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: October 31, 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 December 13, 2004 was 3,036,561. The number of shares outstanding of the registrant’s Class B Common Stock, $.01 par value per share, as December 13, 2004 was 1,000,000. The Class B Common Stock is not publicly traded.

Transitional Small Business Disclosure Format (check one):

Yes o No ý

SHERWOOD BRANDS, INC.

INDEX

PART I			FINANCIAL INFORMATION

	Item 1.		FINANCIAL STATEMENTS

		Consolidated Balance Sheets - October 31, 2004 (unaudited) and July 31, 2004

		Consolidated Statements of Operations - Three months ended October 31, 2004 and 2003 (unaudited)

		Consolidated Statements of Cash Flows - Three months ended October 31, 2004 and 2003 (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
UNAUDITED

	October 31, 2004			July 31, 2004

Assets
Current assets
Cash and cash equivalents	$	13,801		$	10,808
Accounts receivable, less allowance of $134,000 and $103,000	10,087,185			1,038,123
Inventory	12,949,310			9,591,268
Income taxes receivable	—			54,681
Other current assets	631,272			581,411
Deferred taxes on income	864,000			864,000
Total current assets	24,545,568			12,140,291
Net property and equipment	5,866,430			6,103,880
Goodwill	2,001,330			2,001,330
Other assets	180,502			160,952
TOTAL ASSETS	$	32,593,830		$	20,406,453
Liabilities and Stockholders’ Equity
Current liabilities
Line of credit	$	12,471,850		$	5,610,903
Short-term Debt	467,800			—
Current portion of long-term debt	376,850			465,239
Current portion of subordinated debt	3,352,140			3,397,140
Current portion of capital lease obligation	16,688			16,688
Accounts Payable	5,637,116			3,241,708
Accrued expenses	3,452,446			1,761,894
Total current liabilities	25,774,890			14,493,572
Deferred taxes on income	864,000			864,000
Long-term debt	583,055			617,774
Obligations under capital lease	403,125			407,204
TOTAL LIABILITIES	27,625,070			16,382,550
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 3,036,561 shares issued and outstanding	30,366			30,366
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			9,893,349
Retained earnings (deficit)	(4,964,955		)	(5,909,812		)

TOTAL STOCKHOLDERS’ EQUITY	4,968,760			4,023,903
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	32,593,830		$	20,406,453

See accompanying notes to consolidated financial statements.

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

	Three Months Ended October 31,
	2004			2003

Net sales	$	11,692,537		$	17,420,813
Cost of sales	8,352,639			12,384,142
Gross profit	3,339,898			5,036,671
Selling, general and administrative expenses	1,166,121			2,231,517
Salaries and related expenses	921,024			1,062,982
Total operating expenses	2,087,145			3,294,499
Income from operations	1,252,753			1,742,172
Other income (expense)
Interest income	3			19
Interest expense	(297,763		)	(236,766		)
Other (expense)income	(10,136		)	4,537
Total other (expense)income	(307,896		)	(232,210		)
Income before provision for taxes on income	944,857			1,509,962
Provision for taxes on income	—			—
Net income	$	944,857		$	1,509,962
Net income per share-basic	$	0.23		$	0.38
-diluted	0.23			0.37
Weighted average shares outstanding-basic	4,036,561			3,996,199
-diluted	4,146,017			4,136,235

See accompanying notes to consolidated financial statements.

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

	Three months ended October 31,
	2004			2003

Cash flows used in operating activities
Net income	$	944,857		$	1,509,962
Adjustments to reconcile net income to net cash used in operating activities
Depreciation expense	237,450			248,444

Provision for doubtful accounts	30,396			75,682
(Increase) decrease in assets
Accounts receivable	(9,079,458		)	(13,421,200		)
Income taxes receivable	54,681			(49		)
Inventory	(3,358,042		)	(3,012,118		)
Other current assets	(49,861		)	88,878
Other assets	(19,550		)	(5,000		)
Increase (decrease) in liabilities
Accounts payable	2,395,408			2,877,533
Accrued expenses	1,690,552			1,631,901

Net cash used in operating activities	(7,153,567		)	(10,005,966		)
Cash flows from investing activities
Proceeds from sales of assets	—			142,750
Capital expenditures	—			(111,992		)
Net cash provided by investing activities	—			30,759
Cash flows from financing activities
Net borrowings on line of credit	6,860,947			9,995,531
Borrowing on short-term debt	467,800			—
Payments on subordinated debt	(45,000		)	—
Payments on long term debt	(127,187		)	(126,266		)
Net cash provided by financing activities	7,156,560			9,869,265
Net increase in cash and cash equivalents	2,993			(105,943		)
Cash and cash equivalents, at beginning of period	10,808			227,352
Cash and cash equivalents, at end of period	$	13,801		$	121,409

See accompanying 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 direct and indirect 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 (“Overseas”), and Asher Candy, Inc., a Wyoming corporation (collectively referred to herein as, “we”, “our”, “us” or, the “Company”). All material inter-company transactions and balances have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America 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 July 31, 2004 Annual Report and Form 10-K filed on October 29, 2004.

2. ORGANIZATION AND DESCRIPTION OF BUSINESS

Sherwood Brands, Inc. 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 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, 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 and Cookies, (ii) Purchased Candy and Cookies and (iii) Purchased 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, that prior to fiscal 2005, formerly manufactured hard candies and jelly beans and continues to assemble and market 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 October 31, 2004 and for the three months ended October 31, 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.

The July 31, 2004 consolidated balance sheet amounts have been derived from the previously audited Consolidated Balance Sheet of Sherwood Brands, Inc.

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. Inventory consists of the following:

	October 31 2004			July 31 2004
	(unaudited)
Raw materials and ingredients	$	372,459		$	384,216
Components used in assembly	1,341,523			1,043,036
Packaging materials	2,802,970			2,798,591
Work-in-process	84,065			130,634
Finished product	10,413,719			7,262,339

	15,014,736			11,710,690
Less reserve for inventory obsolescence	(2,065,426		)	(2,119,422		)

	$	12,949,310		$	9,591,268

5. USE OF ESTIMATES

6. INCOME TAXES

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%.

7. STOCK BASED COMPENSATION

The Company adopted the disclosure only provisions of Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment of SFAS No. 123” (“SFAS 148”), but continues to measure compensation cost for the stock options using the intrinsic value method prescribed by APB Opinion No. 25. Compensation expense, if any, is measured as the excess of the market price of the stock over the exercise price on the measurement date. No compensation expense is recognized for the Company’s option grants that have an exercise price equal to the market price on the date of the grant. As allowable under SFAS 148, the Black-Sholes method to measure the compensation cost of stock options granted. The Company did not grant any stock options to employees in the quarters ended October 31, 2004 or 2003.

There were no adjustments made in calculating the fair value to account for vesting provisions, for non-transferability or risk of forfeiture. Because our 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 we had elected to recognize compensation cost based on the value at the grant dates with the method prescribed by SFAS 148, net income and earnings per share would have been changed to the pro forma amounts indicated in the following table:

	For the three months ended October 31,
	2004		2003
Net Income
As Reported	$	944,857	$	1,509,962

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

Pro Forma net income	$	944,857	$	1,483,962
Basic Income per Common Share:
As Reported	$	0.23	$	0.38
Pro Forma	0.23		0.37
Diluted income per Common Share:
As Reported	$	0.23	$	0.37
Pro Forma	0.23		0.36

8. EARNINGS PER SHARE

Earnings per share is based on the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during the period. 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. Antidilutive options are excluded from the earnings per share calculations when the option price exceeds the average market price of the common shares for the period. The following table presents a reconciliation between the weighted average shares outstanding for basic and diluted earnings per share for the three months ended October 31, 2004 and October 31, 2003:

For the three months ended October 31, 2004	Income		Shares	Per Share Amount

Basic earnings per share
Income available to common shareholders	$	944,857	4,036,561	$	0.23
Effect of dilutive stock options			109,456
Dilutive earnings per share	$	944,857	4,146,017	$	0.23

For the three months ended October 31, 2003	Income		Shares	Per Share Amount

Basic earnings per share
Income available to common shareholders	$	1,509,962	3,996,199	$	0.38
Effect of dilutive stock options			140,036
Dilutive earnings per share	$	1,509,962	4,136,235	$	0.37

9. CONTINGENCY

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 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 quarter ended October 31, 2004, the Company entered into two licensing agreements to incorporate products into gift sets. The royalty rates for such licenses are from 3% to 5% of net sales and expire in range of three years.

The products are to be incorporated into the Company’s gift set items during the Christmas and Easter holiday season. The Company paid $3,000 in advance fees for the licenses. These advance fees will be offset against any amounts due on royalties. There is a $5,000 minimum guaranteed license fee under these agreements. The Company incurred $172,982 and $212,047 in royalties for the quarters ended October 31, 2004 and 2003, respectively. The Company is currently pursuing other licenses with similar terms and conditions.

11. CREDIT FACILITY

During the quarter ended October 31, 2004, the Company was in compliance with the financial covenants under its credit facility relating to the fixed charge coverage ratio. Management believes that the Company will maintain compliance with the restrictive covenants for the remainder of 2005.

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 quarter ended October 31, 2004 three customers accounted for approximately 21%, 10% and 7% of the Company’s net sales. For the quarter ended October 31, 2003 the same three customers accounted for approximately 16%, 8% and 4% of the Company’s total net sales. The Company had sales to customers in Canada, which represent 0.64% and 0.23% of net sales for the quarters ended October 31, 2004 and 2003, respectively.

13. OPERATING SEGMENTS

We operate in the confectionery industry and align our 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. Our business segments are (i) Manufactured Candy and Cookies, (ii) Purchased Candy and Cookies and (iii) Purchased Gift Items. We report 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.

Our Chief Operating Decision Maker, who is our 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.

Our reportable segments are strategic business units that offer different products. We have minimal 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 October 31, 2004
	Manufactured Candy			Purchased Candy		Gift Items		Other		Consolidated Total
Total revenue	$	2,279,846		$	9,016,923	$	395,768	$	—	$	11,692,537
Gross margin	(832,179		)	4,068,770		103,029		—		3,339,620
Interest expense	142,926			108,438		46,399		—		297,763
Segment assets	8,895,676			12,943,867		9,790,651		963,636		32,593,830
Depreciation and amortization	136,411			57,075		32,649		11,315		237,450

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

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 forward-looking 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, 2004. 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 accounting principles generally accepted in the United States of America 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. Big Lots, Dollar General and Rite Aid accounted for approximately 21%, 10% and 7%, respectively, of sales for the three months ended October 31, 2004. Big Lots, Dollar General and Rite Aid accounted for approximately 17%, 8% and 4%, respectively, of sales for the quarter ended October 31, 2003. Sam’s Club and Wal-Mart accounted for approximately 0% and 4% of our sales for quarter ended October 31, 2004 and 12% and 8% of our sales for quarter ended October 31, 2003, 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.

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. We have historically, until recently, achieved limited profitability. Our operating expenses have increased 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 are not aware of any other infringement claims or other challenges to our rights to use these marks. We have requested some of our marks to be registered in countries other than the U.S. and may apply for additional registration as appropriate, based on our needs to register our marks for worldwide distribution.

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 October 31, 2004 and 2003, approximately 77% and 45%, as a percent of net sales, or $9,016,924 and $8,302,312, 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, Brazil, 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.

Our operating results are subject to fluctuations as a result of new product introductions, the timing of significant operating expenses and customer orders, delays in shipping orders, pricing and seasonality. 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, such regulation governs 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 74% of the voting control of our company, assuming that all of Mr. Frydman’s options 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 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 year ended July 31, 2004 and first quarter ended October 31, 2004, we had a total of eighteen licensing agreements, two signed during first quarter ended October 31, 2004, three signed during the fiscal year ended July 31, 2004 and fifteen signed as of our fiscal year ended July 31, 2003. However, two were not renewed upon expiration. The licenses are to incorporate products into gift sets and to manufacture candies and wafers. The royalty rates for such licenses range from 2% to 12% of net sales and expire in 2 to 3 years. The products to be incorporated into our gift set items are primarily for the first quarter and Easter selling season. We entered into a licensing agreement to produce everyday candies and wafers. We paid a total of $939,000 in advance fees for the rights under the licensing agreement since inception. These advance fees were offset against any amounts due on royalties. There were no other minimum license fees

under this agreement. We incurred $172,982 and $212,047 in royalties for the quarter ended October 31, 2004 and 2003, respectively. We are currently pursuing other licenses with similar terms and conditions. We expect the greatest impact from the agreements will occur in the year ending July 31, 2005.

Christmas and Easter gift sets and gift baskets are assembled and distributed from our Massachusetts facility. We purchase product primarily from the Pacific Rim. We are continually looking to further reduce costs by more efficient sourcing.

During the first quarter of fiscal 2005, Sherwood Brands closed the New Hyde Park, New York location as of October 29, 2004. Sherwood incurred approximately $25,000 expenses in closure and severance costs. The company’s current assets previously located at the New Hyde Park facility have been moved to our Chase City, Virginia facility and some will be moved to our overseas suppliers during the second quarter ending January 31, 2005.

In the fall of 2003, Sherwood Brands began moving its hard candy manufacturing to overseas suppliers. Sherwood Brands finalized a production and manufacturing agreement with the largest manufacturer in Argentina and South America. This Argentine manufacturer is one of Sherwood Brands’ key suppliers, specializing in manufacture of hard candies, chocolates, cookies and butter toffees. The Argentine company does not have the equipment or the facilities to completely take over the production of all our product lines. The Chase City facility continues to produce certain products, which the Argentine company cannot yet produce. The Chase City facility also is being utilized as a warehouse for Christmas seasonal items that need to be shipped to our southeast region customers.

In Spring 2004, Sherwood entered into a production agreement with a second Argentine company to manufacture lollipops. Sherwood benefits from the expertise and technology of the second Argentine company in lollipop production. The second Argentine company is using a combination of Sherwood equipment and their own equipment allowing Sherwood to increase margins, capacity and marketability of Sherwood products.

We did not extend the term of the lease for our Rhode Island facility and we vacated the location on March 31, 2004. Instead we are using our New Bedford, Massachusetts facility and various West Coast facilities to assemble and ship our products. The proximity of these facilities to our customers reduces our freight costs.

Environmental Factors Affecting the Performance in the Quarter Ended October 31, 2004.

During the quarter ended October 31, 2004, West Coast ports experienced a backup of cargo ships, railroads and truck lines, delaying shipments of Asian made goods. Offshoring, outsourcing and importing are on the rise. The Commerce department recently stated that trade deficit (the amount of foreign goods imported into the United States vs. the amount of United States goods shipped abroad), swelled to $54 billion in August, just shy of the $55 billion record deficit in June. Much of the world’s production is rapidly moving to China, which is producing toys, clothes and shoes faster than the rest of the world can import them. Los Angeles and Long Beach receive the majority of the Chinese imports. Volumes flowing through Los Angeles port

alone have climbed 10% this year, on top of a 20% increase in 2003. August, September and October have always been busy months for the ports of Long Beach and Los Angeles because of holiday shipments, but the rise of imports by mega-retailers such as Wal-Mart and Target further increased traffic. There are not enough dockworkers to unload shipments. Machinery used to unload ships is scarce and old. After container ships finally tie up at the dock, it takes more than 10 days to get them unloaded, rather than the usual three to four days. With oil prices climbing and the price of diesel fuel on the rise, a new source of backlog is being created; a lack of truckers willing to haul containers. Many truckers are responding by turning away jobs or by leaving the business, as stated in a recent article in USA Today. The rail systems that transport most of the goods out of the Los Angeles and Long Beach ports have also experienced backlogs, labor shortages and lack of equipment. The contentious relationship between the port operators and the dominant union, the International Longshore and Warehouse Union, has resulted in a shortage of workers and technology needed to keep up with the boom in imports. Tensions hit a breakpoint two years ago, when contract talks shut down the ports. Since then, port operators have been slow to hire workers. Recently an additional 5,000 workers were being hired and the union is training new workers as fast as it can.

Our revenues for the three months ended October 31, 2004 were impacted by the delays and resulted in a delay of approximately $5.0 million in sales. The remaining goods scheduled for shipment in the first quarter will be shipped during the second quarter of fiscal year 2004.

Results of Operations

Three Months Ended October 31, 2004 and 2003

Net Sales

Net sales for the three months ended October 31, 2004 and 2003 were $11,692,537 and $17,420,813, respectively, a decrease of 32.9%, or $5,728,276. The decline in net sales was due to lower sales of manufactured candy of approximately $3.3 million. This was due to a decision by management to curtail manufacturing operations and purchase goods directly from foreign suppliers. This decrease is offset by an increase in sales of purchased candy of $0.8 million and a decrease of $3.0 million on sales of gift sets largely due to similar orders being shipped in the first quarter in the prior year that are being shipped in the second quarter of the fiscal year ending July 31, 2005. Big Lots, Dollar General, Rite Aid and Dollar Tree Stores accounted for approximately 21%, 10%, 7% and 7%, respectively, of sales for the three months ended October 31, 2004. Big Lots, Dollar General, Rite Aid and Dollar Tree Stores accounted for approximately 17%, 8%, 4% and 13%, respectively, of sales for the prior year’s comparable period.

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

Net sales of Manufactured Candy and Cookies decreased from $5.6 million for the three months ended October 31, 2003 to $2.3 million for the three months ended October 31, 2004. The decrease of $3.3 million was primarily due to a decline of $2.7 million of sales of manufactured candy canes, of which $2.3 million of production was shifted to our overseas suppliers as Purchased Candy and Cookies. The remaining decline was primarily related to $0.3 million decline in production of everyday lollipops, $0.2 million decline in Kastins Christmas candy and $0.1 million decline in Cows sales. These declines are primarily due to the impact of shifting our complete manufacturing operations to our overseas suppliers in Argentina and China, which eliminates the variable costs associated with manufacturing in the United States. We are currently purchasing these items from our overseas suppliers.

Net sales of Purchased Candy and Cookies increased from $8.3 million for the three months ended October 31, 2003 to $9.0 million for the three months ended October 31, 2004. The increase of $0.7 million was primarily due to increases in the sale of purchased candy canes of $2.3 million. This was offset by a $1.0 million decline of purchased gift items, which were shifted into the second quarter of the fiscal year ending July 31, 2005 due to the port delays on the west coast, a decrease of Halloween purchased candy of $0.8 million and an increase of $0.2 million of gold coins for Christmas holiday.

Net sales of Purchased Gift Items decreased from $3.5 million for the three months ended October 31, 2003 to $0.4 million for the period ended October 31, 2004. The $3.1 million decrease was primarily a result of a $3.1 million decrease of sales of Christmas assembled goods due to shipment delays of goods not received from the west coast ports due to delayed transportation and unloading of vessels at the ports. See environmental factors effecting performance above for further details.

Gross Margins

Gross margins decreased to $3.3 million for the three months ended October 31, 2004 from $5.0 million for the three months ended October 31, 2003, and decreased to 28.6% from 28.9% as percent of sales, respectively. The decrease was largely attributable to absorption of manufacturing facility costs at our New Hyde Park, New York facility, which was closed for operation in the United States on October 29, 2004.

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

Gross margins on our Manufactured Candy and Cookies decreased from $0.1 million to ($0.8) million for the three months ended October 31, 2003 and 2004, respectively. The decrease was mainly attributable to increased labor costs and overhead absorption expenses at our manufacturing plant in New Hyde Park, New York.

Gross margins for our Purchased Candy and Cookies increased from $3.8 million to $4.1 million for the three months ended October 31, 2003 and 2004, 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 Purchased Gift Items decreased from $1.1 million to $0.1 million for the three months ended October 31, 2003 and 2004, respectively. The decrease was due primarily to the decrease of the number of products being assembled at our New Bedford, MA facility as a result of the delays in our shipments being transferred from the west coast ports, due to shipment delays at the west coast ports due to delayed transportation and unloading of vessels at the ports. See environmental factors effecting performance above for further details.

Operating Expenses

Operating expenses for the three months ended October 31, 2004 decreased to $2.1 million from $3.3 million for the three months ended October 31, 2003 and decreased to 17.9% from 18.9%, respectively, as a percent of sales.

During the three months ended October 31, 2004 and 2003, selling, general and administrative expenses decreased to $1.2 million from $2.2 million, respectively, and decreased to 10.0% from 12.8% as a percent of sales, respectively. The decrease was largely due to decreases in the following: $36,000 in travel expenses in the prior year relating to trips to China, $340,000 of shipping and carrier costs, due to direct shipments to our customers, $4,000 in building rental costs, $237,000 in broker commissions due to better negotiated fees, $205,000 in advertising and promotional costs, $20,000 in bank fees and $158,000 in public warehouse storage costs attributable to the consolidation of public facilities into our own facilities.

Salaries and related expenses decreased to $921,024 for the three months ended October 31, 2004, from $1,062,982 for the three months ended October 31, 2003, or 7.9% from 6.1%, respectively, as a percent of sales. This decrease resulted from a decline of $142,000 in our

overhead due to our reorganization effort started in the fourth quarter of the fiscal year ended July 31, 2004 and continued through the first quarter ending October 31, 2004.

Income From Operations

Income from operations for the three months ended October 31, 2004 was $1.3 million as compared to income of $1.7 million for the prior year’s comparable period, or 10.7% and 10.0% as a percent of net sales, respectfully. Most of the decrease resulted from the decrease in product sales and other expense explained in results from operating expenses.

Interest Income and Expense

For the three months ended October 31, 2004, interest income decreased to $3 from $19 for the three months ended October 31, 2003 as cash reserves declined. For the three months ended October 31, 2004, interest expenses increased to $297,763 from $236,766 for the three months ended October 31, 2003, due to an increase in subordinated debt financing for a total of $3.3 million and increased interest rates from Libor plus 2.35% which was at 4.4% to Prime plus 3.0% currently at 7.75% associated with our new bank agreement extension.

Other Income/Expense

For the three months ended October 31, 2004, other income/expenses increased to expense of $10,137 from income of $4,537 for the three months ended October 31, 2003 due to $10,000 of realized losses on foreign exchange transactions.

Income Tax Benefit

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, 2005. The Company has a net operating loss carry forward which management believes will offset all taxable income generated in fiscal year 2005. Therefore, the Company estimated its effective tax rate at 0%.

Critical Accounting Policies and Estimates

Management has determined that the Company’s most critical accounting policies are those related to revenue recognition, inventory obsolescence, long-lived assets, litigation and income taxes. The Company continues to monitor its accounting policies to ensure proper application. There have been no changes to these policies as discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2004.

Liquidity and Capital Resources

Our primary cash requirements have been to fund the purchase, manufacture and commercialization of our products. We finance our operation and manufacturing with cash flow from operations and bank financing. Our working capital at October 31, 2004 and July 31, 2004 was ($1,229,321) and ($2,353,281), respectively.

The Company during the fiscal year ending July 31, 2004 had a need to borrow $1.4 million of additional subordinated debt to meet its working capital needs and the bank provided additional out of formula advances against is collateral base 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 capital going forward into the fiscal year ending July 31, 2005. In addition, the Company supplemented borrowing during the quarter ended October 31, 2004 with an uncollateralized loan of $467,800 due on December 31, 2004 from an unrelated individual third-party at an interest rate equal to that of our subordinated debt.

Financial Condition

Assets

Total assets increased to $32,593,830 at October 31, 2004 from $20,406,453 at fiscal year ended July 31, 2004. This is an increase of $12,187,377. The increase was mainly attributable to $9,049,062 in accounts receivable and $3,358,042 in inventory, due to the increased level of sales for the Christmas season.

As of October 31, 2004, current assets increased to $24,545,568 from $12,140,291 as of fiscal year ended July 31, 2004, an increase of $12,405,277 or 102.2%. The increase was primarily due to and increase of $9,049,062 in accounts receivable and $3,358,042 in inventory, related to the levels of Christmas season orders to ship.

As of October 31, 2004, plant, property and equipment decreased to $5,866,430 from $6,103,880 as of fiscal year ended July 31, 2004, a decrease of $237,450 or 3.9%. This decrease was associated with the depreciation of the assets of $237,450.

Liabilities

As of October 31, 2004 total liabilities increased to $27,625,070 from $16,382,550 as of the fiscal year ended July 31, 2004, an increase of $11,242,520 or 68.6%. The increase primarily reflects additional borrowing of $6,860,947 on its working capital facility, additional borrowings of $467,800 of short-term debt, $2,395,408 of accounts payables and $1,690,552 of accrued expenses and offset by the payments on its long term and subordinated debt of $172,187. The increases are primarily due to the Company’s Christmas seasonal orders being shipped to our customers in the first and second quarter of our fiscal year ending in July 31, 2005.

Capital Structure

The Company has two classes of stock outstanding, Class A Common Stock and Class B Common Stock (collectively the “Common Stock”), that are substantially identical, except that the Class A Common Stock is entitled to one vote per share and the Class B Common Stock is entitled to seven 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 the 1,000,000 share of Class B Common Stock outstanding and controls the Company.

Cash Flows:

Net cash used in Operating Activities:

Net cash used in operating activities for the three months ended October 31, 2004 and 2003, was $7,153,567 and $10,005,966, respectively. The decrease in cash used by operating activities was due primarily to increases in accounts receivable, inventory, accounts payable and accrued expenses primarily related to inventory purchases and sales for the Christmas selling season.

Net Cash Used in Investing Activities:

Net cash provided by investing activities for the three months ended October 31, 2004 and 2003, decreased to $0 from $30,759, respectively, primarily due to no sales of assets or investment in equipment at our facilities related to moving our production to overseas suppliers.

Net Cash Used by Financing Activities:

Net cash provided by financing activities for the three months ended October 31, 2004 and 2003, was $7,156,560 and $9,869,265, respectively. This decrease from the prior year was primarily due to decreased reliance on borrowings under our line of credit to finance working capital needs for seasonal materials, which was partially offset by borrowings of short-term debt of $467,800. The gross borrowings for the period ended October 31, 2004 were approximately $12,471,850 as compared to $16,255,795 for the prior years comparable period. We have $2,528,150 of our $15,000,000 line of credit available to meet additional seasonal needs to purchase and manufacture inventory subject to availability of accounts receivable and inventory.

Principal payments for our long-term and subordinated debt for the three months ended October 31, 2004, was $172,187. We believe that cash provided by operations during the 2005 fiscal year will be sufficient to finance our operations and fund debt service requirements for the next twelve months.

Schedule of Contractual Obligations

			Payments Due by Period
Contractual Obligations	Total		Less Than 1 year		1-3 years		After 4 years
Long-Term Debt	$	959,905	$	376,850	$	319,664	$	263,391
Subordinated Debt	3,352,140		3,352,140		—		—
Capital Lease Obligation	419,813		16,688		56,497		346,628
Licensing Agreements	907,080		619,580		272,500		15,000
Operating Leases	835,126		164,016		345,781		325,329
Total Contractual Obligations	$	6,474,064	$	4,529,274	$	994,442	$	950,348

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 (*)	$	15,000,000	—	$	15,000,000	—
Total Commercial Commitments	$	15,000,000	—	$	15,000,000	—

(*) 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As a result of its variable rate line of credit, we are exposed to the risk of rising interest rates. Our $15,000,000 line of credit had an interest rate ranging from 4.5% to 7.75% for the three months ended October 31, 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.

Significant Accounting Policies and Estimates

Accounts Receivable and Allowance for Doubtful Accounts.

Accounts receivable are customer obligations due under normal trade terms. We sell our products to those involved in the retail industry. Accounts receivable are reviewed to determine if any receivables will potentially be uncollectible. The Company records an allowance for doubtful accounts based on specifically identified amounts that they believe to be uncollectible along with a general reserve. If the actual collections experience changes, revisions to the allowance may be required. Any unanticipated changes in the customer’s credit worthiness or other matters affecting the collectability of amounts due from such customers, could have a material affect on the results of operations in the period in which such changes or events occur. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Based on the information available, the Company believes the allowance for doubtful accounts of $134,000 as of October 31, 2004 is adequate. However, actual write-offs might exceed the recorded allowance.

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. We provide an allowance for slow moving inventory based on experience and aging of products. We consider the following factors; age of product and sale through of the product 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 changes to its estimates which would be material to our financial position or results from operations. For the quarter ended October 31, 2004, we had an allowance for slow moving inventory of $2,065,426.

Asset Impairment

The Company periodically evaluates the carrying value of long-lived assets when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved.

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. At each Balance Sheet date, management evaluates the recoverability of the goodwill and reviews goodwill and other long-lived assets for impairment. As of October 31, 2004 there was no impairment loss.

Revenue Recognition

Sales are recognized upon shipment of products. Sales discounts and any other price adjustments are accounted for as a reduction in revenue at the later of (1) the date at which the related revenue is recognized by the Company or (2) the date at which the sales incentive is offered.

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 2005. Therefore, the Company estimated its effective tax rate at 0%.

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.

Derivative Financial Instruments

The Company formerly utilized derivative financial instruments to reduce foreign currency risks. The Company did not hold or issue derivative financial instruments for trading purposes. In June 1998, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which was amended in June 2000 by SFAS No. 138. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that a company recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. Changes in the fair value of those instruments will be reported in earnings or other comprehensive income depending on the use of the derivative and whether it qualifies for hedge accounting. The accounting for gains and losses associated with changes in the fair value or the derivative, and the effect on the consolidated financial statements will depend on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value of cash flows of the asset or liability hedged. The Company adopted SFAS 133, as amended in the fourth quarter of fiscal 2001.

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. Increased 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 (collectively, the “certifying officers”) 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). These disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in our periodic reports filed with the Commission is recorded, processed, summarized and reported within the time periods specified by the Commission’s rules and forms, and that the information is communicated to the certifying officers on a timely basis.

The certifying officers concluded, based on their evaluation, that our disclosure controls and procedures are effective, taking into consideration the size and nature of our business and operations.

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 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 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

31.1 Certification of the Chief Executive Officer Purusant 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 Acto of 2002.

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

Current Report on Form 8-K filed on 10-29-04, with attached earnings release for the fiscal year ended July 31, 2004.

SIGNATURES

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

	SHERWOOD BRANDS, INC.

Date: December 12, 2004	/s/ Uziel Frydman
	Chairman, President and Chief Executive Officer

Date: December 12, 2004	/s/ Christopher J. Willi
	Chief Financial Officer and Secretary

Exhibit Index

Exhibit No.		Description

31.1		Certification of the Chief Executive Officer Purusant 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 Acto of 2002.

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

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

SHERWOOD BRANDS INC 10-Q