**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

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

 

**For Quarter Ended September 30, 2005**

 

**Commission File Number 1-3439**

 

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

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                    | ** ** | **36-2041256**                    |
|-----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (IRS Employer Identification No.) |
|                                                            |       |                              |
| **150 North Michigan Avenue, Chicago, Illinois**                |       | **60601**                         |
| (Address of principal executive offices)                        |       | (Zip Code)                        |

 

**(312) 346-6600**

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year,

if changed since last report)

 

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

 

Indicateby check mark if the registrant is an accelerated filer (as defined in Rule 12b-2of the Act).  Yes  o    No  ý

 

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

 

APPLICABLE ONLY TOCORPORATE ISSUERS:

 

As of November 3,2005, the registrant had outstanding 770 shares of common stock, $.01 par valueper share, all of which are owned by Smurfit-Stone Container Corporation.

 

The registrant meets theconditions set forth in General Instruction (H) (1) (a) and (b) ofForm 10-Q and is therefore filing this form with the reduced disclosureformat permitted thereby.

 

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1.    FinancialStatements**

 

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                | ** ** | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In millions)**                         | ** ** | **2005**                                   | ** ** | **2004**                                  |       | **2005** | ** ** | **2004** | ** ** |
| Net sales                                 | ** ** | **$**                                      | **2,103**  |                                      | $          | 2,165 |   | **$** | **6,349** | ** ** | $ | 6,145 |   |
| Costs and expenses                        |       |                                       | ** ** |                                      |       |   | ** ** |   |   |
| Cost of goods  sold                       | ** ** | **1,866**                                  | ** ** | 1,829                                     |       | **5,565** | ** ** | 5,361 |   |
| Selling and  administrative expenses      | ** ** | **188**                                    | ** ** | 190                                       |       | **577** | ** ** | 581 |   |
| Restructuring  charges                    | ** ** | **293**                                    | ** ** | ** **                                |       | **297** | ** ** | 17 |   |
| Loss (gain) on  sale of assets            | ** ** | **1**                                      | ** ** | (3                                        | )          | **1** | ** ** | (3 | ) |
| Income (loss)  from operations            | ** ** | **(245**                                   | **)**      | 149                                       |       | **(91** | **)** | 189 |   |
| Other income (expense)                    |       |                                       | ** ** |                                      |       |   | ** ** |   |   |
| Interest  expense, net                    | ** ** | **(88**                                    | **)**      | (87                                       | )          | **(261** | **)** | (258 | ) |
| Interest income  from SSCC                |       |                                       | ** ** | 21                                        |       |   | ** ** | 62 |   |
| Gain on early  extinguishment of debt     |       |                                       | ** ** | 1                                         |       |   | ** ** | 1 |   |
| Other, net                                | ** ** | **(18**                                    | **)**      | (17                                       | )          | **(20** | **)** | (5 | ) |
| Income (loss)  before income taxes        | ** ** | **(351**                                   | **)**      | 67                                        |       | **(372** | **)** | (11 | ) |
| Benefit from (provision for) income taxes | ** ** | **125**                                    | ** ** | (22                                       | )          | **134** | ** ** | 11 |   |
| Net income  (loss)                        |       | **$**                                      | **(226**   | **)**                                     | $          | 45 |   | **$** | **(238** | **)** | $ |   |   |

 

See notes to consolidatedfinancial statements.

 

1

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

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In millions, except share  data)**                                                                                        | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                                                                                   | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                   |       |                   | ** ** |                  |       |
| ** **                                                                                                                   |       |                   | ** ** |                  |       |
| Current assets                                                                                                               |       |                   | ** ** |                  |       |
| Cash and cash  equivalents                                                                                                   | ** ** | **$**                  | **5**      | ** **            | $          | 6 |   |
| Receivables,  less allowances of $9 in 2005 and $12 in 2004                                                                  | ** ** | **280**                | ** ** | 254                   |       |
| Retained  interest in receivables sold                                                                                       | ** ** | **122**                | ** ** | 158                   |       |
| Inventories,  including amounts valued under LIFO method                                                                     |       |                   | ** ** |                  |       |
| Work-in-process  and finished goods                                                                                          | ** ** | **255**                | ** ** | 265                   |       |
| Materials and  supplies                                                                                                      | ** ** | **492**                | ** ** | 521                   |       |
| ** **                                                                                                                   |       | **747**                | ** ** | 786                   |       |
| Deferred income  taxes                                                                                                       | ** ** | **152**                | ** ** | 142                   |       |
| Prepaid expenses  and other current assets                                                                                   | ** ** | **115**                | ** ** | 60                    |       |
| Total current  assets                                                                                                        | ** ** | **1,421**              | ** ** | 1,406                 |       |
| Net property, plant and equipment                                                                                            | ** ** | **4,276**              | ** ** | 4,638                 |       |
| Timberland, less timber depletion                                                                                            | ** ** | **44**                 | ** ** | 44                    |       |
| Goodwill                                                                                                                     | ** ** | **3,309**              | ** ** | 3,301                 |       |
| Other assets                                                                                                                 | ** ** | **335**                | ** ** | 336                   |       |
| ** **                                                                                                                   |       | **$**                  | **9,385**  | ** **            | $          | 9,725 |   |
| **Liabilities and Stockholder’s Equity**                                                                                |       |                   | ** ** |                  |       |
|                                                                                                                         |       |                   | ** ** |                  |       |
| Current liabilities                                                                                                          |       |                   | ** ** |                  |       |
| Current  maturities of long-term debt                                                                                        | ** ** | **$**                  | **27**     | ** **            | $          | 19 |   |
| Accounts payable                                                                                                             | ** ** | **629**                | ** ** | 604                   |       |
| Accrued  compensation and payroll taxes                                                                                      | ** ** | **187**                | ** ** | 191                   |       |
| Interest payable                                                                                                             | ** ** | **78**                 | ** ** | 95                    |       |
| Other current  liabilities                                                                                                   | ** ** | **176**                | ** ** | 207                   |       |
| Total current  liabilities                                                                                                   | ** ** | **1,097**              | ** ** | 1,116                 |       |
| Long-term debt, less current maturities                                                                                      | ** ** | **4,516**              | ** ** | 4,479                 |       |
| Other long-term liabilities                                                                                                  | ** ** | **1,016**              | ** ** | 1,048                 |       |
| Deferred income taxes                                                                                                        | ** ** | **839**                | ** ** | 966                   |       |
| Stockholder’s equity                                                                                                    |       |                   | ** ** |                  |       |
| Common stock,  par value $.01 per share; 1,000 shares authorized, 770 issued and outstanding  in 2005 and 2004, respectively |       |                   | ** ** |                  |       |
| Additional  paid-in capital                                                                                                  | ** ** | **3,600**              | ** ** | 3,587                 |       |
| Retained  earnings (deficit)                                                                                                 | ** ** | **(1,401**             | **)**      | (1,157                | )          |
| Accumulated  other comprehensive income (loss)                                                                               | ** ** | **(282**               | **)**      | (314                  | )          |
| Total  stockholder’s equity                                                                                             | ** ** | **1,917**              | ** ** | 2,116                 |       |
| ** **                                                                                                                   |       | **$**                  | **9,385**  | ** **            | $          | 9,725 |   |

 

See notes toconsolidated financial statements.

 

2

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| **Nine Months Ended September 30, (In millions)**                                        | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Cash flows from operating activities**                                                      |       |       | ** ** |       |       |
| Net loss                                                                                      | ** ** | **$**      | **(238**   | **)**      | $          |   |
| Adjustments to  reconcile net loss to net cash provided by operating activities               |       |       | ** ** |       |       |
| Gain from early  extinguishment of debt                                                       |       |       | ** ** | (1         | )          |
| Depreciation,  depletion and amortization                                                     | ** ** | **308**    | ** ** | 313        |       |
| Amortization of  deferred debt issuance costs                                                 | ** ** | **7**      | ** ** | 9          |       |
| Deferred income  taxes                                                                        | ** ** | **(159**   | **)**      | (24        | )          |
| Pension and  postretirement benefits                                                          | ** ** | **(33**    | **)**      | (50        | )          |
| Non-cash  restructuring charges                                                               | ** ** | **261**    | ** ** | 7          |       |
| Non-cash foreign  currency losses                                                             | ** ** | **12**     | ** ** | 9          |       |
| Non-cash  interest income from SSCC                                                           |       |       | ** ** | (62        | )          |
| Change in  current assets and liabilities, net of effects from acquisitions and  dispositions | ** ** | ** ** | ** ** |       |       |
| Receivables and  retained interest in receivables sold                                        | ** ** | **9**      | ** ** | (107       | )          |
| Inventories                                                                                   | ** ** | **25**     | ** ** | (41        | )          |
| Prepaid expenses  and other current assets                                                    | ** ** | **1**      | ** ** | (16        | )          |
| Accounts payable  and accrued liabilities                                                     |       | **(12**    | **)**      | 82         |       |
| Interest payable                                                                              | ** ** | **(16**    | **)**      | (21        | )          |
| Other, net                                                                                    | ** ** | **(3**     | **)**      | (3         | )          |
| Net cash  provided by operating activities                                                    | ** ** | **162**    | ** ** | 95         |       |
| **Cash flows from investing activities**                                                      |       |       | ** ** |       |       |
| Expenditures for  property, plant and equipment                                               | ** ** | **(201**   | **)**      | (139       | )          |
| Proceeds from  property and timberland disposals and sale of businesses                       | ** ** | **7**      | ** ** | 20         |       |
| Payments on  acquisitions                                                                     | ** ** | **(5**     | **)**      |       |       |
| Notes receivable  from SSCC                                                                   |       |       | ** ** | 7          |       |
| Net cash used  for investing activities                                                       | ** ** | **(199**   | **)**      | (112       | )          |
| **Cash flows from financing activities**                                                      |       |       | ** ** |       |       |
| Proceeds from  long-term debt                                                                 | ** ** | **72**     | ** ** | 200        |       |
| Net repayments  of debt                                                                       | ** ** | **(29**    | **)**      | (243       | )          |
| Net borrowings  under accounts receivable securitization program                              |       |       | ** ** | 20         |       |
| Dividends paid                                                                                | ** ** | **(6**     | **)**      | (6         | )          |
| Capital contribution  from SSCC                                                               | ** ** | **1**      | ** ** | 50         |       |
| Deferred debt  issuance costs                                                                 | ** ** | **(2**     | **)**      | (4         | )          |
| Net cash provided  by financing activities                                                    | ** ** | **36**     | ** ** | 17         |       |
| **Decrease in cash and cash equivalents**                                                     | ** ** | **(1**     | **)**      |       |       |
| Cash and cash equivalents                                                                     |       |       | ** ** |       |       |
| Beginning of  period                                                                          | ** ** | **6**      | ** ** | 12         |       |
| End of period                                                                                 | ** ** | **$**      | **5**      | ** ** | $          | 12 |   |
|                                                                                               |            |            |            |            |            |  |  |

 

See notes toconsolidated financial statements.

** **

**3**

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** **

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

(Tabular amounts in millions)

 

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

 

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

 

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

 

Prior to November 1,2004, SSCC owned 100% of the equity interest in JSCE, Inc. (“JSCE”) andStone Container Corporation (“Stone”). JSCE owned 100% of the equity interest in Jefferson Smurfit Corporation(U.S.) (“JSC(U.S.)”) and was the guarantor of the senior unsecured indebtednessof JSC(U.S.).  JSCE had no operationsother than its investment in JSC(U.S.). On November 1, 2004, JSCE merged with and into JSC(U.S.), withJSC(U.S.) as the surviving company, and then JSC(U.S.) merged with and intoStone, with Stone as the surviving company (the “Merger”), principally toconsolidate debt financing activities of the Company and its subsidiaries.  Stone was simultaneously renamed SSCE.

 

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

 

Reconciliations of netsales and net income (loss) previously reported by Stone and JSCE to amountsreported in the SSCE consolidated statements of operations are as follows:

 
| ** **   | ** ** | **Three months ended  September 30, 2004** | ** ** | **Nine months ended  September 30, 2004** | ** ** |
|--------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **   | ** ** | **Net Sales**                                   | ** ** | **Net Income**                                 | ** ** | **Net Sales** | ** ** | **Net Income   (Loss)** | ** ** |
|         |       |                                            |       |                                           |       |   |   |   |   |
| Stone        |       | $                                               | 1,464      |                                           | $          | 20 |   | $ | 4,090 |   | $ | (32 | ) |
| JSCE         |       | 1,004                                           |       | 25                                             |       | 2,869 |   | 32 |   |
| Eliminations |       | (303                                            | )          |                                           |       | (814 | ) |   |   |
| SSCE         |       | $                                               | 2,165      |                                           | $          | 45 |   | $ | 6,145 |   | $ |   |   |

 

4

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**2.****     Reclassifications**

 

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

 

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

 

The Company adopted thefair value recognition provisions of Statement of Financial AccountingStandards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,”effective as of January 1, 2003. The Company selected the prospective transition method as allowed inSFAS No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure,” which requires expensing new option grants prospectively,beginning in the year of adoption. Because the prospective transition method was used and awards vest overthree to eight years, the 2004 and 2005 expense is less than what would havebeen recognized if the fair value-based method had been applied to all awardssince the original effective date of SFAS No. 123.

 

The following tableillustrates the effect on net income (loss) if the fair value-based method hadbeen applied to all outstanding and unvested awards in each period.

 
| ** **                                                                                                                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss), as reported                                                                                                                |       | $                                          | (226       | )                                         | $          | 45 |   | $ | (238 | ) | $ |   |   |
| Add: Stock-based  employee compensation expense included in reported net income (loss), net of related  tax effects                           |       | 2                                          |       | 1                                         |       | 5 |   | 4 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value-based  method for all awards, net of related tax effects |       | (4                                         | )          | (3                                        | )          | (10 | ) | (10 | ) |
|                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Pro forma net income (loss)                                                                                                                   |       | $                                          | (228       | )                                         | $          | 43 |   | $ | (243 | ) | $ | (6 | ) |

 

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

 

**4.****     Restructuringand Exit Liabilities**

 

For the nine months endedSeptember 30, 2005, the Company recorded $297 million of restructuringcharges, including total non-cash charges of $261 million.

 

The Company is engaged ina strategic reassessment of its operations. As the first step in this process and in order to better align theCompany’s production capacity with market conditions and demand, during thethird quarter of 2005, the Company permanently closed the New Richmond, Quebeclinerboard mill, the Bathurst, New Brunswick medium mill and the previouslyidled No. 2 paper machine at the Fernandina 

 

5

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Beach, Florida linerboardmill.  The Company’s containerboardmanufacturing capacity was reduced by approximately 700,000 tons, or 8.5% as aresult of these closures.  In addition,the Company initiated a plan to exit its investment in the Groveton, NewHampshire medium mill and exited its investment in the Las Vegas, Nevadaconverting facility.  The Companyrecorded $293 million of restructuring charges, including non-cash charges of$256 million related to the write down of assets, primarily fixed assets, toestimated net realizable value and $3 million related to a pension curtailmentnon-cash charge for terminated employees. The remaining charges were primarily for severance, benefits andpost-closure environmental costs.  Theseshutdowns resulted in approximately 565 employees being terminated.  Additional charges of up to $10 million willbe recorded in future periods for related pension costs.

 

The Company recordedrestructuring charges of zero and $17 million for the three and nine monthsended September 30, 2004, respectively, related to the closure of sevenconverting facilities and exit from its Indonesian operations.

 

At December 31,2004, the Company had $33 million of accrued exit liabilities related to therestructuring of operations.  For thethree and nine months ended September 30, 2005, the Company had $2 millionand $11 million, respectively, of cash disbursements related to these exitliabilities.  In addition, for the threeand nine months ended September 30, 2005, the Company had $6 million ofcash disbursements related to exit liabilities established during 2005.

 

**5.****     Gain on Sale ofAssets**

 

The Company recorded again on sale of assets of $3 million in the third quarter of 2004 for the terminationof its distribution rights for flexible intermediate bulk containers.  The net sales and operating profit for thisbusiness in 2004 prior to disposal were $28 million and $1 million,respectively.  This business was part ofthe Consumer Packaging segment.

 

**6.****     Other, Net**

 

For the three and ninemonths ended September 30, 2005, the Company recorded non-cash foreigncurrency exchange losses of $16 million and $12 million, respectively, relatedto its operations in Canada.  For thethree and nine months ended September 30, 2004, the Company recordednon-cash foreign currency exchange losses of $19 million and $9 million,respectively, related to its operations in Canada.

 

**7.  Accounts Receivable Securitization Programs**

 

At September 30,2005 and December 31, 2004, $626 million and $624 million, respectively,of receivables had been sold under two accounts receivable securitizationprograms, of which the Company retained a subordinated interest.  The off-balance sheet Stone ReceivablesCorporation debt and funding received from the Canadian accounts receivableprogram totaled $492 million and $451 million, respectively, as of those dates.

 

**8.  Long-Term Debt**

 

In the second quarter of2005, the Company issued environmental improvement revenue refunding bonds inthe amount of $72 million.  New bonds inthe principal amount of $30 million were issued at an interest rate of 5.125%and are due in 2013.  New bonds in theprincipal amount of $42 million were issued at an interest rate of 5.25% andare due in 2015.  The proceeds of thesebonds were used to repay revenue refunding bonds at interest rates of 7.875%and 8.25%, respectively.

 

6

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On October 5,2005, the Company and its lending group entered into an amendment to the CreditAgreement to increase the Consolidated Senior Secured Leverage Ratio for theperiod ending September 30, 2005.** **Theother material terms of the Credit Agreement, including interest rate,security, and final maturity, remained the same as under the original CreditAgreement.

 

Subsequent to obtainingthe amendment, the Company determined that it was in compliance with all of theoriginal financial covenants contained in the Credit Agreement at September 30,2005.  However, the Company anticipatesthat its operating performance in the fourth quarter of 2005 will likely resultin the violation of certain financial covenants at December 31, 2005.  As a result, during the fourth quarter of2005, the Company intends to seek an amendment to the Credit Agreement torevise certain of the financial covenants. Although the Company believes that it will obtain such an amendment,failure to obtain the amendment would result in a default under the CreditAgreement if the Company violates any of the financial covenants, which couldresult in a material adverse impact on the Company’s financial condition.

 

**9.  Guarantees**

 

The Company has certainwood chip processing contracts extending from 2010 through 2018 with minimumpurchase commitments.  As part of theagreements, the Company guarantees the third party contractors’ debtoutstanding and has a security interest in the chipping equipment.  At September 30, 2005, the maximumpotential amount of future payments related to these guarantees wasapproximately $37 million and decreases ratably over the life of thecontracts.  In the event the guaranteeson these contracts were called, proceeds from the liquidation of the chippingequipment would be based on current market conditions and the Company may notrecover in full the guarantee payments made.

 

**10.****  Employee BenefitPlans**

 

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

 

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

 

7

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The components of netperiodic benefit costs for the defined benefit plans and the components of thepostretirement 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** | ** ** |
| ** **                                    | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                                  |       | $                                         | 20         |                                     | $          | 17 |   | $ | 2 |   | $ | 2 |   | $ | 61 |   | $ | 53 |   | $ | 6 |   | $ | 5 |   |
| Interest cost                                 |       | 47                                        |       | 45                                       |       | 4 |   | 4 |   | 142 |   | 136 |   | 11 |   | 12 |   |
| Expected return on plan assets                |       | (52                                       | )          | (48                                      | )          |   |   |   |   | (157 | ) | (144 | ) |   |   |   |   |
| Amortization of  prior service cost (benefit) |       | 2                                         |       | 4                                        |       | (1 | ) |   |   | 7 |   | 8 |   | (2 | ) | (1 | ) |
| Amortization of net loss                      |       | 16                                        |       | 12                                       |       | 1 |   | 1 |   | 47 |   | 37 |   | 4 |   | 3 |   |
| Curtailments                                  |       | 3                                         |       | 1                                        |       |   |   |   |   | 3 |   | 3 |   |   |   |   |   |
| Multi-employer plans                          |       | 2                                         |       | 2                                        |       |   |   |   |   | 5 |   | 6 |   |   |   |   |   |
| Net periodic benefit cost                     |       | $                                         | 38         |                                     | $          | 33 |   | $ | 6 |   | $ | 7 |   | $ | 108 |   | $ | 99 |   | $ | 19 |   | $ | 19 |   |

 

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

 

**11.****  DerivativeInstruments and Hedging Activities**

 

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

 

**Commodity Derivative Instruments**

 

The Company uses derivativeinstruments, including fixed price swaps and options, to manage fluctuations incash flows resulting from commodity price risk in the procurement of naturalgas.  The objective is to fix the priceof a portion of the Company’s purchases of natural gas used in themanufacturing process.  The changes inthe market value of such derivative instruments have historically been, and areexpected to continue to be, highly effective at offsetting changes in price ofthe hedged item.  As of September 30,2005, the maximum length of time over which the Company was hedging itsexposure to the variability in future cash flows associated with natural gasforecasted transactions was 27 months. For the three and nine months ended September 30, 2005, the Companyreclassified a $2 million gain (net of tax) and a $1 million gain (net of tax),respectively, from other comprehensive income (“OCI”) to cost of goods soldwhen the hedged items were recognized. For the three and nine months ended September 30, 2004, the Companyreclassified an immaterial amount from OCI to cost of goods sold when thehedged items were recognized.  The fairvalue of the Company’s commodity derivative instruments at September 30,2005 was $73 million, of which $58 million was included in other current assetsand $15 million was included in other assets.

 

For the three and ninemonths ended September 30, 2005, the Company recorded an $8 million gain(net of tax) and an $11 million gain (net of tax), respectively, in cost ofgoods sold related to the change in fair value of certain commodity derivativeinstruments not qualifying for hedge accounting.  For the three and nine months ended September 30,2004, the Company recorded a $3 million gain (net of tax), respectively, incost of goods sold related to the change in fair value of certain commodityderivative instruments not qualifying for hedge accounting.

 

8

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For the three and ninemonths ended September 30, 2005, the Company recorded a $3 million gain(net of tax) and a $2 million gain (net of tax), respectively, in cost of goodssold on settled commodity derivative instruments related to derivativeinstruments not qualifying for hedge accounting.  For the three and nine months ended September 30,2004, the Company recorded an immaterial amount in cost of goods sold onsettled commodity derivative instruments related to derivative instruments notqualifying for hedge accounting.

 

**Foreign Currency Derivative Instruments**

 

The Company’s principalforeign exchange exposure is the Canadian dollar.  The Company uses foreign currency derivativeinstruments, including forward contracts and options, primarily to protectagainst Canadian currency exchange risk associated with expected future cashflows.  As of September 30, 2005,the maximum length of time over which the Company was hedging its exposure tothe variability in future cash flows associated with foreign currency was 15months.  For the three and nine monthsended September 30, 2005, the Company reclassified a $1 million loss (netof tax) and a $1 million gain (net of tax), respectively, from OCI to cost ofgoods sold related to the recognition of the foreign currency derivativeinstruments.  For the three and ninemonths ended September 30, 2004, the Company reclassified an immaterialamount from OCI to cost of goods sold related to the recognition of the foreigncurrency derivative instruments.  Thefair value of the Company’s foreign currency derivative instruments at September 30,2005 was $9 million and was included in other current assets.  The change in fair value of these derivativeinstruments is recorded in OCI until the underlying transaction is recorded.

 

**Interest Rate Swap Contracts**

 

The Company uses interestrate swap contracts to manage interest rate exposure on $300 million of thecurrent Tranche B and Tranche C floating rate bank term debt, effectivelyfixing the interest rate at 4.3%.  Thesecontracts extend until 2011, consistent with the maturity of the Company’sTranche B and Tranche C term loans. Additionally, the Company entered into forward starting interest rateswaps of $225 million during the second quarter of 2005 at a fixed rate of4.75% to eliminate the variability of future interest payments for a ten yearperiod from February 2006 through February 2016.  Changes in the fair value of the interestrate swap contracts are expected to be highly effective in offsetting thefluctuations in the floating interest rate and are recorded in OCI until theunderlying transaction is recorded.  Theaccounting for the cash flow impact of the swap contracts is recorded as anadjustment to interest expense each period. For the three and nine months ended September 30, 2005, the Companyreclassified an immaterial amount and a $2 million loss (net of tax),respectively, from OCI to interest expense when the hedged items wererecognized.  The fair value of theCompany’s interest rate swap contracts at September 30, 2005 was $6million, of which $1 million was included in other current assets and $5million was included in other assets.

 

The cumulative deferredhedge gain on all derivative instruments was $33 million (net of tax) at September 30,2005, including a $27 million gain (net of tax) on commodity derivativeinstruments, a $2 million gain (net of tax) on foreign currency derivativeinstruments and a $4 million gain (net of tax) on interest rate swapcontracts.   The Company expects toreclassify a $23 million gain (net of tax) into cost of goods sold within thenext 12 months, related to the commodity and foreign currency derivativeinstruments.

 

**12.****  Income Taxes**

 

In October 2004, the American JobsCreation Act (the “AJCA”) was signed into law. The AJCA includes a deduction of 85% of certain foreign earnings thatare repatriated, as defined in the AJCA. The Company has completed its evaluation of the effects of therepatriation provision and in October 2005 adopted a Domestic ReinvestmentPlan to repatriate earnings of up to $500 million under this provision, andwill record income taxes of up to $27 million on the amount repatriated duringthe fourth quarter of 2005.

 

9

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**13.****  ComprehensiveIncome (Loss)**

 

Comprehensive income (loss) is asfollows:

 
| ** **                                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)                                 |       | $                                          | (226       | )                                         | $          | 45 |   | $ | (238 | ) | $ |   |
| Other comprehensive income (loss), net of tax:    |       |                                       |       |                                      |       |   |   |   |   |
| Net changes in  fair value of hedging instruments |       | 38                                         |       | 3                                         |       | 39 |   | 3 |   |
| Net hedging gain  reclassified into earnings      |       | (1                                         | )          |                                      |       |   |   |   |   |
| Foreign currency  translation adjustment          |       | (8                                         | )          | 1                                         |       | (7 | ) |   |   |
| Comprehensive income (loss)                       |       | $                                          | (197       | )                                         | $          | 49 |   | $ | (206 | ) | $ | 3 |   |
|                                                   |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |

 

**14.****  Goodwill and OtherIntangible Assets**

 

InDecember 2004, the Company acquired 15% of Innovative Packaging Corp. (“IPC”),a corrugated container facility in Milwaukee, Wisconsin for $13 million.  Previously, the Company owned 85% of IPC and,as a result of the acquisition, now owns 100%. The cost to acquire the remaining 15% of IPC eliminated the Company’sminority interest liability of $1 million with the remaining balance of $12million preliminarily allocated to intangible assets.  In June 2005, the Company completed itsallocation of the purchase price resulting in the reclassification of $8million from intangible assets to goodwill. The remaining $4 million of intangible assets primarily representcustomer relationships with lives of 12 years. The $8 million of goodwill is reflected in the Containerboard andCorrugated Containers segment.

 

**15.****  Business SegmentInformation**

 

The Company 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 Packagingsegment is also highly integrated.  Itincludes a system of mills and plants that produces a broad range of coatedrecycled boxboard that is converted into folding cartons.  Folding cartons are used primarily to protectand market products such as food, fast food, detergents, paper products,beverages, health and beauty aids and other consumer products, while providingpoint of purchase advertising.  Inaddition, the Consumer Packaging segment converts kraft and specialty paperinto multiwall bags and consumer bags that are designed to ship and protect awide range of industrial and consumer products including fertilizers,chemicals, concrete and pet and food products. The Consumer Packaging segment also produces flexible packaging, paperand metalized paper labels and heat transfer labels used in a wide range ofconsumer applications.

 

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

 

10

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

 

A summary by business segment follows:

 
| ** **                            | ** ** | **Container-  board & Corrugated  Containers** | ** ** | **Consumer  Packaging** | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------|------------|-------------------------|------------|-----------|------------|-----------|------------|
| Three months ended September 30, |       |                                                    |       |                    |       |      |       |      |       |
| 2005                                  |       |                                                    |       |                    |       |      |       |      |       |
| Revenues from  external customers     |       | $                                                       | 1,572      |                    | $          | 425       |       | $         | 106        |   | $ | 2,103 |   |
| Intersegment  revenues                |       | 41                                                      |       |                    |       | 76        |       | 117       |       |
| Segment profit  (loss)                |       | 31                                                      |       | 25                      |       | (407      | )          | (351      | )          |
|                                  |       |                                                    |       |                    |       |      |       |      |       |
| 2004                                  |       |                                                    |       |                    |       |      |       |      |       |
| Revenues from  external customers     |       | $                                                       | 1,628      |                    | $          | 426       |       | $         | 111        |   | $ | 2,165 |   |
| Intersegment  revenues                |       | 36                                                      |       |                    |       | 80        |       | 116       |       |
| Segment profit  (loss)                |       | 134                                                     |       | 20                      |       | (87       | )          | 67        |       |
|                                  |       |                                                    |       |                    |       |      |       |      |       |
| Nine months ended September 30,  |       |                                                    |       |                    |       |      |       |      |       |
| 2005                                  |       |                                                    |       |                    |       |      |       |      |       |
| Revenues from  external customers     |       | $                                                       | 4,780      |                    | $          | 1,243     |       | $         | 326        |   | $ | 6,349 |   |
| Intersegment  revenues                |       | 117                                                     |       |                    |       | 222       |       | 339       |       |
| Segment profit  (loss)                |       | 190                                                     |       | 63                      |       | (625      | )          | (372      | )          |
|                                  |       |                                                    |       |                    |       |      |       |      |       |
| 2004                                  |       |                                                    |       |                    |       |      |       |      |       |
| Revenues from  external customers     |       | $                                                       | 4,597      |                    | $          | 1,247     |       | $         | 301        |   | $ | 6,145 |   |
| Intersegment  revenues                |       | 105                                                     |       |                    |       | 227       |       | 332       |       |
| Segment profit  (loss)                |       | 188                                                     |       | 64                      |       | (263      | )          | (11       | )          |

 

**16.Contingencies**

 

In 2003, the Companysettled the antitrust class action cases pending against the Company, whichwere based on allegations of a conspiracy among linerboard manufacturers from1993 to 1995.  The Company, along withother large linerboard manufacturers, is a defendant in nine lawsuits broughton behalf of numerous companies that opted out of these class actions to seektheir own recovery, eight of which have been consolidated for pretrialproceedings in the United States District Court for the Eastern District ofPennsylvania, and one of which has been remanded to the Kansas District Court(the “Direct Action Cases”).  The Companysettled claims of certain plaintiffs in the Direct Action Cases, and madeaggregate settlement payments of approximately $11 million in the secondquarter of 2005 and approximately $3 million in the third quarter of 2005,which were charged against existing reserves. The Company is vigorously defending the remaining Direct Action Cases.  While the ultimate results of the DirectAction Cases cannot be predicted with certainty, the Company believes theresolution of these cases will not have a material adverse effect on theCompany’s consolidated financial condition, results of operations or cashflows.

 

11

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In April 2005, theUnited States Environmental Protection Agency (“EPA”) issued a Notice ofViolation (“NOV”) and Finding of Violation (“FOV”) that alleged the Companyviolated the Prevention of Significant Deterioration regulations and New SourcePerformance Standards of the Clean Air Act in connection with the replacementof burners in a boiler at its medium mill in Ontonagon, Michigan in 1995.  Specifically, the EPA has alleged that theburner replacement project resulted in an increase of the coal burning capacityof the boiler that in turn led to increased emissions of nitrogen oxides andsulfur dioxide.  The Company believesthat the burner replacement project was routine maintenance and did notincrease the coal burning capacity of the boiler, and that differences inemissions resulted from permissible switching of fuels from natural gas tocoal.  The Company has met with the EPAto discuss this matter, and has advised the EPA that it disagrees with theallegations and intends to contest the NOV and FOV.  Based on the information developed to dateand discussion with the EPA, the Company believes the costs to resolve thismatter will not be material and will not exceed established reserves.

 

The Company’s past andpresent operations include activities which are subject to federal, state andlocal environmental requirements, particularly relating to air and waterquality.  The Company faces potentialenvironmental liability as a result of violations of permit terms and similarauthorizations that have occurred from time to time at its facilities.  In addition, the Company faces potentialliability for response costs at various sites for which it has received noticeas being a potentially responsible party (“PRP”) concerning hazardous substancecontamination.  In estimating itsreserves for environmental remediation and future costs, the Company’sestimated liability reflects only the Company’s expected share afterconsideration of the number of other PRPs at each site, the identity andfinancial condition of such parties and experience regarding similarmatters.  As of September 30, 2005,the Company had approximately $31 million reserved for environmentalliabilities included primarily in other long-term liabilities in theconsolidated balance sheet.  The Companybelieves the liability recorded for these matters was adequately reserved at September 30,2005.

 

Ifall or most of the other PRPs are unable to satisfy their portion of the cleanupcosts 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,results of operations or cash flows.

 

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

 

12

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

 

**FORWARD-LOOKINGSTATEMENTS**

 

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

 

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

•      fluctuationsin energy costs;

•      fluctuationsin wood fiber and reclaimed fiber costs;

•      fluctuationsin other costs, including freight, chemicals and employee benefits;

•      disruptionsof transportation;

•      oursubstantial leverage;

•      obtainingrequired consents or waivers from creditors in the event we are unable tosatisfy covenants in our debt instruments; and

•      therisks of loss from fires, floods and other natural disasters.

 

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

 

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# **GENERAL**

 

We meet the conditions set forth in General Instruction (H) (1) (a) and(b) of Form 10-Q and are therefore filing this form with the reduced disclosureformat permitted thereby.  The omittedinformation is substantially similar to the disclosures contained inSmurfit-Stone Container Corporation’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2005 filed with the Securities and ExchangeCommission on the date hereof.  Inaccordance with General Instruction (H) (2) (a), the discussion of our resultsof operations below includes only a narrative analysis of the most recentfiscal year-to-date period presented and the corresponding year-to-date periodin the preceding fiscal year.

 

We are a wholly-ownedsubsidiary of Smurfit-Stone Container Corporation (Smurfit-Stone), a holdingcompany with no business operations of its own. Smurfit-Stone conducts itsbusiness operations through us.  We arethe surviving company resulting from the merger (the Merger) of Smurfit-Stone’sprimary operating subsidiaries on November 1, 2004.  JSCE, Inc. merged with and intoJefferson Smurfit Corporation (U.S.) (JSC(U.S.)), with JSC(U.S.) as thesurviving company, and then JSC(U.S.) merged with and into us, with us as thesurviving entity.  The Merger waseffected principally to consolidate debt financing activities of Smurfit-Stoneand its subsidiaries.  We weresimultaneously renamed Smurfit-Stone Container Enterprises, Inc.

 

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

 

# **RESULTS OF OPERATIONS**

 

**StrategicReassessment Initiative**

 

We are engaged in astrategic reassessment of our operations. During the fourth quarter we intend to report on our initiativesresulting from this reassessment.  As thefirst step in this process and in order to better align our production capacitywith market conditions and demand, in August 2005, we permanently closedproduction capacity at three North American containerboard mills as part of ourstrategic reassessment initiative.  Wepermanently closed:

 

•      theNo. 2 paper machine at our Fernandina Beach, Florida linerboard mill;

•      ourNew Richmond, Quebec linerboard mill; and

•      ourBathurst, New Brunswick medium mill.

 

The No. 2 papermachine at Fernandina Beach, Florida has been idle since April 2001.  Our containerboard manufacturing capacity wasreduced by approximately 700,000 tons, or 8.5%, as a result of theseclosures.  We also initiated a plan toexit our investment in the Groveton, New Hampshire medium mill and we exitedour investment in the Las Vegas, Nevada converting facility.  We recorded a pretax charge of $293 millionin the third quarter of 2005, $259 million of which was non-cash related to thewrite-down of fixed assets and other costs as a result of these closures.  The cash charges related primarily toseverance and benefits and post-closure environmental costs.  The rationalization process resulted in aworkforce reduction of approximately 565 employees.  Additional charges of up to $10 million willbe recorded in future periods for related pension settlement costs.

 

# **Overview**

 

For the nine months endedSeptember 30, 2005, we had a net loss available to common stockholders of$247 million, or $0.97 per diluted share. This compares to a net loss available to common stockholders of $48million, or $0.19 per diluted share, for the same period in 2004.  Net sales for the year-to-date periodincreased 3.3% compared to last year. Our loss was higher in 2005 due principally to higher restructuringcharges.  We recorded pretaxrestructuring charges of $297 million for the nine month period compared to $17million in the same period last year.

 

14

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In the fourth quarter of2005, we expect that costs will likely increase, driven by elevated energy andfreight expense.  We will be implementingpreviously announced price increases across a number of our product lines;however, we expect that average sales prices for corrugated containers will belower in the fourth quarter as a result of containerboard price declines thatpreviously occurred in 2005.

 

**NineMonths 2005 Compared to Nine Months 2004**

 
| ** **                                | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| **(In millions)**                         | ** ** | **Net  Sales**                           | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
|                                      |       |                                     |       |   |   |   |   |   |   |
| Containerboard and corrugated containers  |       | $                                        | 4,780      |   | $ | 190 |   | $ | 4,597 |   | $ | 188 |   |
| Consumer packaging                        |       | 1,243                                    |       | 63 |   | 1,247 |   | 64 |   |
| Other operations                          |       | 326                                      |       | 14 |   | 301 |   | 21 |   |
| Total segment  operations                 |       | $                                        | 6,349      |   | 267 |   | $ | 6,145 |   | 273 |   |
|                                      |       |                                     |       |   |   |   |   |   |   |
| Restructuring charges                     |       |                                     |       | (297 | ) |   |   | (17 | ) |
| (Loss) gain on sale of assets             |       |                                     |       | (1 | ) |   |   | 3 |   |
| Interest expense, net                     |       |                                     |       | (261 | ) |   |   | (258 | ) |
| Interest income from Smurfit-Stone        |       |                                     |       |   |   |   |   | 62 |   |
| Gain from early extinguishment of debt    |       |                                     |       |   |   |   |   | 1 |   |
| Non-cash foreign currency exchange losses |       |                                     |       | (12 | ) |   |   | (9 | ) |
| Corporate expenses and other (1)          |       |                                     |       | (68 | ) |   |   | (66 | ) |
| Loss before  income taxes                 |       |                                     |       | $ | (372 | ) |   |   | $ | (11 | ) |

 

----

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

 

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

 
| **(In millions)**           | ** ** | **Container-  board &  Corrugated  Containers** | ** ** | **Consumer  Packaging** | ** ** | **Other  Operations** | ** ** | **Total** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|-----------|------------|
|                        |       |                                                     |       |                    |       |                  |       |      |       |
| Sales price and product mix |       | $                                                        | 245        |                    | $          | 32                    |       | $         | 1          |   | $ | 278 |   |
| Sales volume                |       | (62                                                      | )          | (36                     | )          | 24                    |       | (74       | )          |
| Total                       |       | $                                                        | 183        |                    | $          | (4                    | )          | $         | 25         |   | $ | 204 |   |

 

Cost of goods soldincreased from $5,361 million in 2004 to $5,565 million in 2005 due primarilyto higher costs for energy ($34 million), reclaimed and wood fiber ($34million), freight ($45 million), chemicals ($24 million) and employee benefits($11 million).  Cost of goods sold as apercent of net sales increased from 87.2% in 2004 to 87.7% in 2005 dueprimarily to the higher costs.

 

Selling andadministrative expense decreased $4 million compared to last year.  Selling and administrative expense as apercent of net sales decreased from 9.5% in 2004 to 9.1% in 2005.

 

We recorded pretaxrestructuring charges of $297 million in the nine months ended September 30,2005, including $293 million in connection with our strategic reassessmentinitiative.

 

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Interest expense, net was$261 million in 2005, an increase of $3 million compared to 2004.  The unfavorable impact of higher averageinterest rates ($17 million) was partially offset by lower average borrowings($14 million).  Our overall averageeffective interest rate in 2005 was approximately 50 basis points higher thanin 2004.

 

Interest income fromSmurfit-Stone in 2005 decreased $62 million compared to 2004 due to thesettlement of the notes receivable in November 2004. The notes receivablefrom Smurfit-Stone of $645 million, including accrued interest, were exchangedfor 230 shares of our common stock owned by Smurfit-Stone.  The exchange, which was accounted for at historicalcost, resulted in a reduction of $645 million to our additional paid-incapital. The fair value of the shares of our stock received, as estimated by athird party valuation, approximated the net book value of the shares at thetime of the exchange.

 

Other, net for 2005included non-cash foreign currency exchange losses of $12 million compared tolosses of $9 million in 2004.

 

Benefit from income taxesdiffered from the amount computed by applying the statutory U.S. federal incometax rate to loss before income taxes due primarily to state income taxes andthe effect of other permanent differences.

 

**Containerboardand Corrugated Containers Segment**

 

Net sales increased 4.0%in 2005 compared to last year primarily as a result of higher average sales prices.  For the year-to-date period, average domesticlinerboard prices increased 9.0% compared to the same period last year.  Our average North American selling price forcorrugated containers was 4.8% higher compared to 2004.  Shipments of corrugated containers decreased1.1% and third party containerboard shipments decreased 11.4% compared to thesame period last year.  Average salesprices for market pulp, SBS and kraft paper increased 4.9%, 4.2%, and 13.4%,respectively, compared to the same period last year.

 

Our containerboard millsoperated at 91.2% of capacity for the nine months ended September 30, 2005and containerboard production decreased 2.7% compared to last year.  Production of market pulp and SBS increased3.2% and 4.4%, respectively, compared to last year.  Production of kraft paper declined 25.0% dueprimarily to the shift of production from kraft paper to containerboard on oneof our paper machines.

 

Profits increased $2million due primarily to the higher average sales prices.  Profits were unfavorably impacted by ourlower mill operating rates, the lower sales volumes and higher costs of wood($27 million), reclaimed fiber ($13 million), energy ($29 million), freight($45 million), chemicals ($22 million) and employee benefits.

 

**ConsumerPackaging Segment**

 

Net sales for 2005 werecomparable to last year.  Net sales werefavorably impacted by higher sales volume for folding cartons and higheraverage sales prices for folding cartons, coated recycled boxboard and multiwallbags, which improved 3.1%, 9.4% and 2.3%, respectively.  Sales volume for folding cartons increased1.7% despite the closure of a converting facility, while sales volume formultiwall bags decreased 4.4% due in part to the closure of a convertingfacility.  Third party shipments ofcoated recycled boxboard were 3.8% lower and laminated product shipmentsdeclined due primarily to the sale of a plant. Net sales were unfavorably impacted by the termination of ourdistribution rights for our flexible intermediate bulk container business inthe third quarter of 2004.  Flexiblepackaging shipments increased 5.0%.  Thecoated recycled boxboard mills operated at 99.5% of capacity during the ninemonths ended September 30, 2005 compared to nearly 100% of capacity duringthe same period in 2004.

 

Profits decreased $1million compared to last year primarily as a result of the lower multiwall bagsales volume and the higher costs of energy ($5 million), chemicals ($2million) and employee benefits.  Inaddition, profits of our multiwall bag operation were unfavorably impacted byhigher kraft paper cost.  

 

16

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Profits were favorablyimpacted by the higher average sales prices and higher sales volume for foldingcartons.

 

**OtherOperations**

 

Net sales increased dueprimarily to the impact of our i2iSM business, higher sales volumefor most of our reclamation products including higher external sales volume forreclaimed fiber.  Total tons of fiberreclaimed and brokered increased 0.9% as a result of the higher external salesvolume, which was partially offset by lower internal consumption due to thecontainerboard mill closures.  Profitsdecreased $7 million dollars compared to last year.

 

**Statistical Data**

 
| ** **                                                       | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands of tons, except  as noted)**                     | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Mill production                                                  |       |                                      |       |   |   |
| Containerboard  (1)                                              |       | 5,402                                     |       | 5,551 |   |
| Kraft paper                                                      |       | 150                                       |       | 200 |   |
| Market pulp                                                      |       | 425                                       |       | 412 |   |
| SBS                                                              |       | 213                                       |       | 204 |   |
| Coated recycled  boxboard                                        |       | 418                                       |       | 421 |   |
| North American corrugated containers sold (billion  sq. ft.) (2) |       | 60.3                                      |       | 61.0 |   |
| Folding cartons sold                                             |       | 393                                       |       | 386 |   |
| Multiwall bags sold (million bags)                               |       | 830                                       |       | 868 |   |
| Fiber reclaimed and brokered                                     |       | 4,902                                     |       | 4,857 |   |

 

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(1)   For the ninemonths ended September 30, 2005 and 2004, our container plants consumed4,088,000 and 4,184,000 tons of containerboard, respectively.

(2)   North Americancorrugated containers sold exclude intercompany shipments.

 

**CRITICALACCOUNTING POLICIES AND USE OF ESTIMATES**

 

**IncomeTaxes**

 

In October 2004, theAmerican Jobs Creation Act (the AJCA) was signed into law.  The AJCA includes a deduction of 85% ofcertain foreign earnings that are repatriated, as defined in the AJCA.  We have completed our evaluation of theeffects of the repatriation provision and, in October 2005, adopted aDomestic Reinvestment Plan to repatriate earnings up to $500 million under thisprovision and will record income taxes of up to $27 million during the fourthquarter of 2005.

 
| **ITEM 3.** | ** ** | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                             |
|-------------|------------|-------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                        |
|        |       | Intentionally  omitted in accordance with General Instruction (H) (2) (c) of  Form 10-Q |
|        |       |                                                                                                        |
| **ITEM 4.** | ** ** | **CONTROLS  AND PROCEDURES**                                                                                |

 

**Evaluationof Disclosure Controls and Procedures**

 

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

 

17

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**Changesin Internal Control**

 

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

 

**PART II - OTHER INFORMATION**

 
| **ITEM 1.** |   | **LEGAL  PROCEEDINGS** |
|-------------|--------|------------------------|

 

In 2003, we settled theantitrust class action cases pending against us, which were based onallegations of a conspiracy among linerboard manufacturers from 1993 to1995.  We, along with other largelinerboard manufacturers, are a defendant in nine lawsuits brought on behalf ofnumerous companies that opted out of these class actions to seek their ownrecovery, eight of which have been consolidated for pretrial proceedings in theUnited States District Court for the Eastern District of Pennsylvania, and oneof which has been remanded to the Kansas District Court (the Direct ActionCases).  We have settled claims ofcertain plaintiffs in the Direct Action Cases, and made aggregate settlementpayments of approximately $11 million during the second quarter of 2005 andapproximately $3 million in the third quarter of 2005, which were chargedagainst existing reserves.  We arevigorously defending the remaining Direct Action Cases.  While the ultimate results of the DirectAction Cases cannot be predicted with certainty, we believe the resolution ofthese cases will not have a material adverse effect on our consolidatedfinancial condition, results of operations or cash flows.

 

In April 2005, theUnited States Environmental Protection Agency (EPA) issued a Notice ofViolation (NOV) and Finding of Violation (FOV) that alleged that we violatedthe Prevention of Significant Deterioration regulations and New SourcePerformance Standards of the Clean Air Act in connection with the replacementof burners in a boiler at its medium mill in Ontonagon, Michigan in 1995.  Specifically, the EPA has alleged that theburner replacement project resulted in an increase of the coal burning capacityof the boiler that in turn led to increased emissions of nitrogen oxides andsulfur dioxide.  We believe that theburner replacement project was routine maintenance and did not increase thecoal burning capacity of the boiler, and that differences in emissions resultedfrom permissible switching of fuels from natural gas to coal.  We have met with the EPA to discuss thismatter, and has advised the EPA that it disagrees with the allegations and intends to contestthe NOV and FOV.  Based on theinformation developed to date and discussion with the EPA, we believe the coststo resolve this matter will not be material and will not exceed establishedreserves.

 
| **ITEM 2.** | ** ** | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                           |
|-------------|------------|------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                       |
|        |       | Intentionally omitted in accordance with General  Instruction (H) (2) (c) of Form 10-Q |
|        |       |                                                                                                       |
| **ITEM 3.** | ** ** | **DEFAULTS  UPON SENIOR SECURITIES**                                                                       |
|        |       |                                                                                                       |
|        |       | Intentionally omitted in accordance with General  Instruction (H) (2) (c) of Form 10-Q |
|        |       |                                                                                                       |
| **ITEM 4.** | ** ** | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                   |
|        |       |                                                                                                       |
|        |       | Intentionally omitted in accordance with General  Instruction (H) (2) (c) of Form 10-Q |
|        |       |                                                                                                       |
| **ITEM 5.** | ** ** | **OTHER  INFORMATION**                                                                                     |
|        |       |                                                                                                       |
|        |       | None                                                                                                       |

 

18

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| **ITEM 6.** |   | **EXHIBITS**                                                                                                                                                                             |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  |   |                                                                                                                                                                                     |
| ** **  |   | The following exhibits are included in this  Form 10-Q:                                                                                                                             |
| ** **  |   |                                                                                                                                                                                     |
| 31.1        |   | Certification pursuant to Rules 13a–14 and  15d–14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. |
|        |   |                                                                                                                                                                                     |
| 31.2        |   | Certification pursuant to Rules 13a–14 and  15d–14 under the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|        |   |                                                                                                                                                                                     |
| 32.1        |   | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                      |
|        |   |                                                                                                                                                                                     |
| 32.2        |   | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                      |

 

19

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Signature

 

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

 

 
|                         | SMURFIT-STONE CONTAINER  ENTERPRISE, INC.       |   |
|------------------------------|-------------------------------------------------|--------|
|                         | (Registrant)                                    |   |
|                         |                                            |
|                         |                                            |
| Date: November 7,  2005 | /s/ Paul K.  Kaufmann                           |   |
|                         | Paul K. Kaufmann                                |   |
|                         | Senior Vice  President and Corporate Controller |   |
|                         | (Principal  Accounting Officer)                 |   |

 

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