ITEM 1. BUSINESS.
OVERVIEW
Pactiv Corporation (Pactiv), previously known as Tenneco Packaging Inc. (TPI), was formerly a wholly-owned subsidiary of Tenneco Inc. (Tenneco) that was spun-off to shareowners of Tenneco on November 4, 1999 (the spin-off). Pactiv includes the assets, liabilities, and operations of Tenneco's former specialty packaging business as well as certain of Tenneco's former corporate and administrative service operations. As used herein, the terms "Pactiv" and "the company" refer to the packaging businesses and corporate and administrative service operations of Tenneco for periods prior to the spin-off, and to Pactiv for periods after the spin-off.
The company was incorporated in the state of Delaware in 1965 under the name Packaging Corporation of America. In November 1995 the company changed its name to Tenneco Packaging Inc., and concurrent with the spin-off changed its name to Pactiv Corporation.
Pactiv is a global supplier of specialty packaging and consumer products with 1999 revenues of $2.9 billion. As of December 31, 1999, the company operated 85 manufacturing facilities in 17 countries around the world and employed approximately 15,000 people. Pactiv's main operating segments are (a) consumer and foodservice/food packaging and (b) protective and flexible packaging. The company's consumer products include plastic, aluminum, and paper-based products, such as disposable tableware, food storage bags, waste bags and aluminum cookware. The company's foodservice/food packaging products include foam, clear plastic, aluminum, pressed paperboard, and molded fiber packaging for customers in the food distribution channel, including wholesalers and supermarkets, and customers who process and prepare food for consumption, known as food packers and processors. Protective packaging is used to protect and cushion various commercial and industrial products from the point of manufacture to the point of delivery or pick-up, and principally serves the electronics, automotive, furniture, and e-commerce markets. Flexible packaging products are mainly used in food, medical, pharmaceutical, chemical, and hygiene applications, and often involve custom design.
PRODUCTS AND MARKETS
Consumer and Foodservice/Food Packaging
The company manufactures, markets, and sells consumer products, such as plastic storage bags for food and household items, plastic waste bags, foam and molded fiber tableware, and aluminum cookware. Many of these products are sold under such recognized brand names as Hefty(R), Baggies(R), Hefty OneZip(R), Kordite(R), and E-Z Foil(R). These products, which are typically used by consumers in their homes, are sold through a variety of retailers, including supermarkets, mass merchandisers, and other stores where consumers purchase household goods. In addition to consumer products, the company manufactures plastic zipper closures for a variety of other packaging applications.
For foodservice customers, the company offers products to merchandize and serve both on-premises and takeout meals. These items include tableware products, such as plates, bowls, and cups, and a broad line of takeout service containers made from clear plastic, microwaveable plastic, molded fiber, paperboard, foam, and aluminum.
The company's food packaging products are designed to protect food during distribution, aid retailers in merchandising food products, and help customers prepare and serve meals in their homes. Food packaging products for supermarkets include clear rigid display packaging for produce, deli, and bakery applications, microwaveable containers for prepared, ready-to-eat meals, plastic foam trays for meat and produce, and plastic bags for produce and bakery applications.
For food processors, the company's products include dual-ovenable paperboard containers, molded fiber egg cartons, foam meat trays, aluminum containers, and modified atmosphere packaging, which extends the shelf life of meat products.
Protective and Flexible Packaging
The company manufactures, markets, and sells protective packaging for use in the automotive, computer, electronic, furniture, durable goods, building, and construction industries. Pactiv's sheet foams and air encapsulated bubble products, for example, are used for cushioning and surface protection, and paperboard honeycomb and engineered foam plank products provide protection against shock, vibration, and thermal damage. Pactiv also offers padded mailers, a variety of laminated protective coverings, and customized packaging systems.
The Company's flexible packaging products are used in consumer, medical, pharmaceutical, chemical, hygiene, and industrial applications. These products include liners for disposable diapers, wrap-around sleeves for glass and plastic bottles, polypropylene medical bags for sterile intravenous fluid delivery, modified atmosphere films, stand-up pouches, food and hygiene packaging, and surgical kits.
The company also offers polyethylene stretch film and film and foam products for use in the construction industry.
GROWTH STRATEGY
Pactiv has grown, and expects to continue to grow, by expanding existing businesses and through strategic acquisitions. In this connection, the company's revenues have grown from approximately $600 million in 1994 to $2.9 billion in 1999.
The company's growth strategy is to focus on markets that have strong expansion characteristics and attractive margins. Through the company's custom design centers and broad product lines, customers are offered "material-neutral" solutions, tailored to their specific packaging needs. With this approach and the availability of worldwide geographic coverage, the company has become a primary supplier to national and international manufacturers and distributors, and has developed long-term relationships with key players in the consolidating packaging and foodservice distribution industries. These relationships are critical in identifying and penetrating new growth markets with attractive margins.
Market Presence
Many of the company's products have strong market positions. For example, in foodservice packaging, Pactiv has the number one market share position in the United States and Canada in four of five main product categories based on unit volume. In addition, management estimates that products representing 80% of sales of the protective packaging business hold the number one or number two market share position in North America based on sales. In the United States, the company also has the leading market share position in disposable tableware, aided by the Hefty(R) brand, and Pactiv's E-Z Foil(R) brand of disposable aluminum cookware leads competition by a wide margin in both sales and market share. The breadth of the company's product lines, its ability to offer "one-stop shopping" to customers and its long-term relationships with key distributors have contributed to the attainment of these leadership positions.
New Products/Design Services
The company further fuels growth by developing proprietary new products and value-added product line extensions, spending $40 million on research and development activities in 1999. The consumer products and foodservice/food packaging business introduced approximately sixty new products and product line extensions during the year, which included expanding the use of its patented OneZip(R) closure system into other zipper closure applications, such as Slide Rite(R) retail packaging for baby wipes and supermarket produce and deli products; adding jumbo two-gallon and sandwich bags to the Hefty(R) OneZip(R) storage and freezer bag line; and introducing proprietary modified atmosphere packaging called ActiveTech(TM), which is used by food processors to extend the shelf life of case-ready red meat.
In the protective and flexible packaging business, where custom design services drive revenues, approximately twenty-five custom product applications were developed in 1999. Examples of recent protective and flexible packaging introductions include engineered foams; Profiles(R) products, which are
foam-based materials used in various markets, such as building products and furniture, to provide custom-designed insulation, cushioning, and surface protection; high-end stand-up pouches for soups and detergents; and Propyflex(R) medical bags for fluids.
State-of-the-Art Service Capabilities
Building on the business' broad product lines and strong relationships with national distributors, Pactiv is implementing a customer linked manufacturing (CLM) system. CLM is a state-of-the-art production planning and order fulfillment system which reduces supply chain costs, enhances customer service, and improves productivity, providing a competitive advantage to both the company and its customers.
Productivity/Cost Reduction
Pactiv's strong focus on improving productivity and reducing manufacturing and logistics costs is key to improving the business' profitability. For example, unit manufacturing costs have continued to decline for many products, such as rigid display packaging, foam products, and performance films.
Strategic Acquisitions
Strategic acquisitions have been, and will continue to be, an important element of the company's growth strategy. In 1999 the company made three acquisitions and additional equity contributions to existing joint ventures totaling $24 million. Management has a successful track record of acquiring businesses and rapidly integrating them into the company. Acquisitions are pursued that strengthen brand presence; expand product offerings and markets; and offer synergies related to rationalizing product lines, reconfiguring and upgrading manufacturing capabilities, and reducing operating, selling, distribution, purchasing, and administrative costs.
MARKETING, DISTRIBUTION, AND CUSTOMERS
Pactiv's two operating segments have a combined sales and marketing staff of approximately 500 people.
Consumer products are sold through a direct salesforce and a national network of brokers and manufacturers' representatives.
Foodservice and supermarket customers are primarily served through a network of independent distributors, while food packaging and processor customers are principally served through a direct salesforce, with some sales going through distributors.
The protective and flexible packaging business sells to distributors, fabricators, and directly to end-users worldwide.
No one customer accounted for more than 10% of the company's 1999 sales. In general, the company's backlog of orders is not material.
ANALYSIS OF SALES
The following table sets forth information relating to sales from continuing operations. Prior to the spin-off, the combined results of the consumer and foodservice/food packaging and protective and flexible businesses were reported under the specialty packaging segment by Tenneco. During the fourth quarter of 1999 the company modified the composition of its operating segments because of changes in its management-reporting structure triggered by the spin-off. Segment information for 1998 and 1997 has been restated to conform with current segment presentation.
SALES
See note 19 to the financial statements for additional segment and geographic information.
COMPETITION
Pactiv conducts business in markets that are highly competitive and faces substantial competition in all of its product lines from numerous global, national, and regional companies, ranging from the largest packaging companies to small, emerging enterprises. Some competitors have greater financial and other resources than Pactiv, while others are significantly smaller with lower fixed costs and more operating flexibility. In general, success in acquiring business is dependent on price, quality, service, response time, and order fulfillment. In addition, competitors use a variety of packaging materials and structures, and serve different geographic regions through various distribution channels.
INTERNATIONAL
Pactiv has facilities and sells products in countries throughout the world. As a result, it is subject to various risks, such as fluctuations in foreign currency exchange rates, limitations on conversion of foreign currencies into U.S. dollars, restrictions on remittance of dividends and other payments by foreign subsidiaries, withholding and other taxes on remittances by foreign subsidiaries, hyperinflation in foreign countries, and restrictions on investments in foreign countries. See note 19 to the financial statements for additional information regarding the company's international operations.
RAW MATERIALS
Plastic resins, such as polystyrene, polyethylene, polypropylene and polyvinyl chloride, aluminum, paperboard, and recycled fiber are the principal raw materials used by the company. Approximately 80% of Pactiv's revenues comes from products made from different types of plastics. In general, these raw materials are readily available from a wide variety of suppliers. Raw material prices can be volatile, and are a function of, among other things, the availability of production capacity and oil and other material costs. The supply of raw materials was adequate in 1999, and is expected to remain that way in 2000.
ENVIRONMENTAL REGULATION
Pactiv is subject to existing and potential federal, state, local, and foreign legislation controlling air emissions. In addition, various consumer and special interest groups have lobbied from time to time for the implementation of a variety of environmental and pollution control measures. Although management believes that laws and regulations promulgated to date have not had a material adverse effect on the company there can be no assurance that future legislative or regulatory efforts or initiatives would not have a material adverse effect on the company.
OTHER
As of December 31, 1999, Pactiv employed approximately 15,000 people, 14% of whom were covered by collective bargaining agreements. One of those agreements, covering a total of 273 employees, is scheduled for renegotiation in 2000. In Europe and the Middle East, approximately 2,350 employees are governed by works councils. Management believes that employee relations are generally satisfactory.
The company owns a number of U.S. and foreign patents and trademarks and other intellectual property relating to its products which are important to their manufacture, marketing, and distribution.
Pactiv's administrative service operations utilize numerous software licenses and operate computer equipment. These operations provide the following services: financial accounting, employee benefits administration, payroll processing, accounts payable, information systems support, telecommunications, and disaster recovery support. The company continues to provide some of these services to certain former affiliates of Tenneco through contractual arrangements.
In December 1999 Pactiv sold certain assets of its administrative service operations to Exult Inc. (Exult), and entered into an agreement under which Exult will provide certain administrative services to the company. Exult also entered into an agreement to provide certain services to Tenneco Automotive Inc., a former affiliate, which previously were provided by Pactiv.
In April 1999 the company contributed its containerboard packaging business to a new joint venture, called Packaging Corporation of America (PCA), in which the company retained a 45% common equity interest (which was subsequently reduced to approximately 43% as a result of equity issued to its management). In June 1999 the company sold its folding carton business, which represented the balance of its paperboard packaging segment, for $73 million. In February 2000 Pactiv sold most of its interest in PCA for $398 million, which was primarily used to reduce debt, retaining a 6% equity interest in PCA. See note 2 to the financial statements for additional information.
In December 1999 the company entered into an agreement to sell its aluminum foil reroll facility in Clayton, New Jersey, and its aluminum packer processer facility in Shelbyville, Kentucky. This sale closed in January 2000.
ITEM 2.
ITEM 2. PROPERTIES.
HEADQUARTERS LOCATION
Pactiv leases its executive offices which are located at 1900 West Field Court, Lake Forest, Illinois 60045. Its telephone number at that address is (847) 482-2000.
MANUFACTURING AND ENGINEERING FACILITIES
In North America, Pactiv operates sixty-three facilities in twenty-one states, Canada, and Mexico. Plastic and aluminum foodservice and consumer products, stretch films, and building products are manufactured at twenty-five plants. The protective packaging business converts paperboard into honeycomb products at twelve plants. Sixteen plants apply extrusion, foaming, and converting technologies to produce clear, foamed, flexible, or rigid plastic protective packaging from polystyrene, polyethylene and polypropylene, and kraft papers. Molded fiber packaging is produced at seven locations, and tooling for molded fiber plants is manufactured at one location. Ovenable paperboard products are manufactured at two facilities. A research and development center for food packaging and process development is located in Canandaigua, New York. Design centers and process development operations for protective and flexible packaging are located in Buffalo Grove, Illinois, Grand Rapids and Troy, Michigan, Atlanta, Georgia and Santa Fe Springs, California. In addition, the company participates in two North American joint ventures, Sentinel Polyolefin LLC and Pactiv de Mexico, S.A. de CV.
Pactiv owns twenty-two international manufacturing facilities. Eleven protective packaging plants in Belgium, England, France, Germany, Italy, The Netherlands, Poland, Spain, and Hungary make plastic air encapsulated bubble and foam sheet products, including mailers. Five flexible packaging plants in Egypt
and Germany make flexible films, bags, labels, pouches, printed and converted paper bags, and disposable medical packaging. Omni-Pac, a European subsidiary, produces cushioning and molded fiber packaging in Elsfleth, Germany, and Great Yarmouth, England. Single-use thermoformed plastic food containers and films are manufactured at four facilities in England, Scotland, and Wales. In addition, Pactiv operates or participates in several international joint ventures, including a folding carton operation in Dongguan, China, a recycling venture in Budapest, Hungary, and a corrugated converting operation in Shaoxing, China.
Management believes that substantially all of its plants and equipment generally are well maintained and in good operating condition.
The company is of the opinion that it generally has satisfactory title to properties owned and used in its businesses, subject to certain liens which do not materially detract from the value or use of the properties.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
In May 1999 Tenneco, the company, and a number of containerboard manufacturers were named as defendants in a civil class-action antitrust lawsuit pending in the United States district court for the Eastern District of Pennsylvania. Pactiv also was named as a defendant in a related class-action antitrust lawsuit. The lawsuits allege that the defendants conspired to raise linerboard prices for corrugated containers and corrugated sheets from October 1, 1993, through November 30, 1995, in violation of Section 1 of the Sherman Act. The lawsuits seek treble damages in an unspecified amount, plus attorney fees. The company's management believes that the allegations have no merit, is vigorously defending the claims, and believes that the outcome will not have a material adverse effect on the company's financial position or results of operations. As between Tenneco and Pactiv, Pactiv is responsible for defending the claims and for any liability resulting therefrom.
See note 3 to the financial statements for information about potential environmental liabilities.
The company and its subsidiaries are parties to various other legal proceedings arising from their operations. The company believes that the outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on its financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth quarter of 1999.
ITEM 4.1. EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the executive officers of the company at April 1, 2000, the positions held by such officers, and the date appointed to such positions:
During the past five years each of the executive officers has been continuously engaged in the business of the company in the positions indicated, except as follows:
(1) Mr. Wambold was Executive Vice President and General Manager of the company's specialty packaging and consumer products business units from June 1997 to May 1999, and prior to that was Vice President and General Manager of such units.
(2) Prior to joining the company, Mr. Campbell served as Acting Chief Financial Officer and Financial Consultant of Foamex International Inc. from May to September 1999. From December 1998 until May 1999, Mr. Campbell pursued personal interests. Prior to that, he was Executive Vice President, Finance and Administration and Chief Financial Officer of Dominick's Supermarkets Inc. from July to November 1998 and Senior Vice President, Finance and Chief Financial Officer of Safety Kleen Corporation from April 1997 to June 1998. From June 1996 to March 1997, he managed his own investments. Prior to that, Mr. Campbell was President and Director of Duplex Products, Inc. from June 1995 to May 1996, and Vice President, Finance and Chief Financial Officer of that company from November 1994 to May 1995.
(3) From 1996, when he joined the company, until being appointed to his current position, Mr. Lazaredes held various senior management positions in the company's specialty packaging unit, with responsibility for marketing and sales of rigid and flexible containers for the foodservice and institutional markets, and, from 1992 to 1996, served as General Manager of Amoco Foam Products Company's tableware business.
(4) From 1995 until assuming his current responsibilities, Mr. Morris held various senior management positions in the company's specialty packaging unit, with responsibility for manufacturing, engineering, and product development, as well as sales, marketing, and business planning for the food packaging/processor operations.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREOWNER MATTERS.
The outstanding shares of common stock ($0.01 par value) of Pactiv are listed on the New York Stock Exchange (NYSE).
The stock began "regular way" trading on the NYSE on November 5, 1999 (the business day immediately following the spin-off). The high and low stock price and dividends paid per share of stock were as follows:
As of January 31, 2000, there were approximately 73,689 holders of record of the company's common stock, including brokers and other nominees.
Dividend declarations are at the discretion of the company's board of directors. The company does not intend to declare a dividend in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
(a) During the periods presented, the company completed numerous acquisitions, the most significant of which were the acquisitions of Mobil Plastics for $1.3 billion in November 1995, Amoco Foam Products for $310 million in August 1996, and the protective and flexible packaging businesses of N.V. Koninklijke KNP BT for $380 million in April 1997.
ITEM 7.
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BASIS OF PRESENTATION
On November 4, 1999, in connection with a corporate reorganization, Pactiv Corporation's former parent company, Tenneco Inc., (Tenneco) and its subsidiaries completed various intercompany transfers and distributions designed to restructure and separate their then-existing businesses, assets, liabilities, and operations so that, among other things, the packaging businesses and certain corporate and administrative service operations of Tenneco would be owned by Pactiv Corporation (Pactiv). Tenneco subsequently distributed pro rata to holders of its common stock all of the outstanding common stock of Pactiv (the spin-off). Prior to the spin-off, Pactiv was named Tenneco Packaging Inc. (TPI).
As used herein, the term "company" or "Pactiv" refers, for periods prior to the spin-off, to TPI and certain other subsidiaries through which Tenneco conducted its packaging businesses, and, for periods after the spin-off, to Pactiv and its consolidated subsidiaries.
Prior to the spin-off, all of the outstanding common stock of the company was owned directly or indirectly by Tenneco. The financial statements in this report present the results of operations, financial position, and cash flows of the company as if it were a separate entity for all periods. The former parent's historical basis in the assets and liabilities of the company has been carried over to Pactiv. All per-share information is presented on a diluted basis, unless otherwise noted.
The company's operating segments include:
Consumer and foodservice/food packaging, which relates to the manufacture and sale of disposable plastic, molded fiber, pressed paperboard, and aluminum packaging products for the consumer, foodservice, and food packaging markets.
Protective and flexible packaging, which relates to the manufacture and sale of plastic, paperboard, and molded fiber protective and flexible packaging products. Major markets served by protective packaging products include electronics, automotive, furniture, and e-commerce, whereas flexible packaging products are used mainly in food, medical, pharmaceutical, chemical, and hygienic applications.
Other, which primarily relates to corporate and administrative service operations and pension plan income and expense.
STRATEGIC REALIGNMENT
In July 1998, Tenneco's board of directors authorized management to develop a broad range of strategic alternatives to separate its automotive, paperboard packaging, and specialty packaging businesses. Subsequently, Tenneco completed the following actions:
- In January 1999, Tenneco reached an agreement to contribute the containerboard assets of its paperboard packaging operation to a new joint venture with Madison Dearborn Partners, Inc. called Packaging Corporation of America (PCA). For the contribution, which was completed in April 1999, Pactiv received approximately $2 billion in the form of cash and the assumption of debt, and retained a 45% equity interest in PCA (subsequently reduced to 43% as a result of equity issued to management) which was valued at approximately $200 million.
- In April 1999, Tenneco reached an agreement to sell the paperboard packaging operation's remaining business, its folding carton operation, to Caraustar Industries for $73 million. This transaction closed in June 1999.
- Also in April 1999, Tenneco's board of directors approved the spin-off.
- In June 1999, Tenneco's board of directors authorized the specialty packaging business to sell its remaining interest in PCA. Approximately 85% of this interest was sold by Pactiv in February 2000 for net proceeds of $398 million through a registered public offering.
- In August 1999, Tenneco received a letter ruling from the Internal Revenue Service that the spin-off would be considered to be a tax-free event for U.S. federal income tax purposes.
- On November 4, 1999, Tenneco completed the spin-off by issuing a dividend of the common stock of Pactiv to Tenneco shareowners.
The paperboard packaging segment is classified as a discontinued operation in the financial statements included in this report. See note 7 to the financial statements for further information.
Before the spin-off, Tenneco realigned substantially all of its existing debt through a combination of tender offers, exchange offers, and other refinancings. The realignment was financed through borrowings by Tenneco Automotive (formerly Tenneco, which changed its name to Tenneco Automotive Inc. in connection with the spin-off) under a new credit facility, the issuance by Tenneco Automotive of subordinated debt, Pactiv's issuance of public debt, and borrowings by Pactiv under new credit facilities.
At the spin-off date, Pactiv had total funded debt of $2.1 billion, comprised of new public-debt securities and drawings under its credit facilities. Pactiv's debt is rated as investment grade by both Standard & Poor's and Moody's. The debt is described in more detail in note 8 to the financial statements.
In connection with the spin-off, Pactiv entered into certain contractual arrangements with Tenneco Automotive, including separate distribution, tax-sharing, human-resource, insurance, and transition-service agreements. These agreements specify, among other things, that the company will provide administrative services relating to information systems, payroll, accounts payable, benefits administration, accounting, cash management, and employee travel to Tenneco Automotive for a specified period of time based on contractual fee arrangements.
UNUSUAL ITEMS
Restructuring and Other
In the fourth quarter of 1998, a restructuring plan was approved to reduce administrative and operating costs. As a result, Pactiv recorded a pre-tax charge against income from continuing operations of $32 million ($20 million after tax, or $0.12 per share). The restructuring plan involved the elimination of production lines at two plants, which was expected to result in the reduction of 104 positions; exiting four joint ventures; and the elimination of 184 administrative positions in business units and at corporate headquarters. All related actions have been substantially completed and were executed in accordance with the company's initial plan. As a result of this restructuring, a total of 252 positions were eliminated as of December 31, 1999.
In the first quarter of 1999, a plan was adopted to realign company functions in connection with the contribution of the containerboard assets to the PCA joint venture, and to close Tenneco's headquarters facility in Greenwich, Connecticut. This plan, for which a $29 million pre-tax charge ($17 million after tax, or $0.10 per share) was recorded, included the elimination of approximately forty positions. Approximately $30 million was received in the second quarter of 1999 related to the sale of the Greenwich facility. These restructuring actions were completed in 1999 and were executed in accordance with the company's initial plan.
In the fourth quarter of 1999, Pactiv adopted an extensive restructuring plan to exit non-core businesses and to reduce overhead costs. As a result, the company recorded a $154 million charge ($91 million after tax, or $0.54 per share). This charge was related to (1) the sale of the company's forest products and aluminum foil container businesses in Europe ($68 million), for which cash proceeds of $20 million were received in the fourth quarter of 1999, and the sale of certain assets of the company's administrative service operations and corporate aircraft operations ($10 million); (2) impairment of long-lived assets held for use in the company's packaging polyethylene business ($68 million); and (3) severance costs ($8 million) associated with the elimination of 161 positions, primarily in the company's international operations. The impairment of the packaging polyethylene business assets was
recorded following completion of an evaluation of strategic alternatives for this business and represented the difference between the carrying value of the assets and their forecasted discounted future cash flows.
In total, Pactiv expects to realize annual savings of $75 million upon completion of the 1998 and 1999 restructuring actions. Of this, an estimated $30 million was realized in 1999, and an additional $45 million is anticipated in 2000 ($40 million) and 2001 ($5 million).
See note 4 to the financial statements for additional information on restructuring and other actions.
Spin-off Transaction Costs
In the fourth quarter of 1999, the company recorded transaction costs related to the spin-off which reduced income before interest expense, income taxes, and minority interest, net income, and earnings per share by $136 million, $96 million, and $0.57, respectively. These costs were related to special curtailment and termination benefits for former Tenneco employees ($72 million), professional services performed in connection with the spin-off ($49 million), and separation from Tenneco operations ($15 million).
YEAR 1999 COMPARED WITH 1998
RESULTS OF CONTINUING OPERATIONS
Sales
Details of sales were as follows:
Sales in 1999 grew 4.7%, to $2.9 billion, reflecting unit volume growth of 7%. Excluding the negative impact of foreign-currency exchange rates, sales increased 5.5%. Sales growth was lower than unit volume gains because of a decline in selling prices in the first half of 1999.
Sales of the consumer and foodservice/food packaging business advanced 4.5% in 1999, principally driven by unit volume increases of 7%. In 1999, sales of protective and flexible products increased 5.9%, primarily as a result of unit volume growth of 10%. Excluding the negative impact of foreign-currency exchange, sales of the protective and flexible business grew 8.9%.
Operating Income (Income (Loss) before Interest Expense, Income Taxes, and Minority Interest)
Operating income by segment appears below.
The $13 million operating loss in 1999 included restructuring and other charges of $183 million and spin-off transaction expenses of $136 million. Operating income in 1998 was $283 million, which included
restructuring charges of $32 million. Excluding the effect of these unusual items, operating income by segment was as follows:
Excluding the impact of unusual items, operating income was $306 million in 1999, a decline of 2.9% from the prior year. The favorable impact of 7% unit volume growth and restructuring savings in 1999 was more than offset by the decline in the spread between selling prices and material costs (principally polyethylene resin) which lowered gross margin as a percent of sales to 26.6% from 28.1% in 1998. In addition, operating income in 1999 was negatively impacted by higher operating costs for the corporate data center.
Consumer and foodservice/food packaging operating income declined 6.9% in 1999, as the favorable impact of 7% unit volume growth was more than offset by a decline in margins because of the rapid escalation of raw material costs.
Protective and flexible packaging operating income increased 8.7% in 1999, principally because of a 10% growth in unit volume and the positive effect of cost-reduction initiatives. Excluding the negative impact of foreign-currency exchange, operating income improved 13% in 1999.
The operating loss in the other segment was reduced to $27 million in 1999 from $31 million in 1998, as a result of reductions in corporate overhead costs and higher pension income, partially offset by an increase in expenses associated with operating the corporate data center.
Interest Expense, Net of Interest Capitalized
Prior to the spin-off, corporate debt of Tenneco and related interest expense had been allocated to Pactiv, and changes in allocated debt and after-tax allocated interest costs were recorded as a component of Pactiv's combined equity.
Interest expense from continuing operations increased from $133 million in 1998 to $146 million in 1999. The $13 million increase in 1999 was driven by higher allocated corporate debt, as well as interest costs related to the realignment of debt in connection with the spin-off.
Income Taxes
Pactiv's effective tax rate for 1999 was 29.6% (benefit), compared with 44.7% for 1998. The company's income tax benefit in 1999 ($47 million) was principally attributable to the previously discussed restructuring and other charges and spin-off transaction expenses. Excluding these items, the effective tax rate for 1999 was 43.3%, compared with 43.4% for 1998.
Income (Loss) from Continuing Operations
The company recorded a net loss from continuing operations of $112 million ($0.67 per share) in 1999, compared with net income of $82 million ($0.49 per share) the previous year. Excluding the restructuring and other charges and spin-off transaction costs, net income for 1999 was $93 million ($0.55 per share), while 1998's net income was $102 million ($0.61 per share).
DISCONTINUED OPERATIONS AND EXTRAORDINARY CHARGE
For 1999, the loss from discontinued operations, net of income tax, was $193 million ($1.15 per share), which was comprised principally of an after-tax loss on the sales of the paperboard packaging operations of $206 million, which included the recording of a $53 million loss ($37 million after tax) in
the fourth quarter of the year, reflecting events which occurred after the sales related to the final settlement of working capital, revisions to actuarially determined estimates of pension plan curtailment costs, and changes in estimates regarding retained liabilities.
Discontinued operations generated after-tax income of $57 million for the year ended December 31, 1998, primarily driven by favorable containerboard pricing in the paperboard packaging business.
In 1999, an extraordinary after-tax charge of $7 million ($0.04 per share) was recorded as a result of the early retirement of debt in connection with the contribution of the containerboard assets to PCA.
LIQUIDITY AND CAPITAL RESOURCES
Capitalization
Details of the company's capital structure appear below.
Pactiv's ratio of debt to total capitalization was 60.1% and 57.8% at December 31, 1999 and December 31, 1998, respectively. Total debt declined in 1999 as a result of the contribution by Pactiv of its containerboard assets to the PCA joint venture.
Equity declined in 1999 as a result of distributions made to Tenneco and the net loss recorded for the year, which included the loss on containerboard assets contributed to PCA, as well as the restructuring and other charges and the spin-off transaction costs discussed previously. See the statement of changes in shareowners' equity for additional information.
Cash Flows
A summary of cash flows appears below.
Cash used by operating activities was $31 million in 1999, while $577 million was generated from operations in 1998. The $608 million decrease in 1999 was comprised of $341 million from continuing operations and $267 million from discontinued operations. The decrease in cash from continuing operations was primarily driven by restructuring and spin-off transaction payments, as well as increases in working capital. The decline in cash from discontinued operations was principally attributable to the repurchase of accounts receivable of the containerboard business previously sold to a third party in connection with the formation of the PCA joint venture, as well as a decline in containerboard sales because of lower linerboard and medium prices.
Investing activities used $994 million of cash in 1999, an increase of $480 million from 1998's level. This increase was driven by the purchase of assets used by the containerboard business in contemplation of
their contribution to the PCA joint venture, partially offset by lower spending on acquisitions and capital projects, and by proceeds from the sale of other businesses.
Pactiv borrowed $1.8 billion in the second quarter of 1999 in connection with the formation of the PCA joint venture, and used $1.2 billion of the proceeds to acquire assets used by the containerboard business under operating leases and timber cutting rights, and to purchase accounts receivable of this business that had previously been sold to a third party. The remaining proceeds ($600 million) from this borrowing, together with $306 million in cash received from the sale of the containerboard and folding carton businesses, were used to retire Tenneco's short-term debt. Excluding these transactions, cash provided by financing activities was $724 million for 1999.
Responsibility for the $1.8 billion in debt discussed in the previous paragraph was transferred to PCA in connection with the formation of the containerboard joint venture. This reduction of debt is shown in the statement of cash flows as a non-cash financing activity.
Capital Commitments
The company estimates that expenditures aggregating approximately $103 million will be required after December 31, 1999, to complete projects authorized at that date, and for which substantial commitments have been made.
Liquidity
Before the spin-off, Tenneco realigned substantially all of its debt through a combination of tender offers, exchange offers, and other refinancings. The realignment was financed, in part, by the exchange of Pactiv public-debt securities for Tenneco public-debt securities, and borrowings by Pactiv under new credit facilities, which are described below. At the date of the spin-off, Pactiv had total funded debt of $2.1 billion, comprised of new public-debt securities and drawings under its credit facilities.
Pactiv's management believes that cash flows from operations, combined with available borrowing capacity under its credit facilities, will generally be sufficient to meet capital requirements.
Former Tenneco notes and debentures with an aggregate principal amount of $1.2 billion were exchanged, in a non-cash transaction, for new public-debt securities of Pactiv, which were recorded based on the fair value of the debt on the date of exchange. The terms of Pactiv's public-debt securities are similar to the terms of the series of Tenneco's original securities for which they were exchanged, except that interest rates are approximately 50 basis points higher. The terms of the new securities will not restrict Pactiv's ability to declare dividends, authorize capital expenditures, or incur additional unsecured debt.
Pactiv entered into a five-year, $750 million revolving-credit agreement and a 364-day, $250 million revolving-credit agreement in connection with the spin-off. Borrowings under these facilities of $644 million at the time of the spin-off were used to fund a portion of the debt realignment. These facilities do not impose any restriction on Pactiv's ability to declare dividends or make capital investments. They do, however, include limitations related to liens, subsidiary debt, disposing of all or substantially all of the company's assets, and discontinuing Pactiv's primary businesses. These agreements require Pactiv to comply with financial and other customary covenants, the most restrictive of which are requirements related to the ratio of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), and the ratio of EBITDA to interest expense. None of these items are expected to limit the company's ability to operate its business in the ordinary course. At Pactiv's option, borrowings under the facilities bear interest at a floating rate based on LIBOR, adjusted for reserve requirements, plus a specified margin, or based on a specified prime or reference rate. Borrowings under these facilities may also bear interest based on competitive bids.
At the time of the spin-off, Pactiv exercised its right to make a one-time draw under a $1.5 billion term-loan agreement in the amount of $300 million at a floating interest rate based on LIBOR, adjusted
for reserve requirements, plus a specified margin. As a result of the sale of the majority of Pactiv's interest in PCA on February 2, 2000, all amounts borrowed under this facility were subsequently repaid.
Pactiv entered into a $175 million syndicated-lease agreement with a third-party lessor and various lenders, a portion of which was used to restructure or replace certain existing operating leases and public warehouse arrangements, with the balance to be used to facilitate additional leasing arrangements for other operating facilities. The syndicated-lease facility contains customary terms and conditions, including residual-value guarantees, default provisions, and financial covenants.
YEAR 1998 COMPARED WITH 1997
RESULTS OF CONTINUING OPERATIONS
Sales
Detail of sales were as follows:
Sales were $2.8 billion in 1998, up 8.9% from 1997. This increase was primarily attributable to the impact ($199 million) on sales of the protective and flexible packaging segment of the acquisition of N.V. Koninklijke KNP BT (KNP BT) in April 1997 and Richter Manufacturing in April 1998.
Operating Income (Income (Loss) before interest expense, income taxes, and minority interest)
Operating income by segment appears below.
Excluding the impact of restructuring charges of $32 million in 1998, segment operating income was as follows:
Excluding the effect of restructuring charges, 1998 operating income was $315 million, up 2.9% from the prior year. This rise was principally driven by the impact of the previously discussed acquisitions on results of the protective and flexible segment, as well as by higher unit volumes, primarily in Hefty OneZip(R), foodservice foam, and consumer tableware products, and lower expenses at Pactiv's administrative service operations. Partially offsetting these items was the effect of one-time expenses associated with information systems projects in the business units and increased costs related to data center consolidation actions.
Interest Expense, Net of Interest Capitalized
Interest expense for 1998 was $133 million, 7.3% higher than in 1997, primarily because of an increase in corporate debt allocated by Tenneco.
Income Taxes
Pactiv's effective tax rate for 1998 was 44.7%, compared with 41.2% for 1997. The tax rate was higher than the statutory rate in both periods primarily because of the impact of state and local income taxes.
Income from Continuing Operations
Income from continuing operations for 1998 and 1997 was $82 million ($0.49 per share) and $106 million ($0.63 per share), respectively. Excluding restructuring charges, income for 1998 was $102 million ($0.61 per share), $4 million (3.8%) lower than 1997.
DISCONTINUED OPERATIONS
Income from discontinued operations (paperboard packaging business) was $57 million ($0.34 per share) in 1998, up from $21 million ($0.12 per share) in 1997, primarily because of improved containerboard pricing.
LIQUIDITY AND CAPITAL RESOURCES Capitalization
Details of the company's capital structure appear below.
Pactiv's debt to capitalization ratio was 57.8% at December 31, 1998, compared with 53.4% at December 31, 1997. The increase in 1998 was principally attributable to the increase in allocated corporate debt from Tenneco and the decline in equity.
Cash Flows
A summary of sources and uses of cash is shown in the following table.
Cash provided by operating activities increased to $577 million in 1998 from $405 million in 1997. The $172 million increase in 1998 was comprised of $74 million from continuing operations and $98 million from discontinued operations. The increase from continuing operations was primarily attributable to working capital, which decreased slightly in 1998, but increased significantly in 1997 to support the growth in sales from 1996 levels. Cash generated by discontinued operations improved because of higher earnings in 1998, primarily resulting from higher containerboard pricing.
Investing activities used $514 million of cash in 1998, down $140 million from 1997's level, primarily because of lower spending on acquisitions, partially offset by higher capital expenditures related to discontinued operations, which primarily reflected the acquisition of leased timberlands in contemplation of the PCA joint venture formation. Acquisitions in 1998 included Champion International's dual-ovenable paperboard tray manufacturing facility in Belvidere, Illinois; Richter Manufacturing; and the protective-packaging assets of Sentinel Products Corporation. The principal acquisition in 1997 was the protective and flexible packaging businesses of KNP BT.
Financing activities used $67 million of cash in 1998, compared with providing $239 million in 1997. The $306 million change occurred primarily because Pactiv distributed $56 million to Tenneco in 1998, while $331 million was contributed to Pactiv by Tenneco in 1997.
CHANGES IN ACCOUNTING PRINCIPLES
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes new accounting and reporting standards requiring that all derivative instruments, including such instruments embedded in other contracts, be recorded in the balance sheet as either an asset or liability measured at fair value. FAS No. 133 will become effective for fiscal years beginning after June 15, 2000. Pactiv is currently evaluating the new standard, but has not yet determined the impact, if any, it will have on its financial position or results of operations.
In April 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-5, Reporting on the Costs of Start-Up Activities, which requires that costs of start-up activities be expensed as incurred. This statement became effective for fiscal years beginning after December 15, 1998. SOP 98-5 required that previously capitalized costs related to start-up activities be expensed as a cumulative effect of changes in accounting principles upon adoption. The company adopted SOP 98-5 on January 1, 1999, and recorded a related after-tax charge of $32 million (net of a $9 million tax benefit), or $0.19 per share, pertaining to previously capitalized start-up costs of its foreign operations and its administrative service operations. If the new accounting method had been applied retroactively, net income for the years ended December 31, 1998 and 1997 would have been lower by $14 million (net of a $8 million tax benefit), or $0.08 per share, and $7 million (net of a $3 million tax benefit), or $0.04 per share, respectively.
In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which establishes new accounting and reporting standards for the costs of computer software developed or obtained for internal use and required prospective application for fiscal years beginning after December 15, 1998. The impact of this new standard, which the company adopted on January 1, 1999, did not have a significant effect on Pactiv's financial position or results of operations.
In the fourth quarter of 1997, Pactiv adopted the FASB's EITF Issue 97-13, Accounting for Costs Incurred in Connection with a Consulting Contract that Combines Business Process Reengineering and Information Technology Transformation, and recorded a related after-tax charge of $38 million (net of a $24 million tax benefit), or $0.23 per share. This charge was reported as a cumulative effect of changes in accounting principles. EITF Issue 97-13 establishes the accounting treatment and allocation methodology to be used for consulting and other costs incurred in connection with information technology transformation activities.
YEAR 2000
Pactiv initiated a Year 2000 compliance program to ensure that its information systems and other date-sensitive equipment continue uninterrupted into the Year 2000. All of the company's essential processes and systems were compliant with Year 2000 requirements by the end of 1999. Pactiv did not experience any Year 2000 consequences that affected the company's financial position, liquidity, or results of operations, and did not experience any disruptions as a result of Year 2000 issues at its major vendors
and customers. The company will continue to monitor Year 2000 issues during the year as other critical dates approach. Contingency plans are in place to cover any problems that might arise at a later date. This multi-year program was executed in accordance with the company's initial plan, and the total cost was approximately $22 million.
EURO CONVERSION
The formation of the European Monetary Union resulted in the adoption of a common currency, the euro, among eleven European nations. The euro is being adopted over a three-year transition period which commenced on January 1, 1999. Pactiv believes it is on course to becoming fully "euro ready" on or before the conclusion of the three-year period. The company believes that the costs associated with transitioning to the euro will not be material.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
DERIVATIVE FINANCIAL INSTRUMENTS
The company is exposed to market risks related to changes in foreign currency-exchange rates, interest rates, and commodity prices. To manage these risks, the company, from time to time, enters into various hedging contracts in accordance with the company's policies and procedures. The company does not use hedging instruments for trading purposes, and is not a party to any transactions involving leveraged derivatives.
Foreign Currency Exchange
The company uses foreign-currency forward contracts to hedge its exposure to adverse changes in exchange rates, primarily related to the European euro, British pound, and Canadian dollar. Hedging is accomplished through the use of financial instruments, with related gains or losses offsetting gains or losses on underlying assets or liabilities.
In managing foreign-currency risk, the company aggregates existing positions and hedges residual exposures through third-party derivative contracts. The following table summarizes foreign-currency forward contracts in effect at December 31, 1999, all of which will mature in 2000.
Interest Rates
Following the realignment of debt in connection with the spin-off, the company is exposed to interest-rate risk on certain of its debt instruments. Pactiv utilizes revolving-credit and term-loan facilities that bear interest at a floating rate based on LIBOR. The amount outstanding under these facilities aggregated $861 million at December 31, 1999. In addition, the company has issued public-debt securities with original maturity dates ranging from six to twenty-eight years that have fixed interest rates. Should the company decide to redeem these securities prior to their stated maturity, it would incur costs based on the fair value of the debt at that time.
The following table provides information about Pactiv's financial instruments that are sensitive to interest rate risks.
Inasmuch as the company's debt was issued in November 1999, its book and fair value were considered to be approximately the same as of December 31, 1999.
Interest-rate risk management is accomplished through the use of swaps to create synthetic-debt instruments. In conjunction with the debt realignment, the company entered into an interest-rate swap to hedge its exposure to interest-rate movements. The company settled this swap in November 1999, incurring a $43 million loss, which is being recognized as additional interest expense over the average life of the underlying debt.
Commodities
The company purchases commodities, such as resin, paper, and aluminum, at market prices and does not currently use financial instruments to hedge commodity prices.
In December 1999, the company entered into a five-year agreement with one of its vendors to exclusively purchase certain materials at prices within a specified range. The agreement does not include minimum purchase commitments.
The statements and other information (including the tables) in this section constitute forward looking statements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO THE FINANCIAL STATEMENTS OF PACTIV CORPORATION AND CONSOLIDATED SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareowners, Pactiv Corporation:
We have audited the accompanying statements of financial position of Pactiv Corporation (a Delaware corporation) and consolidated subsidiaries as of December 31, 1999 and 1998, and the related statements of income (loss), cash flows, changes in shareowners' equity and comprehensive income (loss) for each of the three years ended December 31, 1999. These financial statements and the schedule referred to below are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pactiv Corporation and consolidated subsidiaries as of December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years ended December 31, 1999, in conformity with generally accepted accounting principles.
As explained in note 3 to the financial statements, effective January 1, 1999, the company changed its method of accounting for the costs of start-up activities, and effective December 1, 1997, it changed its method of accounting for certain costs incurred in connection with information technology transformation projects.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. The supplemental schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Chicago, Illinois February 22, 2000
STATEMENT OF INCOME (LOSS)
The accompanying notes to financial statements are an integral part of this statement.
STATEMENT OF FINANCIAL POSITION
The accompanying notes to financial statements are an integral part of this statement.
STATEMENT OF CASH FLOWS
The accompanying notes to financial statements are an integral part of this statement.
STATEMENT OF CHANGES IN SHAREOWNERS' EQUITY
The accompanying notes to financial statements are an integral part of this statement.
STATEMENT OF COMPREHENSIVE INCOME (LOSS)
The accompanying notes to financial statements are an integral part of this statement.
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
On November 4, 1999, in connection with a corporate reorganization, Pactiv Corporation's former parent company, Tenneco Inc. (Tenneco) and its subsidiaries completed various intercompany transfers and distributions designed to restructure and separate their then existing businesses, assets, liabilities, and operations so that, among other things, the packaging businesses and certain corporate and administrative service operations of Tenneco would be owned by Pactiv Corporation (Pactiv). Tenneco subsequently distributed pro rata to holders of its common stock all of the outstanding common stock of Pactiv (the spin-off). Prior to the spin-off, Pactiv was named Tenneco Packaging Inc. (TPI).
As used herein, the term "company" or "Pactiv" refers, for periods prior to the spin-off, to TPI and certain other subsidiaries through which Tenneco conducted its packaging businesses, and, for periods after the spin-off, to Pactiv and its consolidated subsidiaries.
Prior to the spin-off, all of the outstanding common stock of the company was owned directly or indirectly by Tenneco. The financial statements present the results of operations, financial position, and cash flows of the company as if it were a separate entity for all periods. The former parent's historical basis in the assets and liabilities of the company has been carried over to Pactiv. All per-share information is presented on a diluted basis, unless otherwise noted.
The accompanying statement of financial position is presented on a consolidated basis at December 31, 1999. All other financial statements are presented on a combined basis.
2. STRATEGIC REALIGNMENT
In July 1998, Tenneco's board of directors authorized management to develop a broad range of strategic alternatives to separate its automotive, paperboard packaging, and specialty packaging businesses. Subsequently, Tenneco completed the following actions:
- In January 1999, Tenneco reached an agreement to contribute the containerboard assets of its paperboard packaging operation to a new joint venture with Madison Dearborn Partners, Inc. called Packaging Corporation of America (PCA). For the contribution, which was completed in April 1999, Pactiv received approximately $2 billion in the form of cash and debt assumption, and retained a 45% equity interest in PCA (subsequently reduced to 43% as a result of equity issued to management) which was valued at approximately $200 million.
- In April 1999, Tenneco reached an agreement to sell the paperboard packaging segment's remaining business, its folding carton operation, to Caraustar Industries for $73 million. This transaction closed in June 1999.
- Also in April 1999, Tenneco's board of directors approved the spin-off.
- In June 1999, Tenneco's board of directors authorized the specialty packaging business to sell its interest in PCA. Approximately 85% of this interest was sold by Pactiv in February 2000 for net proceeds of $398 million through a registered public offering.
- In August 1999, Tenneco received a letter ruling from the Internal Revenue Service that the spin-off would be considered to be a tax-free event for U.S. federal income tax purposes.
- On November 4, 1999, Tenneco completed the spin-off by issuing a dividend of the common stock of Pactiv to Tenneco shareowners.
The paperboard packaging segment is classified as a discontinued operation in the financial statements. See note 7 for further information.
Before the spin-off, Tenneco realigned substantially all of its existing debt through a combination of tender offers, exchange offers, and other refinancings. The realignment was financed through borrowings by NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Tenneco Automotive (formerly Tenneco, which changed its name to Tenneco Automotive Inc. in connection with the spin-off) under a new credit facility, the issuance by Tenneco Automotive of subordinated debt, Pactiv's issuance of public debt, and borrowings by Pactiv under new credit facilities.
At the spin-off date, Pactiv had total funded debt of $2.1 billion, comprised of new public-debt securities and drawings under its credit facilities. Pactiv's debt is rated as investment grade by both Standard & Poor's and Moody's. The debt is described in more detail in note 8.
In connection with the spin-off, Pactiv has entered into certain contractual arrangements with Tenneco Automotive, including separate distribution, tax-sharing, human-resource, insurance, and transition-service agreements. These agreements specify, among other things, that the company will provide administrative services related to information systems, payroll, accounts payable, benefits administration, accounting, cash management, and employee travel to Tenneco Automotive for a specified period of time based on contractual fee arrangements.
3. SUMMARY OF ACCOUNTING POLICIES
Consolidation
The financial statements of the company include all majority-owned subsidiaries. Investments in 20% to 50% owned companies, where Pactiv has the ability to exert significant influence over operating and financial policies, are carried at cost plus equity in undistributed earnings since date of acquisition. All significant intercompany transactions are eliminated.
Cash and Temporary Cash Investments
The company defines cash and temporary cash investments as checking accounts, money-market accounts, certificates of deposit, and U.S. Treasury notes having an original maturity of ninety days or less.
Accounts and Notes Receivable
The company sells trade receivables ($122 million and $140 million at December 31, 1999 and 1998, respectively) to a third party in the ordinary course of business. Such sales are reflected as a reduction of accounts and notes receivable in the statement of financial position, and receipt of related proceeds are included in cash provided (used) by operating activities in the statement of cash flows.
Inventories
Inventories are stated at the lower of cost or market. A portion of inventories (52% and 61% at December 31, 1999 and 1998, respectively) is valued using the last-in, first-out (LIFO) method of accounting. All other inventories are valued using first-in, first-out (FIFO) or average-cost methods. If FIFO or average-cost methods had been used for all inventories, the total balance at December 31, 1999 and 1998, would have been lower by $9 million and $30 million, respectively.
Property, Plant, and Equipment, Net
Depreciation is recorded on a straight-line basis over the estimated useful lives of assets. Useful lives range from 10 to 40 years for buildings and improvements, and from three to twenty-five years for machinery and equipment.
The company currently expenses start-up costs as incurred. Prior to January 1, 1999, certain start-up expenditures were capitalized and amortized over periods ranging from three to five years. Capitalized start-up costs, net of amortization, at December 31, 1998 were $41 million.
The company capitalizes certain costs related to the purchase and development of software used in its business. Such costs are amortized over their estimated useful lives, ranging from three to twelve years, NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
based on various factors. Capitalized software development costs, net of amortization, were $77 million and $140 million at December 31, 1999 and 1998, respectively. The decrease in 1999 was primarily attributable to the spin-off and asset sales.
The Company periodically re-evaluates carrying values and estimated useful lives of long-lived assets to determine whether current facts and circumstances warrant adjustments. The company uses estimates of undiscounted cash flows from long-lived assets in determining whether the book value of such assets are recoverable over their remaining useful lives.
Goodwill and Intangibles, Net
Goodwill is amortized on a straight-line basis over forty years. The company has capitalized certain intangible assets, primarily trademarks and patents, based on their estimated fair value at the time of acquisition. Amortization of these assets is recorded on a straight-line basis over periods ranging from five to forty years.
Other Long-Term Assets
The company established a grantor trust to fund certain compensation and supplemental retirement benefits payable to former employees of Tenneco. This funding was established through the issuance of debt at the time of the spin-off. Unpaid benefits were $57 million at December 31, 1999. Offsetting liabilities are included in deferred credits and other liabilities in the statement of financial position.
Pactiv has a 50% interest in a U.S. joint venture with Sentinel Products Corporation which manufactures and distributes cross-linked, polyolefin-foam products. Capital contributions to the joint venture were $8 million and $9 million in 1999 and 1998, respectively. At December 31, 1998, Pactiv also had a 37% joint-venture interest in Zhejiana Tenneco Corrugated Packaging Co. Ltd., located in China. During 1999, the company contributed additional capital to the joint venture in exchange for an increase in ownership to 63%. As a result, the joint venture was included in the company's financial statements on a consolidated basis in 1999.
Environmental Liabilities
Expenditures for ongoing compliance with environmental regulations that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations that do not contribute to current or future revenue generation are expensed as incurred. Liabilities are recorded when environmental assessments indicate that remedial efforts are probable and that costs can be reasonably estimated. Estimates of liabilities are based on currently available facts, existing technology, and current laws and regulations, taking into consideration the likely effects of inflation and other factors. All available evidence is considered, including prior experience in remediation of contaminated sites, other companies' clean-up experience, and data released by the United States Environmental Protection Agency or other organizations. Estimated liabilities are subject to revision in subsequent periods based on actual costs or new information. Liabilities are included in the statement of financial position at their undiscounted amounts.
Revenue Recognition
The company recognizes revenue as products are shipped to customers.
General and Administrative Expenses
Included in costs and expenses under selling, general, and administrative(SG&A) in the statement of income (loss) for 1999, 1998, and 1997 were expenses totaling $43 million, $60 million, and $49 million, respectively, for the company's share of Tenneco's corporate, general, and administrative costs related to
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
legal, financial, communications, and other services. Also included in the SG&A category for 1999, 1998, and 1997 were costs aggregating $53 million, $53 million, and $22 million, respectively, related to corporate administrative services which were not allocated by Tenneco to its business units.
Prior to the spin-off, the allocation of Tenneco's corporate general and administrative expenses was based on estimated levels of effort devoted to Tenneco's various operations and the relative size of those operations based on revenues, gross property value, and payroll, which Pactiv's management believes was reasonable.
Research and Development
Research and development costs, which are expensed as incurred, totaled $40 million, $25 million, and $29 million for 1999, 1998, and 1997, respectively.
Advertising
Advertising costs are generally expensed in the year in which the advertising first takes place.
Income Taxes
The company utilizes the liability method of accounting for income taxes, whereby it recognizes deferred-tax assets and liabilities for the future tax consequences of temporary timing differences between the tax basis of assets and liabilities and the corresponding amounts reported in the financial statements. Deferred-tax assets are reduced by a valuation allowance when, based on management's estimates, it is more likely than not that a portion of deferred-tax assets will not be realized in a future period. Estimates utilized in the recognition of deferred-tax assets are subject to revision in subsequent periods based on new facts or circumstances.
The company does not provide for U.S. federal income taxes on unremitted earnings of foreign subsidiaries, as it is the present intention of management to reinvest those earnings in its foreign operations. Unremitted earnings of foreign subsidiaries totaled $70 million at December 31, 1999. It is not practicable to determine the amount of U.S. federal income taxes that would be payable if those earnings were remitted.
Pactiv and Tenneco Automotive have entered into an agreement to file a consolidated U.S. federal income tax return for all periods prior to the spin-off. This agreement provides, among other things, that each company in a taxable income position will be charged an amount equivalent to what its U.S. federal income tax would be if computed on a separate-return basis, and that each company in a tax-loss position will be reimbursed currently. The income-tax amounts reflected in the financial statements of Pactiv under the provisions of this arrangement are not materially different from what they would have been if determined on a separate-return basis.
Liability for foreign income taxes is generally allocated to the legal entity on which such taxes are imposed. In the case of state income taxes, Pactiv is liable for paying its own taxes in states where returns are filed separately. In states where returns are filed on a combined basis, liability is allocated in a manner similar to that for federal income tax.
Changes in Accounting Principles
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes new accounting and reporting standards requiring that all derivative instruments, including such instruments embedded in other contracts, be recorded in the balance sheet as either an asset or liability measured at fair value. FAS No. 133 will become effective for fiscal years beginning after June 15, 2000. Pactiv is currently evaluating the new standard, but has not yet determined the impact, if any, it will have on its financial position or results of operations. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In April 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-5, Reporting on the Costs of Start-Up Activities, which requires that costs of start-up activities be expensed as incurred. This statement became effective for fiscal years beginning after December 15, 1998. SOP 98-5 required that previously capitalized costs related to start-up activities be expensed as a cumulative effect of changes in accounting principles upon adoption. The company adopted SOP 98-5 on January 1, 1999, and recorded a related after-tax charge of $32 million (net of a $9 million tax benefit), or $0.19 per share, pertaining to previously capitalized start-up costs of its foreign operations and its administrative service operations. If the new accounting method had been applied retroactively, net income for the years ended December 31, 1998 and 1997 would have been lower by $14 million (net of a $8 million tax benefit), or $0.08 per share, and $7 million (net of a $3 million tax benefit), or $0.04 per share, respectively.
In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which establishes new accounting and reporting standards for the costs of computer software developed or obtained for internal use, and required prospective application for fiscal years beginning after December 15, 1998. The impact of this new standard, which the company adopted on January 1, 1999, did not have a significant effect on Pactiv's financial position or results of operations.
In the fourth quarter of 1997, Pactiv adopted the FASB's EITF Issue 97-13, Accounting for Costs Incurred in Connection with a Consulting Contract that Combines Business Process Reengineering and Information Technology Transformation, and recorded a related after-tax charge of $38 million (net of a $24 million tax benefit), or $0.23 per share. This charge was reported as a cumulative effect of changes in accounting principles. EITF Issue 97-13 establishes the accounting treatment and allocation methodology to be used for consulting and other costs incurred in connection with information technology transformation activities.
Earnings Per Share
In accordance with requirements of FAS No. 128, Earnings Per Share, basic earnings per share are computed by dividing income available to common shareowners by the weighted-average number of shares outstanding. The computation of diluted earnings per share is similar, except that the weighted-average number of shares outstanding is adjusted to reflect the potential issuances of dilutive shares, and the related change in income available to common shareowners that would occur is factored into the calculation.
Foreign Currency Translation
Financial statements of international operations are translated into U.S. dollars using end-of-period exchange rates for assets and liabilities, and the periods' weighted-average exchange rates for revenues, expenses, gains, and losses. Translation adjustments are recorded as cumulative translation adjustments in shareowners' equity.
Risk Management Activities
From time to time, the company uses derivative financial instruments, principally foreign-currency purchase and sale contracts with terms of less than one year, to hedge its exposure to changes in foreign-currency exchange rates. Net gains or losses on such contracts are recognized in the income statement as an offset to foreign-currency gains or losses on the underlying transactions. The company also has, from time to time, entered into contracts to hedge its net investment in foreign subsidiaries. After-tax gains or losses on such contracts are recognized on an accrual basis in the statement of financial position under accumulated other comprehensive income (loss) for 1999 and combined equity for 1998. In the statement of cash flows, cash receipts and payments related to hedge contracts are classified the same way as cash flows from the transactions being hedged.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Interest-rate risk management is accomplished through the use of swaps to create synthetic-debt instruments. Gains and losses on the settlement of swaps are recognized as additions to or reductions of interest expense.
The company does not use derivative financial instruments for speculative purposes.
Stock-Based Compensation
The company follows requirements of Accounting Principles Board (APB)Opinion No. 25 in accounting for stock options.
Estimates
The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts for assets, liabilities, revenues, and expenses. Actual results may differ from such estimates.
Reclassifications
Certain prior-year amounts have been reclassified to conform with current-year presentation.
4. UNUSUAL ITEMS
Restructuring and Other
In the fourth quarter of 1998, a restructuring plan was approved to reduce administrative and operating costs. As a result, Pactiv recorded a pre-tax charge against income from continuing operations of $32 million ($20 million after tax, or $0.12 per share). The restructuring plan involved the elimination of production lines at two plants, which was expected to result in the reduction of 104 positions; exiting four joint ventures; and the elimination of 184 administrative positions in business units and at corporate headquarters. All related actions have been substantially completed and were executed in accordance with the company's initial plan. As a result of this restructuring, a total of 252 positions were eliminated as of December 31, 1999.
In the first quarter of 1999, a plan was adopted to realign company functions in connection with the contribution of the containerboard assets to the PCA joint venture, and to close Tenneco's headquarters facility in Greenwich, Connecticut. This plan, for which a $29 million pre-tax charge ($17 million after tax, or $0.10 per share) was recorded, included the elimination of approximately forty positions. Approximately $30 million was received in the second quarter of 1999 related to the sale of the Greenwich facility. These restructuring actions were completed in 1999 and were executed in accordance with the company's initial plan.
In the fourth quarter of 1999, Pactiv adopted an extensive restructuring plan to exit non-core businesses and to reduce overhead costs. As a result, the company recorded a $154 million charge ($91 million after tax, or $0.54 per share). This charge was related to (1) the sale of the company's forest products and aluminum foil container businesses in Europe ($68 million), for which cash proceeds of $20 million were received in the fourth quarter of 1999, and the sale of certain assets of the company's administrative service operations and corporate aircraft operations ($10 million); (2) impairment of long-lived assets held for use in the company's packaging polyethylene business ($68 million); and (3) severance costs ($8 million) associated with the elimination of 161 positions, primarily in the company's international operations. The impairment of the packaging polyethylene business assets was recorded following completion of an evaluation of strategic alternatives for the business, and represented the difference between the carrying value of the assets and their forecasted discounted future cash flows.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Amounts related to the restructuring plans described above are shown in the following table.
Spin-off Transaction Costs
In the fourth quarter of 1999, the company recorded transaction costs related to the spin-off which reduced income before interest expense, income taxes, and minority interest, net income, and earnings per share by $136 million, $96 million, and $0.57, respectively. These costs were related to special curtailment and termination benefits for former Tenneco employees ($72 million), professional services performed in connection with the spin-off ($49 million), and separation from Tenneco operations ($15 million).
5. TRANSACTIONS WITH THE FORMER PARENT (TENNECO)
Combined Equity
Combined equity in the statement of changes in shareowners' equity at December 31, 1998 and 1997 represented Tenneco's cumulative net investment in the combined businesses of the company. Changes in combined equity reflected the aggregate of net income (loss), net cash and non-cash contributions from (distributions to) Tenneco, accumulated other comprehensive income (loss), changes in allocated corporate debt, and allocated corporate interest, net of tax.
Corporate Debt and Interest Allocation
Tenneco's historical practice had been to incur indebtedness for the consolidated group at the parent-company level, or at a limited number of subsidiaries, rather than at the operating-company level. Consequently, prior to the spin-off, corporate debt and related interest expense were allocated to Pactiv, generally based on the ratio of the company's net assets to Tenneco's consolidated net assets plus debt. Similarly, interest expense was allocated at a rate equivalent to the weighted-average cost of all corporate debt, which was 6.3%, 7.0%, and 7.4% for 1999 (prior to the spin-off), 1998, and 1997, respectively. Total interest expense allocated to the company in 1999, 1998, and 1997 was $118 million, $130 million, and $120 million, respectively. Although interest costs and the related tax effect were allocated to the company for financial-reporting purposes, Pactiv was not billed for these amounts. Changes in allocated corporate debt and allocated after-tax interest expense were included in combined equity. Although management believes that the historical allocation of corporate debt and interest was reasonable, it is not necessarily indicative of debt requirements and related interest costs of Pactiv as a separate public company.
Notes and Advances Receivable from Tenneco
In the statement of changes in shareowners' equity, amounts shown for cash contributions from (distributions to) Tenneco represented net cash changes in notes and advances receivable from the former parent. Historically, Tenneco had utilized notes and advances to centrally manage cash funding requirements of its consolidated group. Amounts shown in the same statement for non-cash contributions from (distributions to) Tenneco primarily reflected the transfer of assets and liabilities.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Accounts and Notes Receivable and Accounts Payable -- Affiliated Companies
Accounts and notes receivable--affiliated companies, $44 million at December 31, 1998, represented general and administrative costs incurred by Pactiv and allocated to affiliates. Accounts payable--affiliated companies, $6 million at December 31, 1998, represented billings for costs incurred by affiliates and allocated to Pactiv.
Employee Benefits
Certain employees of the company participated in Tenneco's stock option and stock purchase plans. The stock option plan provided for the grant of stock options and other stock awards at prices not less than market value on the date of grant. In connection with the spin-off, outstanding Tenneco options held by Pactiv employees were replaced by options of the company, preserving the aggregate value of Tenneco options held prior to the spin-off. The stock purchase plan allowed employees to purchase the former parent's stock at a 15% discount, subject to certain thresholds. Pactiv has established a stock purchase plan for its employees, which will become effective on April 1, 2000. Employees of the company also participated in certain post-retirement and pension plans of Tenneco. See notes 15 and 18 for information regarding these plans.
6. ACQUISITIONS
During 1999, the company made three acquisitions (the packaging businesses of Whitesell Corporation and Schut Superflex B.V., and Simpla, SpA) and made additional equity contributions to two of its joint ventures, investing a total of $24 million. In 1998, the company made three acquisitions (the dual ovenable paperboard tray manufacturing facility of Champion International, Richter Manufacturing, and the protective-packaging assets of Sentinel Products Corporation) and made additional equity contributions to a joint venture, investing a total of $101 million.
In March 1997, Pactiv entered into an agreement to acquire the protective and flexible packaging division of N.V. Koninklijke KNP BT (KNP BT) for $380 million, including, the assumption of debt and the issuance of preferred stock of a subsidiary to the seller. The KNP BT acquisition was completed in April 1997.
All of the acquisitions were accounted for as purchases, which required that purchase prices be allocated to assets acquired and liabilities assumed based on their fair values, and that the excess of purchase prices over net assets acquired be included in goodwill.
7. DISCONTINUED OPERATIONS AND EXTRAORDINARY LOSS
Discontinued Operations
In January 1999, Tenneco reached an agreement to contribute the containerboard assets of its paperboard packaging operation to a new joint venture with Madison Dearborn Partners, Inc., called PCA. For the contribution, which was completed in April 1999, Pactiv received approximately $2 billion in the form of cash and the assumption of debt, and retained a 45% equity interest in PCA (subsequently reduced to 43% as a result of equity issued to management) which was valued at approximately $200 million.
The containerboard assets contributed to the joint venture represented substantially all of the assets of the company's paperboard packaging operation, and included four mills, sixty-seven corrugated plants, and an ownership or leasehold interest in approximately 950,000 acres of timberland. Prior to the transaction, the company borrowed $1.8 billion and used $1.2 billion of the proceeds to acquire assets used by the containerboard business under operating leases and timber cutting rights, and to purchase accounts receivable of this business that had previously been sold to a third party. The remainder of the borrowings ($600 million) was remitted to Tenneco to repay a portion of its short-term debt. As a result of the NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
transaction, the company recorded an estimated loss of $293 million ($178 million after tax, or $1.07 per share) in the first quarter of 1999 based on the amount by which the carrying value of the containerboard assets exceeded their fair value, less selling costs. During 1999, the company recognized $13 million of income on its equity investment in PCA. See note 21 for additional information.
Under a transition service agreement, the company provides office space and certain administrative services related to information processing, payroll, benefits administration, office building administration, and accounting to PCA based on contractual fee arrangements.
In April 1999, Tenneco reached an agreement, which closed in June 1999, to sell the paperboard packaging operation's remaining business, its folding carton operation, to Caraustar Industries for $73 million. As a result of the sale, the company recorded a gain of $14 million ($9 million after tax, or $0.05 per share), which was included in discontinued operations.
In the fourth quarter of 1999, the company recorded an additional $53 million loss ($37 million after tax, or $0.21 per share) on the disposition of the paperboard packaging operation related to events that occurred subsequent to the sales, including the final settlement of working capital, revisions to actuarially determined estimates of pension plan curtailment costs, and changes in estimates regarding retained liabilities.
Net assets as of December 31, 1999, 1998, and 1997, and results of operations for the years then ended for the paperboard packaging operation were as follows:
(a) Included allocated debt of $548 million and $473 million at December 31, 1998 and 1997, respectively.
Pactiv has retained responsibility for certain contingent liabilities of its former paperboard packaging businesses, and has recorded related reserves where, in the judgement of management, it is probable that a quantifiable liability exists. Management believes that these liabilities will not have a material effect on the financial position or results of operations of the company.
In connection with the formation of the PCA joint venture, Pactiv entered into a five-year agreement to purchase corrugated products from PCA on an arm's length basis.
Extraordinary Loss
In the first quarter of 1999, the company recorded an extraordinary loss on extinguishment of debt of $7 million (net of a $3 million tax benefit), or $0.04 per share, related to early retirement of debt in connection with the sale of the containerboard assets.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. LONG-TERM DEBT, SHORT-TERM DEBT, AND FINANCING ARRANGEMENTS
General
Before the spin-off, Tenneco realigned substantially all of its debt through a combination of tender offers, exchange offers, and other refinancings. The realignment was financed, in part, by the exchange of Pactiv public-debt securities for Tenneco public-debt securities, and borrowings by Pactiv under new credit facilities, which are described below. At the date of the spin-off, Pactiv had total funded debt of $2.1 billion, comprised of new public-debt securities and drawings under its credit facilities.
Former Tenneco notes and debentures with an aggregate principal amount of $1.2 billion were exchanged, in a non-cash transaction, for new public-debt securities of Pactiv, which were recorded based on the fair value of the debt on the date of exchange. The terms of the company's public-debt securities are similar to the terms of the series of Tenneco's original securities for which they were exchanged, except that interest rates are approximately 50 basis points higher. The terms of the new securities will not restrict Pactiv's ability to declare dividends, authorize capital expenditures, or incur additional unsecured debt.
Pactiv entered into a five-year, $750 million revolving-credit agreement and a 364-day, $250 million revolving-credit agreement in connection with the spin-off. Borrowings under these facilities of $644 million at the time of the spin-off were used to fund a portion of the debt realignment. These facilities do not impose any restriction on Pactiv's ability to declare dividends or make capital investments. They do, however, include limitations related to liens, subsidiary debt, disposing of all or substantially all of the company's assets, and discontinuing Pactiv's primary businesses. These agreements require Pactiv to comply with financial and other customary covenants, the most restrictive of which are requirements related to the ratio of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) and the ratio of EBITDA to interest expense. None of these items are expected to limit the company's ability to operate its business in the ordinary course. At Pactiv's option, borrowings under the facilities bear interest at a floating rate based on LIBOR, adjusted for reserve requirements, plus a specified margin, or based on a specified prime or reference rate. Borrowings under these facilities may also bear interest based on competitive bids.
At the time of the spin-off, Pactiv exercised its right to make a one-time draw under a $1.5 billion term-loan agreement in the amount of $300 million at a floating interest rate based on LIBOR, adjusted for reserve requirements, plus a specified margin. As a result of the sale of the majority of Pactiv's interest in PCA on February 2, 2000, all amounts borrowed under this facility were subsequently repaid.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Long-Term Debt
A summary of long-term debt is set forth in the following table.
(a) See note 5 for information related to debt allocated by Tenneco.
The aggregate maturities and sinking-fund requirements for the issues outstanding at December 31, 1999, are $4 million, $4 million, $4 million, $2 million, $563 million, and $1,177 million for 2000, 2001, 2002, 2003, 2004, and thereafter, respectively.
At December 31, 1999, the total amount of floating-rate, long-term debt was $561 million.
Short-Term Debt
A summary of short-term debt appears below.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The company uses lines of credit and overnight borrowings to finance certain of its short-term capital requirements. Information regarding short-term debt is shown below.
(a) Includes borrowings under both committed credit facilities and uncommitted lines of credit.
Financing Arrangements
A summary of the company's drawings under credit facilities follows:
(a) Pactiv is required to pay utilization fees on borrowings under the facilities, and facility fees on total commitments.
In conjunction with the debt realignment, the company entered into an interest-rate swap to hedge its exposure to interest-rate movements. The company settled this swap in November 1999 at a loss of $43 million. In addition, the company paid $10 million in bank facility fees in connection with the realignment of Tenneco debt. Both the loss on the swap and the bank facility fees were deferred and are being recognized as additional interest expense over the average life of the underlying debt.
9. FINANCIAL INSTRUMENTS
Asset and Liability Instruments
At December 31, 1999 and 1998, the fair value of cash and temporary cash investments, short- and long-term receivables, accounts payable, and short- and long-term debt (before allocation of debt by Tenneco at year-end 1998) were considered to be the same as, or not materially different than, the recorded amounts.
Instruments with Off Balance Sheet Risk
From time to time, Pactiv enters into foreign-currency forward purchase and sale contracts with terms of less than one year to mitigate its exposure to exchange-rate changes related to foreign-currency third-party trade receivables and accounts payable.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes foreign-currency contracts entered into by the company at December 31, 1999.
Based on exchange rates at December 31, 1999, the cost of replacing these contracts in the event of non-performance by the counterparties would not have been material.
Prior to the spin-off, exposure to foreign-currency risk was primarily hedged on a net basis by Tenneco. At December 31, 1998, Pactiv had purchase contracts totaling $1 million, principally in U.S. dollars, and sell contracts aggregating $1 million, primarily in British pounds.
Guarantees
The company issued payment and performance guarantees totaling approximately $1 million in both 1999 and 1998, primarily related to letters of credit and other financing and operating activities.
10. INVENTORIES
Inventories by major classification were as follows:
11. GOODWILL AND INTANGIBLES, NET
Goodwill and intangibles, net of amortization, were as follows:
Goodwill amortization amounted to $20 million, $17 million, and $21 million for 1999, 1998, and 1997, respectively. Amortization of intangible assets, primarily trademarks and patents, amounted to $15 million, $18 million, and $17 million in 1999, 1998, and 1997, respectively.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
12. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant, and equipment were as follows:
The decrease in property, plant, and equipment in 1999 was principally attributable to the write-down of polyethylene packaging assets and the sale of assets used in the forest products and aluminum container businesses.
13. OTHER LONG-TERM ASSETS
Other long-term assets were as follows:
14. INCOME TAXES
The domestic and foreign components of income (loss) from continuing operations is summarized below.
Following is a comparative analysis of the components of income tax expense (benefit) applicable to continuing operations:
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Current income tax expense for 1999, 1998, and 1997, included tax benefits of $38 million, $45 million, and $41 million, respectively, related to the allocation of interest expense from the former parent.
Following is a reconciliation of income taxes computed at the statutory U.S. federal income tax rate (35%) with the income tax expense (benefit) reflected in the statement of income (loss):
Summarized below are the components of the company's net deferred-tax liability.
(a) Represents unrecognized tax benefits related to foreign tax-loss carryforwards.
Of the $267 million of U.S. tax-loss carryforwards at December 31, 1999, $127 million will expire in 2017, and the remainder will expire in 2019. The $15 million of state tax-loss carryforwards at December 31, 1999, will expire in varying amounts over the period from 2000 to 2012. Of the $37 million of foreign tax-loss carryforwards at December 31, 1999, $23 million will not expire, and the remainder will expire in varying amounts over the period from 2000 to 2009.
In connection with the spin-off, Pactiv entered into a tax-sharing agreement with Tenneco Automotive. In general, this agreement calls for tax liabilities prior to the spin-off to be assigned based on the legal entity bearing responsibility for the tax, and assigns responsibility for any tax burden resulting from the spin-off. The tax-sharing agreement also assigns responsibility for liabilities related to a 1996 tax-sharing agreement with other former affiliates of Tenneco. See note 3 for further information regarding the tax-sharing agreement.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
15. COMMON STOCK
Pactiv has authorized 350 million shares ($0.01 par value) of common stock, of which 168,372,798 shares were issued and outstanding as of December 31, 1999.
Reserved
Reserved shares of common stock at December 31, 1999, are detailed below.
(a) This plan will become effective on April 1, 2000.
Stock Plans
Stock Ownership Plan -- In November 1999, the company adopted a stock ownership plan, which permits the granting of a variety of awards, including common stock, restricted stock, performance shares, stock appreciation rights (SARs), and stock options to directors, officers, and employees of Pactiv. Under the plan, which will terminate on November 4, 2004, up to 24,000,000 shares of common stock can be issued. In December 1996, Pactiv's former parent adopted a similar plan under which certain key employees of Pactiv were granted restricted stock. In connection with the spin-off, outstanding restricted stock of Tenneco became fully vested, and, as a result, Pactiv recorded an after-tax compensation expense of $7 million in 1999. All of the former parent's stock options granted to Pactiv employees before the spin-off were canceled and replaced with options to purchase the company's common stock. In this connection, the number of Pactiv options received were such that the aggregate option value immediately after the spin-off equaled the aggregate value immediately before the spin-off.
The company granted restricted stock under the stock ownership plan to certain key employees. These awards generally require, among other things, that grantees remain with the company during the restriction period. During 1999, Pactiv granted 147,000 performance shares and 48,381 restricted shares to certain key employees, with a weighted-average fair value of $13.44 based on the market price of the company's stock on the grant date. These shares will vest upon the attainment of specified performance goals in the three years following the date of grant.
Details of stock options issued by Pactiv are summarized in the following table.
Stock options expire ten to twenty years from date of grant, and vest over periods ranging from one to three years.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of stock options granted by Pactiv during 1999 was estimated using the Black-Scholes option-pricing model, with the following weighted-average assumptions: risk-free interest rate of 6.0%, expected life of 5 years, and expected volatility of 27.4%. The weighted-average fair value of options granted during 1999 was $4.63.
The company exchanged Tenneco options for Pactiv options at the date of spin-off. Black-Scholes option-pricing model assumptions and fair value for these options are shown in the following table.
Summarized below is information about stock options outstanding at December 31, 1999.
The company follows the requirements of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for stock-based compensation plans. The company recorded after-tax, stock-based compensation expense of $8 million, $3 million, and $4 million in 1999, 1998 and 1997, respectively. Had compensation costs been determined in accordance with FAS No. 123, Accounting for Stock-Based Compensation, the company's pro-forma net income for 1999, 1998, and 1997, would have been lower by $7 million ($0.04 per share), $14 million ($0.08 per share), and $13 million ($0.08 per share), respectively.
Employee Stock Purchase Plan--In April 2000, the company will initiate a stock purchase plan that allows U.S. and Canadian employees to purchase Pactiv common stock at a 15% discount, subject to an annual limitation of $21,240. Under a similar plan of the company's parent, Pactiv employees purchased 184,370 shares, 311,586 shares, and 216,665 shares of Tenneco stock in 1999, 1998, and 1997, respectively, with a weighted-average fair value $4.30, $6.31, and $11.14 in 1999, 1998, and 1997, respectively. Since the spin-off, the company's employees no longer participate in the former parent's plan.
Grantor Trust--In November 1999, Pactiv established a grantor trust and reserved 3,200,000 shares of common stock for the trust. This trust is a so-called "rabbi trust" designed to assure the payment of deferred compensation and supplemental pension benefits. The shares were issued to the trust in January 2000.
Qualified Offer Rights Plan
In November 1999, Pactiv adopted a qualified offer rights plan (QORP). The plan was adopted to deter coercive takeover tactics, and to prevent a potential acquiror from gaining control of the company in a transaction which would not be in the best interests of shareowners. Under the plan, if a person becomes
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the beneficial owner of 20% or more of the company's outstanding common stock, other than pursuant to a qualified offer, each right will entitle its holder to purchase common stock having a market value of twice the right's exercise price. Rights held by the 20% or more holder would not be exercisable.
The rights would not be exercisable in connection with a qualified offer, which is defined as an all-cash tender offer for all outstanding shares that is fully financed, remains open for a period of at least sixty business days, results in the offeror owning at least 85% of the common stock after consummation of the offer, assures a prompt second-step acquisition of shares not purchased in the initial offer at the same price as the initial offer, and meets certain other requirements.
In connection with the adoption of the QORP, the board of directors also adopted an evaluation mechanism. This mechanism calls for an independent board committee to review, on an ongoing basis, the QORP and developments in rights plans in general, and, if it deems appropriate, to recommend modification or termination of the plan. The independent committee is required to report to the board at least every three years as to whether the QORP continues to be in the best interest of shareowners.
Earnings Per Share
In connection with the spin-off, one share of Pactiv common stock was issued for each share of Tenneco common stock then owned. Accordingly, basic earnings per share for 1999 was calculated using the former parent's weighted-average number of shares outstanding from January 1, 1999 to November 4, 1999, and the weighted-average number of Pactiv shares outstanding from November 5, 1999, to December 31, 1999. Diluted earnings per share was calculated in the same manner, adjusting for the potential issuance of additional shares related to stock options, restricted stock, and performance shares.
Weighted-average basic and diluted shares outstanding were as follows:
16. PREFERRED STOCK
Pactiv had 50 million shares of preferred stock ($0.01 par value) authorized but unissued at December 31, 1999. The company has reserved 750,000 preferred shares as junior preferred stock for the QORP.
17. MINORITY INTEREST
At December 31, 1999 and 1998, minority interest totaled $20 million and $14 million, respectively, and was primarily related to preferred stock of a subsidiary issued in connection with the KNP BT acquisition.
18. PENSION PLANS AND OTHER POST-RETIREMENT BENEFITS
The company has pension plans that cover substantially all of its employees. Benefits are based on years of service and, for most salaried employees, final-average compensation. The company's funding policy is to contribute to the plans amounts necessary to satisfy requirements mandated by federal laws and regulations. Plan assets consist principally of equity and fixed-income securities. Pactiv became the sponsor of Tenneco's retirement plan. Benefits accrued under this plan for employees of Tenneco Automotive were frozen as of November 30, 1999, and all related pension obligations and assets were retained by the company. In addition, all pension obligations and assets associated with participating employees of other former subsidiaries and affiliates of Tenneco were similarly retained by Pactiv.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The company has post-retirement, health-care, and life-insurance plans that cover all of its salaried and certain of its U.S. hourly employees. For salaried employees, the plans cover individuals who retire on or after attaining age fifty-five with at least ten years service after reaching age forty-five. For hourly employees, post-retirement benefit plans generally cover individuals who retire in accordance with the various provisions of those plans. Benefits may be subject to deductibles, co-payment provisions, and other limitations. The company reserves the right to change post-retirement plans. These plans are not funded.
Financial data pertaining to the company's pension and post-retirement benefit plans appear below.
(a) Reflects the inclusion of Tenneco Automotive's pension benefits through the spin-off date.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The effect of pension plans on income from continuing operations was as follows:
Amounts recognized in the statement of financial position pertaining to the pension plan included current assets of $5 million, non-current assets of $941 million, current liabilities of $37 million, and non-current liabilities of $111 million at December 31, 1999, and current assets of $6 million, non-current assets of $742 million, current liabilities of $25 million, and non-current liabilities of $89 million at December 31, 1998.
Actuarial assumptions used to determine costs and benefit obligations for the pension plans are shown below.
The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were $56 million, $52 million, and $1 million, respectively, at September 30, 1999, and $89 million, $83 million, and $27 million, respectively, at September 30, 1998.
The impact of post-retirement benefit plans on continuing operations was as follows:
Actuarial assumptions used to determine post-retirement benefit obligations follow:
Increasing the assumed health-care cost trend by 1% each year would increase 1999, 1998, and 1997 post-retirement benefit obligations by approximately $2 million each year; however, the aggregate of service and interest costs would not change for 1999 and 1998, and would increase $2 million for 1997.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Decreasing the assumed health-care cost trend by 1% each year would decrease post-retirement benefit obligations for 1999 by approximately $2 million, but would not change the aggregate of service and interest costs.
19. SEGMENT AND GEOGRAPHIC AREA INFORMATION
The company's operating segments include:
Consumer and foodservice/food packaging, which relates to the manufacture and sale of disposable plastic, molded fiber, pressed paperboard, and aluminum packaging products for the consumer, foodservice, and food packaging markets.
Protective and flexible packaging, which relates to the manufacture and sale of plastic, paperboard, and molded fiber protective and flexible packaging products. Major markets served by protective packaging products include electronics, automotive, furniture, and e-commerce, whereas flexible-packaging products are used mainly in food, medical, pharmaceutical, chemical, and hygienic applications.
Other, which relates to corporate and administrative service operations and pension plan income and expense.
Prior to the spin-off, the combined results of the consumer and foodservice/food packaging and protective and flexible businesses were reported under the specialty packaging segment by Tenneco. During the fourth quarter of 1999, the company changed the composition of its operating segments because of modifications in its management-reporting structure triggered by the spin-off. Segment information for the first three quarters of 1999, as well as total-year 1998 and 1997 has been restated to conform with current segment presentation.
The accounting policies of the segments are the same as those described in note 3. Products are transferred between segments and geographic areas on a basis intended to reflect, as nearly as possible, market values. No one customer accounted for more than 10% of the company's 1999 sales. In general, the company's backlog of orders is not significant or material.
The following table sets forth certain segment information.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(a) Includes restructuring and other charges of $66 million and $9 million in 1999 and 1998, respectively.
(b) Includes restructuring and other charges of $77 million and $9 million in 1999 and 1998, respectively.
(c) Includes pension plan income, unallocated corporate expenses, restructuring and other charges of $40 million and $14 million in 1999 and 1998, respectively, and spin-off transaction costs of $136 million in 1999.
(d) Includes assets related to pension plans (net), administrative service operations, and the discontinued paperboard packaging business (1998 and 1997).
(e) Includes pension plan income.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth certain geographic area information.
(a) Sales from external customers and long-lived assets for individual countries were not material.
(b) Geographic assignment is based on location of selling business.
(c) Long-lived assets include all long-term assets other than net assets of discontinued operations, goodwill, intangibles, and deferred taxes.
20. COMMITMENTS AND CONTINGENCIES
Capital Commitments
The company estimates that expenditures aggregating approximately $103 million will be required after December 31, 1999, to complete projects authorized at that date, and for which substantial commitments have been made.
Purchase Commitments
In December 1999, the company entered into a five-year agreement with one of its vendors to exclusively purchase certain materials at prices within a specified range. The agreement does not include minimum purchase commitments.
Lease Commitments
Pactiv entered into a $175 million syndicated-lease agreement with a third-party lessor and various lenders, a portion of which was used to restructure or replace certain existing operating leases and public warehouse arrangements, with the balance to be used to facilitate additional leasing arrangements for other operating facilities. The syndicated-lease facility contains customary terms and conditions, including residual-value guarantees, default provisions, and financial covenants.
The company occupies certain warehousing facilities and its corporate headquarters building under operating leases that are part of the syndicated-lease agreement. Following the initial lease periods for the properties, the company may extend the leases on terms negotiated with the lessors, or purchase the leased assets under specified conditions. If the purchase options are not exercised or the leases are not extended, the company is required to make guaranteed residual payments to the lessors, which may be refunded in full depending on the lessors' subsequent sales price for the properties. Throughout the lease periods, the company is required to maintain the properties. At December 31, 1999, residual guarantees on leased properties were $61 million. The company has a commitment from the lessors to lease additional
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
properties during 2000, and the value of the related residual guarantees is expected to be approximately $82 million.
For properties under lease at December 31, 1999, annual lease payments are expected to be approximately $5 million. For properties to be acquired during 2000, annual lease payments are anticipated to aggregate approximately $7 million. Lease agreements on these properties require the company to satisfy certain financial ratio tests.
The company holds certain of its facilities, equipment, and other assets under long-term leases. The minimum lease payments under non-cancelable operating leases with lease terms in excess of one year are $34 million, $21 million, $14 million, $11 million, and $7 million for 2000, 2001, 2002, 2003, and 2004, respectively, and $26 million for subsequent years.
Commitments under capital leases were not significant. Total rental costs for continuing operations for 1999, 1998, and 1997 were $54 million, $35 million, and $37 million, respectively, including minimum rentals under non-cancelable operating leases of $38 million, $45 million, and $42 million for the corresponding periods.
Litigation
In May 1999, Tenneco, Pactiv, and a number of containerboard manufacturers were named as defendants in a civil class-action antitrust lawsuit pending in the United States district court for the eastern district of Pennsylvania. The company also was named as a defendant in a related class-action antitrust lawsuit. The lawsuits allege that the defendants conspired to raise linerboard prices for corrugated containers and corrugated sheets from October 1, 1993 through November 30, 1995, in violation of Section 1 of the Sherman Act. The lawsuits seek treble damages in an unspecified amount, plus attorney fees. Pactiv's management believes that the allegations have no merit, are vigorously defending the claims, and believe that the outcome will not have a material adverse effect on the company's financial position or results of operations. As between Tenneco and Pactiv, Pactiv is responsible for defending the claims and for any liability resulting therefrom.
The company is party to various legal proceedings arising from its operations.
Management believes that the outcome of these proceedings, individually and in the aggregate, will not have a material effect on the company's financial position or results of operations.
Environmental Matters
The company is subject to a variety of environmental and pollution-control laws and regulations in all jurisdictions in which it operates. Pactiv provides related reserves where it is probable that liabilities exist and where reasonable estimates of the liabilities can be made. Estimated liabilities are subject to change as more information becomes available regarding the magnitude of possible clean-up costs, and the cost and effectiveness of alternative clean-up technologies. However, management believes that any additional costs that may be incurred as more information becomes available will not have a material effect on the financial condition or results of operations of the company.
21. SUBSEQUENT EVENTS
In an initial public offering, Pactiv sold the majority of its interest in the PCA joint venture in February 2000. Net proceeds of $398 million were primarily used to repay debt. A 6% common equity interest in PCA was retained by the company.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In December 1999, the company entered into an agreement to sell its aluminum foil reroll facility in Clayton, New Jersey, and its aluminum packer processor facility in Shelbyville, Kentucky, for approximately $45 million. The proceeds from this transaction, which closed in January 2000, were primarily used to repay debt.
In February 2000, the company announced its intention to repurchase approximately $100 million of its own common stock. The company plans to use borrowings to fund the stock repurchases.
22. QUARTERLY FINANCIAL DATA (UNAUDITED)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(a) The sum of amounts shown for individual quarters may not equal the total for the year because of changes in the weighted-average number of shares outstanding throughout the year.
The preceding notes are an integral part of the foregoing financial statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
There has been no change in accountants, nor has there been any disagreement on any matter of accounting principles or practices or financial disclosure, which in either case is required to be reported pursuant to this Item 9.
PART III
Item 10, "Directors and Executive Officers of the Registrant," Item 11, "Executive Compensation," Item 12, "Security Ownership of Certain Beneficial Owners and Management," and Item 13, "Certain Relationships and Related Transactions," have been omitted from this report inasmuch as Pactiv Corporation will file with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report a definitive Proxy Statement for the Annual Meeting of Shareowners of Pactiv Corporation to be held on May 10, 2000, at which meeting the shareowners will vote upon the election of directors. The information under the caption "Election of Directors" in such Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
FINANCIAL STATEMENTS INCLUDED IN ITEM 8
See "Index to Financial Statements of Pactiv Corporation" set forth in Item 8, "Financial Statements and Supplementary Data."
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES INCLUDED IN ITEM 14
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN MILLIONS)
REPORTS ON FORM 8-K
The company filed two Current Reports on Form 8-K during the quarter ended December 31, 1999. On October 28, 1999, the company filed a Current Report on Form 8-K, including information pursuant to item 5 (other events) relating to the public offering of Packaging Corporation of America. On November 12, 1999, the company filed a Current Report on Form 8-K, including information pursuant to item 2 (acquisition or disposition of assets), and item 5 (other events) relating to the spin-off of the company from Tenneco Inc.
INDEX OF EXHIBITS
The following exhibits are filed as part of this Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (exhibits designated by an asterisk are filed with this report; all other exhibits are incorporated by reference):
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on its behalf by the undersigned, thereunto duly authorized.
PACTIV CORPORATION
By: /s/ RICHARD L. WAMBOLD ------------------------------------ Richard L. Wambold Chairman, President and Chief Executive Officer
Date: March 28, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following on behalf of the registrant and in the capacities and on the dates indicated.