10-Q 1 sfholdings2002q01-10q.txt FISCAL 2002 QUARTER 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Thirteen Weeks Ended December 30, 2001 [] Transition Report Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934 for the transition period from _________ to_________ Commission file number 333-50683 SF HOLDINGS GROUP, INC. (Exact name of registrant as specified in its charter) Delaware 13-3990796 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 373 Park Avenue South, New York, New York 10016 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 212/779-7448 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 requirements for the past 90 days. Yes [X] No [ ] The number of shares outstanding of the Registrant's common stock as of February 11, 2002: SF Holdings Group, Inc. Class A Common Stock, $0.001 par value - 562,583 shares SF Holdings Group, Inc. Class B Common Stock, $0.001 par value - 56,459 shares SF Holdings Group, Inc. Class C Common Stock, $0.001 par value - 39,900 shares SF Holdings Group, Inc. Class D Common Stock, $0.001 par value - No shares ================================================================================ PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS SF HOLDINGS GROUP, INC. CONSOLIDATED BALANCE SHEETS (In thousands)

See accompanying Notes to Consolidated Financial Statements. 2 SF HOLDINGS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE LOSS (Unaudited) (In thousands)

See accompanying Notes to Consolidated Financial Statements. 3 SF HOLDINGS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)

See accompanying Notes to Consolidated Financial Statements. 4 SF HOLDINGS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) BASIS OF PRESENTATION SF Holdings Group, Inc. ("SF Holdings"), is a holding company that conducts its operations through its subsidiaries, Sweetheart Holdings Inc. ("Sweetheart") and The Fonda Group, Inc. ("Fonda") (collectively, the "Company"), and therefore has no significant cash flows independent of such subsidiaries. The instruments governing the indebtedness of Sweetheart and Fonda contain numerous restrictive covenants that restrict Sweetheart and Fonda's ability to pay dividends or make other distributions to SF Holdings or to each other. The Company believes that the combined operations of its subsidiaries makes the Company one of the largest converters and marketers of disposable food service and food packaging products in North America. The information included in the foregoing interim financial statements of the Company is unaudited but, in the opinion of management, includes all adjustments (consisting only of normal recurring adjustments and accruals) which the Company considers necessary for a fair presentation of the operating results for these periods. Results for the interim periods are not necessarily indicative of results for the entire year. These condensed consolidated financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2001. (2) RECENTLY ISSUED ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board ("FASB") issued two new pronouncements: Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 prohibits the use of the pooling-of-interest method for business combinations initiated after June 30, 2001 and also applies to all business combinations accounted for by the purchase method that are completed after June 30, 2001. There are also transition provisions that apply to business combinations completed before July 1, 2001, that were accounted for by the purchase method. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 and applies to all goodwill and other intangible assets recognized in an entity's balance sheet. The Company has adopted SFAS No. 141 and is currently evaluating the impact of SFAS No. 142 on its consolidated financial statements. In October 2001, the FASB issued pronouncement SFAS No. 144, Impairment or Disposal of Long-Lived Assets. This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting Principals Board Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). This Statement also amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company is currently evaluating the impact of SFAS No. 144 on its consolidated financial statements. 5 (3) INVENTORIES The components of inventories are as follows (in thousands): (Unaudited) December 30, September 30, 2001 2001 ------------ ------------- Raw materials and supplies $ 57,906 $ 55,955 Finished products 144,537 158,297 Work in progress 9,631 10,769 --------- --------- Total inventories $ 212,074 $ 225,021 ========= ========= (4) RELATED PARTY TRANSACTIONS All of the affiliates referenced below are directly or indirectly under the common ownership of the Company's Chief Executive Officer. The Company believes that transactions entered into with related parties were negotiated on terms which are at least as favorable as it could have obtained from unrelated third parties and were negotiated on an arm's length basis. During the thirteen weeks ending December 30, 2001, the Company sold $1.8 million of scrap paper to Fibre Marketing Group, LLC, a waste paper recovery business in which Fonda has a 25% interest ("Fibre Marketing"). Included in accounts receivable as of December 30, 2001 was $0.9 million due from Fibre Marketing. Other sales, if any, to affiliates during the thirteen weeks ending December 30, 2001 were not significant. During the thirteen weeks ended December 30, 2001, Fibre Marketing issued to Fonda and Sweetheart promissory notes for $0.4 million and $0.8 million respectively in exchange for outstanding accounts receivable from Fibre Marketing, each at an annual interest rate of 7.0% payable in 36 monthly installments. As of December 30, 2001 $0.4 million is due to Fonda and $0.8 million is due to Sweetheart. During the thirteen weeks ending December 30, 2001, the Company purchased $2.6 million of corrugated containers from Box USA Holdings, Inc. ("Box USA"), a converter and seller of interior packaging, corrugated sheets and corrugated containers which the Company's Chief Executive owns in excess of 10% of its outstanding capital stock, and $0.3 million of travel services from Emerald Lady, Inc. ("Emerald Lady"), a company wholly owned by the Company's Chief Executive Officer. Included in accounts payable, as of December 30, 2001, was $0.5 million due to Box USA. Other purchases from affiliates, if any, during the thirteen weeks ending December 30, 2001 were not significant. Fonda had loan receivables from its Chief Executive Officer totaling $0.3 million plus accrued interest at 5.06% at December 30, 2001 and December 24, 2000. The loans are payable upon demand. During Fiscal 2000, Sweetheart entered into a lease agreement with D&L Development, LLC, an entity in which Sweetheart's Chief Executive Officer indirectly owns 47%, to lease a warehouse facility in Hampstead, Maryland. During the thirteen weeks ending December 30, 2001 and the thirteen weeks ending December 24, 2000, rental payments under this lease were $0.9 million and $0.6 million, respectively. Annual rental payments under the 20 year lease are $3.7 million for the first 10 years of the lease and $3.8 million annually, thereafter. During Fiscal 2000, Sweetheart began leasing a facility in North Andover, Massachusetts from D&L Andover Property, LLC, an entity in which Sweetheart's Chief Executive Officer indirectly owns 6 50%. During the thirteen weeks ending December 30, 2001 and the thirteen weeks ending December 24, 2000, rental payments under this lease were $0.4 million and $0.2 million, respectively. Annual rental payments under the 20 year lease are $1.5 million in the first year, which escalates at a rate of 2% each year thereafter. Fonda leases a building in Jacksonville, Florida from the Company's Chief Executive Officer. Annual payments under the lease are $0.2 million plus annual increases based on changes in the Consumer Price Index ("CPI") through December 31, 2014. In addition, the Chief Executive Officer can require Fonda to purchase the facility for $1.5 million, subject to a CPI-based escalation, until July 31, 2006. In Fiscal 1998, Fonda terminated its operations at this facility and is currently subleasing the entire facility. Four M Corporation ("Four M") subleased a portion of this facility through May 1998 and again from October 1999 through February 2000. Rent expense, net of sublease income on the portion of the premises subleased is not significant. During the thirteen weeks ending December 24, 2000, the Company sold $1.6 million of scrap paper to Fibre Marketing. Included in accounts receivable as of December 24, 2000 were $1.4 million due from Fibre Marketing. Other sales, if any, to affiliates during the thirteen weeks ending December 24, 2000 were not significant. During the thirteen weeks ending December 24, 2000, the Company purchased $1.8 million of corrugated containers from Box USA and $0.2 million of travel services from Emerald Lady. Included in accounts payable, as of December 24, 2000, is $0.1 million due to Box USA. Other purchases from affiliates, if any, during the thirteen weeks ending December 24, 2000 were not significant. (5) SF HOLDINGS STOCK OPTION PLAN During the thirteen weeks ended March 25, 2001, the Company adopted the SF Holdings Group, Inc. Share Incentive Plan ("the Share Incentive Plan") in which the Company may grant options to its employees to purchase up to 95,995 shares of the Company's Class D common stock. The Company has reserved 95,995 shares of Class D common stock for issuance upon exercise of these options. The exercise price of each option is determined by the Company at the date of grant and an option's maximum term is 10 years. During the thirteen weeks ended March 25, 2001, the Company granted options to purchase shares of its common stock to certain employees of the Company. Certain officers of the Company were issued options that vested one-third immediately with the remaining options vesting over two years, while all other eligible employees were issued options that vest over a period of three years. The exercise prices of the options granted to the officers and certain employees were below the fair market value of the Company's common stock at the date of the grant. During the vesting periods, these discounts of $1.6 million are being amortized as compensation expense and credited to additional paid-in capital by the Company. Amortization expense relating to the Company's stock options was $0.1 million for the thirteen weeks ended December 30, 2001. (6) OTHER (INCOME) EXPENSE During the thirteen weeks ended December 30, 2001, Sweetheart realized $2.6 million due to the amortization of the deferred gain in conjunction with a sale-leaseback transaction. In Fiscal 2000, Sweetheart sold certain production equipment in connection with a sale-leaseback transaction ("Sale-Leaseback Transaction"). Also, during the thirteen weeks ended December 30, 2001, the Company recognized a $2.4 million gain in association with Sweetheart's sale of a manufacturing facility in 7 Manchester, New Hampshire. These gains were partially offset by $1.5 million reflecting certain costs incurred that are associated with the rationalization, consolidation and improvement of Sweetheart's manufacturing facilities. During the thirteen weeks ended December 24, 2000, Sweetheart realized $2.6 million due to the amortization of the deferred gain in conjunction with the Sale-Leaseback Transaction. Additionally, the Company recognized a gain of $0.5 million from the sale of a building in Indianapolis, Indiana. (7) CONTINGENCIES During Fiscal 2001, Sweetheart experienced a casualty loss at its Somerville, Massachusetts facility. Sweetheart carries business interruption insurance and has filed a claim with the insurance company. Settlement of the recovery amount is to be determined. A lawsuit entitled Aldridge v. Lily-Tulip, Inc. Salary Retirement Plan Benefits Committee and Fort Howard Cup Corporation, Civil Action No. CV 187-084, was filed in state court in Georgia in April 1987 and later removed to federal court. The Plaintiffs claimed, among other things, that Sweetheart wrongfully terminated the Lily Tulip, Inc. Salary Retirement Plan (the "Plan") in violation of the Employee Retirement Income Security Act of 1974, as amended. The relief sought by Plaintiffs was to have the Plan termination declared ineffective. The United States Court of Appeals for the Eleventh Circuit (the "Circuit Court") ruled that the Plan was lawfully terminated on December 31, 1986, and judgment was entered dismissing the case in March 1996. The Circuit Court affirmed the judgment entered in favor of Sweetheart. Plaintiffs filed a petition for writ of certiorari to the United States Supreme Court, which was denied in January 1999. Sweetheart expects to complete paying out the termination liability and associated expenses in connection with the Plan termination by June 30, 2002. As of December 30, 2001, Sweetheart disbursed $19.6 million in termination payments. The estimate of the total termination liability and associated expenses, less payments, exceeds the assets set aside in the Plan by $0.1 million, which amount has been fully reserved by Sweetheart. On November 29, 2001, the liquidating trustee of Ace Baking Company, Limited Partnership, filed a Complaint for Avoidance of Transfers and Disallowance or Subordination of Claims against Sweetheart in the United States Bankruptcy Court Eastern District of Wisconsin. The Complaint, among other things, seeks to avoid a portion of the consideration paid by Ace Baking Company to Sweetheart, as a fraudulent transfer, in connection with the sale by Sweetheart of its bakery business to Ace Baking in November 1997. In addition, the trustee alleges that certain subsequent payments made by Ace Baking to Sweetheart in connection with such sales are avoidable preferences. Sweetheart believes that the trustee's claims are without merit and Sweetheart intends to vigorously defend this matter. In addition, Sweetheart has no reason to believe that the final outcome of this matter will have a material adverse effect on its financial condition or results of operations. However, Sweetheart cannot give assurance as to the ultimate effect on it, if any, given the early stage of this matter. The Company is subject to legal proceedings and other claims arising in the ordinary course of its business. The Company maintains insurance coverage of types and in amounts which it believes to be adequate and believes that it is not presently a party to any litigation, the outcome of which could reasonably be expected to have a material adverse effect on its financial condition or results of operations. (8) BUSINESS SEGMENTS The Company is a holding company and its reportable segments consist of the operations of its two significant operating subsidiaries Sweetheart and Fonda. Sweetheart primarily manufactures and sells disposable paper, plastic and foam foodservice and food packaging products to customers in institutional markets. Fonda primarily manufactures and sells disposable paper and tissue-based foodservice products to 8 customers in institutional and consumer markets. Data for such segments and a reconciliations to consolidated amounts are presented in the table below (in thousands): For the Thirteen For the Thirteen weeks ended weeks ended December 30, 2001 December, 24 2000 ----------------- ----------------- Net sales: Sweetheart $ 228,016 $ 233,579 Fonda 100,788 100,166 Corporate and eliminations (7,929) (7,242) ---------- ---------- Net Sales $ 320,875 $ 326,503 ========== ========== Income from operations excluding other (income) expense: Sweetheart $ 3,779 $ 2,398 Fonda 7,014 6,609 Corporate and eliminations 69 52 ---------- ---------- Income from operations $ 10,862 $ 9,059 ========== ========== (9) SUBSEQUENT EVENTS On January 25, 2002, Newcup, LLC, a newly formed unaffiliated investment entity ("Newcup"), purchased $103,201,000 (approximately 71%) of the aggregate principal amount outstanding of the 12 3/4% Senior Discount Notes due 2008 (the "Discount Notes") of SF Holdings. Newcup's investments will be limited to the ownership of the Discount Notes. Newcup has consented to an amendment of, and SF Holdings has amended effective January 25, 2002, the Indenture governing the Discount Notes to eliminate substantially all of the restrictive covenants and to release all of the collateral securing the Discount Notes. SF Holdings's Certificate of Incorporation has also been amended to conform the terms of the SF Holding's Exchangeable Preferred Stock to the amendments made to the Indenture. Newcup and SF Holdings have also agreed to reduce the aggregate principal amount of the Discount Notes held by Newcup, to reduce the interest rate thereon and to defer the first date on which interest must be paid in cash. Newcup issued $54 million of notes (the "Newcup Notes") to another unaffiliated investment entity (the "Newcup Note Holder") and used the net proceeds thereof to acquire the Discount Notes and, on January 26, 2002, SF Holdings agreed to guarantee the obligations of Newcup under the Newcup Notes in the aggregate amount of $54 million, which guarantee is secured by all of the collateral which formerly secured the Discount Notes. Newcup will pay SF Holdings an annual guarantee fee of 2%, which amount will be deducted from the principal amount of the Discount Notes at the end of each year. In addition, SF Holdings has issued to the Newcup Note Holder a warrant to purchase 76,082 shares of SF Holdings' Class C Common Stock for $0.01 per share. In the event that Newcup is unable to pay cash interest on the Newcup Notes as required thereunder, which in no event would be earlier than March 31, 2004, the Newcup Note Holder would have the right to put a portion of Newcup's obligations to the Newcup Note Holder in exchange for 49% of the collateral. The remaining obligations of Newcup under the Newcup Notes would continue to be secured by SF Holding's guarantee together with the remaining collateral. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Forward-looking statements in this filing, including those in the Notes to Consolidated Financial Statements, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks and uncertainties and actual results could differ materially. Such risks and uncertainties include, but are not limited to, general economic and business conditions, competitive market pricing, increases in raw material costs, energy costs and other manufacturing costs, fluctuations in demand for the Company's products, potential equipment 9 malfunctions and pending litigation. For additional information, see the Company's annual report on Form 10-K for the most recent fiscal year. General SF Holdings Group, Inc. ("SF Holdings") was formed in December 1997. SF Holdings conducts all of its operations through its subsidiaries, Sweetheart Holdings Inc. ("Sweetheart") and The Fonda Group, Inc. ("Fonda") (collectively, the "Company"), and therefore has no significant cash flows or operations independent of such subsidiaries. On March 12, 1998, the Company purchased 48% of Sweetheart's voting stock and 100% of its non-voting stock, or 90% of the total outstanding stock, from Sweetheart's then existing shareholders (the "Sweetheart Investment"). In connection therewith, the then existing shareholders continue to hold 52% of the voting stock of Sweetheart of which American Industrial Partners Capital Fund L.P. ("AIP") holds approximately 27%. In addition, on March 12, 1998, Fonda became a wholly owned subsidiary of the Company. Sweetheart and Fonda are converters and marketers of disposable paper, plastic and foam foodservice and food packaging products. The prices for each subsidiary's raw materials fluctuate. When raw material prices decrease, selling prices have historically decreased. The actual impact on each company from raw materials price changes is affected by a number of factors including the level of inventories at the time of a price change, the specific timing and frequency of price changes, and the lead and lag time that generally accompanies the implementation of both raw materials and subsequent selling price changes. In the event that raw materials prices decrease over a period of several months, each company may suffer margin erosion on the sale of such inventory. Each of Fonda and Sweetheart's business is seasonal with a majority of its net cash flow from operations realized during the last six months of the fiscal year. Sales for such periods reflect the high seasonal demands of the summer months when outdoor and away-from-home consumption increases. In the event that Fonda's and/or Sweetheart's cash flow from operations is insufficient to provide working capital necessary to fund their respective requirements, Fonda and/or Sweetheart will need to borrow under their respective credit facilities or seek other sources of capital. The Company believes that funds available under such credit facilities together with cash generated from operations, will be adequate to provide for each company's respective cash requirements for the next twelve months. Recent Developments On January 25, 2002, Newcup,LLC, a newly formed unaffiliated investment entity ("Newcup"), purchased $103,201,000 (approximately 71%) of the aggregate principal amount outstanding of the 12 3/4% Senior Discount Notes due 2008 (the "Discount Notes") of SF Holdings. Newcup's investments will be limited to the ownership of the Discount Notes. Newcup has consented to an amendment of, and SF Holdings has amended effective January 25, 2002, the Indenture governing the Discount Notes to eliminate substantially all of the restrictive covenants and to release all of the collateral securing the Discount Notes. SF Holdings's Certificate of Incorporation has also been amended to conform the terms of the SF Holding's Exchangeable Preferred Stock to the amendments made to the Indenture. Newcup and SF Holdings have also agreed to reduce the aggregate principal amount of the Discount Notes held by Newcup, to reduce the interest rate thereon and to defer the first date on which interest must be paid in cash. Newcup issued $54 million of notes (the "Newcup Notes") to another unaffiliated investment entity (the "Newcup Note Holder") and used the net proceeds thereof to acquire the Discount Notes and, on January 26, 2002, SF Holdings agreed to guarantee the obligations of Newcup under the Newcup Notes in the aggregate amount of $54 million, which guarantee is secured by all of the collateral which formerly secured the Discount Notes. Newcup will pay SF Holdings an annual guarantee fee of 2%, which amount will be deducted from the principal amount of the Discount Notes at the end of each year. In addition, SF Holdings has issued to 10 the Newcup Note Holder a warrant to purchase 76,082 shares of SF Holdings' Class C Common Stock for $0.01 per share. In the event that Newcup is unable to pay cash interest on the Newcup Notes as required thereunder, which in no event would be earlier than March 31, 2004, the Newcup Note Holder would have the right to put a portion of Newcup's obligations to the Newcup Note Holder in exchange for 49% of the collateral. The remaining obligations of Newcup under the Newcup Notes would continue to be secured by SF Holding's guarantee together with the remaining collateral. Thirteen Weeks Ended December 30, 2001 Compared to Thirteen Weeks Ended December 24, 2000 Net sales decreased $5.6 million, or 1.7%, to $320.9 million for the thirteen weeks ended December 30, 2001 compared to $326.5 million for the thirteen weeks ended December 24, 2000. The following analysis includes sales from Sweetheart to Fonda and sales from Fonda to Sweetheart which were eliminated in consolidation. Sweetheart results: Net sales decreased $5.6 million, or 2.4%, to $228.0 million for the thirteen weeks ended December 30, 2001 compared to $233.6 million for the thirteen weeks ended December 24, 2000, reflecting a 0.1% increase in sales volume and a 2.5% decrease in average realized sales price. Sales volumes increased as a result of the incremental sales obtained from Sweetheart's acquisition of an 80% interest in Global Cup, S.A. De C.V. and its subsidiaries ("Global Cup") in April 2001. Average realized prices decreased as a result of decreased raw material costs and competitive pressures. Fonda results: Net sales increased $0.6 million, or 0.6%, to $100.8 million for the thirteen weeks ending December 30, 2001, compared to $100.2 million for the thirteen weeks ending December 24, 2000, reflecting a 6.4% increase in average realized sales price partially offset by a 5.8% decrease in sales volume. The decrease in sales volume resulted from declining sales of lower priced items which were affected by the general economic slow down in the leisure travel industry. As a consequence, the remaining product mix shifted to those items with higher average selling prices. Gross profit increased $1.9 million, or 4.9%, to $40.4 million for the thirteen weeks ended December 30, 2001 compared to $38.5 million for the thirteen weeks ended December 24, 2000. As a percentage of net sales, gross profit increased to 12.6% for the thirteen weeks ended December 30, 2001 from 11.8% for the thirteen weeks ended December 24, 2000. Sweetheart results: Gross profit increased $0.7 million, or 3.6%, to $20.4 million for the thirteen weeks ended December 30, 2001 compared to $19.7 million for the thirteen weeks ended December 24, 2000. As a percentage of net sales, gross profit increased to 9.0% for the thirteen weeks ended December 30, 2001 from 8.4% for the thirteen weeks ended December 24, 2000. The increase is attributable to lower raw material, transportation and utility expenses. Fonda results: Gross profit increased $0.9 million, or 4.7%, to $19.9 million for the thirteen weeks ending December 30, 2001, compared to $19.0 million for the thirteen weeks ending December 24, 2000. As a percentage of net sales, gross profit increased from 19.0% for the thirteen weeks ending December 24, 2000 to 19.7% for the thirteen weeks ending December 30, 2001. Gross profit for the thirteen weeks ending December 30, 2001 was positively affected by increased selling prices due to an improved product mix. Selling, general and administrative expenses increased $0.1 million, or 0.3%, to $29.5 million for the thirteen weeks ended December 30, 2001 compared to $29.4 million for the thirteen weeks ended 11 December 24, 2000. This increase is primarily attributed to an increase in Fonda's bad debt expense and an increase in Fonda's goodwill amortization expense from Fiscal 2001 business acquisitions. These increases were partially offset by a decrease in Sweetheart's lower variable compensation expenses. Other income, net decreased $0.3 million, or 8.8%, to $3.1 million for the thirteen weeks ended December 30, 2001 compared to $3.4 million for the thirteen weeks ended December 24, 2000. This decrease is attributable to a $1.5 million expense incurred in association with the rationalization, consolidation and improvement of the Company's manufacturing facilities offset by $2.0 million in increased gains from the sale of assets. Operating income increased $1.6 million, or 12.9%, to $14.0 million for the thirteen weeks ended December 30, 2001 compared to $12.4 million for the thirteen weeks ended December 24, 2000, due to the reasons stated above. Interest expense, net decreased $0.2 million, or 1.5%, to $13.2 million for the thirteen weeks ended December 30, 2001 compared to $13.4 million for the thirteen weeks ended December 24, 2000. This decrease is attributable to lower interest rates on higher balances for Sweetheart and lower interest rates on lower balances for Fonda. Income tax expense (benefit) increased $0.9 million, or 450.0%, to an expense of $0.7 million for the thirteen weeks ended December 30, 2001 compared to a benefit of $0.2 million for the thirteen weeks ended December 24, 2000. The effective rate for the thirteen weeks ended December 30, 2001 was 88% compared to 25% for the thirteen weeks ended December 24, 2000. For the thirteen weeks ended December 30, 2001 and for the thirteen weeks ended December 24, 2000, the effective tax rates reflect certain non-deductible costs relating to the investment in Sweetheart, the related financing and the proportionate results of both Fonda and Sweetheart. Minority interest in subsidiaries' income increased $0.1 million, or 100%, to $0.2 million in million for the thirteen weeks ended December 30, 2001 compared to $0.1 million for the thirteen weeks ended December 24, 2000 due primarily to increased earning from Sweetheart. Net loss decreased $0.8 million, or 88.9%, to $0.1 million for the thirteen weeks ended December 30, 2001 compared to $0.9 million for the thirteen weeks ended December 24, 2000, due to the reasons stated above. Liquidity And Capital Resources Historically, the Company has relied on cash flow from operations and revolving credit borrowings to finance its working capital requirements and capital expenditures. In the thirteen weeks ended December 30, 2001, the Company funded its capital expenditures from a combination of cash generated from operations, borrowings from the revolving credit facility and funds generated from asset sales. The Company expects to continue this method of funding for its Fiscal 2002 capital expenditures. Net cash provided by operating activities in the thirteen weeks ended December 30, 2001 was $1.7 million compared to $2.6 million in the thirteen weeks ended December 24, 2000. The decrease in operating cash flow in the thirteen weeks ended December 30, 2001 is primarily a resulted from a decrease in accounts payable and accrued payroll related expenses offset by a decrease in inventories. Net cash used in investing activities in the thirteen weeks ended December 30, 2001 was $2.7 million compared to $5.3 million in the thirteen weeks ended December 24, 2000. This decrease in the use of cash is primarily due to proceeds from the sale of the Manchester, New Hampshire facility, which is partially offset by increased capital expenditures. 12 Net cash used in financing activities in the thirteen weeks ended December 30, 2001 was $3.5 million compared to net cash provided by financing activities of $3.9 million in the thirteen weeks ended December 24, 2000. This decrease in cash provided from financing is primarily a result of proceeds received from the sale of the Manchester, New Hampshire facility being held in the cash escrow account and lower borrowings under the credit facilities. Working capital decreased $1.0 million to $253.2 million at December 30, 2001 from $254.2 million at September 30, 2001. This decrease resulted from current assets decreasing $19.3 million, primarily due to lower inventories, and current liabilities decreasing $18.3 million, primarily due to lower trade payables. Capital expenditures for the thirteen weeks ended December 30, 2001 were $7.9 million compared to $3.5 million for the thirteen weeks ended December 24, 2000. Capital expenditures in the thirteen weeks ended December 30, 2001 included $3.4 million for new production equipment, $1.6 million associated with the implementation of Sweetheart's program to rationalize, consolidate and improve its manufacturing facilities, $1.9 million for facility improvements, with the remaining consisting primarily of routine capital improvements. Sweetheart has a revolving credit facility (the "U.S. Credit Facility") that, subject to borrowing base limitations, allows for a maximum revolving credit borrowing of $145 million through June 15, 2005 and a term loan of $25 million that requires equal monthly principal payments of $0.4 million through June 2005. Both the term loan and the revolving credit facility have an accelerated maturity date of July 1, 2003 if Sweetheart's Senior Subordinated Notes due September 1, 2003 are not refinanced before June 1, 2003. Borrowings under the revolving credit facility bear interest, at Sweetheart's election, at a rate equal to (i) LIBOR plus 2.00% or (ii) a bank's base rate plus 0.25%, plus certain other fees. Borrowings under the term loan bear interest, at Sweetheart's election, at a rate equal to (i) LIBOR plus 2.50% or (ii) a bank's base rate plus 0.50%, plus certain other fees. During the thirteen weeks ended December 30, 2001, the weighted average annual interest rate for the U.S. Credit Facility was 5.17%. The credit facility is collateralized by Sweetheart's inventories and receivables with the term loan portion of the credit facility further collateralized by certain production equipment. As of December 30, 2001, $13.2 million was available under the revolving credit facility and the term loan balance was $11.7 million. The fee for outstanding letters of credit is 2.00% per annum and there is a commitment fee of 0.375% per annum on the daily average unused amount of the commitments. As of December 30, 2001, LIBOR was 2.44% and the bank's base rate was 4.75%. Fonda's credit facility provides for a revolving credit facility, subject to borrowing base limitations of up to $65 million through August 26, 2004, and a term loan in an amount of $15 million that requires equal monthly principal payments of $0.3 million through August 2004 with the balance due on August 26, 2004 (the "Credit Facility"). The Credit Facility is collateralized by all of Fonda's receivables, inventories, and equipment, certain general intangibles and other property, and the proceeds on the sale of receivables and inventories. Borrowings under the revolving credit facility bear interest at the bank's prime rate plus 0.50% or at LIBOR plus 2.50% at the election of Fonda. Borrowings under the term loan bear interest at the bank's prime rate plus 0.75% or at LIBOR plus 2.75% at the election of Fonda. As of December 30, 2001, the bank's prime rate was 4.75%, and the LIBOR rate was 2.44%. In the thirteen weeks ending December 30, 2001, the weighted average interest rate for the Credit Facility was 5.02%. At December 30, 2001, $41.0 million was outstanding and $24.0 million was the maximum remaining advance available based upon eligible collateral. Sweetheart's Canadian subsidiary has a credit agreement (the "Canadian Credit Facility") which provides for a term loan facility balance of Cdn $13.9 million (approximately US $8.7 million) and a revolving credit facility maximum of up to Cdn $16.1 million (approximately US $10.1 million). The 13 term borrowings are payable quarterly through May 2004. Both the revolving credit and term loan borrowings have a final maturity date of June 15, 2004. The Canadian Credit Facility is secured by all existing and thereafter acquired real and personal tangible assets of Lily-Tulip, Inc., a subsidiary of Sweetheart Cup ("Lily") and net proceeds on the sale of any of the foregoing. Borrowings under the Canadian Credit Facility bear interest at an index rate plus 1.75% with respect to the revolving credit facility and an index rate plus 2.00% with respect to the term loan borrowings. As of December 30, 2001, Cdn $2.7 million (approximately US $1.7 million) was available under the revolving facility and the term loan balance was Cdn $13.9 million (approximately US $8.7 million) under the Canadian Credit Facility. In connection with a sale-leaseback transaction, on June 15, 2000, Sweetheart Cup Company Inc. ("Sweetheart Cup"), and Sweetheart Holdings Inc. (Sweetheart Holdings") sold certain production equipment located in Owings Mills, Maryland, Chicago, Illinois and Dallas, Texas to several owner participants for a fair market value of $212.3 million. Pursuant to a lease dated as of June 1, 2000 (the "Lease") between Sweetheart Cup and State Street Bank and Trust Company of Connecticut, National Association ("State Street"), as trustee, Sweetheart Cup leases the production equipment sold in connection with the sale-leaseback transaction from State Street as owner trustee for several owner participants, through November 9, 2010. Sweetheart Cup has the option to renew the Lease for up to four consecutive renewal terms of two years each. Sweetheart Cup also has the option to purchase such equipment for fair market value either at the conclusion of the Lease term or November 21, 2006. Sweetheart's obligations under the Lease are collateralized by substantially all of Sweetheart's property, plant and equipment owned as of June 15, 2000. The Lease contains various covenants, which prohibit, or limit, among other things, dividend payments, equity repurchases or redemption, the incurrence of additional indebtedness and certain other business activities. Sweetheart is accounting for the sale-leaseback transaction as an operating lease, expensing the $32.0 million annualized rental payments. A deferred gain of $107.0 million was realized from this sale and is being amortized over 125 months, which is the term of the Lease. Sweetheart Cup is the obligor and Sweetheart Holdings the guarantor with respect to $110 million of Senior Subordinated Notes. The Senior Subordinated Notes bear interest at 10.50% per annum, payable semi-annually in arrears on March 1 and September 1 and mature on September 1, 2003. The Senior Subordinated Notes are subject to redemption at the option of Sweetheart, in whole or in part, at the redemption price (expressed as percentages of the principal amount), plus accrued interest to the redemption date, at a call premium of 100%. The Senior Subordinated Notes are subordinate in right of payment to the prior payment in full of all borrowings under the U.S. Credit Facility, all obligations under the Lease, and all other indebtedness not otherwise prohibited. The Senior Subordinated Notes contain various covenants which prohibit, or limit, among other things, asset sales, change of control, dividend payments, equity repurchases or redemption, the incurrence of additional indebtedness, the issuance of disqualified stock, certain transactions with affiliates, the creation of additional liens and certain other business activities. In Fiscal 1997, Fonda issued $120 million of 9-1/2% Series A Senior Subordinated Notes due 2007 (the "Notes") with interest payable semi-annually. Payment of the principal and interest is subordinate in right to payment of the Credit Facility. Fonda may, at its election, redeem the Notes at any time after March 1, 2002 at a redemption price equal to a percentage (104.750% after March 1, 2002 and declining in annual steps to 100% after March 1, 2005) of the principal amount thereof plus accrued interest. The Notes provide that upon the occurrence of a change of control (as defined therein), the holders thereof will have the option to require the redemption of the Notes at a redemption price equal to 101% of the principal amount thereof plus accrued interest. On March 12, 1998, the Company issued units consisting of $144 million aggregate principal amount at maturity of 12 3/4% Senior Secured Discount Notes due 2008 (the "Discount Notes") and 14 28,800 shares of Class C Common Stock for net proceeds of $77.5 million. Until March 15, 2003, accrued interest on the Discount Notes will not be paid but will accrete semi-annually, thereby increasing the carrying value of the Discount Notes. The fair value of such Class C Common Stock ($2.4 million) at the date of issuance was recorded as common stock and paid-in capital with a corresponding reduction in the carrying value of the Discount Notes. The resulting discount, as well as $4.5 million of financing fees included in other assets, is being amortized as additional interest expense over the term of the Discount Notes. Also on March 12, 1998, the Company issued units consisting of $30 million of 13 3/4% Exchangeable Preferred Stock due March 13, 2009 (the "Exchangeable Preferred") and 11,100 shares of Class C Common Stock. Until March 12, 2003, cumulative dividends on the Exchangeable Preferred are paid quarterly, at the Company's option, subject to certain restrictions, either in cash or by the issuance of additional shares of Exchangeable Preferred. Thereafter, dividends will be payable in cash, subject to certain exceptions. The fair value of such Class C Common Stock ($0.9 million) at the date of issuance was recorded as common stock and paid-in capital with a corresponding reduction in the carrying value of the Exchangeable Preferred. The resulting discount is being amortized as additional preferred stock dividends over the term of the Exchangeable Preferred. The Exchangeable Preferred is exchangeable at the Company's option into 13 3/4% subordinated notes due March 15, 2009. As of December 12, 2001, all cumulative dividends on the Exchangeable Preferred have been paid by the issuance of additional shares of Exchangeable Preferred. The value of the Exchangeable Preferred, was $49.9 million and $48.2 million as of December 30, 2001 and September 30, 2001, respectively. The Exchangeable Preferred is not entitled to any vote, except as required in the Company's certificate of incorporation and by law. On March 12, 1998, the Company authorized 100,000 shares of Preferred Stock Class B, $.001 par value. On March 12, 1998, 15,000 shares of Class B Series 1 preferred stock, $.001 par value, were issued to CEG in consideration for a $15 million investment. On December 3, 1999, 15,000 shares of Class B Series 2 preferred stock were issued in connection with the merger with CEG in consideration for 87% of shares of CEG's common stock with a liquidation value of $15 million. The Class B Series 1 and Series 2 preferred stock are not entitled to receive dividends. The holder of Class B Series 1 preferred stock is not entitled to any vote, except as otherwise provided by law. The holders of Class B Series 2 preferred stock are entitled to one vote for each share held in all matters voted on by the shareholders. Each series of preferred stock is convertible, at any time, into 133,494 shares of Class A Common Stock and is required to be redeemed on March 13, 2010, provided funds are legally available for such purposes. Pursuant to the terms of the instruments governing the indebtedness of Sweetheart and Fonda, Sweetheart and Fonda are subject to certain affirmative and negative covenants customarily contained in agreements of this type, including, without limitations covenants that restrict, subject to specified exceptions (i) mergers, consolidations, asset sales or changes in capital structure, (ii) creation or acquisition of subsidiaries, (iii) purchase or redemption of capital stock or declaration or payment of dividends or distributions on such capital stock, (iv) incurrence of additional indebtedness, (v) investment activities, (vi) granting or incurrence of liens to secure other indebtedness, (vii) prepayment or modification of the terms of subordinated indebtedness, and (viii) engaging in transactions with affiliates. During Fiscal 2001, Sweetheart experienced a casualty loss at its Somerville, Massachusetts facility. Sweetheart carries business interruption insurance and has filed a claim with the insurance company. Settlement of the recovery amount is to be determined. 15 A lawsuit entitled Aldridge v. Lily-Tulip, Inc. Salary Retirement Plan Benefits Committee and Fort Howard Cup Corporation, Civil Action No. CV 187-084, was filed in state court in Georgia in April 1987 and later removed to federal court. The Plaintiffs claimed, among other things, that Sweetheart wrongfully terminated the Lily Tulip, Inc. Salary Retirement Plan (the "Plan") in violation of the Employee Retirement Income Security Act of 1974, as amended. The relief sought by Plaintiffs was to have the Plan termination declared ineffective. The United States Court of Appeals for the Eleventh Circuit (the "Circuit Court") ruled that the Plan was lawfully terminated on December 31, 1986, and judgment was entered dismissing the case in March 1996. The Circuit Court affirmed the judgment entered in favor of Sweetheart. Plaintiffs filed a petition for writ of certiorari to the United States Supreme Court, which was denied in January 1999. Sweetheart expects to complete paying out the termination liability and associated expenses in connection with the Plan termination by June 30, 2002. As of December 30, 2001, Sweetheart disbursed $19.6 million in termination payments. The estimate of the total termination liability and associated expenses, less payments, exceeds the assets set aside in the Plan by $0.1 million, which amount has been fully reserved by Sweetheart. On November 29, 2001, the liquidating trustee of Ace Baking Company, Limited Partnership, filed a Complaint for Avoidance of Transfers and Disallowance or Subordination of Claims against Sweetheart in the United States Bankruptcy Court Eastern District of Wisconsin. The Complaint, among other things, seeks to avoid a portion of the consideration paid by Ace Baking Company to Sweetheart, as a fraudulent transfer, in connection with the sale by Sweetheart of its bakery business to Ace Baking in November 1997. In addition, the trustee alleges that certain subsequent payments made by Ace Baking to Sweetheart in connection with such sales are avoidable preferences. Sweetheart believes that the trustee's claims are without merit and Sweetheart intends to vigorously defend this matter. In addition, Sweetheart has no reason to believe that the final outcome of this matter will have a material adverse effect on its financial condition or results of operations. However, Sweetheart cannot give assurance as to the ultimate effect on it, if any, given the early stage of this matter. The Company believes that cash generated by each of Fonda's and Sweetheart's operations, combined with amounts available under its respective credit facilities in addition to funds generated by asset sales should be sufficient to fund each of Fonda's and Sweetheart's respective capital expenditures needs, debt service requirements, payments in conjunction with lease commitments and working capital needs, including Sweetheart's termination liabilities under the Plan in the next twelve months. The Company continues to contemplate various strategic options which may include a restructuring of its business debt and capital structure, including, among other things, the public sale or private placement of debt or equity securities of the Company or its subsidiaries, joint venture transactions, new borrowings, the refinancing of the Company's existing debt agreements, open market purchases, tender offers or exchange offers of the Company's outstanding securities. There can be no assurances that any of these strategic options will be consummated. Net Operating Loss Carryforwards As of September 30, 2001, Sweetheart had approximately $28 million of net operating loss ("NOL") carryforwards for federal income tax purposes, which expire in 2018. Although Sweetheart expects that sufficient taxable income will be generated in the future to realize these NOLs, there can be no assurance that future taxable income will be generated to utilize such NOLs. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Sweetheart is exposed to market risk in the ordinary course of business, which consists primarily of interest rate risk associated with its variable rate debt. All borrowing under the U.S. Credit Facility and Canadian Credit Facility, each of which contains a revolving and term credit facility, bear interest at a variable rate. Borrowings under the U.S. Credit Facility's revolving credit facility bear interest, at 16 Sweetheart's election, at a rate equal (i) LIBOR plus 2.00% or (ii) a bank's base rate plus 0.25%, plus certain fees. Borrowings under the U.S. Credit Facility's term loan bear interest, at Sweetheart's election, at a rate equal to (i) LIBOR plus 2.50% or (ii) a bank's base rate plus 0.50%, plus certain other fees. Borrowings under the Canadian Credit Facility bear interest at an index rate plus 1.75% with respect to the revolving credit borrowings and an index rate plus 2.00% with respect to the term loan borrowings. As of December 30, 2001, the outstanding indebtedness under the U.S. Credit Facility was $138.1 million and the Canadian Credit Facility was $15.7 million in U.S. dollars. As of December 30, 2001, $13.2 million was available under the U.S. Credit Facility. As of December 30, 2001, Cdn $2.7 million (approximately US $1.7 million) was available under Canadian Credit Facility. Based upon these amounts, the annual net income would change by approximately $1.5 million for each one percentage point change in the interest rates applicable to the variable rate debt. The level of the exposure to interest rate movements may fluctuate significantly as a result of changes in the amount of indebtedness outstanding under the revolving credit facilities. Fonda is exposed to market risk in the ordinary course of business, which consists primarily of interest rate risk associated with its variable rate debt. Borrowings under the revolving credit facility bear interest at the bank's prime rate plus 0.50% or at LIBOR. Borrowings under the term loan bear interest at the bank's prime rate plus 0.75% or at LIBOR plus 2.75% at the election of Fonda. At December 30, 2001, $41.0 million was outstanding and $24.0 million was the maximum remaining advance available based upon eligible collateral. Based upon these amounts, the annual net income would change by approximately $0.3 million for each one percentage point change in the interest rates applicable to Fonda's variable rate debt. The level of the exposure to interest rate movements may fluctuate significantly as a result of changes in the amount of indebtedness outstanding under the revolving credit facilities. PART II - OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: None (b) Reports on Form 8-K: No reports on Form 8-K were filed during the thirteen weeks ended December 30, 2001. 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, its duly authorized officer and principal financial officer. SF HOLDINGS GROUP, INC. (registrant) Date: February 11, 2002 By: /s/ Hans H. Heinsen ----------------- ------------------- Hans H. Heinsen Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer and Duly Authorized Officer) 18

SF HOLDINGS GROUP INC 10-Q