UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

 

 

 

 

Commission File Number 1-15157

 

 

PACTIV CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

 

 

Registrant’s Telephone Number, including area code: (847) 482-2000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: Common stock, par value $0.01 per share: 133,166,172 as of October 31, 2010. (See Notes to Financial Statements.)

 

 

TABLE OF CONTENTS

 

 

 

 

 

 

The accompanying notes to the financial statements are an integral part of this statement.

 

 

The accompanying notes to the financial statements are an integral part of this statement.

 

 

The accompanying notes to the financial statements are an integral part of this statement.

Consolidated Statement of Changes in Equity

 

The accompanying notes to the financial statements are an integral part of this statement.

 

 

The accompanying notes to the financial statements are an integral part of this statement.

 

 

The consolidated statement of income for the three- and nine-month periods ended September 30, 2010, and 2009, the condensed consolidated statement of financial position at September 30, 2010, the condensed consolidated statement of cash flows for the nine-month periods ended September 30, 2010, and 2009, the consolidated statement of changes in equity for the nine-month period ended September 30, 2010, and 2009, and the consolidated statement of comprehensive income (loss) for the three- and nine-month periods ended September 30, 2010, and 2009 are unaudited. In our opinion, the accompanying financial statements contain all normal recurring adjustments necessary to present fairly the results of operations, financial position, and cash flows for the periods and at the dates indicated. These statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). They do not include all of the information and footnotes required by generally accepted accounting principles. Accordingly, these statements should be read in conjunction with Pactiv’s Form 10-K for the year ended December 31, 2009, which may be found at www.pactiv.com, under the Investor Relations link, in the subsection entitled “SEC Filings,” or a free copy may be obtained by contacting Investor Relations at (866) 456-5439. Certain reclassifications have been made to the prior year financial information to conform with the current year presentation.

 

On April 1, 2010, we purchased PWP Holdings, Inc. and PWP Industries (PWP) for $203 million. PWP Industries manufactures and sells amorphous polyethylene terephthalate (APET) products in the foodservice market. The purchase price was funded by borrowing $160 million on our revolving credit facility, adding $20 million to the asset securitization program, and utilizing $23 million in cash reserves. The results of this business have been included in the consolidated financial statements as of that date.

 

On January 5, 2009, we purchased the polypropylene cup business of WinCup for $20 million. This business operates one manufacturing facility in North Carolina. The results of this business have been included in the consolidated financial statements as of that date.

 

We have three reporting segments:

 

 

The accounting policies of the reporting segments are the same as those for Pactiv as a whole. Where discrete financial information is not available by segment, reasonable allocations of expenses and assets/liabilities are used.

 

Subsequent Events

 

We have evaluated subsequent events through the filing date of this Form 10-Q, and have determined that there were no other subsequent events to recognize or disclose in these financial statements.

 

 

On August 16, 2010, we entered into a definitive merger agreement to be acquired by Reynolds Group Holdings Limited, a leading global manufacturer and supplier of consumer food and beverage packaging and storage products, in a transaction valued at approximately $6 billion. Reynolds is a wholly owned subsidiary

 

of New Zealand-based Rank Group Limited, which is owned by Graeme Hart. Under the terms of the agreement, our shareholders will receive $33.25 in cash for each share of Pactiv common stock held.

 

 

For a complete discussion of our accounting policies, refer to Pactiv’s most recent filing on Form 10-K.

 

Changes in Accounting Principles

 

The Financial Accounting Standards Board (FASB) issued updates to Accounting Standards Codification (ASC) 860-10 “Transfers and Servicing,” which were effective for interim and annual periods beginning after November 15, 2009. The updated provisions require additional information about transfers of financial assets and where companies have continuing exposure to the risk related to transferred financial assets, eliminates the concept of a qualifying special purpose entity, changes the requirements for derecognition of financial assets, and requires additional disclosures. ASC 860-10 was effective on January 1, 2010. See “Accounts and Notes Receivables” below and Note 6 for additional details.

 

The FASB issued updates to ASC 810-10 “Consolidation,” which were effective for interim and annual periods beginning after November 15, 2009. These updated provisions require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity, require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity, and eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity. In addition, the provisions include an additional reconsideration event for determining whether an entity is a variable interest entity when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance. Lastly, the provisions require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. ASC 860-10 was effective on January 1, 2010. See “Accounts and Notes Receivables” below and Note 6 for additional details.

 

Accounts and Notes Receivable

 

We have an asset securitization agreement under which certain of our accounts receivable are sold to our variable interest entity (VIE), Pactiv RSA. Under the accounting principles in effect prior to 2010, Pactiv RSA was not consolidated with our financial statements. In accordance with updated provisions within ASC 810-10 and 860-10, which we adopted January 1, 2010, Pactiv RSA was included in the consolidated financial statements as of that date.

 

Pactiv RSA held $397 million of receivables at September 30, 2010, securing $130 million of short-term debt borrowed from various financial institutions that hold interests in the VIE on a pro-rata basis equal to their shares of the total loan. The collection of these receivables is used first to repay the loans. Any remaining amounts collected are retained by Pactiv RSA. If the collection of the receivables is insufficient to repay the loans, the lenders do not have recourse to Pactiv. We maintain an allowance for doubtful accounts for any potential uncollectable amounts after the loans are repaid. At December 31, 2009, under the prior accounting principles, securitized receivables totaling $110 million were recorded as a reduction to accounts and notes receivable and no debt was recorded.

 

 

On April 1, 2010, we purchased PWP Holdings, Inc. and PWP Industries for $203 million, which includes a $3 million working capital adjustment. The results of this business have been included in the consolidated financial statements as of that date.

 

The total cost of the acquisition was allocated to the assets acquired and the liabilities assumed based on their respective fair values. Allocations were based on preliminary estimates of the fair market value of assets and

 

liabilities, which are subject to revision based on receipt of final appraisals. Goodwill and other intangible assets recorded in connection with the acquisition totaled $100 million and $15 million, respectively. Recorded intangible assets pertaining to customer relationships and non-compete agreements are being amortized over a 15-year period.

 

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed as of the acquisition date.

 

 

 

On October 12, 2005, we completed the sale of most of our protective and flexible packaging businesses. The results of the sold business, as well as costs and charges associated with the transaction, are classified as discontinued operations.

 

In the third quarter of 2010, we recorded $2 million of income from discontinued operations related to the expiration of the statute of limitations on the 2006 tax year for tax liabilities which had been recorded in conjunction with divested businesses. In the third quarter of 2009, we recorded $15 million of income from discontinued operations related to the expiration of the statute of limitations on the 2005 tax year for tax liabilities which had been recorded in conjunction with divested business.

 

Non-current liabilities related to discontinued operations totaled $10 million at September 30, 2010, and $11 million at December 31, 2009.

 

 

Short-Term Debt

 

We have a revolving credit facility, and borrowings under this facility totaled $30 million at September 30, 2010. At that date, the fair value of this debt was equal to the outstanding balance.

 

As a part of our 2007 acquisition of Prairie Packaging, Inc. (Prairie), we assumed Prairie’s liability for $5 million borrowed from the Illinois Department Finance Authority (IDFA), which were funded by industrial development revenue bonds issued by the IDFA. This debt will mature on December 1, 2010, and bears interest at varying rates (0.50% as of September 30, 2010) not to exceed 12% per annum. We decided to repay this debt in full on October 27, 2010.

 

On January 1, 2010, we adopted the accounting principles in accordance with updated provisions within ASC 810-10 and 860-10 as described in Note 2 related to our asset securitization program. Consequently, we consolidated Pactiv RSA as of the date of adoption, resulting in an increase in short-term debt. The asset securitization agreement is a five-year agreement expiring in 2012, which allows us to sell up to $130 million of receivables under the facility. The terms of this agreement are re-negotiated annually; therefore, we have reflected it as short-term debt. The balance as of September 30, 2010, was $130 million. Interest on this debt is recorded in interest expense. Under the accounting prior to 2010, the discount on the sold receivables was

 

recorded as a loss on sale in other income. The amounts recorded in interest expense were immaterial for the three-month period and $1 million for the nine-month period ended September 30, 2010. The recorded losses on the sale were immaterial for the three-month period, and $1 million for the nine-month period ended September 30, 2009.

 

Long-Term Debt

 

On October 4, 2010, the Company commenced tender offers/consent solicitations for its 5.875% Notes due July 15, 2012, in an aggregate principal amount of $250 million (the “2012 Notes”) and its 6.400% Notes due January 15, 2018, in an aggregate principal amount of $250 million (the “2018 Notes”). On October 19, 2010, the Company announced the expiration of the early tender/consent deadline in connection with 2012 Notes and the 2018 Notes. The results of such tender offers/consent solicitations were as follows: (i) 93.36% of the 2018 Notes were tendered and/or the related consents delivered and not validly withdrawn, so such tendered 2018 Notes will be accepted and purchased at closing of the merger, and (ii) the Company terminated the tender offer/consent solicitation for the 2012 Notes without accepting any tendered 2012 Notes.

 

On October 20, 2010, the Company commenced an offer to purchase for cash its 2012 Notes, at a price of 101% of the principal amount of such 2012 Notes, plus accrued and unpaid interest on the principal amount tendered to, but not including, the payment date, in accordance with the trust indenture governing the 2012 Notes based on the pending change of control from the pending acquisition of the Company by Reynolds Group Holdings Limited.

 

 

Asset and Liability Instruments

 

At September 30, 2010, and December 31, 2009, the fair value of cash and temporary cash investments, short- and long-term receivables, accounts payable, and short-term debt were the same as, or not materially different from, the amount recorded for these assets and liabilities. The fair value of long-term debt was approximately $1.6 billion at September 30, 2010, and $1.5 billion at December 31, 2009. The recorded amount was $1.3 billion at September 30, 2010, and December 31, 2009. The fair value of long-term debt was based on quoted market prices for our debt instruments.

 

Instruments with Off-Balance Sheet Risk (Including Derivatives)

 

We use derivative instruments, principally swaps, forward contracts, and options, to manage our exposure to movements in foreign currency values, interest rates, and commodity prices.

 

Cash Flow Hedges

 

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (OCI) and reclassified into earnings in the same period or periods in which the hedged transaction affects earnings. Financial instruments designated as cash flow hedges are assessed both at inception and quarterly thereafter to ensure they are effective in offsetting changes in the cash flows of the related underlying exposures. The fair value of the hedge instruments are reclassified from OCI to earnings if the hedge ceases to be highly effective or if the hedged transaction is no longer probable.

 

Foreign Currency

 

From time to time, we use derivative financial instruments to hedge our exposure to changes in foreign currency exchange rates, principally using foreign currency purchase and sale contracts with terms of less than one year. We do so to mitigate our exposure to exchange rate changes related to third-party trade receivables and accounts payable. Net gains or losses on such contracts are recognized in the statement of income as offsets to foreign currency exchange gains or losses on the underlying transactions. In the statement of cash

 

flows, cash receipts and payments related to hedging contracts are classified in the same way as cash flows from the transactions being hedged. We had no open foreign currency contracts as of September 30, 2010.

 

Interest Rates

 

We entered into interest rate swap agreements in connection with the acquisition of Prairie. The agreements were terminated on June 20, 2007, resulting in a gain of $9 million. This gain is being recorded as a reduction of interest expense over the average life of the underlying debt. Amounts recognized in earnings related to our hedging transactions were $1 million for both the nine months ended September 30, 2010, and September 30, 2009.

 

Commodity

 

During the first nine months of 2010, we entered into natural gas purchase agreements with third parties, hedging a portion of the fourth quarter of 2010 purchases of natural gas used in the production processes at certain of our plants. These purchase agreements are marked to market, with the resulting gains or losses recognized in earnings when hedged transactions are recorded. The mark-to-market adjustments at September 30, 2010, were immaterial.

 

To minimize volatility in our margins due to large fluctuations in the price of commodities, in the third quarter of 2010 we entered into swap contracts to manage risks associated with market fluctuations in resin prices. These contracts were designated as cash flow hedges of forecasted commodity purchases. As of September 30, 2010, we have hedged, on a monthly basis, approximately 1% of the expected resin purchase volume for the remainder of 2010. Assuming the market prices of the swap contracts remained unchanged from the prices at September 30, 2010, the estimated gain expected to be reclassified to earnings in the remainder of 2010 would be immaterial.

 

Fair Value Measurements

 

Financial assets and liabilities that are recorded at fair value consist of derivative contracts that are used to hedge exposures to interest rate, commodity, and currency risks. ASC 820-10-35 “Fair Value Measurements and Disclosures” sets out a fair value hierarchy that groups fair value measurement inputs into three classifications: Level 1, Level 2, or Level 3. Level 1 inputs are quoted prices in an active market for identical assets or liabilities. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. All of our fair value measurements for derivative contracts use Level 2 inputs.

 

The fair value of our derivative instruments recorded in the consolidated balance sheet as of September 30, 2010 was $1 million. There were no outstanding derivative instruments recorded in the consolidated balance sheet as of December 31, 2009.

 

The following table indicates the amounts recognized in OCI for those derivatives designated as cash flow hedges for the nine months ended September 30, 2010, and September 30, 2009.

 

 

 

The changes in the carrying values of goodwill between December 31, 2009, and September 30, 2010, are shown in the following table.

 

 

Intangible assets are summarized in the following table.

 

 

Intangible assets of $15 million were recorded in connection with the acquisition of PWP Industries and are being amortized over a 15-year period for book purposes. Amortization expense for intangible assets was $19 million for both the nine months ended September 30, 2010, and September 30, 2009. Amortization expense is estimated to total $26 million for 2010, $25 million for 2011, $24 million for 2012, $20 million for 2013, and $20 million for 2014.

 

We review the carrying value of our goodwill and indefinite-lived intangibles for possible impairment on an annual basis. Our annual review is conducted in the fourth quarter of the year, or earlier if warranted by events or changes in circumstances. There were no events or changes in circumstances in the first nine months of 2010 that warranted an impairment review of the goodwill and indefinite-lived intangibles.

 

 

 

Capitalized interest was $2 million for the nine months ended September 30, 2010, and $1 million for the nine months ended September 30, 2009.

 

 

Total gross unrecognized income tax benefits were $39 million as of September 30, 2010, and $58 million as of December 31, 2009. The total amount of unrecognized income tax benefits that, if recognized, would favorably impact our effective tax rate for continuing operations in future periods was $31 million at September 30, 2010, and $50 million at December 31, 2009. As of September 30, 2010, it is reasonably possible that the amount of unrecognized income tax benefits may increase or decrease during the following twelve months. However, it is not expected that any such changes, individually or in total, would significantly affect our operating results or financial condition.

 

It is our continuing practice to record accruals for interest and penalties related to income tax matters as income tax expense. Such accruals totaled $10 million as of September 30, 2010, and $11 million as of December 31, 2009. Expense recorded in the first nine months of 2010 for interest and penalties for continuing operations was immaterial.

 

As a result of the expiration of the U.S. federal statute of limitations for the year ended December 31, 2006, we recorded an income tax benefit of $21 million for continuing operations and $2 million for discontinued operations for the three month period ending September 30, 2010. U.S. federal income tax returns filed for the years 2007 through 2009 are open for examination by the Internal Revenue Service. Various state, local, and foreign tax returns filed for the years 2003 through 2009 are open for examination by tax authorities in those jurisdictions.

 

There were no gross unrecognized income tax benefits related to discontinued operations at September 30, 2010. Total gross unrecognized income tax benefits included $1 million related to discontinued operations at December 31, 2009. Expense recorded in the first nine months of 2010 for interest and penalties for discontinued operations was immaterial.

 

In connection with the adoption of ASC 718-10, “Share-Based Payment,” we elected to use the simplified method in calculating our additional paid-in capital pool, as described in prior authoritative guidance. ASC 718-10 requires that tax deductions for compensation costs in excess of amounts recognized for accounting purposes be reported as cash flow from financing activities, rather than as cash flow from operating activities. Such “excess” amounts were $3 million for the nine months ended September 30, 2010.

 

On March 23, 2010, the Patient Protection and Affordable Care Act (the “Act”) was signed into law. Included in the provisions is a change in the federal income tax treatment of the Medicare Part D subsidy. For periods beginning after December 31, 2012, we will no longer be entitled to receive a federal income tax deduction for payments made to provide our retirees with prescription drug benefits which equal previous subsidies we received from the U.S. government for providing retirees with prescription drug benefits. We had previously recorded a deferred income tax asset for the tax benefit of future payments made with respect to this subsidy. As a result of the Act, we have written-off $3 million of deferred income tax assets as a component of income tax expense from continuing operations for the nine month period ended September 30, 2010.

 

 

Earnings Per Share

 

Earnings per share of common stock outstanding were computed as follows:

 

 

We did not repurchase stock in the first nine months of 2010 or 2009.

 

Rabbi Trust

 

In November 1999, we established a rabbi trust and reserved 3,200,000 shares of Pactiv common stock for the trust. These shares were issued to the trust in January 2000. This trust is designed to assure the payment of deferred compensation and supplemental pension benefits. These shares are not considered outstanding for purposes of financial reporting.

 

 

The impact of pension plans on pretax income was as follows:

 

 

We have postretirement health care and life insurance plans that cover certain of our salaried and hourly employees who retire in accordance with the various provisions of such plans. Benefits may be subject to deductibles, copayments, and other limitations. These postretirement plans are not funded, and we reserve the right to change them.

 

The impact of postretirement plans on pretax income was as follows:

 

 

 

Our three segments are Consumer Products, Foodservice/Food Packaging, and Other. See Note 1 for additional details.

 

The following table sets forth certain segment information.

 

 

 

 

 

There were no changes in ownership interest in our subsidiaries for the nine months ended September 30, 2010, or September 30, 2009.

 

The preceding notes are an integral part of the foregoing financial statements.

 

Basis of Presentation

 

Financial statements for all periods presented in this report were prepared on a consolidated basis in accordance with generally accepted accounting principles consistently applied. All per share information is presented on a diluted basis unless otherwise noted. Certain reclassifications have been made to prior year financial information to conform to the current year presentation.

 

On April 1, 2010, we purchased PWP Holdings, Inc. and PWP Industries (PWP) for approximately $203 million. PWP Industries manufactures and sells amorphous polyethylene terephthalate (APET) products in the food service market. The purchase price was funded by borrowing $160 million on our revolving credit facility, adding $20 million to the asset securitization program, and utilizing $23 million in cash reserves. The results of this business have been included in the consolidated financial statements as of that date.

 

On January 5, 2009, we purchased the polypropylene cup business of WinCup for $20 million. This business operates one manufacturing facility in North Carolina. The results of this business have been included in the consolidated financial statements as of that date.

 

On August 16, 2010, we entered into a definitive merger agreement to be acquired by Reynolds Group Holdings Limited, a leading global manufacturer and supplier of consumer food and beverage packaging and storage products, in a transaction valued at approximately $6 billion. Reynolds is a wholly owned subsidiary of New Zealand-based Rank Group Limited, which is owned by Graeme Hart. Under the terms of the agreement, our shareholders will receive $33.25 in cash for each share of Pactiv common stock held.

 

We have three reporting segments:

 

 

The accounting policies of the reporting segments are the same as those for Pactiv as a whole. Where discrete financial information is not available by segment, reasonable allocations of expenses and assets/liabilities are used.

Significant Trends, Opportunities and Challenges

 

The primary raw materials used to manufacture our products are plastic resins, principally polystyrene, polyethylene, polypropylene, and polyethylene terephthalate (PET). Average industry prices as published by Chemical Market Associates, Inc. are depicted in the following graphs.

 

CMAI Polystyrene (cents/lb)

 

 

CMAI Polyethylene (cents/lb)

 

 

CMAI Polypropylene (cents/lb)

 

CMAI PET (cents/lb)

 

 

The prices of plastic resins are affected by the prices of crude oil and natural gas, as well as supply and demand factors of various intermediate petrochemicals. In recent years, there have been significant movements in resin prices, which rose to historic highs in 2008, dropped precipitously at the end of 2008 and into early 2009, and rose throughout the rest of 2009 and then peaked in the middle of the second quarter of 2010. Resin suppliers have announced multiple price increases, to take effect in the fourth quarter of 2010. At this time, it is not clear whether these price increases will be implemented as announced. We have historically adjusted our selling prices to reflect changes in raw material costs, although there is usually a lag of several months. Some of our business is pursuant to contracts that have price indices that automatically adjust after a set number of months, usually three or six, to reflect changes in certain raw materials.

 

Our business is sensitive to other energy-related cost movements, particularly those that affect transportation and utility costs. Historically, we have been able to mitigate the effect of higher energy-related costs with productivity improvements and other cost reductions.

 

In 2006, we began to introduce “lean” principles and tools in many of our operating facilities. We are expanding the use of lean principles to help us accelerate productivity improvements by reducing inventory and scrap levels, providing rapid stock replenishment, shortening scheduling cycles, improving our “one-stop shopping” service, eliminating nonvalue-added activities, and streamlining processes. As this is a long-term process, we expect our ability to use these tools throughout the organization will have a positive effect on our operating results in future years.

 

We believe that cash flow from operations, available cash reserves, and the ability to obtain cash under our credit facility and asset securitization program will be sufficient to meet current and future potential pension funding, liquidity, and capital requirements.

 

Results of Continuing Operations

 

Three Months Ended September 30, 2010, Compared with Three Months Ended September 30, 2009

 

Sales

 

Sales rose 12%. Excluding the impact of the PWP acquisition of $42 million, sales grew 7%, reflecting volume growth of 6% and favorable pricing of 1%.

 

Sales for Consumer Products increased 7%, reflecting higher volume of 9% and 2% unfavorable pricing. The volume growth primarily reflected increases in branded and store brand waste bags which offset declines in branded food bags and cups and cutlery. The lower pricing largely was due to an unfavorable mix of channels and products sold.

 

Sales growth of 16% for Foodservice/Food Packaging sales was attributable to an 8% volume gain from the inclusion of $42 million of sales from the PWP acquisition, as well as 4% volume growth and 4% favorable pricing in the base business. The volume increase primarily was related to continued growth in cups and cutlery, as well as growth in a number of other product areas, including processor trays, paper-based items, and produce packaging, offset partially by a decline in some traditional product lines such as carry-out containers.

 

Operating Income

 

 

Operating income decreased primarily as a result of $46 million of unfavorable spread (the difference between selling prices and raw material costs) and higher operating costs of $7 million, offset by favorable volume of $25 million. Higher operating costs reflected approximately $11 million related to start up of new equipment and processes partially offset by cost reduction and productivity programs.

 

Lower operating income for Consumer Products was driven mainly by a combination of unfavorable spread of $30 million, offset partially by increased volume of $7 million.

 

The decrease in operating income for Foodservice/Food Packaging was driven primarily by unfavorable spread of $16 million, higher operating expenses of $6 million and higher selling, general, and administrative (SG&A) expenses of $3 million, offset partially by increased volume of $18 million.

 

Other operating income remained flat as higher pension income and lower compensation-related expenses were offset by merger-related expenses of $9 million.

 

Income from Continuing Operations Attributable to Pactiv Common Shareholders

 

Income from continuing operations for 2010 and 2009 was $79 million, or $0.59 per share. The 2010 results include approximately $21 million, or $0.16 per share, for a favorable tax liability adjustment related to the expiration of the U.S. federal tax statute of limitations for 2006. This was partially offset by lower operating income in 2010 of $20 million ($31 million before tax) as described previously.

 

Discontinued Operations

 

Income (Loss) from Discontinued Operations

 

In the third quarter of 2010, we recorded $2 million of income from discontinued operations related to the expiration of the statute of limitations on the 2006 tax year for tax liabilities which had been recorded in conjunction with divested businesses. In the third quarter of 2009, we recorded $15 million of income from discontinued operations related to the expiration of the statute of limitations on the 2005 tax year for tax liabilities which had been recorded in conjunction with divested businesses.

Nine Months Ended September 30, 2010, Compared with Nine Months Ended September 30, 2009

 

Sales

 

 

Sales rose 7%. Excluding the impact of the PWP acquisition of $83 million, sales grew 4%, reflecting volume growth of 5% offset partially by lower pricing of 1%.

 

Sales for Consumer Products increased 4%, reflecting higher volume of 6% and unfavorable pricing of 2%. The volume growth primarily reflected an increase in waste bags, which more than offset a decline in food bags.

 

Foodservice/Food Packaging sales rose 10%, driven by acquisition growth of 5%, base business volume growth of 4%, and favorable foreign exchange of 1%. The volume increase primarily was related to continued growth in cups and cutlery, as well as growth in a number of other product areas, including processor trays, paper-based items, and produce-packaging, offset partially by a decline in traditional product lines such as carry-out containers.

 

Operating Income

 

 

Operating income decreased primarily as a result of $151 million of unfavorable spread, partially offset by higher volume of $47 million and lower SG&A expense of $27 million. The decrease in SG&A expense was primarily a result of lower incentive compensation accruals this year, lower advertising and promotional spending, as well as higher pension income, offset partially by merger-related expenses.

 

Lower operating income for Consumer Products was driven mainly by unfavorable spread of $62 million due to lower pricing and higher raw material costs, offset partially by lower SG&A expense of $16 million and higher volume of $7 million.

 

The decrease in operating income for Foodservice/Food Packaging was driven primarily by unfavorable spread of $89 million due to higher raw material costs and higher depreciation costs of $6 million, offset partially by increased volume of $40 million and lower SG&A expense of $8 million.

 

The increase in Other operating income was due mainly to higher pension income of $13 million, offset partially by merger-related expenses of $11 million.

 

Income from Continuing Operations Attributable to Pactiv Common Shareholders

 

We recorded income from continuing operations of $202 million, or $1.51 per share, compared with $237 million, or $1.78 per share, in 2009. The 2010 results include approximately $21 million, or $0.16 per share, for a favorable tax liability adjustment related to the expiration of the U.S. federal tax statute of

limitations for 2006. The remaining change was driven primarily by lower operating income of $55 million ($86 million before tax) as described previously.

 

Liquidity and Capital Resources

 

Capitalization

 

 

 

 

On October 4, 2010, the Company commenced tender offers/consent solicitations for its 5.875% Notes due July 15, 2012, in an aggregate principal amount of $250 million (the “2012 Notes”) and its 6.400% Notes due January 15, 2018, in an aggregate principal amount of $250 million (the “2018 Notes”). On October 19, 2010, the Company announced the expiration of the early tender/consent deadline in connection with 2012 Notes and the 2018 Notes. The results of such tender offers/consent solicitations were as follows: (i) 93.36% of the 2018 Notes were tendered and/or the related consents delivered and not validly withdrawn, so such tendered 2018 Notes will be accepted and purchased at closing of the merger, and (ii) the Company terminated the tender offer/consent solicitation for the 2012 Notes without accepting any tendered 2012 Notes.

 

On October 20, 2010, the Company commenced an offer to purchase for cash its 2012 Notes, at a price of 101% of the principal amount of such 2012 Notes, plus accrued and unpaid interest on the principal amount tendered to, but not including, the payment date, in accordance with the trust indenture governing the 2012 Notes based on the pending change of control from the pending acquisition of the Company by Reynolds Group Holdings Limited.

 

Cash Flows

 

 

There were several factors which caused the increase in cash provided by operating activities. The increase was primarily driven by a $400 million pretax contribution to our U.S. pension plan in 2009, which resulted in favorable cash tax effects of approximately $100 million in 2009 and $54 million in 2010. This was offset

partially by higher raw material costs which increased the investment in inventory by $79 million. Increasing selling prices this year, compared with declining selling prices last year, created an unfavorable swing in accounts receivable of $53 million. In addition, higher incentive compensation payments and lower related accruals of $48 million, as well as lower income from continuing operations of $35 million, lower other liabilities of $30 million and lower tax accruals of $28 million added to the decrease. The adoption of changes to ASC 810 “Consolidation” resulted in a decrease in cash provided by operating activities of $20 million with an offsetting increase in cash provided by financing activities.

 

The increase in cash used by investing activities was driven by the 2010 PWP acquisition for $203 million offset by the 2009 acquisition of WinCup of $20 million and higher capital expenditures in 2010 of $20 million.

 

The increase in cash provided by financing activities was a result of borrowing $160 million against revolving debt and adding $20 million to the asset securitization program to fund the PWP acquisition, partially offset by the repayment of revolving debt of $60 million.

 

Capital Commitments

 

Commitments for authorized capital expenditures totaled approximately $74 million at September 30, 2010. It is anticipated that the majority of these expenditures will be funded from existing cash and short-term investments and internally generated cash.

 

Contractual Obligations

 

There has been no material change in the company’s aggregate contractual obligations since December 31, 2009.

 

Liquidity and Off-Balance-Sheet Financing

 

We use various sources of funding to manage liquidity. Sources of liquidity include cash flow from operations and a 5-year revolving credit facility of $750 million, of which $30 million was outstanding at September 30, 2010. We were in full compliance with the covenants of our revolving credit agreement at the end of the period. The two financial covenant ratios contained in our debt agreements are an interest coverage ratio and the total debt to EBITDA ratio. The interest coverage ratio is defined as consolidated earnings before interest, taxes, depreciation and amortization, and other unusual noncash items (EBITDA) divided by interest expense. The minimum required ratio is 3.50 to 1. The total debt to EBITDA ratio is calculated by dividing the total debt by EBITDA. The maximum permitted total debt to EBITDA ratio is 3.50 to 1.

The interest coverage ratio and the debt to EBITDA ratio are shown in the following table.