Reported on Bukkit forum:
RugRats said: ↑

@Zarius

CREATURE_SHEEP:
- tool: ALL
drop: WOOL
quantity: 0-3
chance: 100
It doesn't drop 0-3 wool anymore it drops the default?

Test, confirm and fix - or close as working.

Haven't been able to test yet but suspect this may have to do with the change to sheep in 1.7.

This is an issue with Bukkit (not firing EntityDeath event for sheep) and is resolved in build 965+ (new CraftBukkit RB should resolve this for everyone)