**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý****                                ****Quarterly Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934.**

 

**o****                                ****Transition Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934.**

 

**ForQuarter Ended March 31, 2005**

 

**CommissionFile Number 1-3439**

 

**SMURFIT-STONE CONTAINER ENTERPRISES, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                    | ** ** | **36-2041256**                    |
|-----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (IRS Employer Identification No.) |

 

**150 North Michigan Avenue,  Chicago, Illinois     60601**

(Address of principal executive offices)              (Zip code)

 

**(312) 346-6600**

(Registrant’s telephone number, including area code)

 

**Stone Container Corporation**

(Former name, former address and former fiscal year, if

changed since last report)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 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 suchreports), and (2) has been subject to such filing requirements for the past 90days.   Yes ý    No o

 

Indicateby check mark if the registrant is an accelerated filer (as defined in Rule12b-2 of the Act).

Yeso  No  ý

 

APPLICABLE ONLY TOCORPORATE ISSUERS:

 

As of May 3, 2005, theregistrant had outstanding 770 shares of common stock, $.01 par value pershare, all of which are owned by Smurfit-Stone Container Corporation.

 

 

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**PART I-FINANCIAL INFORMATION**

 

**Item 1.****                                   FinancialStatements**

 

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| **Three Months Ended March 31, (In millions)** | ** ** | **2005**  | ** ** | **2004**   | ** ** |
|-----------------------------------------------------|------------|-----------|------------|------------|------------|
| Net sales                                           | ** ** | **$**     | **2,093**  | ** ** | $          | 1,942 |   |
| Costs and expenses                                  |       |      | ** ** |       |       |
| Cost of goods sold                                  | ** ** | **1,835** | ** ** | 1,750      |       |
| Selling and administrative expenses                 | ** ** | **196**   | ** ** | 200        |       |
| Restructuring charges                               | ** ** | **1**     | ** ** | 15         |       |
| Income (loss) from operations                       | ** ** | **61**    | ** ** | (23        | )          |
| Other income (expense)                              |       |      | ** ** |       |       |
| Interest expense, net                               | ** ** | **(86**   | **)**      | (86        | )          |
| Interest income from SSCC                           |       |      | ** ** | 20         |       |
| Other, net                                          | ** ** | **(3**    | **)**      | 5          |       |
| Loss before income taxes                            | ** ** | **(28**   | **)**      | (84        | )          |
| Benefit from income taxes                           | ** ** | **12**    | ** ** | 33         |       |
| Net loss                                            | ** ** | **$**     | **(16**    | **)**      | $          | (51 | ) |

 

See notes to consolidated financial statements.

 

1

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONSOLIDATEDBALANCE SHEETS**

 
| **(In millions, except share data)**                                                                                        | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                  | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                  |       |                     | ** ** |                        |       |
| ** **                                                                                                                  |       |                     | ** ** |                        |       |
| Current assets                                                                                                              |       |                     | ** ** |                        |       |
| Cash and cash equivalents                                                                                                   | ** ** | **$**                    | **5**      | ** **                  | $          | 6 |   |
| Receivables, less allowances of $12 in 2005 and 2004                                                                        | ** ** | **301**                  | ** ** | 254                         |       |
| Retained interest in receivables sold                                                                                       | ** ** | **133**                  | ** ** | 158                         |       |
| Inventories, including amounts valued under LIFO  method                                                                    |       |                     | ** ** |                        |       |
| Work-in-process and finished goods                                                                                          | ** ** | **276**                  | ** ** | 265                         |       |
| Materials and supplies                                                                                                      | ** ** | **519**                  | ** ** | 521                         |       |
| ** **                                                                                                                  |       | **795**                  | ** ** | 786                         |       |
| Deferred income taxes                                                                                                       | ** ** | **145**                  | ** ** | 142                         |       |
| Prepaid expenses and other current assets.                                                                                  | ** ** | **83**                   | ** ** | 60                          |       |
| Total current assets                                                                                                        | ** ** | **1,462**                | ** ** | 1,406                       |       |
| Net property, plant and equipment                                                                                           | ** ** | **4,600**                | ** ** | 4,638                       |       |
| Timberland, less timber depletion                                                                                           | ** ** | **44**                   | ** ** | 44                          |       |
| Goodwill                                                                                                                    | ** ** | **3,301**                | ** ** | 3,301                       |       |
| Other assets                                                                                                                | ** ** | **332**                  | ** ** | 336                         |       |
| ** **                                                                                                                  |       | **$**                    | **9,739**  | ** **                  | $          | 9,725 |   |
| **Liabilities and Stockholder’s Equity**                                                                               |       |                     | ** ** |                        |       |
|                                                                                                                        |       |                     | ** ** |                        |       |
| Current liabilities                                                                                                         |       |                     | ** ** |                        |       |
| Current maturities of long-term debt                                                                                        | ** ** | **$**                    | **36**     | ** **                  | $          | 19 |   |
| Accounts payable                                                                                                            | ** ** | **589**                  | ** ** | 604                         |       |
| Accrued compensation and payroll taxes                                                                                      | ** ** | **176**                  | ** ** | 191                         |       |
| Interest payable                                                                                                            | ** ** | **80**                   | ** ** | 95                          |       |
| Other current liabilities                                                                                                   | ** ** | **161**                  | ** ** | 207                         |       |
| Total current liabilities                                                                                                   | ** ** | **1,042**                | ** ** | 1,116                       |       |
| Long-term debt, less current maturities                                                                                     | ** ** | **4,597**                | ** ** | 4,479                       |       |
| Other long-term liabilities                                                                                                 | ** ** | **1,034**                | ** ** | 1,048                       |       |
| Deferred income taxes                                                                                                       | ** ** | **949**                  | ** ** | 966                         |       |
| Stockholder’s equity                                                                                                   |       |                     | ** ** |                        |       |
| Common stock, par value $.01 per share; 1,000 shares  authorized, 770 issued and outstanding in 2005 and 2004, respectively |       |                     | ** ** |                        |       |
| Additional paid-in capital                                                                                                  | ** ** | **3,593**                | ** ** | 3,587                       |       |
| Retained earnings (deficit)                                                                                                 | ** ** | **(1,175**               | **)**      | (1,157                      | )          |
| Accumulated other comprehensive income (loss)                                                                               | ** ** | **(301**                 | **)**      | (314                        | )          |
| Total stockholder’s equity                                                                                             | ** ** | **2,117**                | ** ** | 2,116                       |       |
| ** **                                                                                                                  |       | **$**                    | **9,739**  | ** **                  | $          | 9,725 |   |

 

See notes to consolidated financial statements.

 

2

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| **Three Months Ended March 31, (In millions)**                                          | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Cash flows from operating activities**                                                     |       |       | ** ** |       |       |
| Net loss                                                                                     | ** ** | **$**      | **(16**    | **)**      | $          | (51 | ) |
| Adjustments to reconcile net loss to net cash used  for operating activities                 |       |       | ** ** |       |       |
| Depreciation, depletion and amortization                                                     | ** ** | **103**    | ** ** | 103        |       |
| Amortization of deferred debt issuance costs                                                 | ** ** | **2**      | ** ** | 3          |       |
| Deferred income taxes                                                                        | ** ** | **(28**    | **)**      | (37        | )          |
| Pension and postretirement benefits                                                          | ** ** | **(9**     | **)**      | (8         | )          |
| Non-cash restructuring charges                                                               |       |       | ** ** | 8          |       |
| Non-cash foreign currency losses (gains)                                                     | ** ** | **1**      | ** ** | (3         | )          |
| Non-cash interest income from SSCC                                                           |       |       | ** ** | (20        | )          |
| Change in current assets and liabilities, net of  effects from acquisitions and dispositions | ** ** | ** ** | ** ** |       |       |
| Receivables and retained interest in receivables  sold                                       | ** ** | **(24**    | **)**      | (27        | )          |
| Inventories                                                                                  | ** ** | **(11**    | **)**      | (15        | )          |
| Prepaid expenses and other current assets                                                    | ** ** | **(1**     | **)**      | (1         | )          |
| Accounts payable and accrued liabilities                                                     | ** ** | **(70**    | **)**      | 8          |       |
| Interest payable                                                                             | ** ** | **(15**    | **)**      | (25        | )          |
| Other, net                                                                                   | ** ** | **(2**     | **)**      |       |       |
| Net cash used for operating activities                                                       | ** ** | **(70**    | **)**      | (65        | )          |
| **Cash flows from investing activities**                                                     |       |       | ** ** |       |       |
| Expenditures for property, plant and equipment                                               | ** ** | **(66**    | **)**      | (42        | )          |
| Proceeds from property and timberland disposals and  sale of businesses                      | ** ** | **5**      | ** ** | 3          |       |
| Notes receivable from SSCC                                                                   |       |       | ** ** | 4          |       |
| Net cash used for investing activities                                                       | ** ** | **(61**    | **)**      | (35        | )          |
| **Cash flows from financing activities**                                                     |       |       | ** ** |       |       |
| Net borrowings of debt                                                                       | ** ** | **133**    | ** ** | 68         |       |
| Net repayments under accounts receivable  securitization programs                            |       |       | ** ** | (1         | )          |
| Dividends paid                                                                               | ** ** | **(2**     | **)**      | (2         | )          |
| Capital contribution from SSCC                                                               | ** ** | **1**      | ** ** | 33         |       |
| Deferred debt issuance costs                                                                 | ** ** | **(2**     | **)**      |       |       |
| Net cash provided by financing activities                                                    | ** ** | **130**    | ** ** | 98         |       |
|                                                                                         |       |       | ** ** |       |       |
| **Decrease in cash and cash equivalents**                                                    | ** ** | **(1**     | **)**      | (2         | )          |
| Cash and cash equivalents                                                                    |       |       | ** ** |       |       |
| Beginning of period                                                                          | ** ** | **6**      | ** ** | 12         |       |
| End of period                                                                                | ** ** | **$**      | **5**      | ** ** | $          | 10 |   |

 

See notes to consolidatedfinancial statements.

 

3

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

(Tabular amounts in millions, except share data)

 

**1.****              SignificantAccounting Policies**

 

Theaccompanying consolidated financial statements and notes thereto ofSmurfit-Stone Container Enterprises, Inc. (“SSCE” or the “Company”) have beenprepared in accordance with the instructions to Form 10-Q and reflect alladjustments which management believes necessary (which include only normalrecurring accruals) to present fairly the Company’s financial position, resultsof operations and cash flows.  Thesestatements, however, do not include all information and footnotes necessary fora complete presentation of financial position, results of operations and cashflows in conformity with U.S. generally accepted accounting principles.  Interim results may not necessarily beindicative of results that may be expected for any other interim period or forthe year as a whole.  These financialstatements should be read in conjunction with the audited consolidatedfinancial statements and footnotes included in the SSCE Annual Report on Form10-K for the year ended December 31, 2004 (“10-K”) filed March 8,2005 with the Securities and Exchange Commission (“SEC”).

 

SSCEis a wholly-owned subsidiary of Smurfit-Stone Container Corporation, Inc. (“SSCC”).  SSCE has domestic and internationaloperations.

 

Prior to November 1,2004, SSCC owned 100% of the equity interest in JSCE, Inc. (“JSCE”) and StoneContainer Corporation (“Stone”).  JSCEowned 100% of the equity interest in Jefferson Smurfit Corporation (U.S.) (“JSC(U.S.)”)and was the guarantor of the senior unsecured indebtedness of JSC(U.S.).  JSCE had no operations other than itsinvestment in JSC(U.S.).  On November 1,2004, JSCE merged with and into JSC(U.S.), with JSC(U.S.) as the survivingcompany, and then JSC(U.S.) merged with and into Stone, with Stone as thesurviving company (the “Merger”), principally to consolidate debt financingactivities of the Company and its subsidiaries. Stone was simultaneously renamed SSCE.

 

Stone and JSC(U.S.) werewholly-owned subsidiaries of SSCC and, therefore, the historical cost basis ofthe acquired entity, JSC(U.S.) carried over into SSCE.  As a result of the Merger, the financialstatements of the Company for periods presented prior to the merger have beenrestated to include the combined results of Stone and JSC(U.S.).  In addition, notes receivable due from SSCCwere settled in November, 2004.  TheMerger did not impact the operating activities of the merged companies whichwill continue to do business as SSCC.

 

Reconciliations of netsales and net loss previously reported by Stone and JSCE to amounts reported inthe SSCE consolidated statement of operations are as follows:

 
| ** **   | ** ** | **Three months ended  March 31, 2004** | ** ** |
|--------------|------------|---------------------------------------------|------------|
| ** **   | ** ** | **Net Sales**                               | ** ** | **Net Loss** | ** ** |
|         |       |                                        |       |   |   |
| Stone        |       | $                                           | 1,275      |   | $ | (45 | ) |
| JSCE         |       | 907                                         |       | (6 | ) |
| Eliminations |       | (240                                        | )          |   |   |
| SSCE         |       | $                                           | 1,942      |   | $ | (51 | ) |

 

4

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**2.****              Reclassifications**

 

Certain prior year amounts have beenreclassified to conform to the current year presentation.

 

**3.****              Stock-BasedCompensation**

 

The Company adopted the fair value recognitionprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accountingfor Stock-Based Compensation,” effective as of January 1, 2003.  The Company selected the prospectivetransition method as allowed in SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure,” which requires expensing optionsprospectively, beginning in the year of adoption.  Because the prospective method was used andawards vest over three to eight years, the 2004 and 2005 expense is less thanwhat would have been recognized if the fair value based method had been appliedto all awards since the original effective date of SFAS No. 123.

 

The following table illustrates the effect on net lossif the fair value based method had been applied to all outstanding and unvestedawards in each period.

 
| ** **                                                                                                                                    | ** ** | **Three months ended   March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| Net loss, as reported                                                                                                                         |       | $                                       | (16        | ) | $ | (51 | ) |
| Add: Stock-based employee compensation expense  included in reported net loss, net of related tax effects                                     |       | 2                                       |       | 2 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (3                                      | )          | (4 | ) |
| Pro forma net loss                                                                                                                            |       | $                                       | (17        | ) | $ | (53 | ) |

 

In April 2005, the SEC announced that itwould defer the required implementation of SFAS No. 123(R), “Share-BasedPayment,” to January 1, 2006 for companies with fiscal years ending on December 31.  The Company plans to adopt SFAS No. 123(R) onJanuary 1, 2006.  Had the Companyadopted SFAS No. 123(R) in prior periods, the impact of that standard wouldhave approximated the impact of SFAS No. 123 as described in the pro-forma netloss disclosed above.

 

**4.****              Restructuring andExit Liabilities**

 

The Company has recordedvarious restructuring charges related to the rationalization of itscontainerboard mill and converting operations, including the termination ofemployees and liabilities for lease commitments at the closed facilities.  The Company recorded a $1 millionrestructuring charge during the first quarter of 2005 including severance andbenefits for terminated employees at a converting facility, the closure ofwhich was announced in the fourth quarter of 2004.

 

The Company recorded arestructuring charge of $15 million during the first quarter of 2004 related tothe closure of four converting facilities and exit from its Indonesianoperations.

 

At December 31,2004, the Company had $33 million of exit liabilities related to therestructuring of operations.  During thefirst quarter of 2005, the Company had $5 million of cash disbursements relatedto these exit liabilities.

 

5

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**5.****              Other, Net**

 

For the three monthsended March 31, 2005 and 2004, the Company recorded non-cash foreigncurrency exchange losses of $1 million and gains of $3 million, respectively,related to its operations in Canada.

 

**6.  Accounts Receivable Securitization Programs**

 

At March 31, 2005,and December 31, 2004, $586 million and $624 million, respectively, ofreceivables had been sold under two accounts receivable securitization programs,of which the company retained a subordinated interest.  The off-balance sheet Stone ReceivablesCorporation debt and funding received from the Canadian accounts receivableprogram totaled $448 million and $451 million, respectively, as of those dates.

 

**7.  Guarantees**

 

The Company has certainwood chip processing contracts, entered into prior to January 1, 2003,extending from 2010 through 2018 with minimum purchase commitments.  As part of the agreements, the Companyguarantees the third party contractor’s debt outstanding and has a securityinterest in the chipping equipment.  At March 31,2005, the maximum potential amount of future payments related to theseguarantees was approximately $42 million and decreases ratably over the life ofthe contracts.  Proceeds from theliquidation of the chipping equipment would be based on current marketconditions and the Company may not recover in full the guarantee payments made.

 

**8.****              Employee BenefitPlans**

 

The Company sponsorsnoncontributory defined benefit pension plans covering substantially all U.S.employees.  The Company also sponsorsnoncontributory and contributory defined benefit pension plans for its Canadianoperations.

 

The Company’spostretirement plans provide certain health care and life insurance benefitsfor all salaried as well as certain hourly employees.

 

The components of netperiodic benefit costs for the defined benefit plans and the components of thepostretirement benefit costs are as follows:

 
| ** **                         | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | **Defined Benefit Plans**             | ** ** | **Postretirement Plans** | ** ** |
| ** **                         | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                       |       | $                                     | 20         |   | $ | 19 |   | $ | 2 |   | $ | 2 |   |
| Interest cost                      |       | 48                                    |       | 46 |   | 4 |   | 5 |   |
| Expected return on plan assets     |       | (51                                   | )          | (49 | ) |   |   |   |   |
| Amortization of prior service cost |       | 2                                     |       | 2 |   | (1 | ) | 1 |   |
| Amortization of net loss           |       | 16                                    |       | 13 |   | 1 |   |   |   |
| Curtailment                        |       |                                  |       | 1 |   |   |   |   |   |
| Multi-employer                     |       | 2                                     |       | 2 |   |   |   |   |   |
| Net periodic benefit cost          |       | $                                     | 37         |   | $ | 34 |   | $ | 6 |   | $ | 8 |   |

 

6

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The Company’s 2005expected contributions to its qualified defined benefit plans and benefitpayments to its non-qualified defined benefit plans and postretirement plansare not expected to be materially different from the amounts disclosed at December 31,2004.

 

**9.****              DerivativeInstruments and Hedging Activities**

 

TheCompany’s derivative instruments used for its hedging activities are designatedas cash flow hedges and relate to minimizing exposures to fluctuations in theprice of commodities used in its operations, the movement in foreign currencyexchange rates and the fluctuations in the interest rate on variable rate debt.

 

**Commodity Derivative Instruments**

The Company usesderivative instruments, including fixed price swaps and options, to managefluctuations in cash flows resulting from commodity price risk in the procurementof natural gas.  The objective is to fixthe price of a portion of the Company’s purchases of natural gas used in themanufacturing process.  The changes inthe market value of such derivative instruments have historically been, and areexpected to continue to be, highly effective at offsetting changes in price ofthe hedged item.  As of March 31,2005, the maximum length of time over which the Company was hedging itsexposure to the variability in future cash flows associated with natural gasforecasted transactions was 21 months. For the three months ended March 31, 2005 and 2004, the Companyreclassified a $1 million loss (net of tax) and an immaterial amount,respectively, from other comprehensive income (“OCI”) to cost of goods soldwhen the hedged items were recognized. The fair value of the Company’s commodity derivative instruments at March 31,2005 was $25 million and was included in other current assets.  At March 31, 2005 and 2004, the Companyrecorded a $6 million gain (net of tax) and a $1 million gain (net of tax),respectively, in cost of goods sold on commodity derivative instruments relatedto the ineffective portion of the change in fair value of certain derivativeinstruments not qualifying for hedge accounting.

 

For the three monthsended March 31, 2005 and 2004, the Company recorded a $1 million loss (netof tax) and an immaterial amount, respectively, in cost of goods sold onsettled commodity derivative instruments related to the ineffective portion ofhedges and contracts not qualifying for hedge accounting.

 

**Foreign Currency Derivative Instruments **

The Company’s principalforeign exchange exposure is the Canadian dollar.  The Company uses foreign currency derivativeinstruments, including forward contracts and options, primarily to protectagainst Canadian currency exchange risk associated with expected future cashflows.  As of March 31, 2005, themaximum length of time over which the Company was hedging its exposure to thevariability in future cash flows associated with foreign currency was 15months.  For the three months ended March 31,2005 and 2004, the Company reclassified a $2 million gain (net of tax) and animmaterial amount, respectively, from OCI to cost of goods sold related to therecognition of the foreign currency derivative instruments.  The fair value of the Company’s foreigncurrency derivative instruments at March 31, 2005 was $5 million and wasincluded in other current assets.  Thechange in fair value of these derivative instruments is recorded in OCI untilthe underlying transaction is recorded.

 

**Interest Rate Swap Contracts **

TheCompany uses interest rate swap contracts to manage interest rate exposure on$300 million of the current Tranche B and Tranche C floating rate bank termdebt, effectively fixing the interest rate at 4.3%.  Changes in the fair value of the interestrate swap contracts are expected to be highly effective in offsetting thefluctuations in the floating interest rate and are recorded in OCI until theunderlying transaction is recorded.  Theaccounting for the cash flow impact of the swap contracts is recorded as anadjustment to interest expense each period. As of March 31, 2005, the Company reclassified a $1 million loss(net of tax) from OCI to interest expense when the hedged items wererecognized.  The fair value of theCompany’s interest rate swap contracts at March 31, 2005 was $6 millionand was included in other current assets. Contracts extend until 2011, consistent with the Company’s Tranche B andTranche C term loans.

 

7

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Thecumulative deferred hedge gain on all derivative instruments was $6 million(net of tax) at March 31, 2005, including $2 million (net of tax) oncommodity instruments, an immaterial amount on foreign currency derivativeinstruments and $4 million (net of tax) on interest rate swap contracts.   The Company expects to reclassify $1 million(net of tax) into cost of goods sold during the remainder of 2005, related to thecommodity and foreign currency derivative instruments.

 

**10.****       ComprehensiveIncome (Loss)**

 

Comprehensive income(loss) is as follows:

 
| ** **                                       | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                       | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net loss                                         |       | $                                      | (16        | ) | $ | (51 | ) |
| Other comprehensive income, net of tax:          |       |                                   |       |   |   |
| Net changes in fair value of hedging instruments |       | 12                                     |       |   |   |
| Foreign currency translation adjustment          |       | 1                                      |       |   |   |
| Comprehensive income (loss)                      |       | $                                      | (3         | ) | $ | (51 | ) |

 

**11.****       BusinessSegment Information**

 

The Company has two reportable segments:  (1) Containerboard and Corrugated Containersand (2) Consumer Packaging.  TheContainerboard and Corrugated Containers segment is highly integrated.  It includes a system of mills and plants thatproduces a full line of containerboard that is converted into corrugatedcontainers.  Corrugated containers areused to transport such diverse products as home appliances, electric motors,small machinery, grocery products, produce, books, tobacco and furniture.  The Consumer Packaging segment is also highlyintegrated.  It includes a system ofmills and plants that produces a broad range of coated recycled boxboard thatis converted into folding cartons. Folding cartons are used primarily to protect and market products, suchas food, fast food, detergents, paper products, beverages, health and beautyaids and other consumer products, while providing point of purchaseadvertising.  In addition, the ConsumerPackaging segment converts kraft and specialty paper into multiwall bags andconsumer bags that are designed to ship and protect a wide range of industrialand consumer products including fertilizers, chemicals, concrete and pet andfood products.  The Consumer Packagingsegment also produces flexible packaging, paper and metalized paper labels andheat transfer labels used in a wide range of consumer applications.

 

The Company evaluates performance and allocatesresources based on profit or loss from operations before income taxes, interestexpense and other non-operating gains and losses.  The accounting policies of the reportablesegments are the same as those described in the summary of significantaccounting policies in the Company’s 10-K. Intersegment sales and transfers are recorded at market prices.

 

The Company’s reportable segments are strategicbusiness units that offer different products. The reportable segments are each managed separately because theymanufacture distinct products.  Otherincludes corporate related items and two non-reportable segments, includingReclamation and Innovation to Implementation (i2iSM).  Corporate related items include expenses notallocated to reportable segments including corporate expenses, restructuringcharges, non-cash foreign currency gains or losses and interest expense.

 

8

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A summary by business segment follows:

 
| ** **                        | ** ** | **Container-  board &   Corrugated   Containers** | ** ** | **Consumer  Packaging** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-------------------------------------------------------|------------|-------------------------|------------|-----------|------------|-----------|------------|
| Three months ended March 31, |       |                                                  |       |                    |       |      |       |      |       |
| 2005                              |       |                                                  |       |                    |       |      |       |      |       |
| Revenues from external customers  |       | $                                                     | 1,582      |                    | $          | 404       |       | $         | 107        |   | $ | 2,093 |   |
| Intersegment revenues             |       | 37                                                    |       |                    |       | 72        |       | 109       |       |
| Segment profit (loss)             |       | 67                                                    |       | 15                      |       | (110      | )          | (28       | )          |
|                              |       |                                                  |       |                    |       |      |       |      |       |
| 2004                              |       |                                                  |       |                    |       |      |       |      |       |
| Revenues from external customers  |       | $                                                     | 1,441      |                    | $          | 411       |       | $         | 90         |   | $ | 1,942 |   |
| Intersegment revenues             |       | 34                                                    |       |                    |       | 68        |       | 102       |       |
| Segment profit (loss)             |       | (8                                                    | )          | 21                      |       | (97       | )          | (84       | )          |

 

**12.  Contingencies**

 

In 2003, the Companysettled the antitrust class action cases pending against the Company, whichwere based on allegations of a conspiracy among containerboard manufacturers in1993 to 1995, and made aggregate settlement payments of $92.5 million, one-halfof which was paid in December 2003 and the remainder of which was paid in January 2005.  The Company is a defendant in eleven lawsuitsbrought on behalf of numerous parties that have opted out of the class actionsto seek their own recovery.  The Companyrecorded pretax charges of $3 million and $121 million in 2004 and 2003,respectively, to accrue for the settlement and the estimated liability of theopt-out cases.  The Company believes theliability for these matters was adequately reserved at March 31, 2005.

 

The Company’s past andpresent operations include activities which are subject to federal, state andlocal environmental requirements, particularly relating to air and waterquality.  The Company faces potentialenvironmental liability as a result of violations of permit terms and similarauthorizations that have occurred from time to time at its facilities.  In addition, the Company faces potentialliability for response costs at various sites for which it has received noticeas being a potentially responsible party (“PRP”) concerning hazardous substancecontamination.  In estimating itsreserves for environmental remediation and future costs, the Company’sestimated liability reflects only the Company’s expected share afterconsideration for the number of other PRPs at each site, the identity andfinancial condition of such parties and experience regarding similarmatters.  As of March 31, 2005, theCompany had approximately $18 million reserved for environmental liabilitiesincluded primarily in other long-term liabilities in the consolidated balancesheet.  The Company believes theliability recorded for these matters was adequately reserved at March 31,2005.

 

If all or most of the other PRPs are unable tosatisfy their portion of the cleanup costs at one or more of the significantsites in which the Company is involved or the Company’s expected shareincreases, the resulting liability could have a material adverse effect on theCompany’s consolidated financial condition, results of operations or cashflows.

 

The Company is adefendant in a number of lawsuits and claims arising out of the conduct of itsbusiness, including those related to environmental matters.  While the ultimate results of such suits orother proceedings against the Company cannot be predicted with certainty,management of the Company believes that the resolution of these matters willnot have a material adverse effect on its consolidated financial condition,results of operations or cash flows.

 

9

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| **ITEM 2.** |   | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|--------|-------------------------------------------------------------------------------------------------|

 

**FORWARD-LOOKINGSTATEMENTS**

 

Some information includedin this report may contain forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended.  Although we believe that, in making any suchstatements, our expectations are based on reasonable assumptions, any suchstatement may be influenced by factors that could cause actual outcomes andresults to be materially different from those projected.  When used in this document, the words “anticipates,”“believes,” “expects,” “intends” and similar expressions as they relate toSmurfit-Stone Container Enterprises, Inc. or its management, are intended toidentify such forward-looking statements. These forward-looking statements are subject to numerous risks anduncertainties.  There are importantfactors that could cause actual results to differ materially from those inforward-looking statements, certain of which are beyond our control.  These factors, risks and uncertaintiesinclude the following:

 

•                  the impact of general economicconditions in North America and in other locations in which we do business;

•                  general industry conditions,including competition and product and raw material prices;

•                  fluctuations in interest rates,exchange rates and currency values;

•                  unanticipated capital expenditurerequirements;

•                  legislative or regulatoryrequirements, particularly concerning environmental matters;

•                  access to capital markets;

•                  assumptions relating to pension andpostretirement costs;

•                  fluctuations in energy costs;

•                  fluctuations in wood fiber andreclaimed fiber costs;

•                  fluctuations in other costs,including freight, chemicals and employee benefits;

•                  our substantial leverage;

•                  obtaining required consents orwaivers of creditors in the event we are unable to satisfy covenants in ourdebt instruments; and

•                  the outcome of negotiations forcollective bargaining contracts.

 

Ouractual results, performance or achievements could differ materially from thoseexpressed in, or implied by, these forward-looking statements and, accordingly,we can give no assurances that any of the events anticipated by theforward-looking statements will transpire or occur, or if any of them do, whatimpact they will have on our results of operations or financial condition.  We expressly decline any obligation topublicly revise any forward-looking statements that have been made to reflectthe occurrence of events after the date hereof.

 

10

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# **GENERAL**

 

We are a wholly-ownedsubsidiary of Smurfit-Stone Container Corporation (Smurfit-Stone), a holdingcompany with no business operations of its own. Smurfit-Stone conducts itsbusiness operations through us.  We arethe surviving company resulting from the merger (the Merger) of Smurfit-Stone’sprimary operating subsidiaries on November 1, 2004.  JSCE, Inc. merged with and into JeffersonSmurfit Corporation (U.S.) (JSC(U.S.)), with JSC(U.S.) as the survivingcompany, and then JSC(U.S.) merged with and into us, with us as the survivingentity.  The Merger was effectedprincipally to consolidate debt financing activities of Smurfit-Stone and itssubsidiaries.  We were simultaneouslyrenamed Smurfit-Stone Container Enterprises, Inc.

 

We and JSC(U.S.) werewholly-owned subsidiaries of Smurfit-Stone and, therefore, the historical costbasis of the acquired entity, JSC(U.S.), carried over into us.  As a result of the Merger, our financialstatements for all periods presented have been restated to include the combinedresults of us and JSC(U.S.).  The Mergerdid not impact the operating activities of the merged companies, which willcontinue to do business as Smurfit-Stone.

 

# **RESULTS OF OPERATIONS**

 

**Overview**

 

We had a net loss of $16million for the first quarter of 2005. Net sales increased 7.8% compared to the first quarter of 2004 dueprimarily to improvements in sales prices for most of our products.  Compared to the first quarter of 2004, ourresults improved due primarily to the higher sales prices.  Net sales decreased 2.5% compared to thefourth quarter of 2004 due primarily to seasonally lower demand for corrugatedcontainers and containerboard.  Our firstquarter 2005 results declined compared to the net income of $1 million in thefourth quarter of 2004 due primarily to the lower demand and higher costs foremployee benefits, energy, transportation and fiber.

 

We expect ourprofitability to improve in the second quarter of 2005 as a result of strongerdemand and higher sales prices for containerboard and corrugated containers,higher containerboard mill operating rates and lower costs.  Based on current inventory levels and theexpected stronger demand, we believe the containerboard price increase communicatedto our customers and a corresponding increase for corrugated containers will besuccessfully implemented.  The impact ofthe announced corrugated container price increase is expected to be realized inthe second half of 2005.

 

**First Quarter 2005 Compared to First Quarter 2004**

 
| ** **                                        | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                        | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **(In millions)**                                 | ** ** | **Net   Sales**                       | ** ** | **Profit/   (Loss)** | ** ** | **Net   Sales** | ** ** | **Profit/   (Loss)** | ** ** |
|                                              |       |                                  |       |   |   |   |   |   |   |
| Containerboard and corrugated containers          |       | $                                     | 1,582      |   | $ | 67 |   | $ | 1,441 |   | $ | (8 | ) |
| Consumer packaging                                |       | 404                                   |       | 15 |   | 411 |   | 21 |   |
| Other operations                                  |       | 107                                   |       | 5 |   | 90 |   | 6 |   |
| Total segment operations                          |       | $                                     | 2,093      |   | 87 |   | $ | 1,942 |   | 19 |   |
|                                              |       |                                  |       |   |   |   |   |   |   |
| Restructuring charges                             |       |                                  |       | (1 | ) |   |   | (15 | ) |
| Interest income from Smurfit-Stone                |       |                                  |       |   |   |   |   | 20 |   |
| Interest expense, net                             |       |                                  |       | (86 | ) |   |   | (86 | ) |
| Non-cash foreign currency exchange gains (losses) |       |                                  |       | (1 | ) |   |   | 3 |   |
| Corporate expenses and other (1)                  |       |                                  |       | (27 | ) |   |   | (25 | ) |
| Loss before income taxes                          |       |                                  |       | $ | (28 | ) |   |   | $ | (84 | ) |

 

----

(1)   Amounts includecorporate expenses, corporate charges to segments for working capital interestand other expenses not allocated to segments.

 

11

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The increase in net saleswas due primarily to the improvements in pricing for the Containerboard andCorrugated Containers segment.  Averagesales prices for folding cartons, multiwall bags, coated recycled boxboard andreclamation products also improved.  Thechange in net sales for each of our segments is summarized in the chart below:

 
| **(In millions)**           | ** ** | **Container-  board &   Corrugated   Containers** | ** ** | **Consumer   Packaging** | ** ** | **Other   Operations** | ** ** | **Total** | ** ** |
|-----------------------------|------------|-------------------------------------------------------|------------|--------------------------|------------|------------------------|------------|-----------|------------|
|                        |       |                                                  |       |                     |       |                   |       |      |       |
| Sales price and product mix |       | $                                                     | 158        |                     | $          | 14                     |       | $         | 9          |   | $ | 181 |   |
| Sales volume                |       | (17                                                   | )          | (21                      | )          | 8                      |       | (30       | )          |
| Total                       |       | $                                                     | 141        |                     | $          | (7                     | )          | $         | 17         |   | $ | 151 |   |

 

Cost of goods sold increased from $1,750 million in2004 to $1,835 million in 2005 due primarily to higher costs for energy ($10million), fiber ($19 million), freight, chemicals and employee benefits.  Cost of goods sold as a percent of net salesdecreased from 90.1% in 2004 to 87.7% in 2005 due primarily to the higheraverage sales prices.

 

Sellingand administrative expense decreased $4 million compared to last year.  Selling and administrative expense as apercent of net sales decreased from 10.3% in 2004 to 9.4% in 2005.

 

We recorded restructuringcharges of $1 million in the first quarter of 2005 including severance andbenefits for terminated employees at a converting facility, the closure ofwhich was announced in the fourth quarter of 2004.

 

Interest income fromSmurfit-Stone in 2005 decreased $20 million compared to 2004 due to thesettlement of the notes receivable in November 2004. The notes receivablefrom Smurfit-Stone of $645 million, including accrued interest, were exchangedfor 230 shares of our common stock owned by Smurfit-Stone.  The exchange, which was accounted for athistorical cost, resulted in a reduction of $645 million to our additionalpaid-in capital. The fair value of the shares of our stock received, asestimated by a third party valuation, approximated the net book value of theshares at the time of the exchange.

 

Interest expense was $86million in 2005, comparable to 2004.  Thefavorable impact of lower average borrowings was offset by higher averageinterest rates.  Our overall average effectiveinterest rate in 2005 was higher than 2004 by approximately 50 basis points.

 

Other, net for 2005included non-cash foreign currency exchange losses of $1 million compared togains of $3 million in 2004.

 

Benefit from income taxes differed from the amountcomputed by applying the statutory U.S. federal income tax rate to loss beforeincome taxes due primarily to state income taxes and the effect of otherpermanent differences.

 

**Containerboard and Corrugated Containers Segment**

Net sales increased 9.8%in 2005 compared to last year primarily as a result of higher average salesprices.  Average domestic linerboardprices in the first quarter of 2005 were comparable to the fourth quarter of2004, but increased 25.2% compared to the first quarter of 2004.  Our average North American selling price forcorrugated containers was up .4% compared to the fourth quarter and 9.4%compared to the first quarter of 2004. Shipments of corrugated containers on a per day basis decreased .7%, andthird party containerboard shipments decreased 8.5% compared to the same periodlast year.  First quarter average salesprices for market pulp, solid bleached sulfate (SBS) and kraft paper increasedapproximately 9.4%, 3.0%, and 27.0%, respectively, compared to the same periodlast year.

 

12

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Our containerboard millsoperated at 87.9% of capacity in the first quarter of 2005, and productiondecreased 2.2% compared to last year. Production of market pulp increased by 10.2%, due in part to timing ofmaintenance shutdowns, and SBS production increased by 8.3%.  Production of kraft paper declined 29.7% dueprimarily to the shift of production from kraft paper to containerboard on oneof our paper machines.

 

Profits increased by $75million due primarily to the higher average sales prices.  Profits were unfavorably impacted by ourlower mill operating rates and higher costs of wood ($8 million), reclaimedfiber ($9 million), energy ($10 million), freight and employee benefits.

 

**Consumer Packaging Segment**

Net sales decreased 1.7%in 2005 primarily due to lower volume as a result of the closure of threeconverting facilities and the sale of two operations in 2004.  Net sales were favorably impacted by higheraverage sales prices for folding cartons, multiwall bags and coated recycledboxboard, which improved by 4.2%, 4.9% and 9.5%, respectively.  Folding carton and multiwall bag shipmentsdecreased by 3.1% and 4.3%, respectively. Third party shipments of coated recycled boxboard were lower by 1.7% andlaminated product shipments declined due primarily to the sale of a plant.  Flexible packaging shipments increased1.4%.  The coated recycled boxboard millsoperated at 98.4% of capacity in 2005 as compared to nearly 100% of capacity in2004.

 

Profits decreased by $6million compared to last year primarily as a result of the higher costs ofreclaimed fiber ($1 million), energy ($1 million) and employee benefits.  In addition, profits of our multiwall bagoperation were unfavorably impacted by higher kraft paper cost.  Profits were favorably impacted by the higheraverage sales prices.

 

**Other Operations**

Net sales increased dueprimarily to higher average sales prices for most of our reclamation products,higher external sales volume for reclaimed fiber, and the impact of our newlyformed i2iSM business, which began operating in the second half of2004.  Total tons of fiber reclaimed andbrokered increased by 1.2% as a result of the higher external sales volume.

 

**Statistical Data**

 
| ** **                                                       | ** ** | **Three months ended   March 31,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------|------------|
| **(In thousands of tons, except as noted)**                      | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Mill production                                                  |       |                                    |       |   |   |
| Containerboard (1)                                               |       | 1,751                                   |       | 1,790 |   |
| Kraft paper                                                      |       | 52                                      |       | 74 |   |
| Market pulp                                                      |       | 141                                     |       | 128 |   |
| SBS                                                              |       | 65                                      |       | 60 |   |
| Coated recycled boxboard                                         |       | 138                                     |       | 141 |   |
| North American corrugated containers sold (billion  sq. ft.) (2) |       | 20.9                                    |       | 21.4 |   |
| Folding cartons sold                                             |       | 124                                     |       | 128 |   |
| Multiwall bags sold (million bags)                               |       | 270                                     |       | 282 |   |
| Fiber reclaimed and brokered                                     |       | 1,636                                   |       | 1,616 |   |

 

----

(1)          Forthe three months ended March 31, 2005 and 2004, our corrugated containerplants consumed 1,326,000 tons and 1,377,000 tons of containerboard,respectively.

(2)          Forboth of the three months ended March 31, 2005 and 2004, North Americancorrugated containers sold include intercompany shipments of 1.4 billion squarefeet.

 

13

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#### **Collective Bargaining Contracts**

 

Laboragreements covering approximately 1,400 employees at our five Canadian papermills expired on various dates between April and August 2004.  These five mills have a capacity to produce1,330,000 tons annually.  The employeesof these mills are primarily represented by the Communications, Energy andPaper Union (CEP), which is currently negotiating collective bargainingagreements with other paper companies in Canada.  We expect to meet with the CEP in the secondquarter of 2005 to begin our negotiations with them.  While we consider relations with theseemployees to be good and we do not expect a work stoppage to occur, theoutcomes of the negotiations regarding the expired labor agreements are notentirely within our control, and therefore, we can provide no assuranceregarding the outcomes or the timing of these negotiations or their effect onour results of operations.

 

#### **LIQUIDITY AND CAPITAL RESOURCES**

 

The following tablesummarizes our cash flows for the three months ended March 31: 

 
| **(In millions)**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Net cash provided by (used for): |       |     |       |     |       |
| Operating activities             |       | $        | (70        | )        | $          | (65 | ) |
| Investing activities             |       | (61      | )          | (35      | )          |
| Financing activities             |       | 130      |       | 98       |       |
| Net decrease in cash             |       | $        | (1         | )        | $          | (2 | ) |

 

**Net CashUsed For Operating Activities**

Net cash used foroperating activities for the three months ended March 31, 2005 increased$5 million compared to the same period in 2004 due primarily to higher workingcapital levels.  Working capitalincreased $121 million in the first three months of 2005.  The higher level of working capital in 2005was primarily the result of decreases in accounts payable and accruedliabilities, which was impacted by a payment of $46 million related to thesettlement of the antitrust class action litigation.

 

**Net CashUsed For Investing Activities**

Net cash used forinvesting activities was $61 million for the three months ended March 31,2005.  Expenditures for property, plantand equipment were $66 million for the first quarter of 2005 compared to $42million for the same period last year. The $66 million expended for property,plant and equipment in 2005 included $11 million for environmental projects and$55 million for upgrades, modernization and expansion.

 

**Net CashProvided By Financing Activities**

Net cash provided byfinancing activities for the three months ended March 31, 2005 of $130million included net borrowings of debt of $133 million.  Capital contributions from Smurfit-Stone were$1 million as compared to $33 million for the same period last year.

 

Smurfit-Stone, asguarantor, and we and our subsidiary, Smurfit-Stone Container Canada Inc. (SSCCanada), as borrowers, entered into a new credit agreement (the CreditAgreement) on November 1, 2004.  Ourobligations under the Credit Agreement are unconditionally guaranteed bySmurfit-Stone and our material U.S. subsidiaries.  The obligations of SSC Canada under theCredit Agreement are unconditionally guaranteed by Smurfit-Stone, us, and ourmaterial U.S. subsidiaries and the material Canadian subsidiaries of SSCCanada.  Our obligations under the CreditAgreement are secured by a security interest in substantially all ofSmurfit-Stone’s assets and properties and those of our material U.S.subsidiaries, by a pledge of all of our capital stock and that of our materialU.S. subsidiaries and by a pledge of 65% of the capital stock of SSC Canadathat is directly owned by us.  Thesecurity interests securing our obligation under the Credit Agreement excludecash, cash equivalents, certain trade receivables, three paper mills and theland and buildings of certain corrugated container facilities.  The obligations of SSC Canada under theCredit Agreement are secured by a security interest in substantially all of theassets and properties of SSC Canada and the material Canadian subsidiaries ofSSC Canada, 

 

14

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by a pledge of all of thecapital stock of the material Canadian subsidiaries of SSC Canada and by thesame U.S. assets, properties and capital stock that secure our obligationsunder the Credit Agreement.  The securityinterests securing SSC Canada’s obligation under the Credit Agreement excludethree mills and property related thereto and certain other real propertylocated in New Brunswick and Quebec.

 

The Credit Agreementcontains various covenants and restrictions including (i) limitations ondividends, redemptions and repurchases of capital stock, (ii) limitations onthe incurrence of indebtedness, liens, leases and sale-leaseback transactions,(iii) limitations on capital expenditures and (iv) maintenance of certainfinancial covenants.  The CreditAgreement also requires prepayments if we have excess cash flows, as defined inthe Credit Agreement, or receive proceeds from certain asset sales, insuranceor incurrence of certain indebtedness.

 

**FutureCash Flows**

Scheduled debt payments,including capital lease payments, for the remainder of 2005 and for 2006 are$31 million and $34 million, respectively.

 

As of March 31,2005, we had authorized commitments for future capital expenditures ofapproximately $300 million.  We expectcapital expenditures for 2005 to be approximately $300 million.

 

As described in our 2004Annual Report on Form 10-K (2004 Form 10-K), we continue to study possiblemeans of compliance with Phase II of MACT I of the Cluster Rule and the newBoiler MACT regulation.  Based oncurrently available information, we estimate that the aggregate compliance costof Phase II of MACT I will be approximately $60 million to $70 million ($16million of which was spent in 2004, $3 million in the first quarter of 2005,approximately $34 million to be spent in the remainder of 2005 and the balancein 2006).  Based on currently availableinformation, we estimate that the aggregate compliance cost of Boiler MACT willbe approximately $90 million to $100 million ($1 million of which was spent in2004, $2 million in the first quarter of 2005, approximately $48 million to bespent in the remainder of 2005 and the balance in 2006 and 2007).  In addition to Cluster Rule and Boiler MACTcompliance, we anticipate additional capital expenditures related toenvironmental compliance.  Excluding thespending on the Cluster Rule and Boiler MACT projects, we spent $6 million inthe first quarter of 2005 and anticipate spending approximately $10 millionover the remainder of 2005 on environmental projects.

 

We recorded restructuringcharges of $1 million in the first quarter of 2005 including severance andbenefits for terminated employees at a converting facility, the closure ofwhich was announced in the fourth quarter of 2004.  These exit liabilities are expected to bepaid in the second quarter of 2005.

 

At December 31,2004, we had $33 million of exit liabilities related to restructuringactivities.  During the three monthsended March 31, 2005, we incurred cash expenditures of $5 million forthese exit liabilities.  The remainingcash expenditures in connection with our restructuring activities will continueto be funded through operations as originally planned.

 

As described in our 2004 Form 10-K, our pension obligations exceededthe fair value of pension plan assets by $870 million as of December 31,2004.  For the three months ended March 31,2005, we contributed approximately $47 million to the pension plans and expectto contribute a total of approximately $175 million in 2005.  Future contributions to our pension and otherpostretirement plans will be dependent upon future changes in discount ratesand the earnings performance of our plan assets.

 

We expect our profitability and cash flow fromoperations will improve in the second quarter of 2005.  As of March 31, 2005, we have unusedborrowing capacity under our revolving credit facilities of $409 million.  We expect these cash sources will besufficient for the next several years to meet our obligations and commitments,including debt service, pension funding, severance costs and otherrationalization expenditures, dividends to Smurfit-Stone, expenditures relatedto environmental compliance and other capital expenditures.

 

15

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**ITEM 3.**                             **QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Weare exposed to various market risks, including commodity price risk, foreign currencyrisk and interest rate risk.  To managethe volatility related to these risks, we enter into various derivativecontracts.  The majority of thesecontracts are settled in cash.  However,such settlements have not had a significant effect on our liquidity in thepast, nor are they expected to be significant in the future.  We do not use derivatives for speculative ortrading purposes.

 

**CommodityPrice Risk**

We use financialderivative instruments, including fixed price swaps and options, to manage fluctuationsin cash flows resulting from commodity price risk in the procurement of naturalgas.  Our objective is to fix the priceof a portion of the purchases of natural gas used in the manufacturing process.  The changes in the market value of suchderivative instruments have historically been, and are expected to continue tobe, highly effective at offsetting changes in price of the hedged item.  As of March 31, 2005, we had derivativeinstruments to hedge approximately 70% to 75% of our expected natural gasrequirements through October 2005 and approximately 30% to 40% of ourrequirements through December 2006. The changes in energy cost discussed in Item 2, “Management’s Discussionand Analysis of Financial Condition and Results of Operations,” include theimpact of the natural gas derivative instruments.  See Note 9 of the Notes to ConsolidatedFinancial Statements.

 

**ForeignCurrency Risk**

Our principal foreignexchange exposure is the Canadian dollar. Assets and liabilities outside the United States are primarily locatedin Canada.  The functional currency forour Canadian operations is the U.S. dollar. Our investments in foreign subsidiaries with a functional currency otherthan the U.S. dollar are not hedged.

 

We use financialderivative instruments, including forward contracts and options, primarily toprotect against Canadian currency exchange risk associated with expected futurecash flows.  As of March 31, 2005,we had monthly Canadian dollar forward purchase contracts to hedgeapproximately 55% to 75% of our Canadian dollar requirements through December 2005and 20% to 45% of our Canadian dollar requirements for the first half of 2006.

 

TheCanadian dollar as of March 31, 2005, compared to December 31, 2004weakened against the U.S. dollar by 0.5%. We recognized non-cash foreign currency exchange losses of $1 millionfor the three months ended March 31, 2005 compared to a gain of $3 millionfor the same period last year.

 

**InterestRate Risk**

Ourearnings and cash flow are significantly affected by the amount of interest onour indebtedness.  Our financingarrangements include both fixed and variable rate debt in which changes ininterest rates will impact the fixed and variable rate debt differently.  A change in the interest rate of fixed ratedebt will impact the fair value of the debt, whereas a change in the interestrate on the variable rate debt will impact interest expense and cashflows.  Our objective is to mitigateinterest rate volatility and reduce or cap interest expense within acceptablelevels of market risk.  We periodicallyenter into interest rate swaps, caps or options to hedge interest rate exposureand manage risk within Company policy. Any derivative would be specific to the debt instrument, contract ortransaction, which would determine the specifics of the hedge.

 

Changes in the fair valueof the interest rate swap contracts are expected to be highly effective inoffsetting the fluctuations in the variable interest rate, and are recorded inother comprehensive income until the underlying transaction is recorded.  The accounting for the cash flow impact ofthe swap contracts is recorded as an adjustment to interest expense eachperiod.  Contracts extend until 2011,consistent with the maturity on our Tranche B and Tranche C term loans.

 

16

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**ITEM 4.     CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

Our management, with theparticipation of our principal executive officer and our principal financialofficer, evaluated the effectiveness of our disclosure controls and procedures(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of theperiod covered by this report and have concluded that, as of such date, ourdisclosure controls and procedures were adequate and effective.

 

**Changesin Internal Control**

We have substantiallycompleted the implementation of a time management system designed to eliminatemanual tracking and recording of labor expenses.  As a result of this implementation, we haveupdated our internal controls to ensure a continuing effective controlenvironment remains in place, including proper approval of transactions,segregation of duties and appropriate integration and reconciliation ofprocesses under the new time management system. There have not been any other changes in our internal control overfinancial reporting during the most recent quarter that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

 

**PART II - OTHER INFORMATION**

 
| **ITEM 1.** |   | **LEGAL  PROCEEDINGS**                                                                                                                                                               |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                 |
|        |   | None                                                                                                                                                                                 |
|        |   |                                                                                                                                                                                 |
| **ITEM 2.** |   | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                                                                                     |
|        |   |                                                                                                                                                                                 |
|        |   | None                                                                                                                                                                                 |
|        |   |                                                                                                                                                                                 |
| **ITEM 3.** |   | **DEFAULTS  UPON SENIOR SECURITIES**                                                                                                                                                 |
|        |   |                                                                                                                                                                                 |
|        |   | None                                                                                                                                                                                 |
|        |   |                                                                                                                                                                                 |
| **ITEM 4.** |   | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                                                                             |
|        |   |                                                                                                                                                                                 |
|        |   | None                                                                                                                                                                                 |
|        |   |                                                                                                                                                                                 |
| **ITEM 5.** |   | **OTHER  INFORMATION**                                                                                                                                                               |
|        |   |                                                                                                                                                                                 |
|        |   | None                                                                                                                                                                                 |
|        |   |                                                                                                                                                                                 |
| **ITEM 6.** |   | **EXHIBITS**                                                                                                                                                                         |
|        |   |                                                                                                                                                                                 |
|        |   | The following  exhibits are included in this Form 10-Q:                                                                                                                              |
|        |   |                                                                                                                                                                                 |
| 31.1        |   | Certification  Pursuant to Rules 13a–14 and 15d–14 under the Securities Exchange Act of  1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|        |   |                                                                                                                                                                                 |
| 31.2        |   | Certification  Pursuant to Rules 13a–14 and 15d–14 under the Securities Exchange Act of  1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|        |   |                                                                                                                                                                                 |
| 32.1        |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                  |
|        |   |                                                                                                                                                                                 |
| 32.2        |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                  |

 

17

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Signature

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                    |       |       |                                           |
|-------------------------|------------|------------|------------------------------------------------|
|                    |       |       | SMURFIT-STONE  CONTAINER ENTERPRISES, INC.     |
|                    |       |       | (Registrant)                                   |
|                    |       |       |                                           |
|                    |       |       |                                           |
| Date:  May 9, 2005 |       |       | /s/  Paul K.  Kaufmann                    |
|                    | ** ** | ** ** | Paul K. Kaufmann                               |
|                    | ** ** | ** ** | Senior Vice President and Corporate Controller |
|                    | ** ** | ** ** | (Principal Accounting Officer)                 |

 

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