PACTIV CORP - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 1-15157

PACTIV CORPORATION
(Exact name of Registrant as Specified in its Charter)

DELAWARE 36-2552989
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1900 WEST FIELD COURT 60045
LAKE FOREST, ILLINOIS (Zip Code)
(Address of principal executive offices)

Registrant's telephone number, including area code: (847) 482-2000

SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OF THE ACT:

NAME OF EACH EXCHANGE
ON WHICH REGISTERED
TITLE OF EACH CLASS --------------------------------------------------------
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Common Stock ($.01 par value) and associated Preferred New York Stock Exchange
Stock Purchase Rights

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.

Yes X No __

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

Yes X No __

State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value is computed by reference to the
price at which the stock was sold, or the average bid and asked prices of such
stock, as of the last business day of the registrant's most recently completed
second fiscal quarter.

CLASS OF VOTING STOCK AND NUMBER OF SHARES MARKET VALUE OF COMMON STOCK HELD BY
HELD BY NON-AFFILIATES AT JUNE 28, 2002 NON-AFFILIATES
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COMMON STOCK 157,485,313 SHARES $3,748,150,447

INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANT'S
CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE. Common Stock ($.01
par value). 159,147,846 shares outstanding as of February 28, 2003. (See Note 12
to the Financial Statements.)

DOCUMENTS INCORPORATED BY REFERENCE:

PART OF THE FORM 10-K
DOCUMENT INTO WHICH INCORPORATED
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Pactiv Corporation's Definitive Proxy Statement for Part III
the Annual Meeting of Shareholders to be held May 16,
2003

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TABLE OF CONTENTS

PART I

Item 1. Business.................................................... 1
Item 2. Properties.................................................. 4
Item 3. Legal Proceedings........................................... 5
Item 4. Submission of Matters to a Vote of Security Holders......... 5
Item 4.1 Executive Officers of the Registrant........................ 5

PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 7
Item 6. Selected Financial Data..................................... 8
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 20
Item 8. Financial Statements and Supplementary Data................. 21
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 53

PART III
Item 10. Directors and Executive Officers of the Registrant.......... 53
Item 11. Executive Compensation...................................... 53
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 53
Item 13. Certain Relationships and Related Transactions.............. 54
Item 14. Controls and Procedures..................................... 54

PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 54

ITEM 1. BUSINESS.

OVERVIEW

Pactiv Corporation (Pactiv or the company) is a global supplier of
specialty-packaging and consumer products with 2002 sales of $2.9 billion. The
company operates 73 manufacturing facilities in 14 countries around the world.
Pactiv has two key operating segments: Consumer and Foodservice/Food Packaging
and Protective and Flexible Packaging. The company's consumer products include
plastic, aluminum, and paper-based products such as waste bags, food-storage
bags, and disposable tableware and cookware. Pactiv's foodservice/food packaging
products include foam, clear plastic, aluminum, pressed-paperboard, and
molded-fibre packaging for customers in the food distribution channel, including
wholesalers, supermarkets, and packer processors, who prepare and process food
for consumption. The company's protective-packaging products are generally used
to protect and cushion various commercial and industrial products from the point
of manufacture to the point of delivery or pick-up. Pactiv's flexible-packaging
products are used mainly in food, medical, pharmaceutical, chemical, and
hygienic applications, and often involve custom design.

Pactiv was previously known as Tenneco Packaging Inc. and was formerly a
wholly-owned subsidiary of Tenneco Inc. (Tenneco) that was spun-off to
shareholders of Tenneco on November 4, 1999 (the "spin-off"). Pactiv includes
the assets, liabilities, and operations of Tenneco's former specialty-packaging
business and certain of Tenneco's former corporate and administrative service
operations. As used herein, the terms "Pactiv" and "the company" refer, for
periods prior to the spin-off, to the packaging businesses and corporate and
administrative service operations of Tenneco and, for periods after the
spin-off, to Pactiv and its consolidated subsidiaries.

The company was incorporated in the state of Delaware in 1965 under the
name Packaging Corporation of America. The company changed its name to Tenneco
Packaging Inc. in November 1995 and, concurrent with the spin-off, changed its
name to Pactiv Corporation.

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,
pressed-paperboard, and molded-fibre tableware; and aluminum cookware. Many of
these products are sold under such recognized brand names as Hefty(R),
Baggies(R), Hefty(R) OneZip(R), Hefty(R) Cinch-Sak(R), Hefty(R) The Gripper(TM),
Hefty(R) Zoo Pals(TM), 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 merchandise and
serve 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, foam, molded-fibre, paperboard, 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, delicatessen, and bakery
applications; microwaveable containers for prepared, ready-to-eat meals; and
foam trays for meat and produce.

For food processors, the company's products include dual-ovenable
paperboard containers, molded-fibre egg cartons, red meat and poultry trays,
aluminum containers, and modified atmosphere packaging, which extends the shelf
life of red meat products.

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The company also manufactures, markets, and sells foam products for use in
the construction industry.

Protective and Flexible Packaging

The company manufactures, markets, and sells protective packaging for use
in many industries, including the automotive, computer, electronics, furniture,
durable goods, building, and construction industries. Pactiv's sheet foams and
air-encapsulated bubble products are used for cushioning and surface protection,
and its 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, hygienic, and industrial applications. These products
include liners for disposable diapers, wrap-around sleeves for glass and plastic
bottles, polypropylene bags for sterile intravenous fluid delivery, modified
atmosphere films, stand-up pouches, food and hygienic packaging, surgical
drapes, and medical packaging.

BUSINESS STRATEGY

Pactiv expects to grow by expanding its existing businesses and through
strategic acquisitions. In seeking internal or external growth, the company
focuses on markets that have strong expansion characteristics and attractive
margins. Through its broad product lines and custom design capability, the
company offers customers "material-neutral" packaging solutions. With this
approach and the availability of worldwide geographic coverage, the company has
become a primary supplier to several national and international manufacturers
and distributors and has developed long-term relationships with key participants
in the consolidating packaging and foodservice-distribution industries.
Fostering such relationships is critical in identifying and penetrating new
markets.

Market Presence

Many of Pactiv's products have strong market share positions, including the
number one position in key markets such as consumer waste bags and tableware,
foodservice-foam containers, clear rigid-display packaging, foam trays, and
aluminum cookware. In 2002, more than 80% of the company's sales came from
products that hold the number one or number two share position in markets
served, reflecting the strength of the company's Hefty(R) and E-Z Foil(R)
brands, the breadth of its product lines, and its ability to offer "one-stop
shopping" to customers.

New Products/Design Services

The company drives growth by developing new products and value-added
product line extensions. In 2002, the company spent $35 million on research and
development activities and introduced more than 50 new products. In the Consumer
and Foodservice/Food Packaging business segment, several major new products were
introduced in 2002: Hefty(R) Zoo Pals(TM) disposable plates for children;
thicker, stronger Hefty(R) OneZip(R) freezer and storage bags; Hefty(R) E-Z
Foil(R) cookie sheets with a textured surface; oblong cake pans with covers; a
covered lasagna pan; a single-serving bowl for a major frozen-food manufacturer;
an extra large chicken roaster for a large discount warehouse chain; and items
for major fast-food chains, including new carryout and breakfast containers.

In the U.S., the protective-packaging product line was expanded in 2002
with the introduction of Hefty(R) Express(TM) shipping mailers, leveraging the
Hefty(R) brand name, and the launching of Orca(TM) sheet foam for use in the
moving and storage industry, uniquely positioning the company to offer customers
either polyethylene- or polypropylene-based surface protection.

In 2001 and 2000, the company spent $40 million and $36 million,
respectively, on research and development efforts.

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Service Capabilities

Building on broad product lines and strong relationships with national
distributors, in 2002, Pactiv completed the implementation of its
customer-linked manufacturing system for the Consumer and Foodservice/Food
Packaging segment. Today, the systems and information-management infrastructure
and distribution network are fully in place to support this segment's "One Face
to the Customer" strategy, aimed at reducing supply-chain costs, enhancing
customer service, and improving productivity.

Productivity/Cost Reduction

Pactiv's continuing focus on enhancing productivity and reducing
manufacturing and logistics costs is key to improving the business'
profitability. In 2002, approximately 25% of the company's research and
development spending and roughly 35% of its capital spending was devoted to
efforts to reduce costs and improve manufacturing and distribution productivity.

Strategic Acquisitions

In 2002, the company acquired 6 businesses, most notably Winkler Forming,
Inc., and a 70% ownership stake in Central de Bolsas, S.A. de C.V (Jaguar),
expending a total of $125 million. Strategic acquisitions have been, and will
continue to be, an important element of the company's growth strategy.

MARKETING, DISTRIBUTION, AND CUSTOMERS

The company has a combined sales and marketing staff of approximately 500
people. Consumer products are sold through a direct sales force and a national
network of brokers and manufacturers' representatives. Foodservice and
food-packaging customers are served principally through a direct sales force.
The Protective and Flexible Packaging business sells to distributors,
fabricators, and directly to end-users worldwide.

In 2002, Wal-Mart Stores, Inc. accounted for 10.0% of the company's
consolidated sales. In general, the company's backlog of orders is not material.

ANALYSIS OF SALES

The following table sets forth information regarding sales from continuing
operations.

See note 16 to the financial statements for additional segment and
geographic information.

COMPETITION

Pactiv conducts business in highly competitive markets and faces
significant competition in all of its product lines from numerous global,
national, and regional companies of various sizes. Some competitors have
available to them more extensive financial and other resources than Pactiv,
while others are significantly smaller than the company with lower fixed costs
and more operating flexibility. In addition, certain competitors offer a variety
of packaging materials and concepts and serve geographic regions through various
distribution channels. In general, the company believes that success in
obtaining business is driven by price, quality, product features, service, and
speed of delivery.

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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 16 to the financial statements for
additional information regarding the company's international operations.

RAW MATERIALS

The principal raw materials used by the company are plastic resins,
including polystyrene, polyethylene, polypropylene, polyvinyl chloride and
amorphous polyethylene terephthalate; aluminum; paperboard; pulp; and recycled
fiber. Approximately 80% of Pactiv's sales come 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; oil, natural gas, and other material costs; and geopolitical
circumstances. The supply of raw materials was adequate in 2002, and the
company's management believes that such supply will remain adequate in 2003.

ENVIRONMENTAL REGULATION

Pactiv's operations are required to comply with existing and potential
federal, state, local, and foreign air-emission legislation and other laws and
regulations affecting the environment. 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 that would impose
additional obligations or restrictions on the company. Although management
believes that current laws and regulations have not had a material adverse
effect on the company's results, there can be no assurance that future
legislative and/or regulatory initiatives, if any, will not have a material
adverse effect on the company.

OTHER

As of December 31, 2002, Pactiv employed approximately 16,000 people, of
which approximately 2,000 were employed by joint ventures in which the company
has a controlling interest, and 12% of whom were covered by
collective-bargaining agreements. Five of those agreements, covering a total of
522 employees, are scheduled for renegotiation in 2003. In Europe and the Middle
East, 2,050 employees are represented by works councils. Management believes
that employee relations are generally satisfactory.

The company owns a number of U.S. and foreign patents, trademarks, and
other intellectual property that are significant with regard to the manufacture,
marketing, and distribution of certain products. The company also utilizes
numerous software licenses that are important to its business. The company
believes that its intellectual-property rights and licensing rights are adequate
for its business.

AVAILABLE INFORMATION

The company's website is www.pactiv.com. The company makes available on
this website, under the Investor Relations link, free of charge, its annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to these reports, as soon as reasonably practicable after it
electronically files or furnishes such materials to the Securities and Exchange
Commission.

ITEM 2. PROPERTIES.

Pactiv leases its executive offices at 1900 West Field Court, Lake Forest,
Illinois 60045. Its telephone number at that address is (847) 482-2000.

In North America, Pactiv operates 51 facilities in 21 states, Canada, and
Mexico. Plastic and aluminum foodservice, consumer, and building products are
manufactured at 23 plants. The
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protective-packaging business converts paperboard into honeycomb products at
nine plants. Nine plants apply extrusion, foaming, and converting technologies
to produce flexible or rigid-plastic protective packaging, using polystyrene,
polyethylene, and polypropylene resins. Molded-fibre packaging is produced at
seven locations, and tooling for molded-fibre plants is manufactured at one
location. Ovenable-paperboard products are manufactured at two facilities. A
research and development center for consumer and foodservice/food packaging
products and process development is located in Canandaigua, New York. A design
center and process-development operation for protective-and flexible-packaging
products is located in Buffalo Grove, Illinois. In addition, the company has a
70%-owned joint venture in a high-impact polystyrene and polystyrene foam
operation in Guadalajara, Mexico.

Pactiv has 22 manufacturing facilities outside of North America. Twelve
protective-packaging plants in Belgium, England, France, Germany, Italy, The
Netherlands, Poland, Spain, and the Czech Republic make plastic,
air-encapsulated bubble and foam-sheet products, including mailers. Five
flexible-packaging plants in Egypt and Germany make flexible-packaging films,
bags, labels, pouches, printed and converted paper bags, and disposable medical
packaging. A subsidiary produces cushioning and molded-fibre packaging in
Germany and England. Single-use thermoformed plastic food containers and films
are manufactured at three facilities in England, Scotland, and Wales. In
addition, Pactiv has joint-venture interests in a folding-carton operation in
Dongguan, China (50% owned) and a corrugated-converting operation in Shaoxing,
China (62.5% owned).

In general, management believes that all of the company's plant and
equipment are well maintained and in good operating condition, and that it has
satisfactory title to owned properties, subject to certain liens that do not
detract materially from the value or use of the properties. The company's
headquarters and certain of its warehouse facilities are leased pursuant to
synthetic-lease agreements.

ITEM 3. LEGAL PROCEEDINGS.

In May 1999, Tenneco, Pactiv (through Tenneco's former paperboard packaging
operations), and a number of containerboard manufacturers were named as
defendants in a civil, class-action antitrust lawsuit pending in the U.S.
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 sheets from October 1, 1993, through November 30, 1995, in
violation of Section 1 of the Sherman Act. The lawsuits seek treble damages of
unspecified amounts, plus attorneys' fees. Pactiv's management believes that the
allegations have no merit and is vigorously defending the claims. Tenneco sold
its containerboard business in April 1999, prior to the spin-off of Pactiv in
November 1999. In connection with the spin-off, Pactiv was assigned
responsibility for defending the claims against Tenneco with respect to such
lawsuit and for any liability resulting therefrom.

The company is party to other legal proceedings arising from its
operations.

Management believes that the outcome of all of these legal matters,
individually and in the aggregate, will not have a material adverse effect on
the company's earnings or financial position.

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 2002.

ITEM 4.1. EXECUTIVE OFFICERS OF THE REGISTRANT.

Set forth below are the executive officers of the company at March 25,
2003, the positions held by such officers, and the date of appointment to such
positions. These descriptions are being included in Part I of this Form 10-K
pursuant to Instruction 3 to Item 401(b) of Regulation S-K.

Richard L. Wambold, 51, Chairman of the Board of Directors, President, and
Chief Executive Officer. Mr. Wambold has served as Chairman since March 2000,
President since June 1999, and Chief Executive Officer since the spin-off in
November 1999. Prior to 1999, Mr. Wambold served as Executive Vice

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President and General Manager of the company's specialty-packaging and
consumer-products business units.

Andrew A. Campbell, 57, Senior Vice President and Chief Financial
Officer. Mr. Campbell joined the company in October 1999 as Vice President and
Chief Financial Officer and has served as Senior Vice President and Chief
Financial Officer since January 2001. Prior to joining the company, Mr. Campbell
served as Acting Chief Financial Officer of Foamex International, Inc. from May
to September 1999; as Executive Vice President, Finance and Administration and
Chief Financial Officer of Dominick's Supermarkets, Inc. from July to November
1998; and as Senior Vice President, Finance and Chief Financial Officer of
Safety Kleen Corporation from April 1997 to June 1998;

James V. Faulkner, Jr., 59, Vice President, General Counsel, and
Secretary. Mr. Faulkner has been Vice President and General Counsel of the
company since 1995, and was elected Secretary of the company in December 2002.

Peter H. Lazaredes, 52, Senior Vice President and General Manager,
Foodservice/Food Packaging. Mr. Lazaredes has served as Senior Vice President
and General Manager, Foodservice/Food Packaging, since January 2001. Prior to
2001, and since he joined the company in 1996, Mr. Lazaredes held various senior
management positions in the company's specialty-packaging unit.

James D. Morris, 49, Senior Vice President and General Manager, Protective
and Flexible Packaging. Mr. Morris has served as Senior Vice President and
General Manager, Protective and Flexible Packaging since January 2001. Prior to
2001, and since he joined the company in 1995, Mr. Morris held various senior
management positions in the company's specialty-packaging unit.

John N. Schwab, 53, Senior Vice President and General Manager, Hefty(R)
Consumer Products. Mr. Schwab has served as Senior Vice President and General
Manager, Hefty(R) Consumer Products since January 2001. Prior to 2001, and since
he joined the company in 1995, Mr. Schwab held various senior management
positions in the company's specialty-packaging unit.

Henry M. Wells, III, 58, Vice President and Chief Human Resources
Officer. Mr. Wells has served as Vice President and Chief Human Resources
Officer since April 2000. Prior to joining the company, Mr. Wells served as Vice
President, Human Resources, for Banta Corporation from April 1996 to April 2000.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.

The outstanding shares of common stock ($0.01 par value) of Pactiv
Corporation are listed on the New York Stock Exchange under the symbol "PTV".
Stock price and dividend information for 2002 and 2001 is shown below.

As of February 28, 2003, there were approximately 45,000 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 currently plan to declare a dividend; however,
the company periodically considers alternatives, including dividend payments, to
increase shareholder value.

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ITEM 6. SELECTED FINANCIAL DATA

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

BASIS OF PRESENTATION

Financial statements for all periods presented herein have been 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 amounts in the prior years' financial statements
have been reclassified to conform with the presentation used in 2002.

The company has three operating segments: Consumer and Foodservice/Food
Packaging, which relates to the manufacture and sale of disposable plastic,
molded-fibre, 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-fibre products for protective-packaging markets such as electronics,
automotive, furniture, and e-commerce, and for flexible-packaging applications
in food, medical, pharmaceutical, chemical, and hygienic markets; and Other,
which relates to corporate and administrative service operations and
retiree-benefit income and expense.

RESTRUCTURING AND OTHER AND SPIN-OFF TRANSACTION

Restructuring and Other

In the fourth quarter of 1999, the company recorded a $154 million
restructuring charge, $91 million after tax, or $0.54 per share, related to the
decision to exit noncore businesses and to reduce overhead costs. The
restructuring covered (1) the sale of the company's forest-products and
aluminum-foil container businesses ($68 million), for which cash proceeds of $20
million were received in the fourth quarter of 1999; (2) the sale of certain
assets of the company's administrative service and corporate aircraft operations
($10 million); (3) the impairment of long-lived assets of the company's
packaging-polyethylene business ($68 million); and (4) severance costs
associated with the elimination of 161 positions, primarily in the company's
international operations ($8 million). The impairment charge for the assets of
the packaging-polyethylene business was deemed necessary following completion of
an evaluation of strategic alternatives for the business and represented the
difference between the carrying value of the assets and the forecasted future
cash flows of the business, computed on a discounted basis. In the fourth
quarter of 2000, $1 million of this charge was reversed, as one planned
product-line consolidation was not undertaken and, as a result, 14 positions
were not eliminated. With this exception, all restructuring actions were
completed in 2000.

In the fourth quarter of 2000, the company recorded a restructuring charge
of $71 million, $47 million after tax, or $0.29 per share. Of this amount, $45
million was for the impairment of assets held for sale, including those related
to the packaging-polyethylene business and the company's interest in Sentinel
Polyolefins LLC, a protective-packaging joint venture. In January 2001, the
company received cash proceeds of $72 million from the disposition of these
assets. The remaining $26 million was related to the realignment of operations
and the exiting of low-margin businesses in the company's Protective and
Flexible Packaging segment. Specifically, this charge was for (1) plant closures
in North America and Europe, including the elimination of 202 positions ($6
million); (2) other workforce reductions (187 positions), mainly in Europe ($6
million); (3) impairment of European long-lived assets held for sale ($10
million); and (4) asset write-offs related to the elimination of certain
low-margin product lines ($4 million). The impairment charge for European assets
was recorded following completion of an evaluation of strategic alternatives for
the related businesses and represented the difference between the carrying value
of the assets and their fair value based on market estimates. Restructuring-plan
actions have been completed. Actual cash outlays for severance and other costs
were $3 million less than originally estimated, as 78 fewer positions were
eliminated, while charges for asset write-offs were $3 million more than
initially estimated. Additionally, the company recognized a benefit of $6
million, $4 million after tax, or $0.02 per share, in the fourth quarter of
2001, largely to reflect a lower loss than was originally recorded on the sale
of the company's packaging-polyethylene business.

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In the fourth quarter of 2001, the company recorded a restructuring charge
of $18 million, $10 million after tax, or $0.06 per share. Of this amount, $5
million was related to higher-than-anticipated expenses associated with the exit
of small, noncore European businesses announced in the fourth quarter of 2000.
The remaining $13 million reflected adoption of a restructuring plan to
consolidate operations and reduce costs in both the Consumer and
Foodservice/Food Packaging ($5 million) and Protective and Flexible Packaging
($8 million) segments. Specifically, this charge was for (1) plant closures and
consolidations in North America and Europe, including the elimination of 283
positions ($10 million); (2) other workforce reductions (99 positions -- $2
million); and (3) asset writedowns related to the exit of a North American
product line ($1 million).

In the second quarter of 2002, the company recognized a benefit of $4
million, $2 million after tax, or $0.02 per share, related to a previously
recorded restructuring charge, primarily as a result of incurring a
lower-than-anticipated loss on the sale of a noncore European business.

Spin-off Transaction Costs

In the fourth quarter of 1999, the company recorded transaction costs
related to its spin-off from Tenneco Inc. (Tenneco) in 1999 that 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 pertained to special curtailment and termination benefits for former
Tenneco employees ($72 million), professional services ($49 million), and
separation from Tenneco operations ($15 million). In the fourth quarters of 2000
and 2001, the company reversed $20 million, $12 million after tax, or $0.08 per
share, and $12 million, $7 million after tax, or $0.04 per share, respectively,
of the previously recorded spin-off transaction costs to reflect
lower-than-anticipated expenses. Actions related to the spin-off transaction
have been completed.

YEAR 2002 COMPARED WITH 2001

RESULTS OF CONTINUING OPERATIONS

Sales

Total sales increased $68 million, or 2.4%, in 2002. Excluding the positive
impact of foreign-currency exchange rates ($20 million) and acquisitions ($67
million) and the negative effect of business divestitures ($50 million), sales
grew 1.1%. Volume, excluding divestitures, grew 7.7%, with 5.3% coming from the
base business and 2.4% from acquisitions. Somewhat offsetting the volume gains
were lower selling prices, primarily from the pass through of lower raw-material
costs.

Sales for the Consumer and Foodservice/Food Packaging business increased
$65 million, or 3.3%, in 2002. Excluding the negative effect of divestitures
($15 million), sales for this segment grew 4.0%. Volume in this business
increased 9.0%, with 6.3% coming from the base business and 2.7% from
acquisitions. The higher volume was offset partially by a decline in selling
prices from the pass through of lower raw-material costs. Contributing to the
volume growth was the introduction of new products: Hefty(R) The Gripper(TM)
tall kitchen waste bags, Hefty(R) Zoo Pals(TM) disposable plates for children,
and foodservice products for major fast-food restaurants. Sales of Protective
and Flexible products increased $3 million, or 0.4%, from 2001. Excluding the
positive impact of foreign-currency exchange rates ($20 million) and the
negative effect of businesses divested in 2001 ($35 million), sales for this
segment improved 2.3%. The increase reflected volume growth of 4.5%, with 2.8%
coming from the base business and 1.7% from acquisitions, offset partially by a
decline in selling prices from the pass through of lower raw-material costs,
principally in North America.

10

Operating Income -- Income before Interest Expense, Income Taxes, and
Minority Interest

Total operating income for 2002 was $463 million, up $72 million, or 18.4%,
from last year. Operating income in 2002 included the impact of reversing $4
million of a previously recorded restructuring charge related to the Protective
and Flexible Packaging segment, while operating income for 2001 included $12
million of restructuring and other charges and the reversal of $12 million of
spin-off transaction cost provisions originally recorded in 1999. Excluding the
effect of these items, operating income by segment was as follows:

Total operating income before restructuring and other charges and spin-off
transaction costs was $459 million in 2002, an increase of $68 million, or
17.4%, over 2001. The increase was driven principally by volume growth;
improvement in gross margin, primarily reflecting growth in higher-margin
product lines and benefits from the company's productivity initiatives; and the
elimination of goodwill amortization in 2002 ($19 million benefit), resulting
from the adoption of Statement of Financial Accounting Standard (SFAS) No. 142,
"Goodwill and Other Intangible Assets." See "Changes in Accounting Principles"
for additional information.

Operating income for the Consumer and Foodservice/Food Packaging segment
increased $59 million, or 20.6%, in 2002, driven principally by volume growth,
productivity improvements, lower logistics costs, and the 2002 elimination of
goodwill amortization ($12 million benefit), offset partially by lower spread
(the difference between selling prices and raw-material costs).

Operating income for the Protective and Flexible Packaging segment
increased $16 million, or 38.1%, from 2001, mainly reflecting higher volume,
benefits from a restructuring program initiated in January 2001, and the 2002
elimination of goodwill amortization ($7 million benefit), offset, in part, by
lower spread.

Operating income for the Other segment was $55 million in 2002, a decrease
of $7 million, or 11.3%, from 2001, mainly driven by lower pension income and
higher stock-based compensation costs.

Interest Expense, Net of Interest Capitalized

Interest expense was $96 million in 2002, down $11 million, or 10.3%, from
2001, mainly because of lower borrowings.

Income Taxes

The company's effective tax rate for 2002 was 40.0%, compared with 41.5%
for 2001. This reduction was attributable principally to the elimination of
goodwill amortization.

Income from Continuing Operations

The company recorded income from continuing operations of $220 million, or
$1.37 per share, in 2002, compared with $165 million, or $1.03 per share, in
2001.

11

In accordance with generally accepted accounting principles, income from
continuing operations included the after-tax effects of restructuring and other
charges, spin-off transaction costs, a gain on the sale of a business, pension
income, and goodwill amortization. The company's management believes that by
adjusting income from continuing operations to exclude the effects of these
items, the resulting "core" earnings present a more accurate depiction of the
company's underlying operating performance.

Following is a reconciliation of income from continuing operations and
diluted earnings per share (EPS) from continuing operations with the company's
"core" earnings and "core" EPS, respectively, for 2002, 2001, and 2000:

DISCONTINUED OPERATIONS

In 2001, the company recorded after-tax income from discontinued operations
of $28 million, or $0.17 per share, which represented gains on the sale of the
company's remaining holdings of Packaging Corporation of America (PCA) stock.

CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLES

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142. Effective January 1, 2002, the company adopted SFAS No. 142 and
recorded a goodwill-impairment charge for certain Protective and Flexible
Packaging businesses of $83 million, $72 million after tax, or $0.45 per share,
as a cumulative effect of change in accounting principles in the first quarter
of 2002.

LIQUIDITY AND CAPITAL RESOURCES

Capitalization

12

Shareholders' equity decreased $792 million from December 31, 2001, to
December 31, 2002, primarily as a result of recognizing a minimum pension-plan
liability and reducing net pension-plan assets. The recording of these
transactions was necessitated by requirements of SFAS No. 87, "Employers'
Accounting for Pensions," in that the fair-market value of pension-plan assets
fell below the company's accumulated pension-benefit obligations as of the
annual measurement date for U.S. (September 30) and foreign (December 31) plans.
This resulted from (1) the impact of the sharp decline in equity markets on the
value of the pension plans' assets and (2) the reduction (from 7.25% to 6.75%
for U.S. plans) in the discount rate used to measure pension-plan obligations.
These factors gave rise to a $966 million decrease in shareholders' equity,
which had no effect on 2002 net income, cash flow, bank-covenant compliance, or
requirements to make contributions to the pension plans. This decline was offset
partially by net income of $148 million.

The ratio of debt to total capitalization rose to 57.4% at December 31,
2002, from 41.8% at December 31, 2001, primarily because of the decrease in
shareholders' equity.

Cash Flows

Cash provided by operating activities was $384 million in 2002, compared
with $371 million in 2001. The $13 million improvement reflected the increase in
income from continuing operations, offset partially by the impact of various
other items, primarily higher receivables driven by increased sales and a
decline in the level of asset securitization.

Investing activities used $244 million of cash in 2002, principally for
capital expenditures ($126 million) and acquisitions ($125 million). Cash used
by investing activities was $1 million in 2001, primarily reflecting the net of
expenditures for property, plant, and equipment ($145 million) and proceeds from
the sale of businesses ($69 million) and PCA stock ($87 million).

Cash used by financing activities was $57 million in 2002, driven primarily
by the repurchase of company stock ($40 million) and the retirement of debt ($28
million). Financing activities used $354 million of cash in 2001, primarily for
the retirement of debt.

Capital Commitments

Commitments for authorized expenditures totaled approximately $90 million
at December 31, 2002. It is anticipated that the majority of these expenditures
will be funded over the next 12 months from existing cash and short-term
investments and internally generated cash.

Liquidity and Off-Balance-Sheet Financing

The company uses various sources of funding to manage liquidity, including
off-balance-sheet financing vehicles.

Sources of liquidity include cash flow from operations and a 5-year, $750
million revolving-credit facility, under which $36 million was outstanding at
December 31, 2002. The company was in full compliance with financial and other
covenants included in the revolving-credit agreement at year-end 2002.

Off-balance-sheet financing consists of an asset-securitization program and
a synthetic-lease facility. Asset securitization totaled $10 million and $44
million at December 31, 2002, and December 31, 2001, respectively. The
synthetic-lease agreement, which will expire in 2005, contains customary terms
and conditions covering, among other things, residual-value guarantees, default
provisions, and financial covenants, and requires the company to satisfy certain
financial-ratio tests. Termination of the lease

13

agreement, either before or at expiration, would require the company to make a
termination payment ($169 million at December 31, 2002, and 2001), which, in
essence, represents off-balance-sheet debt in that the company might be required
to obtain alternative financing to fund such a payment. Likewise, termination of
the asset-securitization program would require the company to increase its debt
or decrease its cash balance by a corresponding amount. See "Critical Accounting
Policies" for more information on the company's synthetic-lease agreement.

Management believes that cash flow from operations, available cash
reserves, and the ability to obtain cash under the company's credit facilities
and asset-securitization program will be sufficient to meet current and future
liquidity and capital requirements.

YEAR 2001 COMPARED WITH 2000

RESULTS OF CONTINUING OPERATIONS

Sales

Total sales declined $240 million, or 7.9%, in 2001. Excluding the negative
impact of foreign-currency exchange rates, divestitures, and discontinued
product lines, sales were essentially even with last year.

Sales for the Consumer and Foodservice/Food Packaging business declined
$204 million, or 9.3%, in 2001. Excluding the effects of divestitures and
discontinued product lines, sales for this segment were 0.9% higher than in
2000, primarily because of higher selling prices and volume gains. Sales of
Protective and Flexible Packaging products declined $36 million, or 4.2%, from
2000. Excluding the negative impact of foreign-currency exchange rates and
businesses divested in 2001, sales for this segment were 1.8% lower than in
2000, as higher sales in Europe were more than offset by protective-packaging
volume declines in North America.

Operating Income -- Income before Interest Expense, Income Taxes, and
Minority Interest

Total operating income for 2001 included $12 million of restructuring and
other charges recorded in the fourth quarter and the reversal of $12 million of
spin-off transaction cost provisions originally recorded in 1999. Similarly,
total operating income for 2000 included $70 million of restructuring and other
charges, the reversal of $20 million of spin-off transaction cost provisions
originally recorded in 1999, and a $6 million gain on the sale of a business.
Excluding the effect of these items, operating income by segment was as follows:

Operating income before restructuring and other charges, spin-off
transaction costs, and, for 2000, a gain on the sale of a business, was $391
million in 2001, an increase of $6 million, or 1.6%, over 2000. The
14

increase was driven principally by the effective management of the spread
between selling prices and raw-material costs and cost savings from the 2000
restructuring program, offset partially by protective-packaging volume declines
in North America.

Operating income for the Consumer and Foodservice/Food Packaging segment
increased $8 million, or 2.9%, in 2001, driven principally by the effective
management of spread, volume growth for core products, and lower logistics
costs, offset partially by increased spending in support of branded products and
on new product launches.

Operating income for the Protective and Flexible Packaging segment declined
$2 million, or 4.5%, from 2000, driven principally by lower volume in North
America, offset, in part, by the favorable impact of year 2000 price increases
and manufacturing cost savings related to the 2000 restructuring program.

Operating income for the Other segment was $62 million in 2001, unchanged
from 2000.

Interest Expense, Net of Interest Capitalized

Interest expense was $107 million in 2001, down $27 million, or 20.1%, from
2000, mainly because of lower borrowings.

Income Taxes

Pactiv's effective tax rate for 2001 was 41.5% compared with 44.0% for
2000. Excluding the tax impact of the previously discussed restructuring and
other charges and spin-off transaction expenses, the effective tax rate for 2001
and 2000 was 41.5% and 42.0%, respectively.

Income from Continuing Operations

The company recorded net income from continuing operations of $165 million,
or $1.03 per share, in 2001, compared with net income of $113 million, or $0.70
per share, in 2000. Excluding restructuring and other charges, spin-off
transaction costs, and a gain on the sale of a business, net income from
continuing operations was $165 million, or $1.03 per share, in 2001, compared
with $143 million, or $0.89 per share, in 2000.

DISCONTINUED OPERATIONS

In 2001, the company recorded net income from discontinued operations of
$28 million, or $0.17 per share, which represented the after-tax gain on the
sale of the company's remaining holdings of PCA stock. In 2000, the company
reported net income from discontinued operations of $134 million, or $0.83 per
share, which represented the after-tax gain on the February 2000 sale of the
majority of the company's equity interest in PCA.

LIQUIDITY AND CAPITAL RESOURCES

Capitalization

Pactiv's ratio of debt to total capitalization was 41.8% and 50.2% at
December 31, 2001, and December 31, 2000, respectively. Total borrowings
declined $355 million, or 22.6%, in 2001, as free cash

15

flow and proceeds from the sale of the packaging-polyethylene business, the
company's interest in a joint venture, and PCA stock were used to repay debt.

Shareholders' equity increased $150 million in 2001, reflecting the
recording of income from continuing and discontinued operations of $165 million
and $28 million, respectively, offset partially by a decrease in unrealized
gains on PCA stock holdings.

Cash Flows

Cash provided by operating activities was $371 million in 2001, versus $290
million in 2000. The $81 million increase was driven principally by higher
income from continuing operations, increased utilization of net operating loss
carryforwards, and better working capital management.

Cash used by investing activities was $1 million in 2001, as proceeds ($146
million) from the sale of businesses ($69 million, related primarily to the
disposal of the packaging-polyethylene unit) and PCA stock ($87 million) were
offset principally by expenditures for property, plant, and equipment ($145
million). Cash provided by investing activities was $302 million in 2000, as
proceeds from the sale of PCA stock ($394 million) and certain product lines
($50 million) more than offset expenditures for property, plant, and equipment
($135 million).

Cash used by financing activities was $354 million in 2001, driven
primarily by the retirement of debt. Cash used by financing activities was $578
million in 2000, driven primarily by the retirement of debt and the repurchase
of stock.

CHANGES IN ACCOUNTING PRINCIPLES

In May 2000, the FASB's Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 00-14, "Accounting for Certain Sales Incentives." This
issue addresses the recognition, measurement, and income-statement
classification of various types of sales incentives, including discounts,
coupons, rebates, and free products. With the company's fourth-quarter 2001
adoption of EITF No. 00-14, certain expenses that historically (i.e., 2001 and
prior years) had been included in selling, general, and administrative costs
were reclassified as deductions from sales for all periods presented herein.

In April 2001, the EITF reached a consensus on Issue No. 00-25, "Accounting
for Consideration from a Vendor to a Retailer in Connection with the Purchase or
Promotion of the Vendor's Products." This consensus requires that consideration
provided by a vendor to a purchaser of its products be recognized as a reduction
of sales, except in those instances where an identifiable and measurable benefit
is or will be received by the vendor from the purchaser. With the company's
fourth-quarter 2001 adoption of EITF No. 00-25, certain expenses that
historically (i.e., 2001 and prior years) had been included in selling, general,
and administrative costs were reclassified as deductions from sales for all
periods presented herein.

In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142. SFAS No. 141 requires that business combinations initiated after
June 30, 2001, be accounted for using the purchase method of accounting and
broadens the criteria for recording intangible assets separate from goodwill.
SFAS No. 142 does not permit goodwill and certain intangibles to be amortized,
but requires that an impairment loss be recognized if recorded amounts exceed
fair values. Effective January 1, 2002, the company adopted SFAS No. 142, and
recorded a goodwill-impairment charge of $83 million, $72 million after tax, or
$0.45 per share, in the first quarter of 2002. Adoption of SFAS No. 142 added

16

$19 million, $14 million, and $0.09 to income before interest, income taxes, and
minority interest; net income from continuing operations; and earnings per
share, respectively, for 2002.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the time that a commitment to an exit or disposal plan
is made. Examples of costs covered by the statement include lease-termination
expenses and certain employee-severance costs that are associated with a
restructuring, discontinuing an operation, a plant closing, or other exit or
disposal activities. SFAS No. 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002.

In November 2002, the FASB issued Interpretation (FIN) No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Guarantees of
Indebtedness of Others." FIN No. 45 requires that certain guarantees be recorded
at fair value and requires guarantors to make significant new disclosures, even
if the likelihood of making payments under the guarantees is remote. The initial
recognition and measurement provisions of FIN No. 45 are to be applied on a
prospective basis for guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for financial statements issued after
December 15, 2002.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure." SFAS No. 148 delineates alternative
transition approaches for companies electing to change their method of
accounting for stock-based compensation costs to the fair-value method
prescribed in SFAS No. 123, "Accounting for Stock-Based Compensation." While not
requiring companies to use the fair-value method of accounting for stock-based
compensation, SFAS No. 148 does require companies to provide greater disclosure,
including tabular presentation of pro forma net income and earnings per share as
if the fair-value method had been used for all periods presented, regardless of
whether companies use SFAS No. 123's fair-value method or Accounting Principles
Board Opinion No. 25's intrinsic-value method. SFAS No. 148's transition and
disclosure requirements are effective for quarterly and annual periods ending
after December 15, 2002.

In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN No. 46 addresses accounting for variable interest
entities (VIEs), defined as separate legal structures that either do not have
equity investors with voting rights or have equity investors with voting rights
that do not provide sufficient financial resources for the entities to support
their activities. FIN No. 46 requires that (1) a VIE be consolidated by a
company if that company is subject to a majority of the VIE's gains and losses
and (2) disclosures be made regarding VIEs that a company is not required to
consolidate but in which it has a significant variable interest. Consolidation
requirements apply immediately to VIEs created after January 31, 2003, and in
the first fiscal year or interim period beginning after June 15, 2003, for
existing VIEs. Certain of the disclosure requirements apply to financial
statements issued after January 31, 2003, regardless of when the VIE was
created. Upon Pactiv's July 1, 2003, adoption of FIN No. 46, the company is
likely to consolidate the VIE associated with the properties covered by its
synthetic-lease facility, resulting in an increase in long-term debt and
property, plant, and equipment of $169 million and $152 million, respectively.
Consolidation of the VIE also would require the company to recognize, as a
cumulative effect of change in accounting principles, depreciation expense on
the leased assets from lease inception to June 30, 2003, which would negatively
impact net income by approximately $10 million, or $0.06 per share. On a
going-forward basis, consolidation of the VIE would reduce net income by
approximately $3 million, or $0.02 per share, annually.

CRITICAL ACCOUNTING POLICIES

Following are the accounting policies of Pactiv that, in management's
opinion, are the most important in portraying the company's financial condition
and results of operations. These policies involve a degree of judgment and/or
estimation regarding inherently uncertain factors.

17

Sales Deductions

In arriving at net sales, the company estimates the amount of sales
deductions likely to be earned or taken by customers in conjunction with
incentive programs such as volume rebates, early payment discounts, and coupon
redemptions. Such estimates are based on historical trends and are reviewed
quarterly for possible revision. The company believes the amount of sales
deductions reflected in net sales for the 12 months ended December 31, 2002, is
reasonable. In the event that future sales-deduction trends vary significantly
from past or expected trends, reported sales might increase or decrease by a
material amount.

Inventory Valuation

The company's inventories are stated at the lower of cost or market. A
portion of inventories (56% at December 31, 2002, and 2001) is valued using the
last-in, first-out (LIFO) method of accounting. Management prefers the LIFO
method in that it reflects in cost of sales the current cost of the company's
raw materials (primarily plastic resins), which can be volatile. If the company
had valued these inventories using the first-in, first-out (FIFO) accounting
method, net income would have been $2 million, or $0.01 per share, and $10
million, or $0.06 per share, lower in 2002 and 2001, respectively, and would
have been $10 million, or $0.06 per share, higher in 2000.

The company's Protective and Flexible Packaging businesses value their
inventory using FIFO or average-cost methods. Many of these businesses are
located in countries where use of the LIFO method is not permitted. Management
believes that the cost and complexity of using multiple inventory-accounting
methods in these countries would outweigh the benefits.

Management periodically reviews its inventory balances to identify
slow-moving or obsolete items. This determination is based on a number of
factors, including new product introductions, changes in consumer demand
patterns, and historical usage trends.

Pension Plans

The company accounts for pension plans in accordance with requirements of
SFAS No. 87. Pension-plan income ($109 million, $113 million, and $108 million
for the 12 months ended December 31, 2002, 2001, and 2000, respectively) is
included in the statement of income as an offset to selling, general, and
administrative expenses. Projections indicate that the company's noncash pension
income will decline to approximately $60 million in 2003, principally reflecting
the decline in equity market values, the reduction in the discount rate used to
measure pension obligations from 7.25% to 6.75%, and the impact of the company's
decision to reduce the expected long-term rate of return on pension assets for
2003 from 9.5% to 9%.

Pension income is based on a number of factors, including estimates of
future returns on pension-plan assets; amortization of actuarial gains/losses;
expectations regarding employee compensation; and assumptions pertaining to
participant turnover, retirement age, and life expectancy.

In developing its assumption regarding the rate of return on pension-plan
assets, the company receives input from its outside actuary and investment
advisors on asset-allocation strategies and projections of long-term rates of
return on various asset classes, risk-free rates of return, and long-term
inflation rates. Since inception in 1971, the pension plans' annual rate of
return on assets has averaged 10.5%. Over its history, the plan has invested
approximately 65% of its assets in equities and 35% in fixed income. After
consideration of all of these factors, the company concluded that a 9%
rate-of-return assumption was appropriate for 2003. Holding all other
assumptions constant, a one-half percentage-point change in the rate-of-return
assumption would impact the company's pension income by approximately $20
million pretax.

The company's discount-rate assumption is based on returns on long-term
corporate bonds that receive the second-highest credit rating from recognized
rating agencies as of its measurement date (approximately 6.75% at September 30,
2002). Consequently, the company lowered its discount-rate
18

assumption for 2003 to 6.75% from 7.25%. Holding all other assumptions constant,
a one-half percentage-point change in the discount rate would impact the
company's pension income by approximately $10 million pretax.

The company utilizes a market-related method for calculating the value of
plan assets. This method recognizes the difference between actual and expected
returns on plan assets over 5 years. The resulting unrecognized gains or losses,
along with other actuarial gains and losses, are amortized using the "corridor
approach" outlined in SFAS No. 87. Holding all current assumptions constant, the
company's pension income will decline by approximately $20 million pretax in
2004, principally reflecting the amortization of unrecognized actuarial losses.

Synthetic Leases

The company has entered into a synthetic-lease agreement with a third-party
lessor and various lenders to finance the cost of its headquarters building and
certain of its warehouse facilities. The synthetic-lease agreement, which will
expire in November 2005, contains customary terms and conditions covering, among
other things, residual-value guarantees, default provisions, and financial
covenants, and requires the company to satisfy certain financial-ratio tests,
with which it was in full compliance at December 31, 2002. Termination of the
lease agreement, either before or at expiration, would require the company to
make a termination payment ($169 million at December 31, 2002), which, in
essence, represents off-balance-sheet debt in that the company might be required
to obtain alternative financing to fund such a payment.

In January 2003, the FASB issued FIN No. 46, which revises the accounting
and disclosure requirements for VIEs, such as the company's synthetic-lease
agreement. See "Changes in Accounting Principles" for further information
concerning VIEs.

19

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 established 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 British pound and
the euro. Associated gains or losses offset 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, 2002, all of which will mature in 2003.

Interest Rates

The company is exposed to interest-rate risk on revolving-credit debt ($36
million at December 31, 2002) that bears interest at a floating rate based on
LIBOR. In addition, the company has public-debt securities outstanding ($1,204
million at December 31, 2002) with fixed interest rates and original maturity
dates ranging from 3 to 25 years. Should the company decide to redeem these
securities prior to their stated maturity, it would incur costs based on the
fair value of the securities at that time.

The following table provides information about Pactiv's financial
instruments that are sensitive to interest-rate risks.

Prior to the spin-off, 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.

In the first quarter of 2001, the company entered into interest-rate swap
agreements to convert floating-rate debt on its synthetic-lease obligations to
fixed-rate debt. This action was taken to reduce the company's exposure to
interest-rate risk. During the first quarter of 2002, the company exited these
swap agreements, and related accumulated deferred net losses of $2 million at
December 31, 2002, will be expensed over the remaining life of the underlying
obligations.

Commodities

The company purchases commodities such as plastic resin, paper, aluminum,
and natural gas at market prices, and occasionally uses financial instruments,
primarily short-term forward contracts, to hedge certain commodity prices.
Several contracts for aluminum remained open at December 31, 2002.

20

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX OF THE FINANCIAL STATEMENTS OF PACTIV CORPORATION
AND CONSOLIDATED SUBSIDIARIES

21

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of Pactiv Corporation:

We have audited the accompanying consolidated statements of financial
position of Pactiv Corporation (a Delaware corporation) and consolidated
subsidiaries (the company) as of December 31, 2002, and the related consolidated
statements of income, cash flows, and changes in shareholders' equity and other
comprehensive income (loss) for the year then ended. Our audit also included the
financial statement schedule listed in the index for Item 14, relating to
information as of December 31, 2002 and for the year then ended. These
consolidated financial statements and schedule are the responsibility of the
company's management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule based on our audit. The
consolidated financial statements and schedule as of December 31, 2001, and for
each of the 2 years in the period then ended were audited by another auditor who
has ceased operations and whose report dated January 22, 2002, expressed an
unqualified opinion on such statements before the inclusion of additional
disclosures referred to in the last paragraph of this report.

We conducted our audit in accordance with auditing standards generally
accepted in the United States. 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 audit provides a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the company as
of December 31, 2002, and the consolidated results of its operations and its
cash flows for the year then ended, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects the
information set forth therein.

As discussed in Notes 2 and 9 to the financial statements, the company
changed its method of accounting for goodwill in the year-ended December 31,
2002.

As discussed above, the financial statements of Pactiv Corporation and
consolidated subsidiaries as of December 31, 2001, and for the 2 years in the
period ended December 31, 2001, were audited by another auditor who has ceased
operations. As described in Note 9, these financial statements have been revised
to include the transitional disclosures required by Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets," which was
adopted by the company as of January 1, 2002. Our audit procedures with respect
to the disclosures in Note 9 with respect to 2001 and 2000 included (1) agreeing
the previously reported income from continuing operations to the previously
issued financial statements and agreeing the adjustments to reported income from
continuing operations representing amortization expense (including any related
tax effects) recognized in those periods related to goodwill to the company's
underlying records obtained from management, and (2) testing the mathematical
accuracy of the reconciliation of previously reported income from continuing
operations to adjusted income from continuing operations and net income, and the
related earnings-per-share amounts. In our opinion, the disclosures for 2001 and
2000 in Note 9 are appropriate. However, we were not engaged to audit, review,
or apply any procedures to the 2001 or 2000 financial statements of the company
other than with respect to such disclosures and, accordingly, we do not express
an opinion or any other form of assurance on the 2001 or 2000 financial
statements taken as a whole.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
January 21, 2003

22

BELOW IS A COPY OF THE AUDIT REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP IN
CONNECTION WITH THE COMPANY'S FILING ON FORM 10-K FOR THE YEAR ENDED DECEMBER
31, 2001. THIS AUDIT REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP IN
CONNECTION WITH THIS FILING ON FORM 10-K.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Shareholders of Pactiv Corporation:

We have audited the accompanying statements of financial position of Pactiv
Corporation (a Delaware corporation) and consolidated subsidiaries as of
December 31, 2001, and 2000, and the related statements of income (loss),
retained earnings, cash flows, changes in shareholders' equity, and
comprehensive income (loss) for each of the 3 years ended December 31, 2001.
These financial statements are the responsibility of the company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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, 2001, and 2000, and the results of
its operations and its cash flows for the 3 years ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States.

As explained in Note 3 to the financial statements referred to above,
effective January 1, 1999, the company changed its method of accounting for the
cost of start-up activities.

Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the index of
financial statements are presented for purposes of complying with the Securities
and Exchange Commission's rules and are not part of the basic financial
statements. These schedules have been subjected to the auditing procedures
applied in the audit for the basic financial statements and, in our opinion,
fairly state in all material respects the financial data required to be set
forth therein in relation to the basic financial statement taken as a whole.

/s/ ARTHUR ANDERSEN LLP

Chicago, Illinois
January 22, 2002

23

CONSOLIDATED STATEMENT OF INCOME

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

24

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

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

25

CONSOLIDATED STATEMENT OF CASH FLOWS

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

26

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY AND OTHER COMPREHENSIVE INCOME
(LOSS)

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

27

NOTES TO FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

Financial statements for all periods presented herein have been 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 amounts in the prior years' financial statements
have been reclassified to conform with the presentation used in 2002.

The company has three operating segments: Consumer and Foodservice/Food
Packaging, which relates to the manufacture and sale of disposable plastic,
molded-fibre, 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-fibre products for protective-packaging markets such as electronics,
automotive, furniture, and e-commerce, and for flexible-packaging applications
in food, medical, pharmaceutical, chemical, and hygienic markets; and Other,
which relates to corporate and administrative service operations and
retiree-benefit income and expense.

NOTE 2. SUMMARY OF ACCOUNTING POLICIES

Consolidation

The financial statements of the company include all majority-owned
subsidiaries. Investments in 20%-to 50%-owned companies in which Pactiv has the
ability to exert significant influence over operating and financial policies are
carried at cost plus share of equity in undistributed earnings since date of
acquisition. All significant intercompany transactions are eliminated.

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 sales, expenses, gains, and losses.
Translation adjustments are recorded as a component of shareholders' equity.

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 90 days or less.

Accounts and Notes Receivable

Trade accounts receivable are classified as current assets and are reported
net of allowances for doubtful accounts. The company records such allowances
based on a number of factors, including historical trends and specific customer
liquidity.

On a recurring basis, the company sells an undivided interest in a pool of
trade receivables meeting certain criteria to a third party as an alternative to
debt financing. Amounts sold were $10 million and $44 million at December 31,
2002, and 2001, respectively. Such sales, which represent a form of off-
balance-sheet financing, are recorded as a reduction of accounts and notes
receivable in the statement of financial position, and changes in such amounts
are included in cash provided by operating activities in the statement of cash
flows. Discounts and fees related to these sales totaled $1 million, $5 million,
and $7 million in 2002, 2001, and 2000, respectively, and were included in other
income/expense in the statement of income. In the event that either Pactiv or
the third-party purchaser of the trade receivables were to discontinue this
program, the company's debt would increase or its cash balance would decrease by
an amount corresponding to the level of sold receivables at such time.

Inventories

Inventories are stated at the lower of cost or market. A portion of
inventories (56% at December 31, 2002, and 2001) is valued using the last-in,
first-out method of accounting. All other inventories are valued
28

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

using the first-in, first-out (FIFO) or average-cost methods. If FIFO or
average-cost methods had been used to value all inventories, the total inventory
balance would have been $11 million lower at December 31, 2002, and $9 million
lower at December 31, 2001.

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 3 to 25 years for machinery and equipment. Depreciation
expense totaled $140 million, $145 million, and $150 million for the years ended
December 31, 2002, 2001, and 2000, respectively.

The company capitalizes certain costs related to the purchase and
development of software used in its business. Such costs are amortized over the
estimated useful lives of the assets, ranging from 3 to 12 years. Capitalized
software development costs, net of amortization, were $57 million and $64
million at December 31, 2002, and 2001, respectively.

The company periodically re-evaluates carrying values and estimated useful
lives of long-lived assets to determine if adjustments are warranted. The
company uses estimates of undiscounted cash flows from long-lived assets to
determine whether the book value of such assets is recoverable over the assets'
remaining useful lives.

In 2001, the company changed estimated useful lives for certain assets of
the Protective and Flexible Packaging business in North America and Europe to be
consistent with those used for similar assets in its other business segment.
This change did not have a material impact on the company's financial
statements.

Goodwill and Intangibles, Net

Effective January 1, 2002, the company adopted Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets