As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 5/08/07  Smurfit-Stone Container Corp      424B3                  1:4.7M                                   Merrill Corp-MD/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 424B3       Prospectus                                          HTML   2.82M 

FORWARD-LOOKING STATEMENTS

Except for the historical information contained in this prospectus, certain matters discussed herein contain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Although we believe that, in making any such statements, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected. When used in this prospectus, the words “anticipates,” “believes,” “expects,” “intends” and similar expressions as they relate to us or our management are intended to identify such forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties. Important factors, risks and uncertainties that could cause actual results to differ materially from our expectations are disclosed under “Risk Factors,” including, without limitation, the following:

·       We have a highly leveraged capital structure.

·       The terms of our debt may severely limit our ability to plan for or respond to changes in our business.

·       Our industry is cyclical and highly competitive.

·       Our pension plans are underfunded and will require additional cash contributions.

·       Price fluctuations in energy costs and raw materials could adversely affect our manufacturing costs.

·       Factors beyond our control could hinder our ability to service our debt and meet our operating requirements.

·       We may not realize the cost savings we expect from our strategic initiatives.

·       We are subject to environmental regulations and liabilities that could weaken our operating results and financial condition.

·       Foreign currency risks and exchange rate fluctuations could hinder the results of our Canadian operations.

The risks and uncertainties identified above are not the only risks we face. Additional risks and uncertainties not presently known to us or that we believe to be immaterial also may adversely affect us. Should any known or unknown risks or uncertainties develop into actual events, or underlying assumptions prove inaccurate, these developments could have material adverse effects on our business, financial condition and results of operations. Our actual results, performance or achievement could differ materially from those expressed in, or implied by, these forward-looking statements. Accordingly, the events anticipated by the forward-looking statements may not transpire or occur, or if any of them do so, we cannot predict what impact they will have on our results of operations or financial condition. We assume no obligation or duty to update any of the forward-looking statements included in this prospectus except to the extent required by law.

The “safe harbor” protections provided by the foregoing provisions of the Securities Act and the Exchange Act do not apply to forward-looking statements made in connection with the exchange offer.

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INCORPORATION OF DOCUMENTS BY REFERENCE

SSCE’s Annual Report on Form 10-K for the year ended December 31, 2006, Current Reports on Form 8-K filed March 29 and April 11, 2007, and any future filings we make with the Securities and Exchange Commission (the “SEC” or “Commission”) under Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act before the expiration of the exchange offer are incorporated in this prospectus by reference.

Any statement contained in a document incorporated or deemed to be incorporated by reference in this prospectus shall be deemed to be modified or superseded for purposes of this prospectus to the extent that a statement contained in this prospectus modifies or supersedes that statement. Any statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this prospectus.

We will provide without charge to each person, including any person to whom a prospectus is delivered, upon written or oral request, a copy of any and all of the information that has been referenced in this prospectus other than exhibits to these documents. Requests for these copies should be directed to the Corporate Secretary, Smurfit-Stone Container Enterprises, Inc., 150 North Michigan Avenue, Chicago, Illinois 60601, telephone number (312) 346-6600 and should be made no later than five business days before the expiration of the exchange offer.

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SUMMARY

This summary highlights information contained elsewhere in this prospectus. It does not contain all the information that you may consider important in making your investment decision to tender your outstanding notes in the exchange offer. Therefore, you should read the entire prospectus carefully, including in particular the “Risk Factors” section and the financial information appearing elsewhere in this prospectus. You should also carefully read our Annual Report on Form 10-K for the year ended December 31, 2006, which is incorporated by reference into this prospectus, before making your decision. In this prospectus, unless the context requires otherwise or except as otherwise indicated, “SSCE”, the “Company”, “we”, “us”, and “our” refer solely to Smurfit-Stone Container Enterprises, Inc. and “Smurfit-Stone” and “SSCC” refer to Smurfit-Stone Container Corporation, our parent company. All references in this prospectus to “$” or “dollars” shall mean lawful currency of the United States of America.

Summary of the Exchange Offer

The following summary is provided solely for your convenience. This summary is not intended to be complete. You should read the full text and more specific details contained elsewhere in this prospectus. For a more detailed description of the notes, see “The Exchange Offer” and “Description of the Notes.”

The Exchange Offer		We are offering to exchange up to $675,000,000 in aggregate principal amount of our 8.000% Senior Notes due 2017. We issued and sold the notes on March 26, 2007, in reliance on an exemption from registration under the Securities Act.
		We believe that the registered notes may be offered for resale, resold and otherwise transferred by you without compliance with the registration or prospectus delivery provisions of the Securities Act if:
		·  you are acquiring the registered notes in the ordinary course of your business;
		·  you are not participating, do not intend to participate, and have no arrangement or understanding with any person to participate, in the distribution of the registered notes issued to you; and
		·  you are not an affiliate, under Rule 405 of the Securities Act, of ours.
Expiration Date		The exchange offer, once commenced, will remain open for at least 20 business days and will expire at midnight, New York City time, on June 7, 2007, unless we decide to extend the expiration date, but in no event will we extend the expiration date past September 26, 2007.
Conditions to the Exchange Offer		We may end or amend the exchange offer if at any time at or before the expiration of the exchange offer we determine that the exchange offer violates applicable law or any applicable interpretation of the staff of the SEC or any order of any court of competent jurisdiction in the United States or Canada. We may waive any or all of these conditions. See “The Exchange Offer—Conditions of the Exchange Offer.”
Withdrawal Rights		You may withdraw the tender of your outstanding notes at any time before midnight, New York City time, on the expiration date.

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Procedures for Tendering Outstanding Notes		To participate in the exchange offer, you must:
		·  complete, sign and date the accompanying letter of transmittal, or a facsimile copy of the letter of transmittal; or
		·  tender outstanding notes following the procedures for book-entry transfer described under the heading “The Exchange Offer—Procedures for Tendering Outstanding Notes.”
		You must mail or otherwise deliver the documentation and your outstanding notes to The Bank of New York Trust Company, N.A., as exchange agent, at one of the addresses listed on the letter of transmittal.
Special Procedures for Beneficial Owners		If you hold outstanding notes registered in the name of a broker, dealer, commercial bank, trust company or other nominee, you should contact that person promptly if you wish to tender outstanding notes. Please refer to the section in this prospectus entitled, “The Exchange Offer—Procedures for Tendering Outstanding Notes” for more specific instructions on tendering your outstanding notes.
Guaranteed Delivery Procedures		If you wish to tender your outstanding notes and you cannot get required documents to the exchange agent on time, or you cannot complete the procedure for book-entry transfer on time, you may tender your outstanding notes according to the guaranteed delivery procedures described in this prospectus under the heading “The Exchange Offer—Procedures for Tendering Outstanding Notes.”
Use of Proceeds		We will not receive any proceeds from the exchange offer.
Federal Income Tax Consequences		The exchange of notes will not be a taxable event to you for United States federal income tax purposes. Please refer to the section in this prospectus entitled “Certain Tax Considerations—United States Federal Income Tax Considerations” for a more complete discussion of the tax consequences of tendering your outstanding notes in the exchange offer.
Exchange Agent		The Bank of New York Trust Company, N.A., is serving as exchange agent in the exchange offer. Please refer to the section in this prospectus entitled “The Exchange Offer—Exchange Agent” for more information on the exchange agent.

 

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Summary of the Registered Notes

We use the term “notes” when describing provisions that apply to both the outstanding notes and the registered notes. The registered notes will evidence the same debt as the outstanding notes. The same indenture will govern both the outstanding notes and the registered notes. Please refer to the section in this prospectus entitled “Description of the Notes” for a more complete description of the terms of the notes.

Issuer		Smurfit-Stone Container Enterprises, Inc.
Notes Offered		$675,000,000 aggregate principal amount of senior notes due 2017.
Maturity Date		March 15, 2017
Interest Rate		8.000% per year.
Interest Payment Dates		March 15 and September 15, beginning on September 15, 2007. Interest will accrue from the issue date of the notes.
Optional Redemption		SSCE may redeem any of the notes beginning on March 15, 2012. The initial redemption price is 104.000% of their principal amount, plus accrued interest. The redemption price will decline each year after 2012 and beginning on March 15, 2015 will be 100% of the principal amount, plus accrued and unpaid interest. In addition at any time prior to March 15, 2010, SSCE may redeem up to 35% of the aggregate principal amount of outstanding notes with the proceeds of certain sales of capital stock or equivalent interests at a redemption price equal to 108.000% of their principal amount, plus accrued interest to the redemption date. SSCE may make such redemption only if, after any such redemption, at least 65% of the aggregate principal amount of notes originally issued under the indenture remains outstanding.
Ranking		The notes will be unsecured and will rank equal in right of payment to all existing and future unsecured and unsubordinated indebtedness of SSCE. The notes will be effectively junior in right of payment to our secured debt and all existing and future liabilities, including trade payables, of our subsidiaries. As of December 31, 2006, after giving effect to the offering of the notes and the application of the net proceeds therefrom as described in this prospectus, we would have had $1,224 million aggregate principal amount of secured indebtedness outstanding (including $1,023 million under our existing credit facility) and $526 million of secured debt available for borrowing under our existing credit facility, subject to certain conditions.
		The notes will not be guaranteed and, therefore, will be effectively subordinated to the liabilities of our subsidiaries. Our subsidiaries have significant liabilities.
Change of Control		Upon a change of control, as defined under the section titled “Description of the Notes,” we will be required to make an offer to purchase the notes then outstanding at a purchase price equal to 101% of the principal amount thereof, plus accrued interest to the date of purchase. We may not have sufficient funds available at the time of a change of control to repurchase the notes.

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Covenants		The terms of the registered notes will limit our ability to:
		·  incur additional indebtedness;
		·  pay dividends and make distributions in respect of our capital stock;
		·  make investments or certain other restricted payments;
		·  restrict the ability of subsidiaries to pay dividends or make other payments;
		·  issue or sell stock of certain subsidiaries;
		·  guarantee indebtedness;
		·  enter into transactions with stockholders and affiliates;
		·  create liens;
		·  engage in sale-leaseback transactions;
		·  sell assets;
		·  engage in certain unrelated business activities; and
		·  consolidate or merge.
Registration Rights		We have agreed to consummate an exchange offer for the notes pursuant to an effective registration statement or cause resales of the notes to be registered under the Securities Act. If these events have not occurred on or prior to September 26, 2007, the interest rate on the notes will increase by 0.5%. Holders who do not participate in the exchange or in the registration may thereafter hold a less liquid security than holders who do participate.

 

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The Company

General

Smurfit-Stone Container Enterprises, Inc., incorporated in Delaware in November 2000, is the industry’s leading integrated manufacturer of paperboard and paper-based packaging in North America, including containerboard and corrugated containers, and is one of the world’s largest paper recyclers. In addition, we are a leading producer of solid bleached sulfate (“SBS”). We have a complete line of graphics capabilities for packaging. For the year ended December 31, 2006, our net sales were $7,157 million and net loss was $59 million.

We are a wholly-owned subsidiary of Smurfit-Stone Container Corporation, a holding company with no business operations of its own. Smurfit-Stone conducts its business operations through us. We are the surviving company resulting from the merger of Smurfit-Stone’s primary operating subsidiaries on November 1, 2004 (the “Merger”). JSCE, Inc. merged with and into Jefferson Smurfit Corporation (U.S.) (“JSC (U.S.)”), with JSC (U.S.) as the surviving company, and then JSC (U.S.) merged with and into SSCE, with SSCE as the surviving entity. The Merger was effected principally to consolidate debt financing activities of Smurfit-Stone and its subsidiaries. We were simultaneously renamed Smurfit-Stone Container Enterprises, Inc.

Our principal executive offices are located at 150 North Michigan Avenue, Chicago, Illinois 60601, and our telephone number is (312) 346-6600.

Strategic Initiatives

During 2005, we announced a strategic initiative plan to improve performance and better position us for long-term growth. Our plan focused on cost reduction and productivity initiatives from which we expect to achieve $525 million in annual savings by the end of 2008. In order to achieve our cost reduction initiatives, we expect to close a minimum of 30 converting facilities by the end of 2008. Some plant closures will enable us to transfer production volume to our other plants, thereby lowering costs through higher equipment utilization. Other plant closures will be part of our scaling plan in larger markets, which involves investment in new high-speed corrugators and finishing equipment. We expected to achieve additional cost reductions through (i) mill consolidation; (ii) productivity improvements at the mills and the remaining container plants; (iii) standardization of containerboard trim sizes and grades produced; (iv) transportation and procurement savings; and (v) reductions in selling and administrative expenses.

Since the commencement of the strategic initiative plan through the end of 2006, we have closed two containerboard mills and 16 corrugated container plants, permanently shut down four corrugators and reduced headcount by over 3,600. In 2006, we realized estimated savings of $243 million from these initiatives. In the first quarter of 2007, we closed three converting facilities. As of the date hereof, we have announced the closure of two additional containerboard mills and six additional converting facilities. See “—Recent Developments.” We expect to attain significant additional benefits over the remaining two years of the strategic initiative plan.

Sale of Consumer Packaging Division

As part of the strategic initiative plan, we sold substantially all of the assets of our Consumer Packaging division on June 30, 2006. Reflecting final working capital adjustments and sales transaction costs, net cash proceeds of $897 million were used to repay debt and enhance our financial flexibility. As a result of the sale of our Consumer Packaging division, we have one reportable segment, Containerboard and Corrugated Containers.

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Offer to Purchase 93¤4% Senior Notes due 2011

On March 12, 2007, we launched a cash tender offer and consent solicitation (the “Tender Offer”) to purchase any and all of our outstanding 93¤4% Senior Notes due 2011 (the “93¤4% Senior Notes”) from the holders of those notes. On March 26, 2007, we used a portion of the net proceeds from the issuance on such date of $675 million of 8.000% Senior Notes due 2017 to purchase $546,167,000 aggregate principal amount of the outstanding 93¤4% Senior Notes (approximately 84.3% of the total outstanding principal amount) pursuant to the Tender Offer. The 8.000% Senior Notes were issued in a private placement to qualified institutional buyers under Rule 144A of the Securities Act and outside the United States in compliance with Regulation S under the Securities Act. In accordance with the Tender Offer, we also executed a supplemental indenture effectuating amendments to the indenture governing the 93¤4% Senior Notes as of March 26, 2007.

On April 6, 2007, we completed the Tender Offer, pursuant to which approximately $546 million in aggregate principal amount of the 93¤4% Senior Notes were tendered and accepted for purchase. We used the net proceeds of the 8.000% Senior Notes to purchase the 93¤4% Senior Notes, pay related tender premiums and accrued interest of $19 million and $8 million, respectively, and repay $95 million of borrowings under our revolving credit facility. On April 9, 2007, we called the remaining amount of the 93¤4% Senior Notes outstanding, approximately $102 million, for full redemption on May 9, 2007 (the “Redemption Date”) in accordance with the terms of the indenture governing the 93¤4% Senior Notes. The 93¤4% Senior Notes will be redeemed at a redemption price of $1,032.50 per $1,000 note outstanding, to be paid on the Redemption Date. We will use borrowings under our revolving credit facility to redeem the 93¤4% Senior Notes and pay related call premiums of $3 million and accrued interest of $3 million.

Recent Developments

On April 26, 2007, SSCC, our parent company, reported a net loss available to common stockholders of $55 million, or $0.21 per diluted share, for the first quarter of 2007. These results include:

·       a restructuring charge of $0.06 per diluted share primarily from the closure of container plants and headcount reductions;

·       a $0.05 per diluted share charge related to the early extinguishment of debt; and

·       a loss of $0.01 per diluted share from non-cash foreign currency charges.

We also announced plans to further realign our containerboard mill system over the next six months as part of our strategic initiatives plan. The Carthage, Indiana and Los Angeles, California medium mills, with combined annual capacity of approximately 200,000 tons, will be permanently closed. We expect to incur a restructuring charge of approximately $18 million associated with these actions. The previously idled machine at the Jacksonville, Florida mill with capacity to produce approximately 170,000 tons of containerboard will be restarted.

Risk Factors

See ‘‘Risk Factors’’ immediately following this summary for a discussion of risks relating to us, our business and participating in the exchange offer.

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SUMMARY HISTORICAL FINANCIAL DATA

The following data (not including the statistical data) as of and for the periods indicated was derived from our audited consolidated financial statements. This information is only a summary and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Selected Consolidated Historical Financial Data” and our consolidated historical financial statements appearing elsewhere in this prospectus.

(a)           Results for 2002 include the acquisition of the Stevenson, Alabama containerboard mill and the related corrugated container assets after September 30, 2002, the date of the acquisition.

(b)          We recorded a $5 million charge, net of income tax, in 2003 for the cumulative effect of an accounting change in accordance with Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations.”

(c)           Results for 2003 include the acquisition of Smurfit-MBI after March 31, 2003, the date of the acquisition.

(d)          Effective April 1, 2006, we adopted Emerging Issues Task Force Issue No. 04-13, “Accounting for Purchases and Sales of Inventory With the Same Counterparty,” which required us to prospectively report certain inventory buy/sell transactions of similar containerboard types in our Containerboard and Corrugated Containers segment on a net basis in our consolidated statements of operations, thereby reducing net sales and cost of goods sold by $194 million in 2006.

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

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

(g)           Includes income from discontinued operations and loss on disposition of discontinued operations.

(h)          For purposes of calculating the ratio of earnings to fixed charges, earnings include income (loss) from continuing operations before income taxes, plus fixed charges. Fixed charges consist of interest on indebtedness, amortization of deferred debt issuance costs and that portion of lease rental expense considered to be representative of the interest factors therein. Earnings were inadequate to cover fixed charges for the years ended December 31, 2003, 2004, 2005 and 2006 by $352 million, $125 million, $619 million and $110 million, respectively.

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

(j)              “EBITDA” is defined as income (loss) from continuing operations before cumulative effect of accounting change and before (benefit from) provision for income taxes, interest expense, net, interest income from SSCC and depreciation, depletion and amortization. See “Non-GAAP Financial Measures.”

Non-GAAP Financial Measures

The following table presents a reconciliation of EBITDA to the most directly comparable GAAP financial measure for each year indicated:

(a)           Income from discontinued operations before income taxes for 2002, 2003, 2004 and 2005 excludes $1 million of interest expense allocated to discontinued operations.

We measure our performance primarily through our operating profit. In addition to our audited consolidated financial statements presented in accordance with U.S. generally accepted accounting principles (“GAAP”), management uses certain non-GAAP financial measures, including “EBITDA” to measure our operating performance. We provide a definition of the components of EBITDA and reconciliation to the most directly comparable GAAP financial measure.

EBITDA is considered by our Board of Directors and management as a basis for measuring and evaluating our overall operating performance. It is presented to enhance an understanding of our operating results and is not intended to represent cash flow or results of operations. The use of EBITDA provides an indication of our ability to service debt and we consider it an appropriate measure to use because of our highly leveraged position. We believe EBITDA is useful in evaluating our operating performance compared to other companies in our industry, and is beneficial to investors, potential investors and other key stakeholders, including analysts and creditors who use it in their evaluations of our performance.

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EBITDA has certain material limitations associated with its use as compared to net income. These limitations are primarily due to the exclusion of certain amounts that are material to our consolidated results of operations, such as interest expense, income tax expense and depreciation and amortization. In addition, EBITDA may differ from the EBITDA calculations of other companies in our industry, limiting its usefulness as a comparative measure.

Because of these limitations, EBITDA should not be considered a measure of discretionary cash available to us to invest in our business and should be read in conjunction with our consolidated financial statements prepared in accordance with GAAP. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA only as a supplemental measure of our operating results. The presentation of this additional information is not meant to be considered in isolation or as a substitute for financial statements prepared in accordance with GAAP. The EBITDA presentation includes a reconciliation to income (loss) from continuing operations before cumulative effect of accounting change, which we believe is clear and useful to our stakeholders.

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RISK FACTORS

Investing in the notes involves a high degree of risk. You should carefully consider the specific factors listed below, as well as the other information included in this prospectus, before making an investment decision. The occurrence of any one or more of the following could materially adversely affect your investment in the notes or our business and operating results.

Risks Relating to Our Business

We have a highly leveraged capital structure.

Our substantial leverage could have significant consequences for us, including the following:

·                    we may be required to seek additional sources of capital, including additional borrowings under our existing credit facilities, other private or public debt or equity financings to service or refinance our indebtedness, which borrowings may not be available on favorable terms, particularly in the event that our credit ratings are downgraded by rating agencies;

·                    a substantial portion of our cash flow from operations will be needed to meet the payment of principal and interest on our indebtedness and other obligations and will not be available for our working capital, capital expenditures and other general corporate purposes; and

·                    our level of debt makes us more vulnerable to economic downturns and reduces our operational and business flexibility in responding to changing business and economic conditions and opportunities.

In addition, we are more highly leveraged than some of our competitors, which may place us at a competitive disadvantage.

Our industry is cyclical and highly competitive.

Our operating results reflect the industry’s general cyclical pattern. The majority of our products can be subject to extreme price competition. Some segments of our industry have production overcapacity, which may require us to take downtime periodically to reduce inventory levels during periods of weak demand. In addition, the industry is capital intensive, which leads to high fixed costs and has historically resulted in continued production as long as prices are sufficient to cover marginal costs. These conditions have contributed to substantial price competition and volatility in the industry. Decreases in prices for our products, coupled with our highly leveraged financial position, may adversely impact our ability to respond to competition and to other market conditions or to otherwise take advantage of business opportunities.

The paperboard and packaging products industries are highly competitive and are particularly sensitive to price fluctuations as well as other factors including innovation, design, quality and service, with varying emphasis on these factors depending on the product line. To the extent that one or more of our competitors become more successful with respect to any key competitive factor, our ability to attract and retain customers could be materially adversely affected. Many of our competitors are less leveraged, have financial and other resources greater than ours and are more capable of withstanding the adverse nature of the business cycle. If our facilities are not as cost efficient as those of our competitors, we may need to temporarily or permanently close such facilities and suffer a consequent reduction in our revenues.

Our pension plans are underfunded and will require additional cash contributions.

We have made substantial contributions to our pension plans in the past five years and expect to continue to make substantial contributions in the coming years in order to ensure that our funding levels remain adequate in light of projected liabilities and to meet the requirements of the Pension Protection

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Act of 2006. These contributions reduce the amount of cash available for us to repay indebtedness or make capital investments.

Price fluctuations in energy costs and raw materials could adversely affect our manufacturing costs.

The cost of producing and transporting our products is highly sensitive to the price of energy. Energy prices, in particular oil and natural gas, have experienced significant volatility in recent years, with a corresponding effect on our production costs. Energy prices may continue to fluctuate and may rise to higher levels in future years. This could adversely affect our production costs and results of operations. Although we may enter into agreements to hedge our energy costs, these agreements may be inadequate to protect us fully against the volatility of energy costs. To the extent we have positions that are not hedged or our hedging procedures do not perform as planned, fluctuating energy costs could reduce our operating profit.

Wood fiber and reclaimed fiber, the principal raw materials used in the manufacture of our paper products, are purchased in highly competitive, price-sensitive markets, which have historically exhibited price and demand cyclicality. Adverse weather, conservation regulations and the shutdown of a number of sawmills have caused, and will likely continue to cause, a decrease in the supply of wood fiber and higher wood fiber costs in some of the regions in which we procure wood fiber. Fluctuations in supply and demand for reclaimed fiber have occasionally caused tight supplies of reclaimed fiber. At such times, we may experience an increase in the cost of fiber or may temporarily have difficulty obtaining adequate supplies of fiber.

Factors beyond our control could hinder our ability to service our debt and meet our operating requirements.

Our ability to meet our obligations and to comply with the financial covenants contained in our debt instruments will largely depend on our future performance. Our performance will be subject to financial, business and other factors affecting 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, our products;

·                    performance of our major customers;

·                    costs of raw materials and energy;

·                    hurricanes and other major weather-related disruptions; and

·                    legislation and other factors relating to the paperboard and packaging products industries generally or to specific competitors.

If operating cash flows or net proceeds from borrowings, any divestitures and other financing sources do not provide us with sufficient liquidity to meet our operating and debt service requirements, we will be required to pursue other alternatives to repay debt and improve liquidity. Such alternatives may include:

·                    sales of assets;

·                    cost reductions;

·                    deferral of certain discretionary capital expenditures and benefit payments; and

·                    amendments or waivers to our debt instruments.

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We might not successfully complete any of these measures or they may not generate the liquidity we require to operate our business and service our obligations. If we are not able to generate sufficient cash flow or otherwise obtain funds necessary to make required debt payments or we fail to comply with our debt covenants, we would be in default under the terms of our various debt instruments. This would permit our debt holders to accelerate the maturity of such debt and would cause defaults under our other debt.

We may not realize the cost savings we expect from our strategic initiatives.

Our ability to generate sufficient cash flows to meet our operating and debt service requirements depends in part on our ability to execute certain strategic initiatives, which are intended to result in a lower cost structure through increased efficiency in our manufacturing processes. Although we have implemented several restructuring initiatives in the past, there are inherent risks related to these programs. These risks include the closure of manufacturing facilities, disruption of business operations, inability to meet customer demand, higher costs than anticipated, environmental issues associated with the closed facilities and a failure to complete these initiatives in the time frames contemplated. Costs incurred in restructuring our operations, as well as increases in other expenses unrelated to the restructuring, might offset any cost savings. We cannot provide assurance that the restructuring activities will achieve the full expected benefits of the cost savings within the expected time frame.

We are subject to environmental regulations and liabilities that could weaken our operating results and financial condition.

Federal, state, provincial, foreign and local environmental requirements, particularly those relating to air and water quality, are a significant factor in our business. The Environmental Protection Agency (“EPA”) has issued a comprehensive rule governing air emissions (Maximum Achievable Control Technology (“MACT”)) and water discharges (Effluent Limitation Guidelines) for the pulp, paper and paperboard industry, known as the “Cluster Rule,” which has required significant capital expenditures. Substantially all Cluster Rule spending will be incurred by the end of the first quarter of 2007. The EPA has also promulgated a Boiler MACT regulation that will limit hazardous air pollutant emissions from industrial boilers. Several of our mills are subject to the Boiler MACT regulation and are required to install new pollution control equipment in order to meet the September 13, 2007 compliance deadline. Changes in existing environmental laws or the promulgation of new environmental laws may require capital expenditures for compliance.

In the past we have had, and in the future we may face, environmental liability for the costs of remediating soil or groundwater that we or a third party contaminated at various sites that we currently own or operate or previously owned or operated. There may be liability at third party sites with respect to which we either have received, or in the future may receive, notice that we may be a potentially responsible party (“PRP”) and which are the subject of cleanup activity under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”), analogous state laws and other laws concerning hazardous substance contamination. Ongoing remediation costs and future remediation liability may materially adversely affect our results of operations and financial condition.

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Foreign currency risks and exchange rate fluctuations could hinder the results of our Canadian operations.

Our assets and liabilities outside the United States are primarily located in Canada. Our principal foreign exchange exposure is the Canadian dollar. The functional currency for our Canadian operations is the U.S. dollar. To the extent we have un-hedged positions or our hedging procedures do not perform as planned, fluctuating currencies could reduce our sales and net income. Our financial performance is directly affected by exchange rates because:

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

·                    the monetary assets and liabilities of our Canadian operations are translated into U.S. dollars for financial reporting purposes.

Risks Relating to the Exchange Offer

If you do not exchange your outstanding notes for registered notes, your notes will continue to have restrictions on transfer.

If you do not exchange your outstanding notes for registered notes in the exchange offer, or if your outstanding notes are tendered but not accepted, your notes will continue to have restrictions on transfer. In general, you may offer or sell any outstanding notes only if the notes are registered under the Securities Act and applicable state laws, or resold under an exemption from these laws. We do not intend to register the outstanding notes under the Securities Act, other than in the limited circumstances in the registration rights agreement discussed in the section ‘‘Description of the Notes—Registration Rights.’’

The issuance of the registered notes may adversely affect the market for outstanding notes.

If outstanding notes are tendered for exchange, the trading market for untendered and tendered but unaccepted outstanding notes could be adversely affected. Please refer to the section in this prospectus entitled ‘‘The Exchange Offer—Consequences of Failure to Exchange.’’

Risks Relating to the Registered Notes

We have substantial debt outstanding that could negatively impact our business and prevent us from fulfilling our obligations on the registered notes.

We have a substantial amount of debt outstanding. As of December 31, 2006, after giving effect to the offering of the outstanding notes and the application of the net proceeds therefrom, we would have had total consolidated outstanding debt of $3,674 million, including $1,224 million of secured debt, and $526 million of unused borrowing capacity under our secured bank credit facility, subject to certain conditions.

Our indebtedness, together with our capital expenditures, requires significant cash outlays that have exceeded our cash flows from operations for each of the last three years. In 2006, we had interest expense, net, of $341 million, capital expenditures of $274 million and net cash provided by operating activities of $265 million. In 2005, we had interest expense, net, of $345 million, capital expenditures of $276 million and net cash provided by operating activities of $221 million. In 2004, we had interest expense, net, of $342 million, capital expenditures of $219 million and net cash provided by operating activities of $265 million.

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Our high level of debt could:

·                    make it difficult for us to satisfy our obligations, including making interest payments under the registered notes and our other debt obligations;

·                    limit our ability to obtain additional financing to operate our business;

·                    limit our financial flexibility in planning for and reacting to industry changes;

·                    place us at a disadvantage as compared to less leveraged competitors;

·                    increase our vulnerability to general adverse economic and industry conditions, including changes in interest rates;

·                    require us to dedicate a substantial portion of our cash flow to payments on our debt, reducing the availability of our cash flow for other purposes; and

·                    limit our ability to take advantage of business opportunities.

We may borrow additional amounts to fund our capital expenditures and working capital needs. We also may incur additional debt to finance future acquisitions. The incurrence of substantial additional debt could cause us to experience one or more of the risks described above and could exacerbate the effects of some or all of the risks described above.

If we cannot make scheduled payments on our debt, we will be in default and, as a result:

·                    our debt holders could declare all outstanding principal and interest to be due and payable;

·                    our secured debt lenders could terminate their commitments and commence foreclosure proceedings against our assets; and

·                    we could be forced into bankruptcy or liquidation.

As of December 31, 2006, we had scheduled principal debt payments of $84 million in 2007, $8 million in 2008, $145 million in 2009, $125 million in 2010, $1,507 million in 2011 and $1,765 million thereafter. After giving effect to the offering of 8.000% senior notes due 2017 and the repayment of approximately $648 million outstanding 93¤4% senior notes due 2011, we would have had scheduled principal payments on our debt of $84 million in 2007, $8 million in 2008, $158 million in 2009, $125 million in 2010 and $859 million in 2011 and $2,440 million thereafter.

The registered notes are effectively subordinated to our secured debt and the obligations of our subsidiaries.

The registered notes are unsecured and are effectively subordinated to our secured debt, to the extent of the value of the assets securing such debt. As of December 31, 2006, after giving effect to the offering of the outstanding notes and the application of net proceeds therefrom, we would have had $1,224 million aggregate principal amount of secured debt outstanding (including $1,023 million outstanding under our existing senior secured credit facility). In the event we are the subject of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding, our assets securing our debt could not be used to pay you until all secured claims against us have been fully paid.

Because our subsidiaries do not guarantee and are not otherwise liable for the payment of principal or interest on the registered notes, claims of holders of the registered notes will be effectively subordinated to the claims of all the creditors, including the trade creditors, of those subsidiaries.

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

Our ability to incur additional debt, and in certain cases refinance outstanding debt, is significantly limited or restricted under the agreements relating to our and our subsidiaries’ existing debt. Our senior secured credit facility and the indentures governing our outstanding senior notes restrict our ability to take specific actions, even if such actions may be in our best interest. These restrictions limit our ability to:

·       incur liens or make negative pledges on our assets;

·       merge, consolidate or sell our assets;

·       issue additional debt;

·       pay dividends or repurchase or redeem capital stock;

·       make investments and acquisitions;

·       enter into certain transactions with stockholders and affiliates;

·       make capital expenditures;

·       materially change our business;

·       amend our debt and other material agreements;

·       issue and sell capital stock;

·       make investments in unrestricted subsidiaries; or

·       prepay specified indebtedness or other debt.

Our senior secured credit facility requires us to maintain specified financial ratios. Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we were unable to make this repayment or otherwise refinance these borrowings, our lenders could foreclose on our assets. If we were unable to refinance these borrowings on favorable terms, our costs of borrowing could increase significantly.

Our senior debt bears interest at fixed and floating rates. Currently, only a portion of our floating interest rate debt is capped. If interest rates rise, our senior debt interest payments also will increase. Although we may enter into agreements to hedge our interest rate risk, these agreements may be inadequate to protect us fully against our interest rate risk.

You may find it difficult to sell your registered notes because no public trading market for the registered notes exists.

The registered notes are a new issue of securities for which there is currently no active trading market. The registered notes will be registered under the Securities Act, but will constitute a new issue of securities with no established trading market. We do not intend to list the registered notes on any national securities exchange or to seek the admission of the registered notes for quotation through the Nasdaq Stock Market, Inc. In addition, the registered notes will not be eligible for trading on the Private Offerings, Resales, and Trading through Automatic Linkages Market, also known as the PORTAL Market. PORTAL is a computerized communications facility for primary offering and secondary trading of securities that are eligible for resale pursuant to Rule 144A and that are (1) restricted securities, as defined in Rule 144(a)(3), or (2) contractually required to be resold only in compliance with Rule 144, Rule 144A, Regulation S or in secondary private placements. If the registered notes are traded after their initial issuance, they may trade at a discount from their initial offering price, depending on prevailing interest

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rates, the market for similar securities and other factors, including general economic conditions and our financial condition, performance and prospects.

Accordingly,

·       a market for the registered notes may not develop;

·       you may not be able to sell your registered notes; and

·       you may not be able to sell your registered notes at any particular price.

We may not be able to repurchase registered notes upon a change of control which would be an event of default under the indenture.

Upon the occurrence of certain specific kinds of change of control events, we will be required to offer to repurchase all outstanding registered notes. Our senior credit facility restricts us from repurchasing the registered notes without the approval of the lenders. In addition, it is possible that we will not have sufficient funds at the time of the change of control to make the required repurchase of registered notes or that restrictions in our senior credit facility will not allow such repurchases. Certain corporate events would also constitute a change of control under our senior secured credit facility which might not constitute a change of control under our other debt instruments, including the registered  notes. This would constitute an event of default under our senior secured credit facility, entitling the lenders to, among other things, cause all our outstanding debt obligations thereunder to become due and payable, and to proceed against their collateral. For example, certain important corporate events, such as leveraged recapitalizations that would increase the level of our indebtedness, would constitute a change of control under our senior credit facility but would not constitute a change of control under the indenture.

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SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA

The following data (not including the statistical data) as of and for the periods indicated was derived from our audited consolidated financial statements. You should read all of this information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes thereto appearing elsewhere in this prospectus.

		Year Ended December 31,
		2002(a)			2003(b)(c)					2004			2005			2006
		(in millions, except statistical data)
Summary of Operations:
Net sales(d)		$	6,025			$	6,146			$	6,716		$	6,812		$	7,157
Operating income (loss)(e)(f)		337				(42		)		172			(253		)	276
Interest expense, net		354				340				342			345			341
Income (loss) from continuing operations before cumulative effect of accounting change		33				(200		)		(53		)	(378		)	(70		)
Discontinued operations, net of income tax provision(g)		80				59				54			51			11
Net income (loss)		113				(146		)		1			(327		)	(59		)
Other Financial Data:
Net cash provided by operating activities		$	502			$	155			$	265		$	221		$	265
Net cash provided by (used for) investing activities(h)		(456		)		48				(192		)	(277		)	706
Net cash provided by (used for) financing activities		(58		)		(197		)		(79		)	55			(967		)
Depreciation, depletion and amortization		401				415				416			408			377
Capital investments and acquisitions		570				238				232			285			274
Working capital, net		591				137				148			(3		)	(139		)
Net property, plant, equipment and timberland		5,182				4,974				4,682			4,289			3,774
Total assets		11,366				10,538				9,583			9,114			7,776
Long-term debt(i)		4,990				4,807				4,498			4,571			3,634
Stockholder’s equity		2,786				2,737				2,116			1,739			1,664
Statistical Data (tons in thousands):
Containerboard production (tons)		6,860				7,185				7,438			7,215			7,402
Kraft paper production (tons)		283				293				259			204			199
Market pulp production (tons)		567				497				549			563			564
Solid bleached sulfate production (tons)		296				290				276			283			313
Corrugated containers sold (billion sq. ft.)		76.9				79.7				81.8			81.3			80.0
Fiber reclaimed and brokered (tons)		6,582				6,549				6,542			6,501			6,614
Number of employees at December 31(j)		38,600				36,700				35,300			33,500			25,200

 

(a)           Results for 2002 include the acquisition of the Stevenson, Alabama containerboard mill and the related corrugated container assets after September 30, 2002, the date of the acquisition.

(b)          We recorded a $5 million charge, net of income tax for the cumulative effect of an accounting change in accordance with Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations.”

(c)           Results for 2003 include the acquisition of Smurfit-MBI after March 31, 2003, the date of the acquisition.

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(d)          Effective April 1, 2006, we adopted Emerging Issues Task Force Issue No. 04-13, “Accounting for Purchases and Sales of Inventory With the Same Counterparty”, which required us to prospectively report certain inventory buy/sell transactions of similar containerboard types in our Containerboard and Corrugated Containers segment on a net basis in our consolidated statements of operations, thereby reducing net sales and cost of goods sold by $194 million in 2006.

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

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

(g)           Includes income from discontinued operations and loss on disposition of discontinued operations.

(h)          Includes proceeds from property disposals and sale of businesses in 2002, 2003, 2004, 2005 and 2006, of $108 million, $253 million, $32 million, $8 million and $980 million, respectively.

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

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

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Overview

Smurfit-Stone Container Enterprises, Inc. is an integrated manufacturer of paperboard and paper-based packaging. Our major products are containerboard, corrugated containers, SBS, market pulp, recycled fiber and kraft paper. We operate in one reportable industry segment. Approximately 95% of our 2006 net sales were generated by the Containerboard and Corrugated Containers segment and 5% were generated by our reclamation operation. Our mill operations supply paper to our corrugated container converting operations. The products of our converting operations, as well as the mill and reclamation tonnage in excess of what is consumed internally, are the main products sold to third parties. Our operating facilities and customers are located primarily in the United States and Canada.

Market conditions and demand for our products are subject to cyclical changes in the economy and changes in industry capacity, both of which can significantly impact selling prices and our profitability. In recent years, the continued loss of domestic manufacturing to offshore competition and the changing retail environment in the 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 the impacts from online shopping, has resulted in a shifting of demand to packaging which is more condensed, lighter weight and less expensive. These factors have greatly influenced the corrugated industry.

In 2006, U.S. industry per day shipments of corrugated containers increased 1.3%. Principally as a result of 17 plant closures since we began implementing our strategic initiative plan in 2005, our North American per day shipments of corrugated containers decreased 1.3% compared to 2005. Although our volume declined during the year, 2006 was an important year for us as we implemented significant price increases, made substantial progress executing our strategic initiative plan and strengthened our management team. In addition, as part of our strategic initiative plan, we sold our Consumer Packaging division on June 30, 2006 and used the proceeds to repay debt. For 2006, we recorded a net loss of $59 million, a significant improvement compared to 2005. Higher prices, savings from our strategic initiatives, and lower restructuring charges in 2006 were partially offset by significant cost inflation on key input costs including freight, energy, fiber and chemicals.

Our outlook for 2007 is that business fundamentals and packaging demand will remain stable. We expect improved earnings in 2007 due to higher average prices compared to 2006 and incremental benefits from our strategic initiatives. Regarding costs trends, we expect higher fiber costs in 2007. Virgin fiber prices are increasing as a result of wet weather conditions and sawmill closures stemming from the housing slowdown. We expect old corrugated containers (“OCC”) prices to increase in 2007 due to greater waste paper export demand from China. We believe fiber costs will be approximately $29 million higher than we initially anticipated for the first quarter of 2007. In addition, we expect continued inflation in our other key input costs.

Strategic Initiatives

During 2005, we announced a strategic initiative plan to improve performance and better position us for long-term growth. Our plan focused on cost reduction and productivity initiatives from which we expect to achieve $525 million in annual savings by the end of 2008. As part of the initiative plan, we completed the sale of our Consumer Packaging division on June 30, 2006 and used the proceeds to reduce debt. See “Business, Discontinued Operations.” Our original initiative target included cost savings benefits to be derived from the Consumer Packaging division and accordingly, we have adjusted this target to exclude the impact of the Consumer Packaging division from both the target and actual savings achieved.

In order to achieve our cost reduction initiatives, we expect to close a minimum of 30 converting facilities by the end of 2008 (inclusive of 17 facilities closed through December 31, 2006). Some plant

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closures will enable us to transfer production volume to our other plants, thereby lowering costs through higher equipment utilization. Other plant closures will be part of our scaling plan in larger markets, which involves investment in new-high speed corrugators and finishing equipment. We expected to achieve additional cost reductions through i) mill consolidation, ii) productivity improvements at the mills and the remaining container plants, iii) standardization of containerboard trim sizes and grades produced, iv) transportation and procurement savings and v) reductions in selling and administrative expenses.

In 2005, as the first step in this cost reduction process and in order to better align production capacity with market conditions and demand, we permanently closed the New Richmond, Quebec linerboard mill, the Bathurst, New Brunswick medium mill and the previously idled No. 2 paper machine at the Fernandina Beach, Florida linerboard mill. Our containerboard manufacturing capacity was reduced by 700,000 tons, or 8.5%, as a result of these closures. In addition, we also closed two converting facilities, exited our investment in the Las Vegas, Nevada converting facility, and agreed to the closure of the Groveton, New Hampshire medium mill, in which we owned a minority interest. As a result of these closures, we recorded restructuring charges of $321 million, including non-cash charges of $267 million related to the write-down of assets, primarily property, plant and equipment, to estimated net realizable values. The remaining charges were primarily for severance, benefits, lease commitments and post-closure environmental costs. These shutdowns resulted in approximately 780 employees being terminated. In 2005, we realized savings of approximately $45 million from our strategic initiatives. The savings included a reduction of fixed costs primarily related to the closures of the two containerboard mills, other workforce reductions in the Containerboard and Corrugated Container segment and a one-time curtailment gain related to the elimination of postretirement health care and life insurance benefits for certain employees.

In 2006, in conjunction with the strategic initiative plan, we closed 15 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. We recorded restructuring charges of $43 million, net of an $18 million gain from the sale of three closed facilities and the No. 2 paper machine at the Fernandina Beach, Florida linerboard mill. The fixed assets of the shutdown operations were adjusted to the estimated net realizable value, resulting in a non-cash charge of $21 million.

For 2006, we targeted $240 million of cost savings and productivity improvements from our strategic initiatives. In 2006, we realized estimated savings of $243 million from these initiatives compared to cost levels prior to the start of the initiative plan as adjusted for the impact of inflation. Since we announced our strategic initiative plan, we have realized cumulative initiative savings of approximately $288 million. Through December 31, 2006, we have closed two containerboard mills, shut down 17 converting facilities and permanently shutdown four corrugators. As a result of these actions, we have reduced our headcount by approximately 3,600 since June 30, 2005.

For 2007, we are targeting $177 million in incremental savings and productivity improvements from our strategic initiatives. For the two month-period ended February 28, 2007, we have announced four additional plant closures and the permanent shutdown of one corrugator, which will result in the termination of approximately 350 employees. For the first quarter of 2007, we expect total reductions in headcount of approximately 600 employees.

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

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

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Results of Operations for the Years Ended December 31, 2006, 2005 and 2004

Discontinued Operations

Our Consumer Packaging segment, which was sold on June 30, 2006, has been classified as discontinued operations and is excluded from the segment results for all periods presented. See “Business, Discontinued Operations.”

Recently Adopted Accounting Standards

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

Segment Data

(a)           Corporate expenses and other includes corporate expenses, corporate charges to segments for working capital interest and other expenses not allocated to segments. The higher expense in 2006 compared to 2005 is primarily due to higher mark-to-market adjustments on energy hedges ($24 million), higher stock-based compensation expense ($13 million) and costs related to the implementation of the strategic initiatives ($13 million).

2006 Compared to 2005

For 2006, we had a net loss of $59 million, compared to a net loss $327 million in 2005. Our loss was lower in 2006 due primarily to lower restructuring charges and higher Containerboard and Corrugated Containers segment profit. In 2006, we recorded pretax restructuring charges of $43 million compared to $321 million in 2005. In 2006, the Containerboard and Corrugated Containers segment profit of $433 million was $242 million higher compared to 2005 due primarily to higher average selling prices for

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containerboard and corrugated containers and cost savings achieved from our strategic initiative plan, which were partially offset by higher key input costs.

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

 

Cost of goods sold increased from $6,054 million in 2005 to $6,185 million in 2006 due primarily to higher sales volume ($37 million), and higher costs for freight ($47 million), energy ($35 million), wood fiber ($17 million) and chemicals ($16 million). 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 of goods sold as a percent of net sales decreased from 88.9% in 2005 to 86.4% in 2006 due primarily to the higher average sales prices.

Selling and administrative expense decreased $12 million in 2006 compared to 2005 due primarily to lower litigation charges and settlements, net. In 2005, we recorded charges of $36 million for the settlement of Direct Action Cases. Selling and administrative expense in 2006 was unfavorably impacted by higher stock-based compensation expense ($13 million), including $5 million due to the impact of adopting Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”) on January 1, 2006, and costs related to the implementation of the strategic initiatives ($13 million). For information concerning stock-based compensation, see Note 4 of the Notes to Consolidated Financial Statements. Selling and administrative expense as a percent of net sales decreased from 10.1% in 2005 to 9.5% in 2006 due primarily to the higher average sales prices.

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

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

Other, net included a non-cash foreign currency exchange gain of $1 million in 2006 compared to a loss of $9 million in 2005. See “Quantitative and Qualitative Disclosures About Market Risk—Foreign Currency Risk.”

Benefit from income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to loss before income taxes due primarily to state income taxes and the effect of other permanent differences. In connection with the sale of the Consumer Packaging division, during the year ended December 31, 2006, we recorded a pretax gain of $171 million, offset by a $174 million income tax provision, 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 higher than the statutory income tax rate due to the non-deductibility of goodwill. The sale of the Consumer Packaging division generated a $14 million U.S. federal alternative minimum tax, which was paid in 2006.

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Containerboard and Corrugated Containers Segment

Net sales increased 5.1% in 2006 compared to 2005 primarily as a result of higher average sales prices for containerboard and corrugated containers. Net sales were unfavorably impacted by the adoption of EITF No. 04-13. For 2006, average domestic linerboard prices increased 14.8% compared to the same period last year. Our average North American selling price for corrugated containers was 5.2% higher compared to 2005. Shipments of corrugated containers decreased 1.6% compared to 2005 due to one less shipping day and the container plant closures. On a per day basis, shipments of corrugated containers declined by 1.3%. Third party containerboard shipments increased 19.4% compared to 2005. Average sales prices for market pulp, SBS and kraft paper increased 10.8%, 3.0%, and 8.9%, respectively, compared to last year.

Our containerboard mills operated at 100% of capacity in 2006 and containerboard production increased 2.6% compared to last year despite the closure of two containerboard mills in August 2005. Production of market pulp was comparable to last year. Production of SBS increased 10.6%, while kraft paper decreased by 2.5% compared to last year.

Profits increased $242 million due primarily to the higher average sales prices and benefits from our strategic initiatives, which were partially offset by significant inflation on key input costs. Profits also benefited in 2006 from higher third party containerboard shipments, due in part to our planned reduction of 65,000 tons in our containerboard inventories. Profits were unfavorably impacted by the lower sales 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 partially offset by lower average selling prices. The average price for OCC decreased approximately $10 per ton compared to 2005. Total tons of fiber reclaimed and brokered for 2006 was 1.7% higher compared to last year as a result of higher external sales volume and higher internal consumption. Profits in 2006 of $19 million were comparable to last year.

2005 Compared to 2004

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

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

 

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

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

For 2005, we recorded restructuring charges of $321 million, including non-cash charges of $267 million related to the write-down of assets, primarily property, plant and equipment, to estimated net realizable values, and $4 million related to a pension curtailment charge for terminated employees. The remaining charges were primarily for severance, benefits, lease commitments and post-closure environmental costs. These shutdowns resulted in approximately 780 employees being terminated.

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

In November 2004, the notes receivable from Smurfit-Stone of $645 million, including accrued interest, were exchanged for 230 shares of our stock which were owned by Smurfit-Stone. The exchange, which was accounted for at historical cost, resulted in a reduction of $645 million to our additional paid-in capital. The fair value of the shares of our stock received, as estimated by a third party valuation, approximated the net book value of the shares at the time of the exchange. Interest income from Smurfit-Stone was recorded through the date of the settlement of the notes receivable.

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

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

Containerboard and Corrugated Containers 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 corrugated container prices increased 2.2% and average domestic linerboard prices were higher by 4.1% compared to 2004. Average sales prices for market pulp, SBS and kraft 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 2004 due 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 same period of 2004.

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

Profits decreased $130 million due primarily to higher costs and lower containerboard sales volume. Profits were unfavorably impacted by our lower containerboard mill production, the lower sales volume

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and higher costs of energy ($70 million), wood fiber ($38 million), freight ($60 million) and chemicals ($30 million). Profits were favorably impacted by the higher average sales prices.

Reclamation Operations

Net sales decreased 3.6% in 2005 compared to 2004 due primarily to lower sales prices for reclaimed fiber. The average price of OCC decreased by approximately $5 per ton compared to 2004. Total tons of fiber reclaimed and brokered in 2005 were comparable to 2004. Higher external sales volume was offset by lower internal consumption due primarily to the containerboard mill closures. Profits in 2005 decreased $9 million compared to 2004 due primarily to the lower average sales prices and the loss of a profitable customer account.

Liquidity and Capital Resources

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

 

Net Cash Provided By Operating Activities

The change in net cash provided by operating activities in 2006 compared to 2005 was due primarily to higher segment profits partially offset by lower cash generated from working capital. Working capital increased $35 million in 2006 due primarily to decreases in accounts payable and accrued liabilities, including a payment of $46 million related to the settlement of certain antitrust class action litigation. Working capital decreased $123 million in 2005 due to lower inventory levels, an increase in accounts payable and 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 by investing 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 environmental projects and $212 million for projects related to upgrades, cost reductions and strategic initiatives. In 2006, we received proceeds from the sale of property and businesses of $980 million, principally from the sale of our Consumer Packaging division and from the divestiture of our Port St. Joe, Florida joint venture.

Net Cash Provided By (Used For) Financing Activities

Net cash used for financing activities in 2006 of $967 million included net repayment of debt of $937 million due primarily to the application of the Consumer Packaging division sale net proceeds. Cash proceeds from the exercise of stock options in 2006 were $2 million. During 2006, 2005 and 2004 we paid annual dividends of $8 million to Smurfit-Stone.

Smurfit-Stone as guarantor, and we and our subsidiary, Smurfit-Stone Container Canada Inc. (“SSC Canada”), as borrowers, 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

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their entirety, provides for (i) a revolving credit facility of $600 million to us, of which $70 million was borrowed as of December 31, 2006 and (ii) a revolving credit facility of $200 million to us and SSC Canada, of which $66 million was borrowed as of December 31, 2006. The revolving credit facilities include sub-limits for the issuance of letters of credit and swingline loans. Each of these revolving credit facilities matures on November 1, 2009. The Credit Agreement also provided for a Tranche B term loan to us in the aggregate principal amount of $975 million and a Tranche C term loan to SSC Canada in the aggregate principal amount of $300 million. The credit facilities bear interest at rates selected at our option, equal to LIBOR plus 2.50% or alternate base rate (“ABR”) plus 1.50%, in the case of the revolving credit facilities and LIBOR plus 2.25% or ABR plus 1.25%, in the case of the term loan facilities. We pay a 0.5% commitment fee on the unused portions of our revolving credit facilities. The term loans are payable in quarterly installments ending on November 1, 2011. In addition, the Credit Agreement provides for a deposit funded letter of credit facility to us, related to our variable rate industrial revenue bonds, for approximately $122 million that matures on November 1, 2010.

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

The interest rate with respect to term loan facilities decreased by 0.25% effective March 1, 2007, as a result of our Consolidated Senior Secured Leverage Ratio decreasing to less than 3.0 to 1.0.

Our obligations under the Credit Agreement are unconditionally guaranteed by Smurfit-Stone and our material U.S. subsidiaries. The obligations of SSC Canada under the Credit Agreement are unconditionally guaranteed by Smurfit-Stone, us, our material U.S. subsidiaries and the material Canadian subsidiaries of SSC Canada. Our obligations under the Credit Agreement are secured by a security interest in substantially all of Smurfit-Stone’s assets and properties, and those of us and our material U.S. subsidiaries, by a pledge of all of our capital stock and our material U.S. subsidiaries and by a pledge of 65% of the capital stock of SSC Canada that is directly owned by us. The security interests securing our obligation under the Credit Agreement exclude cash, cash equivalents, certain trade receivables, three paper mills and the land and buildings of certain corrugated container facilities. The obligations of SSC Canada under the Credit Agreement are secured by a security interest in substantially all of the assets and properties of SSC Canada and the material Canadian subsidiaries of SSC Canada, by a pledge of all of the capital stock of the material Canadian subsidiaries of SSC Canada and by the same U.S. assets, properties and capital stock that secure our obligations under the Credit Agreement. The security interests securing SSC Canada’s obligation under the Credit Agreement exclude three mills and property related thereto and certain other real property located in New Brunswick and Quebec.

The Credit 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-leaseback transactions, (iii) limitations on capital expenditures and (iv) maintenance

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of certain financial covenants. The Credit Agreement also requires prepayments if we have excess cash flows, as defined therein, or receive proceeds from certain asset sales, insurance or incurrence of certain indebtedness. Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in us being required to repay these borrowings before their due date. If we were unable to make this repayment or otherwise refinance these borrowings, our lenders could foreclose on our assets. If we were unable to refinance these borrowings on favorable terms, our costs of borrowing could increase significantly. At March 31, 2007, we were in compliance with the financial covenants required by the Credit Agreement. As of March 31, 2007, subject to the above limitations, we have unused borrowing capacity under our revolving credit facilities of $488 million, after giving consideration to outstanding letters of credit.

In June 2006, Smurfit-Stone, as guarantor, we and our subsidiary, SSC Canada, as borrowers, entered into an amendment to the senior credit facility with our lending group permitting us to use a portion of the net cash proceeds to be received from the sale of our Consumer Packaging division and additional borrowings, if necessary, to prepay certain unsecured debt. In addition, the amendment provided for the release of the 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 term loans, (ii) permitted the use of up to $400 million of the proceeds to prepay the unsecured senior notes and (iii) permitted the reinvestment of up to $250 million of the balance of the proceeds in the business of the Company and its subsidiaries.

On June 30, 2006, we completed the sale of the Consumer Packaging division (see Note 2 of the Notes to Consolidated Financial Statements) and used net proceeds of $902 million to repay $240 million of Tranche B term loans, $218 million of revolving credit facilities due November 1, 2009, $298 million of 9.25% unsecured senior notes due February 1, 2008, $102 million of 9.75% unsecured senior notes due February 1, 2011 and $20 million of other debt. In addition, we paid tender premiums and other 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 net proceeds from the sale of the Consumer Packaging division were reduced by $5 million as a result of final working capital adjustments, which were previously accrued.

In September 2006, $137 million of containerboard customer accounts receivables, net of related allowance for doubtful accounts, were sold into the Stone Receivables Corporation (“SRC”) accounts receivable securitization program, of which $78 million were retained by us as a subordinated interest and recorded in retained interest in receivables sold in the consolidated balance sheet. We used $59 million of proceeds received from the SRC accounts receivable securitization program to repay $50 million of the outstanding Tranche B term loan due November 1, 2011 and $9 million of the revolving credit facility.

On March 12, 2007, we commenced a cash tender offer to purchase all of the $648 million in 93¤4% Senior Notes due 2011. As of March 23, 2007, the early tender expiration date of the tender offer, approximately $546 million of the outstanding 93¤4% Senior Notes were accepted for purchase at a price equal to 103.5% of the principal amount plus accrued interest. On March 26, 2007, we issued $675 million of 8.000% unsecured senior notes due March 15, 2017. The net proceeds were used to purchase approximately $546 million outstanding aggregate principal amount of the 9 3¤4% Senior Notes, together with accrued interest of approximately $8 million, to reduce borrowings against our senior secured credit facility by approximately $95 million and to pay tender premiums of approximately $19 million and fees and expenses of $7 million related to the transaction. We have called the remaining amount of the 93¤4% Senior Notes outstanding, approximately $102 million, for full redemption on May 9, 2007 at a redemption price of $1,032.50 per $1,000 note outstanding. We will use borrowings under our revolving credit facility to redeem the 93¤4% Senior Notes and pay related call premiums of $3 million and accrued interest of $3 million.

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On March 30, 2007, we used approximately $66 million in borrowings against our senior secured credit facility together with an escrow balance of $3 million to prepay the $69 million outstanding aggregate principal balance of our 8.45% mortgage notes, which were payable on September 1, 2007.

Future Cash Flows

Contractual Obligations and Commitments

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

 

*                    This data has been updated to reflect the offering of the 8.000% senior notes and the use of proceeds thereof. See “Use of Proceeds” and “Capitalization.”

(1)          Projected contractual interest payments are excluded. Based on interest rates in effect and long-term debt balances outstanding as of December 31, 2006, hypothetical projected contractual interest payments would be approximately $289 million in 2007 and for each future year. For the purpose of this disclosure, our variable and fixed rate long-term debt would be replaced at maturity with similar long-term debt. This disclosure does not attempt to predict future cash flows or changes in interest rates. See “Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Risk.”

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

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

(4)          Amounts shown consist primarily of minimum pension contribution obligations, severance costs and other rationalization expenditures and environmental liabilities which have been recorded in our December 31, 2006 balance sheet. The table does not include our deferred income tax liability and accruals for self-insured losses because it is not certain when these liabilities will become due. We contributed $147 million to our pension plans and $11 million to other postretirement plans in 2006 and expect to contribute approximately $140 million and $18 million, respectively, to such plans in 2007. Future contributions to our pension and other postretirement plans will be dependent upon pending legislation, future changes in discount rates and the earnings performance of our plan assets.

Scheduled debt payments, including capital lease payments, for 2007 and 2008 are $84 million and $8 million, respectively. We expect further improvement in our cash flow from operations in 2007. We expect that our cash flow from operations and our unused borrowing capacity under our revolving credit facilities, in combination, will be sufficient for the next several years to meet our obligations and

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commitments, including debt service, pension funding, settlement of pending litigation, costs related to the strategic initiative plan, preferred stock dividends, expenditures related to environmental compliance and other capital expenditures.

Contingent Obligations

We issue standby letters of credit primarily for performance bonds and for self-insurance. Letters of credit are issued under our revolving credit facilities, generally have a one-year maturity and are renewed annually. As of December 31, 2006, we had $125 million of letters of credit outstanding.

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

In 2006, we entered into an agreement to guarantee a portion of a third party’s debt in decreasing amounts through January 2010. The guarantee was entered into in connection with the third party’s progress payment financing for the purchase and installation of machinery and equipment for the manufacture of corrugated containerboard. We and the third party are parties to a supply agreement through 2021, whereby we sell 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 guarantee was approximately $12 million, and decreases as the third party’s contractual financial targets are met. We have no recourse to the assets of the third party, other than that of a general unsecured creditor. The fair value of this guarantee at December 31, 2006 was an immaterial amount and is included in other assets, with an offset in other long-term liabilities in the accompanying consolidated balance sheet.

Pension Obligations

As of December 31, 2006, our pension benefit obligations exceeded the fair value of pension plan assets by $633 million, down from $891 million at the end of 2005. 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 of our defined benefit pension plans and postretirement plans, measured as the difference between plan assets at fair value and the benefit obligations, be recorded as an asset or liability with the after-tax impact recorded to other comprehensive income (“OCI”) in the December 31, 2006 balance sheet, based on an actuarial valuation as of that date. Upon adoption of SFAS No. 158, we recorded an increase to the minimum pension liability of $181 million and a decrease to other comprehensive income of $115 million, which is net of an income tax benefit of $66 million. Subsequent changes in the funded status of the plans will be recognized in OCI in the year in which the changes occur. See the information set forth in Note 15 of the Notes to Consolidated Financial Statements.

Exit Liabilities

We recorded restructuring charges 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 of exit liabilities as of December 31, 2005, related to the restructuring of our operations. During 2006, we incurred cash expenditures of $26 million for these exit liabilities and reduced environmental exit liabilities by $4 million. The exit liabilities remaining as of December 31, 2006, including the 2006 restructuring activities, totaled $47 million. Future cash outlays, principally for

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severance and benefits cost and long-term lease commitments and facility closure cost, are expected to be $36 million in 2007, $5 million in 2008 and $6 million thereafter. We intend to continue funding exit liabilities through operations as originally planned.

Environmental Matters

The United States Environmental Protection Agency (“EPA”) issued its comprehensive rule governing air emissions (Maximum Achievable Control Technology (“MACT”)) and water discharges for the pulp, paper and paperboard industry known as the “Cluster Rule.” Phase II of MACT I of the Cluster Rule requires us to implement systems to collect and control high volume, low concentration gases (or implement an approved compliance alternative) at various mills and had a compliance date of April 16, 2006, although certain of our mills were granted one-year extensions to April 16, 2007. The aggregate compliance cost of Phase II of MACT I of the Cluster Rule was approximately $74 million. We spent approximately $65 million through 2006 and $5 million in the first quarter of 2007 and we anticipate spending the balance over the remainder of 2007. As of the end of the first quarter of 2007, all of the projects required to bring us into compliance with Phase II of MACT I were complete.

The EPA has promulgated a MACT regulation to limit hazardous air pollutant emissions from certain industrial boilers (“Boiler MACT”). Several of our mills are installing, or have already installed, new pollution control equipment in order to meet the rule’s present compliance deadline of September 13, 2007. Based on currently available information, we estimate that the aggregate cost of complying with the existing Boiler MACT rule will be approximately $82 million. We have spent approximately $50 million through 2006, $10 million in the first quarter of 2007 and we anticipate spending the balance during the remainder of 2007. With the exception of one of our facilities that has received a six-month extension to the Boiler MACT compliance deadline to March 13, 2008, all projects required to bring us into compliance with the Boiler MACT requirements currently in effect will be complete by September 13, 2007. The Boiler MACT rule has been challenged by third parties in litigation, and in March 2007, the EPA filed a motion in the litigation to voluntarily vacate and remand the technology-based emissions limitations and compliance deadlines in Boiler MACT. The outcome of this litigation and its impact on the Boiler MACT is presently uncertain, and it is also unclear whether future EPA rulemaking will require us to install additional pollution control equipment on industrial boilers at our facilities.

In addition to Cluster Rule and Boiler MACT compliance, we anticipate additional capital expenditures related to environmental compliance. Excluding the spending on the Cluster Rule and Boiler MACT projects, we anticipate spending approximately $5 million over the remainder of 2007 on environmental projects.

Off-Balance Sheet Arrangements

At December 31, 2006, we had three off-balance sheet financing arrangements. We have a $475 million accounts receivable securitization program whereby we sell, without recourse, on an ongoing basis, certain of our accounts receivable to SRC. SRC is our wholly-owned non-consolidated subsidiary and a qualified special-purpose entity under the provisions of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” Accordingly, accounts receivable sold to SRC for which we do not retain an interest are not included in our consolidated balance sheets. SRC transfers the receivables to a non-consolidated subsidiary, a limited liability company, which has issued notes to third-party investors. At December 31, 2006, $522 million of accounts receivable had been sold under the program, of which $164 million was retained by us as a subordinated interest and recorded in retained interest in receivables sold in the accompanying consolidated balance sheet. The investors and the limited liability company have no recourse to us for failure of debtors to pay when due.

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We, through Smurfit-MBI, have an accounts receivable securitization program whereby we sell, without recourse, on an ongoing basis, certain of our Canadian accounts receivable to a trust in which we hold a variable interest, but are not the primary beneficiary. Accordingly, under Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,” accounts receivable sold to the trust, for which we are not the primary beneficiary, are not included in the accompanying consolidated balance sheet. At December 31, 2006, $68 million of accounts receivable had been sold under the program, of which $15 million was retained by us as a subordinated interest and recorded in retained interest in receivables sold in the accompanying consolidated balance sheet. The investors and the securitization trust have no recourse to us for failure of debtors to pay when due.

We sold 980,000 acres of owned and leased timberland in October 1999. The final purchase price, after adjustments, was $710 million. We received $225 million in cash and $485 million in the form of installment notes, which mature from December 31, 2007 to December 31, 2014. Under our program to monetize the installment notes receivable, 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. The residual interest included in other assets in the accompanying consolidated balance sheet was $48 million at December 31, 2006. TNH and its creditors have no recourse to us in the event of a default on the installment notes.

Effects of Inflation

Increases in costs for energy, fiber, freight, chemicals and employee benefits have had an adverse impact on our operating results during the past three years. Energy, fiber and freight cost increases are strongly influenced by supply and demand factors such as from hurricanes or other natural disasters in certain regions of the United States, and when supplies become tight, we have experienced increases in the cost of these items. We continue to seek ways to mitigate the impact of such cost increases and, to the extent permitted by competition, pass the increased 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 at December 31, 2006. Under this method, the cost of goods sold reported in the financial statements approximates current cost and thus provides a closer matching of revenue and expenses in periods of increasing costs.

Replacement of assets acquired in prior years will be at higher costs, but this will take place over many years. New assets will result in higher depreciation charges; but, in many cases, due to technological improvements, there may be operating cost savings as well.

Critical Accounting Policies and Use of Estimates

Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in accordance with U.S. GAAP requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Our estimates and assumptions are based on historical experiences and changes in the business environment. However, actual results may differ from these estimates. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and results and require management’s most subjective judgments. Our most critical accounting policies and use of estimates are described below.

Long-Lived Assets Including Goodwill

We conduct impairment reviews of long-lived assets including goodwill in accordance with SFAS No. 144 and SFAS No. 142, “Goodwill and Other Intangible Assets. Such reviews require us to make

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estimates of future cash flows and fair values. Our cash flow projections include significant assumptions about economic conditions, demand and pricing for our products and cost as well as, for 2006, estimates of the achievement of the strategic initiatives as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Strategic Initiatives.” Our estimates of fair value are determined using a variety of valuation techniques, including pricing of recent industry acquisitions. While significant judgment is required, we believe that our estimates of future cash flows and fair value are reasonable. However, should our assumptions change in future years, our fair value models could result in lower fair values for long-lived assets and goodwill, which could materially affect the value of property, plant and equipment and goodwill and results of operations.

Restructurings and Idle Paper Machine

In recent years, we have closed a number of operating facilities and exited non-core businesses. Identifying and calculating the cost to exit these businesses requires certain assumptions to be made, the most significant of which are anticipated future liabilities, including leases and other contractual obligations, and the net realizable value of assets held for sale. We believe our estimates are reasonable, considering our knowledge of the paper industry, previous experience in exiting activities and valuations received from independent third parties in the calculation of such estimates. Although our estimates have been reasonably accurate in the past, significant judgment is required, and these estimates and assumptions may change as additional information becomes available and facts or circumstances change.

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

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

Allowance for Doubtful Accounts

We evaluate the collectibility of accounts receivable on a case-by-case basis and make adjustments to the bad debt reserve for expected losses. We also estimate reserves for bad debts based on historical experience and past due status of the accounts. We perform credit evaluations and adjust credit limits based upon each customer’s payment history and credit worthiness. While credit losses have historically been within our expectations and the provisions established, actual bad debt write-offs may differ from our estimates, resulting in higher or lower charges in the future for our allowance for doubtful accounts.

Pension and Postretirement Benefits

We have significant long-term liabilities related to our defined benefit pension and postretirement benefit plans. The determination of pension obligations and expense is dependent upon our selection of certain assumptions, the most significant of which are the expected long-term rate of return on plan assets and the discount rates applied to plan liabilities. Consulting actuaries assist us in determining these assumptions, which are described in Note 15 of the Notes to Consolidated Financial Statements. In 2006, we adjusted the expected long-term rate of return on our U.S. plan assets to 8.75% from 9.00%, which increased retirement plan expense approximately $5 million for 2006.

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Effective for 2007, the expected long-term rate of return on U.S. plan assets was reduced from 8.75% in 2006 to 8.5% and the expected long-term rate of return on certain foreign plan assets was reduced from 8.00% in 2006 to 7.75%. The discount rates used to determine the benefit obligations for the U.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 based upon target asset allocations and expected long-term rates of return by asset class. Our assumed discount rate was developed using a portfolio of Moody’s Aa-rated fixed income securities that approximate the duration of our pension liabilities. A decrease in the assumed rate of return of 0.50% would increase pension expense by approximately $14 million. A decrease in the discount rate of 0.50% would increase our pension expense by approximately $22 million and our pension obligations by approximately $207 million.

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

Income Taxes

Deferred tax assets and liabilities reflect our assessment of future taxes to be paid in the jurisdictions in which we operate. These assessments involve temporary differences resulting from differing treatment of items for tax and accounting purposes, as well as estimates of our current tax exposures. Based on our evaluation of our tax positions, we believe we were adequately reserved for these matters at December 31, 2006.

At December 31, 2006, we had deferred tax assets related to net operating loss, alternative minimum tax and other tax credit carryforwards in the amount of $439 million. A valuation allowance of $36 million has been established for a portion of these deferred tax assets based on projected future taxable income, the expected timing of deferred tax liability reversals and the expiration dates of these carryforwards. See Note 14 of the Notes to Consolidated Financial Statements. We expect our deferred tax assets, net of the valuation allowance, will be fully realized through the reversal of net taxable temporary differences at December 31, 2006, in combination with expected improvement in our operating results. Substantially all of our valuation allowance was recorded in connection with a prior purchase business combination and a reduction in the valuation allowance would result principally in a corresponding reduction to goodwill. Should additional valuation 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 Consumer Packaging division generated a taxable gain for U.S. income tax purposes that will be offset by available net operating loss (“NOL”) carryforwards, a portion of which were subject to valuation allowances previously established in a prior purchase business combination. Due to the utilization of these NOL carryforwards, the related valuation allowance was reduced by $157 million in the second quarter of 2006 with a corresponding reduction to goodwill that resulted from a prior purchase business combination.

In October 2004, the American Jobs Creation Act (the “AJCA”) was signed into law. The AJCA includes a temporary incentive for U.S. multinationals to repatriate foreign earnings by providing an elective 85% dividends received deduction for certain cash dividends from controlled foreign corporations. Under this law, in December 2005, we repatriated dividends of $483 million from earnings of foreign subsidiaries previously considered indefinitely reinvested. The income tax expense associated with the repatriation was $34 million. Excluding the repatriation discussed above, through December 31, 2006, no provision has been made for income taxes on the remaining undistributed earnings of our foreign subsidiaries, as we intend to indefinitely reinvest such earnings in our foreign subsidiaries.

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

Legal and Environmental Contingencies

Accruals for legal and environmental matters are recorded when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Such liabilities are developed based on currently available information and require judgments as to probable outcomes. Assumptions are based on historical experience and recommendations of legal counsel. Environmental estimates include assumptions and judgments about particular sites, remediation alternatives and environmental regulations. We believe our accruals are adequate. However, due to uncertainties associated with these assumptions and judgments, as well as potential changes to governmental regulations and environmental technologies, actual costs could differ materially from the estimated amounts.

Self-Insurance

We self-insure a majority of our workers’ compensation and general liability costs subject to specific retention levels for certain policies and coverage. Losses above these retention levels are transferred to insurance companies. In addition, we self-insure the majority of our group health care costs. All of the health care, workers’ compensation and general liability claims are handled by third-party administrators. Consulting actuaries and administrators assist us in determining our liability for self-insured claims. Losses are accrued based upon the aggregate self-insured claims determined by the third-party administrators, actuarial assumptions and our historical experience. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our workers’ compensation, general liability and group health care costs.

Prospective Accounting Standards

In September 2006, the FASB issued FASB Staff Position (“FSP”) No. AUG AIR-1 “Accounting for Planned Major Maintenance Activities,” effective for fiscal years beginning after December 15, 2006. We plan to adopt this standard effective January 1, 2007. This FSP prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods. The FSP requires retrospective application to all financial statements presented. The new standard will not impact our annual 2006 financial statements; however the after-tax impact on the 2006 interim income from continuing operations would have been income (expense) of $(1) million, an immaterial amount, $6 million and $(5) million in the first, second, third and fourth quarters, respectively.

In June 2006, the FASB issued 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 minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN No. 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We plan to adopt FIN No. 48 as of January 1, 2007, and the cumulative effect of the new standard will be recorded as an

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adjustment to retained earnings. The impact of the adoption of FIN No. 48 is not expected to have a material impact on our financial position.

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to various market risks, including commodity price risk, foreign currency risk and interest rate risk. To manage the volatility related to these risks, we enter into various derivative contracts. The majority of these contracts are settled in cash. However, such settlements have not had a significant effect on our liquidity in the past, nor are they expected to be significant in the future. We do not use derivatives for speculative or trading purposes.

Commodity Price Risk

We use financial derivative instruments, including fixed price swaps and options, to manage fluctuations in cash flows resulting from commodity price risk in the procurement 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 these commodities used in the manufacturing process. The changes in the market value of such derivative instruments have historically been, and are expected to continue to be, highly effective at offsetting changes in price of the hedged item. As of December 31, 2006, the maximum length of time over which we are hedging our exposure to the variability in future cash flows associated with natural gas forecasted transactions is two years. As of December 31, 2006, we had monthly derivative instruments to hedge approximately 60% of our expected natural gas requirements in the first quarter of 2007 and approximately 30% to 45% the remainder of 2007. Excluding the impact of derivative instruments, the potential change in our expected 2007 and 2006 natural gas cost, based upon our expected annual usage and unit cost, resulting from a hypothetical 10% adverse price change, would be approximately $13 million and $23 million, respectively. The changes in energy cost discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” include the impact of the natural gas derivative instruments. See Note 10 of the Notes to Consolidated Financial Statements.

Foreign Currency Risk

Our principal foreign exchange exposure is the Canadian dollar. Assets and liabilities outside the United States are primarily located in Canada. The functional currency for our Canadian operations is the U.S. dollar. Our investments in foreign subsidiaries with a functional currency other than the U.S. dollar are not hedged.

We use financial derivative instruments, including forward contracts and options, primarily to protect against Canadian currency exchange risk associated with expected future cash flows. These instruments typically have maturities of twelve months or less. As of December 31, 2006, we had monthly Canadian dollar forward purchase contracts to hedge approximately 75% of our estimated requirements for 2007.

We performed a sensitivity analysis as of December 31, 2006 and 2005 that measures the change in the book value of our net monetary Canadian liability arising from a hypothetical 10% adverse movement in the exchange rate of the Canadian dollar relative to the U.S. dollar with all other variables held constant. The potential change in fair value resulting from a hypothetical 10% adverse change in the Canadian dollar exchange rate at December 31, 2006 and 2005, would be $29 million and $32 million, respectively. Fluctuations in Canadian dollar monetary assets and liabilities result in gains or losses, which are credited or charged to income.

In 2006, 2005 and 2004, the average exchange rates for the Canadian dollar strengthened against the U.S. dollar by 6.4%, 6.9% and 7.1%, respectively.

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Interest Rate Risk

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

In 2004, we entered into interest 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. Changes in the fair value of the interest rate swap contracts are expected to be highly effective in offsetting the fluctuations in the variable interest rate, and are recorded in other comprehensive income until the underlying transaction is recorded. The accounting for the cash flow impact of the swap contracts is recorded as an adjustment to interest expense each period. The fair value of our interest rate swap contracts at December 31, 2006 was a $9 million asset, included in other assets. These contracts extend until 2011, consistent with the maturity on our Tranche B and Tranche C term loans.

We performed a sensitivity analysis as of December 31, 2006 and 2005 that measures the change in interest expense on our variable rate debt arising from a hypothetical 100 basis point adverse movement in interest rates. Based on our outstanding variable rate debt as of December 31, 2006 and 2005, a hypothetical 100 basis point adverse change in interest rates would increase interest expense by approximately $8 million and $13 million, respectively.

The table below presents principal amounts by year of anticipated maturity for our debt obligations and related average interest rates based on the weighted average interest rates at the end of the period. Variable interest rates disclosed do not attempt to project future interest rates and do not reflect the impact of our interest rate swap contracts. This information should be read in conjunction with Note 9 of the Notes to Consolidated Financial Statements.

Short and Long-Term Debt

Outstanding as of December 31, 2006*

		2007					2008					2009			2010			2011			Thereafter					Total			Fair Value
		(U.S.$, in millions)
Bank term loans and revolver 7.7% average interest rate (variable)			$	4				$	4			$	153		$	4		$	858			$				$	1,023		$	1,028
U.S. senior notes 8.1% average interest rate (fixed)								2														2,275				2,277			2,220
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			$	158		$	125		$	859			$	2,440			$	3,674		$	3,622

*                    This data has not been updated to reflect the offering of the 8.000% senior notes and the use of proceeds thereof. See “Use of Proceeds” and “Capitalization.”

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