** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

** **

**FORM 10-Q**

** **

**x****     ****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.**

** **

**For Quarter Ended June 30, 2009**

** **

**Commission File Number 1-3439**

** **

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices)  (Zip Code)

 

**(312)346-6600**

(Registrant’stelephone number, including area code)

 

###### **Not Applicable**

(Former name, formeraddress and former fiscal year, if

changed since lastreport)

 

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 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.   Yes x No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).   Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large  accelerated filer o                     |   | Accelerated  filer o         |
|------------------------------------------------|--------|------------------------------|
|                                           |   |                         |
| Non-accelerated  filer x                       |   | Smaller  Reporting Company o |
| (Do not check if  a smaller reporting company) |   |                         |

 

Indicateby check mark if the registrant is a shell company (as defined in Rule 12b-2of the Act).   Yes o No x

 

APPLICABLE ONLY TOCORPORATE ISSUERS:

 

As of August 7,2009, the registrant had outstanding 770 shares of common stock, $.01 par valueper share, all of which are owned by Smurfit-Stone Container Corporation.

 

 

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1.            FinancialInformation**

 

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**(DEBTOR-IN-POSSESSION)**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                                                                                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **(In millions)**                                                                                                                                                              | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  sales                                                                                                                                                                     | ** ** | **$**                  | **1,407**  |                 | $          | 1,835 | ** ** | **$** | **2,778** |   | $ | 3,630 |   |
| Costs  and expenses                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Cost  of goods sold                                                                                                                                                            | ** ** | **1,256**              |       | 1,659                | ** ** | **2,473** |   | 3,242 |   |
| Selling  and administrative expenses                                                                                                                                           | ** ** | **146**                |       | 157                  | ** ** | **291** |   | 348 |   |
| Restructuring  expenses                                                                                                                                                        | ** ** | **11**                 |       | 9                    | ** ** | **24** |   | 13 |   |
| (Gain)  loss on disposal of assets                                                                                                                                             | ** ** | **(1**                 | **)**      | (1                   | )          | **1** |   | (4 | ) |
| Other  operating income                                                                                                                                                        | ** ** | **(276**               | **)**      |                 |       | **(276** | **)** |   |   |
| Operating  income                                                                                                                                                              | ** ** | **271**                |       | 11                   | ** ** | **265** |   | 31 |   |
| Other  income (expense)                                                                                                                                                        |       |                   |       |                 |       |   |   |   |   |
| Interest  expense, net (including $50 million and $98 million for the three and six  months ended June 30, 2009, respectively, that is stayed and subject to  compromise) |       | **(74**                | **)**      | (61                  | )          | **(145** | **)** | (124 | ) |
| Debtor-in-possession  debt issuance costs                                                                                                                                      | ** ** |                   |       |                 |       | **(63** | **)** |   |   |
| Loss  on early extinguishment of debt                                                                                                                                          | ** ** |                   |       |                 |       | **(20** | **)** |   |   |
| Foreign  currency exchange gains (losses)                                                                                                                                      | ** ** | **(2**                 | **)**      | (4                   | )          | **1** |   | 11 |   |
| Other,  net                                                                                                                                                                    | ** ** | **6**                  |       | (3                   | )          | **4** |   | (6 | ) |
| Income  (loss) before reorganization items and income taxes                                                                                                                    | ** ** | **201**                |       | (57                  | )          | **42** |   | (88 | ) |
| Reorganization  items                                                                                                                                                          | ** ** | **(39**                | **)**      |                 |       | **(93** | **)** |   |   |
| Income  (loss) before income taxes                                                                                                                                             | ** ** | **162**                |       | (57                  | )          | **(51** | **)** | (88 | ) |
| (Provision  for) benefit from income taxes                                                                                                                                     | ** ** | **(4**                 | **)**      | 20                   | ** ** | **(5** | **)** | 38 |   |
| Net  income (loss)                                                                                                                                                             |       | **$**                  | **158**    | ** **           | $          | (37 | ) | **$** | **(56** | **)** | $ | (50 | ) |

 

See notes toconsolidated financial statements.

 

1

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**(DEBTOR-IN-POSSESSION)**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                     | ** ** | **June 30,** | ** **      | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------|-----------------|-----------------------|------------|
| **(In millions, except share  data)**                                                                          | ** ** | **2009**          | ** **      | **2008**              | ** ** |
| ** **                                                                                                     | ** ** | **(Unaudited)**   | ** **      | ** **            | ** ** |
| **Assets**                                                                                                     |       |              |            |                  |       |
|                                                                                                           |       |              |            |                  |       |
| Current  assets                                                                                                |       |              |            |                  |       |
| Cash  and cash equivalents                                                                                     | ** ** | **$**             | **590**         |                  | $          | 126 |   |
| Restricted  cash                                                                                               | ** ** | **13**            |            |                  |       |
| Receivables,  less allowances of $25 in 2009 and $7 in 2008                                                    | ** ** | **648**           |            | 96                    |       |
| Receivable  for alternative energy tax credits                                                                 | ** ** | **89**            |            |                  |       |
| Retained  interest in receivables sold                                                                         |       |              |            | 120                   |       |
| Inventories                                                                                                    |       |              |            |                  |       |
| Work-in-process  and finished goods                                                                            | ** ** | **121**           |            | 112                   |       |
| Materials  and supplies                                                                                        | ** ** | **381**           |            | 400                   |       |
| ** **                                                                                                     |       | **502**           |            | 512                   |       |
| Prepaid  expenses and other current assets                                                                     | ** ** | **34**            |            | 27                    |       |
| Total  current assets                                                                                          | ** ** | **1,876**         |            | 881                   |       |
| Net  property, plant and equipment                                                                             | ** ** | **3,405**         |            | 3,509                 |       |
| Timberland,  less timber depletion                                                                             | ** ** | **32**            |            | 32                    |       |
| Other  assets                                                                                                  | ** ** | **68**            |            | 117                   |       |
| ** **                                                                                                     |       | **$**             | ** 5,381** |                  | $          | 4,539 |   |
| **Liabilities and Stockholder’s Equity (Deficit)**                                                        |       |              |            |                  |       |
|                                                                                                           |       |              |            |                  |       |
| Liabilities  not subject to compromise                                                                         |       |              |            |                  |       |
| Current  liabilities                                                                                           |       |              |            |                  |       |
| Current  maturities of long-term debt                                                                          | ** ** | **$**             | **1,783**       |                  | $          | 3,718 |   |
| Accounts  payable                                                                                              | ** ** | **336**           |            | 506                   |       |
| Accrued  compensation and payroll taxes                                                                        | ** ** | **144**           |            | 164                   |       |
| Interest  payable                                                                                              | ** ** | **9**             |            | 66                    |       |
| Income  taxes payable                                                                                          | ** ** | **10**            |            | 9                     |       |
| Current  deferred income taxes                                                                                 | ** ** | **21**            |            | 21                    |       |
| Other  current liabilities                                                                                     | ** ** | **134**           |            | 194                   |       |
| Total  current liabilities                                                                                     | ** ** | **2,437**         |            | 4,678                 |       |
| Other  long-term liabilities                                                                                   | ** ** | **123**           |            | 1,320                 |       |
| Deferred  income taxes                                                                                         | ** ** | **119**           |            | 89                    |       |
| Total  liabilities not subject to compromise                                                                   | ** ** | **2,679**         |            | 6,087                 |       |
|                                                                                                           |       |              |            |                  |       |
| Liabilities  subject to compromise                                                                             | ** ** | **4,251**         |            |                  |       |
| Total  liabilities                                                                                             | ** ** | **6,930**         |            | 6,087                 |       |
|                                                                                                           |       |              |            |                  |       |
| Stockholder’s  equity                                                                                     |       |              |            |                  |       |
| Common  stock, par value $.01 per share; 1,000 shares authorized; 770 issued and outstanding  in 2009 and 2008 |       |              |            |                  |       |
| Additional  paid-in capital                                                                                    | ** ** | **3,672**         |            | 3,668                 |       |
| Retained  earnings (deficit)                                                                                   | ** ** | **(4,578**        | **)**           | (4,522                | )          |
| Accumulated  other comprehensive income (loss)                                                                 | ** ** | **(643**          | **)**           | (694                  | )          |
| Total  stockholder’s equity (deficit)                                                                     | ** ** | **(1,549**        | **)**           | (1,548                | )          |
| ** **                                                                                                     |       | **$**             | ** 5,381** |                  | $          | 4,539 |   |

 

See notes toconsolidated financial statements.

 

2

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**(DEBTOR-IN-POSSESSION)**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| **Six Months Ended June 30,  (In millions)**                                             | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Cash flows from operating activities**                                                      |       |     |       |     |       |
| Net  loss                                                                                     | ** ** | **$**    | **(56**    | **)**    | $          | (50 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used for) operating activities    |       |     |       |     |       |
| Loss  on early extinguishment of debt                                                         | ** ** | **20**   |       |     |       |
| Depreciation,  depletion and amortization                                                     | ** ** | **182**  |       | 175      |       |
| Debtor-in-possession  debt issuance costs                                                     | ** ** | **63**   |       |     |       |
| Amortization  of deferred debt issuance costs                                                 | ** ** | **3**    |       | 4        |       |
| Deferred  income taxes                                                                        | ** ** | **3**    |       | (73      | )          |
| Pension  and postretirement benefits                                                          | ** ** | **20**   |       | (12      | )          |
| (Gain)  loss on disposal of assets                                                            | ** ** | **1**    |       | (4       | )          |
| Non-cash  restructuring expenses                                                              | ** ** | **4**    |       | 2        |       |
| Non-cash  stock-based compensation                                                            | ** ** | **4**    |       | 9        |       |
| Non-cash  foreign currency exchange gains                                                     | ** ** | **(1**   | **)**      | (11      | )          |
| Non-cash  reorganization items                                                                | ** ** | **61**   |       |     |       |
| Change  in restricted cash                                                                    | ** ** | **(13**  | **)**      |     |       |
| Change  in current assets and liabilities, net of effects from acquisitions and  dispositions |       |     |       |     |       |
| Receivables  and retained interest in receivables sold                                        | ** ** | **(38**  | **)**      | (52      | )          |
| Receivable  for alternative energy tax credits                                                | ** ** | **(89**  | **)**      |     |       |
| Inventories                                                                                   | ** ** | **19**   |       | (25      | )          |
| Prepaid  expenses and other current assets                                                    | ** ** | **(5**   | **)**      | (8       | )          |
| Accounts  payable and accrued liabilities                                                     |       | **204**  | ** ** | 36       |       |
| Interest  payable                                                                             | ** ** | **77**   |       |     |       |
| Other,  net                                                                                   | ** ** | **33**   |       | 1        |       |
| Net  cash provided by (used for) operating activities                                         | ** ** | **492**  |       | (8       | )          |
| **Cash flows from investing activities**                                                      |       |     |       |     |       |
| Expenditures  for property, plant and equipment                                               | ** ** | **(69**  | **)**      | (207     | )          |
| Proceeds  from property disposals                                                             | ** ** | **4**    |       | 8        |       |
| Advances  to affiliates, net                                                                  | ** ** | **(15**  | **)**      |     |       |
| Net  cash used for investing activities                                                       | ** ** | **(80**  | **)**      | (199     | )          |
| **Cash flows from financing activities**                                                      |       |     |       |     |       |
| Proceeds  from debtor-in-possession debt                                                      | ** ** | **440**  |       |     |       |
| Net  borrowings of long-term debt                                                             | ** ** | **60**   |       | 213      |       |
| Repurchase  of receivables                                                                    | ** ** | **(385** | **)**      |     |       |
| Debtor-in-possession  debt issuance costs                                                     | ** ** | **(63**  | **)**      |     |       |
| Dividends  paid                                                                               |       |     |       | (4       | )          |
| Net  cash provided by financing activities                                                    | ** ** | **52**   |       | 209      |       |
|                                                                                          |       |     |       |     |       |
| **Increase in cash and cash equivalents**                                                     | ** ** | **464**  |       | 2        |       |
| Cash  and cash equivalents                                                                    |       |     |       |     |       |
| Beginning  of period                                                                          | ** ** | **126**  |       | 7        |       |
| End  of period                                                                                | ** ** | **$**    | **590**    |     | $          | 9 |   |

 

See notes toconsolidated financial statements.

 

3

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** **

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**(DEBTOR-IN-POSSESSION)**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

(Tabular amounts in millions)

 

**1.****             ****Bankruptcy Proceedings**

 

**Chapter 11 Bankruptcy Filings**

On January 26, 2009 (the “Petition Date”),Smurfit-Stone Container Corporation (“SSCC”), Smurfit-Stone ContainerEnterprises, Inc. (“SSCE” or the “Company”) and its U.S. and Canadiansubsidiaries (collectively, the “Debtors”) filed a voluntary petition (the “Chapter11 Petition”) for relief under Chapter 11 of the United States Bankruptcy Code(the “Bankruptcy Code”) in the United States Bankruptcy Court in Wilmington,Delaware (the “U.S. Court”).  On the sameday, the Company’s Canadian subsidiaries also filed to reorganize (the “CanadianPetition”) under the Companies’ Creditors Arrangement Act (the “CCAA”) in theOntario Superior Court of Justice in Canada (the “Canadian Court”).  The Company’s operations in Mexico and Asia andcertain U.S. and Canadian legal entities (the “Non-Debtor Subsidiaries”) werenot included in the filing and will continue to operate outside of the Chapter11 process.

 

The filing of theChapter 11 Petition and the Canadian Petition constituted an event ofdefault under the Company’s debt obligations, and those debt obligations becameautomatically and immediately due and payable, although any actions to enforcesuch payment obligations are stayed as a result of the filing of the Chapter 11Petition and the Canadian Petition.  Aspreviously disclosed in the SSCE Annual Report on Form 10-K for the yearended December 31, 2008 (the “2008 Form 10-K”) filed with theSecurities and Exchange Commission, the accompanying consolidated balance sheetas of December 31, 2008 includes a reclassification of $3,032 million tocurrent maturities of long-term debt from long-term debt.  Due to the filing of the bankruptcypetitions, the Company’s unsecured long-term debt of $2,439 million is includedin liabilities subject to compromise at June 30, 2009 (See Note 5).

 

SSCC, the Company and its U.S. and Canadiansubsidiaries are currently operating as “debtors in possession” under thejurisdiction of the U.S. Court and Canadian Court (the “Bankruptcy Courts”) andin accordance with the applicable provisions of the Bankruptcy Code and theCCAA.  In general, SSCE and itssubsidiaries are authorized to continue to operate as ongoing businesses, butmay not engage in transactions outside the ordinary course of business withoutthe approval of the Bankruptcy Courts.

 

**Debtor-In-Possession (“DIP”) Financing**

In connection with filing the Chapter 11 Petitionand the Canadian Petition on the Petition Date, the Company and certain of itsaffiliates filed a motion with the Bankruptcy Courts seeking approval to enterinto a Post-Petition Credit Agreement (the “DIP Credit Agreement”).  On January 27, 2009, the BankruptcyCourts granted interim approval of the DIP Credit Agreement.  Based on such interim approval, on January 28,2009, the Company entered into the DIP Credit Agreement, subject to finalapproval of the Bankruptcy Courts.  Finalapproval of the DIP Credit Agreement was granted by the U.S. Court on February 23,2009 and by the Canadian Court on February 24, 2009.  Amendments to the DIP Credit Agreement wereentered into on February 25 and 27, 2009.

 

The DIP Credit Agreement, as amended, provides forborrowings up to an aggregate committed amount of $750 million, consisting of a$400 million U.S. term loan for borrowings by the Company; a $35 millionCanadian term loan for borrowings by Smurfit-Stone Container Canada Inc. (“SSCCanada”); a $250 million U.S. revolving loan for borrowings by the Companyand/or SSC Canada; and a $65 million Canadian revolving loan (“DIP CanadianRevolver”) for borrowings by the Company and/or SSC Canada.

 

The outstanding principal amount of the loans underthe DIP Credit Agreement, plus interest accrued and unpaid, will be due andpayable in full at maturity, which is January 28, 2010; provided, that thematurity

 

4

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date may be extended through April 28, 2010,and subsequently through July 28, 2010 upon the satisfaction of certainconditions precedent (including the payment of specified fees).

 

For additionalinformation on the DIP Credit Agreement, see Note 12.

 

**Reorganization Process**

The Bankruptcy Courtshave approved payment of certain of the Company’s pre-petition obligations,including employee wages, salaries and benefits, and the payment of vendors andother providers in the ordinary course for goods and services received afterthe filing of the Chapter 11 Petition and Canadian Petition and otherbusiness-related payments necessary to maintain the operation of theCompany’s business.  The Company hasretained legal and financial professionals to advise it on the bankruptcyproceedings.  From time to time, theCompany may seek the U.S. Court’s approval for the retention of additionalprofessionals.

 

Immediately after filingthe Chapter 11 Petition and Canadian Petition, the Company began notifying allknown current or potential creditors of the bankruptcy filings.  Subject to certain exceptions under theBankruptcy Code and the CCAA, the Company’s bankruptcy filings automaticallyenjoined, or stayed, the continuation of any judicial or administrativeproceedings or other actions against the Company or its property to recover,collect or secure a claim arising prior to the filing of the Chapter 11Petition and Canadian Petition.  Thus,for example, most creditor actions to obtain possession of property from theCompany, or to create, perfect or enforce any lien against its property, or tocollect on monies owed or otherwise exercise rights or remedies with respect toa pre-petition claim are enjoined unless and until the Bankruptcy Courts liftthe automatic stay.

 

As required by theBankruptcy Code, the United States Trustee for the District of Delawareappointed an official committee of unsecured creditors (the “Creditors’Committee”). The Creditors’ Committee and its legal representatives have aright to be heard on all matters that come before the U.S. Court with respectto the Company.  A monitor has beenappointed by the Canadian Court with respect to proceedings before the CanadianCourt.

 

Under the Bankruptcy Code, the Debtors generally mustassume or reject pre-petition executory contracts, including but not limited toreal property leases, subject to the approval of the Bankruptcy Courts andcertain other conditions.  In thiscontext, “assumption” means that the Company agrees to perform its obligationsand cure all existing defaults under the contract or lease, and “rejection”means that it is relieved from its obligations to perform further under thecontract or lease, but is subject to a pre-petition claim for damages for thebreach thereof subject to certain limitations. Any damages resulting from rejection of executory contracts that arepermitted to be recovered under the Bankruptcy Code will be treated asliabilities subject to compromise unless such claims were secured prior to thePetition Date.

 

Since the Petition Date,the Company has received approval from the Bankruptcy Courts to reject a numberof leases and other executory contracts of various types.  The Company is reviewing all of its executorycontracts and unexpired leases to determine which additional contracts and leasesit will reject.  The Company expects thatadditional liabilities subject to compromise will arise due to rejection of executorycontracts, including leases, and from the determination of the U.S. Court (oragreement by parties in interest) of allowed claims for contingencies and otherdisputed amounts.  The Company alsoexpects that the assumption of additional executory contracts and unexpired leaseswill convert certain of the liabilities shown on the accompanying consolidatedbalance sheet as liabilities subject to compromise to liabilities not subjectto compromise.  Due to the uncertainnature of many of the potential claims, the Company cannot project themagnitude of such claims with certainty.

 

On June 22, 2009,the Bankruptcy Courts entered an order establishing August 28, 2009, asthe bar date for potential creditors to file claims.  The bar date is thedate by which certain claims against the  Company must be filed if the claimants wish toreceive any distribution in the bankruptcy cases (See Note 5).

 

5

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In order to successfullyemerge from bankruptcy, the Company will need to propose and obtainconfirmation by the Bankruptcy Courts of a plan of reorganization thatsatisfies the requirements of the Bankruptcy Code and the CCAA.  A plan of reorganization would resolve theCompany’s pre-petition obligations, set forth the revised capital structure ofthe newly reorganized entity and provide for corporate governance subsequent tothe Company’s exit from bankruptcy.

 

The Company had theexclusive right for 120 days after the filing of the Chapter 11 Petition tofile a plan of reorganization.  On May 18,2009, the U.S. Court approved a motion to extend the exclusivity period throughSeptember 23, 2009.  The Companywill likely file additional motions to request extensions of this exclusivityperiod, which are routinely granted in bankruptcy cases of this size andcomplexity.  If the Company’s exclusivityperiod lapsed, any party in interest would be able to file a plan ofreorganization.  In addition to beingvoted on by holders of impaired claims and equity interests, a plan ofreorganization must satisfy certain requirements of the Bankruptcy Code and theCCAA and must be approved, or confirmed, by the Bankruptcy Courts in order tobecome effective.

 

The timing of filing aplan of reorganization by the Company will depend on the timing and outcome ofnumerous other ongoing matters in the bankruptcy proceedings.  There can be no assurance at this time that aplan of reorganization will be confirmed by the Bankruptcy Courts or that anysuch plan will be implemented successfully.

 

Under the priority schemeestablished by the Bankruptcy Code and the CCAA, unless creditors agreeotherwise, pre-petition liabilities and post-petition liabilities must besatisfied in full before SSCC’s stockholders are entitled to receive anydistribution or retain any property under a plan of reorganization.  The ultimate recovery to creditors and/orstockholders, if any, will not be determined until confirmation of a plan orplans of reorganization. No assurance can be given as to what values, if any,will be ascribed to each of these constituencies or what types or amounts ofdistributions, if any, they would receive. A plan of reorganization could result in holders of the Company’sliabilities and/or securities receiving no distribution on account of theirinterests and cancellation of their holdings. Because of such possibilities, the value of the Company’s liabilitiesand securities is highly speculative. Appropriate caution should be exercised with respect to existing andfuture investments in any of the Company’s liabilities and/or securities.  At this time there is no assurance theCompany will be able to restructure as a going concern or successfully proposeor implement a plan of reorganization.

 

For periods subsequent tothe bankruptcy filings, the Company has applied the American Institute ofCertified Public Accountants’ Statement of Position (“SOP”) 90-7, “Financial Reporting by Entities inReorganization under the Bankruptcy Code” (“SOP 90-7”), in preparing theconsolidated financial statements. SOP 90-7 requires that the financial statements distinguishtransactions and events that are directly associated with the reorganizationfrom the ongoing operations of the business. Accordingly, certain revenues, expenses (including professional fees),realized gains and losses and provisions for losses that are realized orincurred in the bankruptcy proceedings have been recorded in reorganizationitems in the consolidated statement of operations (See Note 4).  In addition, pre-petition obligations thatmay be impacted by the bankruptcy reorganization process have been classifiedon the consolidated balance sheet in liabilities subject to compromise (SeeNote 5).  These liabilities are reportedat the amounts expected to be allowed by the Bankruptcy Courts, even if theymay be settled for lesser amounts.

 

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** **

**GoingConcern Matters**

The consolidatedfinancial statements and related notes have been prepared assuming that theCompany will continue as a going concern, although its bankruptcy filings raisesubstantial doubt about its ability to continue as a going concern.  The consolidated financial statements do notinclude any adjustments related to the recoverability and classification ofrecorded assets or to the amounts and classification of liabilities or anyother adjustments that might be necessary should the Company be unable tocontinue as a going concern.  The Company’sability to continue as a going concern is dependent on market conditions andits ability to improve profitability, obtain alternative financing to replacethe DIP Credit Agreement and pre-petition Credit Agreement and restructure itsobligations in a manner that allows it to obtain confirmation of a plan ofreorganization by the Bankruptcy Courts.

 

In order to improve profitability, management istaking actions to further reduce corporate and operational expenses and iscontinuing to align manufacturing capacity to meet market demands andstandardize manufacturing processes throughout all operations.  These actions will result in the closure ofadditional manufacturing facilities and reductions in headcount during the nexttwelve months.

 

**Debtor Financial Statements**

The following unauditedcondensed combined financial statements represent the financial statements for the Debtorsonly.  The Company’s Non-DebtorSubsidiaries are accounted for as non-consolidated subsidiaries in thesefinancial statements and, as such, their net loss is included in “Equity inlosses of Non-Debtor Subsidiaries,” in the consolidated statement of operationsand their net assets are included as “Investments in and advances to Non-DebtorSubsidiaries” in the consolidated balance sheet.  The Debtor’s financial statements have beenprepared in accordance with the guidance in SOP 90-7.

 

Intercompany transactions between the Debtors havebeen eliminated in the financial statements. Intercompany transactions betweenthe Debtors and Non-Debtor Subsidiaries have not been eliminated in the Debtors’financial statements.

 

7

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** **

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

**CONDENSED COMBINED STATEMENTS OF OPERATIONS — DEBTORS**

**(Unaudited)**

 
| ** **                                                                                                                                                                          | ** ** | **Three**              | ** ** | **Six**                | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **Months Ended**       | ** ** | **Months Ended**       | ** ** |
| ** **                                                                                                                                                                          | ** ** | **June 30, 2009** | ** ** | **June 30, 2009** | ** ** |
| Net sales                                                                                                                                                                           | ** ** | **$**                  | **1,378**  | ** **             | **$**      | **2,734** | ** ** |
| Costs and expenses                                                                                                                                                                  | ** ** | ** **             | ** ** | ** **             | ** ** |
| Cost of goods sold                                                                                                                                                                  | ** ** | **1,232**              | ** ** | **2,436**              | ** ** |
| Selling and administrative expenses                                                                                                                                                 | ** ** | **140**                | ** ** | **281**                | ** ** |
| Restructuring expenses                                                                                                                                                              | ** ** | **11**                 | ** ** | **23**                 | ** ** |
| (Gain) loss on disposal of assets                                                                                                                                                   | ** ** | **(1**                 | **)**      | **1**                  | ** ** |
| Other operating income                                                                                                                                                              | ** ** | **(276**               | **)**      | **(276**               | **)**      |
| Operating income                                                                                                                                                                    | ** ** | **272**                | ** ** | **269**                | ** ** |
| Other income (expense)                                                                                                                                                              | ** ** | ** **             | ** ** | ** **             | ** ** |
| Interest expense, net (including $50 million and  $98 million for the three and****six  months ended June 30, 2009, respectively, that is stayed and****subject to compromise) | ** ** | **(74**                | **)**      | **(145**               | **)**      |
| Debtor-in-possession debt issuance costs                                                                                                                                            | ** ** | ** **             | ** ** | **(63**                | **)**      |
| Loss on early extinguishment of debt                                                                                                                                                | ** ** | ** **             | ** ** | **(20**                | **)**      |
| Foreign currency exchange gains (losses)                                                                                                                                            | ** ** | **(2**                 | **)**      | **1**                  | ** ** |
| Equity in losses of non-debtor subsidiaries                                                                                                                                         | ** ** | **(1**                 | **)**      | **(5**                 | **)**      |
| Other, net                                                                                                                                                                          | ** ** | **6**                  | ** ** | **5**                  | ** ** |
| Income before reorganization items and income  taxes                                                                                                                                | ** ** | **201**                | ** ** | **42**                 | ** ** |
| Reorganization items                                                                                                                                                                | ** ** | **(39**                | **)**      | **(93**                | **)**      |
| Income (loss) before income taxes                                                                                                                                                   | ** ** | **162**                | ** ** | **(51**                | **)**      |
| Provision for income taxes                                                                                                                                                          | ** ** | **(4**                 | **)**      | **(5**                 | **)**      |
| Net income (loss)                                                                                                                                                                   | ** ** | **$**                  | **158**    | ** **             | **$**      | **(56** | **)** |

 

8

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONDENSEDCOMBINED BALANCE SHEET — DEBTORS**

**(Unaudited)**

 
| ** **                                              | ** ** | **June 30,** | ** **      |
|---------------------------------------------------------|------------|-------------------|-----------------|
| **(In millions)**                                       | ** ** | **2009**          | ** **      |
| **Assets**                                              |       |              |            |
| ** **                                              | ** ** | ** **        | ** **      |
| Current  assets                                         | ** ** | ** **        | ** **      |
| Cash  and cash equivalents                              | ** ** | **$**             | **571**         | ** ** |
| Restricted  cash                                        | ** ** | **13**            | ** **      |
| Receivables                                             | ** ** | **613**           | ** **      |
| Receivable  for alternative energy tax credits          | ** ** | **89**            | ** **      |
| Inventories                                             | ** ** | **486**           | ** **      |
| Prepaid  expenses and other current assets              | ** ** | **32**            | ** **      |
| Total  current assets                                   | ** ** | **1,804**         | ** **      |
| Net  property, plant and equipment                      | ** ** | **3,372**         | ** **      |
| Timberland,  less timber depletion                      | ** ** | **32**            | ** **      |
| Investments  in and advances to non-debtor subsidiaries | ** ** | **76**            | ** **      |
| Other  assets                                           | ** ** | **68**            | ** **      |
| ** **                                              | ** ** | **$**             | **5,352**       | ** ** |
| **Liabilities and Stockholders’ Equity (Deficit)** | ** ** | ** **        | ** **      |
| ** **                                              | ** ** | ** **        | ** **      |
| Liabilities  not subject to compromise                  | ** ** | ** **        | ** **      |
| Current  liabilities                                    | ** ** | ** **        | ** **      |
| Current  maturities of long-term debt                   | ** ** | **$**             | **1,779**       | ** ** |
| Accounts  payable                                       | ** ** | **316**           | ** **      |
| Accrued  compensation and payroll taxes                 | ** ** | **141**           | ** **      |
| Interest  payable                                       | ** ** | **9**             | ** **      |
| Income  taxes payable                                   | ** ** | **11**            | ** **      |
| Current  deferred income taxes                          | ** ** | **21**            | ** **      |
| Other  current liabilities                              | ** ** | **129**           | ** **      |
| Total  current liabilities                              | ** ** | **2,406**         | ** **      |
| Deferred  income taxes                                  | ** ** | **121**           | ** **      |
| Other  long-term liabilities                            | ** ** | **123**           | ** **      |
| Total  liabilities not subject to compromise            | ** ** | **2,650**         | ** **      |
| ** **                                              | ** ** | ** **        | ** **      |
| Liabilities  subject to compromise                      | ** ** | **4,251**         | ** **      |
| Total  liabilities                                      | ** ** | **6,901**         | ** **      |
| ** **                                              | ** ** | ** **        | ** **      |
| Total  equity (deficit)                                 | ** ** | **(1,549**        | **)**           |
| ** **                                              | ** ** | **$**             | ** 5,352** | ** ** |

 

9

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONDENSEDCOMBINED STATEMENT OF CASH FLOWS — DEBTORS**

**(Unaudited)**

 
| **Six Months Ended June 30,  (In millions)**                                            | ** ** | **2009** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|
| **Cash flows from operating activities**                                                     |       |     |       |
| Net  loss                                                                                    | ** ** | **$**    | **(56**    | **)** |
| Adjustments  to reconcile net loss to net cash provided byoperating activities               |       |     |       |
| Loss  on early extinguishment of debt                                                        | ** ** | **20**   |       |
| Depreciation,  depletion and amortization                                                    | ** ** | **180**  |       |
| Debtor-in-possession  debt issuance costs                                                    | ** ** | **63**   |       |
| Amortization  of deferred debt issuance costs                                                | ** ** | **3**    |       |
| Deferred  income taxes                                                                       | ** ** | **3**    |       |
| Pension  and postretirement benefits                                                         | ** ** | **20**   |       |
| Loss  on disposal of assets                                                                  | ** ** | **1**    |       |
| Non-cash  restructuring expenses                                                             | ** ** | **4**    |       |
| Non-cash  stock-based compensation                                                           | ** ** | **4**    |       |
| Non-cash  foreign currency exchange gains                                                    | ** ** | **(1**   | **)**      |
| Non-cash  reorganization items                                                               | ** ** | **61**   |       |
| Change  in restricted cash                                                                   | ** ** | **(13**  | **)**      |
| Change  in current assets and liabilities,net of effects from acquisitions and  dispositions |       |     |       |
| Receivables                                                                                  | ** ** | **(41**  | **)**      |
| Receivable  for alternative energy tax credit                                                | ** ** | **(89**  | **)**      |
| Inventories                                                                                  | ** ** | **19**   |       |
| Prepaid  expenses and other current assets                                                   | ** ** | **(6**   | **)**      |
| Accounts  payable and accrued liabilities                                                    |       | **205**  | ** ** |
| Intercompany  receivable with non-debtors                                                    | ** ** | **(12**  | **)**      |
| Interest  payable                                                                            | ** ** | **78**   |       |
| Other,  net                                                                                  | ** ** | **38**   |       |
| Net  cash provided by operating activities                                                   | ** ** | **481**  |       |
| **Cash flows from investing activities**                                                     |       |     |       |
| Expenditures  for property, plant and equipment                                              | ** ** | **(69**  | **)**      |
| Proceeds  from property disposals                                                            | ** ** | **4**    |       |
| Advances  to affiliates, net                                                                 | ** ** | **(18**  | **)**      |
| Net  cash used for investing activities                                                      | ** ** | **(83**  | **)**      |
| **Cash flows from financing activities**                                                     |       |     |       |
| Proceeds  from debtor-in-possession debt                                                     | ** ** | **440**  |       |
| Net  borrowings of long-term debt                                                            | ** ** | **61**   |       |
| Repurchase  of receivables                                                                   | ** ** | **(385** | **)**      |
| Debtor-in-possession  debt issuance costs                                                    | ** ** | **(63**  | **)**      |
| Net  cash provided by financing activities                                                   | ** ** | **53**   |       |
|                                                                                         |       |     |       |
| **Increase in cash and cash equivalents**                                                    | ** ** | **451**  |       |
| Cash  and cash equivalents                                                                   |       |     |       |
| Beginning  of period                                                                         | ** ** | **120**  |       |
| End  of period                                                                               | ** ** | **$**    | **571**    |   |

 

10

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**2.****             ****Significant Accounting Policies**

 

**Basis of Presentation:**  The accompanyingconsolidated financial statements and notes of the Company have been preparedin 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 notes necessary for acomplete 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 notes included in the 2008 Form 10-K.

 

TheCompany is a wholly-owned subsidiary of SSCC. The Company has domestic and international operations.

 

**Recently Adopted AccountingStandards:**  Effective January 1, 2009, the Companyadopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 160“Non-controlling Interest in Consolidated Financial Statements — An Amendmentof ARB No. 51” (“SFAS No. 160”). SFAS No. 160 changes the accounting for non-controlling (minority)interests in consolidated financial statements, requires non-controllinginterests to be reported as part of equity and changes the income statementpresentation of income or losses attributable to non-controllinginterests.  SFAS No. 160 did nothave a material impact on the Company’s consolidated financial statements.

 

Effective June 15,2009, the Company adopted the provisions of SFAS No. 165 “SubsequentEvents” (“SFAS No. 165”).  SFAS No. 165requires entities to disclose the date through which subsequent events havebeen evaluated and the basis for such date. As of August 10, 2009, the date the financial statements wereissued, the Company has determined that no material subsequent events haveoccurred.

 

Effective June 15,2009, the Company adopted the Financial Accounting Standards Board (“FASB”)Staff Position (“FSP”) No. FAS 107-1 and APB 28-1, “Interim DisclosuresAbout Fair Value of Financial Instruments” (“FSP FAS 107-1”).  This FSP extends the disclosure requirementsof SFAS No. 107, “Disclosure about Fair Value of Financial Instruments,”to interim financial statements (See Note 17).

 

**Prospective Accounting Pronouncements:**  In June 2009, the FASB issued SFAS No. 166,“Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140”(SFAS No. 166”), effective for fiscal years beginning after November 15,2009.  SFAS No. 166 modifies SFAS No. 140by removing the concept of a qualifying special-purpose entity, thuspotentially requiring consolidation of such special-purpose entities previouslyexcluded from the consolidated financial statements.  The Company is currently evaluating the impactof SFAS No. 166 on its consolidated financial statements.

 

**3.****             ****Reclassifications**

 

Certainprior year amounts have been reclassified to conform to the current yearpresentation.

 

**4.****             ****Reorganization Items and OtherBankruptcy Related Costs**

 

**Reorganization Items**

SOP 90-7 requiresseparate disclosure of reorganization items such as realized gains and lossesfrom the settlement of pre-petition liabilities, provisions for lossesresulting from the reorganization of the business, as well as professional feesdirectly related to the process of reorganizing the Company under 

 

11

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Chapter 11 and theCCAA.  The Company’s reorganization itemsfor the three and six months ended June 30, 2009 consist of the following:

 
| ** **                                                     | ** ** | **Three months ended  June 30, 2009** | ** ** | **Six months ended  June 30, 2009** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
|                                                           |       |                                       |       |                                     |       |
| Provision  for rejected/settled executory contracts and leases |       | $                                          | 25         |                                     | $          | 64 |   |
| Professional  fees                                             |       | 16                                         |       | 32                                       |       |
| Accounts  payable settlement gains                             |       | (2                                         | )          | (3                                       | )          |
| Total  reorganization items                                    |       | $                                          | 39         |                                     | $          | 93 |   |

 

Provision forrejected/settled executory contracts and leases for the three and six monthsended June 30, 2009, includes a $9 million special termination benefitscharge due to funding obligations related to certain non-qualified pensionplans.

 

Professional feesdirectly related to the reorganization include fees associated with advisors tothe Company, the Creditors’ Committee and certain secured creditors.

 

Net cash paid forreorganization items for the three and six months ended June 30, 2009totaled $11 million and $17 million, respectively, related to professionalfees.

 

Reorganization itemsexclude employee severance and other restructuring charges recorded during thethree and six months ended June 30, 2009.

 

**Other Bankruptcy Related Costs**

Debtor-in-possession debtissuance costs of $63 million were incurred and paid during the first quarterof 2009 in connection with entering into the DIP Credit Agreement, and areseparately disclosed in the consolidated statements of operations.

 

**5.****             ****Liabilities Subject to Compromise**

 

Liabilities subject tocompromise represent unsecured obligations that will be accounted for under aplan of reorganization. Generally, actions to enforce or otherwise effectpayment of pre-Chapter 11 or CCAA liabilities are stayed. SOP 90-7 requirespre-petition liabilities that are subject to compromise to be reported at theamounts expected to be allowed, even if they may be settled for lesseramounts.  These liabilities represent theamounts expected to be allowed on known or potential claims to be resolved throughthe Chapter 11 and CCAA process, and remain subject to future adjustmentsarising from negotiated settlements, actions of the Bankruptcy Courts,rejection of executory contracts and unexpired leases, the determination as tothe value of collateral securing the claims, proofs of claim, or otherevents.  Liabilities subject tocompromise also include certain items that may be assumed under the plan ofreorganization, and as such, may be subsequently reclassified to liabilitiesnot subject to compromise.

 

The Bankruptcy Courtshave approved payment of certain pre-petition obligations, including employeewages, salaries and benefits, and the payment of vendors and other providers inthe ordinary course for goods and services received after the filing of theChapter 11 Petition and the Canadian Petition and other business-relatedpayments necessary to maintain the operation of the Company’s business.Obligations associated with these matters are not classified as liabilitiessubject to compromise.

 

12

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In accordance with SOP90-7, deferred debt issuance costs (“DDIC”) should be viewed as valuations ofthe related debt.  DDIC associated withunsecured debt is included as a valuation adjustment within the liabilitiessubject to compromise.

 

The Company has rejected certain pre-petitionexecutory contracts and unexpired leases with respect to the Company’soperations with the approval of the Bankruptcy Courts and may reject additionalones in the future.  Damages resultingfrom rejection of executory contracts and unexpired leases are generallytreated as general unsecured claims and are classified as liabilities subjectto compromise.

 

On June 22, 2009, the Bankruptcy Courts enteredan order establishing August 28, 2009 as the bar date for potentialcreditors to file claims.  The bar date is the date by which certainclaims against the Company must be filed if the claimants wish to receive anydistribution in the bankruptcy cases. Proof of claim forms received after this time will not be eligible forconsideration of recovery as part of the Company’s bankruptcy cases. Creditorswere notified of the bar date and the requirement to file a proof of claim withthe Bankruptcy Courts.  Differencesbetween liability amounts estimated by the Company and claims filed bycreditors will be investigated and, if necessary, the Bankruptcy Courts willmake a final determination of the allowable claim.  The determination of how liabilities will ultimatelybe treated cannot be made until the Bankruptcy Courts approve a plan ofreorganization.  Accordingly, theultimate amount or treatment of such liabilities is not determinable at thistime.

 

Liabilities subject tocompromise consisted of the following:

 
| ** **                         | ** ** | **June 30, 2009** | ** ** |
|------------------------------------|------------|------------------------|------------|
|                               |       |                   |       |
| Unsecured  debt                    |       | $                      | 2,439      |   |
| DDIC  for unsecured debt           |       | (15                    | )          |
| Accounts  payable                  |       | 394                    |       |
| Interest  payable                  |       | 130                    |       |
| Retiree  medical obligations       |       | 163                    |       |
| Pension  obligations               |       | 1,009                  |       |
| Unrecognized  tax benefits         |       | 38                     |       |
| Executory  contracts and leases    |       | 61                     |       |
| Other                              |       | 32                     |       |
| Liabilities  subject to compromise |       | $                      | 4,251      |   |

 

**6.****             ****Alternative Energy Tax Credits**

 

The U.S. InternalRevenue Code allows an excise tax credit for alternative fuel mixtures producedby a taxpayer for sale, or for use as a fuel in a taxpayer’s trade orbusiness.  The credit is scheduled toexpire on December 31, 2009.  On May 6,2009, the Company was notified that its registration as an alternative fuelmixer was approved by the Internal Revenue Service.   The Company submitted refund claims ofapproximately $294 million for the periods January 1, 2009 through June 30,2009 related to production at ten of its U.S. mills, of which $205 million ofthis refund request was received during the second quarter.  During the second quarter of 2009, theCompany recorded other operating income of $276 million, net of expected fees,in its consolidated statements of operations related to this matter.

 

13

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**7.****             ****Calpine Corrugated LLC**

 

In the firstquarter of 2008, the Company recorded a charge of $22 million to fully reserveall amounts due from Calpine Corrugated LLC (“Calpine Corrugated”).  Calpine Corrugated, formerly an independentcorrugated container producer in Fresno, California for which the Company wasthe primary containerboard supplier, experienced start-up losses since it beganoperations in 2006.

 

On July 29,2008, the Company acquired a 90 percent ownership interest in CalpineCorrugated.  In conjunction with theacquisition, the Company guaranteed approximately $45 million of CalpineCorrugated’s third party outstanding debt. There was no cash consideration paid. The transaction was accounted for as a purchase business combination andresults of operations of Calpine Corrugated are included in the consolidatedstatements of operations beginning July 29, 2008.  The purchase price allocation completed inthe fourth quarter of 2008 resulted in assets and liabilities of approximately$50 million, including approximately $45 million of debt.  No goodwill was recorded for the transaction.  The acquisition of Calpine Corrugated’soperations enables the Company to accelerate the optimization of its NorthernCalifornia business unit and improve its position in the agricultural marketsegment.

 

**8.****             ****Restructuring Activities**

 

During the second quarterof 2009, the Company closed four converting facilities and recordedrestructuring charges of $11 million, including non-cash charges of $3 million,related to the write-down of assets, primarily property, plant and equipment,to estimated net realizable values and the acceleration of depreciation forconverting equipment expected to be abandoned or taken out of service.  The remaining charges of $8 million wereprimarily for severance and benefits.  Asa result of the closures in the second quarter of 2009 and other ongoinginitiatives, the Company reduced its headcount by approximately 500 employees.

 

For the six months ended June 30,2009, the Company closed seven converting facilities and announced the closureof one additional converting facility. As a result of these closures and other ongoing initiatives, the Companyreduced its headcount by approximately 1,500 employees.  The Company recorded restructuring charges of$24 million, including non-cash charges of $4 million, related to the write-downof assets, primarily property, plant and equipment, to estimated net realizablevalues and the acceleration of depreciation for converting equipment expectedto be abandoned or taken out of service. The remaining charges of $20 millionwere primarily for severance and benefits. The net sales of the announced and closed converting facilities in 2009prior to closure and for the year ended December 31, 2008 were $26 millionand $138 million, respectively.  Themajority of these net sales are expected to be transferred to other operatingfacilities.  Additional charges of up to$4 million will be recorded in future periods for severance and benefitsrelated to the closure of these and previously closed facilities.

 

The Company continues toreview and evaluate various restructuring and other alternatives to streamlineoperations, improve efficiencies and reduce costs.  Such initiatives may include selling assets,idling facilities, consolidating operations and functions, relocating orreducing production and voluntary and involuntary employee separationprograms.  In addition, such actions willsubject the Company to additional short-term costs, which may include facilityshutdown costs, asset impairment charges, lease commitment costs, employeeretention and severance costs and other closing costs.

 

The Company recordedrestructuring charges of $9 million and $13 million for the three and sixmonths ended June 30, 2008, respectively, which were net of a gain of $2million in the first quarter on the sale of a previously closed facility.   Restructuring charges included non-cashcharges of $2 million and $4 million for the three and six months ended June 30,2008, respectively, related to the acceleration of depreciation for equipmentexpected to be abandoned or taken out of service.  The remaining charges were primarily forseverance and benefits.

 

14

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At December 31,2008, the Company had $33 million of accrued exit liabilities related to therestructuring of operations.  For thethree and six months ended June 30, 2009, the Company incurred $2 millionand $10 million, respectively, of cash disbursements, primarily severance andbenefits, related to these exit liabilities. In addition, exit liabilities have decreased by $5 million due torejecting leases related to previously closed facilities as permitted under theBankruptcy Code.  During the three andsix months ended June 30, 2009, the Company incurred $7 million and $14million, respectively, of cash disbursements, primarily severance and benefits,related to exit liabilities established during 2009.

 

**9.****             ****Restricted Cash**

 

At June 30, 2009,the Company had restricted cash of $13 million as approved by the U.S. Court toprovide financial assurance to certain utility vendors.  Changes in restricted cash are reflected ascash used for operating activities in the consolidated statements of cashflows.

 

**10.****      ****Accounts ReceivableSecuritization Programs**

 

The Company, under twoseparate accounts receivable securitization programs, sold without recourse, onan ongoing basis, certain of its accounts receivable to non-consolidatedfinancing entities.  The Company’sretained interest in these non-consolidated entities was carried at fair valueand included in retained interest in receivables sold in the accompanying December 31,2008 consolidated balance sheet.  On January 28,2009, in conjunction with the filing of the Chapter 11 Petition and theCanadian Petition, the accounts receivable securitization programs wereterminated and all outstanding receivables previously sold to thenon-consolidated financing entities were repurchased with proceeds fromborrowings under the DIP Credit Agreement (See Note 12).  The repurchase of receivables of $385 millionhas been included in the cash flows from financing activities in theconsolidated statement of cash flows.

 

**11.****      ****Guarantees and Commitments**

 

The Company has certainwood chip processing contracts extending from 2012 through 2018 with minimumpurchase commitments.  As part of the agreements,the Company guarantees the third party contractors’ debt outstanding and has asecurity interest in the chipping equipment. At June 30, 2009, the maximum potential amount of future paymentsrelated to these guarantees was approximately $27 million, which decreasesratably over the life of the contracts. In the event the guarantees on these contracts are called, proceeds fromthe liquidation of the chipping equipment would be based on current marketconditions and the Company may not recover in full the guarantee payments made.

 

The Company wascontingently liable for $18 million under a one year letter of credit, whichwas to expire in April 2009, which supported the borrowings of apreviously non-consolidated affiliate. On March 4, 2009, this letter of credit was drawn on, whichincreased borrowings under the Company’s pre-petition credit facilities by $18million (See Note 12).  As a result ofproviding substantial financial support for the affiliate, in accordance withFASB Interpretation No. 46 (R), “Consolidation of Variable InterestEntities,” the Company consolidated the affiliate’s balance sheet and resultsof operations into its consolidated financial statements in March 2009.

 

15

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**12.****      ****Long-Term Debt**

 

The filing of theChapter 11 Petition and the Canadian Petition constituted an event ofdefault under the Company’s debt obligations, and those debt obligations becameautomatically and immediately due and payable. Any efforts to enforce such payment obligations are stayed as a resultof the filing of the Chapter 11 Petition and the Canadian Petition.  As previously disclosed in the 2008 Form 10-K,the accompanying consolidated balance sheet as of December 31, 2008includes a reclassification of $3,032 million to current maturities oflong-term debt from long-term debt.  Dueto the filing of the bankruptcy petitions, the Company’s unsecured long-termdebt of $2,439 million is included in liabilities subject to compromise at June 30,2009 (See Note 5).  Since the PetitionDate, the Company discontinued interest payments on its unsecured senior notesand certain other unsecured debt. Interest expense ($50 million and $98 million in the three and sixmonths ended June 30, 2009) continues to be accrued on the unsecured debtuntil a determination is made that it will not be an allowed claim in thebankruptcy proceedings.

 

**DIP Credit Agreement**

In connection with filing the Chapter 11 Petitionand the Canadian Petition, on January 26, 2009 the Company and certain ofits affiliates filed a motion with the Bankruptcy Courts seeking approval toenter into a DIP Credit Agreement.  On January 27,2009, the Bankruptcy Courts granted interim approval of the DIP CreditAgreement.  Based on such interim approval,on January 28, 2009 the Company entered into the DIP Credit Agreement,subject to final approval of the Bankruptcy Courts.  Final approval of the DIP Credit Agreementwas granted by the U.S. Court on February 23, 2009 and by the CanadianCourt on February 24, 2009. Amendments to the DIP Credit Agreement were entered into on February 25and 27, 2009.

 

The DIP Credit Agreement, as amended, provides forborrowings up to an aggregate committed amount of $750 million, consisting of a$400 million U.S. term loan for borrowings by the Company; a $35 millionCanadian term loan for borrowings by SSC Canada; a $250 million U.S. revolvingloan for borrowings by the Company and/or SSC Canada; and a $65 million DIPCanadian Revolver for borrowings by the Company and/or SSC Canada.

 

The use of proceeds under the DIP Credit Agreementis limited to (i) working capital, letters of credit and capitalexpenditures; (ii) other general corporate purposes of the Company and certainof its subsidiaries (including certain intercompany loans); (iii) therefinancing in full of indebtedness outstanding under the receivablessecuritization programs; (iv) payment of any related transaction costs,fees and expenses; and (v) the costs of administration of the casesarising out of the Chapter 11 Petition and the Canadian Petition.

 

In accordance with the terms of the DIP CreditAgreement, on January 28, 2009 the Company used U.S. term loan proceeds of$360 million, net of lenders fees of $40 million, and Canadian term loanproceeds of $30 million, net of lenders fees of $5 million, to terminate thereceivables securitization programs and repay all indebtedness outstandingunder the programs of $385 million and to pay other expenses of $1million.  In addition, other fees andexpenses of $17 million related to the DIP Credit Agreement were paid for withproceeds of $5 million from the DIP Canadian Revolver and available cash.

 

The Company has the option to borrow under the DIPCredit Agreement at a rate of: (i) Alternate Base Rate (“ABR”) Loans bearinterest at a rate per annum equal to the applicable margin (“Applicable Margin”)plus the ABR; (ii) Eurodollar loans bear interest at a rate per annumequal to the Applicable Margin plus the Adjusted LIBO Rate; (iii) Canadianprime rate loans bear interest at a rate per annum equal to the ApplicableMargin plus the Canadian prime rate; and (iv) discount rate loans bearinterest at a rate per annum equal to the Applicable Margin plus the discount rate. The DIP Credit Agreement provides that the Applicable Margin adjustsupon extensions of the maturity date.** **As of June 30, 2009, theweighted average interest rate on outstanding borrowings under the DIP CreditAgreement was 10%.

 

16

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Under the DIP Credit Agreement,****interest and fees are payable in arrearson each interest payment date as defined in the DIP Credit Agreement.  If the Company defaults on its obligationsunder the DIP Credit Agreement, the default rate of interest in most cases willbe the rate otherwise in effect plus 2.0% per annum.  In addition to interest, a commitment fee of1.0% per annum is required in respect of the unutilized commitments under theDIP Credit Agreement. The DIP Credit Agreement also imposes letter of creditfees.

 

The outstanding principal amount of the loans underthe DIP Credit Agreement, plus interest accrued and unpaid, will be due andpayable in full at maturity, which is January 28, 2010 (subject to anearlier maturity date under certain circumstances); provided, that the maturitydate may be extended by the Company through April 28, 2010 andsubsequently through July 28, 2010, upon the satisfaction of certainconditions precedent (including the payment of specified fees) by the Company.

 

U.S. and Canadian borrowings are each subject to aborrowing base derived from a formula based on certain eligible accountsreceivable and inventory, and an amount attributable to real property andequipment, less certain reserves.  As of June 30,2009, the applicable borrowing base was $597 million and the amount availablefor borrowings under the DIP Credit Agreement was $163 million.  The Company’s borrowing base as of June 30, 2009as compared to March 31, 2009 decreased approximately $135 million dueprincipally to a reduction of $107 million in the real property and equipment component of the borrowing base.  The Company is in the process of obtainingappraisals for certain real property and equipment and expects theborrowing base attributable to real property and equipment to be restoredduring August 2009.

 

Borrowings under the DIP Credit Agreement areguaranteed by the Company and certain of its affiliates, and are secured byfirst priority liens on the collateral and all presently owned and hereafteracquired assets of the Company and each of its subsidiaries party to the DIPCredit Agreement, subject to certain permitted prior liens.  Subject to certain exceptions, the DIP CreditAgreement requires certain mandatory prepayments of borrowings from the netproceeds of certain asset dispositions, and casualty or condemnationpayments.  The only Canadian entity thatguarantees U.S. obligations is SSC Canada.

 

The DIP Credit Agreement includes affirmative,negative and financial covenants that impose substantial restrictions on thefinancial and business operations of the Company and those of certain of itssubsidiaries, including their ability to incur or secure debt, makeinvestments, sell assets, pay dividends or make acquisitions.  The DIP Credit Agreement contains events ofdefault customary for debtor-in-possession financings of this type.

 

**Bank Credit Facilities**

The Company’s CreditAgreement provided for a deposit funded letter of credit facility, related tothe variable rate industrial revenue bonds, for approximately $122 million thatwas due to mature on November 1, 2010. In February 2009, due to an event of default under the bondindentures, this credit facility was drawn on to fully repay the industrialrevenue bonds in the aggregate principal amount of $120 million.  A loss on the early extinguishment of debt of$20 million was recorded to write-off the unamortized deferred debt issuancecosts related to the industrial revenue bonds.

 

During the six monthsended June 30, 2009, letters of credit in the amount of $68 million weredrawn on to fund obligations principally related to non-qualified pensionplans, commodity derivative instruments and a guarantee for a previouslynon-consolidated affiliate, which increased borrowings under the Company’sCredit Agreement.

 

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**13.****      ****Employee Benefit Plans**

 

The Company sponsorsnoncontributory defined benefit pension plans for its U.S. employees and alsosponsors noncontributory and contributory defined benefit pension plans for itsCanadian employees.  The Company’sdefined benefit pension plans cover substantially all hourly employees, as wellas salaried employees hired prior to January 1, 2006.  The U.S. and Canadian defined benefit pensionplans for salaried employees were frozen effective January 1, 2009 and March 1,2009, respectively.

 

The Company’spostretirement plans provide certain health care and life insurance benefitsfor all retired salaried and certain retired hourly employees, and for salariedand certain hourly employees who have reached the age of 60 with ten years ofservice as of January 1, 2007.

 

The components ofnet periodic benefit costs for the defined benefit plans and the components ofthe postretirement benefit costs are as follows:

 
| ** **                                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **Defined  Benefit Plans**           | ** ** | **Postretirement  Plans**          | ** ** | **Defined  Benefit Plans** | ** ** | **Postretirement  Plans** | ** ** |
| ** **                                    | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| Service  cost                                 |       | $                                    | 5          |                               | $          | 10 |   | $ |   |   | $ | 1 |   | $ | 11 |   | $ | 23 |   | $ | 1 |   | $ | 2 |   |
| Interest  cost                                |       | 51                                   |       | 51                                 |       | 2 |   | 2 |   | 101 |   | 102 |   | 5 |   | 5 |   |
| Expected  return on plan assets               |       | (49                                  | )          | (61                                | )          |   |   |   |   | (99 | ) | (124 | ) |   |   |   |   |
| Amortization  of prior service cost (benefit) |       |                                 |       | 1                                  |       |   |   | (1 | ) | 1 |   | 2 |   | (1 | ) | (2 | ) |
| Amortization  of net (gain) loss              |       | 22                                   |       | 11                                 |       | (1 | ) |   |   | 42 |   | 21 |   | (2 | ) | (1 | ) |
| Special  termination benefits charge          |       | 9                                    |       |                               |       |   |   |   |   | 9 |   |   |   |   |   |   |   |
| Multi-employer  plans                         |       | 1                                    |       | 1                                  |       |   |   |   |   | 2 |   | 2 |   |   |   |   |   |
| Net  periodic benefit cost                    |       | $                                    | 39         |                               | $          | 13 |   | $ | 1 |   | $ | 2 |   | $ | 67 |   | $ | 26 |   | $ | 3 |   | $ | 4 |   |

 

The 2009 specialtermination benefits charge is due to funding obligations related to certainnon-qualified pension plans and is included in reorganization items in theconsolidated statements of operations (See Note 4).

 

**14.****      ****Derivative Instruments and Hedging Activities**

 

OnJanuary 26, 2009, the Chapter 11 Petition and the Canadian Petition effectivelyterminated all existing derivative instruments. Termination fair values were calculated based on the potentialsettlement value.  During the six monthsended June 30, 2009, a letter of credit in the amount of $18 million wasdrawn on related to the settlement of certain commodity derivative instruments(See Note 12).  Excluding these settledliabilities, the Company’s termination value related to its remainingderivative liabilities was approximately $60 million, recorded in other currentliabilities in the consolidated balance sheet. These derivative liabilities were stayed due to the filing of theChapter 11 Petition and the Canadian Petition. These derivative liabilities were adjusted through other comprehensiveincome (loss) (“OCI”) for derivative instruments qualifying for hedgeaccounting and cost of goods sold for derivative instruments not qualifying forhedge accounting.  The remaining amountin OCI will be recorded through earnings during the period the underlyingtransaction is recognized or when the underlying transaction is no longerexpected to occur.

 

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TheCompany’s derivative instruments previously used for its hedging activitieswere designed as cash flow hedges and related to minimizing exposures tofluctuations in the price of commodities used in its operations, the movementin foreign currency exchange rates and the fluctuations in the interest rate onvariable rate debt.  All cash flowsassociated with the Company’s derivative instruments were classified asoperating activities in the consolidated statements of cash flows.

 

#### **CommodityDerivative Instruments**

The Company usedderivative instruments, including fixed price swaps, to manage fluctuations incash flows resulting from commodity price risk in the procurement of naturalgas and other commodities, including fuel oil and diesel fuel.  The objective was to fix the price of aportion of the Company’s purchases of these commodities used in themanufacturing process.  The changes inthe market value of such derivative instruments historically offset the changesin the price of the hedged item.

 

For the three andsix months ended June 30, 2009, the Company reclassified an $8 millionloss (net of tax) and a $19 million loss (net of tax), respectively, from OCIto cost of goods sold when the hedged items were recognized.  For the three and six months ended June 30,2008, the Company reclassified an immaterial amount and a $1 million loss (netof tax), respectively, from OCI to cost of goods sold when the hedged itemswere recognized.

 

For the six monthsended June 30, 2009, the Company recorded a $3 million gain (net of tax)in cost of goods sold related to the change in fair value, prior to thePetition Date, of certain commodity derivative instruments not qualifying forhedge accounting.  For the three and sixmonths ended June 30, 2008, the Company recorded a $1 million gain (net oftax) in cost of goods sold related to the change in fair value of certaincommodity derivative instruments not qualifying for hedge accounting.

 

For the six monthsended June 30, 2009, the Company recorded a $3 million loss (net of tax)in cost of goods sold on commodity derivative instruments, settled prior to thePetition Date, not qualifying for hedge accounting.  For the three and six months ended June 30,2008, the Company recorded an immaterial amount in cost of goods sold onsettled commodity derivative instruments not qualifying for hedge accounting.

 

#### **ForeignCurrency Derivative Instruments**

**The Company’s principal foreign exchange exposure is theCanadian dollar.  The Company usedforeign currency derivative instruments, including forward contracts andoptions, primarily to protect against Canadian currency exchange riskassociated with expected future cash flows.**

** **

**For the three and six months ended June 30, 2009, theCompany reclassified a $2 million loss (net of tax) and a $4 million loss (netof tax), respectively, from OCI to cost of goods sold when the hedged itemswere recognized.  For the three and sixmonths ended June 30, 2008, the Company reclassified a $1 million gain(net of tax) and a $3 million gain (net of tax), respectively, from OCI to costof goods sold when the hedged items were recognized.**

** **

During the secondquarter of 2009, the Company reclassified the remaining foreign currencyderivative instruments from OCI to cost of goods sold since the underlyingtransactions were no longer expected to occur, resulting in an additional lossof $2 million (net of tax).

 

#### **InterestRate Swap Contracts**

The Company used interestrate swap contracts to manage interest rate exposure on $300 million of thecurrent Tranche B and Tranche C floating rate bank term debt.  The accounting for the cash flow impact ofthe swap contracts is recorded as an adjustment to interest expense eachperiod.

 

For the three and sixmonths ended June 30, 2009, the Company reclassified a $1 million loss(net of tax) and a $2 million loss (net of tax), respectively, from OCI tointerest expense when the hedged items were 

 

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recognized.  For the three and six months ended June 30,2008, the Company reclassified an immaterial amount from OCI to interestexpense when the hedged items were recognized.

 

**DeferredHedge Gain (Loss)**

The cumulative deferredhedge loss in OCI on all derivative instruments was $11 million (net of tax) atJune 30, 2009, including an $8 million loss (net of tax) on commodityderivative instruments and a $3 million loss (net of tax) on interest rate swapcontracts.  The Company expects toreclassify the remaining $11 million loss (net of tax) into cost of goods soldand interest expense within the next nine months.

 

**15.****      ****Income Taxes**

 

Duringthe three and six months ended June 30, 2009, the Company recordedprovisions for income taxes of $4 million and $5 million, respectively, relatedto U.S. alternative minimum income taxes, state and local income taxes,Canadian withholding taxes and interest on unrecognized tax benefits previouslyrecorded.  Because it is more likely thannot that substantially all of the deferred tax assets that are generated in2009 may not be realized, the Company has recorded a full valuation allowance,and has not recorded any additional tax benefit for the three and six monthsended June 30, 2009.

 

As previously disclosed,the Canada Revenue Agency (“CRA”) is examining the Company’s income tax returnsfor tax years 1999 through 2005. Certain matters, including transfer prices ofinventory sold by the Company’s Canadian subsidiaries to its U.S. subsidiaries,are currently under review.  With respectto the transfer price issue, the CRA issued assessments of additional incometaxes, interest and penalties, which the Company has appealed.  In order to appeal the assessment, theCompany made payments of $25 million to the CRA in 2008.

 

The remaining matters maybe resolved at the examination level or subsequently upon appeal within thenext twelve months.  While the finaloutcome of the remaining CRA examination matters, including an estimate of therange of the reasonably possible changes to unrecognized tax benefits, is notyet determinable, the Company believes that the examination or subsequentappeals will not have a material adverse effect on its consolidated financialcondition or results of operations.

 

**16.****      ****Comprehensive Income (Loss)**

 

Comprehensiveincome (loss) is as follows:

 
| ** **                                                             | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                             | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  income (loss)                                                     |       | $                                     | 158        |                                | $          | (37 | ) | $ | (56 | ) | $ | (50 | ) |
| Other  comprehensive income (loss), net of tax:                        |       |                                  |       |                                |       |   |   |   |   |
| Net  changes in fair value of hedging instruments                      |       |                                  |       | 11                                  |       | (1 | ) | 8 |   |
| Net  hedging (gain) loss reclassified into earnings                    |       | 13                                    |       | (1                                  | )          | 27 |   | (2 | ) |
| Net  deferred employee benefit plan expense reclassified into earnings |       | 13                                    |       | 6                                   |       | 24 |   | 12 |   |
| Foreign  currency translation adjustment                               |       | 1                                     |       | 1                                   |       | 1 |   | 1 |   |
| Comprehensive  income (loss)                                           |       | $                                     | 185        |                                | $          | (20 | ) | $ | (5 | ) | $ | (31 | ) |

 

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**17.****      ****Fair Value Measurements**

 

Certain financial assetsand liabilities are recorded at fair value on a recurring basis, includingderivative instruments prior to termination (See Note 14), the Company’s retainedinterest in receivables sold to the accounts receivable programs (See Note 10)prior to the termination of these programs on January 28, 2009 and theCompany’s residual interest in the Timber Note Holdings (“TNH”) investment.

 

Fair value is defined asthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date.  In determining fairvalue, the Company uses various valuation approaches, including market, incomeand/or cost approaches.  SFAS No. 157,“Fair Value Measurements”, establishes a hierarchy for inputs used in measuringfair value that maximizes the use of observable inputs and minimizes the use ofunobservable inputs by requiring that the most observable inputs be used whenavailable.  Observable inputs are inputsthat market participants would use in pricing the asset or liability based onmarket data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflectthe Company’s assumptions about the assumptions market participants would usein pricing the asset or liability developed based on the best informationavailable in the circumstances.  Thehierarchy for inputs is broken down into three levels based on their reliabilityas follows:

 

*Level 1* — Valuations based on quoted prices inactive markets for identical assets or liabilities that the Company has theability to access.  The Company has noassets or liabilities measured at fair value on a recurring basis utilizingLevel 1 inputs.

 

*Level 2* — Valuations based on quoted prices inmarkets that are not active or for which all significant inputs are observable,either directly or indirectly.  TheCompany has no assets or liabilities measured at fair value on a recurringbasis utilizing Level 2 inputs.

 

*Level 3* — Valuations based on inputs that areunobservable and significant to the overall fair value measurement.  The Company’s asset utilizing Level 3 inputsat June 30, 2009 is the residual interest in the TNH investment.  The fair value of the residual interest inthe TNH investment is estimated using discounted residual cash flows.

 

**Fair Value on a Recurring Basis**

Assets and liabilitiesmeasured at fair value on a recurring basis are categorized in the table belowbased upon the level of input to the valuations.

 
| ** **                           | ** ** | **June 30, 2009** | ** ** |
|--------------------------------------|------------|------------------------|------------|
| ** **                           | ** ** | **Level 1**            | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|                                 |       |                   |       |   |   |   |   |   |   |
| Residual  interest in TNH investment |       | $                      |       |   | $ |    |   | $ | 36 |   | $ | 36 |   |
|                                      |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 

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The following tablepresents the changes in Level 3 assets (liabilities) measured at fair value ona recurring basis for the three and six months ended June 30, 2009:

 
| ** **                             | ** ** | **Retained   Interest in  Receivables  Sold** | ** ** | **Residual  Interest in  TNH   Investment** | ** ** | **Derivative  Instruments** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|-----------------------------|------------|-----------|------------|
| Balance  at January 1, 2009       |       | $                                             | 120        |                                        | $          | 34                          |       | $         | (87        | ) | $ | 67 |   |
| Net  payments, sales and settlements   |       | (119                                          | )          |                                        |       | 30                          |       | (89       | )          |
| Realized  gains/(losses)               |       | (1                                            | )          | 1                                           |       |                        |       |      |       |
| Unrealized  gains/(losses)             |       |                                          |       |                                        |       | (3                          | )          | (3        | )          |
| Termination  of derivative instruments |       |                                          |       |                                        |       | 60                          |       | 60        |       |
| Balance  at March 31, 2009        |       |                                          |       | 35                                          |       |                        |       | 35        |       |
| Realized  gains/(losses)               |       |                                          |       | 1                                           |       |                        |       | 1         |       |
| Balance  at June 30, 2009         |       | $                                             |       |                                        | $          | 36                          |       | $         |       |   | $ | 36 |   |

 

Unrealized gains (losses) associated with derivativeinstruments represent the change in fair value included in other comprehensiveincome for derivative instruments qualifying for hedge accounting and cost ofgoods sold for derivative instruments not qualifying for hedge accounting priorto termination (See Note 14).

 

The netsettlements associated with retained interest in receivables sold are due tothe termination of the securitization programs (See Note 10).  The net payments associated with derivativeinstruments relate to pre-bankruptcy filing contract settlements and thesettlement of contracts at termination, which were supported by letters ofcredit (See Note 12).

 

Due to terminationof all existing derivative instruments, these liabilities are no longermeasured at fair value on a recurring basis (See Note 14).

 

**Financial Instruments NotMeasured at Fair Value**

Some of the Company’s financial instruments are notmeasured at fair value on a recurring basis but are recorded at amounts thatapproximate fair value due to their liquid or short-term nature.  The carrying amount of cash equivalentsapproximates fair value because of the short maturity of thoseinstruments.  The carrying amount of costmethod investments approximates fair value. The fair values of notes receivable are based on discounted future cashflows or the applicable quoted market price.

 

The Company’s borrowings are recorded at historicalamounts.  The fair value of the Company’sdebt is estimated based on the quoted market prices for the same or similarissues or on the current rates offered to the Company for debt of the sameremaining maturities.  As of June 30,2009, the carrying value and fair value of the Company’s secured borrowingswere $1,783 million and $1,667 million, respectively.  As of June 30, 2009, the carrying valueand the fair value of the Company’s unsecured borrowings, included inliabilities subject to compromise, were $2,439 million and $1,023 million,respectively.

 

**18.****      ****Contingencies**

 

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 these environmentalrequirements, environmental permit terms and similar authorizations that haveoccurred from time to time at its facilities. In addition, the Company faces potential liability for remediation atcertain owned and formerly owned facilities, as well as response costs atvarious sites for which it has received notice as being a potentiallyresponsible party 

 

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(“PRP”) concerninghazardous substance contamination.  Inestimating its reserves for environmental remediation and future costs at siteswhere it is a PRP, the Company’s estimated liability of $5 million reflects theCompany’s expected share of costs after consideration for the relativepercentage of waste deposited at each site, the number of other PRPs, theidentity and financial condition of such parties and experience regardingsimilar matters.  As of June 30,2009, the Company had approximately $17 million reserved for environmentalliabilities included primarily in other long-term liabilities in theconsolidated balance sheets.  The Companybelieves the liability for these matters was adequately reserved at June 30,2009.

 

If all or most of theother PRPs are unable to satisfy their portion of the clean-up costs at one ormore of the significant sites in which the Company is involved or the Company’sexpected share increases, the resulting liability could have a material adverseeffect on the Company’s consolidated financial condition, results of operationsor cash flows.

 

The Company settled twoputative class action cases filed in California state court on behalf ofcurrent and former hourly employees at the Company’s California corrugatedcontainer facilities.  These casesalleged violations of the California on-duty meal break and rest periodstatutes.  The court approved asettlement for a total of $9 million for both cases on January 21,2009.  The cases were automaticallystayed due to the filing of the Chapter 11 Petition on January 26, 2009(See Note 1).  The Company establishedreserves of $9 million during 2008 related to these matters, which wereincluded in selling and administrative expenses in the accompanyingconsolidated statement of operations.

 

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**ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

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 intendedto identify 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 uncertainties arediscussed in our Annual Report on Form 10-K for the year ended December 31,2008 (2008 Form 10-K) filed with the Securities and Exchange Commission.

 

Our actual results,performance or achievements could differ materially from those expressed in, orimplied by, these forward-looking statements. Accordingly, we can give no assurances that any of the eventsanticipated by the forward-looking statements will occur, or if any of them do,what impact they will have on our results of operations or financialcondition.  We expressly decline anyobligation to publicly revise any forward-looking statements that have beenmade to reflect the occurrence of events after the date hereof.

 

# **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 its business operations through us.

 

**BANKRUPTCYPROCEEDINGS**

 

**Chapter11 Bankruptcy Filings**

 

On January 26, 2009 (the Petition Date), we,Smurfit-Stone and our U.S. and Canadian subsidiaries filed a voluntary petition(the Chapter 11 Petition) for relief under Chapter 11 of the United StatesBankruptcy Code (the Bankruptcy Code) in the United States Bankruptcy Court inWilmington, Delaware (the U.S. Court). On the same day, our Canadian subsidiaries also filed to reorganize (theCanadian Petition) under the Companies’ Creditors Arrangement Act (the CCAA) inthe Ontario Superior Court of Justice in Canada (the Canadian Court).  Our operations in Mexico and Asia were not included in thefiling and will continue to operate outside of the Chapter 11 process.

 

The filing of the Chapter 11 Petition and theCanadian Petition constituted an event of default under our debt obligations,and those debt obligations became automatically and immediately due andpayable, although any actions to enforce such payment obligations are stayed asa result of the filing of the Chapter 11 Petition and the Canadian Petition.  As previously disclosed in our 2008 Form 10-K,our consolidated balance sheet as of December 31, 2008 included areclassification of $3,032 million to current maturities of long-term debt fromlong-term debt.  Due to the filing of thebankruptcy petitions, our unsecured long-term debt of $2,439 million isincluded in liabilities subject to compromise at June 30, 2009.

 

We, Smurfit-Stone and our U.S. and Canadiansubsidiaries are currently operating as “debtors in possession” under thejurisdiction of the U.S. Court and Canadian Court (the Bankruptcy Courts) andin accordance with the applicable provisions of the Bankruptcy Code and theCCAA.  In general, we and our 

 

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subsidiaries are authorized to continue to operateas ongoing businesses, but may not engage in transactions outside the ordinarycourse of business without the approval of the Bankruptcy Courts.

 

**Debtor-In-Possession (DIP) Financing**

 

In connection with filing the Chapter 11 Petitionand the Canadian Petition on January 26, 2009, we and certain of ouraffiliates filed a motion with the Bankruptcy Courts seeking approval to enterinto a Post-Petition Credit Agreement (the DIP Credit Agreement).  On January 27, 2009, the BankruptcyCourts granted interim approval of the DIP Credit Agreement.  Based on such interim approval, on January 28,2009, we entered into the DIP Credit Agreement, subject to final approval ofthe Bankruptcy Courts.  Final approval ofthe DIP Credit Agreement was granted by the U.S. Court on February 23,2009 and by the Canadian Court on February 24, 2009.  Amendments to the DIP Credit Agreement wereentered into on February 25 and 27, 2009.

 

The DIP Credit Agreement, as amended, provides forborrowings up to an aggregate amount of $750 million, consisting of a $400million U.S. term loan for borrowings by us; a $35 million Canadian term loanfor borrowings by Smurfit-Stone Container Canada Inc. (SSC Canada); a $250million U.S. revolving loan for borrowings by us and/or SSC Canada; and a $65million Canadian revolving loan (DIP Canadian Revolver) for borrowings by usand/or SSC Canada.

 

The outstanding principal amount of the loans underthe DIP Credit Agreement, plus interest accrued and unpaid, will be due andpayable in full at maturity, which is January 28, 2010 (subject to anearlier maturity date under certain circumstances); provided, that the maturitydate may be extended through April 28, 2010, and subsequently through July 28,2010 upon the satisfaction of certain conditions (including the payment ofspecified fees).

 

For additionalinformation on the DIP Credit Agreement, as amended, see Part I, Item 2, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources - DIP Credit Agreement.”

 

**Reorganization Process**

 

The Bankruptcy Courtshave approved payment of certain of our pre-petition obligations, includingemployee wages, salaries and benefits, and the payment of vendors and otherproviders in the ordinary course for goods and services received after thefiling of the Chapter 11 Petition and Canadian Petition and otherbusiness-related payments necessary to maintain the operation of theCompany’s business.  We have retainedlegal and financial professionals to advise us on the bankruptcyproceedings.  From time to time, we mayseek the U.S. Court’s approval for the retention of additional professionals.

 

Immediately after filingthe Chapter 11 Petition and Canadian Petition, we began notifying all knowncurrent or potential creditors of the bankruptcy filings.  Subject to certain exceptions under theBankruptcy Code and the CCAA, our bankruptcy filings automatically enjoined, orstayed, the continuation of any judicial or administrative proceedings or otheractions against the Company or our property to recover, collect or secure aclaim arising prior to the filing of the Chapter 11 Petition and CanadianPetition.  Thus, for example, mostcreditor actions to obtain possession of property from us, or to create, perfector enforce any lien against our property, or to collect on monies owed orotherwise exercise rights or remedies with respect to a pre-petition claim areenjoined unless and until the Bankruptcy Courts lift the automatic stay.

 

As required by the BankruptcyCode, the United States Trustee for the District of Delaware appointed anofficial committee of unsecured creditors (the Creditors’ Committee).  The Creditors’ Committee and its legalrepresentatives have a right to be heard on all matters that come before theU.S. Court with respect to us.  A monitorhas been appointed by the Canadian Court with respect to proceedings before theCanadian Court.

 

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Under the BankruptcyCode, the Debtors generally must assume or reject pre-petition executorycontracts, including but not limited to real property leases, subject to theapproval of the Bankruptcy Courts and certain other conditions.  In this context, “assumption” means that theCompany agrees to perform its obligations and cure all existing defaults underthe contract or lease, and “rejection” means that it is relieved from itsobligations to perform further under the contract or lease, but is subject to apre-petition claim for damages for the breach thereof subject to certainlimitations.  Any damages resulting fromrejection of executory contracts that are permitted to be recovered under theBankruptcy Code will be treated as liabilities subject to compromise unlesssuch claims were secured prior to the Petition Date.

 

In order to successfullyemerge from bankruptcy, we will need to propose and obtain confirmation by theBankruptcy Courts of a plan of reorganization that satisfies the requirementsof the Bankruptcy Code and the CCAA.  Aplan of reorganization would resolve our pre-petition obligations, set forththe revised capital structure of the newly reorganized entity and provide forcorporate governance subsequent to our exit from bankruptcy.

 

We had the exclusiveright for 120 days after the filing of the Chapter 11 Petition to file a planof reorganization.  On May 18, 2009,the U.S. Court approved a motion to extend the exclusivity period through September 23,2009.  We will likely file additionalmotions to request extensions of this exclusivity period, which are routinelygranted in bankruptcy cases of this size and complexity.  If our exclusivity period lapsed, any partyin interest would be able to file a plan of reorganization.  In addition to being voted on by holders ofimpaired claims and equity interests, a plan of reorganization must satisfycertain requirements of the Bankruptcy Code and the CCAA and must be approved,or confirmed, by the Bankruptcy Courts in order to become effective.

 

The timing of filing aplan of reorganization by us will depend on the timing and outcome of numerousother ongoing matters in the bankruptcy proceedings.  There can be no assurance at this time that aplan of reorganization will be confirmed by the Bankruptcy Courts or that anysuch plan will be implemented successfully.

 

Under the priority schemeestablished by the Bankruptcy Code and the CCAA, unless creditors agreeotherwise, pre-petition liabilities and post-petition liabilities must besatisfied in full before SSCC’s stockholders are entitled to receive anydistribution or retain any property under a plan of reorganization.  The ultimate recovery to creditors and/orstockholders, if any, will not be determined until confirmation of a plan orplans of reorganization.  No assurancecan be given as to what values, if any, will be ascribed to each of theseconstituencies or what types or amounts of distributions, if any, they wouldreceive.  A plan of reorganization couldresult in holders of our liabilities and/or securities receiving nodistribution on account of their interests and cancellation of theirholdings.  Because of such possibilities,the value of our liabilities and securities is highly speculative.  Appropriate caution should be exercised withrespect to existing and future investments in any of our liabilities and/orsecurities.  At this time there is noassurance we will be able to restructure as a going concern or successfullypropose or implement a plan of reorganization.

 

For periods subsequent tothe bankruptcy filings, we have applied the American Institute of CertifiedPublic Accountants’ Statement of Position (SOP) 90-7, “Financial Reportingby Entities in Reorganization under the Bankruptcy Code” (SOP 90-7), inpreparing the consolidated financial statements.  SOP 90-7 requires that the financialstatements distinguish transactions and events that are directly associatedwith the reorganization from the ongoing operations of the business.  Accordingly, certain revenues, expenses(including professional fees), realized gains and losses and provisions forlosses that are realized or incurred in the bankruptcy proceedings have beenrecorded in reorganization items in the consolidated statements ofoperations.  In addition, pre-petitionobligations that may be impacted by the bankruptcy reorganization process havebeen classified on the consolidated balance sheet in liabilities subject tocompromise.  These liabilities arereported at the amounts expected to be allowed by the Bankruptcy Courts, evenif they may be settled for lesser amounts.

 

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**LiabilitiesSubject to Compromise**

 

Liabilities subject tocompromise represent unsecured obligations that will be accounted for under aplan of reorganization. Generally, actions to enforce or otherwise effectpayment of pre-Chapter 11 or CCAA liabilities are stayed. SOP 90-7 requirespre-petition liabilities that are subject to compromise to be reported at theamounts expected to be allowed, even if they may be settled for lesser amounts.  These liabilities represent the amountsexpected to be allowed on known or potential claims to be resolved through theChapter 11 and CCAA process, and remain subject to future adjustments arisingfrom negotiated settlements, actions of the Bankruptcy Courts, rejection ofexecutory contracts and unexpired leases, the determination as to the value ofcollateral securing the claims, proofs of claim, or other events.  Liabilities subject to compromise alsoinclude certain items that may be assumed under the plan of reorganization, andas such, may be subsequently reclassified to liabilities not subject tocompromise.

 

The Bankruptcy Courtshave approved payment of certain pre-petition obligations, including employeewages, salaries and benefits, and the payment of vendors and other providers inthe ordinary course for goods and services received after the filing of theChapter 11 Petition and the Canadian Petition and other business-relatedpayments necessary to maintain the operation of our business. Obligationsassociated with these matters are not classified as liabilities subject tocompromise.

 

On June 22, 2009,the Bankruptcy Courts entered an order establishing August 28, 2009, asthe bar date for potential creditors to file claims. The bar date is thedate by which certain claims against us must be filed if the claimants wish toreceive any distribution in the bankruptcy cases.  Proof of claim forms received after this timewill not be eligible for consideration of recovery as part of our bankruptcycases. Creditors were notified of the bar date and the requirement to file aproof of claim with the Bankruptcy Courts. Differences between liabilityamounts estimated by us and claims filed by creditors will be investigated and,if necessary, the Bankruptcy Courts will make a final determination of theallowable claim. The determination of how liabilities will ultimately betreated cannot be made until the Bankruptcy Courts approve a plan ofreorganization. Accordingly, the ultimate amount or treatment of suchliabilities is not determinable at this time. See Note 5 of the Notes toConsolidated Financial Statements.

 

**GoingConcern Matters**

 

The consolidatedfinancial statements and related notes have been prepared assuming that we willcontinue as a going concern, although our bankruptcy filings raise substantialdoubt about our ability to continue as a going concern.  The consolidated financial statements do notinclude any adjustments related to the recoverability and classification of recordedassets or to the amounts and classification of liabilities or any otheradjustments that might be necessary should we be unable to continue as a goingconcern.  Our ability to continue as agoing concern is dependent on market conditions and our ability to improveprofitability, obtain alternative financing to replace the DIP Credit Agreementand prepetition Credit Agreement and restructure our obligations in a mannerthat allows us to obtain confirmation of a plan of reorganization by theBankruptcy Courts.

 

In order to improveprofitability, management is taking actions to further reduce corporate andoperational expenses and is continuing to align manufacturing capacity to meetmarket demands and standardize manufacturing processes throughout alloperations. These actions will result in the closure of additionalmanufacturing facilities and further headcount reductions during the nexttwelve months.

 

27

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**RESULTS OF OPERATIONS**

 

# **Overview**

#  

We had net income of $158million for the second quarter of 2009 compared to a net loss of $37 millionfor the second quarter of 2008.  The 2009results benefited from the alternative fuel tax credit income of $276 million,but were negatively impacted by reorganization items of $39 million and higherrestructuring charges.  The segment operating results for the secondquarter of 2009 increased slightly over the results for the comparable 2008period.  While sales volumes andaverage selling prices for containerboard and corrugated containers were lowerfor the second quarter of 2009, results benefited from lower costs compared to2008.

 

For the six months ended June 30,2009, we had a net loss of $56 million compared to a net loss of $50 millionfor the same period last year.  The 2009results benefited from the alternative fuel tax credit income of $276 million,but were negatively impacted by debtor-in-possession debt issuance costs of $63million, reorganization items of $93 million, lower segment operating profitsof $40 million, loss on early extinguishment of debt of $20 million and higherrestructuring charges.  The 2008 resultsbenefited from higher non-cash foreign currency exchange gains, but werenegatively impacted by a charge of $22 million to fully reserve for all amountsdue from Calpine Corrugated, LLC and litigation charges of $8 million.  Thesegment operating results for the six months ended June 30, 2009 werenegatively impacted by lower sales volume for containerboard and corrugatedcontainers, lower average selling prices for containerboard and corrugatedcontainers and higher costs for wood fiber and chemicals compared to last year.The 2009 first half results benefited from lower reclaimed fiber costcompared to the comparable period in 2008.

 

For the third quarter of2009, while we anticipate our financial performance will continue to benegatively impacted by weak economic conditions, we expect our operatingresults for our containerboard, corrugated containers and reclamationoperations to be comparable to the second quarter of 2009.  We expect higher containerboard productionand increased shipments of corrugated containers.  We also anticipate lower cost for energy andadditional benefits as a result of converting plant closures and other ongoingreorganization initiatives. These favorable items are expected to be offset bylower sales prices and higher fiber costs. In the second quarter of 2009, we recognized alternative fuel taxcredits of $276 million which related to the first six months of 2009. Weexpect to continue to receive the alternative fuel tax credits in the thirdquarter of 2009.  We will continue toincur significant costs associated with our bankruptcy proceedings.

 

**Reorganization Items and OtherBankruptcy Related Costs**

 

**ReorganizationItems**

SOP 90-7 requiresseparate disclosure of reorganization items such as realized gains and lossesfrom the settlement of pre-petition liabilities, provisions for lossesresulting from the reorganization of the business, as well as professional feesdirectly related to the process of reorganizing the Company under Chapter 11and the CCAA. Our reorganization items for the three and six months ended June 30,2009 consist of the following:

 
| ** **                                                     | ** ** | **Three months  ended June 30,  2009** | ** ** | **Six months  ended June 30,   2009** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
|                                                           |       |                                        |       |                                       |       |
| Provision  for rejected/settled executory contracts and leases |       | $                                           | 25         |                                       | $          | 64 |   |
| Professional  fees                                             |       | 16                                          |       | 32                                         |       |
| Accounts  payable settlement gains                             |       | (2                                          | )          | (3                                         | )          |
| Total  reorganization items                                    |       | $                                           | 39         |                                       | $          | 93 |   |

 

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Since the Petition Date, we have received approvalfrom the Bankruptcy Courts to reject a number of leases and other executorycontracts of various types.  We arereviewing all of our executory contracts and unexpired leases to determinewhich additional contracts and leases we will reject.  We expect that additional liabilities subjectto compromise will arise due to rejection of executory contracts, includingleases, and from the determination of the U.S. Court (or agreement by partiesin interest) of allowed claims for contingencies and other disputedamounts.  We also expect that theassumption of additional executory contracts and unexpired leases will convertcertain of the liabilities shown on the accompanying consolidated balance sheetas liabilities subject to compromise to liabilities not subject tocompromise.  Due to the uncertain natureof many of the potential claims, we cannot project the magnitude of such claimswith certainty.

 

Provision forrejected/settled executory contracts and leases for the three and six monthsended June 30, 2009, includes a $9 million special termination benefitscharge due to funding obligations related to certain non-qualified pensionplans.

 

Professional feesdirectly related to the reorganization include fees associated with advisors tous, the Creditors’ Committee and certain secured creditors.

 

Reorganization itemsexclude employee severance and other restructuring charges recorded during thethree and six months ended June 30, 2009.

 

**Other Bankruptcy Related Costs**

 

Debtor-in-possession debtissuance costs of $63 million were incurred and paid during the first half of2009 in connection with entering into the DIP Credit Agreement.

 

# **Alternative Fuel Tax Credit**

#  

The U.S. InternalRevenue Code allows an excise tax credit for alternative fuel mixtures producedby a taxpayer for sale, or for use as a fuel in a taxpayer’s trade orbusiness.  The credit is scheduled toexpire on December 31, 2009.  On May 6,2009, we were notified that our registration as an alternative fuel mixer wasapproved by the Internal Revenue Service. We submitted refund claims ofapproximately $294 million for the periods January 1, 2009 through June 30,2009 related to production at ten of our U.S. mills, of which $205 million ofthis refund request was received during the second quarter.  During the second quarter of 2009, werecorded other operating income of $276 million, net of expected fees, in ourconsolidated statements of operations related to this matter.

 

# **Restructuring Activities**

#  

During the second quarterof 2009, we closed four converting facilities. We recorded restructuring charges of $11 million, including non-cashcharges of $3 million related to the write-down of assets, primarily property,plant and equipment, to estimated net realizable values and the acceleration ofdepreciation for converting equipment expected to be abandoned or taken out ofservice.  The remaining charges of $8million were primarily for severance and benefits.  As a result of the closures in the secondquarter of 2009 and other ongoing initiatives, we reduced our headcount byapproximately 500 employees.

 

For the six months ended June 30,2009, we closed seven converting facilities and announced the closure of oneadditional converting facility.  As aresult of the closures in the first half of 2009 and other ongoing initiatives,we reduced our headcount by approximately 1,500 employees.  We recorded restructuring charges of $24million, including non-cash charges of $4 million related to the write-down ofassets, primarily property, plant and equipment, to estimated net realizablevalues and the acceleration of depreciation for converting equipment expectedto be abandoned or taken out of service. The remaining charges of $20 million were primarily for severance andbenefits.  The net sales of the announcedand closed converting facilities as of June 30, 2009 prior to closure andfor the year ended December 31, 

 

29

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2008 were $26 million and$138 million, respectively.  The majorityof these net sales are expected to be transferred to other operatingfacilities.  Additional charges of up to$4 million are expected to be recorded in future periods for severance andbenefits related to the closure of these and previously closed facilities.

 

We continue to review andevaluate various restructuring and other alternatives to streamline ouroperations, improve efficiencies and reduce cost.  Such initiatives may include selling assets,idling facilities, consolidating operations and functions, relocating or reducingproduction and voluntary and involuntary employee separation programs.  In addition, such actions will subject us toadditional short-term costs, which may include facility shutdown costs, assetimpairment charges, lease commitment costs, employee retention and severancecosts and other closing costs.

 

**SecondQuarter 2009 Compared to Second Quarter 2008**

 
| ** **                                                        | ** ** | **Three months ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                        | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| **(In millions)**                                                 | ** ** | **Net   Sales**                      | ** ** | **Profit/   (Loss)** | ** ** | **Net   Sales** | ** ** | **Profit/   (Loss)** | ** ** |
|                                                              |       |                                 |       |   |   |   |   |   |   |
| Containerboard,  corrugated containers and reclamation operations |       | $                                    | 1,407      |   | $ | 76 |   | $ | 1,835 |   | $ | 74 |   |
|                                                              |       |                                 |       |   |   |   |   |   |   |
| Restructuring  charges                                            |       |                                 |       | (11 | ) |   |   | (9 | ) |
| Gain  on sale of assets                                           |       |                                 |       | 1 |   |   |   | 1 |   |
| Other  operating income                                           |       |                                 |       | 276 |   |   |   |   |   |
| Interest  expense, net                                            |       |                                 |       | (74 | ) |   |   | (61 | ) |
| Non-cash  foreign currency exchange (losses)                      |       |                                 |       | (2 | ) |   |   | (4 | ) |
| Reorganization  items                                             |       |                                 |       | (39 | ) |   |   |   |   |
| Corporate  expenses and other (Note 1)                            |       |                                 |       | (65 | ) |   |   | (58 | ) |
| Income  (loss) before income taxes                                |       |                                 |       | $ | 162 |   |   |   | $ | (57 | ) |
|                                                                   |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 

Note 1: Amounts includecorporate expenses and other expenses not allocated to operations.

 

Net sales decreased 23.3%in the second quarter of 2009 compared to last year.  Net sales were negatively impacted by $266million in 2009 as a result of lower third-party sales volume of containerboardand corrugated containers. Third party shipments of containerboard were lowerdue primarily to weaker demand in the markets in which we operate. NorthAmerican shipments of corrugated containers in 2009 were negatively impacted byweaker market conditions, container plant closures and actions to improvemargins by exiting unprofitable accounts. Net sales were also negatively impacted by lower average selling prices($162 million) for reclaimed material, containerboard and corrugated containers.The average price for old corrugated containers (OCC) decreased approximately$70 per ton compared to last year.

 

Our containerboard millsoperated at 85.0% of capacity in the second quarter of 2009.  Containerboard production was 15.3% lowercompared to last year due primarily to the market related downtime taken by ourmills as a result of lower demand. Production of market pulp decreased by 44.1% compared to last year dueprimarily to the closure of the Pontiac pulp mill in October 2008.  Production of kraft paper decreased 36.4%compared to last year due primarily to lower demand, which resulted in marketrelated downtime in the second quarter of 2009.** **Total tons of fiber reclaimed andbrokered decreased 23.7% compared to last year due to the lower containerboardproduction and weaker demand.

 

Cost of goods soldas a percent of net sales in the second quarter of 2009 was 89.3%, compared to90.4% last year.  Cost of goods solddecreased from $1,659 million for the second quarter of 2008 to $1,256 millionfor the second quarter of 2009 due primarily to lower sales of containerboardand corrugated containers in the second quarter of 2009 and lower costs ofreclaimed material ($99 million), energy ($16 million) and wood fiber ($3million).

 

30

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Selling andadministrative expense decreased $11 million in the second quarter of 2009compared to the second quarter of 2008 due primarily to cost reductions fromongoing and prior-year initiatives.

 

During the second quarterof 2009, we recorded other operating income of $276 million, net of expectedfees, related to the alternative fuel tax credit.

 

Interest expense, net was$74 million in the second quarter of 2009. The $13 million increase compared to the second quarter of 2008 wasimpacted by higher average borrowings ($11 million) and higher average interestrates ($2 million).  Our overall averageeffective interest rate in the second quarter of 2009 was higher than 2008 by0.17%.  Since the Petition Date, wediscontinued interest payments on our unsecured notes and certain otherunsecured debt.  Interest expense ($50million in the three months ended June 30, 2009) continues to be accruedon the unsecured debt until a determination is made that it will not be anallowed claim in the bankruptcy proceedings.

 

In the second quarter of2009, we recorded non-cash foreign currency exchange losses of $2 millioncompared to losses of $4 million for the same period in 2008.

 

Duringthe three months ended June 30, 2009, we recorded a provision for incometaxes of $4 million for U.S. alternative minimum income taxes, state and localtaxes, Canadian withholding taxes and interest on unrecognized tax benefitspreviously recorded.  For additional information on incometaxes see Part I, Item 2, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — Income Taxes.”

 

**SixMonths 2009 Compared to Six Months 2008**

 
| ** **                                                        | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                        | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **(In millions)**                                                 | ** ** | **Net  Sales**                     | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
|                                                              |       |                               |       |   |   |   |   |   |   |
| Containerboard,  corrugated containers and reclamation operations |       | $                                  | 2,778      |   | $ | 142 |   | $ | 3,630 |   | $ | 182 |   |
|                                                              |       |                               |       |   |   |   |   |   |   |
| Restructuring  charges                                            |       |                               |       | (24 | ) |   |   | (13 | ) |
| Gain  (loss) on sale of assets                                    |       |                               |       | (1 | ) |   |   | 4 |   |
| Other  operating income                                           |       |                               |       | 276 |   |   |   |   |   |
| Interest  expense, net                                            |       |                               |       | (145 | ) |   |   | (124 | ) |
| Debtor-in-possession  debt issuance costs                         |       |                               |       | (63 | ) |   |   |   |   |
| Loss  on early extinguishment of debt                             |       |                               |       | (20 | ) |   |   |   |   |
| Non-cash  foreign currency exchange gains                         |       |                               |       | 1 |   |   |   | 11 |   |
| Reorganization  items                                             |       |                               |       | (93 | ) |   |   |   |   |
| Corporate  expenses and other (Note 1)                            |       |                               |       | (124 | ) |   |   | (148 | ) |
| Loss  before income taxes                                         |       |                               |       | $ | (51 | ) |   |   | $ | (88 | ) |
|                                                                   |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 

Note 1: Amounts includecorporate expenses and other expenses not allocated to operations, includingCalpine Corrugated charges and litigation charges for 2008.

 

Net sales decreased 23.5%in the first half of 2009 compared to last year.  Net sales were negatively impacted by $587million in the first six months of 2009 as a result of lower third-party salesvolume of containerboard and corrugated containers. Third party shipments ofcontainerboard were lower due primarily to weaker demand in the markets inwhich we operate. North American shipments of corrugated containers in thefirst six months of 2009 were negatively impacted by weaker market conditions,container plant closures and actions to improve margins by exiting unprofitableaccounts.  Net sales were 

 

31

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also negatively impactedby lower average selling prices ($265 million) for reclaimed material,containerboard and corrugated containers. The average price for old corrugatedcontainers (OCC) decreased approximately $75 per ton compared to last year.

 

Our containerboard millsoperated at 83.7% of capacity in the first half of 2009.  Containerboard production was 17.4% lowercompared to last year due primarily to the market related downtime taken by ourmills as a result of lower demand. Production of market pulp decreased by 45.2% compared to last year dueprimarily to the closure of the Pontiac pulp mill in October 2008.  Production of kraft paper decreased 46.0%compared to last year due primarily to lower demand, which resulted in marketrelated downtime in the first six months of 2009.** **Total tons of fiber reclaimed andbrokered decreased 25.7% compared to last year due to weaker demand.

 

Cost of goods soldas a percent of net sales in the first half of 2009 was 89.0%, compared to89.3% last year.  Cost of goods solddecreased from $3,242 million in 2008 to $2,473 million in 2009 due primarilyto lower sales volumes for containerboard and corrugated containers in thefirst six months of 2009 and lower costs of reclaimed material ($208 million),which were partially offset by higher costs of wood fiber ($13 million), andchemicals ($13 million).

 

Selling andadministrative expense decreased $57 million in the first half of 2009 comparedto the first half of 2008 due primarily to cost reductions from ongoing andprior-year initiatives and the impacts of the Calpine Corrugated charges andlitigation charges recorded in 2008 totaling $30 million.

 

During the six monthsended June 30, 2009, we recorded other operating income of $276 million,net of expected fees, related to the alternative fuel tax credit.

 

Interest expense, net was$145 million in the first half of 2009. The $21 million increase compared to the first half of 2008 was impactedby higher average borrowings ($23 million), which were partially offset bylower average interest rates ($2 million). Our overall average effective interest rate in the first half of 2009was lower than 2008 by 0.07%.  Since thePetition Date, we discontinued interest payments on our unsecured notes andcertain other unsecured debt.  Interestexpense ($98 million in the six months ended June 30, 2009) continues tobe accrued on the unsecured debt until a determination is made that it will notbe an allowed claim in the bankruptcy proceedings.

 

In the first six monthsof 2009, we recorded a loss on early extinguishment of debt of $20 million forthe non-cash write-off of deferred debt issuance cost related to the Stevenson,Alabama mill industrial revenue bonds, which were repaid.

 

In the first half of2009, we recorded non-cash foreign currency exchange gains of $1 millioncompared to gains of $11 million for the same period in 2008.

 

Duringthe six months ended June 30, 2009, we recorded a provision for incometaxes of $5 million for U.S. alternative minimum income taxes, state and localtaxes, Canadian withholding taxes and interest on unrecognized tax benefitspreviously recorded.

 

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#### ** **

#### **Statistical Data**

#### ** **

| ** **                                                   | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(In thousands of tons, except  as noted)**                 | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Mill  production                                             |       |                                  |       |                                |       |   |   |   |   |
| Containerboard  (1)                                          |       | 1,497                                 |       | 1,767                               |       | 2,932 |   | 3,551 |   |
| Kraft  paper                                                 |       | 28                                    |       | 44                                  |       | 47 |   | 87 |   |
| Market  pulp                                                 |       | 76                                    |       | 136                                 |       | 142 |   | 259 |   |
| SBL                                                          |       | 32                                    |       | 29                                  |       | 65 |   | 62 |   |
| North  American corrugated containers sold (billion sq. ft.) |       | 16.7                                  |       | 18.1                                |       | 33.3 |   | 35.7 |   |
| Fiber  reclaimed and brokered                                |       | 1,280                                 |       | 1,677                               |       | 2,521 |   | 3,393 |   |

 

----

(1) Forthe three months ended June 30, 2009 and 2008, our corrugated containerplants consumed 1,112,000 tons and 1,191,000 tons of containerboard,respectively.  For the six months ended June 30,2009 and 2008, our corrugated container plants consumed 2,247,000 tons and2,362,000 tons of containerboard, respectively.

 

#### **LIQUIDITYAND CAPITAL RESOURCES**

#### ** **

Liquidity improved significantly during the first halfof 2009.  At June 30, 2009, we hadcash and cash equivalents of $590 million and the amount available forborrowings under the DIP Credit Agreement was $163 million.  Our cash flows from operations and workingcapital were favorably impacted by the receipt of $205 million for thealternative fuel tax credit and the stay of payment of liabilities subject tocompromise resulting from the bankruptcy filings.  The improvement in liquidity was positivelyimpacted by the additional availability resulting from the DIP Credit Agreemententered into on January 28, 2009.

 

The following tablesummarizes our cash flows for the six months ended June 30:

 
| **(In millions)**                 | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Net  cash provided by (used for): |       |     |       |     |       |
| Operating  activities             |       | $        | 492        |     | $          | (8 | ) |
| Investing  activities             |       | (80      | )          | (199     | )          |
| Financing  activities             |       | 52       |       | 209      |       |
| Net  increase in cash             |       | $        | 464        |     | $          | 2 |   |

 

**Net Cash Provided By (Used For)Operating Activities**

The net cash provided by(used for) operating activities for the six months ended June 30, 2009improved compared to the same period in 2008 due primarily to the alternativefuel tax credit receipts of $205 million and lower working capital.  Working capital, principally accounts payableand interest payable, was favorably impacted by the stay of payment ofliabilities subject to compromise resulting from the bankruptcy filings.  Since the Petition Date, we discontinuedinterest payments on our unsecured senior notes and certain other unsecureddebt. Interest expense ($98 million in the six months ended June 30, 2009)will continue to be accrued on the unsecured debt until a determination is madethat it will not be an allowed claim in the bankruptcy proceedings.

 

**Net Cash Provided By (Used For)Investing Activities**

Net cash used forinvesting activities was $80 million for the six months ended June 30,2009.  Expenditures for property, plantand equipment were $69 million for the first six months of 2009, compared to$207 million for the same period last year. The amount expended for property, plant and equipment in the first sixmonths of 2009 was principally for projects related to upgrades, cost reductionsand ongoing initiatives.  Advances to affiliates,net in 2009 of $15 million are principally related to funding 

 

33

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an obligation pertainingto a guarantee for a previously non-consolidated affiliate.  See Note 11 of the Notes to ConsolidatedFinancial Statements.  For the six monthsended June 30, 2009, we received proceeds of $4 million from the sale ofproperties primarily related to previously closed facilities.

 

**Net Cash Provided By (Used For)Financing Activities**

Net cash provided by financingactivities for the six months ended June 30, 2009 of $52 million includedproceeds from the DIP Credit Agreement of $440 million which were used toterminate our receivables securitization programs and repay all indebtednessoutstanding under the programs of $385 million. Debt issuance cost of $63 million was incurred and paid with the DIPproceeds and available cash.  During thefirst quarter of  2009, letters of creditin the amount of $68 million were drawn on to fund obligations principally relatedto non-qualified pension plans, commodity derivative instruments and aguarantee for a previously non-consolidated affiliate, which increasedborrowings under our Credit Agreement. We paid dividends to Smurfit-Stone in the aggregate amount of approximately$4 million in the first six months of 2008 to fund the dividend obligations ofSmurfit-Stone to the holders of its 7% Series A Cumulative ExchangeableRedeemable Convertible Preferred Stock. We are restricted from paying future dividends under the DIP CreditAgreement.

 

**DIP Credit Agreement**

In connection with filing the Chapter 11 Petitionand the Canadian Petition on January 26, 2009, we and certain of ouraffiliates filed a motion with the Bankruptcy Courts seeking approval to enterinto a DIP Credit Agreement.  On January 27,2009, the Bankruptcy Courts granted interim approval of the DIP CreditAgreement.  Based on such interimapproval, on January 28, 2009 we entered into the DIP Credit Agreement,subject to final approval of the Bankruptcy Courts.  Final approval of the DIP Credit Agreementwas granted by the U.S. Court on February 23, 2009 and by the CanadianCourt on February 24, 2009. Amendments to the DIP Credit Agreement were entered into on February 25and 27, 2009.

 

The DIP Credit Agreement, as amended, provides forborrowings up to an aggregate committed amount of $750 million, consisting of a$400 million U.S. term loan for borrowings by us; a $35 million Canadian termloan for borrowings by SSC Canada; a $250 million U.S. revolving loan forborrowings by us and/or SSC Canada; and a $65 million Canadian revolving loanfor borrowings by us and/or SSC Canada.

 

The use of proceeds under the DIP Credit Agreementis limited to (i) working capital, letters of credit and capitalexpenditures; (ii) other general corporate purposes of ours and certain of oursubsidiaries (including certain intercompany loans); (iii) the refinancingin full of indebtedness outstanding under our receivables securitizationprograms; (iv) payment of any related transaction costs, fees andexpenses; and (v) the costs of administration of the cases arising out ofthe Chapter 11 Petition and the Canadian Petition.

 

In accordance with the terms of the DIP CreditAgreement, on January 28, 2009, we used U.S. term loan proceeds of $360million, net of lenders fees of $40 million, and Canadian term loan proceeds of$30 million, net of lenders fees of $5 million, to terminate the receivablessecuritization programs and repay all indebtedness outstanding under theprograms of $385 million and to pay other expenses of $1 million.  In addition, other fees and expenses of $17million related to the DIP Credit Agreement were paid for with proceeds of $5million from the DIP Canadian Revolver and available cash.

 

We have the option to borrow under the DIP CreditAgreement at a rate of: (i) Alternate Base Rate (ABR) Loans bear interestat a rate per annum equal to the applicable margin (Applicable Margin) plus theABR; (ii) Eurodollar loans bear interest at a rate per annum equal to theApplicable Margin plus the Adjusted LIBO Rate; (iii) Canadian prime rateloans bear interest at a rate per annum equal to the Applicable Margin plus theCanadian prime rate; and (iv) discount rate loans bear interest at a rateper annum equal tothe ApplicableMargin plus the discount rate.  The DIPCredit Agreement provides that the Applicable Margin adjusts upon extensions ofthe maturity date.** **As of June 30, 2009, theweighted average interest rate on outstanding borrowings under the DIP CreditAgreement was 10%.

 

34

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Under the DIP Credit Agreement,****interest and fees are payable in arrearson each interest payment date as defined in the DIP Credit Agreement.  If we default on our obligations under theDIP Credit Agreement, the default rate of interest in most cases will be therate otherwise in effect plus 2.0% per annum. In addition to interest, a commitment fee of 1.0% per annum is requiredin respect of the unutilized commitments under the DIP Credit Agreement.  The DIP Credit Agreement also imposes letterof credit fees.

 

The outstanding principal amount of the loans underthe DIP Credit Agreement, plus interest accrued and unpaid, will be due andpayable in full at maturity, which is January 28, 2010 (subject to anearlier maturity date under certain circumstances); provided, that the maturitydate may be extended through April 28, 2010, and subsequently through July 28,2010 upon the satisfaction of certain conditions precedent (including thepayment of specified fees).

 

U.S. and Canadian borrowings are each subject to aborrowing base derived from a formula based on certain eligible accountsreceivable and inventory, and an amount attributable to real property andequipment, less certain reserves.  As of June 30,2009, the applicable borrowing base was $597 million and the amount availablefor borrowings under the DIP Credit Agreement was $163 million. The borrowing base as of June 30,2009 as compared to March 31, 2009 decreased approximately $135 milliondue principally to a $107 million reduction in the real property and equipment component of the borrowing base.  We are in the process of obtaining appraisalsfor certain real property and equipment and expect the borrowing baseattributable to real property and equipment to be restored during August 2009.

 

Borrowings under the DIP Credit Agreement areguaranteed by us and certain of our affiliates, and are secured by firstpriority liens in the collateral accounts and all presently owned and hereafteracquired assets of ours and each of our subsidiaries party to the DIP CreditAgreement, subject to certain permitted prior liens.  Subject to certain exceptions, the DIP CreditAgreement requires certain mandatory prepayments of borrowings from the netproceeds of certain asset dispositions, and casualty or condemnationpayments.  The only Canadian entity thatguarantees U.S. obligations is SSC Canada.

 

The DIP Credit Agreement includes affirmative,negative and financial covenants that impose substantial restrictions on ourfinancial and business operations and those of certain of our subsidiaries,including their ability to incur or secure debt, make investments, sell assets,pay dividends or make acquisitions. The DIP Credit Agreement contains events ofdefault customary for debtor-in-possession financings of this type.

 

**Bank Credit Facilities**

Smurfit-Stone, asguarantor, and we and our subsidiary, SSC Canada, as borrowers, entered into acredit agreement, as amended (the Credit Agreement) on November 1,2004.  Our obligations under the CreditAgreement are unconditionally guaranteed by Smurfit-Stone and our material U.S.subsidiaries.  The obligations of SSCCanada under the Credit Agreement are unconditionally guaranteed by us,Smurfit-Stone, our material U.S. subsidiaries and the material Canadiansubsidiaries of SSC Canada.  Ourobligations under the Credit Agreement are secured by a security interest insubstantially all of our assets and properties, and those of our material U.S.subsidiaries, by a pledge of all of our capital stock and the material our U.S.subsidiaries and by a pledge of 65% of the capital stock of SSC Canada that isdirectly owned by us.  The securityinterests securing our obligation under the Credit Agreement exclude cash, cashequivalents, certain trade receivables, three paper mills and the land andbuildings 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, by a pledge of all of the capital stock of the material Canadiansubsidiaries of SSC Canada and by the same U.S. assets, properties and capitalstock that secures our obligations under the Credit Agreement.  The security interests securing SSC Canada’sobligation under the Credit Agreement exclude three mills and property relatedthereto and certain other real property located in New Brunswick and Quebec.

 

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The Credit Agreementcontains various covenants and restrictions including (i) limitations ondividends, redemptions and repurchases of capital stock, (ii) limitationson the incurrence of indebtedness, liens, leases and sale-leasebacktransactions, (iii) limitations on capital expenditures and (iv) maintenanceof certain financial covenants.  TheCredit Agreement also requires prepayments if we have excess cash flows, asdefined therein, or receive proceeds from certain asset sales, insurance orincurrence of certain indebtedness.

 

On January 15, 2009our credit ratings were lowered, increasing the Applicable Rate by 0.25%.  We have the option to borrow at a rate equalto LIBOR plus 2.25% or alternate base rate (ABR) plus 1.00% for the term loanfacilities and LIBOR plus 2.50% or ABR plus 1.25% for the revolving creditfacilities (the Applicable Rate).

 

The filing of theChapter 11 Petition and the Canadian Petition constituted an event ofdefault under our debt obligations, and those debt obligations becameautomatically and immediately due and payable, although any actions to enforcesuch payment obligations are stayed as a result of the filing of the Chapter 11Petition and the Canadian Petition.  Aspreviously disclosed in our 2008 Form 10-K, our consolidated balance sheetas of December 31, 2008 included a reclassification of $3,032 million tocurrent maturities of long-term debt from long-term debt. Since the PetitionDate, we discontinued interest payments on our unsecured senior notes andcertain other unsecured debt.

 

We had a deposit funded letter of credit facility,related to our variable rate industrial revenue bonds, for approximately $122 million that was due to mature on November 1,2010. In February 2009, due to an event of default under the bondindentures, this credit facility was drawn on to fully repay the industrialrevenue bonds in the principal amount of $120 million.

 

**FutureCash Flows**

 

We submitted refundclaims for the alternative fuel tax credit of approximately $294 million forthe period January 1, 2009 through June 30, 2009, of which $205million was received as of June 30, 2009. In July 2009, the outstanding refund claims of $89 million werereceived.  We expect to submit monthlyrefund claims of approximately $55 million for the remainder of 2009.  The monthly claims are expected to bereceived in the month following the submission.

 

Under the DIP CreditAgreement, capital expenditures for the 11-month period ending December 31,2009 are not allowed to exceed $205 million. In the first half of 2009, capital spending of $69 million included $48million for the five month period ended June 30, 2009.

 

We recorded restructuringcharges of $24 million during the first six months of 2009, including $20million for exit liabilities, which were principally for severance andbenefits.  During the six months ended June 30,2009, we incurred cash expenditures of $14 million for these exitliabilities.  The remaining exitliabilities are expected to be paid principally in the third quarter of 2009.

 

At December 31,2008, we had $33 million of exit liabilities related principally torestructuring activities.  During the sixmonths ended June 30, 2009, we incurred cash expenditures of $10 millionfor these exit liabilities.  In addition,exit liabilities have been decreased by $5 million due to rejecting leasesrelated to previously closed facilities as permitted under the BankruptcyCode.  The remaining cash expenditures inconnection with our restructuring activities will continue to be funded throughoperations as originally planned.

 

In the first quarter of 2009, letters of credit weredrawn on in the amount of $27 million related to funding certain of ournonqualified pension plan obligations. Excluding the impact of these letters ofcredit, we contributed approximately $6 million to our defined benefit plans inthe first half of 2009.

 

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**INCOME TAXES**

 

Duringthe three and six months ended June 30, 2009, we recorded provisions forincome taxes of $4 million and $5 million, respectively, for U.S. alternativeminimum income taxes, state and local taxes, Canadian withholding taxes andinterest on unrecognized tax benefits previously recorded.  Because it is more likely than not that substantiallyall of the deferred tax assets that are generated in 2009 may not be realized,we have recorded a full valuation allowance, and have not recorded anyadditional tax benefit for the three and six months ended June 30, 2009.

 

As previously disclosed,the Canada Revenue Agency (CRA) is examining our income tax returns for taxyears 1999 through 2005. Certain matters, including transfer prices ofinventory sold by our Canadian subsidiaries to our U.S. subsidiaries, arecurrently under review.  With respect tothe transfer price issue, the CRA issued assessments of additional incometaxes, interest and penalties, which we have appealed.  In order to appeal the assessment, we madepayments of $25 million to the CRA in 2008.

 

The remaining matters maybe resolved at the examination level or subsequently upon appeal within thenext twelve months.  While the finaloutcome of the remaining CRA examination matters, including an estimate of therange of the reasonably possible changes to unrecognized tax benefits, is notyet determinable, we believe that the examination or subsequent appeals willnot have a material adverse effect on our consolidated financial condition orresults of operations.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

We, under two separateaccounts receivable securitization programs, sold without recourse, on anongoing basis, certain of our accounts receivable to non-consolidated financingentities.  Our retained interest in thesenon-consolidated entities was carried at fair value and included in retainedinterest in receivables sold in the accompanying December 31, 2008consolidated balance sheet.  On January 28,2009, in conjunction with the filing of the Chapter 11 Petition and theCanadian Petition, the accounts receivable securitization programs wereterminated and all outstanding receivables previously sold to thenon-consolidated financing entities were repurchased with proceeds fromborrowings under the DIP Credit Agreement. The repurchase of receivables of $385 million has been included in thecash flows from financing activities in the consolidated statement of cashflows.

 

**PROSPECTIVEACCOUNTING PRONOUNCEMENTS**

 

In June 2009,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 166, “Accounting for Transfers ofFinancial Assets, an Amendment of FASB Statement No. 140” (SFAS No. 166),effective for fiscal years beginning after November 15, 2009.  SFAS No. 166 modifies SFAS No. 140by removing the concept of a qualifying special-purpose entity, thuspotentially requiring consolidation of such special-purpose entities previouslyexcluded from the consolidated financial statements. We are currentlyevaluating the impact of SFAS No. 166 on the consolidated financialstatements.

 

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**ITEM 3.**                        **QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

###### **Weare exposed to various market risks, including commodity price risk, foreigncurrency risk and interest rate risk.  Tomanage the volatility related to these risks, we have historically entered intovarious derivative contracts.  Themajority of these contracts are settled in cash.  However, such settlements have not had asignificant effect on our liquidity in the past, nor are they expected to besignificant in the future.  We do not usederivatives for speculative or trading purposes.**

###### ** **

On January 26, 2009,the Chapter 11 Petition and the Canadian Petition effectively terminated allexisting derivative instruments. Termination fair values were calculated based on the potentialsettlement value. During the first half of 2009, letters of credit of $18million were drawn on related to the settlement of certain of our derivativeinstruments.  Excluding these settledliabilities, the termination value related to the remaining derivative liabilitieswas approximately $60 million, which were stayed due to the filing of theChapter 11 Petition and the Canadian Petition. These derivative liabilities were adjusted through other comprehensiveincome (loss) (OCI) for derivative instruments qualifying for hedge accountingand cost of goods sold for derivative instruments not qualifying for hedgeaccounting.  The remaining amount in OCIwill be recorded through earnings during the period the underlying transaction isrecorded or when the underlying transaction is no longer expected tooccur.  During the second quarter of2009, we reclassified the remaining foreign currency derivative instrumentsfrom OCI to cost of goods sold since the underlying transactions were no longerexpected to occur, resulting in a loss of $2 million (net of tax).

 

**Commodity Price Risk**

We used derivativeinstruments, including fixed price swaps, to manage fluctuations in cash flowsresulting from commodity price risk in the procurement of natural gas and othercommodities, including fuel oil and diesel fuel.  The objective was to fix the price of aportion of our purchases of these commodities used in the manufacturingprocess.  The changes in the market valueof such derivative instruments historically offset the changes in the price ofthe hedged item.  The changes in energycost discussed in Item 2, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” include the impact of the natural gasderivative instruments.  See Note 14 ofthe Notes to Consolidated Financial Statements.

 

**Foreign Currency Risk**

Our principal foreignexchange exposure is the Canadian dollar. Assets and liabilities outside the United States are primarily locatedin Canada. The functional currency for our Canadian operations is the U.S.dollar.  Our investments in foreignsubsidiaries with a functional currency other than the U.S. dollar are nothedged.

 

We used financialderivative instruments, including forward contracts and options, primarily toprotect against Canadian currency exchange risk associated with expected futurecash flows.  The Canadian dollar as of June 30,2009, compared to December 31, 2008, strengthened 5.07% against the U.S.dollar.  We recognized non-cash foreigncurrency exchange gains of $1 million for the six month period ended June 30,2009 compared to gains of $11 million for the same period in 2008.

 

**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 market interest rate of fixedrate debt will impact the fair value of the debt, whereas a change in theinterest rate 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.

 

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We used interest rateswap contracts to manage interest rate exposure on $300 million of the currentTranche B and Tranche C floating rate bank term debt.  The accounting for the cash flow impact ofthe swap contracts is recorded as an adjustment to interest expense eachperiod.

 

**ITEM 4.****                       ****CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controlsand 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 theend of the period covered by this report and concluded that, as of such date,our disclosure controls and procedures were adequate and effective.

 

**Changes in Internal Control**

 

There have not been anychanges in our internal control over financial reporting during the most recentquarter that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 1.****                       ****LEGAL PROCEEDINGS**

 

On May 18, 2009, aclass action complaint was filed in the United States District Court forthe Northern District of Illinois naming as defendants Patrick J. Moore, ChiefExecutive Officer, and the members of the Administrative Committee of ourretirement plans.  The complaint, asamended, alleges that the defendants breached their fiduciary duty to planparticipants by improperly allowing investments of plan assets in ourcommon stock and by failing to communicate complete and accurate information toplan participants relating to plan assets and investments.  The plaintiffsseek the recovery of all alleged losses incurred by the plan participants inconnection with the significant decline in the price of our commonstock, and other relief.  We believe that each of the defendants inthis matter would be entitled to indemnification protection under our bylaws,and the costs of defending this action and any damages or settlements would bepaid by applicable insurance coverage, and, therefore, we do notbelieve this matter will have a material adverse effect on results ofoperations.

 

**ITEM 1A.****              ****RISK FACTORS**

 

There are no materialchanges to the risk factors as disclosed in our 2008 Form 10-K.

 

**ITEM 2.****                       ****UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3.****                       ****DEFAULTS UPON SENIORSECURITIES**

 

The filing of theChapter 11 Petition and the Canadian Petition constituted an event ofdefault under our debt obligations, and those debt obligations becameautomatically and immediately due and payable. See Part I, Item 2. “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — Liquidity and CapitalResources.”

 

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**ITEM 4.****                       ****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5.****                       ****OTHER INFORMATION**

 

(a)                                                            There have been no material changes tothe procedures by which security holders may recommend nominees to the Company’sBoard of Directors implemented since the filing of the Company’s QuarterlyReport on Form 10-Q for the quarter ended March 31, 2009.

 

**ITEM 6.****                       ****EXHIBITS**

 

The followingexhibits are included in this Form 10-Q:

 

31.1                                                Certification pursuant to Rules 13a—14(a) and15d—14(a) under the Securities Exchange Act of 1934, as adopted pursuantto Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                                                Certification pursuant to Rules 13a—14(a) and15d—14(a) under the Securities Exchange Act of 1934, as adopted pursuantto 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.

 

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Signature

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                        | SMURFIT-STONE CONTAINER  ENTERPRISES, INC.      |
|-----------------------------|-------------------------------------------------|
|                        | (Registrant)                                    |
|                        |                                            |
|                        |                                            |
| Date: August 10,  2009 | /s/ Paul K.  Kaufmann                           |
|                        | Paul K. Kaufmann                                |
|                        | Senior Vice  President and Corporate Controller |
|                        | (Principal  Accounting Officer)                 |

 

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