**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

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

** **

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

 

**For Quarter Ended September 30, 2004**

** **

**Commission File Number 1-3439**

 

**SMURFIT-STONE CONTAINER 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 of principal  executive offices)                   |   | (Zip Code)                         |
|                                                        |   |                               |
| **(312)  346-6600**                                         |
| (Registrant’s telephone  number, including area code)  |
|                                                        |   |                               |
| **Stone  Container Corporation**                            |
| (Former name, former  address and former fiscal year, if    |
| changed since last  report)                                 |

 

                                                Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes ý    Noo

 

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

 

**APPLICABLE ONLY TO CORPORATEISSUERS:**

 

                                                As of September30, 2004, the registrant had outstanding 1,000 shares of common stock, $.01 parvalue per share, all of which are owned by Smurfit-Stone Container Corporation.

 

 

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**PART I—FINANCIALINFORMATION**

 

**ITEM 1.****                             FINANCIALSTATEMENTS**

 

**STONECONTAINER CORPORATION**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

** **

**(Unaudited)**

 
| ** **                                                                                               | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** |   |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|--------|
|                                                                                                     |       |                                   |       |                                  |   |
|                                                                                                     |       |                                   |       |                                  |   |   |   |   |   |
| **(In millions)**                                                                                        | ** ** | **2004**                               | ** ** | **2003**                              |   | **2004** | ** ** | **2003** |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Net sales                                                                                                |       | **$**                                  | **1,464**  | ** **                            | $      | 1,273 |   | **$** | **4,090** | ** ** | $ | 3,797 |   |
| Costs and expenses                                                                                       |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Cost of goods sold                                                                                       |       | **1,250**                              | ** ** | 1,118                                 |   | **3,619** | ** ** | 3,326 |   |
| Selling and  administrative expenses                                                                     |       | **111**                                | ** ** | 185                                   |   | **340** | ** ** | 418 |   |
| Restructuring charges                                                                                    |       |                                   | ** ** | 2                                     |   | **10** | ** ** | 4 |   |
| (Gain) loss on sale of  assets                                                                           |       | **(3**                                 | **)**      | ** **                            |   | **(3** | **)** | 2 |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Income (loss) from  operations                                                                           |       | **106**                                | ** ** | (32                                   | )      | **124** | ** ** | 47 |   |
| Other income (expense)                                                                                   |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Interest expense, net                                                                                    |       | **(60**                                | **)**      | (58                                   | )      | **(178** | **)** | (178 | ) |
| Gain (loss) from early  extinquishment of debt                                                           |       | **1**                                  | ** ** | ** **                            |   | **1** | ** ** | (1 | ) |
| Other, net                                                                                               |       | **(18**                                | **)**      | ** **                            |   | **(7** | **)** | (33 | ) |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Income (loss) from continuing operations before  income taxes and cumulative effect of accounting change |       | **29**                                 | ** ** | (90                                   | )      | **(60** | **)** | (165 | ) |
| Benefit from (provision  for) income taxes                                                               |       | **(9**                                 | **)**      | 33                                    |   | **28** | ** ** | 71 |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Income (loss) from continuing operations before  cumulative effect of accounting change                  |       | **20**                                 | ** ** | (57                                   | )      | **(32** | **)** | (94 | ) |
| Discontinued operations                                                                                  |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Income from discontinued operations, net of income taxes  of $4                                          |       |                                   | ** ** |                                  |   |   | ** ** | 6 |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Income (loss) before cumulative effect of accounting  change                                             |       | **20**                                 | ** ** | (57                                   | )      | **(32** | **)** | (88 | ) |
| Cumulative effect of  accounting change                                                                  |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Asset retirement obligations, net of income tax  benefit of $1                                           |       |                                   | ** ** |                                  |   |   | ** ** | (2 | ) |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
| Net income (loss)                                                                                        |       | **$**                                  | **20**     | ** **                            | $      | (57 | ) | **$** | **(32** | **)** | $ | (90 | ) |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |
|                                                                                                     |       |                                   | ** ** |                                  |   |   | ** ** |   |   |

 

See notes toconsolidated financial statements.

 

1

----

 

**STONE CONTAINER CORPORATION**

** **

**CONSOLIDATED BALANCE SHEETS**

 
| **(In millions, except  share data)**                                                    | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| ** **                                                                               | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| **Assets**                                                                               |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| Current assets                                                                           |       |                    |       |                   |       |
| Cash and cash  equivalents                                                               | ** ** | **$**                   | **3**      | ** **             | $          | 4 |   |
| Accounts receivable,  less allowances of $20 in 2004 and $25 in 2003                     | ** ** | **287**                 | ** ** | 233                    |       |
| Inventories                                                                              |       |                    | ** ** |                   |       |
| Work-in-process and  finished goods                                                      | ** ** | **163**                 | ** ** | 163                    |       |
| Materials and supplies                                                                   | ** ** | **372**                 | ** ** | 334                    |       |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| ** **                                                                               |       | **535**                 | ** ** | 497                    |       |
| Deferred income taxes                                                                    | ** ** | **149**                 | ** ** | 136                    |       |
| Prepaid expenses and  other current assets                                               | ** ** | **60**                  | ** ** | 41                     |       |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| Total current assets                                                                     | ** ** | **1,034**               | ** ** | 911                    |       |
| Net property, plant and  equipment                                                       | ** ** | **3,428**               | ** ** | 3,561                  |       |
| Timberland, less timber  depletion                                                       | ** ** | **42**                  | ** ** | 42                     |       |
| Goodwill                                                                                 | ** ** | **3,117**               | ** ** | 3,117                  |       |
| Other assets                                                                             | ** ** | **208**                 | ** ** | 225                    |       |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| ** **                                                                               |       | **$**                   | **7,829**  | ** **             | $          | 7,856 |   |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| **Liabilities  and Stockholder’s Equity**                                           |       |                    | ** ** |                   |       |
|                                                                                     |       |                    | ** ** |                   |       |
| Current liabilities                                                                      |       |                    | ** ** |                   |       |
| Current maturities of  long-term debt                                                    | ** ** | **$**                   | **6**      | ** **             | $          | 17 |   |
| Accounts payable                                                                         | ** ** | **379**                 | ** ** | 306                    |       |
| Accrued compensation  and payroll taxes                                                  | ** ** | **112**                 | ** ** | 113                    |       |
| Interest payable                                                                         | ** ** | **38**                  | ** ** | 78                     |       |
| Other current  liabilities                                                               | ** ** | **139**                 | ** ** | 106                    |       |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| Total current  liabilities                                                               | ** ** | **674**                 | ** ** | 620                    |       |
| Long-term debt, less  current maturities                                                 | ** ** | **3,256**               | ** ** | 3,211                  |       |
| Other long-term  liabilities                                                             | ** ** | **634**                 | ** ** | 696                    |       |
| Deferred income taxes                                                                    | ** ** | **547**                 | ** ** | 581                    |       |
| Stockholder’s equityj                                                               |       |                    | ** ** |                   |       |
| Common stock, par value  $.01 per share; 1,000 shares authorized, issued and outstanding |       |                    | ** ** |                   |       |
| Additional paid-in  capital                                                              | ** ** | **3,016**               | ** ** | 3,016                  |       |
| Retained earnings  (deficit)                                                             | ** ** | **(181**                | **)**      | (149                   | )          |
| Accumulated other  comprehensive income (loss)                                           | ** ** | **(117**                | **)**      | (119                   | )          |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| Total stockholder’s  equity                                                         | ** ** | **2,718**               | ** ** | 2,748                  |       |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |
| ** **                                                                               |       | **$**                   | **7,829**  | ** **             | $          | 7,856 |   |
|                                                                                     |       |                    |       |                   |       |
|                                                                                     |       |                    |       |                   |       |

 

See notes to consolidatedfinancial statements.

 

2

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**STONECONTAINER CORPORATION**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

** **

**(Unaudited)**

 
| **Nine months ended  September 30, (In millions)**                                           | ** ** | **2004** | ** ** | **2003**   |   |
|----------------------------------------------------------------------------------------------|------------|----------|------------|------------|--------|
|                                                                                         |       |     |       |       |   |
|                                                                                         |       |     |       |       |   |
| **Cash  flows from operating activities**                                                    |       |     | ** ** |       |   |
| Net loss                                                                                     | ** ** | **$**    | **(32**    | **)**      | $      | (90 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities:             |       |     | ** ** |       |   |
| (Gain) loss from early  extinquishment of debt                                               | ** ** | **(1**   | **)**      | 1          |   |
| Cumulative effect of  accounting change for asset retirement obligations                     |       |     | ** ** | 3          |   |
| Depreciation and  amortization                                                               | ** ** | **206**  | ** ** | 208        |   |
| Amortization of  deferred debt issuance costs                                                | ** ** | **5**    | ** ** | 4          |   |
| Deferred income taxes                                                                        | ** ** | **(40**  | **)**      | (81        | )      |
| Pension and  postretirement benefits                                                         | ** ** | **(22**  | **)**      | 6          |   |
| Non-cash restructuring  charges                                                              | ** ** | **5**    | ** ** |       |   |
| Non-cash foreign  currency losses                                                            | ** ** | **9**    | ** ** | 38         |   |
| Change in current  assets and liabilities, net of effects from acquisitions and dispositions |       |     | ** ** |       |   |
| Accounts receivable                                                                          | ** ** | **(58**  | **)**      | 41         |   |
| Inventories                                                                                  | ** ** | **(38**  | **)**      | 11         |   |
| Prepaid expenses and  other current assets                                                   | ** ** | **(14**  | **)**      | (14        | )      |
| Accounts payable and  other current liabilities                                              | ** ** | **64**   | ** ** | 43         |   |
| Interest payable                                                                             | ** ** | **(40**  | **)**      | (46        | )      |
| Other, net                                                                                   | ** ** | **(9**   | **)**      | (9         | )      |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| Net cash provided by  operating activities                                                   | ** ** | **35**   | ** ** | 115        |   |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| **Cash  flows from investing activities**                                                    |       |     | ** ** |       |   |
| Expenditures for  property, plant and equipment                                              | ** ** | **(83**  | **)**      | (85        | )      |
| Proceeds from sales of  assets                                                               | ** ** | **15**   | ** ** | 204        |   |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| Net cash provided by  (used for) investing activities                                        | ** ** | **(68**  | **)**      | 119        |   |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| **Cash  flows from financing activities**                                                    |       |     | ** ** |       |   |
| Proceeds from long-term  debt                                                                | ** ** | **200**  | ** ** |       |   |
| Net repayments of debt                                                                       | ** ** | **(164** | **)**      | (215       | )      |
| Deferred debt issuance  costs                                                                | ** ** | **(4**   | **)**      |       |   |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| Net cash provided by  (used for) financing activities                                        |       | **32**   | ** ** | (215       | )      |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| Effect of exchange rate  changes on cash                                                     |       |     | ** ** | (2         | )      |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| **Increase  (decrease) in cash and cash equivalents**                                        |       | **(1**   | **)**      | 17         |   |
| Cash and cash  equivalents                                                                   |       |     | ** ** |       |   |
| Beginning of period                                                                          | ** ** | **4**    | ** ** | 3          |   |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |
| End of period                                                                                | ** ** | **$**    | **3**      | ** ** | $      | 20 |   |
|                                                                                         |       |     | ** ** |       |   |
|                                                                                         |       |     | ** ** |       |   |

 

See notes toconsolidated financial statements.

 

3

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**STONECONTAINER CORPORATION**

** **

**Notes to Consolidated Financial Statements**

 

(Tabularamounts in millions)

 

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

 

                                                Theaccompanying consolidated financial statements and notes thereto of StoneContainer Corporation (“Stone” or the “Company”) have been prepared inaccordance with the instructions to Form 10-Q and reflect all adjustments whichmanagement believes necessary (which include only normal recurring accruals) topresent fairly the Company’s financial position, results of operations and cashflows.  These statements, however, do notinclude all information and footnotes necessary for a complete presentation offinancial position, results of operations and cash flows in conformity withgenerally accepted accounting principles. Interim results may not necessarily be indicative of results which maybe expected for any other interim period or for the year as a whole.  These financial statements should be read inconjunction with the audited consolidated financial statements and footnotesincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2003 (“10-K”), filed March 3, 2004, with the Securities andExchange Commission.

 

                                                TheCompany is a wholly-owned subsidiary of Smurfit-Stone Container Corporation (“SSCC”)and has domestic and international operations.

 

                                                Priorto November 1, 2004, SSCC also owned 100% of the common equity interest inJSCE, Inc. (“JSCE”).  JSCE owned 100% ofthe common equity interest in Jefferson Smurfit Corporation (U.S.) (“JSC(U.S.)”)and was the guarantor of the senior indebtedness of JSC(U.S.).  JSC(U.S.) had operations throughout theUnited States.  SSCC had no operationsother than its investments in JSCE and the Company.

 

                                                OnNovember 1, 2004, JSCE merged with and into JSC(U.S.), with JSC(U.S.) as thesurviving company, and then JSC(U.S.) merged with and into the Company, withthe Company as the surviving entity (the “Merger”).  The Company was then renamed Smurfit-StoneContainer Enterprises, Inc. (“SSCE”) (See Note 19).

 

**2.****                                      Reclassifications**

 

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

 

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

 

                                                Employeesof the Company participate in SSCC’s 1998 and 2004 Long-Term Incentive Planwhich reserves shares of SSCC common stock for non-qualified stock options,restricted stock units and performance awards.

 

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

 

4

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                                                Thefollowing table illustrates the effect on net income (loss) if the fair valuebased method had been applied to all outstanding and unvested awards under the1998 and 2004 SSCC Long-Term Incentive Plan in each period.

 
| ** **                                                                                                                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |
| ** **                                                                                                                                    | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |   |   |
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss), as  reported                                                                                                               |       | $                                     |  20   |                                 | $          | (57 | ) | $ | (32 | ) | $ | (90 | ) |
| Add: Stock-based  employee compensation expense included in reported net income (loss), net of  related tax effects                           |       |                                  |       |                                 |       | 2 |   | 1 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (2                                    | )          | (2                                   | )          | (6 | ) | (5 | ) |
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |   |   |
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |   |   |
| Pro forma net income  (loss)                                                                                                                  |       | $                                     | 18         |                                 | $          | (59 | ) | $ | (36 | ) | $ | (94 | ) |
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |   |   |
|                                                                                                                                          |       |                                  |       |                                 |       |   |   |   |   |

 

**4.****                                      DiscontinuedOperations**

 

                                                In December 2002, the Company reachedagreements with an affiliate of Jefferson Smurfit Group (“JS Group”), formerlySSCC’s largest stockholder, to exchange, in two separate transactions, itsEuropean packaging operations for JS Group’s 50% ownership in Smurfit-MBI, aCanadian packaging business, and a payment from JS Group of approximately $189million.  The Company recorded a loss ondisposition of discontinued European operations of $40 million arising from aprovision for taxes on the disposition during the fourth quarter of 2002.  Net sales for the European operations were$192 million for the three months ended March 31, 2003.  The results of operations from the Europeanoperations were reclassified as discontinued operations.

 

                                                On March 31, 2003, the Company completedthese exchange transactions, resulting in no additional adjustments to theCompany’s results of operations. Previously, the Company owned 50% of Smurfit-MBI, and as a result of thecompleted transactions now owns 100% of Smurfit-MBI.  Smurfit-MBI operates 16 converting facilitiesin Canada and employs approximately 2,500 hourly and salaried employees.  The results of operations have been includedin the consolidated statements of operations after March 31, 2003.  The cost to acquire the remaining 50% ofSmurfit-MBI of $137 million, including $26 million of debt assumed, wasallocated to the assets acquired and liabilities assumed according to fairvalues.  The purchase price allocationresulted in acquired goodwill of $94 million, including a reclassification of$52 million associated with the Company’s original 50% investment, andintangible assets of $45 million which were allocated to the Containerboard andCorrugated Containers segment.

 

**5.****                                      Transfersof Financial Assets**

 

                                                OnMarch 30, 2004, the Company, through Smurfit-MBI, entered into an accountsreceivable securitization program whereby the Company sells, without recourse,on an ongoing basis, certain of its Canadian accounts receivable to a trust inwhich the Company holds a variable interest, but is not the primarybeneficiary.  Accordingly, underFinancial Accounting Standards Board (“FASB”) Interpretation No. 46,“Consolidation of Variable Interest Entities,” accounts receivable sold to thetrust, for which the Company is not the primary beneficiary, are not includedin the accompanying consolidated balance sheet. The Company has retained servicing responsibilities and a subordinatedinterest in future cash flows from the receivables.  The Company receives rights to future cashflows arising after the investors in the securitization trust have received thereturn for which they have contracted. The investors and securitization trust have no recourse to the Company’sother assets, except the Company’s subordinated interest, for failure ofdebtors to pay when due.

 

5

----

 

                                                AtSeptember 30, 2004, $67 million of accounts receivable had been sold under theprogram, of which $24 million was retained by the Company as a subordinatedinterest and recorded in accounts receivable in the accompanying consolidatedbalance sheet.

 

**6.****                                      AssetRetirement Obligations**

 

                                                EffectiveJanuary 1, 2003, the Company adopted SFAS No. 143, “Accounting for AssetRetirement Obligations.”  SFAS No. 143establishes accounting standards for the recognition and measurement of anasset retirement obligation and its associated asset retirement cost.  It also provides accounting guidance forlegal obligations associated with the retirement of tangible long-livedassets.  The Company’s asset retirementobligations relate primarily to environmental requirements upon closure of anoperating facility.  Certain of theCompany’s facilities have indeterminate lives because they are expected toremain in operation for the foreseeable future. Consequently, the asset retirement obligations related to thesefacilities cannot be reasonably estimated.

 

                                                Uponadoption of SFAS No. 143, the Company recorded an increase in net property,plant and equipment of $1 million, an asset retirement obligation liability of$4 million and a charge for the cumulative effect of an accounting change of $2million, net of income taxes of $1 million. The net cumulative effect charge reflected the offset of a $5 millionaccrual recorded under the Company’s previous accounting for landfills.

 

**7.****                                      Restructuringand Exit Liabilities**

 

                                                As partof the Company’s continued overall strategy to rationalize operations and cutcosts in response to market conditions, the Company closed three convertingfacilities and exited its Indonesian operations resulting in restructuringcharges of zero and $10 million for the three and nine months ended September30, 2004.  The assets of these facilitieswere adjusted to the estimated net realizable value resulting in a $5 millionnon-cash write-down.  The remainingcharges are primarily for severance and benefits resulting from approximately435 employees being terminated.  The netsales and operating losses of these facilities in 2004 prior to closure were$12 million and $2 million, respectively. The net sales and operating losses of these facilities for the yearended December 31, 2003 were $51 million and $5 million, respectively.  The Company had $1 million and $5 million ofcash disbursements related to these charges for the three and nine months endedSeptember 30, 2004.

 

                                                TheCompany recorded restructuring charges of $2 million during the first quarterof 2003 related to the closure of a converting facility and $2 million duringthe third quarter of 2003 related to severance costs within the Containerboardand Corrugated Containers segment as a result of its rationalization and costreduction plan.

 

                                                AtDecember 31, 2003, the Company had $27 million of exit liabilities related torestructuring of operations.  The Companyhad $3 million and $9 million of cash disbursements related to these exitliabilities for the three and nine months ended September 30, 2004,respectively.

 

**8.****                                      Gainon Sale of Assets**

 

                                                TheCompany recorded a gain on sale of assets of $3 million in the third quarter of2004 for the termination of its distribution rights for flexible intermediatebulk containers.  The net sales andoperating profit for this business in 2004 prior to disposal were $28 millionand $1 million, respectively.  The netsales and operating profit for this business for the year ended December 31,2003 were $36 million and $1 million, respectively.  This business was part of the ConsumerPackaging segment.

 

6

----

 

**9.****                                      Other,Net**

 

                                                For thethree and nine months ended September 30, 2004, the Company recorded foreigncurrency exchange losses of $19 million and $9 million, respectively, relatedto its operations in Canada.  For thethree and nine months ended September 30, 2003, the Company recorded foreigncurrency exchange losses of $1 million and $37 million, respectively, relatedto its operations in Canada.

 

**10.****                               Long-TermDebt**

 

                                                TheCompany refinanced its bank credit agreement, effective November 1, 2004 inconnection with the Merger with JSC(U.S.) (see Note 19).

 

                                                InJuly 2004, the Company, through a wholly-owned subsidiary, completed anoffering of $200 million of 7.375% unsecured senior notes due 2014.  The Company used the proceeds of thisissuance to redeem the $185 million aggregate principal 11.5% senior notes dueAugust 15, 2006, prepay approximately $13 million of secured Tranche B termloan outstanding under its credit agreement, and to pay fees and other expensesof approximately $2 million related to this transaction.  A gain of $1 million was recorded due to theearly extinguishment of debt.

 

                                                InApril 2004, the Company obtained an amendment from its lender group easingcertain financial covenant requirements under its bank credit agreement as ofMarch 31, 2004, and for future periods through December 31, 2004.

 

                                                InMarch 2004, the Company used $38 million of proceeds received from theSmurfit-MBI securitization program (See Note 5) primarily to prepay a portionof its outstanding Tranche C term loan.

 

                                                InMarch 2003, the Company repaid $190 million of the Tranche C term loan and $7million of the Tranche B term loan from proceeds received from the sale of theEuropean operations (See Note 4) and other asset sales.  A loss of $1 million was recorded due to theearly extinguishment of debt.

 

**11.****                               Guarantees**

 

                                                EffectiveJanuary 1, 2003, the Company adopted FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others,” which clarifies and expands on existingdisclosure requirements for guarantees and requires the Company to recognize aliability for the fair value of its obligations under that guarantee.

 

                                                TheCompany has certain woodchip processing contracts, entered into prior toJanuary 1, 2003, extending from 2012 through 2018 with minimum purchasecommitments.  As part of the agreements,the Company guarantees the third party contractor’s debt outstanding and has asecurity interest in the chipping equipment. At September 30, 2004, the maximum potential amount of future paymentsrelated to these guarantees is approximately $23 million, which decreasesratably over the life of the contracts. Proceeds from the liquidation of the chipping equipment would be basedon current market conditions and the Company may not recover in full theguarantee payments made.

 

**12.****                               EmployeeBenefit Plans**

 

                                                TheCompany participates in the SSCC sponsored noncontributory defined benefitpension plans covering substantially all employees.  The defined benefit plans of the Company arecombined with defined benefit plans of JSC(U.S.).  The Company also sponsors noncontributory andcontributory defined benefit pension plans for its Canadian operations.

 

7

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                                                TheCompany’s postretirement plans provide certain health care and life insurancebenefits for all salaried as well as certain hourly employees.

 

                                                Thecomponents of net periodic benefit costs for the defined benefit plans and thecomponents of the postretirement benefit costs are as follows:

 
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
|                                          |       |                                  |       |                                 |       |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                    | ** ** | **Defined Benefit  Plans**            | ** ** | **Postretirement   Plans**           | ** ** | **Defined Benefit  Plans** | ** ** | **Postretirement  Plans** | ** ** |
|                                          |       |                                  |       |                                 |       |   |   |   |   |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                    | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Service cost                                  |       | $                                     | 10         |                                 | $          | 9 |   | $ | 1 |   | $ | 1 |   | $ | 31 |   | $ | 27 |   | $ | 3 |   | $ | 3 |   |
| Interest cost                                 |       | 25                                    |       | 24                                   |       | 2 |   | 3 |   | 75 |   | 71 |   | 7 |   | 8 |   |
| Expected return on plan  assets               |       | (24                                   | )          | (21                                  | )          |   |   |   |   | (71 | ) | (63 | ) |   |   |   |   |
| Amortization of  prior service cost (benefit) |       | 2                                     |       | 1                                    |       |   |   |   |   | 3 |   | 3 |   | (1 | ) | (1 | ) |
| Amortization of net  loss                     |       | 6                                     |       | 4                                    |       | 1 |   | 1 |   | 18 |   | 12 |   | 2 |   | 2 |   |
| Multi-employer plans                          |       | 2                                     |       | 2                                    |       |   |   |   |   | 6 |   | 6 |   |   |   |   |   |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net periodic benefit  cost                    |       | $                                     | 21         |                                 | $          | 19 |   | $ | 4 |   | $ | 5 |   | $ | 62 |   | $ | 56 |   | $ | 11 |   | $ | 12 |   |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                          |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |

 

                                                TheCompany’s 2004 expected contributions to its qualified defined benefit plans,non-qualified defined benefit plans and postretirement plans are not expectedto be materially different from the amounts disclosed at December 31, 2003.

 

                                                InDecember 2003, the Medicare Prescription Drug, Improvement and ModernizationAct of 2003, (the “Act”) was enacted. The Act introduced a prescription drug benefit under Medicare Part D aswell as a federal subsidy to sponsors of retiree health care benefit plans thatprovide a benefit that is at least actuarially equivalent to Medicare PartD.  Under FASB Financial Staff Position(“FSP”) 106-1, issued in January 2004, related to the Act, the Company electedto defer recognizing the effects of the Act on its accumulated postretirementbenefit obligation (“APBO”) and net periodic postretirement benefit costs untilpending authoritative guidance on the accounting for the federal subsidy wasissued.

 

                                                In May2004, the FASB issued FSP 106-2, which provides guidance on the accounting forthe effects of the Act and also requires employers to provide certaindisclosures provided by the Act.  TheCompany has determined that certain of its plans are actuarially equivalent toMedicare Part D and estimates the impact of the Act would reduce its APBO as ofDecember 31, 2003 by approximately $9 million. In accordance with FSP 106-2, the Company reduced postretirement benefitcosts by $1 million in the third quarter of 2004.

 

**13.****                               Non-ConsolidatedAffiliates**

 

                                                TheCompany has several non-consolidated affiliates that are engaged in paper andpackaging operations that are accounted for under the equity method.

 

                                                Priorto the Company’s acquisition of the remaining 50% interest from JS Group onMarch 31, 2003, (See Note 4), Smurfit-MBI was accounted for as an equity affiliate and, as such, isincluded in the 2003 summarized financial information below.  Smurfit-MBI had net sales of $110 million forthe three months ended March 31, 2003.

 

                                                In July2004, the Company acquired the remaining 51% interest of an affiliate for $1million.  In connection with this acquisition,the Company wrote-off receivables due from the affiliate of $5 million.  The allowance

 

8

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for doubtful accounts wasalso reduced as the receivables due from the affiliate were reserved for in prioryears.

 

                                                Combinedsummarized financial information for all of the Company’s non-consolidatedaffiliates that are accounted for under the equity method of accounting is asfollows:

 
| ** **                                                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                     |       |                                  |       |                                 |       |
|                                                                     |       |                                  |       |                                 |       |
| ** **                                                               | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                     |       |                                  |       |                                 |       |   |   |   |   |
|                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Results of  operations                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Net sales                                                                |       | $                                     | 66         |                                 | $          | 58 |   | $ | 192 |   | $ | 269 |   |
| Cost of sales                                                            |       | 55                                    |       | 52                                   |       | 162 |   | 238 |   |
| Income before income  taxes, minority interest and extraordinary charges |       | 3                                     |       | 1                                    |       | 8 |   | 11 |   |
| Net income                                                               |       | 2                                     |       | 1                                    |       | 5 |   | 11 |   |
|                                                                          |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |

 

**14.****                               DerivativeInstruments and Hedging Activities**

 

                                                SFASNo. 133, “Accounting for Derivative Instruments and Hedging Activities,” asamended by SFAS No. 137, SFAS No. 138 and SFAS No. 149, requires that all derivativesbe recorded on the consolidated balance sheets at fair value.  Changes in the fair value of derivatives notqualifying as hedges are recorded each period in earnings. Changes in the fairvalue of derivatives qualifying as hedges are either offset against the changein fair value of the hedged item through earnings or recognized in OtherComprehensive Income (“OCI”) until the hedged item is recognized in earnings,depending on the nature of the hedge. The ineffective portion of the change infair value of all derivatives is recognized in earnings. Hedges related toanticipated transactions are designated and documented at hedge inception ascash flow hedges and evaluated for hedge effectiveness quarterly.

 

                                                TheCompany’s derivative instruments and hedging activities relate to minimizingexposure to fluctuations in the price of commodities used and sold in itsoperations and the movement in foreign currency exchange rates and aredesignated as cash flow hedges.

 

**Commodity Futures Contracts**

 

                                                TheCompany uses exchange traded futures contracts to manage fluctuations in cashflows resulting from commodity price risk in the procurement of naturalgas.  The objective is to fix or cap theprice of a portion of the Company’s forecasted purchases of natural gas used inthe manufacturing process. The changes in the market value of such contractshave historically been, and are expected to continue to be, highly effective atoffsetting changes in price of the hedged item. As of September 30, 2004, the maximum length of time over which theCompany is hedging its exposure to the variability in future cash flowsassociated with natural gas forecasted transactions is approximately 2years.  For the three and nine monthsended September 30, 2004, the Company reclassified an immaterial amount fromOCI to cost of goods sold when the hedged items were recognized.  For the three and nine months ended September30, 2003, the Company reclassified an immaterial amount and a $1 million gain(net of tax), respectively, from OCI to cost of goods sold when the hedgeditems were recognized.

 

                                                Thefair value of the Company’s futures contracts at September 30, 2004 is a $7million gain included in other current assets. For the three and nine months ended September 30, 2004, the Companyrecorded gains of $3 million and $2 million, respectively, in cost of goodssold related to the settlement and the change in fair value of natural gasfutures contracts not qualifying for hedge accounting.  For the three and nine months ended September30, 2003, the Company recorded losses of $2 million and $3 million,respectively, in cost of goods sold related to the settlement and the change infair value of natural gas futures contracts not qualifying for hedgeaccounting.

 

9

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**Foreign Currency Forward Contracts**

 

                                                The Companyenters into foreign currency forward contracts with financial institutions topurchase Canadian dollars, primarily to protect against currency exchange riskassociated with expected future cash flows. Contracts typically have maturitiesof one year or less. The fair value of the Company’s foreign currency forwardcontracts at September 30, 2004 is a $6 million gain included in other currentassets.  The change in fair value of thesecontracts is recorded in OCI until the underlying transaction is recorded. Forthe three and nine months ended September 30, 2004, the Company recorded animmaterial amount in cost of goods related to the foreign currency forwardcontracts.  For the three and nine monthsended September 30, 2003, the Company recorded a $9 million gain (net of tax)in cost of goods related to the foreign currency forward contracts.

 

                                                Thecumulative deferred hedge gain on all commodity and foreign currency contractsis $3 million (net of tax) at September 30, 2004.   The Company expects to reclassify $2 million(net of tax) into cost of goods sold during the remainder of 2004.

 

**15.****                               IncomeTaxes**

 

                                                In thesecond quarter of 2003, the Company recorded an income tax benefit of $6million related to the resolution of certain prior year tax matters.

 

**16.****                               ComprehensiveIncome (Loss)**

 

                                                Comprehensiveincome (loss) is as follows:

 
| ** **                                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
|                                              |       |                                  |       |                                 |       |
|                                              |       |                                  |       |                                 |       |
| ** **                                        | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                              |       |                                  |       |                                 |       |   |   |   |   |
|                                              |       |                                  |       |                                 |       |   |   |   |   |
| Net income  (loss)                                |       | $                                     | 20         |                                 | $          | (57 | ) | $ | (32 | ) | $ | (90 | ) |
| Other  comprehensive income (loss), net of tax:   |       |                                  |       |                                 |       |   |   |   |   |
| Net changes in  fair value of hedging instruments |       | 2                                     |       | 3                                    |       | 2 |   | 10 |   |
| Net hedging gain  reclassified into earnings      |       |                                  |       | (9                                   | )          |   |   | (10 | ) |
| Foreign currency  translation adjustment          |       | 1                                     |       |                                 |       |   |   | 25 |   |
|                                              |       |                                  |       |                                 |       |   |   |   |   |
|                                              |       |                                  |       |                                 |       |   |   |   |   |
| Comprehensive  income (loss)                      |       | $                                     | 23         |                                 | $          | (63 | ) | $ | (30 | ) | $ | (65 | ) |
|                                              |       |                                  |       |                                 |       |   |   |   |   |
|                                              |       |                                  |       |                                 |       |   |   |   |   |

 

**17.****                               BusinessSegment Information**

 

                                                TheCompany has two reportable segments: (1) Containerboard and CorrugatedContainers and (2) Consumer Packaging. The Containerboard and Corrugated Containers segment is highlyintegrated.  It includes a system ofmills and plants that produces a full line of containerboard that is convertedinto corrugated containers.  Corrugatedcontainers are used to transport such diverse products as home appliances,electric motors, small machinery, grocery products, produce, books, tobacco andfurniture. The Consumer Packaging segment converts kraft and specialty paperinto multiwall bags, consumer bags, and intermediate bulk containers.  These bags and intermediate bulk containersare designed to ship and protect a wide range of industrial and consumerproducts, including fertilizers, chemicals, concrete and pet and food products.

 

                                                TheCompany evaluates performance and allocates resources based on profit or lossfrom operations before income taxes, interest expense and other non-operatinggains and losses.  The accountingpolicies of the reportable segments are the same as those described in thesummary of significant accounting policies in the Company’s 10-K.  Intersegment sales and transfers are recordedat market prices.

 

10

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                                                TheCompany’s reportable segments are strategic business units that offer differentproducts.  The reportable segments areeach managed separately because they manufacture distinct products.  Other includes corporate related items andone non-reportable segment, International. Corporate related items include expenses not allocated to reportablesegments including corporate expenses, restructuring charges, non-cash foreigncurrency gains or losses and interest expense.

 

                                                Asummary by business segment follows:

 

 
| ** **                        | ** ** | **Container-  board &  Corrugated  Containers** | ** ** | **Consumer  Packaging** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|-----------|------------|-----------|------------|
|                              |       |                                                |       |                    |       |      |       |      |       |
|                              |       |                                                |       |                    |       |      |       |      |       |
| Three months  ended September 30, |       |                                                |       |                    |       |      |       |      |       |
| 2004                              |       |                                                |       |                    |       |      |       |      |       |
| Revenues from  external customers |       | $                                                   | 1,289      |                    | $          | 161       |       | $         | 14         |   | $ | 1,464 |   |
| Intersegment  revenues            |       | 25                                                  |       |                    |       |      |       | 25        |       |
| Segment profit  (loss)            |       | 103                                                 |       | 8                       |       | (82       | )          | 29        |       |
|                              |       |                                                |       |                    |       |      |       |      |       |
| 2003                              |       |                                                |       |                    |       |      |       |      |       |
| Revenues from  external customers |       | $                                                   | 1,113      |                    | $          | 157       |       | $         | 3          |   | $ | 1,273 |   |
| Intersegment  revenues            |       | 26                                                  |       |                    |       |      |       | 26        |       |
| Segment profit  (loss)            |       | 38                                                  |       | 12                      |       | (140      | )          | (90       | )          |
|                              |       |                                                |       |                    |       |      |       |      |       |
| Nine months ended September 30,   |       |                                                |       |                    |       |      |       |      |       |
| 2004                              |       |                                                |       |                    |       |      |       |      |       |
| Revenues from  external customers |       | $                                                   | 3,590      |                    | $          | 481       |       | $         | 19         |   | $ | 4,090 |   |
| Intersegment  revenues            |       | 73                                                  |       |                    |       |      |       | 73        |       |
| Segment profit  (loss)            |       | 138                                                 |       | 27                      |       | (225      | )          | (60       | )          |
|                              |       |                                                |       |                    |       |      |       |      |       |
| 2003                              |       |                                                |       |                    |       |      |       |      |       |
| Revenues from  external customers |       | $                                                   | 3,321      |                    | $          | 470       |       | $         | 6          |   | $ | 3,797 |   |
| Intersegment  revenues            |       | 70                                                  |       |                    |       |      |       | 70        |       |
| Segment profit  (loss)            |       | 124                                                 |       | 29                      |       | (318      | )          | (165      | )          |

 

**18.****                               Contingencies**

 

                                                InNovember 2003, the Company reached an agreement to settle the antitrust classaction cases pending against the Company, which were based on allegations of aconspiracy among containerboard manufacturers in 1993-95.  The Company will make aggregate settlementpayments of $56.5 million, one-half of which was paid in December 2003 and theremainder of which will be paid in January 2005.  All of the other defendants have also enteredinto agreements to settle these class actions; however, most of the defendantsin the class actions continue to be defendants in twelve lawsuits brought onbehalf of numerous parties that have opted out of the class actions to seektheir own recovery.  The Company recordedpretax charges of $77 million in 2003 to accrue for the class action settlementand the estimated liability of the opt-out cases.  The Company believes the liability recordedfor these matters was adequately reserved at September 30, 2004.

 

                                                TheCompany’s past and present operations include activities which are subject tofederal, state and local environmental requirements, particularly relating toair and water quality.  The Company facespotential

 

11

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environmental liabilityas a result of violations of permit terms and similar authorizations that haveoccurred from time to time at its facilities. In addition, the Company faces potential liability for response costs atvarious sites for which it has received notice as being a potentiallyresponsible party (“PRP”) concerning hazardous substance contamination.  The Company’s relative percentage of wastedeposited at these sites is less than 1%. In estimating its reserves for environmental remediation and futurecosts, the Company’s estimated liability reflects only the Company’s expectedshare after consideration for the relative percentage of waste deposited ateach site, the number of other PRPs, the identity and financial condition ofsuch parties and experience regarding similar matters.  As of September 30, 2004, the Company hadapproximately $16 million reserved for environmental liabilities includedprimarily in other long-term liabilities in the consolidated balancesheet.  The Company believes theliability recorded for these matters was adequately reserved at September 30,2004.

 

                                                If allor most of the other PRPs are unable to satisfy their portion of the clean-upcosts at one or more of the significant sites in which the Company is involvedor the Company’s expected share increases, the resulting liability could have amaterial adverse effect on the Company’s consolidated financial condition orresults of operations.

 

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

 

**19.****                               SubsequentEvents**

 

                                                OnNovember 1, 2004, JSCE merged with and into JSC(U.S.), with JSC(U.S.) as thesurviving company, and then JSC(U.S.) merged with and into the Company, withthe Company as the surviving entity, principally to consolidate debt financingactivities of SSCC and its subsidiaries. The Company was then renamed “Smurfit-Stone Container Enterprises, Inc.”.  The Company and JSC(U.S.) were wholly-ownedsubsidiaries of SSCC and, therefore, the historical cost basis of the acquiredentity, JSC(U.S.), carried over into SSCE.  The Merger will not impact the operatingactivities of the merged companies, which will continue to do business as SSCC.

 

                                                Thefollowing table includes selected financial data of SSCE on a combined basisgiving effect to the merger.

 
| ** **                                                   | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
|                                                         |       |                                  |       |                                 |       |
|                                                         |       |                                  |       |                                 |       |
| ** **                                                   | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                         |       |                                  |       |                                 |       |   |   |   |   |
|                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Net sales                                                    |       | $                                     | 2,165      |                                 | $          | 1,944 |   | $ | 6,145 |   | $ | 5,809 |   |
| Income (loss) before cumulative effect of accounting  change |       | 45                                    |       | (59                                  | )          |   |   | (65 | ) |
| Net income  (loss)                                           |       | 45                                    |       | (59                                  | )          |   |   | (70 | ) |
|                                                              |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |

 
| ** **   | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------|------------|-------------------------|------------|------------------------|------------|
|         |       |                    |       |                   |       |
|         |       |                    |       |                   |       |
| Total assets |       | $                       | 10,709     |                   | $          | 10,684 |   |
| Total debt   |       | 4,788                   |       | 4,807                  |       |
| Total equity |       | 2,784                   |       | 2,737                  |       |
|              |            |                         |            |                        |            |  |  |

 

                                                Inconnection with the Merger, SSCE and its subsidiary, Smurfit-Stone ContainerCanada Inc. (“SSC Canada”), as borrowers, and SSCC, as guarantor, entered intoa new credit agreement (the “Credit

 

12

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Agreement”) on November 1, 2004. The Credit Agreement, which refinances and replaces SSCC’s existingcredit agreements in their entirety, provides for (i) a revolving creditfacility of $600 million to SSCE, of which $179 million was borrowed upon theclosing of the Credit Agreement, and (ii) a revolving credit facility of $200million to SSCE and SSC Canada, none of which was borrowed.  The revolving credit facilities includesub-limits for the issuance of letters of credit and swingline loans.  Each of these revolving credit facilitiesterminates on November 1, 2009.  TheCredit Agreement also provides for a Tranche B term loan to SSCE in theaggregate principal amount of $975 million and a Tranche C term loan to SSCCanada in the aggregate principal amount of $300 million.  The term loans are payable in quarterlyinstallments beginning on April 1, 2005 and ending on November 1, 2011.  In addition, the Credit Agreement providesfor a deposit funded letter of credit facility to SSCE of approximately $122million that terminates on November 1, 2010.

 

                                                Theobligations of SSCE under the Credit Agreement are unconditionally guaranteedby SSCC and the material U.S. subsidiaries of SSCE.  The obligations of SSC Canada under theCredit Agreement are unconditionally guaranteed by SSCC, SSCE, the materialU.S. subsidiaries of SSCE and the material Canadian subsidiaries of SSCCanada.  The obligations of SSCE underthe Credit Agreement are secured by a security interest in substantially all ofthe assets and properties of SSCC, SSCE and the material U.S. subsidiaries ofSSCE, by a pledge of all of the capital stock of SSCE and the material U.S.subsidiaries of SSCE and by a pledge of 65% of the capital stock of SSC Canadathat is directly owned by SSCE.  Theobligations of SSC Canada under the Credit Agreement are secured by a securityinterest in substantially all of the assets and properties of SSC Canada andthe material Canadian subsidiaries of SSC Canada, by a pledge of all of thecapital stock of the material Canadian subsidiaries of SSC Canada and by thesame U.S. assets, properties and capital stock that secure SSCE’s obligationsunder the Credit Agreement.

 

                                                TheCredit Agreement contains various covenants and restrictions including, (i)limitations on dividends, redemptions and repurchases of capital stock, (ii)limitations on 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 the Company has excess cashflows, as defined, or receives proceeds from certain asset sales, insurance orincurrence of certain indebtedness.

 

                                                SSCEalso entered into two supplemental indentures pursuant to which SSCE assumedthe obligations of JSC(U.S.) with respect to $700 million in aggregateprincipal amount of JSC(U.S.)’s 8.25% Senior Notes due October 1, 2012 and $300million in aggregate principal amount of JSC(U.S.)’s 7.50% Senior Notes dueJune 1, 2013.

 

                                                SSCEused the proceeds of the Credit Agreement along with $19 million of available cashto repay all outstanding obligations under the existing credit facilities,consisting of approximately $1,013 million of Tranche B term loans, $120million of a Tranche C Canadian term loan and $329 million under the existingrevolving credit facilities, and to pay fees and other expenses ofapproximately $11 million related to this transaction.  A loss of $12 million will be recorded duringthe fourth quarter of 2004 due to the early extinguishment of debt.

 

13

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**ITEM 2.****                                           MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

                                                Someinformation included in this report may contain forward-looking statementswithin the meaning of Section 21 E of the Securities Exchange Act of 1934, asamended.  Although we believe that, inmaking any such statements, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from those projected.When used in this document, the words “anticipates,” “believes,” “expects,” “intends”and similar expressions as they relate to Smurfit-Stone Container Enterprise,Inc. (formerly Stone Container Corporation) or its management, are intended toidentify such forward-looking statements. These forward-looking statements aresubject to numerous risks and uncertainties. There are important factors that could cause actual results to differmaterially from those in forward-looking statements, certain of which arebeyond our control.  These factors, risksand uncertainties include the following:

 

•                                         theimpact of general economic conditions in North America and in other locationsin which we  currently do business;

•                                         generalindustry conditions, including competition and product and raw material prices;

•                                         fluctuationsin interest rates, exchange rates and currency values;

•                                         unanticipatedcapital expenditure requirements;

•                                         legislativeor regulatory requirements, particularly concerning environmental matters;

•                                         accessto capital markets;

•                                         assumptionsrelating to pension and postretirement costs;

•                                         assumptionsrelating to cost savings expected from rationalization;

•                                         fluctuationsin energy cost;

•                                         fluctuationsin wood fiber and reclaimed fiber costs;

•                                         oursubstantial leverage; and

•                                         obtainingrequired consents or waivers of creditors in the event we are unable to satisfycovenants in our debt instruments.

 

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

 

14

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# **RESULTS OF OPERATIONS**

 

# **Overview**

 

                                                We hadnet income of $20 million for the third quarter of 2004. Net sales increased8.4% compared to the second quarter of 2004 and 15.0% compared to the thirdquarter of 2003. The results for the third quarter mark our return toprofitability, reflecting solid improvement in our core business, theContainerboard and Corrugated Containers segment. Profits of our Containerboardand Corrugated Containers segment more than doubled compared to both the secondquarter of 2004 and the third quarter of 2003. Pricing of our containerboardand corrugated container products has increased, operating rates of our papermills have improved and costs were flat compared to the second quarter of 2004.In addition, containerboard shipments were up strongly as a result of thehigher demand. Business fundamentals are strong and inventories remain atrelatively low levels as we begin the fourth quarter.

 

                                                Ourresults improved sequentially each quarter this year, from a net loss of $45million in the first quarter, to a net loss of $7 million for the secondquarter and to a net profit of $20 million in the third quarter. For the ninemonths ended September 30, 2004, we had a net loss of $32 million. Thiscompares to a net loss of $90 million for the same period in 2003. The loss forthe nine months ended September 30, 2003 was negatively impacted by litigationcharges and settlements totaling $66 million. Net sales for the year-to-dateperiod increased 7.7% compared to last year.

 

                                                OnNovember 1, 2004, we were re-named “Smurfit-Stone Container Enterprises, Inc.”(SSCE) in connection with the merger of Jefferson Smurfit Corporation (U.S.)(JSC(U.S.)) with and into us (Merger). See Note 19 of the Notes to ConsolidatedFinancial Statements.

 

**Third Quarter 2004 Compared toThird Quarter 2003**

 
| ** **                                                                                               | ** ** | **Three months ended September  30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                               | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                               | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                               | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                                                                                               | ** ** | ** **                            | ** ** | ** ** | ** ** |
| ** **                                                                                               | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(In millions)**                                                                                        | ** ** | **Net  Sales**                        | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
| ** **                                                                                               | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                               | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Containerboard  and corrugated containers                                                                |       | $                                     | 1,289      |   | $ | 103 |   | $ | 1,113 |   | $ | 38 |   |
| Consumer  packaging                                                                                      |       | 161                                   |       | 8 |   | 157 |   | 12 |   |
| Other operations                                                                                         |       | 14                                    |       | 1 |   | 3 |   |   |   |
|                                                                                                     |       |                                  |       |   |   |   |   |   |   |
|                                                                                                     |       |                                  |       |   |   |   |   |   |   |
| Total segment  operations                                                                                |       | $                                     | 1,464      |   | 112 |   | $ | 1,273 |   | 50 |   |
|                                                                                                     |       |                                  |       |   |   |   |   |   |   |
|                                                                                                     |       |                                  |       |   |   |   |   |   |   |
| Restructuring  charges                                                                                   |       |                                  |       |   |   |   |   | (2 | ) |
| Gain (loss) on  sale of assets                                                                           |       |                                  |       | 3 |   |   |   |   |   |
| Interest  expense, net                                                                                   |       |                                  |       | (60 | ) |   |   | (58 | ) |
| Gain from early  extinguishment of debt                                                                  |       |                                  |       | 1 |   |   |   |   |   |
| Non-cash foreign  currency exchange losses                                                               |       |                                  |       | (19 | ) |   |   | (1 | ) |
| Litigation  charges and settlements                                                                      |       |                                  |       |   |   |   |   | (67 | ) |
| Corporate  expenses and other (1)                                                                        |       |                                  |       | (8 | ) |   |   | (12 | ) |
|                                                                                                     |       |                                  |       |   |   |   |   |   |   |
|                                                                                                     |       |                                  |       |   |   |   |   |   |   |
| Income (loss) from continuing operations before  income taxes and cumulative effect of accounting change |       |                                  |       | $ | 29 |   |   |   | $ | (90 | ) |
|                                                                                                     |       |                                  |       |   |   |   |   |   |   |

 

----

(1)                                  Amountsinclude corporate expenses, corporate charges to segments for working capitalinterest and other expenses not allocated to segments.

 

15

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                                                Theincrease in net sales was due primarily to higher prices and shipments for theContainerboard and Corrugated Containers segment. The change in net sales foreach of our segments is summarized in the chart below:

 
| **(In  millions)**           | ** ** | **Container-  board &  Corrugated  Containers** | ** ** | **Consumer  Packaging** | ** ** | **Other  Operations** | ** ** | **Total**  | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|------------|------------|
| ** **                   | ** ** | ** **                                          | ** ** | ** **              | ** ** | ** **            | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                                          | ** ** | ** **              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Sales price and  product mix |       | $                                                   | 99         |                    | $          | (1                    | )          | $          | 6          |   | $ | 104 |   |
| Sales volume                 |       | 77                                                  |       | 5                       |       | 5                     |       | 87         |       |
|                         |       |                                                |       |                    |       |                  |       |       |       |
|                         |       |                                                |       |                    |       |                  |       |       |       |
| Total                        |       | $                                                   | 176        |                    | $          | 4                     |       | $          | 11         |   | $ | 191 |   |
|                         |       |                                                |       |                    |       |                  |       |       |       |

 

                                                Cost ofgoods sold increased from $1,118 million in 2003 to $1,250 million in 2004 dueprimarily to higher product shipments ($74 million) and higher costs forreclaimed fiber ($8 million) and wood fiber ($5 million). Cost of goods sold asa percent of net sales decreased from 87.8% in 2003 to 85.4% in 2004 dueprimarily to the higher average sales prices.

 

                                                Sellingand administrative expense decreased $74 million compared to last year. Theexpense in 2003 was negatively impacted by litigation charges and settlementsof $67 million. Selling and administrative expense as a percent of net salesdecreased from 14.5% in 2003 to 7.6% in 2004.

 

                                                Werecorded a gain on sale of assets of $3 million in the three and nine monthperiods ended September 30, 2004, for the termination of our distributionrights for  flexible intermediate bulkcontainers. Net sales for this business, which was part of our ConsumerPackaging segment, were $36 million for the year ended December 31, 2003 and$28 million in 2004 prior to the sale.

 

                                                Interestexpense was $60 million in 2004, an increase of $2 million compared to 2003.  The increase was primarily due to higheraverage borrowings ($2 million). Our overall average effective interest rate in2004 was comparable to 2003.

 

                                                Other,net for 2004 included non-cash foreign currency exchange losses of $19 millioncompared to $1 million in 2003.

 

                                                Theprovision for income taxes differed from the amount computed by applying thestatutory U.S. federal income tax rate to income from continuing operationsbefore income taxes and cumulative effect of accounting change due primarily tostate income taxes and the effect of other permanent differences.

 

**Containerboard and CorrugatedContainers Segment**

 

                                                Netsales increased 15.8% compared to last year as a result of higher prices andshipments. Demand for corrugated containers and containerboard was strong inthe third quarter enabling us to implement our second containerboard priceincrease of the year. The related corrugated container price increase announcedto our customers was implemented by the end of the third quarter. Third quarteraverage domestic linerboard prices increased approximately 15% compared to thesecond quarter and approximately 17% compared to the third quarter of 2003. Ouraverage selling price for corrugated containers was up approximately 5%compared to the third quarter of 2003. Corrugated container shipments increased2.0% compared to last year. Third quarter sales prices for our market pulpincreased approximately 3%.

 

                                                Ourcontainerboard mills operated at 96.2% of capacity in the 2004 period, withproduction increasing 10.9% compared to last year. Production of solid bleachedsulfate (SBS) increased by 3.8% and market pulp increased by 25.5%, due in partto timing of maintenance shutdowns. Mill production was negatively impacted bysevere weather conditions in the Southeastern U.S. in the third quarter of thisyear and last year. The storms this year have left the Southeastern U.S.woodlands in poor condition, making harvesting more expensive. These effectswill be felt in the fourth quarter of 2004, negatively impacting the cost oftransportation and wood fiber.

 

16

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                                                Profitsincreased by $65 million due primarily to the higher average sales prices,improvements in our mill operating rates and savings from our restructuringactivities announced in the fourth quarter of 2003.

 

**Consumer Packaging Segment**

 

                                                Netsales increased in 2004 by 2.5% primarily as a result of higher volume for ourflexible and specialty packaging products. Prices of flexible packaging werehigher, but third quarter prices for multiwall bags were lower due primarily tochanges in our product mix.

 

                                                Profitsdecreased by $4 million as a result of the lower average sales prices for multiwall bags, higher employeebenefits and the impact of a fire at the Salt Lake City bag facility ($2million) .

 

**Nine Months 2004 Compared to NineMonths 2003**

 
| ** **                                                                                      | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                      | ** ** |                                |       |   |   |   |   |   | ** ** |
| ** **                                                                                      | ** ** |                                |       |   |   |   |   |   | ** ** |
| ** **                                                                                      | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                                                                      | ** ** | ** **                          | ** ** | ** ** | ** ** |
| ** **                                                                                      | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(In millions)**                                                                               | ** ** | **Net  Sales**                      | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
| ** **                                                                                      | ** ** |                                |       |   |   |   |   |   | ** ** |
| ** **                                                                                      | ** ** |                                |       |   |   |   |   |   | ** ** |
| Containerboard  and corrugated containers                                                       |       | $                                   | 3,590      |   | $ | 138 |   | $ | 3,321 |   | $ | 124 |   |
| Consumer  packaging                                                                             |       | 481                                 |       | 27 |   | 470 |   | 29 |   |
| Other operations                                                                                |       | 19                                  |       | 2 |   | 6 |   |   |   |
|                                                                                            |       |                                |       |   |   |   |   |   |   |
|                                                                                            |       |                                |       |   |   |   |   |   |   |
| Total segment  operations                                                                       |       | $                                   | 4,090      |   | 167 |   | $ | 3,797 |   | 153 |   |
|                                                                                            |       |                                |       |   |   |   |   |   |   |
|                                                                                            |       |                                |       |   |   |   |   |   |   |
| Restructuring  charges                                                                          |       |                                |       | (10 | ) |   |   | (4 | ) |
| Gain (loss) on  sale of assets                                                                  |       |                                |       | 3 |   |   |   | (2 | ) |
| Interest  expense, net                                                                          |       |                                |       | (178 | ) |   |   | (178 | ) |
| Gain (loss) from  early extinguishment of debt                                                  |       |                                |       | 1 |   |   |   | (1 | ) |
| Non-cash foreign  currency exchange losses                                                      |       |                                |       | (9 | ) |   |   | (38 | ) |
| Litigation  charges and settlements, net                                                        |       |                                |       |   |   |   |   | (66 | ) |
| Corporate  expenses and other                                                                   |       |                                |       | (34 | ) |   |   | (29 | ) |
|                                                                                            |       |                                |       |   |   |   |   |   |   |
|                                                                                            |       |                                |       |   |   |   |   |   |   |
| Loss from continuing operations before income taxes  and cumulative effect of accounting change |       |                                |       | $ | (60 | ) |   |   | $ | (165 | ) |
|                                                                                            |       |                                |       |   |   |   |   |   |   |

 

                                                Netsales increased due primarily to our acquisition of the remaining 50% ofSmurfit-MBI on March 31, 2003, higher corrugated containers sales volume andhigher pricing for containerboard. The change in net sales for each of oursegments is summarized in the chart below:

 
| **(In millions)**            | ** ** | **Container-  board &  Corrugated  Containers** | ** ** | **Consumer  Packaging** | ** ** | **Other  Operations** | ** ** | **Total**  | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|------------|------------|
| ** **                   | ** ** | ** **                                          | ** ** | ** **              | ** ** | ** **            | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                                          | ** ** | ** **              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Sales price and  product mix |       | $                                                   | 52         |                    | $          | (4                    | )          | $          | 7          |   | $ | 55 |   |
| Sales volume                 |       | 98                                                  |       | 15                      |       | 6                     |       | 119        |       |
| Smurfit-MBI acquisition      |       | 119                                                 |       |                    |       |                  |       | 119        |       |
|                         |       |                                                |       |                    |       |                  |       |       |       |
|                         |       |                                                |       |                    |       |                  |       |       |       |
| Total                        |       | $                                                   | 269        |                    | $          | 11                    |       | $          | 13         |   | $ | 293 |   |
|                         |       |                                                |       |                    |       |                  |       |       |       |
|                         |       |                                                |       |                    |       |                  |       |       |       |

 

                                                Cost ofgoods sold increased from $3,326 million in 2003 to $3,619 million in 2004 dueprimarily to the acquisition of Smurfit-MBI ($111 million), higher productshipments ($105 million) and higher costs for reclaimed fiber ($19 million) andwood fiber ($19 million). Cost of goods sold as a percent of net salesincreased from 87.6% in 2003 to 88.5% in 2004 due primarily to the higherreclaimed fiber and wood fiber costs.

 

17

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                                                Sellingand administrative expense decreased $78 million compared to last year. Theexpense in 2003 included litigation charges and settlements of $66 million.Selling and administrative expense as a percent of net sales decreased from11.0% in 2003 to 8.3% in 2004.

 

                                                Werecorded restructuring charges of $10 million in 2004 related to the closure ofthree converting facilities and the exit from our Indonesian operation. The assetsof these facilities were adjusted to the estimated net realizable valueresulting in a $5 million non-cash write-down. The remaining charges wereprimarily for severance and benefits resulting from approximately 435 employeesbeing terminated.

 

                                                The 2004restructuring activities are a continuation of Smurfit-Stone’s restructuringstrategy announced in the fourth quarter of 2003 to rationalize operations andcut costs in response to expected future market conditions. Thisrationalization process, when completed, is expected to result in annualsavings of approximately $140 million, a portion of which will be realized byus.  Smurfit-Stone has achieved theplanned reduction of 1,400 positions in its workforce and, for the nine monthsended September 30, 2004, has realized approximately $122 million in savingsfrom the headcount reductions, reduced fixed costs and process improvements.

 

                                                Interestexpense, net for 2004 was comparable to 2003.

 

                                                Other,net for 2004 included non-cash foreign currency exchange losses of $9 millioncompared to losses of $38 million in 2003.

 

                                                Benefitfrom income taxes differed from the amount computed by applying the statutoryU.S. federal income tax rate to loss from continuing operations before incometaxes and cumulative effect of accounting change due primarily to state incometaxes and the effect of other permanent differences.

 

**Containerboard and CorrugatedContainers Segment**

 

                                                Netsales increased 8.1% compared to last year. The increase resulted primarilyfrom higher corrugated container shipments, due in part to the acquisition ofSmurfit-MBI, and higher sales prices. Corrugated container prices, which declined steadily in 2003 and thefirst part of 2004, have increased since their low point in April 2004. For theyear-to-date period, average North American corrugated container prices wereflat, while average domestic linerboard prices were higher by approximately 2%compared to last year. Market pulp prices were approximately 5% higher thanlast year. Shipments of corrugated containers increased 2.2% compared to 2003,exclusive of the Smurfit-MBI acquisition. The increase in corrugated containershipments was negatively impacted by the shutdown of five converting facilitiessince January 2003.

 

                                                Containerboardproduction increased by 3.0% compared to 2003. Our containerboard millsoperated at an average rate of 95.2% of capacity in 2004, as compared to 89.4%in 2003. Production of market pulp increased 11.7%, while kraft paper declined5.2%. Production of SBS decreased by 11.0% due primarily to the timing ofmaintenance shutdowns

 

                                                Profitsincreased by $14 million due primarily to the higher average sales prices,improvements in our mill operating rates and savings from our restructuringactivities announced in the fourth quarter of 2003. The improvements werepartially offset by higher costs of wood fiber ($19 million), reclaimed fiber($19 million) and employee benefits.

 

**Consumer Packaging Segment**

 

                                                Netsales increased in 2004 by 2.3% primarily as a result of higher volume for ourmultiwall, flexible and specialty packaging products. Prices of flexiblepackaging were higher, but prices for multiwall bags were lower due primarilyto changes in our product mix.

 

                                                Profitsdecreased by $2 million as a result of the lower average sales prices formultiwall bags, higher employee benefits and the impact of the fire at the SaltLake City bag facility ($2 million). Profits were favorably impacted bybenefits from cost control efforts implemented since the fourth quarter of2003.

 

18

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**Statistical Data**

 
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | ** **                            | ** ** | ** **                           | ** ** |
| ** **                                    | ** ** | ** **                            | ** ** | ** **                           | ** ** |
| **(In thousands of tons, except  as noted)**  | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mill production                               |       |                                  |       |                                 |       |   |   |   |   |
| Containerboard                                |       | 1,371                                 |       | 1,236                                |       | 3,987 |   | 3,870 |   |
| Kraft paper                                   |       | 54                                    |       | 75                                   |       | 200 |   | 211 |   |
| Market pulp                                   |       | 138                                   |       | 110                                  |       | 412 |   | 369 |   |
| Solid bleached  sulfate                       |       | 27                                    |       | 26                                   |       | 73 |   | 82 |   |
| Corrugated  containers sold (billion sq. ft.) |       | 14.5                                  |       | 14.2                                 |       | 42.6 |   | 40.7 |   |
| Multiwall bags  sold (million bags)           |       | 295                                   |       | 292                                  |       | 868 |   | 859 |   |

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

                                                Thefollowing table summarizes our cash flows for the nine months ended September30,:

 
| **(In millions)**                        | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|------------------------------------------|------------|------------|------------|------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash  provided by (used for):        |       |       |       |       |       |
| Operating  activities                    |       | $          | 35         |       | $          | 115 |   |
| Investing  activities                    |       | (68        | )          | 119        |       |
| Financing  activities                    |       | 32         |       | (215       | )          |
| Effect of  exchange rate changes on cash |       |       |       | (2         | )          |
|                                     |       |       |       |       |       |
|                                     |       |       |       |       |       |
| Net increase (decrease)  in cash         |       | $          | (1         | )          | $          | 17 |   |
|                                     |       |       |       |       |       |

 

**Net Cash Provided By OperatingActivities**

 

                                                Netcash provided by operating activities for the nine months ended September 30,2004 decreased $80 million compared to 2003 due primarily to higher workingcapital levels. Working capital increased $86 million in the first nine monthsof 2004. The improvement in our results compared to last year partially offsetthe increase in working capital. The higher level of working capital in 2004was primarily the result of increases in accounts receivable, which wasimpacted by higher product pricing, and inventories.

 

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

 

                                                Netcash used for investing activities was $68 million for the nine months endedSeptember 30, 2004. The 2003 period included approximately $189 million of cashreceived related to the exchange transactions with Jefferson Smurfit Group (seeNote 4 of the Notes to Consolidated Financial Statements). Expenditures forproperty, plant and equipment were $83 million as compared to $85 million lastyear. The $83 million expended for property, plant and equipment in 2004included $24 million for environmental projects and $59 million for upgrades,modernization and expansion.

 

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

 

                                                Netcash provided by financing activities for the nine months ended September 30,2004, of $32 million included proceeds from long-term debt of $200 million,which was used for net debt payments of $164 million and to fund net cash usedby investing activities.

 

                                                OnMarch 30, 2004, we used $38 million of proceeds received from the Smurfit-MBIsecuritization program primarily to prepay a portion of our Tranche C termloan. See “Off-Balance Sheet Arrangement” below.

 

                                                OnApril 21, 2004, we obtained amendments from our lender groups easingcertain financial covenant requirements under our bank credit agreements as ofMarch 31, 2004, and for future periods through December 31, 2004.

 

                                                On July 20, 2004, Stone Container FinanceCompany of Canada II, a wholly-owned subsidiary of ours, issued $200 million of7.375% unsecured senior notes due 2014. The proceeds were used to redeem at

 

19

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parthe $185 million outstanding aggregate principal amount of 11.5% senior notesdue August 15, 2006, prepay approximately $13 million of outstanding Tranche Bterm loan under the Stone Container credit facility and pay approximately $2million of fees and expenses related to the transaction. We commenced aregistered exchange offer for the notes on October 19, 2004. However, if by April16, 2005, we do not consummate the registered exchange offer for the notes orcause resales of the notes to be declared effective, the interest rate on thenew notes will be increased by 50 basis points per annum until the consummationof a registered exchange offer or a resale registration statement is declaredeffective. We will not receive any proceeds from the exchange offer.

 

                                                OnNovember 1, 2004, JSCE, Inc. merged with and into JSC(U.S.), with JSC(U.S.) asthe surviving entity. JSC(U.S.) then merged into us principally to simplify andconsolidate debt financing activities of Smurfit-Stone and itssubsidiaries.  We were then renamedSmurfit-Stone Container Enterprises, Inc. We and JSC(U.S.) were wholly-owned subsidiaries of Smurfit-Stone  and, therefore, the historical cost basis ofthe acquired entity, JSC(U.S.), carried over into us. The Merger will notimpact the operating activities of the merged companies, which will continue todo business as Smurfit-Stone Container Corporation.

 

                                                In connection with the Merger, we and oursubsidiary, Smurfit-Stone Container Canada Inc. (SSC Canada), as borrowers, andSmurfit-Stone, as guarantor, entered into a new credit agreement (CreditAgreement) on November 1, 2004.  TheCredit Agreement, which refinances and replaces Smurfit-Stone’s existing creditagreements in their entirety, provides for (i) a revolving credit facility of$600 million to SSCE, of which $179 million was borrowed upon the closing ofthe Credit agreement, and (ii) a revolving credit facility of $200 million toSSCE and SSC Canada, none of which was borrowed. The revolving creditfacilities include sub-limits for the issuance of letters of credit andswingline loans. Each of theserevolving credit facilities terminates on November 1, 2009.  The Credit Agreement also provides for aTranche B term loan to us in the aggregate principal amount of $975 million anda Tranche C term loan to SSC Canada in the aggregate principal amount of $300million.  The credit facilities bearinterest at rates selected at our option, equal to LIBOR plus 2.25% oralternate base rate (ABR) plus 1.25%, in the case of the revolving creditfacilities and LIBOR plus 2.00% or ABR plus 1.00%, in the case of the term loanfacilities.  The term loans are payablein quarterly installments beginning on April 1, 2005 and ending on November 1,2011.  In addition, the Credit Agreementprovides for a deposit funded letter of credit facility to us of approximately$122 million that terminates on November 1, 2010.

 

                                                Our obligations under the Credit Agreementare unconditionally guaranteed by Smurfit-Stone and our material U.S.subsidiaries. The obligations of SSC Canada under the Credit Agreement areunconditionally guaranteed by Smurfit-Stone, us, our material U.S. subsidiariesand the material Canadian subsidiaries of SSC Canada.  Obligations under the Credit Agreement aresecured by a security interest in substantially all of our assets andproperties and those of Smurfit-Stone and our material U.S. subsidiaries, by apledge of all of our capital stock and our material U.S. subsidiaries and by apledge of 65% of the capital stock of SSC Canada that is directly owned byus.The obligations of SSC Canada under the Credit Agreement are secured by asecurity interest in substantially all of the assets and properties of SSCCanada and the material Canadian subsidiaries of SSC Canada, by a pledge of allof the capital stock of the material Canadian subsidiaries of SSC Canada and bythe same U.S. assets, properties and capital stock that secure our obligationsunder the Credit Agreement.

 

                                                TheCredit Agreement contains various covenants and restrictions including, (i)limitations on dividends, redemptions and repurchases of capital stock, (ii)limitations on 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, or receive proceeds from certain asset sales, insurance or incurrenceof certain indebtedness.

 

                                                We also entered into two supplementalindentures pursuant to which we assumed the obligations of JSC(U.S.) withrespect to $700 million in aggregate principal amount of JSC(U.S.)’s 8.25%Senior Notes due October 1, 2012 and $300 million in aggregate principal amountof JSC(U.S.)’s 7.50% Senior Notes due June 1, 2013.

 

20

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                                                We used the proceeds of the Credit Agreementalong with $19 million of available cash to repay all outstanding obligations under the existing credit agreements,consisting of approximately $1,013 million of Tranche B term loans, $120million of a Tranche C Canadian term loan and $329 million under the existingrevolving credit facilities, and to pay fees and other expenses ofapproximately $11 million related to this transaction.

 

**Future Cash Flows**

 

                                                Aftergiving effect to the Merger and the new bank credit facilities, scheduled debtmaturities, including capital lease payments, for the remainder of 2004 and2005 are $199 million and $18 million, respectively. Scheduled debt maturitiesinclude the JSC(U.S.) Accounts Receivable Securitization Program (JSC(U.S.)Securitization Program), which matures in December 2004. The JSC(U.S.)Securitization Program had an outstanding balance of $197 million at November1, 2004.

 

                                                Weexpect to finalize a new five-year accounts receivable securitization programfor up to $500 million in November 2004, to replace the JSC(U.S.) SecuritizationProgram and our existing accounts receivable securitization program.  Under the new program, we will sell ouraccounts receivable, without recourse, on an ongoing basis to Stone ReceivablesCorporation (SRC), a wholly-owned non-consolidated subsidiary of ours and aqualified special-purpose entity under the provisions of Statement of FinancialAccounting Standards No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities.”  Accordingly, accounts receivable sold to SRCfor which we do not retain an interest, will not be included in ourconsolidated balance sheets. 

 

                                                As ofSeptember 30, 2004, we had authorized commitments for capital expenditures ofapproximately $124 million and JSC(U.S.) had $71 million. On a combined basis,we and JSC(U.S.) intend to hold capital expenditures for 2004 to approximately$225 million.

 

                                                Asdescribed in our annual report on Form 10-K for the year ended December 31,2003 (2003 10-K), our operations, as well as the operations of JSC(U.S.) aresubject to extensive environmental regulation by federal, state and localauthorities.  The United StatesEnvironmental Protection Agency (EPA) has finalized its comprehensive rulegoverning air emissions (Maximum Achievable Control Technology (MACT)) andwater discharges from the pulp, paper and paperboard industry, known as the “ClusterRule.”  In recent years, we havecompleted projects to achieve compliance with the various portions of theCluster Rule.  Based on currentlyavailable information, Smurfit-Stone estimates that its remaining aggregatecompliance cost of the Cluster Rule will be approximately $75 million ($57million for us and $18 million for JSC(U.S.)), of which approximately $25million will be spent in 2004 and the remainder in 2005. In addition, the EPAhas promulgated regulations limiting hazardous air pollutants from industrialboilers (Boiler MACT).  Smurfit-Stone’sestimate of the aggregate compliance cost of Boiler MACT will require spendingapproximately $95 million, the majority of which will be spent in 2005 and2006.

 

                                                We andJSC(U.S.) recorded restructuring charges in 2004 of $10 million and $7 million,respectively, which included $5 million and $5 million, respectively, for exitliabilities. The exit liabilities were principally for severance cost. Duringthe nine months ended September 30, 2004, we incurred cash expenditures of $5million and JSC(U.S.) incurred $3 million for these exit liabilities. Theremaining exit liabilities will be paid in the fourth quarter of 2004.

 

                                                AtDecember 31, 2003, we had $27 million of exit liabilities related to our shareof Smurfit-Stone’s restructuring activities and JSC(U.S.) had $24 million.During the nine months ended September 30, 2004, we incurred cash expendituresof $9 million and JSC(U.S.) incurred $9 million for these exit liabilities. Theremaining cash expenditures in connection with the restructuring activitieswill continue to be funded through operations as originally planned.

 

                                                Asof December 31, 2003, our pension obligations exceeded the fair value ofpension plan assets by $545 million and JSC(U.S.)’s pension obligationsexceeded the fair value of its pension plan assets by $335 million. For thenine months ended September 30, 2004, we contributed $81 million and JSC(U.S.)contributed $68 million to the Smurfit-Stone pension plans. We and JSC(U.S.),on a combined basis,

 

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expect to contribute a total of approximately $170 million in 2004.Future contributions to our pension and other postretirement plans will bedependent upon future changes in discount rates and the earnings performance ofour plan assets.

#  

                                                Weexpect our profitability and cash flow from operations to continue improvingfor the remainder of 2004. As of November 1, 2004, after giving effect to theMerger and the new Credit Agreement, we have unused borrowing capacity of $462million. We expect these cash sources and our anticipated financing activitieswill be sufficient for the next several years to meet our obligations andcommitments, including debt service, pension funding, the litigationsettlement, severance costs and other rationalization expenditures,expenditures related to environmental compliance and other capitalexpenditures.

 

**OFF-BALANCE SHEET ARRANGEMENT**

 

                                                OnMarch 30, 2004, we, through Smurfit-MBI, entered into an accounts receivablesecuritization program whereby we sell, without recourse, on an ongoing basis,certain of our Canadian accounts receivable to a trust in which we hold a variableinterest, but are not the primary beneficiary. Accordingly, accounts receivable sold to the trust, for which we did notretain an interest, are not included in our consolidated balance sheet. AtSeptember 30, 2004, $67 million of accounts receivable had been sold under theprogram, of which $24 million were retained by us as a subordinated interestand recorded in accounts receivable in the accompanying consolidated balancesheet. The investors and securitization trust have no recourse to our other assets,except for our subordinated interest, for failure of debtors to pay when due.

 

**ITEM 3.**                             **QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

###### **                                               **We are exposedto various market risks, including commodity price risk, foreign currency riskand interest rate risk. To manage the volatility related to these risks, weenter into various derivative contracts. The majority of these contracts aresettled in cash. However, such settlements have not had a significant effect onour liquidity in the past, nor are they expected to be significant in thefuture. We do not use derivatives for speculative or trading purposes.

 

**Commodity Price Risk**

 

                                                Weperiodically enter into exchange traded futures contracts to managefluctuations in cash flows resulting from commodity price risk in theprocurement of natural gas. As of September 30, 2004, we had monthly futurescontracts to hedge up to 55% of our expected natural gas requirements throughDecember 2005. Our objective is to fix or cap the price of a portion of our forecastedpurchases of natural gas used in the manufacturing process. See Note 14 of theNotes to Consolidated Financial Statements.

 

**Foreign Currency Risk**

 

                                                Ourprincipal foreign exchange exposure is the Canadian dollar. Assets andliabilities outside the United States are primarily located in Canada. Thefunctional currency for our Canadian operations is the U.S. dollar. Ourinvestments in foreign subsidiaries with a functional currency other than theU.S. dollar are not hedged.

 

                                                TheCanadian dollar, as of September 30, 2004 compared to December 31, 2003,strengthened against the U.S. dollar by 2.2%. We recognized non-cash foreigncurrency exchange losses of $9 million for the nine months ended September 30,2004 and losses of $38 million last year due to the stronger Canadian dollar.

 

                                                Weperiodically enter into foreign exchange forward contracts with financialinstitutions to purchase Canadian dollars in order to protect against currencyexchange risk associated with expected future cash flows. Contracts typicallyhave maturities of approximately one year. As of September 30, 2004, we hadCanadian dollar forward purchase contracts to hedge substantially all of ourrequirements for the months of September 2004 through March 2005 andapproximately 70% for the month of April 2005. Cost of goods sold includes theimpact of the forward purchase contracts that expired in the nine months endedSeptember 30, 2004. See Note 14 of the Notes to Consolidated FinancialStatements.

 

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**Interest Rate Risk**

 

                                                Ourearnings and cash flows are significantly affected by the amount of interest onour indebtedness. Our objective is to protect Stone Container from interestrate volatility and reduce or cap interest expense within acceptable levels ofmarket risk. We may periodically enter into interest rate swaps, caps oroptions to hedge interest rate exposure and manage risk within company policy.Any derivative would be specific to the debt instrument, contract ortransaction, which would determine the specifics of the hedge. There were nointerest rate derivatives outstanding at September 30, 2004.

 

**ITEM 4.****                             CONTROLSAND PROCEDURES**

 

**Evaluation of Disclosure Controlsand Procedures**

 

                                                Ourmanagement, with the participation of our principal executive officer andprincipal financial officer, evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) as of the end of the period covered by this report and haveconcluded that, as of such date, our disclosure controls and procedures wereadequate and effective.

 

**Changes in Internal Control**

 

                                                Wecompleted the implementation of a new company-wide financial system inSeptember 2004. The new financial system is an integrated financial accountingand reporting system for all of  ourNorth American facilities. Its functional areas include general ledger,accounts receivable, accounts payable, fixed assets and financial reporting.The new system was implemented in order to provide us with one common financialaccounting and reporting system, thereby making the financial accounting andreporting process more efficient. We are also in the process of implementing atime management system designed to eliminate manual tracking and recording oflabor expenses. As a result of these implementations, we have updated ourinternal controls to ensure a continuing effective control environment remainsin place, including proper approval of transactions, segregation of duties andappropriate integration and reconciliation processes under the new financialand time management systems. There have not been any other changes in ourinternal controls over financial reporting during the most recent quarter thathave materially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

**PART II—OTHERINFORMATION**

 

**ITEM 1.****                             LEGALPROCEEDINGS**

 

None

 

**ITEM 2.****                             CHANGESIN SECURITIES**

 

None

 

**ITEM 3.****                             DEFAULTSUPON SENIOR SECURITIES**

 

None

 

**ITEM 4.****                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5.****                             OTHERINFORMATION**

 

None

 

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

 

                                                                        Thefollowing exhibits are included in this Form 10-Q:

 

                           31.1                        CertificationPursuant to Rules 13a–14 and 15d–14 under the Securities Exchange Act of 1934,as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

                           31.2                        CertificationPursuant to Rules 13a–14 and 15d–14 under the Securities Exchange Act of 1934,as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

                           32.1                        CertificationPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

                           32.2                        CertificationPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

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Signature

 

                                                Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                               |                  | SMURFIT-STONE  CONTAINER ENTERPRISES, INC. |
|------------------------------------|-----------------------|--------------------------------------------|
|                               |                  | (Registrant)                               |
|                               |                  |                                       |
| Date:  November  8, 2004 | /s/ Paul K.  Kaufmann |
|                               |                  | Paul K. Kaufmann                           |
|                               |                  | *Vice  President and*                      |
|                               |                  | *Corporate  Controller*                    |
|                               |                  | *(Principal  Accounting Officer)*          |

 

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