**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.** |

 

**ForQuarter Ended September 30, 2008**

**CommissionFile Number 1-3439**

 

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

(Exact name ofregistrant as specified in its charter)

 

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

 

| **150  North Michigan Avenue, Chicago, Illinois**        **60601**                                     |
|-------------------------------------------------------------------------------------------------------------------------------------------|
| (Address of principal  executive offices)               (Zip  Code) |

 

**(312)346-6600**

(Registrant’stelephone number, including area code)

 

###### **Not Applicable**

 (Former name, former address and former fiscalyear, if

changed since lastreport)

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 ofthe Exchange Act.
| Large accelerated filer o                |   |   |   | Accelerated filer  o        |
|-----------------------------------------------|--------|--------|--------|----------------------------------|
| Non-accelerated filer x                  |   |   |   | Smaller Reporting Company o |
| (Do not check if a smaller reporting company) |   |   |   |                             |

 

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

Yes o     No  x

 

APPLICABLE ONLY TOCORPORATE ISSUERS:

 

As of November 3,2008, the registrant had outstanding 770 shares of common stock, $.01 par valueper share, all of which are owned by Smurfit-Stone Container Corporation.

 

**The registrant meets theconditions set forth in General Instruction (H) (1) (a) and (b) ofForm 10-Q and is therefore filing this form with the reduced disclosureformat permitted thereby.**

** **

 

 

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**PART 1 - FINANCIAL INFORMATION**

 

**Item 1.    FinancialStatements**

 

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                 | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **(In millions)**                     | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                       |       |                             |       |                            |       |   |   |   |   |
| Net sales                                  | ** ** | **$**                            | **1,879**  |                            | $          | 1,885 | ** ** | **$** | **5,509** |   | $ | 5,579 |   |
| Costs and  expenses                        |       |                             |       |                            |       |   |   |   |   |
| Cost of goods  sold                        | ** ** | **1,696**                        |       | 1,596                           | ** ** | **4,938** |   | 4,815 |   |
| Selling and  administrative expenses       | ** ** | **148**                          |       | 163                             | ** ** | **496** |   | 496 |   |
| Restructuring  expenses                    | ** ** | **14**                           |       | 11                              | ** ** | **27** |   | 45 |   |
| (Gain) loss on  disposal of assets         | ** ** | **(1**                           | **)**      | 64                              | ** ** | **(5** | **)** | 64 |   |
| Income from  operations                    | ** ** | **22**                           |       | 51                              | ** ** | **53** | ** ** | 159 |   |
| Other income  (expense)                    |       |                             |       |                            |       |   | ** ** |   |   |
| Interest  expense, net                     | ** ** | **(63**                          | **)**      | (73                             | )          | **(187** | **)** | (220 | ) |
| Loss on early  extinguishment of debt      |       |                             |       | (1                              | )          |   | ** ** | (29 | ) |
| Foreign currency  exchange gains (losses)  | ** ** | **8**                            |       | (22                             | )          | **19** | ** ** | (47 | ) |
| Other, net                                 |       |                             | ** ** | (4                              | )          | **(6** | **)** | (2 | ) |
| Loss before  income taxes                  | ** ** | **(33**                          | **)**      | (49                             | )          | **(121** | **)** | (139 | ) |
| Benefit from  (provision for) income taxes | ** ** | **98**                           |       | (44                             | )          | **136** | ** ** | (8 | ) |
| Net income  (loss)                         | ** ** | **$**                            | **65**     |                            | $          | (93 | ) | **$** | **15** |   | $ | (147 | ) |

 

See notes to consolidatedfinancial statements.

 

1

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

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In millions, except share data)**                                                                     | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                                                                   | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| ** **                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets                                                                                                               |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                   | ** ** | **$**                  | **7**      |                  | $          | 7 |   |
| Receivables,  less allowances of $5 in 2008 and $7 in 2007                                                                   | ** ** | **172**                |       | 170                   |       |
| Retained  interest in receivables sold                                                                                       | ** ** | **254**                |       | 249                   |       |
| Inventories,  including amounts valued under LIFO method                                                                     |       |                   |       |                  |       |
| Work-in-process  and finished goods                                                                                          | ** ** | **157**                |       | 145                   |       |
| Materials and  supplies                                                                                                      | ** ** | **398**                |       | 395                   |       |
| ** **                                                                                                                   |       | **555**                |       | 540                   |       |
| Prepaid expenses  and other current assets                                                                                   | ** ** | **31**                 |       | 36                    |       |
| Total current  assets                                                                                                        | ** ** | **1,019**              |       | 1,002                 |       |
| Net property,  plant and equipment                                                                                           | ** ** | **3,518**              |       | 3,454                 |       |
| Timberland, less  timber depletion                                                                                           | ** ** | **32**                 |       | 32                    |       |
| Goodwill                                                                                                                     | ** ** | **2,727**              |       | 2,727                 |       |
| Other assets                                                                                                                 | ** ** | **154**                |       | 172                   |       |
| ** **                                                                                                                   |       | **$**                  | **7,450**  |                  | $          | 7,387 |   |
| **Liabilities  and Stockholder’s Equity**                                                                               |       |                   |       |                  |       |
|                                                                                                                         |       |                   |       |                  |       |
| Current  liabilities                                                                                                         |       |                   |       |                  |       |
| Current  maturities of long-term debt                                                                                        | ** ** | **$**                  | **56**     |                  | $          | 11 |   |
| Accounts payable                                                                                                             | ** ** | **637**                |       | 582                   |       |
| Accrued  compensation and payroll taxes                                                                                      | ** ** | **183**                |       | 193                   |       |
| Interest payable                                                                                                             | ** ** | **60**                 |       | 66                    |       |
| Income taxes  payable                                                                                                        | ** ** | **18**                 |       | 10                    |       |
| Current deferred  income taxes                                                                                               | ** ** | **21**                 |       | 21                    |       |
| Other current  liabilities                                                                                                   | ** ** | **162**                |       | 105                   |       |
| Total current  liabilities                                                                                                   | ** ** | **1,137**              |       | 988                   |       |
| Long-term debt,  less current maturities                                                                                     | ** ** | **3,515**              |       | 3,348                 |       |
| Other long-term  liabilities                                                                                                 | ** ** | **696**                |       | 834                   |       |
| Deferred income  taxes                                                                                                       | ** ** | **377**                |       | 505                   |       |
| Stockholder’s  equity                                                                                                   |       |                   |       |                  |       |
| Common stock,  par value $.01 per share; 1,000 shares authorized, 770 issued and outstanding  in 2008 and 2007, respectively |       |                   |       |                  |       |
| Additional paid-in  capital                                                                                                  | ** ** | **3,667**              |       | 3,661                 |       |
| Retained  earnings (deficit)                                                                                                 | ** ** | **(1,687**             | **)**      | (1,696                | )          |
| Accumulated  other comprehensive income (loss)                                                                               | ** ** | **(255**               | **)**      | (253                  | )          |
| Total  stockholder’s equity                                                                                             | ** ** | **1,725**              |       | 1,712                 |       |
| ** **                                                                                                                   |       | **$**                  | **7,450**  |                  | $          | 7,387 |   |

 

See notes toconsolidated financial statements.

 

2

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**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| **Nine Months Ended September 30, (In millions)**               | ** ** | **2008** | ** ** | **2007**   | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|------------|------------|
|                                                                                          |       |     |       |       |       |
| **Cash  flows from operating activities**                                                     |       |     |       |       |       |
| Net income  (loss)                                                                            | ** ** | **$**    | **15**     |       | $          | (147 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities      |       |     |       |       |       |
| Loss on early  extinguishment of debt                                                         |       |     |       | 29         |       |
| Depreciation,  depletion and amortization                                                     | ** ** | **265**  |       | 272        |       |
| Amortization of  deferred debt issuance costs                                                 | ** ** | **5**    |       | 6          |       |
| Deferred income  taxes                                                                        | ** ** | **(173** | **)**      | (3         | )          |
| Pension and  postretirement benefits                                                          | ** ** | **(25**  | **)**      | (58        | )          |
| (Gain) loss on  disposal of assets                                                            | ** ** | **(5**   | **)**      | 64         |       |
| Non-cash  restructuring expenses                                                              | ** ** | **7**    | ** ** | 8          |       |
| Non-cash  stock-based compensation                                                            | ** ** | **2**    | ** ** | 16         |       |
| Non-cash foreign  currency exchange (gains) losses                                            | ** ** | **(19**  | **)**      | 47         |       |
| Change in  current assets and liabilities, net of effects from acquisitions and  dispositions |       |     | ** ** |       |       |
| Receivables and  retained interest in receivables sold                                        | ** ** | **(9**   | **)**      | (83        | )          |
| Inventories                                                                                   | ** ** | **(14**  | **)**      | 2          |       |
| Prepaid expenses  and other current assets                                                    |       |     | ** ** | 2          |       |
| Accounts payable  and accrued liabilities                                                     | ** ** | **69**   | ** ** | (4         | )          |
| Interest payable                                                                              | ** ** | **(5**   | **)**      | (19        | )          |
| Other, net                                                                                    | ** ** | **21**   | ** ** | 2          |       |
| Net cash provided  by operating activities                                                    | ** ** | **134**  | ** ** | 134        |       |
| **Cash  flows from investing activities**                                                     |       |     | ** ** |       |       |
| Expenditures for  property, plant and equipment                                               | ** ** | **(304** | **)**      | (268       | )          |
| Proceeds from  property disposals                                                             | ** ** | **8**    | ** ** | 399        |       |
| Net cash  provided by (used for) investing activities                                         | ** ** | **(296** | **)**      | 131        |       |
| **Cash  flows from financing activities**                                                     |       |     | ** ** |       |       |
| Proceeds from  long-term debt                                                                 |       |     | ** ** | 675        |       |
| Net borrowings  (repayments) of long-term debt                                                | ** ** | **168**  | ** ** | (904       | )          |
| Debt repurchase  premiums                                                                     |       |     | ** ** | (23        | )          |
| Dividends paid                                                                                | ** ** | **(6**   | **)**      | (6         | )          |
| Capital  contribution from SSCC                                                               |       |     | ** ** | 2          |       |
| Deferred debt  issuance costs                                                                 |       |     | ** ** | (7         | )          |
| Net cash  provided by (used for) financing activities                                         | ** ** | **162**  | ** ** | (263       | )          |
| **Increase  in cash and cash equivalents**                                                    |       |     | ** ** | 2          |       |
| Cash and cash  equivalents                                                                    |       |     | ** ** |       |       |
| Beginning of  period                                                                          | ** ** | **7**    | ** ** | 9          |       |
| End of period                                                                                 | ** ** | **$**    | **7**      | ** ** | $          | 11 |   |

 

See notes toconsolidated financial statements.

 

3

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** **

**SMURFIT-STONECONTAINER ENTERPRISES, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

(Tabular amounts in millions)

 

**1.****             ****Significant Accounting Policies**

 

**Basis of Presentation:**  The accompanyingconsolidated financial statements and notes thereto of Smurfit-Stone ContainerEnterprises, Inc. (“SSCE” or the “Company”) have been prepared inaccordance with the instructions to Form 10-Q and reflect all adjustmentswhich management believes necessary (which include only normal recurringaccruals) to present fairly the Company’s financial position, results ofoperations and cash flows.  Thesestatements, however, do not include all information and footnotes necessary fora complete presentation of financial position, results of operations and cashflows in conformity with U.S. generally accepted accounting principles.  Interim results may not necessarily beindicative of results that may be expected for any other interim period or forthe year as a whole.  These financialstatements should be read in conjunction with the audited consolidatedfinancial statements and footnotes included in the SSCE Annual Report on Form 10-Kfor the year ended December 31, 2007 (“2007 10-K”) filed February 28,2008 with the Securities and Exchange Commission.

 

SSCEis a wholly-owned subsidiary of Smurfit-Stone Container Corporation (“SSCC”).  SSCE has domestic and internationaloperations.

 

**Recently Adopted AccountingStandard:**   Effective January 1, 2008, the Companyadopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157,“Fair Value Measurements” (“SFAS No. 157”) for financial assets andliabilities.  SFAS No. 157 definesfair value, establishes a framework for measuring fair value and expandsdisclosures about fair value measurements (See Note 14).  SFAS No. 157 applies under otheraccounting pronouncements that require or permit fair value measurements and,accordingly, SFAS No. 157 does not require any new fair valuemeasurements.

 

**2.****             ****Reclassifications**

 

Certainprior year amounts have been reclassified to conform to the current yearpresentation.

 

**3.****             ****Calpine Corrugated LLC**

 

In the firstquarter of 2008, the Company recorded a charge of $22 million to fully reserveall amounts due from Calpine Corrugated LLC (“Calpine Corrugated”).  Calpine Corrugated, an independent corrugatedcontainer producer in Fresno, California for which the Company is the primarycontainerboard supplier, experienced start-up losses since it began operationsin 2006.

 

On July 29,2008, the Company acquired a 90 percent ownership interest in CalpineCorrugated.  In conjunction with theacquisition, the Company guaranteed approximately $45 million of CalpineCorrugated’s third party outstanding debt. There was no cash consideration paid. The transaction was accounted for as a purchase business combination andresults of operations of Calpine Corrugated are included in the Company’sconsolidated statements of operations beginning July 29, 2008.  The preliminary purchase price allocationresulted in approximately $48 million of assets and liabilities, includingapproximately $45 million of debt.  Nogoodwill is expected to be recorded for the transaction.  The Company expects to finalize the purchaseprice allocation during the fourth quarter of 2008, pending completion of thefixed asset appraisal.  The acquisitionof Calpine Corrugated’s operations enables the Company to accelerate theoptimization of its northern California packaging system and improve itsposition in the agricultural market segment.

 

4

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In 2007, theCompany recorded charges of $10 million to reserve for amounts due from CalpineCorrugated, of which $5 million and $10 million, respectively, were recorded inthe three and nine months ended September 30, 2007.

 

**4.****             ****Strategic Initiatives andRestructuring Activities**

 

During 2005, the Companyannounced a strategic initiative plan to improve performance and betterposition the Company for long-term growth. The plan focused on cost reduction, productivity initiatives and reinvestmentin the Company’s operations.  The Companyexpects to achieve $525 million in annual savings in 2008, compared to levelsprior to the start of the plan.

 

During the third quarterof 2008, in conjunction with the strategic initiative plan, the Company closedfour converting facilities and announced the closure of three additionalconverting facilities.  As a result ofthe closures which occurred in the third quarter and other ongoing strategicinitiatives, the Company reduced its headcount by approximately 230employees.  The Company recordedrestructuring charges of $14 million, including non-cash charges of $5 millionrelated to the acceleration of depreciation for mill and converting equipmentexpected to be abandoned or taken out of service. The remaining charges of $9million were primarily for severance and benefits.

 

For the nine months endedSeptember 30, 2008, the Company closed five converting facilities.  As a result of these closures and otherongoing strategic initiatives, the Company reduced its headcount byapproximately 610 employees.  The Companyrecorded restructuring charges of $27 million, net of a gain of $2 million fromthe sale of a previously closed facility. Restructuring charges included non-cash charges of $9 million related tothe acceleration of depreciation for mill and converting equipment expected tobe abandoned or taken out of service. The remaining charges of $20 million were primarily for severance andbenefits.  The net sales of the announcedand closed converting facilities as of September 30, 2008 prior to closureand for the year ended December 31, 2007 were $212 million and $344million, respectively.  The majority ofthese net sales are expected to be transferred to other operatingfacilities.  Additional charges of up to$5 million are expected to be recorded in future periods for severance andbenefits related to the closure of these facilities.

 

In October 2008, theCompany permanently ceased operations of its containerboard machine at theSnowflake, Arizona mill and production at its Pontiac pulp mill located inPortage-du-Fort, Quebec.  The Snowflake,Arizona containerboard machine had the capacity to produce 135,000 tons ofmedium annually. The customers will be supplied by the Company’s othermills.  Accelerated depreciation chargesof $3 million related to the Snowflake, Arizona mill were recorded in the thirdquarter of 2008.  The Pontiac pulp millhad annual production capacity of 253,000 tons of northern bleached hardwoodkraft paper-grade pulp, which was non-core to the Company’s primary business.  The closure of the Pontiac pulp mill resultedin a headcount reduction of approximately 218 employees.  In connection with the Pontiac pulp millclosure, the Company expects to incur pretax restructuring charges ofapproximately $39 million in the fourth quarter of 2008, includingapproximately $20 million of non-cash charges.

 

The Companyrecorded restructuring charges of $11 million and $45 million for the three andnine months ended September 30, 2007, respectively, which were net ofgains of $8 million and $41 million, respectively, on the sale of propertiesrelated to previously closed facilities. Restructuring charges included non-cash charges of $12 million and $49million for the three and nine months ended September 30, 2007,respectively, related to the write-down of assets, primarily property, plantand equipment, to estimated net realizable value and the acceleration ofdepreciation for equipment expected to be abandoned or taken out of service.  The remaining charges were primarily forseverance and benefits.

 

5

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At December 31, 2007the Company had $29 million of accrued exit liabilities related to therestructuring of operations.  For thethree and nine months ended September 30, 2008, the Company incurred $3million and $9 million, respectively, of cash disbursements related to theseexit liabilities.  In addition, for thethree and nine months ended September 30, 2008, the Company incurred $6million and $13 million, respectively, of cash disbursements related to exitliabilities established during 2008.

 

**5.****             ****Loss on Disposal of Assets**

 

On September 28,2007, the Company completed the sale of its Brewton, Alabama, mill assets for$355 million. The Company received cash proceeds of $338 million, whichexcluded $16 million of accounts receivable previously sold to StoneReceivables Corporation under the accounts receivable securitization programand was net of $1 million of other closing adjustments.  Current liabilities of $22 million wereretained and were paid by the Company. The Brewton mill had annual production capacity of approximately 300,000tons of white top linerboard and 190,000 tons of solid bleached sulfate.  The Company will continue to produce whitetop linerboard at two of its mills. Substantially all of the proceeds from the sale were applied directly todebt reduction (See Note 8).  The Companyrecorded a pretax loss of $65 million, and a $32 million income tax provision,resulting in a net loss of $97 million. The after-tax loss was the result of a provision for income taxes thatwas higher than the statutory income tax rate due to non-deductible goodwill of$146 million.

 

**6.  Accounts Receivable Securitization Programs**

 

At September 30,2008 and December 31, 2007, $645 million and $656 million, respectively,of receivables had been sold under two accounts receivable securitizationprograms, of which the Company retained a subordinated interest.  The off-balance sheet debt related to the twoaccounts receivable programs totaled $391 million and $422 million,respectively, as of those dates.

 

**7.  Guarantees and Commitments**

 

The Company has certainwood chip processing contracts extending from 2012 through 2018 with minimumpurchase commitments.  As part of theagreements, the Company guarantees the third party contractors’ debtoutstanding and has a security interest in the chipping equipment.  At September 30, 2008, the maximumpotential amount of future payments related to these guarantees wasapproximately $29 million, which decreases ratably over the life of thecontracts.  In the event the guaranteeson these contracts are called, proceeds from the liquidation of the chippingequipment would be based on current market conditions and the Company may notrecover in full the guarantee payments made.

 

The Company iscontingently liable for $18 million under a one year letter of credit whichexpires in April 2009 to support borrowings of one of the Company’snon-consolidated affiliates.  The letterof credit is collateralized by a pledge of affiliate stock owned by the othershareholder in the event the letter of credit is drawn upon and the othershareholder is unable to reimburse the Company for their 50% share of theletter of credit obligation.

 

6

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**8.  Long-Term Debt**

 

In March 2007,the Company completed an offering of $675 million of 8.00% unsecured seniornotes due March 15, 2017.  TheCompany used the proceeds of this issuance to repay $546 million of the 9.75%unsecured senior notes due 2011, which were purchased in connection with a cashtender offer, pay related tender premiums and accrued interest of $19 millionand $8 million, respectively, and repay $95 million of the Company’s revolvingcredit facility.  In addition, theCompany used the proceeds to pay fees and expenses of $7 million related tothis transaction.  A loss on earlyextinguishment of debt of $23 million was recorded in the first quarter of2007, including $19 million for tender premiums and a $4 million write-off ofunamortized deferred debt issuance costs.

 

In May 2007,the Company redeemed the remaining $102 million of the 9.75% Senior Notesutilizing borrowings under the Company’s revolving credit facility to redeem thenotes and pay related call premiums and accrued interest.  A loss on early extinguishment of debt of $5million was recorded in the second quarter of 2007, including $4 million fortender premiums and a $1 million write-off of unamortized deferred debt issuancecosts.

 

In September 2007,the Company completed the sale of its Brewton, Alabama mill (See Note 5) andused the net proceeds of $338 million to prepay $301 million of its Tranche Bterm loan and $21 million of its revolving credit facility.  In addition, the Company paid fees andexpenses of $16 million related to the sale transaction.  The Company recorded a loss on earlyextinguishment of debt of $1 million related to the write-off of unamortizeddeferred debt issuance costs.

 

**9.  Employee Benefit Plans**

 

The Company sponsorsnoncontributory defined benefit pension plans for its U.S. employees and alsosponsors noncontributory and contributory defined benefit pension plans for itsCanadian employees.  The Company’sdefined benefit pension plans cover substantially all hourly employees, as wellas salaried employees hired prior to January 1, 2006.

 

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

 

On August 31, 2007,the Company announced the freeze of its defined benefit pension plans forsalaried employees, effective January 1, 2009.  In accordance with SFAS No. 88, “EmployersAccounting for Settlements and Curtailments of Defined Benefit Pension Plansand for Termination Benefits,” the Company accounted for this freeze as a plancurtailment, remeasured its assets and obligation as of August 31, 2007and recognized a curtailment gain of approximately $3 million during the thirdquarter of 2007.

 

7

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The components of netperiodic benefit costs for the defined benefit plans and the components of thepostretirement benefit costs are as follows:

 
| ** **                                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **Defined Benefit   Plans**                    | ** ** | **Postretirement  Plans**                               | ** ** | **Defined Benefit  Plans** | ** ** | **Postretirement  Plans** | ** ** |
| ** **                                    | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                                  |       | $                                                        | 11         |                                                    | $          | 14 |   | $ |   |   | $ | 1 |   | $ | 34 |   | $ | 40 |   | $ | 2 |   | $ | 3 |   |
| Interest cost                                 |       | 51                                                       |       | 50                                                      |       | 3 |   | 3 |   | 153 |   | 148 |   | 8 |   | 8 |   |
| Expected return  on plan assets               |       | (62                                                      | )          | (60                                                     | )          |   |   |   |   | (186 | ) | (177 | ) |   |   |   |   |
| Amortization of  prior service cost (benefit) |       |                                                     |       | 2                                                       |       | (1 | ) | (1 | ) | 2 |   | 6 |   | (3 | ) | (2 | ) |
| Amortization of  net (gain) loss              |       | 11                                                       |       | 13                                                      |       | (1 | ) |   |   | 32 |   | 42 |   | (2 | ) | (1 | ) |
| Curtailment  (gain) loss                      |       |                                                     |       | (2                                                      | )          |   |   | (2 | ) |   |   |   |   |   |   | (3 | ) |
| Settlements                                   |       |                                                     |       |                                                    |       |   |   |   |   |   |   | 2 |   |   |   |   |   |
| Multi-employer  plans                         |       | 1                                                        |       | 1                                                       |       |   |   |   |   | 3 |   | 3 |   |   |   |   |   |
| Net periodic  benefit cost                    |       | $                                                        | 12         |                                                    | $          | 18 |   | $ | 1 |   | $ | 1 |   | $ | 38 |   | $ | 64 |   | $ | 5 |   | $ | 5 |   |

 

The Company’s 2008expected contributions to its qualified defined benefit plans and benefitpayments under its non-qualified defined benefit plans and postretirement plansare not expected to be materially different than the amounts disclosed in the2007 10-K.

 

The curtailment gain inthe third quarter of 2007 is primarily related to the salaried defined benefitplan freeze.  For the nine months ended September 30,2007, the curtailment gain was offset by charges related to closed facilitiesthat are included as part of restructuring charges (See Note 4).

 

The 2007 settlementcharges are related to closed facilities and are included as part ofrestructuring charges (See Note 4).

 

**10.  Derivative Instruments and Hedging Activities**

 

TheCompany’s derivative instruments used for its hedging activities are designedas cash flow hedges and relate to minimizing exposures to fluctuations in theprice of commodities used in its operations, the movement in foreign currencyexchange rates and the fluctuations in the interest rate on variable ratedebt.  All cash flows associated with theCompany’s derivative instruments are classified as operating activities in theconsolidated statements of cash flows.

 

#### **Commodity DerivativeInstruments**

#### ** **

The Company usesderivative instruments, including fixed price swaps, to manage fluctuations incash flows resulting from commodity price risk in the procurement of naturalgas and other commodities, including fuel oil and diesel fuel.  The objective is to fix the price of aportion of the Company’s purchases of these commodities used in themanufacturing process.  The changes inthe market value of such derivative instruments have historically offset, andare expected to continue to offset, the changes in the price of the hedgeditem.  As of September 30, 2008, themaximum length of time over which the Company was hedging its exposure to thevariability in future cash flows associated with the commodities’ forecastedtransactions was 17 months.

 

8

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For the three andnine months ended September 30, 2008, the Company reclassified animmaterial amount and a $1 million loss (net of tax), respectively, from othercomprehensive income (loss) (“OCI”) to cost of goods sold when the hedged itemswere recognized.  For the three and ninemonths ended September 30, 2007, the Company reclassified a $2 millionloss (net of tax) and an $8 million loss (net of tax), respectively, from OCIto cost of goods sold when the hedged items were recognized.  The fair value of these commodity derivativeinstruments at September 30, 2008 was a $44 million liability, of which$42 million was included in other current liabilities, and $2 million wasincluded in other long-term liabilities.

 

For the three andnine months ended September 30, 2008, the Company recorded an $11 millionloss (net of tax) and a $10 million loss (net of tax), respectively, in cost ofgoods sold related to the change in fair value of certain commodity derivativeinstruments not qualifying for hedge accounting.  For the three and nine months ended September 30,2007, the Company recorded a $1 million gain (net of tax) and a $4 million gain(net of tax), respectively, in cost of goods sold related to the change in fairvalue of certain commodity derivative instruments not qualifying for hedgeaccounting.

 

For the three andnine months ended September 30, 2008, the Company recorded a $1 millionloss (net of tax) in cost of goods sold on settled commodity derivativeinstruments not qualifying for hedge accounting.  For the three and nine months ended September 30,2007, the Company recorded a $1 million loss (net of tax) and a $6 million loss(net of tax), respectively, in cost of goods sold on settled commodityderivative instruments not qualifying for hedge accounting.

 

#### **Foreign Currency DerivativeInstruments**

#### ** **

**The Company’s principal foreign exchange exposure is theCanadian dollar.  The Company usesforeign currency derivative instruments, including forward contracts andoptions, primarily to protect against Canadian currency exchange riskassociated with expected future cash flows. As of September 30, 2008, the maximum length of time over which theCompany was hedging its exposure to the variability in future cash flowsassociated with foreign currency was 15 months. For the three and nine months ended September 30, 2008, the Companyreclassified an immaterial amount and a $3 million gain (net of tax),respectively, from OCI to cost of goods sold related to the recognition of theforeign currency derivative instruments. For the three and nine months ended September 30, 2007, the Companyreclassified a $1 million gain (net of tax) and an immaterial amount,respectively, from OCI to cost of goods sold related to the recognition of theforeign currency derivative instruments. The change in fair value of these derivative instruments is recorded inOCI until the underlying transaction is recorded.  The fair value of the Company’s foreigncurrency derivative instruments at September 30, 2008 was a $1 million netliability, of which $1 million was included in prepaid expenses and othercurrent assets and $2 million was included in other current liabilities.**

** **

#### **Interest Rate Swap Contracts**

#### ** **

The Company uses interestrate swap contracts to manage interest rate exposure on $300 million of thecurrent Tranche B and Tranche C floating rate bank term debt, effectivelyfixing the interest rate at 4.3%.  Thesecontracts extend until 2011, consistent with the maturity of the Company’sTranche B and Tranche C term loans. Changes in the fair value of the interest rate swap contracts areexpected to be highly effective in offsetting the fluctuations in the floatinginterest rate and are recorded in OCI until the underlying transaction isrecorded.  The accounting for the cashflow impact of the swap contracts is recorded as an adjustment to interestexpense each period.  For the three andnine months ended September 30, 2008, the Company reclassified a $1million loss (net of tax) from OCI to interest expense when the hedged itemswere recognized.  For the three and ninemonths ended September 30, 2007, the Company reclassified a $1 milliongain (net of tax) and a $2 million gain (net of tax), respectively, from OCI tointerest expense when the hedged items were recognized.  The fair value of the Company’s interest rateswap contracts at September 30, 2008 was a $6 million liability includedin other long-term liabilities.

 

9

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**DeferredHedge Gain (Loss)**

 

The cumulative deferredhedge loss in OCI on all derivative instruments was $21 million (net of tax) atSeptember 30, 2008, including a $17 million loss (net of tax) on commodityderivative instruments, a $1 million loss (net of tax) on foreign currencyderivative instruments and a $3 million loss (net of tax) on interest rate swapcontracts.  The Company expects toreclassify a $16 million loss (net of tax) into cost of goods sold within thenext 12 months, related to the commodity and foreign currency derivativeinstruments.

 

**11.  Income Taxes**

 

As previously disclosed,the Canada Revenue Agency (“CRA”) is examining the Company’s tax returns forthe tax years 1999 through 2005.  Inconnection with the examination, the CRA was considering certain significantadjustments related principally to taxable income related to the Company’sacquisition of a Canadian company and to transfer prices of inventory, sold bythe Company’s Canadian subsidiaries to its U.S. subsidiaries.  In the third quarter of 2008, the Company wasinformed by the CRA that the matters related to the Company’s acquisition of aCanadian company had been resolved in the Company’s favor.  As a result of this favorable ruling, theCompany reduced its liability for unrecognized tax benefits and recorded anincome tax benefit of approximately $84 million in the quarter ended September 30,2008.

 

With respect to the transferprice issue, the CRA has issued assessments of additional income taxes,interest, and penalties related to transfer prices of inventory sold by theCompany’s Canadian subsidiaries to its U.S. subsidiaries.   The Company has appealed theassessments.  For the nine months ended September 30,2008, the Company made payments of $23 million to the CRA and expects to make a$2 million payment in the fourth quarter of 2008 related to the assessments. Asa result of these payments, future interest charges will be reduced.

 

While the final outcomeof the remaining CRA examination matters, including an estimate of the range ofthe reasonably possible changes to unrecognized tax benefits, is not yetdeterminable, the Company believes that the examination or subsequent appealswill not have a material adverse effect on its consolidated financial conditionor results of operations.

 

During the three monthsended September 30, 2008, unrecognized tax benefits were decreased by $90million primarily due to the favorable resolution of the Canadian income taxexamination matters, of which $73 million was related to the tax positions, $4million related to accrued interest and penalties and $13 million related tofluctuations in the foreign currency exchange rate.  During the nine months ended September 30,2008, unrecognized tax benefits were decreased by $88 million, of which $70million was related to the tax positions, $2 million related to accruedinterest and penalties and $16 million related to fluctuations in the foreigncurrency exchange rate.

 

The benefit for income taxesfor the three and nine months ended September 30, 2008 differed from theamount computed by applying the statutory U.S. federal income tax rate to lossbefore income taxes primarily due to the favorable resolution of the Canadianincome tax examination matters, non-cash foreign currency exchange gains, stateincome taxes, lower effective tax rates in certain foreign jurisdictions andthe effect of other permanent differences. The expectedincome tax benefit is calculated on a discrete quarterly basis which moreaccurately reflects income tax benefit as it is realized.

 

10

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**12.  Comprehensive Income (Loss)**

 

Comprehensive income (loss) is asfollows:

 
| ** **                                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                             | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net income  (loss)                                                     |       | $                                                    | 65         |                                                | $          | (93 | ) | $ | 15 |   | $ | (147 | ) |
| Other  comprehensive income (loss), net of tax:                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net changes in  fair value of hedging instruments                      |       | (25                                                  | )          | (4                                                  | )          | (17 | ) | 4 |   |
| Net hedging  (gain) loss reclassified into earnings                    |       | 1                                                    |       |                                                |       | (1 | ) | 6 |   |
| Net deferred  employee benefit plan expense reclassified into earnings |       | 5                                                    |       | 27                                                  |       | 17 |   | 27 |   |
| Foreign currency  translation adjustment                               |       | (2                                                   | )          | 1                                                   |       | (1 | ) | 1 |   |
| Net impact of  defined benefit plan remeasurement (See Note 9)         |       |                                                 |       | 64                                                  |       |   |   | 64 |   |
| Comprehensive  income (loss)                                           |       | $                                                    | 44         |                                                | $          | (5 | ) | $ | 13 |   | $ | (45 | ) |

 

**13.  Stock-Based Compensation**

 

Certain officers and key managers of the Companyparticipate in various stock-based compensation plans sponsored by SSCC, whichissues stock options and restricted stock units (“RSUs”).  During the third quarter of 2008, the Companygranted approximately 1,338,000 SSCC stock options with a weighted-averageexercise price and grant date fair value of $4.43 and $1.67, respectively.  For the nine months ended September 30,2008, the Company granted approximately 2,380,000 SSCC stock options with aweighted-average exercise price and grant date fair value of $6.36 and $2.24,respectively.  These options vest andbecome exercisable on the third anniversary of the award date.  Compensation expense is being recorded overthe three-year period on a straight-line basis.

 

During the third quarter of 2008, the Company issuedapproximately 37,000 non-vested SSCC RSUs to certain employees with aweighted-average grant date fair value of $4.82 per RSU.  For the nine months ended September 30,2008, the Company granted approximately 501,000 non-vested SSCC RSUs to certainemployees and non-employee directors with a weighted-average grant date fairvalue of $7.89 per RSU.  In addition, tosettle its 2007 management incentive plan liability, the Company issuedapproximately 347,000 vested SSCC RSUs, which had been accrued for in the prioryear, and approximately 69,000 related premium non-vested SSCC RSUs at a fairvalue of $9.14 per RSU.  In accordancewith the Company’s applicable management incentive plan and long-term incentiveplan, the non-vested SSCC RSUs vest in three years.

 

Stock-based compensation (income) expense was $(6) millionand $2 million for the three and nine months ended September 30, 2008, andreflects changes in estimates related to the vesting of options.  Stock-based compensation expense was $4 and$16 million for the three and nine months ended September 30, 2007.

 

11

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**14.  Fair Value Measurements**

 

Certain financial assetsand liabilities are recorded at fair value on a recurring basis, including theCompany’s retained interest in receivables sold to the accounts receivableprograms (See Note 6), the Company’s residual interest in the Timber NoteHoldings (“TNH”) investment, and derivative assets and liabilities (See Note10).

 

Fair value is defined asthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date.  In determining fairvalue, the Company uses various valuation approaches, including market, incomeand/or cost approaches.  SFAS No. 157establishes a hierarchy for inputs used in measuring fair value that maximizesthe use of observable inputs and minimizes the use of unobservable inputs byrequiring that the most observable inputs be used when available.  Observable inputs are inputs that marketparticipants would use in pricing the asset or liability based on market dataobtained from sources independent of the Company.  Unobservable inputs are inputs that reflectthe Company’s assumptions about the assumptions market participants would usein pricing the asset or liability developed based on the best informationavailable in the circumstances.  Thehierarchy for inputs is broken down into three levels based on theirreliability as follows:

 

*Level 1* – Valuations based on quoted prices inactive markets for identical assets or liabilities that the Company has theability to access.  The Company has noassets or liabilities measured at fair value on a recurring basis utilizingLevel 1 inputs.

 

*Level 2* – Valuations based on quoted prices inmarkets that are not active or for which all significant inputs are observable,either directly or indirectly.  TheCompany has no assets or liabilities measured at fair value on a recurringbasis utilizing Level 2 inputs.

 

*Level 3* – Valuations based on inputs that areunobservable and significant to the overall fair value measurement.  The Company’s assets and liabilitiesutilizing Level 3 inputs include the retained interest in receivables sold tothe accounts receivable programs, the residual interest in the TNH investmentand derivative assets and liabilities. The fair values of the retained interest in receivables sold areestimated using discounted residual cash flows, expected loss and dilutionrates, and variable returns to investors. The fair value of the residual interest in the TNH investment isestimated using discounted residual cash flows. The fair values of the derivative assets and liabilities are estimatedusing model inputs specific to the derivative, including interest rate yieldcurves, commodity forward spread curves and volatility of the underlyingcommodities.

 

**Fair value on a recurring basis**

Assets and liabilitiesmeasured at fair value on a recurring basis are categorized in the table belowbased upon the level of input to the valuations.

 
| ** **                             | ** ** | **September 30, 2008** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **Level 1**                 | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Retained  interest in receivables sold |       | $                                |       |   | $ |   |   | $ | 254 |   | $ | 254 |   |
| Residual  interest in TNH investment   |       |                             |       |   |   | 33 |   | 33 |   |
| Derivative  instruments                |       |                             |       |   |   | (51 | ) | (51 | ) |
|                                   |       | $                                |       |   | $ |   |   | $ | 236 |   | $ | 236 |   |

 

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The following tablepresents the changes in Level 3 assets (liabilities) measured at fair value ona recurring basis for the three and nine months ended September 30, 2008:

 
| ** **                           | ** ** | **Retained  Interest in  Receivables  Sold** | ** ** | **Residual  Interest in  TNH  Investment** | ** ** | **Derivative  Instruments** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------|------------|-----------|------------|
| Balance at  January 1, 2008     |       | $                                                 | 249        |                                            | $          | 44                          |       | $         | (3         | ) | $ | 290 |   |
| Net payments,  sales and settlements |       | 33                                                |       | (12                                             | )          | (1                          | )          | 20        |       |
| Realized  gains/(losses)             |       | (23                                               | )          | 1                                               |       |                        |       | (22       | )          |
| Unrealized  gains/(losses)           |       |                                              |       |                                            |       | (6                          | )          | (6        | )          |
| Balance at  March 31, 2008      |       | 259                                               |       | 33                                              |       | (10                         | )          | 282       |       |
| Net payments,  sales and settlements |       | 34                                                |       |                                            |       | (1                          | )          | 33        |       |
| Realized  gains/(losses)             |       | (5                                                | )          |                                            |       |                        |       | (5        | )          |
| Unrealized  gains/(losses)           |       |                                              |       |                                            |       | 19                          |       | 19        |       |
| Balance at  June 30, 2008       |       | 288                                               |       | 33                                              |       | 8                           |       | 329       |       |
| Net payments,  sales and settlements |       | (30                                               | )          | (1                                              | )          | 3                           |       | (28       | )          |
| Realized  gains/(losses)             |       | (4                                                | )          | 1                                               |       |                        |       | (3        | )          |
| Unrealized  gains/(losses)           |       |                                              |       |                                            |       | (62                         | )          | (62       | )          |
| Balance at  September 30, 2008  |       | $                                                 | 254        |                                            | $          | 33                          |       | $         | (51        | ) | $ | 236 |   |

 

Realized gains (losses) in the first quarter of 2008associated with the retained interest in receivables sold principally relate tothe charge to reserve for the Calpine Corrugated receivables previously sold tothe Company’s accounts receivable program, which is included in selling andadministrative expenses (See Note 3).  Unrealized gains (losses) associated with derivative instrumentsrepresents the change in fair value included in other comprehensive income forderivative instruments qualifying for hedge accounting and cost of goods soldfor derivative instruments not qualifying for hedge accounting (See Note 10).

 

**16. Contingencies**

 

The Company’s past andpresent operations include activities which are subject to federal, state andlocal environmental requirements, particularly relating to air and waterquality.  The Company faces potentialenvironmental liability as a result of violations of these environmentalrequirements, environmental permit terms and similar authorizations that haveoccurred from time to time at its facilities. In addition, the Company faces potential liability for remediation at certainowned and formerly owned facilities, as well as response costs at various sitesfor which it has received notice as being a potentially responsible party (“PRP”)concerning hazardous substance contamination. In estimating its reserves for environmental remediation and futurecosts at sites where it has been named as a PRP, the Company’s estimatedliability of $5 million reflects the Company’s expected share of costs afterconsideration for the relative percentage of waste deposited at each site, the numberof other PRPs, the identity and financial condition of such parties andexperience regarding similar matters.  Asof September 30, 2008, the Company had approximately $14 million reservedfor environmental liabilities included primarily in other long-term liabilitiesin the consolidated balance sheet.  TheCompany believes the liability for these matters was adequately reserved at September 30,2008.

 

If all or most of theother PRPs are unable to satisfy their portion of the clean-up costs at one ormore of the significant sites in which the Company is involved or the Company’sexpected share increases, the resulting liability could have a material adverseeffect on the Company’s consolidated financial condition, results of operationsor cash flows.

 

The Company is currentlya defendant in two putative class action cases filed in California state courton behalf of current and former hourly employees at the Company’s Californiacorrugated container facilities.  Thesecases allege violations of the California on-duty meal break and rest periodstatutes and seek 

 

13

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damages prescribed bysuch statutes.  The Company has reached atentative agreement to settle these cases, subject to court approval.  In addition, the Company is a defendant in anumber of lawsuits and claims arising out of the conduct of its business.  During the three and nine months ended September 30,2008, the Company recorded charges of an immaterial amount and $8 million,respectively, related to litigation matters. While the ultimate outcome of such suits or other proceedings againstthe Company cannot be predicted with certainty, management of the Companybelieves that the resolution of these matters will not have a material adverseeffect on its consolidated financial condition, results of operations or cashflows.

 

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**ITEM2.    MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

Some information includedin this report may contain forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended.  Although we believe that, in making any suchstatements, our expectations are based on reasonable assumptions, any suchstatement may be influenced by factors that could cause actual outcomes andresults to be materially different from those projected.  When used in this document, the words “anticipates,”“believes,” “expects,” “intends” and similar expressions as they relate toSmurfit-Stone Container Enterprises, Inc. or its management, are intendedto identify such forward-looking statements. These forward-looking statements are subject to numerous risks anduncertainties.  There are importantfactors that could cause actual results to differ materially from those inforward-looking statements, certain of which are beyond our control.  These factors, risks and uncertainties arediscussed in our 2007 Annual Report on Form 10-K (2007 Form 10-K).

 

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

 

# **GENERAL**

#  

# We meet the conditions set forth inGeneral Instruction (H) (1) (a) and (b) of Form 10-Qand are therefore filing this form with the reduced disclosure format permittedthereby.  The omitted information issubstantially similar to the disclosures contained in Smurfit-Stone ContainerCorporation’s Quarterly Report on Form 10-Q for the quarter ended September 30,2008 filed with the Securities and Exchange Commission on the date hereof.  In accordance with General Instruction (H) (2) (a),the discussion of our results of operations below includes only a narrativeanalysis of the most recent fiscal year-to-date period presented and thecorresponding year-to-date period in the preceding fiscal year.

#  

We are a wholly-ownedsubsidiary of Smurfit-Stone Container Corporation (Smurfit-Stone), a holdingcompany with no business operations of its own. Smurfit-Stone conducts its business operations through us.  We operate as one segment, theContainerboard, Corrugated Containers and Reclamation segment.

 

**RECENTLY ADOPTED ACCOUNTINGSTANDARDS**

 

Effective January 1,2008, we adopted the provisions of Statement of Financial Accounting Standards(SFAS) No. 157, “Fair Value Measurements” (SFAS No. 157) forfinancial assets and liabilities.  SFAS No. 157defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements.  SFAS No. 157 applies under otheraccounting pronouncements that require or permit fair value measurements and,accordingly, SFAS No. 157 does not require any new fair valuemeasurements.  For information concerningSFAS No. 157, see Note 15 of the Notes to Consolidated FinancialStatements.

 

# **RESULTS OF OPERATIONS**

#  

**Non-GAAP Financial Measures**

 

In the accompanyinganalysis of financial information, we use the financial measure “adjusted netincome (loss),” which is derived from our consolidated financial informationbut are not presented in our financial statements prepared in accordance withU.S. generally accepted accounting principles (GAAP). This measure isconsidered a “non-GAAP financial measures” under the U.S. Securities andExchange 

 

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Commission (SEC)rules.  Adjusted net Income (loss) is a non-GAAP financial measure thatexcludes from net income (loss) available to common stockholders the effects ofnon-cash foreign currency exchange gains or losses, losses on earlyextinguishment of debt, restructuring charges, litigation charges, gains orlosses on sale of assets and the resolution of certain tax matters.  We believe these non-GAAP financial measuresprovide investors, potential investors, security analysts and others withuseful information to evaluate the performance of our business because theyexclude gains and losses and charges that management believes are notindicative of the ongoing operating results of the business.  In addition, these measures may differ fromthe adjusted net income (loss) calculations of other companies in our industry,limiting their usefulness as a comparative measure.  For such measures, we have provided thefollowing reconciliations to the most directly comparable GAAP financialmeasure.

 

**Reconciliationto GAAP Financial Measures**

 
| **(In millions)**                                     | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
|                                                       |       |                                                |       |   |   |
| **Net  income (loss) (GAAP)**                              |       | $                                                   | 15         |   | $ | (147 | ) |
| Loss on early  extinguishment of debt, net of income taxes |       |                                                |       | 17 |   |
| Non-cash foreign  currency exchange (gains) losses         |       | (19                                                 | )          | 47 |   |
| (Gain) loss on  disposal of assets, net of income taxes    |       | (1                                                  | )          | 97 |   |
| Restructuring  charges, net of income taxes                |       | 17                                                  |       | 22 |   |
| Litigation  charges, net of income taxes                   |       | 5                                                   |       |   |   |
| Pension curtailment,  net of income taxes                  |       |                                                |       | (2 | ) |
| Resolution of  income tax matters                          |       | (84                                                 | )          | (4 | ) |
| Adjusted net  income (loss)                                |       | $                                                   | (67        | ) | $ | 30 |   |

#  

# **Overview**

#  

For the nine months endedSeptember 30, 2008, we had net income of $15 million compared to a netloss of $147 million for the same period last year.  The results for the nine months ended September 30,2008 benefited $84 million from the resolution of the Canadian income taxexamination matters, non-cash foreign currency exchange gains of $19 millionand lower restructuring charges as compared to 2007.  Results in 2007 were negatively impacted bythe loss on the sale of the Brewton, Alabama mill, a loss on earlyextinguishment of debt, net of income taxes, of $17 million, non-cash foreigncurrency exchange losses of $47 million and higher restructuring charges.

 

For the ninemonths ended September 30, 2008, we had an adjusted net loss $67 millioncompared to adjusted net income of $30 million for the first nine months of2007.  The results for the first nine months of 2008 were negatively impactedby higher costs for energy, fiber, freight and chemicals.  These items were partially offset by higheraverage selling prices for most of our products, benefits from our strategicinitiatives and lower interest expense compared to the same period last year.

 

While the global economicslowdown is impacting the U.S. packaging market, we currently expect improvedresults in the fourth quarter of 2008 as a result of higher average sellingprices and declining costs for reclaimed fiber, energy and freight.  In addition, we expect incremental savingsfrom our strategic initiatives.

 

# **Strategic Initiatives and Restructuring Activities**

#  

We are in the final yearof our three year transformation plan to achieve $525 million in savings andproductivity improvements, net of transition costs, from our strategicinitiatives, compared to levels prior to the start of our plan as adjusted forthe impact of inflation.  We expect toachieve the $525 million in cumulative annual savings in 2008.

 

16

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For the nine months endedSeptember 30, 2008, we closed five converting facilities and announced theclosure of three additional converting facilities.  As a result of these closures and otherongoing strategic initiatives, the Company reduced its headcount byapproximately 610 employees.  We recordedrestructuring charges of $27 million, net of a gain of $2 million from the saleof a previously closed facility. Restructuring charges included non-cash charges of $9 million related tothe acceleration of depreciation for mill and converting equipment expected tobe abandoned or taken out of service. The remaining charges of $20 million were primarily for severance andbenefits.  The net sales of the announcedand closed converting facilities as of September 30, 2008 prior to closureand for the year ended December 31, 2007 were $212 million and $344million, respectively.  The majority ofthese net sales are expected to be transferred to other operatingfacilities.  Additional charges of up to$5 million are expected to be recorded in future periods for severance andbenefits related to the closure of these facilities.

 

In October 2008, wepermanently ceased operations of our containerboard machine at the Snowflake,Arizona mill and production at our Pontiac pulp mill located inPortage-du-Fort, Quebec.  The Snowflake,Arizona containerboard machine had the capacity to produce 135,000 tons ofmedium annually. The customers will be supplied by our other mills.  Accelerated depreciation charges of $3million related to the Snowflake, Arizona mill were recorded in the thirdquarter of 2008.  The Pontiac pulp millhad annual production capacity of 253,000 tons of northern bleached hardwoodkraft paper-grade pulp, which was non-core to our primary business.  The closure of the Pontiac pulp mill resultedin a headcount reduction of approximately 218 employees.  In connection with the Pontiac pulp millclosure, we expect to incur pretax restructuring charges of approximately $39million in the fourth quarter of 2008, including approximately $20 million ofnon-cash charges.  Cash charges will bepaid principally in the fourth quarter of 2008 and the first quarter of 2009.

 

**NineMonths 2008 Compared to Nine Months 2007**

** **
| ** **                                                        | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                        | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| **(In millions)**                                            | ** ** | **Net  Sales**                                          | ** ** | **Profit/  (Loss)** | ** ** | **Net  Sales** | ** ** | **Profit/  (Loss)** | ** ** |
|                                                              |       |                                                    |       |   |   |   |   |   |   |
| Containerboard,  corrugated containers and reclamation operations |       | $                                                       | 5,509      |   | $ | 282 |   | $ | 5,579 |   | $ | 446 |   |
|                                                              |       |                                                    |       |   |   |   |   |   |   |
| Restructuring  charges                                            |       |                                                    |       | (27 | ) |   |   | (45 | ) |
| Gain (loss) on  disposal of assets                                |       |                                                    |       | 5 |   |   |   | (64 | ) |
| Interest  expense, net                                            |       |                                                    |       | (187 | ) |   |   | (220 | ) |
| Loss on early  extinguishment of debt                             |       |                                                    |       |   |   |   |   | (29 | ) |
| Non-cash foreign  currency exchange gains (losses)                |       |                                                    |       | 19 |   |   |   | (47 | ) |
| Corporate expenses  and other (Note 1)                            |       |                                                    |       | (213 | ) |   |   | (180 | ) |
| Loss before  income taxes                                         |       |                                                    |       | $ | (121 | ) |   |   | $ | (139 | ) |
|                                                                   |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |

 

Net sales decreased 1.3%in 2008 compared to last year.  Net saleswere negatively impacted by $294 million in 2008 as a result of the sale of theBrewton, Alabama mill in September of 2007 and a change in mix resultingin more containerboard tons sold directly to third parties due to lowercorrugated container sales volume primarily as a result of plant closures.  Net sales were favorably impacted by higheraverage selling prices ($224 million) for containerboard, corrugatedcontainers, market pulp and reclaimed fiber. Average domestic linerboard prices for the first nine months of 2008were 7.7% higher compared to 2007.  Ouraverage North American selling price for corrugated containers increased by4.0% compared to 2007.  Our average salesprices for market pulp, SBS/SBL and kraft paper increased 10.1%, 0.7% and 6.0%,respectively, compared to the same period last year.  The average price for old corrugated containers(OCC) increased approximately $5 per ton compared to last year. Third partyshipments of containerboard increased 0.7% compared to the same period lastyear.  North American shipments ofcorrugated containers on a total and a per day basis were 3.9% and 4.4% lower,respectively, compared to last year due primarily to container plant closures,actions to improve margins by exiting unprofitable accounts and weaker marketconditions.

 

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Our containerboard millsoperated at 99.5% of capacity in the first nine months of 2008, whilecontainerboard production was 3.8% lower compared to last year due primarily tothe sale of the Brewton, Alabama mill and other mill closures.  Production of market pulp and kraft paperdecreased 4.4% and 8.3%, respectively, compared to last year.** **Production ofSBS/SBL****decreased by****61.0%compared to last year due primarily to the sale of the Brewton, Alabama mill.** **Total tons of fiberreclaimed and brokered were comparable to last year.

 

Cost of goods soldas a percent of net sales in the first nine months of 2008 was 89.6%, comparedto 86.3% last year.  Cost of goods soldincreased from $4,815 million in 2007 to $4,938 million in 2008 due primarily tohigher costs of reclaimed material ($54 million), energy ($110 million),freight ($60 million), wood fiber ($53 million), chemicals ($31 million) andmaintenance ($12 million).  Cost of goodssold was impacted by a reduction in costs resulting from the sale of theBrewton, Alabama mill and the sales mix change between corrugated containersand containerboard.

 

Selling andadministrative expense in 2008 was comparable to 2007.

 

# In September 2007, we completedthe sale of the Brewton, Alabama, mill assets. The sale resulted in a pre-taxloss of approximately $65 million, which reflected the allocation of $146million of goodwill to this operation. We recorded an after-tax loss ofapproximately $97 million related to the transaction, reflecting a provisionfor income taxes higher than the statutory income tax rate due to thenon-deductibility of goodwill.

#  

Interest expense, net was$187 million in 2008.  The $33 milliondecrease compared to 2007 was the result of lower average borrowings ($11million) and lower average interest rates ($22 million).  The lower average borrowings were primarilydue to debt reduction from the sale of the Brewton, Alabama mill.  Our overall average effective interest ratein the first nine months of 2008 was lower than 2007 by 0.91%.

 

In the first nine months of2007, we recorded a loss on early extinguishment of debt of $29 millionincluding $23 million for tender premiums and $6 million for the non-cashwrite-off of deferred debt issuance cost.

 

In the first nine monthsof 2008, we recorded non-cash foreign currency exchange gains of $19 millioncompared to losses of $47 million for the same period in 2007.

 

The benefit from income taxes for the nine months ended September 30,2008 differed from the amount computed by applying the statutory U.S. federalincome tax rate to loss before income taxes due primarily to the $84 millionbenefit related to the favorable resolution of the Canadian income taxexamination matters, non-cash foreign currency exchange gains, state incometaxes, lower effective tax rates in certain foreign jurisdictions and theeffect of other permanent differences. Due to fluctuations in pretax income, lower effective tax rates incertain foreign jurisdictions and the effect of permanent differences, theexpected income tax benefit is calculated on a discrete quarterly basis, whichmore accurately reflects income tax benefit as it is realized.

 

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#### **Statistical Data**

 
| ** **                                                                | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(In thousands of tons, except as noted)** | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Mill production                                                           |       |                                                |       |   |   |
| Containerboard  (1)(2)                                                    |       | 5,345                                               |       | 5,557 |   |
| Kraft paper                                                               |       | 121                                                 |       | 132 |   |
| Market pulp                                                               |       | 409                                                 |       | 428 |   |
| SBS/SBL (2)                                                               |       | 92                                                  |       | 236 |   |
| North American  corrugated containers sold (billion sq. ft.)              |       | 54.1                                                |       | 56.4 |   |
| Fiber reclaimed  and brokered                                             |       | 5,071                                               |       | 5,088 |   |

 

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| (1)    | For the nine months  ended September 30, 2008 and 2007, our corrugated container plants  consumed 3,586,000 tons and 3,732,000 tons of containerboard, respectively. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                      |
| (2)    | Results for 2007  include the Brewton, Alabama mill, which had annual production capacity of  approximately 300,000 tons of white top linerboard and 190,000 tons of SBS. |

 

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

 

Intentionallyomitted in accordance with General Instruction (H) of Form 10-Q.

 

**ITEM4.      CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controlsand Procedures**

 

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

 

**Changes in Internal Control**

 

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

 

**PART II - OTHER INFORMATION**

 

**ITEM 1.          LEGAL PROCEEDINGS**

 

We are currently adefendant in two putative class action cases filed in California state court onbehalf of current and former hourly employees at our California corrugatedcontainer facilities.  These cases allegeviolations of the California on-duty meal break and rest period statutes andseek damages prescribed by such statutes. We have reached a tentative agreement to settle these cases, subject tocourt approval. We have previously established reserves sufficient to accountfor our liability in these cases.

 

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**ITEM 1A.       RISK FACTORS**

 

The following riskfactor should be considered in addition to those disclosed in our 2007 AnnualReport on Form 10-K:

 

**We have a significant amount of goodwill and may berequired to record a non-cash impairment charge with respect to our goodwill.**

 

As of September 30,2008, we had $2,727 million of goodwill. In accordance with Financial Accounting Standards Board Statement ofFinancial Accounting Standards No. 142, Goodwill and Other IntangibleAssets, our goodwill is not amortized but rather we are required to evaluategoodwill and other intangibles for impairment annually, or more frequently whenevents or changes in circumstances indicate the carrying value of goodwill maynot be recoverable.  Factors that may beconsidered a change in circumstance, indicating that the carrying value of ourgoodwill may not be recoverable, include a decline in our stock price andmarket capitalization, market prices of common stock of other companies in ourindustry, earnings multiples from mergers and acquisitions activity within theindustry, adverse changes in the economy, reduced future cash flow estimates,and slower growth rates in our industry. There can be no assurance that future evaluations of goodwill will notresult in an impairment and we may be required to record a non-cash impairment chargeagainst income, which could be material.

 

**ITEM 2.          UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

Intentionallyomitted in accordance with General Instruction (H) of Form 10-Q.

 

**ITEM 3.          DEFAULTS UPON SENIOR SECURITIES**

 

Intentionallyomitted in accordance with General Instruction (H) of Form 10-Q.

 

**ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

Intentionallyomitted in accordance with General Instruction (H) of Form 10-Q.

 
| **ITEM 5.** | **OTHER INFORMATION** |
|-------------|-----------------------|
|        |                  |   |
| (a)         |                  | The Employment Security  Agreements of certain executive officers of the company, including  Mr. Craig A. Hunt, Senior Vice President, Secretary and General Counsel,  and Mack C. Jackson, Senior Vice President and General Manager -  Containerboard Mill Division, were revised in the fourth quarter 2008 in  accordance with the requirements of Internal Revenue Code Section 409A  and are filed herewith as exhibits 10.3 and 10.4, respectively. |
|        |                  |   |
| (b)         |                  | There have been no  material changes to the procedures by which security holders may recommend  nominees to the Company’s Board of Directors implemented since the filing of  the Company’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2008. |

 

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| **ITEM 6.** | **EXHIBITS** |
|-------------|--------------|
|        |         |   |
|        |         | The following exhibits are  included in this Form 10-Q: |
|        |         |   |
| 10.1        |         | Amended and Restated Guaranty dated as of  July 28, 2008, made by Smurfit-Stone Container Enterprises, Inc.  (“SSCE”) in favor of The CIT Group/Equipment Financing, Inc., as the  initial lender and as Administrative Agent for the benefit of the Lenders. |
|        |         |   |
| 10.2        |         | Continuing Guaranty, dated as of July 28, 2008,  made by and between SSCE and Union Bank of California, N.A. |
|        |         |   |
| 10.3        |         | Employment Security Agreement, dated  November 4, 2008, between Smurfit-Stone Container Corporation (“SSCC”)  and Craig A. Hunt (incorporated by reference to Exhibit 10.1 to SSCC’s  Quarterly Report on Form 10-Q for the quarter ended September 30,  2008 (File No. 0-23876)). |
|        |         |   |
| 10.4        |         | Employment Security  Agreement, dated November 4, 2008, between SSCC and Mack C. Jackson  (incorporated by reference to Exhibit 10.2 to SSCC’s Quarterly Report on  Form 10-Q for the quarter ended September 30, 2008 (File  No. 0-23876)). |
|        |         |   |
| 31.1        |         | Certification pursuant  to Rules 13a–14(a) and 15d–14(a) under the Securities Exchange  Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002. |
|        |         |   |
| 31.2        |         | Certification pursuant  to Rules 13a–14(a) and 15d–14(a) under the Securities Exchange  Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002. |
|        |         |   |
| 32.1        |         | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002. |
|        |         |   |
| 32.2        |         | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002. |

 

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Signature

 

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

 

 
|   | SMURFIT-STONE  CONTAINER ENTERPRISES, INC. |
|--------|--------------------------------------------|
|   | (Registrant)                               |

 

 
| Date: November 7,  2008 | /s/ Paul K.  Kaufmann                           |
|------------------------------|-------------------------------------------------|
|                         |      Paul  K. Kaufmann |
|                         | Senior Vice  President and Corporate Controller |
|                         | (Principal  Accounting Officer)                 |

 

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