UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x                              Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

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

 

For Quarter Ended June 30, 2006

 

Commission File Number 0-23876

 

SMURFIT-STONE CONTAINER CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	43-1531401
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
150 North Michigan Avenue, Chicago, Illinois 60601
(Address of principal executive offices) (Zip Code)
(312) 346-6600
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

 

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

 

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of August 3, 2006, the registrant had outstanding 254,672,725 shares of common stock, $.01 par value per share.

PART I - FINANCIAL INFORMATION

Item 1.                          Financial Statements

SMURFIT-STONE CONTAINER CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

		Three Months Ended						Six Months Ended
		June 30,						June 30,
(In millions, except per share data)		2006			2005			2006			2005
Net sales		$	1,765		$	1,760		$	3,494		$	3,469
Costs and expenses
Cost of goods sold		1,513			1,524			3,102			3,023
Selling and administrative expenses		170			164			343			330
Restructuring charges		13			3			22			4
Gain on sale of assets		(1		)				(24		)
Income from operations		70			69			51			112
Other income (expense)
Interest expense, net		(96		)	(86		)	(188		)	(172		)
Loss on early extinguishment of debt		(28		)				(28		)
Other, net		(20		)	1			(23		)	(2		)
Loss from continuing operations before income taxes		(74		)	(16		)	(188		)	(62		)
Benefit from income taxes		30			6			73			25
Loss from continuing operations		(44		)	(10		)	(115		)	(37		)
Discontinued operations
Income from discontinued operations, net of income tax provision of $3 and $9 for the three and six months ended June 30, 2006 and $9 and $16 for the three and six months ended June 30, 2005		4			14			14			25
Loss on sale of discontinued operations, net of income tax provision of $175		(1		)				(1		)
Net income (loss)		(41		)	4			(102		)	(12		)
Preferred stock dividends and accretion		(3		)	(3		)	(6		)	(6		)
Net income (loss) available to common stockholders		$	(44	)	$	1		$	(108	)	$	(18	)
Basic and diluted earnings per common share
Loss from continuing operations		(.18		)	$	(.05	)	$	(.47	)	$	(.17	)
Discontinued operations		.01			.05			.05			.10
Net income (loss) available to common stockholders		$	(.17	)	$	.00		$	(.42	)	$	(.07	)
Weighted average shares outstanding		255			255			255			254

 

See notes to consolidated financial statements.

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SMURFIT-STONE CONTAINER CORPORATION
CONSOLIDATED BALANCE SHEETS

		June 30,			December 31,
(In millions, except share data)		2006			2005
		(Unaudited)
Assets
Current assets
Cash and cash equivalents		$	9		$	5
Receivables, less allowances of $11 in 2006 and $10 in 2005		283			224
Retained interest in receivables sold		132			139
Inventories, including amounts valued under LIFO method
Work-in-process and finished goods		154			234
Materials and supplies		399			500
		553			734
Prepaid expenses and other current assets		50			82
Total current assets		1,027			1,184
Net property, plant and equipment		3,804			4,245
Timberland, less timber depletion		43			44
Goodwill		2,873			3,309
Other assets		306			332
		$	8,053		$	9,114
Liabilities and Stockholders’ Equity
Current liabilities
Current maturities of long-term debt		$	30		$	35
Accounts payable		582			654
Accrued compensation and payroll taxes		158			186
Interest payable		79			97
Income taxes payable		14			17
Current deferred income taxes		16			15
Other current liabilities		132			184
Total current liabilities		1,011			1,188
Long-term debt, less current maturities		3,785			4,536
Other long-term liabilities		1,158			1,123
Deferred income taxes		318			385
Stockholders’ equity
Preferred stock, aggregate liquidation preference of $116; 25,000,000 shares authorized; 4,599,300 issued and outstanding		91			89
Common stock, par value $.01 per share; 400,000,000 shares authorized; 255,264,290 and 254,652,321 issued and outstanding in 2006 and 2005, respectively		3			3
Additional paid-in capital		4,026			4,009
Retained earnings (deficit)		(1,954		)	(1,846		)
Accumulated other comprehensive income (loss)		(385		)	(373		)
Total stockholders’ equity		1,781			1,882
		$	8,053		$	9,114

 

See notes to consolidated financial statements.

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SMURFIT-STONE CONTAINER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Six Months Ended June 30, (In millions)		2006			2005
Cash flows from operating activities
Net loss		$	(102	)	$	(12	)
Adjustments to reconcile net loss to net cash provided by (used for) operating activities
Gain on disposition of discontinued operations		(174		)
Loss on early extinguishment of debt		28
Depreciation, depletion and amortization		199			207
Amortization of deferred debt issuance costs		5			4
Deferred income taxes		91			(27		)
Pension and postretirement benefits		17			(20		)
Gain on sale of assets		(24		)
Non-cash restructuring charges		10			2
Non-cash stock-based compensation		12			5
Non-cash foreign currency (gains) losses		12			(4		)
Change in current assets and liabilities, net of effects from acquisitions and dispositions
Receivables and retained interest in receivables sold		(61		)	(44		)
Inventories		33			(1		)
Prepaid expenses and other current assets		(1		)	1
Accounts payable and accrued liabilities		(62		)	(45		)
Interest payable		(18		)	1
Other, net		11			(2		)
Net cash provided by (used for) operating activities		(24		)	65
Cash flows from investing activities
Expenditures for property, plant and equipment		(139		)	(139		)
Proceeds from property disposals and sale of businesses		949			6
Payments on acquisitions					(5		)
Net cash provided by (used for) investing activities		810			(138		)
Cash flows from financing activities
Proceeds from long-term debt					72
Net borrowings (repayments) of debt		(756		)	7
Debt repurchase premiums		(24		)
Preferred dividends paid		(4		)	(4		)
Proceeds from exercise of stock options		2			1
Deferred debt issuance costs					(2		)
Net cash provided by (used for) financing activities		(782		)	74
Increase in cash and cash equivalents		4			1
Cash and cash equivalents
Beginning of period		5			6
End of period		$	9		$	7

 

See notes to consolidated financial statements.

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SMURFIT-STONE CONTAINER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in millions, except share data)

1.                 Significant Accounting Policies

Basis of Presentation: The accompanying consolidated financial statements and notes thereto of Smurfit-Stone Container Corporation (“SSCC” or the “Company”) have been prepared in accordance with the instructions to Form 10-Q and reflect all adjustments which management believes necessary (which include only normal recurring accruals) to present fairly the Company’s financial position, results of operations and cash flows. These statements, however, do not include all information and footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with U.S. generally accepted accounting principles. Interim results may not necessarily be indicative of results that may be expected for any other interim period or for the year as a whole. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the SSCC Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 10-K”) filed March 6, 2006 with the Securities and Exchange Commission.

SSCC is a holding company that owns 100% of the equity interest in Smurfit-Stone Container Enterprises, Inc. (“SSCE”). The Company has no operations other than its investment in SSCE. SSCE has domestic and international operations.

Recently Adopted Accounting Standards: In September 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 04-13, “Accounting for Purchases and Sales of Inventory With the Same Counterparty,” effective for the Company April 1, 2006, 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. The Company adopted EITF No. 04-13 effective April 1, 2006. EITF No. 04-13 required the Company to prospectively report certain inventory buy/sell transactions of similar containerboard types in the Containerboard and Corrugated Containers segment on a net basis in the consolidated statements of operations, thereby reducing net sales and cost of goods sold by $70 million for the three months ended June 30, 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 six months ended June 30, 2006, and $81 million and $153 million, respectively, for the three and six months ended June 30, 2005.

2.                 Reclassifications

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

3.                 Discontinued Operations

During the second quarter of 2006, the Company entered into an agreement to sell substantially all of the assets of the Consumer Packaging division to a company formed by Texas Pacific Group (“TPG”) for approximately $1.04 billion. On June 30, 2006, the Company completed the sale transaction and received cash proceeds of $902 million, which excluded $126 million for certain accounts receivable previously sold to Stone Receivables Corporation (“SRC”) under the accounts receivable securitization program and was net of sales transaction costs and other closing adjustments. The Company recorded a pretax gain of $174 million, offset by a $175 million income tax provision, resulting in a net loss on sale of discontinued operations of $1 million, subject to post-closing adjustments as provided in the sale agreement. The after-tax loss is the result of a provision for income taxes that is higher than the statutory income tax rate due to non-deductible goodwill of $273 million.

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The Consumer Packaging division was a reportable segment of the Company comprised of four coated recycled boxboard mills, 39 consumer packaging operations in the United States, including folding carton, multiwall and specialty bag, flexible packaging, label, contract packaging and lamination businesses and one consumer packaging plant in Brampton, Ontario. Net sales for these operations were $391 million and $787 million, respectively, for the three and six months ended June 30, 2006, and $393 million and $777 million, respectively, for the three and six months ended June 30, 2005. These facilities employed approximately 6,600 hourly and salaried employees. The results of operations from the Consumer Packaging segment have been reclassified as discontinued operations for all periods presented.

The assets and liabilities of the discontinued operations included in the accompanying consolidated balance sheet as of December 31, 2005 consisted of the following:

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

 

4.                 Strategic Initiatives and Restructuring Activities

During the fourth quarter of 2005, the Company announced a strategic reassessment plan to improve performance and better position the Company for long-term growth. The plan focuses on (i) cost reduction initiatives from which the Company expects to achieve $525 million in annual savings by the end of 2008, (ii) revenue growth initiatives, and (iii) organizational changes to enable the cost reduction and revenue growth initiatives. As part of the initiative plan, the Company completed the sale of its Consumer Packaging division on June 30, 2006 and used the proceeds to reduce debt. The original cost reduction initiatives target included cost savings benefits to be derived from the Consumer Packaging division and accordingly, the Company has adjusted this target to exclude the impact of the Consumer Packaging division from both the target and actual savings achieved.

For 2006, the Company is targeting $240 million of cost savings from the strategic initiatives. During the three and six months ended June 30, 2006, the Company realized cost savings of approximately $45 million and $78 million, respectively, from its strategic initiatives compared to levels prior to the commencement of the initiatives.

In connection with this plan, during the second quarter of 2006, the Company recorded restructuring charges of $13 million, including non-cash charges of $5 million related to the write-down of assets, primarily property, plant and equipment, to estimated net realizable value. The Company announced the closure of three converting facilities and idled one corrugator, which resulted in the termination of approximately 270 employees. The remaining charges were primarily for severance and benefits.

For the six months ended June 30, 2006, the Company recorded restructuring charges of $22 million, including non-cash charges of $10 million related to the write-down of assets, primarily property, plant and equipment, to estimated net realizable value. The Company has shut down or announced the

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closure of six converting facilities and idled two corrugators, which resulted in the termination of approximately 480 employees. The net sales and operating losses of these facilities in 2006 prior to closure were $30 million and $8 million, respectively. The net sales and operating losses of these facilities for the year ended December 31, 2005 were $96 million and $12 million, respectively. Additional charges of up to $10 million will be recorded in future periods for severance and benefits related to the closure of these converting facilities and for pension settlement costs.

The Company recorded restructuring charges of $3 million and $4 million for the three and six months ended June 30, 2005, respectively, including a $2 million non-cash charge to write-down assets, primarily property, plant and equipment, to estimated net realizable value. The remaining charges were primarily for severance and benefits.

At December 31, 2005, the Company had $55 million of accrued exit liabilities related to the restructuring of operations. For the three and six months ended June 30, 2006, the Company incurred $4 million and $16 million, respectively, of cash disbursements related to these exit liabilities. In addition, for the three and six months ended June 30, 2006, the Company incurred $4 million and $7 million, respectively, of cash disbursements related to exit liabilities established during 2006.

5.                 Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Shared-Based Payment,” effective January 1, 2006, which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The Company adopted SFAS No. 123(R) on January 1, 2006, under the modified prospective method, in which the requirements of SFAS No. 123(R) must be applied to new awards and to previously granted awards that are not fully vested on the effective date, but does not require a restatement of previous years’ financial statements. Upon adoption, the Company implemented a lattice option pricing model to estimate the value of stock options granted after January 1, 2006.

The lattice option pricing model considers a range of assumptions related to volatility, risk-free interest rate and historical employee behavior. Expected volatility was based on historical volatility on the Company’s common stock and current implied volatilities from traded options on the Company’s common stock. The risk-free interest rate was based on U.S. Treasury security yields at the time of grant. The dividend yield on the Company’s common stock is assumed to be zero since the Company has not paid dividends and has no current plans to do so in the future. The expected life was determined from the lattice option pricing model. The lattice option pricing model incorporates exercise and post-vesting forfeiture assumptions based on analysis of historical data. The following table provides the assumptions used in determining the fair value of the stock-based awards granted during the three and six months ended June 30, 2006.

		Three months ended June 30, 2006		Six months ended June 30, 2006
Weighted-average dividend yield		0.00	%	0.00	%
Weighted-average volatility		36	%	36	%
Risk-free interest rate		4.98	%	4.60	%
Weighted-average expected life		5		5

 

The impact of adopting SFAS No. 123(R) for the three and six months ended June 30, 2006 was a $2 million and $3 million increase, respectively, in selling and administrative expenses (an impact of $(.01) on earnings per share) due to recognizing expense on non-vested, outstanding shares issued prior to the adoption of SFAS No. 123 on January 1, 2003. At June 30, 2006, the total compensation cost related to

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non-vested awards not yet recognized was approximately $38 million to be recognized through March 31, 2009, with a weighted-average expense period of approximately 2 years.

During the first and second quarters of 2006, the Company granted performance-based stock options to management level employees responsible for implementing the strategic initiative plan. Vesting is dependent upon the financial performance of the Company and the attainment of the strategic initiative savings from 2006 to 2008. These performance-based stock options expire no later than seven years from the date of grant. Compensation expense is recorded over the three-year performance period based on the achievement of the performance criteria.

Prior to the adoption of SFAS No. 123(R), the Company accounted for stock-based compensation under SFAS No. 123. The Company selected the prospective transition method as allowed in SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which requires expensing options prospectively, beginning in the year of adoption, and utilized the Black-Scholes formula to estimate the value of stock options granted to employees. The assumptions used in the Black-Scholes formula are described in the 2005 10-K. Because the prospective transition method was used and awards vest over three to eight years, the expense for the three and six months ended June 30, 2005 is less than what would have been recognized if the fair value-based method had been applied to all awards since the original effective date of SFAS No. 123. The following table illustrates the effect on net (loss) and earnings per share if the fair value based method had been applied to all outstanding and unvested awards for the three and six month periods ended June 30, 2005.

		Three months ended June 30, 2005			Six months ended June 30, 2005
Net income (loss) available to common stockholders, as reported		$	1		$	(18	)
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects		1			3
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects		(3		)	(6		)
Pro forma net loss available to common stockholders		$	(1	)	$	(21	)
Earnings per share:
Basic and diluted — as reported		$	.00		$	(.07	)
Basic and diluted — pro forma		$	.00		$	(.08	)

 

6.                 Gain on Sale of Assets

The Company recorded a gain of $23 million in the first quarter of 2006 related to the divestiture of its Port St. Joe, Florida joint venture interest and related real estate.

7.                 Other, Net

For the three and six months ended June 30, 2006, the Company recorded non-cash foreign currency losses of $14 million and $12 million, respectively, related to its operations in Canada. For the three and six months ended June 30, 2005, the Company recorded non-cash foreign currency gains of $5 million and $4 million, respectively, related to its operations in Canada.

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8.                 Accounts Receivable Securitization Programs

At June 30, 2006 and December 31, 2005, $655 million and $592 million, respectively, of receivables had been sold under two accounts receivable securitization programs, of which the Company retained a subordinated interest. The off-balance sheet SRC debt and funding received from the Canadian accounts receivable program totaled $527 million and $472 million, respectively, as of those dates.

At June 30, 2006, the Consumer Packaging division receivables sold under the accounts receivable securitization program were approximately $126 million. As these outstanding accounts receivable are collected, the cash will be used to reduce the related off-balance sheet debt.

9.                 Long-Term Debt

On May 23, 2006, SSCE commenced a cash tender offer to purchase up to $400 million in unsecured senior notes, applicable to any and all of its $300 million aggregate principal amount of outstanding 9.25% unsecured senior notes due 2008 and a portion of its $750 million aggregate principal amount of outstanding 9.75% unsecured senior notes due 2011. As of June 29, 2006, the expiration date of the offer, approximately $298 million of the outstanding 9.25% unsecured senior notes had been tendered and were purchased by SSCE at a price equal to 105.8% of the principal amount thereof (together with accrued interest thereon) and approximately $725 million of the outstanding 9.75% unsecured senior notes were tendered. Pursuant to the terms of the tender offer, SSCE purchased approximately $102 million of the 9.75% unsecured senior notes on a pro-rata basis at a price equal to 105.1% of the principal amount thereof (together with accrued interest thereon).

On June 9, 2006, the Company, as guarantor, and SSCE and its subsidiary, Smurfit-Stone Container Canada Inc., as borrowers, entered into an amendment to the senior credit facility with its lending group permitting the Company to use a portion of the net cash proceeds to be received from the sale of the Company’s Consumer Packaging division and additional borrowings, if necessary, to prepay certain unsecured debt. 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. If, after giving effect to the payments described above, the remaining balance of the proceeds exceeds $10 million, the Company would be required to use the remaining balance of the proceeds to make a further repayment of the term loans in accordance with the provisions of the senior credit facility.

On June 30, 2006, the Company completed the sale of the Consumer Packaging division (See Note 3) and used the proceeds to repay the following obligations under SSCE’s senior secured credit facilities and unsecured senior notes:

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

 

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In the second quarter of 2006, the Company recorded a loss on early extinguishment of debt of $28 million related to the repayment of borrowings with net proceeds from the sale of its Consumer Packaging division. The loss included $24 million for tender premiums and fees for the unsecured senior notes called and a $4 million non-cash write-off of related unamortized deferred debt issuance costs.

10.          Guarantees

The Company has certain wood chip processing contracts extending from 2012 through 2018 with minimum purchase commitments. As part of the agreements, the Company guarantees the third party contractors’ debt outstanding and has a security interest in the chipping equipment. At June 30, 2006, the maximum potential amount of future payments related to these guarantees was approximately $35 million and decreases ratably over the life of the contracts. In the event the guarantees on these contracts were called, which the Company currently believes is not probable, proceeds from the liquidation of the chipping equipment would be based on current market conditions and the Company may not recover in full the guarantee payments made.

11.          Employee Benefit Plans

The Company sponsors noncontributory defined benefit pension plans covering substantially all U.S. employees. The Company also sponsors noncontributory and contributory defined benefit pension plans for its Canadian operations.

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

The components of net periodic benefit costs for the defined benefit plans and the components of the postretirement benefit costs, including the discontinued Consumer Packaging division, are as follows:

		Three months ended June 30,												Six months ended June 30,
		Defined Benefit Plans						Postretirement Plans						Defined Benefit Plans						Postretirement Plans
		2006			2005			2006			2005			2006			2005			2006			2005
Service cost		$	19		$	21		$	2		$	2		$	39		$	41		$	3		$	4
Interest cost		48			47			3			3			96			95			7			7
Expected return on plan assets		(56		)	(54		)							(111		)	(105		)
Amortization of prior service cost (benefit)		3			3			(1		)				5			5			(2		)	(1		)
Amortization of net loss		22			15			1			2			43			31			2			3
Settlements														2
Multi-employer plans		1			1									3			3
Net periodic benefit cost		$	37		$	33		$	5		$	7		$	77		$	70		$	10		$	13

 

The Company’s 2006 expected contributions to its qualified defined benefit plans and benefit payments to its non-qualified defined benefit plans and postretirement plans are not expected to be materially different from the amounts disclosed at December 31, 2005.

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12.          Derivative Instruments and Hedging Activities

The Company’s derivative instruments used for its hedging activities are designed as cash flow hedges and relate to minimizing exposures to fluctuations in the price of commodities used in its operations, the movement in foreign currency exchange rates and the fluctuations in the interest rate on variable rate debt.

Commodity Derivative Instruments

The Company uses 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. The objective is to fix the price of a portion of the Company’s purchases of natural gas 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 June 30, 2006, the maximum length of time over which the Company was hedging its exposure to the variability in future cash flows associated with natural gas forecasted transactions was 30 months. For the three and six months ended June 30, 2006, the Company reclassified a $1 million loss (net of tax) and an immaterial amount, respectively, from other comprehensive income (“OCI”) to cost of goods sold when the hedged items were recognized. For the three and six months ended June 30, 2005, the Company reclassified an immaterial amount and a $1 million loss (net of tax), respectively, from OCI to cost of goods sold when the hedged items were recognized. The fair value of these commodity derivative instruments at June 30, 2006 was a $3 million liability, of which $2 million was included in other current liabilities, and $1 million was included in other long-term liabilities.

For the three and six months ended June 30, 2006, the Company recorded a $3 million loss (net of tax) and an $8 million loss (net of tax), respectively, in cost of goods sold related to the change in fair value of certain commodity derivative instruments not qualifying for hedge accounting. For the three and six months ended June 30, 2005, the Company recorded a $3 million loss (net of tax) and a $3 million gain (net of tax), respectively, in cost of goods sold related to the change in fair value of certain commodity derivative instruments not qualifying for hedge accounting.

For the three and six months ended June 30, 2006, the Company recorded a $1 million loss (net of tax) and a $2 million loss (net of tax), respectively, in cost of goods sold on settled commodity derivative instruments related to commodity derivative instruments not qualifying for hedge accounting. For the three and six months ended June 30, 2005, the Company recorded an immaterial amount and a $1 million loss (net of tax), respectively, in cost of goods sold on settled commodity derivative instruments related to commodity derivative instruments not qualifying for hedge accounting

Foreign Currency Derivative Instruments

The Company’s principal foreign exchange exposure is the Canadian dollar. The Company uses foreign currency derivative instruments, including forward contracts and options, primarily to protect against Canadian currency exchange risk associated with expected future cash flows. As of June 30, 2006, the maximum length of time over which the Company was hedging its exposure to the variability in future cash flows associated with foreign currency was 18 months. For the three and six months ended June 30, 2006, the Company reclassified a $1 million gain (net of tax) and a $2 million gain (net of tax), respectively, from OCI to cost of goods sold related to the recognition of the foreign currency derivative instruments. For the three and six months ended June 30, 2005, the Company reclassified an immaterial amount and a $2 million gain (net of tax), respectively, from OCI to cost of goods sold related to the recognition of the foreign currency derivative instruments. The change in fair value of these derivative instruments is recorded in OCI until the underlying transaction is recorded. The fair value of the Company’s foreign currency derivative instruments at June 30, 2006 was a $6 million asset, included in prepaid expenses and other current assets.

For the three and six months ended June 30, 2006, the Company recorded an immaterial amount in cost of goods sold related to the change in fair value of certain foreign currency derivative instruments not qualifying

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for hedge accounting. For the three and six months ended June 30, 2005, the Company recorded an immaterial amount and a $1 million loss (net of tax), respectively, in cost of goods sold related to the change in fair value of certain foreign currency derivative instruments not qualifying for hedge accounting.

For the three and six months ended June 30, 2006, the Company recorded an immaterial amount in cost of goods sold on settled foreign currency derivative instruments not qualifying for hedge accounting. For the three and six months ended June 30, 2005, the Company recorded an immaterial amount and a $1 million gain (net of tax), respectively, in cost of goods sold on settled foreign currency derivative instruments not qualifying for hedge accounting

Interest Rate Swap Contracts

The Company uses interest rate swap contracts to manage interest rate exposure on $300 million of the current Tranche B and Tranche C floating rate bank term debt, effectively fixing the interest rate at 4.3%. These contracts extend until 2011, consistent with the maturity of the Company’s Tranche B and Tranche C 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 floating interest rate and are recorded in OCI 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. For the three and six months ended June 30, 2006, the Company reclassified an immaterial amount from OCI to interest expense when the hedged items were recognized. For the three and six months ended June 30, 2005, the Company reclassified a $1 million loss (net of tax) and a $2 million loss (net of tax), respectively, from OCI to interest expense when the hedged items were recognized. The fair value of the Company’s interest rate swap contracts at June 30, 2006 was an $18 million asset included in other assets.

The cumulative deferred hedge gain on all derivative instruments was $12 million (net of tax) at June 30, 2006, including a $1 million loss (net of tax) on commodity derivative instruments, a $2 million gain (net of tax) on foreign currency derivative instruments and an $11 million gain (net of tax) on interest rate swap contracts. The Company expects to reclassify a $1 million gain (net of tax) into cost of goods sold within the next 12 months, related to the commodity and foreign currency derivative instruments.

13.          Income Taxes

The sale of the Consumer Packaging division (See Note 3) 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 are subject to valuation allowances previously established in a prior purchase business combination. Due to the utilization of these NOL carryforwards, the related valuation allowances were reduced by $157 million in the second quarter of 2006 with a corresponding reduction in goodwill related to the prior business combination.

U.S. federal alternative minimum tax of approximately $14 million is expected to be paid during the second half of 2006 related to the sale of the Consumer Packaging division.

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14.          Comprehensive Income (Loss)

Comprehensive income (loss) is as follows:

		Three months ended June 30,						Six months ended June 30,
		2006			2005			2006			2005
Net income (loss)		$	(41	)	$	4		$	(102	)	$	(12	)
Other comprehensive income (loss), net of tax:
Net changes in fair value of hedging instruments					(11		)	(9		)	1
Net hedging loss (gain) reclassified into earnings					1			(2		)	1
Foreign currency translation adjustment								(1		)	1
Comprehensive income (loss)		$	(41	)	$	(6	)	$	(114	)	$	(9	)

 

15.          Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

		Three months ended June 30,						Six months ended June 30,
		2006			2005			2006			2005
Numerator:
Loss from continuing operations		$	(44	)	$	(10	)	$	(115	)	$	(37	)
Preferred stock dividends and accretion		(3		)	(3		)	(6		)	(6		)
Net loss available to common stockholders		(47		)	(13		)	(121		)	(43		)
Denominator:
Denominator for basic and diluted earnings per share — adjusted weighted average shares		255			255			255			254
Basic and diluted earnings per share from continuing operations		$	(.18	)	$	(.05	)	$	(.47	)	$	(.17	)

 

SSCC preferred stock that is convertible into three million shares of common stock with an earnings effect of $3 million and $6 million is excluded from the diluted earnings per share computations for each of the three and six months ended June 30, 2006 and 2005, respectively, because they are antidilutive.

Employee stock options and non-vested restricted stock are excluded from the diluted earnings per share calculation for each of the three and six months ended June 30, 2006 and the six months ended June 30, 2005, because they are antidilutive.

16.          Restricted Stock

In May 2006, the Company issued 127,500 non-vested restricted stock units (“RSUs”) at a weighted average grant date fair value of $13.10 per RSU. The non-vested RSUs vest in three years, in accordance with the Company’s 2004 Long-Term Incentive Plan.

In March 2006, the Company issued approximately 190,000 non-vested RSUs at a weighted average grant date fair value of $13.05 per RSU. In addition, the Company issued approximately 168,000 vested RSUs and approximately 34,000 related premium non-vested RSUs at $13.05 per RSU to settle its 2005 management incentive plan liability, which had been accrued for in the prior year. The non-vested RSUs

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vest in three years, in accordance with the Company’s applicable management incentive plan and long-term incentive plan.

17.          Goodwill

The following table summarizes the activity of goodwill by segment for the six months ended June 30, 2006:

		Containerboard & Corrugated Containers			Consumer Packaging			Total
Balance at January 1, 2006		$	3,030		$	279		$	3,309
Goodwill included in loss on sale of discontinued operations					(279		)	(279		)
Goodwill reduced as a result of a reduction of valuation allowances associated with NOL utilization		(157		)				(157		)
Balance at June 30, 2006		$	2,873		$			$	2,873

 

The Consumer Packaging segment goodwill was eliminated as part of the Consumer Packaging division sale (see Note 3). Goodwill was reduced by $157 million as a result of a reduction of the valuation allowances associated with NOL carryforwards utilized as a result of the sale (see Note 13).

18.          Business Segment Information

The Company’s Consumer Packaging segment, which was sold as of June 30, 2006 (See Note 3), has been classified as discontinued operations and is excluded from the segment results for all periods presented. As a result, the Company has one reportable segment, Containerboard and Corrugated Containers. The Containerboard and Corrugated Containers segment is highly integrated. It includes a system of mills and plants that produces a full line of containerboard that is converted into corrugated containers. It also provides single source full merchandising solutions to retailers and consumer packaging companies. Corrugated containers are used to transport such diverse products as home appliances, electric motors, small machinery, grocery products, produce, books, tobacco and furniture.

The Company evaluates performance and allocates resources based on profit or loss from operations before income taxes, interest expense and other non-operating gains and losses. The accounting policies of the reportable segment are the same as those described in the summary of significant accounting policies in the 2005 10-K. Intersegment sales and transfers are recorded at market prices.

Other includes corporate related items and a non-reportable segment, Reclamation. Corporate related items include expenses not allocated to reportable segments, including corporate expenses, restructuring charges, unrealized gains or losses on derivative instruments not qualifying for hedge accounting, non-cash foreign currency gains or losses, gains or losses from the sale of businesses and real estate and interest expense.

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A summary by business segment follows:

		Containerboard & Corrugated Containers			Other			Total
Three months ended June 30,
2006
Revenues from external customers		$	1,677		$	88		$	1,765
Intersegment revenues					56			56
Segment profit (loss)		118			(192		)	(74		)
2005
Revenues from external customers		$	1,661		$	99		$	1,760
Intersegment revenues					59			59
Segment profit (loss)		94			(110		)	(16		)
Six months ended June 30,
2006
Revenues from external customers		$	3,323		$	171		$	3,494
Intersegment revenues					101			101
Segment profit (loss)		128			(316		)	(188		)
2005
Revenues from external customers		$	3,270		$	199		$	3,469
Intersegment revenues					116			116
Segment profit (loss)		160			(222		)	(62		)

 

19.          Contingencies

The Company’s past and present operations include activities which are subject to federal, state and local environmental requirements, particularly relating to air and water quality. The Company faces potential environmental liability as a result of violations of permit terms and similar authorizations that have occurred from time to time at its facilities. In addition, the Company faces potential liability for response costs at various sites for which it has received notice as being a potentially responsible party (“PRP”) concerning hazardous substance contamination. In estimating its reserves for environmental remediation and future costs, the Company’s estimated liability of $4 million reflects the Company’s expected share of costs after consideration for the relative percentage of waste deposited at each site, the number of other PRPs, the identity and financial condition of such parties and experience regarding similar matters. As of June 30, 2006, the Company had approximately $25 million reserved for environmental liabilities included primarily in other long-term liabilities in the consolidated balance sheet. The Company believes the liability for these matters was adequately reserved at June 30, 2006.

If all or most of the other PRPs are unable to satisfy their portion of the clean-up costs at one or more of the significant sites in which the Company is involved or the Company’s expected share increases, the resulting liability could have a material adverse effect on the Company’s consolidated financial condition or results of operations.

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

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

FORWARD-LOOKING STATEMENTS

Some information included in this report may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. 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 document, the words “anticipates,” “believes,” “expects,” “intends” and similar expressions as they relate to Smurfit-Stone Container Corporation or its management, are intended to identify such forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties. There are important factors that could cause actual results to differ materially from those in forward-looking statements, certain of which are beyond our control. These factors, risks and uncertainties are discussed in our 2005 Annual Report on Form 10-K (2005 Form 10-K).

Our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements. Accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what impact they will have on our results of operations or financial condition. We expressly decline any obligation to publicly revise any forward-looking statements that have been made to reflect the occurrence of events after the date hereof.

GENERAL

Smurfit-Stone Container Corporation, incorporated in Delaware in 1989, is a holding company with no business operations of its own. We conduct our business operations through our wholly-owned subsidiary Smurfit-Stone Container Enterprises, Inc. (SSCE), a Delaware corporation. SSCE is the surviving company resulting from the merger (the Merger) of our primary operating subsidiaries on November 1, 2004. 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 Stone Container Corporation, with Stone Container as the surviving company. Stone Container was simultaneously renamed Smurfit-Stone Container Enterprises, Inc. The Merger was effected principally to consolidate our debt financing activities. Stone Container and JSC(U.S.) were wholly-owned subsidiaries of Smurfit-Stone and, therefore, the Merger did not impact our consolidated financial statements. The Merger did not impact the operating activities of the merged companies, which continue to do business as Smurfit-Stone.

Our Consumer Packaging segment, which was sold as of June 30, 2006 (see “Discontinued Operations”), has been classified as discontinued operations and is excluded from the segment results for all periods presented. As a result, we have one reportable segment, Containerboard and Corrugated Containers.

DISCONTINUED OPERATIONS

During the second quarter of 2006, we entered into an agreement to sell substantially all of the assets of the Consumer Packaging division to a company formed by Texas Pacific Group for approximately $1.04 billion. On June 30, 2006, we completed the sale transaction and received cash proceeds of $902 million, which excluded $126 million of certain accounts receivables previously sold by us to Stone Receivables Corporation under the accounts receivable securitization program and was net of sales transaction costs and other closing adjustments. We recorded a pretax gain of $174 million, offset by a $175 million income tax provision, resulting in a net loss on sale of discontinued operations of $1 million, subject to post-closing adjustments as provided in the sale agreement. The after-tax loss is the result of a provision for income taxes that is higher than the statutory income tax rate due to non-deductible goodwill of $273 million.

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The Consumer Packaging division was a reportable segment comprised of four coated recycled boxboard mills, 39 consumer packaging operations in the United States, including folding carton, multiwall and specialty bag, flexible packaging, label, contract packaging and lamination businesses, and one consumer packaging plant in Brampton, Ontario. Net sales for these operations were $391 million and $787 million, respectively, for the three and six months ended June 30, 2006, and $393 million and $777 million, respectively, for the three and six months ended June 30, 2005. These facilities employed approximately 6,600 hourly and salaried employees. The results of operations from the Consumer Packaging segment have been reclassified as discontinued operations for all periods presented.

RESULTS OF OPERATIONS

Strategic Initiatives

During the fourth quarter of 2005, we announced a strategic reassessment plan to improve performance and better position us for long-term growth. Our plan focuses on (i) cost reduction initiatives from which we expect to achieve $525 million in annual savings by the end of 2008, (ii) revenue growth initiatives and (iii) organizational changes to enable the cost reduction and revenue growth initiatives.

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. Our original cost reduction 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.

For 2006, we are targeting $240 million of cost savings from our strategic initiatives. For the six months ended June 30, 2006, we realized cost savings of approximately $78 million from our strategic initiatives. Since we announced our strategic reassessment plan, we have realized cumulative cost savings of approximately $123 million. The cumulative savings include a reduction of fixed costs primarily related to the closures of two containerboard mills in August 2005, other workforce reductions in the Containerboard and Corrugated Containers segment and a one-time curtailment gain related to the elimination of postretirement health care and life insurance benefits for certain employees. To date, we have closed two containerboard mills, shut down or announced the closures of eleven converting facilities and idled two corrugators. As a result of these actions, we have reduced our headcount by more than 2,500 since June 30, 2005, including 1,000 during the first half of 2006.

Recently Adopted Accounting Standards

In September 2005, the Emerging Issues Task Force reached a consensus on Issue No. 04-13, “Accounting for Purchases and Sales of Inventory With the Same Counterparty” (EITF No. 04-13) effective for us April 1, 2006, 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. We adopted EITF No. 04-13 effective April 1, 2006 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 $70 million for the three months ended June 30, 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 six months ended June 30, 2006, and $81 million and $153 million, respectively, for the three and six months ended June 30, 2005.

Overview

We had a net loss available to common stockholders of $44 million, or $0.17 per diluted share, for the second quarter of 2006 compared to net income of $1 million, or breakeven on a per diluted share basis, for the same period last year. Net sales were comparable to the second quarter of 2005. Net sales for the second quarter of 2006 were favorably impacted by increased sales volume for containerboard and

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higher average sales prices for corrugated containers and containerboard. Net sales for the second quarter of 2006 were unfavorably impacted by the adoption of EITF No. 04-13. Compared to the second quarter of 2005, our net loss increased due primarily to a loss on early extinguishment of debt, higher non-cash foreign currency losses, restructuring charges and interest expense and higher costs for energy and freight.

We had a net loss available to common stockholders of $108 million, or $0.42 per diluted share, for the first half of 2006. Net sales increased 0.7% compared to the first half of 2005 due primarily to higher average sales prices and higher sales volume for corrugated containers and containerboard. Net sales for the first half of 2006 were unfavorably impacted by the adoption of EITF No. 04-13. Compared to the first half of 2005, our net loss increased due primarily to the loss on early extinguishment of debt, higher non-cash foreign currency losses, restructuring charges and interest expense and higher costs for energy, freight and chemicals.

We expect our results from operations to improve in the second half of 2006 as a result of higher average sales prices for containerboard and corrugated containers, lower interest expense, lower energy and employee benefit costs and the continuing benefit from our strategic initiatives.

Second Quarter 2006 Compared to Second Quarter 2005

		Three months ended June 30,
		2006			2005
(In millions)		Net Sales			Profit/ (Loss)			Net Sales			Profit/ (Loss)
Containerboard and corrugated containers		$	1,677		$	118		$	1,661		$	94
Other operations (1)		88			4			99			6
Total segment operations		$	1,765		122			$	1,760		100
Restructuring charges					(13		)				(3		)
Gain on sale of assets					1
Interest expense, net					(96		)				(86		)
Loss on early extinguishment of debt					(28		)
Non-cash foreign currency gains (losses)					(14		)				5
Mark-to-market unrealized losses on derivative instruments (2)					(6		)				(6		)
Corporate expenses and other (3)					(40		)				(26		)
Loss from continuing operations before income taxes					$	(74	)				$	(16	)

(1)             Other operations consist of our Reclamation division, which is a non-reportable segment.

(2)             Amounts include mark-to-market unrealized gains or losses on natural gas commodity and foreign currency derivative instruments not qualifying for hedge accounting.

(3)             Amounts include corporate expenses, corporate charges to segments for working capital interest and other expenses not allocated to segments.

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The increase in net sales was due primarily to the improvement in average sales prices 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:

(In millions)		Container- board & Corrugated Containers			Other Operations			Total
Sales price and product mix		$	84		$	(9	)	$	75
Sales volume		2			(2		)
EITF No. 04-13		(70		)				(70		)
Total		$	16		$	(11	)	$	5

 

Cost of goods sold decreased from $1,524 million in 2005 to $1,513 million in 2006 due primarily to the impact of adopting EITF No. 04-13 in the second quarter of 2006 ($70 million) and lower cost for reclaimed materials ($12 million). Higher costs for energy ($4 million), wood fiber ($1 million), freight ($14 million) and chemicals ($4 million) partially offset the impact of adopting EITF No. 04-13. Cost of goods sold as a percent of net sales decreased from 86.6% in 2005 to 85.7% in 2006 due primarily to higher average sales prices and the impact of adopting EITF No. 04-13.

Selling and administrative expense increased $6 million compared to last year due primarily to higher stock-based compensation expense ($3 million), including $2 million due to the impact of adopting Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (SFAS No. 123(R)) on January 1, 2006, and costs related to the implementation of the strategic initiatives ($5 million). For information concerning stock-based compensation, see Note 5 of the Notes to Consolidated Financial Statements. Selling and administrative expense as a percent of net sales increased from 9.3% in 2005 to 9.6% in 2006 due in part to the adoption of EITF No. 04-13.

In connection with our strategic initiatives, during the second quarter of 2006, we recorded restructuring charges of $13 million, including non-cash charges of $5 million related to the write-down of assets, primarily property, plant and equipment, to estimated net realizable value. We announced the closure of three converting facilities and idled one corrugator, which resulted in the termination of approximately 270 employees. The remaining charges were primarily for severance and benefits.

Interest expense, net was $96 million in 2006. The $10 million increase over 2005 was the result of higher interest rates ($7 million), increased average borrowings ($2 million) and the reclassification of $1 million of interest expense in the second quarter of 2005 to discontinued operations. Our overall average effective interest rate in 2006 was higher than 2005 by approximately 0.55%.

In the second quarter of 2006, we recorded a loss on early extinguishment of debt of $28 million related to the repayment of borrowings with net proceeds from the sale of our Consumer Packaging division. The loss included $24 million for tender premiums and fees for the redemption of unsecured senior notes and a $4 million non-cash write-off of related deferred debt issuance costs.

Other, net for 2006 included non-cash foreign currency losses of $14 million compared to gains of $5 million in 2005.

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 second quarter of 2006, we recorded a pretax gain of $174 million, offset by a $175 million income tax provision, resulting in a net loss on sale of discontinued operations of $1 million. The after-tax loss is the

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result of a provision for income taxes that is higher than the statutory income tax rate due to the non-deductibility of goodwill. U.S. federal alternative minimum tax of approximately $14 million is expected to be paid during the second half of 2006 related to the sale of the Consumer Packaging division.

Containerboard and Corrugated Containers Segment

Net sales increased 1.0% in 2006 compared to last year primarily as a result of higher average sales prices for corrugated containers and containerboard and higher sales volume for containerboard. Net sales were unfavorably impacted by the adoption of EITF No. 04-13. Average domestic linerboard prices in the second quarter of 2006 were 10.1% higher than the first quarter of 2006 and increased 9.9% compared to the second quarter of 2005. Our average North American selling price for corrugated containers was 4.3% higher compared to the first quarter of 2006 and increased 3.5% compared to the second quarter of 2005. Second quarter average sales prices for market pulp and solid bleached sulfate (SBS) increased approximately 6.8% and 1.0%, respectively, compared to the same period last year. The average sales price for kraft paper increased 9.3% compared to the same period last year. Shipments of containerboard to third parties increased 21.1%, while shipments of corrugated containers declined by 1.1% compared to the same period last year.

Our containerboard mills operated at 100% of capacity in the second quarter of 2006 and production increased 0.4% compared to last year. Production of market pulp and kraft paper decreased 2.2% and 6.0%, respectively, while production of SBS increased 6.9% compared to last year.

Profits increased $24 million compared to last year due primarily to the higher average sales prices and the higher sales volume for containerboard. Profits were unfavorably impacted by higher costs of energy ($4 million), freight ($14 million), chemicals ($4 million) and wood fiber ($1 million).

Other Operations

Net sales decreased 11.1% due primarily to lower average sales prices for reclaimed fiber. The average price for old corrugated containers (OCC) decreased approximately $10 per ton compared to last year. Total tons of fiber reclaimed and brokered decreased 1.9% as a result of lower external sales volume, which was partially offset by higher internal consumption. Profits in 2006 decreased $2 million compared to last year due primarily to the lower average selling prices and a loss due to a fire at a reclamation facility.

Six Months 2006 Compared to Six Months 2005

		Six months ended June 30,
		2006						2005
(In millions)		Net Sales			Profit/ (Loss)			Net Sales			Profit/ (Loss)
Containerboard and corrugated containers		$	3,323		$	128		$	3,270		$	160
Other operations (1)		171			8			199			12
Total segment operations		$	3,494		136			$	3,469		172
Restructuring charges					(22		)				(4		)
Gain on sale of assets					24
Interest expense, net					(188		)				(172		)
Loss on early extinguishment of debt					(28		)
Non-cash foreign currency gains (losses)					(12		)				4
Mark-to-market unrealized gains (losses) on derivative instruments (2)					(15		)				2
Corporate expenses and other (3)					(83		)				(64		)
Loss from continuing operations before income taxes					$	(188	)				$	(62	)

(1)             Other operations consist of our Reclamation division, which is a non-reportable segment.

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(2)             Amounts include mark-to-market unrealized gains or losses on natural gas commodity and foreign currency derivative instruments not qualifying for hedge accounting.

(3)             Amounts include corporate expenses, corporate charges to segments for working capital interest and other expenses not allocated to segments.

The increase in net sales was due primarily to the improvement in average sales prices and sales volume 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:

(In millions)		Container- board & Corrugated Containers			Other Operations			Total
Sales price and product mix		$	59		$	(26	)	$	33
Sales volume		64			(2		)	62
EITF No. 04-13		(70		)				(70		)
Total		$	53		$	(28	)	$	25

 

Cost of goods sold increased from $3,023 million in 2005 to $3,102 million in 2006 due primarily to the higher sales volume ($55 million) and higher costs for energy ($40 million), freight ($29 million), chemicals ($10 million) and wood fiber ($6 million). Cost of goods sold was favorably impacted by lower cost for reclaimed material ($46 million) and the impact of adopting EITF No. 04-13. Cost of goods sold as a percent of net sales increased from 87.1% in 2005 to 88.8% in 2006 due primarily to the higher costs.

Selling and administrative expense increased $13 million compared to last year due primarily to higher stock-based compensation expense ($6 million), including $3 million due to the impact of adopting SFAS No. 123(R) on January 1, 2006, and costs related to the implementation of the strategic initiatives ($8 million). Selling and administrative expense as a percent of net sales increased from 9.5% in 2005 to 9.8% in 2006 due in part to the adoption of EITF No. 04-13.

In connection with our strategic initiatives, for the six months ended June 30, 2006, we recorded restructuring charges of $22 million, including non-cash charges of $10 million related to the write-down of assets, primarily property, plant and equipment, to estimated net realizable value. We shut down or announced the closure of six converting facilities and idled two corrugators, which resulted in the termination of approximately 480 employees. The remaining charges were primarily for severance and benefits. Additional charges of up to $10 million will be recorded in future periods for severance and benefits related to the closure of three converting facilities and for pension settlement costs.

Interest expense, net was $188 million in 2006. The $16 million increase over 2005 was the result of higher interest rates ($12 million), higher average borrowings ($3 million) and the reclassification of $1 million of interest expense to discontinued operations. Our overall average effective interest rate in 2006 was higher than 2005 by approximately 0.50%.

We recorded a gain 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 for 2006 included non-cash foreign currency losses of $12 million compared to gains of $4 million in 2005.

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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.

Containerboard and Corrugated Containers Segment

Net sales increased 1.6% in 2006 compared to last year primarily as a result of higher sales volume and higher average sales prices for corrugated containers and containerboard. Shipments of corrugated containers increased 0.8% and containerboard shipments to third parties increased 16.8% compared to the same period last year. Average domestic linerboard prices in the first half of 2006 were 5.4% higher compared to the first half of 2005. Our average North American selling price for corrugated containers was 0.5% higher compared to the first half of 2005. Our average sales prices for market pulp, kraft paper and SBS increased approximately 3.9%, 2.1% and 1.9%, respectively, compared to the first half of last year.

Our containerboard mills operated at 98.5% of capacity in the first half of 2006 and production increased 0.8% compared to last year. Production of market pulp and kraft paper were comparable, while production of SBS increased by 8.8%, compared to last year.

Profits decreased $32 million compared to last year due primarily to higher costs of energy ($40 million), freight ($29 million), chemicals ($10 million) and wood fiber ($6 million). Profits were favorably impacted by the higher sales volume, higher average sales prices and lower costs for reclaimed fiber ($12 million).

Other Operations

Net sales decreased 14.1% due primarily to lower average sales prices for reclaimed fiber. The average price for OCC decreased approximately $20 per ton compared to last year. Total tons of fiber reclaimed and brokered for the six months ended June 30, 2006 was comparable to the same period last year. Lower external sales volume was offset by higher internal consumption. Profits in 2006 decreased $4 million compared to last year due primarily to the lower average selling prices and the loss of a profitable customer account.

Statistical Data

		Three months ended June 30,				Six months ended June 30,
(In thousands of tons, except as noted)		2006		2005		2006		2005
Mill production
Containerboard (1)		1,860		1,852		3,631		3,603
Kraft paper		47		50		101		102
Market pulp		136		139		281		280
SBS		77		72		149		137
North American corrugated containers sold (billion sq. ft.) (2)		20.2		20.4		40.3		40.0
Fiber reclaimed and brokered		1,630		1,662		3,296		3,298

(1)             For the three months ended June 30, 2006 and 2005, our corrugated container plants consumed 1,346,000 tons and 1,375,000 tons of containerboard, respectively. For the six months ended June 30, 2006 and 2005, our corrugated container plants consumed 2,701,000 tons and 2,708,000 tons of containerboard, respectively.

(2)             Excludes intercompany shipments. Includes our proportionate share of affiliates reported on an equity ownership basis.

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