#  

# **Securities and Exchange Commission**

## **Washington, D.C. 20549**

## ** **

### **Form 10-K**

### ** **

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

** **

**For the fiscal year endedDecember 31, 2006**

** **

**Or**

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

** **

**For the transition period from                       to               **

** **

**Commission file number 0-23876**

 

#### **Smurfit-Stone Container Corporation**

(Exact name ofregistrant as specified in its charter)

 
| **Delaware**                              | ** ** | **43-1531401**                        |
|-------------------------------------------|------------|---------------------------------------|
| (State of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                      |       |                                  |
| **150  North Michigan Avenue**            | ** ** | ** **                            |
| **Chicago,  Illinois**                    | ** ** | **60601**                             |
| (Address of  principal executive offices) |       | (Zip Code)                            |

 

## **Registrant’sTelephone Number:**(312) 346-6600

 

## ****

 

Securities registeredpursuant to Section 12(b) of the Act:

 
| **Title of Each Class**                                                        | ** ** | **Name of Each Exchange on Which Registered** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| Common Stock,  $0.01 Par Value                                                                |       | NASDAQ Global Select  Market                                                |       |
| 7% Series A  Cumulative Exchangeable Redeemable Convertible Preferred Stock, $0.01 Par  Value |       | NASDAQ Global Select  Market                                                |       |

###### ** **

###### **Securities registered pursuant to Section 12(g)of the Act: **None

###### ** **

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.  Yes  x  No  o

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act.  Yes  o  No  x

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  x  No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.  x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

| Large  accelerated filer x |   | Accelerated filer o |   | Non-accelerated filer o |
|----------------------------|--------|---------------------|--------|-------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

 

Yes  o  No  x

 

Theaggregate market value of the voting stock held by non-affiliates of theregistrant as of the last business day of the registrant’s most recentlycompleted second fiscal quarter was approximately $2.8 billion, based on theclosing sales price of $10.94 per share of such stock on The NASDAQ GlobalSelect Market on June 30, 2006.

 

The number of sharesoutstanding of the registrant’s common stock as of February 23, 2007: 254,810,328

 

**DOCUMENTS INCORPORATED BYREFERENCE:**

 
| ** **                                                                                                                                                   | ** ** | **Part of Form 10-K Into Which** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **Document**                                                                                                                                                 | ** ** | **Document Is Incorporated**                    | ** ** |
| Sections of the Registrant’s Proxy Statement to be  filed on or before April 3, 2007 for the Annual Meeting of Stockholders to be  held on May 9, 2007. |       | Part III                                                  |       |

 

 

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SMURFIT-STONECONTAINER CORPORATION

ANNUAL REPORT ONFORM 10-K

December 31, 2006

 

TABLE OF CONTENTS

 
| **PART I**   | ** **                                                                                                          | ** ** | ** ** |
|--------------|---------------------------------------------------------------------------------------------------------------------|------------|------------|
| Item 1.      | Business                                                                                                            |       |       |
| Item 1A.     | Risk Factors                                                                                                        |       |       |
| Item 1B.     | Unresolved Staff Comments                                                                                           |       |       |
| Item 2.      | Properties                                                                                                          |       |       |
| Item 3.      | Legal Proceedings                                                                                                   |       |       |
| Item 4.      | Submission of Matters to a  Vote of Security Holders                                                                |       |       |
|         |                                                                                                                |       |       |
| **PART  II** |                                                                                                                |       |       |
| Item  5.     | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |       |       |
| Item 6.      | Selected Financial Data                                                                                             |       |       |
| Item  7.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       |       |
| Item 7A.     | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       |       |
| Item 8.      | Financial  Statements and Supplementary Data                                                                        |       |       |
| Item 9.      | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure                               |       |       |
| Item 9A.     | Controls and Procedures                                                                                             |       |       |
| Item 9B.     | Other Information                                                                                                   |       |       |
|         |                                                                                                                |       |       |
| **PART III** |                                                                                                                |       |       |
| Item 10.     | Directors,  Executive Officers and Corporate Governance                                                             |       |       |
| Item 11.     | Executive Compensation                                                                                              |       |       |
| Item 12.     | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                     |       |       |
| Item 13.     | Certain Relationships and Related  Transactions, and Director Independence                                          |       |       |
| Item 14.     | Principal Accounting Fees and Services                                                                              |       |       |
|         |                                                                                                                |       |       |
| **PART IV**  |                                                                                                                |       |       |
| Item 15.     | Exhibits and Financial Statement  Schedules                                                                         |       |       |

 

###### **FORWARD-LOOKING STATEMENTS**

###### ** **

Exceptfor the historical information contained in this Annual Report on Form 10-K,certain matters discussed herein, including (without limitation) under Part I,Item 1, “Business - Environmental Compliance,” under Part I, Item 3, “LegalProceedings” and under Part II, Item 7, “Management’s Discussion and Analysisof Financial Condition and Results of Operations,” contain forward-lookingstatements within the meaning of Section 21E of the Securities Exchange Act of1934, as amended. Although we believe that, in making any such statements, ourexpectations are based on reasonable assumptions, any such statements may beinfluenced by factors that could cause actual outcomes and results to bematerially different from those projected. When used in this document, thewords “anticipates,” “believes,” “expects,” “intends” and similar expressionsas they relate to Smurfit-Stone Container Corporation or its management areintended to identify such forward-looking statements. These forward-lookingstatements are subject to numerous risks and uncertainties. There are importantfactors that could cause actual results to differ materially from those inforward-looking statements, certain of which are beyond our control. Thesefactors, risks and uncertainties are discussed in Part 1, Item 1A, “RiskFactors.”

 

Ouractual results, performance or achievement could differ materially from thoseexpressed in, or implied by, these forward-looking statements. Accordingly, wecan give no assurances that any of the events anticipated by theforward-looking statements will transpire or occur or, if any of them do so,what impact they will have on our results of operations or financial condition.We expressly decline any obligation to publicly revise any forward-lookingstatements that have been made to reflect the occurrence of events after thedate hereof.

 

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** **

**PART I**

 

**ITEM 1.     BUSINESS**

 

Unless the contextotherwise requires, “we,” “us,” “our,” “Company” or “Smurfit-Stone” refers tothe business of Smurfit-Stone Container Corporation and its subsidiaries.

 

**GENERAL**

 

Smurfit-Stone ContainerCorporation, incorporated in Delaware in 1989, is the industry’s leadingintegrated manufacturer of paperboard and paper-based packaging in NorthAmerica, including containerboard and corrugated containers, and is one of theworld’s largest paper recyclers. In addition, we are a leading producer ofsolid bleached sulfate (SBS). We have a complete line of graphics capabilitiesfor packaging. For the year ended December 31, 2006, our net sales were $7,157million and net loss available to common stockholders was $71 million.

 

Smurfit-Stone is aholding company with no business operations of its own. Smurfit-Stone conductsits business operations through its wholly-owned subsidiary Smurfit-StoneContainer Enterprises, Inc. (SSCE), a Delaware corporation. SSCE is thesurviving company resulting from the merger (the Merger) of our primaryoperating subsidiaries on November 1, 2004. JSCE, Inc. merged with and intoJefferson Smurfit Corporation (U.S.) (JSC(U.S.)), with JSC(U.S.) as thesurviving company, and then JSC(U.S.) merged with and into Stone ContainerCorporation, with Stone Container as the surviving company. Stone Container wassimultaneously renamed Smurfit-Stone Container Enterprises, Inc. The Merger waseffected principally to consolidate our debt financing activities. StoneContainer and JSC(U.S.) were wholly-owned subsidiaries of Smurfit-Stone and,therefore, the Merger did not impact the Smurfit-Stone consolidated financialstatements. The Merger did not impact the operating activities of the mergedcompanies, which continue to do business as Smurfit-Stone.

 

**DISCONTINUED OPERATIONS**

 

On June 30, 2006, wecompleted the sale of substantially all of the assets of our Consumer Packagingdivision to a company formed by Texas Pacific Group for $1.04 billion. Reflectingfinal working capital adjustments and sales transaction costs, net cashproceeds were $897 million, which excluded $130 million of accounts receivablepreviously sold to Stone Receivables Corporation (SRC) under our accountsreceivable securitization program. We recorded a pretax gain of $171 million,offset by a $174 million income tax provision, resulting in a net loss on saleof discontinued operations of $3 million. The after-tax loss was the result ofa provision for income taxes that was higher than the statutory income tax ratedue to non-deductible goodwill of $273 million.

 

The Consumer Packagingdivision was a reportable segment comprised of four coated recycled boxboardmills and 39 consumer packaging operations in the United States, includingfolding carton, multiwall and specialty bag, flexible packaging, label,contract packaging and lamination businesses and one consumer packaging plantin Brampton, Ontario. Net sales for these operations were $787 million for thesix months ended June 30, 2006, and $1,584 million and $1,575 million for 2005and 2004, respectively. These facilities employed approximately 6,600 hourlyand salaried employees. The results of operations of the Consumer Packagingsegment have been reclassified as discontinued operations for all periodspresented.

 

**FINANCIAL INFORMATION CONCERNINGINDUSTRY SEGMENTS**

 

As a result of the saleof our Consumer Packaging division, we have one reportable segment,Containerboard and Corrugated Containers. For financial information relating toour segments for the last three fiscal years, including our net sales toexternal customers by country of origin and total assets, see the informationset forth in Note 25 of the Notes to Consolidated Financial Statements.

 

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###### **PRODUCTS**

###### ** **

###### **CONTAINERBOARD AND CORRUGATED CONTAINERS SEGMENT**

###### ** **

The Containerboard andCorrugated Containers segment includes 19 paper mills (16 located in the UnitedStates and three in Canada), 136 container plants (113 located in the UnitedStates, 16 in Canada, four in Mexico, two in China and one in Puerto Rico), onepaper tube and core plant and one wood products plant located in the UnitedStates and one lamination plant located in Canada. In addition, we have equityownership in three corrugated container plants in Asia (two in China and one inThailand), as well as two sheet plants and a lithographic printing plant inChina. Also, we own approximately one million acres of timberland in Canada andoperate wood harvesting facilities in Canada and the United States. The primaryproducts of our Containerboard and Corrugated Containers segment include:

 

•                  corrugatedcontainers;

•                  containerboard;

•                  SBS;

•                  kraftpaper; and

•                  marketpulp.

 

We produce a full rangeof high quality corrugated containers designed to protect, ship, store anddisplay products made to our customers’ merchandising and distribution specifications.Corrugated containers are sold to a broad range of manufacturers of consumergoods. Corrugated containers are used to ship such diverse products as homeappliances, electric motors, small machinery, grocery products, produce,computers, books, furniture and many other products. We provide customers with innovative packaging solutions to advertise andsell their products. In addition, we manufacture and sell a variety of retailready, point of purchase displays and a full line of specialty products,including pizza boxes, corrugated clamshells for the food industry, Cordeck®recyclable pallets and custom die-cut boxes to display packaged merchandise onthe sales floor. Our container plants serve local customers and largenational accounts. Net sales of corrugated containers for 2006, 2005 and 2004represented 64%, 65% and 65%, respectively, of the Company’s total net sales.

 

Our containerboard millsproduce a full line of containerboard, which is used primarily in theproduction of corrugated packaging. We produced 3,663,000 tons of unbleachedkraft linerboard, 995,000 tons of white top linerboard and 2,744,000 tons ofmedium in 2006. Our containerboard mills and corrugated container operationsare highly integrated, with the majority of our containerboard used internallyby our corrugated container operations. In 2006, our corrugated containerplants consumed 5,300,000 tons of containerboard. Net sales of containerboardto third parties for 2006, 2005 and 2004 represented 24%, 23% and 23%,respectively, of the Company’s total net sales.

 

Our paper mills alsoproduce SBS, kraft paper, market pulp and other specialty products. Wespecialize in high-quality grades of SBS, which are designed to meet thedemanding print requirements of folding carton and carded packaging customersin the food, pharmaceutical, cosmetics and other niche markets. Kraft paper isused in numerous products, including consumer and industrial bags, grocery andshopping bags, counter rolls, handle stock and refuse bags. In addition, weproduce bleached northern and southern hardwood pulp and bleached southernsoftwood pulp, which is sold to manufacturers of paper products, includingphotographic and other specialty papers, as well as the printing and writingsectors.

 

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Production for our papermills and sales volume for our corrugated container facilities for the lastthree years were:

 
| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tons produced  (in thousands)                        |       |     |       |     |       |     |       |
| Containerboard                                       |       | 7,402    |       | 7,215    |       | 7,438    |       |
| SBS                                                  |       | 313      |       | 283      |       | 276      |       |
| Kraft paper                                          |       | 199      |       | 204      |       | 259      |       |
| Market pulp                                          |       | 564      |       | 563      |       | 549      |       |
| Corrugated  containers sold (in billion sq. ft.) (1) |       | 80.0     |       | 81.3     |       | 81.8     |       |

 

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(1)          Includes ourproportionate share of affiliates reported on an equity ownership basis.

 

**NON-REPORTABLE SEGMENT**

 

**Reclamation**

Our reclamationoperations procure fiber resources for our paper mills as well as otherproducers. We operate 23 reclamation facilities in the United States thatcollect, sort, grade and bale recovered paper. We also collect aluminum andplastics for resale to manufacturers of these products. In addition, we operatea nationwide brokerage system whereby we purchase and resell recovered paper toour recycled paper mills and other producers on a regional and national contractbasis. Our waste reduction services extract additional recyclables from thewaste stream by partnering with customers to reduce their waste expenses andincrease efficiencies. Brokerage contracts provide bulk purchasing, oftenresulting in lower prices and cleaner recovered paper. Many of our reclamationfacilities are located close to our recycled paper mills, ensuring availabilityof supply with minimal shipping costs. Total tons of fiber reclaimed andbrokered for 2006, 2005 and 2004 were 6,614,000, 6,501,000 and 6,542,000,respectively. In 2006, our paper mills consumed 2,891,000 tons of the fiberreclaimed and brokered by our reclamation operations, representing anintegration level of approximately 44%.

 

**RAWMATERIALS**

 

Woodfiber and reclaimed fiber are the principal raw materials used in themanufacture of our paper products. We satisfy the majority of our need for woodfiber through purchases on the open market or under supply agreements. Wesatisfy essentially all of our need for reclaimed fiber through our reclamationfacilities and nationwide brokerage system.

 

**MARKETINGAND DISTRIBUTION**

 

Ourmarketing strategy is to sell a broad range of paper-based packaging productsto manufacturers of industrial and consumer products. We seek to meet the qualityand service needs of the customers of our converting plants at the mostefficient cost, while balancing those needs against the demands of our openmarket paperboard customers. Our converting plants focus on supplying bothspecialized packaging with high value graphics that enhance a product’s marketappeal and high-volume commodity products.

 

We serve a broad customerbase for each of our segments. As a result, we serve thousands of accounts fromour plants. We sell packaging and other products directly to end users andconverters, as well as through resellers. In 2005, in response to challengingmarket conditions we reorganized our corrugated container sales organization tocentralize the sales responsibilities for all converting plants. This reorganizationhas allowed us to better focus on revenue growth and assign the appropriateresources to the best opportunities. Marketingof containerboard and pulp to third parties is centralized in our board salesgroup. Total tons of containerboard and market pulp sold in 2006, 2005and 2004 were 3,093,000, 2,651,000 and 2,840,000, respectively.

 

Ourbusiness is not dependent upon a single customer or upon a small number ofmajor customers. We do not believe the loss of any one customer would have amaterial adverse effect on our business.

 

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**COMPETITION**

 

Themarkets in which we sell our principal products are highly competitive andcomprised of many participants. Although no single company is dominant, we doface significant competitors, including large vertically integrated companiesas well as numerous smaller companies. The markets in which we compete havehistorically been sensitive to price fluctuations brought about by shifts inindustry capacity and other cyclical industry conditions. While we competeprimarily on the basis of price in many of our product lines, other competitivefactors include design, quality and service, with varying emphasis depending onproduct line.

 

**BACKLOG**

 

Demandfor our major product lines is relatively constant throughout the year, andseasonal fluctuations in marketing, production, shipments and inventories arenot significant. Backlog orders are not a significant factor in the industry. Wedo not have a significant backlog of orders as most orders are placed fordelivery within 30 days.

 

**RESEARCHAND NEW PRODUCT DEVELOPMENT**

 

Themajority of our research and development activities are performed at ourfacilities located in Carol Stream and Westmont, Illinois. We use advancedtechnology to assist all levels of the manufacturing and sales processes, fromraw material supply through finished packaging performance. Research programshave provided improvements in coatings and barriers, stiffeners, inks andprinting. Our technical staff conducts basic, applied and diagnostic research,develops processes and products and provides a wide range of other technicalservices. In 2006, 2005 and 2004, we spent approximately $4 million, $9 millionand $8 million, respectively, on research and new product developmentactivities.

 

**INTELLECTUAL PROPERTY**

 

Weactively pursue applications for patents on new inventions and designs andattempt to protect our patents against infringement. Nevertheless, we believeour success and growth are more dependent on the quality of our products andour relationships with customers than on the extent of our patent protection. Wehold or are licensed to use certain patents, licenses, trademarks and tradenames on products, but do not consider the successful continuation of anymaterial aspect of our business to be dependent upon such intellectualproperty.

 

**EMPLOYEES**

 

Wehad approximately 25,200 employees at December 31, 2006, of which approximately20,100 were employees of U.S. operations. Approximately 12,100 (60%) of ourU.S. employees are represented by collective bargaining units. The expirationdates of union contracts for our major paper mill facilities are as follows:

 

•                  Missoula, Montana -  June 2007

•                  Hopewell, Virginia - July 2007

•                  Brewton, Alabama -  October 2007

•                  Panama City, Florida - March 2008

•                  FernandinaBeach, Florida - June 2008

•                  WestPoint, Virginia - September 2008

•                  Pontiac,Quebec, Canada - April 2009

•                  Florence,South Carolina - August 2009

•                  La Tuque, Quebec, Canada - August 2009

•                  Hodge, Louisiana - June 2010

•                  Jacksonville, Florida -  June 2010

 

Webelieve our employee relations are generally good. While the terms of ourcollective bargaining agreements may vary, we believe the material terms of theagreements are customary for the industry, the type of facility, theclassification of the employees and the geographic location covered thereby.

 

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**ENVIRONMENTALCOMPLIANCE**

 

Ouroperations are subject to extensive environmental regulation by federal, stateand local authorities. In the past, we have made significant capitalexpenditures to comply with water, air, solid and hazardous waste and otherenvironmental laws and regulations. We expect to make significant expendituresin the future for environmental compliance. Because various environmentalstandards are subject to change, it is difficult to predict with certainty theamount of capital expenditures that will ultimately be required to comply withfuture standards.

 

The United StatesEnvironmental Protection Agency (EPA) issued its comprehensive rule governingair emissions (Maximum Achievable Control Technology (MACT)) and waterdischarges for the pulp, paper and paperboard industry known as the “ClusterRule.”  Phase II of MACT I of the ClusterRule requires us to implement systems to collect and control high volume, lowconcentration gases at various mills and had a compliance date of April 16,2006, although certain of our mills were granted one-year extensions to April16, 2007. Based on currently available information, we estimate that theaggregate compliance cost of Phase II of MACT I of the Cluster Rule will beapproximately $80 million. We have spent approximately $65 million through 2006and we anticipate spending the balance in the first quarter of 2007, which willsubstantially complete all of the projects to bring us into compliance withPhase II of MACT I.

 

The EPA has alsopromulgated a MACT regulation that will limit hazardous air pollutantemissions, including emissions of mercury and hydrogen chloride, from certainindustrial boilers (Boiler MACT). Several of our mills are required to installnew pollution control equipment in order to meet the September 13, 2007compliance deadline. Based on currently available information, we estimate thatthe aggregate compliance cost of Boiler MACT will be approximately $100 million.We have spent approximately $50 million through 2006 and we anticipate spendingthe balance by the compliance deadline, which will substantially complete allof the projects to bring us into compliance with Boiler MACT.

 

In addition to ClusterRule and Boiler MACT compliance, we anticipate additional capital expendituresrelated to environmental compliance. Excluding the spending on Cluster Rule andBoiler MACT projects described above, for the past three years we have spent anaverage of approximately $12 million annually on capital expenditures forenvironmental purposes. Since our principal competitors are subject tocomparable environmental standards, including the Cluster Rule and Boiler MACT,it is our opinion, based on current information, that compliance withenvironmental standards should not adversely affect our competitive position oroperating results. However, we could incur significant expenditures due to changesin law or the discovery of new information, which could have a material adverseeffect on our operating results. See Part 1, Item 3, “Legal Proceedings,Environmental Matters.”

 

**EXECUTIVEOFFICERS OF THE REGISTRANT**

 

**Jeffrey S. Beyersdorfer,**bornNovember 21, 1961, was appointed Vice President and Treasurer in June 2002. Priorto joining Smurfit-Stone, Mr. Beyersdorfer served as Vice President of Financeand Treasurer of Premcor Inc. from April 1997 to June 2002.

 

**Mathew Blanchard,**bornSeptember 9, 1959, was appointed Vice President and General Manager - BoardSales Division in July 2000.

 

**James E.Burdiss,** born May 15,1951, was appointed Senior Vice President and Chief Information Officer onFebruary 23, 2005, and prior to that had been Vice President and ChiefInformation Officer since January 2002. He was Senior Director of Smurfit-Stone’sEnterprise Transformation Project from January 2001 to January 2002.

 

**Ronald D. Hackney,**bornNovember 9, 1946, was appointed Senior VicePresident – Human Resources on February 23, 2005, and prior to that had beenVice President - Human Resources since July 2003. He was Division HumanResource Manager for the Containerboard Mill and Forest Resources Division fromApril 1995 to July 2003.

 

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**Charles A. Hinrichs**,born December 3, 1953, was appointed SeniorVice President and Chief Financial Officer on February 23, 2005, and prior tothat had been Vice President and Chief Financial Officer since January2002. He was Vice President and Treasurer from November 1998 to January 2002.

 

**Craig A. Hunt**,born May 31, 1961, was appointed SeniorVice President, Secretary and General Counsel on February 23, 2005, and priorto that had been Vice President, Secretary and General Counsel sinceNovember 1998.

 

**Mack C. Jackson**,born May 18, 1955, was appointed SeniorVice President and General Manager – Containerboard Mill and Forest ResourcesDivision on February 23, 2005, and prior to that had been Vice Presidentand General Manager – Containerboard Mill and Forest Resources Division sinceJanuary 2005. He was Vice President of Mill Operations from August 2002 toJanuary 2005. Prior to that, he was General Manager of two of ourcontainerboard mills since 1994.

 

**Paul K. Kaufmann**,born May 11, 1954, was appointed SeniorVice President and Corporate Controller on February 23, 2005, and prior to thathad been Vice President and Corporate Controller since November 1998.

 

**Steven J. Klinger**,born March 5, 1959, was appointed Presidentand Chief Operating Officer on May 11, 2006. Prior to joining Smurfit-Stone,Mr. Klinger was employed by Georgia Pacific Corporation for 23 years, mostrecently as Executive Vice President, Packaging from February 2003 to May 2006and President, Packaging and Containerboard Sales / Logistics from August 2001to January 2003.

 

**John L. Knudsen**,born August 29, 1957, was appointed Senior Vice President of Manufacturing forthe Container Division in October 2005. He was Vice President of StrategicPlanning for the Container Division from April 2005 to October 2005. Prior tothat, he was Vice President and Regional Manager for the Container Divisionfrom August 2000 to April 2005.

 

**Patrick J. Moore**,born September 7, 1954, was named Chairman and Chief Executive Officer in May2006. He had been Chairman, President and Chief Executive Officer since May2003, and prior to that he was President and Chief Executive Officer sinceJanuary 2002, when he was elected as a Director. He was Vice President andChief Financial Officer from November 1998 until January 2002. Mr. Moore is adirector of Archer Daniels Midland Company.

 

**Susan M. Neumann**,born February 5, 1954, was appointed SeniorVice President, Corporate Communications on November 15, 2006. Prior to joiningSmurfit-Stone, Ms. Neumann was employed by Albertsons, Inc. most recently asSenior Vice President, Education, Communications and Public Affairs fromNovember 2003 to November 2006, Group Vice President, Communications andEducation from January 2002 to November 2003 and Vice President, Communicationsfrom January 1996 to January 2002.

 

**Mark R. O’Bryan**,born January 15, 1963, was appointed Senior Vice President – StrategicInitiatives in July 2005. He was Vice President - Operational Improvement forthe Consumer Packaging Division from April 2004 to July 2005. Prior to that, hewas Vice President – Procurement from October 1999 to April 2004.

 

**Michael R. Oswald**,born October 29, 1956, was appointed Senior Vice President and General Managerof the Reclamation Division in August 2005. Prior to that, he was VicePresident of Operations for the Reclamation Division from January 1997 toAugust 2005.

 

**Thomas A. Pagano**,born January 21, 1947, was appointed SeniorVice President – Corporate Development on February 23, 2005, and prior to thathad been Vice President – Corporate Development since April 2004. Priorto that, he was Vice President - Planning from November 1998 to April 2004.

 

**StevenC. Strickland**, born July 12, 1952, was appointed Senior VicePresident of Sales for the Container Division on October 27, 2006. Prior tojoining Smurfit-Stone, Mr. Strickland was employed by Unisource most recentlyas Senior Vice President of Packaging and Supply from September 2006 to October2006, Senior Vice President of Packaging from March 2004 to August 2006, SeniorVice 

 

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President of Operations –East from March 2003 to March 2004 and Vice President of National Sales fromSeptember 1999 to March 2003.

 

**AVAILABLEINFORMATION**

 

Wemake available free of charge our annual report on Form 10-K, quarterly reportson Form 10-Q, current reports on Form 8-K and amendments to those reports filedor furnished as required by Section 13(a) or 15(d) of the Securities ExchangeAct of 1934, as amended (the Exchange Act), through our Internet Website(www.smurfit-stone.com) as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the Securities andExchange Commission (SEC). You may access these SEC filings via the hyperlinkthat we provide on our Website to a third-party SEC filings Website.

 

**ITEM 1A.  RISK FACTORS**

 

Weare subject to certain risks and events that, if one or more of them occur,could adversely affect our business, our financial condition and results ofoperations and the trading price of our common stock. You should consider thefollowing risk factors, in addition to the other information presented in thisreport, as well as the other reports and registration statements we file fromtime to time with the SEC, in evaluating us, our business and an investment inour securities. The risks below are not the only ones we face. Additional risksnot currently known to us or that we currently deem immaterial also mayadversely impact our business.

 

**We have a highly leveraged capital structure.**

 

Oursubstantial leverage could have significant consequences for us, including thefollowing:

 

•      wemay be required to seek additional sources of capital, including additionalborrowings under our existing credit facilities, other private or public debtor equity financings to service or refinance our indebtedness, which borrowingsmay not be available on favorable terms, particularly in the event that ourcredit ratings are downgraded by rating agencies;

•      asubstantial portion of our cash flow from operations will be needed to meet thepayment of principal and interest on our indebtedness and other obligations andwill not be available for our working capital, capital expenditures and othergeneral corporate purposes; and

•      ourlevel of debt makes us more vulnerable to economic downturns and reduces ouroperational and business flexibility in responding to changing business andeconomic conditions and opportunities.

 

Inaddition, weare more highly leveraged than some of our competitors, which may placeus at a competitive disadvantage.

 

**The terms of our debt may severelylimit our ability to plan for or respond to changes in our business.**

 

Ourability to incur additional debt, and in certain cases refinance outstanding debt,is significantly limited or restricted under the agreements relating to our andour subsidiaries’ existing debt. Our senior secured credit facilities and theindentures governing our outstanding senior notes restrict our ability to takespecific actions, even if such actions may be in our best interest. Theserestrictions limit our ability to:

 

•    incur liens or make negative pledges on ourassets;

•    merge, consolidate or sell our assets;

•    issue additional debt;

•    pay dividends or repurchase or redeemcapital stock

•    make investments and acquisitions;

•    enter into certain transactions withstockholders and affiliates;

•    make capital expenditures;

•    materially change our business;

•    amend our debt and other materialagreements;

•    issue and sell capital stock;

•    make investments in unrestrictedsubsidiaries; or

•    prepay specified indebtedness or other debt.

 

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Oursenior secured credit facility requires us to maintain specified financialratios. Our failure to comply with these covenants could result in an event ofdefault that, if not cured or waived, could result in our being required torepay these borrowings before their due date. If we were unable to make thisrepayment or otherwise refinance these borrowings, our lenders could forecloseon our assets. If we were unable to refinance these borrowings on favorableterms, our costs of borrowing could increase significantly.

 

Oursenior debt bears interest at fixed and floating rates. Currently, only a portionof our floating interest rate debt is capped. If interest rates rise, oursenior debt interest payments also will increase. Although we may enter intoagreements to hedge our interest rate risk, these agreements may be inadequateto protect us fully against our interest rate risk.

 

**Our industry is cyclical andhighly competitive****.**

 

Ouroperating results reflect the industry’s general cyclical pattern. The majorityof our products can be subject to extreme price competition. Some segments ofour industry have production overcapacity, which may require us to takedowntime periodically to reduce inventory levels during periods of weak demand. In addition, the industry is capitalintensive, which leads to high fixed costs and has historically resulted incontinued production as long as prices are sufficient to cover marginal costs. Theseconditions have contributed to substantial price competition and volatility inthe industry. Decreases in prices for our products, coupled with our highlyleveraged financial position, may adversely impact our ability to respond tocompetition and to other market conditions or to otherwise take advantage ofbusiness opportunities.

 

Thepaperboard and packaging products industries are highly competitive and areparticularly sensitive to price fluctuations as well as other factors includinginnovation, design, quality and service, with varying emphasis on these factorsdepending on the product line. To the extent that one or more of ourcompetitors become more successful with respect to any key competitive factor,our ability to attract and retain customers could be materially adverselyaffected. Many of our competitors are less leveraged, have financial and otherresources greater than ours and are more capable to withstand the adversenature of the business cycle. If our facilities are not as cost efficient asthose of our competitors, we may need to temporarily or permanently close suchfacilities and suffer a consequent reduction in our revenues.

 

**Our pension plans are underfunded and will requireadditional cash contributions.**

 

Wehave made substantial contributions to our pension plans in the past five yearsand expect to continue to make substantial contributions in the coming years inorder to ensure that our funding levels remain adequate in light of projectedliabilities and to meet the requirements of the Pension Protection Act of 2006.These contributions reduce the amount of cash available for us to repayindebtedness or make capital investments.

 

**Price fluctuations in energy costs and rawmaterials could adversely affect our manufacturing costs.**

 

Thecost of producing and transporting our products is highly sensitive to theprice of energy. Energy prices, in particular oil and natural gas, haveexperienced significant volatility in recent years, with a corresponding effecton our production costs. Energy prices may continue to fluctuate and may riseto higher levels in future years. This could adversely affect our productioncosts and results of operations. Although we may enter into agreements to hedgeour energy costs, these agreements may be inadequate to protect us fullyagainst the volatility of energy costs. To the extent we have  positions that are not hedged or our hedgingprocedures do not perform as planned, fluctuating energy costs could reduce ouroperating profit.

 

Woodfiber and reclaimed fiber, the principal raw materials used in the manufactureof our paper products, are purchased in highly competitive, price-sensitivemarkets, which have historically exhibited price and demand cyclicality. Adverseweather, conservation regulations and the shutdown of a number of sawmills havecaused, and will likely continue to cause, a decrease in the supply of woodfiber and 

 

9

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higherwood fiber costs in some of the regions in which we procure wood fiber. Fluctuationsin supply and demand for reclaimed fiber have occasionally caused tightsupplies of reclaimed fiber. At such times, we may experience an increase inthe cost of fiber or may temporarily have difficulty obtaining adequatesupplies of fiber.

 

**Factors beyond our control****could hinder our ability toservice our debt and meet our operating requirements.**

 

Ourability to meet our obligations and to comply with the financial covenantscontained in our debt instruments will largely depend on our future performance.Our performance will be subject to financial, business and other factorsaffecting us. Many of these factors are beyond our control, such as:

 

•    the state of the economy;

•    the financial markets;

•    demand for, and selling prices of, ourproducts;

•    performance of our major customers;

•    costs of raw materials and energy;

•    hurricanes and other major weather-relateddisruptions; and

•    legislation and other factors relating tothe paperboard and packaging products industries generally or to specificcompetitors.

 

Ifoperating cash flows or net proceeds from borrowings, any divestitures andother financing sources do not provide us with sufficient liquidity to meet ouroperating and debt service requirements, we will be required to pursue otheralternatives to repay debt and improve liquidity. Such alternatives mayinclude:

 

•    sales of assets;

•    cost reductions;

•    deferral of certain discretionary capitalexpenditures and benefit payments; and

•    amendments or waivers to our debtinstruments.

 

Wemight not successfully complete any of these measures or they may not generatethe liquidity we require to operate our business and service our obligations. Ifwe are not able to generate sufficient cash flow or otherwise obtain fundsnecessary to make required debt payments or we fail to comply with our debtcovenants, we would be in default under the terms of our various debtinstruments. This would permit our debt holders to accelerate the maturity ofsuch debt and would cause defaults under our other debt.

 

**We may not realize thecost savings we expect from our strategic initiatives.**

 

Ourability to generate sufficient cash flows to meet our operating and debtservice requirements depends in part on our ability to execute certainstrategic initiatives, which are intended to result in a lower cost structurethrough increased efficiency in our manufacturing processes. Although we haveimplemented several restructuring initiatives in the past, there are inherentrisks related to these programs. These risks include the closure ofmanufacturing facilities, disruption of business operations, inability to meetcustomer demand, higher costs than anticipated, environmental issues associatedwith the closed facilities and a failure to complete these initiatives in thetime frames contemplated. Costs incurred in restructuring our operations, aswell as increases in other expenses unrelated to the restructuring, mightoffset any cost savings. We cannot provide assurance that the restructuring activities will achieve thefull expected benefits of the cost savings within the expected time frame.

 

**We are subject to environmentalregulations and liabilities that could weaken our operating results andfinancial condition.**

 

Federal,state, provincial, foreign and local environmental requirements, particularlythose relating to air and water quality, are a significant factor in ourbusiness. The EPA has issued a comprehensive rule governing air emissions(Maximum Achievable Control Technology (MACT)) and water discharges (EffluentLimitation Guidelines) for the pulp, paper and paperboard industry, known asthe “Cluster Rule,” which has required significant capital expenditures. Substantiallyall Cluster Rule spending will be incurred by the end of the first quarter of2007. The EPA has also promulgated a Boiler MACT regulation 

 

10

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thatwill limit hazardous air pollutant emissions from industrial boilers. Severalof our mills are subject to the Boiler MACT regulation and are required toinstall new pollution control equipment in order to meet the September 13, 2007compliance deadline. Changes in existing environmental laws or the promulgationof new environmental laws may require capital expenditures for compliance.

 

Inthe past we have had, and in the future we may face, environmental liabilityfor the costs of remediating soil or groundwater that we or a third partycontaminated at various sites that we currently own or operate or previouslyowned or operated. There may be liability at third party sites with respect towhich we either have received, or in the future may receive, notice that we maybe a potentially responsible party (PRP) and which are the subject of cleanupactivity under the Comprehensive Environmental Response, Compensation andLiability Act of 1980 (CERCLA), analogous state laws and other laws concerninghazardous substance contamination. Ongoing remediation costs and futureremediation liability may materially adversely affect our results of operationsand financial condition.

 

**Foreign currency risks andexchange rate fluctuations could hinder the results of our Canadian operations.**

 

Ourassets and liabilities outside the United States are primarily located inCanada. Our principal foreign exchange exposure is the Canadian dollar. Thefunctional currency for our Canadian operations is the U.S. dollar. To theextent we have un-hedged positions or our hedging procedures do not perform asplanned, fluctuating currencies could reduce our sales and net income. Ourfinancial performance is directly affected by exchange rates because:

 

•    certain of our products are manufactured inCanada, but sold in U.S. dollars; and

•            themonetary assets and liabilities of our Canadian operations are translated intoU.S. dollars for financial reporting purposes.

 

**ITEM 1B.  UNRESOLVED STAFF COMMENTS**

 

None

 

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**ITEM 2.     PROPERTIES**

 

Themanufacturing facilities of our consolidated subsidiaries are located primarilyin North America. We believe that our facilities are adequately insured,properly maintained and equipped with machinery suitable for our use. Wecontinue to study the economics of modernization or adopting other alternativesfor higher cost facilities. See Part II, Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations, StrategicInitiatives.”  Our manufacturingfacilities as of December 31, 2006 are summarized below:

 
| ** **                                         | ** ** | **Number of Facilities** | ** ** | **State** | ** ** |
|----------------------------------------------------|------------|------------------------------------|------------|-----------|------------|
| ** **                                         | ** ** | **Total**                          | ** ** | **Owned** | ** ** | **Leased** | ** ** | **Locations(a)** | ** ** |
| **United  States**                                 |       |                               |       |      |       |   |   |   |   |
| Containerboard  and Corrugated Containers Segment: |       |                               |       |      |       |   |   |   |   |
| Paper mills                                        |       | 16                                 |       | 16        |       |   |   | 12 |   |
| Corrugated  container plants                       |       | 113                                |       | 77        |       | 36 |   | 31 |   |
| Wood products  plant                               |       | 1                                  |       | 1         |       |   |   | 1 |   |
| Paper tube and  core plant                         |       | 1                                  |       | 1         |       |   |   | 1 |   |
| Non-Reportable  Segment:                           |       |                               |       |      |       |   |   |   |   |
| Reclamation  plants                                |       | 23                                 |       | 16        |       | 7 |   | 14 |   |
| Subtotal                                           |       | 154                                |       | 111       |       | 43 |   | 36 |   |
|                                               |       |                               |       |      |       |   |   |   |   |
| **Canada  and Other North America**                |       |                               |       |      |       |   |   |   |   |
| Containerboard and  Corrugated Containers Segment: |       |                               |       |      |       |   |   |   |   |
| Paper mills                                        |       | 3                                  |       | 3         |       |   |   | N/A |   |
| Corrugated  container plants                       |       | 21                                 |       | 17        |       | 4 |   | N/A |   |
| Laminating plant                                   |       | 1                                  |       | 1         |       |   |   | N/A |   |
| Subtotal                                           |       | 25                                 |       | 21        |       | 4 |   |   |   |
|                                               |       |                               |       |      |       |   |   |   |   |
| **China**                                          |       |                               |       |      |       |   |   |   |   |
| Containerboard  and Corrugated Containers Segment: |       |                               |       |      |       |   |   |   |   |
| Corrugated  container plants                       |       | 2                                  |       | 1         |       | 1 |   | N/A |   |
| Total                                              |       | 181                                |       | 133       |       | 48 |   | N/A |   |

 

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(a)Reflects the number of states in which we have at least one manufacturingfacility.

 

Ourpaper mills represent approximately 77% of our investment in property, plantand equipment. In addition to manufacturing facilities, we own approximatelyone million acres of timberland in Canada and operate wood harvestingfacilities in Canada and the United States. The approximate annual tons of productivecapacity of our paper mills at December 31, 2006, were:

 
| ** **     | ** ** | **Annual Capacity (in thousands)** | ** ** |
|----------------|------------|---------------------------------------------------|------------|
| ** **     | ** ** | **United States**                            | ** ** | **Canada** | ** ** | **Total** | ** ** |
| Containerboard |       | 7,050                                             |       | 516 |   | 7,566 |   |
| SBS            |       | 187                                               |       | 126 |   | 313 |   |
| Kraft paper    |       | 208                                               |       |   |   | 208 |   |
| Market pulp    |       | 305                                               |       | 245 |   | 550 |   |
| Total          |       | 7,750                                             |       | 887 |   | 8,637 |   |

 

###### **Substantiallyall of our North American operating facilities have been pledged as collateralunder our various credit agreements. See Part II, Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,Liquidity and Capital Resources - Net Cash Provided By (Used For) FinancingActivities.”**

 

12

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###### **ITEM 3.     LEGALPROCEEDINGS**

###### ** **

**LITIGATION**

 

In 2003, we settled allof the antitrust class action cases pending against Smurfit-Stone, which werebased on allegations of a conspiracy among linerboard manufacturers from 1993to 1995, and made aggregate settlement payments of $92.5 million, one-half ofwhich was paid in December 2003 and the remainder of which was paid in January2005. We subsequently settled all of the lawsuits brought on behalf of numerous****companies that opted out of these classactions to seek their own recovery (Direct Action Cases), and made aggregatepayments of $60 million, including $14 million in 2005 and $46 million in 2006.We recorded additional charges of $36 million in 2005 in connection with thesesettlements.

 

We are a defendant in a number of lawsuits and claims arising out ofthe conduct of our business. While the ultimate results of such suits or otherproceedings against us cannot be predicted with certainty, we believe theresolution of these matters will not have a material adverse effect on ourconsolidated financial condition or results of operations.

 

**ENVIRONMENTAL MATTERS**

 

Federal, state and localenvironmental requirements are a significant factor in our business. We employprocesses in the manufacture of pulp, paperboard and other products whichresult in various discharges, emissions and wastes. These processes are subjectto numerous federal, state and local environmental laws and regulations,including reporting and disclosure obligations. We operate and expect tocontinue to operate under permits and similar authorizations from variousgovernmental authorities that regulate such discharges, emissions and wastes.

 

In May 2003, we receiveda Violation Notice from the Illinois Environmental Protection Agency (IEPA)alleging that our consumer packaging facility in Schaumburg, Illinois violatedvarious provisions of the Illinois Environmental Protection Act and variousconditions of the applicable Clean Air Act permit issued to the facility. InJune 2003, we received a Notice of Violation (NOV) and Finding of Violation(FOV) from the EPA containing similar allegations. The allegations primarilyrelate to the alleged failure of two afterburner systems designed to captureand reduce certain emissions from printing presses below required levels andthe potential impact of such failure on past and future regulatory standards,permitting requirements, emission credit requirements, recordkeeping andreporting. After making certain repairs to the two old systems, we subsequentlyreplaced these systems with a single regenerative thermal oxidizer to eliminatefuture failures and ensure long-term compliance. The Schaumburg facility wasamong the assets of the Consumer Packaging division, which we sold on June 30,2006. In the fourth quarter of 2006, we entered into a Consent Decree with IEPAand EPA to resolve the matter. The buyer of the Consumer Packaging divisionassumed the obligation to pay the civil penalty of $325,000 and the EmissionsReduction Market System fee of approximately $150,000 required under theConsent Decree.

 

In April 2005, EPA issuedan NOV and an FOV that alleged that we violated the Prevention of SignificantDeterioration regulations and New Source Performance Standards of the Clean AirAct in connection with the replacement of burners in a boiler at our mediummill in Ontonagon, Michigan in 1995. Specifically, the EPA has alleged that theburner replacement project resulted in an increase of the coal burning capacityof the boiler that in turn led to increased emissions of nitrogen oxides andsulfur dioxide. We believe that the burner replacement project was routinemaintenance and did not increase the coal burning capacity of the boiler, andthat differences in emissions resulted from permissible switching of fuels fromnatural gas to coal. We have met with the EPA to discuss this matter, and haveadvised the EPA that we disagree with the allegations and intend to contest theNOV and FOV. Based on the information developed to date and discussion with theEPA, we believe the costs to resolve this matter will not be material and willnot exceed established reserves.

 

We also face potentialliability as a result of releases, or threatened releases, of hazardoussubstances into the environment from various sites owned and operated by thirdparties at which Company-generated wastes have allegedly been deposited. Generatorsof hazardous substances sent to off-site disposal locations at whichenvironmental problems exist, as well as the owners of those sites and certainother classes of persons (PRPs) are, in most instances, subject to joint andseveral liability for response costs 

 

13

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for the investigation andremediation of such sites under CERCLA and analogous state laws, regardless offault or the lawfulness of the original disposal. We have received notice thatwe are or may be a PRP at a number of federal and/or state sites where responseaction may be required and as a result may have joint and several liability forcleanup costs at such sites. However, liability for CERCLA sites is typicallyshared with other PRPs and costs are commonly allocated according to relativeamounts of waste deposited. In estimating our reserves for environmentalremediation and future costs, our estimated liability of $4 million reflectsour expected share of costs after consideration for the relative percentage ofwaste deposited at each site, the number of other PRPs, the identity andfinancial condition of such parties and experience regarding similar matters. Inaddition to participating in the remediation of sites owned by third parties,we have entered into consent orders for the investigation and/or remediation ofcertain of our owned properties.

 

Based on currentinformation, we believe the probable costs of the potential environmentalenforcement matters discussed above, response costs under CERCLA and similarstate laws, and the remediation of owned property will not have a materialadverse effect on our financial condition or results of operations. As ofDecember 31, 2006, we had approximately $17 million reserved for environmentalliabilities. We believe our liability for these matters was adequately reservedat December 31, 2006, and that the possibility is remote that we would incurany material liabilities for which we have not recorded adequate reserves.

 

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

###### ** **

No matters were submittedto a vote of security holders, through the solicitation of proxies orotherwise, during the fourth quarter ended December 31, 2006.

 

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## **PART II**

## ** **

| **ITEM  5.** | **MARKET  FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF EQUITY SECURITIES** |
|--------------|-------------------------------------------------------------------------------------------------------------------------|

 

**MARKETINFORMATION**

 

AtDecember 31, 2006, approximately 51,000 stockholders, including stockholders ofrecord, beneficial owners and employee participants in our voluntary savingsplans, held our common stock. Our common stock trades on The NASDAQ GlobalSelect Market under the symbol “SSCC.” The high and low sales prices of our common stock in 2006 and 2005 were:

 
| ** **     | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 14.40      |     | $          | 12.13 |   | $ | 18.85 |   | $ | 14.92 |   |
| Second Quarter |       | $        | 15.15      |     | $          | 10.21 |   | $ | 15.76 |   | $ | 10.11 |   |
| Third Quarter  |       | $        | 11.80      |     | $          | 9.77 |   | $ | 13.12 |   | $ | 9.87 |   |
| Fourth Quarter |       | $        | 11.62      |     | $          | 9.88 |   | $ | 14.18 |   | $ | 9.06 |   |

 

**DIVIDENDSON COMMON STOCK**

 

Wehave not paid cash dividends on our common stock and do not intend to paydividends in the foreseeable future. Our ability to pay dividends in the futureis restricted by certain provisions contained in various agreements andindentures relating to SSCE’s outstanding indebtedness. See Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,Liquidity and Capital Resources - Net Cash Provided By (Used For) FinancingActivities.”

 

**STOCK PERFORMANCEGRAPH**

 

The information set forthunder this caption shall not be deemed to be “filed” or incorporated byreference into any of our other filings with the SEC.

 

The graph below comparesthe cumulative total stockholder return on an investment in the Common Stock,the S&P 500 Index, and an index of a peer group of paper companies (thePeer Group) for the five-year period ended December 31, 2006. In 2005, thePeer Group was comprised of the following nine medium- to large-sized companieswhose primary business was the manufacture and sale of paper products andpackaging: Caraustar Industries, Inc., Graphic Packaging Corporation,International Paper Company, MeadWestvaco Corporation, Norampac Inc., PackagingCorporation of America, Rock-Tenn Company, Temple-Inland Inc. and WeyerhaeuserCompany. For 2006, in connection with the sale of our Consumer Packingdivision, we have removed the following companies from the Peer Group becausewe no longer have similar lines of business: Caraustar Industries, Inc.,Graphic Packaging Corporation, MeadWestvaco Corporation and Rock-Tenn Company,and we have added Greif Inc. In addition, we have removed Norampac Inc. becauseits stock performance data is no longer available. The graph assumes the valueof an investment in the Common Stock and each index was $100.00 atDecember 31, 2001 and that all dividends were reinvested.

 

 
| ** **                              | ** ** | **Base  Period**      | ** ** | **INDEXED RETURNS**           | ** ** |
|-----------------------------------------|------------|-----------------------|------------|------------------------------------|------------|
| ** **                              | ** ** | **December 31,** | ** ** | **Years Ending December 31,** | ** ** |
| **Company Name / Index** | ** ** | **2001**              | ** ** | **2002**                           | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| **SMURFIT-STONE  CONTAINER CORP**       | ** ** | **100**               |       | 96.37                              |       | 116.28 |   | 116.97 |   | 88.73 |   | 66.12 |   |
| **S&P  500 INDEX**                  | ** ** | **100**               |       | 77.90                              |       | 100.25 |   | 111.15 |   | 116.61 |   | 135.03 |   |
| **NEW  PEER GROUP**                     | ** ** | **100**               |       | 90.06                              |       | 117.50 |   | 123.83 |   | 119.03 |   | 130.11 |   |
| **OLD  PEER GROUP**                     | ** ** | **100**               |       | 90.71                              |       | 117.49 |   | 124.46 |   | 116.52 |   | 125.91 |   |

 

 

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**ITEM 6.  SELECTED FINANCIAL DATA**

(In millions, except pershare and statistical data)

 
| ** **                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003(a)(b)** | ** ** | **2002(c)** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-------------|------------|
| **Summary  of Operations**                                                              |       |     |       |     |       |     |       |           |       |        |       |
| Net sales (d)                                                                           |       | $        | 7,157      |     | $          | 6,812    |       | $              | 6,716      |        | $          | 6,146 |   | $ | 6,025 |   |
| Operating income  (loss) (e)(f)                                                         |       | 276      |       | (253     | )          | 172      |       | (42            | )          | 337         |       |
| Income (loss)  from continuing operations before cumulative effect of accounting change |       | (70      | )          | (378     | )          | (100     | )          | (251           | )          | (15         | )          |
| Discontinued  operations, net of income tax provision (g)                               |       | 11       |       | 51       |       | 54       |       | 59             |       | 80          |       |
| Net income  (loss) available to common stockholders                                     |       | (71      | )          | (339     | )          | (57      | )          | (208           | )          | 54          |       |
|                                                                                    |       |     |       |     |       |     |       |           |       |        |       |
| Basic and  diluted earnings per share of common stock                                   |       |     |       |     |       |     |       |           |       |        |       |
| Income (loss)  from continuing operations before cumulative effect of accounting change |       | (.32     | )          | (1.53    | )          | (.44     | )          | (1.07          | )          | (.10        | )          |
| Discontinued  operations (g)                                                            |       | .04      |       | .20      |       | .21      |       | .24            |       | .32         |       |
| Net income  (loss) available to common stockholders                                     |       | (.28     | )          | (1.33    | )          | (.23     | )          | (.85           | )          | .22         |       |
| Weighted average  shares outstanding (h)                                                |       | 255      |       | 255      |       | 253      |       | 246            |       | 246         |       |
|                                                                                    |       |     |       |     |       |     |       |           |       |        |       |
| **Other  Financial Data**                                                               |       |     |       |     |       |     |       |           |       |        |       |
| Net cash  provided by operating activities                                              |       | $        | 265        |     | $          | 221      |       | $              | 273        |        | $          | 162 |   | $ | 503 |   |
| Net cash provided  by (used for) investing activities                                   |       | 706      |       | (277     | )          | (200     | )          | 15             |       | (462        | )          |
| Net cash  provided by (used for) financing activities                                   |       | (967     | )          | 55       |       | (79      | )          | (171           | )          | (53         | )          |
| Depreciation,  depletion and amortization                                               |       | 377      |       | 408      |       | 416      |       | 415            |       | 401         |       |
| Capital  investments and acquisitions                                                   |       | 274      |       | 285      |       | 232      |       | 238            |       | 570         |       |
| Working capital,  net                                                                   |       | (141     | )          | (4       | )          | 148      |       | 136            |       | 590         |       |
| Net property,  plant, equipment and timberland                                          |       | 3,774    |       | 4,289    |       | 4,682    |       | 4,974          |       | 5,182       |       |
| Total assets                                                                            |       | 7,777    |       | 9,114    |       | 9,583    |       | 9,956          |       | 10,805      |       |
| Long-term debt (i)                                                                      |       | 3,634    |       | 4,571    |       | 4,498    |       | 4,807          |       | 4,990       |       |
| Redeemable  preferred stock                                                             |       | 93       |       | 89       |       | 85       |       | 82             |       | 79          |       |
| Stockholders’  equity                                                              |       | 1,807    |       | 1,882    |       | 2,259    |       | 2,270          |       | 2,320       |       |
|                                                                                    |       |     |       |     |       |     |       |           |       |        |       |
| **Statistical  Data (tons in thousands)**                                               |       |     |       |     |       |     |       |           |       |        |       |
| Containerboard  production (tons)                                                       |       | 7,402    |       | 7,215    |       | 7,438    |       | 7,185          |       | 6,860       |       |
| Kraft paper  production (tons)                                                          |       | 199      |       | 204      |       | 259      |       | 293            |       | 283         |       |
| Market pulp  production (tons)                                                          |       | 564      |       | 563      |       | 549      |       | 497            |       | 567         |       |
| Solid bleached  sulfate production (tons)                                               |       | 313      |       | 283      |       | 276      |       | 290            |       | 296         |       |
| Corrugated  containers sold (billion sq. ft.)                                           |       | 80.0     |       | 81.3     |       | 81.8     |       | 79.7           |       | 76.9        |       |
| Fiber reclaimed  and brokered (tons)                                                    |       | 6,614    |       | 6,501    |       | 6,542    |       | 6,549          |       | 6,582       |       |
| Number of  employees (j)                                                                |       | 25,200   |       | 33,500   |       | 35,300   |       | 36,700         |       | 38,600      |       |

 

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**Notes to Selected Financial Data**

 

(a)          Results for2003 include the acquisition of Smurfit-MBI after March 31, 2003, the date ofthe acquisition.

(b)         We recordeda $5 million charge, net of income tax, or $.02 per diluted share, in 2003 forthe cumulative effect of an accounting change in accordance with Statement ofFinancial Accounting Standards (SFAS) No. 143, “Accounting for Asset RetirementObligations.”

(c)          Results for2002 include the acquisition of the Stevenson, Alabama containerboard mill andthe related corrugated container assets after September 30, 2002, the date ofthe acquisition.

(d)         EffectiveApril 1, 2006, we adopted Emerging Issues Task Force Issue No. 04-13, “Accountingfor Purchases and Sales of Inventory With the Same Counterparty” which requiredus to prospectively report certain inventory buy/sell transactions of similarcontainerboard types in our Containerboard and Corrugated Containers segment ona net basis in our consolidated statements of operations, thereby reducing netsales and cost of goods sold by $194 million in 2006.

(e)          In 2004,operating income (loss) included an asset impairment charge of $73 millionattributable to the write-down of non-core pulp mill fixed assets.

(f)            In 2006, 2005, 2004, 2003 and 2002, we recorded restructuring charges of$43 million, $321 million, $16 million, $115 million and $24 million,respectively.

(g)         Includesincome from discontinued operations and loss on disposition of discontinuedoperations.

(h)         Sharesoutstanding for 2006, 2005, 2004 and 2003 reflect both basic and dilutedshares. Shares outstanding for 2002 reflect diluted shares, while basic shareswere 244 million.

(i)             In 2006, 2005, 2004, 2003 and 2002, long-term debt includes obligationsunder capital leases of $7 million, $12 million, $13 million, $12 million and$16 million, respectively.

(j)             Number of employees for 2006 excludes approximately 6,600 employees ofour former Consumer Packaging division, which was sold on June 30, 2006.

 

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| **ITEM 7.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION****AND RESULTS OF  OPERATIONS** |
|-------------|-----------------------------------------------------------------------------------------------------|

 

**OVERVIEW**

 

Smurfit-Stone ContainerCorporation is an integrated manufacturer of paperboard and paper-basedpackaging. Our major products are containerboard, corrugated containers, SBS,market pulp, recycled fiber and kraft paper. We operate in one reportableindustry segment. Approximately 95% of our 2006 net sales were generated by theContainerboard and Corrugated Containers segment and 5% were generated by ourreclamation operation. Our mill operations supply paper to our corrugatedcontainer converting operations. The products of our converting operations, aswell as the mill and reclamation tonnage in excess of what is consumed internally,are the main products sold to third parties. Our operating facilities andcustomers are located primarily in the United States and Canada.

 

Market conditions anddemand for our products are subject to cyclical changes in the economy andchanges in industry capacity, both of which can significantly impact sellingprices and our profitability. In recent years, the continued loss of domesticmanufacturing to offshore competition and the changing retail environment inthe U.S. have also played a key role in reducing growth in domestic packaging demand.The influence of superstores and discount retailing giants, as well as theimpacts from online shopping, has resulted in a shifting of demand to packagingwhich is more condensed, lighter weight and less expensive. These factors havegreatly influenced the corrugated industry.

 

In2006, U.S. industry per day shipments of corrugated containers increased 1.3%.Principally as a result of 17 plant closures since we began implementing ourstrategic initiative plan in 2005, our North American per day shipments ofcorrugated containers decreased 1.3% compared to 2005. Although our volumedeclined during the year, 2006 was an important year for us as we implementedsignificant price increases, made substantial progress executing our strategicinitiative plan and strengthened our management team. In addition, as part ofour strategic initiative plan, we sold our Consumer Packaging division on June30, 2006 and used the proceeds to repay debt. For 2006, we recorded a net lossavailable to common stockholders of $71 million, a significant improvementcompared to 2005. Higher prices, savings from our strategic initiatives, andlower restructuring charges in 2006 were partially offset by significant costinflation on key input costs including freight, energy, fiber and chemicals.

 

Our outlook for 2007 isthat business fundamentals and packaging demand will remain stable. We expectimproved earnings in 2007 due to higher average prices compared to 2006 andincremental benefits from our strategic initiatives. Regarding costs trends, weexpect higher fiber costs in 2007. Virgin fiber prices are increasing as aresult of wet weather conditions and sawmill closures stemming from the housingslowdown. We expect old corrugated containers (OCC) prices to increase in 2007due to greater waste paper export demand from China. In addition, we expectcontinued inflation in our other key input costs.

 

# **STRATEGIC INITIATIVES**

#  

During 2005, we announceda strategic initiative plan to improve performance and better position us forlong-term growth. Our plan focused on cost reduction and productivityinitiatives from which we expect to achieve $525 million in annual savings bythe end of 2008. As part of the initiative plan, we completed the sale of ourConsumer Packaging division on June 30, 2006 and used the proceeds to reducedebt. See Part I, Item 1, “Business, Discontinued Operations.”  Our original initiative target included costsavings benefits to be derived from the Consumer Packaging division andaccordingly, we have adjusted this target to exclude the impact of the ConsumerPackaging division from both the target and actual savings achieved.

 

In order to achieve ourcost reduction initiatives, we expect to close a minimum of 30 converting facilitiesby the end of 2008 (inclusive of 17 facilities closed through December 31,2006). Some plant closures will enable us to transfer production volume to ourother plants, thereby lowering costs through higher equipment utilization. Otherplant closures will be part of our scaling plan in larger markets, whichinvolves investment in new-high speed corrugators and finishing equipment. Weexpected to achieve additional cost reductions through i) mill consolidation,ii) productivity improvements at the mills and the 

 

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remaining containerplants, iii) standardization of containerboard trim sizes and grades produced,iv) transportation and procurement savings and v) reductions in selling andadministrative expenses.

 

In 2005, as the firststep in this cost reduction process and in order to better align productioncapacity with market conditions and demand, we permanently closed the NewRichmond, Quebec linerboard mill, the Bathurst, New Brunswick medium mill andthe previously idled No. 2 paper machine at the Fernandina Beach, Floridalinerboard mill. Our containerboard manufacturing capacity was reduced by700,000 tons, or 8.5%, as a result of these closures. In addition, we alsoclosed two converting facilities, exited our investment in the Las Vegas,Nevada converting facility, and agreed to the closure of the Groveton, NewHampshire medium mill, in which we owned a minority interest. As a result ofthese closures, we recorded restructuring charges of $321 million, includingnon-cash charges of $267 million related to the write-down of assets, primarilyproperty, plant and equipment, to estimated net realizable values. Theremaining charges were primarily for severance, benefits, lease commitments andpost-closure environmental costs. These shutdowns resulted in approximately 780employees being terminated. In 2005, we realized savings of approximately $45million from our strategic initiatives. The savings included a reduction offixed costs primarily related to the closures of the two containerboard mills,other workforce reductions in the Containerboard and Corrugated Containersegment and a one-time curtailment gain related to the elimination ofpostretirement health care and life insurance benefits for certain employees.

 

In 2006, in conjunctionwith the strategic initiative plan, we closed 15 converting facilities andpermanently shutdown four corrugators, resulting in the termination ofapproximately 1,400 employees. In addition, another 700 employees wereterminated as part of the strategic initiative plan. We recorded restructuringcharges of $43 million, net of an $18 million gain from the sale of threeclosed facilities and the No. 2 paper machine at the Fernandina Beach, Floridalinerboard mill. The fixed assets of the shutdown operations were adjusted tothe estimated net realizable value, resulting in a non-cash charge of $21million.

 

For 2006, we targeted$240 million of cost savings and productivity improvements from our strategicinitiatives. In 2006, we realized estimated savings of $243 million from theseinitiatives compared to  cost levelsprior to the start of the initiative plan as adjusted for the impact ofinflation. Since we announced our strategic initiative plan, we have realizedcumulative initiative savings of approximately $288 million. Through December31, 2006, we have closed two containerboard mills, shut down 17 convertingfacilities and permanently shutdown four corrugators. As a result of theseactions, we have reduced our headcount by approximately 3,600 since June 30,2005.

 

# For 2007, we are targeting $177 million inincremental savings and productivity improvements from our strategicinitiatives. For the two month-period ended February 28, 2007, we haveannounced four additional plant closures and the permanent shutdown of onecorrugator, which will result in the termination of approximately 350 employees.For the first quarter of 2007, we expect total reductions in headcount of approximately600 employees.

#  

# We expect to incur capital expenditures ofapproximately $300 million to $350 million per year during the next two years. Weexpect to fund the capital expenditures through anticipated improvements in ouroperating cash flows and with borrowings under our revolving credit facility.

#  

# During the next two years, to implement theplanned initiatives, we expect to record additional restructuring charges ofapproximately $125 million, including accelerated depreciation of approximately$40 million related to equipment expected to be abandoned or taken out ofservice in conjunction with the future closure of certain corrugated containerfacilities.

 

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**RESULTS OF OPERATIONS**

 

**Discontinued Operations**

 

Our Consumer Packagingsegment, which was sold on June 30, 2006, has been classified as discontinuedoperations and is excluded from the segment results for all periods presented. SeePart I, Item 1, “Business, Discontinued Operations.”

 

**Recently Adopted AccountingStandards**

 

Effective April 1, 2006,we adopted Emerging Issues Task Force Issue No. 04-13, “Accounting forPurchases and Sales of Inventory With the Same Counterparty” (EITF No. 04-13),for new arrangements and modifications or renewals of existing arrangements. EITFNo. 04-13 requires certain inventory buy/sell transactions betweencounterparties within the same line of business to be viewed as a singleexchange transaction. EITF No. 04-13 required us to prospectively report,beginning in the second quarter of 2006, certain inventory buy/selltransactions of similar containerboard types in our Containerboard andCorrugated Containers segment on a net basis in our consolidated statements ofoperations, thereby reducing net sales and cost of goods sold by $194 millionin 2006. Had EITF No. 04-13 previously been in effect, net sales and cost ofgoods sold would have been reduced by an additional $58 million for the firstquarter of 2006 and $296 million and $268 million for 2005 and 2004,respectively.

 

**Segment Data**

(In millions)

 
| ** **                                           | ** ** | **2006**       | ** ** | **2005**            | ** ** | **2004**       | ** ** |
|------------------------------------------------------|------------|----------------|------------|---------------------|------------|----------------|------------|
| ** **                                           | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
| Containerboard  and corrugated containers            |       | $              | 6,765      |                | $          | 433            |       | $ | 6,438 |   | $ | 191 |   | $ | 6,328 |   | $ | 321 |   |
| Reclamation  operations                              |       | 392            |       | 19                  |       | 374            |       | 19 |   | 388 |   | 28 |   |
| Total segment  operations                            |       | $              | 7,157      |                | 452        |           | $          | 6,812 |   | 210 |   | $ | 6,716 |   | 349 |   |
|                                                 |       |           |       |                |       |           |       |   |   |   |   |   |   |
| Restructuring  charges                               |       |           |       | (43                 | )          |           |       | (321 | ) |   |   | (16 | ) |
| Asset impairment  charge                             |       |           |       |                |       |           |       |   |   |   |   | (73 | ) |
| Gain (loss) on  sale of assets                       |       |           |       | 24                  |       |           |       | (1 | ) |   |   | 7 |   |
| Interest  expense, net                               |       |           |       | (341                | )          |           |       | (345 | ) |   |   | (342 | ) |
| Loss on early  extinguishment of debt                |       |           |       | (28                 | )          |           |       |   |   |   |   | (11 | ) |
| Litigation  charges and settlements, net             |       |           |       |                |       |           |       | (36 | ) |   |   | (3 | ) |
| Corporate expenses  and other (1)                    |       |           |       | (174                | )          |           |       | (126 | ) |   |   | (110 | ) |
| Loss from  continuing operations before income taxes |       |           |       | $                   | (110       | )              |       |   | $ | (619 | ) |   |   | $ | (199 | ) |

 

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(1)Corporate expenses and other includes corporate expenses, corporate charges tosegments for working capital interest and other expenses not allocated tosegments. The higher expense in 2006 is primarily due to higher mark-to-marketadjustments on energy hedges ($24 million), higher stock-based compensationexpense ($13 million) and costs related to the implementation of the strategicinitiatives ($13 million).

 

**2006 COMPARED TO 2005**

 

For 2006, we had a netloss available to common stockholders of $71 million, or $.28 per diluted share.This compares to a net loss available to common stockholders of $339 million, or$1.33 per diluted share in 2005. Our loss was lower in 2006 due primarily tolower restructuring charges and higher Containerboard and Corrugated Containerssegment profit. In 2006, we recorded pretax restructuring charges of $43million compared to $321 million in 2005. In 2006, the Containerboard andCorrugated Containers segment profit of $433 million was $242 million highercompared to 2005 due primarily to higher average selling prices forcontainerboard and corrugated containers and cost savings achieved from ourstrategic initiative plan, which were partially offset by higher key inputcosts.

 

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Net sales in 2006increased 5.1% compared to 2005 due primarily to improvements in pricing forthe Containerboard and Corrugated Containers segment. The change in net salesfor each of our segments, including the impact of adopting EITF No. 04-13, asdescribed in “Recently Adopted Accounting Standards,” is summarized in thechart below:

 
| **(In millions)**       | ** ** | **Container-  board &  Corrugated  Containers** | ** ** | **Reclamation  Operations** | ** ** | **Total** | ** ** |
|------------------------------|------------|----------------------------------------------------------|------------|-----------------------------|------------|-----------|------------|
|                         |       |                                                     |       |                        |       |      |       |
| Sales price and  product mix |       | $                                                        | 505        |                        | $          | (8        | )          | $ | 497 |   |
| Sales volume                 |       | 16                                                       |       | 26                          |       | 42        |       |
| EITF No. 04-13               |       | (194                                                     | )          |                        |       | (194      | )          |
| Total                        |       | $                                                        | 327        |                        | $          | 18        |       | $ | 345 |   |

###### ** **

Cost of goods soldincreased from $6,054 million in 2005 to $6,185 million in 2006 due primarilyto higher sales volume ($37 million), and higher costs for freight ($47million), energy ($35 million), wood fiber ($17 million) and chemicals ($16million). Cost of goods sold was favorably impacted by adopting EITF No. 04-13($194 million) and by lower cost for reclaimed material ($24 million). Cost ofgoods sold as a percent of net sales decreased from 88.9% in 2005 to 86.4% in2006 due primarily to the higher average sales prices.

 

Selling andadministrative expense decreased $12 million in 2006 compared to 2005 dueprimarily to lower litigation charges and settlements, net. In 2005, werecorded charges of $36 million for the settlement of Direct Action Cases. SeePart I, Item 3, “Legal Proceedings.” Selling and administrative expense in 2006 was unfavorably impacted byhigher stock-based compensation expense ($13 million), including $5 million dueto the impact of adopting SFAS No. 123(R) on January 1, 2006, and costs relatedto the implementation of the strategic initiatives ($13 million). Forinformation concerning stock-based compensation, see Note 4 of the Notes toConsolidated Financial Statements. Selling and administrative expense as apercent of net sales decreased from 10.1% in 2005 to 9.5% in 2006 due primarilyto the higher average sales prices.

 

Interest expense, net was$341 million in 2006. The $4 million decrease compared to 2005 was the resultof lower average borrowings ($28 million), partially offset by higher average interestrates ($24 million). Our overall average effective interest rate in 2006 washigher than 2005 by approximately 0.57%.

 

We recorded a gain onsale of assets of $23 million in the first quarter of 2006 related to thedivestiture of our Port St. Joe, Florida joint venture interest and relatedreal estate.

 

Other, net included anon-cash foreign currency exchange gain of $1 million in 2006 compared to aloss of $9 million in 2005. See Item 7A, “Quantitative and QualitativeDisclosures About Market Risk, Foreign Currency Risk.”

 

Benefit from income taxesdiffered from the amount computed by applying the statutory U.S. federal incometax rate to loss before income taxes due primarily to state income taxes andthe effect of other permanent differences. In connection with the sale of theConsumer Packaging division, during the year ended December 31, 2006, werecorded a pretax gain of $171 million, offset by a $174 million income taxprovision, resulting in a net loss on sale of discontinued operations of $3 million.The after-tax loss is the result of a provision for income taxes that is higherthan the statutory income tax rate due to the non-deductibility of goodwill. Thesale of the Consumer Packaging division generated a $14 million U.S. federalalternative minimum tax, which was paid in 2006.

 

**Containerboard and CorrugatedContainers Segment**

Net sales increased 5.1%in 2006 compared to 2005 primarily as a result of higher average sales pricesfor containerboard and corrugated containers. Net sales were unfavorablyimpacted by the adoption of EITF No. 04-13. For 2006, average domesticlinerboard prices increased 14.8% compared to the same period last year. Ouraverage North American selling price for corrugated containers was 5.2% higher 

 

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compared to 2005. Shipmentsof corrugated containers decreased 1.6% compared to 2005 due to one lessshipping day and the container plant closures. On a per day basis, shipments ofcorrugated containers declined by 1.3%. Third party containerboard shipmentsincreased 19.4% compared to 2005. Average sales prices for market pulp, SBS andkraft paper increased 10.8%, 3.0%, and 8.9%, respectively, compared to lastyear.

 

Our containerboard millsoperated at 100% of capacity in 2006 and containerboard production increased2.6% compared to last year despite the closure of two containerboard mills inAugust 2005. Production of market pulp was comparable to last year. Productionof SBS increased 10.6%, while kraft paper decreased by 2.5% compared to lastyear.

 

Profits increased $242million due primarily to the higher average sales prices and benefits from ourinitiatives, which were partially offset by significant inflation on key inputcosts. Profits also benefited in 2006 from higher third party containerboardshipments, due in part to our planned reduction of 65,000 tons in ourcontainerboard inventories. Profits were unfavorably impacted by the lowersales volume for corrugated containers and higher costs of energy ($35 million),freight ($47 million), chemicals ($16 million) and wood fiber ($17 million).

 

**Reclamation Operations**

Net sales increased 4.8%due primarily to higher sales volume for reclaimed fiber, which was partiallyoffset by lower average selling prices. The average price for OCC decreasedapproximately $10 per ton compared to 2005. Total tons of fiber reclaimed andbrokered for  2006 was 1.7% highercompared to last year as a result of higher external sales volume and higherinternal consumption. Profits in 2006 of $19 million were comparable to lastyear.

 

**2005 COMPARED TO 2004**

 

The increase in our lossfrom continuing operations was due primarily to higher restructuring charges,lower segment profits and higher litigation charges and settlements, net. Segmentprofits were negatively impacted by higher costs of wood fiber, freight, energyand chemicals and lower containerboard sales and production volumes. Segmentprofits were favorably impacted by higher average sale prices for most of ourproducts.

 

Net sales of $6,812million in 2005 increased 1.4% compared to 2004 due primarily to improvementsin pricing for the Containerboard and Corrugated Containers segment. The changein net sales for each of our segments is summarized in the chart below:

 
| **(In millions)**       | ** ** | **Container-  board &  Corrugated  Containers** | ** ** | **Reclamation  Operations** | ** ** | **Total** | ** ** |
|------------------------------|------------|----------------------------------------------------------|------------|-----------------------------|------------|-----------|------------|
|                         |       |                                                     |       |                        |       |      |       |
| Sales price and  product mix |       | $                                                        | 174        |                        | $          | (20       | )          | $ | 154 |   |
| Sales volume                 |       | (64                                                      | )          | 6                           |       | (58       | )          |
| Total                        |       | $                                                        | 110        |                        | $          | (14       | )          | $ | 96 |   |

###### ** **

###### **Costof goods sold increased from $5,807 million in 2004 to $6,054 million in 2005due primarily to higher costs, including energy ($70 million), wood fiber ($38million), freight ($60 million) and chemicals ($30 million). Cost of goods soldas a percent of net sales increased from 86.5% in 2004 to 88.9% in 2005 dueprimarily to the higher costs.**

###### ** **

Selling andadministrative expenses increased from $655 million in 2004 to $689 million in2005 due to the increase in litigation and settlement charges, net. Selling andadministrative expenses as a percent of net sales increased from 9.8% in 2004to 10.1% in 2005.

 

For 2005, we recordedrestructuring charges of $321 million, including non-cash charges of $267million related to the write-down of assets, primarily property, plant andequipment, to estimated net realizable values, and $4 million related to apension curtailment charge for terminated employees. The remaining charges wereprimarily for severance, benefits, lease commitments and post-closureenvironmental costs. These shutdowns resulted in approximately 780 employeesbeing terminated.

 

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Interest expense, net was$345 million in 2005, an increase of $3 million compared to 2004. The increasewas due to higher average interest rates ($19 million), which were partiallyoffset by lower average borrowings ($16 million). Our overall average effectiveinterest rate in 2005 was higher than 2004 by approximately 0.45%.

 

Other, net for 2005included non-cash foreign exchange losses of $9 million compared to losses of$22 million in 2004. See Item 7A, “Quantitative and Qualitative DisclosuresAbout Market Risk, Foreign Currency Risk.”

 

Benefit from income taxesin 2005 differed from the amount computed by applying the statutory U.S.federal income tax rate to loss from continuing operations before income taxesand cumulative effect of accounting change due primarily to a $44 millionbenefit related to the resolution of certain prior year tax matters, aprovision of $34 million related to the repatriation of foreign earnings, stateincome taxes, foreign income taxes and the effects of other permanentdifferences. For information concerning income taxes, see Note 14 of the Notesto Consolidated Financial Statements.

 

**Containerboard and CorrugatedContainers Segment**

Net sales increased 1.7%in 2005 compared to 2004 primarily as a result of higher average sales prices. For  2005, average North American corrugatedcontainer prices increased 2.2% and average domestic linerboard prices werehigher by 4.1% compared to 2004. Average sales prices for market pulp, SBS andkraft paper increased 6.6%, 3.3% and 6.1%, respectively, compared to last year.Shipments of corrugated containers in 2005 were lower by 0.7% compared to 2004due to weak demand in the first half of 2005 and the impact of plant closures.Third party containerboard shipments decreased by 10.0% compared to the sameperiod of 2004.

 

Containerboard productiondecreased 3.0% compared to 2004. Our containerboard mills operated at anaverage rate of 92.6% of capacity in 2005 compared to 93.9% in 2004. Productionof market pulp increased 2.6% and production of SBS increased 2.5%. Productionof kraft paper declined 21.2% due primarily to the shift of production fromkraft paper to containerboard on one of our paper machines.

 

Profits decreased $130million due primarily to higher costs and lower containerboard sales volume. Profitswere unfavorably impacted by our lower containerboard mill production, thelower sales volume and higher costs of energy ($70 million), wood fiber ($38million), freight ($60 million) and chemicals ($30 million). Profits werefavorably impacted by the higher average sales prices.

 

#### **Reclamation Operations**

#### Net sales decreased 3.6% in 2005 compared to2004 due primarily to lower sales prices for reclaimed fiber. The average priceof OCC decreased by approximately $5 per ton compared to 2004. Total tons offiber reclaimed and brokered in 2005 were comparable to 2004. Higher externalsales volume was offset by lower internal consumption due primarily to the containerboardmill closures. Profits in 2005 decreased $9 million compared to 2004 dueprimarily to the lower average sales prices and the loss of a profitablecustomer account.

####  

**LIQUIDITY AND CAPITAL RESOURCES**

 

The following tablepresents a summary of our cash flows for the years ended December 31:

 
| **(In millions)**            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net cash  provided by (used for): |       |     |       |     |       |     |       |
| Operating  activities             |       | $        | 265        |     | $          | 221      |       | $ | 273 |   |
| Investing  activities             |       | 706      |       | (277     | )          | (200     | )          |
| Financing  activities             |       | (967     | )          | 55       |       | (79      | )          |
| Net increase  (decrease) in cash  |       | $        | 4          |     | $          | (1       | )          | $ | (6 | ) |

 

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**Net Cash Provided By OperatingActivities**

The change in net cashprovided by operating activities in 2006 compared to 2005 was due primarilyto  higher segment profits partiallyoffset by lower cash generated from working capital. Working capital increased$35 million in 2006 due primarily to decreases in accounts payable and accruedliabilities, including a payment of $46 million related to the settlement ofcertain antitrust class action litigation. Working capital decreased $123million in 2005 due to lower inventory levels, an increase in accounts payableand a decrease in accounts receivable. Contributions to our pension plans were$147 million in 2006 compared to $174 million in 2005 and $177 million in 2004.

 

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

Net cash provided byinvesting activities was $706 million for 2006. Expenditures for property,plant and equipment were $274 million in 2006, comparable to 2005. Property,plant and equipment expenditures in 2006 included $62 million for environmentalprojects and $212 million for projects related to upgrades, cost reductions andstrategic initiatives. In 2006, we received proceeds from the sale of propertyand businesses of $980 million, principally from the sale of our ConsumerPackaging division and from the divestiture of our Port St. Joe, Florida jointventure.

 

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

Net cash used for financingactivities in 2006 of $967 million included net repayment of debt of $937million due primarily to the application of the Consumer Packaging divisionsale net proceeds. Cash proceeds from the exercise of stock options in 2006were $2 million. Preferred dividends paid were $8 million in 2006.

 

We as guarantor, and SSCEand its subsidiary, Smurfit-Stone Container Canada Inc. (SSC Canada), asborrowers, entered into a credit agreement, as amended (the Credit Agreement)on November 1, 2004,   The Credit Agreement,which refinanced and replaced our former credit agreements in their entirety,provides for (i) a revolving credit facility of $600 million to SSCE, of which$70 million was borrowed as of December 31, 2006 and (ii) a revolving creditfacility of $200 million to SSCE and SSC Canada, of which $66 million wasborrowed as of December 31, 2006. The revolving credit facilities includesub-limits for the issuance of letters of credit and swingline loans. Each ofthese revolving credit facilities matures on November 1, 2009. The CreditAgreement also provided for a Tranche B term loan to SSCE in the aggregateprincipal amount of $975 million and a Tranche C term loan to SSC Canada in theaggregate principal amount of $300 million. The credit facilities bear interestat rates selected at the option of SSCE, equal to LIBOR plus 2.50% or alternatebase rate (ABR) plus 1.50%, in the case of the revolving credit facilities andLIBOR plus 2.25% or ABR plus 1.25%, in the case of the term loan facilities. Wepay a 0.5% commitment fee on the unused portions of our revolving creditfacilities. The term loans are payable in quarterly installments ending onNovember 1, 2011. In addition, the Credit Agreement provides for a depositfunded letter of credit facility to us, related to our variable rate industrialrevenue bonds, for approximately $122 million that matures on November 1, 2010.

 

In December 2005, we andour lenders entered into an agreement and amendment (Incremental Term LoanAssumption Agreement and Amendment No. 2) to the Credit Agreement to (i) easecertain financial covenant requirements as of December 31, 2005 and for futureperiods through September 30, 2007, (ii) increase interest rates for the creditfacilities by 0.25% and (iii) provide for a new term loan. The interest ratewith respect to the term loan and revolving credit facilities will increase by0.25% if at any time our senior secured indebtedness is rated lower than BB- byStandard & Poor’s and Ba3 by Moody’s Investors Service. The interestrate with respect to the term loan facilities will decrease by 0.25% if, at anytime, the Company’s Consolidated Senior Secured Leverage Ratio, as defined inthe Incremental Term Loan Assumption Agreement and Amendment No. 2, is lessthan 3.0 to 1.0. The other material terms of the Credit Agreement, includingsecurity and final maturity, remained the same as under the original CreditAgreement. The Incremental Term Loan Assumption Agreement and Amendment No. 2also provided for a new SSC Canada Incremental Term Loan (Tranche C-1) in theaggregate principal amount of $90 million. The term loan is payable inquarterly installments and matures on November 1, 2011. We used the proceeds ofthe Tranche C-1 to repay $90 million of Tranche B term loan. We paid fees andother expenses of $4 million related to this transaction.

 

The interest rate withrespect to term loan facilities will decrease by 0.25% effective March 2007, asa result of our Consolidated Senior Secured Leverage Ratio decreasing to lessthan 3.0 to 1.0.

 

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The obligations of SSCEunder the Credit Agreement are unconditionally guaranteed by us and thematerial U.S. subsidiaries of SSCE. The obligations of SSC Canada under theCredit Agreement are unconditionally guaranteed by us, SSCE, the material U.S.subsidiaries of SSCE and the material Canadian subsidiaries of SSC Canada. Theobligations of SSCE under the Credit Agreement are secured by a securityinterest in substantially all of our assets and properties, and those of SSCEand the material U.S. subsidiaries of SSCE, by a pledge of all of the capitalstock of SSCE and the material U.S. subsidiaries of SSCE and by a pledge of 65%of the capital stock of SSC Canada that is directly owned by SSCE. The securityinterests securing SSCE’s obligation under the Credit Agreement exclude cash,cash equivalents, certain trade receivables, three paper mills and the land andbuildings of certain corrugated container facilities. The obligations of SSCCanada under the Credit Agreement are secured by a security interest insubstantially all of the assets and properties of SSC Canada and the materialCanadian subsidiaries of SSC Canada, by a pledge of all of the capital stock ofthe material Canadian subsidiaries of SSC Canada and by the same U.S. assets,properties and capital stock that secure SSCE’s obligations under the CreditAgreement. The security interests securing SSC Canada’s obligation under theCredit Agreement exclude three mills and property related thereto and certainother 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) limitations onthe incurrence of indebtedness, liens, leases and sale-leaseback transactions,(iii) limitations on capital expenditures and (iv) maintenance of certainfinancial covenants. The Credit Agreement also requires prepayments if we haveexcess cash flows, as defined therein, or receive proceeds from certain assetsales, insurance or incurrence of certain indebtedness. Our failure to complywith these covenants could result in an event of default that, if not cured orwaived, could result in us being required to repay these borrowings beforetheir due date. If we were unable to make this repayment or otherwise refinancethese borrowings, our lenders could foreclose on our assets. If we were unableto refinance these borrowings on favorable terms, our costs of borrowing couldincrease significantly. At December 31, 2006, we were in compliance with thefinancial covenants required by the Credit Agreement. As of December 31, 2006,subject to the above limitations, we have unused borrowing capacity under SSCE’srevolving credit facilities of $539 million, after giving consideration tooutstanding letters of credit.

 

In June 2006, we, asguarantor, and SSCE and its subsidiary, SSC Canada, as borrowers, entered intoan amendment to the senior credit facility with our lending group permitting usto use a portion of the net cash proceeds to be received from the sale of ourConsumer Packaging division and additional borrowings, if necessary, to prepaycertain unsecured debt. In addition, the amendment provided for the release ofthe lien on the assets of the Consumer Packaging division. The amendment (i)required the use of $240 million of the proceeds to prepay Tranche B termloans, (ii) permitted the use of up to $400 million of the proceeds to prepaythe unsecured senior notes and (iii) permitted the reinvestment of up to $250million of the balance of the proceeds in the business of the Company and itssubsidiaries.

 

On June 30, 2006, wecompleted the sale of the Consumer Packaging division (see Note 2 of the Notesto Consolidated Financial Statements) and used net proceeds of $902 million torepay $240 million of Tranche B term loans, $218 million of revolving creditfacilities due November 1, 2009, $298 million of 9.25% unsecured senior notesdue February 1, 2008, $102 million of 9.75% unsecured senior notes due February1, 2011 and $20 million of other debt. In addition, we paid tender premiums andother fees of approximately $24 million related to this transaction. A loss of$28 million was recorded due to the early extinguishment of debt, including a$4 million write-off of related unamortized deferred debt issuance costs.

 

In October 2006, the netproceeds from the sale of the Consumer Packaging division were reduced by $5million as a result of final working capital adjustments, which were previouslyaccrued.

 

In September 2006, $137million of containerboard customer accounts receivables, net of relatedallowance for doubtful accounts, were sold into the SRC accounts receivablesecuritization program, of which $78 million were retained by us as asubordinated interest and recorded in retained interest in receivables sold inthe consolidated balance sheet. We used $59 million of proceeds received fromthe SRC accounts receivable securitization program to repay $50 million of theoutstanding Tranche B term loan due November 1, 2011 and $9 million of therevolving credit facility.

 

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**FUTURE CASH FLOWS**

 

**Contractual Obligations andCommitments**

At December 31, 2006, ourcontractual obligations and commitments were as follows:

 
| ** **                                    | ** ** | ** ** | ** ** | **Amounts Payable During** | ** ** |
|-----------------------------------------------|------------|------------|------------|--------------------------------------|------------|
| **(In millions)**                        | ** ** | **Total**  | ** ** | **2007**                             | ** ** | **2008-09** | ** ** | **2010-11** | ** ** | **2012 &  Beyond** | ** ** |
|                                          |       |       |       |                                 |       |   |   |   |   |   |   |
| Long-term debt,  including capital leases (1) |       | $          | 3,634      |                                 | $          | 84 |   | $ | 153 |   | $ | 1,632 |   | $ | 1,765 |   |
| Operating leases                              |       | 383        |       | 78                                   |       | 108 |   | 66 |   | 131 |   |
| Purchase  obligations (2)                     |       | 1,113      |       | 320                                  |       | 425 |   | 205 |   | 163 |   |
| Commitments for  capital expenditures (3)     |       | 260        |       | 251                                  |       | 9 |   |   |   |   |   |
| Other long-term  liabilities (4)              |       | 710        |       | 100                                  |       | 302 |   | 274 |   | 34 |   |
| Total  contractual obligations                |       | $          | 6,100      |                                 | $          | 833 |   | $ | 997 |   | $ | 2,177 |   | $ | 2,093 |   |

 

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(1)          Projected contractualinterest payments are excluded. Based on interest rates in effect and long-termdebt balances outstanding as of December 31, 2006, hypothetical projectedcontractual interest payments would be approximately $297 million in 2007 andfor each future year. For the purpose of this disclosure, our variable andfixed rate long-term debt would be replaced at maturity with similar long-termdebt. This disclosure does not attempt to predict future cash flows or changesin interest rates. See Item 7A, “Quantitative and Qualitative Disclosures AboutMarket Risk, Interest Rate Risk.”

(2)          Amounts shown consistprimarily of national supply contracts to purchase containerboard, wood,reclaimed fiber, natural gas and other energy resources for which value isreceived. We do not aggregate open purchase orders executed in the normalcourse of business by each of our operating locations and such purchase ordersare therefore excluded from the table.

(3)          Amounts shown areestimates of future spending on capital projects which were committed to priorto December 31, 2006, but were not completed by December 31, 2006. We expectcapital expenditures for 2007 to be approximately $300 million to $350 million.

(4)          Amounts shown consistprimarily of minimum pension contribution obligations, severance costs andother rationalization expenditures and environmental liabilities which havebeen recorded in our December 31, 2006 balance sheet. The table does notinclude our deferred income tax liability and accruals for self-insured lossesbecause it is not certain when these liabilities will become due. Wecontributed $147 million to our pension plans and $11 million to otherpostretirement plans in 2006 and expect to contribute approximately $140million and $18 million, respectively, to such plans in 2007. Futurecontributions to our pension and other postretirement plans will be dependentupon pending legislation, future changes in discount rates and the earningsperformance of our plan assets.

 

Scheduled debt payments,including capital lease payments, for 2007 and 2008 are $84 million and $8million, respectively. We expect further improvement in our cash flow fromoperations in 2007. We expect that our cash flow from operations and our unusedborrowing capacity under SSCE’s revolving credit facilities, in combination,will be sufficient for the next several years to meet our obligations andcommitments, including debt service, pension funding, settlement of pendinglitigation, costs related to the strategic initiative plan, preferred stockdividends, expenditures related to environmental compliance and other capitalexpenditures.

 

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**ContingentObligations**

We issue standby lettersof credit primarily for performance bonds and for self-insurance. Letters ofcredit are issued under SSCE’s revolving credit facilities, generally have aone-year maturity and are renewed annually. As of December 31, 2006, SSCE had$125 million of letters of credit outstanding.

 

We have certain woodchipprocessing contracts, which provide for guarantees of third party contractors’debt outstanding, with a security interest in the chipping equipment. Guaranteepayments would be triggered in the event of a loan default by any of thecontractors. The maximum potential amount of future payments related to all ofsuch arrangements as of December 31, 2006 was $34 million. Cash proceedsreceived from liquidation of the chipping equipment would be based on marketconditions at the time of sale, and we may not recover in full the guaranteepayments made.

 

In 2006, we entered intoan agreement to guarantee a portion of a third party’s debt in decreasingamounts through January 2010. The guarantee was entered into in connection withthe third party’s progress payment financing for the purchase and installationof machinery and equipment for the manufacture of corrugated containerboard. Weand the third party are parties to a supply agreement through 2021, whereby wesell containerboard to the third party, and a purchase agreement through 2014,whereby the third party sells corrugated sheets to us. At December 31, 2006,the maximum potential amount of the future payments related to this guaranteewas approximately $12 million, and decreases as the third party’s contractualfinancial targets are met. We have no recourse to the assets of the thirdparty, other than that of a general unsecured creditor. The fair value of thisguarantee at December 31, 2006 was an immaterial amount and is included inother assets, with an offset in other long-term liabilities in the accompanyingconsolidated balance sheet.

 

**Pension Obligations**

Asof December 31, 2006, our pension benefit obligations exceeded the fair valueof pension plan assets by $633 million, down from $891 million at the end of2005. At December 31, 2006, we adopted SFAS No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans.”  This standard requires the funded status ofour defined benefit pension plans and postretirement plans, measured as thedifference between plan assets at fair value and the benefit obligations, berecorded as an asset or liability with the after-tax impact recorded to othercomprehensive income (OCI) in the December 31, 2006 balance sheet, based on anactuarial valuation as of that date. Upon adoption of SFAS No. 158, we recordedan increase to the minimum pension liability of $181 million and a decrease toother comprehensive income of $115 million, which is net of an income taxbenefit of $66 million. Subsequent changes in the funded status of the planswill be recognized in OCI in the year in which the changes occur. See theinformation set forth in Note 15 of the Notes to Consolidated FinancialStatements.

 

#### **Exit Liabilities**

We recorded restructuringcharges of $43 million in 2006, including $42 million for exit liabilities,which were principally for severance and benefit cost and facility closure cost.In 2006, we incurred cash expenditures of $20 million for these exit liabilities.

 

We had $55 million ofexit liabilities as of December 31, 2005, related to the restructuring of ouroperations. During 2006, we incurred cash expenditures of $26 million for theseexit liabilities and reduced environmental exit liabilities by $4 million. Theexit liabilities remaining as of December 31, 2006, including the 2006restructuring activities, totaled $47 million. Future cash outlays, principallyfor severance and benefits cost and long-term lease commitments and facilityclosure cost, are expected to be $36 million in 2007, $5 million in 2008 and $6million thereafter. We intend to continue funding exit liabilities throughoperations as originally planned.

 

**EnvironmentalMatters**

As discussed in Part IItem 1, “Business, Environmental Compliance,” based on currently availableinformation, we estimate that the aggregate compliance cost of Phase II of MACTI will be approximately $80 million. We spent $65 million through December 31,2006 and anticipate spending the balance in the first quarter of 2007 forprojects related to Phase II of MACT I. Based on currently availableinformation, we estimate that the aggregate compliance cost for Boiler MACTwill be approximately $100 million. We spent $50 million through December 31,2006 and anticipate spending the remainder by the compliance deadline, forprojects related to Boiler MACT. In addition to Cluster Rule and Boiler MACTcompliance, we anticipate additional capital expenditures related toenvironmental compliance. Excluding the spending on the Cluster Rule and BoilerMACT projects, we have spent an average of approximately $12 

 

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million in each of thelast three years on capital expenditures for environmental purposes. Weanticipate that environmental capital expenditures, exclusive of the ClusterRule and Boiler MACT projects, will be approximately $4 million in 2007.

 

#### **OFF-BALANCE SHEET ARRANGEMENTS**

####  

At December 31, 2006, wehad three off-balance sheet financing arrangements.

 

SSCE has a $475 millionaccounts receivable securitization program whereby it sells, without recourse,on an ongoing basis, certain of its accounts receivable to SRC. SRC is awholly-owned non-consolidated subsidiary of SSCE and a qualifiedspecial-purpose entity under the provisions of SFAS No. 140, “Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities.”  Accordingly, accounts receivable sold to SRCfor which we do not retain an interest are not included in our consolidated balancesheets. SRC transfers the receivables to a non-consolidated subsidiary, alimited liability company, which has issued notes to third-party investors. AtDecember 31, 2006, $522 million of accounts receivable had been sold under theprogram, of which $164 million was retained by SSCE as a subordinated interestand recorded in retained interest in receivables sold in the accompanyingconsolidated balance sheet. The investors and the limited liability companyhave no recourse to SSCE for failure of debtors to pay when due.

 

SSCE, throughSmurfit-MBI, has an accounts receivable securitization program whereby itsells, without recourse, on an ongoing basis, certain of its Canadian accountsreceivable to a trust in which SSCE holds a variable interest, but is not theprimary beneficiary. Accordingly, under Financial Accounting Standards Board(FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities,”accounts receivable sold to the trust, for which SSCE is not the primarybeneficiary, are not included in the accompanying consolidated balance sheet. AtDecember 31, 2006, $68 million of accounts receivable had been sold under theprogram, of which $15 million was retained by SSCE as a subordinated interestand recorded in retained interest in receivables sold in the accompanyingconsolidated balance sheet. The investors and the securitization trust have norecourse to SSCE for failure of debtors to pay when due.

 

We sold 980,000 acres ofowned and leased timberland in October 1999. The final purchase price, afteradjustments, was $710 million. We received $225 million in cash and $485million in the form of installment notes, which mature from December 31, 2007to December 31, 2014. Under our program to monetize the installment notesreceivable, the notes were sold, without recourse, to Timber Note Holdings LLC(TNH), a qualified special purpose entity under the provisions of SFAS No. 140,for $430 million in cash proceeds and a residual interest in the notes. Theresidual interest included in other assets in the accompanying consolidatedbalance sheet was $48 million at December 31, 2006. TNH and its creditors haveno recourse to us in the event of a default on the installment notes.

 

###### **EFFECTS OF INFLATION**

 

Increases in costs forenergy, fiber, freight, chemicals and employee benefits have had an adverseimpact on our operating results during the past three years. Energy, fiber andfreight cost increases are strongly influenced by supply and demand factorssuch as from hurricanes or other natural disasters in certain regions of theUnited States, and when supplies become tight, we have experienced increases inthe cost of these items. We continue to seek ways to mitigate the impact ofsuch cost increases and, to the extent permitted by competition, pass theincreased cost on to customers by increasing sales prices over time.

 

We used the last-in,first-out method of accounting for approximately 44% of our inventories atDecember 31, 2006. Under this method, the cost of goods sold reported in thefinancial statements approximates current cost and thus provides a closermatching of revenue and expenses in periods of increasing costs.

 

Replacement of assetsacquired in prior years will be at higher costs, but this will take place overmany years. New assets will result in higher depreciation charges; but, in manycases, due to technological improvements, there may be operating cost savingsas well.

 

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###### **CRITICAL ACCOUNTING POLICIES AND USE OFESTIMATES**

 

Our consolidatedfinancial statements have been prepared in accordance with U.S. generallyaccepted accounting principles (GAAP). The preparation of financial statementsin accordance with U.S. GAAP requires our management to make estimates andassumptions that affect the amounts reported in the consolidated financialstatements and accompanying notes. Our estimates and assumptions are based onhistorical experiences and changes in the business environment. However, actualresults may differ from these estimates. Critical accounting policies andestimates are defined as those that are both most important to the portrayal ofour financial condition and results and require management’s most subjectivejudgments. Our most critical accounting policies and use of estimates aredescribed below.

 

# **Long-Lived Assets Including Goodwill**

We conduct impairment reviews of long-lived assetsincluding goodwill in accordance with SFAS No. 144 and  SFAS No. 142, “Goodwill and Other Intangible Assets. Suchreviews require us to make estimates of future cash flows and fair values. Ourcash flow projections include significant assumptions about economicconditions, demand and pricing for our products and cost as well as, for 2006,estimates of the achievement of the strategic initiatives as described in Item7, “Management’s Discussion and Analysis of Financial Condition and Results ofOperations, Strategic Initiatives.”  Ourestimates of fair value are determined using a variety of valuation techniques,including pricing of recent industry acquisitions. While significant judgmentis required, we believe that our estimates of future cash flows and fair valueare reasonable. However, should our assumptions change in future years, ourfair value models could result in lower fair values for long-lived assets andgoodwill, which could materially affect the value of property, plant andequipment and goodwill and results of operations.

 

## **Restructurings and IdlePaper Machine**

In recent years, we haveclosed a number of operating facilities and exited non-core businesses. Identifyingand calculating the cost to exit these businesses requires certain assumptionsto be made, the most significant of which are anticipated future liabilities,including leases and other contractual obligations, and the net realizablevalue of assets held for sale. We believe our estimates are reasonable,considering our knowledge of the paper industry, previous experience in exitingactivities and valuations received from independent third parties in thecalculation of such estimates. Although our estimates have been reasonablyaccurate in the past, significant judgment is required, and these estimates andassumptions may change as additional information becomes available and facts orcircumstances change.

 

We have temporarily shutdown one of our paper machines in Jacksonville, Florida. Our decision to shutdown this machine was based upon anticipated supply and demand factors, itslocations and operating cost. The Jacksonville machine, which was idled in thefourth quarter of 2003, has the annual capacity to produce 174,000 tons ofmedium. No decision has been made to permanently shut down this machine, as itmay be restarted, subject to future demand and industry conditions. As ofDecember 31, 2006, the Jacksonville paper machine had a net book value ofapproximately $17 million. For accounting purposes, this machine isclassified as held and used and continues to be depreciated.

 

Our strategic initiativeplan may include future closures of converting facilities or shutdowns oflong-lived assets. Once we commit to a plan to abandon a long-lived assetbefore the end of its previously estimated useful life, depreciation estimatesare revised to reflect the use of the asset over its shortened useful life.

 

## **Allowance for DoubtfulAccounts**

Weevaluate the collectibility of accounts receivable on a case-by-case basis andmake adjustments to the bad debt reserve for expected losses. We also estimatereserves for bad debts based on historical experience and past due status ofthe accounts. We perform credit evaluations and adjust credit limits based uponeach customer’s payment history and credit worthiness. While credit losses havehistorically been within our expectations and the provisions established,actual bad debt write-offs may differ from our estimates, resulting in higheror lower charges in the future for our allowance for doubtful accounts.

 

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## **Pension andPostretirement Benefits**

We have significantlong-term liabilities related to our defined benefit pension and postretirementbenefit plans.

 

The determination ofpension obligations and expense is dependent upon our selection of certainassumptions, the most significant of which are the expected long-term rate ofreturn on plan assets and the discount rates applied to plan liabilities. Consultingactuaries assist us in determining these assumptions, which are described inNote 15 of the Notes to Consolidated Financial Statements. In 2006, we adjustedthe expected long-term rate of return on our U.S. plan assets to 8.75% from9.00%, which increased retirement plan expense approximately $5 million for2006. Effective for 2007, the expected long-term rate of return on U.S. planassets was reduced from 8.75% in 2006 to 8.5% and the expected long-term rateof return on certain foreign plan assets was reduced from 8.00% in 2006 to7.75%. The discount rates used to determine the benefit obligations for theU.S. and foreign retirement plans at December 31, 2006 were 5.84% and 5.0%, respectively.The assumed rate for the long-term return on plan assets was determined basedupon target asset allocations and expected long-term rates of return by assetclass. Our assumed discount rate was developed using a portfolio of Moody’sAa-rated fixed income securities that approximate the duration of our pensionliabilities. A decrease in the assumed rate of return of 0.50% would increasepension expense by approximately $14 million. A decrease in the discount rateof 0.50% would increase our pension expense by approximately $22 million andour pension obligations by approximately $207 million.

 

Related to ourpostretirement benefit plans, we make assumptions for future trends for medicalcare costs. The effect of a 1% change in the assumed health care cost trendrate would increase our accumulated postretirement benefit obligation as ofDecember 31, 2006 by $18 million and would increase the annual net periodicpostretirement benefits cost by $2 million for 2006.

 

## **Income Taxes**

Deferred tax assets andliabilities reflect our assessment of future taxes to be paid in thejurisdictions in which we operate. These assessments involve temporarydifferences resulting from differing treatment of items for tax and accountingpurposes, as well as estimates of our current tax exposures. Based on ourevaluation of our tax positions, we believe we were adequately reserved forthese matters at December 31, 2006.

 

At December 31, 2006, wehad deferred tax assets related to net operating loss, alternative minimum tax andother tax credit carryforwards in the amount of $583 million. A valuationallowance of $36 million has been established for a portion of thesedeferred tax assets based on projected future taxable income, the expectedtiming of deferred tax liability reversals and the expiration dates of thesecarryforwards. See Note 14 of the Notes to Consolidated Financial Statements. Weexpect our deferred tax assets, net of the valuation allowance, will be fullyrealized through the reversal of net taxable temporary differences at December31, 2006, in combination with expected improvement in our operating results. Substantiallyall of our valuation allowance was recorded in connection with a prior purchasebusiness combination and a reduction in the valuation allowance would resultprincipally in a corresponding reduction to goodwill. Should additionalvaluation allowances be necessary because of changes in economic circumstances,those allowances would be established through a charge to income tax expense.

 

The sale of the ConsumerPackaging division generated a taxable gain for U.S. income tax purposes thatwill be offset by available net operating loss (NOL) carryforwards, a portionof which were subject to valuation allowances previously established in a priorpurchase business combination. Due to the utilization of these NOLcarryforwards, the related valuation allowance was reduced by $157 million inthe second quarter of 2006 with a corresponding reduction to goodwill thatresulted from a prior purchase business combination.

 

In October 2004, theAmerican Jobs Creation Act (the AJCA) was signed into law. The AJCA includes atemporary incentive for U.S. multinationals to repatriate foreign earnings byproviding an elective 85% dividends received deduction for certain cashdividends from controlled foreign corporations. Under this law, in December2005, we repatriated dividends of $483 million from earnings of foreignsubsidiaries previously considered indefinitely reinvested. The income taxexpense associated with the repatriation was $34 million. Excluding therepatriation discussed above, through December 31, 2006, no provision 

 

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has been made for incometaxes on the remaining undistributed earnings of our foreign subsidiaries, aswe intend to indefinitely reinvest such earnings in our foreign subsidiaries.

 

We frequently facechallenges from domestic and foreign tax authorities regarding the amount oftaxes due. These challenges include questions regarding the timing and amountof income and deductions and the allocation of income among various taxjurisdictions. In 2005, we settled the Internal Revenue Service’s examinationof tax years through 2003. Due principally to this settlement, we recorded atax benefit of $44 million in the fourth quarter of 2005. The Canadian RevenueAgency is currently examining the years 1999 through 2005 of our Canadiansubsidiaries. While the ultimate results cannot be predicted with certainty, webelieve that the examinations will not have a material adverse effect on ourconsolidated financial condition or results of operations, and that the accruedtax liabilities are adequate for all years.

 

## **Legal and EnvironmentalContingencies**

Accruals for legal andenvironmental matters are recorded when it is probable that a liability hasbeen incurred and the amount of loss can be reasonably estimated. Suchliabilities are developed based on currently available information and requirejudgments as to probable outcomes. Assumptions are based on historicalexperience and recommendations of legal counsel. Environmental estimatesinclude assumptions and judgments about particular sites, remediationalternatives and environmental regulations. We believe our accruals areadequate. However, due to uncertainties associated with these assumptions andjudgments, as well as potential changes to governmental regulations andenvironmental technologies, actual costs could differ materially from theestimated amounts.

 

### **Self-Insurance**

We self-insure a majorityof our workers’ compensation and general liability costs subject to specificretention levels for certain policies and coverage. Losses above theseretention levels are transferred to insurance companies. In addition, weself-insure the majority of our group health care costs. All of the healthcare, workers’ compensation and general liability claims are handled bythird-party administrators. Consulting actuaries and administrators assist usin determining our liability for self-insured claims. Losses are accrued basedupon the aggregate self-insured claims determined by the third-partyadministrators, actuarial assumptions and our historical experience. While webelieve that our assumptions are appropriate, significant differences in ouractual experience or significant changes in our assumptions may materiallyaffect our workers’ compensation, general liability and group health carecosts.

 

**PROSPECTIVE ACCOUNTING STANDARDS**

 

In September 2006, theFASB issued FASB Staff Position (“FSP”) No. AUG AIR-1 “Accounting for PlannedMajor Maintenance Activities,” effective for fiscal years beginning afterDecember 15, 2006. We plan to adopt this standard effective January 1, 2007. ThisFSP prohibits the use of the accrue-in-advance method of accounting for plannedmajor maintenance activities in annual and interim financial reporting periods.The FSP requires retrospective application to all financial statementspresented. The new standard will not impact our annual 2006 financialstatements; however the after-tax impact on the 2006 interim income fromcontinuing operations and net income (loss) available to common stockholderswill be income (expense) of $(1) million, an immaterial amount, $6 million and$(5) million in the first, second, third and fourth quarters, respectively. Therelated impact on earnings per share is an immaterial amount for the first andsecond quarters and $.02 and $(.02) for the third and fourth quarters,respectively.

 

In June 2006, the FASBissued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,”(FIN No. 48), an interpretation of SFAS No. 109, “Accounting for Income Taxes,”to create a single model to address accounting for uncertainty in tax positions.FIN No. 48 clarifies the accounting for income taxes by prescribing a minimumrecognition threshold a tax position is required to meet before beingrecognized in the financial statements. FIN No. 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN No. 48 is effective forfiscal years beginning after December 15, 2006. We plan to adopt FIN No. 48 asof January 1, 2007, and the cumulative effect of the new standard will berecorded as an adjustment to retained earnings. The impact of the adoption ofFIN No. 48 is not expected to have a material impact on our financial position.

 

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**ITEM 7A.               QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

###### **Weare exposed to various market risks, including commodity price risk, foreigncurrency risk and interest rate risk. To manage the volatility related to theserisks, we enter into various derivative contracts. The majority of thesecontracts 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 use derivatives for speculative or tradingpurposes.**

###### ** **

**Commodity Price Risk**

We use financialderivative instruments, including fixed price swaps and options, to managefluctuations in cash flows resulting from commodity price risk in theprocurement of natural gas and other commodities including fuel and heating oil.Our objective is to fix the price of a portion of the purchases of thesecommodities used in the manufacturing process. The changes in the market valueof such derivative instruments have historically been, and are expected tocontinue to be, highly effective at offsetting changes in price of the hedgeditem. As of December 31, 2006, the maximum length of time over which we arehedging our exposure to the variability in future cash flows associated withnatural gas forecasted transactions is two years. As of December 31, 2006, wehad monthly derivative instruments to hedge approximately 60% of our expectednatural gas requirements in the first quarter of 2007 and approximately 30% to45% the remainder of 2007. Excluding the impact of derivative instruments, thepotential change in our expected 2007 and 2006 natural gas cost, based upon ourexpected annual usage and unit cost, resulting from a hypothetical 10% adverseprice change, would be approximately $13 million and $23 million, respectively.The changes in energy cost discussed in Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” include the impactof the natural gas derivative instruments. See Note 10 of the Notes toConsolidated Financial Statements.

 

**Foreign Currency Risk**

Our principal foreignexchange exposure is the Canadian dollar. Assets and liabilities outside theUnited States are primarily located in Canada. The functional currency for ourCanadian operations is the U.S. dollar. Our investments in foreign subsidiarieswith a functional currency other than the U.S. dollar are not hedged.

 

We use financialderivative instruments, including forward contracts and options, primarily toprotect against Canadian currency exchange risk associated with expected futurecash flows. These instruments typically have maturities of twelve months orless. As of December 31, 2006, we had monthly Canadian dollar forward purchasecontracts to hedge approximately 75% of our estimated requirements for 2007.

 

Weperformed a sensitivity analysis as of December 31, 2006 and 2005 that measuresthe change in the book value of our netmonetary Canadian liability****arisingfrom a hypothetical 10% adverse movement in the exchange rate of the Canadiandollar relative to the U.S. dollar with all other variables held constant. Thepotential change in fair value resulting from a hypothetical 10% adverse changein the Canadian dollar exchange rate at December 31, 2006 and 2005, would be$29 million and $32 million, respectively. Fluctuations in Canadian dollarmonetary assets and liabilities result in gains or losses, which are creditedor charged to income.

 

In2006, 2005 and 2004, the average exchange rates for the Canadian dollarstrengthened against the U.S. dollar by 6.4%, 6.9% and 7.1%, respectively.

 

**Interest Rate Risk**

Ourearnings and cash flow are significantly affected by the amount of interest onour indebtedness. Our financing arrangements include both fixed and variablerate debt in which changes in interest rates will impact the fixed and variablerate debt differently. A change in the interest rate of fixed rate debt willimpact the fair value of the debt, whereas a change in the interest rate on thevariable rate debt will impact interest expense and cash flows. Our objectiveis to mitigate interest rate volatility and reduce or cap interest expensewithin acceptable levels of market risk. We periodically enter into interestrate swaps, caps or options to hedge interest rate exposure and manage riskwithin Company policy. Any derivative would be specific to the debt instrument,contract or transaction, which would determine the specifics of the hedge.

 

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In 2004, we entered intointerest rate swap contracts effectively fixing the interest rate at 4.3% for$300 million of the Tranche B and Tranche C variable rate term loans. Changesin the fair value of the interest rate swap contracts are expected to be highlyeffective in offsetting the fluctuations in the variable interest rate, and arerecorded in other comprehensive income until the underlying transaction isrecorded. The accounting for the cash flow impact of the swap contracts isrecorded as an adjustment to interest expense each period. The fair value ofour interest rate swap contracts at December 31, 2006 was a $9 million asset,included in other assets. These contracts extend until 2011, consistent withthe maturity on our Tranche B and Tranche C term loans.

 

Weperformed a sensitivity analysis as of December 31, 2006 and 2005 that measuresthe change in interest expense on our variable rate debt arising from ahypothetical 100 basis point adverse movement in interest rates. Based on ouroutstanding variable rate debt as of December 31, 2006 and 2005, a hypothetical100 basis point adverse change in interest rates would increase interestexpense by approximately $8 million and $13 million, respectively.

 

Thetable below presents principal amounts by year of anticipated maturity for ourdebt obligations and related average interest rates based on the weightedaverage interest rates at the end of the period. Variable interest ratesdisclosed do not attempt to project future interest rates and do not reflectthe impact of our interest rate swap contracts. This information should be readin conjunction with Note 9 of the Notes to Consolidated Financial Statements.

 

###### **Short and Long-Term Debt**

 

**Outstanding as of December 31, 2006**

 
| **(U.S.$ , in millions)**                                         | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **There-  after** | ** ** | **Total** | ** ** | **Fair  Value** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|-------------------|------------|-----------|------------|-----------------|------------|
| Bank term loans  and revolver  7.8% average interest  rate  (variable) |       | $        | 4          |     | $          | 4        |       | $        | 140        |     | $          | 4                 |       | $         | 858        |            |       |   | $ | 1,010 |   | $ | 1,015 |   |
| U.S. senior  notes 8.5% average interest rate (fixed)                            |       |     |       | 2        |       |     |       |     |       | 648      |       | 1,600             |       | 2,250     |       | 2,213           |       |
| U.S. industrial  revenue bonds  6.5% average interest  rate (fixed)         |       | 5        |       |     |       | 4        |       |     |       |     |       | 164               |       | 173       |       | 173             |       |
| U.S. industrial  revenue bonds  6.7% average interest  rate (variable)      |       |     |       |     |       |     |       | 120      |       |     |       |              |       | 120       |       | 120             |       |
| Other U.S.                                                                       |       | 75       |       | 2        |       | 1        |       | 1        |       | 1        |       | 1                 |       | 81        |       | 81              |       |
| Total debt                                                                       |       | $        | 84         |     | $          | 8        |       | $        | 145        |     | $          | 125               |       | $         | 1,507      |            | $          | 1,765 |   | $ | 3,364 |   | $ | 3,602 |   |
|                                                                                  |            |          |            |          |            |          |            |          |            |          |            |                   |            |           |            |                 |            |  |  |  |  |  |  |  |  |

 

**ITEM 8. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

Index to FinancialStatements:

 
| Management’s Report on  Internal Control Over Financial Reporting |   |   |
|------------------------------------------------------------------------|--------|--------|
| Reports of Independent  Registered Public Accounting Firm              |   |   |
| Consolidated Balance Sheets -  December 31, 2006 and 2005              |   |   |
| For the years ended  December 31, 2006, 2005 and 2004:                 |   |   |
| Consolidated Statements of  Operations                                 |   |   |
| Consolidated Statements of  Stockholders’ Equity                  |   |   |
| Consolidated Statements of  Cash Flows                                 |   |   |
| Notes to  Consolidated Financial Statements                            |   |   |

 

The followingconsolidated financial statement schedule is included in Item 15(a):

 
| II:  Valuation and Qualifying Accounts and  Reserves |   |   |
|-----------------------------------------------------------|--------|--------|

 

Allother schedules specified under Regulation S-X have been omitted because theyare not applicable, because they are not required or because the informationrequired is included in the financial statements or notes thereto.

 

33

----

 

**Management’s Report on Internal Control OverFinancial Reporting**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting for Smurfit-Stone Container Corporation, assuch term is defined in Rule 13a-15(f) under the Exchange Act. As required byRule 13a-15(c) under the Exchange Act, we carried out an evaluation, with theparticipation of our principal executive officer and principal financial officer,of the effectiveness of our internal control over financial reporting as of theend of the latest fiscal year. The framework on which such evaluation was basedis contained in the report entitled “InternalControl - Integrated Framework”**issuedby the Committee of Sponsoring Organizations of the Treadway Commission. Thisevaluation included review of the documentation of controls, evaluation of thedesign effectiveness of controls, testing of the operating effectiveness ofcontrols and a conclusion on this evaluation. Although there are inherentlimitations in the effectiveness of any system of internal control overfinancial reporting, based on our evaluation, we have concluded that ourinternal control over financial reporting was effective as of December 31,2006.

 

Ernst & Young LLP,our independent registered public accounting firm, has issued an attestationreport on management’s assessment of internal control over financial reportingfor Smurfit-Stone Container Corporation as of December 31, 2006, which isincluded herein.

 

 
| /s/  Patrick  J. Moore                        |   |
|----------------------------------------------------|--------|
| Patrick J. Moore                                   |
| Chairman and Chief  Executive Officer              |
| (Principal Executive  Officer)                     |
|                                               |
|                                               |
| /s/  Charles  A. Hinrichs                     |   |
| Charles A. Hinrichs                                |
| Senior Vice President  and Chief Financial Officer |
| (Principal Financial  Officer)                     |
|                                               |
|                                               |
| /s/  Paul K.  Kaufmann                        |   |
| Paul K. Kaufmann                                   |
| Senior Vice President  and Corporate Controller    |
| (Principal Accounting  Officer)                    |

 

34

----

 

REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM

 

Boardof Directors

Smurfit-StoneContainer Corporation

 

We have auditedmanagement’s assessment, included in the accompanying Management’s Report onInternal Control over Financial Reporting, that Smurfit-Stone ContainerCorporation (the Company) maintained effective internal control over financialreporting as of December 31, 2006, based on criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). Smurfit-StoneContainer Corporation’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generally acceptedaccounting principles and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use or disposition of the company’sassets that could have a material effect on the financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions or that the degree of compliance with thepolicies or procedures may deteriorate.

 

In our opinion,management’s assessment that Smurfit-Stone Container Corporation maintainedeffective internal control over financial reporting as of December 31, 2006, isfairly stated, in all material respects, based on the COSO criteria. Also, inour opinion, Smurfit-Stone Container Corporation maintained, in all materialrespects, effective internal control over financial reporting as of December31, 2006, based on the COSO criteria.

 

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets as of December 31, 2006 and2005, and the related consolidated statements of operations, stockholders’equity and cash flows for each of the three years in the period ended December31, 2006, of Smurfit-Stone Container Corporation, and our report dated February27, 2007, expressed an unqualified opinion thereon.

 
|                | /s/  Ernst  & Young LLP |
|---------------------|----------------------------------|
|                | Ernst & Young LLP            |
|                |                             |
| St. Louis, Missouri |
| February 27, 2007   |

 

35

----

 

REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors

Smurfit-Stone ContainerCorporation

 

We have audited theaccompanying consolidated balance sheets of Smurfit-Stone Container Corporation(the Company) as of December 31, 2006 and 2005, and the related consolidatedstatements of operations, stockholders’ equity and cash flows for each of thethree years in the period ended December 31, 2006. Our audits also included thefinancial statement schedule listed in the Index at Item 15(a). These financialstatements and schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andschedule based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Smurfit-Stone ContainerCorporation at December 31, 2006 and 2005, and the consolidated results of itsoperations and its cash flows for each of the three years in the period endedDecember 31, 2006, in conformity with U.S. generally accepted accountingprinciples. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 

As discussed in Note 1 tothe financial statements, in 2006 the Company changed its method of accountingfor purchases and sales of inventory with the same counterparty, share-basedpayments and its method of accounting for defined benefit pension and otherpostretirement plans.

 

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Smurfit-Stone Container Corporation’sinternal control over financial reporting as of December 31, 2006, based on thecriteria established in Internal Control – Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated February 27, 2007, expressed an unqualified opinion thereon.

 

 
|                | /s/  Ernst  & Young LLP |
|---------------------|----------------------------------|
|                | Ernst & Young LLP            |
|                |                             |
| St. Louis, Missouri |
| February 27, 2007   |

 

36

----

 

**SMURFIT-STONECONTAINER CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

 
| **December 31, (In millions, except share data)**                                                                            | ** ** | **2006**   | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|
| **Assets**                                                                                                                                                 |       |       |       |     |       |
|                                                                                                                                                       |       |       |       |     |       |
| Current assets                                                                                                                                             |       |       |       |     |       |
| Cash and cash  equivalents                                                                                                                                 | ** ** | **$**      | **9**      |     | $          | 5 |   |
| Receivables,  less allowances of $7 in 2006 and $10 in 2005                                                                                                | ** ** | **166**    |       | 224      |       |
| Retained  interest in receivables sold                                                                                                                     | ** ** | **179**    |       | 139      |       |
| Inventories                                                                                                                                                |       |       |       |     |       |
| Work-in-process  and finished goods                                                                                                                        | ** ** | **155**    |       | 234      |       |
| Materials and  supplies                                                                                                                                    | ** ** | **383**    |       | 500      |       |
| ** **                                                                                                                                                 |       | **538**    |       | 734      |       |
| Prepaid expenses  and other current assets                                                                                                                 | ** ** | **34**     |       | 82       |       |
| Total current  assets                                                                                                                                      | ** ** | **926**    |       | 1,184    |       |
| Net property,  plant and equipment                                                                                                                         | ** ** | **3,731**  |       | 4,245    |       |
| Timberland, less  timber depletion                                                                                                                         | ** ** | **43**     |       | 44       |       |
| Goodwill                                                                                                                                                   | ** ** | **2,873**  |       | 3,309    |       |
| Other assets                                                                                                                                               | ** ** | **204**    |       | 332      |       |
| ** **                                                                                                                                                 |       | **$**      | **7,777**  |     | $          | 9,114 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                             |       |       |       |     |       |
|                                                                                                                                                       |       |       |       |     |       |
| Current  liabilities                                                                                                                                       |       |       |       |     |       |
| Current  maturities of long-term debt                                                                                                                      | ** ** | **$**      | **84**     |     | $          | 35 |   |
| Accounts payable                                                                                                                                           | ** ** | **542**    |       | 654      |       |
| Accrued  compensation and payroll taxes                                                                                                                    | ** ** | **211**    |       | 186      |       |
| Interest payable                                                                                                                                           | ** ** | **79**     |       | 97       |       |
| Income taxes  payable                                                                                                                                      | ** ** | **2**      |       | 17       |       |
| Current deferred  taxes                                                                                                                                    | ** ** | **2**      |       | 15       |       |
| Other current  liabilities                                                                                                                                 | ** ** | **147**    |       | 184      |       |
| Total current  liabilities                                                                                                                                 | ** ** | **1,067**  |       | 1,188    |       |
| Long-term debt,  less current maturities                                                                                                                   | ** ** | **3,550**  |       | 4,536    |       |
| Other long-term  liabilities                                                                                                                               | ** ** | **1,010**  |       | 1,123    |       |
| Deferred income  taxes                                                                                                                                     | ** ** | **343**    |       | 385      |       |
| Stockholders’  equity                                                                                                                                 |       |       |       |     |       |
| Preferred stock,  aggregate liquidation preference of $116; 25,000,000 shares authorized;  4,599,300 issued and outstanding                                | ** ** | **93**     |       | 89       |       |
| Common stock,  par value $.01 per share; 400,000,000 shares authorized, 255,300,904 and  254,652,321 issued and outstanding in 2006 and 2005, respectively | ** ** | **3**      |       | 3        |       |
| Additional  paid-in capital                                                                                                                                | ** ** | **4,040**  |       | 4,009    |       |
| Retained  earnings (deficit)                                                                                                                               | ** ** | **(1,917** | )          | (1,846   | )          |
| Accumulated  other comprehensive income (loss)                                                                                                             | ** ** | **(412**   | )          | (373     | )          |
| Total  stockholders’ equity                                                                                                                           | ** ** | **1,807**  |       | 1,882    |       |
| ** **                                                                                                                                                 |       | **$**      | **7,777**  |     | $          | 9,114 |   |

 

See notes to consolidated financial statements.

 

37

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**SMURFIT-STONECONTAINER CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| **Year Ended December 31, (In millions, except per share data)**   | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Net sales                                                                                                       | ** ** | **$**      | **7,157**  |     | $          | 6,812    |       | $ | 6,716 |   |
| Costs and  expenses                                                                                             | ** ** | ** ** |       |     |       |     |       |
| Cost of goods  sold                                                                                             | ** ** | **6,185**  |       | 6,054    |       | 5,807    |       |
| Selling and  administrative expenses                                                                            | ** ** | **677**    |       | 689      |       | 655      |       |
| Restructuring  charges                                                                                          | ** ** | **43**     |       | 321      |       | 16       |       |
| Asset impairment  charge                                                                                        |       |       |       |     |       | 73       |       |
| (Gain) loss on  sale of assets                                                                                  | ** ** | **(24**    | )          | 1        |       | (7       | )          |
| Operating income  (loss)                                                                                        | ** ** | **276**    |       | (253     | )          | 172      |       |
| Other income  (expense)                                                                                         | ** ** | ** ** |       |     |       |     |       |
| Interest expense,  net                                                                                          | ** ** | **(341**   | )          | (345     | )          | (342     | )          |
| Loss on early  extinguishment of debt                                                                           | ** ** | **(28**    | )          |     |       | (11      | )          |
| Other, net                                                                                                      | ** ** | **(17**    | )          | (21      | )          | (18      | )          |
| Loss from  continuing operations before income taxes                                                            | ** ** | **(110**   | )          | (619     | )          | (199     | )          |
| Benefit from  income taxes                                                                                      | ** ** | **40**     |       | 241      |       | 99       |       |
| Loss from  continuing operations                                                                                | ** ** | **(70**    | )          | (378     | )          | (100     | )          |
| Discontinued  operations                                                                                        |       |       |       |     |       |     |       |
| Income from  discontinued operations, net of income tax provisions of $9 in 2006, $34 in  2005, and $36 in 2004 | ** ** | **14**     |       | 51       |       | 54       |       |
| Loss on  disposition of discontinued operations, net of income tax provision of $174                            | ** ** | **(3**     | )          |     |       |     |       |
| Net loss                                                                                                        | ** ** | **(59**    | )          | (327     | )          | (46      | )          |
| Preferred stock  dividends and accretion                                                                        | ** ** | **(12**    | )          | (12      | )          | (11      | )          |
| Net loss  available to common stockholders                                                                      | ** ** | **$**      | **(71**    | )        | $          | (339     | )          | $ | (57 | ) |
|                                                                                                            |       |       |       |     |       |     |       |
| **Basic  and diluted earnings per common share**                                                                |       |       |       |     |       |     |       |
| Loss from  continuing operations                                                                                | ** ** | **$**      | **(.32**   | )        | $          | (1.53    | )          | $ | (.44 | ) |
| Discontinued  operations                                                                                        | ** ** | **.05**    |       | .20      |       | .21      |       |
| Loss on  disposition of discontinued operations                                                                 | ** ** | **(.01**   | )          |     |       |     |       |
| Net loss  available to common stockholders                                                                      | ** ** | **$**      | **(.28**   | )        | $          | (1.33    | )          | $ | (.23 | ) |
| Weighted average  shares outstanding                                                                            | ** ** | **255**    |       | 255      |       | 253      |       |

 

See notes to consolidated financial statements.

 

38

----

 

**SMURFIT-STONECONTAINER CORPORATION**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS' EQUITY**

 

**(In millions, except share data)**
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **Preferred Stock** | ** ** | ** ** | ** **    | ** ** | ** ** | **Accumulated** | ** ** | ** **    | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|------------|---------------|------------|------------|-----------------|------------|---------------|------------|
| ** **                                                                  | ** ** | **Number**            | ** ** | **Par**                  | ** ** | **Number** | ** **    | ** ** | ** ** | **Additional**  | ** ** | **Retained**  | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **of**                | ** ** | **Value,**               | ** ** | **of**     | ** **    | ** ** | ** ** | **Paid-In**     | ** ** | **Earnings**  | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Shares**            | ** ** | **$.01**                 | ** ** | **Shares** | ** **    | **Amount** | ** ** | **Capital**     | ** ** | **(Deficit)** | ** ** | **Income (Loss)** | ** ** | **Total** | ** ** |
|                                                                        |       |                  |       |                     |       |       |          |       |       |            |       |          |       |   |   |   |   |
| **Balance  at January 1, 2004**                                             |       | 250,547,712           |       | $                        | 3          |       | 4,599,300     |       | $          | 82              |       | $             | 3,924      |   | $ | (1,450 | ) | $ | (289 | ) | $ | 2,270 |   |
| Comprehensive  income (loss)                                                | ** ** | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                    |       |                  |       |                     |       |       |          |       |       |            |       | (46           | )          |   |   | (46 | ) |
| Other  comprehensive income (loss)                                          |       |                  |       |                     |       |       |          |       |       |            |       |          |       |   |   |   |   |
| Deferred hedge  loss, net of tax benefit of $4                         |       |                  |       |                     |       |       |          |       |       |            |       |          |       | (7 | ) | (7 | ) |
| Foreign currency  translation adjustment, net of tax benefit of $2          |       |                  |       |                     |       |       |          |       |       |            |       |          |       | (4 | ) | (4 | ) |
| Minimum pension  liability adjustment, net of tax benefit of $7             |       |                  |       |                     |       |       |          |       |       |            |       |          |       | (14 | ) | (14 | ) |
| Comprehensive  income (loss)                                                |       |                  |       |                     |       |       |          |       |       |            |       |          |       |   |   | (71 | ) |
| Issuance of  common stock under stock option and restricted stock plans     |       | 3,690,933             |       |                     |       |       |          |       |       | 68              |       |          |       |   |   | 68 |   |
| Preferred stock  dividends and accretion                                    |       |                  |       |                     |       |       |          | 3          |       |            |       | (11           | )          |   |   | (8 | ) |
| **Balance  at December 31, 2004**                                           |       | 254,238,645           |       | 3                        |       | 4,599,300  |          | 85         |       | 3,992           |       | (1,507        | )          | (314 | ) | 2,259 |   |
| Comprehensive  income (loss)                                                | ** ** | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                    |       |                  |       |                     |       |       |          |       |       |            |       | (327          | )          |   |   | (327 | ) |
| Other  comprehensive income (loss)                                          |       |                  |       |                     |       |       |          |       |       |            |       |          |       |   |   |   |   |
| Deferred hedge  gain, net of tax expense of $18                        |       |                  |       |                     |       |       |          |       |       |            |       |          |       | 29 |   | 29 |   |
| Foreign currency  translation adjustment, net of tax benefit of $4          |       |                  |       |                     |       |       |          |       |       |            |       |          |       | (7 | ) | (7 | ) |
| Minimum pension  liability adjustment, net of tax benefit of $44       |       |                  |       |                     |       |       |          |       |       |            |       |          |       | (81 | ) | (81 | ) |
| Comprehensive  income (loss)                                                |       |                  |       |                     |       |       |          |       |       |            |       |          |       |   |   | (386 | ) |
| Issuance of  common stock under stock option and restricted stock plans     |       | 413,676               |       |                     |       |       |          |       |       | 17              |       |          |       |   |   | 17 |   |
| Preferred stock  dividends and accretion                                    |       |                  |       |                     |       |       |          | 4          |       |            |       | (12           | )          |   |   | (8 | ) |
| **Balance  at December 31, 2005**                                           |       | 254,652,321           |       | 3                        |       | 4,599,300  |          | 89         |       | 4,009           |       | (1,846        | )          | (373 | ) | 1,882 |   |
| Comprehensive  income (loss)                                                | ** ** | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                    |       | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | **(59**       | **)**      | ** ** | ** ** | **(59** | **)** |
| Other  comprehensive income (loss)                                          |       | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deferred hedge  loss, net of tax benefit of $20                        |       | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | **(31** | **)** | **(31** | **)** |
| Minimum pension  liability adjustment, net of tax expense of $64            |       | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | **107** | ** ** | **107** | ** ** |
| Comprehensive  income                                                       |       | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** | **17** | ** ** |
| Adjustment to  initially apply SFAS No. 158, net of tax benefit of $66 |       | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | **(115** | **)** | **(115** | **)** |
| Issuance of  common stock under stock option and restricted stock plans     |       | **648,583**           | ** ** | ** **               | ** ** | ** ** | ** **    | ** ** | ** ** | **31**          | ** ** | ** **    | ** ** | ** ** | ** ** | **31** | ** ** |
| Preferred stock  dividends and accretion                                    |       | ** **            | ** ** | ** **               | ** ** | ** ** | ** **    | **4**      | ** ** | ** **      | ** ** | **(12**       | **)**      | ** ** | ** ** | **(8** | **)** |
| **Balance  at December 31, 2006**                                           |       | **255,300,904**       | ** ** | **$**                    | **3**      | ** ** | **4,599,300** | ** ** | **$**      | **93**          | ** ** | **$**         | **4,040**  | ** ** | **$** | **(1,917** | **)** | **$** | **(412** | **)** | **$** | **1,807** | ** ** |

 

See notes to consolidated financial statements.

 

39

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**SMURFIT-STONECONTAINER CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| **Year Ended December 31, (In millions)**                            | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| **Cash  flows from operating activities**                                                     |       |       |       |       |       |     |       |
| Net loss                                                                                      | ** ** | **$**      | **(59**    | **)**      | $          | (327     | )          | $ | (46 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities               |       | ** ** | ** ** |       |       |     |       |
| Gain on  disposition of discontinued operations                                               | ** ** | **(171**   | **)**      |       |       |     |       |
| Loss on early  extinguishment of debt                                                         | ** ** | **28**     | ** ** |       |       | 11       |       |
| Depreciation,  depletion and amortization                                                     | ** ** | **377**    | ** ** | 408        |       | 416      |       |
| Amortization of  deferred debt issuance costs                                                 | ** ** | **9**      | ** ** | 9          |       | 11       |       |
| Deferred income  taxes                                                                        | ** ** | **108**    | ** ** | (233       | )          | (80      | )          |
| Pension and  postretirement benefits                                                          | ** ** | **(14**    | **)**      | (44        | )          | (48      | )          |
| (Gain) loss on  sale of assets                                                                | ** ** | **(24**    | **)**      | 1          |       | (7       | )          |
| Non-cash  impairment and restructuring charges                                                | ** ** | **23**     | ** ** | 271        |       | 80       |       |
| Non-cash  stock-based compensation                                                            | ** ** | **25**     | ** ** | 12         |       | 10       |       |
| Non-cash foreign  currency (gains) losses                                                     | ** ** | **(1**     | **)**      | 9          |       | 22       |       |
| Change in  current assets and liabilities, net of effects from acquisitions and  dispositions |       | ** ** | ** ** |       |       |     |       |
| Receivables                                                                                   | ** ** | **11**     | ** ** | 48         |       | (99      | )          |
| Inventories                                                                                   | ** ** | **46**     | ** ** | 39         |       | (50      | )          |
| Prepaid expenses  and other current assets                                                    | ** ** | **15**     | ** ** | 5          |       | (18      | )          |
| Accounts payable  and accrued liabilities                                                     |       | **(90**    | **)**      | 28         |       | 64       |       |
| Interest payable                                                                              | ** ** | **(17**    | **)**      | 3          |       | (4       | )          |
| Income tax  benefit on exercise of employee stock options                                     |       | ** ** | ** ** |       |       | 8        |       |
| Other, net                                                                                    | ** ** | **(1**     | **)**      | (8         | )          | 3        |       |
| Net cash  provided by operating activities                                                    | ** ** | **265**    | ** ** | 221        |       | 273      |       |
| **Cash  flows from investing activities**                                                     |       | ** ** | ** ** |       |       |     |       |
| Expenditures for  property, plant and equipment                                               | ** ** | **(274**   | **)**      | (276       | )          | (219     | )          |
| Proceeds from  property and sale of businesses                                                | ** ** | **980**    | ** ** | 8          |       | 32       |       |
| Payments on  acquisitions, net of cash received                                               |       | ** ** | ** ** | (9         | )          | (13      | )          |
| Net cash  provided by (used for) investing activities                                         | ** ** | **706**    | ** ** | (277       | )          | (200     | )          |
| **Cash  flows from financing activities**                                                     |       | ** ** | ** ** |       |       |     |       |
| Proceeds from  long-term debt                                                                 |       | ** ** | ** ** | 162        | ** ** | 1,480    |       |
| Net repayments  of debt                                                                       | ** ** | **(937**   | **)**      | (93        | )          | (1,615   | )          |
| Debt repurchase  premiums                                                                     | ** ** | **(24**    | **)**      |       |       |     |       |
| Net repayments  under accounts receivable securitization programs                             |       | ** ** | ** ** |       |       | (177     | )          |
| Net proceeds  from sale of receivables                                                        |       | ** ** | ** ** |       |       | 203      |       |
| Preferred  dividends paid                                                                     | ** ** | **(8**     | **)**      | (8         | )          | (8       | )          |
| Proceeds from  exercise of stock options                                                      | ** ** | **2**      | ** ** | 1          |       | 54       |       |
| Deferred debt  issuance costs                                                                 |       | ** ** | ** ** | (7         | )          | (16      | )          |
| Net cash  provided by (used for) financing activities                                         | ** ** | **(967**   | **)**      | 55         |       | (79      | )          |
|                                                                                          |       | ** ** | ** ** |       |       |     |       |
| **Increase  (decrease) in cash and cash equivalents**                                         | ** ** | **4**      | ** ** | (1         | )          | (6       | )          |
| Cash and cash  equivalents                                                                    |       | ** ** | ** ** |       |       |     |       |
| Beginning of  year                                                                            | ** ** | **5**      | ** ** | 6          |       | 12       |       |
| End of year                                                                                   | ** ** | **$**      | **9**      | ** ** | $          | 5        |       | $ | 6 |   |

 

See notes to consolidated financial statements.

 

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**SMURFIT-STONE CONTAINER CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

(Tabular amounts in millions, except share data)

 

**1.   Significant Accounting Policies**

 

**Basisof Presentation:**  Smurfit-Stone Container Corporation (“SSCC”or the “Company”) is a holding company that owns 100% of the equity interest inSmurfit-Stone Container Enterprises, Inc. (“SSCE”). The Company has nooperations other than its investment in SSCE.

 

Priorto November 1, 2004, SSCC owned 100% of the equity interest in JSCE, Inc. (“JSCE”)and Stone Container Corporation (“Stone”). JSCE owned 100% of the equityinterest in Jefferson Smurfit Corporation (U.S.) (“JSC(U.S.)”) and was theguarantor of the senior unsecured indebtedness of JSC(U.S.). JSCE had nooperations other than its investment in JSC(U.S.). On November 1, 2004, JSCEmerged with and into JSC(U.S.), with JSC(U.S.) as the surviving company, andthen JSC(U.S.) merged with and into Stone, with Stone as the surviving company(the “Merger”), principally to consolidate debt financing activities of theCompany and its subsidiaries. Stone was simultaneously renamed SSCE. Stone andJSC(U.S.) were wholly-owned subsidiaries of SSCC and, therefore, the Merger didnot impact SSCC’s consolidated financial statements. The Merger did not impactthe operating activities of the merged companies which continue to do businessas SSCC.

 

**Natureof Operations:**  The Company’s major operations arecontainerboard, corrugated containers and reclamation. The Company’s paperboardmills procure virgin and reclaimed fiber and produce paperboard for conversioninto corrugated containers at Company-owned facilities and third-partyconverting operations. The Company also provides single source full servicemerchandising solutions to retailers and consumer packaging companies. Paperproduct customers represent a diverse range of industries including paperboardpackaging and a broad range of manufacturers of consumer goods. Recyclingoperations collect or broker wastepaper for sale to Company-owned and third-partypaper mills. Customers and operations are located principally in North America.

 

**Principlesof Consolidation:**  The consolidated financial statements includethe accounts of the Company and majority-owned and controlled subsidiaries. Investmentsin non-majority owned affiliates are accounted for using the equity method. Significantintercompany accounts and transactions are eliminated in consolidation.

 

**Cashand Cash Equivalents:**  The Company considers all highly liquidinvestments with an original maturity of three months or less to be cashequivalents.

 

**RevenueRecognition:**  The Company recognizes revenue at the timepersuasive evidence of an agreement exists, price is fixed and determinable,title passes to external customers and collectibility is reasonably assured. Shippingand handling costs are included in cost of goods sold.

 

EffectiveApril 1, 2006, the Company adopted Emerging Issues Task Force (“EITF”) IssueNo. 04-13, “Accounting for Purchases and Sales of Inventory With the SameCounterparty,” for new arrangements and modifications or renewals of existingarrangements. EITF No. 04-13 requires certain inventory buy/selltransactions between counterparties within the same line of business to beviewed as a single exchange transaction. EITF No. 04-13 required the Company toprospectively report, beginning in the second quarter of 2006, certaininventory buy/sell transactions of similar containerboard types in theContainerboard and Corrugated Containers segment on a net basis in theconsolidated statements of operations, thereby reducing net sales and cost ofgoods sold by $194 million for 2006. Had EITF No. 04-13 previously been ineffect, net sales and cost of goods sold would have been reduced by anadditional $58 million for the first quarter of 2006, and $296 million and $268million for 2005 and 2004, respectively.

 

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**Receivables,Less Allowances:**  Credit is extended to customers based on anevaluation of their financial condition. The Company evaluates thecollectibility of accounts receivable on a case-by-case basis and makesadjustments to the bad debt reserve for expected losses, considering suchthings as ability to pay, bankruptcy, credit ratings and payment history. TheCompany also estimates reserves for bad debts based on historical experienceand past due status of the accounts.

 

**Inventories:** Inventories are valued at the lower of cost or market under the last-in,first-out (“LIFO”) method, except for $299 million in 2006 and $337 million in2005, which are valued at the lower of average cost or market. First-in,first-out (“FIFO”) costs (which approximate replacement costs) exceed the LIFOvalue by $81 million and $123 million at December 31, 2006 and 2005,respectively.

 

**NetProperty, Plant and Equipment:**  Property, plant and equipmentare carried at cost. The costs of additions, improvements and majorreplacements are capitalized, while maintenance and repairs are charged toexpense as incurred. Provisions for depreciation and amortization are madeusing straight-line rates over the estimated useful lives of the related assetsand the shorter of useful lives or terms of the applicable leases for leaseholdimprovements. Papermill machines have been assigned a useful life of 18 to 23years, while major converting equipment has been assigned a useful life rangingfrom 12 to 20 years (See Note 7).

 

**Timberland,Less Timber Depletion:**  Timberland is stated at cost less accumulatedcost of timber harvested. The portion of the costs of timberland attributed tostanding timber is charged against income as timber is cut, at rates determinedannually, based on the relationship of unamortized timber costs to theestimated volume of recoverable timber. The costs of seedlings andreforestation of timberland are capitalized.

 

**Goodwilland Other Intangible Assets:**  Goodwill and other intangibleassets with indefinite lives are no longer amortized, but instead are reviewedannually or more frequently, if impairment indicators arise. For purposes of measuringgoodwill impairment, the Company’s reporting units are its business segments. Otherintangible assets represent the fair value of identifiable intangible assetsacquired in purchase business combinations. Other intangible assets areamortized over their expected useful life, unless the assets are deemed to havean indefinite life. Other intangible assets are included in other assets in theCompany’s consolidated balance sheets (See Note 20).

 

**DeferredDebt Issuance Costs and Losses From Extinguishment of Debt:** Deferred debt issuance costs included in other assets are amortized overthe terms of the respective debt obligations using the interest method. TheCompany records losses due to early extinguishment of debt as a component ofincome (loss) from continuing operations.

 

**Long-LivedAssets:**  Long-lived assets held and used by theCompany are reviewed for impairment when events or changes in circumstancesindicate that their carrying amount may not be recoverable. Circumstances whichcould trigger a review include, but are not limited to: significant decreasesin the market price of the asset; significant adverse changes in the businessclimate or legal factors; accumulation of costs significantly in excess of theamount originally expected for the acquisition or construction of the asset;current period cash flow or operating losses combined with a history of lossesor a forecast of continuing losses associated with the use of the asset; andcurrent expectation that the asset will more likely than not be sold ordisposed of significantly before the end of its estimated useful life.

 

Recoverabilityis assessed based on the carrying amount of the asset compared to the sum ofthe undiscounted cash flows expected to result from the use and the eventual disposalof the asset, as well as specific appraisal in certain instances. An impairmentloss is recognized when the carrying amount is not recoverable and exceeds fairvalue (See Note 6).

 

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Oncethe Company commits to a plan to abandon or take out of service a long-livedasset before the end of its previously estimated useful life, depreciationestimates are revised to reflect the use of the asset over its shortened usefullife (See Note 3).

 

Acomponent of the Company is classified as a discontinued operation if theoperations and cash flows of the component will be (or have been) eliminatedfrom the ongoing operations of the Company (See Note 2).

 

**IncomeTaxes:**  The Company accounts for income taxes in accordancewith the liability method of accounting for income taxes. Under the liabilitymethod, deferred assets and liabilities are recognized based upon anticipatedfuture tax consequences attributable to differences between financial statementcarrying amounts of assets and liabilities and their respective tax bases (SeeNote 14).

 

**ForeignCurrency Translation:**  The functional currency for Canadianoperations is the U.S. dollar. Fluctuations in Canadian dollar monetary assetsand liabilities result in gains or losses which are credited or charged toincome. Foreign currency transactional gains or losses are also credited orcharged to income.

 

TheCompany’s remaining foreign operations’ functional currency is the applicablelocal currency. Assets and liabilities for these foreign operations aretranslated at the exchange rate in effect at the balance sheet date, and incomeand expenses are translated at average exchange rates prevailing during theyear. Translation gains or losses are included within stockholders’ equity aspart of accumulated other comprehensive income (loss) (“OCI”) (See Note 18).

 

**Derivativesand Hedging Activities:**  The Company recognizes all derivatives on thebalance sheet at fair value. Derivatives not qualifying for hedge accounting areadjusted to fair value through income. Derivatives qualifying for cash flowhedge accounting are recognized in OCI until the hedged item is recognized inearnings. Hedges related to anticipated transactions are designated anddocumented at hedge inception as cash flow hedges and evaluated for hedgeeffectiveness quarterly (See Note 10).

 

**Transfersof Financial Assets:**  Certain financial assets are transferred toqualifying special-purpose entities and variable interest entities where theCompany is not the primary beneficiary. The assets and liabilities of suchentities are not reflected in the consolidated financial statements of theCompany. Gains or losses on sale of financial assets depend in part on theprevious carrying amount of the financial assets involved in the transfer,allocated between the assets sold and the retained interests based on theirrelative fair value at the date of transfer. Quoted market prices are notavailable for retained interests, so the Company estimates fair value based on thepresent value of expected cash flows estimated by using management’s bestestimates of key assumptions (See Note 8).

 

**Stock-BasedCompensation: **At December 31, 2006, the Company hasstock-based employee compensation plans, including stock options and restrictedstock units (“RSUs”). The Company adopted Statement of Financial AccountingStandards (“SFAS”) No. 123(R), “Share-Based Payment” effective January 1,2006, which is a revision of SFAS No. 123, “Accounting for Stock-BasedCompensation” (“SFAS No. 123”), which the Company had previously adopted onJanuary 1, 2003. SFAS No. 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair values as of the grant date (See Note4).

 

**EnvironmentalMatters:**  The Company expenses environmentalexpenditures related to existing conditions resulting from past or currentoperations from which no current or future benefit is discernible. Expendituresthat extend the life of the related property or mitigate or prevent futureenvironmental contamination are capitalized. The Company records a liability atthe time when it is probable and can be reasonably estimated. Such liabilitiesare not discounted or reduced for potential recoveries from insurance carriers.

 

43

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**AssetRetirement Obligations:**  The Company accounts for asset retirementobligations in accordance with SFAS No. 143, “Accounting for Asset RetirementObligations,” which establishes accounting standards for the recognition andmeasurement of an asset retirement obligation and its associated assetretirement cost. It also provides accounting guidance for legal obligationsassociated with the retirement of tangible long-lived assets. Asset retirementobligations recorded consist primarily of landfill capping and closure andpost-closure maintenance on the landfills. The Company has other assetretirement obligations upon closure of facilities, principally costs for theremoval of asbestos and chemicals, for which retirement obligations are notrecorded because the fair value of the liability could not be reliably measureddue to the uncertainty and timing of facility closures or demolition. Theseasset retirement obligations have indeterminate settlement dates because theperiod over which the Company may settle these obligations is unknown andcannot be estimated. The Company will recognize a liability when sufficientinformation is available to reasonably estimate its fair value (See Note 13).

 

**Restructuring:**  Costsassociated with exit or disposal activities are generally recognized when theyare incurred rather than at the date of a commitment to an exit or disposalplan (See Note 3).

 

**Guarantees:**  TheCompany accounts for guarantees in accordance with Financial AccountingStandards Board (“FASB”) Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others,” which clarifies and expands on existing disclosurerequirements for guarantees and requires the Company to recognize a liabilityfor the fair value of its obligations under that guarantee. The initialmeasurement and recognition provisions are prospective for guarantees issuedafter December 31, 2002. Disclosure requirements are effective for allguarantees (See Note 12).

 

**EmployeeBenefit Plans: **At December 31, 2006, the Company adoptedSFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans,” which requires the funded status of the Company’sdefined benefit pension plans and postretirement plans, measured as thedifference between plan assets at fair value and the benefit obligations, berecorded as an asset or liability with the after-tax impact recorded to OCI inthe December 31, 2006 balance sheet, based on an actuarial valuation as of thatdate. Subsequent changes in the funded status of the plans will be recognizedin OCI in the year in which the changes occur (See Note 15).

 

**Use ofEstimates:**  The preparation of financial statements inconformity with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

 

**Reclassifications:** Certain reclassifications of prior year presentations have been made toconform to the 2006 presentation.

 

**ProspectiveAccounting Pronouncements**:  In June 2006, the FASB issuedInterpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No.48”), an interpretation of SFAS No. 109, “Accounting for Income Taxes,” tocreate a single model to address accounting for uncertainty in tax positions. FINNo. 48 clarifies the accounting for income taxes by prescribing a minimumrecognition threshold a tax position is required to meet before beingrecognized in the financial statements. FIN No. 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN No. 48 is effective forfiscal years beginning after December 15, 2006. The Company will adopt FIN No.48 as of January 1, 2007, and the cumulative effect of the new standard will berecorded as an adjustment to retained earnings. The impact of the adoption ofFIN No. 48 is not expected to have a material impact on the Company’s financialposition.

 

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In September 2006, the FASB issued FASB StaffPosition (“FSP”) No. AUG AIR-1 “Accounting for Planned Major MaintenanceActivities,” effective for fiscal years beginning after December 15, 2006, andthe Company plans to adopt this standard effective January 1, 2007. This FSPprohibits the use of the accrue-in-advance method of accounting for plannedmajor maintenance activities in annual and interim financial reporting periods.The FSP requires retrospective application to all financial statementspresented. The new standard will not impact the Company’s annual 2006 financialstatements; however the after-tax impact on the Company’s 2006 interim income (loss)from continuing operations and net income (loss) available to commonstockholders would have been income (expense) of $(1) million, an immaterialamount, $6 million and $(5) million in the first, second, third and fourthquarters, respectively. The related impact on earnings per share would havebeen an immaterial amount for the first and second quarters and $.02 and $(.02)for the third and fourth quarters, respectively.

 

**2.   Discontinued Operations**

 

On June 30, 2006, theCompany completed the sale of substantially all of the assets of its ConsumerPackaging division to a company formed by Texas Pacific Group for approximately$1.04 billion. Reflecting final working capital adjustments and salestransaction costs, net cash proceeds were $897 million, which excluded $130million of accounts receivable previously sold to Stone Receivables Corporation(“SRC”) under the accounts receivable securitization program. The Companyrecorded a pretax gain of $171 million, offset by a $174 million income taxprovision, resulting in a net loss on sale of discontinued operations of $3million. The after-tax loss was the result of a provision for income taxes thatwas higher than the statutory income tax rate due to non-deductible goodwill of$273 million.

 

The Consumer Packagingdivision was a reportable segment of the Company comprised of four coatedrecycled boxboard mills, 39 consumer packaging operations in the United States,including folding carton, multiwall and specialty bag, flexible packaging,label, contract packaging and lamination businesses and one consumer packagingplant in Brampton, Ontario. Net sales for these operations were $787 millionfor the six months ended June 30, 2006, and $1,584 million and $1,575 millionfor the years ended December 31, 2005 and 2004, respectively. These facilitiesemployed approximately 6,600 hourly and salaried employees. The results ofoperations from the Consumer Packaging segment have been reclassified asdiscontinued operations for all periods presented.

 

Prior to the sale, theCompany sold kraft paper, bleached linerboard, corrugated boxes and recycledfiber to the Consumer Packaging division. These intercompany sales, which havebeen eliminated in the Company’s consolidated financial statements, were $108million, $209 million and $207 million in 2006, 2005 and 2004, respectively.

 

The Company has enteredinto supply agreements with the purchaser of the Consumer Packaging division tocontinue to sell these products to the divested business for up to a two yearperiod. Pursuant to these agreements, the Company sold $81 million in thesecond half of 2006. The Company has entered into a transition servicesagreement to provide corporate administrative services and informationtechnology infrastructure for a period of up to 18 months. Under thisagreement, the Company billed $6 million for transition services in the secondhalf of 2006.

 

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The assets andliabilities of the discontinued operations included in the accompanying consolidatedbalance sheet as of December 31, 2005 consisted of the following:

 
| Receivables                               |   | $      | 10     |   |
|-------------------------------------------|--------|--------|--------|--------|
| Inventories                               |   | 150    |   |
| Prepaid expenses and other current assets |   | 3      |   |
| Net property, plant and equipment         |   | 356    |   |
| Goodwill                                  |   | 279    |   |
| Other assets                              |   | 9      |   |
|                                      |   | $      | 807    |   |
|                                      |   |   |   |
| Accounts payable                          |   | $      | 78     |   |
| Accrued compensation and payroll taxes    |   | 24     |   |
| Other current liabilities                 |   | 15     |   |
| Long-term debt                            |   | 16     |   |
| Other long-term liabilities               |   | 1      |   |
|                                      |   | $      | 134    |   |

 

**3.   Strategic Initiatives and RestructuringActivities**

 

During2005, the Company announced a strategic initiative plan to improve performanceand better position the Company for long-term growth. The plan focused on costreduction and productivity initiatives from which the Company expects toachieve $525 million in annual savings by the end of 2008. As part of theinitiative plan, the Company completed the sale of its Consumer Packagingdivision on June 30, 2006 and used the proceeds to reduce debt (See Notes 2 and9). The original cost reduction and productivity initiatives target includedcost savings benefits to be derived from the Consumer Packaging division and,accordingly, the Company has adjusted this target to exclude the impact of theConsumer Packaging division from both the target and the actual savingsachieved.

 

In2005, as the first step in this cost reduction process and in order to betteralign production capacity with market conditions and demand, the Companypermanently closed the New Richmond, Quebec linerboard mill, the Bathurst, NewBrunswick medium mill and the previously idled No. 2 paper machine at theFernandina Beach, Florida linerboard mill. The Company’s containerboardmanufacturing capacity was reduced by 700,000 tons, or 8.5% as a result ofthese closures. In addition, the Company also closed two converting facilities,exited its investment in the Las Vegas, Nevada converting facility, and agreedto the closure of the Groveton, New Hampshire medium mill, in which the Companyowns a minority interest. The Company recorded restructuring charges of $321million, including non-cash charges of $267 million related to the write-downof assets, primarily property, plant and equipment, to estimated net realizablevalues and $4 million related to a pension curtailment charge for terminatedemployees. The remaining charges were primarily for severance, benefits, leasecommitments and post-closure environmental costs. These shutdowns resulted inapproximately 780 employees being terminated. The net sales and operatinglosses of the two shutdown converting operations in 2005 prior to closure were$24 million and $5 million, respectively. The net sales and operating losses ofthese facilities in 2004 were $28 million and $3 million, respectively.

 

In2006, in conjunction with the strategic initiative plan, the Company closedfifteen converting facilities and permanently shutdown four corrugators,resulting in the termination of approximately 1,400 employees. In addition,another 700 employees were terminated as part of the strategic initiative plan.The Company recorded restructuring charges of $43 million, net of an $18million gain from the sale of three shutdown facilities and the No. 2 papermachine at the Fernandina Beach, Florida linerboard mill. The fixed assets ofthe shutdown operations were adjusted to the estimated net realizable value,resulting in a non-cash charge of $21 million. In addition, in accordance withSFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”the Company recorded a $2 million non-cash restructuring charge in the fourthquarter of 2006 to accelerate the related depreciation over the revised usefullife of 

 

46

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equipmentexpected to be abandoned. The remaining charges were primarily for severanceand benefits, including pension settlement costs of $6 million. The net salesand operating losses of these facilities in 2006 prior to closure were $169million and $30 million, respectively. The net sales and operating losses ofthese facilities in 2005 were $262 million and $27 million, respectively. Thenet sales and operating losses of these facilities in 2004 were $251 millionand $15 million, respectively. Additional charges of up to $4 million will berecorded in future periods related to the closure of these converting facilitiesfor pension settlement costs.

 

Duringthe next two years, to implement the planned initiatives, the Company expectsto record additional restructuring charges of approximately $125 million,including accelerated depreciation of approximately $40 million related toequipment expected to be abandoned or taken out of service in conjunction withthe future closure of certain corrugated container facilities.

 

During2004, the Company closed ten converting facilities and exited its Indonesianoperations, resulting in restructuring charges of $16 million, net of a $5million gain from sales of three shutdown facilities. The fixed assets of theshutdown operations were adjusted to the estimated net realizable value,resulting in a $7 million non-cash write-down. The remaining charges wereprimarily severance and benefits resulting from approximately 1,000 employeesbeing terminated. The net sales and operating losses of these shutdownoperations in 2004 prior to closure were $99 million and $15 million, respectively.

 

Thefollowing is a summary of the restructuring liabilities recorded as part of therationalization of the Company’s mill and converting operations, including thetermination of employees and liabilities for lease commitments at the closedfacilities.

 
| ** **                          | ** ** | **Write-down of   Property,  Equipment and  Investments to  Fair Value** | ** ** | **Severance  and  Benefits** | ** ** | **Lease  Commitments** | ** ** | **Facility  Closure  Costs** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| Balance at   January 1, 2004   |       | $                                                                                                 |       |                         | $          | 17                     |       | $                            | 12         |       | $          | 15         |       | $ |   |   | $ | 44 |   |
|                                |       |                                                                                              |       |                         |       |                   |       |                         |       |       |       |       |       |
| Charge                              |       | 7                                                                                                 |       | 11                           |       | 1                      |       | 2                            |       | (5         | )          | 16         |       |
| Payments                            |       |                                                                                              |       | (23                          | )          | (2                     | )          | (5                           | )          |       |       | (30        | )          |
| Non-cash reduction                  |       | (7                                                                                                | )          |                         |       |                   |       |                         |       |       |       | (7         | )          |
| Sale of assets                      |       |                                                                                              |       |                         |       |                   |       |                         |       | 5          |       | 5          |       |
| Balance at   December 31, 2004 |       |                                                                                              |       | 5                            |       | 11                     |       | 12                           |       |       |       | 28         |       |
|                                |       |                                                                                              |       |                         |       |                   |       |                         |       |       |       |       |       |
| Charge                              |       | 267                                                                                               |       | 35                           |       | 7                      |       | 12                           |       |       |       | 321        |       |
| Payments                            |       |                                                                                              |       | (21                          | )          | (3                     | )          | (3                           | )          |       |       | (27        | )          |
| Non-cash reduction                  |       | (267                                                                                              | )          | (4                           | )          |                   |       |                         |       |       |       | (271       | )          |
| Balance at   December 31, 2005 |       |                                                                                              |       | 15                           |       | 15                     |       | 21                           |       |       |       | 51         |       |
|                                |       |                                                                                              |       |                         |       |                   |       |                         |       |       |       |       |       |
| Charge                              | ** ** | **23**                                                                                            | ** ** | **38**                       | ** ** | **4**                  | ** ** | **(4**                       | **)**      | **(18**    | **)**      | **43**     | ** ** |
| Payments                            | ** ** | ** **                                                                                        | ** ** | **(34**                      | **)**      | **(2**                 | **)**      | **(8**                       | **)**      | ** ** | ** ** | **(44**    | **)**      |
| Non-cash reduction                  | ** ** | **(23**                                                                                           | **)**      | ** **                   | ** ** | ** **             | ** ** | ** **                   | ** ** | ** ** | ** ** | **(23**    | **)**      |
| Sale of assets                      | ** ** | ** **                                                                                        | ** ** | ** **                   | ** ** | ** **             | ** ** | ** **                   | ** ** | **18**     | ** ** | **18**     | ** ** |
| Balance at   December 31, 2006 | ** ** | **$**                                                                                             | ** ** | **$**                        | **19**     | ** **             | **$**      | **17**                       | ** ** | **$**      | **9**      | ** ** | **$**      | ** ** | **$** | **45** | ** ** |
|                                     |            |                                                                                                   |            |                              |            |                        |            |                              |            |            |            |            |            |  |  |  |  |  |  |

 

The$4 million adjustment to facility closure costs in 2006 is due primarily torevising environmental exit liabilities, based on current information andexperience.

 

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**CashRequirements**

Futurecash outlays under the restructuring of operations are anticipated to be $35million in 2007, $5 million in 2008, $3 million in 2009 and $2 millionthereafter.

 

**4.   Stock–Based Compensation**

 

TheCompany has stock options and RSUs outstanding under several long-termincentive plans. The stock options granted under plans prior to the 1998Long-Term Incentive Plan (the “1998 Plan”) are fully vested and exercisable.

 

The1998 Plan and the 2004 Long-Term Incentive Plan (the “2004 Plan”) have reserved16.5 million and 12.5 million shares, respectively, of Company common stock fornon-qualified stock options, RSUs and performance awards to officers, keyemployees and non-employee directors of the Company. The stock options areexercisable at a price equal to the fair market value of the Company’s stock onthe date of grant. The vesting schedule and other terms and conditions ofoptions granted under each plan are established separately for each grant. Theoptions expire no later than seven to ten years from the date of grant.

 

Certaingrants under the 1998 Plan and the 2004 Plan contain change in controlprovisions which provide for immediate vesting and exercisability in the eventthat specific ownership conditions are met. Grants issued before December 31,2005 allowed for immediate vesting and exercisability in the event ofretirement. For grants issued after December 31, 2005, unvested awards do notvest upon retirement. These options remain exercisable until the earlier offive years from retirement or ten years from the initial grant date.

 

**SFASNo. 123**

In2003, the Company adopted the fair value recognition provisions of SFAS No. 123.The Company selected the prospective transition method as allowed in SFAS No.148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” whichrequired expensing options prospectively, beginning in the year of adoption,and utilized the Black-Scholes formula to estimate the value of stock optionsgranted to employees. Because the prospective transition method was used andawards vest over three to eight years (see below), the expense for 2005 and2004 is less than what would have been recognized if the fair value-basedmethod had been applied to all awards since the original effective date of SFASNo. 123. The following table illustrates the effect on net loss available tocommon stockholders and earnings per share if the fair value based method hadbeen applied to all outstanding and unvested awards in each period.

 
| ** **                                                                                                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net loss available to common stockholders,  as reported                                                                                                    |       | $        | (339       | )        | $          | (57 | ) |
| Add:   Stock-based employee compensation expense included in reported net  loss, net of related  tax effects                                     |       | 7        |       | 6        |       |
| Deduct:   Total stock-based employee compensation expense determined under fair  value-based method for all  awards, net  of related tax effects |       | (12      | )          | (15      | )          |
| Pro forma net loss available to common  stockholders                                                                                                       |       | $        | (344       | )        | $          | (66 | ) |
|                                                                                                                                                       |       |     |       |     |       |
| Earnings per share:                                                                                                                                        |       |     |       |     |       |
| Basic and diluted – as reported                                                                                                                       |       | $        | (1.33      | )        | $          | (.23 | ) |
| Basic and diluted – pro forma                                                                                                                         |       | $        | (1.35      | )        | $          | (.26 | ) |

 

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**SFASNo. 123(R)**

TheCompany adopted SFAS No. 123(R) on January 1, 2006, under the modifiedprospective method, in which the requirements of SFAS No. 123(R) must beapplied to new awards and to previously granted awards that are not fullyvested on the effective date, but does not require a restatement of previousyears’ financial statements. Upon adoption, the Company implemented a latticeoption pricing model to estimate the fair value of stock options granted afterJanuary 1, 2006. The Company changed to a lattice option pricing model as itaccommodates dynamic assumptions of expected volatility over the option’scontractual term, and estimates of expected option exercise patterns during theoption’s contractual term, including the effect of blackout periods, whichprovides a better estimate of the options’ fair value and more fully reflectsthe substantive characteristics of the Company’s stock-based compensation.

 

Thelattice option pricing model considers a range of assumptions related tovolatility, risk-free interest rate and historical employee behavior. Expectedvolatility was based on historical volatility on the Company’s common stock andcurrent implied volatilities from traded options on the Company’s common stock.The risk-free interest rate was based on U.S. Treasury security yields at thetime of grant. The dividend yield on the Company’s common stock is assumed tobe zero since the Company has not paid dividends and has no current plans to doso in the future. The expected life was determined from the lattice optionpricing model. The lattice option pricing model incorporates exercise andpost-vesting forfeiture assumptions based on analysis of historical data.

 

Thefollowing table provides the assumptions used in determining the fair value ofthe stock-based awards using a lattice option pricing model in 2006 and aBlack-Scholes option pricing model in 2005 and 2004.

 
| ** **                               | ** ** | **2006**  | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|
| Weighted-average volatility              | ** ** | **35.65** | %          | 41.00    | %          | 31.00    | %          |
| Weighted-average risk-free interest rate | ** ** | **4.59**  | %          | 4.10     | %          | 4.08     | %          |
| Weighted-average dividend yield          | ** ** | **0.00**  | %          | 0.00     | %          | 0.00     | %          |
| Weighted-average expected life in years  | ** ** | **5**     |       | 6        |       | 6        |       |

 

Stockoptions and RSUs granted prior to December 31, 2005 allowed for immediatevesting and exercisability in the event of retirement. The Company hadrecognized compensation expense over the explicit service period (up to thedate of actual retirement) and will continue this method for awards grantedprior to the adoption of SFAS No. 123(R). For options granted after January 1,2006, the Company is recognizing expense over the explicit service period sincethe options do not fully vest upon retirement.

 

Theimpact of adopting SFAS No. 123(R) for 2006 was an increase in selling andadministrative expenses of $5 million due to recognizing expense on non-vested,outstanding shares issued prior to the adoption of SFAS No. 123 on January 1,2003. The related tax benefit was $2 million for 2006. The net earnings pershare impact was $(.01) for 2006.

 

Totalpretax stock-based compensation costs recognized in selling and administrativeexpense in the consolidated statements of operations for 2006, 2005 and 2004were $23 million, $10 million, and $9 million, respectively, excludingstock-based compensation costs related to discontinued operations of $2million, $2 million and $1 million for 2006, 2005 and 2004, respectively. Therelated tax benefit for 2006, 2005 and 2004 was $9 million, $4 million, and $3million, respectively, excluding the tax benefit related to discontinuedoperations of $1 million for each of 2006, 2005 and 2004.

 

AtDecember 31, 2006, the total compensation cost related to non-vested awards notyet recognized was approximately $33 million to be recognized through November30, 2009, with a weighted-average expense period of approximately two years.

 

49

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**StockOptions**

Thestock options granted prior to January 1999 are fully vested and exercisable. Thestock options granted between January 1999 and March 2001 vest and becomeexercisable eight years after the date of grant subject to acceleration based uponthe attainment of pre-established stock price targets. For grants between April2001 and June 2004, the stock options vest and become exercisable at the rateof 25% each year for four years. All non-performance based grants issuedsubsequent to June 2004 vest and become exercisable on the third anniversary ofthe award date. Awards with pro rata vesting are expensed on a straight-linebasis.

 

During2006, the Company granted performance-based stock options under the 2004 Planto management level employees responsible for implementing the strategicinitiatives plan. Vesting is dependent upon the financial performance of theCompany and the attainment of the strategic initiatives savings from 2006 to2008. These performance-based stock options expire no later than seven yearsfrom the date of grant. Compensation expense is recorded over the performanceperiod ranging from two to three years based on the achievement of theperformance criteria. As of December 31, 2006, the Company is on target toattain the vesting requirements.

 

Additionalinformation relating to stock options is as follows:

 
| ** **                       | ** ** | **Options**    | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term  (in years)** | ** ** |
|----------------------------------|------------|----------------|------------|----------------------------------------|------------|----------------------------------------------------------------------|------------|
| Outstanding at January 1, 2004   |       | 17,324,903     |       | $                                      | 14.20      |                                                                 |       |   |
| ** **                       | ** ** | ** **     | ** ** | ** **                             | ** ** | ** **                                                           | ** ** |
| Granted                          |       | 992,144        |       | 18.78                                  | ** ** | ** **                                                           | ** ** |
| Exercised                        |       | (3,546,349     | )          | 13.17                                  | ** ** | ** **                                                           | ** ** |
| Cancelled                        |       | (497,459       | )          | 14.54                                  | ** ** | ** **                                                           | ** ** |
| Outstanding at December 31, 2004 |       | 14,273,239     |       | 14.76                                  | ** ** | ** **                                                           | ** ** |
|                             |       |           |       |                                   |       |                                                                 |       |
| Granted                          |       | 1,054,508      |       | 13.78                                  | ** ** | ** **                                                           | ** ** |
| Exercised                        |       | (100,044       | )          | 13.40                                  | ** ** | ** **                                                           | ** ** |
| Cancelled                        |       | (770,577       | )          | 17.41                                  | ** ** | ** **                                                           | ** ** |
| Outstanding at December 31, 2005 |       | 14,457,126     |       | 14.55                                  | ** ** | ** **                                                           | ** ** |
|                             |       |           |       |                                   |       |                                                                 |       |
| Granted                          | ** ** | **5,469,775**  | ** ** | **12.74**                              | ** ** | ** **                                                           | ** ** |
| Exercised                        | ** ** | **(140,761**   | **)**      | **12.78**                              | ** ** | ** **                                                           | ** ** |
| Cancelled                        | ** ** | **(2,197,181** | **)**      | **13.99**                              | ** ** | ** **                                                           | ** ** |
| Outstanding at December 31, 2006 | ** ** | **17,588,959** | ** ** | **14.08**                              | ** ** | **5.07**                                                             | ** ** |
|                             |       |           |       |                                   |       |                                                                 |       |
| Exercisable at December 31, 2006 | ** ** | **10,776,801** | ** ** | **$**                                  | **14.32**  | ** **                                                           | **3.94**   | ** ** |

 

Theweighted-average grant date fair value of stock options granted during 2006,2005 and 2004 was $4.62, $6.29 and $7.17 respectively.

 

Thetotal intrinsic value of stock options exercised during 2006, 2005 and 2004 wasan immaterial amount, $1 million and $19 million, respectively.

 

Theaggregate intrinsic value of stock options exercisable at December 31, 2006 wasan immaterial amount. The aggregate intrinsic value represents the total pretaxintrinsic value, based on options with an exercise price less than the Company’sclosing stock price as of December 31, 2006, which would have been received bythe option holders had those option holders exercised their options as of thatdate.

 

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**RSUs**

TheCompany issues RSUs to pay a portion of employee bonuses under its annualmanagement incentive plan. These RSUs vest immediately, but will not bedistributed to active employees until the third anniversary of the award date. TheCompany pays a premium on the employee bonuses in the form of RSUs (“PremiumRSUs”) to certain employees. The Company also issues non-vested RSUs under the2004 Plan to certain employees. Non-employee directors are also annuallyawarded non-vested RSUs as part of their director compensation. Thesenon-vested RSUs and Premium RSUs vest at the earlier of a change in control,death, disability or three years after the award date. The RSUs arenon-transferable and do not have voting rights.

 

Additionalinformation relating to RSUs is as follows:

 
| ** **                                        | ** ** | **RSUs**      | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|---------------------------------------------------|------------|---------------|------------|---------------------------------------------------------|------------|
| **Vested  RSUs**                                  |       |          |       |                                                    |       |
| Outstanding vested RSUs at January 1, 2004        |       | 639,793       |       | $                                                       | 14.32      |   |
|                                              |       |          |       |                                                    |       |
| Granted                                           |       | 160,090       |       | 17.15                                                   |       |
| Converted                                         |       | (32,918       | )          | 14.62                                                   |       |
| Transfer from non-vested                          |       |          |       |                                                    |       |
| Outstanding vested RSUs at December 31,  2004     |       | 766,965       |       | 14.90                                                   |       |
|                                              |       |          |       |                                                    |       |
| Granted                                           |       | 208,833       |       | 15.06                                                   |       |
| Converted                                         |       | (345,352      | )          | 14.82                                                   |       |
| Transfer from non-vested                          |       | 102,392       |       | 15.53                                                   |       |
| Outstanding vested RSUs at December 31,  2005     |       | 732,838       |       | 15.07                                                   |       |
|                                              |       |          |       |                                                    |       |
| Granted                                           | ** ** | **180,759**   | ** ** | **12.96**                                               | ** ** |
| Converted                                         | ** ** | **(663,626**  | **)**      | **14.33**                                               | ** ** |
| Transfer from non-vested                          | ** ** | **326,607**   | ** ** | **14.68**                                               | ** ** |
| Outstanding vested RSUs at December 31,  2006     | ** ** | **576,578**   | ** ** | **15.04**                                               | ** ** |
|                                              |       |          |       |                                                    |       |
| **Non-Vested  RSUs**                              | ** ** | ** **    | ** ** | ** **                                              | ** ** |
| Outstanding non-vested RSUs at January 1,  2004   |       | 229,823       |       | $                                                       | 14.86      |   |
|                                              |       |          |       |                                                    |       |
| Granted                                           |       | 434,211       |       | 18.54                                                   |       |
| Forfeited                                         |       | (13,659       | )          | 16.60                                                   |       |
| Transfer to vested                                |       |          |       |                                                    |       |
| Outstanding non-vested RSUs at December 31,  2004 |       | 650,375       |       | 17.28                                                   |       |
|                                              |       |          |       |                                                    |       |
| Granted                                           |       | 763,631       |       | 12.79                                                   |       |
| Forfeited                                         |       | (43,748       | )          | 16.06                                                   |       |
| Transfer to vested                                |       | (102,392      | )          | 15.53                                                   |       |
| Outstanding non-vested RSUs at December 31,  2005 |       | 1,267,866     |       | 14.76                                                   |       |
|                                              |       |          |       |                                                    |       |
| Granted                                           | ** ** | **817,973**   | ** ** | **12.03**                                               | ** ** |
| Forfeited                                         | ** ** | **(157,231**  | **)**      | **12.51**                                               | ** ** |
| Transfer to vested                                | ** ** | **(326,607**  | **)**      | **14.68**                                               | ** ** |
| Outstanding non-vested RSUs at December 31,  2006 | ** ** | **1,602,001** | ** ** | **13.60**                                               | ** ** |
|                                              |       |          |       |                                                    |       |
| Total outstanding RSUs at December 31, 2006       | ** ** | **2,178,579** | ** ** | **$**                                                   | **13.98**  | ** ** |

 

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**5.   Acquisitions and Mergers**

 

**EquityAffiliates**

During2005, the Company invested in four separate joint ventures for a total of $9million. The largest is an investment of $7 million in a producer of corrugatedsheets and packaging products located in China.

 

**InnovativePackaging**

InDecember 2004, the Company acquired 15% of Innovative Packaging Corp. (“IPC”),a corrugated container facility in Milwaukee, Wisconsin, for $13 million. Previously,the Company owned 85% of IPC and, as a result of the acquisition, now owns 100%.The cost to acquire the remaining 15% of IPC eliminated the Company’s minorityinterest liability of $1 million with the remaining balance of $12 millionallocated to intangible assets for $4 million and to goodwill for $8 million. Thegoodwill is reflected in the Containerboard and Corrugated Containers segment.

 

Thefollowing table is a summary of the remaining exit liabilities recorded as partof acquisition and merger transactions completed in prior years.

 
| ** **                   | ** ** | **Lease  Commitments** | ** ** | **Other  Commitments** | ** ** | **Facility Closure  Costs** | ** ** | **Total** | ** ** |
|------------------------------|------------|------------------------|------------|------------------------|------------|----------------------------------|------------|-----------|------------|
| Balance at January 1, 2004   |       | $                      | 4          |                   | $          | 2                                |       | $         | 1          |   | $ | 7 |   |
| Payments                     |       | (1                     | )          |                   |       | (1                               | )          | (2        | )          |
| Balance at December 31, 2004 |       | 3                      |       | 2                      |       |                             |       | 5         |       |
| Payments                     |       | (1                     | )          |                   |       |                             |       | (1        | )          |
| Balance at December 31, 2005 |       | 2                      |       | 2                      |       |                             |       | 4         |       |
| Payments                     | ** ** | **(1**                 | **)**      | **(1**                 | **)**      | ** **                       | ** ** | **(2**    | **)**      |
| Balance at December 31, 2006 | ** ** | **$**                  | **1**      | ** **             | **$**      | **1**                            | ** ** | **$**     | ** ** | **$** | **2** | ** ** |
|                              |            |                        |            |                        |            |                                  |            |           |            |  |  |  |  |

 

**CashRequirements**

Futurecash outlays under the exit liabilities are anticipated to be $1 million in2007, an immaterial amount in 2008 and 2009 and $1 million thereafter.

 

**6.   Asset Impairment Charge**

 

TheCompany recorded an asset impairment charge of $73 million in 2004 related tothe write-down of non-core pulp mill property, plant and equipment. The Companyperformed the impairment review as a result of significant operating and cashflow losses in 2004, combined with a history of losses due to a prolongedeconomic downturn affecting the pulp mill. The Company evaluated therecoverability of its long-lived assets and recorded the impairment chargebased on the amounts by which the carrying value of the assets exceeded theirfair value. Fair value of the assets was determined based on discounted cashflow analysis of the pulp mill’s projected operating results. No goodwill hadbeen assigned to the pulp mill, which is included in the Containerboard andCorrugated Containers segment.

 

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**7.   Net Property, Plant and Equipment**

 

Netproperty, plant and equipment at December 31 consist of:

 

 
| ** **                           | ** ** | **2006**   | ** ** | **2005** | ** ** |
|--------------------------------------|------------|------------|------------|----------|------------|
| Land and land improvements           | ** ** | **$**      | **164**    |     | $          | 185 |   |
| Buildings and leasehold improvements | ** ** | **600**    |       | 681      |       |
| Machinery, fixtures and equipment    | ** ** | **5,482**  |       | 6,080    |       |
| Construction in progress             | ** ** | **166**    |       | 169      |       |
| ** **                           |       | **6,412**  |       | 7,115    |       |
| Less accumulated depreciation        | ** ** | **(2,681** | )          | (2,870   | )          |
| Net property, plant and equipment    | ** ** | **$**      | **3,731**  |     | $          | 4,245 |   |

 

Depreciationexpense was $352 million, $364 million and $375 million for 2006, 2005 and2004, respectively, excluding depreciation expense related to discontinuedoperations of $20 million, $40 million and $38 million in 2006, 2005 and 2004,respectively. Property, plant and equipment include capitalized leases of $22million and $31 million and related accumulated amortization of $17 million and$21 million at December 31, 2006 and 2005, respectively.

 

**8.   Transfers of Financial Assets**

 

**ReceivablesSecuritization Program**

InNovember 2004, in connection with the Merger, the Company replaced its former$265 million off-balance sheet accounts receivable securitization program witha new $475 million accounts receivable securitization program whereby theCompany sells, without recourse, on an ongoing basis, certain of its accountsreceivable to Stone Receivables Corporation (“SRC”), a wholly-ownednon-consolidated subsidiary of the Company.

 

SRCtransfers the receivables to a non-consolidated subsidiary, a limited liabilitycompany which has issued notes to third-party investors. The Company hasretained servicing responsibilities and a subordinated interest in the limitedliability company. The Company receives annual servicing fees of 1% of theunpaid balance of the receivables and rights to future cash flows arising afterthe investors in the securitization limited liability company have received thereturn for which they have contracted.

 

SRCis a qualified special–purpose entity under the provisions of SFAS No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.”  Accordingly, accountsreceivable sold to SRC, for which the Company does not retain an interest, arenot included in the Company’s consolidated balance sheets.

 

InSeptember 2006, $137 million of containerboard customer accounts receivables,net of related allowance for doubtful accounts, were sold into the SRC accountsreceivable securitization program, of which $78 million were retained by theCompany as a subordinated interest and recorded in retained interest inreceivables sold in the consolidated balance sheet. The Company used theinitial proceeds of $59 million to repay debt (See Note 9).

 

Accountsreceivable of the Consumer Packaging division previously sold under theaccounts receivable securitization program were substantially collected during2006 and were used to reduce the related off-balance sheet debt (See Note 2).

 

53

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AtDecember 31, 2006 and 2005, $522 million and $521 million, respectively, ofaccounts receivable had been sold to SRC, of which $164 million and $118million, respectively, were retained by the Company as a subordinated interest.The Company’s retained interest is carried at fair value and is included inretained interest in receivables sold in the accompanying consolidated balancesheets. The Company recognized a loss on sales of receivables to SRC of $23million and $20 million in 2006 and 2005, respectively, which is included inother, net in the consolidated statements of operations.

 

Keyeconomic assumptions used in measuring the retained interest are as follows:

 
| ** **                        | ** ** | **Year Ended  December 31,  2006** | ** ** | **December 31,  2006** | ** ** | **Year Ended  December 31,  2005** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|-----------------------------|------------|----------------------------------------------|------------|-----------------------------|------------|
| Residual cash flows discounted at | ** ** | **8.00%**                                    | ** ** | **8.00**                    | %          | 8.00%                                        |       | 8.00                        | %          |
| Expected loss and dilution rate   | ** ** | **1.89%-4.14%**                              | ** ** | **2.77**                    | %          | 1.96%-3.35%                                  |       | 2.54                        | %          |
| Variable return to investors      | ** ** | **LIBOR plus 23 to  135 basis points**       | ** ** | **5.72**                    | %          | LIBOR plus 23 to  135 basis points           |       | 4.77                        | %          |

 

AtDecember 31, 2006, the sensitivity of the current fair value of residual cashflows to immediate 10% and 20% adverse changes in the expected loss anddilution rate was $1 million and $3 million, respectively. The effects of thesensitivity analysis on the residual cash flow discount rate and the variablereturn to investors were insignificant.

 

Thetable below summarizes certain cash flows received from SRC:

 
| ** **                                      | ** ** | **2006** | ** ** | **2005**   | ** ** |
|-------------------------------------------------|------------|----------|------------|------------|------------|
| Cash proceeds from sales of receivables         | ** ** | **$**    | **5,795**  |       | $          | 5,903 |   |
| Servicing fees received                         | ** ** | **6**    |       | 6          |       |
| Other cash flows received on retained  interest | ** ** | **41**   |       | 85         |       |
| Interest income received                        | ** ** | **2**    |       | ** ** |       |
|                                                 |            |          |            |            |            |  |  |

 

**CanadianSecuritization Program**

OnMarch 30, 2004, the Company entered into a $70 million Canadian (approximately$60 million U.S. as of December 31, 2006) accounts receivable securitizationprogram whereby the Company sells, without recourse, on an ongoing basis,certain of its Canadian accounts receivable to a trust in which the Companyholds a variable interest, but is not the primary beneficiary. Accordingly,under FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,”accounts receivable sold to the trust, for which the Company is not the primarybeneficiary, are not included in the accompanying consolidated balance sheets. TheCompany has retained servicing responsibilities and a subordinated interest infuture cash flows from the receivables. The Company receives rights to futurecash flows arising after the investors in the securitization trust havereceived the return for which they have contracted.

 

Theamount available to the Company under the receivables program fluctuates basedon the amount of eligible receivables available and by the performance of thereceivables portfolio. The Company’s residual interest in the securitizationprogram is recorded at fair value and is based upon the total outstandingreceivables sold, adjusted for dilution and loss reserves of approximately 3.7%and 4.0%, at December 31, 2006 and 2005, respectively, less the amount fundedto the Company.

 

54

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AtDecember 31, 2006 and 2005, $68 million and $71 million, respectively, ofaccounts receivable had been sold under the program, of which $15 million and$21 million, respectively, were retained by the Company as a subordinatedinterest. The amount funded to the Company at December 31, 2006 and 2005, was$50 million and $47 million, respectively. The Company’s retained interest isincluded in retained interest in receivables sold in the accompanyingconsolidated balance sheets. The Company recognized a loss on sales ofreceivables to the trust of $2 million and $1 million in 2006 and 2005,respectively, which is included in other, net in the consolidated statements ofoperations.

 

**TimberlandSale and Note Monetization**

TheCompany sold approximately 980,000 acres of owned and leased timberland inFlorida, Georgia and Alabama in October 1999. The final purchase price, afteradjustments, was $710 million. The Company received $225 million in cash, withthe balance of $485 million in the form of installment notes.

 

TheCompany entered into a program to monetize the installment notes receivable. Thenotes were sold without recourse to Timber Note Holdings LLC, a qualifiedspecial-purpose entity under the provisions of SFAS No. 140, for $430 millioncash proceeds and a residual interest in the notes. The transaction wasaccounted for as a sale under SFAS No. 140. The cash proceeds from the sale andmonetization transactions were used to prepay borrowings under the Company’sCredit Agreement. The residual interest was $48 million and $46 million atDecember 31, 2006 and 2005, respectively, and is included in other assets inthe accompanying consolidated balance sheets. The key economic assumption usedin measuring the residual interest at the date of monetization was the rate atwhich the residual cash flows were discounted (9%). At December 31, 2006, thesensitivity on the current fair value of the residual cash flows to immediate10% and 20% adverse changes in the assumed rate at which the residual cashflows were discounted (9%) was $1 million and $2 million, respectively.

 

55

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**9.   Long-Term Debt**

 

Long-termdebt as of December 31 is as follows:

 
| ** **                                                                                                                                                | ** ** | **2006**  | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|
| **Bank Credit Facilities**                                                                                                                                |       |      |       |     |       |
| Tranche B Term Loan (7.6% weighted average  variable rate), due in various installments through November 1, 2011                                          | ** ** | **$**     | **490**    |     | $          | 878 |   |
| Tranche C Term Loan (7.6% weighted average  variable rate), due in various installments through November 1, 2011                                          | ** ** | **295**   |       | 298      |       |
| Tranche C-1 Term Loan (7.6% weighted  average variable rate), due in various installments through November 1, 2011                                        | ** ** | **89**    |       | 90       |       |
| SSCE revolving credit facility (9.8%  weighted average variable rate), due November 1, 2009                                                               | ** ** | **70**    |       | 98       |       |
| SSC Canada revolving credit facility (8.4%  weighted average variable rate), due November 1, 2009                                                         | ** ** | **66**    |       | 147      |       |
| ** **                                                                                                                                                |       | **1,010** |       | 1,511    |       |
| ** **                                                                                                                                                |       |      |       |     |       |
| **Senior Notes**                                                                                                                                          |       |      |       |     |       |
| 8.45% mortgage notes, payable in monthly  installments through August 1, 2007 and $69 on September 1, 2007                                                | ** ** | **70**    |       | 72       |       |
| 9.25% unsecured senior notes, due February  1, 2008                                                                                                       | ** ** | **2**     |       | 300      |       |
| 9.75% unsecured senior notes, due February  1, 2011                                                                                                       | ** ** | **648**   |       | 750      |       |
| 8.375% unsecured senior notes, due July 1,  2012                                                                                                          | ** ** | **400**   |       | 400      |       |
| 8.25% unsecured senior notes, due October  1, 2012                                                                                                        | ** ** | **700**   |       | 700      |       |
| 7.50% unsecured senior notes, due June 1,  2013                                                                                                           | ** ** | **300**   |       | 300      |       |
| 7.375% unsecured senior notes, due July 15,  2014                                                                                                         | ** ** | **200**   |       | 200      |       |
| ** **                                                                                                                                                |       | **2,320** |       | 2,722    |       |
|                                                                                                                                                      |       |      |       |     |       |
| **Other Debt**                                                                                                                                            |       |      |       |     |       |
| Fixed rate utility systems and pollution  control revenue bonds (fixed rates ranging from 5.1% to 8.1%), payable in varying  annual payments through 2027 | ** ** | **172**   |       | 193      |       |
| Variable rate industrial revenue bonds  (6.7% weighted average variable rate), payable in varying annual payments  through 2035                           | ** ** | **120**   |       | 120      |       |
| Other (including obligations under  capitalized leases of $7 and $12)                                                                                     | ** ** | **12**    |       | 25       |       |
| ** **                                                                                                                                                |       | **304**   |       | 338      |       |
| Total debt                                                                                                                                                | ** ** | **3,634** |       | 4,571    |       |
| Less current maturities                                                                                                                                   | ** ** | **(84**   | )          | (35      | )          |
| **Total long-term debt**                                                                                                                                  | ** ** | **$**     | **3,550**  |     | $          | 4,536 |   |

 

Theamounts of total debt outstanding at December 31, 2006 maturing during the nextfive years are as follows:

 
| 2007       |   | $     | 84     |   |
|------------|--------|-------|--------|--------|
| 2008       |   | 8     |   |
| 2009       |   | 145   |   |
| 2010       |   | 125   |   |
| 2011       |   | 1,507 |   |
| Thereafter |   | 1,765 |   |

 

56

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**BankCredit Facilities**

Inconnection with the Merger, the Company, as guarantor, and SSCE and itssubsidiary, Smurfit-Stone Container Canada Inc. (“SSC Canada”), as borrowers,entered into a new credit agreement, as amended (the “Credit Agreement”) onNovember 1, 2004. The Credit Agreement, which refinanced and replaced SSCC’sformer credit agreements in their entirety, provided for (i) a revolving creditfacility of $600 million to SSCE, of which $70 million was borrowed as ofDecember 31, 2006 and (ii) a revolving credit facility of $200 million to SSCEand SSC Canada, of which $66 million was borrowed as of December 31, 2006. Therevolving credit facilities include sub-limits for the issuance of letters ofcredit and swingline loans. The Company pays a 0.5% commitment fee on theunused portions of its revolving credit facilities. At December 31, 2006, theunused portion of these facilities, after giving consideration to outstandingletters of credit, was $539 million subject to limitations in the CreditAgreement described below. Each of these revolving credit facilities mature onNovember 1, 2009. The Credit Agreement also provided for a Tranche B term loanto SSCE in the aggregate principal amount of $975 million and a Tranche C termloan to SSC Canada in the aggregate principal amount of $300 million, withoutstanding balances of $490 million and $295 million, respectively, atDecember 31, 2006. The term loans are payable in quarterly installments andmature on November 1, 2011. In addition, the Credit Agreement provides for adeposit funded letter of credit facility, related to the variable rateindustrial revenue bonds, for approximately $122 million that matures onNovember 1, 2010. A loss of $12 million was recorded in 2004 due to the earlyextinguishment of the Company’s former credit agreements, primarily related tothe payment of fees and expenses of $11 million.

 

InDecember 2005, the Company and its lenders entered into an agreement andamendment (“Incremental Term Loan Assumption Agreement and Amendment No. 2”) tothe Credit Agreement to i) ease certain financial covenant requirements as ofDecember 31, 2005 and for future periods through September 30, 2007, ii)increase interest rates for the credit facilities by 0.25% and iii) provide fora new term loan. Under the Incremental Term Loan Assumption Agreement andAmendment No. 2, the Company has the option to borrow at a rate equal to LIBORplus 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 Applicable Rate will increase by 0.25%if at any time the Company’s senior secured indebtedness is rated lower thanBB- by Standard & Poor’s and Ba3 by Moody’s Investors Service. TheApplicable Rate with respect to term loan facilities will decrease by 0.25% if,at any time, the Company’s Consolidated Senior Secured Leverage Ratio is lessthan 3.0 to 1.0. The other material terms of the Credit Agreement, includingsecurity and final maturity, remained the same as under the original CreditAgreement. The Incremental Term Loan Assumption Agreement and Amendment No. 2also provided for a new SSC Canada Incremental Term Loan (“Tranche C-1”) in theaggregate principal amount of $90 million, with an outstanding balance of $89million at December 31, 2006. The term loan is payable in quarterlyinstallments and matures on November 1, 2011. The Company used the proceeds ofthe Tranche C-1 to repay $90 million of Tranche B term loan. The Company paidfees and other expenses of $4 million in 2005 related to this transaction.

 

Theinterest rate with respect to term loan facilities will decrease by 0.25%effective March 1, 2007, as a result of the Company's Consolidated SeniorSecured Leverage Ratio decreasing to less than 3.0 to 1.0.

 

Theobligations of SSCE under the Credit Agreement are unconditionally guaranteed bythe Company and the material U.S. subsidiaries of SSCE. The obligations of SSCCanada under the Credit Agreement are unconditionally guaranteed by theCompany, SSCE, the material U.S. subsidiaries of SSCE and the material Canadiansubsidiaries of SSC Canada. The obligations of SSCE under the Credit Agreementare secured by a security interest in substantially all of the assets andproperties of the Company, SSCE (except for three paper mills) and the materialU.S. subsidiaries of SSCE, by a pledge of all of the capital stock of SSCE andthe material U.S. subsidiaries of SSCE and by a pledge of 65% of the capitalstock of SSC Canada that is directly owned by SSCE. The security interestssecuring SSCE’s 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 SSCCanada under the Credit Agreement are secured by a security interest insubstantially all of the assets and properties of SSC Canada (except threepaper mills) and the material Canadian subsidiaries of SSC Canada, by a 

 

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pledgeof all of the capital stock of the material Canadian subsidiaries of SSC Canadaand by the same U.S. assets, properties and capital stock that secure SSCE’sobligations under the Credit Agreement. The security interests securing SSCCanada’s obligation under the Credit Agreement exclude three mills and propertyrelated thereto and certain other real property located in New Brunswick andQuebec.

 

TheCredit Agreement contains various covenants and restrictions including (i)limitations on dividends, redemptions and repurchases of capital stock, (ii)limitations on the incurrence of indebtedness, liens, leases and sale-leasebacktransactions, (iii) limitations on capital expenditures and (iv) maintenance ofcertain financial covenants. The Credit Agreement also requires prepayments ifthe Company has excess cash flows, as defined, or receives proceeds fromcertain asset sales, insurance or incurrence of certain indebtedness.

 

AtDecember 31, 2006, the Company was in compliance with the financial covenantsrequired by the Credit Agreement.

 

TheCompany has entered into interest rate swap contracts effectively fixing theinterest rate at 4.3% for $300 million of the Tranche B and Tranche C variablerate term loans (See Note 10).

 

**SeniorNotes**

The9.75% unsecured senior notes of $648 million are redeemable in whole or in partat the option of SSCE at a price of 104.875% plus accrued interest. Theredemption price will decline each year after 2006 and beginning on February 1,2009 will be 100% of the principal amount, plus accrued interest.

 

The8.375% unsecured senior notes of $400 million are redeemable in whole or inpart at the option of SSCE beginning on July 1, 2007 at a price of 104.188%plus accrued interest. The redemption price will decline each year after 2007and beginning on July 1, 2010 will be 100% of the principal amount, plus accruedinterest.

 

The8.25% unsecured senior notes of $700 million are redeemable in whole or in partat the option of SSCE beginning on October 1, 2007 at a price of 104.125% plusaccrued interest. The redemption price will decline each year after 2007 andbeginning on October 1, 2010 will be 100% of the principal amount, plus accruedinterest.

 

The7.50% unsecured senior notes of $300 million are redeemable in whole or in partat the option of SSCE beginning on June 1, 2008 at a price of 103.75% plus accruedinterest. The redemption price will decline each year after 2008 and beginningon June 1, 2011 will be 100% of the principal amount, plus accrued interest.

 

The7.375% unsecured senior notes of $200 million are redeemable in whole or inpart at the option of SSCE beginning on July 15, 2009 at a price of 103.688%plus accrued interest. The redemption price will decline each year after 2009and beginning on July 15, 2012 will be 100% of the principal amount, plusaccrued interest.

 

The9.25% unsecured senior notes aggregating $2 million are not redeemable prior tomaturity.

 

Thesenior notes contain business and financial covenants which are lessrestrictive than those contained in the Credit Agreement.

 

The8.45% mortgage notes are secured by the assets of 37 corrugated containerplants. In February 2007, the Company gave notice of its intention to prepaythese notes in March 2007.

 

**2006Transactions**

In2006, the Company, as guarantor, and SSCE and SSC Canada, as borrowers, enteredinto an amendment to the Credit Agreement with its lending group permitting theCompany to use a portion of the net cash proceeds to be received from the saleof the Company’s Consumer Packaging division and additional borrowings, ifnecessary, to prepay certain 

 

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unsecureddebt. In addition, the amendment provided for the release of the lien on theassets of the Consumer Packaging division. The amendment (i) required the useof $240 million of the proceeds to prepay Tranche B term loans; (ii) permittedthe use of up to $400 million of the proceeds to prepay the unsecured seniornotes; and (iii) permitted the reinvestment of up to $250 million of thebalance of the proceeds in the business of the Company and its subsidiaries. If,after giving effect to the payments described above, the remaining balance ofthe proceeds exceeded $10 million, the Company would be required to use theremaining balance of the proceeds to make a further repayment of the term loansin accordance with the provisions of the Credit Agreement.

 

OnJune 30, 2006, the Company completed the sale of the Consumer Packagingdivision and used the proceeds to repay the following obligations:

 
| Tranche B term loan, due in various  installments through  November 1, 2011 |   | $   | 240    |   |
|----------------------------------------------------------------------------------|--------|-----|--------|--------|
| SSCE revolving credit facility, due  November 1, 2009                            |   | 218 |   |
| 9.25% unsecured senior notes, due February  1, 2008                              |   | 298 |   |
| 9.75% unsecured senior notes, due February  1, 2011                              |   | 102 |   |
| Other debt                                                                       |   | 20  |   |
| Total debt repayment                                                             |   | 878 |   |
| Tender premium and fees                                                          |   | 24  |   |
| Total application of net proceeds                                                |   | $   | 902    |   |

 

InOctober 2006, the net proceeds were reduced by $5 million as a result of finalworking capital adjustments, which were previously accrued.

 

TheCompany recorded a loss on early extinguishment of debt of $28 million relatedto the repayment of borrowings with net proceeds from the sale of its ConsumerPackaging division. The loss included $24 million for tender premiums and feesfor the unsecured senior notes called and a $4 million non-cash write-off ofrelated unamortized deferred debt issuance costs.

 

InSeptember 2006, the Company used $59 million of proceeds received from the SRCaccounts receivable securitization program to repay $50 million of theoutstanding Tranche B term loan due November 1, 2011 and $9 million of therevolving credit facility (See Note 8).

 

**Other**

InMay 2005, the Company issued environmental improvement revenue refunding bondsin the amount of $72 million. New bonds in the principal amount of $30 millionwere issued at an interest rate of 5.125% and are due in 2013. New bonds in theprincipal amount of $42 million were issued at an interest rate of 5.25% andare due in 2015. The proceeds of these bonds were used to repay $72 million ofrevenue refunding bonds at interest rates of 7.875% and 8.25%, respectively.

 

Interestcosts capitalized on construction projects in 2006, 2005 and 2004 totaled $8million, $8 million and $5 million, respectively. Interest payments on all debtinstruments for 2006, 2005 and 2004 were $360 million, $344 million and $340million, respectively.

 

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**10. Derivative Instruments and Hedging Activities**

 

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

 

**CommodityDerivative Instruments**

TheCompany uses derivative instruments, including fixed price swaps and options,to manage fluctuations in cash flows resulting from commodity price risk in theprocurement of natural gas and other commodities, including fuel and heatingoil. The objective is to fix the price of a portion of the Company’s purchasesof these commodities used in the manufacturing process. The changes in themarket value of such derivative instruments have historically offset, and areexpected to continue to offset, the changes in the price of the hedged item. Asof December 31, 2006, the maximum length of time over which the Company ishedging its exposure to the variability in future cash flows associated withthe commodities’ forecasted transactions was two years.

 

Forthe years ended December 31, 2006 and 2005, the Company reclassified a $3million loss (net of tax) and a $7 million gain (net of tax), respectively,from OCI to cost of goods sold when the hedged items were recognized. The fairvalue of the Company’s commodity derivative instruments at December 31, 2006was a $27 million liability, of which $22 million was included in other currentliabilities and $5 million was included in other long-term liabilities. Thefair value of the Company’s commodity derivative instruments at December 31,2005 was a $40 million asset, of which $31 million was included in prepaidexpenses and other current assets and $9 million was included in other assets.

 

Forthe years ended December 31, 2006 and 2005, the Company recorded a $10 millionloss (net of tax) and $2 million gain (net of tax), respectively, in cost ofgoods sold related to the change in fair value of certain commodity derivativeinstruments not qualifying for hedge accounting.

 

Forthe years ended December 31, 2006 and 2005, the Company recorded an $8 millionloss (net of tax) and $8 million gain (net of tax), respectively, in cost ofgoods sold on settled commodity derivative instruments related to commodityderivative instruments not qualifying for hedge accounting.

 

**ForeignCurrency Derivative Instruments**

TheCompany’s principal foreign exchange exposure is the Canadian dollar. TheCompany uses foreign currency derivative instruments, including forwardcontracts and options, primarily to protect against Canadian currency exchangerisk associated with expected future cash flows. As of December 31, 2006, themaximum length of time over which the Company is hedging its exposure to thevariability in future cash flows associated with foreign currency exchange riskis one year. For the years ended December 31, 2006 and 2005, the Companyreclassified a $3 million gain (net of tax) and $1 million gain (net of tax),respectively, from OCI to cost of goods sold related to the recognition of theforeign currency derivative instruments. The change in fair value of thesederivative instruments is recorded in OCI until the underlying transaction isrecorded. The fair value of the Company’s foreign currency derivativeinstruments at December 31, 2006 and 2005 was a $1 million asset and $6 millionasset, respectively, included in prepaid expenses and other current assets.

 

Forthe years ended December 31, 2006 and 2005, the Company recorded an immaterialamount and $2 million loss (net of tax), respectively, in cost of goods soldrelated to the change in fair value of certain foreign currency derivativeinstruments not qualifying for hedge accounting.

 

Forthe years ended December 31, 2006 and 2005, the Company recorded an immaterialamount and $2 million gain (net of tax), respectively, in cost of goods sold onsettled foreign currency derivative instruments not qualifying for hedgeaccounting.

 

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**InterestRate Swap Contracts**

 

TheCompany uses interest rate swap contracts to manage interest rate exposure on$300 million of the current Tranche B and Tranche C floating rate bank termdebt, effectively fixing the interest rate at 4.3%. These contracts extenduntil 2011, consistent with the maturity of the Company’s Tranche B and TrancheC term loans. Changes in the fair value of the interest rate swap contracts areexpected to be highly effective in offsetting the fluctuations in the floatinginterest rate and are recorded in OCI until the underlying transaction isrecorded. The accounting for the cash flow impact of the swap contracts isrecorded as an adjustment to interest expense each period. For the years endedDecember 31, 2006 and 2005, the Company reclassified a $1 million gain (net oftax) and $2 million loss (net of tax), respectively, from OCI when the hedgeditems were recognized.

 

Inthe second quarter of 2005, the Company entered into forward starting interestrate swaps of $225 million at a fixed rate of 4.75%, based on an expected debtrefinancing to occur in 2006. At December 31, 2005, the Company determined thatthe expected debt refinancing was no longer probable of occurring. As a result,these forward starting interest rate swaps were marked-to-market through incomeresulting in a $2 million gain (net of tax) recorded as an adjustment tointerest expense.

 

Thefair value of the Company’s interest rate swap contracts at December 31, 2006was a $9 million asset, included in other assets. The fair value of the Company’sinterest rate swap contracts at December 31, 2005 was an $11 million asset, ofwhich $3 million was included in prepaid expenses and other current assets and$8 million was included in other assets.

 

**DeferredHedge Gain (Loss)**

Thecumulative deferred hedge loss in OCI on all derivative instruments was $8million (net of tax) at December 31, 2006, including a $13 million loss (net oftax) on commodity derivative instruments, a $1 million loss (net of tax) onforeign currency derivative instruments and a $6 million gain (net of tax) oninterest rate swap contracts. The cumulative deferred hedge gain on allderivative instruments was $23 million (net of tax) at December 31, 2005,including a $16 million gain (net of tax) on commodity derivative instruments,a $2 million gain (net of tax) on foreign currency derivative instruments and a$5 million gain (net of tax) on interest rate swap contracts. The Companyexpects to reclassify an $11 million loss (net of tax) into cost of goods soldduring 2007 related to the commodity and foreign currency derivativeinstruments.

 

**11. Leases**

 

TheCompany leases certain facilities and equipment for production, selling andadministrative purposes under operating leases. Certain leases contain renewaloptions for varying periods, and others include options to purchase the leasedproperty during or at the end of the lease term. Future minimum rentalcommitments (exclusive of real estate taxes and other expenses) under operatingleases having initial or remaining noncancelable terms in excess of one year,excluding lease commitments on closed facilities, are reflected below:

 
| 2007                         |   | $   | 78     |   |
|------------------------------|--------|-----|--------|--------|
| 2008                         |   | 60  |   |
| 2009                         |   | 48  |   |
| 2010                         |   | 40  |   |
| 2011                         |   | 26  |   |
| Thereafter                   |   | 131 |   |
| Total minimum lease payments |   | $   | 383    |   |

 

Netrental expense for operating leases, including leases having a duration of lessthan one year, was approximately $150 million, $137 million and $137 millionfor 2006, 2005 and 2004, respectively, excluding rental expense related todiscontinued operations of $16 million, $30 million and $31 million in 2006,2005 and 2004, respectively.

 

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**12.****      ****Guarantees**

 

TheCompany has certain wood chip processing contracts extending from 2012 through2018 with minimum purchase commitments. As part of the agreements, the Companyguarantees the third party contractor’s debt outstanding and has a security interestin the chipping equipment. At December 31, 2006 and 2005, the maximum potentialamount of future payments related to these guarantees was approximately $34million and $36 million, respectively, and decreases ratably over the life ofthe contracts. In the event the guarantees on these contracts were called,proceeds from the liquidation of the chipping equipment would be based oncurrent market conditions and the Company may not recover in full the guaranteepayments made.

 

In2006, the Company entered into an agreement to guarantee a portion of a thirdparty’s debt in decreasing amounts through January 2010. The guarantee wasentered into in connection with the third party’s progress payment financingfor the purchase and installation of machinery and equipment for themanufacture of corrugated containerboard. The Company and the third party areparties to a supply agreement through 2021, whereby the Company sellscontainerboard to the third party, and a purchase agreement through 2014,whereby the third party sells corrugated sheets to the Company. At December 31,2006, the maximum potential amount of the future payments related to thisguarantee was approximately $12 million, and decreases as the third party’scontractual financial targets are met. The Company has no recourse to theassets of the third party, other than that of a general unsecured creditor. Thefair value of this guarantee at December 31, 2006 was an immaterial amount andis included in other assets, with an offset in other long-term liabilities inthe accompanying consolidated balance sheet.

 

**13.****      ****Asset Retirement Obligations**

 

Thefollowing provides a reconciliation of the asset retirement obligations:

 
| Balance at January 1, 2004    |       | $      | 13         |       |
|-------------------------------|------------|--------|------------|------------|
| Accretion expense             |       | 1      |       |
| Balance at  December 31, 2004 |       | 14     |       |
| Accretion expense             |       | 1      |       |
| Adjustments                   |       | (1     | )          |
| Balance at  December 31, 2005 |       | 14     |       |
| Accretion expense             |       | **1**  | ** ** |
| Adjustments                   |       | **(1** | **)**      |
| Balance at  December 31, 2006 | ** ** | **$**  | **14**     | ** ** |

 

The2005 adjustments relate to the closures of containerboard mill facilities andthe reclassification of these liabilities to a restructuring accrual. The 2006adjustments relate to revising the estimated life for certain asset retirementobligations.

 

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**14.****      ****Income Taxes**

 

Significantcomponents of the Company’s deferred tax assets and liabilities at December 31are as follows:

 
| ** **                                                                | ** ** | **2006**   | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|----------|------------|
| Deferred tax  liabilities                                                 |       |       | ** ** |     |       |
| Property, plant and equipment and  timberland                             | ** ** | **$**      | **(1,140** | **)**    | $          | (1,320 | ) |
| Inventory                                                                 | ** ** | **(41**    | **)**      | (61      | )          |
| Timber installment sale                                                   | ** ** | **(134**   | **)**      | (134     | )          |
| Other                                                                     | ** ** | **(63**    | **)**      | (29      | )          |
| Total deferred tax liabilities                                            | ** ** | **(1,378** | **)**      | (1,544   | )          |
|                                                                      | ** ** | ** ** | ** ** |     |       |
| Deferred tax assets                                                       | ** ** |       | ** ** |     |       |
| Employee benefit plans                                                    | ** ** | **313**    | ** ** | 310      |       |
| Net operating loss, alternative minimum tax  and tax credit carryforwards | ** ** | **583**    | ** ** | 925      |       |
| Purchase accounting liabilities                                           | ** ** | **13**     | ** ** | 6        |       |
| Restructuring                                                             | ** ** | **16**     | ** ** | 17       |       |
| Other                                                                     | ** ** | **144**    | ** ** | 94       |       |
| Total deferred tax assets                                                 | ** ** | **1,069**  | ** ** | 1,352    |       |
| Valuation allowance for deferred tax assets                               | ** ** | **(36**    | **)**      | (208     | )          |
|                                                                      | ** ** |       | ** ** |     |       |
| Net deferred tax assets                                                   | ** ** | **1,033**  | ** ** | 1,144    |       |
|                                                                      | ** ** |       | ** ** |     |       |
| Net deferred tax liabilities                                              | ** ** | **$**      | **(345**   | **)**    | $          | (400 | ) |

 

AtDecember 31, 2006, the Company had $943 million of net operating loss (“NOL”)carryforwards for U.S. federal income tax purposes that expire from 2018through 2025, with a tax value of $330 million. The Company had NOLcarryforwards for state purposes with a tax value of $87 million, which expirefrom 2007 to 2023. A valuation allowance of $36 million exists for a portion ofthese deferred tax assets. Substantially all of the valuation allowance wasrecorded in connection with a prior purchase business combination and areduction in the valuation allowance would result principally in acorresponding reduction to goodwill. Further, the Company had $206 million ofNOL carryforwards for Canadian tax purposes that expire from 2007 to 2013, witha tax value of $68 million, and Canadian investment tax credits that expirefrom 2013 to 2016, with a tax value of $5 million. The Company had $84 millionof alternative minimum tax credit carryforwards for U.S. federal income taxpurposes, which are available indefinitely. In addition, the Company had othertax carryforwards of $9 million at December 31, 2006, which can be carriedforward indefinitely. Deferred income taxes related to NOL carryforwards havebeen classified as noncurrent to reflect the expected utilization of thecarryforwards.

 

Thesale of the Consumer Packaging division (See Note 2) generated a taxable gainfor U.S. income tax purposes that was offset by available NOL carryforwards, aportion of which was subject to valuation allowances previously established ina prior purchase business combination. Due to the utilization of these NOLcarryforwards, the related valuation allowance was reduced by $157 million inthe second quarter of 2006 with a corresponding reduction in goodwill relatedto the prior business combination. Due to the expiration and non-utilization ofstate NOL carryforwards, the related valuation allowance was reduced by anadditional $15 million in 2006.

 

InOctober 2004, the American Jobs Creation Act (the “AJCA”) was signed into law. TheAJCA includes a temporary incentive for U.S. multinationals to repatriateforeign earnings by providing an elective 85% dividends received deduction forcertain cash dividends from controlled foreign corporations. Under this law, inDecember 2005, the Company repatriated dividends of $483 million from earningsof foreign subsidiaries previously considered indefinitely reinvested. Theincome tax expense associated with the repatriation was $34 million. Excluding therepatriation discussed above, through December 31, 2006, 

 

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noprovision has been made for income taxes on the remaining undistributedearnings of the Company’s foreign subsidiaries, as the Company intends toindefinitely reinvest such earnings in its foreign subsidiaries.

 

Benefitfrom income taxes on loss from continuing operations before income taxes is asfollows:

 
| ** **                      | ** ** | **2006** | ** ** | **2005**   | ** ** | **2004** | ** ** |
|---------------------------------|------------|----------|------------|------------|------------|----------|------------|
| Current                         |       |     | ** ** |       |       |     |       |
| Federal                         | ** ** | **$**    | **(14**    | **)**      | $          | (10      | )          | $ |   |   |
| State and local                 | ** ** | **(1**   | **)**      | (5         | )          | (1       | )          |
| Foreign                         | ** ** | **(6**   | **)**      | (21        | )          | (16      | )          |
| Total current benefit (expense) | ** ** | **(21**  | **)**      | (36        | )          | (17      | )          |
|                            |       |     | ** ** |       |       |     |       |
| Deferred                        |       |     | ** ** |       |       |     |       |
| Federal                         | ** ** | **38**   | ** ** | 176        |       | 94       |       |
| State and local                 | ** ** | **4**    | ** ** | 34         |       | 16       |       |
| Foreign                         | ** ** | **19**   | ** ** | 67         |       | 6        |       |
| Total deferred benefit          | ** ** | **61**   | ** ** | 277        |       | 116      |       |
| Total benefit from income taxes | ** ** | **$**    | **40**     | ** ** | $          | 241      |       | $ | 99 |   |

 

TheCompany’s benefit from income taxes differed from the amount computed byapplying the statutory U.S. federal income tax rate to loss from continuingoperations before income taxes as follows:

 
| ** **                                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| U.S. federal  income tax benefit at federal statutory rate | ** ** | **$**    | **39**     |     | $          | 217      |       | $ | 69 |   |
| Permanent  differences and other items                     | ** ** | **(3**   | **)**      | 53       |       | 16       |       |
| State income  taxes, net of federal income tax effect      | ** ** | **3**    |       | 19       |       | 10       |       |
| Foreign  taxes                                             | ** ** | **1**    |       | (14      | )          | 4        |       |
| Repatriation  of foreign earnings                          |       |     |       | (34      | )          |     |       |
| Total  benefit from income taxes                           | ** ** | **$**    | **40**     |     | $          | 241      |       | $ | 99 |   |

 

TheCompany has settled the Internal Revenue Service examinations of tax yearsthrough 2003. Permanent differences in the preceding table include benefits of$44 million and $10 million in 2005 and 2004, respectively, for the resolutionof tax matters related to prior years.

 

Thecomponents of the loss from continuing operations before income taxes are asfollows:

 
| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| United  States                                       | ** ** | **$**    | **(70**    | **)**    | $          | (442     | )          | $ | (239 | ) |
| Foreign                                              | ** ** | **(40**  | **)**      | (177     | )          | 40       |       |
| Loss from  continuing operations before income taxes | ** ** | **$**    | **(110**   | **)**    | $          | (619     | )          | $ | (199 | ) |

 

TheCanadian Revenue Agency is currently examining the years 1999 through 2005 ofthe Company’s Canadian subsidiaries. While the ultimate results cannot bepredicted with certainty, the Company’s management believes that theexamination will not have a material adverse effect on its consolidatedfinancial condition or results of operations, and that the accrued taxliabilities are adequate for all years.

 

TheCompany made income tax payments of $37 million, $36 million and $18 million in2006, 2005 and 2004, respectively.

 

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**15.****      ****Employee Benefit Plans**

 

**DefinedBenefit Plans**

TheCompany sponsors noncontributory defined benefit pension plans for its U.S.employees and also sponsors noncontributory and contributory defined benefitpension plans for its Canadian employees. The Company’s defined benefit pensionplans cover substantially all hourly employees, as well as salaried employeeshired prior to January 1, 2006. The Company’s pension plans’ weighted-averageasset allocations at December 31 by asset category are as follows:

 
| ** **         | ** ** | **U.S. Plans** |       | **Canadian Plans** | ** ** |
|--------------------|------------|----------------|------------|--------------------|------------|
| ** **         | ** ** | **2006**       | ** ** | **2005**           |       | **2006** | ** ** | **2005** | ** ** |
| ** **         | ** ** | ** **     | ** ** | ** **         |       | ** ** | ** ** | ** ** | ** ** |
| Cash  equivalents  | ** ** | **3**          | **%**      | 3                  | %          | **1** | **%** | 1 | % |
| Debt  securities   | ** ** | **33**         | **%**      | 35                 | %          | **42** | **%** | 43 | % |
| Equity  securities | ** ** | **63**         | **%**      | 61                 | %          | **54** | **%** | 53 | % |
| Real estate        | ** ** | ** **     | ** ** |               |       | **3** | **%** | 3 | % |
| Other              | ** ** | **1**          | **%**      | 1                  | %          |   | ** ** |   |   |
| Total              | ** ** | **100**        | **%**      | 100                | %          | **100** | **%** | 100 | % |

 

Equitysecurities for the U.S. plans at December 31, 2006 and 2005 include 2.7 millionshares of SSCC common stock with a market value of approximately $28 millionand $38 million, respectively (1% and 2%, respectively, of total U.S. planassets).

 

Theprimary objective of the Company’s investment policy is to provide eligibleemployees with scheduled pension benefits. The basic strategy of thisinvestment policy is to earn the highest risk adjusted rate of return on assetsconsistent with prudent investor standards identified in the EmployeeRetirement Income Security Act of 1974 for the U.S. plans and the QuebecSupplemental Pension Plans Act and other applicable legislation in Canada forthe Canadian plans. In identifying the target asset allocation that would bestmeet the above policy, consideration is given to a number of factors includingthe various pension plans’ demographic characteristics, the long-term nature ofthe liabilities, the sensitivity of the liabilities to interest rates andinflation, the long-term return expectations and risks associated with keyasset classes as well as their return correlation with each other,diversification among asset classes and other practical considerations forinvesting in certain asset classes. The target asset allocation for the pensionplans during a complete market cycle is as follows:

 
| ** **                 | ** ** | **U.S. Plans** | ** ** | **Canadian Plans** | ** ** |
|----------------------------|------------|----------------|------------|--------------------|------------|
| Equity  securities         |       | 58%            |       | 52%                |       |
| Debt  securities           |       | 35%            |       | 45%                |       |
| Alternative  asset classes |       | 7%             |       | 3%                 |       |

 

EffectiveJanuary 1, 2007, the Company’s salaried defined benefit pension plan formulaswere adjusted to reduce the future benefits earned by employees. The impact ofthese changes will decrease 2007 expense by approximately $8 million.

 

65

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**PostretirementHealth Care and Life Insurance Benefits**

TheCompany provides certain health care and life insurance benefits for allretired salaried and certain retired hourly employees, and for salaried andcertain hourly employees who have reached the age of 60 with ten years ofservice as of January 1, 2007. The assumed health care cost trend rates used inmeasuring the accumulated postretirement benefit obligation (“APBO”) atDecember 31 are as follows:

 
| ** **                                                                         | ** ** | **2006**       | ** ** | **2005**   | ** ** |
|------------------------------------------------------------------------------------|------------|----------------|------------|------------|------------|
| **U.S.  Plans**                                                                    | ** ** | ** **     | ** ** | ** ** | ** ** |
| Health care cost trend rate assumed for  next year                                 | ** ** | **9.00%**      | ** ** | 10.00%     |       |
| Rate to which the cost trend rate is  assumed to decline (the ultimate trend rate) | ** ** | **5.00%**      | ** ** | 5.00%      |       |
| Year the rate reaches the ultimate trend  rate                                     | ** ** | **2011**       | ** ** | 2011       |       |
| **Foreign  Plans**                                                                 | ** ** | ** **     | ** ** | ** ** | ** ** |
| Health care cost trend rate assumed for  next year                                 | ** ** | **8.30-9.20%** | ** ** | 8.30-9.20% |       |
| Rate to which the cost trend rate is  assumed to decline (the ultimate trend rate) | ** ** | **4.80-4.90%** | ** ** | 4.80-4.90% |       |
| Year the rate reaches the ultimate trend  rate                                     | ** ** | **2014**       | ** ** | 2011       |       |

 

Theeffect of a 1% change in the assumed health care cost trend rate wouldincrease/(decrease) the APBO as of December 31, 2006 by $18 million and $15million, respectively, and would increase/(decrease) the annual net periodicpostretirement benefit cost by $2 million for 2006.

 

InDecember 2005, the Company announced the elimination of postretirement healthcare and related life insurance benefits for all salaried and certain hourlyemployees who have not reached the age of 60 with 10 years of service as ofJanuary 1, 2007. As a result of the plan changes, the Company recorded an $8million curtailment gain in 2005.

 

TheConsumer Packaging division employees participated in the Company’s definedbenefit pension and postretirement plans through June 30, 2006 (See Note 2). Theassociated defined benefit pension and postretirement plan liabilities areincluded in the Company’s total benefit obligations. The related definedbenefit pension and postretirement expense is included through June 30, 2006.

 

66

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Thefollowing provides a reconciliation of benefit obligations, plan assets andfunded status of the plans:

 
| ** **                                                                         | ** **   | **Defined Benefit   Plans** |         | **Postretirement   Plans** | ** ** |
|------------------------------------------------------------------------------------|--------------|-----------------------------|--------------|----------------------------|------------|
| ** **                                                                         | ** **   | **2006**                    | ** **   | **2005**                   |       | **2006** | ** ** | **2005** | ** ** |
| **Change  in benefit obligation:**                                                 | ** **   | ** **                  | ** **   | ** **                 |       | ** ** | ** ** | ** ** | ** ** |
| Benefit  obligation at January 1                                                   | ** **   | **$**                       | **3,591**    | ** **                 | $          | 3,336 |   | **$** | **260** |   | $ | 283 |   |
| Service cost                                                                       | ** **   | **68**                      | ** **   | 81                         |       | **5** |   | 7 |   |
| Interest  cost                                                                     | ** **   | **196**                     | ** **   | 189                        |       | **13** |   | 16 |   |
| Amendments                                                                         | ** **   | **8**                       | ** **   | 8                          |       | **(4** | **)** | (21 | ) |
| Settlements                                                                        | ** **   | **(36**                     | **)**        | ** **                 | ** ** | **(1** | **)** | ** ** | ** ** |
| Curtailments                                                                       | ** **   | **(26**                     | **)**        | (11                        | )          | **(13** | **)** | (1 | ) |
| Actuarial  loss (gain)                                                             | ** **   | **(78**                     | **)**        | 123                        |       | **(16** | **)** | (7 | ) |
| Plan  participants’ contributions                                             | ** **   | **6**                       | ** **   | 6                          |       | **13** | ** ** | 16 |   |
| Benefits  paid and expected expenses                                               | ** **   | **(190**                    | **)**        | (173                       | )          | **(24** | **)** | (35 | ) |
| Foreign  currency rate changes                                                     | ** **   | **2**                       | ** **   | 32                         |       |   |   | 2 |   |
| Benefit  obligation at December 31                                                 | ** **   | **$**                       | **3,541**    | ** **                 | $          | 3,591 |   | **$** | **233** |   | $ | 260 |   |
|                                                                               |         |                        | ** **   |                       |       |   |   |   |   |
| **Change  in plan assets:**                                                        | ** **   | ** **                  | ** **   | ** **                 |       | ** ** | ** ** | ** ** | ** ** |
| Fair value  of plan assets at January 1                                            | ** **   | **$**                       | **2,700**    | ** **                 | $          | 2,466 |   | **$** | ** ** | ** ** | **$** | ** ** | ** ** |
| Actual  return on plan assets                                                      | ** **   | **279**                     | ** **   | 200                        |       |   |   |   |   |
| Settlements                                                                        | ** **   | **(36**                     | **)**        | ** **                 |       | ** ** | ** ** | ** ** | ** ** |
| Employer  contributions                                                            | ** **   | **147**                     | ** **   | 174                        |       | **11** |   | 19 |   |
| Plan  participants’ contributions                                             | ** **   | **6**                       | ** **   | 6                          |       | **13** |   | 16 |   |
| Benefits  paid                                                                     | ** **   | **(186**                    | **)**        | (169                       | )          | **(24** | **)** | (35 | ) |
| Foreign  currency rate changes                                                     | ** **   | **(2**                      | **)**        | 23                         |       |   |   |   |   |
| Fair value  of plan assets at December 31                                          | ** **   | **$**                       | **2,908**    | ** **                 | $          | 2,700 |   | **$** | ** ** | ** ** | **$** | ** ** | ** ** |
|                                                                               |         |                        | ** **   |                       |       |   |   |   |   |
| **Over  (under) funded status:**                                                   | ** **   | **$**                       | **(633**     | **)**                      | $          | (891 | ) | **$** | **(233** | **)** | $ | (260 | ) |
| Unrecognized  actuarial loss                                                       |         |                        |         | 823                        |       |   |   | 61 |   |
| Unrecognized  prior service cost (benefit)                                         |         |                        |         | 74                         |       |   |   | (30 | ) |
| Net amount  recognized                                                             | ** **   | **$**                       | **(633**     | **)**                      | $          | 6 |   | **$** | **(233** | **)** | $ | (229 | ) |
|                                                                               |         |                        |         |                       |       |   |   |   |   |
| ***For years prior to adoption of the funded  status provisions of SFAS No. 158*** | *** *** | *** ***                | *** *** | *** ***               | * *   | *** *** | *** *** | *** *** | *** *** |
| *** ***                                                                       | *** *** | *** ***                | *** *** | *** ***               | * *   | *** *** | *** *** | *** *** | *** *** |
| **Amounts recognized in the balance sheet:**                                       | ** **   | ** **                  | ** **   | ** **                 |       | ** ** | ** ** | ** ** | ** ** |
| Accrued benefit liability                                                          |         |                        |         |                       | $          | (710 | ) |   |   | $ | (229 | ) |
| Intangible asset                                                                   |         |                        |         | 77                         |       |   |   |   |   |
| Accumulated other comprehensive (income)  loss                                     |         |                        |         | 639                        |       |   |   |   |   |
| Net asset (liability) recognized in balance  sheet                                 |         |                        |         |                       | $          | 6 |   |   |   | $ | (229 | ) |

 

67

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| ** **                                                                                                     | ** **   | **Defined Benefit** | ** **   | **Postretirement** | ** **   |
|----------------------------------------------------------------------------------------------------------------|--------------|--------------------------|--------------|--------------------|--------------|
| ** **                                                                                                     | ** **   | **Plans**                | ** **   | **Plans**          | ** **   |
| ** **                                                                                                     | ** **   | **2006**                 | ** **   | **2006**           | ** **   |
| ***For years subsequent to adoption of the  funded status provisions of SFAS No. 158***                        | *** *** | *** ***             | *** *** | *** ***       | *** *** |
| ** **                                                                                                     | ** **   | ** **               | ** **   | ** **         | ** **   |
| **Amounts recognized in the balance sheet:**                                                                   | ** **   | ** **               | ** **   | ** **         | ** **   |
| Current liabilities                                                                                            | ** **   | **$**                    | **(8**       | **)**              | **$**        | **(18** | **)** |
| Non-current liabilities                                                                                        | ** **   | **(625**                 | **)**        | **(215**           | **)**        |
| Net liability recognized in balance sheet                                                                      | ** **   | **$**                    | **(633**     | **)**              | **$**        | **(233** | **)** |
| **Reconciliation of amounts recognized in  accumulated OCI to net liability recognized in the balance sheet:** | ** **   | ** **               | ** **   | ** **         | ** **   |
| Prior service credit (cost)                                                                                    | ** **   | **$**                    | **(58**      | **)**              | **$**        | **25** | ** ** |
| Net actuarial gain (loss)                                                                                      | ** **   | **(586**                 | **)**        | **(29**            | **)**        |
| Accumulated other comprehensive income  (loss)                                                                 | ** **   | **(644**                 | **)**        | **(4**             | **)**        |
| Prepaid (unfunded accrued) benefit cost                                                                        | ** **   | **34**                   | ** **   | **(229**           | **)**        |
| Foreign currency remeasurement                                                                                 | ** **   | **(23**                  | **)**        | ** **         | ** **   |
| Net liability recognized in balance sheet                                                                      | ** **   | **$**                    | **(633**     | **)**              | **$**        | **(233** | **)** |
| ** **                                                                                                     | ** **   | ** **               | ** **   | ** **         | ** **   |
| **Change in accumulated OCI due to  application of SFAS No. 158:**                                             | ** **   | ** **               | ** **   | ** **         | ** **   |
| Additional minimum liability before SFAS  No. 158                                                              | ** **   | **$**                    | **(529**     | **)**              | **$**        | ** ** | ** ** |
| Intangible asset offset before SFAS No. 158                                                                    | ** **   | **62**                   | ** **   | ** **         | ** **   |
| Accumulated other comprehensive income  (loss) before SFAS No. 158                                             | ** **   | **(467**                 | **)**        | ** **         | ** **   |
| Net increase in accumulated other  comprehensive income (loss) due to SFAS No. 158                             | ** **   | **(177**                 | **)**        | **(4**             | **)**        |
| Accumulated other comprehensive income  (loss) subsequent to adoption of SFAS No. 158                          | ** **   | **(644**                 | **)**        | **(4**             | **)**        |
| Deferred income taxes                                                                                          | ** **   | **243**                  | ** **   | **1**              | ** **   |
| Accumulated other comprehensive income  (loss) subsequent to adoption of SFAS No. 158, net of tax              | ** **   | **$**                    | **(401**     | **)**              | **$**        | **(3** | **)** |
| ** **                                                                                                     | ** **   | ** **               | ** **   | ** **         | ** **   |
| **Estimated amounts to be amortized from  accumulated OCI over the next fiscal year:**                         | ** **   | ** **               | ** **   | ** **         | ** **   |
| Prior service credit (cost)                                                                                    | ** **   | **$**                    | **(8**       | **)**              | **$**        | **3** | ** ** |
| Net actuarial gain (loss)                                                                                      | ** **   | **(60**                  | **)**        | **(2**             | **)**        |
| Total                                                                                                          | ** **   | **$**                    | **(68**      | **)**              | **$**        | **1** | ** ** |

 

**Incrementaleffect of applying SFAS No. 158 on individual line items in the December 31,2006 balance sheet :**

 
| ** **                                      | ** ** | **Before  application of  SFAS No. 158** | ** ** | **Adjustments** | ** ** | **After  application of  SFAS No. 158** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------|------------|--------------------------------------------------------|------------|
| Other assets                                    |       | **$**                                                   | **266**    | ** **      | **$**      | **(62**                                                | **)**      | **$** | **204** | ** ** |
| Total assets                                    |       | **7,839**                                               | ** ** | **(62**         | **)**      | **7,777**                                              | ** ** |
| Other long-term liabilities                     |       | **891**                                                 | ** ** | **119**         | ** ** | **1,010**                                              | ** ** |
| Deferred income taxes                           |       | **409**                                                 | ** ** | **(66**         | **)**      | **343**                                                | ** ** |
| Accumulated other comprehensive income  (loss)  |       | **(297**                                                | **)**      | **(115**        | **)**      | **(412**                                               | **)**      |
| Total stockholders’ equity                 |       | **1,922**                                               | ** ** | **(115**        | **)**      | **1,807**                                              | ** ** |
| Total liabilities and stockholders’ equity |       | **7,839**                                               | ** ** | **(62**         | **)**      | **7,777**                                              | ** ** |
|                                                 |            |                                                         |            |                 |            |                                                        |            |  |  |  |

 

68

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Theaccumulated benefit obligation for all defined benefit pension plans was $3,406million and $3,411 million at December 31, 2006 and 2005, respectively.

 

Theprojected benefit obligation, accumulated benefit obligation and fair value ofplan assets for the pension plans with accumulated benefit obligations inexcess of plan assets were $3,424 million, $3,304 million, and $2,803 million,respectively, as of December 31, 2006 and $3,578 million, $3,400 million, and$2,688 million, respectively, as of December 31, 2005.

 

Theprojected benefit obligation and fair value of plan assets for the pensionplans with projected benefit obligations in excess of plan assets were $3,540million and $2,906 million, respectively, as of December 31, 2006 and $3,590million and $2,699 million, respectively, as of December 31, 2005.

 

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

 
| ** **                                    | ** ** | **Defined Benefit Plans** | ** ** | **Postretirement Plans** | ** ** |
|-----------------------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **2006**                            | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                                  | ** ** | **$**                               | **68**     |                          | $          | 81 |   | $ | 72 | ** ** | **$** | **5** |   | $ | 7 |   | $ | 7 |   |
| Interest cost                                 | ** ** | **196**                             |       | 189                           |       | 183 | ** ** | **13** |   | 16 |   | 16 |   |
| Expected return on plan assets                | ** ** | **(224**                            | )          | (210                          | )          | (194 | ) |   |   |   |   |   |   |
| Amortization of prior service cost  (benefit) | ** ** | **9**                               |       | 10                            |       | 10 | ** ** | **(3** | **)** | (2 | ) | (2 | ) |
| Amortization of net loss                      | ** ** | **71**                              |       | 62                            |       | 49 | ** ** | **3** | ** ** | 4 |   | 5 |   |
| Curtailment (gain) loss                       | ** ** | **16**                              |       | 4                             |       | 3 | ** ** | **(5** | **)** | (8 | ) |   |   |
| Settlement                                    | ** ** | **7**                               | ** ** | ** **                    | ** ** |   |   | **(1** | **)** |   |   |   |   |
| Multi-employer plans                          | ** ** | **4**                               |       | 6                             |       | 6 |   |   |   |   |   |   |   |
| Net periodic benefit cost                     | ** ** | **$**                               | **147**    |                          | $          | 142 |   | $ | 129 | ** ** | **$** | **12** |   | $ | 17 |   | $ | 26 |   |

 

The2006 curtailment (gains) losses are related to the sale of the ConsumerPackaging division and are included in the net loss on disposition ofdiscontinued operations (See Note 2).

 

The2006 settlement charges are related to closed facilities and are included as partof restructuring charges (See Note 3).

 

Theweighted average assumptions used to determine the benefit obligations atDecember 31 are as follows:

 
| ** **                    | ** ** | **Defined Benefit Plans** | ** ** | **Postretirement Plans** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|
| ** **                    | ** ** | **2006**                            | ** ** | **2005**                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **U.S. Plans**                |       |                                |       |                          |       |   |   |   |   |
| Discount rate                 | ** ** | **5.84**                            | **%**      | 5.61                          | %          | **5.84** | **%** | 5.61 | % |
| Rate of compensation increase | ** ** | **3.11**                            | **%**      | 3.11                          | %          | **N/A** | ** ** | N/A |   |
| **Foreign Plans**             |       |                                | ** ** |                          |       |   | ** ** |   |   |
| Discount rate                 | ** ** | **5.10**                            | **%**      | 5.00                          | %          | **5.10** | **%** | 5.00 | % |
| Rate of compensation increase | ** ** | **3.40**                            | **%**      | 3.60                          | %          | **N/A** | ** ** | N/A |   |

 

69

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Theweighted average assumptions used to determine net periodic benefit cost forthe years ended December 31 are as follows:

 
| ** **                               | ** ** | **Defined Benefit Plans** | ** ** | **Postretirement Plans** | ** ** |
|------------------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|
| ** **                               | ** ** | **2006**                            | ** ** | **2005**                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **U.S. Plans**                           |       |                                |       |                          |       |   |   |   |   |
| Discount rate                            | ** ** | **5.61-6.36%**                      | ** ** | 5.84%                         |       | **5.61-6.36%** | ** ** | 5.84% |   |
| Expected long-term return on plan assets | ** ** | **8.75%**                           | ** ** | 9.00%                         |       | **N/A** | ** ** | N/A |   |
| Rate of compensation increase            | ** ** | **3.11%**                           | ** ** | 4.00%                         |       | **N/A** | ** ** | N/A |   |
| **Foreign Plans**                        |       |                                | ** ** |                          |       |   | ** ** |   |   |
| Discount rate                            | ** ** | **5.00%**                           | ** ** | 5.75%                         |       | **5.00%** | ** ** | 5.75% |   |
| Expected long-term return on plan assets | ** ** | **7.75-8.00%**                      | ** ** | 7.75-8.00%                    |       | **N/A** |   | N/A |   |
| Rate of compensation increase            | ** ** | **3.60%**                           | ** ** | 3.95%                         |       | **N/A** |   | N/A |   |

 

Asa result of the Consumer Packaging division sale on June 30, 2006, the Companycompleted a remeasurement for the U.S. defined benefit pension andpostretirement plans resulting in the discount rate being changed from 5.61% to6.36%. The impact of the discount rate change reduced defined benefit pensionand postretirement plan expense by approximately $13 million in the second halfof 2006.

 

EffectiveJanuary 1, 2007, the expected long-term rate of return using the current targetasset allocation for U.S. and foreign pension plans is 8.50% and 7.75%,respectively. The fundamental assumptions behind the expected rate of returnare the cumulative effect of several estimates, including the anticipated yieldon high quality debt securities, the equity risk premium earned by investing inequity securities over a long-term time horizon and active investmentmanagement.

 

TheCompany expects to contribute $140 million to its defined benefit plans and $18million to its postretirement plans in 2007.

 

**ExpectedFuture Benefit Plan Payments**

 

Expectedfuture benefit plan payments to participants, which reflect expected futureservice, are as follows:

 
| ** ** | ** ** | **Defined Benefit Plans** | ** ** | **Postretirement Plans** | ** ** |
|------------|------------|-------------------------------------|------------|-------------------------------|------------|
| 2007       |       | 211                                 |       |                          | 18         |   |
| 2008       |       | 211                                 |       |                          | 18         |   |
| 2009       |       | 214                                 |       |                          | 18         |   |
| 2010       |       | 223                                 |       |                          | 18         |   |
| 2011       |       | 229                                 |       |                          | 18         |   |
| 2012-2016  |       | 1,266                               |       |                          | 90         |   |

 

Thedefined benefit plan payments in 2007 include lump sum settlement payments toemployees terminated during 2006 (See Note 3).

 

**SavingsPlans**

 

TheCompany sponsors voluntary savings plans covering substantially all salariedand certain hourly employees. The Company match was paid in SSCC common stockthrough 2005, up to an annual maximum. Beginning in 2006, the Company match ispaid according to the employees’ selected investment allocation. The Company’sexpense for the savings plans totaled $21 million in 2006 and $23 million ineach of 2005 and 2004.

 

70

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**16.  Preferred Stock**

 

Theholders of the Company’s preferred stock are entitled to cumulative dividendsof $0.4375 per quarter, payable in cash except in certain circumstances. SSCChad approximately 4.6 million shares of preferred stock issued and outstandingas of December 31, 2006 and 2005. Preferred stock dividends of $8 million werepaid during 2006, 2005 and 2004. Preferred stock accretion of $4 million in2006 and 2005 and $3 million in 2004 was charged to stockholders’ equity. Theholders of preferred stock are not entitled to voting rights on matterssubmitted to the Company’s stockholders. The preferred stock is convertible, atthe option of the holder, into shares of SSCC common stock at a conversionprice of $34.28 (equivalent to a conversion rate of 0.729 shares of SSCC commonstock for each share of preferred stock), subject to adjustment based oncertain events. The preferred stock may alternatively be exchanged, at theoption of the Company, for new 7% Convertible Subordinated Exchange Debenturesdue February 15, 2012. The preferred stock is redeemable at the Company’soption until February 15, 2012, at which time the preferred stock must beredeemed. The preferred stock may be redeemed, at the Company’s option, withcash or SSCC common stock with an equivalent fair value. The redemption priceis 100% of the liquidation preference. It is the Company’s intention to redeemthe preferred stock with SSCC common stock. The liquidation preference is $25per share plus dividends accrued and unpaid.

 

**17.  Stockholder Rights Plan**

 

InSeptember 2002, the Company adopted a stockholder rights plan under which theBoard of Directors declared a dividend of one preferred stock purchase right (“Right”)for each outstanding share of the Company’s common stock held of record as ofthe close of business on September 17, 2002. Each Right entitles the holder topurchase one one-thousandth of a share of Series B Junior ParticipatingPreferred Stock (“Preferred Stock”). The Rights become exercisable following apublic announcement that an acquiring person (“Acquiring Person”), asdetermined by the Board of Directors, has obtained beneficial ownership of 15%or more of the outstanding shares of the Company’s common stock or commenced atender or exchange offer that would result in such ownership threshold beingattained. Each Right, if and when it becomes exercisable, will entitle holdersof the Rights (other than an Acquiring Person), upon payment of the exerciseprice, to the number of shares of Preferred Stock having a fair value equal toapproximately two times the exercise price. In addition, if after a person orgroup becomes an Acquiring Person and the Company was acquired in a merger orother business combination, each holder of Rights (other than an AcquiringPerson) will have the right to acquire, upon payment of the exercise price,that number of shares of common stock of the acquiring company having a fairvalue equal to approximately two times the exercise price. The Rights expire onSeptember 9, 2012 unless earlier redeemed or exchanged by the Company.

 

71

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**18.  Accumulated Other Comprehensive Income (Loss)**

 

Accumulatedother comprehensive income (loss), net of tax is as follows:

 
| ** **                                         | ** ** | **Foreign  Currency  Translation  Adjustments** | ** ** | **Employee  Benefit Plans  Liability  Adjustments** | ** ** | **Deferred  Hedge  Gain  (Loss)** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------|------------|
| Balance at January 1, 2004                         |       | $                                               | 11         |                                                     | $          | (301                              | )          | $                                                         | 1          |   | $ | (289 | ) |
| Net changes in fair value of hedging  transactions |       |                                            |       |                                                     |       | (4                                | )          | (4                                                        | )          |
| Net gain reclassified into earnings                |       |                                            |       |                                                     |       | (3                                | )          | (3                                                        | )          |
| Current period change                              |       | (4                                              | )          | (14                                                      | )          |                              |       | (18                                                       | )          |
| Balance at December 31, 2004                       |       | 7                                               |       | (315                                                     | )          | (6                                | )          | (314                                                      | )          |
| Net changes in fair value of hedging  transactions |       |                                            |       |                                                     |       | 35                                |       | 35                                                        |       |
| Net gain reclassified into earnings                |       |                                            |       |                                                     |       | (6                                | )          | (6                                                        | )          |
| Current period change                              |       | (7                                              | )          | (81                                                      | )          |                              |       | (88                                                       | )          |
| Balance at December 31, 2005                       |       |                                            |       | (396                                                     | )          | 23                                |       | (373                                                      | )          |
| Net changes in fair value of hedging  transactions | ** ** | ** **                                      | ** ** | ** **                                               | ** ** | **(30**                           | **)**      | **(30**                                                   | **)**      |
| Net gain reclassified into earnings                | ** ** | ** **                                      | ** ** | ** **                                               | ** ** | **(1**                            | **)**      | **(1**                                                    | **)**      |
| Current period change                              | ** ** | ** **                                      | ** ** | **107**                                                  | ** ** | ** **                        | ** ** | **107**                                                   | ** ** |
| Adjustment to initially apply SFAS No. 158         | ** ** | ** **                                      | ** ** | **(115**                                                 | **)**      | ** **                        | ** ** | **(115**                                                  | **)**      |
| Balance at December 31, 2006                       | ** ** | **$**                                           | ** ** | **$**                                                    | **(404**   | **)**                             | **$**      | **(8**                                                    | **)**      | **$** | **(412** | **)** |
|                                                    |            |                                                 |            |                                                          |            |                                   |            |                                                           |            |  |  |  |  |

 

**19. Earnings Per Share**

 

Thefollowing table sets forth the computation of basic and diluted earnings pershare:

 
| ** **                                                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Numerator:                                                                                                   |       |     |       |     |       |     |       |
| Loss from continuing operations                                                                              | ** ** | **$**    | **(70**    | **)**    | $          | (378     | )          | $ | (100 | ) |
| Preferred stock dividends and accretion                                                                      | ** ** | **(12**  | **)**      | (12      | )          | (11      | )          |
| Net loss from continuing operations  available to common stockholders                                        | ** ** | **$**    | **(82**    | **)**    | $          | (390     | )          | $ | (111 | ) |
|                                                                                                         |       |     |       |     |       |     |       |
| Denominator:                                                                                                 |       |     |       |     |       |     |       |
| Denominator for basic and diluted earnings  per share – weighted average shares and assumed conversions | ** ** | **255**  |       | 255      |       | 253      |       |
|                                                                                                         |       |     |       |     |       |     |       |
| Basic and diluted earnings per share from  continuing operations                                             | ** ** | **$**    | **(.32**   | **)**    | $          | (1.53    | )          | $ | (.44 | ) |

 

Convertiblepreferred stock to acquire three million shares of common stock with an effectof $12 million, $12 million, and $11 million on net loss from continuingoperations available to common stockholders for 2006, 2005 and 2004, respectively,is excluded from the diluted earnings per share computation because they areantidilutive for all years presented. Employee stock options and non-vestedRSUs are excluded from the diluted earnings per share calculation for 2006,2005 and 2004 because they are antidilutive.

 

72

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**20.  Goodwill and Other Intangible Assets**

 

TheCompany has completed the required annual impairment tests and determined thereto be no impairment.

 

During2006, the Consumer Packaging segment goodwill of $279 million was eliminated aspart of the Consumer Packaging division sale (See Note 2). Goodwill was alsoreduced by $157 million as a result of a reduction of the valuation allowancesassociated with NOL carryforwards utilized as a result of the sale (See Note14).

 

During 2004, theCompany preliminarily allocated $12 million to intangible assets related to theacquisition of the remaining 15% of IPC, a corrugated container facility inMilwaukee, Wisconsin. In 2005, the Company completed its allocation of thepurchase price related to IPC, resulting in the reclassification of $8 millionfrom intangible assets to goodwill (See Note 5).

 

**Goodwill**

 

Thefollowing table summarizes the activity of goodwill by segment:

 
| ** **                                                                                           | ** ** | **Containerboard  & Corrugated  Containers** | ** ** | **Consumer  Packaging** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------|------------|------------|------------|
| Balance at January 1, 2005                                                                           |       | $                                                     | 3,022      |                    | $          | 279        |       | $ | 3,301 |   |
| Adjustment                                                                                           |       | 8                                                     |       |                    |       | 8          |       |
| Balance at December 31, 2005                                                                         |       | 3,030                                                 |       | 279                     |       | 3,309      |       |
| Goodwill included in loss on disposition of  discontinued operations                                 | ** ** | ** **                                            | ** ** | **(279**                | **)**      | **(279**   | **)**      |
| Goodwill reduced as a result of a reduction  of valuation allowances associated with NOL utilization | ** ** | **(157**                                              | **)**      | ** **              | ** ** | **(157**   | **)**      |
| Balance at December 31, 2006                                                                         | ** ** | **$**                                                 | **2,873**  | ** **              | **$**      | ** ** | ** ** | **$** | **2,873** | ** ** |

 

**OtherIntangible Assets**

 

Intangibleasset activity is as follows:

 
| ** **                                                                   | ** ** | **Definite Life** | ** ** | **Indefinite Life** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|--------------------------|------------|-----------|------------|
| Balance at January 1, 2005                                                   |       | $                      | 43         |                     | $          | 12        |       | $ | 55 |   |
| Adjustment                                                                   |       | (8                     | )          |                     |       | (8        | )          |
| Amortization                                                                 |       | (4                     | )          |                     |       | (4        | )          |
| Balance at December 31, 2005                                                 |       | 31                     |       | 12                       |       | 43        |       |
| Intangible asset included in loss on  disposition of discontinued operations | ** ** | **(2**                 | **)**      | ** **               | ** ** | **(2**    | **)**      |
| Amortization                                                                 | ** ** | **(3**                 | **)**      | ** **               | ** ** | **(3**    | **)**      |
| Balance at December 31, 2006                                                 | ** ** | **$**                  | **26**     | ** **               | **$**      | **12**    | ** ** | **$** | **38** | ** ** |

 

Thegross carrying value of the definite life intangible assets, primarily customerrelationships, is $37 million and $40 million and related accumulatedamortization of $11 million and $9 million at December 31, 2006 and 2005,respectively. The weighted-average amortization period of the definite lifeintangible assets is 14 years.

 

73

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**21.  Related Party Transactions**

 

**Transactionswith Non-consolidated Affiliates**

 

TheCompany sold paperboard, market pulp and fiber to and purchased containerboardand kraft paper from various non-consolidated affiliates on terms generallysimilar to those prevailing with unrelated parties. The following tablesummarizes the Company’s related party transactions with its non-consolidatedaffiliates for each year presented:

 
| ** **                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Product sales                      | ** ** | **$**    | **91**     |     | $          | 67       |       | $ | 77 |   |
| Product and raw material purchases | ** ** | **55**   |       | 36       |       | 32       |       |
| Trade receivables at December 31   | ** ** | **9**    |       | 7        |       | 8        |       |
| Notes receivable at December 31    | ** ** | **4**    |       | 2        |       |     |       |
| Trade payables at December 31      | ** ** | **4**    |       | 5        |       | 3        |       |
|                                    |            |          |            |          |            |          |            |  |  |  |

 

**OtherTransactions**

 

ThomasA. Reynolds, III, a member of the Company’s Board of Directors, is a member ofthe Executive Committee of the law firm of Winston & Strawn LLP, which hasprovided, and continues to provide, legal services to the Company and itssubsidiaries.

 

WilliamD. Smithburg, a member of the Company’s Board of Directors is a member of theBoard of Directors of Barry-Wehmiller Companies, Inc., which sold the Companyequipment for $15 million, $9 million and $9 million during 2006, 2005 and2004, respectively. All such sales were made on an arm’s-length basis.

 

PatrickJ. Moore, Chairman and Chief Executive Officer and a member of the Company’sBoard of Directors, is a member of the Board of Directors of Archer DanielsMidland Company (“ADM”). ADM sold the Company $10 million, $9 million and $8million of supplies used in mill operations in 2006, 2005 and 2004,respectively. The Company sold products to ADM of $15 million, $21 million and$15 million in 2006, 2005 and 2004, respectively. All such sales were made onan arm’s-length basis.

 

**22.  Fair Value of Financial Instruments**

 

Thecarrying amounts and fair values of the Company’s financial instruments as ofDecember 31 are as follows:

 
| ** **                                    | ** ** | **2006**             | ** ** | **2005**        | ** ** |
|-----------------------------------------------|------------|----------------------|------------|-----------------|------------|
| ** **                                    | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| Cash and cash equivalents                     | ** ** | **$**                | **9**      | ** **      | **$**      | **9** |   | $ | 5 |   | $ | 5 |   |
| Cost method investments                       | ** ** | **1**                | ** ** | **1**           |       | 2 |   | 2 |   |
| Notes receivable                              | ** ** | **12**               | ** ** | **12**          |       | 8 |   | 8 |   |
| Residual interest in receivables sold         | ** ** | **179**              | ** ** | **179**         |       | 139 |   | 139 |   |
| Residual interest in timber notes             | ** ** | **48**               | ** ** | **48**          |       | 46 |   | 46 |   |
| Net derivative assets (liabilities)           | ** ** | **(17**              | **)**      | **(17**         | **)**      | 57 |   | 57 |   |
| Long-term debt, including current  maturities | ** ** | **3,634**            | ** ** | **3,602**       |       | 4,571 |   | 4,485 |   |
|                                               |            |                      |            |                 |            |  |  |  |  |  |  |  |  |

 

Thecarrying amount of cash equivalents approximates fair value because of theshort maturity of those instruments. The carrying amount of cost methodinvestments approximates fair value. The fair values of notes receivable arebased on discounted future cash flows or the applicable quoted market price. Thefair values of the residual interest in receivables sold and timber notes arebased on discounted future cash flows. The fair values of the Company’s derivativesare based on prevailing market rates. The fair value of the Company’s debt isestimated based on the quoted market prices for the same or similar issues oron the current rates offered to the Company for debt of the same remainingmaturities.

 

74

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**23.  Other, Net**

 

Thesignificant components of other, net in the Company’s consolidated statementsof operations are as follows:

 
| ** **                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Foreign currency exchange gains (losses) | ** ** | **$**    | **1**      |     | $          | (9       | )          | $ | (20 | ) |
| Loss on sales of receivables             | ** ** | **(25**  | **)**      | (21      | )          | (8       | )          |
| Income from non-consolidated affiliates  |       |     |       |     |       | 3        |       |
| Other                                    | ** ** | **7**    |       | 9        |       | 7        |       |
| Total other, net                         | ** ** | **$**    | **(17**    | **)**    | $          | (21      | )          | $ | (18 | ) |

 

**24.  Contingencies**

 

In 2003, the Company settledall of the antitrust class action cases pending against the Company, which werebased on allegations of a conspiracy among linerboard manufacturers from 1993to 1995 and made aggregate settlement payments of $92.5 million, one-half ofwhich was paid in December 2003 and the remainder of which was paid in January2005. The Company subsequently settled all of the lawsuits brought on behalf ofnumerous companies that opted out of these class actions to seek their ownrecovery, and made aggregate payments of $60 million, including $14 million in2005 and $46 million in 2006. The Company recorded charges of $36 million in2005 in connection with these settlements.

 

TheCompany’s past and present operations include activities which are subject tofederal, state and local environmental requirements, particularly relating toair and water quality. The Company faces potential environmental liability as aresult of violations of permit terms and similar authorizations that haveoccurred from time to time at its facilities. In addition, the Company facespotential liability for response costs at various sites for which it hasreceived notice as being a potentially responsible party (“PRP”) concerninghazardous substance contamination. In estimating its reserves for environmentalremediation and future costs, the Company’s estimated liability of $4 millionreflects the Company’s expected share of costs after consideration for therelative percentage of waste deposited at each site, the number of other PRPs,the identity and financial condition of such parties and experience regardingsimilar matters. As of December 31, 2006, the Company had approximately $17million reserved for environmental liabilities included primarily in otherlong-term liabilities in the consolidated balance sheet. The Company believesthe liability for these matters was adequately reserved at December 31, 2006.

 

Ifall or most of the other PRPs are unable to satisfy their portion of theclean-up costs at one or more of the significant sites in which the Company isinvolved or the Company’s expected share increases, the resulting liabilitycould have a material adverse effect on the Company’s consolidated financialcondition or results of operations.

 

TheCompany is a defendant in a number of lawsuits and claims arising out of theconduct of its business. While the ultimate results of such suits or otherproceedings against the Company cannot be predicted with certainty, themanagement of the Company believes that the resolution of these matters willnot have a material adverse effect on its consolidated financial condition,results of operations or cash flows.

 

75

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**25.  Business Segment Information**

 

TheCompany’s Consumer Packaging segment, which was sold as of June 30, 2006 (SeeNote 2), has been classified as discontinued operations and is excluded fromthe segment results for items relating to the consolidated statements of operations for all periods presented. Asa result, the Company has one reportable segment, Containerboard and CorrugatedContainers. Two operating facilities of the Consumer Packaging segment, whichwere not included as part of the sale transaction, were reclassified to theContainerboard and Corrugated Containers segment for all periods presented. TheContainerboard and Corrugated Containers segment is highly integrated. Itincludes a system of mills and plants that produces a full line ofcontainerboard that is converted into corrugated containers. It also providessingle source full merchandising solutions to retailers and consumer packagingcompanies. Corrugated containers are used to transport such diverse products ashome appliances, electric motors, small machinery, grocery products, produce,books, tobacco and furniture.

 

TheCompany evaluates performance and allocates resources based on profit or lossfrom operations before income taxes, interest expense and other non-operatinggains and losses. The accounting policies of the reportable segment are thesame as those described in the summary of significant accounting policies. Intersegmentsales and transfers are recorded at market prices.

 

Otherincludes corporate related items and one non-reportable segment, Reclamation. Corporaterelated items include expenses not allocated to the reportable segmentincluding corporate expenses, asset impairment charges, restructuring charges,unrealized gains or losses on derivative instruments not qualifying for hedgeaccounting, non-cash foreign currency gains or losses, gains or losses from thesale of business or real estate and interest expense.

 

76

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| ** **                               | ** ** | **Container-  board &  Corrugated  Containers** | ** ** | **Other**  | ** ** | **Total** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|------------|------------|-----------|------------|
| **Year ended December 31, 2006**         |       |                                                     |       |       |       |      |       |
| Revenues from external customers         | ** ** | **$**                                                    | **6,765**  | ** ** | **$**      | **392**   | ** ** | **$** | **7,157** | ** ** |
| Intersegment revenues                    | ** ** | ** **                                               | ** ** | **230**    | ** ** | **230**   | ** ** |
| Depreciation, depletion and amortization | ** ** | **324**                                                  | ** ** | **33**     | ** ** | **357**   | ** ** |
| Segment profit (loss)                    | ** ** | **433**                                                  | ** ** | **(543**   | **)**      | **(110**  | **)**      |
| Total assets                             | ** ** | **4,483**                                                | ** ** | **3,294**  | ** ** | **7,777** | ** ** |
| Expenditures for long-lived assets (a)   | ** ** | **211**                                                  | ** ** | **63**     | ** ** | **274**   | ** ** |
|                                     |       |                                                     |       |       |       |      |       |
| **Year ended December 31, 2005**         |       |                                                     |       |       |       |      |       |
| Revenues from external customers         |       | $                                                        | 6,438      |       | $          | 374       |       | $ | 6,812 |   |
| Intersegment revenues                    |       |                                                     |       | 226        |       | 226       |       |
| Depreciation, depletion and amortization |       | 333                                                      |       | 35         |       | 368       |       |
| Segment profit (loss)                    |       | 191                                                      |       | (810       | )          | (619      | )          |
| Total assets (a)                         |       | 4,653                                                    |       | 4,461      |       | 9,114     |       |
| Expenditures for long-lived assets (a)   |       | 215                                                      |       | 61         |       | 276       |       |
|                                     |       |                                                     |       |       |       |      |       |
| **Year ended December 31, 2004**         |       |                                                     |       |       |       |      |       |
| Revenues from external customers         |       | $                                                        | 6,328      |       | $          | 388       |       | $ | 6,716 |   |
| Intersegment revenues                    |       |                                                     |       | 240        |       | 240       |       |
| Depreciation, depletion and amortization |       | 341                                                      |       | 37         |       | 378       |       |
| Segment profit (loss)                    |       | 321                                                      |       | (520       | )          | (199      | )          |
| Total assets (a)                         |       | 5,171                                                    |       | 4,412      |       | 9,583     |       |
| Expenditures for long-lived assets (a)   |       | 164                                                      |       | 55         |       | 219       |       |

 

----

(a)          Thediscontinued Consumer Packaging operations’ total assets are included in otherin 2005 and 2004 and its expenditures for long-lived assets are included inother for 2004 through 2006.

 

Thefollowing table presents net sales to external customers by country of origin:

 
| ** **      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------|------------|----------|------------|----------|------------|----------|------------|
| United States   | ** ** | **$**    | **6,314**  |     | $          | 5,985    |       | $ | 5,907 |   |
| Foreign         | ** ** | **843**  |       | 827      |       | 809      |       |
| Total net sales | ** ** | **$**    | **7,157**  |     | $          | 6,812    |       | $ | 6,716 |   |

 

Thefollowing table presents long-lived assets by country:

 
| ** **              | ** ** | **2006**  | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|-----------|------------|----------|------------|----------|------------|
| United States           | ** ** | **$**     | **3,185**  |     | $          | 3,647    |       | $ | 3,894 |   |
| Canada                  | ** ** | **571**   |       | 623      |       | 768      |       |
| Other                   | ** ** | **18**    |       | 19       |       | 20       |       |
| ** **              |       | **3,774** |       | 4,289    |       | 4,682    |       |
| Goodwill                | ** ** | **2,873** |       | 3,309    |       | 3,301    |       |
| Total long-lived assets | ** ** | **$**     | **6,647**  |     | $          | 7,598    |       | $ | 7,983 |   |

 

TheCompany’s export sales from the United States were approximately $601 millionfor 2006, $462 million for 2005 and $411 million for 2004.

 

77

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**26.  Quarterly Results (Unaudited)**

 

Thefollowing is a summary of the unaudited quarterly results of operations:

 
| ** **                                          | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| **2006**                                            |       |               |       |                |       |               |       |                |       |
| Net sales (a)                                       | ** ** | **$**              | **1,729**  | ** **          | **$**      | **1,765**          | ** ** | **$**               | **1,844**  | ** ** | **$** | **1,819** | ** ** |
| Gross profit                                        | ** ** | **140**            | ** ** | **252**             | ** ** | **293**            | ** ** | **287**             | ** ** |
| Income (loss) from continuing operations  (b)       | ** ** | **(71**            | **)**      | **(44**             | **)**      | **20**             | ** ** | **25**              | ** ** |
| Discontinued operations                             | ** ** | **10**             | ** ** | **4**               | ** ** | ** **         | ** ** | ** **          | ** ** |
| Loss on disposition of discontinued  operations     | ** ** | ** **         | ** ** | **(1**              | **)**      | **(2**             | **)**      | ** **          | ** ** |
| Net income (loss)                                   | ** ** | **(61**            | **)**      | **(41**             | **)**      | **18**             | ** ** | **25**              | ** ** |
| Preferred stock dividends and accretion             | ** ** | **(3**             | **)**      | **(3**              | **)**      | **(3**             | **)**      | **(3**              | **)**      |
| Net income (loss) available to common  stockholders | ** ** | **(64**            | **)**      | **(44**             | **)**      | **15**             | ** ** | **22**              | ** ** |
| ** **                                          | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| **Basic and diluted earnings per share:**           | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| Income (loss) from continuing operations            | ** ** | **(.29**           | **)**      | **(.18**            | **)**      | **.07**            | ** ** | **.09**             | ** ** |
| Discontinued operations                             | ** ** | **.04**            | ** ** | **.01**             | ** ** | ** **         | ** ** | ** **          | ** ** |
| Loss on disposition of discontinued  operations     | ** ** | ** **         | ** ** | ** **          | ** ** | **(.01**           | **)**      | ** **          | ** ** |
| Net income (loss) available to common  stockholders | ** ** | **(.25**           | **)**      | **(.17**            | **)**      | **.06**            | ** ** | **.09**             | ** ** |
|                                                |       |               |       |                |       |               |       |                |       |
| **2005**                                            |       |               |       |                |       |               |       |                |       |
| Net sales                                           |       | $                  | 1,709      |                | $          | 1,760              |       | $                   | 1,696      |   | $ | 1,647 |   |
| Gross profit                                        |       | 210                |       | 236                 |       | 183                |       | 129                 |       |
| Loss from continuing operations (c)                 |       | (27                | )          | (10                 | )          | (241               | )          | (100                | )          |
| Discontinued operations                             |       | 11                 |       | 14                  |       | 15                 |       | 11                  |       |
| Net income (loss)                                   |       | (16                | )          | 4                   |       | (226               | )          | (89                 | )          |
| Preferred stock dividends and accretion             |       | (3                 | )          | (3                  | )          | (3                 | )          | (3                  | )          |
| Net income (loss) available to common  stockholders |       | (19                | )          | 1                   |       | (229               | )          | (92                 | )          |
| ** **                                          | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| **Basic and diluted earnings per share:**           | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| Loss from continuing operations                     |       | (.12               | )          | (.05                | )          | (.96               | )          | (.40                | )          |
| Discontinued operations                             |       | .05                |       | .05                 |       | .06                |       | .04                 |       |
| Net income (loss) available to common  stockholders |       | (.07               | )          | .00                 |       | (.90               | )          | (.36                | )          |

 

----

(a)          Netsales after April 1, 2006 were impacted by the adoption of EITF No. 04-13 (SeeNote 1 Revenue Recognition).

 

(b)         Income(loss) from continuing operations includes restructuring pretax charges of $8million in the fourth quarter of 2006.

 

(c)          Lossfrom continuing operations includes litigation settlement pretax charges of $36million and restructuring pretax charges of $24 million in the fourth quarterof 2005.

 

78

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**SMURFIT-STONE CONTAINER CORPORATION**

**SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS AND RESERVES**

(In millions)

 
| **Column A**                                                      | ** ** | **Column B**                              | ** ** | **Column C**                                        | ** ** | **Column D**   | ** ** | **Column E**        | ** ** | **Column F**                        | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------|------------|--------------------------|------------|------------------------------------------|------------|
| **Description**                                                        | ** ** | **Balance at  Beginning of  Period** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Other  Describe** | ** ** | **Deductions  Describe** | ** ** | **Balance at  End of  Period** | ** ** |
| **Allowance for doubtful accounts and sales  returns and allowances:** |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
|                                                                   |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
| Year ended December 31, 2006                                           | ** ** | **$**                                          | **10**     | ** **                                               | **$**      | **5**               | ** ** | **$**                    | **(5**     | **)(a)(b)**                              | **$**      | **3** | **(c)** | **$** | **7** | ** ** |
|                                                                   |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
| Year ended December 31, 2005                                           |       | $                                              | 12         |                                                     | $          | 3                   |       | $                        | (1         | )(a)                                     | $          | 4 | (c) | $ | 10 |   |
|                                                                   |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
| Year ended December 31, 2004                                           |       | $                                              | 38         |                                                     | $          | 8                   |       | $                        | (24        | )(a)                                     | $          | 10 | (c) | $ | 12 |   |
|                                                                   |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
| **Restructuring:**                                                     |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
|                                                                   |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
| Year ended December 31, 2006                                           | ** ** | **$**                                          | **51**     | ** **                                               | **$**      | **43**              | **(d)**    | **$**                    | **18**     | **(d)**                                  | **$**      | **67** | **(e)** | **$** | **45** | ** ** |
|                                                                   |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
| Year ended December 31, 2005                                           |       | $                                              | 28         |                                                     | $          | 321                 |       | $                        |       | $                                        | 298        | (e) | $ | 51 |   |
|                                                                   |       |                                           |       |                                                     |       |                |       |                     |       |                                     |       |
| Year ended December 31, 2004                                           |       | $                                              | 44         |                                                     | $          | 16                  | (d)        | $                        | 5          | (d)                                      | $          | 37 | (e) | $ | 28 |   |

 

----

| (a) | Includes  the effect of the accounts receivable securitization application.                                                                                                                      |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b) | Includes  $6 million in connection with containerboard customer accounts receivables  sold into the SRC accounts receivable program.                                                             |
| (c) | Uncollectible  amounts written off, net of recoveries.                                                                                                                                           |
| (d) | Gain  on sale of closed properties reduces the charge by $18 million and $5 million  for 2006 and 2004, respectively, and is added back to other, since there is  no impact on exit liabilities. |
| (e) | Charges  against the reserves.                                                                                                                                                                   |

 

79

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| **ITEM 9.** | **CHANGES IN AND DISAGREEMENTS  WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

 

None.

 
| **ITEM  9A.** | **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 the end of theperiod covered by this report and have concluded that, as of such date, ourdisclosure 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.

 

The Sarbanes-Oxley Act of 2002 (the Act) imposed many requirementsregarding corporate governance and financial reporting. One requirement under Section404 of the Act, beginning with our 2004 Annual Report, was for management toreport on the Company’s internal control over financial reporting and for ourindependent registered public accountants to attest to this report. Management’sReport on Internal Control over Financial Reporting and our independent registeredpublic accounting firm’s report with respect to management’s assessment of theeffectiveness of internal control over financial reporting are included in Item8, “Financial Statements and Supplementary Data.”

 

**ITEM 9B.****                 OTHERINFORMATION**

 

None.

 

**PART III**

 

**ITEM 10.****                   DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

 

Additional informationregarding Smurfit-Stone’s directors, executive officers and corporategovernance matters, and called for by this Item 10, is set forth in the ProxyStatement for the annual meeting to be held May 9, 2007 (the Proxy Statement)and is incorporated herein by reference.

 

# **Directors**

#  

Set forth below is certaininformation concerning Smurfit-Stone’s directors.

 

**James R. Boris,**born****October 25, 1944,****is the retiredChairman and Chief Executive Officer of EVEREN Capital Corporation and itsprimary subsidiary, EVEREN Securities, Inc. (now known as Wachovia Securities,Inc.). Mr. Boris is the non-executive Chairman of the Board of Integrys EnergyGroup, Inc., and a director of Midwest Air Group, Inc. and the Chicago BoardOptions Exchange.

 

**Connie K. Duckworth**,born November 3, 1954, has been President and Chairman of Arzu, Inc. sinceAugust 2003 and a partner of 8Wings Enterprises, LLC since July 2001. She was apartner of Circle Financial Group, LLC from January 2003 to December 2004. Ms.Duckworth retired from Goldman Sachs & Co. as Advisory Director in 2001. Ms.Duckworth is a director of Northwestern Mutual, Frank Russell Company, DNPSelect Income Fund and Nuveen Investments, Inc.

 

80

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**Alan E.Goldberg**, born September 1, 1954, co-founded and has been aCo-Managing Partner of Lindsay Goldberg & Bessemer G.P. LLC and its relatedinvestment manager, Goldberg Lindsay & Co. LLC, since March 2001.

 

**William T. Lynch, Jr.,**bornDecember 3, 1942, has been President and Chief Executive Officer of LiamHoldings, LLC since April 1997. He is the retired President and Chief ExecutiveOfficer of Leo Burnett Company. Mr. Lynch is a director of Pella Corporation.

 

**Patrick J. Moore**,born September 7, 1954, was named Chairman and Chief Executive Officer in May2006. He had been Chairman, President and Chief Executive Officer since May2003, and prior to that he was President and Chief Executive Officer sinceJanuary 2002, when he was also elected as a Director. He was Vice President andChief Financial Officer from November 1998 until January 2002. Mr. Moore is adirector of Archer Daniels Midland Company.

 

**James J.O’Connor**, born March 15, 1937, is the former Chairman andChief Executive Officer of Unicom Corporation and its subsidiary, CommonwealthEdison Company. Mr. O’Connor is a director of Corning Incorporated. and UALCorporation.

 

**Jerry K.Pearlman**, born March 27, 1939, is the retired Chairman of theBoard and Chief Executive Officer of Zenith Electronics Corporation. Mr.Pearlman is a director of Ryerson Inc. and Nanophase Technologies Corporationand, from 1984 to 1998, served as director of Stone Container, a predecessor ofSmurfit-Stone.

 

**Thomas A.Reynolds, III**, born May 12, 1952, has been a partner ofWinston & Strawn LLP, a law firm that regularly represents Smurfit-Stone onnumerous matters, since 1984. Mr. Reynolds is a member of Winston & StrawnLLP’s executive committee.

 

**Eugene C. Sit**,born August 8, 1938, has been Chairman, Chief Executive Officer and ChiefInvestment Officer of Sit Investment Associates for more than five years. Mr.Sit is a director of Corning Incorporated.

 

**William D.Smithburg,**born July 9, 1938, is the retired Chairman,President and Chief Executive Officer of The Quaker Oats Company. Mr. Smithburgis a director of Abbott Laboratories, Northern Trust Corporation and CorningIncorporated.

 

**ExecutiveOfficers**

 

Certaininformation concerning the executive officers of Smurfit-Stone is contained inPart I, Item 1, of this annual report on Form 10-K under the caption “ExecutiveOfficers Of The Registrant” and is incorporated by reference herein.

 

**Audit Committee**

 

We have a separately designatedstanding Audit Committee established in accordance with Section 3(a)(58)(A) ofthe Exchange Act. The members of the Audit Committee are Mr. Pearlman(Chairman), Mr. Boris, Mr. O’Connor and Mr. Sit.

 

**Audit Committee Financial Expert**

 

Our Board of Directorshas determined that Mr. Pearlman is an audit committee expert as defined byItem 407(d)(5)(ii) of Regulation S-K of the Exchange Act and is independent, assuch term is defined in the listing standard of the NASDAQ Global Select Market.

 

**Code of Ethics**

 

We have adopted a Code ofEthics for Senior Financial Officers (including our Principal Executive Officer,Principal Financial Officer and Principal Accounting Officer). The Code of Ethicsis available on our Internet Website (www.smurfit-stone.com). We intend tosatisfy our disclosure requirements under Item 10 of Form 8-K regarding anamendment to, or a waiver from, a provision of our code of ethics that appliesto

 

81

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our Senior Financial Officersand that relates to any element of the code of ethics definition enumerated in Item406(b) of Regulation S-K by posting such information on our Website.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

 

Information regardingSection 16(a) Beneficial Ownership Reporting Compliance is set forth under thecaption “Security Ownership of Certain Beneficial Owners and Management-Section16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement and isincorporated herein by reference.

 

**Recommendation of DirectorNominees by Stockholders**

 

There have been nomaterial changes to the procedures by which stockholders may recommend directornominees to our Board of Directors since the filing of our proxy statement in2005.

 
| **ITEM  11.** | **EXECUTIVE COMPENSATION** |
|---------------|----------------------------|

 

Information required in response to this item is set forth under thecaptions “Executive Compensation,” “Compensation Committee Report,”  “Compensation Discussion and Analysis” and “CompensationCommittee Interlocks and Insider Participation” in our Proxy Statement and isincorporated herein by reference.

 
| **ITEM  12.** | **SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS** |
|---------------|-----------------------------------------------------------------------------------------------------|

 

Informationrequired in response to this item is set forth under the captions “PrincipalStockholders” and “Executive Compensation, Existing Equity Compensation PlanInformation” in the Proxy Statement and is incorporated herein by reference.

 
| **ITEM  13.** | **CERTAIN RELATIONSHIPS AND  RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE** |
|---------------|--------------------------------------------------------------------------------|

 

Informationrequired in response to this item is set forth under the caption “Certain Relationshipsand Related Transactions” and “Board Committee Meetings, Committee Functionsand Composition” in the Proxy Statement and is incorporated herein byreference.

 
| **ITEM  14.** | **PRINCIPAL ACCOUNTING FEES AND  SERVICES** |
|---------------|---------------------------------------------|

 

Information required inresponse to this item is set forth under the proposal “Ratification ofAppointment of Independent Registered Public Accounting Firm” in our ProxyStatement and is incorporated herein by reference.

 

82

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**PART IV**

 
| **ITEM  15.** | **EXHIBITS AND FINANCIAL  STATEMENT SCHEDULES**                                                                                                                                                                                                                                                                                                                                             |
|---------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| (a)           | (1) and (2) The list of  Financial Statements and Financial Statement Schedules required by this item  is included in Item 8.                                                                                                                                                                                                                                                          |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
|          | (3) Exhibits.                                                                                                                                                                                                                                                                                                                                                                               |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 2.1(a)        | Asset Purchase  Agreement, dated May 11, 2006, by and among Smurfit-Stone Container  Enterprises, Inc.(“SSCE”), Smurfit-Stone Container Canada Inc. and Bluegrass  Container Company, LLC (incorporated by reference to Exhibit 2.1  to Smurfit-Stone Container Corporation’s (“SSCC”) Current Report on Form 8-K dated  July 6, 2006  (File No. 0-23876)).        |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 2.1(b)        | Amendment No. 1 to  Asset Purchase Agreement, dated June 30, 2006, by and among Smurfit-Stone  Container Enterprises, Inc., Smurfit-Stone Container Canada Inc. and  Bluegrass Container Company, LLC (incorporated by reference to Exhibit 2.2 to  SSCC’s Current Report on Form 8-K dated July 6, 2006 (File No. 0-23876)).                                                          |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.1           | Restated Certificate of  Incorporation of Smurfit-Stone Container Corporation (“SSCC”) (incorporated  by reference to Exhibit 3(a) to SSCC’s Registration Statement on Form S-4  (File No. 333-65431)).                                                                                                                                                                      |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.2           | Second Amended and  Restated Bylaws of Smurfit-Stone Container Corporation (incorporated by  reference to Exhibit 3.2 to SSCC’s Annual Report on Form 10-K for the fiscal  year ended December 31, 2002 (File No. 0-23876)).                                                                                                                                                           |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1           | Certificate for  Smurfit-Stone Container Corporation’s Common Stock (incorporated by reference  to Exhibit 4.3 to SSCC’s Registration Statement on Form S-8 (File No.  33-57085)).                                                                                                                                                                                                |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.2           | Form of Certificate of  Designation establishing the terms of Smurfit-Stone Container Corporation’s  Series A Preferred Stock (incorporated by reference to Exhibit 4.2 to SSCC’s  Registration Statement on Form S-4 (File No. 333-43656)).                                                                                                                                      |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.3           | Certificate for  Smurfit-Stone Container Corporation’s Series A Preferred Stock (incorporated  by reference to Exhibit 4.4 to SSCC’s Registration Statement on Form S-4  (File No. 333-43656)).                                                                                                                                                                                   |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.4           | Certificate of  Designation of Series B Junior Participating Preferred Stock (incorporated by  reference to Exhibit 4.1 to SSCC’s Quarterly Report on Form 10-Q for the  quarter ended September 30, 2002 (File No. 0-23876)).                                                                                                                                                         |
|          |                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.5           | Rights Agreement dated  as of September 9, 2002 by and between SSCC and Mellon Investor Services, as  Rights Agent. The Rights Agreement includes as Exhibit B the form of Rights  Certificate and as Exhibit C the form of Certificate of Designations  (incorporated by reference to Exhibit 4.1 to SSCC’s Current Report on Form  8-K dated September 10, 2002 (File No. 0-23876)). |

 

Indenturesand other debt instruments with respect to long-term debt that do not exceed10% of the total assets of SSCC and its subsidiaries on a consolidated basisare not filed herewith. The Registrant agrees to furnish a copy of suchdocuments to the Commission upon request.

 
| 4.6(a) | Master Indenture dated  as of November 23, 2004 between SSCE Funding, LLC, as Issuer, and Deutsche  Bank Trust Company Americas, as Indenture Trustee (incorporated by |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

83

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|    | reference to Exhibit  4.1 to SSCE Current Report on Form 8-K dated November 24, 2004 (File No.  0-23876)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 4.6(b)  | Series 2004-1 Indenture  Supplement to Master Indenture dated as of November 23, 2004 between SSCE  Funding, LLC, as Issuer, and Deutsche Bank Trust Company Americas, as  Indenture Trustee (incorporated by reference to Exhibit 4.2 to SSCE’s Current  Report on Form 8-K dated November 24, 2004 (File No. 0-23876)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 4.6(c)  | Series 2004-2 Indenture  Supplement to Master Indenture dated as of November 23, 2004 between SSCE  Funding, LLC, as Issuer, and Deutsche Bank Trust Company Americas, as  Indenture Trustee (incorporated by reference to Exhibit 4.3 to SSCE’s Current  Report on Form 8-K dated November 24, 2004 (File No. 0-23876)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1(a) | Credit Agreement, dated  November 1, 2004, by and among SSCC, as guarantor, SSCE and Smurfit-Stone  Container Canada Inc., as borrowers, JPMorgan Chase Bank, N.A., as Senior  Agent, Deposit Account Agent and Deposit Funded Facility Facing Agent,  Deutsche Bank and Trust Company Americas, as Senior Agent, Administrative  Agent, Collateral Agent, Swingline Lender and Revolving Facility Facing  Agent, Deutsche Bank AG, as Canadian Administrative Agent and Revolving (Canadian)  Facility Facing Agent, and the other financial institutions party thereto, as  lenders (incorporated by reference to Exhibit 10.1 to SSCC’s Current Report  on Form 8-K dated November 1, 2004 (File No. 0-23876)).                                                                                                                                                                                                                                                                  |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1(b) | Amendment No. 1, dated  as of September 30, 2005, to the Credit Agreement, dated as of November 1,  2004, among SSCC, as Guarantor, SSCE and Smurfit-Stone Container Canada Inc.,  as Borrowers, the Lenders party thereto, Deutsche Bank Trust Company  Americas, as Senior Agent, Administrative Agent, Collateral Agent, Swingline  Lender and Revolving Facility Facing Agent, Deutsche Bank AG, as Canadian  Administrative Agent and Revolving (Canadian) Facility Facing Agent, and  JPMorgan Chase Bank, N.A., as Senior Agent, Deposit Account Agent and Deposit  Funded Facility Facing Agent (incorporated by reference to Exhibit 10.1 to  SSCC’s Current Report on Form 8-K dated October 5, 2005 (File No. 0-23876)).                                                                                                                                                                                                                                                 |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1(c) | Incremental Term Loan  Assumption and Amendment No. 2, dated as of December 20, 2005, related to the  Credit Agreement, dated as of November 1, 2004, as amended by Amendment No. 1  dated as of September 30, 2005, among SSCC, as Guarantor, SSCE and  Smurfit-Stone Container Canada Inc., as Borrowers, the Lenders party thereto,  Deutsche Bank Trust Company Americas, as Senior Agent, Administrative Agent,  Collateral Agent, Swingline Lender and Revolving Facility Facing Agent,  Deutsche Bank AG, as Canadian Administrative Agent and Revolving (Canadian)  Facility Facing Agent, and JPMorgan Chase Bank, N.A., as Senior Agent,  Deposit Account Agent and Deposit Funded Facility Facing Agent (incorporated  by reference to Exhibit 10.1 to SSCC’s Current Report on Form 8-K dated  December 20, 2005 (File No. 0-23876)).                                                                                                                                   |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1(d) | Amendment No. 3 dated  as of June 9, 2006, to the Credit Agreement dated as of November 1, 2004, as  amended by Amendment No. 1 dated as of September 30, 2005, and Incremental  Term Loan Assumption Agreement and Amendment No. 2 dated as of December 20,  2005, among Smurfit-Stone Container Corporation, as Guarantor; Smurfit-Stone  Container Enterprises, Inc. and Smurfit-Stone Container Canada Inc., as  Borrowers; the Lenders from time to time party thereto; Deutsche Bank Trust  Company Americas, as Senior Agent, Administrative Agent, Collateral Agent,  Swingline Lender and Revolving Facility Facing Agent; Deutsche Bank AG, as  Canadian Administrative Agent and Revolving (Canadian) Facility Facing Agent;  and JPMorgan Chase Bank, N.A., as Senior Agent, Deposit Account Agent and  Deposit Funded Facility Facing Agent (incorporated by reference to Exhibit  10.1 to SSCC’s Current Report on Form 8-K dated June 13, 2006 (File No.  0-23876)). |

 

84

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| 10.2      | Sale Agreement dated as  of November 23, 2004 by and between SSCE, as Seller, and Stone Receivables  Corporation (“SRC”) (incorporated by reference to Exhibit 10.1 to SSCE’s  Current Report on Form 8-K dated November 24, 2004 (File No. 0-23876)).                                                                                                                                                                                               |
|-----------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.3      | Transfer and Servicing  Agreement dated as of November 23, 2004 by and among SRC, SSCE Funding, LLC  and SSCE, as Servicer (incorporated by reference to Exhibit 10.2 to SSCE’s  Current Report on Form 8-K dated November 24, 2004 (File No. 0-23876)).                                                                                                                                                                                                       |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.4      | Variable Funding Note  Purchase Agreement dated as of November 23, 2004 by and among SSCE Funding,  LLC, as issuer, Barton Capital LLC, as conduit purchaser, certain financial  institutions, as committed purchasers, and Societe Generale, as agent for the  purchasers (incorporated by reference to Exhibit 10.3 to SSCE’s Current Report  on Form 8-K dated November 24, 2004 (File No. 0-23876)).                                                       |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.5(a)   | Receivables Purchase  Agreement, dated March 30, 2004, among MBI Limited/Limitee, in its capacity  as General Partner of Smurfit-MBI, an Ontario Limited Partnership and  Computershare Trust Company of Canada, in its capacity as Trustee of King  Street Funding Trust and Scotia Capital Inc. (incorporated by reference to  Exhibit 10.2(a) to Stone Container’s Quarterly Report on Form 10-Q for the  quarter ended March 31, 2004 (File No. 0-23876)). |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.5(b)   | Support Agreement,  dated March 30, 2004, between Stone Container Corporation (“Stone Container”)  and Computershare Trust Company of Canada, in its capacity as Trustee of King  Street Funding Trust, by its Administrator, Scotia Capital Inc. (incorporated  by reference to Exhibit 10.2(b) to Stone Container’s Quarterly Report on Form  10-Q for the quarter ended March 31, 2004 (File No. 0-23876)).                                       |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.6(a)*  | Jefferson Smurfit  Corporation Amended and Restated 1992 Stock Option Plan, dated as of May 1,  1997 (incorporated by reference to Exhibit 10.10 to SSCC’s Annual Report on  Form 10-K for the fiscal year ended December 31, 1997 (File No. 0-23876)).                                                                                                                                                                                                        |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.6(b)*  | Amendment of the  Jefferson Smurfit Corporation Amended and Restated 1992 Stock Option Plan  (incorporated by reference to Exhibit 10.3 to SSCC’s Quarterly Report on Form  10-Q for the quarter ended September 30, 1999 (File No. 0-23876)).                                                                                                                                                                                                                 |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.7(a)*  | Stone Container  Corporation 1993 Stock Option Plan (incorporated by reference to Appendix A to  Stone Container’s Proxy Statement dated as of April 10, 1992 (File No.  0-23876)).                                                                                                                                                                                                                                                                            |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.7(b)*  | Amendment of the Stone  Container Corporation 1993 Stock Option Plan (incorporated by reference to  Exhibit 10.3 to Stone Container’s Quarterly Report on Form 10-Q for the  quarter ended September 30, 1999 (File No. 0-23876)).                                                                                                                                                                                                                             |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.8*     | Jefferson Smurfit  Corporation Deferred Compensation Plan as amended (incorporated by reference  to Exhibit 10.7 to SSCC’s Annual Report on Form 10-K for the fiscal year  ended December 31, 1996 (File No. 0-23876)).                                                                                                                                                                                                                                        |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.9*     | Jefferson Smurfit  Corporation Management Incentive Plan (incorporated by reference to Exhibit  10.10 to SSCC’s Annual Report on Form 10-K for the fiscal year ended December  31, 1995 (File No. 0-23876)).                                                                                                                                                                                                                                                   |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.10(a)* | Stone Container  Corporation 1995 Long-Term Incentive Plan (incorporated by reference to  Exhibit A to Stone Container’s Proxy Statement dated as of April 7, 1995  (File No. 0-23876)).                                                                                                                                                                                                                                                                       |

 

85

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| 10.10(b)* | Amendment of the 1995  Long-Term Incentive Plan of Stone Container Corporation (incorporated by  reference to Exhibit 10.2 to Stone Container’s Quarterly Report on Form 10-Q  for the quarter ended September 30, 1999 (File No. 0-23876)).                                                                                    |
|-----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.11(a)* | Smurfit-Stone Container  Corporation 1998 Long-Term Incentive Plan (incorporated by reference to  Exhibit 10.14 to SSCC’s Annual Report on Form 10-K for the fiscal year ended  December 31, 1998 (File No. 0-23876)).                                                                                                          |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.11(b)* | First Amendment of the  Smurfit-Stone Container Corporation 1998 Long-Term Incentive Plan  (incorporated by reference to Exhibit 10.2 to SSCC’s Quarterly Report on Form  10-Q for the quarter ended September 30, 1999 (File No. 0-23876)).                                                                                    |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.11(c)* | Second Amendment of the  Smurfit-Stone Container Corporation 1998 Long-Term Incentive Plan  (incorporated by reference to Exhibit 10.1 to SSCC’s Quarterly Report on Form  10-Q for the quarter ended June 30, 2001 (File No. 0-23876)).                                                                                        |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.11(d)* | Third Amendment of the  Smurfit-Stone Container Corporation 1998 Long-Term Incentive Plan  (incorporated by reference to Exhibit 10.1 to SSCC’s Quarterly Report on Form  10-Q for the quarter ended September 30, 2001 (File No. 0-23876)).                                                                                    |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.12(a)* | Smurfit-Stone Container  Corporation 2004 Long-Term Incentive Plan (incorporated by reference to  Appendix I to SSCC’s Proxy Statement dated April 5, 2004 (File No. 0-23876)).                                                                                                                                                 |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.12(b)* | First Amendment of the  Smurfit-Stone Container Corporation 2004 Long-Term Incentive Plan  (incorporated by reference to Exhibit 10.1 to SSCC’s Quarterly Report on Form  10-Q for the quarter ended June 30, 2004 (File No. 0-23876)).                                                                                         |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.13*    | Jefferson Smurfit  Corporation Supplemental Income Pension Plan II (incorporated by reference to  Exhibit 10.1 to SSCC’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2006 (File No. 0-23876)).                                                                                                           |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.14*    | Form of Employment  Security Agreements (incorporated by reference to Exhibit 10(h) to SSCC’s  Registration Statement on Form S-4 (File No. 333-65431)).                                                                                                                                                                        |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.15*    | Consulting Agreement,  dated as of October 24, 1996, by and between James E. Terrill and Jefferson  Smurfit Corporation (U.S.) (incorporated by reference to Exhibit 10.15 to  SSCC’s Annual Report on Form 10-K for the fiscal year ended December 31, 1996  (File No. 0-23876)).                                              |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.16(a)* | Employment Agreement  for Patrick J. Moore (incorporated by reference to Exhibit 10.28 to SSCC’s  Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (File  No. 0-23876)).                                                                                                                                  |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.16(b)* | First Amendment of  Employment Agreement of Patrick J. Moore (incorporated by reference to  Exhibit 10.2 to SSCC’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2002 (File No. 0-23876)).                                                                                                                 |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.16(c)* | Second Amendment of  Employment Agreement of Patrick J. Moore effective as of July 25, 2006, between  Smurfit-Stone Container Corporation (“SSCC”) and Patrick J. Moore  (incorporated by reference to Exhibit 10.1 to SSCC’s Quarterly Report on Form  10-Q for the quarter ended June 30, 2006 (File No. 0-23876)). |
|      |                                                                                                                                                                                                                                                                                                                                 |
| 10.17(a)* | Restricted Stock Unit  Agreement dated as of January 4, 2002 by and between SSCC and Patrick J.  Moore (incorporated by reference to Exhibit 10.3 to SSCC’s Quarterly Report  on Form 10-Q for the quarter ended September 30, 2002 (File No. 0-23876)).                                                                        |

 

86

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| 10.17(b)* | Amendment, dated June  1, 2004, of Restricted Stock Unit Agreement dated as of January 4, 2002 by  and between SSCC and Patrick J. Moore (incorporated by reference to Exhibit  10.2 to SSCC’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2004 (File No. 0-23876)).                            |
|-----------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.17(c)* | Amendment No. 2, dated  December 31, 2004, of Restricted Stock Unit Agreement dated as of January 4,  2002 by and between SSCC and Patrick J. Moore (incorporated by reference to  Exhibit 10.20(c) to SSCC’s Annual Report on Form 10-K for the fiscal year  ended December 31, 2004 (File No. 0-23876)).        |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.18(a)* | Offer Letter dated as  of May 11, 2006 between the Company and Steven J. Klinger (incorporated by  reference to Exhibit 10.1 to SSCC’s Current Report on Form 8-K dated May 12,  2006 (File No. 0-23876)).                                                                                                        |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.18(b)* | Employment Agreement  dated as of May 11, 2006 between the Company and Steven J. Klinger  (incorporated by reference to Exhibit 10.2 to SSCC’s Current Report on Form  8-K dated May 12, 2006 (File No. 0-23876)).                                                                                           |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.18(c)* | Executive Retirement  Agreement, dated as of October 2, 2006, between Smurfit-Stone Container  Corporation (“SSCC”) and Steven J. Klinger (incorporated by reference to  Exhibit 10.1 to SSCC’s Current Report on Form 8-K dated October 5, 2006 (File  No. 0-23876)).                                  |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.19(a)* | Employment Agreement of  John M. Riconosciuto (incorporated by reference to Exhibit 10.23 to SSCC’s  Annual Report on Form 10-K for the fiscal year ended December 31, 2004 (File  No. 0-23876)).                                                                                                                 |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.19(b)* | Letter Agreement dated  as of May 10, 2006 between the Company and John M. Riconosciuto  (incorporated by reference to Exhibit 10.3 to SSCC’s Current Report on Form  8-K dated May 12, 2006 (File No. 0-23876)).                                                                                            |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.20(a)* | Employment Agreement of  Charles A. Hinrichs (incorporated by reference to Exhibit 10.22 to SSCC’s  Annual Report on Form 10-K for the fiscal year ended December 31, 2003 (File  No. 0-23876)).                                                                                                                  |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.20(b)* | First Amendment of  Employment Agreement of Charles A. Hinrichs effective as of July 25, 2006,  between Smurfit-Stone Container Corporation and Charles A. Hinrichs  (incorporated by reference to Exhibit 10.2 to SSCC’s Quarterly Report on Form  10-Q for the quarter ended June 30, 2006 (File No. 0-23876)). |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.21*    | Consulting Agreement of  William N. Wandmacher (incorporated by reference to Exhibit 10.21(b) to  SSCC’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004  (File No. 0-23876)).                                                                                                             |
|      |                                                                                                                                                                                                                                                                                                                   |
| 10.22*    | Smurfit-Stone Container  Corporation Executive Deferred Compensation Plan (incorporated by reference  to Exhibit 10.25 to SSCC’s Annual Report on Form 10-K for the fiscal year  ended December 31, 2004 (File No. 0-23876)).                                                                                     |
|      |                                                                                                                                                                                                                                                                                                                   |
| 21.1      | Subsidiaries of  Smurfit-Stone Container Corporation.                                                                                                                                                                                                                                                                  |
|      |                                                                                                                                                                                                                                                                                                                   |
| 23.1      | Consent of Independent  Registered Public Accounting Firm.                                                                                                                                                                                                                                                             |
|      |                                                                                                                                                                                                                                                                                                                   |
| 24.1      | Powers of Attorney.                                                                                                                                                                                                                                                                                                    |

 

87

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| 31.1   | Certification Pursuant  to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as  Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                 |
| 31.2   | Certification Pursuant  to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as  Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|   |                                                                                                                                                                 |
| 32.1   | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                            |
|   |                                                                                                                                                                 |
| 32.2   | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                            |
|   |                                                                                                                                                                 |
| (b)    | Exhibits filed with  this annual report are included under Item (a) (3).                                                                                             |
|   |                                                                                                                                                                 |
| (c)    | None.                                                                                                                                                                |

 

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*Indicates a management contract or compensation plan or arrangement.

 

88

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
| DATE   | February 28, 2007 |                                              |   | SMURFIT-STONE CONTAINER CORPORATION |
|--------|-------------------|---------------------------------------------------|--------|-------------------------------------|
|   | (Registrant)      |
|   |              |                                              |
|   | By                |   /s/ Charles A. Hinrichs               |   |
|   |              |   Charles A. Hinrichs                   |
|   |              | Senior Vice President and Chief Financial Officer |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant in the capacities and on the dates indicated.

 
| **SIGNATURE**                     | ** ** | **TITLE**                                 | ** ** | **DATE**          |
|-----------------------------------|------------|-------------------------------------------|------------|-------------------|
|                              |       |                                      |       |              |
|  /s/ Patrick J. Moore        |       | Chairman and Chief Executive              |       | February 28, 2007 |
|  Patrick J. Moore            |       | Officer and Director                      |       |              |
|                              |       | (Principal Executive Officer)             |       |              |
|                              |       |                                      |       |              |
|  /s/ Charles A. Hinrichs     |       | Senior Vice President and Chief Financial |       | February 28, 2007 |
|  Charles A. Hinrichs         |       | Officer                                   |       |              |
|                              |       | (Principal Financial Officer)             |       |              |
|                              |       |                                      |       |              |
|  /s/ Paul K. Kaufmann        |       | Senior Vice President and Corporate       |       | February 28, 2007 |
|  Paul K. Kaufmann            |       | Controller                                |       |              |
|                              |       | (Principal Accounting Officer)            |       |              |
| *                       |       |                                      |       |              |
|  James R. Boris              |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  Connie K. Duckworth         |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  Alan E. Goldberg            |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  William T. Lynch, Jr.       |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  James J. O’Connor      |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  Jerry K. Pearlman           |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  Thomas A. Reynolds, III     |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  Eugene C. Sit               |       | Director                                  |       |              |
|                              |       |                                      |       |              |
| *                       |       |                                      |       |              |
|  William D. Smithburg        |       | Director                                  |       |              |
|                              |       |                                      |       |              |
|  *By /s/ Charles A. Hinrichs |       | Pursuant to Powers of Attorney filed      |       | February 28, 2007 |
|  Charles A. Hinrichs         |       | as part of Form 10-K.                     |       |              |
|                              |       |                                      |       |              |

 

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