 millionin fiscal 1998 to over $46 million in fiscal 2004, management began to takesteps to reduce costs in future years by consolidating operations andcontinuing to build its infrastructure. The objectives are to establish newproduction and assembly facilities with more efficient and effective cost structures.The Company began implementing these plans during the year ended July 31, 2004.

 

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Over the past two fiscal years ended July 31, 2004 and 2003. TheCompany had seen declines in its net sales largely attributable to decreasedconsumer confidence and spending and the weak environment, which contributed tothe declines in its earnings. The following highlights the attributing factorsfor the declines:

 

For fiscal year ended July 31, 2003

 

•                  Sales to Sam’sClub and Wal-mart declined from prior year 2002 as a result of a one time orderof specialty gift items as part of their Easter seasonal items, includingshadow boxes, steamer trunks and leather clocks which accounted for $4.4million of gift items sales decline.

•                  The Chase Citymanufacturing facility inefficiencies and capacity levels running at 38% on adaily basis.  The impact of thistransition resulted in approximately $1.9 million of pre-production start upcosts, or 4% of net sales and resulted in a write down of obsolete film andpackaging inventory of approximately $2.2 million or 4.6% of net sales. Theinventory write down was a direct result of our decision in the third quarterending April 30, 2003 to shift certain production to our overseas third partymanufacturing suppliers. We had reduced our work force from 280 employees to 68at the Chase City facility, and began moving hard and soft candy production toour third party manufacturing suppliers overseas. We had additional expensesdue to movement from Chase City to our overseas suppliers. The company incurredapproximately $100,000 in severance costs associated with the reduction of itsstaff at the Chase City facility.

•                  On September 30,2002, 29 west coast ports were shut down abruptly and remained closed ascontract negotiations between dock-workers and shipping companies broke offnegotiations for new contracts. The shut down occurred during the Company’speak inventory shipping period for orders for the holiday season. The shut downhad an effect on our first quarter of shipments to our customers. A largeportion of containers, which were to be received, remained either at ports oron shipping vessels on the water. In addition, empty containers were notbrought back to ports in the Pacific Rim, which we needed to move some of ourother products. A slow down by the long shore-men on shipping products wasstill prevalent. Our first quarter revenues were impacted by the shut down andresulted in a delay of approximately $6.0 million in sales, which was recoupedin later quarters during the fiscal year ended July 31, 2003.

 

For fiscal year ended July 31, 2004

 

•                  TheConfectionery industry was shifting a large portion, of its manufacturing intooverseas markets. The advantage of setting up operations in other countriesincluded purchasing sugar at world sugar prices vs. domestic sugar prices;lower labor costs; and benefiting from the lower cost and overhead structure ofoverseas factories. Sherwood Brands decided based on full evaluation that itwould too benefit by moving its operations to suppliers outside the USA

•                  Sherwood began ashift to overseas operations. An Argentine company with operations in many S.American countries offered many advantages including a highly talented laborand management force, brand new state of the art facilities, and a willingnessto move the equipment and train their labor. The process was done in stages tomitigate any disruptions. Between January 2004 and October 2004, both the Asherfacility in New Hyde Park and the Argentine facility were running concurrently.The Argentine Company quickly sped through the learning curve achieving similarproduction output as New Hyde Park but at lower costs due to the materials andlabor structure enjoyed in Brazil. The Argentine company uses Asher equipmentexclusively.

•                  Manufacturingoperations continued to lose money due to higher cost structures in the US forlabor, fuel and commodity prices, mainly sugar prices of $0.26 to $0.32 perpound in Domestic markets compared to overseas world prices of $0.08 to $0.10per pound.

•                  A write down ofobsolete film and packaging inventory of approximately $1.8 million or 3.9% ofnet sales. The inventory write down was a direct result of our decision in thefirst and second quarter ending January 31, 2004 to shift more production toour overseas third party manufacturing suppliers.

•                  Sales declinesin its HBA line of Products of $1.5 million due to a one-time purchase of itemsby Sam’s Club in fiscal year 2003.

•                  Declines of $1.0million in sales in Kastin Jellies and $300,000 on Kastins Hard candy line ofproducts, due to shifting production to our overseas suppliers.  Due to the shift to our overseas suppliers ofother product lines, the Company decided to sell the equipment associated withthese product lines due to their un-profitability.  The sales of the equipment resulted in a$39,000 gain.

•                  Valentine candysales decline of $900,000 due to declining Valentines Day sales nationwide.

•                  $2.2 million inone time sales of Shadow boxes, three wood trunk set and leather clocks sold infiscal year 2003 and not in fiscal year 2004.

 

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The retail market in theConvenience gift and Easter basket markets have shifted significantly over thelast few years.  No longer do buyersdesire generic mugs and toys to comprise these gifts, they want higher qualityitems at better prices depicting popular licensed properties or brands.  This significant shift in buyer’s demand hasrequired the Company to put a greater emphasis on licensing popular brands andproperties.  In addition, consumers andbuyers want a wide variety of property and brands of options to choose from, soin order to remain competitive in our category, we have to add a wide varietyof properties and brands.

 

In the last three years almost every consumer product category fromcereal to kids’ tennis shoes has had to join the licensing band wagon, toremain competitive.  With fewer retailersdue to acquisitions and store closings competition to sell into these retailoutlets is even greater.  No massconsumer products company can ignore the importance pf licensing in today’smarketplace.

 

During the year ended July 31, 2004, the Company hadentered into a total of eighteen licensing agreements, three during the fiscalyear ended July 31, 2004, nine during the fiscal year ended July 31, 2003 andsix in fiscal year ended July 31, 2002, to incorporate its products into giftsets and to manufacturing of candies and wafers. The royalty rates for suchlicenses range from 2% to 15% of net sales and expire in two to three years.The products to be incorporated into the Company’s gift set items are primarilyfor the first quarter and Easter selling season. The Company entered into alicensing agreement to produce everyday candies and wafers. The Company paid$12,500 in advance for the rights under the licensing agreements. These advancefees were offset against any amounts due on royalties. There are no otherminimum license fees under these agreements. The Company incurred $936,000 and$227,000 in royalties during the year ended July 31, 2004 and 2003,respectively. The Company is currently pursuing other licenses with similarterms and conditions. The Company expects to see increased revenue for productsrelated to the agreements beginning in the year ending July 31, 2005.

 

The Company’s Rhode Island manufacturing facility,which occupied five stories in an old building, closed on May 31, 2002 and theCompany’s Rhode Island assembly and distribution facility, which occupied fourstories was closed on March 31, 2004. All the manufacturing productionequipment, together with the electrical, piping, steam and air-conditioningwere disassembled and transferred to the Company’s expanded Chase City, VAfacility. This 75,000 square foot facility, with an additional 25,000 squarefeet from a recent expansion, and the 73,000 square foot facility at Keysville,VA (about 20 miles from Chase City, VA), would become the single manufacturingand distribution facility under one plant management for all products producedat the Chase City facility. The Company incurred start up costs ofapproximately $1,900,000 in fiscal 2003 in an attempt to meet plannedproduction schedules and product quality standards.  Ultimately, in the third quarter of fiscal2003, the Company decided to transfer production overseas to third partysuppliers in Argentina.   Also, over thepast two fiscal years ended in July 31, 2004 and 2003, the Company wrote downinventory by approximately $4,000,000 in total, since certain packagingmaterials could no longer be used due to the transfer of its production of itshard and soft candy production to its overseas suppliers.  The Company will continue to manufacture certainbiscuits and cookie products at the Chase City facility.

 

In the fall of 2003 Sherwood Brands began moving itsoperations of hard candy to its overseas suppliers to meet demands for the upcoming seasons.  Sherwood Brandsfinalized a production and manufacturing agreement with the largestmanufacturer in Argentina and South America, one of its key suppliers,specializing in manufacture of hard candies, chocolates, cookies and buttertoffees. This agreement includes achieving volume commitments of 8,000,000pounds of products. The Argentine company and Sherwood had already establisheda long relationship over the years working successfully in developing brands.The Argentine company did not have the equipment or the facilities tocompletely take over the production of all our product lines.  Therefore, the Chase City facility continuesto be utilized to produce certain products which the Argentine company couldnot yet produce or could not produce within the time frame Sherwood Brandsneeded in order to meet its demands with its customers.  In addition, the Chase City facility iscurrently being utilized as a warehouse for the Christmas seasonal items thatneed to be shipped to our southeast region customers.  The Argentine company was selected initiallyfor its ability to produce the butter toffee as the Argentine company is anexpert in this field. Later given the Argentine company’s success andavailability of a new facility, Sherwood and the Argentine company agreed tomove Asher Candy Cane Production to the Argentine company during the third andfourth quarters of fiscal 2004.

 

In addition, in Spring 2004, Sherwood entered into aproduction agreement with a second Argentine company to facilitate theobjective of producing lollipops in South America- again

 

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benefiting from lowersugar prices, lower labor costs and state of the art facilities. The move overseveral months is near completion with Sherwood benefiting from the expertiseand technology of the second Argentine company in lollipop production. Thesecond Argentine company is using a combination of Sherwood equipment and theirown equipment to help Sherwood increase margins, capacity and marketability ofSherwood products.

 

During the spring of 2004, an appraisal of equipmentand machinery and the real estate assets of the Sherwood Brands Chase Cityfacility were done by its banking institution related to impairmentconcerns.  The real estate appraisedvalued was $1.4 million, and equipment and machinery was appraised at $2.7million. The current book value on the Company’s books is $1.2 million for thereal estate and $2.7 million on our equipment and machinery. In evaluating thepossible impairment of the Chase City facility and looking at the currentoperations, the facilities operations has been reduced to the original squarefootage required for the biscuit line as equipment for the hard candy –lollipoplines and butter candy lines has moved to outside manufacturers. The facilitiesutilization of its square footage is between 70% and 75% for production, andthe remaining 25% as warehousing and distribution of Christmas products for thesoutheast region customers. Sherwood is currently evaluating its publicwarehouse in Vineland, NJ and can potentially shift complete warehousing and distributioninto the Chase City and Keysville facilities for some seasonal items, whichwill save the company in working capital. The facility has moved some assets to South America under agreements,which extend for three to five years. These arrangements are based on a minimum production of 8,000,000 poundsover the three to five year agreement periods and are evaluated on a yearlybasis with set budgets developed by both Sherwood and the manufacturer toachieve the demands of our customer’s commitments and orders.  These assets are provided with costamortization of the depreciation of the assets that have been provided toproduce our products.  Management feelsthat the assets have not been impaired. The assets are now increasing theprofitability of the company’s products, reducing working capital requirementsas Sherwood now purchases only finished goods rather than materials andpackaging; and are being serviced and maintained at the overseas factoriescosts at no expense to Sherwood Brands. The assets have improved theefficiencies and potential top line and bottom line growth for the company. Theassets continue to hold their value based on the appraised value.   Given the improvements we believe thatSherwood’s assets are not impaired as they are being utilized and maintained toimprove efficiencies and reduce costs. The Company’s arrangements with these South American suppliers haveimproved the pricing on the Company’s products due to price discounts, sincethey are using our assets to produce our products.

 

Christmas and Easter gift sets and gift baskets areassembled and distributed at its Massachusetts facilities. The Companypurchases product primarily from the Pacific Rim. The Company is continuallylooking to further reduce costs by more efficient sourcing.

 

We did not exercise the options on our office andassembly facility in Rhode Island and vacated the location on March 31,2004.  After March 31, 2004, our NewBedford, Massachusetts facility together with a planned West Coast assembly anddistribution facility will be utilized to improve our shipping costs andassembly of our products.

 

Environmental Factors Affecting the Performance in the Year Ending July31, 2003.

 

On September 30, 2002, 29 west coast ports were shutdown abruptly and remained closed as contract negotiations between dock-workersand shipping companies broke off negotiations for new contracts. The shut downoccurred during the Company’s peak inventory shipping period for orders for theholiday season. In mid-October 2002, the President of the United States ofAmerica signed an order under the Taft-Hartley Act to reopen the ports and puta moratorium on the strike for 60 days. The shut down had an adverse effect onour first quarter shipments to our customers. A large portion of containers,which were to be received, remained either at ports or on shipping vessels onthe water. In addition, empty containers were not brought back to ports in thePacific Rim, which we needed to move some of our other products. In mid-October2002, our inventory began to be released for shipment to our facility in NewBedford, MA. A slow down by the long shore-men on shipping products was stillprevalent. Our first quarter revenues were impacted by the shut down andresulted in a delay of approximately $6.0 million in sales.

 

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**Results of Operations**

 

**Fiscal Year Ended July 31, 2004compared to Fiscal Year ended July 31, 2003**

 

Net Sales

 

Net sales for the years ended July 31, 2004 and 2003 were $45,881,039and $49,162,787, respectively, a decrease of 6.68%.  Wal-Mart, Dollar General and Big Lotsaccounted for approximately 27%, 7% and 6.5% of sales, respectively, during thefiscal year ended July 31, 2004, and Sam’s Club, Wal-Mart and Big Lots accountedfor approximately 16%, 10.2% and 9.5% of sales, respectively, for the prioryear’s comparable period.  Net sales foreach of our business segments was as follows:

 

Net sales of Manufactured Candy and Cookies decreased from $17.1million for the year ended July 31, 2003 to $8.4 million in the year ended July31, 2004.  The decrease of $8.7 millionwas primarily due to $3.6 million of sales in manufactured candy canes that areincluded in net sales of purchased candy and cookies due to our shift of productionto our overseas suppliers. $1.0 million in Valentine Candy sales; $1.0 millionin hard candy sales for Christmas and Easter seasonal items; $1.4 million inKastins hard and jelly sales; and $1.7 million in Cows sales.  The majority of these declines in sales wereheavily impacted by our shift to our overseas suppliers and the economic cycleof sales activity due to market demands on those items.

 

Net sales of Purchased Candy and Cookies increased from $15.9 millionfor the year ended July 31, 2003 to $22.5 million for the year ended July 31,2004. The increase of $6.6 million was primarily due to the $4.4 million saleof Christmas purchased gift items, which had been assembled at the Company’sNew Bedford, Massachusetts facility in the prior fiscal year; $1.0 million inCows and $1.7 million candy canes which was partially offset by decrease inHealth and Beauty Aids items of $1.1 million which was a one time order sold infiscal year 2003 for Sam’s Club.

 

Net sales of Purchased Gift Items decreased from $16.1 million for theyear ended July 31, 2003 to $15.0 million for the year ended July 31,2004.  The $1.1 million decrease wasprimarily a result of $1.0 million of Easter assembled goods, $0.1 million ofValentine assembled items and a one time order by Sam’s Club of $2.3 million ofspecialty gift items as part of their Easter seasonal items in fiscal year2003, which was offset against an increase of $2.3 million of Christmas giftitems in fiscal year 2004. The decline on all the categories was primarily dueto the industry decline of product buying during the seasonal periods.

 

Gross Margins

 

For the fiscal years ended July 31, 2004 and 2003, gross marginsincreased to $9,336,845 from $9,290,685, respectively, and increased to 20.4%from 18.9% as a percent of sales, respectively. Gross margins for each of our business segments were as follows:

 

Gross margins on our Manufactured Candy and Cookies decreased from($2.6) million for the fiscal year ended July 31, 2003 to ($4.3) million forthe fiscal year ended July 31, 2004.  Thedecrease of $1.7 million was primarily due to the absorption of labor costs andmaterial costs in packaging and raw materials at our New Hyde Park, New York of$1,100,000 and $600,000 of other burden and overhead absorption at our ChaseCity, Virginia facility.  We haveexpensed these unfavorable variances as incurred. Write downs of obsoleteinventory of $2.2 million and $1.8 million in the fiscal year ended July 31,2003 and the fiscal year ended July 31, 2004, respectively, resulting from filmand packaging materials that became obsolete due to the transfer of hard candyproduct manufacturing to purchasing from third party overseas suppliers and areduction of products manufactured at our Chase City, Virginia and New Hyde Park,New York facilities.

 

Gross margins for our Purchased Candy and Cookies increased from $6.9million for the year ended July 31, 2003 to $9.5 million for the year endedJuly 31, 2004, but margins decreased from 44% for the fiscal year ended July31, 2003 to 42% for the fiscal year ended July 31, 2004.  The primary decrease in margins was mainlyattributable to the weakening of the dollar against the euro foreign currency,which is currently on average of $1.24 to 1 Euro.

 

Gross margins on our Purchased Gift Items decreased from $4.9 millionfor the fiscal year ended July 31, 2003 to $4.1 million for the fiscal yearended July 31, 2004.  The decrease wasprimarily due to the absorption of $800,000 in labor costs for assembly of theCompany’s Easter program and $200,000 in freight costs due to higher fuelabsorption costs from our freight

 

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forwarders, which was offset by the decreased costs associated with ourRhode Island facility closure in March 2004.

 

Operating Expenses

 

 Operating expenses for thefiscal year ended July 31, 2004 decreased to $12,574,635 from $15,181,965during the fiscal year ended July 31, 2003 decreased to $27.4% from 30.9% as apercent of sales.  This change resultedin the following:

 

Selling, general and administrative expenses for the fiscal year endedJuly 31, 2004 as compared to the fiscal year ended July 31, 2003 increased to$8,420,600 from $8,192,774 and increased to 18.4% from 16.7% as a percent ofsales, respectively. The increase was largely due to $808,000 in brokercommission expenses and $133,000 drayage and distribution costs, which werepartially offset by reductions of $160,000 of travel expenses, $105,000 inbuilding rental costs, $162,000 in shipping and carrier cost associated withsamples, $89,000 of communication costs, $144,000 in professional fees and$53,000 of warehouse transfer costs.

 

Pre-production startup costs decreased to $0 during the fiscal yearended July 31, 2004 from $1,932,075 during the fiscal year ended July 31, 2003or a decrease of 3.9% as a percent of sales, as a result of the trainingrequired for new employees at our Chase City, Virginia facility during thefiscal year ended July 31, 2003.

 

During the fiscal year ended July 31, 2004, salaries and relatedexpenses decreased to $4,154,036 from $5,057,115 during the fiscal ended July31, 2003, or 9.1% from 10.3%, respectively, as a percent of sales. Thisdecrease resulted from a decline of $903,000 in the Company’s overhead due toits restructuring effort in the fourth quarter of the fiscal year ended July31, 2003.

 

Loss From Operations

 

Loss from operations for the fiscal year ended July 31, 2004 was$3,237,791, as compared to a loss of $5,891,279 for the prior year’s comparableperiod or (7%) of net sales from (12%) of net sales. Most of the improvement inthe loss from operations is the result of the restructuring of our operationsat the end of the fiscal year ended July 31, 2003 to cease the production ofcertain items and have these produced instead by our overseas suppliers.  In addition, we reduced other expenses asexplained in results from operating expenses along with reduced pre-productioncosts of $1.9 million that were incurred in fiscal year ended July 31, 2003that we did not incur in the fiscal year ended July 31, 2004.

 

Interest Income and Expense

 

For the fiscal year ended July 31, 2004, interest income decreased to$100 from $2,636 for the fiscal year ended July 31, 2003 as reserves declined.For the fiscal year ended July 31, 2004, interest expenses increased to$1,032,694 from $623,021 for the fiscal year ended July 31, 2003 due to anincrease in our term debt financing of $1.3 million associated with the mergerwith Asher Candy and an additional $1.4 million borrowing of the subordinateddebt the Company entered into during the fiscal year ended July 31, 2003 fromLana, LLC.

 

Other Income

 

For the fiscal year ended July 31, 2004, other income decreased to($131,572) from $274,728 for the fiscal year ended July 31, 2003 due to $180,000of realized losses on foreign exchange transactions during the fiscal yearended July 31, 2004, and the legal settlement on trade infringement of $580,000offset by $149,000 in legal expenses associated with the settlement during thefiscal year ended July 31, 2003.

 

Income Tax Benefit

 

The Company recognized an income tax benefit of approximately $301,245for the additional recognition of deferred tax assets for timing differences onthe carry-back of the net operating loss during the fiscal year ended July 31,2003 and the fiscal year ended July 31, 2004 to recover income taxes previouslypaid.  The company was refunded $1.0million for the net loss carry-back from its prior years losses.

 

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#### **FiscalYear Ended July 31, 2003 compared to Fiscal Year ended July 31, 2002**

#### ** **

Net Sales

 

Net sales for the fiscal years ended July 31, 2003 and 2002 were$49,162,787 and $52,782,341, respectively, a decrease of 6.85%.  Sams Club, Big Lots and Wal-Mart accountedfor approximately 16%, 10.2% and 9.5% of sales, respectively, during the fiscalyear ended July 31, 2003.  Sams Club,Wal-Mart and Big Lots accounted for approximately 29%, 14% and 8% of sales,respectively, for the fiscal year ended July 31, 2002.  Net sales for each of our business segmentswere as follows:

 

Net sales of Manufactured Candy and Cookies increased from $13.6million for the fiscal year ended July 31, 2002 to $17.1 million for the fiscalyear ended July 31, 2003.  The increaseof $3.5 million was primarily due to $10.0 million of sales in manufacturedcandy canes in connection with our acquisition of Asher Candy.  This increase was partially offset by a $6.5million decrease in our manufactured items for the Valentine’s Day and Easterseasons which was comprised of the following decreases: $2.4 million in cookiesales; $2.7 million in biscuit sales; and $1.4 million in Cows sales.

 

Net sales of Purchased Candy and Cookies increased from $11.9 millionfor the fiscal year ended July 31, 2002 to $15.9 million for the fiscal yearended July 31, 2003. The increase of $4.0 million was primarily due to the saleof Christmas purchased gift items, which had been assembled at the Company’sNew Bedford, Massachusetts facility in the prior fiscal year.

 

Net sales of Purchased Gift Items decreased from $27.2 million for thefiscal year ended July 31, 2002 to $16.1 million for the fiscal year ended July31, 2003.  The $11.1 million decrease wasprimarily a result of the shift of $5.7 million of Christmas assembled goods topurchased assembled goods, $1.0 million of HBA items and a one time order bySam’s Club and Wal-Mart for $4.4 million of specialty gift items as part oftheir Easter seasonal items in fiscal year 2002.

 

Gross Margins

 

For the fiscal years ended July 31, 2003 and 2002, gross marginsdecreased to $9,290,685 from $15,067,661, respectively, and decreased to 18.9%from 28.5% as percent of sales, respectively. Gross margins for each of our business segments were as follows:

 

Gross margins on our Manufactured Candy and Cookies decreased due tolow capacity and efficiency levels at our Chase City, Virginia facility.  The facility ran at 38% capacity for most offiscal year ended July 31, 2003.  Thedecrease in the production levels created unfavorable labor costs and materialvariances in packaging and raw materials of approximately $3.06 million, or a6.2% effect on gross margins for the fiscal year ended July 31, 2003.  We have expensed these unfavorable variancesas incurred. The write down of inventory of $2,192,005, or 4.5% for the thirdquarter of the fiscal year ended July 31, 2003, resulted from film andpackaging materials that became obsolete due to the transfer of certain productmanufacturing to third party overseas suppliers and a reduction of productsmanufactured at our Chase City, Virginia facility.

 

Gross margins for our Purchased Candy and Cookies increased by $2.3million primarily due to the purchase of assembled gift items that were notassembled in our New Bedford, Massachusetts facility.

 

Gross margins on our Purchased Gift Items decreased by $5.8 million dueprimarily to shifts of product lines from assembled to purchase candy and theone time order by Sam’s Club and Wal-Mart for $4.4 million of gift items infiscal 2002 and $515,000 of additional freight and duty costs associated withthe west coast dockworkers strike during the fiscal year ended July 31, 2003.

 

Operating Expenses

 

Operating expenses for the fiscal year ended July 31, 2003 increased to$15,181,964 from $14,121,321 for the fiscal year ended July 31, 2002 andincreased to 30.9% from 26.8%, respectively, as a percent of sales.  This change resulted from the following:

 

During the fiscal years ended July 31, 2003 and 2002, selling, generaland administrative expenses decreased to $8,192,774 from $8,313,603,respectively, and increased to 16.7% from 15.8% as a percent of sales,respectively. The increase was largely due to $174,000 in travel expenses, ofwhich approximately $85,000 was for trips to China, $48,000 of shipping violation

 

23

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fees resulting from our inability to meet shipping dates for ourcustomers due to the dockworkers strike, $23,000 in building rental costs,$159,000 in professional fees, $56,000 in shipping and carrier cost associatedwith samples, and $143,000 of warehouse transfer costs, which was partiallyoffset by a decrease of $159,000 of brokers commissions.

 

Pre-production startup costs increased to $1,932,075 during the fiscalyear ended July 31, 2003 compared to $707,551 from during the fiscal year endedJuly 31, 2002, or an increase to 3.9% from 1.3% as a percent of sales,respectively, as a result of the training required for new employees at ourChase City, Virginia facility.

 

During the fiscal year ended July 31, 2003, salaries and relatedexpenses decreased to $5,057,115 from $5,100,167 during the fiscal ended July31, 2002, or 10.3% from 9.7%, respectively, as a percent of sales. Thisdecrease resulted from a decline of $45,000 in the Company’s overhead due toits restructuring effort in the fourth quarter of the fiscal year ended July31, 2003, offset by an increase in Health insurance premiums.

 

Loss From Operations

 

Loss from operations for the fiscal year ended July 31, 2003 was$5,891,279, as compared to income of $946,340 for the fiscal year ended July31, 2002. Most of the loss resulted from the write down of film and packagingmaterials that had become obsolete due to production transferring to our thirdparty overseas suppliers and reduction of product lines manufactured at ourChase City, Virginia facility of approximately $2.2 million, pre productionstart up costs of approximately $2.0 million, $515,000 of additional freightand duty costs associated with the west coast dockworkers strike and otherexpenses explained in Operating Expenses above along with reduced revenues fromproduct sales.

 

Interest Income and Expense

 

For the fiscal year ended July 31, 2003, interest income decreased to$2,636 from $4,881 for the fiscal year ended July 31, 2002 as reservesdeclined. For the fiscal year ended July 31, 2003, interest expenses increasedto $623,201 from $468,687 for the fiscal year ended July 31, 2002 due to anincrease in our term debt financing of $1.3 million associated with ouracquisition of Asher Candy and interest on the subordinated debt the Companyentered into during the fiscal year ended July 31, 2003.

 

Other Income

 

For the fiscal year ended July 31, 2003, other income increased to$274,728 from $90,535 for the fiscal year ended July 31, 2002 due to $248,000of realized losses on foreign exchange transactions, legal settlement on tradeinfringement of $580,000 offset by $149,000 in legal expenses associated withthe settlement.

 

Income Tax Benefit

 

The Company recognized an income tax benefit of approximately $866,000for the carry-back of the net operating loss during the fiscal year ended July31, 2003 to recover income taxes previously paid. The Company was refundedapproximately $1.4 million during the fiscal year ended July 31, 2004 for thenet loss carry-back from it’s fiscal year ended July 31, 2003 losses.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Our working capital at fiscal year end July 31, 2004 declined to adeficit of ($2,353,281) from working capital of $639,014 at July 31, 2003,respectively.  Our primary cashrequirements have been to fund the purchase, manufacture and commercializationof our products. We finance our operations and manufacturing with cash flowfrom operations and bank financing along with favorable payment terms from someof our vendors.

 

The Company during the fiscal year ending July 31, 2004 had a need toborrow $1.4 million of additional subordinated debt to meet its working capitalneeds and the bank provided additional out of formula advances against is collateralbase of $1,000,000 to support the up coming seasonal activity in the Company.Management feels that it should be able to sustain positive working capitalgoing forward into the fiscal year ending July 31, 2005. The Company originallyprojected borrowing an additional $500,000 on subordinated debt during the 1stquarter ending October 31, 2004 to meet its working capital needs.  $467,000 of the additional subordinated debthas been borrowed against, as of October 8, 2004.

 

24

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**Senior Credit Facility**

 

TheCompany has a senior $15,000,000 line of credit with Wachovia Bank, N.A.  The line of credit expires on August 1, 2005and is due and payable at such time. Interest accrues on all amounts extended at the rate of prime plus3%.  Advances under the credit facilityare based on a borrowing formula equal to 85% of eligible domestic accountsreceivable plus 60% of eligible finished goods and 30% of eligible components inventory.Borrowings on inventory are capped based upon the Company’s seasonalrequirements and are limited to $9,000,000. The credit facility is alsoavailable for the issuance of letters of credit. The credit facility iscollateralized by the cash and cash equivalents, accounts receivable andinventories of the Company. The credit facility also contains business andfinancial covenants, including, a minimum tangible net worth, a fixed chargeratio and a limit on capital expenditures. The Company currently has $5,610,903 outstanding under the line ofcredit of which Wachovia advanced $1,000,000 out of formula.  The Company will be required to reduce thisout of formula amount as follows: prior to November 14, 2004 it must be reducedto no more than $500,000; prior to November 21, 2004 it must be reduced to nomore than $250,000; and prior to November 22, 2004 it must be fullyrepaid.  After repayment of the out offormula borrowing, management believes that the Company will be able to satisfythe financial covenants for the line of credit. The Company currently expects it will be able to meet the bankrequirements of reducing the out of Formula advance on November 14, 2004 to the$500,000.

 

The Company has two term loans with Wachovia Bank,N.A., in the amount of $156,000 for Term Loan A and $239,445 for Term Loan B asof July 31, 2004.  Interest accrues onthe unpaid principal balances of Term Loan A and Term Loan B at an annual rateof prime plus 3 1/2%.  Term Loan B is dueand payable on or before December 1, 2005 and Term Loan A is due and payable onor before February 1, 2005.

 

#### **SubordinatedDebt**

#### ** **

TheCompany has borrowed $3,400,000 pursuant to a subordinated debt agreement withLana, LLC.  The shareholders of Lana, LLCinclude individuals who are related to board members and officers of the Company.The subordinated debt is collateralized by a security interest in the Company’saccounts receivable and inventory, which is subordinate to all obligations,liens, security interests, rights and remedies in favor of Wachovia. Thesubordinated indebtedness bears interest, payable annually, at the rate of16.575% per annum.  The Subordinated debtbecomes due when the excess cash exceeds the Net excess availability defined bythe Bank.

 

In June 1996 andMay 1997, the Company borrowed $935,000 and $580,000, respectively, fromIndustrial Development Authority of Mecklenburg County (“IDAMC”) for theacquisition and improvement of the Chase City facility and the purchase andinstallation of new production equipment, financed through the issuance of twoseries of Industrial Revenue Bonds (“IRB”) (Series 1996 and Series 1997). TheIRBs were backed by irrevocable letters of credit issued by Wachovia, NA.Advances on the letters of credit (which expire June 2011 and 2002,respectively) were, in turn, secured by the Company’s Chase City facility andall other real and personal property of the Company pursuant to a reimbursementagreement between Wachovia and the Company.

 

On August 13,2002, the Company borrowed $350,000 from Lake Country Development Corporationof Mecklenburg County for the acquisition and purchase of new equipment toexpand the business facility located at Chase City, Mecklenburg County,Virginia.  The Company agreed to createsixty-five jobs within a twenty-four months of the completion of the project.  If at least one job for every $10,000borrowed (35 jobs) has not been met within the two years, the loan can becalled. A good faith effort must be made to create sixty-five jobs.  The repayment of the loan is in eighty-fourmonthly installments beginning on October 1, 2002 for the amount of $4,784.08at a interest rate of 4% per annum. There have been no penalties or paydown onour term debt, since we have supplied new employees currently and the creationof jobs was over a two-year period.

 

In the normalcourse of business the Company may be exposed to fluctuations in interestrates. These fluctuations can vary the costs of financing, investing andoperating transactions.

 

**Tabular Disclosure of ContractualObligations**

 

Thefollowing tables summarize the Company’s obligations and commitments to makefuture payments under certain contractual obligations. For additionalinformation on debt, see Notes 4 to 7.

 

25

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Schedule of Contractual Obligations

 
| ** **                    | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------|------------|----------------------------|------------|
| **Contractual  Obligation**   | ** ** | **Less Than  Total**       | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **After 4 years** | ** ** |
|                          |       |                       |       |   |   |   |   |   |   |
| Long-Term Debt                |       | $                          | 1,083,013  |   | $ | 488,016 |   | $ | 319,664 |   | $ | 275,333 |   |
| Capital Lease  Obligation     |       | 423,892                    |       | 16,688 |   | 56,497 |   | 350,707 |   |
| Subordinated  Debt            |       | 3,397,140                  |       | 3,397,140 |   | — |   | — |   |
| Licensing  Agreements         |       | 899,080                    |       | 619,580 |   | 264,500 |   | 15,000 |   |
| Operating Leases              |       | 1,182,513                  |       | 260,025 |   | 597,159 |   | 325,329 |   |
| Israel Joint  Venture         |       | 800,000                    |       | 800,000 |   |   |   |   |   |
| Total  Contractual Obligation |       | $                          | 7,785,638  |   | $ | 5,581,449 |   | $ | 1,237,820 |   | $ | 966,369 |   |

 

Schedule of Commercial Commitments

 
| ** **                    | ** ** | **Amount of Commitment  expiration per period** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|
| **Commercial Commitments**    | ** ** | **Less Than  Total**                            | ** ** | **1 Year** | ** ** | **1-3 years** | ** ** | **After 4 years** | ** ** |
|                          |       |                                            |       |   |   |   |   |   |   |
| Line of Credit  (*)           |       | $                                               | 15,000,000 |   | — |   | $ | 15,000,000 |   | — |   |
| Total  Contractual Obligation |       | $                                               | 15,000,000 |   | — |   | $ | 15,000,000 |   | — |   |

 

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(*) The line of credit is available for advances to finance workingcapital and the issuance of letter of credits. Advances under the line ofcredit are based on a borrowing formula equal to 85% of eligible domesticaccounts receivable plus 60% of eligible finished goods and 30% of eligiblecomponents inventory. The line of credit facility varies from quarter toquarter based on working capital needs and pay-downs.

 

**Financial Condition**

 

**   Assets**

 

Total assets declined to $20,407,000 million at July31, 2004 from $26,500,000 million at July 31, 2003.  The decline was primarily due to a $1,800,000million write down in obsolete film and packaging inventory, net collection of$1,500,000 income tax receivables and $1,200,000 lower inventory levels due tobetter sell off of its excess inventory levels from prior year and $1,112,783depreciation of assets and $132,000 of sales of equipment.

 

As of July 31, 2004, current assets decreased to$12,140,291 from $17,058,410 as of July 31, 2003, a decrease of $4,918,119, or28.8%. The decrease primarily reflected decreased inventories, property andequipment and income tax receivables. The Company’s $152,000 decrease inprepaid expenses was principally due to the payment of fees related to theCompany’s insurance and a decrease in prepaid royalty fees. The $250,000increase in deferred taxes on income was attributable to carry back of netoperating losses related to the Company’s fiscal year end July 31, 2003.

 

As of July 31, 2004, plant, property and equipmentdecreased to $6,103,880 from $7,129,227 as of July 31, 2003, a decrease ofapproximately $1,025,347 or 14.4%. The decrease was primarily due todepreciation of assets of $1,112,783 and sale of equipment of $132,000.

 

**   Liabilities**

 

As of July 31, 2004, total liabilities decreased to$16,382,550 from $18,427,800 as of July 31, 2003, a decrease of $2,045,250 or11.1%. The decrease primarily reflects the Company’s decrease in borrowing fromthe Company’s revolving line of credit, a decrease in trade payables, andpay-down of its long-term debt partially offset by additional borrowings of itssubordinated debt.

 

26

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**   Capital Structure**

 

The Company has two classes of stock outstanding,Class A Common Stock and Class B Common Stock (collectively the “Common Stock”),which classes are substantially identical, except that the Class A Common Stockis entitled to one vote per share and the Class B Common Stock is entitled toseven votes per share on all matters, including the election of directors.Uziel Frydman, Chairman, President and Chief Executive Officer of the Company,beneficially owns 400,000 shares of Class A Common Stock and all of the1,000,000 share of Class B Common Stock outstanding and controls the Company.

 

**Cash Flows:**

 

**Net cash used in OperatingActivities:**

 

Net cash used by operating activities for the fiscal year ended July31, 2004, was $241,801  compared to cashprovided of $321,093 in fiscal 2003, respectively. The decrease in cash fromoperating activities was due primarily to decreases in net income, income taxesreceivable, inventory and accounts payable, which were partially offset by anincrease in accounts receivable, accrued expenses and current assets.

 

Net cash provided by operating activities for the fiscal year endedJuly 31, 2003 was $321,093 compared to cash used of $478,710 in fiscal 2002,respectively.  The improvement in cashprovided by operating activities was due to primarily to decreases ininventory, accounts receivable, income tax receivable and accrued expenses,which were partially offset by an increase in the net loss.

 

**Net Cash Used in InvestingActivities:**

 

Net cash used in investing activities for the fiscal year ended July31, 2004 and 2003 decreased to $158,833 from $740,451, respectively, primarilydue to the reduction in purchases of production equipment lines and capitalimprovements at our facilities offset by the sale of certain equipment at ourChase City, Virginia facility.

 

Net cash used in investing activities for the fiscal year ended July31, 2003 and 2002 decreased to $740,451 from $2,161,005, respectively,primarily due to the reduction in purchase of production equipment lines andcapital improvements for our facility in Chase City, Virginia.

 

**Net Cash Used by FinancingActivities:**

 

Net cash provided by financing activities was $184,090 compared to cashused of $62,537 in prior period primarily due to reliance on $1,397,140borrowings on the Company’s subordinated debt to finance working capital needswhich was partially offset by the payoff of $649,361 of the working operatingfacility and $613,595 of long-term debt and cash proceeds from the exercise ofstock options of $49,906. The Company had gross borrowings of $5,610,903 forthe fiscal year ended July 31, 2004 and $6,260,264 for the fiscal year endedJuly 31, 2003 under the line of credit and had no letters of creditoutstanding.

 

Net cash used by financing activities for the fiscal year ended July 31,2003 and 2002 was $62,537 and cash provided of $2,963,767, respectively. Thisdecrease was primarily due to $1,943,707 pay-down on our credit facility offset by additional subordinated debt financing of $2,000,000, $495,915 pay-downon term debt offset by proceeds of $350,000 on additional term debt. Theborrowings for the fiscal year ended July 31, 2003, were approximately$6,260,264 as compared to $8,203,971 for the prior years comparable period. Thedecrease in borrowing was largely due to restrictions imposed by our bank alongwith a lower borrowing base used to incorporate eligible collateral. TheCompany believes that the new credit facility is adequate to meet our cash flowrequirements foe fiscal 2004. The impact of lower borrowing from our line ofcredit facility and financing of subordinated debt offset somewhat the higherinterest rates. We have $8,739,739, of our $15,000,000 line of credit availableto meet additional seasonal needs to purchase and manufacture inventory subjectto availability of accounts receivable and inventory.

 

During the fiscal year ended July 31, 2004, the Company was inviolation of the fixed charge coverage ratio and tangible net worthcovenant.  As of the filing date of thisannual report for the fiscal year ended July 31, 2004, the bank waived theviolation of those covenants for the fiscal 2004. We have amended the creditagreement to modify the covenants and to help ensure our compliance goingforward.  Management believes that withthe amended credit

 

27

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facility, the Company will be able to meet its covenants.

 

Principal payments for our long-term debt for the twelve months endingJuly 31, 2005 are $504,704. During the first quarter ending October 31, 2004,the Company originally projected borrowing additional subordinated debt ofapproximately $500,000, which would be paid back based on the excess availablecash the Company will sustain over the course of the fiscal year ending July31, 2005 from operations.  $467,000 hasbeen borrowed on the additional subordinated debt as of October 8, 2004. Webelieve that cash provided by operations for the year will be sufficient tofinance our operations and fund debt service requirements for the next twelvemonths.

 

Principal payments for the Company’s long term debt for the years endedJuly 31, 2004 and 2003 were $613,595 and $495,914, respectively. The Companybelieves that the cash used by operations was not sufficient to finance itsoperations and fund debt service requirements and therefore had to addborrowings of additional funds against its subordinated debt.

 

Principal payments for the Company’s long term debt for the years endedJuly 31, 2003 and 2002 were $495,914 and $254,748, respectively. The Companybelieves that cash provided by operations will be sufficient to finance itsoperations and fund debt service requirements.

 

The Company anticipates that its material capital expenditures for thenext 12 months will consist of improvements to the Company’s assembly facilitiesof approximately $100,000. In addition, the Company will continue to exploreopportunities to expand the Company’s business, including possibleacquisitions, although the Company has no current agreements or commitments andis not currently engaged in any material negotiations with respect to specificacquisitions. The Company believes that cash provided from operations andavailable borrowing capacity will be sufficient to fund these expenditures.

 

#### **ITEM 7A**.                    Quantitativeand Qualitative Disclosures About Market Risk

#### ** **

From time to time, the Company may utilize derivative financialinstruments to reduce foreign currency risks. The Company does not hold orissue derivative financial instruments for trading purposes. During the fiscalyear ended July 31, 2004, 2003 and 2002 the Company had no derivative financialinstruments.

 

**ITEM 8****.****                             FinancialStatements**

 

The consolidated financial statements of the Companyand Subsidiaries and the report of independent certified public accountantsthereto are set forth on pages 38 through 58 hereof.

 

#### **ITEM 9**.                             Changein Accountants

#### ** **

There have been no changes in or disagreements withour independent auditors in the last two years.

 

#### **ITEM 9A**.                    Controlsand Procedures

#### ** **

Based on their evaluation, as of the end of the periodcovered by this annual report, our Chief Executive Officer and Chief FinancialOfficer have concluded that our disclosures and procedures (as defined in Rules13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended)are effective.  There have been nosignificant changes in our internal control over financial reporting or inother factors that occurred during the period covered by this annual reportthat has materially affect, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

#### **ITEM 9B**.                    OtherInformation

#### ** **

No information was required to be disclosed in a report on Form 8-Kduring the fourth quarter of the fiscal year ended July 31, 2004 and notreported.

 

#### **ITEM10**.                      Codeof Ethics

#### ** **

On October 28, 2004, the Company adopted a Code ofEthics that applies to the Company’s Chief Executive Officer and SeniorFinancial Officers.  A copy of the Codeof Ethics is attached as Exhibit 14.1 to this annual report on Form 10-K. Acopy of the Code of Ethics will be provided, without charge, upon writtenrequest to Sherwood Brands, Inc., 1803 Research Boulevard, Suite 201,Rockville, Maryland 20850, Attention: Chief Financial Officer.

 

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**PART III****.**

 

**ITEM10.****                      Directors,Executive Officers, Promoters and Control Persons; Compliance with Section16(A) of the Exchange Act**

 

**Directors and Executive Officers**

 

The following are the directors and executive officersof the Company, as well as certain other key employees of the Company:

 
| **Name**              | ** ** | **Age** | ** ** | **Position**                                                                             |
|-----------------------|------------|---------|------------|------------------------------------------------------------------------------------------|
|                  |       |    |       |                                                                                     |
| Uziel Frydman         |       | 68      |       | Chairman, President and Chief Executive Officer                                          |
| Amir Frydman          |       | 42      |       | Director, Treasurer and Executive Vice  President—Marketing and Product Development |
| Christopher J.  Willi |       | 44      |       | Chief Financial Officer and Secretary                                                    |
| Douglas A.  Cummins   |       | 62      |       | Director                                                                                 |
| Kenneth J.  Lapiejko  |       | 56      |       | Director                                                                                 |
| Guy Blynn             |       | 59      |       | Director                                                                                 |
| Paul J.  Splitek(1)   |       | 54      |       | Vice President—Sales                                                                |
| Arthur  Wlodarski(1)  |       | 47      |       | Vice President—Purchasing                                                           |

 

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(1)          Messrs. Woldarski andSplitek are key employees, but not executive officers of the Company.

 

Uziel Frydman hasbeen the President and Chief Executive Officer of the Company and each of itssubsidiaries since inception. Mr. Frydman has served as the Chairman of theBoard of Directors of the Company since December 1997. Mr. Frydman served asDirector of Marketing and Planning Sciences at R.J. Reynolds Tobacco Companyfrom 1977 to 1980, and prior to that, as Manager, Planning and OperationsImprovement at Lever Brothers Company from 1971 to 1977. He also served asProjects Manager at Sperry & Hutchinson Company and as an independentconsultant to local governments in Turkey, Burma and Sierra Leone from 1962 to1965. Mr. Frydman was an adjunct professor at the Graduate School of Businessat Rutgers University from 1970 to 1975. Mr. Frydman earned a Masters ofBusiness Administration, Management Science degree from Case Western ReserveUniversity in 1968 and a Bachelor of Science degree in Civil Engineering fromTechnion Institute of Technology, Haifa, Israel in 1960. Mr. Frydman is thefather of Amir Frydman.

 

Amir Frydman hasbeen a director of the Company and has served as Treasurer and Executive VicePresident—Marketing and Product Development since 1985. Prior to joining theCompany, Mr. Frydman was Commercial Branch Manager at NCNB National Bank ofFlorida, from 1984 to 1985. Mr. Frydman earned a Bachelor of Arts degree fromthe University of North Carolina in 1983. Mr. Frydman is the son of UzielFrydman.

 

Christopher J.Willi has been Chief Financial Officer since May 2001. Mr. Willi has over 19years of financial and operational experience. From 1998 until joining theCompany, Mr. Willi was Chief Financial Officer of CynterCorp, a global ITservice business. From 1992 to 1998, Mr. Willi was Corporate Controller of PGI,Inc., a global communication services company, where he directed more than adozen acquisitions. Prior to that he was Director of Finance for National TradeProductions, Inc and a Asset Manager with a unit of Canadian Pacific Corporation.Before that he was with Arthur Andersen & Co., where he worked in the auditand consulting practice. Mr. Willi earned his J.D. from Southern MethodistUniversity Law School and his B.S. in accounting and finance from theUniversity of Utah.

 

Douglas A. Cumminshas been a director of the Company since December 1997. In 1996, Mr. Cumminsserved as President and Chief Executive Officer of the Liggett Group, amanufacturer and distributor of cigarettes. From 1993 to 1996, Mr. Cumminsserved as President and Chief Executive Officer of North Atlantic Trading Co, acigarette paper manufacturer and distributor. From 1990 to 1993, Mr. Cumminsserved as the President and Chief Executive Officer of Decision Marketing, anadvertising and consulting firm. From 1984 to 1990, Mr. Cummins served as thePresident and Chief Operating Officer of Salem Carpet Mills, a carpetmanufacturer, and from 1981 to 1984, served as President of Stellar Group, aconsulting firm. From 1973 to 1981, Mr. Cummins was Director of Marketing—Internationaland Vice President—Foods Marketing at R.J. Reynolds Industries. Mr. Cumminscurrently sits on the Boards of Carolina Biological

 

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Supply Company, Smokey Mountain Products, Inc. and the Fort TiconderogaAssociation. Mr. Cummins earned a Masters of Business Administration degreefrom Columbia University in 1966 and a Bachelor of Arts degree from HarvardUniversity in 1964.

 

Kenneth J.Lapiejko has been a director of the Company since January 2003. Mr. Lapiejkoserved as Executive Vice President and Chief Financial Officer for R.J.Reynolds Tobacco Holdings, Inc. from June 1999 to July 2002. From June 1995 toMay 1999, Mr. Lapiejko served as Senior Vice President and Chief FinancialOfficer of Reynolds Tobacco Company, which was an operating unit ofRJR/Nabisco. Prior to 1995 Mr. Lapiejko served in various financial roles withvarious companies. Mr. Lapiejko earned a bachelor’s degree in business fromFairleigh Dickinson University. Mr. Lapiejko completed the Young ExecutiveInstitute Program of the University of North Carolina at Chapel Hill. Mr.Lapiejko served on the board of directors of Targacept, Inc. and in July 2002resigned from his position on the Targacept, Inc. board of directors.

 

Guy M. Blynn hasserved as Vice President, Deputy General Counsel and Secretary of R.J. ReynoldsTobacco Company, a manufacturer and distributor of cigarettes, since October1989. From 1982 to 1990, Mr. Blynn was a member of the board of directors ofthe International Trademark Association. From 1980 to 1993, Mr. Blynn was amember of the Adjunct Faculty at Wake Forest University School of Law teachingUnfair Trade Practices. Mr. Blynn currently sits on the board of directors ofthe Winston-Salem Urban League and the Anti-Defamation League. Mr. Blynn earneda Juris Doctorate degree from Harvard Law School in 1970 and a Bachelor ofScience degree in economics with a major in accounting from University ofPennsylvania in 1967.

 

Paul J. Splitekhas been Vice President of Sales of the Company since September 1999. Mr.Splitek has over 28 years of sales, marketing and manufacturing experience.From 1996 until being hired by the Company, Mr. Splitek was Vice President andGeneral Sales Manager of E. Rosen. Prior to joining E. Rosen, from 1991 to1996, Mr.Splitek was Vice President and General Manager of Mille Lacs MPCompany, a wholesale division of The Wisconsin Cheeseman Inc. (“TWC”), andprior to that, Operations Manager of TWC.

 

Arthur Wlodarskihas been Vice President of Purchasing of the Company since April 2000. Mr.Wlodarski has over 20 years of purchasing experience. From 1985 until 2000, MrWlodarski was Vice President of Purchasing of Houston Foods, a leading giftbasket packer responsible for purchasing components and food items from allover the world.

 

Compliance with Section 16(A) of the SecuritiesExchange Act of 1934

 

Section 16(a) ofthe Securities Exchange Act of 1934, as amended, requires certain officers,directors, and beneficial owners of more than ten percent (10%) of our commonstock to file reports of ownership and changes in their ownership of our equitysecurities with the Securities and Exchange Commission and Amex. Based solelyon a review of the reports and representations furnished to us during the lastfiscal year, we believe that each of the persons are in compliance with allapplicable filing requirements.

 

Audit Committee Financial Expert

 

TheBoard of Directors has determined that the Company has at least one auditcommittee financial expert serving on its Audit Committee, Director, Mr.Kenneth J. Lapiejko is “independent” as that term is used in Schedule 14A,Item, 7(d)(3)(iv) under the Securities Exchange Act of 1934, as amended.

 

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**ITEM 11****.****                      Executive Compensation**

 

Informationconcerning the Executive Compensation of the Company is hereby incorporated bythe reference from the Company’s definitive proxy statement relating to itsAnnual Meeting of Shareholders to be filed with the Commission pursuant toRegulation 14A on or before November 28, 2004.

 

#### **ITEM 12**.                      SecurityOwnership of Certain Beneficial Owners and Management

#### ** **

Informationconcerning the security ownership of the Company is hereby incorporated byreference from the Company’s definitive proxy statement relating to its AnnualMeeting of Shareholders to be filed with the Commission pursuant to Regulation14A on or before November 28, 2004.

 

**ITEM 13****.****                      Certain Relationships and RelatedTransactions**

 

Informationconcerning Certain Relationships and Related Transactions of the Company ishereby incorporated by reference from the Company’s definitive proxy statementrelating to its Annual Meeting of Shareholders to be filed with the Commissionpursuant to Regulation 14A on or before November 28, 2004.

 

**ITEM 14****.****                      Principal Accountant Fees andServices**

 

Informationconcerning Principal Accountant Fees and Services of the Company is herebyincorporated by reference from the Company’s definitive proxy statementrelating to its Annual Meeting of Shareholders to be filed with the Commissionpursuant to Regulation 14A on or before November 28, 2004.

 

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**PART IV.**

 

#### **ITEM 15.**                      Exhibits,Financial Statements and Reports on Form 8-K

#### ** **

**(a)1. Financial Statements. The following financial statements, related notes andthe Report of Independent Auditors, are included in response to Item 8 hereof.**

 

Index to ConsolidatedFinancial Statements

 
| Report  of Independent Registered Public Accountants’                                               |   |   |
|----------------------------------------------------------------------------------------------------------|--------|--------|
| Consolidated Balance Sheets  at July 31, 2004 and 2003                                                   |   |   |
| Consolidated  Statements of Operations for the years ended July 31, 2004, 2003 and 2002                  |   |   |
| Consolidated  Statements of Shareholders’ Equity for the years ended July 31, 2004, 2003  and 2002. |   |   |
| Consolidated  Statements of Cash Flows for the years ended July 31, 2004, 2003 and 2002                  |   |   |
| Summary of  Accounting policies                                                                          |   |   |
| Notes to  Consolidated Financial Statements                                                              |   |   |
| Schedule II-Valuation and Qualifying  Accounts                                                           |   |   |

 

Schedules otherthan those listed above have been omitted because they are not required or arenot applicable, or the required information has been included in theConsolidated Financial Statements or the Notes thereto.

 

**(b)Reports on Form 8-K**

 

     None

 

**(c) Exhibits**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                    |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1        |       | Articles of Incorporation, as amended, of the  Registrant.(1)                                                                                                                                                                                      |
| 3.2        |       | Bylaws, as amended, of the Registrant.(1)                                                                                                                                                                                                          |
| 4.1        |       | Form of Registrant’s Class A Common Stock  Certificate.(2)                                                                                                                                                                                    |
| 4.2        |       | Form of Underwriter’s Warrant Agreement, including  Form of Warrant Certificate.(2)                                                                                                                                                           |
| 4.3        |       | Form of Public Warrant Agreement among the  Registrant, Paragon Capital Corporation, as Underwriter and Continental Stock  Transfer & Trust Company, as Warrant Agent.(2)                                                                      |
| 4.4        |       | Form of Registrant’s Public Warrant Certificate.(2)                                                                                                                                                                                           |
| 10.1       |       | Amended and Restated Reimbursement Agreement between  Central Fidelity National Bank and the Registrant, dated as of May 1,  1997.(1)                                                                                                              |
| 10.2       |       | Loan Agreement between Industrial Development  Authority of Mecklenburg County, Virginia and the Registrant, dated as of May  1, 1997.(1)                                                                                                          |
| 10.3       |       | Irrevocable Letter of Credit dated May 15, 1997  issued on behalf of the Registrant to the Trustee for the holders of  Industrial Revenue Bonds (Series 1997) issued by the Industrial Development  Authority of Mecklenburg County, Virginia.(1)  |
| 10.4       |       | Amended and Restated Credit Line Deed of Trust and  Security Agreement, among the Registrant and Trustees, for the benefit of  Central Fidelity National Bank dated May 1, 1997.(1)                                                                |
| 10.5       |       | Pledge and Security Agreement between the Registrant  and Central Fidelity National Bank, dated as of May 1, 1997.(1)                                                                                                                              |
| 10.6       |       | Guaranty between Uziel Frydman, the Registrant and  Central Fidelity National Bank, dated as of May 1, 1997.(1)                                                                                                                                    |
| 10.7       |       | Loan Agreement between Industrial Development  Authority of Mecklenburg County, Virginia and the Registrant, dated as of  June 1, 1996.(1)                                                                                                         |
| 10.8       |       | Irrevocable Letter of Credit dated June 20, 1996  issued on behalf of the Registrant to the Trustee for the holders of  Industrial Revenue Bonds (Series 1996) issued by the Industrial Development  Authority of Mecklenburg County, Virginia.(1) |
| 10.9       |       | Pledge and Security Agreement between the Registrant  and Central Fidelity National Bank, dated as of June 1, 1996.(1)                                                                                                                             |

 

32

----

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                      |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10      |       | Company Loan Agreement between the Industrial  Development Authority of Mecklenburg County, Virginia Loan Agreement through  the Virginia Small Business Financing Administration and the Registrant,  dated as of June 20, 1996.(1)                                                                                                                 |
| 10.11      |       | Revolving Loan Fund Agreement between the Registrant  and Lake Country Development Corporation, $250,000 Promissory Note to Lake  Country Development Corporation, Guaranty of Note by the Registrant and Uziel  Frydman, and Deed of Trust between the Registrant and Trustee for Lake  Country Development Corporation, all dated May 15, 1996.(1) |
| 10.12      |       | Loan Agreement, Promissory Note, and Security  Agreement between the Registrant and First Union National Bank, all dated  November 29, 1996, and Guaranty between Uziel Frydman and First Union, dated  November 29, 1996.(1)                                                                                                                        |
| 10.13      |       | Promissory Note issued to Ilana Frydman by the  Registrant, dated August 28, 1991.(1)                                                                                                                                                                                                                                                                |
| 10.14      |       | Lease, as amended, for the Registrant’s Rockville  offices, executed November 30, 1992.(1)                                                                                                                                                                                                                                                      |
| 10.15      |       | 1998 Stock Option Plan.(2)                                                                                                                                                                                                                                                                                                                           |
| 10.16      |       | Receiver’s Bill of Sale by Allen M. Shine, as  receiver of E. Rosen Company, dated September 24, 1998.(3)                                                                                                                                                                                                                                       |
| 10.17      |       | Loan and Security Agreement between the Registrant  and First Union National Bank, dated June 12, 2001.(4)                                                                                                                                                                                                                                           |
| 10.18      |       | First Amendment to Loan and Security Agreement  between the Registrant and Wachovia Bank, National Association, dated April  30, 2001.(5)                                                                                                                                                                                                            |
| 10.19      |       | Fifth Amendment to Loan agreements with Wachovia  dated July 30, 2003.                                                                                                                                                                                                                                                                               |
| 10.20      |       | Loan Agreements, Promissory Note with Lake Country  Development dated August 15, 2003.                                                                                                                                                                                                                                                               |
| 10.21      |       | Sixth Amendment to Loan agreements with Wachovia  dated November 24, 2003.                                                                                                                                                                                                                                                                           |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.22      |       | Seventh Amendment to Loan agreements with Wachovia  dated February 13, 2004.                                                                                                                                                                                                                                                                         |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.23      |       | Eighth Amendment to Loan agreements with Wachovia  dated April 8, 2004.                                                                                                                                                                                                                                                                              |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.24      |       | Ninth Amendment to Loan agreements with Wachovia  dated June 11, 2004.                                                                                                                                                                                                                                                                               |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.25      |       | Tenth Amendment to Loan agreements with Wachovia  dated July 31, 2004.                                                                                                                                                                                                                                                                               |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.26      |       | Eleventh Amendment to Loan agreements with Wachovia  dated August 20, 2004.                                                                                                                                                                                                                                                                          |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.27      |       | Twelfth Amendment to Loan agreements with Wachovia  dated August 31, 2004.                                                                                                                                                                                                                                                                           |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.28      |       | Thirteenth Amendment to Loan agreements with  Wachovia dated September 13, 2004.                                                                                                                                                                                                                                                                     |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.29      |       | Fourteenth Amendment to Loan agreements with  Wachovia dated September 13, 2004.                                                                                                                                                                                                                                                                     |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 10.30      |       | Fifteenth Amendment to Loan agreements with Wachovia  dated October 8, 2004.                                                                                                                                                                                                                                                                         |
|       |       | (filed herewith).                                                                                                                                                                                                                                                                                                                                    |
| 14.1       |       | Code of Ethics (filed herewith)                                                                                                                                                                                                                                                                                                                      |
| 21.1       |       | Subsidiaries of the Registrant.(5)                                                                                                                                                                                                                                                                                                                   |
| 23.1       |       | Consent of BDO Seidman, LLP (filed herewith)                                                                                                                                                                                                                                                                                                         |
| 31.1       |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a)/15d-14(a). (filed herewith)                                                                                                                                                                                                                                                     |
| 31.2       |       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)/15d-14(a). (filed herewith)                                                                                                                                                                                                                                                     |
| 32.1       |       | Certification of Chief Executive Officer pursuant to  Section 1350. (filed herewith)                                                                                                                                                                                                                                                                 |
| 32.2       |       | Certification of Chief Financial Officer pursuant to  Section 1350. (filed herewith)                                                                                                                                                                                                                                                                 |

 

----

(1)          Incorporated herein byreference to the Company’s Registration Statement on Form SB-2, dated as ofJanuary 21, 1998 (Registration No. 333-44655)

 

(2)          Incorporated herein byreference to Amendment No. 2 to the Company’s Registration Statement on FormSB-2, dated as of May 4, 1998 (Registration No. 333-44655)

 

(3)          Incorporated herein byreference to the Company’s Current Report on Form 8-K, dated as of October 9,1998.

 

33

----

 

(4)          Incorporated herein byreference to the Registrant’s Amendment No.1 to the Registration Statement onForm 3-3/A, dated as of September 2002 (registration No. 333-92012).

 

(5)          Incorporated herein byreference to the Company’s Annual Report on Form 10-K, filed with theSecurities and Exchange Commission on October 29, 2002

 

(6)          Incorporated herein byreference to the Company’s Definitive Proxy Statement, filed with theSecurities and Exchange Commission on November 21, 2002

 

34

----

 

*SIGNATURES*

 

Pursuant to the requirements of Section 13 and 15(d) of the SecuritiesExchange Act of 1934, the Company has duly caused this Amended Report to besigned on its behalf by the undersigned, thereunto duly authorized on the dateindicated.

 

Date: October 28, 2004

 

SHERWOOD BRANDS, INC.
| By:    | /s/    UZIEL  FRYDMAN        |   |
|--------|--------------------------------------------------|--------|
|   | Uziel Frydman                                    |   |
|   | President and Chief  Executive                   |   |
|   | Officer                                          |   |
|   | Principal Executive  Officer                     |   |
|   |                                             |   |
| By:    | /S/    AMIR  FRYDMAN         |   |
|   | Amir Frydman                                     |   |
|   | Executive Vice President,                        |   |
|   | Treasurer and Director                           |   |
|   |                                             |   |
| By:    | /s/    CHRISTOPHER  J. WILLI |   |
|   | Christopher J. Willi                             |   |
|   | Chief Financial  Officer,                        |   |
|   | Secretary                                        |   |
|   | Principal Financial  Officer                     |   |
|   |                                             |   |
| By:    | /s/    DOUGLAS  A. CUMMINS   |   |
|   | Douglas A. Cummins                               |   |
|   | Director                                         |   |
|   |                                             |   |
| By:    | /s/    KENNETH  J. LAPIEJKO  |   |
|   | Kenneth J. Lapiejko                              |   |
|   | Director                                         |   |
|   |                                             |   |
| By:    | /s/    GUY  BLYNN            |   |
|   | Guy Blynn                                        |   |
|   | Director                                         |   |

 

35

----

 

REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON FINANCIALSTATEMENT SCHEDULE

 

Board of Directors andStockholders

Sherwood Brands, Inc.

 

The audits referred to inour report to Sherwood Brands, Inc. dated October 8, 2004 which iscontained in this Form 10-K, included the audit of the financial statement schedule listedin the accompanying index. This financial statement schedule is the responsibilityof the Company’s management. Our responsibility is to express an opinion on thefinancial statement schedule based on our audits.

 

In our opinion, such schedule presentsfairly, in all material respects, the information set forth therein.

 

BDO SEIDMAN, LLP

 

Bethesda, Maryland

October 8, 2004

 

SCHEDULE II

 

VALUATION ANDQUALIFYING ACCOUNTS

 
| **Description**                                     | ** ** | **Balance Beginning  Of Period** | ** ** | **Charged To Costs  And Expenses** | ** ** | **Deduction** | ** ** | **Balance At End  Of Period** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|------------------------------------|------------|---------------|------------|-------------------------------|------------|
| Year  ended July 31, 2002                      |       |                             |       |                               |       |          |       |                          |       |
| Allowance  for doubtful accounts                    |       | $                                | 188,600    |                               | $          | 227,811       |       | $                             | (290,239   | ) | $ | 126,172 |   |
| Allowance  for customer credits                     |       | $                                | 83,539     |                               | —     |          | $          | (1,960                        | )          | $ | 81,579 |   |
| Reserve  for slow moving inventory                  |       | $                                | 700,428    |                               | $          | 399           |       | —                        |       | $ | 700,827 |   |
| Year  ended July 31, 2003                      |       |                             |       |                               |       |          |       |                          |       |
| Allowance  for doubtful accounts                    |       | $                                | 126,172    |                               | $          | 186,811       |       | $                             | (220,965   | ) | $ | 92,018 |   |
| Allowance  for customer credits                     |       | $                                | 81,579     |                               | 34,085     |          | $          | —                        |       | $ | 115,664 |   |
| Reserve  for slow moving inventory                  |       | $                                | 700,827    |                               | $          | 2,192,005     |       | $                             | (1,749,122 | ) | $ | 1,143,710 |   |
| Year  ended July 31, 2004                      |       |                             |       |                               |       |          |       |                          |       |
| Allowance  for doubtful accounts                    |       | $                                | 92,018     |                               | $          | 181,195       |       | $                             | (169,920   | ) | $ | 103,293 |   |
| Allowance  for customer credits                     |       | $                                | 115,664    |                               | $          | 14,181        |       | $                             | —     |   | $ | 129,845 |   |
| Reserve  for slow moving inventory moving inventory |       | $                                | 1,143,710  |                               | $          | 1,817,322     |       | $                             | (841,610   | ) | $ | 2,119,422 |   |

 

36

----

 

REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directorsand Stockholders

 

Sherwood Brands, Inc.

 

We have audited theaccompanying consolidated balance sheets of Sherwood Brands, Inc. andSubsidiaries as of July 31, 2004 and 2003 and the related consolidatedstatements of operations, stockholders’ equity and cash flows for each of thethree years in the period ended July 31, 2004. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Accounting Oversight Board(PCAOB). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes, examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principals used and significantestimates made by management, as well as evaluating the overall presentation ofthe financial statements. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Sherwood Brands, Inc. andSubsidiaries at July 31, 2004 and 2003 and the results of its operationsand cash flows for each of the three years in the period ended July 31,2004 in conformity with accounting principals generally accepted in the UnitedStates of America.

 

BDO SEIDMAN, LLP

 

Bethesda, Maryland

October 8, 2004

 

37

----

 

SHERWOOD BRANDS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCESHEETS

 
| **For the years ended July 31,**                                                                                 | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Assets                                                                                                                |       |       |       |       |       |
| Current  assets                                                                                                       |       |       |       |       |       |
| Cash  and cash equivalents                                                                                            |       | $          | 10,808     |       | $          | 227,352 |   |
| Accounts  receivable, less allowance of $103,000 and $92,000                                                          |       | 1,038,123  |       | 899,230    |       |
| Income  taxes receivable                                                                                              |       | 54,681     |       | 1,020,379  |       |
| Inventory                                                                                                             |       | 9,591,268  |       | 13,719,294 |       |
| Other  current assets                                                                                                 |       | 581,411    |       | 578,155    |       |
| Deferred  taxes on income                                                                                             |       | 864,000    |       | 614,000    |       |
| Total  current assets                                                                                                 |       | 12,140,291 |       | 17,058,410 |       |
| Net  property and equipment                                                                                           |       | 6,103,880  |       | 7,129,227  |       |
| Goodwill                                                                                                              |       | 2,001,330  |       | 2,001,330  |       |
| Other  assets                                                                                                         |       | 160,952    |       | 313,504    |       |
| Total  Assets                                                                                                         |       | $          | 20,406,453 |       | $          | 26,502,471 |   |
|                                                                                                                  |       |       |       |       |       |
| Liabilities and Stockholders’ Equity                                                                             |       |       |       |       |       |
| Current  liabilities                                                                                                  |       |       |       |       |       |
| Line  of credit                                                                                                       |       | $          | 5,610,903  |       | $          | 6,260,264 |   |
| Current  portion of long-term debt                                                                                    |       | 465,239    |       | 530,377    |       |
| Current  portion of subordinated debt                                                                                 |       | 3,397,140  |       | 2,000,000  |       |
| Current  portion of capital lease obligation                                                                          |       | 16,688     |       | 15,718     |       |
| Accounts  payable                                                                                                     |       | 3,241,708  |       | 6,257,145  |       |
| Accrued  expenses                                                                                                     |       | 1,761,894  |       | 1,325,891  |       |
| Total  current liabilities                                                                                            |       | 14,493,572 |       | 16,389,395 |       |
| Long-term  debt                                                                                                       |       | 617,774    |       | 1,150,513  |       |
| Capital  lease obligation                                                                                             |       | 407,204    |       | 423,892    |       |
| Deferred  taxes on income                                                                                             |       | 864,000    |       | 464,000    |       |
| Total  Liabilities                                                                                                    |       | 16,382,550 |       | 18,427,800 |       |
| Commitments  and Contingencies                                                                                        |       |       |       |       |       |
| 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, 3,036,561 and  3,003,476 issued and outstanding |       | 30,366     |       | 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                                                                                           |       | 9,893,349  |       | 9,843,774  |       |
| Retained  (deficit)earnings                                                                                           |       | (5,909,812 | )          | (1,809,138 | )          |
| Accumulated  other comprehensive income (loss)                                                                        |       | —     |       | —     |       |
| Total  Stockholders’ Equity                                                                                      |       | 4,023,903  |       | 8,074,671  |       |
| Total  Liabilities and Stockholders’ Equity                                                                      |       | $          | 20,406,453 |       | $          | 26,502,471 |   |

 

See accompanyingsummary of accounting policies and notes to consolidated financial statements.

 

38

----

 

SHERWOOD BRANDS,INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTSOF OPERATIONS

 
| ** **                                          | ** ** | **For years ended July 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales                                           |       | $                                 | 45,881,039 |   | $ | 49,162,787 |   | $ | 52,782,341 |   |
| Cost  of sales                                      |       | 34,726,872                        |       | 37,680,097 |   | 37,714,680 |   |
| Write  down of inventory                            |       | 1,817,322                         |       | 2,192,005 |   | — |   |
| Gross  profit                                       |       | 9,336,845                         |       | 9,290,685 |   | 15,067,661 |   |
| Selling,  general and administrative expenses       |       | 8,420,600                         |       | 8,192,774 |   | 8,313,603 |   |
| Salaries  and related expenses                      |       | 4,154,036                         |       | 5,057,115 |   | 5,100,167 |   |
| Non-recurring  costs                                |       | —                            |       | 1,932,075 |   | 707,551 |   |
| Total  operating expenses                           |       | 12,574,635                        |       | 15,181,964 |   | 14,121,321 |   |
| (Loss)  income from operations                      |       | (3,237,791                        | )          | (5,891,279 | ) | 946,340 |   |
| Other  income (expense)                             |       |                              |       |   |   |   |   |
| Interest  income                                    |       | 100                               |       | 2,636 |   | 4,881 |   |
| Interest  expense                                   |       | (1,032,694                        | )          | (623,201 | ) | (468,687 | ) |
| Other  income (expense)                             |       | (131,534                          | )          | 274,728 |   | 90,535 |   |
| Total  other (expense) income                       |       | (1,164,128                        | )          | (345,837 | ) | (373,271 | ) |
| (Loss)  income before provision for taxes on income |       | (4,401,919                        | )          | (6,237,116 | ) | 573,069 |   |
| (Benefit)  provision for taxes on income            |       | (301,245                          | )          | (866,224 | ) | 248,039 |   |
| Net  (loss) income                                  |       | $                                 | (4,100,674 | ) | $ | (5,370,892 | ) | $ | 325,030 |   |
| Net  (loss) income per share                        |       |                              |       |   |   |   |   |
| —basic                                         |       | $                                 | (1.02      | ) | $ | (1.34 | ) | $ | 0.09 |   |
| —diluted                                       |       | (1.02                             | )          | (1.34 | ) | 0.08 |   |
| Weighted  average common shares outstanding         |       |                              |       |   |   |   |   |
| —basic                                         |       | 4,017,255                         |       | 3,996,199 |   | 3,778,375 |   |
| —diluted                                       |       | 4,017,255                         |       | 3,996,199 |   | 4,312,762 |   |

 

See accompanyingsummary of accounting policies and notes to consolidated financial statements.

 

39

----

 

SHERWOOD BRANDS,INC. AND SUBSIDIARIES

CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY

 
| ** **                      | ** ** | **Common  Stock** | ** ** | **Accumulated  Additional** | ** ** | ** **  | ** ** | **Other**    | ** ** | ** **        | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------------|------------|-------------|------------|--------------|------------|-------------------|------------|
| ** **                      | ** ** | **Class A**       | ** ** | **Class B**                 | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Shares**        | ** ** | **Amount**                  | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **Capital**       | ** ** | **Earnings** | ** ** | **Income  (Loss)** | ** ** | **Total** | ** ** |
| Balance,  at July 31, 2001 |       | 2,700,000         |       | $                           | 27,000     |        | 1,000,000  |         | $          | 10,000            |       | $ | 7,973,538 |   | $ | 3,236,724 |   | $ | (18,270 | ) | $ | 11,228,992 |   |
| Foreign  currency (loss)        |       | —            |       | —                      |       | —      |       | —       |       | —            |       | — |   | (12,869 | ) | — |   |
| Exercise  of stock options      |       | 16,250            |       | 163                         |       | —      |       | —       |       | 40,931            |       | — |   | — |   | 41,094 |   |
| Restricted  stock               |       | —            |       | —                      |       | —      |       | —       |       | 19,401            |       | — |   | — |   | 19,401 |   |
| Issued  stock Acquisition       |       | 270,559           |       | 2,706                       |       | —      |       | —       |       | 1,674,760         |       | — |   | — |   | 1,677,466 |   |
| Warrants  issued Acquisition    |       | —            |       | —                      |       | —      |       | —       |       | 108,226           |       | — |   | — |   | 108,226 |   |
| Net  income                     |       | —            |       | —                      |       | —      |       | —       |       | —            |       | 325,030 |   | — |   | — |   |
| Comprehensive  income           |       | —            |       | —                      |       | —      |       | —       |       | —            |       | — |   | — |   | 312,161 |   |
| Balance,  at July 31 ,2002 |       | 2,986,809         |       | 29,869                      |       | 1,000,000   |       | 10,000       |       | 9,816,856         |       | 3,561,754 |   | (31,139 | ) | 13,387,340 |   |
| Foreign  currency (loss)        |       | —            |       | —                      |       | —      |       | —       |       | —            |       | — |   | 31,139 |   | — |   |
| Exercise  of stock options      |       | 16,667            |       | 166                         |       | —      |       | —       |       | 26,918            |       | — |   | — |   | 27,084 |   |
| Net  loss                       |       | —            |       | —                      |       | —      |       | —       |       | —            |       |  (5,370,892 | ) | — |   | — |   |
| Comprehensive  income           |       | —            |       | —                      |       | —      |       | —       |       | —            |       | — |   | — |   |  (5,339,753 | ) |
| Balance,  at July 31, 2003 |       | 3,003,476         |       | $                           | 30,035     |        | 1,000,000  |         | $          | 10,000            |       | $ | 9,843,774 |   | $ | (1,809,138 | ) | $ | — |   | $ | 8,074,671 |   |
| Foreign  currency (loss)        |       | —            |       | —                      |       | —      |       | —       |       | —            |       | — |   | — |   | — |   |
| Exercise  of stock options      |       | 25,000            |       | 250                         |       | —      |       | —       |       | 49,656            |       | — |   | — |   | 49,906 |   |
| Vesting  of restricted stock    |       | 8,085             |       | 81                          |       | —      |       | —       |       | (81               | )          | — |   | — |   | — |   |
| Net  loss                       |       | —            |       | —                      |       | —      |       | —       |       | —            |       | (4,100,674 | ) | — |   | — |   |
| Comprehensive  income           |       | —            |       | —                      |       | —      |       | —       |       | —            |       | — |   | — |   | (4,100,674 | ) |
| Balance,  at July 31, 2004 |       | 3,036,561         |       | $                           | 30,366     |        | 1,000,000  |         | $          | 10,000            |       | $ | 9,893,349 |   | $ | (5,909,812 | ) | $ | — |   | $ | 4,023,903 |   |
|                                 |            |                   |            |                             |            |             |            |              |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanyingsummary of accounting policies and notes to consolidated financial statements.

 

40

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SHERWOOD BRANDS,INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTSOF CASH FLOWS

 
| ** **                                                                                           | ** ** | **For the years ended July 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                           | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash  flows from operating activities                                                                |       |                                  |       |   |   |   |   |
| Net  income (loss)                                                                                   |       | $                                     | (4,100,674 | ) | $ | (5,370,892 | ) | $ | 325,030 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                                  |       |   |   |   |   |
| Depreciation  expense                                                                                |       | 1,141,178                             |       | 961,712 |   | 680,013 |   |
| Deferred  income taxes                                                                               |       | 150,000                               |       | 31,000 |   | — |   |
| Restricted  stock                                                                                    |       | —                                |       | — |   | 19,401 |   |
| Gain  (loss) on disposal of equipment                                                                |       | 43,002                                |       | — |   | (3,674 | ) |
| (Gain)  loss on foreign currency exchange                                                            |       | —                                |       | — |   | 422 |   |
| Provision  for inventory allowance                                                                   |       | 975,712                               |       | 2,192,005 |   | 399 |   |
| Provision  for doubtful accounts                                                                     |       | 181,195                               |       | 186,811 |   | 227,811 |   |
| (Increase)  decrease in assets                                                                       |       |                                  |       |   |   |   |   |
| Accounts  receivable                                                                                 |       | (320,088                              | )          | 1,461,411 |   | (798,168 | ) |
| Inventory                                                                                            |       | 2,130,704                             |       | 44,846 |   | 1,346,920 |   |
| Income  taxes receivable                                                                             |       | 1,817,322                             |       | 534,699 |   | (674,520 | ) |
| Other  current assets                                                                                |       | 1,435,866                             |       | (127,780 | ) | (87,672 | ) |
| Other  assets                                                                                        |       | 152,552                               |       | (4,665 | ) | (210,204 | ) |
| Increase  (decrease) in liabilities                                                                  |       |                                  |       |   |   |   |   |
| Accounts  payable                                                                                    |       | (3,015,437                            | )          | 423,844 |   | 213,014 |   |
| Accrued  expenses                                                                                    |       | 436,040                               |       | (11,898 | ) | (795,008 | ) |
| Income  taxes payable                                                                                |       | —                                |       | — |   | (722,474 | ) |
| Net  cash (used in) provided by operating activities                                                 |       | (241,801                              | )          | 321,093 |   | (478,710 | ) |
| Cash  flows from investing activities                                                                |       |                                  |       |   |   |   |   |
| Acquisition  costs of Asher Candy                                                                    |       | —                                |       | — |   | (58,628 | ) |
| Proceeds  from sale of property, plant & equipment                                               |       | 142,750                               |       | — |   | 26,058 |   |
| Capital  expenditures                                                                                |       | (301,583                              | )          | (740,451 | ) | (2,128,435 | ) |
| Net  cash used in investing activities                                                               |       | (158,833                              | )          | (740,451 | ) | (2,161,005 | ) |
| Cash  flows from financing activities                                                                |       |                                  |       |   |   |   |   |
| Net  borrowings on line of credit                                                                    |       | (649,361                              | )          | (1,943,707 | ) | 3,177,584 |   |
| Proceeds  from LT debt                                                                               |       | —                                |       | 350,000 |   | — |   |
| Proceeds  from Subordinated debt                                                                     |       | 1,397,140                             |       | 2,000,000 |   | — |   |
| Payments  on debt                                                                                    |       | (613,595                              | )          | (495,914 | ) | (254,748 | ) |
| Exercise  of Stock options                                                                           |       | 49,906                                |       | 27,084 |   | 40,931 |   |
| Net  cash provided by (used in) financing activities                                                 |       | 184,090                               |       | (62,537 | ) | 2,963,767 |   |
| Net  (decrease) increase in cash and cash equivalents                                                |       | (216,544                              | )          | (481,895 | ) | 324,052 |   |
| Cash  and cash equivalents, at beginning of period                                                   |       | 227,352                               |       | 709,247 |   | 385,195 |   |
| Cash  and cash equivalents, at end of period                                                         |       | $                                     | 10,808     |   | $ | 227,352 |   | $ | 709,247 |   |
| Interest  Paid                                                                                       |       | $                                     | 1,032,694  |   | $ | 623,201 |   | $ | 468,687 |   |
| Income  Taxes Paid                                                                                   |       | $                                     | —     |   | $ | — |   | $ | 1,623,448 |   |

 

See accompanyingsummary of accounting policies and notes to consolidated financial statements.

 

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SHERWOOD BRANDS, INC. AND SUBSIDIARIESSUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

 

Basis of Presentation,Organization and Description of Business

 

The consolidatedfinancial statements include the accounts of Sherwood Brands, Inc. and itswholly-owned subsidiaries, Sherwood Brands, LLC, Sherwood Brands Overseas, Inc.(“Overseas”), Sherwood Brands of RI, Inc. and Asher Candy, Inc. (collectively,the “Company”). All material inter-company transactions and balances have beeneliminated in consolidation.

 

Sherwood Brands, Inc. wasincorporated in December 1982 in the state of North Carolina. SherwoodBrands, Inc. is engaged in the manufacture, marketing and distribution of adiverse line of candies, cookies and chocolates. The Company also manufacturesjelly beans, lollipops, biscuits, soft and hard candies and assembles seasonalgift items including gift baskets. The Company operates in the confectionaryindustry and****aligns its operationsinto three business segments for management to measure financial performance byproduct type.  The Company’s businesssegments are (i) Manufactured Candy, (ii) Purchased Candy and (iii) Gift Items.

 

Sherwood Brands, Inc. isthe owner of Sherwood Brands, LLC, a Maryland limited liability company.Sherwood Brands, LLC markets and distributes its own line of confectioneryproducts in the United States.

 

Overseas (a wholly-ownedsubsidiary of Sherwood Brands, LLC) was incorporated in July 1993 in theBahamas to market and distribute the Sherwood lines of confectionery productsinternationally.

 

Sherwood Brands of RI,Inc. was incorporated in September, 1998 in the state of Rhode Island. SherwoodBrands of RI, Inc. d/b/a E. Rosen Company is a manufacturer of hard candies,jelly beans and packer of gift items and baskets. On September 24, 1998the Company completed the acquisition of certain assets of the E. Rosen Company—d/b/aSchool House Candy Co. (“Rosen”). Rosen was a Rhode Island corporation, whichassembled a variety of holiday gift items including gift baskets. Rosen soldits holiday gift items to such chains as Wal-Mart, Kmart and CVS. The Companypaid $4.0 million in cash for the machinery and equipment, inventory and tradenames, trademarks and customer lists of Rosen. For financial accountingpurposes, the entire purchase price of $4.0 million was allocated to theinventories of raw material, components and finished product.

 

Sherwood AcquisitionCorporation (a wholly-owned subsidiary of the Company) was incorporated in April 2002in the state of Wyoming. Sherwood Acquisition merged with and into Asher CandyAcquisition Corporation, a Wyoming corporation. On May 1, 2002, the Companyacquired all of the outstanding common stock of Asher Candy AcquisitionCorporation, a Wyoming corporation with operations located in New Hyde Park,New York. Asher Candy Acquisition Corporation is a manufacturer of candy canesand other hard candies under the “Asher” name. The surviving corporation of themerger is Asher Candy Acquisition Corporation, which has changed its name toAsher Candy, Inc. (See Note 3).

 

Cash Equivalents

 

For purposes of thestatement of cash flows, the Company considers all highly liquid investmentswith maturities at original date of acquisition of three months or less to becash equivalents.

 

Accounts Receivable andAllowance for Doubtful Accounts.

 

Accounts receivable arecustomer obligations due under normal trade terms.  We sell our products to those involved in theretail industry.  Accounts receivable arereviewed to determine if any receivables will potentially be uncollectible.  The Company records an allowance for doubtfulaccounts based on specifically identified amounts that they believe to beuncollectible along with a general reserve. If the actual collections experience changes, revisions to the allowancemay be required.  Any unanticipatedchange in the customer’s credit worthiness or other matters affecting thecollectability of amounts due from such customers, could have a material affecton the results of operations in the period in which such changes or events occur.  After all attempts to collect a receivablehave failed, the receivable is written off against the allowance.  Based on the information available, theCompany believes the allowance for doubtful accounts as of July 31, 2004 and2003 is adequate. However, actual write-offs might exceed the recordedallowance.

 

42

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Inventory

 

Inventory consists of rawmaterials, packaging materials, components used in assembly, work-in-processand finished goods and is stated at the lower of cost or market. Cost isdetermined by the FIFO (first-in, first-out) method.

 

Property and Equipment

 

Property and equipmentare stated at cost. Depreciation is computed using accelerated andstraight-line methods over the estimated useful lives of the individual assetswhich range from five to seven years for machinery and equipment to thirty-nineyears for the building.

 

Asset Impairment

 

The Company periodicallyevaluates the carrying value of long-lived assets when events and circumstanceswarrant such a review. The carrying value of a long-lived asset is considered impairedwhen the anticipated undiscounted cash flow from such asset is separatelyidentifiable and is less than the carrying value. In that event, a loss isrecognized based on the amount by which the carrying value exceeds the fairmarket value of the long-lived asset. Fair market value is determined primarilyusing the anticipated cash flows discounted at a rate commensurate with therisk involved.

 

Revenue Recognition

 

Sales are recognized uponshipment of products. Sales discounts and any other price adjustments areaccounted for as a reduction in revenue at the later of (1) the date at whichthe related revenue is recognized by the Company or (2) the date at which the salesincentive is offered.

 

In September 2000,the Emerging Issues Task Force issued EITF 00-10, Accounting for Shipping andHandling Fees and Costs (EITF 00-10). EITF 00-10 requires that shipping andhandling fees billed to customers be classified as revenue and shipping andhandling costs be either classified as cost of sales or disclosed in the notesto the financial statements. The Company includes shipping and handling feesbilled to customers in net sales. Shipping and handling costs associated with inboundfreight are included in cost of sales. Shipping and handling costs associatedwith outbound freight are included in selling, general and administrativeexpenses and totaled approximately $2,819,000, $3,529,000 and $2,973,000 infiscal 2004, 2003 and 2002, respectively.

 

Income Taxes

 

Income taxes arecalculated using the liability method specified by Statement of FinancialAccounting Standards No. 109, “Accounting for Income Taxes (SFAS 109).” UnderSFAS 109, deferred taxes are determined using the liability method whichrequires the recognition of deferred tax assets and liability based ondifferences between the financial statement and the income tax basis usingpresently enacted tax rates.

 

The income tax rateutilized on an interim basis is based on the Company’s estimate of theeffective income tax rate for the fiscal year ending July 31, 2004. TheCompany has a net operating loss carry forward which management believes willoffset all taxable income generated in fiscal year 2004.  Therefore, the Company estimated itseffective tax rate at 0%. During the quarter ended April 30, 2004, theCompany recorded $151,245 of additional income tax benefits as a result ofamended returns filed with the Internal Revenue Service and State income tax.These refunds are partially offset by a change in deferred taxes of $150,000.

 

Use of Estimates

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimates andassumptions 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.

 

Financial Instruments

 

Financial instruments ofthe Company include long-term debt. Based upon current borrowing ratesavailable to the Company, estimated fair values of these financial instrumentsapproximate their recorded amounts.

 

43

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Derivative FinancialInstruments

 

The Company formerlyutilized derivative financial instruments to reduce foreign currency risks. TheCompany did not hold or issue derivative financial instruments for tradingpurposes. In June 1998, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities,” which was amended in June 2000 by SFAS No. 138, SFAS No. 133,as amended, establishes accounting and reporting standards for derivativeinstruments and hedging activities. It requires that a company recognize all derivativesas either assets or liabilities in the statement of financial condition andmeasure those instruments at fair value. Changes in the fair value of thoseinstruments will be reported in earnings or other comprehensive incomedepending on the use of the derivative and whether it qualifies for hedgeaccounting. The accounting for gains and losses associated with changes in thefair value or the derivative, and the effect on the consolidated financialstatements will depend on its hedge designation and whether the hedge is highlyeffective in achieving offsetting changes in the fair value of cash flows ofthe asset or liability hedged. The Company adopted SFAS 133, as amended in thefourth quarter of fiscal 2001. See Note 16.

 

Comprehensive Income

 

Comprehensive income(loss) is reported on the Consolidated Statements of Stockholders’ Equity andaccumulated other comprehensive (loss) is reported on the Consolidated BalanceSheets. For the Company, other comprehensive income (loss) consists of changesin the fair market value of derivatives. Prior to the fourth quarter of 2001,the Company had no derivative financial instruments or items of othercomprehensive income. During the fiscal year ended July 31, 2002 theCompany executed a foreign exchange forward contract to purchase 766,000 Euros.In accordance with SFAS 133, as amended, the Company marked the contract to marketas of July 31, 2002 and recorded a loss of $31,139 in other comprehensiveincome since the Company designated the contract as a cash flow hedge. Duringthe fiscal year ended July 31, 2004 the Company had no derivativefinancial instruments.

 

Earnings Per Share

 

The Company accounts forearnings per share in accordance with Statement of Financial AccountingStandards No. 128, Earnings Per Share (SFAS 128). SFAS 128 requires twopresentations of earnings per share-”basic” and “diluted”. Basic earnings pershare is computed by dividing net income available to common stockholders forthe period by the weighted average number of common shares outstanding for theperiod. The computation of diluted earnings per share is similar to basicearnings per share, except the denominator is increased to include the numberof additional common shares that would have been outstanding if the potentiallydilutive common shares had been issued. Basic and dilutive earnings per shareare the same for 2004 and 2003 because the impact of dilutive securities isanti-dilutive. As of fiscal year ending July 31, 2004 the Company has 999,451options exercisable.

 
| ** **                               | ** ** | **For the year ended July 31,  2002** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|
| ** **                               | ** ** | **Income**                                 | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic  earnings per share                |       |                                       |       |   |   |   |   |
| Income  available to common stockholders |       | $                                          | 325,030    |   | 3,778,375 |   | $ | 0.09 |   |
| Effect  of dilutive stock options        |       |                                       |       | 534,386 |   |   |   |
| Diluted  earnings per share              |       | $                                          | 325,030    |   | 4,312,761 |   | $ | 0.08 |   |
|                                          |            |                                            |            |  |  |  |  |  |  |  |  |

 

Stock compensation ofstock options

 

The Company has adoptedthe disclosure only provisions of Statement of Financial Accounting StandardsNo. 123, “Accounting for Stock-Based Compensation” (SFAS 123”), but itcontinues to measure compensation cost for the stock options using theintrinsic value method prescribed by APB Opinion No. 25. As allowable underSFAS 123, the Company used the Black-Sholes method to measure the compensationcost of stock options granted in 2002 and 2001 with the following assumptions:risk-free interest rate of 4.66% and 6.00%, a dividend payout rate of zero, andan expected option life of ten years, respectively. The volatility is 66%.Using these assumptions, the fair value of stock options granted during fiscal2002 and 2001 was $3.76 and $2.56, respectively.

 

44

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There were no adjustmentsmade in calculating the fair value to account for vesting provisions, fornon-transferability or risk of forfeiture. Because the Company’s employee stockoptions have characteristics significantly different from those of tradedoptions, and because changes in the subjective input assumptions can materiallyaffect the fair value estimate, in management’s opinion, the existing models donot necessarily provide a reliable single measure of the fair value of itsemployee stock options.

 

If the Company hadelected to recognize compensation cost based on the value at the grant dateswith the method prescribed by SFAS 123, net income and earnings per share wouldhave been changed to the pro forma amounts indicated in the following table:

 
| ** **                                                                     | ** ** | **For years ended July 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net  Income/(loss)                                                             |       |                              |       |   |   |   |   |
| As  Reported                                                                   |       | $                                 | (4,100,674 | ) | $ | (5,370,892 | ) | $ | 325,030 |   |
|                                                                           |       |                              |       |   |   |   |   |
| Deduct:  Total stock-based employee                                            |       |                              |       |   |   |   |   |
| Compensation  expense determined under Fair value based method for all awards, |       |                              |       |   |   |   |   |
| Net  of related tax effects                                                    |       | 104,000                           |       | 149,000 |   | 242,000 |   |
|                                                                           |       |                              |       |   |   |   |   |
| Pro  Forma net income (loss)                                                   |       | (4,204,674                        | )          | (5,519,892 | ) | 83,030 |   |
| Basic  Income/(loss) per Common Share:                                         |       |                              |       |   |   |   |   |
| As  Reported                                                                   |       | $                                 | (1.02      | ) | $ | (1.34 | ) | $ | 0.09 |   |
| Pro  Forma                                                                     |       | (1.05                             | )          | (1.38 | ) | 0.02 |   |
|                                                                           |       |                              |       |   |   |   |   |
| Diluted  income/(loss) per Common Share:                                       |       |                              |       |   |   |   |   |
| As  reported                                                                   |       | $                                 | (1.02      | ) | $ | (1.34 | ) | $ | 0.08 |   |
| Pro  Forma                                                                     |       | (1.05                             | )          | (1.38 | ) | 0.02 |   |

 

The Company has issued38,562 warrants exercisable for shares of Class A common stock exercisable at$6.49 and expire on April 30, 2005.

 

The Company has issuedand outstanding 775,000 warrants to purchase shares of Class A common stock.The warrants are exercisable at $7.50 and expired on May 6, 2003.  The Company did not extend the warrantsbeyond the expiration date.

 

Recent AccountingPronouncements

 

In December 2003, the FASB issued Interpretation No. 46-R (FIN 46-R), Consolidation of Variable Interest Entities. FIN 46-R, which modifies certain provisions and effective dates of FIN No. 46, sets forth criteria to be used in determining whether an investment in a variable interest entity should be consolidated, and is based on the general premise that companies that control another entity through interests other than voting interests should consolidate the controlled entity. The provisions of FIN 46 became effective for the Company during the third quarter of Fiscal 2004. The adoption of this new standard did not have any impact on the Company’s financial position, results of operations or cash flows.

 

In December, 2003, the FASB issued a revision to SFAS No. 132, “Employers’ Disclosures about Pensions and Other Post retirement Benefits.” This revised statement requires additional annual disclosures regarding types of pension plan assets, investment strategy, future plan contributions, expected benefit payments and other items. The statement also requires quarterly disclosure of the components of net periodic benefit cost and plan contributions. This currently has no effect on the Company.

 

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SHERWOOD BRANDS, INC. ANDSUBSIDIARIES

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

1. INVENTORY

 

Inventories consist ofthe following:

 
| ** **                               | ** ** | **For years ended July 31,** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | **2004**                          | ** ** | **2003** | ** ** |
| Raw  materials and ingredients           |       | $                                 | 384,216    |   | $ | 423,497 |   |
| Components  used in assembly             |       | 1,043,036                         |       | 1,496,166 |   |
| Packaging  materials                     |       | 2,798,591                         |       | 2,936,702 |   |
| Work-in-process                          |       | 130,634                           |       | 648,539 |   |
| Finished  product                        |       | 7,262,339                         |       | 9,358,100 |   |
|                                     |       | 11,710,690                        |       | 14,863,004 |   |
| Less  reserve for inventory obsolescence |       | (2,119,422                        | )          | (1,143,710 | ) |
| Total                                    |       | $                                 | 9,591,268  |   | $ | 13,719,294 |   |
|                                          |            |                                   |            |  |  |  |  |  |

 

2. PROPERTY, PLANT ANDEQUIPMENT

 

Property, plant andequipment consist of the following:

 
| ** **                        | ** ** | **For years ended July  31,** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|
| ** **                        | ** ** | **2004**                      | ** ** | **2003** | ** ** |
| Land                              |       | $                             | 85,282     |   | $ | 85,282 |   |
| Buildings  and improvements       |       | 2,834,403                     |       | 2,800,050 |   |
| Machinery  and equipment          |       | 6,558,797                     |       | 6,529,588 |   |
| Furniture  and computer equipment |       | 357,014                       |       | 335,911 |   |
| Transportation  equipment         |       | 105,188                       |       | 102,414 |   |
|                              |       | 9,940,684                     |       | 9,853,245 |   |
| Accumulated  depreciation         |       | (3,836,804                    | )          | (2,724,018 | ) |
| Total                             |       | $                             | 6,103,880  |   | $ | 7,129,227 |   |

 

Depreciation expense forthe years ended July 31, 2004, 2003 and 2002 was $1,141,178, $961,712 and$674,973, respectively.

 

3. ACQUISITION

 

On May 1, 2002, theCompany acquired all of the outstanding common stock of Asher Candy Company (“Asher”).The results of Asher’s operations have been included in the consolidatedfinancial statements since that date. Asher manufactures and markets candycanes and sells primarily to mass merchandisers and supermarkets through outthe United States. The Company acquired Asher to continue the diversificationof its product mix. Also, the Company and Asher share a similar customer basewhich it hopes will create marketing efficiencies and accelerated sales ofAsher’s products to mass merchandisers.

 

The purchase price wasapproximately $1,783,000 consisting of 270,559 shares of Class A common stockand warrants to purchase 38,562 shares of Class A common stock. The Companyvalued the common shares issued at the closing market price on April 30,2002 ($1,675,000) and valued the warrants using the Black-Scholes optionpricing model ($108,000).

 

46

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The following tablesummarizes the estimated fair values of the assets acquired and liabilitiesassumed as of May 1, 2002:

 
| Current  assets         |   | $          | 3,424,000 |   |
|-------------------------|--------|------------|-----------|--------|
| Property  and equipment |   | 1,060,000  |      |
| Goodwill                |   | 1,775,000  |      |
| Total  assets acquired  |   | 6,259,000  |      |
| Current  liabilities    |   | (4,346,000 | )         |
| Net  assets acquired    |   | $          | 1,913,000 |   |
|                         |        |            |           |        |  |

 

The Company expects allof the goodwill associated with the Asher acquisition to be tax deductible.

 

The following proformaconsolidated results of operations assume the Company acquired Asher on August 1,2002:

 
| ** **                                | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|
| Net  sales                                |       | $        | 63,153,000 |   |
| Income  before provision for income taxes |       | 324,000  |       |
| Net  Income                               |       | 234,000  |       |
| Earnings  per share-basic                 |       | $        | 0.062      |   |
| Earnings  per share-diluted               |       | $        | 0.054      |   |

 

4. CREDIT FACILITY

 

The Company has a senior$15,000,000 line of credit with Wachovia Bank, N.A.  The line of credit expires on August 1,2005 and is due and payable at such time. Interest accrues on all amounts extended at the rate of prime plus3%.  Advances under the credit facilityare based on a borrowing formula equal to 85% of eligible domestic accounts receivableplus 60% of eligible finished goods and 30% of eligible components inventory.Borrowings on inventory are capped based upon the Company’s seasonalrequirements and are limited to $9,000,000. The credit facility is alsoavailable for the issuance of letters of credit. The credit facility iscollateralized by the cash and cash equivalents, accounts receivable andinventories of the Company. The credit facility also contains business andfinancial covenants, including, a minimum tangible net worth, a fixed chargeratio and a limit on capital expenditures. The bank waived all of its financial covenant defaults for the quartersended April 30, 2004 and July 31, 2004.  As of July 31, 2004, the Company had$5,610,903 outstanding under the line of credit of which Wachovia advanced$1,000,000 out of formula.  The Companywill be required to reduce this out of formula amount as follows: prior to November 14,2004 it must be reduced to no more than $500,000; prior to November 21,2004 it must be reduced to no more than $250,000; and prior to November 22,2004 it must be fully repaid.  Afterrepayment of the out of formula borrowing, management believes that the Companywill be able to satisfy the financial covenants for the line of credit.  The Company currently expects it will be ableto meet the bank requirements of reducing the out of Formula advance on November 14,2004 to the $500,000.

 

The Company obtainedsubordinated debt from Lana, LLC in an amount equal to $2,000,000. Thesubordinated debt is collateralized by a security interest in the Company’saccounts receivable and inventory.  Thesubordinated debt is fully subordinated to all obligations and all liens,security interests, rights and remedies in favor of Lana, LLC, a related partyto the board and officers.  Managementfeels that it will be able to comply with the new structure of the financialagreements.

 

At July 31, 2004 and2003, the Company had borrowed $5,610,903 and $6,260,264, respectively underthe line of credit and had no letters of credit outstanding. During the yearsended July 31, 2004, 2003 and 2002, the Company incurred and paidapproximately $476,446, $527,047 and $439,473 of interest expense on the lineof credit, respectively.

 

47

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Average short termborrowings and the related interest rates are as follows:

 
| ** **                                             | ** ** | **For years ended July 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                             | ** ** | **2004**                          | ** ** | **2003** | ** ** |
| Borrowings  under revolving line of credit at year end |       | $                                 | 5,610,903  |   | $ | 6,260,264 |   |
| Weighted  average interest rate                        |       | 4.15                              | %          | 3.99 | % |
| Maximum  month-end balance during period               |       | $                                 | 10,647,245 |   | $ | 11,663,335 |   |
| Average  balance during the period                     |       | $                                 | 9,089,197  |   | $ | 10,620,242 |   |

 

On July 30, 2003,the Company entered into a subordinated debt agreement with Lana, LLC for$2,000,000.  The shareholders of Lana,LLC include individuals who are related to board members and officers of theCompany.  The subordinated debt bearsinterest at 16.575% with interest payable annually.  During the fiscal year ending July 31,2004 the Company borrowed an additional $1.4 million to meet its workingcapital needs. During the years ended July 31, 2004 and 2003, the Companyincurred approximately $496,693 and $49,216 of interest expense on thesubordinated debt, respectively.

 

5. LETTERS OF CREDIT

 

The Company has availablean irrevocable letter of credit of $635,000 with a bank, to be used forpayments of principal portions of Virginia Revenue Bonds in the event theCompany defaults on payment. The letter is collateralized by a first deed oftrust and security interest in the Company’s land, building and equipment. Theletter of credit expires in 2011. The letter of credit agreement has a debt toworth and a debt coverage requirement as well as a limitation on dividends paidand on borrowings. The letter of credit agreement contains various business andfinancial covenants, including, among other things, a minimum debt coverage.

 

In addition, the Companyhas available another irrevocable letter of credit of $130,000 with a bank, tobe used for payment of principal portions of Virginia Revenue Bonds in theevent the Company defaults on payment. The letter is collateralized by a firstdeed of trust in the Company’s commercial property as well as a lien on certainassets of the Company. This letter of credit expired in June 2002.

 

48

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6. LONG-TERM DEBT

 

Long-term debt consists of the following:

 
| ** **                                                                                                                                                                                                                                                                                                    | ** ** | **For years ended July  31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                    | ** ** | **2004**                      | ** ** | **2003** | ** ** |
| Mecklenberg  County, Virginia Variable Rate Demand Revenue Bonds issued on June 1, 1996;  collateralized by an irrevocable Letter of credit (see Note 5); payable in  varying annual amounts; To be redeemed in whole by June 1, 2011; interest at  variable Market tax exempt rates (4.40% at July 31, 2004) |       | $                             | 420,000    |   | $ | 460,000 |   |
| Wachovia term  loan on April 30, 2002; collateralized by assets of Asher Candy (see Note 5);  payable in monthly amounts of $19,000; to be paid whole by February 1, 2005  interest at Libor Market rate (4.90% at July 31, 2004)                                                                             |       | 156,000                       |       | 384,000 |   |
| Wachovia term  loan on April 30, 2002; collateralized by assets of Asher Candy (see Note 5);  payable in monthly amounts of $18,056 starting in December 31, 2002; to be  paid whole by December 1, 2005 interest at Libor Market rate (4.90% at July  31, 2004)                                              |       | 239,444                       |       | 523,611 |   |
| Lake Country  Development on October 30, 2002; collateralized by assets of equipment;  payable in monthly amounts of $4,784 starting in October 1, 2003; to be paid  whole by September 30, 2009 interest at 4.0%                                                                                             |       | 267,569                       |       | 313,279 |   |
|                                                                                                                                                                                                                                                                                                          |       | 1,083,013                     |       | 1,680,890 |   |
| Less current  maturities                                                                                                                                                                                                                                                                                      |       | (465,239                      | )          | (530,377 | ) |
| Long-term  portion                                                                                                                                                                                                                                                                                            |       | $                             | 617,774    |   | $ | 1,150,513 |   |

 

The scheduled maturities of long-term debt are as follows:

 
| ** **                    | ** ** | **Amount** | ** ** |
|-------------------------------|------------|------------|------------|
| Fiscal years  ending July 31, |       |       |       |
| 2005                          |       | $          | 465,239    |   |
| 2006                          |       | 122,287    |       |
| 2007                          |       | 106,527    |       |
| 2008                          |       | 113,627    |       |
| 2009                          |       | 120,812    |       |
| Thereafter                    |       | 154,521    |       |
| Total                         |       | $          | 1,083,013  |   |

 

7. CAPITAL LEASE OBLIGATION

 

In May 2000, the Company entered into a capital lease agreement withthe New Bedford Redevelopment Authority to lease a 430,000 square foot buildingin New Bedford, Massachusetts. The facility will be used for assembly andstorage of components. Under the terms of the lease the Company paid $400,000up front and has commitments to pay rent of $25,000 per annum for years one andtwo and $41,666.66 per annum for years three to twenty. The Company has theoption to purchase the building at any time during the lease for $1,200,000less any amounts of rental payments made. Buildings and improvements includes$855,577, less amortization of $0 and $0 for the year ended July 31, 2004 and 2003,respectively. Lease amortization is included in depreciation expense.

 

49

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Future minimum payments under the capital lease are as follows:

 
| ** **                                   | ** ** | **Amount** | ** ** |
|----------------------------------------------|------------|------------|------------|
| Fiscal years  ending July 31,                |       |       |       |
| 2005                                         |       | 41,667     |       |
| 2006                                         |       | 41,667     |       |
| 2007                                         |       | 41,667     |       |
| 2008                                         |       | 41,667     |       |
| 2009                                         |       | 41,667     |       |
| Thereafter                                   |       | 447,917    |       |
| Total                                        |       | $          | 656,2252   |   |
| Less amount  representing interest           |       | (232,368   | )          |
| Present value of  net minimum lease payments |       | $          | 423,883    |   |

 

8. STOCK TRANSACTIONS

 

In November 1997, the Company adopted the 1998 Stock Option Plan (the “Plan”).Under the Plan, the Company may grant qualified and nonqualified stock options toselected employees, consultants and directors. Options vest over a three yearperiod and have a ten year life. The Company had reserved 350,000 shares ofcommon stock for issuance under the Plan. In August 2000, the Board of Directorsapproved increasing the number of shares available by 750,000 for a total of1,100,000 as part of the Company’s ongoing Employee Incentive CompensationPlan.

 

The following table relates to options activity in 2002, 2003 and 2004under the Plan:

 
| ** **                            | ** ** | **Number  of Shares** | ** ** | **Weighted average  Exercise price per  Share** | ** ** |
|---------------------------------------|------------|-----------------------|------------|-------------------------------------------------|------------|
| Options  outstanding at July 31, 2001 |       | 915,168               |       | $                                               | 2.21       |   |
| Granted                               |       | 142,200               |       | $                                               | 5.30       |   |
| Cancelled                             |       | (16,250               | )          | $                                               | 2.53       |   |
| Options  outstanding at July 31, 2002 |       | 1,041,118             |       | $2.93                                           |       |
| Granted                               |       | —                |       | $                                               | —     |   |
| Exercised                             |       | (16,667               | )          | $                                               | 1.63       |   |
| Options  outstanding at July 31, 2003 |       | 1,024,451             |       | $2.95                                           |       |
| Granted                               |       | —                |       | $                                               | —     |   |
| Exercised                             |       | (25,000               | )          | $                                               | 2.00       |   |
| Options  outstanding at July 31, 2004 |       | 999,451               |       | $                                               | 2.98       |   |
| Options  exercisable at July 31, 2002 |       | 749,718               |       | $                                               | 2.64       |   |
| Options  exercisable at July 31, 2003 |       | 744,162               |       | $                                               | 2.64       |   |
| Options  exercisable at July 31, 2004 |       | 731,829               |       | $                                               | 2.65       |   |

 

A summary of stock options outstanding and exercisable as of July 31,2004 is as follows:

 
| ** **                   | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                         | ** ** |
|------------------------------|------------|-------------------------|------------|-------------------------------------------------|------------|
| **Range  of Exercise Price** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Life  (years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $1.63 to $1.63               |       | 559,751                 |       | 6.0                                             |       | $ | 1.63 |   | 489,829 |   | $ | 1.63 |   |
| $2.31 to $3.10               |       | 155,000                 |       | 5.2                                             |       | $ | 2.99 |   | 99,500 |   | $ | 2.98 |   |
| $5.30 to $5.95               |       | 284,700                 |       | 5.4                                             |       | $ | 5.63 |   | 142,500 |   | $ | 5.95 |   |

 

50

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The options under the Plan granted in fiscal year 2001 expire August 2,2010 and those granted in fiscal year 2002 expire April 2011.

 

10. INCOME TAXES

 

The provisions for income taxes was as follows:

 
| ** **                                    | ** ** | **For the years ended July 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current tax  provisions (benefit):            |       |                             |       |   |   |   |   |
| Federal                                       |       | $                                | (137,275   | ) | $ | (837,181 | ) | $ | 220,039 |   |
| State                                         |       | (13,970                          | )          | (60,043 | ) | 28,000 |   |
| Current  (benefit) provision for income taxes |       | (151,245                         | )          | (897,224 | ) | 248,039 |   |
| Deferred Tax                                  |       |                             |       |   |   |   |   |
| Federal                                       |       | (134,000                         | )          | 25,000 |   | — |   |
| State                                         |       | (16,000                          | )          | 6,000 |   | — |   |
| Total Deferred  Tax                           |       | (150,000                         | )          | 31,000 |   | — |   |
| Total (benefit)  provision on income taxes    |       | $                                | (301,245   | ) | $ | (866,224 | ) | $ | 248,039 |   |

 

During 1999, the IRS examined the tax returns for Sherwood Brands, Inc.and Sherwood Brands Overseas, Inc. for the tax years ended July 31, 1995 toJuly 31, 1997. The IRS proposed an adjustment, which the Company contests. TheCompany did not agree with the IRS position and had settled the adjustment forthe tax year ended July 31, 1997. Under the settlement with the IRS the Companypaid $90,000 for the taxes due during the fiscal year ended July 31, 2002 andfiled an amendment, which the Company was able to carry back an NOL whichaccounted for a refund due the company of approximately $83,000. In the fiscalyear ended 2003 the company received the tax refund of $83,000 for the amendedreturn.

 

The tax effects of the significant temporary differences, whichcomprised the deferred tax assets and liabilities, were as follows:

 
| ** **                                             | ** ** | **For the years ended  July 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                             | ** ** | **2004**                          | ** ** | **2003** | ** ** |
| Deferred tax  assets                                   |       |                              |       |   |   |
| Net operating  losses                                  |       | $                                 | 1,912,000  |   | $ | 2,089,000 |   |
| Officers salary  payable                               |       | 15,000                            |       | 15,000 |   |
| Allowance for  doubtful accounts and customer credits. |       | 85,000                            |       | 81,000 |   |
| Inventory  obsolescence reserve                        |       | 780,000                           |       | 444,000 |   |
| Uniform  capitalization on inventories                 |       | 282,000                           |       | 34,000 |   |
| Other                                                  |       | 49,000                            |       | 40,000 |   |
| Total deferred  tax asset                              |       | 3,123,000                         |       | 2,703,000 |   |
| Deferred tax  liabilities                              |       |                              |       |   |   |
| Accumulated  depreciation                              |       | (761,000                          | )          | (413,000 | ) |
| Goodwill                                               |       | (103,000                          | )          | (51,000 | ) |
| Total deferred  tax liability                          |       | (864,000                          | )          | (464,000 | ) |
| Valuation  allowance                                   |       | $                                 | (2,259,000 | ) | (2,089,000 | ) |
| Net deferred tax  asset                                |       | $                                 | 0          |   | $ | 150,000 |   |
| Net current  deferred tax asset                        |       | $                                 | 864,000    |   | $ | 614,000 |   |
| Net long-term  deferred tax (liability)                |       | $                                 | (864,000   | ) | $ | (464,000 | ) |

 

51

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The following summary reconciles taxes at the federal statutory ratewith recorded tax (benefit) expense:

 
| ** **                                                 | ** ** | **For the years ended July 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                 | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Income tax  (benefit) expense at statutory rate            |       | $                                | (1,529,902 | ) | $ | (2,120,619 | ) | $ | 194,839 |   |
| Increase  (decrease) in taxes resulting from:              |       |                             |       |   |   |   |   |
| Effect of  untaxed income from foreign subsidiary          |       | —                           |       | 9,800 |   | 54,700 |   |
| Valuation  allowance on net operating losses               |       | 1,648,000                        |       | 2,089,000 |   | — |   |
| State and local  taxes, net of federal income tax benefits |       | (207,887                         | )          | (60,043 | ) | 50,000 |   |
| Federal and  State, net operating losses and credits used  |       | (151,245                         | )          | (837,181 | ) | (22,000 | ) |
| Other                                                      |       | (60,211                          | )          | 52,819 |   | (29,500 | ) |
| Total (benefit)  provision for taxes                       |       | $                                | (301,245   | ) | $ | (866,224 | ) | $ | 248,039 |   |

 

10. COMMITMENTS AND CONTINGENCIES

 

The Company leases office space in Maryland, and office and warehousefacilities in Rhode Island and a manufacturing facility in New Hyde Park, NewYork. Rental expense under these leases aggregated approximately $688,832,$809,618 and $762,437 for the years ended July 31, 2004, 2003 and 2002,respectively. The lease for office space in Maryland is subject to annualincreases based upon both certain allocated operating costs and increases inthe Consumer Price Index.

 

Future minimum rentalcommitments under operating leases as of July 31, 2004 are summarized in thefollowing table:

 
| ** **            | ** ** | **Amount** | ** ** |
|-----------------------|------------|------------|------------|
| Years Ended July  31, |       |       |       |
| 2005                  |       | $          | 260,025    |   |
| 2006                  |       | 251,378    |       |
| 2007                  |       | 171,099    |       |
| 2008                  |       | 174,681    |       |
| 2009                  |       | 178,370    |       |
| Thereafter            |       | 146,961    |       |
| Total                 |       | $          | 1,182,514  |   |

 

The Company leases approximately 10,000 square feet of office space inRumford, Rhode Island which has access to skilled and unskilled labor. TheCompany did not exercise its option to extend the term of our leases on its oldoffice in Pawtucket, Rhode Island, which it vacated on March 31, 2004. The NewBedford, Massachusetts facility together with a relationship with its ship linecarrier now has various assembly and distribution facilities which it canutilize to improve our shipping costs and assembly of our products.

 

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’s landlord at its Rhode Island facility hasnamed the Company as a defendant in an action seeking security for claimsrelating to the lease agreement. The Company deposited $180,000 with theregistry of the court relating to claims for payment of real estate taxes,water and sewer, rent of other occupied space and repair expenses. The Companyin November 2003 settled the claims with the landlord, which resulted in a$275,000 settlement of which the $180,000 deposit was offset against the amountagreed in the settlement. The accrual in the financial statements wassufficient to cover all outstanding obligations to the landlord. We vacated thespace 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 acquiredsecurities of Asher Candy Acquisition Corporation and

 

52

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agreed to sell securities in Sherwood Brands to prior shareholders ofAsher Candy. The complaint alleges that the Company was fraudulently induced toenter into the merger agreement on the basis of, among other things, materialmisrepresentations and omissions by the shareholders of Asher Candy. SherwoodBrands seeks 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. Pendingresolution of the litigation, the Company has refused to honor the demand ofthe former shareholders for the Company to repurchase half of the shares issuedto them at a price of $4.50 per share. Certain of the shareholders have filed acounterclaim seeking $7.0 million in damages. The Company believes that it hasdefenses to the counterclaim. There can be no assurance that the Company willnot be a party to other litigation in the future.

 

The Company has entered into employment agreements with the ChiefExecutive Officer, Executive Vice President-Finance and Secretary, and theExecutive Vice President—Marketing and Product Development and Treasurer. Theagreements were renewed and amended on August 1, 2001.

 

On August 1, 2001, the employment agreements for Uziel Frydman and AmirFrydman were extended for additional three year terms (until July 31, 2004),each on substantially the same terms and conditions as in effect under theirrespective existing employment agreements. The annual base salaries payable toUziel Frydman, Amir Frydman under the amended agreements were increased to$451,333 and $389,149, respectively, effective August 1, 2001 and are subjectto annual increases. Under the amendments to the employment agreements, each ofUziel Frydman and Amir Frydman are entitled to participate in the Company’s1998 Executive Compensation Incentive Plan. For fiscal years beginning on orafter August 1, 2001, the bonus pool will be increased proportionately to the extentthat earnings before interest, taxes, and depreciation and amortization(EBITDA) in any year exceeds the EBITDA for the fiscal year ended July 31,2001. There currently are no employment agreements for all the key executivesas of the fiscal year ended July 31, 2004.

 

11. EMPLOYEE BENEFIT PLANS

 

Effective January 15, 1987, the Company established a profit-sharingplan and a money purchase pension plan covering all full-time employees meetingthe minimum age and service requirements. Under the terms of the Money PurchasePension Plan, the Company contributed 5.7% of total wages in the year endedJuly 31, 1997.

 

The Money Purchase Pension Plan was terminated and the assets weremerged with the 401(k) Plan. All participants in the Money Purchase Pension Planwere fully vested in the 401(k) Plan as of August 1, 1997. There were nocontributions made in 2004, 2003 and 2002.

 

12. LICENSING AGREEMENTS

 

During the year ended July 31, 2004, the Company had a total ofeighteen licensing agreements, three during the fiscal year ended July 31,2004, nine during the fiscal year ended July 31, 2003 and six in fiscal yearended July 31, 2002, to incorporate its products into gift sets and tomanufacturing of candies and wafers. The royalty rates for such licenses are from2% to 15% of net sales and expire in range of two to three years. The productsto be incorporated into the Company’s gift set items are primarily for thefirst quarter and Easter selling season. The Company entered into a licensingagreement to produce everyday candies and wafers. The Company paid $12,500 inadvance fees for the rights under the licensing agreements. These advance feeswere be offset against any amounts due on royalties. There are no other minimumlicense fees under these agreements. The Company incurred $926,000 and $227,000in royalties during the year ended July 31, 2004 and 2003, respectively. TheCompany is currently pursuing other licenses with similar terms and conditions.The Company expects to see increased revenue for products related to theagreements beginning in the year ending July 31, 2005.

 

13. SUPPLEMENTAL CASH FLOWS DISCLOSURE

 
| ** **                             | ** ** | **For the years ended July  31,** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **2003**                          | ** ** | **2002** | ** ** | **2001** | ** ** |
| Stock issued for  Asher acquisition    |       | $                                 | —     |   | $ | 1,675,000 |   | $ | — |   |
| Warrants issued  for Asher acquisition |       | —                            |       | 108,000 |   | — |   |
|                                        |            |                                   |            |  |  |  |  |  |  |  |

 

53

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14. CONCENTRATION OF 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 theyear ended July 31, 2004 three customers accounted for approximately 4%, 27%and 7% of the Company’s net sales. For the year ended July 31, 2003 the samethree customers accounted for approximately 16%, 10% and 9% of the Company’stotal net sales. For the year ended July 31, 2002 the same two customersaccounted for approximately 29%, 8% and 14% of the Company’s total net sales. Thesenet sales are included in the three business segments**.**The Company had sales to customers in Canada which represent1.0%, 0.4% and 0.4% of net sales in fiscal 2004, 2003 and 2002, respectively.

 

15. NON-RECURRING COSTS

 

During the year ended July 31, 2004, the Company incurred no start upcosts but incurred during the fiscal year ended July 31, 2003 $1,932,075 instart-up costs associated with the consolidation of its manufacturing facilityin Rhode Island into its Chase City facility. These costs primarily consist oftraining and production inefficiency on machinery and equipment in the ChaseCity facility.

 

During the year ended July 31, 2002 the Company incurred $707,551 ofmoving and start-up costs associated with the consolidation of itsmanufacturing facility in Rhode Island into its Chase City facility. Thesecosts primarily consist of freight and dismantling of machinery and equipmentin Rhode Island and courier costs in relocating the machinery and equipment toits Chase City facility.

 

The Company wrote down $1,200,000 of packagingmaterials and $1,000,000 of inventory of hard candy product lines that will nolonger be manufactured at the Company’s Chase City facility during it fiscalyear ended July 31, 2003 and wrote down $1,817,000 of packaging materials thatwill no longer be utilized for fiscal year ended July 31, 2004. These productlines will be manufactured by the Company’s overseas third party suppliers.

 

16. ADVERTISING COSTS

 

Advertising costs, included in selling, general and administrativeexpenses, are expensed as incurred and were $1,418,000, $928,000 and $1,127,000for the years ended July 31, 2004, 2003 and 2002, respectively.

 

17. ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 
| ** **                            | ** ** | **July 31,** | ** ** |
|---------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2004**     | ** ** | **2003** | ** ** |
| Payroll and  benefits                 |       | $            | 212,648    |   | $ | 226,117 |   |
| Compensation  expense-Options Granted |       | 184,930      |       | 184,930 |   |
| Professional  fees                    |       | 201,091      |       | 169,080 |   |
| Commissions                           |       | 56,414       |       | 35,576 |   |
| Inventory costs                       |       | 71,848       |       | 60,228 |   |
| Personal  property taxes              |       | 29,630       |       | 351,586 |   |
| Water and sewer                       |       | —       |       | 85,452 |   |
| Accrued travel  expenses              |       | 55,000       |       | 55,000 |   |
| Sales and use  tax                    |       | 96,158       |       | 68,585 |   |
| Accrued Subdebt  interest             |       | 392,577      |       | — |   |
| Other                                 |       | 461,598      |       | 89,337 |   |
| Total                                 |       | 1,761,894    |       | 1,325,891 |   |
|                                       |            |              |            |  |  |  |  |

 

54

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18. QUARTERLY DATA

 

Summary quarterly results were as follows:

 
| ** **                         | ** ** | **Quarter** | ** ** |
|------------------------------------|------------|-------------|------------|
| **Year  2004**                     | ** ** | **First**   | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Net Sales                          |       | $           | 17,420,813 |   | $ | 17,413,159 |   | $ | 9,344,200 |   | $ | 1,702,867 |   |
| Gross profit                       |       | 5,036,671   |       | 5,256,229 |   | 1,657,144 |   | (2,613,199 | ) |
| Net income  (loss)                 |       | 1,509,962   |       | 1,281,075 |   | (1,703,390 | ) | (5,186,359 | ) |
| Basic earnings  (loss) per share   |       | $           | 0.38       |   | $ | 0.32 |   | $ | (0.42 | ) | $ | (1.29 | ) |
| Diluted earnings  (loss) per share |       | $           | 0.37       |   | $ | 0.29 |   | $ | (0.42 | ) | $ | (1.29 | ) |
|                               |       |        |       |   |   |   |   |   |   |
| ** **                         | ** ** | **Quarter** | ** ** |
| **Year  2003**                     | ** ** | **First**   | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Net Sales                          |       | $           | 18,462,212 |   | $ | 19,390,601 |   | $ | 9,482,412 |   | $ | 1,827,562 |   |
| Gross profit                       |       | 5,506,469   |       | 5,047,301 |   | (629,368 | ) | (633,717 | ) |
| Net income  (loss)                 |       | 708,949     |       | (77,865 | ) | (2,750,026 | ) | (3,251,950 | ) |
| Basic earnings  (loss) per share   |       | $           | 0.18       |   | $ | (0.02 | ) | $ | (0.69 | ) | $ | (0.81 | ) |
| Diluted earnings  (loss) per share |       | $           | 0.16       |   | $ | (0.02 | ) | $ | (0.69 | ) | $ | (0.81 | ) |

 

The Company’s sales and net income historically are greater during thefirst and second quarters of the fiscal year relative to the third and fourth quartersdue to sales associated with major holidays celebrated during these periods.

 

19. OPERATING SEGMENTS

 

The Company operates in the confectionary 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 certain unallocated expenses. Unallocated expenses represent corporateexpenditures that are not specifically allocated to the segments.

 

The Company’s reportable segments are strategic business units that offer different products in different geographic areas. The Company has no assets outside of the United States. There is no concentration of net sales in any one area within the United States. Net sales outside of the United States are minimal (see Note 15).

 
| ** **                     | ** ** | **Year ended July 31, 2004** | ** ** |
|--------------------------------|------------|------------------------------|------------|
| ** **                     | ** ** | **Manufactured  Candy**      | ** ** | **Purchased  Candy** | ** ** | **Gift  Items** | ** ** | **Other  Total** | ** ** | **Consolidated** | ** ** |
| Total revenue                  |       | $                            | 8,372,195  |   | $ | 22,547,967 |   | $ | 14,960,877 |   | $ | — |   | $ | 45,881,039 |   |
| Gross margin                   |       | (4,265,921                   | )          | 9,499,351 |   | 4,103,414 |   | — |   | 9,336,844 |   |
| Interest expense               |       | 498,708                      |       | 378,370 |   | 161,895 |   | — |   | 1,038,973 |   |
| Segment assets                 |       | 11,385,327                   |       | 3,100,985 |   | 3,651,474 |   | 2,268,667 |   | 20,406,453 |   |
| Depreciation and  amortization |       | 874,664                      |       | 8,702 |   | 153,039 |   | 76,378 |   | 1,112,783 |   |
|                                |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

55

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| ** **                     | ** ** | **Year ended July 31, 2003** | ** ** |
|--------------------------------|------------|------------------------------|------------|
| ** **                     | ** ** | **Manufactured  Candy**      | ** ** | **Purchased  Candy** | ** ** | **Gift  Items** | ** ** | **Other** | ** ** | **Consolidated  Total** | ** ** |
| Total revenue                  |       | $                            | 17,164,078 |   | $ | 15,934,155 |   | $ | 16,064,554 |   | $ | — |   | $ | 49,162,787 |   |
| Gross margin                   |       | (2,599,646                   | )          | 6,934,383 |   | 4,955,948 |   | — |   | 9,290,685 |   |
| Interest expense               |       | 154,992                      |       | 295,160 |   | 173,049 |   | — |   | 623,201 |   |
| Segment assets                 |       | 15,492,718                   |       | 3,625,358 |   | 5,949,931 |   | 1,434,464 |   | 26,502,471 |   |
| Depreciation and  amortization |       | 802,353                      |       | — |   | 106,206 |   | 53,153 |   | 961,712 |   |
|                           |       |                         |       |   |   |   |   |   |   |   |   |
| ** **                     | ** ** | **Year ended July 31, 2002** | ** ** |
| ** **                     | ** ** | **Manufactured  Candy**      | ** ** | **Purchased  Candy** | ** ** | **Gift  Items** | ** ** | **Other** | ** ** | **Consolidated  Total** | ** ** |
| Total revenue                  |       | $                            | 13,638,031 |   | $ | 11,891,627 |   | $ | 27,252,683 |   | $ | — |   | $ | 52,782,341 |   |
| Gross margin                   |       | (316,308                     | )          | 4,630,738 |   | 10,753,231 |   | — |   | 15,067,661 |   |
| Interest expense               |       | 224,970                      |       | 170,685 |   | 73,032 |   | — |   | 468,687 |   |
| Segment assets                 |       | 16,561,958                   |       | 4,002,755 |   | 10,210,136 |   | 805,235 |   | 31,390,954 |   |
| Depreciation and  amortization |       | 567,383                      |       | — |   | 75,063 |   | 37,567 |   | 680,013 |   |

 

20. MANAGEMENT PLANS BASED ON A YEAR OF SIGNIFICANTLOSSES

 

The Company’s management feels that by moving its completemanufacturing operations in the United States to its overseas suppliers inArgentina and other overseas suppliers the Company will reduce its operatinglosses associated with the manufacturing segment of its business. Theagreements put in place with its South American partners will greatly reduceour cost structures going forward from variable to fixed. Managements continuedreduction in its overhead and burden absorption structure going into fiscalyear 2005 will enable the Company to direct its operations on the right paththrough fiscal year 2005 and onward. The following highlights various keyinitiatives that have been done and will continue to improve the overalloperations.

 

•                  Closing of AsherCandy at its New Hyde Park, New York facility

•                  Reduction ofvariable cost pricing in manufacturing. Fixed cost pricing for purchasedproducts, eliminating continual changes in commodity or labor cost variablesfor manufactured products.

•                  Direct Shipmentto customers from South America and China.

•                  Reduction inoverhead and burden absorption at its manufacturing facility in New Hyde Park,New York and Chase City, Virginia as a result of purchasing instead ofmanufacturing products.

•                  Reduction ofproducts not profitable to the Company

•                  Consolidation ofits public warehouse into the Company’s own facilities.

 

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