10-Q 1 sweetheart2002q03-10q.txt SWEETHEART FY02 Q3 10Q ================================================================================ 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 Thirty-nine Weeks Ended August 6, 2002 [ ] 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 33-91600 SWEETHEART HOLDINGS INC.* (Exact name of registrant as specified in its charter) Delaware 06-1281287 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 10100 Reisterstown Road, Owings Mills, Maryland 21117 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 410/363-1111 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 July 31, 2002: Sweetheart Holdings Inc. Class A Common Stock, $0.01 par value- 1,046,000 shares Sweetheart Holdings Inc. Class B Common Stock, $0.01 par value- 4,393,200 shares * The Registrant is the guarantor of the 12.0% Senior Subordinated Notes due 2003 of Sweetheart Cup Company Inc., a wholly owned subsidiary of the Registrant. ================================================================================ PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS SWEETHEART HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data)

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

See accompanying Notes to Consolidated Financial Statements. 3 SWEETHEART HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)

See accompanying Notes to Consolidated Financial Statements. 4 SWEETHEART HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) BASIS OF PRESENTATION On March 25, 2002, pursuant to an Agreement and Plan of Merger, The Fonda Group, Inc. ("Fonda") was merged (the "Merger") with and into Sweetheart Cup Company Inc. ("Sweetheart Cup"), with Sweetheart Cup as the surviving entity. In connection with the Merger, all of the assets and operations of Fonda were assigned to, and all liabilities of Fonda were assumed by, Sweetheart Cup by operation of law and all of the outstanding shares of Fonda were cancelled. Sweetheart Cup, the surviving entity, is a wholly owned subsidiary of Sweetheart Holdings Inc. ("Sweetheart Holdings") which is a wholly owned subsidiary of SF Holdings Group, Inc. ("SF Holdings"). Pre-merger, Sweetheart Holdings and Fonda were under common control, and therefore, the transaction has been accounted for in a manner similar to a pooling-of-interests. The accompanying consolidated financial statements of Sweetheart Holdings and its subsidiaries (the "Company") have been restated for all periods presented. Pursuant to an agreement, dated as of March 22, 2002 by and among Dennis Mehiel, the Company's Chairman and Chief Executive Officer, SF Holdings, American Industrial Partners Management Company, Inc., American Industrial Partners Capital Fund L.P. ("AIP") and the other stockholders of Sweetheart Holdings signatory to that certain Stockholders' Agreement, dated as of March 12, 1998, (together with AIP and any permitted transferee of shares of Class A common stock or Class B common stock of Sweetheart Holdings ("the Shares"), the "Original Stockholders"), all of the outstanding Shares not held by SF Holdings (which consisted of 52% of the voting stock of Sweetheart Holdings) were delivered to SF Holdings and exchanged for 96,000 shares of Class C common stock of SF Holdings. As a result, SF Holdings became the sole beneficial owner of 100% of the issued and outstanding capital stock of Sweetheart Holdings. In addition and in connection therewith, the Stockholders Agreement and related stockholders' right agreement were terminated. 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 consolidated financial statements and notes thereto included in the annual reports on Form 10-K/A of Sweetheart Holdings and Form 10-K of Fonda 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 regardless of when these assets were originally recognized. SFAS No. 142 requires that goodwill and certain intangibles with an indefinite life not be amortized, but subject to an impairment test on an annual basis. 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 5 reporting provisions of Accounting Principals Board Opinion No. 30, ("APB 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. In April 2002, the FASB issued pronouncement SFAS No. 145, Recission of FASB No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement addresses, among other items, the classification of gains and losses from extinguishment of debt. In accordance with the statement, any gain or loss on extinguishment of debt that does not meet the criteria in APB No. 30 will no longer be classified as an extraordinary item for all periods presented. This statement is effective for fiscal years beginning after May 15, 2002. The Company is currently evaluating the impact of SFAS No. 145 on its consolidated financial statements. (3) INVENTORIES The components of inventories are as follows (in thousands): (Unaudited) June 30, September 30, 2002 2001 --------------- ----------------- Raw materials and supplies $ 47,679 $ 55,955 Finished products 148,863 158,297 Work in progress 10,029 10,769 ---------- ---------- Total inventories $ 206,571 $ 225,021 ========== ========== (4) RELATED PARTY TRANSACTIONS All of the affiliates (other than Fibre Marketing , LLC, a waste recovery business in which the Company has a 25% interest ("Fibre Marketing")) referenced below are directly or indirectly under the common ownership of the Company's Chief Executive Officer. The Company believes that the transactions described below which were 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 thirty-nine weeks ended June 30, 2002, the Company sold $5.5 million of scrap paper and plastic to Fibre Marketing Group. Accounts receivable as of June 30, 2002 included $1.2 million due from Fibre Marketing. On November 1, 2001, Fibre Marketing issued to Fonda and Sweetheart Cup promissory notes in the aggregate principal amount of approximately $1.2 million in exchange for outstanding accounts receivable from Fibre Marketing. The notes are secured by all of Fibre Marketing's account receivables, bear interest at an annual rate of 7.0% and are payable in 36 equal monthly installments. As of June 30, 2002, $1.0 million is due to the Company. During the thirty-nine weeks ended June 30, 2002, the Company purchased $8.2 million of corrugated containers from Box USA Holdings, Inc. ("Box USA"), a company in which the Company's Chief Executive Officer owns in excess of 10% of its outstanding capital stock, and $0.8 million of travel 6 services from Emerald Lady, Inc, a company wholly owned by the Company's Chief Executive Officer ("Emerald Lady"). Accounts payable, as of June 30, 2002 included $1.2 million due to Box USA. The Company had a loan receivable from its Chief Executive Officer of $0.3 million plus accrued interest at 5.06% at June 30, 2002. The loan is payable upon demand. During Fiscal 2000, the Company entered into a lease agreement with D&L Development, LLC, an entity in which the Company's Chief Executive Officer indirectly owns 47%, to lease a warehouse facility in Hampstead, Maryland. During the thirty-nine weeks ending June 30, 2002 and the thirty-nine weeks ending June 24, 2001, rental payments under this lease were $2.8 million and $2.6 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, the Company began leasing a facility in North Andover, Massachusetts from D&L Andover Property, LLC, an entity in which the Company's Chief Executive Officer indirectly owns 50%. During the thirty-nine weeks ending June 30, 2002 and the thirty-nine weeks ending June 24, 2001, rental payments under this lease were $1.1 million and $1.0 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. The Company 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 the Company to purchase the facility for $1.5 million, subject to a CPI-based escalation, until July 31, 2006. In Fiscal 1998, the Company terminated its operations at this facility and is currently subleasing the entire facility. Rent expense, net of sublease income on the portion of the premises subleased is $0.1 million during the thirty-nine weeks ending June 30, 2002. During the thirty-nine weeks ended June 24, 2001, the Company sold $5.2 million of scrap paper and plastic to Fibre Marketing. Accounts receivable as of June 24, 2001 included $2.5 million due from Fibre Marketing and $0.7 million due from SF Holdings. During the thirty-nine weeks ended June 24, 2001, the Company purchased $5.7 million of corrugated containers from Box USA and $0.8 million of travel services from Emerald Lady. Accounts payable, as of June 24, 2001, included $0.5 million due to Box USA. On December 3, 1999, Creative Expressions Group, Inc. ("CEG"), an affiliate of the Company in the disposable party goods products business, became an 87% owned subsidiary of SF Holdings pursuant to a merger (the "CEG Merger"). On December 6, 1999, pursuant to the CEG Asset Purchase Agreement, the Company purchased the intangible assets of CEG, including domestic and foreign trademarks, patents, copyrights and customer lists. CEG's net assets and liabilities that were not acquired by the Company pursuant to the CEG Asset Purchase Agreement were acquired by SF Holdings and have been classified as "Due to/from SF Holdings". (5) LONG-TERM DEBT OBLIGATIONS On June 10, 2002, the Company entered into a loan agreement with the Department of Business and Economic Development, a principal department of the State of Maryland, to borrow $2.0 million (the "Maryland Loan"). The Maryland Loan bears interest at a rate ranging from 3.0% to 8.0% per annum depending on certain employment rates at the Company's Owings Mills, Maryland facility. The Maryland Loan is payable in quarterly installments through March 1, 2007. As of June 30, 2002, $2.0 7 million was outstanding at an annual interest rate of 3.0%. On March 25, 2002, the Company entered into a supplemental indenture to the Indenture (the "Indenture") governing its $110 million 10 1/2% Senior Subordinated Notes due 2003 (the "$110 Senior Subordinated Notes") to amend the definition of "Change of Control" in the Indenture to substitute Dennis Mehiel, the Company's Chairman and Chief Executive Officer, for AIP and to make certain other conforming changes. The Company offered to pay $5.00 for each $1,000 in principal amount of the $110 Senior Subordinated Notes (the "Consent Fee") to holders of the $110 Senior Subordinated Notes who had properly furnished, and not revoked, their consent on or prior to the expiration date of the consent solicitation (the "Consent Solicitation"). As a result of the consummation of the Consent Solicitation, the $110 Senior Subordinated Notes began to accrue interest at 12% per annum as of March 1, 2002. The Company paid the Consent Fee to the holders of the $110 Senior Subordinated Notes who consented prior to the expiration of the Consent Solicitation. Such Consent Fee has been capitalized in other assets and is being amortized over the term of the $110 Senior Subordinated Notes. On March 25, 2002, the Company refinanced its senior revolving credit facility with Bank of America, N.A., as agent (the "Senior Credit Facility"), which replaced each of Sweetheart Cup's and Fonda's existing domestic revolving credit and term loan facilities. The Senior Credit Facility has a maturity date of March 25, 2007; however, in the event that the Company has not refinanced, repaid or extended the $110 Senior Subordinated Notes prior to March 1, 2003, the Senior Credit Facility shall terminate on that date. The Senior Credit Facility allows for a maximum credit borrowing of $235 million subject to borrowing base limitations and satisfaction of other conditions of borrowing. The revolving borrowings have a maximum of the lesser of $235 million less the balance of the term loans or $215 million. The term loans have a maximum of $25 million and are payable monthly through March 2005. Borrowings under the Senior Credit Facility, at the Company's election, bear interest at either (i) a bank's base rate revolving loan reference rate plus 0.5% or (ii) LIBOR plus 2.5%. For the thirty-nine weeks ended June 30, 2002, the weighted average annual interest rate for the Senior Credit Facility was 4.85%. The Senior Credit Facility is collateralized by the Company's accounts, inventory, general intangibles and certain other assets. 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 June 30, 2002, $31.7 million was available under the Senior Credit Facility. Extraordinary loss on debt extinguishment was $1.1 million, net of the income tax benefit in the thirty-nine weeks ended June 30, 2002, resulting from the refinancing of the Company's Senior Credit Facility. (6) SF HOLDINGS STOCK OPTION PLAN During the thirty-nine weeks ended June 24, 2001, SF Holdings granted options to purchase shares of its common stock to certain employees of the Company. The options vest over a period of three years. Certain of the exercise prices of the options were below the fair market value of SF Holdings' common stock at the date of the grant. During the vesting period, these discounts of $0.3 million are being amortized as compensation expense and credited to additional paid-in capital by the Company. Amortization expense relating to SF Holdings' stock options was $47,000 and $104,000 for the thirty-nine weeks ended June 30, 2002 and the thirty-nine weeks ended June 24, 2001, respectively. 8 (7) ACCUMULATED OTHER COMPREHENSIVE LOSS The components of accumulated other comprehensive loss are as follows (in thousands): (Unaudited) June 30, September 30, 2002 2001 ------------- --------------- Foreign currency translation adjustment $ (1,987) $ (1,811) Minimum pension liability adjustment (7,282) (5,941) --------- --------- Accumulated other comprehensive loss $ (9,269) $ (7,752) ========= ========= (8) OTHER EXPENSE (INCOME), NET During the thirty-nine weeks ended June 30, 2002, the Company realized $7.7 million due to the amortization of the deferred gain in conjunction with the Fiscal 2000 sale-leaseback transaction. Also, during the thirty-nine weeks ended June 30, 2002, the Company recognized a $3.0 million gain associated with the sale of the Company's manufacturing facility in Manchester, New Hampshire. These gains were offset by a $5.4 million write-off of the management services agreement between Sweetheart Holdings and SF Holdings, which had been assigned and assumed by Fonda in 1998 and the Company's write-off of $2.6 million of assets related to business initiatives which were abandoned subsequent to the Merger. Additionally, the Company incurred $7.6 million of costs in connection with the rationalization, consolidation and improvement of the Company's manufacturing facilities. Included in the $7.6 million of costs is a $1.6 million restructuring reserve which the Company established in conjunction with a workforce reduction program as a result of the Company's consolidation initiatives. The workforce reduction program was approved by management on June 19, 2002 and announced to employees on June 28, 2002. Severance payments of $1.6 million will be paid in the fourth quarter of Fiscal 2002 and the first three quarters of Fiscal 2003. The $1.6 million reserve has been included in the "Other current liabilities" on the consolidated balance sheet as of June 30, 2002. During the thirty-nine weeks ended June 24, 2001, the Company realized $7.7 million due to the amortization of the deferred gain in connection with the Fiscal 2000 sale-leaseback transaction. Also, during the thirty-nine weeks ended June 24, 2001, the Company recognized $1.1 million of expense in association with the relocation of a manufacturing facility from Somerville, Massachusetts to North Andover, Massachusetts. (9) CONTINGENCIES During Fiscal 2001, the Company experienced a casualty loss at its Somerville, Massachusetts facility. The Company 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 the Company 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 the Company. Plaintiffs filed a petition for writ of certiorari to the United States 9 Supreme Court, which was denied in January 1999. The Company expects to complete paying out the termination liability and associated expenses in connection with the Plan termination by December 31, 2002. As of June 30, 2002, the Company 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 $0.6 million, which amount has been fully reserved by the Company. 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. 10 (10) SWEETHEART CUP COMPANY INC. All of the outstanding stock of Sweetheart Cup is owned by Sweetheart Holdings and thereby Sweetheart Holdings is the only guarantor of the $110 Senior Subordinated Notes, as amended. The guarantee is full and unconditional. The following financial information for Sweetheart Cup and its subsidiaries, Sweetheart Holdings and the Company is presented in accordance with Rule 3-10 of Regulation S-K (in thousands):

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 Sweetheart Holdings Inc. ("Sweetheart Holdings"), together with its wholly owned subsidiary Sweetheart Cup Company Inc. ("Sweetheart Cup"), and collectively with its other subsidiaries, (the "Company") products, potential equipment malfunctions and pending litigation. Critical Accounting Policies and Estimates Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United Sates of America. The preparation of these financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. On an on-going basis, management evaluates its estimates and judgments, including those related to 18 accounts receivable reserves, inventory reserves, long-lived assets, revenue recognition, income taxes and contingencies. Management bases its estimates and judgment on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a list of the critical accounting policies that management believes, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements, refer to Management's Discussion and Analysis in the annual reports on Form 10-K/A of Sweetheart Holdings and Form 10-K of The Fonda Group, Inc. ("Fonda") for Fiscal 2001. General The Company believes it is one of the largest producers and marketers of disposable foodservice and food packaging products in North America. The Company sells a broad line of disposable paper, plastic and foam foodservice and food packaging products at all major price points under both branded and private labels to institutional foodservice, consumer foodservice and food packaging customers. The Company markets its products under its well recognized: Sweetheart(R), Lily(R), Trophy(R), Jazz(R), Preference(TM), Go Cup(R), Silent Service(R), Centerpiece(R), Basix(R), Guildware(R), Simple Elegance(R), Sensations(R), Hoffmaster(R), Paper Art(R), and Touch of Color(R) brands. The Company's product offerings cover a broad range within the industry, including (i) paper, plastic and foam foodservice products, primarily cups, lids, plates, bowls, plastic cutlery, food trays and food containers; (ii) tissue and specialty foodservice products, primarily napkins, table covers, placemats and lunch bags; and (iii) food packaging products, primarily containers for the dairy and food processing industries. To enhance product sales, the Company designs, manufactures and leases container filling and lidding equipment to dairies and other food processors to package food items in the Company's containers at customers' plants. Types of products packaged in the Company's machines include: ice cream, factory-filled jacketed ice cream cones, cottage cheese, yogurt and squeeze-up desserts. The Company also sells paper converting equipment used primarily in the manufacture of paper cups and food containers. The Company sells its products to institutional foodservice and consumer customers, including large national accounts, located throughout the United States, Canada and Mexico. The Company has developed and maintained long-term relationships with many of its customers. The Company's institutional foodservice customers include (i) major foodservice distributors, (ii) national accounts, including quick service restaurants and catering services, and (iii) schools, hospitals and (iv) other major institutions. The Company's consumer customers include (i) supermarkets, (ii) mass merchandisers, (iii) warehouse clubs, (iv) party good stores and (v) other retailers. The Company's food packaging customers include (i) national and regional dairy and (ii) food companies. Revenue is recognized upon shipment of product and when collectability is reasonably assured. Also, the Company rents filling equipment to certain of its customers and recognizes this income over the life of the lease. The Company's sales are evidenced and the sales price fixed based upon either a purchase order, contract or buying agreement with the customer. The Company's freight terms are either FOB shipping point or freight prepaid by the customer. The customer may also be eligible for promotional incentives or rebates. The Company at the time of sale records a reserve for promotional allowances, rebates and other discounts based on historical experience, which are charged to net sales. Raw materials are critical components of the Company's cost structure. The prices for these raw materials may fluctuate. When raw material prices decrease, selling prices have historically decreased. 19 The actual impact 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, the Company may suffer margin erosion on the sale of such inventory. Selling, general and administrative expenses consist primarily of salaries, benefits, promotional and advertising costs, rent, depreciation of equipment and broker fees. The Company'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 the Company's cash flow from operations is insufficient to provide working capital necessary to fund its requirements, the Company will need to borrow under its credit facility or seek other sources of capital. The Company believes that funds available under such credit facility together with cash generated from operations, will be adequate to provide for cash requirements for the next twelve months. On March 25, 2002, pursuant to an Agreement and Plan of Merger, Fonda was merged (the "Merger") with and into Sweetheart Cup, with Sweetheart Cup as the surviving entity. In connection with the Merger, all of the assets and operations of Fonda were assigned to, and all liabilities of Fonda were assumed by, Sweetheart Cup by operation of law and all of the outstanding shares of Fonda were cancelled. Sweetheart Cup is a wholly owned subsidiary of Sweetheart Holdings which is a wholly owned subsidiary of SF Holdings. Sweetheart Holdings and Fonda are under common control, and therefore, the transaction has been accounted for in a manner similar to a pooling-of-interests. The accompanying financial information has been restated for all periods presented. Thirteen Weeks Ended June 30, 2002 Compared to Thirteen Weeks Ended June 24, 2001 (Unaudited) Net sales decreased $1.9 million, or 0.6%, to $340.2 million for the thirteen weeks ended June 30, 2002 compared to $342.1 million for the thirteen weeks ended June 24, 2001, reflecting a 2.2% increase in sales volume and a 2.8% decrease in average realized sales prices. Sales volume increased as a result of incremental sales obtained from the Company's acquisition of an 80% interest in Global Cup, S.A. De C.V. and its subsidiaries ("Global") in April 2001 and the Company's acquisition of substantially all of the property, plant and equipment, intangible and net working capital of the consumer division of Dopaco, Inc. ("Dopaco") in August 2001. Average realized sales prices decreased as a result of lower raw material costs and competitive pressures. Gross profit decreased $10.1 million, or 19.9%, to $40.6 million for the thirteen weeks ended June 30, 2002 compared to $50.7 million for the thirteen weeks ended June 24, 2001. As a percentage of net sales, gross profit decreased to 11.9% for the thirteen weeks ended June 30, 2002 from 14.8% for the thirteen weeks ended June 24, 2001. Gross profit was negatively impacted by lower average realized sales prices reflecting a decrease in raw material costs and manufacturing inefficiencies related to the Company's initiatives to rationalize, consolidate and improve its manufacturing facilities. Selling, general and administrative expense increased $3.7 million, or 15.2%, to $28.1 million for the thirteen weeks ended June 30, 2002 compared to $24.4 million for the thirteen weeks ended June 24, 2001. This increase resulted primarily from $1.7 million of increased promotional and advertising expenses, $0.9 million of increased legal fees, and $0.5 million of increased expenses resulting from the acquisition of Dopaco. Other expense (income), net changed $9.8 million, to an expense of $8.9 million for the thirteen weeks ended June 30, 2002 compared to income of $0.9 million for the thirteen weeks ended June 24, 2001. This change is primarily due to (i) a $4.6 million write-off of the management services agreement between Sweetheart Holdings and SF Holdings, which had been assigned and assumed by Fonda in 1998 (ii) a $2.6 million write-off of assets related to certain business initiatives which were abandoned 20 subsequent to the Merger and (iii) $3.3 million of costs incurred in connection with the rationalization, consolidation and improvement of the Company's manufacturing facilities, which included a $1.6 million restructuring reserve that the Company established in conjunction with a workforce reduction program as a result of these consolidation initiatives. Operating income (loss) decreased $23.4 million, or 86.3%, to $3.7 million for the thirteen weeks ended June 30, 2002 compared to income of $27.1 million for the thirteen weeks ended June 24, 2001, due to the reasons stated above. Interest expense, net decreased $0.1 million, or 1.0%, to $9.5 million for the thirteen weeks ended June 30, 2002 compared to $9.6 million for the thirteen weeks ended June 24, 2001. This decrease is attributable to lower interest rates on higher average balances which was partially offset by the increase in coupon interest on the $110 Senior Subordinated Notes from 10.5% to 12.0% which was effective March 1, 2002. Income tax expense (benefit) decreased $9.1 million, or 133.8%, to a benefit of $2.3 million in the thirteen weeks ended June 30, 2002 compared to an expense of $6.8 million for the thirteen weeks ended June 24, 2001 as a result of a pre-tax loss in Fiscal 2002 compared to a profit in Fiscal 2001. The effective rates for the thirteen weeks ended June 30, 2002 and the thirteen weeks ended June 24, 2001 were 40% and 39%, respectively. Minority interest in subsidiary decreased $17,000, or 29.8%, to $40,000 in the thirteen weeks ended June 30, 2002 compared to $57,000 in the thirteen weeks ended June 24, 2001. This amount represents the 20% ownership of Global's income. Net income (loss) decreased $14.1 million, or 133.0%, to a $3.5 million loss for the thirteen weeks ended June 30, 2002 compared to income of $10.6 million for the thirteen weeks ended June 24, 2001, due to the reasons stated above. Thirty-nine Weeks Ended June 30, 2002 Compared to Thirty-nine Weeks Ended June 24, 2001 (Unaudited) Net sales decreased $3.9 million, or 0.4%, to $957.5 million for the thirty-nine weeks ended June 30, 2002 compared to $961.4 million for the thirty-nine weeks ended June 24, 2001, reflecting a 2.4% decrease in average realized sales prices and a 2.0% increase in sales volume. Average realized sales prices decreased as a result of lower raw material costs and competitive pressures. Sales volume increased as a result of incremental sales obtained from the Company's acquisitions of Global in April 2001 and Dopaco in August 2001. Gross profit decreased $13.6 million, or 11.0%, to $109.7 million for the thirty-nine weeks ended June 30, 2002 compared to $123.3 million for the thirty-nine weeks ended June 24, 2001. As a percentage of net sales, gross profit decreased to 11.5% for the thirty-nine weeks ended June 30, 2002 from 12.8% for the thirty-nine weeks ended June 24, 2001. The decrease in gross profit reflects a decrease in fixed costs absorption as the Company's inventory production was down from the prior year. In addition, gross profit was negatively impacted by lower average realized sales prices reflecting decreases in raw material costs and manufacturing inefficiencies related to the Company's consolidation initiatives. Selling, general and administrative expense increased $3.4 million, or 4.1%, to $86.0 million for the thirty-nine weeks ended June 30, 2002 compared to $82.6 million for the thirty-nine weeks ended June 24, 2001. This increase resulted primarily from $1.6 million of increased promotional and advertising expenses, $1.5 million of increased bad debt expense due to customer bankruptcy filings and $1.0 million and $1.3 million of increased expenses due to the acquisitions of both Global and Dopaco, respectively. These increases were partially offset by $2.0 million in reduced salaries and benefits. 21 Other expense (income), net changed $12.3 million, or 175.7%, to an expense of $5.3 million for the thirty-nine weeks ended June 30, 2002 compared to a benefit of $7.0 million for the thirty-nine weeks ended June 24, 2001. This decrease is primarily due to (i) a $5.4 million write-off of the management services agreement between Sweetheart Holdings and SF Holdings, which had been assigned and assumed by Fonda in 1998 (ii) a $2.6 million write-off of assets related to business initiatives which were abandoned subsequent to the Merger and (iii) $7.6 million of costs incurred in connection with the rationalization, consolidation and improvement of the Company's manufacturing facilities, which included a $1.6 million restructuring reserve that the Company established in conjunction with a workforce reduction program as a result of these consolidation initiatives. These expenses were partially offset by a $3.0 million gain associated with the sale of the Company's manufacturing facility in Manchester, New Hampshire. Operating income (loss) decreased $29.3 million, or 61.4%, to $18.4 million for the thirty-nine weeks ended June 30, 2002 compared to $47.7 million for the thirty-nine weeks ended June 24, 2001, due to the reasons stated above. Interest expense, net decreased $1.1 million, or 3.8%, to $28.2 million for the thirty-nine weeks ended June 30, 2002 compared to $29.3 million for the thirty-nine weeks ended June 24, 2001. This decrease is attributable to lower interest rates on higher average balances which was partially offset by the increase in interest rate on the $110 Senior Subordinated Notes form 10.5% to 12.0% which was effective March 1, 2002. Income tax expense (benefit) decreased $11.1 million, or 154.2%, to a benefit of $3.9 million in the thirty-nine weeks ended June 30, 2002 compared to an expense of $7.2 million for the thirty-nine weeks ended June 24, 2001 as a result of pre-tax loss in Fiscal 2002 compared to a profit in Fiscal 2001. The effective rates for the thirty-nine weeks ended June 30, 2002 and the thirty-nine weeks ended June 24, 2001 were 40%, respectively. Minority interest in subsidiary increased $56,000, or 98.2%, to $113,000 in the thirty-nine weeks ended June 30, 2002 compared to $57,000 in the thirty-nine weeks ended June 24, 2001. This amount represents the 20% ownership of Global's income. Extraordinary loss on debt extinguishment was $1.1 million net of the income tax benefit in the thirty-nine weeks ended June 30, 2002 resulting from the refinancing of the Company's Senior Credit Facility. Net income (loss) decreased $18.1 million, or 164.5%, to a loss of $7.1 million for the thirty-nine weeks ended June 30, 2002 compared to income of $11.0 million for the thirty-nine weeks ended June 24, 2001, 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 thirty-nine weeks ended June 30, 2002, 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 the remainder of its Fiscal 2002 capital expenditures. Net cash provided by operating activities was $18.9 million in the thirty-nine weeks ended June 30, 2002 compared $5.7 million in the thirty-nine weeks ended June 24, 2001. This increase is primarily due to a reduction in inventories and decreased account receivable balances which resulted from lower raw material price levels combined with higher account payable balances due to longer terms. Net cash used in investing activities was $12.4 million in the thirty-nine weeks ended June 30, 22 2002 compared to $39.6 million in the thirty-nine weeks ended June 24, 2001. This decrease is primarily due to the receipt of net proceeds from the sale of the Manchester, New Hampshire facility in the thirty-nine weeks ended June 30, 2002 and the Company's purchase of substantially all of the property, plant and equipment, intangibles and net working capital of Springprint Medallion, a division of Marcal Paper Mills, Inc. in the thirty-nine weeks ended June 24, 2001. Net cash used in financing activities was $10.1 million in the thirty-nine weeks ended June 30, 2002 compared to net cash provided by financing activities of $35.9 million in the thirty-nine weeks ended June 24, 2001. This change is primarily due to a reduction of the Company's Senior Credit Facility balances. Working capital decreased $27.7 million to $222.8 million at June 30, 2002 from $250.5 million at September 30, 2001. This decrease resulted from current assets decreasing $31.4 million, primarily due to lower inventories and account receivable balances which resulted from lower raw material price levels. Capital expenditures for the thirty-nine weeks ended June 30, 2002 were $17.6 million compared to $21.7 million for the thirty-nine weeks ended June 24, 2001. Capital expenditures in the thirty-nine weeks ended June 30, 2002 included $7.8 million for new production equipment; $5.8 million associated with the implementation of the Company's consolidation program; $2.8 million for facility improvements; and $1.2 million primarily for routine capital improvements. On June 10, 2002, the Company entered into a loan agreement with the Department of Business and Economic Development, a principal department of the State of Maryland, to borrow $2.0 million (the "Maryland Loan"). The Maryland Loan bears interest at a rate ranging from 3.0% to 8.0% per annum depending on certain employment rates at the Company's Owings Mills, Maryland facility. The Maryland Loan is payable in quarterly installments through March 1, 2007. As of June 30, 2002, $2.0 million was outstanding at an annual interest rate of 3.0%. The Company has a senior revolving credit facility with Bank of America, N.A., as agent (the "Senior Credit Facility"). The Senior Credit Facility has a maturity date of March 25, 2007; however, in the event that the Company has not refinanced, repaid or extended the $110 Senior Subordinated Notes prior to March 1, 2003, the Senior Credit Facility shall terminate on that date. The Senior Credit Facility allows for a maximum credit borrowing of $235 million subject to borrowing base limitations and satisfaction of other conditions of borrowing. The revolving borrowings have a maximum of the lesser of $235 million less the balance of the term loans or $215 million. The term loans have a maximum of $25 million and are payable monthly through March 2005. Borrowings under the Senior Credit Facility, at the Company's election, bear interest at either (i) a bank's base rate revolving loan reference rate plus 0.5% or (ii) LIBOR plus 2.5%. For the thirty-nine weeks ended June 30, 2002, the weighted average annual interest rate for the Senior Credit Facility was 4.85%. The Senior Credit Facility is collateralized by the Company's accounts, inventory, general intangibles and certain other assets. 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 June 30, 2002, $31.7 million was available under the Senior Credit Facility. The Company's Canadian subsidiary has a credit agreement (the "Canadian Credit Facility") which provides for a term loan and a credit facility with a maximum credit borrowing of Cdn $30 million (approximately US $18.8 million) subject to borrowing base limitations and satisfaction of other conditions of borrowing. The 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 the Company's Canadian subsidiary and net proceeds on the sale of any of the foregoing. Borrowings under 23 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. For the thirty-nine weeks ended June 30, 2002, the weighted average annual interest rate for the Canadian Credit Facility was 4.32%. As of June 30, 2002, Cdn $1.4 million (approximately US $0.9 million) was available under the revolving facility and the term loan balance was Cdn $12.9 million (approximately US $8.5 million) under the Canadian Credit Facility. In connection with a sale-leaseback transaction, on June 15, 2000, Sweetheart Cup, and 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. The Company's obligations under the Lease are collateralized by substantially all of the Company'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. The Company 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. The taxable gain in the amount of $147.8 million has allowed the Company to utilize a substantial portion of its net operating loss carry-forward. Sweetheart Cup is the obligor and Sweetheart Holdings the guarantor with respect to the $110 Senior Subordinated Notes which are due September 1, 2003. Interest on the $110 Senior Subordinated Notes is payable semi-annually in arrears on March 1 and September 1. The $110 Senior Subordinated Notes began to accrue interest at 12% per annum as of March 1, 2002. The $110 Senior Subordinated Notes are subject to redemption at the option of the Company, 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 $110 Senior Subordinated Notes are Subordinated in right of payment to the prior payment in full of all borrowings under the Senior Credit Facility, all obligations under the Lease, and all other indebtedness not otherwise prohibited. The $110 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, the Company issued $120 million of 9-1/2% Series A Senior Subordinated Notes due 2007 (the "$120 Senior Subordinated Notes") with interest payable semi-annually. Payment of the principal and interest is subordinate in right to payment of the Senior Credit Facility. The Company may, at its election, redeem the $120 Senior Subordinated 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 $120 Senior Subordinated 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 $120 Senior Subordinated Notes at a redemption price equal to 101% of the principal amount thereof plus accrued interest. The instruments governing the indebtedness of the Company contain customary covenants and events of default, including without limitation, restrictions on, subject to defined exceptions, the payment 24 of dividends, the incurrence of additional indebtedness, investment activities and transactions with affiliates. During Fiscal 2001, the Company experienced a casualty loss at its Somerville, Massachusetts facility. The Company 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 the Company 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 the Company. Plaintiffs filed a petition for writ of certiorari to the United States Supreme Court, which was denied in January 1999. The Company expects to complete paying out the termination liability and associated expenses in connection with the Plan termination by December 31, 2002. As of June 30, 2002, the Company 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 $0.6 million, which amount has been fully reserved by the Company. 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. Management believes that cash generated by operations, amounts available under the Company's credit facilities and funds generated from asset sales should be sufficient to meet the Company's expected operating needs, planned capital expenditures, payments in conjunction with the Company's lease commitments and debt service requirements in the next twelve months. The Company is evaluating 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, sale of assets, 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, the Company had approximately $28 million of net operating loss ("NOL") carryforwards for federal income tax purposes, which expire in 2018. Although the Company 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. 25 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company 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 Senior 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 Senior Credit Facility, at the Company's election, bear interest at either (i) a bank's base rate revolving loan reference rate plus 0.5% or (ii) LIBOR plus 2.5%. 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 June 30, 2002, the outstanding indebtedness under the Senior Credit Facility was $178.3 million and the Canadian Credit Facility was $17.4 million in U.S. dollars. As of June 30, 2002, $31.7 million was available under the Senior Credit Facility and Cdn $1.4 million (approximately US $0.9 million) was available under Canadian Credit Facility. Based upon these amounts, the annual net income would change by approximately $1.2 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. PART II - OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 10.67 Loan Agreement between Sweetheart Cup Company, Inc. and the Department of Business and Economic Development, a principal department of the State of Maryland 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - Chief Executive Officer 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - Chief Financial Officer (b) Reports on Form 8-K: None. 26 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. SWEETHEART HOLDINGS INC. (registrant) Date: August 6, 2002 By: /s/ Hans H. Heinsen -------------- ------------------- Hans H. Heinsen Senior Vice President - Finance and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer) 27

SWEETHEART HOLDINGS INC \DE\ 10-Q