UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

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

For Quarter Ended September 30, 2008

Commission File Number 0-23876

SMURFIT-STONE CONTAINER CORPORATION

(Exact name of registrant as specified in its charter)

(312) 346-6600

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if

changed since last report)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

(Do not check if a smaller reporting company)

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of November 3, 2008, the registrant had outstanding 256,127,479 shares of common stock, $.01 par value per share.

PART I - FINANCIAL INFORMATION

Item 1.        Financial Statements

SMURFIT-STONE CONTAINER CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See notes to consolidated financial statements.

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SMURFIT-STONE CONTAINER CORPORATION

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.

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SMURFIT-STONE CONTAINER CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to consolidated financial statements.

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SMURFIT-STONE CONTAINER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Tabular amounts in millions, except per share data)

1.    Significant Accounting Policies

Basis of Presentation:  The accompanying consolidated financial statements and notes thereto of Smurfit-Stone Container Corporation (“SSCC” or the “Company”) have been prepared in accordance with the instructions to Form 10-Q and reflect all adjustments which management believes necessary (which include only normal recurring accruals) to present fairly the Company’s financial position, results of operations and cash flows.  These statements, however, do not include all information and footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with U.S. generally accepted accounting principles.  Interim results may not necessarily be indicative of results that may be expected for any other interim period or for the year as a whole.  These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the SSCC Annual Report on Form 10-K for the year ended December 31, 2007 (“2007 10-K”) filed February 28, 2008 with the Securities and Exchange Commission.

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

Recently Adopted Accounting Standard:  Effective January 1, 2008, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”) for financial assets and liabilities.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements (See Note 15).  SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements and, accordingly, SFAS No. 157 does not require any new fair value measurements.

2.     Reclassifications

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

3.    Calpine Corrugated LLC

In the first quarter of 2008, the Company recorded a charge of $22 million to fully reserve all amounts due from Calpine Corrugated LLC (“Calpine Corrugated”).  Calpine Corrugated, an independent corrugated container producer in Fresno, California for which the Company is the primary containerboard supplier, experienced start-up losses since it began operations in 2006.

On July 29, 2008, the Company acquired a 90 percent ownership interest in Calpine Corrugated.  In conjunction with the acquisition, the Company guaranteed approximately $45 million of Calpine Corrugated’s third party outstanding debt.  There was no cash consideration paid.  The transaction was accounted for as a purchase business combination and results of operations of Calpine Corrugated are included in the Company’s consolidated statements of operations beginning July 29, 2008.  The preliminary purchase price allocation resulted in approximately $48 million of assets and liabilities, including approximately $45 million of debt.  No goodwill is expected to be recorded for the transaction.  The Company expects to finalize the purchase price allocation during the fourth quarter of 2008, pending completion of the fixed asset appraisal.  The acquisition of Calpine Corrugated’s operations enables the Company to accelerate the optimization of its northern California packaging system and improve its position in the agricultural market segment.

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In 2007, the Company recorded charges of $10 million to reserve for amounts due from Calpine Corrugated, of which $5 million and $10 million, respectively, were recorded in the three and nine months ended September 30, 2007.

4.    Strategic Initiatives and Restructuring Activities

During 2005, the Company announced a strategic initiative plan to improve performance and better position the Company for long-term growth.  The plan focused on cost reduction, productivity initiatives and reinvestment in the Company’s operations.  The Company expects to achieve $525 million in annual savings in 2008, compared to levels prior to the start of the plan.

During the third quarter of 2008, in conjunction with the strategic initiative plan, the Company closed four converting facilities and announced the closure of three additional converting facilities.  As a result of the closures which occurred in the third quarter and other ongoing strategic initiatives, the Company reduced its headcount by approximately 230 employees.  The Company recorded restructuring charges of $14 million, including non-cash charges of $5 million related to the acceleration of depreciation for mill and converting equipment expected to be abandoned or taken out of service. The remaining charges of $9 million were primarily for severance and benefits.

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

In October 2008, the Company permanently ceased operations of its containerboard machine at the Snowflake, Arizona mill and production at its Pontiac pulp mill located in Portage-du-Fort, Quebec.  The Snowflake, Arizona containerboard machine had the capacity to produce 135,000 tons of medium annually. The customers will be supplied by the Company’s other mills.  Accelerated depreciation charges of $3 million related to the Snowflake, Arizona mill were recorded in the third quarter of 2008.  The Pontiac pulp mill had annual production capacity of 253,000 tons of northern bleached hardwood kraft paper-grade pulp, which was non-core to the Company’s primary business.  The closure of the Pontiac pulp mill resulted in a headcount reduction of approximately 218 employees.  In connection with the Pontiac pulp mill closure, the Company expects to incur pretax restructuring charges of approximately $39 million in the fourth quarter of 2008, including approximately $20 million of non-cash charges.

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

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At December 31, 2007, the Company had $29 million of accrued exit liabilities related to the restructuring of operations.  For the three and nine months ended September 30, 2008, the Company incurred $3 million and $9 million, respectively, of cash disbursements related to these exit liabilities.  In addition, for the three and nine months ended September 30, 2008, the Company incurred $6 million and $13 million, respectively, of cash disbursements related to exit liabilities 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, which excluded $16 million of accounts receivable previously sold to Stone Receivables Corporation under the accounts receivable securitization program and was net of $1 million of other closing adjustments.  Current liabilities of $22 million were retained and were paid by the Company.  The Brewton mill had annual production capacity of approximately 300,000 tons of white top linerboard and 190,000 tons of solid bleached sulfate.  The Company will continue to produce white top linerboard at two of its mills.  Substantially all of the proceeds from the sale were applied directly to debt reduction (See Note 8).  The Company recorded 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 that was 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 securitization programs, of which the Company retained a subordinated interest.  The off-balance sheet debt related to the two accounts receivable programs totaled $391 million and $422 million, respectively, as of those dates.

7.    Guarantees and Commitments

The Company has certain wood chip processing contracts extending from 2012 through 2018 with minimum purchase commitments.  As part of the agreements, the Company guarantees the third party contractors’ debt outstanding and has a security interest in the chipping equipment.  At September 30, 2008, the maximum potential amount of future payments related to these guarantees was approximately $29 million, which decreases ratably over the life of the contracts.  In the event the guarantees on these contracts are called, proceeds from the liquidation of the chipping equipment would be based on current market conditions and the Company may not recover in full the guarantee payments made.

The Company is contingently liable for $18 million under a one year letter of credit which expires in April 2009 to support borrowings of one of the Company’s non-consolidated affiliates.  The letter of credit is collateralized by a pledge of affiliate stock owned by the other shareholder in the event the letter of credit is drawn upon and the other shareholder is unable to reimburse the Company for their 50% share of the letter of credit obligation.

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8.    Long-Term Debt

In March 2007, SSCE completed an offering of $675 million of 8.00% unsecured senior notes due March 15, 2017.  The Company 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 cash tender offer, pay related tender premiums and accrued interest of $19 million and $8 million, respectively, and repay $95 million of the SSCE revolving credit facility.  In addition, the Company used the proceeds to pay fees and expenses of $7 million related to this transaction.  A loss on early extinguishment of debt of $23 million was recorded in the first quarter of 2007, including $19 million for tender premiums and a $4 million write-off of unamortized deferred debt issuance costs.

In May 2007, the Company redeemed the remaining $102 million of the 9.75% Senior Notes utilizing borrowings under the SSCE revolving credit facility to redeem the notes and pay related call premiums and accrued interest.  A loss on early extinguishment of debt of $5 million was recorded in the second quarter of 2007, including $4 million for tender premiums and a $1 million write-off of unamortized deferred debt issuance costs.

In September 2007, SSCE completed the sale of its Brewton, Alabama mill (See Note 5) and used the net proceeds of $338 million to prepay $301 million of its Tranche B term loan and $21 million of its revolving credit facility.  In addition, the Company paid fees and expenses of $16 million related to the sale transaction.  The Company recorded a loss on early extinguishment of debt of $1 million related to the write-off of unamortized deferred debt issuance costs.

9.    Employee Benefit Plans

The Company sponsors noncontributory defined benefit pension plans for its U.S. employees and also sponsors noncontributory and contributory defined benefit pension plans for its Canadian employees.  The Company’s defined benefit pension plans cover substantially all hourly employees, as well as salaried employees hired prior to January 1, 2006.

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

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

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The components of net periodic benefit costs for the defined benefit plans and the components of the postretirement benefit costs are as follows:

The Company’s 2008 expected contributions to its qualified defined benefit plans and benefit payments under its non-qualified defined benefit plans and postretirement plans are not expected to be materially different than the amounts disclosed in the 2007 10-K.

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

The 2007 settlement charges are related to closed facilities and are included as part of restructuring charges (See Note 4).

10.  Derivative Instruments and Hedging Activities

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

Commodity Derivative Instruments

The Company uses derivative instruments, including fixed price swaps, to manage fluctuations in cash flows resulting from commodity price risk in the procurement of natural gas and other commodities, including fuel oil and diesel fuel.  The objective is to fix the price of a portion of the Company’s purchases of these commodities used in the manufacturing process.  The changes in the market value of such derivative instruments have historically offset, and are expected to continue to offset, the changes in the price of the hedged item.  As of September 30, 2008, the maximum length of time over which the Company was hedging its exposure to the variability in future cash flows associated with the commodities’ forecasted transactions was 17 months.

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

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

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

Foreign Currency Derivative Instruments

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

Interest Rate Swap Contracts

The Company uses interest rate swap contracts to manage interest rate exposure on $300 million of the current Tranche B and Tranche C floating rate bank term debt, effectively fixing the interest rate at 4.3%.  These contracts extend until 2011, consistent with the maturity of the Company’s Tranche B and Tranche C term loans.  Changes in the fair value of the interest rate swap contracts are expected to be highly effective in offsetting the fluctuations in the floating interest rate and are recorded in OCI until the underlying transaction is recorded.  The accounting for the cash flow impact of the swap contracts is recorded as an adjustment to interest expense each period.  For the three and nine months ended September 30, 2008, the Company reclassified a $1 million loss (net of tax) from OCI to interest expense when the hedged items were recognized.  For the three and nine months ended September 30, 2007, the Company reclassified a $1 million gain (net of tax) and a $2 million gain (net of tax), respectively, from OCI to interest expense when the hedged items were recognized.  The fair value of the Company’s interest rate swap contracts at September 30, 2008 was a $6 million liability included in other long-term liabilities.

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Deferred Hedge Gain (Loss)

The cumulative deferred hedge loss in OCI on all derivative instruments was $21 million (net of tax) at September 30, 2008, including a $17 million loss (net of tax) on commodity derivative instruments, a $1 million loss (net of tax) on foreign currency derivative instruments and a $3 million loss (net of tax) on interest rate swap contracts.  The Company expects to reclassify a $16 million loss (net of tax) into cost of goods sold within the next 12 months, related to the commodity and foreign currency derivative instruments.

11.  Income Taxes

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

With respect to the transfer price issue, the CRA has issued assessments of additional income taxes, interest, and penalties related to transfer prices of inventory sold by the Company’s Canadian subsidiaries to its U.S. subsidiaries.  The Company has appealed the assessments.  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. As a result of these payments, future interest charges will be reduced. 

While the final outcome of the remaining CRA examination matters, including an estimate of the range of the reasonably possible changes to unrecognized tax benefits, is not yet determinable, the Company believes that the examination or subsequent appeals will not have a material adverse effect on its consolidated financial condition or results of operations.

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

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

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12.  Comprehensive Income (Loss)

Comprehensive income (loss) is as follows:

13.  Earnings Per Share

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

Shares of SSCC preferred stock convertible into three million shares of common stock with an earnings effect of $3 million and $9 million are excluded from the diluted earnings per share computations for each of the three and nine months ended September 30, 2008 and 2007, respectively, because they are antidilutive.

Employee stock options and non-vested restricted stock are excluded from the diluted earnings per share calculation for the three and nine months ended September 30, 2007, because they are antidilutive.

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14.  Stock-Based Compensation

During the third quarter of 2008, the Company granted approximately 1,338,000 stock options with a weighted-average exercise 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 stock options with a weighted-average exercise price and grant date fair value of $6.36 and $2.24, respectively.  These options vest and become exercisable on the third anniversary of the award date.  Compensation expense is being recorded over the three-year period on a straight-line basis.

During the third quarter of 2008, the Company issued approximately 37,000 non-vested restricted stock units (“RSUs”) to certain employees with a weighted-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 RSUs to certain employees and non-employee directors with a weighted-average grant date fair value of $7.89 per RSU.  In addition, to settle its 2007 management incentive plan liability, the Company issued approximately 347,000 vested RSUs, which had been accrued for in the prior year, and approximately 69,000 related premium non-vested RSUs at a fair value of $9.14 per RSU.  In accordance with the Company’s applicable management incentive plan and long-term incentive plan, the non-vested RSUs vest in three years.

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

15.  Fair Value Measurements

Certain financial assets and liabilities are recorded at fair value on a recurring basis, including the Company’s retained interest in receivables sold to the accounts receivable programs (See Note 6), the Company’s residual interest in the Timber Note Holdings (“TNH”) investment, and derivative assets and liabilities (See Note 10).

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  In determining fair value, the Company uses various valuation approaches, including market, income and/or cost approaches.  SFAS No. 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  The hierarchy for inputs is broken down into three levels based on their reliability as follows:

Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.  The Company has no assets or liabilities measured at fair value on a recurring basis utilizing Level 1 inputs.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.  The Company has no assets or liabilities measured at fair value on a recurring basis utilizing Level 2 inputs.

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Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement.  The Company’s assets and liabilities utilizing Level 3 inputs include the retained interest in receivables sold to the accounts receivable programs, the residual interest in the TNH investment and derivative assets and liabilities.  The fair values of the retained interest in receivables sold are estimated using discounted residual cash flows, expected loss and dilution rates, and variable returns to investors.  The fair value of the residual interest in the TNH investment is estimated using discounted residual cash flows.  The fair values of the derivative assets and liabilities are estimated using model inputs specific to the derivative, including interest rate yield curves, commodity forward spread curves and volatility of the underlying commodities.

Fair value on a recurring basis

Assets and liabilities measured at fair value on a recurring basis are categorized in the table below based upon the level of input to the valuations.

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

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

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16.  Contingencies

The Company’s past and present operations include activities which are subject to federal, state and local environmental requirements, particularly relating to air and water quality.  The Company faces potential environmental liability as a result of violations of these environmental requirements, environmental permit terms and similar authorizations that have occurred from time to time at its facilities.  In addition, the Company faces potential liability for remediation at certain owned and formerly owned facilities, as well as response costs at various sites for which it has received notice as being a potentially responsible party (“PRP”) concerning hazardous substance contamination.  In estimating its reserves for environmental remediation and future costs at sites where it has been named as a PRP, the Company’s estimated liability of $5 million reflects the Company’s expected share of costs after consideration for the relative percentage of waste deposited at each site, the number of other PRPs, the identity and financial condition of such parties and experience regarding similar matters.  As of September 30, 2008, the Company had approximately $14 million reserved for environmental liabilities included primarily in other long-term liabilities in the consolidated balance sheet.  The Company believes the liability for these matters was adequately reserved at September 30, 2008.

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

The Company is currently a defendant in two putative class action cases filed in California state court on behalf of current and former hourly employees at the Company’s California corrugated container facilities.  These cases allege violations of the California on-duty meal break and rest period statutes and seek damages prescribed by such statutes.  The Company has reached a tentative agreement to settle these cases, subject to court approval.  In addition, the Company is a defendant in a number 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 against the Company cannot be predicted with certainty, management of the Company believes that the resolution of these matters will not have a material adverse effect on its consolidated financial condition, results of operations or cash flows.

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

FORWARD-LOOKING STATEMENTS

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

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

GENERAL

Smurfit-Stone Container Corporation, incorporated in Delaware in 1989, is a holding company with no business operations of its own.  We conduct our business operations through our wholly-owned subsidiary Smurfit-Stone Container Enterprises, Inc. (SSCE), a Delaware corporation.  We operate as one segment, the Containerboard, Corrugated Containers and Reclamation segment.

RECENTLY ADOPTED ACCOUNTING STANDARDS

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

RESULTS OF OPERATIONS

Non-GAAP Financial Measures

In the accompanying analysis of financial information, we use the financial measures “adjusted net income (loss) available to common stockholders” and “adjusted net income (loss) per diluted share available to common stockholders,” which are derived from our consolidated financial information but are not presented in our financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP). These measures are considered “non-GAAP financial measures” under the U.S. Securities and Exchange Commission (SEC) rules.  Adjusted net income (loss) available to common stockholders and adjusted net income (loss) per diluted share available to common stockholders are non-GAAP financial measures that exclude from net income (loss) available to common stockholders the effects of non-cash foreign currency exchange gains or losses, losses on early extinguishment of debt, restructuring charges, litigation charges, gains or losses on sale of assets and the resolution of certain tax matters.  We believe these non-GAAP financial measures provide investors, potential investors, security analysts and others with useful information to evaluate the performance of our

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business because they exclude gains and losses and charges that management believes are not indicative of the ongoing operating results of the business.  In addition, these measures may differ from the adjusted net income (loss) calculations of other companies in our industry, limiting their usefulness as a comparative measure.  For such measures, we have provided the following reconciliations to the most directly comparable GAAP financial measure.

Reconciliation to GAAP Financial Measures

Overview

For the third quarter of 2008, we had net income available to common stockholders of $62 million, or $0.24 per share, compared to a net loss of $96 million, or $0.38 per share, for the third quarter of 2007.  The third quarter of 2008 results benefited $84 million, or $0.33 per share, from the resolution of Canadian income tax examination matters.  For information concerning the resolution of the Canadian income tax examination matters, see Liquidity and Capital Resources, “Canadian Income Taxes”.  The third quarter of 2007 included a pretax loss on the sale of our Brewton, Alabama mill of $65 million and a $32 million income tax provision, which resulted in a net loss on the sale of $97 million, or $0.38 per share.

For the third quarter of 2008, we had adjusted net loss available to common stockholders of $21 million, or $0.08 per diluted share, compared to adjusted net income available to common stockholders of $28 million, or $0.11 per diluted share, for the third quarter of 2007.  The results for the third quarter of 2008 were negatively impacted by higher costs for energy, fiber, freight and chemicals.  These items were partially offset by higher average selling prices for most of our products, benefits from our strategic initiatives and lower interest expense compared to the third quarter of last year.

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For the nine months ended September 30, 2008, we had net income available to common stockholders of $6 million, or $0.02 per share, compared to a net loss of $156 million, or $0.61 per share, for the same period last year.  The results for the nine months ended September 30, 2008 benefited from the resolution of the Canadian income tax examination matters, non-cash foreign currency exchange gains of $19 million, or $0.07 per share, and lower restructuring charges as compared to 2007.  Results in 2007 were negatively impacted by the loss on the sale of the Brewton, Alabama mill, a loss on early extinguishment of debt, net of income taxes, of $17 million, or $0.07 per share, non-cash foreign currency exchange losses of $47 million, or $0.18 per share, and higher restructuring charges.

For the nine months ended September 30, 2008, we had an adjusted net loss available to common stockholders of $76 million, or $0.30 per diluted share, compared to adjusted net income available to common stockholders of $21 million, or $0.08 per diluted share, for the first nine months of 2007.  The results for the first nine months of 2008 were negatively impacted by higher costs for energy, fiber, freight and chemicals.  These items were partially offset by higher average selling prices for most of our products, benefits from our strategic initiatives and lower interest expense compared to the same period last year.

While the global economic slowdown is impacting the U.S. packaging market, we currently expect improved results in the fourth quarter of 2008 as a result of higher average selling prices and declining costs for reclaimed fiber, energy and freight.  In addition, we expect incremental savings from our strategic initiatives.

Strategic Initiatives and Restructuring Activities

We are in the final year of our three year transformation plan to achieve $525 million in savings and productivity improvements, net of transition costs, from our strategic initiatives, compared to levels prior to the start of our plan as adjusted for the impact of inflation.  We expect to achieve the $525 million in cumulative annual savings in 2008.

During the third quarter of 2008, in conjunction with the strategic initiative plan, we closed four converting facilities and announced the closure of three additional converting facilities.  As a result of the closures that occurred in the third quarter and other ongoing strategic initiatives, we reduced our headcount by approximately 230 employees.  We recorded restructuring charges of $14 million, including non-cash charges of $5 million related to the acceleration of depreciation for mill and converting equipment expected to be abandoned or taken out of service. The remaining charges of $9 million were primarily for severance and benefits.

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

In October 2008, we permanently ceased operations of our containerboard machine at the Snowflake, Arizona mill and production at our Pontiac pulp mill located in Portage-du-Fort, Quebec.  The Snowflake, Arizona containerboard machine had the capacity to produce 135,000 tons of medium annually. The customers will be supplied by our other mills.  Accelerated depreciation charges of $3 million related to the Snowflake, Arizona mill were recorded in the third quarter of 2008.  The Pontiac pulp mill had annual production capacity of 253,000 tons of northern bleached hardwood kraft paper-grade pulp, which was non-core to our primary business.  The closure of

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the Pontiac pulp mill resulted in a headcount reduction of approximately 218 employees.  In connection with the Pontiac pulp mill closure, we expect to incur pretax restructuring charges of approximately $39 million in the fourth quarter of 2008, including approximately $20 million of non-cash charges.  Cash charges will be paid principally in the fourth quarter of 2008 and the first quarter of 2009.

Third Quarter 2008 Compared to Third Quarter 2007

Note 1: Amounts include corporate expenses and other expenses not allocated to operations, including Calpine Corrugated charges and litigation charges.

Net sales decreased 0.3% in the third quarter of 2008 compared to last year.  Net sales were negatively impacted by $92 million in 2008 primarily as a result of the sale of the Brewton, Alabama mill in September 2007.  Net sales were favorably impacted by higher average selling prices ($86 million) for containerboard, corrugated containers, market pulp and reclaimed fiber.  Average domestic linerboard prices in the third quarter of 2008 increased by 4.2% compared to the second quarter of 2008 and were 8.9% higher compared to the third quarter of 2007.  Our average North American selling price for corrugated containers increased by 0.4% compared to the second quarter of 2008 and was 3.7% higher compared to the third quarter of 2007.  The increase in the average North American selling price compared to the second quarter of 2008 was negatively impacted by a weaker Canadian dollar.  Third quarter average sales prices for market pulp and kraft paper increased 4.1% and 7.9%, respectively, compared to the same period last year.  Third quarter average sales price for SBS/SBL decreased 1.7% compared to the same period last year.  The average price for old corrugated containers (OCC) decreased approximately $15 per ton compared to last year.  Third party shipments of containerboard decreased 4.1% compared to the same period last year.  North American shipments of corrugated containers on a total and per day basis were 0.3% and 1.9% lower, respectively, compared to last year due primarily to container plant closures, actions to improve margins by exiting unprofitable accounts and weaker market conditions.

Our containerboard mills operated at 99.5% of capacity in the third quarter of 2008, while containerboard production was 5.2% lower compared to last year due primarily to the sale of the Brewton, Alabama mill.  Production of market pulp increased 0.7% while kraft paper production decreased 12.8% compared to last year.  Production of SBS/SBL decreased by 60.5% compared to last year due primarily to the sale of the Brewton, Alabama mill.  Total tons of fiber reclaimed and brokered was comparable to last year.

Cost of goods sold as a percent of net sales in the third quarter of 2008 was 90.3%, compared to 84.7% last year.  Cost of goods sold increased from $1,596 million in 2007 to $1,696 million in 2008 due primarily to higher costs of energy ($58 million), wood fiber ($32 million), freight ($21 million), chemicals ($14 million) and maintenance ($4 million).  Cost of goods sold was impacted by a reduction in costs resulting from the sale of the Brewton, Alabama mill.

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Selling and administrative expenses in the third quarter of 2008 decreased $15 million compared to the same period last year due primarily to a reduction in compensation and benefit expenses and benefits achieved from our strategic initiatives. Selling and administrative expenses were 7.9% of net sales compared to 8.6% last year.

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

Interest expense, net was $63 million in the third quarter of 2008.  The $10 million decrease compared to the third quarter of 2007 was the result of lower average borrowings ($2 million) and lower average interest rates ($8 million).  The lower average borrowings were primarily due to debt reduction from the sale of the Brewton, Alabama mill in the third quarter of 2007.  Our overall average effective interest rate in the third quarter of 2008 was lower than 2007 by 0.87%.

In the third quarter of 2007, we recorded a loss on early extinguishment of debt of $1 million for the non-cash write-off of deferred debt issuance cost.

In the third quarter of 2008, we recorded non-cash foreign currency exchange gains of $8 million compared to losses of $22 million in 2007.

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

Nine Months 2008 Compared to Nine Months 2007

Net sales decreased 1.3% in 2008 compared to last year.  Net sales were negatively impacted by $294 million in 2008 as a result of the sale of the Brewton, Alabama mill in September of 2007 and a change in mix resulting in more containerboard tons sold directly to third parties due to lower corrugated container sales volume primarily as a result of plant closures.  Net sales were favorably impacted by higher average

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selling prices ($224 million) for containerboard, corrugated containers, market pulp and reclaimed fiber.  Average domestic linerboard prices for the first nine months of 2008 were 7.7% higher compared to 2007.  Our average North American selling price for corrugated containers increased by 4.0% compared to 2007.  Our average sales prices 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 party shipments of containerboard increased 0.7% compared to the same period last year.  North American shipments of corrugated 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 market conditions.

Our containerboard mills operated at 99.5% of capacity in the first nine months of 2008, while containerboard production was 3.8% lower compared to last year due primarily to the sale of the Brewton, Alabama mill and other mill closures.  Production of market pulp and kraft paper decreased 4.4% and 8.3%, respectively, compared to last year.  Production of SBS/SBL decreased by 61.0% compared to last year due primarily to the sale of the Brewton, Alabama mill.  Total tons of fiber reclaimed and brokered were comparable to last year.

Cost of goods sold as a percent of net sales in the first nine months of 2008 was 89.6%, compared to 86.3% last year.  Cost of goods sold increased from $4,815 million in 2007 to $4,938 million in 2008 due primarily to higher costs of reclaimed material ($54 million), energy ($110 million), freight ($60 million), wood fiber ($53 million), chemicals ($31 million) and maintenance ($12 million).  Cost of goods sold was impacted by a reduction in costs resulting from the sale of the Brewton, Alabama mill and the sales mix change between corrugated containers and containerboard.

Selling and administrative expense in 2008 was comparable to 2007.

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

In the first nine months of 2007, we recorded a loss on early extinguishment of debt of $29 million including $23 million for tender premiums and $6 million for the non-cash write-off of deferred debt issuance cost.

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

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Statistical Data

(1) For the three months ended September 30, 2008 and 2007, our corrugated container plants consumed 1,224,000 tons and 1,221,000 tons of containerboard, respectively.  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.

LIQUIDITY AND CAPITAL RESOURCES

The following table summarizes our cash flows for the nine months ended September 30:

Net Cash Provided By (Used For) Operating Activities

The net cash provided by operating activities for the nine months ended September 30, 2008 was comparable to the same period in 2007.

Net Cash Provided By (Used For) Investing Activities

Net cash used for investing activities was $296 million for the nine months ended September 30, 2008.  Expenditures for property, plant and equipment were $304 million for the first nine months of 2008, compared to $268 million for the same period last year.  The amount expended for property, plant and equipment in the first nine months of 2008 included $298 million for projects related to upgrades, cost reductions and strategic initiatives and $6 million for environmental projects.  For the nine months ended September 30, 2008, we received proceeds of $8 million from the sale of properties primarily related to previously closed facilities.  For the nine months ended September 30, 2007, we received proceeds of $339 million from property disposals and sale of businesses including $338 million from the sale of the Brewton, Alabama mill and $57 million from properties at previously closed facilities.

Net Cash Provided By (Used For) Financing Activities

Net cash provided by financing activities for the nine months ended September 30, 2008 of $162 million included a net increase of debt of $168 million. The net increase in debt primarily funded our capital investments.  Preferred dividends paid were $6 million for this period.

We, as guarantor, and SSCE and its subsidiary, Smurfit-Stone Container Canada Inc. (SSC Canada), as borrowers, entered into a new credit agreement (the Credit Agreement) on November 1, 2004.  The obligations of SSCE under the Credit Agreement are unconditionally guaranteed by us and the material U.S. subsidiaries of SSCE.  The obligations of SSC Canada under the Credit Agreement are unconditionally guaranteed by us, SSCE, the material U.S. subsidiaries of SSCE and the material

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

The Credit Agreement contains various covenants and restrictions including (i) limitations on dividends, redemptions and repurchases of capital stock, (ii) limitations on the incurrence of indebtedness, liens, leases and sale-leaseback transactions, (iii) limitations on capital expenditures and (iv) maintenance of certain financial covenants.  The Credit Agreement also requires prepayments if we have excess cash flows, as defined therein, or receive proceeds from certain asset sales, insurance or incurrence of certain indebtedness.  Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in us being required to repay these borrowings before their due date.  If we were unable to make this repayment or otherwise refinance these borrowings, our lenders could foreclose on our assets.  If we were unable to refinance these borrowings on favorable terms, our costs of borrowing could increase significantly.

As of September 30, 2008, subject to the above limitations, we had unused borrowing capacity under SSCE’s revolving credit facilities of $171 million, after giving consideration to outstanding letters of credit.  In response to the current economic environment, we are taking actions to maintain liquidity, including deferral of certain capital expenditures, cost reductions, sale of assets and improvements of working capital.

At September 30, 2008, we were in compliance with the financial covenants required by the Credit Agreement. However, if market conditions change and sales prices or volumes for our products decrease materially, negatively impacting our future results, we may not be in compliance with such covenants. In such an event, we would seek an amendment to the Credit Agreement.  Although we believe that we could obtain such an amendment, failure to obtain an amendment would result in a default under the Credit Agreement, which could result in a material adverse impact on our financial condition.

Future Cash Flows

We expect capital expenditures for 2008 to be approximately $400 million.

In 2004, the EPA promulgated a MACT regulation to limit hazardous air pollutant emissions from certain industrial boilers (Boiler MACT).  Several of our mills were required to install new pollution control equipment in order to meet the compliance deadline of September 2007.  The Boiler MACT rule was challenged by third parties in litigation, and the United States District Court of Appeals for the D.C. Circuit issued a decision vacating Boiler MACT and remanding the rule to the EPA.  All projects required to bring us into compliance with the now vacated Boiler MACT requirements were completed.  It is presently unclear whether future rulemaking will require us to install additional pollution control equipment on industrial boilers at our facilities.  For the first nine months of 2008, we spent approximately $6 million on other environmental projects and anticipate spending approximately $1 million in the fourth quarter of 2008.

We recorded restructuring charges of $27 million in the first nine months of 2008, net of a gain of $2 million from the sale of a previously closed facility.  Restructuring charges include $20 million for exit liabilities, which were principally for severance and benefits.  During the nine months ended September 30, 2008,

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we incurred cash expenditures of $13 million for these exit liabilities.  The remaining exit liabilities are expected to be paid in the fourth quarter of 2008.

At December 31, 2007, we had $29 million of exit liabilities related to restructuring activities.  During the nine months ended September 30, 2008, we incurred cash expenditures of $9 million for these exit liabilities.  The remaining cash expenditures in connection with our restructuring activities will continue to be funded through operations as originally planned.

For the nine months ended September 30, 2008, we contributed $56 million to our pension plans and expect to contribute a total of approximately $75 million in 2008.  During 2008, the fair value of our pension plan assets have declined.  Future contributions to our pension and other postretirement plans will be dependent upon future returns on our pension plan assets and changes in discount rates which would impact our benefit obligations.