**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

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

 

**For Quarter Ended September 30, 2009**

** **

**Commission File Number 1-3439**

 

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

(Exact name of registrant as specified in its charter)

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

 

**222 North LaSalle Street,Chicago, Illinois 60601**

(Address of principalexecutive offices) (Zip Code)

 

**(312) 346-6600**

(Registrant’s telephone number, including area code)

 

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

(Former name, former address and former fiscal year,ifchanged since last report)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

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

 

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

 

APPLICABLEONLY TO CORPORATE ISSUERS:

 

Asof November 4, 2009, the registrant had outstanding 770 shares of commonstock, $.01 par value per share, all of which are owned by Smurfit-StoneContainer Corporation.

 

 

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

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

**(DEBTOR-IN-POSSESSION)**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                                                                                                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| **(In millions)**                                                                                                                                                                   | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                                                                                                                                                                           | ** ** | **$**                  | **1,417**  | ** **             | $          | 1,879 | ** ** | **$** | **4,195** | ** ** | $ | 5,509 |   |
| Costs and expenses                                                                                                                                                                  |       | ** **             | ** ** |                   |       | ** ** | ** ** |   |   |
| Cost of goods sold                                                                                                                                                                  | ** ** | **1,284**              | ** ** | 1,696                  | ** ** | **3,757** | ** ** | 4,938 |   |
| Selling and administrative expenses                                                                                                                                                 | ** ** | **137**                | ** ** | 148                    | ** ** | **428** | ** ** | 496 |   |
| Restructuring expenses                                                                                                                                                              | ** ** | **14**                 | ** ** | 14                     | ** ** | **38** | ** ** | 27 |   |
| (Gain) loss on disposal of assets                                                                                                                                                   | ** ** | **2**                  | ** ** | (1                     | )          | **3** | ** ** | (5 | ) |
| Other operating income                                                                                                                                                              | ** ** | **(179**               | **)**      |                   |       | **(455** | **)** |   |   |
| Operating income                                                                                                                                                                    | ** ** | **159**                | ** ** | 22                     | ** ** | **424** | ** ** | 53 |   |
| Other income (expense)                                                                                                                                                              |       | ** **             | ** ** |                   |       | ** ** | ** ** |   |   |
| Interest expense, net (including $49 million and $147 millionfor the three and nine months ended  September 30, 2009, respectively,  that is stayed and subject to compromise) |       | **(72**                | **)**      | (63                    | )          | **(217** | **)** | (187 | ) |
| Debtor-in-possession debt issuance costs                                                                                                                                            |       | ** **             | ** ** |                   | ** ** | **(63** | **)** |   |   |
| Loss on early extinguishment of debt                                                                                                                                                |       | ** **             | ** ** |                   | ** ** | **(20** | **)** |   |   |
| Foreign currency exchange gains (losses)                                                                                                                                            | ** ** | **(11**                | **)**      | 8                      | ** ** | **(10** | **)** | 19 |   |
| Other, net                                                                                                                                                                          | ** ** | **6**                  | ** ** |                   |       | **10** | ** ** | (6 | ) |
| Income (loss) before reorganization items and income taxes                                                                                                                          | ** ** | **82**                 | ** ** | (33                    | )          | **124** | ** ** | (121 | ) |
| Reorganization items                                                                                                                                                                | ** ** | **(16**                | **)**      |                   | ** ** | **(109** | **)** |   |   |
| Income (loss) before income taxes                                                                                                                                                   | ** ** | **66**                 | ** ** | (33                    | )          | **15** | ** ** | (121 | ) |
| (Provision for) benefit from income taxes                                                                                                                                           | ** ** | **2**                  | ** ** | 98                     | ** ** | **(3** | **)** | 136 |   |
| Net income                                                                                                                                                                          | ** ** | **$**                  | **68**     | ** **             | $          | 65 | ** ** | **$** | **12** | ** ** | $ | 15 |   |

 

Seenotes to consolidated financial statements.

 

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

**(DEBTOR-IN-POSSESSION)**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In millions, except share data)**                                                                           | ** ** | **2009**               | ** ** | **2008**              | ** ** |
|                                                                                                           |       | **(Unaudited)**        | ** ** |                  |       |
| **Assets**                                                                                                     |       |                   | ** ** |                  |       |
| ** **                                                                                                     |       |                   | ** ** |                  |       |
| Current assets                                                                                                 |       |                   | ** ** |                  |       |
| Cash and cash equivalents                                                                                      | ** ** | **$**                  | **561**    | ** **            | $          | 126 |   |
| Restricted cash                                                                                                | ** ** | **9**                  | ** ** |                  |       |
| Receivables, less allowances of $24 in 2009 and $7 in 2008                                                     | ** ** | **661**                | ** ** | 96                    |       |
| Receivable for alternative energy tax credits                                                                  | ** ** | **58**                 | ** ** |                  |       |
| Retained interest in receivables sold                                                                          |       |                   | ** ** | 120                   |       |
| Inventories                                                                                                    |       |                   | ** ** |                  |       |
| Work-in-process and finished goods                                                                             | ** ** | **113**                | ** ** | 112                   |       |
| Materials and supplies                                                                                         | ** ** | **374**                | ** ** | 400                   |       |
|                                                                                                           | ** ** | **487**                | ** ** | 512                   |       |
| Prepaid expenses and other current assets                                                                      | ** ** | **71**                 | ** ** | 27                    |       |
| Total current assets                                                                                           | ** ** | **1,847**              | ** ** | 881                   |       |
| Net property, plant and equipment                                                                              | ** ** | **3,343**              | ** ** | 3,509                 |       |
| Timberland, less timber depletion                                                                              | ** ** | **2**                  | ** ** | 32                    |       |
| Other assets                                                                                                   | ** ** | **65**                 | ** ** | 117                   |       |
|                                                                                                           | ** ** | **$**                  | **5,257**  | ** **            | $          | 4,539 |   |
| **Liabilities and Stockholder’s Equity (Deficit)**                                                        |       |                   | ** ** |                  |       |
| ** **                                                                                                     |       |                   | ** ** |                  |       |
| Liabilities not subject to compromise                                                                          |       |                   | ** ** |                  |       |
| Current liabilities                                                                                            |       |                   | ** ** |                  |       |
| Current maturities of long-term debt                                                                           | ** ** | **$**                  | **1,484**  | ** **            | $          | 3,718 |   |
| Accounts payable                                                                                               | ** ** | **368**                | ** ** | 506                   |       |
| Accrued compensation and payroll taxes                                                                         | ** ** | **139**                | ** ** | 164                   |       |
| Interest payable                                                                                               | ** ** | **10**                 | ** ** | 66                    |       |
| Income taxes payable                                                                                           | ** ** | **8**                  | ** ** | 9                     |       |
| Current deferred income taxes                                                                                  | ** ** | **21**                 | ** ** | 21                    |       |
| Other current liabilities                                                                                      | ** ** | **138**                | ** ** | 194                   |       |
| Total current liabilities                                                                                      | ** ** | **2,168**              | ** ** | 4,678                 |       |
| Other long-term liabilities                                                                                    | ** ** | **124**                | ** ** | 1,320                 |       |
| Deferred income taxes                                                                                          | ** ** | **125**                | ** ** | 89                    |       |
| Total liabilities not subject to compromise                                                                    | ** ** | **2,417**              | ** ** | 6,087                 |       |
| Liabilities subject to compromise                                                                              | ** ** | **4,301**              | ** ** |                  |       |
| Total liabilities                                                                                              | ** ** | **6,718**              | ** ** | 6,087                 |       |
| Stockholder’s equity                                                                                      |       |                   | ** ** |                  |       |
| Common stock, par value $.01 per share; 1,000 shares authorized; 770  issued and  outstanding in 2009 and 2008 |       |                   | ** ** |                  |       |
| Additional paid-in capital                                                                                     | ** ** | **3,675**              | ** ** | 3,668                 |       |
| Retained earnings (deficit)                                                                                    | ** ** | **(4,510**             | **)**      | (4,522                | )          |
| Accumulated other comprehensive income (loss)                                                                  | ** ** | **(626**               | **)**      | (694                  | )          |
| Total stockholder’s equity (deficit)                                                                      | ** ** | **(1,461**             | **)**      | (1,548                | )          |
|                                                                                                           | ** ** | **$**                  | **5,257**  | ** **            | $          | 4,539 |   |

 

See notes to consolidatedfinancial statements.

 

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**(DEBTOR-IN-POSSESSION)**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| **Nine  Months Ended September 30, (In millions)**                                    | ** ** | **2009** | ** ** | **2008**   | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------|------------|------------|------------|
| **Cash flows from operating activities**                                                   |       |     | ** ** |       |       |
| Net income                                                                                 | ** ** | **$**    | **12**     | ** ** | $          | 15 |   |
| Adjustments to reconcile net income to net cash provided byoperating activities            |       |     | ** ** |       |       |
| Loss on early extinguishment of debt                                                       | ** ** | **20**   | ** ** |       |       |
| Depreciation, depletion and amortization                                                   | ** ** | **273**  | ** ** | 265        |       |
| Debtor-in-possession debt issuance costs                                                   | ** ** | **63**   | ** ** |       |       |
| Amortization of deferred debt issuance costs                                               | ** ** | **5**    | ** ** | 5          |       |
| Deferred income taxes                                                                      | ** ** | **1**    | ** ** | (173       | )          |
| Pension and postretirement benefits                                                        | ** ** | **49**   | ** ** | (25        | )          |
| (Gain) loss on disposal of assets                                                          | ** ** | **3**    | ** ** | (5         | )          |
| Non-cash restructuring expenses                                                            | ** ** | **6**    | ** ** | 7          |       |
| Non-cash stock-based compensation                                                          | ** ** | **7**    | ** ** | 2          |       |
| Non-cash foreign currency exchange (gains) losses                                          | ** ** | **10**   | ** ** | (19        | )          |
| Non-cash reorganization items                                                              | ** ** | **65**   | ** ** |       |       |
| Change in restricted cash                                                                  | ** ** | **(9**   | **)**      |       |       |
| Change in current assets and liabilities,net of effects from acquisitions and dispositions |       |     | ** ** |       |       |
| Receivables and retained interest in receivables sold                                      | ** ** | **(50**  | **)**      | (9         | )          |
| Receivable for alternative energy tax credits                                              | ** ** | **(58**  | **)**      |       |       |
| Inventories                                                                                | ** ** | **35**   | ** ** | (14        | )          |
| Prepaid expenses and other current assets                                                  | ** ** | **(13**  | **)**      |       |       |
| Accounts payable and accrued liabilities                                                   | ** ** | **200**  | ** ** | 69         |       |
| Interest payable                                                                           | ** ** | **128**  | ** ** | (5         | )          |
| Other, net                                                                                 | ** ** | **46**   | ** ** | 21         |       |
| Net cash provided by operating activities                                                  | ** ** | **793**  | ** ** | 134        |       |
| **Cash flows from investing activities**                                                   |       |     | ** ** |       |       |
| Expenditures for property, plant and equipment                                             | ** ** | **(112** | **)**      | (304       | )          |
| Proceeds from property disposals                                                           | ** ** | **16**   | ** ** | 8          |       |
| Advances to affiliates, net                                                                | ** ** | **(15**  | **)**      |       |       |
| Net cash used for investing activities                                                     | ** ** | **(111** | **)**      | (296       | )          |
| **Cash flows from financing activities**                                                   |       |     | ** ** |       |       |
| Net borrowings of debtor-in-possession debt                                                | ** ** | **130**  | ** ** |       |       |
| Net borrowings of long-term debt                                                           | ** ** | **71**   | ** ** | 168        |       |
| Repurchase of receivables                                                                  | ** ** | **(385** | **)**      |       |       |
| Debtor-in-possession debt issuance costs                                                   | ** ** | **(63**  | **)**      |       |       |
| Dividends paid                                                                             |       |     | ** ** | (6         | )          |
| Net cash provided by (used for) financing activities                                       | ** ** | **(247** | **)**      | 162        |       |
| **Increase in cash and cash equivalents**                                                  | ** ** | **435**  | ** ** |       |       |
| Cash and cash equivalents                                                                  |       |     | ** ** |       |       |
| Beginning of period                                                                        | ** ** | **126**  | ** ** | 7          |       |
| End of period                                                                              | ** ** | **$**    | **561**    | ** ** | $          | 7 |   |

 

See notes to consolidatedfinancial statements.

 

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

**(DEBTOR-IN-POSSESSION)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

(Tabular amounts in millions)

 

**1. Bankruptcy Proceedings**

 

**Chapter 11Bankruptcy Filings**

On January 26, 2009(the “Petition Date”), Smurfit-Stone Container Corporation (“SSCC”),Smurfit-Stone Container Enterprises, Inc. (“SSCE” or the “Company”) andits U.S. and Canadian subsidiaries (collectively, the “Debtors”) filed avoluntary petition (the “Chapter 11 Petition”) for relief under Chapter 11 ofthe United States Bankruptcy Code (the “Bankruptcy Code”) in the United StatesBankruptcy Court in Wilmington, Delaware (the “U.S. Court”). On the same day,the Company’s Canadian subsidiaries also filed to reorganize (the “CanadianPetition”) under the Companies’ Creditors Arrangement Act (the “CCAA”) in theOntario Superior Court of Justice in Canada (the “Canadian Court”). The Company’soperations in Mexico and Asia and certain U.S. and Canadian legal entities (the“Non-Debtor Subsidiaries”) were not included in the filing and will continue tooperate outside of the Chapter 11 process.

 

The filing of the Chapter 11Petition and the Canadian Petition constituted an event of default under theCompany’s debt obligations, and those debt obligations became automatically andimmediately due and payable, although any actions to enforce such paymentobligations are stayed as a result of the filing of the Chapter 11 Petition andthe Canadian Petition. As previously disclosed in the SSCE Annual Report on Form 10-Kfor the year ended December 31, 2008, (the “2008 Form 10-K”), filedwith the Securities and Exchange Commission, the accompanying consolidatedbalance sheet as of December 31, 2008 includes a reclassification of$3,032 million to current maturities of long-term debt from long-term debt. Dueto the filing of the bankruptcy petitions, the Company’s unsecured long-termdebt of $2,439 million is included in liabilities subject to compromise at September 30,2009 (See Note 5).

 

SSCC, the Company and itsU.S. and Canadian subsidiaries are currently operating as “debtors-in-possession”under the jurisdiction of the U.S. Court and Canadian Court (the “BankruptcyCourts”) and in accordance with the applicable provisions of the BankruptcyCode and the CCAA. In general, SSCE and its subsidiaries are authorized tocontinue to operate as ongoing businesses, but may not engage in transactionsoutside the ordinary course of business without the approval of the BankruptcyCourts.

 

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

In connection with filingthe Chapter 11 Petition and the Canadian Petition on the Petition Date, theCompany and certain of its affiliates filed a motion with the Bankruptcy Courtsseeking approval to enter into a Post-Petition Credit Agreement (the “DIPCredit Agreement”). On January 27, 2009, the Bankruptcy Courts grantedinterim approval of the DIP Credit Agreement. Based on such interim approval,on January 28, 2009, the Company entered into the DIP Credit Agreement,subject to final approval of the Bankruptcy Courts. Final approval of the DIPCredit Agreement was granted by the U.S. Court on February 23, 2009 and bythe Canadian Court on February 24, 2009. Amendments to the DIP CreditAgreement were entered into on February 25 and 27, 2009.

 

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

 

The outstanding principalamount of the loans under the DIP Credit Agreement, plus interest accrued andunpaid, will be due and payable in full at maturity, which is January 28,2010; provided, that the maturity

 

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date may be extendedthrough April 28, 2010, and subsequently through July 28, 2010, uponthe satisfaction of certain conditions precedent (including the payment ofspecified fees).

 

For additional information on the DIP CreditAgreement, see Note 13.

 

**Reorganization Process**

The Bankruptcy Courts approved payment of certain ofthe Company’s pre-petition obligations, including employee wages, salaries andbenefits, and the payment of vendors and other providers in the ordinary coursefor goods and services received after the filing of the Chapter 11 Petition andCanadian Petition and other business-related payments necessary to maintain theoperation of the Company’s business. The Company retained legal and financialprofessionals to advise it on the bankruptcy proceedings. From time to time,the Company may seek the U.S. Court’s approval for the retention of additionalprofessionals.

 

Immediately after filing the Chapter 11 Petition andCanadian Petition, the Company began notifying all known current or potentialcreditors of the bankruptcy filings. Subject to certain exceptions under theBankruptcy Code and the CCAA, the Company’s bankruptcy filings automaticallyenjoined, or stayed, the continuation of any judicial or administrativeproceedings or other actions against the Company or its property to recover,collect or secure a claim arising prior to the filing of the Chapter 11Petition and Canadian Petition. Thus, for example, most creditor actions toobtain possession of property from the Company, or to create, perfect orenforce any lien against its property, or to collect on monies owed orotherwise exercise rights or remedies with respect to a pre-petition claim areenjoined unless and until the Bankruptcy Courts lift the automatic stay.

 

As required by the Bankruptcy Code, the United StatesTrustee for the District of Delaware appointed an official committee ofunsecured creditors (the “Creditors’ Committee”). The Creditors’ Committee andits legal representatives have a right to be heard on all matters that comebefore the U.S. Court with respect to the Company. A monitor has been appointedby the Canadian Court with respect to proceedings before the Canadian Court.

 

The United States Trustee denied a request by certainholders of SSCC’s common stock and Preferred Stock to form an official equitycommittee to represent the interests of equity holders on matters before theU.S. Court, but such holders subsequently filed a motion for the appointment ofan equity committee with the U.S. Court, which has scheduled a hearing on thematter for December 4, 2009.

 

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

 

Since the Petition Date, the Company has receivedapproval from the Bankruptcy Courts to reject a number of leases and otherexecutory contracts of various types. The Company is reviewing all of itsexecutory contracts and unexpired leases to determine which additionalcontracts and leases it will reject. The Company expects that additionalliabilities subject to compromise will arise due to rejection of executorycontracts, including leases, and from the determination of the U.S. Court (oragreement by parties in interest) of allowed claims for contingencies and otherdisputed amounts. The Company also expects that the assumption of additionalexecutory contracts and unexpired leases will convert certain of theliabilities shown on the accompanying consolidated balance sheet as liabilitiessubject to compromise to liabilities not subject to compromise. Due to theuncertain nature of many of the potential claims, the Company cannot projectthe magnitude of such claims with certainty.

 

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On June 22, 2009, the Bankruptcy Courts enteredan order establishing August 28, 2009, as the bar date for potentialcreditors to file claims. The bar date is the date by which certain claimsagainst the Company must be filed if the claimants wish to receive anydistribution in the bankruptcy cases. Proof of claim forms received after thistime are not eligible for consideration of recovery as part of the Company’sbankruptcy cases. Creditors were notified of the bar date and the requirementto file a proof of claim with the Bankruptcy Courts. Differences betweenliability amounts estimated by the Company and claims filed by creditors arebeing investigated and, if necessary, the Bankruptcy Courts will make a finaldetermination of the allowable claim. The determination of how liabilities willultimately be treated cannot be made until the Bankruptcy Courts approve a planof reorganization. Accordingly, the ultimate amount or treatment of suchliabilities is not determinable at this time (See Note 5).

 

In order to successfully emerge from bankruptcy, theCompany will need to propose and obtain confirmation by the Bankruptcy Courtsof a plan of reorganization that satisfies the requirements of the BankruptcyCode and the CCAA. A plan of reorganization would resolve the Company’spre-petition obligations, set forth the revised capital structure of the newlyreorganized entity and provide for corporate governance subsequent to theCompany’s exit from bankruptcy.

 

The Debtors have the exclusive right for 120 daysafter the filing of the Chapter 11 Petition to file a plan of reorganization.On May 18, 2009, the U.S. Court approved a motion to extend theexclusivity period through September 23, 2009. On September 9, 2009,the U.S. Court granted approval to extend for 120 additional days theexclusivity period to January 21, 2010, and granted the Debtors approvalto solicit acceptance of a plan of reorganization until March 23, 2010. Ifthe Debtors’ exclusivity period lapsed, any party in interest would be able tofile a plan of reorganization. In addition to being voted on by holders ofimpaired claims and equity interests, a plan of reorganization must satisfycertain requirements of the Bankruptcy Code and the CCAA and must be approved,or confirmed, by the Bankruptcy Courts in order to become effective.

 

The Debtors presently intend to file a plan ofreorganization prior to January 21, 2010, although the timing of filing aplan of reorganization by the Debtors will depend on the timing and outcome ofnumerous other ongoing matters in the bankruptcy proceedings. There can be noassurance at this time that a plan of reorganization will be confirmed by theBankruptcy Courts or that any such plan will be implemented successfully.

 

Under the priority scheme established by theBankruptcy Code and the CCAA, unless creditors agree otherwise, pre-petitionliabilities and post-petition liabilities must be satisfied in full before SSCC’sstockholders are entitled to receive any distribution or retain any propertyunder a plan of reorganization. The ultimate recovery to creditors and/orstockholders, if any, will not be determined until confirmation of a plan orplans of reorganization. No assurance can be given as to what values, if any,will be ascribed to each of these constituencies or what types or amounts ofdistributions, if any, they would receive. A plan of reorganization couldresult in holders of the Company’s liabilities and/or securities receiving nodistribution on account of their interests and cancellation of their holdings.Because of such possibilities, the value of the Company’s liabilities andsecurities is highly speculative. Appropriate caution should be exercised withrespect to existing and future investments in any of the Company’s liabilitiesand/or securities. At this time there is no assurance the Company will be ableto restructure as a going concern or successfully implement a plan ofreorganization.

 

For periods subsequent to the bankruptcy filings, theCompany has applied the Financial Accounting Standards Board (“FASB”)Accounting Standards Codification (“ASC”) 852, Reorganizations (“ASC-852”), inpreparing the consolidated financial statements. ASC-852 requires that thefinancial statements distinguish transactions and events that are directlyassociated with the reorganization from the ongoing operations of the business.Accordingly, certain revenues, expenses (including professional fees), realizedgains and losses and provisions for losses that are realized or incurred in thebankruptcy proceedings have been recorded in reorganization items in theconsolidated statement of operations (See

 

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Note 4). In addition, pre-petition obligations thatmay be impacted by the bankruptcy reorganization process have been classifiedon the consolidated balance sheet in liabilities subject to compromise (SeeNote 5). These liabilities are reported at the amounts expected to be allowedby the Bankruptcy Courts, even if they may be settled for lesser amounts.

 

**Going Concern Matters**

The consolidated financial statements and relatednotes have been prepared assuming that the Company will continue as a goingconcern, although its bankruptcy filings raise substantial doubt about itsability to continue as a going concern. The consolidated financial statementsdo not include any adjustments related to the recoverability and classificationof recorded assets or to the amounts and classification of liabilities or anyother adjustments that might be necessary should the Company be unable tocontinue as a going concern. The Company’s ability to continue as a goingconcern is dependent on market conditions and its ability to improveprofitability, obtain alternative financing to replace the pre-petition CreditAgreement and restructure its obligations in a manner that allows it to obtainconfirmation of a plan of reorganization by the Bankruptcy Courts.

 

In order to improve profitability, management istaking actions to further reduce corporate and operational expenses and iscontinuing to align manufacturing capacity to meet market demands andstandardize manufacturing processes throughout all operations. These actionswill result in the closure of additional manufacturing facilities andreductions in headcount during the next twelve months.

 

**Debtor Financial Statements**

The following unaudited condensed combined financialstatements represent the financial statements for the Debtors only. The Company’sNon-Debtor Subsidiaries are accounted for as non-consolidated subsidiaries inthese financial statements and, as such, their net income (loss) is included in“Equity in income (losses) of Non-Debtor Subsidiaries,” in the consolidatedstatement of operations and their net assets are included as “Investments inand advances to Non-Debtor Subsidiaries” in the consolidated balance sheet. TheDebtor’s financial statements have been prepared in accordance with theguidance in ASC-852.

 

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

 

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

**CONDENSED COMBINED STATEMENTS OF OPERATIONS – DEBTORS**

**(Unaudited)**

 
| ** **                                                                                                                                                                         | ** ** | **Three**                    | ** ** | **Nine**                     | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **Months  Ended**            | ** ** | **Months  Ended**            | ** ** |
| **(In  millions)**                                                                                                                                                                 | ** ** | **September 30,  2009** | ** ** | **September 30,  2009** | ** ** |
| Net sales                                                                                                                                                                          | ** ** | **$**                        | **1,391**  | ** **                   | **$**      | **4,125** | ** ** |
| Costs and expenses                                                                                                                                                                 |       |                         |       |                         |       |
| Cost of goods sold                                                                                                                                                                 | ** ** | **1,262**                    | ** ** | **3,698**                    | ** ** |
| Selling and administrative expenses                                                                                                                                                | ** ** | **134**                      | ** ** | **415**                      | ** ** |
| Restructuring expenses                                                                                                                                                             | ** ** | **15**                       | ** ** | **38**                       | ** ** |
| Loss on disposal of assets                                                                                                                                                         | ** ** | **2**                        | ** ** | **3**                        | ** ** |
| Other operating income                                                                                                                                                             | ** ** | **(179**                     | **)**      | **(455**                     | **)**      |
| Operating income                                                                                                                                                                   | ** ** | **157**                      | ** ** | **426**                      | ** ** |
| Other income (expense)                                                                                                                                                             |       |                         |       |                         |       |
| Interest expense, net (including $49 million and $147 million for the  three andnine months ended September 30, 2009, respectively, that is  stayed andsubject to compromise) |       | **(71**                      | **)**      | **(216**                     | **)**      |
| Debtor-in-possession debt issuance costs                                                                                                                                           |       |                         | ** ** | **(63**                      | **)**      |
| Loss on early extinguishment of debt                                                                                                                                               |       |                         | ** ** | **(20**                      | **)**      |
| Foreign currency exchange losses                                                                                                                                                   | ** ** | **(11**                      | **)**      | **(10**                      | **)**      |
| Equity in income (losses) of non-debtor subsidiaries                                                                                                                               | ** ** | **1**                        | ** ** | **(4**                       | **)**      |
| Other, net                                                                                                                                                                         | ** ** | **6**                        | ** ** | **11**                       | ** ** |
| Income before reorganization items and income taxes                                                                                                                                | ** ** | **82**                       | ** ** | **124**                      | ** ** |
| Reorganization items                                                                                                                                                               | ** ** | **(16**                      | **)**      | **(109**                     | **)**      |
| Income before income taxes                                                                                                                                                         | ** ** | **66**                       | ** ** | **15**                       | ** ** |
| (Provision for) benefit from income taxes                                                                                                                                          | ** ** | **2**                        | ** ** | **(3**                       | **)**      |
| Net income                                                                                                                                                                         | ** ** | **$**                        | **68**     | ** **                   | **$**      | **12** | ** ** |

 

8

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**SMURFIT-STONE CONTAINER ENTERPRISES, INC. CONDENSED COMBINED BALANCE SHEET — DEBTORS**

**(Unaudited)**

 
| ** **                                              | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|
| **(In millions)**                                       | ** ** | **2009**               | ** ** |
| **Assets**                                              |       |                   |       |
|                                                    |       |                   |       |
| Current assets                                          |       |                   |       |
| Cash and cash equivalents                               | ** ** | **$**                  | **543**    | ** ** |
| Restricted cash                                         | ** ** | **9**                  | ** ** |
| Receivables                                             | ** ** | **628**                | ** ** |
| Receivable for alternative energy tax credits           | ** ** | **58**                 | ** ** |
| Inventories                                             | ** ** | **471**                | ** ** |
| Prepaid expenses and other current assets               | ** ** | **68**                 | ** ** |
| Total current assets                                    | ** ** | **1,777**              | ** ** |
| Net property, plant and equipment                       | ** ** | **3,311**              | ** ** |
| Timberland, less timber depletion                       | ** ** | **2**                  | ** ** |
| Investments in and advances to non-debtor subsidiaries  | ** ** | **77**                 | ** ** |
| Other assets                                            | ** ** | **66**                 | ** ** |
|                                                    | ** ** | **$**                  | **5,233**  | ** ** |
| **Liabilities and Stockholders’ Equity (Deficit)** |       |                   |       |
| ** **                                              |       |                   |       |
| Liabilities not subject to compromise                   |       |                   |       |
| Current liabilities                                     |       |                   |       |
| Current maturities of long-term debt                    | ** ** | **$**                  | **1,480**  | ** ** |
| Accounts payable                                        | ** ** | **351**                | ** ** |
| Accrued compensation and payroll taxes                  | ** ** | **137**                | ** ** |
| Interest payable                                        | ** ** | **10**                 | ** ** |
| Income taxes payable                                    | ** ** | **9**                  | ** ** |
| Current deferred income taxes                           | ** ** | **21**                 | ** ** |
| Other current liabilities                               | ** ** | **133**                | ** ** |
| Total current liabilities                               | ** ** | **2,141**              | ** ** |
| Other long-term liabilities                             | ** ** | **124**                | ** ** |
| Deferred income taxes                                   | ** ** | **128**                | ** ** |
| Total liabilities not subject to compromise             | ** ** | **2,393**              | ** ** |
|                                                    | ** ** | ** **             | ** ** |
| Liabilities subject to compromise                       | ** ** | **4,301**              | ** ** |
| Total liabilities                                       | ** ** | **6,694**              | ** ** |
|                                                    | ** ** | ** **             | ** ** |
| Total equity (deficit)                                  | ** ** | **(1,461**             | **)**      |
|                                                    | ** ** | **$**                  | **5,233**  | ** ** |

 

9

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** **

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONDENSEDCOMBINED STATEMENT OF CASH FLOWS — DEBTORS**

**(Unaudited)**

** **
| **Nine  Months Ended September 30, (In millions)**                                      | ** ** | **2009** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|
| **Cash flows from operating activities**                                                     |       |     |       |
| Net income                                                                                   | ** ** | **$**    | **12**     | ** ** |
| Adjustments to reconcile net income to net cash provided by operating  activities            |       |     |       |
| Loss on early extinguishment of debt                                                         | ** ** | **20**   | ** ** |
| Depreciation, depletion and amortization                                                     | ** ** | **270**  | ** ** |
| Debtor-in-possession debt issuance costs                                                     | ** ** | **63**   | ** ** |
| Amortization of deferred debt issuance costs                                                 | ** ** | **5**    | ** ** |
| Deferred income taxes                                                                        | ** ** | **1**    | ** ** |
| Pension and postretirement benefits                                                          | ** ** | **49**   | ** ** |
| Loss on disposal of assets                                                                   | ** ** | **3**    | ** ** |
| Non-cash restructuring expenses                                                              | ** ** | **6**    | ** ** |
| Non-cash stock-based compensation                                                            | ** ** | **7**    | ** ** |
| Non-cash foreign currency exchange losses                                                    | ** ** | **10**   | ** ** |
| Non-cash reorganization items                                                                | ** ** | **65**   | ** ** |
| Change in restricted cash                                                                    | ** ** | **(9**   | **)**      |
| Change in current assets and liabilities, net of effects from  acquisitions and dispositions |       |     |       |
| Receivables                                                                                  | ** ** | **(54**  | **)**      |
| Receivable for alternative energy tax credit                                                 | ** ** | **(58**  | **)**      |
| Inventories                                                                                  | ** ** | **36**   | ** ** |
| Prepaid expenses and other current assets                                                    | ** ** | **(15**  | **)**      |
| Accounts payable and accrued liabilities                                                     | ** ** | **205**  | ** ** |
| Intercompany receivable with non-debtors                                                     | ** ** | **(12**  | **)**      |
| Interest payable                                                                             | ** ** | **128**  | ** ** |
| Other, net                                                                                   | ** ** | **49**   | ** ** |
| Net cash provided by operating activities                                                    | ** ** | **781**  | ** ** |
| **Cash flows from investing activities**                                                     |       |     |       |
| Expenditures for property, plant and equipment                                               | ** ** | **(111** | **)**      |
| Proceeds from property disposals                                                             | ** ** | **16**   | ** ** |
| Advances to affiliates                                                                       | ** ** | **(18**  | **)**      |
| Net cash used for investing activities                                                       | ** ** | **(113** | **)**      |
| **Cash flows from financing activities**                                                     |       |     |       |
| Net borrowings of debtor-in-possession debt                                                  | ** ** | **130**  | ** ** |
| Net borrowings of long-term debt                                                             | ** ** | **73**   | ** ** |
| Repurchase of receivables                                                                    | ** ** | **(385** | **)**      |
| Debtor-in-possession debt issuance costs                                                     | ** ** | **(63**  | **)**      |
| Net cash used for financing activities                                                       | ** ** | **(245** | **)**      |
| **Increase in cash and cash equivalents**                                                    | ** ** | **423**  | ** ** |
| Cash and cash equivalents                                                                    |       |     |       |
| Beginning of period                                                                          | ** ** | **120**  | ** ** |
| End of period                                                                                | ** ** | **$**    | **543**    | ** ** |

 

 

10

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**2.Significant Accounting Policies**

 

**Basis of Presentation:**The accompanying consolidated financialstatements and notes of the Company have been prepared in accordance with theinstructions to Form 10-Q and reflect all adjustments which managementbelieves necessary (which include only normal recurring accruals) to presentfairly the Company’s financial position, results of operations and cash flows.These statements, however, do not include all information and notes necessaryfor a complete presentation of financial position, results of operations andcash flows in conformity with U.S. generally accepted accounting principles (“GAAP”).Interim results may not necessarily be indicative of results that may beexpected for any other interim period or for the year as a whole. Thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes included in the 2008 Form 10-K.

 

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

 

**Recently Adopted AccountingStandards:**TheFASB’s Accounting Standards Codification was released on July 1, 2009 andbecame the single source of authoritative U.S. GAAP. The change was establishedby ASC 105 “Generally Accepted Accounting Principles” (“ASC 105”). Pursuant tothe provisions of ASC 105, the Company has updated its references to GAAP inits consolidated financial statements issued for the period ended September 30,2009. The adoption of ASC 105 does not impact the Company’s financial position,results of operations or cash flows.

 

Effective June 15, 2009, the Company adopted theprovisions of ASC 855 “Subsequent Events” (“ASC 855”). ASC 855 requiresentities to disclose the date through which subsequent events have beenevaluated and the basis for such date. As of November 9, 2009, the datethe financial statements were issued, the Company has determined that nomaterial subsequent events have occurred.

 

Effective June 15, 2009, the Company adopted ASC825-10-65-1, “Transition related to FSP FAS 107-1 and APB 28-1, InterimDisclosures About Fair Value of Financial Instruments” (“ASC 825-10-65-1”),which extends the disclosure requirements of ASC 825, “Financial Instruments,”to interim financial statements (See Note 18).

 

Effective January 1, 2009, the Company adoptedthe provisions of ASC 810-10-65-1, “Transition Related to FASB Statement No. 160,Non-controlling Interest in Consolidated Financial Statements - An Amendment ofARB No. 51” (“ASC 810-10-65-1”). ASC 810-10-65-1 changes the accountingfor non-controlling (minority) interests in consolidated financial statements,requires non-controlling interests to be reported as part of equity and changesthe income statement presentation of income or losses attributable tonon-controlling interests. ASC 810-10-65-1 did not have a material impact onthe Company’s consolidated financial statements.

 

**Prospective AccountingPronouncements:**InJune 2009, the FASB issued Statement of Financial Standards (“SFAS”) No. 166,“Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140”(“SFAS No. 166”), effective for fiscal years beginning after November 15,2009. SFAS No. 166 modifies SFAS No. 140 by removing the concept of aqualifying special-purpose entity, thus potentially requiring consolidation ofsuch special-purpose entities previously excluded from the consolidatedfinancial statements. The Company is currently evaluating the impact of SFAS No. 166on its consolidated financial statements.

 

**3. Reclassifications**

 

Certain prior year amounts have been reclassified toconform to the current year presentation.

 

11

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

 

**Reorganization Items**

The Company’s reorganization items directly related tothe process of reorganizing the Company under Chapter 11 and the CCAA for thethree and nine months ended September 30, 2009 consist of the following:

 
| ** **                                                     | ** ** | **Three  months ended**      | ** ** | **Nine  months ended**       | ** ** |
|----------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                     | ** ** | **September 30,  2009** | ** ** | **September 30,  2009** | ** ** |
|                                                           |       |                         |       |                         |       |
| Provision for  rejected/settled executory contracts and leases |       | $                            | 9          |                         | $          | 73 |   |
| Professional  fees                                             |       | 12                           |       | 44                           |       |
| Accounts payable  settlement gains                             |       | (5                           | )          | (8                           | )          |
| Total  reorganization items                                    |       | $                            | 16         |                         | $          | 109 |   |

 

Provision for rejected/settled executory contracts andleases for the nine months ended September 30, 2009, includes a $9 millionspecial termination benefits charge due to funding obligations related tocertain non-qualified pension plans.

 

Professional fees directly related to thereorganization include fees associated with advisors to the Company, theCreditors’ Committee and certain secured creditors.

 

Net cash paid for reorganization items for the threeand nine months ended September 30, 2009 totaled $9 million and $26million, respectively, related to professional fees.

 

Reorganization items exclude employee severance andother restructuring charges recorded during the three and nine months ended September 30,2009.

 

**Other Bankruptcy Related Costs**

Debtor-in-possession debt issuance costs of $63million were incurred and paid during the first quarter of 2009 in connectionwith entering into the DIP Credit Agreement, and are separately disclosed inthe consolidated statements of operations.

 

**5.Liabilities Subject to Compromise**

 

Liabilities subject to compromise represent unsecuredobligations that will be accounted for under a plan of reorganization.Generally, actions to enforce or otherwise effect payment of pre-Chapter 11 orCCAA liabilities are stayed. Pre-petition liabilities that are subject tocompromise are reported at the amounts expected to be allowed, even if they maybe settled for lesser amounts. These liabilities represent the amounts expectedto be allowed on known or potential claims to be resolved through the Chapter11 and CCAA process, and remain subject to future adjustments arising fromnegotiated settlements, actions of the Bankruptcy Courts, rejection ofexecutory contracts and unexpired leases, the determination as to the value ofcollateral securing the claims, proofs of claim, or other events. Liabilitiessubject to compromise also include certain items that may be assumed under theplan of reorganization, and as such, may be subsequently reclassified toliabilities not subject to compromise.

 

The Bankruptcy Courts have approved payment of certainpre-petition obligations, including employee wages, salaries and benefits, andthe payment of vendors and other providers in the ordinary course for goods andservices received after the filing of the Chapter 11 Petition and the CanadianPetition and

 

12

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other business-related payments necessary to maintainthe operation of the Company’s business. Obligations associated with thesematters are not classified as liabilities subject to compromise.

 

Deferred debt issuance costs (“DDIC”) are viewed asvaluations of the related debt. DDIC associated with unsecured debt is includedas a valuation adjustment within the liabilities subject to compromise.

 

The Company has rejected certain pre-petitionexecutory contracts and unexpired leases with respect to the Company’soperations with the approval of the Bankruptcy Courts and may reject additionalones in the future. Damages resulting from rejection of executory contracts andunexpired leases are generally treated as general unsecured claims and areclassified as liabilities subject to compromise.

 

On June 22, 2009, the Bankruptcy Courts enteredan order establishing August 28, 2009 as the bar date for potentialcreditors to file claims. The bar date is the date by which certain claimsagainst the Company must be filed if the claimants wish to receive anydistribution in the bankruptcy cases. Proof of claim forms received after thistime are not eligible for consideration of recovery as part of the Company’sbankruptcy cases. Creditors were notified of the bar date and the requirementto file a proof of claim with the Bankruptcy Courts. Differences betweenliability amounts estimated by the Company and claims filed by creditors arebeing investigated and, if necessary, the Bankruptcy Courts will make a finaldetermination of the allowable claim. The determination of how liabilities willultimately be treated cannot be made until the Bankruptcy Courts approve a planof reorganization. Accordingly, the ultimate amount or treatment of suchliabilities is not determinable at this time.

 

Liabilitiessubject to compromise consisted of the following:

 
| ** **                         | ** ** | **September 30, 2009** | ** ** |
|------------------------------------|------------|-----------------------------|------------|
| Unsecured debt                     |       | $                           | 2,439      |   |
| DDIC for  unsecured debt           |       | (15                         | )          |
| Accounts payable                   |       | 364                         |       |
| Interest payable                   |       | 178                         |       |
| Retiree medical  obligations       |       | 164                         |       |
| Pension  obligations               |       | 1,028                       |       |
| Unrecognized tax  benefits         |       | 44                          |       |
| Executory  contracts and leases    |       | 67                          |       |
| Other                              |       | 32                          |       |
| Liabilities  subject to compromise |       | $                           | 4,301      |   |

 

**6. Alternative Energy Tax Credits**

 

The U.S. Internal Revenue Code allows an excise taxcredit for alternative fuel mixtures produced by a taxpayer for sale, or foruse as a fuel in a taxpayer’s trade or business. The credit is scheduled toexpire on December 31, 2009. On May 6, 2009, the Company was notifiedthat its registration as an alternative fuel mixer was approved by the InternalRevenue Service. The Company submitted refund claims of approximately $179million and $473 million for the three and nine months ended September 30,2009, respectively, related to production at ten of its U.S. mills. The Companyreceived refund claims of approximately $210 million and $415 million for thethree and nine months ended September 30, 2009, respectively. During thethree and nine months ended September 30, 2009, the Company recorded otheroperating income of $179 million and $455 million, respectively, net of feesand expenses, in its consolidated statements of operations related to thismatter.

 

13

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**7.(Gain) Loss on Disposal of Assets**

 

During September 2009, the Company completed thesale of its Canadian timberlands resulting in a loss of approximately $2million. At September 30, 2009, the net proceeds of approximately $28million were held in escrow and recorded in prepaid expenses and other currentassets in the consolidated balance sheet. On October 22, 2009,approximately $27 million was received by the Company and $1 million remainedin escrow pending completion of the title registration process on certainparcels. Cash received from the sale was used to repay a portion of theCanadian DIP term loan.

 

**8.Calpine Corrugated LLC**

 

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

 

On July 29, 2008, the Company acquired a 90percent ownership interest in Calpine Corrugated. In conjunction with theacquisition, the Company guaranteed approximately $45 million of CalpineCorrugated’s third party outstanding debt. There was no cash considerationpaid. The transaction was accounted for as a purchase business combination andresults of operations of Calpine Corrugated are included in the consolidatedstatements of operations beginning July 29, 2008. The purchase priceallocation completed in the fourth quarter of 2008 resulted in assets andliabilities of approximately $50 million, including approximately $45 millionof debt. No goodwill was recorded for the transaction. The acquisition ofCalpine Corrugated’s operations enabled the Company to accelerate theoptimization of its Northern California business unit and improve its positionin the agricultural market segment.

 

**9.Restructuring Activities**

 

During the third quarter of 2009, the Company closedfour converting facilities and recorded restructuring charges of $14 million,which were net of a $2 million gain on the sale of previously closedfacilities. Restructuring charges included non-cash charges of $4 millionrelated to the write-down of assets, primarily property, plant and equipment,to estimated net realizable values and the acceleration of depreciation forconverting equipment expected to be abandoned or taken out of service. Theremaining charges of $12 million were primarily for severance and benefits,including pension settlement costs of $3 million. As a result of the closuresin the third quarter of 2009 and other ongoing initiatives, the Company reducedits headcount by approximately 300 employees.

 

For the nine months ended September 30, 2009, theCompany closed eleven converting facilities. As a result of these closures andother ongoing initiatives, the Company reduced its headcount by approximately1,800 employees. The Company recorded restructuring charges of $38 million,which were net of a $2 million gain on the sale of previously closedfacilities. Restructuring charges included non-cash charges of $8 millionrelated to the write-down of assets, primarily property, plant and equipment, toestimated net realizable values and the acceleration of depreciation forconverting equipment expected to be abandoned or taken out of service. The remainingcharges of $32 million were primarily for severance and benefits, includingpension settlement costs of $3 million. The net sales of the announced andclosed converting facilities in 2009 prior to closure and for the year ended December 31,2008 were $62 million and $217 million, respectively. The majority of these netsales are expected to be transferred to other operating facilities. Additionalcharges of up to $4 million are expected to be recorded in the fourth quarterof 2009 for severance and benefits related to the closure of these andpreviously closed facilities.

 

14

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The Company continues to review and evaluate variousrestructuring and other alternatives to streamline operations, improveefficiencies and reduce costs. Such initiatives may include selling assets,idling facilities, consolidating operations and functions, relocating orreducing production and voluntary and involuntary employee separation programs.In addition, such actions will subject the Company to additional short-termcosts, which may include facility shutdown costs, asset impairment charges,lease commitment costs, severance costs and other closing costs.

 

The Company recorded restructuring charges of $14million and $27 million for the three and nine months ended September 30,2008, respectively, which were net of a $2 million gain on the sale of apreviously closed facility in the first quarter of 2008. Restructuring chargesincluded non-cash charges of $5 million and $9 million for the three and ninemonths ended September 30, 2008, respectively, related to the accelerationof depreciation for equipment expected to be abandoned or taken out of service.The remaining charges were primarily for severance and benefits.

 

At December 31, 2008, the Company had $33 millionof accrued exit liabilities related to the restructuring of operations. For thethree and nine months ended September 30, 2009, the Company incurred $1million and $11 million, respectively, of cash disbursements, primarilyseverance and benefits, related to these exit liabilities. In addition, exitliabilities have decreased by $5 million due to rejecting leases related topreviously closed facilities as permitted under the Bankruptcy Code. During thethree and nine months ended September 30, 2009, the Company incurred $9million and $23 million, respectively, of cash disbursements, primarilyseverance and benefits, related to exit liabilities established during 2009.

 

**10. Restricted Cash**

 

At September 30, 2009, the Company had restrictedcash of $9 million as approved by the U.S. Court to provide financial assuranceto certain utility vendors. Changes in restricted cash are reflected as cashused for operating activities in the consolidated statements of cash flows.

 

**11. Accounts ReceivableSecuritization Programs**

 

The Company, under two separate accounts receivable securitizationprograms, sold without recourse, on an ongoing basis, certain of its accountsreceivable to non-consolidated financing entities. The Company’s retainedinterest in these non-consolidated entities was carried at fair value andincluded in retained interest in receivables sold in the accompanying December 31,2008 consolidated balance sheet. On January 28, 2009, in conjunction withthe filing of the Chapter 11 Petition and the Canadian Petition, the accountsreceivable securitization programs were terminated and all outstandingreceivables previously sold to the non-consolidated financing entities wererepurchased with proceeds from borrowings under the DIP Credit Agreement (SeeNote 13). The repurchase of receivables of $385 million has been included inthe cash flows from financing activities in the consolidated statement of cashflows.

 

**12. Guarantees and Commitments**

 

The Company has certain wood chip processing contractsextending from 2012 through 2018 with minimum purchase commitments. As part ofthe agreements, the Company guarantees the third party contractors’ debtoutstanding and has a security interest in the chipping equipment. At September 30,2009, the maximum potential amount of future payments related to theseguarantees was approximately $26 million, which decreases ratably over the lifeof the contracts. In the event the guarantees on these contracts are exercised,proceeds from the liquidation of the chipping equipment would be based oncurrent market conditions and the Company may not fully recover the guaranteepayments made.

 

15

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The Company was contingently liable for $18 millionunder a one year letter of credit, which was to expire in April 2009,which supported the borrowings of a previously non-consolidated affiliate. On March 4,2009, this letter of credit was drawn on, which increased borrowings under theCompany’s pre-petition credit facilities by $18 million (See Note 13). As aresult of providing substantial financial support for the affiliate, inaccordance with ASC-810-10-05, “Consolidation of Variable Interest Entities,”the Company consolidated the affiliate’s balance sheet and results ofoperations into its consolidated financial statements in March 2009.

 

**13. Long-Term Debt**

 

The filing of the Chapter 11 Petition and the CanadianPetition constituted an event of default under the Company’s debt obligations,and those debt obligations became automatically and immediately due andpayable. Any efforts to enforce such payment obligations arestayedasaresult of thefiling ofthe Chapter11 Petition andthe Canadian Petition. As previously disclosed in the2008 Form 10-K, the accompanying consolidated balance sheet as of December 31,2008 includes a reclassification of $3,032 million to current maturities oflong-term debt from long-term debt. Due to the filing of the bankruptcypetitions, the Company’s unsecured long-term debt of $2,439 million is includedin liabilities subject to compromise at September 30, 2009 (See Note 5).Since the Petition Date, the Company discontinued interest payments on itsunsecured senior notes and certain other unsecured debt. Interest expense ($49million and $147 million in the three and nine months ended September 30,2009, respectively) continues to be accrued on the unsecured debt until adetermination is made that it will not be an allowed claim in the bankruptcyproceedings.

 

**DIP Credit Agreement**

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

 

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

 

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

 

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

 

16

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In September 2009, the Company made voluntaryprepayments of $290 million on the $400 million U.S. DIP term loan withavailable cash provided by operating activities. In addition, during the ninemonths ended September 30, 2009 the Company repaid approximately $15million of the U.S. DIP term loan with proceeds from property sales and $5million of the Canadian revolver under the DIP Credit Agreement.

 

During September 2009, the Company completed thesale of its Canadian timberlands. At September 30, 2009, the net proceedsof approximately $28 million were held in escrow and recorded in prepaidexpenses and other current assets in the consolidated balance sheet. On October 22,2009, approximately $27 million was received and $1 million remained in escrowpending the completion of the title registration process on certain parcels.Cash received from the sale was used to repay a portion of the Canadian DIPterm loan.

 

On October 28, 2009, the Company made a $50million voluntary prepayment on the $400 million U.S. DIP term loan withavailable cash provided by operating activities leaving an outstandingprincipal balance of $51 million under the DIP term loans, which the Company currentlyexpects to prepay in full during the fourth quarter of 2009. No borrowings areoutstanding under the DIP revolving loans.

 

U.S. and Canadian borrowings are each subject to aborrowing base derived from a formula based on certain eligible accountsreceivable and inventory, and an amount attributable to real property andequipment, less certain reserves. As of September 30, 2009, the applicableborrowing base was $709 million and the amount available for borrowings underthe DIP Credit Agreement was $283 million. The applicable borrowing base as of September 30,2009 as compared to June 30, 2009 increased approximately $112 million dueprincipally to a $107 million increase in the real property and equipmentcomponent of the borrowing base resulting from appraisals received on realproperty and equipment in August 2009.

 

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

 

Under the DIP Credit Agreement,****interest and fees are payable in arrearson each interest payment date as defined in the DIP Credit Agreement. If theCompany defaults on its obligations under the DIP Credit Agreement, the defaultrate of interest in most cases will be the rate otherwise in effect plus 2.0%per annum. In addition to interest, a commitment fee of 1.0% per annum isrequired in respect of the unutilized commitments under the DIP CreditAgreement. The DIP Credit Agreement also imposes letter of credit fees.

 

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

 

Borrowings under the DIP Credit Agreement areguaranteed by the Company and certain of its affiliates, and are secured byfirst priority liens on the collateral and all presently owned and hereafteracquired assets of the Company and each of its subsidiaries party to the DIP CreditAgreement, subject to certain permitted prior liens. Subject to certainexceptions, the DIP Credit Agreement requires certain mandatory

 

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prepayments of borrowings from the net proceeds ofcertain asset dispositions, and casualty or condemnation payments. The onlyCanadian entity that guarantees U.S. obligations is SSC Canada.

 

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

 

**Bank Credit Facilities**

The Company’s Credit Agreement provided for a depositfunded letter of credit facility, related to the variable rate industrialrevenue bonds, for approximately $122 million that was due to mature on November 1,2010. In February 2009, due to an event of default under the bondindentures, this credit facility was drawn on to fully repay the industrialrevenue bonds in the aggregate principal amount of $120 million. A loss on theearly extinguishment of debt of $20 million was recorded to write-off theunamortized deferred debt issuance costs related to the industrial revenuebonds.

 

During the nine months ended September 30, 2009,letters of credit in the amount of $71 million were drawn on to fundobligations principally related to non-qualified pension plans, commodityderivative instruments and a guarantee for a previously non-consolidatedaffiliate, which increased borrowings under the Company’s Credit Agreement.

 

**14. Employee Benefit Plans**

 

The Company sponsors noncontributory defined benefitpension plans for its U.S. employees and also sponsors noncontributory andcontributory defined benefit pension plans for its Canadian employees. TheCompany’s defined benefit pension plans cover substantially all hourlyemployees, as well as salaried employees hired prior to January 1, 2006.The U.S. and Canadian defined benefit pension plans for salaried employees werefrozen effective January 1, 2009 and March 1, 2009, respectively.

 

The Company’s postretirement plans provide certainhealth care and life insurance benefits for all retired salaried and certainretired hourly employees, and for salaried and certain hourly employees whohave reached the age of 60 with ten years of service as of January 1,2007.

 

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The components of net periodic benefit costs for thedefined benefit plans and the components of the postretirement benefit costsare as follows:

 
| ** **                                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | **Defined**                               | ** ** | **Postretirement**                       | ** ** | **Defined** | ** ** | **Postretirement** | ** ** |
| ** **                                    | ** ** | **Benefit Plans**                         | ** ** | **Plans**                                | ** ** | **Benefit Plans** | ** ** | **Plans** | ** ** |
| ** **                                    | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| Service cost                                  |       | $                                         | 8          |                                     | $          | 11 |   | $ | 1 |   | $ |   | $ | 19 |   | $ | 34 |   | $ | 2 |   | $ | 2 |   |
| Interest cost                                 |       | 52                                        |       | 51                                       |       | 2 |   | 3 |   | 153 |   | 153 |   | 7 |   | 8 |   |
| Expected returnon plan assets                 |       | (51                                       | )          | (62                                      | )          |   |   |   |   | (150 | ) | (186 | ) |   |   |   |   |
| Amortization of  priorservice  cost (benefit) |       | 1                                         |       |                                     |       | (1 | ) | (1 | ) | 2 |   | 2 |   | (2 | ) | (3 | ) |
| Amortization of  net(gain)  loss              |       | 22                                        |       | 11                                       |       | (1 | ) | (1 | ) | 64 |   | 32 |   | (3 | ) | (2 | ) |
| Special  terminationbenefits charge           |       |                                      |       |                                     |       |   |   |   |   | 9 |   |   |   |   |   |   |   |
| Settlements                                   |       | 3                                         |       |                                     |       |   |   |   |   | 3 |   |   |   |   |   |   |   |
| Multi-employer  plans                         |       | 1                                         |       | 1                                        |       |   |   |   |   | 3 |   | 3 |   |   |   |   |   |
| Net periodic  benefit cost                    |       | $                                         | 36         |                                     | $          | 12 |   | $ | 1 |   | $ | 1 |   | $ | 103 |   | $ | 38 |   | $ | 4 |   | $ | 5 |   |
|                                               |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The 2009 special termination benefits charge is due tofunding obligations related to certain non-qualified pension plans and isincluded in reorganization items in the consolidated statements of operations(See Note 4).

 

The 2009 settlement charges are related to closedfacilities and are included as part of the restructuring charges (See Note 9).

 

**15. Derivative Instruments andHedging Activities**

 

On January 26, 2009, the Chapter 11 Petition andthe Canadian Petition effectively terminated all existing derivativeinstruments. Termination fair values were calculated based on the potentialsettlement value. During the nine months ended September 30, 2009, aletter of credit in the amount of $18 million was drawn on related to thesettlement of certain commodity derivative instruments (See Note 13). Excludingthese settled liabilities, the Company’s termination value related to itsremaining derivative liabilities was approximately $60 million, recorded inother current liabilities in the consolidated balance sheet at September 30,2009. These derivative liabilities were stayed due to the filing of the Chapter11 Petition and the Canadian Petition. These derivative liabilities wereadjusted through other comprehensive income (loss) (“OCI”) for derivativeinstruments qualifying for hedge accounting and cost of goods sold forderivative instruments not qualifying for hedge accounting. The remainingamount in OCI will be recorded through earnings during the period theunderlying transaction is recognized or when the underlying transaction is nolonger expected to occur.

 

The Company’s derivative instruments previously usedfor its hedging activities were designed as cash flow hedges and related tominimizing exposures to fluctuations in the price of commodities used in itsoperations, the movement in foreign currency exchange rates and thefluctuations in the interest rate on variable rate debt. All cash flowsassociated with the Company’s derivative instruments were classified asoperating activities in the consolidated statements of cash flows.

 

**Commodity Derivative Instruments**

The Company used derivative instruments, includingfixed price swaps, to manage fluctuations in cash flows resulting fromcommodity price risk in the procurement of natural gas and other commodities,

 

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including fuel oil and diesel fuel. The objective wasto fix the price of a portion of the Company’s purchases of these commoditiesused in the manufacturing process. The changes in the market value of suchderivative instruments historically offset the changes in the price of thehedged item.

 

For the three and nine months ended September 30,2009, the Company reclassified a $5 million loss (net of tax) and a $24 millionloss (net of tax), respectively, from OCI to cost of goods sold when the hedgeditems were recognized. For the three and nine months ended September 30,2008, the Company reclassified an immaterial amount and a $1 million loss (netof tax), respectively, from OCI to cost of goods sold when the hedged itemswere recognized.

 

For the nine months ended September 30, 2009, theCompany recorded a $3 million gain (net of tax) in cost of goods sold relatedto the change in fair value, prior to the Petition Date, of certain commodityderivative instruments not qualifying for hedge accounting. For the three andnine months ended September 30, 2008, the Company recorded an $11 millionloss (net of tax) and a $10 million loss (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 nine months ended September 30, 2009, theCompany recorded a $3 million loss (net of tax) in cost of goods sold oncommodity derivative instruments, settled prior to the Petition Date, notqualifying for hedge accounting. For the three and nine months ended September 30,2008, the Company recorded a $1 million loss (net of tax) in cost of goods soldon settled commodity derivative instruments not qualifying for hedgeaccounting.

 

**Foreign Currency DerivativeInstruments**

The Company’s principal foreign exchange exposure isthe Canadian dollar. The Company used foreign currency derivative instruments,including forward contracts and options, primarily to protect against Canadiancurrency exchange risk associated with expected future cash flows.

 

During the second quarter of 2009, the Companyreclassified the remaining foreign currency derivative instruments from OCI tocost of goods sold since the underlying transactions were no longer expected tooccur, resulting in an additional loss of $2 million (net of tax).  For the nine months ended September 30,2009, the Company reclassified a $4 million loss (net of tax) from OCI to costof goods sold. For the three and nine months ended September 30, 2008, theCompany reclassified an immaterial amount and a $3 million gain (net of tax),respectively, from OCI to cost of goods sold when the hedged items wererecognized.

 

**Interest Rate Swap Contracts**

The Company used interest rate swap contracts tomanage interest rate exposure on $300 million of the current Tranche B andTranche C floating rate bank term debt. The accounting for the cash flow impactof the swap contracts is recorded as an adjustment to interest expense eachperiod.

 

For the three and nine months ended September 30,2009, the Company reclassified a $1 million loss (net of tax) and a $3 millionloss (net of tax), respectively, from OCI to interest expense when the hedgeditems were recognized. For the three and nine months ended September 30,2008, the Company reclassified a $1 million loss (net of tax) from OCI tointerest expense when the hedged items were recognized.

 

**Deferred Hedge Gain (Loss)**

The cumulative deferred hedge loss in OCI on allderivative instruments was $5 million (net of tax) at September 30, 2009,including a $3 million loss (net of tax) on commodity derivative instrumentsand a $2 million loss (net of tax) on interest rate swap contracts. The Companyexpects to reclassify the remaining $5 million loss (net of tax) into cost ofgoods sold and interest expense within the next six months.

 

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**16. Income Taxes**

 

During the nine months ended September 30, 2009,the Company recorded a provision for income taxes of $3 million related toCanadian withholding taxes and interest on unrecognized tax benefits previouslyrecorded. Because it is more likely than not that substantially all of thedeferred tax assets that are generated in 2009 may not be realized, the Companyhas recorded a full valuation allowance, and has not recorded any additionaltax benefit for the three and nine months ended September 30, 2009.

 

As previously disclosed, the Canada Revenue Agency (“CRA”)is examining the Company’s income tax returns for tax years 1999 through 2005.Certain matters, including transfer prices of inventory sold by the Company’sCanadian subsidiaries to its U.S. subsidiaries, are currently under review.With respect to the transfer price issue, the CRA issued assessments ofadditional income taxes, interest and penalties, which the Company hasappealed. In order to appeal the assessment, the Company made payments of $25million to the CRA in 2008.

 

The remaining matters are expected to be resolved atthe examination level or subsequently upon appeal within the next twelvemonths. While the final outcome of the remaining CRA examination matters,including an estimate of the range of the reasonably possible changes tounrecognized tax benefits, is not yet determinable, the Company believes thatthe examination or subsequent appeals will not have a material adverse effecton its consolidated financial condition or results of operations.

 

**17. Comprehensive Income**

 

Comprehensiveincome is as follows:

 
| ** **                                                            | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                            | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income                                                            |       | $                      | 68         |                   | $          | 65 |   | $ | 12 |   | $ | 15 |   |
| Other  comprehensive income, net of tax:                              |       |                   |       |                   |       |   |   |   |   |
| Net changes in  fair value of hedging instruments                     |       |                   |       | (25                    | )          | (1 | ) | (17 | ) |
| Net hedging  (gain) loss reclassified into earnings                   |       | 6                      |       | 1                      |       | 33 |   | (1 | ) |
| Net deferred  employee benefit plan expensereclassified into earnings |       | 11                     |       | 5                      |       | 35 |   | 17 |   |
| Foreign currency  translation adjustment                              |       |                   |       | (2                     | )          | 1 |   | (1 | ) |
| Comprehensive  income                                                 |       | $                      | 85         |                   | $          | 44 |   | $ | 80 |   | $ | 13 |   |

** **

**18. FairValue Measurements**

 

Certain financial assets and liabilities are recordedat fair value on a recurring basis, including derivative instruments prior totermination (See Note 15), the Company’s retained interest in receivables soldto the accounts receivable programs (See Note 11) prior to the termination ofthese programs on January 28, 2009 and the Company’s residual interest inthe Timber Note Holdings (“TNH”) investment.

 

Fair value is defined as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date. In determiningfair value, the Company uses various valuation approaches, including market,income and/or cost approaches. ASC 820, “Fair Value Measurements andDisclosures”, establishes a hierarchy for inputs used in measuring fair valuethat maximizes the use of observable inputs and minimizes the use ofunobservable inputs by requiring that the most observable inputs be used whenavailable. Observable inputs are inputs that market participants would use inpricing the asset or liability based on market data obtained from sources

 

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independent of the Company. Unobservable inputs areinputs that reflect the Company’s assumptions about the assumptions marketparticipants would use in pricing the asset or liability developed based on thebest information available in the circumstances. The hierarchy for inputs isbroken down into three levels based on their reliability as follows:

 

*Level 1* - Valuations based on quoted prices inactive markets for identical assets or liabilities that the Company has theability to access. The Company has no assets or liabilities measured at fairvalue on a recurring basis utilizing Level 1 inputs.

 

*Level 2* - Valuations based on quoted prices inmarkets that are not active or for which all significant inputs are observable,either directly or indirectly. The Company has no assets or liabilitiesmeasured at fair value on a recurring basis utilizing Level 2 inputs.

 

*Level 3* - Valuations based on inputs that areunobservable and significant to the overall fair value measurement. The Company’sasset utilizing Level 3 inputs at September 30, 2009 is the residualinterest in the TNH investment. The fair value of the residual interest in theTNH investment is estimated using discounted residual cash flows.

 

**Fair Value on a Recurring Basis**

Assets and liabilities measured at fair value on arecurring basis are categorized in the table below based upon the level ofinput to the valuations.

 
| ** **                           | ** ** | **September 30, 2009** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **Level 1**                 | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Residual  interest in TNH investment |       | $                           |       | $ |   |   |   | $ | 35 |   | $ | 35 |   |
|                                      |            |                             |            |  |  |  |  |  |  |  |  |  |  |

 

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

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

 

Unrealized gains (losses) associated with derivativeinstruments represent the change in fair value included in other comprehensiveincome for derivative instruments qualifying for hedge accounting and cost ofgoods sold for derivative instruments not qualifying for hedge accounting priorto termination (See Note 15).

 

The net settlements associated with retained interestin receivables sold are due to the termination of the securitization programs(See Note 11). The net payments associated with derivative instruments relateto

 

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pre-bankruptcy filing contract settlements and thesettlement of contracts at termination, which were supported by letters ofcredit (See Note 13).

 

Due to termination of all existing derivativeinstruments, these liabilities are no longer measured at fair value on arecurring basis (See Note 15).

 

**Financial Instruments Not Measured atFair Value**

Some of the Company’s financial instruments are notmeasured at fair value on a recurring basis but are recorded at amounts thatapproximate fair value due to their liquid or short-term nature. The carryingamount of cash equivalents approximates fair value because of the shortmaturity of those instruments. The carrying amount of cost method investmentsapproximates fair value. The fair values of notes receivable are based ondiscounted future cash flows or the applicable quoted market price.

 

The Company’s borrowings are recorded at historicalamounts. The fair value of the Company’s debt is estimated based on the quotedmarket prices for the same or similar issues or on the current rates offered tothe Company for debt of the same remaining maturities. As of September 30,2009, the carrying value and fair value of the Company’s secured borrowingswere $1,484 million and $1,445 million, respectively. As of September 30,2009, the carrying value and the fair value of the Company’s unsecuredborrowings, included in liabilities subject to compromise, were $2,439 millionand $1,804 million, respectively.

 

**19. Contingencies**

 

The Company’s past and present operations includeactivities which are subject to federal, state and local environmentalrequirements, particularly relating to air and water quality. The Company facespotential environmental liability as a result of violations of theseenvironmental requirements, environmental permit terms and similarauthorizations that have occurred from time to time at its facilities. Inaddition, the Company faces potential liability for remediation at certainowned and formerly owned facilities, as well as response costs at various sitesfor which it has received notice as being a potentially responsible party (“PRP”)concerning hazardous substance contamination. In estimating its reserves forenvironmental remediation and future costs at sites where it is a PRP, theCompany’s estimated liability of $5 million reflects the Company’s expectedshare of costs after consideration for the relative percentage of wastedeposited at each site, the number of other PRPs, the identity and financialcondition of such parties and experience regarding similar matters. As of September 30,2009, the Company had approximately $17 million reserved for environmentalliabilities included primarily in other long-term liabilities in theconsolidated balance sheets. The Company believes the liability for thesematters was adequately reserved at September 30, 2009.

 

If all or most of the other PRPs are unable to satisfytheir portion of the clean-up costs at one or more of the significant sites inwhich the Company is involved or the Company’s expected share increases, theresulting liability could have a material adverse effect on the Company’sconsolidated financial condition, results of operations or cash flows.

 

The Company settled two putative class action casesfiled in California state court on behalf of current and former hourlyemployees at the Company’s California corrugated container facilities. Thesecases alleged violations of the California on-duty meal break and rest periodstatutes. The court approved a settlement for a total of $9 million for bothcases on January 21, 2009. The cases were automatically stayed due to thefiling of the Chapter 11 Petition on January 26, 2009 (See Note 1). TheCompany established reserves of $9 million during 2008 related to thesematters, which were included in selling and administrative expenses in theaccompanying consolidated statement of operations.

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

Some information includedin this report may contain forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended.  Although we believe that, in making any suchstatements, our expectations are based on reasonable assumptions, any suchstatement may be influenced by factors that could cause actual outcomes andresults to be materially different from those projected.  When used in this document, the words “anticipates,”“believes,” “expects,” “intends,” “estimates” and similar expressions as theyrelate to Smurfit-Stone Container Enterprises, Inc. or its management, areintended to identify such forward-looking statements.  These forward-looking statements are subjectto 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 are discussed in our Annual Report on Form 10-K for theyear ended December 31, 2008 (2008 Form 10-K), filed with theSecurities and Exchange Commission.

 

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

 

# **GENERAL**

#  

We are a wholly-ownedsubsidiary of Smurfit-Stone Container Corporation (Smurfit-Stone), a holdingcompany with no business operations of its own. Smurfit-Stone conducts its business operations through us.

 

# **RECENTLY ADOPTED ACCOUNTING STANDARDS**

#  

The Financial AccountingStandards Board’s (FASB) Accounting Standards Codification (ASC) was releasedon July 1, 2009 and became the single source of authoritative U.S.generally accepted accounting principles (GAAP).  The change was established by ASC 105 “GenerallyAccepted Accounting Principles” (ASC 105). Pursuant to provisions of ASC 105, we have updated our references toGAAP in our consolidated financial statements issued for the period ended September 30,2009.  The adoption of ASC 105 does notimpact our financial position, results of operations or cash flows.

 

**BANKRUPTCYPROCEEDINGS**

 

**Chapter11 Bankruptcy Filings**

 

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

 

The filing of the Chapter 11 Petition and theCanadian Petition constituted an event of default under our debt obligations,and those debt obligations became automatically and immediately due andpayable, although any actions to enforce such payment obligations are stayed asa result of the filing of the Chapter 11 Petition and the CanadianPetition.  As previously disclosed in our2008 Form 10-K, our 

 

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consolidated balance sheet as of December 31,2008 included a reclassification of $3,032 million to current maturities oflong-term debt from long-term debt.  Dueto the filing of the bankruptcy petitions, our unsecured long-term debt of$2,439 million is included in liabilities subject to compromise at September 30,2009.

 

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

 

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

 

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

 

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

 

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

 

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

 

**Reorganization Process**

 

The Bankruptcy Courtsapproved payment of certain of our pre-petition obligations, including employeewages, salaries and benefits, and the payment of vendors and other providers inthe ordinary course for goods and services received after the filing of theChapter 11 Petition and Canadian Petition and other business-related paymentsnecessary to maintain the operation of the Company’s business.  We retained legal and financial professionalsto advise us on the bankruptcy proceedings. From time to time, we may seek the U.S. Court’s approval for theretention of additional professionals.

 

Immediately after filingthe Chapter 11 Petition and Canadian Petition, we began notifying all knowncurrent or potential creditors of the bankruptcy filings.  Subject to certain exceptions under theBankruptcy Code and the CCAA, our bankruptcy filings automatically enjoined, orstayed, the continuation of any judicial or administrative proceedings or otheractions against the Company or our property to recover, collect or secure aclaim arising prior to the filing of the Chapter 11 Petition and CanadianPetition.  Thus, for example, mostcreditor actions to obtain possession of property from us, or to create,perfect or enforce any lien against our property, or to collect on monies owedor otherwise exercise rights or 

 

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remedies with respect toa pre-petition claim are enjoined unless and until the Bankruptcy Courts liftthe automatic stay.

 

As required by theBankruptcy Code, the United States Trustee for the District of Delawareappointed an official committee of unsecured creditors (the Creditors’Committee).  The Creditors’ Committee andits legal representatives have a right to be heard on all matters that comebefore the U.S. Court with respect to us. A monitor has been appointed by the Canadian Court with respect toproceedings before the Canadian Court.

 

The United States Trusteedenied a request by certain holders of Smurfit-Stone’s common stock andPreferred Stock to form an official equity committee to represent the interestsof equity holders on matters before the U.S. Court, but such holderssubsequently filed a motion for the appointment of an equity committee with theU.S. Court, which has scheduled a hearing on the matter for December 4,2009.

 

Under the BankruptcyCode, the Debtors generally must assume or reject pre-petition executorycontracts, including but not limited to real property leases, subject to theapproval of the Bankruptcy Courts and certain other conditions.  In this context, “assumption” means that we agreeto perform our obligations and cure all existing defaults under the contract orlease, and “rejection” means that we are relieved from our obligations toperform further under the contract or lease, but is subject to a pre-petitionclaim for damages for the breach thereof subject to certain limitations.  Any damages resulting from rejection ofexecutory contracts that are permitted to be recovered under the BankruptcyCode will be treated as liabilities subject to compromise unless such claimswere secured prior to the Petition Date.

 

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

 

We had the exclusiveright for 120 days after the filing of the Chapter 11 Petition to file a planof reorganization.  On May 18, 2009,the U.S. Court approved a motion to extend the exclusivity period through September 23,2009. On September 9, 2009, the U.S.Court granted approval to extend for120 additional days the exclusivity period to January 21, 2010, andgranted us and our subsidiaries approval to solicit acceptance of a plan ofreorganization until March 23, 2010. If our exclusivity period lapsed, any party in interest would be able tofile a plan of reorganization.  Inaddition to being voted on by holders of impaired claims and equity interests,a plan of reorganization must satisfy certain requirements of the BankruptcyCode and the CCAA and must be approved, or confirmed, by the Bankruptcy Courtsin order to become effective.

 

We presently intend tofile a plan of reorganization prior to January 21, 2010, although thetiming of filing a plan of reorganization by us will depend on the timing andoutcome of numerous other ongoing matters in the bankruptcy proceedings.  There can be no assurance at this time that aplan of reorganization will be confirmed by the Bankruptcy Courts or that anysuch plan will be implemented successfully.

 

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

 

26

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assurance we will be ableto restructure as a going concern or successfully implement a plan ofreorganization.

 

For periods subsequent tothe bankruptcy filings, we have applied the FASB Accounting Standards Codification(ASC), Reorganization (ASC-852), in preparing the consolidated financialstatements.  ASC-852 requires that thefinancial statements distinguish transactions and events that are directlyassociated with the reorganization from the ongoing operations of thebusiness.  Accordingly, certain revenues,expenses (including professional fees), realized gains and losses andprovisions for losses that are realized or incurred in the bankruptcyproceedings have been recorded in reorganization items in the consolidatedstatements of operations.  In addition,pre-petition obligations that may be impacted by the bankruptcy reorganizationprocess have been classified on the consolidated balance sheet in liabilitiessubject to compromise.  These liabilitiesare reported at the amounts expected to be allowed by the Bankruptcy Courts,even if they may be settled for lesser amounts.

 

**LiabilitiesSubject to Compromise**

 

Liabilities subject tocompromise represent unsecured obligations that will be accounted for under aplan of reorganization. Generally, actions to enforce or otherwise effectpayment of pre-Chapter 11 or CCAA liabilities are stayed.  Pre-petition liabilities that are subject tocompromise are reported at the amounts expected to be allowed, even if they maybe settled for lesser amounts.  Theseliabilities represent the amounts expected to be allowed on known or potentialclaims to be resolved through the Chapter 11 and CCAA process, and remainsubject to future adjustments arising from negotiated settlements, actions ofthe Bankruptcy Courts, rejection of executory contracts and unexpired leases,the determination as to the value of collateral securing the claims, proofs ofclaim, or other events.  Liabilities subjectto compromise also include certain items that may be assumed under the plan ofreorganization, and as such, may be subsequently reclassified to liabilitiesnot subject to compromise.

 

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

 

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

 

**GoingConcern Matters**

 

The consolidatedfinancial statements and related notes have been prepared assuming that we willcontinue as a going concern, although our bankruptcy filings raise substantialdoubt about our ability to continue as a going concern.  The consolidated financial statements do notinclude any adjustments related to the recoverability and classification ofrecorded assets or to the amounts and classification of liabilities or anyother adjustments that might be necessary should we be unable to continue as agoing concern.  Our ability to continueas a going concern is dependent on market conditions and our ability to improveprofitability, obtain alternative financing to replace the prepetition CreditAgreement and restructure our obligations in a manner that allows us to obtainconfirmation of a plan of reorganization by the Bankruptcy Courts.

 

27

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

 

**RESULTS OF OPERATIONS**

 

# **Overview**

#  

We had net income of $68million for the third quarter of 2009 compared to net income of $65 million forthe third quarter of 2008.  The thirdquarter of 2009 results benefited from the alternative fuel tax credit incomeof $179 million, but were negatively impacted by reorganization items of $16million and lower segment operating profits of $40 million.  The third quarter of 2008 results benefited$84 million from the resolution of certain Canadian income tax examinationmatters.  While sales volumes and averageselling prices for containerboard and corrugated containers were lower for thethird quarter of 2009, results benefited from lower costs compared to 2008.

 

For the nine months endedSeptember 30, 2009, we had net income of $12 million compared to netincome of $15 million for the same period last year.  The 2009 results benefited from thealternative fuel tax credit income of $455 million, but were negativelyimpacted by debtor-in-possession debt issuance costs of $63 million,reorganization items of $109 million, lower segment operating profits of $80million, higher interest expense of $30 million and loss on earlyextinguishment of debt of $20 million. The 2008 results benefited from the resolution of certain Canadianincome tax examination matters and higher non-cash foreign currency exchangegains, but were negatively impacted by a charge of $22 million to fully reservefor all amounts due from Calpine Corrugated, LLC and litigation charges of $8million.  The segment operating results for the nine months ended September 30,2009 were negatively impacted by lower sales volume for containerboard andcorrugated containers and lower average selling prices for containerboard andcorrugated containers. The 2009 nine month results benefited from lower energyand reclaimed fiber costs compared to the comparable period in 2008.

 

For the fourth quarter of2009, we anticipate our financial performance will continue to be negativelyimpacted by weak economic conditions. Our operating results for our containerboard, corrugated containers andreclamation operations are expected to be lower compared to the third quarterof 2009.  We expect lower sales pricesfor corrugated containers, lower seasonal volumes for corrugated containers andcontainerboard and higher cost for energy. We expect to continue to receive the alternative fuel tax credits in thefourth quarter of 2009.  We will continueto incur significant costs associated with our bankruptcy proceedings.

 

**Reorganization Items and OtherBankruptcy Related Costs**

 

**ReorganizationItems**

Our reorganization itemsdirectly related to the process of reorganizing the Company under Chapter 11and the CCAA for the three and nine months ended September 30, 2009consist of the following:

 
| ** **                                                     | ** ** | **Three months   ended   September 30,  2009** | ** ** | **Nine months   ended   September 30,   2009** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
|                                                           |       |                                                |       |                                                |       |
| Provision  for rejected/settled executory contracts and leases |       | $                                                   |  9    |                                                | $          |  73 |   |
| Professional  fees                                             |       | 12                                                  |       | 44                                                  |       |
| Accounts  payable settlement gains                             |       | (5                                                  | )          | (8                                                  | )          |
| Total  reorganization items                                    |       | $                                                   |  16   |                                                | $          |  109 |   |

 

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

 

Provision forrejected/settled executory contracts and leases for the nine months ended September 30,2009, includes a $9 million special termination benefits charge due to fundingobligations related to certain non-qualified pension plans.

 

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

 

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

 

**Other Bankruptcy Related Costs**

Debtor-in-possession debtissuance costs of $63 million were incurred and paid principally during thefirst quarter of 2009 in connection with entering into the DIP CreditAgreement.

 

# **Alternative Fuel Tax Credit**

#  

The U.S. InternalRevenue Code allows an excise tax credit for alternative fuel mixtures producedby a taxpayer for sale, or for use as a fuel in a taxpayer’s trade orbusiness.  The credit is scheduled toexpire on December 31, 2009.  On May 6,2009, we were notified that our registration as an alternative fuel mixer wasapproved by the Internal Revenue Service. We submitted refund claims ofapproximately $473 million for the periods January 1, 2009 through September 30,2009 related to production at ten of our U.S. mills, of which $415 million ofthis refund request was received during the nine months ended September 30,2009.  During the three and nine monthsended September 30, 2009, we recorded other operating income of $179million and $455 million, respectively, net of fees and expenses, in ourconsolidated statements of operations related to this matter.

 

# **Restructuring Activities**

#  

During the third quarterof 2009, we closed four converting facilities. We recorded restructuring charges of $14 million, which were net of a $2million gain on the sale of previously closed facilities.  Restructuring charges included non-cashcharges of $4 million related to the write-down of assets, primarily property,plant and equipment, to estimated net realizable values and the acceleration ofdepreciation for converting equipment expected to be abandoned or taken out ofservice.  The remaining charges of $12million were primarily for severance and benefits.  As a result of the closures in the thirdquarter of 2009 and other ongoing initiatives, we reduced our headcount byapproximately 300 employees.

 

For the nine months endedSeptember 30, 2009, we closed 11 converting facilities.  As a result of the closures in the first ninemonths of 2009 and other ongoing initiatives, we reduced our headcount byapproximately 1,800 employees.  Werecorded restructuring charges of $38 million, which were net of a $2 milliongain on the sale of previously closed facilities.  Restructuring charges included non-cashcharges of $8 million related to the write-down of assets, primarily property,plant and equipment, to estimated net realizable values and the acceleration ofdepreciation for converting equipment expected to be abandoned or taken out ofservice.  The remaining charges of $32million were primarily for severance 

 

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and benefits.  The net sales of the announced and closedconverting facilities as of September 30, 2009 prior to closure and forthe year ended December 31, 2008 were $62 million and $217 million,respectively.  The majority of these netsales are expected to be transferred to other operating facilities.  Additional charges of up to $4 million areexpected to be recorded in the fourth quarter of 2009 for severance andbenefits related to the closure of these and previously closed facilities.

 

We continue to review andevaluate various restructuring and other alternatives to streamline ouroperations, improve efficiencies and reduce cost.  Such initiatives may include selling assets,idling facilities, consolidating operations and functions, relocating orreducing production and voluntary and involuntary employee separationprograms.  In addition, such actions willsubject us to additional short-term costs, which may include facility shutdowncosts, asset impairment charges, lease commitment costs, severance costs andother closing costs.

 

**ThirdQuarter 2009 Compared to Third Quarter 2008**

 
| ** **                                                        | ** ** | **Three months ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                        | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| **(In millions)**                                                 | ** ** | **Net  Sales**                            | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
|                                                              |       |                                      |       |   |   |   |   |   |   |
| Containerboard,  corrugated containers and reclamation operations |       | $                                         | 1,417      |   | $ |  60 |   | $ | 1,879 |   | $ |  100 |   |
|                                                              |       |                                      |       |   |   |   |   |   |   |
| Restructuring  charges                                            |       |                                      |       | (14 | ) |   |   | (14 | ) |
| Gain  (loss) on sale of assets                                    |       |                                      |       | (2 | ) |   |   | 1 |   |
| Other  operating income                                           |       |                                      |       | 179 |   |   |   |   |   |
| Interest  expense, net                                            |       |                                      |       | (72 | ) |   |   | (63 | ) |
| Non-cash  foreign currency exchange gains (losses)                |       |                                      |       | (11 | ) |   |   | 8 |   |
| Reorganization  items                                             |       |                                      |       | (16 | ) |   |   |   |   |
| Corporate  expenses and other (Note 1)                            |       |                                      |       | (58 | ) |   |   | (65 | ) |
| Income  (loss) before income taxes                                |       |                                      |       | $ |  66 |   |   |   | $ |  (33 | ) |
|                                                                   |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 

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

 

Net sales decreased 24.6%in the third quarter of 2009 compared to last year.  Net sales were negatively impacted by $266million in 2009 as a result of lower third-party sales volume of containerboard,corrugated containers and reclaimed material. Third-party shipments ofcontainerboard were lower due primarily to weaker demand in the markets inwhich we operate. North American shipments of corrugated containers in 2009were negatively impacted by weaker market conditions and container plantclosures.  Net sales were also negativelyimpacted by lower average selling prices ($196 million) for containerboard,corrugated containers and reclaimed material. The average price for oldcorrugated containers (OCC) decreased approximately $30 per ton compared tolast year.

 

Our containerboard millsoperated at 87.2% of capacity in the third quarter of 2009, compared to 99.5%in the third quarter of 2008. Containerboard production was 13.5% lowercompared to last year due primarily to the market related downtime taken by ourmills as a result of lower demand. Production of market pulp decreased by 48.0% compared to last year dueprimarily to the closure of the Pontiac pulp mill in October 2008.  Production of kraft paper was consistent withlast year.** **Totaltons of fiber reclaimed and brokered decreased 21.5% compared to last year dueto the lower containerboard production and weaker demand.

 

Cost of goods soldas a percent of net sales in the third quarter of 2009 was 90.6%, compared to90.3% last year.  Cost of goods solddecreased from $1,696 million for the third quarter of 2008 to $1,284 millionfor the third quarter of 2009 due primarily to lower sales volumes ofcontainerboard and corrugated containers in the third quarter of 2009 and lowercosts of reclaimed material ($58 million) and energy ($43 million).

 

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

 

During the third quarterof 2009, we recorded other operating income of $179 million, net of expectedfees, related to the alternative fuel tax credit.

 

Interest expense, net was$72 million in the third quarter of 2009. The $9 million increase compared to the third quarter of 2008 was dueprimarily to higher average borrowings. Our overall average effective interest rate in the third quarter of 2009was comparable to 2008.  Since thePetition Date, we discontinued interest payments on our unsecured notes andcertain other unsecured debt.  Interestexpense ($49 million in the three months ended September 30, 2009)continues to be accrued on the unsecured debt until a determination is madethat it will not be an allowed claim in the bankruptcy proceedings.

 

In the third quarter of2009, we recorded non-cash foreign currency exchange losses of $11 millioncompared to gains of $8 million for the same period in 2008.

 

**NineMonths 2009 Compared to Nine Months 2008**

** **
| ** **                                                        | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                        | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| **(In millions)**                                                 | ** ** | **Net  Sales**                           | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
|                                                              |       |                                     |       |   |   |   |   |   |   |
| Containerboard,  corrugated containers and reclamation operations |       | $                                        | 4,195      |   | $ |  202 |   | $ | 5,509 |   | $ |  282 |   |
|                                                              |       |                                     |       |   |   |   |   |   |   |
| Restructuring  charges                                            |       |                                     |       | (38 | ) |   |   | (27 | ) |
| Gain  (loss) on sale of assets                                    |       |                                     |       | (3 | ) |   |   | 5 |   |
| Other  operating income                                           |       |                                     |       | 455 |   |   |   |   |   |
| Interest  expense, net                                            |       |                                     |       | (217 | ) |   |   | (187 | ) |
| Debtor-in-possession  debt issuance costs                         |       |                                     |       | (63 | ) |   |   |   |   |
| Loss  on early extinguishment of debt                             |       |                                     |       | (20 | ) |   |   |   |   |
| Non-cash  foreign currency exchange gains (losses)                |       |                                     |       | (10 | ) |   |   | 19 |   |
| Reorganization  items                                             |       |                                     |       | (109 | ) |   |   |   |   |
| Corporate  expenses and other (Note 1)                            |       |                                     |       | (182 | ) |   |   | (213 | ) |
| Income  (loss) before income taxes                                |       |                                     |       | $ |  15 |   |   |   | $ |  (121 | ) |
|                                                                   |            |                                          |            |  |  |  |  |  |  |  |  |  |  |

 

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

 

Net sales decreased 23.9%in the first nine months of 2009 compared to last year.  Net sales were negatively impacted by $856million in the first nine months of 2009 as a result of lower third-party salesvolume of containerboard, corrugated containers and reclaimed material.Third-party shipments of containerboard were lower due primarily to weakerdemand in the markets in which we operate. North American shipments ofcorrugated containers in the first nine months of 2009 were negatively impactedby weaker market conditions and container plant closures.  Net sales were also negatively impacted bylower average selling prices ($458 million) for containerboard, corrugatedcontainers and reclaimed material. The average price for old corrugatedcontainers (OCC) decreased approximately $60 per ton compared to last year.

 

Our containerboard millsoperated at 84.9% of capacity in the first nine months of 2009, compared to99.5% in the first nine months of 2008. Containerboard production was 16.1%lower compared to last year due primarily to the market related downtime takenby our mills as a result of lower demand. Production of market pulp decreased by 46.2% compared to last 

 

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year due primarily to theclosure of the Pontiac pulp mill in October 2008.  Production of kraft paper decreased 33.1%compared to last year due primarily to lower demand, which resulted in marketrelated downtime in the first nine months of 2009.** **Total tons of fiber reclaimed andbrokered decreased 24.3% compared to last year due to the lower containerboardproduction and weaker demand.

 

Cost of goods soldas a percent of net sales in the first nine months of 2009 was 89.6%, the sameas the first nine months of 2008.  Costof goods sold decreased from $4,938 million in 2008 to $3,757 million in 2009due primarily to lower sales volumes for containerboard and corrugatedcontainers in the first nine months of 2009 and lower costs of reclaimedmaterial ($267 million) and energy ($43 million), which were partially offsetby higher costs of wood fiber ($14 million), and chemicals ($14 million).

 

Selling andadministrative expense decreased $68 million in the first nine months of 2009compared to the first nine months of 2008 due primarily to cost reductions fromongoing and prior-year initiatives and the impacts of the Calpine Corrugatedcharges and litigation charges recorded in 2008 totaling $30 million.

 

During the nine monthsended September 30, 2009, we recorded other operating income of $455million, net of expected fees, related to the alternative fuel tax credit.

 

Interest expense, net was$217 million for the first nine months of 2009. The $30 million increase compared to the first nine months of 2008 wasimpacted by higher average borrowings ($32 million), which were partiallyoffset by lower average interest rates ($2 million).  Our overall average effective interest ratein the first nine months of 2009 was lower than 2008 by 0.05%.  Since the Petition Date, we discontinuedinterest payments on our unsecured notes and certain other unsecured debt.  Interest expense ($147 million in the ninemonths ended September 30, 2009) continues to be accrued on the unsecureddebt until a determination is made that it will not be an allowed claim in thebankruptcy proceedings.

 

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

 

In the first nine monthsof 2009, we recorded non-cash foreign currency exchange losses of $10 millioncompared to gains of $19 million for the same period in 2008.

 

Duringthe nine months ended September 30, 2009, we recorded a provision forincome taxes of $3 million related to Canadian withholding taxes and intereston unrecognized tax benefits previously recorded.

 

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#### **Statistical Data**

#### ** **

| ** **                                                   | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands of tons, except  as noted)**                 | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Mill  production                                             |       |                                       |       |                                      |       |   |   |   |   |
| Containerboard  (1)                                          |       | 1,551                                      |       | 1,794                                     |       | 4,483 |   | 5,345 |   |
| Kraft  paper                                                 |       | 34                                         |       | 34                                        |       | 81 |   | 121 |   |
| Market  pulp                                                 |       | 78                                         |       | 150                                       |       | 220 |   | 409 |   |
| SBL                                                          |       | 29                                         |       | 30                                        |       | 94 |   | 92 |   |
| North  American corrugated containers sold (billion sq. ft.) |       | 16.7                                       |       | 18.4                                      |       | 50.0 |   | 54.1 |   |
| Fiber  reclaimed and brokered                                |       | 1,317                                      |       | 1,678                                     |       | 3,838 |   | 5,071 |   |

#### ** **

----

(1) Forthe three months ended September 30, 2009 and 2008, our corrugatedcontainer plants consumed 1,107,000 tons and 1,224,000 tons of containerboard,respectively.  For the nine months ended September 30,2009 and 2008, our corrugated container plants consumed 3,354,000 tons and3,586,000 tons of containerboard, respectively.

 

#### **LIQUIDITYAND CAPITAL RESOURCES**

#### ** **

Liquidity improved significantly during the first ninemonths of 2009.  In September 2009,we made voluntary prepayments of $290 million on the $400 million U.S. DIPterm loan with available cash provided by operating activities.  At September 30, 2009, we hadunrestricted cash and cash equivalents of $561 million and the amount availablefor borrowings under the DIP Credit Agreement was $283 million.  Our cash flows from operations and working capitalwere favorably impacted by the receipt of $415 million for the alternative fueltax credit and the stay of payment of liabilities subject to compromiseresulting from the bankruptcy filings. The improvement in liquidity was positively impacted by the additionalavailability resulting from the DIP Credit Agreement entered into on January 28,2009.

 

The following tablesummarizes our cash flows for the nine months ended September 30:

 
| **(In millions)**                 | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Net  cash provided by (used for): |       |     |       |     |       |
| Operating  activities             |       | $        |  793  |     | $          |  134 |   |
| Investing  activities             |       | (111     | )          | (296     | )          |
| Financing  activities             |       | (247     | )          | 162      |       |
| Net  increase in cash             |       | $        |  435  |     | $          |  — |   |

 

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

The net cash provided by(used for) operating activities for the nine months ended September 30,2009 improved compared to the same period in 2008 due primarily to thealternative fuel tax credit receipts of $415 million and the impact of thebankruptcy filing.  Certain pre-petitionliabilities, including accounts payable and interest payable, were favorablyimpacted by the stay of payment of liabilities subject to compromise resultingfrom the bankruptcy filings.  Since thePetition Date, we discontinued interest payments on our unsecured senior notesand certain other unsecured debt. Interest expense ($147 million in the ninemonths ended September 30, 2009) will continue to be accrued on theunsecured debt until a determination is made that it will not be an allowedclaim in the bankruptcy proceedings.

 

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

Net cash used forinvesting activities was $111 million for the nine months ended September 30,2009.  Expenditures for property, plantand equipment were $112 million for the first nine months of 2009, compared to$304 million for the same period last year. The amount expended for property, plant and equipment in the first ninemonths of 2009 was principally for projects related to upgrades, cost 

 

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reductions and ongoinginitiatives.  Advances to affiliates, netin 2009 of $15 million are principally related to funding an obligationpertaining to a guarantee for a previously non-consolidated affiliate.  See Note 12 of the Notes to ConsolidatedFinancial Statements.  For the ninemonths ended September 30, 2009, we received proceeds of $16 million fromthe sale of properties primarily related to previously closed facilities.

 

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

Net cash used forfinancing activities for the nine months ended September 30, 2009 of $247million included proceeds from the DIP Credit Agreement of $440 million whichwere used to terminate our receivables securitization programs and repay allindebtedness outstanding under the programs of $385 million.  In September 2009, we madevoluntary prepayments of $290 million on the $400 million U.S. DIP term loanwith available cash provided by operating activities.  In addition, during the nine months ended September 30,2009, we repaid approximately $15 million of the U.S. DIP term loan withproceeds from property sales and $5 million of the Canadian revolver under theDIP Credit Agreement.  Debt issuance costof $63 million was incurred and paid with the DIP proceeds and available cash.  During the nine months ended September 30,2009, letters of credit in the amount of $71 million were drawn on to fundobligations principally related to non-qualified pension plans, commodityderivative instruments and a guarantee for a previously non-consolidatedaffiliate, which increased borrowings under our Credit Agreement.  We paid dividends to Smurfit-Stone in theaggregate amount of approximately $6 million in the first nine months of 2008to fund the dividend obligations of Smurfit-Stone to the holders of its 7% Series ACumulative Exchangeable Redeemable Convertible Preferred Stock.  We are restricted from paying futuredividends under the DIP Credit Agreement.

 

**DIP Credit Agreement**

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

 

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

 

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

 

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

 

In September 2009,we made voluntary prepayments of $290 million on the $400 million U.S. DIPterm loan with available cash provided by operating activities.  In addition, during the nine months ended September 30,2009, we repaid approximately $15 million of the U.S. DIP term loan withproceeds from property sales and $5 million of the Canadian revolver under theDIP Credit Agreement.

 

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During September 2009,SSC Canada completed the sale of its Canadian timberlands.  At September 30, 2009, the net proceedsof approximately $28 million were held in escrow and recorded in prepaidexpenses and other current assets in the consolidated balance sheet.  On October 22, 2009, approximately $27million was received by us and $1 million remained in escrow pending thecompletion of the title registration process on certain parcels.  Cash received from the sale was used to repaya portion of the Canadian DIP term loan.

 

On October 28, 2009,we made a $50 million voluntary prepayment on the $400 million U.S. DIP termloan with available cash provided by operating activities, leaving anoutstanding principal balance of $51 million under the DIP term loans, which wecurrently expect to prepay in full during the fourth quarter of 2009.  No borrowings are outstanding under the DIPrevolving loans.

 

U.S. and Canadian borrowings are each subject to aborrowing base derived from a formula based on certain eligible accountsreceivable and inventory, and an amount attributable to real property andequipment, less certain reserves.  As of September 30,2009, the applicable borrowing base was $709 million and the amount availablefor borrowings under the DIP Credit Agreement was $283 million. The applicable borrowing base as of September 30,2009 as compared to June 30, 2009 increased approximately $112 million dueprincipally to a $107 million increase in the real property and equipment component of the borrowing base resultingfrom appraisals received on real property and equipment in August 2009.

 

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

 

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

 

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

 

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

 

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

 

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**Bank Credit Facilities**

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

 

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

 

On January 15, 2009our credit ratings were lowered, increasing the Applicable Rate by 0.25%.  We have the option to borrow at a rate equalto LIBOR plus 2.25% or alternate base rate (ABR) plus 1.25% for the term loanfacilities and LIBOR plus 2.50% or ABR plus 1.50% for the revolving creditfacilities (the Applicable Rate).

 

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

 

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

 

**FutureCash Flows**

 

We submitted refundclaims for the alternative fuel tax credit of approximately $473 million forthe period January 1, 2009 through September 30, 2009, of which $415million was received as of September 30, 2009.  We expect to submit monthly refund claims ofapproximately $58 million for the remainder of 2009.  The monthly claims are expected to bereceived in the month following the submission.

 

Under the DIP CreditAgreement, capital expenditures for the 11-month period ending December 31,2009 are not allowed to exceed $205 million. In the first nine months of 2009, capital spending of $112 millionincluded $91 million for the eight month period ended September 30, 2009.

 

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We recorded restructuringcharges of $38 million during the first nine months of 2009, including $32million for exit liabilities, which were principally for severance andbenefits.  During the nine months ended September 30,2009, we incurred cash expenditures of $23 million for these exitliabilities.  The remaining exitliabilities are expected to be paid principally in the fourth quarter of 2009.

 

At December 31,2008, we had $33 million of exit liabilities related principally torestructuring activities.  During thenine months ended September 30, 2009, we incurred cash expenditures of $11million for these exit liabilities.  Inaddition, exit liabilities have decreased by $5 million due to rejecting leasesrelated to previously closed facilities as permitted under the Bankruptcy Code.  The remaining cash expenditures in connectionwith our restructuring activities will continue to be funded through operationsas originally planned.

 

In the first quarter of 2009, letters of credit weredrawn on in the amount of $27 million related to funding certain of ournonqualified pension plan obligations. Excluding the impact of these letters ofcredit, we contributed approximately $7 million to our defined benefit plans inthe first nine months of 2009.

 

**PensionPlan Contributions**

 

At December 31, 2008, the qualifieddefined benefit retirement plans maintained by the Company were under funded byapproximately $900 million.  We estimatethat this level of under funding increased by approximately $140 million duringthe nine months ended September 30, 2009, due primarily to decreases inthe discount rate assumptions used to determine the amount of plan benefitobligations, which were less than fully offset by positive returns on planassets.  Assuming that the plan ofreorganization confirmed by the Bankruptcy Courts provides for the assumptionof the qualified defined benefit retirement plans, we will likely be requiredto make significant cash contributions to these plans under applicable U.S. andCanadian laws over the next several years following emergence from bankruptcyin order to amortize the existing under funding and satisfy current serviceobligations under the plans. These contributions will significantly impactfuture cash flows that might otherwise be available for repayment of debt,capital expenditures, and other corporate purposes.  We currently estimate that these cashcontributions under the United States and Canadian qualified plans will beapproximately $75 million in 2010, and potentially up to approximately $105million depending upon how unpaid Canadian contributions for 2009 are impactedby the plan of reorganization.  Wecurrently estimate that these contributions will potentially be in the range ofapproximately $275 million to $325 million annually in 2011 through 2014, andwill then decrease to approximately $220 million in 2015 and approximately $130million in 2016, at which point almost all of the shortfall would befunded.  The actual required amounts andtiming of such future cash contributions will be highly sensitive to changes inthe applicable discount rates and returns on plan assets, and could also beimpacted by future changes in the laws and regulations applicable to planfunding.

 

**INCOME TAXES**

 

Duringthe nine months ended September 30, 2009, we recorded a provision forincome taxes of $3 million related to Canadian withholding taxes and intereston unrecognized tax benefits previously recorded.  Because it is more likely than not thatsubstantially all of the deferred tax assets that are generated in 2009 may notbe realized, we have recorded a full valuation allowance, and have not recordedany additional tax benefit for the three and nine months ended September 30,2009.

 

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

 

The remaining matters areexpected to be resolved at the examination level or subsequently upon appealwithin the next twelve months.  While thefinal outcome of the remaining CRA examination matters, including an estimateof the range of the reasonably possible changes to unrecognized tax benefits,is not 

 

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yet determinable, webelieve that the examination or subsequent appeals will not have a materialadverse effect on our consolidated financial condition or results ofoperations.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

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

 

**PROSPECTIVEACCOUNTING PRONOUNCEMENTS**

 

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

 

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

 

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

###### ** **

On January 26, 2009,the Chapter 11 Petition and the Canadian Petition effectively terminated allexisting derivative instruments. Termination fair values were calculated based on the potentialsettlement value. During the first nine months of 2009, letters of credit of$18 million were drawn on related to the settlement of certain of ourderivative instruments.  Excluding thesesettled liabilities, the termination value related to the remaining derivativeliabilities was approximately $60 million, which were stayed due to the filingof the Chapter 11 Petition and the Canadian Petition.  These derivative liabilities were adjustedthrough other comprehensive income (loss) (OCI) for derivative instrumentsqualifying for hedge accounting and cost of goods sold for derivativeinstruments not qualifying for hedge accounting.  The remaining amount in OCI will be recordedthrough earnings during the period the underlying transaction is recorded orwhen the underlying transaction is no longer expected to occur.  During the second quarter of 2009, wereclassified the remaining foreign currency derivative instruments from OCI tocost of goods sold since the underlying transactions were no longer expected tooccur, resulting in a loss of $2 million (net of tax).

 

**Commodity Price Risk**

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

 

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impact of the natural gasderivative instruments.  See Note 15 ofthe Notes to Consolidated Financial Statements.

 

**Foreign Currency Risk**

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

 

We used financialderivative instruments, including forward contracts and options, primarily toprotect against Canadian currency exchange risk associated with expected futurecash flows.  The Canadian dollar as of September 30,2009, compared to December 31, 2008, strengthened 12.44% against the U.S.dollar.  We recognized non-cash foreigncurrency exchange losses of $10 million for the nine month period ended September 30,2009 compared to gains of $19 million for the same period in 2008.

 

**InterestRate Risk**

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

 

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

 

**ITEM 4.     CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controlsand Procedures**

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

 

**Changes in Internal Control**

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

 

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**PART II - OTHER INFORMATION**

 

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

 

None

 

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

 

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

 

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

 

None

 

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

 

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

 

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

 

None

 

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

 

(a)                                                          There have been no material changes tothe procedures by which security holders may recommend nominees to the Company’sBoard of Directors implemented since the filing of the Company’s QuarterlyReport on Form 10-Q for the quarter ended June 30, 2009.

 

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

 

The following exhibits are included in this Form 10-Q:

 

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

 

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

 

32.1                                                 Certification pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2                                                 Certification pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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Signature

 

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

 

 
|                              | SMURFIT-STONE CONTAINER  ENTERPRISES, INC. |
|-----------------------------------|--------------------------------------------|
|                              | (Registrant)                               |
|                              |                                       |
|                              |                                       |
| Date:  November 9, 2009 |                                       | /s/  Paul K. Kaufmann |
|                              |                                       | Paul K. Kaufmann |
|                              |                                       | Senior Vice  President and Corporate Controller |
|                              |                                       | (Principal  Accounting Officer) |

 

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