Form 10-Q

10-Q 1 d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

¨	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from to .

Commission file number: 0-15399

DREAMS, INC.

(Exact name of small business issuer as specified in its charter)

Utah

87-0368170

State or other jurisdiction of

incorporation or organization

(I.R.S. Employer

Identification No.)

2 South University Drive, Suite 325, Plantation, Florida 33324

(Address of principal executive offices)

Issuer’s telephone number, including area code: (954) 377-0002

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 report(s)), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Larger accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x

APPLICABLE ONLY TO CORPORATE ISSUERS

As of November 1, 2006, there were 208,871,951 shares of Common Stock, no par value per share outstanding.

DREAMS, INC.

INDEX


		PAGE
Part I.	Financial Information	1

Item 1.	Financial Statements (Unaudited)	1

	Condensed Consolidated Balance Sheet	1

	Condensed Consolidated Statements of Operations	2

	Condensed Consolidated Statements of Cash Flows	3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	19

Item 4.	Controls and Procedures	19

Part II.	Other Information	20

Item 1.	Legal Proceedings	20

Item 1A.	Risk Factors	20

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	23

Item 3.	Defaults upon Senior Securities	23

Item 4.	Submission of Matters to Vote of Security Holders	23

Item 5.	Other Information	24

Item 6.	Exhibits	24

Part I. Financial Information

Item 1. Financial Statements

Dreams, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets - Unaudited

(Dollars in Thousands, except share amounts)


	September 30, 2006			March 31, 2006
				(Audited)
ASSETS
Current assets:
Cash and cash equivalents	$	320		433
Accounts receivable, net		2,620		6,903
Inventories, net		15,956		12,207
Prepaid expenses and deposits		1,044		841
Notes receivable		22		—

Total current assets		19,962		20,384

Property and equipment, net		2,026		1,619

Deferred tax asset, net		972		543

Deferred loan costs, net		63		68

Other intangible assets, net		3,976		4,005

Goodwill		1,932		1,932

Total assets	$	28,931		28,551

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,327		3,250
Accrued liabilities		1,560		1,929
Current portion of long-term debt		129		251
Deferred tax liability		1,071		1,071
Deferred credits		438		245

Total current liabilities		6,525		6,746

Borrowings against line of credit		6,981		5,744
Commitments and contingencies		—		—

Stockholders’ equity:
Preferred stock authorized 10,000,000, issued and outstanding -0- shares		—		—
Common stock and additional paid-in capital, no par value; authorized 500,000,000 shares; shares issued and outstanding 178,102,720 at September 30 and March 31, 2006		26,305		26,286
Accumulated deficit		(10,880	)	(10,225	)

Total stockholders’ equity		15,425		16,061

Total liabilities and stockholders’ equity	$	28,931		28,551

The accompanying notes are an integral part of these condensed consolidated financial statements.

Dreams, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations – Unaudited

(Dollars in Thousands, except share amounts and earnings per share amounts)


	Six Months Ended September 30,					Three Months Ended September 30,
	2006			2005		2006			2005
Revenues:						$
Manufacturing/Distribution		6,157		5,396			2,718		2,993
Retail		9,566		6,968			5,432		3,745
Management fees, net		164		122			36		(86	)
Franchise fees and royalties		516		424			317		224
Other		78		21			55		2

Total Revenues		16,481		12,931			8,558		6,878
Expenses:
Cost of sales-mfg/distribution		3,717		2,805			1,639		1,518
Cost of sales-retail		5,494		3,887			3,060		1,968
Operating expenses		7,766		6,401			4,082		3,432
Depreciation and amortization		289		189			148		106

Total Expenses		17,266		13,282			8,929		7,024

Loss before interest and taxes		(785	)	(351	)		(371	)	(146	)

Interest expense, net		286		237			133		83

Loss before provision for income taxes		(1,071	)	(588	)		(504	)	(229	)

Income tax benefit		(416	)	(235	)		(202	)	(91	)

Net loss	$	(655	)	(353	)	$	(302	)	(138	)

Earnings (Loss) per share:

Basic and diluted: Earnings (Loss) per share	$	(0.00	)	(0.00	)	$	(0.00	)	(0.00	)

Weighted average shares outstanding – Basic and Diluted		178,102,720		150,677,882			178,102,720		178,102,720

The accompanying notes are an integral part of these condensed consolidated financial statements.

Dreams, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows – Unaudited

(Dollars in Thousands)


	2006			2005
Cash Flow from Operating Activities
Net Loss	$	(655	)	$	(353	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization
Property & Equipment		270			150
Intangible Assets		19			39
Loan Cost		5			4
Stock based compensation		18			—
Deferred tax benefit, net		(428	)		(281	)
(Increase) decrease in:
Accounts receivable		4,280			(50	)
Notes receivable		(23	)
Inventories		(3,749	)		(84	)
Prepaid expenses and deposits		(218	)		213
Other assets		30			162
(Decrease) increase in:
Accounts payable		77			(612	)
Accrued liabilities		32			(742	)
Deferred revenues		193			125

Net cash used in operating activities		(149	)		(1,429	)

Cash Flows from Investing Activities
Payment of contingent consideration		(401	)		(269	)
Sale of property and equipment		—			66
Purchase of property and equipment		(677	)		(435	)

Net cash used in investing activities		(1,078	)		(638	)

Cash Flows from Financing Activities
Proceeds from LaSalle Line of Credit,net		1,236			5,568
Payoff of Merrill Lynch Line of Credit		—			(4,499	)
Deferred loan costs		—			(41	)
Cash received from rights offering		—			1,907
Repayment of Notes payable		(122	)		(1,041	)
Rights Offering Costs		—			(38	)

Net cash provided by financing activities		1,114			1,856

Net decrease in cash and cash equivalents		(113	)		(211	)

Cash and cash equivalents at beginning of period		433			211

Cash and cash equivalents at end of period	$	320		$	0

Supplemental Disclosure of Cash Flow Information:
Cash paid during the six month period ended September 30:
Interest	$	277		$	202
Income taxes	$	—		$	—

Non-cash investing and financing activities:

On May 11, 2005, the Company completed its rights offering. Pursuant to the terms and conditions of the rights offerings, the Company issued 121,739,525 shares of its common stock. The Company received approximately $3.7 million in new capital from the rights offering, which consisted of approximately $1.9 million of cash proceeds and approximately $1.8 million of then current debt obligations and accrued liabilities being converted into shares of the Company’s common stock on the same terms and conditions as set forth in the rights offering.

$1,000,000 of the proceeds of the rights offering was used in partial payment of indebtedness under the Company’s previous line of credit with MLBFS. Additionally, the following obligations were satisfied by the issuance of shares of the Company’s common stock in lieu of payment of the subscription price (at the equivalent issue price of $0.03 per share): (i) $1.0 million of indebtedness to the brother of the Company’s president and chief executive office; (ii) approximately $150,000 of accrued salary to the Company’s president and chief executive officer; (iii) $73,000 of accrued consulting fees owed to the Company’s chairman of the board pursuant to a consulting agreement; and (iv) the obligation to pay approximately $200,000 from principal amount of indebtedness to a third party was transferred to the Company’s chairman. The chairman was the guarantor of such note.

Dreams, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements - Unaudited

Dollars in Thousands, Except per Share Amounts

1.	Management’s Representations

The condensed consolidated interim financial statements included herein have been prepared by Dreams, Inc. (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in 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, although the Company believes that the disclosures made are adequate to make the information presented not misleading. The condensed consolidated interim financial statements and notes thereto should be read in conjunction with the financial statements and the notes thereto, included in the Company’s Annual Report on Form 10-KSB, for the fiscal year ended March 31, 2006.

The accompanying condensed consolidated interim financial statements have been prepared, in all material respects, in conformity with the standards of accounting measurements set forth in Accounting Principles Board Opinion No. 28 and reflect, in management’s opinion, all adjustments, which are of normal recurring nature, necessary to summarize fairly the financial position and results of operations for such periods. The results of operations for such interim periods are not necessarily indicative of the results expected for future quarters or the full fiscal year.

2.	Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated interim financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions and accounts have been eliminated in consolidation.

Earnings per Share

For the six months ended September 30, 2006, weighted average shares outstanding for basic earnings per share purposes and diluted earnings per share purposes was 178,102,720. Stock options to purchase up to 4,836,559 shares of the Company’s common stock with an exercise price ranging from $.08 to $.25 per share were not considered in the calculation of diluted earnings per share for the six month period ended September 30, 2006, due to their anti-dilutive effects.

For the six months ended September 30, 2005, weighted average shares outstanding for basic earnings per share purposes and diluted earnings per share purposes was 150,677,882. Stock options to purchase up to 3,936,559 shares of the Company’s common stock with an exercise price ranging from $.15 to $.25 per share were not considered in the calculation of diluted earnings per share for the six month period ended September 30, 2005, due to their anti-dilutive effects.

For the three months ended September 30, 2006, weighted average shares outstanding for basic earnings per share purposes and diluted earnings per share purposes was 178,102,720. Stock options to purchase up to 4,836,559 shares of the Company’s common stock with an exercise price ranging from $0.08 to $0.25 per share were not considered in the calculation of diluted earnings per share for the three month period ended September 30, 2006, due to their anti-dilutive effects.

For the three months ended September 30, 2005, weighted average shares outstanding for basic earnings per share purposes and diluted earnings per share purposes was 178,102,720. Stock options to purchase up to 3,936,559 shares of the Company’s common stock with an exercise price ranging from $0.15 to $0.25 per share were not considered in the calculation of diluted earnings per share for the three month period ended September 30, 2005, due to their anti-dilutive effects.

Stock Compensation

On April 1, 2006, the Company adopted Statement of Financial Accounting Standards 123(R), Share-Based Payment. Accordingly, the Company is now recognizing share-based compensation expense for all awards granted to employees, which is based on the fair value of the award on the date of grant. The Company adopted FAS No. 123(R) under the modified prospective transition method and, consequently, prior period results have not been restated. Under this transition method, in fiscal 2007, the Company’s reported share-based compensation expense will include expense related to share-based compensation awards granted subsequent to April 1, 2006, which is based on the grant date fair value estimated in accordance with the provisions of FAS No. 123(R), as well as any unrecognized compensation expense related to non-vested awards that were outstanding as of the date of adoption. Prior to April 1, 2006, the Company applied APB Opinion No. 25 “Accounting for Stock Issued to Employees” in accounting for its employee share-based compensation and applied FAS No. 123 “Accounting for Stock Issued to Employees” for disclosure purposes only. Under APB 25, the intrinsic value method was used to account for share-based employee compensation plans and compensation expense was not recorded for awards granted with no intrinsic value. The FAS No. 123 disclosures include pro forma net earnings (loss) and earnings (loss) per share as if the fair value-based method of accounting had been used. Determining the appropriate fair value model and calculating the fair value of share-based compensation awards requires the input of certain highly complex and subjective assumptions, including the expected life of the share-based compensation awards, the Company’s common stock price volatility, and the rate of employee forfeitures. The assumptions used in calculating the fair value of share-based compensation awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of judgment. As a result, if factors change and the Company deems it necessary to use different assumptions, share-based compensation expense could be materially different from what has been recorded in the current period.

For the three and six months ended September 30, 2006, the Company recorded $8,400 and $18,300 of pre-tax share-based compensation expense under FAS No. 123(R), recorded in selling and administrative expense in the Condensed Consolidated Statement of Operations, respectively. This expense was offset by a $7,300 deferred tax benefit for non-qualified share–based compensation.

Share-Based Compensation Awards

The following disclosure provides information regarding the Company’s share-based compensation awards, all of which are classified as equity awards in accordance with FAS No. 123(R):

Stock Options - The Company grants stock options to employees that allow them to purchase shares of the Company’s common stock. Options are also granted to outside members of the Board of Directors of the Company as well as independent contractors. The Company determines the fair value of stock options at the date of grant using the Black-Scholes valuation model. Options generally vest immediately, however, the Company has granted options that vest over three and five years. No options were granted during the three and six months ended September 30, 2006, however, certain options awarded prior to March 31, 2006 vested during the three months and six month periods ended September 30, 2006. Awards generally expire three to five years after the date of grant.

No stock options were issued during the three and six months ended September 30, 2006. During FYQ2 no options vested. The Total Weighted Average (TWA) of shares vested for the six months was 477,311. The TWA price vested during the period was $.0393.

As of September 30, 2006 there were 4,836,559 options outstanding with an average price of $.14. Vested options totaled 4,036,559 with an average price of $.15. Total outstanding options that were “in the money” at September 30, 2006 were 2,345,000 with an average price per option of $.0966. Of those options, the vested “in the money” options totaled 1,589,000 with an average price of $.095 and the “in the money” unvested options totaled 756,000.

The following table breaks down the number of outstanding options with their corresponding contractual life as well as the exerciseable weighted average (WA) outstanding exercise price, number of vested options with the corresponding strike price by price range.

Options Breakdown by Range at 2006/09/30


Outstanding			Exerciseable
Range	Outstanding Options	Remaining Contractual Life	WA Outstanding Exercise Price		Vested Options	WA Vested Exercise Price
$0.000 to $0.090	400,000	3	$	.08	400,000	$	.08
$0.100 to $0.190	3,200,000	3.04	$	.1196	2,400,000	$	.1252
$0.200 to $0.290	1,236,559	1.72	$	.2197	1,236,559	$	.2197

$0.000 to $0.290	4,836,559	2.7	$	.1419	4,036,559	$	.1497

At September 30, 2006, exercisable options had aggregate intrinsic values of approximately $54,900.

The Company did not grant any options during the three and six months ended September 30, 2006. The weighted average grant date fair value of the Company’s options to which share-based compensation expense was recognized during the three and six months ended September 30, 2006 was $.23 and $.21, respectively. The fair value was estimated on the date of the grant using the Black-Scholes valuation model with the following weighted-average assumptions:


Expected Dividend Yield (1)	N/A
Expected Stock Price Volatility (2)	94.00	%
Risk-Free Interest Rate (3)	4.64	%
Expected Life in Years (4)	3

(1)	The dividend yield assumption is based on the history and expectation of the Company’s dividend payouts. The Company has not paid dividends in the past and is prohibited from paying dividends without the consent of its secured lender.

(2)	The determination of expected stock price volatility for options granted was based on historical Company common stock prices over a period commensurate with the expected life of the option.

(3)	The risk-free interest rate is based on the yield of a U.S. treasury bond with a similar maturity as the expected life of the options.

(4)	The expected life is based on historical employee exercise patterns.

Reported net earnings for the three and six months ended September 30, 2005, adjusting for share-based compensation that would have been recognized if FAS No. 123(R) had been followed, is as follows:

Three Months Ended September 30, 2005

(In Thousands; Except Per Share Amounts)


Net Loss as reported	$	(138	)
Pro Forma Net Loss	$	(138	)
Basic and diluted earnings per share
As reported		(0.00	)
Proforma		(0.00	)
Six Months Ended September 30, 2005
Net Loss as reported	$	(353	)
Pro Forma Net Loss	$	(353	)
Basic and diluted earnings per share
As reported		(0.00	)
Pro Forma		(0.00	)

Reclassification

Certain prior period amounts have been reclassified to conform with current periods presentation.

3.	Business Segment Information

The Company has three reportable segments as identified by information reviewed by the Company’s chief operating decision maker: the Manufacturing/Distribution segment, the Retail Operations segment and the Franchise Operations segment.

The Manufacturing/Distribution segment represents the manufacturing and wholesaling of sports memorabilia products and acrylic display cases. Sales are handled primarily through in-house salespersons that sell to specialty retailers and other distributors in the United States. The Company’s manufacturing and distributing facilities are located in the United States. The majority of the Company’s products are manufactured in these facilities.

The Retail Operations segment represents the Company-owned Field of Dreams® retail stores and the Company’s e-commerce division. As of September 30, 2006, the Company owned and operated 9 Field of Dreams® stores. The Company also owns FansEdge Incorporated (“FansEdge”), an e-commerce retailer selling a diversified selection of sports licensed products and memorabilia on the Web and Pro Sports Memorabilia (“ProSports”), an e-commerce retailer of sports memorabilia products on the Web.

The Franchise Operations segment represents the results of the Company’s franchise program. The Company is in the business of selling Field of Dreams® retail store franchises in the United States and generates revenues through the sale of those franchises and continuing royalties. As of September 30, 2006 there were 20 franchises operating in the United States.

All of the Company’s revenue generated in the first three and six months ended September 30, 2006 and 2005 was derived in the United States and all of the Company’s assets are located in the United States.

Summarized financial information concerning the Company’s reportable segments is shown in the following tables. Corporate related items, results of insignificant operations and income and expenses not allocated to reportable segments are included in the reconciliations to consolidated results table.

Dreams, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements - Unaudited

Dollars in Thousands, Except per Share Amounts

3.	Business Segment Information (Continued)

Segment information for the six month periods ended September 30, 2006 and 2005 was as follows:


Six Months Ended:	Manufacturing/ Distribution			Retail Operations			Franchise Operations			Total
September 30, 2006
Net sales	$	7,453		$	9,570		$	471		$	17,494
Intersegment net sales		(1,239	)		0			(65	)		(1,304	)
Operating earnings (loss)		261			(357	)		124			28
Total assets		11,812			10,126			202			22,140

September 30, 2005
Net sales	$	6,479		$	6,973		$	332		$	13,784
Intersegment net sales		(1,120	)		0			(22	)		(1,142	)
Operating earnings (loss)		508			(443	)		144			209
Total assets		9,430			5,250			114			14,794

Reconciliation to consolidated amounts is as follows:


	YTD FY2007			YTD FY2006
Revenues:
Total revenues for reportable segments	$	17,494		$	13,784
Other revenues		291			289
Eliminations of intersegment revenues		(1,304	)		(1,142	)

Total consolidated revenues	$	16,481		$	12,931

Pre-tax earnings (loss):
Total operating earnings (loss) for reportable segments	$	28		$	209
Other loss (primarily parent company expenses)*		(813	)		(560	)
Interest expense		(286	)		(237	)

Total consolidated loss before taxes	$	(1,071	)	$	(588	)

These are “unallocated” costs and expenses that have not been allocated to the reportable segments. Some examples of these unallocated overhead costs which is consistent with the Company’s internal accounting policies are executive salaries and benefits; corporate office occupancy costs; professional fees, bank charges; certain insurance policy premiums and public relations/investor relations expenses.

Dreams, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements - Unaudited

Dollars in Thousands, Except per Share Amounts

3.	Business Segment Information (Continued)

Segment information for the three month periods ended September 30, 2006 and 2005 was as follows:


Three Months Ended:	Manufacturing/ Distribution			Retail Operations			Franchise Operations			Total
September 30, 2006
Net sales	$	3,313		$	5,434		$	196		$	8,943
Intersegment net sales		(516	)		0			(12	)		(528	)
Operating earnings (loss)		(15	)		26			123			134
Total assets		11,812			10,126			202			22,140

September 30, 2005
Net sales	$	3,528		$	3,747		$	146		$	7,421
Intersegment net sales		(554	)		0			(4	)		(558	)
Operating earnings (loss)		398			(191	)		47			254
Total assets		9,430			5,250			114			14,794

Reconciliation to consolidated amounts is as follows:


	Q2 YTD FY2007			Q2 YTD FY2006
Revenues:
Total revenues for reportable segments	$	8,943		$	7,421
Other revenues		143			15
Eliminations of intersegment revenues		(528	)		(558	)

Total consolidated revenues	$	8,558		$	6,878

Pre-tax earnings (loss):
Total operating earnings (loss) for reportable segments	$	134		$	254
Other loss (primarily parent company expenses)*		(505	)		(400	)
Interest expense		(133	)		(83	)

Total consolidated loss before taxes	$	(504	)	$	(229	)

4.	Inventories

The components of inventories are as follows:


	September 30, 2006		March 31, 2006
			(audited)
Raw materials	$	335	$	369
Work in process		166		95
Finished goods, net		15,455		11,743

	$	15,956	$	12,207

Dreams, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements - Unaudited

Dollars in Thousands, Except per Share Amounts

5.	Related Party Transactions

In August 2004, the Company obtained a convertible loan to borrow up to $1.0 million due January 15, 2005 from the brother of the Company’s president and chief executive officer. The initial advance of $700 as of September 30, 2004, was used for working capital purposes. As of November 22, 2004 the remaining $300 has been funded and used for working capital purposes as well. In consideration for such loan, the Company has agreed to pay such third party interest at the rate of 12% per annum and granted five year options to purchase 1,000,000 shares of common stock at an exercise price of $0.25 per share. In an event of a default under the loan, the loan is convertible into our common stock at $0.05 per share. On January 25, 2005, the Company extended the maturity date of the note to April 29, 2005 and modified the convertibility feature to provide for conversion of the note, only upon an event of default, at the lower of (i) the average closing sales price for a share of our common stock for the three trading days immediately prior to conversion or (ii) in the event we sell or issue common stock or other convertible securities after December 31, 2004, at the lowest issue or conversion price per share of such securities, as applicable. Also, the five year options to purchase 1,000,000 shares of common stock at an exercise price of $0.25 per share were canceled effective January 15, 2005. On May 31, 2005 the Company’s president agreed to assume the Company’s obligations under the loan. In consideration for such transaction the Company’s president received 33,333,333 shares of the Company’s common stock.

To provide the Company with additional working capital, nine of our senior employees, including the Company’s chairman and chief executive officer, agreed to defer all but $1 of their monthly salary effective August 1, 2004. In consideration for such deferral, each employee received options to purchase that number of shares of our common stock equal to the dollar amount deferred. The five year options are exercisable at $0.25 per share. In addition, upon payment of such accrued amounts, each employee received a 5% deferral bonus. The deferrals ceased and accrued amounts were paid on November 19, 2004 for each of the Company’s senior employees other than our president and chief executive officer and our chairman, which continued in effect until February 2005 for our chairman and June 3, 2005 for our president and chief executive officer. As of March 31, 2005, stock options to purchase up to 486,559 shares were issued at an exercise price of $0.25 per share. These options are exercisable immediately. The Company accrued $285 of salaries and deferral bonuses for these two executives ($212 of the aggregate accrued salary to the Company’s president and chief executive officer and $73 of the consulting fees to the Company’s chairman of the board). In May 2005, all of the chairman of the board’s accrued consulting fees was satisfied with issuance of an aggregate of 2,433,333 shares of the Company’s common stock in lieu of salary and $149 of

the accrued amount to the Company’s president was satisfied with the issuance of 4,939,000 shares of common stock. The Company paid its president the remaining $63 in December 2005.

On January 12, 2005, the Company entered into a licensing agreement with Pro Stars, Inc., a corporation in which our chairman of the board is an executive officer. Under the terms of the agreement, the Company receives a 10% licensing fee on the revenues generated from our 365 live marketing concept which we licensed to Pro Stars, Inc. The licensing fees for the three and six months ended September 30, 2006 were $72 and $125, respectively; and for the three and six months ended September 2005 were $100 and $160, respectively. As of September 30, 2006 and March 31, 2006, Pro Stars owed the Company $1.1 million and $243 for licensing fees and product purchases, respectively. These amounts were reflected in the Company’s accounts receivables for both periods.

In order to fund the substitute collateral in connection with the appeal of the Unitas Management litigation matter on February 16, 2005, the Company issued unsecured subordinated convertible promissory notes in the aggregate amount of $446. These notes included notes issued to our president and chief executive officer, his brother-in-law and his father-in-law in the amounts of $121, $125, and $100, respectively, and notes to two other shareholders, each in the amount of $50. These notes accrue interest at the rate of 12% per annum and are due on (i) December 31, 2005, if the bond is either released or drawn upon prior to December 31, 2005, (ii) the date that is 10 business days after the bond is released, if the bond is released on or after December 31, 2005, or (iii) the date that is 45 business days after the bond is drawn upon if the bond is drawn upon on or after December 31, 2005. These notes provide for a 10% origination fee to be paid no later than the earlier to occur of the maturity date and December 31, 2005. These notes are convertible at any time at the lower of (i) the average closing sales price for a share of our common stock

for the three trading days immediately prior to conversion or (ii) in the event we sell or issue common tock or other convertible securities after February 16, 2005, at the lowest issue or conversion price per share of such securities, as applicable. In June 2005 the note payable to the Company’s president was repaid. The remaining $325 of notes was converted as of May 31, 2005 into an aggregate of 10,833,333 shares of common stock.

On May 31, 2005, the Company’s chairman agreed to assume the Company’s obligations under a note payable to an individual, which bears interests at 12% per annum and $199 of principal amount is due on December 1, 2007. The note was unsecured and previously guaranteed by the Company’s chairman. In exchange for the obligation to pay the principal amount of indebtedness to the third party, the Company chairman received 6,633,333 shares of the Company’s common stock.

6.	Legal Proceedings

The Company is subject to legal proceedings that arise in the ordinary course of its business. The amount of ultimate liability, if any, in excess of applicable insurance coverage, is not likely to have a material effect on the financial condition, results of operations or liquidity of the Company. However, as the outcome of litigation or other legal claims is difficult to predict, significant changes in the estimated exposures could occur, which could have a material impact on the Company’s operations.

7.	Commitments

The Company has certain contracts with several athletes which will require the Company to make minimum payments to these athletes over the next two years. The payments are in exchange for autographs and licensing rights on inventory items to be received in the future.

8.	New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation Number 48 (FIN 48), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” The interpretation contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The interpretation is effective for the first interim period for fiscal years beginning after December 15, 2006. Dreams has not yet analyzed the impact this interpretation will have on its financial condition, results of operations, cash flows or disclosures, and such impact may have a material adverse effect.

In September 2006, the SEC Office of the Chief Accountant and Divisions of Corporation Finance and Investment Management released SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. This guidance is effective for fiscal years ending after November 15, 2006. Dreams does not expect the adoption of SAB No. 108 to have a material impact on its financial position, results of operations, or cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). This statement provides a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures. SFAS No. 157 applies to those previously issued pronouncements that prescribe fair value as the relevant measure of value, except SFAS No. 123(R) and related interpretations and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. This pronouncement is effective for fiscal years beginning after November 15, 2007. Dreams does not expect the adoption of SFAS No. 157 to have a material impact on its financial position, results of operations, or cash flows.

A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to our consolidated financial statements.

9.	Debt Refinancing

10.

Subsequent Events

On November 1, 2006, the Company entered into a Securities Purchase Agreement with The Frost Group, LLC, a Florida limited liability company (“Frost”). Pursuant to the Agreement, the Company sold to Frost 30,769,231 shares of the Company’s common stock. The purchase price for the Common Stock was $0.065 per share in cash for an aggregate price of $2,000,000. As a result of the purchase, Frost owns approximately 14.7% of the Company’s outstanding common stock. Pursuant to the Agreement, the Company also agreed to appoint one designee of Frost to its board of directors, which has not yet been designated. The common stock issued in the transaction was not registered under the Securities Act of 1933 (the “Act”) and was issued pursuant to an exemption from registration under Section 4(2) of the Act.

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

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Form 10-Q under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” constitute “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such statements are indicated by words or phrases such as “anticipates,” “projects,” “management believes,” “Dreams believes,” “intends,” “expects,” and similar words or phrases. Such factors include, among others, the following: competition; seasonality; success of operating initiatives; new product development and introduction schedules; acceptance of new product offerings; franchise sales; advertising and promotional efforts; adverse publicity; expansion of the franchise chain; availability, locations and terms of sites for franchise development; changes in business strategy or development plans; availability and terms of capital; labor and employee benefit costs; changes in government regulations; our ability to successfully operate retail stores, and other factors particular to the Company.

Should one or more of these risks, uncertainties or other factors materialize, or should underlying assumptions prove incorrect, actual results, performance, or achievements of Dreams may vary materially from any future results, performance or achievements expressed or implied by such forward-looking statements. All subsequent written and oral forward-looking statements attributable to Dreams or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in this paragraph. Dreams disclaims any obligation to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

GENERAL

As used in this Form 10-Q “we”, “our”, “us” and “Dreams” refer to Dreams, Inc. and its subsidiaries unless the context requires otherwise. Dreams, Inc. (the “Company”) is a Utah Corporation which was formed in April 1980. We are engaged in multiple aspects of the licensed products and sports memorabilia industry through a variety of distribution channels.

We generate revenues from:

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our manufacturing/distribution segment, through manufacturing and wholesaling of sports memorabilia products and acrylic display cases;

•

our retail segment which includes our 9 Company owned stores and our e-commerce component;

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our franchise segment through our 20 Field of Dreams^{^®} franchise stores presently owned and operated; and

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our representation and corporate marketing of individual athletes, including personal appearances, endorsement and marketing opportunities.

We have a strategic acquisition program for the expansion of our e-commerce component. Our previous acquisitions included Fansedge.com and ProSports Memorabilia.com. While these acquisitions have presented both significant challenges and opportunities for us; we have grown the e-commerce component revenues significantly. The growth has been supported by our larger and more efficient warehouse; the ability to have the right product mix in stock; increased traffic growth and better conversion rates. Our continued success depends, in part, on our ability to integrate operations with these companies as well as other potential e-commerce companies that we may consider acquiring in the future.

Historically, the third quarter of our fiscal year (October to December) has accounted for a greater proportion of our operating income than have each of the other three quarters of our fiscal year. This is primarily due to increased activities as a result of the holiday season. We expect that we will continue to experience quarterly variations and operating results principally as a result of the seasonal nature of our industry. Other factors also make

for a significant fluctuation of our quarterly results, including the timing of special events, the general popularity of a specific team that wins a championship or individual athlete who enters their respective sports’ Hall of Fame, the amount and timing of new sales contributed by new stores, the timing of personal appearances by particular athletes and general economic conditions. Additional factors may cause fluctuations and expenses, including the costs associated with the opening of new stores, the integration of acquired businesses and stores into our operations and corporate expenses to support our expansion and growth strategy.

We set ourselves apart from other companies with our diversified product and services line, as well as our relationships with sports leagues, agents and athletes.

RESULTS OF OPERATIONS

Six Months Ended September 30, 2006 Compared to the Six Months Ended September 30, 2005

Revenues. Total revenues increased 28% to $16.5 million in the first six months of fiscal 2007 from $12.9 million in the same period last year due primarily to an increase in revenues generated through our manufacturing/distribution segment and retail revenues generated through e-commerce.

Manufacturing and distribution revenues increased from $6.5 million in the first six months of fiscal 2006 to $7.5 million in the first six months of fiscal 2007, a 15.3% increase. Net revenues (after eliminating intercompany sales) increased to $6.2 million in the fiscal 2007 period from $5.4 million in the same period last year, for a 14.8% increase. The increase primarily is the result of sales generated from our Super Bowl MVP’s product lines introduced in the first quarter of fiscal 2007.

Retail operations revenues increased significantly from $7.0 million in the first six months of fiscal 2006 to $9.6 million in the same period this year, a 37% increase. Our internet retail division had retail sales of $4.8 million during the six months of fiscal 2006 versus $7.6 million during the same period in fiscal 2007, a 58% increase. The increase is as a result of our having taken advantage of our larger and more efficient warehouse, improving our user interface, better merchandising of our products on-line, increased traffic and better conversion rates. Additionally, retail sales through our nine company-owned Field of Dreams stores were $2 million for the first six months of fiscal 2007 versus $2.2 million for the first six months of fiscal 2006 when we had 12 stores. Same store sales for stores opened for the entire period increased 10%.

Franchise operation revenues were $332 for the first six months of fiscal 2006 compared to $471 for the same period in this fiscal year, a 42% increase. The increase is attributable to our Somerset Field of Dreams store being converted to a franchise and executing the franchise division’s objectives of improving its support structure for existing franchisees by creating “value-added” services such as: assisting franchisees in resolving real estate issues from expansion to renewal and beyond; bringing in new vendor relationships that enhance both the store’s top line revenues and operating expense savings and creating marketing and advertising action plans with the landlord’s marketing departments to create better traffic opportunities. This has yielded greater sales volumes throughout the chain. Same store sales increased 20%.

The Company realized $164 in net management fees for the first six months of fiscal 2007 compared to $122 for the same period last year, a 34% increase.

Costs and expenses. Total cost of sales for the first six months of fiscal 2006 was $6.7 million versus $9.2 million in the same period in fiscal 2007, a 37% increase. The increase relates to an increase in Company sales. As a percentage of total sales, cost of sales was 52% for the six months of fiscal 2006 and 56% for the first six months of fiscal 2007.

Cost of sales of manufacturing/distribution products were $2.8 million in the first six months of fiscal 2006 versus $3.7 million in the same period of fiscal 2007, a 32% increase. As a percentage of manufacturing/distribution revenues cost of sales was approximately 51.8% for the first six months of fiscal 2006 versus 59.6% for the same period in fiscal 2007. However, as a percentage of total manufacturing/distribution revenues before the elimination of inter-company sales, costs were 61.5% for the first six months of fiscal 2006 versus 66.6% for the same period in fiscal 2007. The previous year the Company was fortunate to have one of its marquee players named to the Pro Football Hall of Fame where we enjoyed better margins on various Dan Marino Hall of Fame items. This year’s cost of sales was consistent with historical margins.

Cost of sales of retail products were $5.5 million in the first six months of fiscal 2007 versus $3.9 million in the same period of fiscal 2006, a 41% increase. The increase is a direct result of incremental retail sales. As a percentage of total retail sales, costs were 57% for the first six months of fiscal 2007 compared to 56% in the same period of fiscal 2006.

Operating expenses increased from $6.4 million in the first six months of fiscal 2006 to $7.8 million in the same period this fiscal year, a 20% increase. However, as a percentage of sales, operating expenses declined from 50% for the first six months of fiscal 2006 to 47% this year. The Company had previously built infrastructure to support future growth. Upon achieving incremental sales, our operating costs should continue to decrease as a percentage of sales as a significant portion of our expenses are fixed in nature.

Interest expense, net. Net interest expense increased from $237 in the first six months of fiscal 2006 to $286 this year due to greater levels of borrowing to facilitate pre-holiday inventory purchases and higher interest rates.

Provision for income taxes. The Company recognized an income tax benefit of $416 for the first six months of fiscal 2007 versus an income tax benefit of $235 for the first six months of the previous fiscal year. Each quarter, the Company evaluates whether the realizability of its net deferred tax assets is more likely than not. Should the Company determine that a valuation reserve is necessary, it would have a material impact on the Company’s operations. The Company has prepared an analysis based upon historical data and forecasted earnings projections to determine its ability to realize its net deferred tax asset. The Company believes that it is more likely than not that the net deferred tax asset will be realized. Therefore, the Company has determined that a valuation allowance is not necessary as of September 30, 2006 and 2005. The effective tax rate for both periods was approximately 40%.

Three Months Ended September 30, 2006 Compared to the Three Months Ended September 30, 2005

Revenue. Total revenues increased 25% from $6.9 million in the second quarter of fiscal 2006 to $8.6 million in the same quarter of fiscal 2007, primarily due to an increase in retail revenues generated through e-commerce.

Manufacturing and distribution revenues decreased slightly to $3.3 million in the second quarter of fiscal 2007 from $3.5 million in the second quarter of fiscal 2006, or 6%. Net revenues (after eliminating intercompany sales) decreased 10% from $3.0 in the fiscal 2006 period to $2.7 million in the same period this year. This is as a result of not generating comparable revenues associated with the Pro Football Hall of Fame Induction weekend that takes place in August. Last year, the Company was fortunate to have one of its marquee clients named to the Pro Football Hall of Fame, Dan Marino.

Retail operations revenues increased 46% from $3.7 million in the second quarter of fiscal 2006 to $5.4 million in the current year quarter. Our internet retail division had sales of $2.6 million during the second three months of fiscal 2006 versus $4.5 million during the second three months of fiscal 2007, a 73% increase. The increase is as a result of our having taken advantage of our larger and more efficient warehouse, improving our user interface, better merchandising of our products on-line, increased traffic and better conversion rates. Additionally, retail sales through our nine company-owned Field of Dreams stores were $928 for the current quarter of fiscal 2007 versus $1.1 million for the same period last fiscal year when we operated 12 stores. Same store sales for stores opened for the entire period were up 4%.

Franchise operations revenues were $196 in the second quarter of fiscal 2007 compared to $146 in the same quarter last year, a 34% increase. The increase is attributable to our Somerset Field of Dreams store being converted to a franchise and executing the franchise division’s objectives of improving its support structure for existing franchisees by creating “value-added” services such as: assisting franchisees in resolving real estate issues from expansion to renewal and beyond; bringing in new vendor relationships that enhance both the store’s top line revenues and operating expense savings and creating marketing and advertising action plans with the landlord’s marketing departments to create better traffic opportunities. This has yielded greater sales volumes throughout the chain. Same store sales increased 27%.

The Company realized $36 in net management fees for the second quarter of fiscal 2007 compared to a negative $86 result in the same quarter last year.

Costs and expenses. Total cost of sales for the second quarter of fiscal 2006 was $3.5 million versus $4.7 million in the same quarter in fiscal 2007, a 34% increase. This increase directly relates to the increase in company sales. However, as a percentage of total sales, cost of sales was 51% for the second three months of fiscal 2006 and 55% for the second three months of fiscal 2007.

Cost of sales of manufacturing/distribution products were $1.5 million in the second three months of fiscal 2006 versus $1.6 million in the same period of fiscal 2007. As a percentage of manufacturing/distribution revenues, cost of sales was approximately 50% a year ago and 59% in the current quarter. However, as a percentage of manufacturing/distribution revenues before elimination of inter-company sales, costs were 60.8% a year ago and 66.1% in the current quarter. The previous year the Company was fortunate to have one of its marquee players named to the Pro Football Hall of Fame where we enjoyed better margins on various Dan Marino Hall of Fame items. This year’s cost of sales was consistent with historical margins.

Cost of sales of retail products were $3.1 million in the second quarter of fiscal 2007 versus $2.0 million in the same period of fiscal 2006, a 55% increase. The increase is a direct result of incremental retail sales. As a percentage of total retail sales, costs were 56% in the second quarter of fiscal 2007 versus 54% for the same period of fiscal 2006. The increase in costs of sales of retail products is attributable to experiencing a higher percentage of retail sales volumes at the e-commerce level which operates with lower margins than our brick and mortar retail sales.

Operating expenses increased from $3.4 million in the second quarter of fiscal 2006 to $4.1 million in the same period this fiscal year, a 20.5%. However, as a percentage of sales, operating expenses declined from 50% for the second three months of fiscal 2006 to 48% for the second three months of fiscal 2007. The Company had previously built infrastructure to support future growth. Upon achieving incremental sales, our operating cost should continue to decrease as a percentage of sales as a significant portion of our expenses are fixed in nature.

Interest Expense., net. Net interest expense was $133 for the second quarter of fiscal 2007 versus $83 for the same period last year. The Company carried slightly larger loan balances to facilitate its pre-holiday inventory purchases that were subjected to higher interest rates.

Provision for income taxes. The Company recognized an income tax benefit of $202 for the second three months of fiscal 2007 versus an income tax benefit of $91 for the second three months of the previous fiscal year. Each quarter, the Company evaluates whether the realizability of its net deferred tax assets is more likely than not. Should the Company determine that a valuation reserve is necessary, it would have a material impact on the Company’s operations. The Company has prepared an analysis based upon historical data and forecasted earnings projections to determine its ability to realize its net deferred tax asset. The Company believes that it is more likely than not that the net deferred tax asset will be realized. Therefore, the Company has determined that a valuation allowance is not necessary as of September 30, 2006 and 2005. The effective tax rate for both periods was approximately 40%.

LIQUIDITY AND CAPITAL RESOURCES

The balance sheet as of September 30, 2006 reflects working capital of $13.4 million versus working capital of $9.9 million one year earlier. The increase is partly attributed to the Company receiving its insurance claim proceeds of $3.6 million from hurricane Wilma in the period ended June 30, 2006. With the improvement of the financial results of the Company and a further strengthening of our balance sheet, our ability to capitalize on market opportunities should be enhanced.

At September 30, 2006, the Company’s cash and cash equivalents were $320 thousand compared to $0 at September 30, 2005. The structure of the Company’s loan agreement with La Salle Bank provides for daily sweeps of the Company’s bank accounts. The Company has as of September 30, 2006 and November 1, 2006 $1.1 million and $4.0 million excess availability respectively, under its loan with La Salle and is not adversely affected by the $320 thousand cash amount on the balance sheet. Net accounts receivable at September 30, 2006 were $2.6 million compared to $1.8 million at September 30, 2005.

Cash used in operations amounted to $149 thousand for fiscal 2007, compared to $1.4 million used in operations in the same period in fiscal 2006. This is a direct result of collections of accounts receivable partially

offset by an increased build up of inventory. Cash used in investing activities were $1.1 million in fiscal 2007 and $638 in fiscal 2006. During fiscal 2007 and fiscal 2006, the Company made cash disbursements of $401 and $269, respectively, to the previous shareholders of its internet division, FansEdge, consistent with the earn-out provision in the purchase agreement. Cash provided by financing activities was $1.1 million for fiscal 2007 compared to cash provided by financing activities of $1.8 million in fiscal 2006.

The future aggregate minimum annual lease payments under the Company’s non-cancelable operating leases are as follow: (As of September 30, 2006)


Fiscal
2007		691,824
2008		1,295,426
2009		975,381
2010		800,146
2011		796,191
Thereafter		729,490

Total lease commitments	$	5,288,458

On June 3, 2005, the Company and its subsidiaries entered into a loan and security agreement and related loan documents with LaSalle Business Credit LLC as an agent for Standard Federal Bank National Association acting through its division of LaSalle Retail Finance providing for a three year revolving credit line up to $10.0 million. The LaSalle line of credit replaces the Company’s previous line of credit with Merrill Lynch Business Financial Services. The line of credit is collateralized by all of the Company’s assets and a pledge of stock of the Company’s subsidiaries. Under the line of credit, a portion of the proceeds of the borrowings of the line of credit had been used to pay off the balances of its prior lender. The initial loan on the LaSalle line of credit bears interest at prime or LIBOR plus 200 basis points. As of September 30, 2006, The La Salle line of credit bears interest at prime or Libor plus 200 basis points. Four million of The Company’s current loan balances bear interest at 7.37% (libor plus 200 basis points) while the remaining three-million loan balances bear interest at prime or 8.25%. The $10.0 million line of credit facility includes borrowing capacity limits based on the eligibility criteria of inventories and account receivables. As of September 30 and November 1, 2006, inventory eligibility was 55.3% and 56.8%, while accounts receivable was 85%. This resulted in total line availability of $8.1 million at September 30, 2006 and $9.2 million as of November 1, 2006 with an excess availability of $1.1 million at September 30, 2006 and $4.1 million at November 1, 2006. The Loan Security Agreement also requires that certain financial performance covenants be met. These covenants included minimum cumulative EBITDA, minimum tangible net worth and maximum capital expenditures, all of which were met by the Company.

On November 1, 2006, the Company entered into a Securities Purchase Agreement (the “Agreement”) with The Frost Group, LLC, a Florida limited liability company (“Frost”). Pursuant to the Agreement, the Company sold to Frost 30,769,231 shares of the Company’s common stock. The purchase price for the common stock was $0.065 per share in cash for an aggregate price of $2,000,000. As a result of the purchase, Frost will own approximately 14.7% of the Company’s outstanding common stock. Pursuant to the Agreement, the Company also agreed to appoint one designee of Frost to its board of directors, which has not yet been designated. The Agreement is attached as an exhibit to this filing and is incorporated by reference herein. The common stock issued in the transaction was not registered under the Securities Act of 1933 (the “Act”) and was issued pursuant to an exemption from registration under Section 4(2) of the Act.

We are currently analyzing our company-owned retail store business model and looking at the profitability of each store. We expanded this new model rapidly. Our first two company-owned stores opened in March 2002 and grew to 15 stores by June 2004. As of September 30, 2006, we owned and operated 9 stores. We sold our Somerset store to an existing franchisee on June 30, 2006. Effective December 31, 2005 we entered into early lease termination agreements which allowed us to cease operations for two under-performing stores, (the Beverly Center in Los Angeles, CA and the Glendale Galleria in Glendale, CA) in return for an “early exit” fee of $50 and $35 respectively. On August 1, 2005, the Company sold the assets, inventory and leasehold improvements of its Wellington Green store to an existing franchisee, of which one of the partners is the President of Dreams Products, Inc. The leases for two previously under-performing stores expired in late December 2004 and we elected not to renew those leases. We have and will continue to analyze the performance of each of the store operations and determine whether they are providing The Company with its desired results. This may include additional future closings and/or conversion to franchise stores.

We are continuing to review our operational expenses and examining ways to reduce costs on a going-forward basis. Additionally, we will be required in fiscal 2008 to comply with the new annual internal control certification pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and the related SEC rules. While we expect some relaxing of the initial requirements mandated by Sarbanes-Oxley due to our relative company size, these and other compliance costs of being a public company will increase.

We have not created and are not a party to any special purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. However, we may not generate sufficient cash flow from operations, our anticipated revenue growth and operating improvements may not be realized and future borrowings may not be available in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. Except as described herein, our management is not aware of any known trends or demands, commitments, events or uncertainties, as they relate to liquidity which could negatively affect our ability to operate and grow as planned, other than those previously disclosed.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Market risk generally represents the risk of loss that may result from the potential change in value of a financial instrument as a result of fluctuations in interest rates and market prices. We do not currently have any trading derivatives nor do we expect to have any in the future. We have established policies and internal processes related to the management of market risks, which we use in the normal course of our business operations.

Interest Rate Risk. We have interest rate risk, in that borrowings under our credit facility with LaSalle Business Credit LLC are based on variable market interest rates. As of September 30, 2006, we had $7.0 million of variable rate debt outstanding under our credit facility of which $4 million was fixed at Libor plus 200 basis points, or 7.37% until October 13, 2006. Presently, the revolving credit line bears interest at the prime rate (8.25%). A hypothetically 10% increase in our credit facility’s weighted average interest rate of 7.95% per annum for the six months ended September 30, 2006 would correspondingly decrease our pre-tax earnings and our operating cash flows by approximately $28.

Intangible Asset Risk. We have a substantial amount of intangible assets. We are required to perform goodwill impairment tests whenever events or circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. As a result of our periodic evaluations, we may determine that the intangible asset values need to be written down to their fair values, which could result in material changes that could be adverse to our operating results and financial position. Although at September 30, 2006 we believed our intangible assets were recoverable, changes in the economy, the business in which we operate and our own relative performance could change the assumptions used to evaluate intangible asset recoverability. We continue to monitor those assumptions and their effect on the estimated recoverability of our intangible assets.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures. Our management has conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13A-15(e) and 15(d)-15(e) promulgated under the Securities Exchange Act of 1934, as amended) as of the end of the fiscal quarter covered by this report. Based upon that evaluation, our management has concluded our disclosure controls and procedures are effective for timely gathering, analyzing and disclosing the information we are required to disclose in the reports filed in the Securities Exchange Act of 1934, as amended.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Management necessarily applied its judgment in assessing the benefits of controls relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and may not be detected.

Change in Internal Controls. There have been no significant changes made in the internal controls and there were no other factors that could significantly affect our internal controls during the fiscal quarter covered by this report.

Part II. Other Information

Item 1. Legal Proceedings.

None.

Item 1A. Risk Factors.

You should consider the risks described below before making an investment decision. We believe that the risks and uncertainties described below are the principal material risks facing our company as of the date of this Form 10-Q. In the future, we may become subject to additional risks that are not currently known to us. Our business, financial condition or results of operations could be materially adversely affected by any of the following risks. The trading price of our common stock could decline due to any of the following risks.

Risk Factors Relating to Dreams, Inc.

Our line of credit facility imposes significant operating and financial restrictions which may limit our ability to finance future operations or capital needs and pursue business opportunities, thereby limiting our growth.

Our line of credit facility imposes significant operating and financial restrictions on us. These restrictions limit our ability to, among other things:

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Incur additional debt;

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Create or permit certain liens, other than customary and ordinary liens;

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Sell assets other than in the ordinary course of our business;

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Create or permit restrictions on our ability to pay dividends or make other distributions;

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Engage in transactions with affiliates; and

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Consolidate or merge with or into other companies or sell all or substantially all of our assets.

These restrictions could limit our ability to finance our future operations or capital needs, make acquisitions or pursue available business opportunities. In addition, our line of credit facility requires us to maintain specified financial ratios and satisfy certain financial covenants and maintain the collateral value of our borrowing base. We may be required to take action to reduce our debt or to act in a manner contrary to our business objectives to meet these ratios and satisfy these covenants. A breach of any of the covenants in, or our inability to maintain the required financial ratios under our line of credit facility could result in a default. In the event of a default of our obligations under our line of credit or the forbearance agreement, La Salle Business Credit LLC may, among other things, seize and sell all of our assets or appoint a receiver for our operations.

A significant portion of our growth has come from acquisitions, and we plan to make more acquisitions in the future as part of our continuing growth strategy. This growth strategy subjects us to numerous risks.

A very important aspect of our growth strategy has been and is to pursue strategic acquisitions of related businesses that we believe can expand or compliment our business. Acquisitions require significant capital resources and divert management’s attention from our existing business. Acquisitions also entail an inherent risk that we could become subject to contingent or other liabilities, including liabilities arising from events or conduct pre-dating our acquisition of a business that were not known to us at the time of acquisition. We may also incur significantly greater expenditures in integrating an acquired business than we had anticipated at the time of its purchase. In addition, acquisitions may create unanticipated tax and accounting problems, including the possibility that we might be required to write-off goodwill which we have paid for in connection with an acquisition. A key element of our acquisition strategy has been to retain management of acquired businesses to operate the acquired business for us. Many of these individuals maintain important contacts with clients of the acquired business. Our inability to retain these individuals could materially

impair the value of an acquired business. Our failure to successfully accomplish future acquisitions or to manage and integrate completed or future acquisitions could have a material adverse effect on our business, financial condition or results of operations. We cannot assure you that:

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We will identify suitable acquisition candidates;

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We can consummate acquisitions on acceptable terms;

•

We can successfully integrate any acquired business into our operations or successfully manage the operations of any acquired business; or

•

We will be able to retain an acquired company’s significant client relationship, goodwill and key personnel or otherwise realize the intended benefits of any acquisition.

As a result of competition, and the strength of some of our competitors in the market, we may not be able to compete effectively.

The markets for our services and products are highly competitive. We compete with numerous local, regional and national companies, including certain or our suppliers, some of which possess substantially greater financial, marketing, personnel and other resources than us. Our retail stores compete with other retail establishments, including our franchise stores and other stores that sell sports related merchandise, memorabilia and similar products. Our e-commerce business competes with a variety of online and multi-channel competitors including mass merchants, fan shops, major sporting goods chains and online retailers. Mounted Memories, or MMI, competes with several major companies and numerous individuals in the sports and celebrity memorabilia industry. We also compete with various manufacturers of acrylic cases. We may not be able to compete successfully, particularly as we seek to enter into new markets.

We have grown rapidly, and our growth has placed, and is expected to continue to place, significant demands on us.

We have grown rapidly in the past few years, including through acquisitions. Businesses that grow rapidly often have difficulty managing their growth. Our rapid growth has placed and is expected to continue to place significant demands on our management, on our accounting, financial, information and other systems and on our business. Although we have expanded our management, we need to continue recruiting and employing experienced executives and key employees capable of providing the necessary support. In addition, we will need to continue to improve our financial, accounting, information and other systems in order to effectively manage our growth. We will be required in fiscal 2008 to comply with the new annual internal control certification pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and the related SEC rules. We cannot assure you that our management will be able to manage our growth effectively or successfully, or that our financial, accounting, information or other systems will be able to successfully accommodate our growth or that we will be able to timely comply with Section 404 of the Sarbanes-Oxley Act. Our failure to meet these challenges could materially impair our business.

If we are required to write-off goodwill or other intangible assets, our financial position and results of operations would be adversely affected.

As of September 30, 2006, we had goodwill and other intangible assets of approximately $5.9 million, which constituted approximately 21% of our total assets. We periodically evaluate goodwill and other intangible assets for impairment. Any determination requiring the write-off of a significant portion of our goodwill or other intangible assets, could adversely affect our results of operations and financial condition.

Lack of available retail store sites on terms acceptable to us, rising rents and other costs and risks relating to new store openings could severely limit our growth opportunities.

Our strategy includes opening stores in new and existing markets. We must successfully choose store sites, execute favorable leases on terms that are acceptable to us, hire competent personnel and effectively open and operate these new stores. Our plans to increase the number of our company-owned retail stores will depend in part on the availability of existing retail stores or store sites. We may not have stores or sites available to us for lease or available on terms acceptable to us. If additional retail store sites are unavailable on acceptable terms, we may not be able to carry out a significant part of our growth strategy. Rising rents in

malls and other retail shopping areas could also inhibit our ability to grow. If we fail to locate desirable sites, obtain lease rights to these sites on terms acceptable to us, hire adequate personnel and open and effectively operate these new stores, our financial performance could be adversely affected.

Our business depends on anticipating consumer tastes and identifying, forming and maintaining relationships with popular athletes.

A significant portion of our revenues is generated by the sale of sports memorabilia and sports licensed products. Our success depends upon our ability to anticipate and respond in a timely manner to trends in sports memorabilia and sports licensed products and our ability to identify, form and maintain relationships with popular athletes. If we fail to anticipate changes in consumer preferences for these products or fail to identify, form and maintain relationships with these athletes, we may experience lower revenues, higher inventory markdowns and lower margins. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty. These preferences are also subject to change. Sports memorabilia, licensed products and the popularity of athletes are often subject to short-lived trends, such as the short-lived popularity of certain athletes or sports teams. If we misjudge the popularity or staying power of a sports team or an athlete, we may over-stock unpopular products and force inventory markdowns that could have a negative impact on profitability, or have insufficient inventory of a popular item that can be sold at full markup.

We are dependent upon the Field of Dreams® trademark.

Field of Dreams® is a copyright and trademark owned by Universal City Studios, Inc. with all rights reserved. We license certain rights to use the name “Field of Dreams®” from an affiliate of Universal City Studios in connection with retail operations and catalog sales pursuant to an agreement that expires in December 2010. We believe that the rights in the licensed name 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 this trademark. We cannot assure you that we will be able to renew the license agreement on favorable terms, if at all. Any inability to do so could have a material adverse effect on our business, financial condition and results of operation.

Our retail business segment is highly seasonal.

Historically, the third quarter of our fiscal year (October through December) has accounted for a greater proportion of our operating income than have each of the other three quarters of our fiscal year. In the year ended March 31, 2006, more than 58% of the revenues from our retail business segment and a substantial portion of our operating earnings and cash flows from operations were generated in the third quarter. Our results of operations depend significantly upon the holiday selling season in the third quarter. If less than satisfactory revenues, operating earnings or cash flows from operations are achieved during the key third quarter, we may not be able to compensate sufficiently for the lower revenues, operating earnings, or cash flows from operations during the other three quarters of the fiscal year. Our manufacturing/distribution segment and our franchise segment are not as significantly impacted by seasonality.

The loss of key management personnel would adversely impact our business.

Our success is largely dependent upon the efforts of our key management personnel, including our chief executive officer and chairman, the loss of the services of any of them would have a material adverse effect on our business and prospects. We do not have employment agreements in effect with, or key-man life insurance in the event of the death of, our president and chief executive officer or any of our other key employees, except for two of our divisional presidents. In addition, we do not currently have a chief financial officer. If we are unable to recruit and employ an experienced chief financial officer, our financial, accounting, information and other systems may be adversely affected.

The trading price of our common stock is subject to significant volatility, which is due, in part, to the lack of liquidity of our shares. This lack of liquidity may continue for the foreseeable future.

Our common stock currently trades on the Over-The-Counter Bulletin Board. The trading markets for securities quoted on the Over-The-Counter Bulletin Board typically lack the depth, liquidity and orderliness necessary to maintain an active market in the trading of such securities. The development of a public trading market depends upon the existence of willing buyers and sellers, the presence of which is not within the control of Dreams nor assured by listing our common stock on the Over-The-Counter Bulletin Board. The absence of a liquid and active trading market, or the discontinuance thereof, may have an adverse effect on both the price and liquidity of our common stock.

Additionally, disclosures of our operating results, announcements of regulatory changes affecting our franchise segment, other factors affecting our operations and general conditions in the securities markets unrelated to our operating performance may cause the market price of our common stock to change significantly over short periods of time. The trading price of our common stock has been and is likely to continue to be volatile.

Risks related to the E-commerce Industry

Government regulation of the Internet and E-commerce is evolving and unfavorable changes could harm our business.

A significant portion of our revenues are generated from our e-commerce business. Our e-commerce business is subject to regulations and laws specifically governing the Internet and e-commerce. Such existing and future laws and regulations may impede the growth of the Internet or other online services. These regulations and laws may cover taxation, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel, and personal privacy apply to the Internet and e-commerce. Unfavorable resolution of these issues may harm our business.

We buy a significant portion of our inventory from a few vendors.

Although we continue to increase our direct purchasing from manufacturers, we source a significant amount of inventory from relatively few vendors. However, no vendor accounts for 10% or more of our inventory purchases. We do not have long-term contracts or arrangements with most of our vendors to guarantee the availability of merchandise, particular payment terms, or the extension of credit limits. If our current vendors were to stop selling to us on acceptable terms, we may not be able to acquire merchandise from other suppliers in a timely and efficient manner and on acceptable terms.

We could be liable for breaches of security on our website.

A fundamental requirement for e-commerce is the secure transmission of confidential information over public networks. Although we have developed systems and processes that are designed to protect consumer information and prevent fraudulent credit card transactions and other security breaches, failure to mitigate such fraud or breaches may adversely affect our operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults upon Senior Securities.

None.

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

None.

Item 5. Other Information.

None.

Item 6. Exhibits.


No.
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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

32.2		Certification of Principal Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002

SIGNATURE

In accordance with the Exchange Act, the Registrant has caused this report to be signed on behalf of the Registrant by the undersigned in the capacities indicated, thereunto duly authorized on November 14, 2006.


DREAMS, INC.

By:		/s/ Ross Tannenbaum
		Ross Tannenbaum, Chief Executive Officer,
		Principal Accounting Officer

Exhibit Index


Exhibit No.		Description
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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

32.2		Certification of Principal Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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