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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission file number 1-3439

STONE CONTAINER CORPORATION
(Exact name of registrant as specified in its charter)

Registrant's Telephone Number: (312) 346-6600

Securities registered pursuant to Section 12(b) of the Act: None

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

        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 ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

        As of February 28, 2003, none of the registrant's voting stock was held by non-affiliates.

        The number of shares outstanding of the registrant's common stock as of February 28, 2003: 1,000

DOCUMENTS INCORPORATED BY REFERENCE: None

        The registrant meets the conditions set forth in General Instruction (I) (1) (a) and (b) of Form 10-K and is therefore filing this form with the reduced disclosure format permitted thereby.

STONE CONTAINER CORPORATION
ANNUAL REPORT ON FORM 10-K
December 31, 2002

TABLE OF CONTENTS

FORWARD-LOOKING STATEMENTS

        Except for the historical information contained in this Annual Report on Form 10-K, certain matters discussed herein, including (without limitation) under Part I, Item 1, "Business-Environmental Compliance," under Part I, Item 3, "Legal Proceedings" and under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," 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 statements 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 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 include the following:

•

the impact of general economic conditions in North America and in other locations where we currently do business;



•

general industry conditions, including competition and product and raw material prices;



•

fluctuations in interest rates, exchange rates and currency values;



•

unanticipated capital expenditure requirements;



•

legislative or regulatory requirements, particularly concerning environmental matters;



•

access to capital markets;



•

fluctuations in energy prices; and



•

obtaining required consents or waivers of creditors in the event we are unable to satisfy covenants in our debt instruments.

        Our actual results, performance or achievement 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.

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PART I

ITEM 1.    BUSINESS

        Unless the context otherwise requires, "we," "us," "our" or "Stone Container" refers to the business of Stone Container Corporation and its subsidiaries.

GENERAL

        Stone Container Corporation, a Delaware corporation, is an integrated producer of containerboard, corrugated containers, multiwall bags and other packaging products. Excluding the discontinued European operations discussed below, our operations are primarily in North America. For the year ended December 31, 2002, our net sales were $4,970 million and net income was $2 million.

        We are a wholly-owned subsidiary of Smurfit-Stone Container Corporation, a Delaware corporation. Smurfit-Stone is a holding company with no business operations of its own. Smurfit-Stone conducts its business operations through two wholly-owned subsidiaries: Stone Container and JSCE, Inc., a Delaware corporation. Smurfit-Stone acquired Stone Container through the November 18, 1998 merger of a wholly-owned subsidiary of Smurfit-Stone, with and into Stone Container.

        On May 31, 2000, Stone Container, through a subsidiary, acquired St. Laurent Paperboard, Inc. Amounts included in the discussion below include St. Laurent's operations after May 31, 2000.

PRODUCTS

        We report our results of operations in three industry segments, two of which are reportable, 1) Containerboard and Corrugated Containers and 2) Consumer Packaging. On January 1, 2002, we combined the former Specialty Packaging segment with the Consumer Packaging segment. These segments were previously not reportable. The information for 2001 and 2000 has been restated in order to conform to the 2002 presentation. Our European operations, which are held for sale, have been classified as discontinued and are excluded from the segment results for all periods presented. The European operations were previously included in the International segment. For financial information relating to our segments, see the information set forth in Note 21 of the Notes to Consolidated Financial Statements.

CONTAINERBOARD AND CORRUGATED CONTAINERS SEGMENT

        The Containerboard and Corrugated Containers segment includes 17 paper mills (11 located in the United States and six in Canada) and 92 container plants (88 located in the United States, one in Canada and three in Mexico). In addition, we own approximately 1.1 million acres of timberland and operate wood harvesting facilities in Canada. The primary products of our Containerboard and Corrugated Containers segment include:

•

corrugated containers;



•

containerboard;



•

kraft paper; and



•

market pulp.

        We produce a full range of high quality corrugated containers designed to protect, ship, store and display products made to our customers' merchandising and distribution specifications. Corrugated containers are sold to a broad range of manufacturers of consumer goods. Corrugated containers are used to ship such diverse products as home appliances, electric motors, small machinery, grocery products, produce, computers, books, furniture and many other products. We provide customers with innovative packaging

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solutions to advertise and sell their products. In addition, we manufacture and sell a variety of retail ready, point of purchase displays and a full line of specialty products, including pizza boxes, corrugated clamshells for the food industry, Cordeck® recyclable pallets and custom die-cut boxes to display packaged merchandise on the sales floor. Our container plants serve local customers and large national accounts.

        Our containerboard mills produce a full line of containerboard, which is used primarily in the production of corrugated packaging. We produced 3,044,000 tons of unbleached kraft linerboard, 687,000 tons of white top linerboard and 1,625,000 tons of medium in 2002. Our containerboard mills and corrugated container operations are highly integrated, with the majority of our containerboard used internally by our corrugated container operations or by JSCE's corrugated container operations. In 2002, our corrugated container plants consumed 3,577,000 tons of containerboard, representing an integration level of approximately 61%.

        Our paper mills also produce solid bleached sulfate, kraft paper, market pulp and other specialty products. Kraft paper is used in numerous products, including consumer and industrial bags, grocery and shopping bags, counter rolls, handle stock and refuse bags. A significant portion of our kraft paper is consumed by our consumer packaging operations. In addition, we produce bleached northern and southern hardwood pulp, which is sold to manufacturers of paper products, including photographic and other specialty papers, as well as the printing and writing sectors.

        Production for our paper mills and sales volume for our corrugated container facilities for the last three years were:

        Corrugated container sales volumes shown above include our 50% share of the operations of Smurfit-MBI, a Canadian producer of corrugated containers, and other affiliates reported on an equity ownership basis.

        In December 2002, we reached agreements with an affiliate of Jefferson Smurfit Group (JS Group), formerly Smurfit-Stone's largest stockholder, to acquire JS Group's 50% ownership interest in Smurfit-MBI. The agreements were finalized in February 2003. See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—General."

CONSUMER PACKAGING SEGMENT

        The Consumer Packaging segment includes 15 plants located in the United States and two in Canada. The primary products of our Consumer Packaging segment include:

•

multiwall bags;



•

consumer bags; and



•

laminated products.

        Multiwall bags are designed to safely and effectively ship a wide range of industrial and commercial products, including fertilizers, chemicals, pharmaceuticals, building products, concrete, food, feed, seed and salt. Bags can be customized with easy-open features, handles and resealable closures, with a

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variety of liners, coatings and other treatments. We have developed and patented many innovative styles, including Cap-Sac®, PeelPak®, Soni-Loc®, Peel-N-Pour™, SquareStack™ and SquareSak™. We also manufacture small consumer bags for food and other products sold at retail outlets, including pet food and litter, cookies, flour, baking mixes and microwave popcorn. In 2002, our consumer packaging operations consumed approximately 60% of the kraft paper produced by our kraft paper mills. Multiwall bag shipments (in millions) for 2002, 2001 and 2000 were 1,162, 1,108 and 1,054, respectively.

NON-REPORTABLE SEGMENT

International Segment

        We operate one corrugated container plant in Indonesia and have a 50% ownership interest in three corrugated container plants and one sheet plant in China.

RAW MATERIALS

        Wood fiber and reclaimed fiber are the principal raw materials used in the manufacture of our paper products. We satisfy the majority of our need for wood fiber through purchases on the open market or under supply agreements. We satisfy essentially all of our need for reclaimed fiber through Smurfit-Stone's reclamation operations and nationwide brokerage system.

        Wood fiber and reclaimed fiber are purchased in highly competitive, price-sensitive markets, which have historically exhibited price and demand cyclicality. Conservation regulations 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 those times, we have experienced an increase in the cost of such fiber.

MARKETING

        Our marketing strategy is to sell a broad range of paper-based packaging products to marketers of industrial and consumer products. In managing the marketing activities of our paperboard mills, we seek to meet the quality and service needs of the customers of our converting plants at the most efficient cost, while balancing those needs against the demands of our open market customers. Our converting plants focus on supplying both specialized packaging with high value graphics that enhance a product's market appeal and high-volume commodity products. Our board sales group is responsible for marketing and selling pulp, paper and paperboard products to third parties worldwide.

        We seek to serve a broad customer base for each of our industry segments. As a result we serve thousands of accounts from our plants. Each plant has its own sales force and many have product design engineers and other service professionals who are in close contact with customers to respond to their specific needs. We complement our local plants' marketing and service capabilities with regional and national design and service capabilities, as well as national sales offices for customers who purchase through a centralized purchasing office. National account business may be allocated to more than one plant due to production capacity, logistics and equipment requirements.

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

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COMPETITION

        The markets in which we sell our principal products are highly competitive and comprised of many participants. Although no single company is dominant, we do face significant competitors in each of our businesses. Our competitors include large vertically integrated companies as well as numerous smaller companies. The industries in which we compete have historically been sensitive to price fluctuations brought about by shifts in industry capacity and other cyclical industry conditions. While we compete primarily on the basis of price in many of our product lines, other competitive factors include design, quality and service, with varying emphasis depending on product line.

BACKLOG

        Demand for our major product lines is relatively constant throughout the year and seasonal fluctuations in marketing, production, shipments and inventories are not significant. Backlogs are not a significant factor in the industry. We do not have a significant backlog of orders as most orders are placed for delivery within 30 days.

RESEARCH AND DEVELOPMENT

        Our research and development center, located in Carol Stream, Illinois, uses advanced technology to assist all levels of the manufacturing and sales processes, from raw material supply through finished packaging performance. Research programs have provided improvements in coatings and barriers, stiffeners, inks and printing. Our technical staff conducts basic, applied and diagnostic research, develops processes and products and provides a wide range of other technical services.

        We actively pursue applications for patents on new inventions and designs and attempt to protect our patents against infringement. Nevertheless, we believe our success and growth are more dependent on the quality of our products and our relationships with customers than on the extent of our patent protection. We hold or are licensed to use certain patents, licenses, trademarks and trade names on products, but do not consider the successful continuation of any material aspect of our business to be dependent upon such intellectual property.

EMPLOYEES

        We had approximately 24,700 employees at December 31, 2002, of which approximately 18,100 were employees of U.S. operations. Our European operations, which are held for sale, employ 3,200 people. Approximately 11,500 (64%) of our U.S. employees are represented by collective bargaining units. The expiration dates of union contracts for our major paper mill facilities are as follows:

•

La Tuque, Quebec, Canada—August 2004



•

Jacksonville, Florida—June 2006



•

Hodge, Louisiana—June 2006



•

Missoula, Montana—June 2007



•

Hopewell, Virginia—July 2007



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Panama City, Florida—March 2008



•

West Point, Virginia—September 2008



•

Florence, South Carolina—August 2009

        We believe our employee relations are generally good. We are currently in the process of bargaining with unions representing production employees at a number of our operations. There were no significant or material work stoppages during 2002. While the terms of our collective bargaining agreements may vary, we believe the material terms of the agreements are customary for the industry, the type of facility, the classification of the employees and the geographic location covered thereby.

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ENVIRONMENTAL COMPLIANCE

        Our operations are subject to extensive environmental regulation by federal, state and local authorities. In the past, we have made significant capital expenditures to comply with water, air, solid and hazardous waste and other environmental laws and regulations. We expect to make significant expenditures in the future for environmental compliance. Because various environmental standards are subject to change, it is difficult to predict with certainty the amount of capital expenditures that will ultimately be required to comply with future standards.

        In particular, the United States Environmental Protection Agency (EPA) has finalized significant portions of its comprehensive rule governing air emissions (Maximum Achievable Control Technology-MACT) and water discharges (Effluent Limitation Guidelines) from the pulp, paper and paperboard industry, known as the "Cluster Rule." Phase I of MACT I and the Effluent Limitation Guidelines of the Cluster Rule required us to convert our bleached market pulp mill at Panama City, Florida to an elemental chlorine free bleaching process, to install systems at several of our mills for the collection and destruction of low volume, high concentration gases and to implement best management practices, such as spill controls. These projects have been completed at a cost of approximately $155 million. Phase II of MACT I of the Cluster Rule will require the implementation of systems to collect high volume, low concentration gases at various mills and has a compliance date of 2006. MACT II of the Cluster Rule will require control of particulate from recovery boilers, smelt tanks and lime kilns and has a compliance date of 2004. We have spent approximately $11 million (of which approximately $10 million was spent in 2002) for capital projects related to MACT II of the Cluster Rule. We continue to study possible means of compliance with phase II of MACT I and MACT II of the Cluster Rule. Based on currently available information, we estimate that the aggregate compliance cost of phase II of MACT I and MACT II of the Cluster Rule is likely to be in the range of $75 million to $80 million and that such cost will be incurred over the next four years.

        In recent years, the EPA has undertaken significant air quality initiatives associated with nitrogen oxide emissions, regional haze and national ambient air quality standards. Several of our mills are located in states affected by these EPA initiatives. The EPA is also currently proposing to limit particulate emissions from industrial boilers in a new Boiler MACT regulation. Several of our mills will be subject to the Boiler MACT regulation when it is finalized. When regulatory requirements for new and changing standards are finalized, we will add any resulting future cost projections to our expenditure forecast.

        In addition to Cluster Rule compliance, we anticipate additional capital expenditures related to environmental compliance. Excluding the spending on Cluster Rule projects described above, for the past three years, we have spent an average of approximately $9 million annually on capital expenditures for environmental purposes. Since our principal competitors are subject to comparable environmental standards, including the Cluster Rule, it is our opinion, based on current information, that compliance with environmental standards should not adversely affect our competitive position. However, we could incur significant expenditures due to changes in law or the discovery of new information, which could have a material adverse effect on our operating results.

AVAILABLE INFORMATION

        Smurfit-Stone's Internet address is www.smurfit-stone.com. Smurfit Stone's Internet address is included in this annual report on Form 10-K as an inactive textual reference only. The information contained on Smurfit-Stone's website is not incorporated by reference into this annual report on Form 10-K and should not be considered part of this report. We file annual, quarterly and current reports and other information with the Securities and Exchange Commission (SEC) and we make available free of charge most of our SEC filings through Smurfit-Stone's Internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. You may access these SEC filings via the hyperlink provided on Smurfit-Stone's Internet website to a third-party SEC filings website.

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ITEM 2.    PROPERTIES

        Our manufacturing facilities, excluding the European operations which are accounted for as discontinued operations, are located primarily in North America. We believe that our facilities are adequately insured, properly maintained and equipped with machinery suitable for our use. Our manufacturing facilities, excluding the European operations, as of December 31, 2002 are summarized below:

(a)

Reflects the number of states in which we have at least one manufacturing facility.

        The paper mills represent approximately 82% of our investment in property, plant and equipment. In addition to manufacturing facilities, we own approximately 1.1 million acres of timberland and operate wood harvesting facilities in Canada. The approximate annual tons of productive capacity of our paper mills at December 31, 2002 were:

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        Substantially all of our North American operating facilities have been pledged as collateral under our various credit agreements. See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Financing Activities."

ITEM 3.    LEGAL PROCEEDINGS

LITIGATION

        In 1998, seven putative class action complaints were filed in the United States District Court for the Northern District of Illinois and in the United States District Court for the Eastern District of Pennsylvania. These complaints alleged that we reached agreements in restraint of trade that affected the manufacture, sale and pricing of corrugated products in violation of antitrust laws. The complaints have been amended to name several other defendants, including Jefferson Smurfit (U.S.) and Smurfit-Stone. The suits seek an unspecified amount of damages arising out of the sale of corrugated products for the period from October 1, 1993 through March 31, 1995. Under the provisions of the applicable statutes, any award of actual damages could be trebled. The complaints have been transferred to and consolidated in the United States District Court for the Eastern District of Pennsylvania, which has certified two plaintiff classes. The defendants' appeal of the class certification rulings in the Third Circuit Court of Appeals has been denied. We continue to vigorously defend these cases.

        We are a defendant in a number of lawsuits and claims arising out of the conduct of our business, including those related to environmental matters. While the ultimate results of such suits or other proceedings against us cannot be predicted with certainty, we believe the resolution of these matters will not have a material adverse effect on our consolidated financial condition or results of operations.

ENVIRONMENTAL MATTERS

        In September 1997, we received a Notice of Violation and a Compliance Order from the United States EPA alleging non-compliance with air emissions limitations for the smelt dissolving tank at our Hopewell, Virginia mill and for failure to comply with New Source Performance Standards applicable to certain other equipment at the mill. In cooperation with the EPA, we responded to information requests, conducted tests and took measures to ensure continued compliance with applicable emission limits. In December 1997 and November 1998, we received additional requests from the EPA for information about past capital projects at the mill. In April 1999, the EPA issued a Notice of Violation alleging that we "modified" the recovery boiler and increased nitrogen oxide emissions without obtaining a required construction permit. We responded to this notice and indicated the EPA's allegations were without merit. We entered into a tolling agreement with the EPA to allow us to continue settlement discussions without litigation, which tolls the statute of limitations in this matter until at least May 2, 2003. The tolling agreement does not restrict the EPA from bringing suit against us.

        In April 1999, the EPA and the Virginia Department of Environmental Quality (Virginia DEQ) each issued a Notice of Violation under the Clean Air Act to St. Laurent's mill located in West Point, Virginia, which St. Laurent acquired from Chesapeake Corporation in May 1997. In general, the Notices of Violation allege that, from 1984 to the present, the West Point mill installed certain equipment and modified certain production processes without obtaining the required permits. St. Laurent made a claim for indemnification from Chesapeake for its costs relating to these Notices of Violation pursuant to the purchase agreement between St. Laurent and Chesapeake, and the parties appointed a third-party arbitrator to resolve the issues relating to the indemnification claim. The arbitrator has established a binding cost-sharing formula between the parties as to the cost of any capital expenditures that might be required to resolve the Notices of Violation, as well as any fines and penalties imposed in connection therewith. St. Laurent and Chesapeake are attempting to reach agreement with the EPA and Virginia DEQ on a capital expenditure plan to remedy the Notices of Violation, and based on the information developed to date and discussions with the EPA and Virginia DEQ, we believe our share of the costs to resolve this matter will not be material and will not exceed established reserves. We entered into a tolling agreement with the EPA to

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allow us to continue settlement discussions without litigation, which tolls the statute of limitations in this matter until at least May 2, 2003. The tolling agreement does not restrict the EPA from bringing suit against St. Laurent. St. Laurent and Chesapeake are continuing to participate in settlement discussions with the EPA.

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

        We also face potential liability as a result of releases, or threatened releases, of hazardous substances into the environment from various sites owned and operated by third parties at which company-generated wastes have allegedly been deposited. Generators of hazardous substances sent to off-site disposal locations at which environmental problems exist, as well as the owners of those sites and certain other classes of persons (generally referred to as "potentially responsible parties" or "PRPs") are, in most instances, subject to joint and several liability for response costs for the investigation and remediation of such sites under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and analogous state laws, regardless of fault or the lawfulness of the original disposal. We have received notice that we are or may be a PRP at a number of federal and/or state sites where response action may be required, and as a result may have joint and several liability for cleanup costs at such sites. However, liability for CERCLA sites is typically shared with other PRPs and costs are commonly allocated according to relative amounts of waste deposited. Our relative percentage of waste deposited at these sites is 1% or less. In addition to participating in the remediation of sites owned by third parties, we have entered into consent orders for investigation and/or remediation of certain of our owned properties.

        Based on current information, we believe the probable costs of the potential environmental enforcement matters discussed above, response costs under CERCLA and similar state laws, and the remediation of owned property, will not have a material adverse effect on our financial condition or results of operations. As of December 31, 2002, we had approximately $25 million reserved for environmental liabilities. We believe our liability for these matters was adequately reserved at December 31, 2002.

PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

        We are a wholly-owned subsidiary of Smurfit-Stone. Therefore, all of our outstanding common stock is owned by Smurfit-Stone. As a result, there is no established public market for our common stock.

DIVIDENDS ON COMMON STOCK

        We have not paid cash dividends on our common stock and do not intend to pay dividends in the foreseeable future. Our ability to pay dividends in the future is restricted by certain restrictive provisions contained in our credit agreement, senior note indentures and restated certificate of incorporation. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.

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ITEM 6.    SELECTED FINANCIAL DATA (h)

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Notes to Selected Financial Data

(a)

Results for 2000 include St. Laurent's operations after May 31, 2000, the date of acquisition.

(b)

On November 18, 1998, we completed a merger with a wholly-owned subsidiary of Smurfit-Stone. The merger was accounted for as a purchase business combination. Accordingly, purchase accounting adjustments, including goodwill, have been pushed down and are reflected in our financial statements subsequent to November 18, 1998. The financial statements for the period before November 18, 1998 were prepared using the historical basis of accounting and are designated as "Predecessor." The comparability of operating results for the Predecessor period and the periods subsequent to November 18, 1998 are affected by the purchase accounting adjustments.

(c)

In 2002, 2001 and 2000, we recorded restructuring charges of $20 million, $6 million, and $53 million, respectively.

(d)

Includes income from discontinued operations (net of income taxes) and gain or loss on disposition of discontinued operations (net of income taxes).

(e)

Subsequent to the 1998 merger with Smurfit-Stone, earnings per share information is no longer presented because we are a wholly-owned subsidiary of Smurfit-Stone.

(f)

Effective January 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill no longer be amortized, but instead be tested for impairment at least annually. Depreciation, depletion and amortization includes goodwill amortization of $84 million in 2001, $82 million in 2000, $71 million in 1999, $8 million for the period from November 19, 1998 to December 31, 1998 and $10 million for the period from January 1, 1998 to November 18, 1998.

(g)

Excludes discontinued operations.

(h)

Certain prior year amounts have been restated to conform to current year presentation.

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ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                   RESULTS OF OPERATIONS

GENERAL

        Market conditions and demand for containerboard and corrugated containers, our primary products, have historically been subject to cyclical changes in the economy and changes in industry capacity, both of which can significantly impact selling prices and our profitability.

        Containerboard market conditions were generally strong in the first half of 2000. Linerboard prices increased to $480 per ton during the first quarter and held through the end of the year. Domestic economic growth began to slow in the second half of 2000, however, and market conditions began to deteriorate. In addition, the sustained strength of the U.S. dollar made products manufactured in the U.S. less competitive in global markets. Industry shipments of corrugated containers for 2000 declined 1% compared to 1999 and declined an additional 6% in 2001, the worst performance since 1975. The slowdown in the U.S. economy, in addition to weak export markets, exerted downward pressure on containerboard demand. In order to maintain a balance between supply and demand, certain companies in the containerboard industry took extensive market related downtime in 2000 and 2001. The sluggish corrugated demand in 2001 and the excess supply of containerboard resulted in an 11% decline in linerboard pricing to $425 per ton as of December 31, 2001. Linerboard prices decreased an additional $5 per ton in the first quarter of 2002. Corrugated container prices also declined during this period. Certain companies in the containerboard industry continued to take market related downtime in 2002. Markets gradually improved in 2002, and a linerboard price increase was implemented effective July 1, 2002. Corresponding price increases were implemented for corrugated containers in the third and fourth quarters of 2002. As of December 31, 2002, linerboard prices were approximately $440 per ton, but have decreased $10 per ton in the first quarter of 2003. Industry shipments of corrugated containers in 2002 were flat compared to 2001. We do not expect a recovery in demand for corrugated containers until the U.S. economy strengthens.

        Market pulp is also subject to cyclical changes in the economy and changes in industry capacity. Market conditions were strong in the first half of 2000. Prices rose during this period, reaching $680 per metric ton by the end of 2000. Demand for market pulp weakened in the second half of 2000 and certain pulp producers began taking market related downtime to reduce inventories. Market conditions were very weak in 2001 and prices declined rapidly. By the end of 2001, market pulp prices had declined to $430 per metric ton. Prices dropped an additional $30 per metric ton in the first quarter of 2002. Pulp producers continued to take market related downtime after a modest increase in demand during the summer months of 2002. Prices moved gradually higher during the year, reaching $450 per metric ton by year-end. Markets are continuing to improve and we announced price increases totaling $60 per metric ton effective in the first quarter of 2003.

        Wood fiber and reclaimed fiber are the principal raw materials used in the manufacture of our products. Fluctuations in supply and demand have occasionally caused tight supplies of fiber and, at those times, we have experienced a temporary increase in the cost of such fiber. Demand for reclaimed fiber, which was generally strong in 1999 and early 2000, has weakened in recent years as certain domestic companies in the containerboard industry have taken extensive market related downtime. Prices declined in 2000 and continued to be depressed throughout 2001 as more paper mills took downtime to manage their inventories. The average price of old corrugated containers, commonly known as OCC, the principal grade used in recycled containerboard mills, was lower in 2001 compared to 2000 by approximately 40%. Higher demand and tight supplies in the second and third quarters of 2002 caused OCC prices to temporarily escalate. Although prices subsequently dropped, the high prices in the second and third quarters caused the average price of OCC to be higher than 2001 by 55%. Wood fiber prices, in areas where we procure wood, increased 1% in 2001 compared to 2000, but declined in 2002 by 6% compared to 2001. Recent wet weather in the southeast United States has resulted in lower availability and higher prices for wood fiber in the first quarter of 2003.

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RESULTS OF OPERATIONS

Segment Data

        Corporate expenses and other include corporate expenses, intracompany profit elimination and LIFO expense, corporate charges to segments for working capital interest and other expenses not allocated to segments. The effects of lower intracompany profit elimination and LIFO expense favorably impacted corporate expenses and other in 2001 and 2000.

        Amortization of goodwill ceased on January 1, 2002, when we adopted SFAS No. 142, "Goodwill and Other Intangible Assets."

2002 COMPARED TO 2001

        Consolidated net sales of $4,970 million in 2002 decreased by 4% compared to 2001 due primarily to lower average sales prices for containerboard and corrugated containers and higher shipments of containerboard and corrugated containers. The net sales decrease was partially offset by acquisitions, primarily in the Consumer Packaging segment and higher shipments of containerboard and corrugated containers. The increase or decrease in net sales for each of our segments is summarized in the chart below.

        Cost of goods sold decreased compared to 2001 due to the elimination of goodwill amortization ($82 million), lower energy cost ($30 million) and the impact from closures ($68 million). Higher reclaimed fiber cost ($53 million) partially offset the costs decreases. Cost of goods sold as a percent of net sales was 84.6% for 2002 compared to 84.3% for 2001 due primarily to the lower average sales prices.

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        Selling and administrative expenses for 2002 were lower than last year due to reduced compensation expense and insurance proceeds received in 2002. Selling and administrative expenses as a percent of net sales was 9% in 2002, comparable to last year.

        During 2002, we recorded restructuring charges of $20 million related to the permanent shutdown of the No. 1 containerboard machine at our Missoula, Montana paper mill, which had the capacity to produce approximately 180,000 tons of linerboard per year, and the closure of two converting facilities.

        Interest expense, net decreased $69 million due to the favorable impacts of lower interest rates ($47 million) partially resulting from refinancing activities in 2002 and 2001and from lower average borrowings ($27 million), which were partially offset by a $5 million reduction in interest income. Our overall average effective interest rate in 2002 was lower than 2001 by approximately 135 basis points.

        Income from continuing operations before income taxes and extraordinary item was $40 million, an increase of $4 million compared to 2001. Lower segment earnings were offset by lower interest expense and the elimination of goodwill amortization. The decline in segment earnings was due primarily to the lower average sales prices. Net income was $2 million in 2002 compared to $10 million in 2001.

        The effective income tax rate for 2002 decreased compared to last year due primarily to discontinuing non-deductible goodwill amortization upon the adoption of SFAS No. 142. The effective tax rate for 2002 differed from the federal statutory tax rate due to the effect of permanent differences. For information concerning income taxes, see Liquidity and Capital Resources and Note 11 of the Notes to Consolidated Financial Statements.

Containerboard and Corrugated Containers Segment

        Net sales decreased by 5% due primarily to lower average sales prices for containerboard and corrugated containers. Corrugated container sales prices and linerboard sales prices were lower by 4%. The average sales price for market pulp was comparable to last year.

        Production of containerboard increased by 1%. We continued to take market related downtime (approximately 510,000 tons) in 2002 in order to maintain a lower level of inventory. Shipments of corrugated containers were comparable to 2001. Our production of market pulp increased by 4%, SBS production decreased 2% and kraft paper production decreased by 1% compared to last year.

        Profits decreased by $112 million due primarily to the lower average sales prices. Reclaimed fiber cost was higher than last year by approximately $53 million. Profits were favorably impacted by the lower energy cost. Cost of goods sold as a percent of net sales was 84% for 2002 compared to 83% for 2001 due primarily to the lower average sales prices.

Consumer Packaging Segment

        Net sales for 2002 increased by 4% compared to last year due to the acquisition of a multiwall bag plant and a flexible packaging plant in the second half of 2001. Net sales were unfavorably impacted by lower sales volume for consumer bags. Multiwall bag shipments were higher by 5% due to the multiwall acquisition. Sales prices of flexible and specialty packaging products were lower than last year by approximately 1%, and sales prices for multiwall bags were 1% lower.

        Profits improved by $12 million due primarily to the acquisitions and lower kraft paper cost.

Discontinued Operations

        In December 2002, we reached agreements with an affiliate of JS Group to sell our European packaging operations to JS Group. See Liquidity and Capital Resources—General. In anticipation of the sale, we reclassified these operations as discontinued and recorded a loss of $40 million, arising from a provision for taxes on the disposition. We finalized the agreements in February 2003 and the transactions are expected to close in the first quarter of 2003. Our European operations include three paper mills (located

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in Hoya and Viersen, Germany and Cordoba, Spain), 20 corrugated container plants (11 located in Germany, three in Spain, four in Belgium, one in the Netherlands and one in France) and five reclamation plants located in Germany. In 2002, the European operations produced approximately 500,000 short tons of containerboard and boxboard. Net sales and operating profits were approximately $632 million and $31 million, respectively, in 2002.

2001 COMPARED TO 2000

        Consolidated net sales of $5,189 million increased marginally compared to 2000 due to the inclusion of results for St. Laurent Paperboard, Inc. for a full year. The effect of including St. Laurent's operations for the full year and the acquisition of a multiwall bag facility added $444 million to our net sales compared to 2000. St. Laurent's results of operations have been included in our consolidated results since May 31, 2000, the date of the acquisition. Poor market conditions for our major products led to lower sales prices for containerboard, corrugated containers and market pulp, and reduced shipments of corrugated containers. In addition, we closed four and sold three operating facilities. The increase (decrease) in net sales for each of our segments is summarized in the chart below.

        Cost of goods sold increased due to the inclusion of St. Laurent's cost for a full year and higher energy cost of $26 million. Cost of goods sold was favorably impacted by lower reclaimed fiber cost of $69 million. Cost of goods sold as a percent of net sales increased to 84% in 2001 from 80% in 2000 due primarily to the lower average sales prices.

        Selling and administrative expenses for 2001 increased due primarily to the St. Laurent acquisition. Selling and administrative expenses as a percent of net sales increased to 9% in 2001 from 8% in 2000 due primarily to the lower average sales prices.

        Gain on sale of assets in the Consolidated Statements of Operations increased in 2001 due primarily to a gain of $7 million related to the sale of a sawmill operation.

        During 2001, we recorded a restructuring charge of $6 million related to the permanent shutdown of two converting facilities and two wood products operations.

        Interest expense, net decreased $41 million due to the favorable impact of $48 million from lower interest rates, which was partially offset by the unfavorable impact of $7 million on higher average borrowings. Our overall average effective interest rate in 2001 was lower than 2000 by approximately 130 basis points.

        Income from continuing operations before income tax and extraordinary item was $36 million, a decrease of $172 million compared to 2000. The decrease was due primarily to the decline in segment earnings, particularly in the Containerboard and Corrugated Containers segment. Interest expense and restructuring charges were lower compared to 2000, partially offsetting the declines in segment earnings. Net income in 2001 was $10 million as compared to $108 million in 2000.

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        The effective income tax rate for 2001 differed from the federal statutory tax rate due to several factors, the most significant of which was the effect of permanent differences from applying purchase accounting. For information concerning income taxes, see Liquidity and Capital Resources and Note 11 of the Notes to Consolidated Financial Statements.

Containerboard and Corrugated Containers Segment

        Net sales for 2001 decreased slightly due to lower average sales prices for containerboard, corrugated containers and market pulp and lower sales volume for corrugated containers. Net sales were favorably impacted by the St. Laurent acquisition. The weak market conditions during 2001 resulted in excessive supplies of containerboard and prices declined. We took market related downtime in order to maintain a lower level of inventory. On average, corrugated container prices decreased by 3%, linerboard prices were lower by 5% and kraft paper prices decreased 2%. The lower demand for market pulp in the second half of 2000 and throughout 2001 had a significant effect on pricing. The average price for market pulp dropped $250 per metric ton from January to December 2001, reducing our average price for the year by 34% compared to 2000.

        Production of containerboard increased 5% due to the St. Laurent acquisition. We took approximately 776,000 tons of containerboard market related downtime in 2001 compared to 533,000 tons in 2000. Shipments of corrugated containers were comparable to 2000. Production of kraft paper declined by 1% and our production of market pulp declined by 1% compared to 2000.

        Profits decreased by $280 million due to the lower average sales prices. The higher levels of market related downtime taken in 2001 and higher energy costs also had a negative impact on profits. Profits were favorably impacted by the St. Laurent acquisition and lower reclaimed fiber cost. Cost of goods sold as a percent of net sales increased to 83% for 2001 compared to 77% for 2000 due primarily to the lower average sales prices.

Consumer Packaging Segment

        Net sales increased 8% compared to 2000 due primarily to the consumer packaging operations acquired as part of the St. Laurent acquisition and the acquisition of a multiwall bag packaging facility. Net sales were also favorably impacted by higher average prices of multiwall bags. Profits improved by $3 million due primarily to the higher sales prices and lower operating cost.

International Segment

        Net sales for 2001 were $7 million and profits were $1 million. The change in nets sales and profits compared to 2000 was due primarily to an operation sold.

RESTRUCTURINGS AND EXIT LIABILITIES

        We have from time to time restructured certain operations and closed operating facilities based upon assessments of supply and demand, productive capacity within a market area, operating cost and other economic considerations. In addition, certain of our recent acquisitions have included operations that overlap existing operations. In the first quarter of 2003, we will record a restructuring charge of approximately $3 million for the closure of a converting facility. Additional plant closures may occur in the future.

        During 2002, we recorded restructuring charges totaling $20 million related to the permanent shutdown of the No. 1 paper machine at our Missoula, Montana paper mill and the closure of two converting facilities. The assets of these closed operations were adjusted to the estimated fair value less cost to sell resulting in a $15 million non-cash charge. Approximately 100 employees were terminated. Severance and facility closure costs related to these closed operations were incurred and paid in 2002.

        As explained in our 2001 Annual Report on Form 10-K, we had $37 million of exit liabilities as of December 31, 2001 related primarily to the restructuring of operations in connection with the merger with

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Smurfit-Stone, the acquisition of St. Laurent and our restructuring activities. During 2002, we incurred cash expenditures of $11 million for these exit liabilities and reduced equipment removal commitments associated with a containerboard mill by $4 million. The exit liabilities remaining as of December 31, 2002, total $27 million. Future cash outlays, principally for long-term commitments, are expected to be $6 million in 2003, $6 million in 2004 and $15 million thereafter. We intend to continue funding the remaining exit liabilities through operations as originally planned.

LIQUIDITY AND CAPITAL RESOURCES

General

        In 2002, net cash provided by operating activities of $264 million, additional cash provided from new borrowings, which, net of financing fees, call premiums and other refinancing costs totaled $1,673 million and proceeds from asset sales of $26 million were used to fund $1,839 million of debt repayments and $130 million of expenditures for property, plant and equipment and acquisitions.

        In February 2003, we finalized agreements with an affiliate of JS Group to exchange, in two separate transactions, our European packaging operations and receive JS Group's 50% ownership in Smurfit-MBI, a Canadian packaging business, and a payment from JS Group of approximately $190 million. We currently owns 50% of Smurfit-MBI. Upon completion of the transactions, we will own 100% of Smurfit-MBI and will end our manufacturing presence in Europe. The transactions are expected to close in the first quarter of 2003. The net impact of the transactions on our future results of operations and liquidity are not expected to be material. Proceeds from the transactions will be used to reduce borrowings outstanding under our credit facility.

        We expect internally generated cash flows, available borrowing capacity under our credit agreement and future financing activities will be sufficient for the next several years to meet our obligations, including debt service, pension funding, expenditures relating to environmental compliance and other capital expenditures. Scheduled debt payments for 2003 and 2004 are $35 million and $31 million, respectively, with increasing amounts thereafter.

        We intend to hold capital expenditures for 2003 significantly below our anticipated annual depreciation level of $282 million. As of December 31, 2002, we had authorized commitments for capital expenditures of $103 million, including $35 million for environmental projects, $16 million to maintain competitiveness and $52 million for upgrades, modernization and expansion.

        We expect to use any excess cash flows provided by operations to make further debt reductions. As of December 31, 2002, we had $461 million of unused borrowing capacity under our credit agreement.

Financing Activities

        In April 2002, we redeemed our 12.58% rating adjustable unsecured senior notes due 2016 aggregating $125 million and paid $7 million in call premiums and other expenses from borrowings under the revolving credit facility.

        In June 2002, we issued $400 million of 8.375% senior notes due 2012. The proceeds of this issuance, along with additional borrowings on the our revolving credit facility of $52 million, were used to redeem $443 million of our secured Tranche C, D and E term loans under our credit agreement and to pay $9 million in fees and other expenses related to this transaction. The Tranche C, D and E term loans had a variable interest rate of LIBOR plus 3.5% (5.375% as of the redemption date) and were payable in various installments through October 1, 2003.

        In July 2002, we and Smurfit-Stone Container Canada Inc. amended, restated and replaced our existing credit agreements pursuant to which a group of financial institutions provided (i) $1,300 million in new term loan financing in the form of a $950 million Tranche B term loan to us maturing on June 30, 2009 and a $350 million Tranche C term loan to Smurfit-Stone Container Canada Inc. maturing on June 30,

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2009, and (ii) a $560 million revolving credit facility for us and a $100 million revolving credit facility for Smurfit-Stone Container Canada Inc., each maturing on December 31, 2005. The interest rates at the time of the transaction were equal to LIBOR plus 2.50% in the case of the term loan facilities, and LIBOR plus 3.00% or ABR plus 2.00%, in the case of the revolving credit facilities. The net proceeds of the Tranche B and C term loans, along with borrowings on our revolving credit facility of approximately $20 million, were used to refinance our $560 million Tranche F term loan (5.125% variable rate as of the redemption date) payable in various installments through October 31, 2005, our $402 million Tranche G term loan (5.375% variable rate as of the redemption date) due December 31, 2006, Smurfit-Stone Container Canada Inc.'s $347 million Tranche H term loan (5.375% variable rate as of the redemption date) due December 31, 2006, and to pay $11 million in fees and other expenses related to these transactions. The new credit agreement also permitted the distribution of Smurfit-Stone common stock by JS Group to its stockholders, which otherwise would have constituted a change of control event of default and allowed us to make an offer to repurchase the 11.5% unsecured senior notes due 2006 issued by our subsidiary, Stone Container Finance Company of Canada, at a price equal to 101% of the principal amount thereof (together with accrued, but unpaid interest thereon) provided certain conditions were satisfied. Our new credit agreement also permits the merger of us and Jefferson Smurfit (U.S.) under certain circumstances.

        In December 2002, Stone Container Finance Company of Canada commenced an offer to purchase its 11.5% senior notes due 2006, aggregating $200 million principal amount. The sole purpose of this offer was to fulfill Stone Container Finance Company of Canada's obligation under the indenture governing the 11.5% senior notes, which required it to make such an offer due to the Smurfit-Stone merger on November 18, 1998, which constituted a change in control under the indenture. The offer was made at a price equal to 101% of the principal amount thereof (together with accrued but unpaid interest thereon). As of January 3, 2003, the expiration date of the offer, approximately $15 million principal amount had been validly tendered and was redeemed with borrowings from our revolving credit facility.

        We and our subsidiary, Smurfit-Stone Container Canada Inc. have a bank credit agreement which provides for (a) $1,300 million in term loans in the form of a $950 million Tranche B term loan to us maturing June 30, 2009 and a $350 million Tranche C term loan to Smurfit-Stone Container Canada Inc. maturing June 30, 2009 and (b) a $560 million senior secured revolving credit facility for us and a $100 million senior secured revolving credit facility for Smurfit-Stone Canada Inc., each maturing on December 31, 2005. Up to $200 million of the revolving credit facilities may consist of letters of credit. Our Tranche B and Smurfit-Stone Container Canada Inc.'s Tranche C term loans bear interest at rates selected at our option equal to adjusted LIBOR plus a margin ranging from 2.25% to 2.5% or ABR plus a margin ranging from 1.25% to 1.5%. Outstanding loans under our and Smurfit-Stone Container Canada Inc.'s revolving credit facilities bear interest at variable rates equal to adjusted LIBOR plus a margin ranging from 2.0% to 3.0% or ABR plus a margin ranging from 1.0% to 2.0%. Commitment fees on the unused portion of the revolving credit facilities range from 0.375% to 0.5%. The margins and fees are determined by the ratio of total indebtedness to EBITDA, as defined in the credit agreement.

        Our obligations under our credit agreement are unconditionally guaranteed by our material U.S. subsidiaries. The obligations of Smurfit-Stone Container Canada Inc. under the credit agreement are unconditionally guaranteed by us, our material U.S. subsidiaries and the material Canadian subsidiaries of Smurfit-Stone Container Canada Inc. Our obligations under the credit agreement are secured by a security interest in substantially all of our assets and the assets of our material U.S. subsidiaries, 100% of the capital stock of our material U.S. subsidiaries and 65% of the capital stock of Smurfit-Stone Container Canada Inc. The security interests securing our obligations 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 Smurfit-Stone Container Canada Inc. under the credit agreement are secured by a security interest in substantially all of the assets of Smurfit-Stone Container Canada Inc. and its material Canadian subsidiaries, the same U.S. assets and capital stock that secure our obligations under the credit agreement and all of the capital stock of the material Canadian subsidiaries of Smurfit-Stone Container Canada Inc. The security interests securing Smurfit-Stone Container Canada Inc.'s obligations under the credit agreement exclude three mills and property related thereto and certain other real property located in New Brunswick and Quebec.

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        The credit agreements contain various covenants and restrictions including, among other things: (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 of certain financial covenants. The credit agreement also requires prepayments of the term loans from excess cash flow, as defined, and proceeds from certain asset sales, insurance, and incurrence of certain indebtedness. These restrictions, together with our highly leveraged position, could restrict our corporate activities, including our ability to respond to market conditions, to provide for unanticipated capital expenditures or to take advantage of business opportunities. We believe the risk of our breaching the debt covenants in 2003 is unlikely absent any material adverse event affecting the U.S. economy as a whole. However, our expectations of future operating results and continued compliance with our debt covenants cannot be assured and we cannot control our lenders' actions. If our debt is placed in default, we would experience a material adverse impact on our financial condition.

Pension Obligations

        As of December 31, 2002, our pension benefit obligations exceeded the fair value of pension plan assets by $621 million, up from $502 million at the end of 2001. The increase in the under-funded status was due primarily to interest cost on our pension obligations, the actuarial loss resulting primarily from the decreases in discount rates used for plan liabilities and negative investment returns resulting in a reduction of plan assets. As a result, in 2002, we recorded an increase to the minimum pension liability of $161 million, an increase to intangible assets of $13 million and a reduction to other comprehensive income of $90 million, net of tax of $58 million. In 2002, we contributed $118 million to our pension plans. Contributions to our plans will likely be higher in 2003 and 2004, but will be dependent upon future changes in discount rates and the earnings performance of our plan assets.

Environmental Matters

        Phase I of MACT I and the Effluent Limitation Guidelines of the Cluster Rule required us to convert our bleached market pulp mill at Panama City, Florida to an elemental chlorine free bleaching process, to install systems at several of our mills for the collection and destruction of low volume, high concentration gases and to implement best management practices, such as spill controls. These projects have been completed at a cost of approximately $155 million. Phase II of MACT I of the Cluster Rule will require the implementation of systems to collect high volume, low concentration gases at various mills and has a compliance date of 2006. MACT II of the Cluster Rule will require control of particulate from recovery boilers, smelt tanks and lime kilns and has a compliance date of 2004. We have spent approximately $11 million (of which approximately $10 million was spent in 2002) for capital projects related to MACT II of the Cluster Rule. We continue to study possible means of compliance with phase II of MACT I and MACT II of the Cluster Rule. Based on currently available information, we estimate that the aggregate compliance cost of phase II of MACT I and MACT II of the Cluster Rule is likely to be in the range of $75 million to $80 million and that such cost will be incurred over the next four years.

        In recent years, the EPA has undertaken significant air quality initiatives associated with nitrogen oxide emissions, regional haze and national ambient air quality standards. Several of our mills are located in states affected by these EPA initiatives. The EPA is also currently proposing to limit particulate emissions from industrial boilers in a new Boiler MACT regulation. Several of our mills will be subject to the Boiler MACT regulation when it is finalized. When regulatory requirements for new and changing standards are finalized, we will add any resulting future cost projections to our expenditure forecast.

        In addition to Cluster Rule compliance, we anticipate additional capital expenditures related to environmental compliance. Excluding the spending on Cluster Rule projects described above, for the past three years, we have spent an average of approximately $9 million annually on capital expenditures for environmental purposes. We anticipate that environmental capital expenditures, exclusive of the Cluster Rule projects, will be approximately $16 million in 2003.

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TRANSFER OF FINANCIAL ASSETS

        At December 31, 2002 and 2001, we had one off-balance sheet financing arrangement with a qualified special purpose entity. In 1999, we entered into a six-year $250 million accounts receivable securitization program whereby we sell, without recourse, on an ongoing basis, certain of our accounts receivable to Stone Receivables Corporation (SRC). SRC is a wholly-owned, non-consolidated subsidiary of Stone Container 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." SRC transfers the receivables to a trust for which it has sold beneficial interest to third-party investors. At December 31, 2002, $270 million of accounts receivable had been sold under the program, of which $59 million was retained by us as a subordinated interest and recorded in accounts receivable in the accompanying consolidated balance sheet. The investors and securitization trusts have no recourse to us for the failure of debtors to pay when due.

EFFECTS OF INFLATION

        Although inflation has slowed in recent years, it is still a factor in the economy and we continue to seek ways to mitigate its impact. Energy resources have been tight in certain areas of the United States in recent years and prices of natural gas and purchased electricity have fluctuated. Our paper mills are large users of energy and we attempt to mitigate cost increases through hedging programs and supply contracts. Natural gas prices, which peaked in the first quarter of 2001, were lower for most of 2002. Prices began increasing in the fourth quarter of 2002, however, and the upward trend has continued into 2003. With the exception of energy costs, inflationary increases in operating costs have been moderate during the past three years and have not had a material impact on our financial position or operating results.

        We use the last-in, first-out method of accounting for approximately 58% of our inventories. 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.

        As a result of our merger with Smurfit-Stone and the St. Laurent acquisition, our property, plant and equipment were adjusted to estimated fair value in the allocations of the purchase prices in both transactions. Therefore, depreciation expense for the next several years will approximate current cost of productive capacity being consumed.

CRITICAL ACCOUNTING POLICIES

        Certain accounting issues require management estimates and judgments for the preparation of financial statements. Our most significant policies requiring the use of estimates and judgments are listed below.

Goodwill

        Effective January 1, 2002, goodwill is no longer amortized, but instead is tested for impairment at least annually in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, an impairment is recognized when a reporting unit's carrying amount of goodwill exceeds its implied fair value. We performed our transitional and annual impairment tests for each of our reporting units, as required by SFAS No. 142. We determined the fair value of our reporting units based upon discounted cash flow models supported by recent acquisitions within our industry and various other valuation techniques. Based upon the results of these impairment tests, the carrying amount of goodwill was not determined to be impaired.

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Paper Machine Shutdowns

        As a result of excess capacity in Smurfit-Stone's containerboard system and its policy of producing to meet demand, Smurfit-Stone temporarily shut down four of its paper machines in 2001. Stone Container owns two of these machines, located at Missoula, Montana and Hodge, Louisiana. The Hodge machine was subsequently restarted. The Missoula No.1 paper machine remained closed during the first ten months of 2002. In September 2002, Jefferson Smurfit (U.S.), an affiliate of Smurfit-Stone, purchased a corrugating medium mill located in Stevenson, Alabama, with an annual capacity of 830,000 tons (the Stevenson Mill Acquisition). In light of the 830,000 tons of additional capacity added with the Stevenson Mill Acquisition, Smurfit-Stone performed an evaluation of its overall containerboard requirements. Consideration was given to such things as supply and demand, location of our containerboard mills and operating cost of paper machines. As a result of the study, we permanently closed the Missoula No.1 paper machine in November 2002, and recorded an impairment charge of approximately $14 million related to the closure of this paper machine in the fourth quarter of 2002.

Allowance for Doubtful Accounts

        We evaluate the collectibility of selected accounts receivable on a case-by-case basis and make adjustments to the bad debt reserve for expected losses. We consider such things as ability to pay, bankruptcy, credit ratings and payment history. For all other accounts, we estimate reserves for bad debts based on historical experience and past due status of the accounts.

Pension

        Our defined benefit pension plans are accounted for in accordance with SFAS No. 87, "Employers' Accounting for Pensions." 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 used to discount plan liabilities. Our assumptions are described in Note 12 of the Notes to Consolidated Financial Statements. The assumption for the long-term rate of return on plan assets is determined based on historical results of the portfolio and management's expectation of the current environment. Effective January 1, 2003, we reduced the expected long-term rate of return on plan assets to 9.0%, down from 9.5%. At December 31, 2002, our discount rate assumptions, which are developed using Moody's Average Aa-Rated Corporate Bonds index as a benchmark, were reduced by 0.5% to 6.75% for our U.S. plans and generally 6.5% for our foreign plans. The decrease in the discount rate increased our pension obligations by approximately $50 million. The changes in assumptions, in addition to the increase in pension obligations and negative investment returns on plan assets in 2002, will increase our pension expense in 2003 by an estimated $17 million.

Income Tax Matters

        At December 31, 2002, we had approximately $1,231 million of net operating loss carryforwards for U.S. federal income tax purposes that expire from 2011 through 2019, with a tax value of $431 million, and $55 million of capital loss carryforwards for U.S. federal income tax purposes that expire from 2004 to 2007, with a tax value of $19 million. A valuation allowance of $152 million has been established for a portion of these deferred tax assets. We had net operating loss carryforwards for state purposes with a tax value of $77 million, which expire from 2003 through 2020. A valuation allowance of $46 million has been established for a portion of these deferred taxes. Further, we had approximately $29 million of net operating loss carryforwards for Canadian tax purposes that expire from 2004 to 2007, with a tax value of $10 million, and Canadian investment tax credits that expire from 2004 to 2011, with a tax value of $16 million. We had approximately $31 million of alternative minimum tax credit carryforwards for U.S. federal income tax purposes, which are available indefinitely. The realization of these deferred tax assets is dependent upon future taxable income. Based upon recent levels of taxable income, we expect that our deferred tax assets, net of valuation allowances, will be fully realized. Essentially all of our valuation allowances were recorded in the purchase price allocation at the time of the merger with Smurfit-Stone. As a result, if the valuation allowance is reduced, goodwill will be reduced by a corresponding amount. Should additional valuation allowances be necessary because of changes in economic circumstances, those allowances would be established through a charge to income tax expense.

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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 deductions and the allocation of income among various tax jurisdictions. The Internal Revenue Service is currently examining years 1998 through 2001. All years through 1997 are closed. In evaluating the exposure associated with our various filing positions, we record reserves for probable exposures. Based on our evaluation of our tax position, we believe we have appropriately accrued for probable exposures. To the extent we were to prevail in matters for which accruals have been established or be required to pay amounts in excess of our reserves, our effective tax rate in a given financial statement period may be materially impacted.

Environmental Liabilities

        We accrue environmental expenditures related to existing conditions, resulting from past or current operations, when they become probable and estimable. Our estimates are based on our knowledge of the particular site, environmental regulations, or the potential enforcement matter. Based on current information, we believe the probable costs of the potential environmental enforcement matters, response costs under CERCLA and similar state laws, and the remediation of owned property discussed in Part 1, Item 3, Legal Proceedings—Environmental Matters, will not have a material adverse effect on our financial condition or results of operations. As of December 31, 2002, we had approximately $25 million reserved for environmental liabilities. We believe our liability for these matters was adequately reserved at December 31, 2002.

PROSPECTIVE ACCOUNTING STANDARDS

        In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations," effective for fiscal years beginning after June 15, 2002. SFAS No. 143 establishes accounting standards for the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. It also provides accounting guidance for legal obligations associated with the retirement of tangible long-lived assets. We will apply the new accounting for asset retirement obligations beginning the first quarter of 2003. However, the impact to our financial position and results of operations is not expected to be material.

        In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 62, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 requires, in most cases, gains and losses on extinguishments of debt to be classified as income or loss from continuing operations, rather than as extraordinary items. The statement is effective for fiscal years beginning after May 15, 2002. Upon adoption of SFAS No. 145, we expect to reclassify previously recognized extraordinary gains and losses from the early extinguishment of debt.

        In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 replaces Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

        In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which clarifies and expands on existing disclosure requirements for guarantees and requires us to recognize a liability for the fair value of our obligations under that guarantee. The initial measurement and recognition provisions are prospective for guarantees issued after December 31, 2002. However, the disclosure requirements are effective for financial statements ending after December 15, 2002. See Note 1 of the Notes to Consolidated Financial Statements.

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ITEM 7A.    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 periodically enter into exchange traded futures contracts to manage fluctuations in cash flows resulting from commodity price risk in the procurement of natural gas. As of December 31, 2002, we have futures contracts to hedge approximately 20% to 25% of our expected natural gas requirements for the months of January 2003 through June 2003. We have futures contracts to hedge approximately 10% of our expected natural gas requirements for the months of July 2003 through December 2003. Our objective is to fix the price of a portion of our forecasted purchases of natural gas used in the manufacturing process. Excluding the impact of future contracts, the potential change in our total natural gas cost, based upon our current expected annual usage and unit cost, resulting from a hypothetical 10% change, would be approximately $10 million. The change in energy cost discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, included the impact of the natural gas futures contracts. See Note 9 of the Notes to Consolidated Financial Statements.

Foreign Currency Risk

        Our principal foreign exchange exposures are the Canadian dollar and the euro. Assets and liabilities outside the United States are primarily located in Canada and Germany. The functional currency for the majority of our foreign operations is the applicable local currency except for the operations in Canada. The functional currency for the Canadian operations was changed from the local currency to the U.S. dollar beginning on June 1, 2000, in conjunction with the St. Laurent acquisition. Our investments in foreign subsidiaries with a functional currency other than the U.S. dollar are not hedged.

        We periodically enter into foreign exchange forward contracts with financial institutions to purchase Canadian dollars in order to protect against currency exchange risk associated with expected future cash flows. Contracts typically have maturities of approximately one year. As of December 31, 2002, we have Canadian dollar forward purchase contracts to hedge approximately 40% to 60% of our Canadian dollar requirements for the months of January 2003 through September 2003.

        In anticipation of completing the exchange transaction of Stone Container's European operations for Smurfit-MBI with an affiliate of JS Group, we hedged the proceeds of 185 million euros to protect against the related exchange risk.

        We have performed a sensitivity analysis as of December 31, 2002 and 2001 that measures the change in the fair values 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% change in the Canadian dollar exchange rate at December 31, 2002 and 2001 would be $21 million and $13 million, respectively. A gain or loss in fair value, associated with the Canadian dollar, in the Consolidated Balance Sheets would be recorded as a gain or loss on foreign currency transactions.

        In 2002 and 2001, the average exchange rates for the Canadian dollar weakened against the U.S. dollar by 1.4% and 4.3%, respectively, and was unchanged in 2000.

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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 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 protect Stone Container from interest rate volatility and reduce or cap interest expense within acceptable levels of market risk. We may periodically enter into interest rate swaps, caps or options to hedge interest rate exposure and manage risk within company policy. We do not utilize derivatives for speculative or trading purposes. Any derivative would be specific to the debt instrument, contract or transaction, which would determine the specifics of the hedge. There were no interest rate derivatives outstanding at December 31, 2002.

        We have performed a sensitivity analysis as of December 31, 2002 and 2001 that measures the change in interest expense on our variable rate debt arising from a hypothetical 100 basis point adverse movement in the interest rate. Based on our outstanding variable rate debt as of December 31, 2002 and 2001, a hypothetical 100 basis point adverse change in interest rates would impact interest expense by approximately $15 million and $18 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. This information should be read in conjunction with Note 7 of the Notes to Consolidated Financial Statements.

Short and Long-Term Debt

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS

        The management of Stone Container is responsible for the information contained in the consolidated financial statements. The consolidated financial statements have been prepared by us in accordance with accounting principles generally accepted in the United States appropriate in the circumstances and necessarily include certain amounts based on management's best estimate and judgment.

        We maintain a system of internal accounting control, which we believe is sufficient to provide reasonable assurance that in all material respects transactions are properly authorized and recorded, financial reporting responsibilities are met and accountability for assets is maintained. In establishing and maintaining any system of internal control, judgment is required to assess and balance the relative costs and expected benefits. Management believes that through the careful selection of employees, the division of responsibilities and the application of formal policies and procedures, Stone Container has an effective and responsive system of internal accounting controls. The system is monitored by our staff of internal auditors, who evaluate and report to management on the effectiveness of the system. In addition, our business ethics policy requires employees to maintain a high level of ethical standards in the conduct of the company's business.

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REPORT OF INDEPENDENT AUDITORS

Board of Directors
Stone Container Corporation

        We have audited the accompanying consolidated balance sheets of Stone Container Corporation as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Stone Container Corporation at December 31, 2002 and 2001 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        As discussed in Note 1 to the financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangible assets, and in 2001 the Company changed its method of accounting for derivative instruments and hedging activities.

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STONE CONTAINER CORPORATION

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.

28

STONE CONTAINER CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to consolidated financial statements.

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STONE CONTAINER CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY