SHERWOOD BRANDS INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

For the quarterly period ended: April 30, 2004

Commission File Number: 1-14091

SHERWOOD BRANDS, INC.

(Exact name of Registrant as specified in its charter)

North Carolina		56-1349259
(State or other jurisdictions of incorporation or organization)		(I.R.S. Employer Identification No.)

1803 Research Boulevard, Suite 201 Rockville, MD 20850
(Address of principal executive offices)

Registrant’s telephone number, including area code: (301) 309-6161

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports and (2) has been subject to such filing requirement for the past 90 days.

Yes ý No o

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

Yes o No ý

The number of shares outstanding of the registrant’s Class A Common Stock, $.01 par value per share, as of June 11, 2004 was 3,033,476. The number of shares outstanding of the registrant’s Class B Common Stock, $.01 par value per share, as June 11 , 2004 was 1,000,000. The Class B Common Stock is not publicly traded.

SHERWOOD BRANDS, INC.

INDEX

PART I	FINANCIAL INFORMATION

Item 1.	FINANCIAL STATEMENTS

Consolidated Balance Sheets - April 30, 2004 (unaudited) and July 31, 2003
Consolidated Statements of Operations - Three and nine months ended April 30, 2004 and 2003 (unaudited)
Consolidated Statements of Cash Flows - Nine months ended April 30, 2004 and 2003 (unaudited)
Consolidated Statements of Stockholders Equity - Nine months ended April 30, 2004 (unaudited)

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

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Item 4.	Controls and Procedures

PART II OTHER INFORMATION

Item 1.	Legal Proceedings

Item 6.	Exhibits and Reports on Form 8-K

SIGNATURES

SHERWOOD BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

	April 30, 2004			July 31, 2003
	(unaudited)			(audited)
Assets
Current assets
Cash and cash equivalents	$	91,879		$	227,352
Accounts receivable, less allowance of $232,000 and $92,000	3,279,174			899,230
Inventory	10,036,966			13,719,294
Income taxes receivable	1,502,489			1,020,379
Other current assets	593,128			578,155
Deferred taxes on income	346,000			614,000
Total current assets	15,849,636			17,058,410
Net property and equipment	6,435,684			7,129,227
Goodwill	2,001,330			2,001,330
Other assets	155,952			313,504
TOTAL ASSETS	$	24,442,602		$	26,502,471
Liabilities and Stockholders’ Equity
Current liabilities
Line of credit	$	6,400,321		$	6,260,264
Current portion of long-term debt	515,377			530,377
Current portion of subordinated debt	3,397,140			2,000,000
Current portion of capital lease obligation	15,718			15,718
Accounts payable	1,828,011			6,257,145
Accrued expenses	1,467,179			1,325,891
Total current liabilities	13,623,746			16,389,395
Deferred taxes on income	464,000			464,000
Long-term debt	730,402			1,150,513
Obligations under capital lease	412,192			423,892
TOTAL LIABILITIES	15,230,340			18,427,800
Stockholders’ equity
Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares issued or outstanding	—			—
Common stock, Class A, $.01 par value, 30,000,000 shares authorized, 3,033,476 and 3,003,476 shares issued and outstanding	30,335			30,035
Common stock, Class B, $.01 par value, 5,000,000 shares authorized, 1,000,000 shares issued and outstanding	10,000			10,000
Additional paid-in-capital	9,893,380			9,843,774
Retained earnings (deficit)	(721,453		)	(1,809,138		)

TOTAL STOCKHOLDERS’ EQUITY	9,212,262			8,074,671
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	24,442,602		$	26,502,471

See accompanying summary of accounting policies and notes to consolidated financial statements.

SHERWOOD BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED

	Three Months Ended						Nine Months Ended April 30,
	2004			2003			2004			2003

Net sales	$	9,344,200		$	9,482,412		$	44,178,172		$	47,335,225
Cost of sales	7,687,056			7,919,775			32,228,128			35,218,817
Write-down obsolescence inventory	—			2,192,005			—			2,192,005

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

See accompanying summary of accounting policies and notes to consolidated financial statements.

SHERWOOD BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED

	Nine months ended April 30,
	2004			2003

Cash flows from operating activities
Net income	$	1,087,685		$	(2,118,941	)
Adjustments to reconcile net income to net
Cash used in operating activities
Depreciation expense	768,227			719,377
Gain on disposal of assets	(14,609		)	—
Provision for inventory obsolescence	38,185			146,390
Provision for doubtful accounts	303,515			157,275
Deferred income taxes	268,000			—
(Increase) decrease in assets
Accounts receivable	(2,683,458		)	(2,237,837		)
Inventory	3,644,143			4,843,496
Other current assets	(14,973		)	628,153
Income tax receivable	(482,110		)	(544,000		)
Other assets	157,513			(30,671		)
Increase (decrease) in liabilities
Accounts payable	(4,429,133		)	(714,693		)
Accrued expenses	141,325			91,576
Income taxes payable	—			—
Net cash provided by (used in) operating activities	(1,215,690		)	940,125

Cash flows from investing activities
Proceeds from sales of assets	142,750			—
Capital expenditures	(202,825		)	(693,857		)
Net cash used in investing activities	(60,075		)	(693,857		)

Cash flows from financing activities
Net borrowings (repayments) on line of credit	140,057			(996,390		)
Proceeds from exercise of options	49,906			27,084
Borrowing on debt	—			350,000
Borrowing on subordinated debt	1,397,140			—
Payments on long term debt	(446,811		)	(279,819		)
Net cash (used in) provided by financing activities	1,140,292			(899,125		)
Net decrease in cash and cash equivalents	(135,473		)	(652,857		)
Cash and cash equivalents, at beginning of period	227,352			709,247
Cash and cash equivalents, at end of period	$	91,879		$	56,390

See accompanying summary of accounting policies and notes to consolidated financial statements

SHERWOOD BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

	Common Stock						Accumulated		Other
	Class A			Class B			Additional Paid-		Retained			Comprehensive
	Shares	Amount		Shares	Amount		In Capital		Earnings			Income (Loss)		Total

Balance, July 31, 2004	3,003,476	$	30,035	1,000,000	$	10,000	$	9,843,774	$	(1,809,138)		$	—	$	8,074,671

Exercise of stock options	30,000	300		—	—		49,606		—			—		49,906

Net income (loss)	—	—		—	—		—		1,087,685					1,087,685

Balance April 30, 2004	3,033,476	$	30,335	1,000,000	$	10,000	$	9,893,380	$	(721,453	)	$	—	$	9,212,262

See accompanying summary of accounting policies and notes to consolidated financial statements

SHERWOOD BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Sherwood Brands, Inc., and its wholly-owned subsidiaries, Sherwood Brands, LLC, a Maryland limited liability company, Sherwood Brands of RI Inc., a Rhode Island corporation, Sherwood Brands Overseas, Inc., a Bahamas entity, and Asher Candy, Inc., a Wyoming corporation (collectively referred to herein as, “we”, “our” “us” or, the “Company”). All material inter-company transactions and balances have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the consolidated financial statements, and the notes thereto, included in the Company’s Annual Report and Form 10-K filed on October 29, 2003.

2. ORGANIZATION AND DESCRIPTION OF BUSINESS

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

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

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

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

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

3. INTERIM FINANCIAL INFORMATION

The financial information as of April 30, 2004 and for the three and nine months ended April 30, 2004 and 2003 is un-audited. In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for such periods. Results for interim periods are not necessarily indicative of results to be expected for an entire year.

4. INVENTORY

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

Inventory consists of the following:

	April 30, 2004			July 31, 2003
	(unaudited)			(audited)
Raw materials and ingredients	$	445,832		$	423,497
Components used in assembly	927,873			1,496,166
Packaging materials	2,843,675			2,936,702
Work-in-process	297,303			648,539
Finished product	5,824,383			9,358,100

	10,339,066			14,863,004
Less reserve for inventory obsolescence	(302,100		)	(1,143,710		)

	$	10,036,966		$	13,719,294

5. USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

6. INCOME TAXES

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

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

7. STOCK COMPENSATION OF STOCK OPTIONS

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

There were no adjustments made in calculating the fair value to account for vesting provisions, for non-transferability or risk of forfeiture. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

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

	For the three months ended April 30,
	2004			2003
Net income/(loss)
As reported	$	(1,703,390	)	$	(2,750,027	)

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	26,000			37,000

Pro forma net income (loss)	(1,729,390		)	(2,787,027		)
Basic income/(loss) per common share:
As reported	$	(0.42	)	$	(0.69	)
Pro forma	(0.43		)	(0.70		)
Diluted income/(loss) per common share:
As reported	$	(0.42	)	$	(0.69	)
Pro forma	(0.43		)	(0.70		)

	For the nine months ended April 30,
	2004		2003
Net income/(loss)
As reported	$	1,087,685	$	(2,118,942	)

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	78,000		112,000

Pro forma net income (loss)	1,009,685		(2,230,942		)
Basic income/(loss) per common share:
As reported	$	0.27	$	(0.53	)
Pro forma	0.25		(0.56		)
Diluted income/(loss) per common share:
As reported	$	0.25	$	(0.53	)
Pro forma	0.23		(0.56		)

8. EARNINGS PER SHARE

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

for the three months ended April 30, 2003 and April 30, 2004 and the nine months ended April 30, 2003, where the common stock equivalents outstanding were anti-dilutive:

For the nine months ended April 30, 2004	Income		Shares	Per Share Amount

Basic earnings per share
Income available to common shareholders	$	1,087,685	4,015,100	$	0.27
Effect of dilutive stock options			337,507
Dilutive earnings per share	$	1,087,685	4,352,607	$	0.25

9. CONTINGENCIES

The Company is, from time to time, involved in litigation incidental to the conduct of its business. The Company is currently involved in several actions. In particular, the Company’s landlord at its Rhode Island facility named the Company as a defendant in an action seeking security for claims relating to the lease agreement. The Company deposited $180,000 with the registry of the court relating to claims for payment of real estate taxes, water and sewer, rent of other occupied space and repair expenses. In September 2002, the landlord claimed other breaches of the lease agreement, alleging an obligation of $932,000 under the lease and demanded $750,000 to settle the disputes. The Company had claims against the landlord it is pursuing. The Company had accrued amounts to cover current charges. In November 2003, the Company settled its claims with the landlord. The accrual reflected in the financial statements was sufficient to cover all outstanding obligations to the landlord. The Company vacated the space on March 31, 2004.

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

under which Sherwood Brands acquired securities of Asher Candy Acquisition Corporation and agreed to sell securities in Sherwood Brands to prior shareholders of Asher Candy. The complaint alleges that the Company was fraudulently induced to enter into the merger agreement on the basis of, among other things, material misrepresentations and omissions by the shareholders of Asher Candy. Sherwood Brands is seeking declaratory and injunctive relief and award of damages against the former shareholders of Asher Candy for violations of the merger agreement and for common law fraud and violations of applicable securities laws. Pending resolution of the litigation, the Company has refused to honor the demand of the former shareholders for the Company to repurchase half of the shares issued to them at a price of $4.50 per share. Certain of the shareholders have filed a counterclaim seeking $7.0 million in damages. The Company believes that it has defenses to the counterclaim. There can be no assurance that the Company will not be a party to other litigation in the future.

10. LICENSING AGREEMENTS

During the nine months ended April 30, 2004, the Company entered into three licensing agreements to incorporate products into gift sets. The Company now has a total of eighteen

licensing agreements. The royalty rates for such licenses are 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 products to be sold during the Easter holiday season and become effective on the selling season of January 2005. The Company paid $12,500 in advance fees for the rights to incorporate products into its gift set items. These advance fees will be offset against any amounts due on royalties. There are minimum guaranteed license fees under these agreements. The Company incurred $150,000 in royalty expense for the three months ended April 30, 2004 and $926,000 for the nine months ended April 30, 2004. There were no royalty expenses for the three and nine months ended April 30, 2003. The Company is currently pursuing other licenses with similar terms and conditions.

11. CREDIT FACILITY

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

12. 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 the nine months ended April 30, 2004, three customers accounted for approximately 28%, 9% and 7% of the Company’s net sales. For the nine months ended April 30, 2003, the same three customers accounted for approximately 10%, 16% and 8% of the Company’s total net sales. The Company had sales to customers in Canada which represent 0.82% and 0.32% of net sales for the nine months ended April 30, 2004 and 2003, respectively.

13. OPERATING SEGMENTS

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

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

Unallocated expenses represent corporate expenditures 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.

				Three Months ended April 30, 2004
	Manufactured Candy			Purchased Candy		Gift Items		Other		Consolidated Total
Total revenue	$	364,409		$	1,979,001	$	7,000,790	$	—	$	9,344,200
Gross margin	(994,112		)	774,815		1,876,441		—		1,657,144
Interest expense	118,104			89,605		38,340		—		246,049
Segment assets	11,529,033			5,233,023		6,286,391		1,394,155		24,442,602
Depreciation and amortization	202,558			—		45,131		25,865		273,554

				Three Months ended April 30, 2003
	Manufactured Candy			Purchased Candy		Gift Items		Other		Consolidated Total
Total revenue	$	1,013,178		$	1,604,823	$	6,864,411	$	—	$	9,482,412
Gross margin	(1,820,410		)	273,048		917,994		—		(629,368		)
Interest expense	60,909			46,212		19,772		—		126,893
Segment assets	13,299,204			7,327,918		5,672,987		1,449,661		27,749,770
Depreciation and amortization	237,794			—		25,747		9,584		273,125

				Nine Months ended April 30, 2004
	Manufactured Candy			Purchased Candy		Gift Items		Other		Consolidated Total
Total revenue	$	7,471,729		$	21,762,197	$	14,944,246	$	—	$	44,178,172
Gross margin	(1,927,916		)	9,318,163		4,559,797		—		11,950,044
Interest expense	372,854			282,885		121,039		—		776,778
Segment assets	11,529,033			5,233,023		6,286,391		1,394,155		24,442,602
Depreciation and amortization	578,660			—		113,187		76,380		768,227

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

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

Important Information Regarding Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Those statements include statements regarding the intent, belief or current expectations of the Company and its management. Such statements are subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those contemplated in such forward-looking statements, including in particular the risks and uncertainties described under “Risk Factors” in our Form 10-K filed with the commission on October 29, 2003. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update or revise the information contained in this quarterly report on Form 10-Q, whether as a result of new information, future events or circumstances or otherwise.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities at the date of the financial statements. Significant estimates in our financial statements include the accounts receivable and inventory reserves. We continually evaluate these reserves based upon historical experience. Although actual results could differ from those disclosed, management feels that the estimates used to establish the reserves are conservative in nature. Furthermore, management contends that it would be unlikely that the reserve level would be materially different from any other independently prudently established reserve.

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 an adverse effect on our business. We are dependent on a limited number of customers for a significant portion of our revenues. Wal-Mart, Sam’s Club and Dollar General accounted for approximately 28%, 9% and 7%, respectively, of our sales for the nine months ended April 30, 2004 and for the nine months ended April 30, 2003

Wal-Mart, Sam’s Club, and Dollar General accounted for approximately 10%, 16% and 8%, respectively. We do not maintain agreements with our customers and sell products pursuant to purchase orders placed from time to time in the ordinary course of business. The loss of a significant customer could have an adverse effect on our business.

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

We face various risks relating to a recent acquisition. In May 2002, we acquired the business of Asher Candy Acquisition Corporation. Asher Candy Acquisition Corporation manufactured candy canes, a product which we had no prior experience in manufacturing. If we cannot continue to successfully produce a quality product, and maintain or increase the customer base, our profitability could be adversely affected.

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

We have limited historical profitability and may not be profitable in the future. Our operating expenses have decreased for the nine months ended April 30, 2004 and can be expected to continue to increase in connection with any expansion activities undertaken by us, including those relating to advertising and product manufacturing. Accordingly, our profitability will depend on our ability to improve our operating margins and increase revenues from operations. Unanticipated expenses, unfavorable currency exchange rates, increased price competition and adverse changes in economic conditions could have a material adverse effect on our operating results. If we are unable to achieve significantly increased levels of revenues, our future operations may not continue to be profitable.

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

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

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

We face various risks relating to foreign manufacturing. During the three months ended April 30, 2004 and 2003, approximately 22% and 17%, respectively, of our products were manufactured in foreign countries. During the nine months ended April 30, 2004 and 2003, approximately 49% and 31%, respectively, of our products were manufactured in foreign countries. We have been and will continue to be subject to risks associated with the manufacture of products in foreign countries, primarily in Argentina, Austria, Belgium, China and Holland. These risks include material 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 or destruction of products when shipped by a manufacturer. Because we pay for some of our products manufactured outside the United States in foreign currencies, any weakening of the United States dollar in relation to relevant foreign currencies, could result in significantly increased costs to us. In addition, some products manufactured overseas are subject to import duties. Deliveries of products from our foreign manufacturers could also be delayed or restricted by the future imposition of quotas. If quotas were imposed, it is possible that we would not be able to obtain quality products at favorable prices from domestic or other suppliers whose quotas have not been exceeded by the supply of products to their existing customers.

We are subject to government regulation. We are subject to extensive regulation by the United States Food and Drug Administration, the United States Department of Agriculture and by other state and local authorities in jurisdictions in which our products are manufactured or sold. Among other things, these regulations govern the importation, manufacturing, packaging, storage, distribution and labeling of our products, as well as sanitary conditions and public health and safety. Applicable statutes and regulations governing our products include “standards of identity” for the content of specific types of products, nutritional labeling and serving size requirements and general “Good Manufacturing Practices” with respect to manufacturing processes. Our facilities and products are subject to periodic inspection by federal, state and local

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

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

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

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

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

We are prohibited from paying dividends by the terms of our financing agreements. We have never paid any cash dividends on our common stock and do not anticipate paying cash dividends

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

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

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

Christmas and Easter gift sets and baskets are distributed at the Rhode Island and Massachusetts facilities. We source product for these gift sets and baskets primarily from the Pacific Rim. We are continually looking to further reduce costs by more efficient sourcing on our gift set and baskets items through other overseas suppliers.

We did not exercise the option to extend the term of the lease on our office and assembly facility in Rhode Island and we vacated the location on March 31, 2004. Our New Bedford, Massachusetts facility together with a planned West Coast assembly and distribution facility will be utilized to improve our shipping costs and assembly of our products. There is no facility or commitments at this time relating to the planned West Coast facility.

Environmental Factors Affecting the Performance in the Quarter Ended October 31, 2002.

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

portion of containers, which were to be received, remained either at ports or on shipping vessels on the water. In addition, empty containers were not brought back to ports in the Pacific Rim, which we needed to move some of our other products. In mid-October 2002, our inventory began to be released for shipment to our facility in New Bedford, Massachusetts. A slow down by the long shore-men on shipping products was still prevalent. Our revenues for the three months ended October 31, 2002 were impacted by the shut down and resulted in a delay of approximately $6.0 million in sales. Approximately $3.5 million in inventory was shipped out during the second quarter and approximately $1.5 million of the inventory was shipped during the first and second quarters of fiscal year 2004. We shipped $0.5 million of this inventory in the quarter ended October 31, 2003 and $1.0 million of this inventory was shipped in the quarter ended January 31, 2004.

Results of Operations

Three Months Ended April 30, 2004 and 2003

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

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

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

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

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

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

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

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

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

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

Gross margins for our Purchased Candy increased to $0.8 million from $0.3 million for the three months ended April 30, 2004 and 2003, and to 39.1% from 17.0% as a percent of sales, respectively. The $0.4 million increase was primarily due to better pricing of purchased candy from our third party overseas suppliers.

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

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

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

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

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

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

Interest income decreased to $23 for the three months ended April 30, 2004 from $116 for the three months ended April 30, 2003 as reserves declined. For the three months ended April 30, 2004, interest expense increased to $246,049 from $126,893 for the three months ended April 30, 2003 due to an increase in our term debt financing of $1.3 million associated with the merger with Asher Candy and interest on the subordinated debt instrument we entered into during the fiscal year ended July 31, 2003.

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

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

Nine Months Ended April 30, 2004 and 2003

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

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

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

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

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

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

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

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

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

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

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

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

ended April 30, 2003 and 2004, respectively or 26.5% and 30.5% as a percent of sales, respectively. The increase was due primarily to the Christmas assembled gift items and Valentine cards and pops assembled in China.

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

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

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

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

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

For the nine months ended April 30, 2004, interest income decreased to $83 from $2,608 for the nine months ended April 30, 2003 as reserves declined. For the nine months ended April 30, 2004, interest expenses increased to $776,778 from $463,965 for the nine months ended April 30, 2003 due to an $1.3 million increase in our term debt financing associated with the merger with Asher Candy and interest on the subordinated debt instrument we entered into during the fiscal year ended July 31, 2003.

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

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

Liquidity and Capital Resources

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

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

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

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

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

Schedule of Contractual Obligations

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

Schedule of Commercial Commitments

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

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As a result of our variable rate line of credit, we are exposed to the risk of rising interest rates. Our $18.0 million line of credit had an interest rate ranging from 4.09% to 4.10% for the nine months ended April 30, 2004. Our long-term debt is at variable market tax exempt rates, which exposes us to fluctuations in the market. However, since the rate is based on the tax exempt rate, it is below the market rate.

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

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

estimate of un-collectible accounts could change in the near future, management is not aware of any events that would result in a change to its estimates which would be material to our financial position or results from operations. For the quarter ended April 30, 2004, we had an allowance for doubtful accounts of approximately $232,000.

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

Goodwill represents the excess of consideration over the net assets acquired resulting from acquisitions of companies accounted for by the purchase method. We utilize the annual evaluation as required by SFAS 142. Management evaluates the recoverability of the goodwill annually and reviews goodwill and other long-lived assets for impairment. As of April 30, 2004 there was no impairment loss.

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

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

Seasonality and Cylicality; Fluctuation in Quarterly Operating Results

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

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

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

Item 4. Controls and Procedures

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

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

PART II OTHER INFORMATION

Item 1. Legal Proceedings

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

We are currently involved as Plaintiff in a suit brought before the Circuit Court for Montgomery County, Maryland, presenting claims in connection with the merger agreement under which Sherwood Brands acquired securities of Asher Candy Acquisition Corporation and agreed to sell securities in Sherwood Brands to prior shareholders of Asher Candy. The complaint alleges that we were fraudulently induced to enter into the merger agreement on the basis of, among other things, material misrepresentations and omissions by the shareholders of Asher Candy. We are seeking declaratory and injunctive relief and award of damages against the former shareholders of Asher Candy for violations of the merger agreement and for common law fraud and violations of applicable securities laws. Pending resolution of the litigation, we have refused to honor the demand of the former shareholders for us to repurchase half of the shares issued to them at a

price of $4.50 per share. Some of the shareholders have filed a counterclaim seeking $7.0 million in damages. We believe that we have defenses to the counterclaim. There can be no assurance that we will not be a party to other litigation in the future.

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 6. Exhibits and Reports on Form 8-K

(a)		Exhibits

31.1		Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)		Reports on Form 8-K

None.

SIGNATURES

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

		SHERWOOD BRANDS, INC.

Date: June 11, 2004		/s/ Uziel Frydman
		Chairman, President and Chief Executive Officer

Date: June 11, 2004		/s/ Christopher J. Willi
		Chief Financial Officer and Secretary

Exhibit Index

Exhibit No.		Description

31.1		Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.