Table of Contents

 

 

** **

**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 AND EXCHANGE ACT OF 1934**  |
|--------|-------------------------------------------------------------------------------------------------------------|
|   |                                                                                                        |
|   | **For  the quarterly period year ended March 31, 2009**                                                |
|   |                                                                                                        |
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934** |

** **

**For the transition period from                              to                              **

** **

**Commission File Number: 001-33494**

 

**KapStone Paper and PackagingCorporation**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                    | **20-2699372**      |
|---------------------------------|---------------------|
| (State or Other Jurisdiction of | (I.R.S. Employer    |
| Incorporation or Organization)  | Identification No.) |

 

**KapStone Paper and PackagingCorporation**

**1101 Skokie Blvd., Suite 300**

**Northbrook, IL 60062**

(Address of Principal Executive Offices including zip code)

 

Registrant’s Telephone Number, including area code**(847)239-8800**

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Exchange Act during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  Noo

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 
| Large accelerated filer o                     | Accelerated filer x         |
|-----------------------------------------------|----------------------------------|
|                                          |                             |
| Non-accelerated filer o                       | Smaller reporting company o |
| (Do not check if a smaller reporting company) |                             |

 

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

 

There were 28,370,248shares of the Registrant’s Common Stock, $0.0001 par value, outstanding at April 30,2009, excluding 40,000 shares held as treasury shares.

 

 

 

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**KapStone Paper and PackagingCorporation Index to Form 10-Q**

 

**TABLE OF CONTENTS**

 
| PART I.  — FINANCIAL INFORMATION |                                                                                                          |   |
|--------------------------------------------|---------------------------------------------------------------------------------------------------------------|--------|
|                                       |                                                                                                          |   |   |
|                                       | Item  1. — Consolidated Financial Statements (Unaudited) and Notes to Consolidated  Financial Statements |   | 1 |
|                                       |                                                                                                          |   |   |
|                                       | Item 2. — Management’s Discussion and Analysis of  Financial Condition and Results of Operations    |   | 10 |
|                                       |                                                                                                          |   |   |
|                                       | Item 3. — Quantitative and Qualitative Disclosures  about Market Risk                                    |   | 15 |
|                                       |                                                                                                          |   |   |
|                                       | Item 4. — Controls  and Procedures                                                                       |   | 16 |
|                                       |                                                                                                          |   |   |
| PART II.  — OTHER INFORMATION    |                                                                                                          |   |
|                                       |                                                                                                          |   |   |
|                                       | Item  1. — Legal Proceedings                                                                             |   | 17 |
|                                       |                                                                                                          |   |   |
|                                       | Item  1A. — Risk Factors                                                                                 |   | 17 |
|                                       |                                                                                                          |   |   |
|                                       | Item 2. — Unregistered Sales of Equity Securities and  Use of Proceeds                                   |   | 17 |
|                                       |                                                                                                          |   |   |
|                                       | Item 3. — Defaults Upon Senior Securities                                                                |   | 17 |
|                                       |                                                                                                          |   |   |
|                                       | Item 4. — Submission of Matters to a Vote of Security  Holders                                           |   | 17 |
|                                       |                                                                                                          |   |   |
|                                       | Item  5. — Other Information                                                                             |   | 17 |
|                                       |                                                                                                          |   |   |
|                                       | Item 6. —  Exhibits                                                                                      |   | 18 |
|                                       |                                                                                                          |   |   |
| SIGNATURES                                 |                                                                                                          | 19     |

 

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**Part 1. Financial Information**

** **

**Item 1. Financial Statements**

**KapStone Paper and PackagingCorporation**

**Consolidated Balance Sheets**

**(In thousands, except share and pershare amounts)**

 
| ** **                                                                                                                                                                         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                         | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                         |       |               |       |                  |       |
| Current assets:                                                                                                                                                                    |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                          |       | $                  | 1,520      |                  | $          | 4,165 |   |
| Trade accounts receivable, less allowances of $2,771 in 2009 and  $2,421 in 2008                                                                                                   |       | 56,704             |       | 71,489                |       |
| Other receivables                                                                                                                                                                  |       | 27,714             |       | 6,207                 |       |
| Inventories                                                                                                                                                                        |       | 79,256             |       | 89,692                |       |
| Refundable and prepaid income taxes                                                                                                                                                |       | 2,921              |       | 14,145                |       |
| Prepaid expenses and other current assets                                                                                                                                          |       | 4,255              |       | 1,748                 |       |
| Deferred income taxes                                                                                                                                                              |       | 1,234              |       | 3,363                 |       |
| Total current assets                                                                                                                                                               |       | 173,604            |       | 190,809               |       |
|                                                                                                                                                                               |       |               |       |                  |       |
| Plant, property and equipment, net                                                                                                                                                 |       | 478,754            |       | 483,780               |       |
| Restricted cash                                                                                                                                                                    |       | 2,500              |       | —                |       |
| Other assets                                                                                                                                                                       |       | 1,157              |       | 882                   |       |
| Intangible assets, net                                                                                                                                                             |       | 36,202             |       | 45,195                |       |
| Goodwill                                                                                                                                                                           |       | 5,461              |       | 6,524                 |       |
|                                                                                                                                                                               |       |               |       |                  |       |
| Total assets                                                                                                                                                                       |       | $                  | 697,678    |                  | $          | 727,190 |   |
|                                                                                                                                                                               |       |               |       |                  |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                      |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                               |       |               |       |                  |       |
| Current portion of long-term debt and notes                                                                                                                                        |       | $                  | 37,605     |                  | $          | 40,556 |   |
| Accounts payable                                                                                                                                                                   |       | 38,135             |       | 42,214                |       |
| Accrued expenses                                                                                                                                                                   |       | 19,043             |       | 30,462                |       |
| Accrued compensation costs                                                                                                                                                         |       | 8,405              |       | 13,646                |       |
| Total current liabilities                                                                                                                                                          |       | 103,188            |       | 126,878               |       |
|                                                                                                                                                                               |       |               |       |                  |       |
| Other liabilities:                                                                                                                                                                 |       |               |       |                  |       |
| Long-term debt and notes, net                                                                                                                                                      |       | 367,184            |       | 389,374               |       |
| Pension and post-retirement benefits                                                                                                                                               |       | 9,227              |       | 8,355                 |       |
| Deferred income taxes                                                                                                                                                              |       | 19,874             |       | 15,951                |       |
| Other liabilities                                                                                                                                                                  |       | 5,829              |       | 5,865                 |       |
| Total other liabilities                                                                                                                                                            |       | 402,114            |       | 419,545               |       |
|                                                                                                                                                                               |       |               |       |                  |       |
| Commitments and contingencies                                                                                                                                                      |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                                                         |       |               |       |                  |       |
| Preferred stock $.0001 par value; 1,000,000 shares authorized;  no shares issued and outstanding                                                                              |       | —             |       | —                |       |
| Common stock $.0001 par value, 175,000,000 shares authorized; 28,370,248 shares  outstanding (40,000 treasury shares) at March 31, 2009 and  December 31, 2008 |       | 3                  |       | 3                     |       |
| Additional paid-in capital                                                                                                                                                         |       | 132,712            |       | 132,206               |       |
| Retained earnings                                                                                                                                                                  |       | 59,878             |       | 48,766                |       |
| Accumulated other comprehensive loss                                                                                                                                               |       | (217               | )          | (208                  | )          |
| Total stockholders’ equity                                                                                                                                                    |       | 192,376            |       | 180,767               |       |
|                                                                                                                                                                               |       |               |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                    |       | $                  | 697,678    |                  | $          | 727,190 |   |

 

See notes to consolidated financial statements

 

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**KapStone Paper and PackagingCorporation**

**Consolidated Statements of Income**

**(In thousands, except share and pershare amounts)**

** **

**(unaudited)**

** **
| ** **                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                             | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
|                                                   |       |                                                 |       |   |   |
| Net sales                                              |       | $                                                    | 140,584    |   | $ | 67,129 |   |
| Cost of sales, excluding depreciation and amortization |       | 96,484                                               |       | 41,558 |   |
| Freight and distribution expenses                      |       | 13,328                                               |       | 6,587 |   |
| Selling, general and administrative expenses           |       | 8,557                                                |       | 4,930 |   |
| Depreciation and amortization                          |       | 13,609                                               |       | 2,593 |   |
| Gain on sale of business                               |       | 17,399                                               |       | — |   |
| Other operating income                                 |       | 232                                                  |       | 184 |   |
| Operating income                                       |       | 26,237                                               |       | 11,645 |   |
| Foreign exchange losses                                |       | 298                                                  |       | — |   |
| Interest income                                        |       | 1                                                    |       | 547 |   |
| Interest expense                                       |       | 5,733                                                |       | 753 |   |
| Income before provision for income taxes               |       | 20,207                                               |       | 11,439 |   |
| Provision for income taxes                             |       | 9,095                                                |       | 4,209 |   |
| Net income                                             |       | $                                                    | 11,112     |   | $ | 7,230 |   |
|                                                   |       |                                                 |       |   |   |
| Weighted-average number of shares outstanding:         |       |                                                 |       |   |   |
| Basic                                                  |       | 28,370,248                                           |       | 25,282,047 |   |
| Diluted                                                |       | 28,480,055                                           |       | 34,557,324 |   |
| Net income per share:                                  |       |                                                 |       |   |   |
| Basic                                                  |       | $                                                    | 0.39       |   | $ | 0.29 |   |
| Diluted                                                |       | $                                                    | 0.39       |   | $ | 0.21 |   |

 

See notes to consolidated financial statements

 

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**KapStonePaper and Packaging Corporation**

**Consolidated Statements of Cash Flows**

**(In thousands)**

** **

**(unaudited)**

 
| ** **                                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| **Operating activities**                                                                     |       |                                                 |       |   |   |
| Net income                                                                                   |       | $                                                    | 11,112     |   | $ | 7,230 |   |
| Adjustments to reconcile net income to net cash (used in) provided by  operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                                |       | 13,609                                               |       | 2,593 |   |
| Stock based compensation expense                                                             |       | 506                                                  |       | 236 |   |
| Amortization of debt issuance costs                                                          |       | 823                                                  |       | 59 |   |
| Loss on disposal of fixed assets                                                             |       | 375                                                  |       | — |   |
| Deferred income taxes                                                                        |       | 7,165                                                |       | 1,411 |   |
| Gain on sale of business                                                                     |       | (17,399                                              | )          | — |   |
| Changes in operating assets and liabilities:                                                 |       |                                                 |       |   |   |
| Trade accounts receivable, net                                                               |       | 11,992                                               |       | 789 |   |
| Other receivables                                                                            |       | (23,773                                              | )          | (1,107 | ) |
| Inventories                                                                                  |       | 5,586                                                |       | 1,872 |   |
| Refundable and prepaid income taxes                                                          |       | 11,224                                               |       | — |   |
| Prepaid expenses and other current assets                                                    |       | (2,507                                               | )          | (1,106 | ) |
| Accounts payable                                                                             |       | (2,575                                               | )          | 448 |   |
| Accrued expenses                                                                             |       | (14,451                                              | )          | (1,206 | ) |
| Accrued compensation costs                                                                   |       | (5,281                                               | )          | (1,871 | ) |
| Accrued income taxes                                                                         |       | —                                               |       | 568 |   |
| Net cash (used in) provided by operating activities                                          |       | (3,594                                               | )          | 9,916 |   |
|                                                                                         |       |                                                 |       |   |   |
| **Investing activities**                                                                     |       |                                                 |       |   |   |
| CKD acquisition                                                                              |       | —                                               |       | (469 | ) |
| Proceeds from sale of business                                                               |       | 36,083                                               |       | — |   |
| Restricted cash                                                                              |       | (2,500                                               | )          | — |   |
| Capital expenditures                                                                         |       | (6,323                                               | )          | (2,301 | ) |
| Net cash provided by (used in) investing activities                                          |       | 27,260                                               |       | (2,770 | ) |
|                                                                                         |       |                                                 |       |   |   |
| **Financing activities**                                                                     |       |                                                 |       |   |   |
| Proceeds from revolving credit facility                                                      |       | 37,900                                               |       | — |   |
| Repayments on revolving credit facility                                                      |       | (21,000                                              | )          | — |   |
| Repayments of long-term debt and notes                                                       |       | (42,806                                              | )          | (3,539 | ) |
| Proceeds from the exercises of warrants into common stock                                    |       | —                                               |       | 18 |   |
| Debt issuance costs                                                                          |       | (405                                                 | )          | — |   |
| Net cash used in financing activities                                                        |       | (26,311                                              | )          | (3,521 | ) |
|                                                                                         |       |                                                 |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                         |       | (2,645                                               | )          | 3,625 |   |
| Cash and cash equivalents-beginning of period                                                |       | 4,165                                                |       | 56,635 |   |
| Cash and cash equivalents-end of period                                                      |       | $                                                    | 1,520      |   | $ | 60,260 |   |

 

See notes to consolidated financial statements

 

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**KAPSTONE PAPER AND PACKAGINGCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**(In thousands, except share and pershare amounts)**

 

**(unaudited)**

 

# **1.**                                      Financial Statements

# ** **

The accompanyingunaudited consolidated financial statements of KapStone Paper and PackagingCorporation (the “Company,” “we,” “us,” “our” or “KapStone”) have been preparedin accordance with U.S. generally accepted accounting principles for interimfinancial information, the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the informationand footnotes required by generally accepted accounting principles for completefinancial statements. In the opinion of management, all adjustments (consistingof a normal recurring nature) considered necessary for a fair presentation havebeen included. Operating results for the three months ended March 31, 2009are not necessarily indicative of the results that may be expected for the yearending December 31, 2009. For further information, refer to theconsolidated financial statements and related footnotes included in our AnnualReport on Form 10-K for the year ended December 31, 2008.

 

# **2.**                                      Reclassification

# ** **

Receivables from sales ofshaft horsepower of $2.9 million as of December 31, 2008 have beenreclassified from prepaid and other current assets to trade account receivablesto conform to the current period presentation.

 

# **3.**                                      Accounting Pronouncements

# ** **

 In April 2009,the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”)FAS 157-4,*Determining Fair Value When theVolume and Level of Activity for the Asset or Liability Have SignificantlyDecreased and Identifying Transactions That Are Not Orderly* . ThisFSP provides additional guidance for estimating fair value in accordance withFASB Statement No. 157,*Fair ValueMeasurements*, when the volume and level of activity for the asset orliability have significantly decreased. This FSP also includes guidance onidentifying circumstances that indicate a transaction is not orderly. This FSPemphasizes that even if there has been a significant decrease in the volume andlevel of activity for the asset or liability and regardless of the valuationtechnique(s) used, the objective of a fair value measurement remains thesame. Fair value is the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction (that is, not a forcedliquidation or distressed sale) between market participants at the measurementdate under current market conditions. FSP FAS 157-4 is effective for interimand annual reporting periods ending after June 15, 2009, and is appliedprospectively. The Company does not believe that the implementation of thisstandard will have a material impact on its consolidated financial statements.

 

In April 2009, theFASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”) 28-1,*Interim Disclosures about Fair Value of FinancialInstruments.*  This FSP amendsFASB Statement No. 107,*Disclosuresabout Fair Value of Financial Instruments*, to require disclosuresabout fair value of financial instruments for interim reporting periods ofpublicly traded companies as well as in annual financial statements. This FSPalso amends APB Opinion No. 28,*InterimFinancial Reporting*, to require those disclosures in summarizedfinancial information at interim reporting periods. FSP FAS 107-1 and APB 28-1are effective for interim and annual reporting periods ending after June 15,2009. The Company does not believe that the implementation of these standardswill have a material impact on its consolidated financialstatements.

 

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# **4.**                                      Sale of Dunnage Bag Business

# ** **

On March 31, 2009the Company consummated the sale of its dunnage bag business to Illinois ToolWorks Inc. for $36.0 million. The Company considered the sale an opportunity tolower its debt and focus on its core business. As a condition of sale, $2.5million of the sale proceeds are being held in escrow for a period of 18 monthsto be available to satisfy any losses and indemnity claims against the Companythat may arise.  The Company realized again on the sale of the dunnage bag business as follows ($000’s):

 
| Sale price                                     |   | $       | 36,000 |   |
|------------------------------------------------|--------|---------|--------|--------|
| Working capital adjustment                     |   | 83      |   |
| Total cash proceeds                            |   | 36,083  |   |
| Transaction costs                              |   | (237    | )      |
| Net assets of dunnage bag business             |   | (18,447 | )      |
| Gain on sale before provision for income taxes |   | $       | 17,399 |   |

 

The following table showsthe major categories of net assets of the dunnage bag business as of March 31,2009 and December 31, 2008, respectively ($000’s):

 
| ** **                            | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
|---------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                            | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| Trade accounts receivable, net        |       | $                  | 2,793      |                  | $          | 2,742 |   |
| Inventories                           |       | 4,850              |       | 5,281                 |       |
| Plant, property and equipment         |       | 2,261              |       | 2,318                 |       |
| Intangible assets                     |       | 5,701              |       | 5,727                 |       |
| Goodwill                              |       | 3,934              |       | 1,064                 |       |
| Accounts payable and accrued expenses |       | (1,092             | )          | (2,522                | )          |
| Total net assets                      |       | $                  | 18,447     |                  | $          | 14,610 |   |

 

As a result of the sale,the Company recorded an earn-out liability of $4.0 million in accordance withthe Company’s asset purchase agreement dated June 23, 2006 withInternational Paper Company (“IP”). The terms of the asset purchase agreementinclude a contingent earn-out payment on the fifth anniversary of theacquisition; however, in the event of a sale of the dunnage bag business, priorto that date a percentage of the earn-out becomes due and payable within 30days following the sale, or April 30, 2009 provided certain criteria ismet. The contingent earn-out obligation is recorded in accrued expenses in theaccompanying consolidated balance sheet.

# ** **

# **Forsegment reporting purposes, the dunnage bag business is included in all other.**

# ** **

# **5.**                                      Alternative Fuel Tax Credit

# ** **

The federal governmenthas implemented an incentive program through the U.S. Internal Revenue Codethat provides payments under certain circumstances for the use of alternativefuels and alternative fuel mixtures in lieu of fossil-based fuels.  The credit is based on the amount ofalternative fuel contained in the mixture. KapStone qualifies for thealternative fuel mixtures tax credit because it uses a bio-fuel known as blackliquor, which is a byproduct of its wood pulping process, to power its mills.

 

In March, the Company wasnotified that its registration as an alternative fuel mixer was approved by theInternal Revenue Service. The Company submitted refund claims totaling $23.9million for the first quarter of 2009 covering fuel used at its Charleston millfrom January 29 through March 31 and at its Roanoke Rapids mill from February 14through March 31. On April 20, 2009, the Company received a $23.9million refund.   Thecredit is currently scheduled to expire on December 31, 2009.

 

The total amount of thealternative fuel tax credit recorded was $23.9 million in the first quarter of2009, however due to the Company’s accounting policy, $18.5 million wasincluded as a reduction to the cost of our finished goods inventory as of March 31,2009. The Company recorded $5.4 million as a reduction to cost of goods sold inthe quarter ended March 31, 2009.

# ** **

# **5**

# ****

# **Table of Contents**

# ** **

# **6.**                                      Inventories

# ** **

Inventories consist ofthe following at March 31, 2009, and December 31, 2008, respectively($000’s):

 
| ** **                     | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
|--------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                     | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| Raw materials                  |       | $                  | 17,052     |                  | $          | 19,877 |   |
| Work in process                |       | 2,829              |       | 2,070                 |       |
| Finished goods                 |       | 41,534             |       | 49,804                |       |
| Replacement parts and supplies |       | 17,841             |       | 17,941                |       |
|                           |       |               |       |                  |       |
| Inventories                    |       | $                  | 79,256     |                  | $          | 89,692 |   |

# ** **

# **7.**                                      Income Taxes

# ** **

The Company’s U.S.federal statutory income tax rate is 35% for 2009 and 2008. The Company’seffective tax rate for the three months ended March 31, 2009 and 2008 was45.0% and 36.8%, respectively.  The primary reasons for the higher 2009effective tax rate are a difference between the book and tax basis of thedunnage bag assets and a lower expected benefit from the domestic manufacturingtax deduction. Differences between the effective tax rate and the federalstatutory tax rate are due to the impact of state tax net of federal benefit,the domestic manufacturing tax deduction and the gain on the sale of thedunnage bag assets.

 

In the normal course ofbusiness, we are subject to examination by taxing authorities. The Company’sopen tax years are 2005 through 2008. The Company’s 2007 tax year is currentlyunder examination by the IRS.

 

**8.****            ****Net Income per Share**

 

Basic and diluted netincome per share is calculated as follows ($000’s except for share and pershare data):

 
| ** **                                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Net income as reported                                                   |       | $                                                    | 11,112     |   | $ | 7,230 |   |
| Weighted-average number of common shares for basic net income per  share |       | 28,370,248                                           |       | 25,282,047 |   |
| Incremental effect of dilutive common stock equivalents:                 |       |                                                 |       |   |   |
| Common stock warrants                                                    |       | —                                               |       | 9,219,778 |   |
| Unvested restricted stock awards                                         |       | 109,807                                              |       | 55,499 |   |
|                                                                     |       |                                                 |       |   |   |
| Weighted-average number of shares for diluted net income                 |       | 28,480,055                                           |       | 34,557,324 |   |
|                                                                     |       |                                                 |       |   |   |
| Net income per share — basic                                        |       | $                                                    | 0.39       |   | $ | 0.29 |   |
|                                                                     |       |                                                 |       |   |   |
| Net income per share — diluted                                      |       | $                                                    | 0.39       |   | $ | 0.21 |   |

 

Common stock warrants at March 31,2009, were not included in the calculation of diluted earnings per share sincethe weighted average share price per share of common stock for the quarterended March 31, 2009 was $1.91 compared to the warrant’s conversion priceof $5.00 and the effect would be anti-dilutive.

 

Stock option grantstotaling 1.3 million and 0.6 million were outstanding during the three monthperiods ended March 31, 2009 and 2008, but were not included in thecomputation of diluted earnings per share because the effect of including thestock option grants would be anti-dilutive.

 

Underwriter’s purchaseoption of 1,000,000 units were outstanding during the three month periods endedMarch 31, 2009 and 2008, but were not included in the computation ofdiluted earnings per share because the effect of including the underwriter’s optionwould be anti-dilutive.

 

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# **9.**                                      Pension Plan and Post Retirement Benefits

# ** **

**DefinedBenefit Plan**

 

The KapStone Paper andPackaging Corporation Defined Benefit Plan (“Plan”) provides benefits forapproximately 1,000 union employees.

 

As part of the July 1,2008 Charleston Kraft Division acquisition, approximately 615 union employeeswere added to the Company’s Plan. As a consequence of the sale of the dunnagebag business approximately 124 union employees ceased earning benefits underthe Plan as of March 31, 2009.

 

Net pension costrecognized for the three months ended March 31, 2009 and 2008 for thePlan, is as follows ($000’s):

 
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                          | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
|                                                |       |                                            |       |   |   |
| Service cost for benefits earned during the quarter |       | $                                               | 739        |   | $ | 306 |   |
| Interest cost on projected benefit obligations      |       | 93                                              |       | 39 |   |
| Expected return on plan assets                      |       | (38                                             | )          | (6 | ) |
| Net pension cost                                    |       | $                                               | 794        |   | $ | 339 |   |

 

KapStone funds its Planaccording to IRS funding requirements. Based on those limitations, KapStoneexpects to fund $7.5 million to the Plan in 2009.

 

**OtherPost-retirement Benefits**

 

Net post-retirement costrecognized for each of the three months ended March 31, 2009 and 2008 forthe Company’s retiree medical and life insurance plan was less than $0.1million.

 

**DefinedContribution Plans**

 

The KapStone DefinedContribution Plan (“Plan”) covers all eligible employees. Company contributionsto the Plan are based on matching of employee contributions, vest immediatelyfor salaried and non-bargained hourly employees and vest after three years forunion employees. For the three months ended March 31, 2009 and 2008, theCompany recognized expense of $0.8 million and $0.4 million, respectively, formatching contributions.

 

The Company’s RetirementSavings Plan, which covers all eligible salaried and non-bargained hourlyemployees, provides for contributions based on an employee’s salary andage.  The Company contributions vest 100% after three years. For the threemonths ended March 31, 2009 and 2008, the Company recognized expense of $0and $0.2 million, respectively.

 

The Company temporarilysuspended these benefits for salaried and non-bargained hourly employees on March 1,2009 due to current economic conditions.

 

**10.****         ****Stock-Based Compensation**

 

On December 29,2006, stockholders approved the 2006 Incentive Plan (“2006 Plan”).  Amaximum of 3.0 million shares of our common stock, available for issuancepursuant to stock options, restricted stock awards or stock appreciation rights(collectively called “Awards”), may be granted under the 2006 Plan. At March 31,2009, 1.3 million shares are reserved for future awards under the 2006Plan.  If any Award is forfeited orexpires without being exercised, or if restricted stock is repurchased by theCompany, the shares of stock subject to the Award shall be available foradditional grants under the 2006 Plan. The number of shares available under the2006 Plan is subject to adjustment in the event of any stock split, stockdividend, recapitalization, spin-off or other similar action. Awards may begranted to employees, officers and directors of, and consultants or advisorsto, the Company and any subsidiary corporations. Options intended to qualify,under 

 

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the standards set forthin certain federal tax rules, as incentive stock options (“ISOs”) may begranted only to employees while actually employed the Company. Non-employeedirectors, consultants and advisors are not entitled to receive ISOs. OptionAwards granted under the 2006 Plan are exercisable for a period fixed by theadministrator, but not longer than 10 years from the date of grant, at anexercise price which is not less than the fair market value of the shares onthe date of the grant.

 

The Company accounts forstock awards under SFAS No. 123(R), *Share-BasedPayment*, which requires that the cost resulting from all share-basedpayment transactions be recognized as compensation cost over the vesting periodbased on the fair value of the instrument on the date of grant. The Companyrecognized $0.5 million and $0.2 million of compensation cost for the threemonths ended March 31, 2009 and 2008, respectively.

 

**StockOptions**

 

Stock options grantedunder the 2006 Plan vest as follows: 50% after two years and the remaining 50%after three years.  The stock options have a contractual term of seven toten years. The stock options are subject to forfeiture should these employeesterminate their employment with the Company for certain reasons prior tovesting in their awards, or the occurrence of certain other events such astermination with cause. The exercise price of these stock options is based onclosing market price of our common stock on the date of grant and compensationexpense is recorded on an accelerated basis over the awards’ vesting periods.

 

A summary of informationrelated to stock options is as follows:

 
| ** **                          | ** ** | ** **  | ** ** | **Weighted** | ** ** | **Weighted**          | ** ** | **Intrinsic**        | ** ** |
|-------------------------------------|------------|-------------|------------|--------------|------------|-----------------------|------------|----------------------|------------|
| ** **                          | ** ** | ** **  | ** ** | **Average**  | ** ** | **Average**           | ** ** | **Value**            | ** ** |
| ** **                          | ** ** | ** **  | ** ** | **Exercise** | ** ** | **Remaining**         | ** ** | **(dollars in** | ** ** |
| ** **                          | ** ** | **Options** | ** ** | **Price**    | ** ** | **Life (Years)** | ** ** | **Thousands)**       | ** ** |
| Outstanding at January 1, 2009 |       | 1,346,347   |       | $            | 6.87       |                  | 7.7        |                 | $          | (6,045 | ) |
| Granted                             |       | —      |       | —       |       | —                |       | —               |       |
| Exercised                           |       | —      |       | —       |       | —                |       | —               |       |
| Lapsed (forfeited or canceled)      |       | (9,522      | )          | 6.85         |       | —                |       | —               |       |
| Outstanding at March 31, 2009  |       | 1,336,825   |       | $            | 6.87       |                  | 7.3        |                 | $          | (5,896 | ) |
| Exercisable at March 31, 2009  |       | —      |       | —       |       |                  |       |                 |       |

 

Total stock-basedcompensation expense related to the stock option grants was $0.3 million and$0.1 million for the three months ended March 31, 2009 and 2008,respectively.

 

As of March 31, 2009and 2008, there was $1.2 million and $0.8 million, respectively, of totalunrecognized compensation cost related to non-vested stock options. That costis expected to be recognized over a weighted average period of 1.6 years. Nostock options were vested as of March 31, 2009 and 2008.

 

**RestrictedStock**

 

The Company’sCompensation Committee grants restricted shares of common stock to executiveofficers and employees as compensation for service. These common stock sharesare restricted as to transferability until they vest three years from the grantdate. These restricted shares are subject to forfeiture should these employeesterminate their employment with the Company for certain reasons prior tovesting in their awards, or the occurrence of certain other events. The valueof these restricted shares is based on the closing market price of our common stockon the date of grant and compensation expense is recorded on a straight-linebasis over the awards’ vesting periods.

 

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The following tablesummarizes our restricted stock amounts and activity:

 
| ** **                              | ** ** | ** ** | ** ** | **Weighted** | ** ** |
|-----------------------------------------|------------|------------|------------|--------------|------------|
| ** **                              | ** ** | ** ** | ** ** | **Average**  | ** ** |
| ** **                              | ** ** | **Units/** | ** ** | **Grant**    | ** ** |
| ** **                              | ** ** | **Shares** | ** ** | **Price**    | ** ** |
| **Outstanding at January 1, 2009** |       | 368,903    |       | $            | 6.88       |   |
| Granted                                 |       | —     |       | —       |       |
| Vested                                  |       | —     |       | —       |       |
| Forfeited                               |       | (3,098     | )          | 6.84         |       |
| **Outstanding at March 31, 2009**  |       | 365,805    |       | $            | 6.88       |   |

 

Total stock-basedcompensation expense related to the restricted stock awards was $0.2 millionand $0.1 million for the three months ended March 31, 2009 and 2008,respectively.

 

As of March 31, 2009and 2008, there was $1.3 million and $0.7 million, respectively, of totalunrecognized compensation cost related to the restricted stock which will berecognized over the remaining vesting period of approximately 1.6 years.

 

# **11.**                             Stockholder’s Equity

# ** **

 In connection withthe Company’s initial public offering, on August 19, 2005, the Companysold 20,000,000 units (“Units”) for a gross price of $6.00 per Unit. Each Unitconsists of one share of the Company’s common stock, $0.0001 par value, and twowarrants. Each warrant entitles the holder to purchase from the Company oneshare of common stock at an exercise price of $5.00 and expires on August 15,2009. The warrants are redeemable by the Company at a price of $0.01 perwarrant upon 30 days notice after the warrants become exercisable, only inthe event that the last sale price of the common stock is at least $8.50 pershare for any 20 trading days within a 30 day trading period ending on thethird day prior to the date on which notice of redemption is given. The shareprice of the Company’s common stock at March 31, 2009 was $2.46.

 

**12.****         ****Segment Information**

 

The Company has tworeportable segments, unbleached kraft and all other.  The unbleached kraft segment consists of theCompany’s paper mills in Roanoke Rapids, North Carolina and North Charleston,South Carolina, which produce unbleached kraft paper, linerboard, unbleachedkraft board and saturating kraft. These products are sold to customers whoconvert our products into end-market finished products. The all other segmentconsists of the Company’s dunnage bag business, based in Fordyce Arkansas,which convert unbleached kraft paper and film into inflatable dunnage bags andthe lumber mill operations, based in Summerville, South Carolina, which producedimensional softwood board lumber that is sold primarily to regional and localretailers, wood treating operations and industrial customers.

 

On March 31, 2009the Company consummated the sale of its dunnage bag business to Illinois ToolWorks Inc.

 

Corporate expenses thatbenefit the entire organization are not charged to the operating segments.

 
| ** **                                                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **Operating Segment (in thousands of U.S. dollars):** | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Net sales:                                                                          |       |                                                 |       |   |   |
| Unbleached kraft                                                                    |       | $                                                    | 129,460    |   | $ | 60,360 |   |
| All other                                                                           |       | 12,023                                               |       | 7,892 |   |
| Intersegment sales                                                                  |       | (899                                                 | )          | (1,123 | ) |
|                                                                                |       |                                                 |       |   |   |
| Total                                                                               |       | $                                                    | 140,584    |   | $ | 67,129 |   |
|                                                                                |       |                                                 |       |   |   |
| Net sales to external customers:                                                    |       |                                                 |       |   |   |
| Unbleached kraft                                                                    |       | $                                                    | 128,605    |   | $ | 59,237 |   |
| All other                                                                           |       | 11,979                                               |       | 7,892 |   |
|                                                                                |       |                                                 |       |   |   |
| Total                                                                               |       | $                                                    | 140,584    |   | $ | 67,129 |   |
|                                                                                |       |                                                 |       |   |   |
| Operating income / (loss):                                                          |       |                                                 |       |   |   |
| Unbleached kraft                                                                    |       | $                                                    | 15,482     |   | $ | 14,550 |   |
| All other                                                                           |       | (837                                                 | )          | 1,331 |   |
| Gain on sale of business                                                            |       | 17,399                                               |       | — |   |
| Corporate                                                                           |       | (5,807                                               | )          | (4,236 | ) |
|                                                                                |       |                                                 |       |   |   |
| Total                                                                               |       | $                                                    | 26,237     |   | $ | 11,645 |   |

 

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| ** **                     | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
|--------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| **Operating Segment ($000s):** | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| Total assets:                  |       |               |       |                  |       |
| Unbleached kraft               |       | $                  | 658,809    |                  | $          | 657,610 |   |
| All other                      |       | 22,559             |       | 39,128                |       |
| Corporate                      |       | 16,310             |       | 30,452                |       |
|                           |       |               |       |                  |       |
| Total                          |       | $                  | 697,678    |                  | $          | 727,190 |   |

 

**Item 2.****                        ****MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This Quarterly Report on Form 10-Qincludes forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. We have based these forward-lookingstatements on our current expectations and projections about future events.These forward-looking statements are subject to known and unknown risks,uncertainties and assumptions about us that may cause our actual results,levels of activity, performance or achievements to be materially different fromany future results, levels of activity, performance or achievements expressedor implied by such forward-looking statements. In some cases, you can identifyforward-looking statements by terminology such as “may,” “should,” “could,” “would,”“expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” or the negativeof such terms or other similar expressions. Factors that might cause orcontribute to such a discrepancy include, but are not limited to, thosedescribed in Part II Item 1A in this Form 10-Q and in our otherSecurities and Exchange Commission filings.  The information contained inthis form 10-Q represents our best judgment at the date of this report based oninformation currently available.  In providing forward-looking statements,KapStone does not intend, and does not undertake any duty or obligations, toupdate its statements as a result of new information, future events orotherwise.

 

The following discussionshould be read in conjunction with our Consolidated Financial Statements andrelated Notes thereto included elsewhere in this report.

 

**Overview**

 

We were formed on April 15,2005 to serve as a vehicle to effect a merger, capital stock exchange, assetacquisition or other similar business combination with an operating business inthe paper, packaging, forest products and related industries.

 

On January 2, 2007,the Company purchased substantially all of the assets and  assumed certain liabilities of the KraftPapers Business (“ KPB”), a division of IP, consisting of an unbleached kraftpaper manufacturing facility in Roanoke Rapids, North Carolina and Ride Rite®Converting, an inflatable dunnage bag manufacturer located in Fordyce,Arkansas, for a cash purchase price of $155 million in cash, less certainpost-closing adjustments of $7.8 million, plus two contingent earn-out paymentsof up to $60 million (in aggregate), based on KPB’s annual earnings beforeinterest, income taxes, depreciation and amortization, or EBITDA, during thefive years immediately following the acquisition.

 

On July 1, 2008, theCompany consummated an asset purchase agreement with MeadWestvaco Corporation (“MWV”)to purchase substantially all of the assets and assume certain liabilities ofMWV’s Charleston Kraft Division (“CKD”) for $485 million, subject to certainclosing adjustments.  The acquisitionconsists of an unbleached kraft paper manufacturing facility in NorthCharleston, South Carolina, including a cogeneration facility, chip millslocated in Elgin, Hampton, Andrews and Kinards, South Carolina and a lumbermill located in Summerville, South Carolina.

 

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The results reportedbelow do not reflect any actual or pro forma adjustments related to theacquisition prior to the consummation of the acquisition on July 1, 2008.The results reported below include the results of CKD since the date ofacquisition, July 1, 2008.

 

On March 31, 2009the Company consummated the sale of its dunnage bag business for $36.0million.  The results of operations forthe dunnage bag business are included below in the all other segment until thedate of the sale.

 

# **As aresult of the sale of the dunnage bag business, the Company recorded anearn-out liability of $4.0 million in accordance with the IP asset purchaseagreement. The earn-out is recorded in accrued expenses at March 31, 2009and was paid on April 30, 2009.**

# ** **

# **Inconnection with the sale of the dunnage bag business the Company entered into along-term paper supply agreement with ITW.**

# ** **

**Comparisonof Results of Operations for the Three Months Ended March 31, 2009 and theThree Months Ended March 31, 2008**

 
| ** **                                              | ** ** | **Three Months Ended March 31,** | ** ** | **Increase/** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------------------|------------|---------------|------------|
| **(in thousands of U.S. dollars):** | ** ** | **2009**                                             | ** ** | **2008**      | ** ** | **(Decrease)** | ** ** |
| Net sales                                               |       | $                                                    | 140,584    |          | $          | 67,129 |   | $ | 73,455 |   |
| Cost of sales, excluding depreciation and amortization  |       | 96,484                                               |       | 41,558        |       | 54,926 |   |
| Freight and distribution expenses                       |       | 13,328                                               |       | 6,587         |       | 6,741 |   |
| Selling, general and administrative expenses            |       | 8,557                                                |       | 4,930         |       | 3,627 |   |
| Depreciation and amortization                           |       | 13,609                                               |       | 2,593         |       | 11,016 |   |
| Gain on sale of business                                |       | 17,399                                               |       | —        |       | 17,399 |   |
| Other operating income                                  |       | 232                                                  |       | 184           |       | 48 |   |
| Operating income                                        |       | 26,237                                               |       | 11,645        |       | 14,592 |   |
| Foreign exchange loss                                   |       | 298                                                  |       | —        |       | 298 |   |
| Interest income                                         |       | 1                                                    |       | 547           |       | (546 | ) |
| Interest expense                                        |       | 5,733                                                |       | 753           |       | 4,980 |   |
| Income before provision for income taxes                |       | 20,207                                               |       | 11,439        |       | 8,768 |   |
| Provision for income taxes                              |       | 9,095                                                |       | 4,209         |       | 4,886 |   |
| Net income                                              |       | $                                                    | 11,112     |          | $          | 7,230 |   | $ | 3,882 |   |

 

Net sales for the quarterended March 31, 2009 were $140.6 million compared to $67.1 million for thefirst quarter of 2008, an increase of $73.5 million or 109.5%. The increase innet sales was driven by the CKD acquisition on July 1, 2008, whichaccounted for $85.8 million of the increase. Excluding the CKD acquisition,sales volume was lower in the first quarter of 2009 compared to the firstquarter of 2008 by $11.4 million, mainly due to lower demand reflecting currenteconomic conditions.

 

Cost of sales for thequarter ended March 31, 2009 was $96.5 million compared to $41.6 millionfor the first quarter of 2008, an increase of $54.9 million, or 132.0%. Theincrease in cost of sales was mainly due to the CKD acquisition, whichaccounted for $66.1 million of the increase and was partially offset by $5.4million for the alternative fuel tax credit, which reduced our cost of sales.The total amount of the alternative fuel tax recorded was $23.9 million,covering fuel used at the Charleston mill from January 29 through March 31and at the Roanoke Rapids mill from February 14 through March 31,however due to our accounting policy, $18.5 million was included as a reductionto the cost of our finished goods inventory as of March 31, 2009.Excluding the impact of the CKD acquisition, cost of sales decreased by $5.1million mainly due to lower sales volume partially offset by inflation on rawmaterials of approximately $0.8 million, primarily as a result of higher costsfor caustic soda and coal.

 

Freight and distributionexpenses for the quarter ended March 31, 2009 totaled $13.3 millioncompared to $6.6 million for the quarter ended March 31, 2008. Theincrease of $6.7 million was primarily due to the CKD acquisition, whichaccounted for $8.3 million of the increase. Excluding the CKD acquisition,freight and distribution expenses were lower due to a 20% reduction in sales volume,mainly due to lower demand reflecting current economic conditions and lowerfuel oil surcharges.

 

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Selling, general andadministrative expenses for the quarter ended March 31, 2009 totaled $8.6million compared to $4.9 million for the quarter ended March 31, 2008. Theincrease of $3.7 million reflects $1.9 million of CKD’sdirect selling and administrative expenses, $1.6 million of transitionalservices provided by MWV and $0.9 million of CKD acquisition support expensesoffset by $0.8 million of lower compensation and benefit expenses as theCompany temporarily suspended certain benefits as a result of current economic conditions.

 

Depreciation andamortization for the quarter ended March 31, 2009 totaled $13.6 millioncompared to $2.6 million for the quarter ended March 31, 2008. Theincrease of $11.0 million is primarily due to the CKD acquisition, which addedan additional $7.2 million of depreciation and $3.4 million of amortization ofintangibles, including $2.4 million of amortization for the intangible assetrelated to an acquired coal contract with below market prices at July 1,2008. The acquired coal contract expires December 31, 2009. The balance ofthe increase mainly reflects amortization of the Company’s new ERP system whichwas placed into service in April 2008.

 

The $17.4 million gain onsale of business is the result of the sale of the dunnage bag business toIllinois Tool Works Inc.

 

Interestincome for the quarter ended March 31, 2009 decreased by $0.5 millioncompared with the same period in 2008, reflecting lower cash balances beinginvested as the Company used cash and cash equivalents to fund a portion of theCKD acquisition.

 

Interestexpense for the quarters ended March 31, 2009 and 2008 was $5.7 millionand $0.8 million, respectively. Interest expense reflects interest on theCompany’s long-term debt and amortization of debt issuance costs. Interestexpense was $5.0 million higher in the quarter ended March 31, 2009primarily due to higher debt levels relating to the CKD acquisition. Amortizationof debt issuance costs for the quarters ended March 31, 2009 and 2008 was$0.8 million and $0.1 million, respectively, and reflects higher costs for thenew Senior Credit Facility.

 

Provisionfor income taxes for the quarters ended March 31, 2009 and 2008 were $9.1million and $4.2 million, respectively, reflecting an effective tax rate of45.0% compared to 36.8% for the similar period in 2008. The primary reasons forthe increase in the effective tax rate are due to differences between the bookand tax basis of the dunnage bag assets and a lower expected benefit from thedomestic manufacturing tax deduction.

 

**S****egment Results**

 

The following tablepresents a reconciliation of consolidated net sales and operating income toamounts reported by operating segment:

 
| ** **                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|
| **Operating Segment ($000’s):** | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Consolidated net sales:                        |       |                                                 |       |   |   |
| Unbleached kraft                               |       | $                                                    | 129,460    |   | $ | 60,360 |   |
| All other                                      |       | 12,023                                               |       | 7,892 |   |
| Intersegment sales                             |       | (899                                                 | )          | (1,123 | ) |
|                                           |       |                                                 |       |   |   |
| Total net sales                                |       | $                                                    | 140,584    |   | $ | 67,129 |   |
|                                           |       |                                                 |       |   |   |
| Operating income / (loss):                     |       |                                                 |       |   |   |
| Unbleached kraft                               |       | $                                                    | 15,482     |   | $ | 14,550 |   |
| All other                                      |       | (837                                                 | )          | 1,331 |   |
| Gain on sale of business                       |       | 17,399                                               |       | — |   |
| Corporate                                      |       | (5,807                                               | )          | (4,236 | ) |
|                                           |       |                                                 |       |   |   |
| Total operating income                         |       | $                                                    | 26,237     |   | $ | 11,645 |   |

 

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The following representsanalysis and commentary for results of operations for the Company’s twooperating segments: unbleached kraft and all other.

 

***Unbleached Kraft***

 
| ** **                      | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Net sales                       |       | $                                                    | 129,460    |   | $ | 60,360 |   |
| Operating income                |       | $                                                    | 15,482     |   | $ | 14,550 |   |
| Operating income % of net sales |       | 12.0                                                 | %          | 24.1 | % |
|                            |       |                                                 |       |   |   |
| Average revenue per ton         |       | $                                                    | 595        |   | $ | 571 |   |
| Tons of paper sold              |       | 217,412                                              |       | 105,650 |   |

 

For the three monthsended March 31, 2009, unbleached kraft segment net sales increased by$69.1 million, or 114.4%, to $129.5 million compared to$60.4 million for the three months ended March 31, 2008. The increasein net sales is due to the CKD acquisition, which increased sales by $80.7million and 132,503 tons of paper sold. Average selling prices in the firstquarter of 2009 were $595/ton, or $24/ton higher than average selling prices inthe first quarter of 2008. Excluding the acquisition, net sales were lower by$11.6 million in the first quarter of 2009 compared to the first quarter of2008, mainly due to lower demand reflecting current economic conditions.

 

Unbleached kraft segmentoperating income increased by $0.9 million, or 6.2%, to $15.5 millionfor the three months ended March 31, 2009 compared to $14.6 millionfor the three months ended March 31, 2008.Operating income increasedprimarily due to the alternate fuel mixture tax credit of $5.4 million, andsalary and benefit curtailments of $1.5 million offset by lower sales volume of$3.9 million, inflation on raw materials and energy of $0.8 million, severancecosts of $0.7 million and bad debt expense of $0.5 million (due to a customer’sbankruptcy). Included in operating income is a $2.4 million charge for theamortization of an intangible asset recorded for an acquired coal contract withfavorable prices valued at $14.1 million at the date of acquisition.  The coal contract and its relatedamortization expense will terminate December 31, 2009.

 

For the quarter ending March 31,2009, operating income as a percentage of net sales declined to 12.0% from24.1% for the first quarter of 2008 mainly due to lower margin on sales forCKD.

 

***All Other***

* *
| ** **                      | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Net sales                       |       | $                                                    | 12,023     |   | $ | 7,892 |   |
| Operating loss                  |       | $                                                    | (837       | ) | $ | 1,331 |   |
| Operating income % of net sales |       | -7.0                                                 | %          | 16.9 | % |

 

For the three monthsended March 31, 2009, net sales for the all other segment increased by$4.1 million, or 51.2%, to $12.0 million compared to $7.9 million for the firstthree months of 2008. The increase is due to the acquisition of the CKD lumberbusiness, which increased sales by $5.1 million, offset by a $1.0 million decreasein sales of dunnage bags.

 

Operating loss for thethree months ended March 31, 2009 was $0.8 million reflecting low salesvolume and selling prices in the lumber business, mainly due to a continuedslowdown in the number of new housing starts, lower consumer spending and lowervolume in dunnage bag sales.

 

***Corporate***

 

Corporate expenses forthe three months ended March 31, 2009 totaled $5.8 million comparedto $4.2 million for the year three months March 31, 2008. Theincrease of $1.6 million is primarily due to support services related tothe CKD acquisition partially offset by $0.8 million of lower compensation andbenefit expenses as the Company temporarily suspended certain benefits as aresult of current economic conditions.

 

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**Liquidityand Capital Resources**

 

***Senior Credit Agreement and Senior Notes***

 

We entered into a SeniorCredit Agreement, dated as of June 12, 2008. The Senior Credit Agreementprovides for an aggregate of up to $515 million consisting of a $390 millionterm A loan facility, a $25 million term B loan facility and a $100 millionrevolving credit facility (including a letter of credit subfacility).  The Senior Credit Facilities are guaranteedby KapStone Kraft and our other domestic subsidiaries and are secured bysubstantially all of our assets, including all of our capital stock, thecapital stock of our guarantor subsidiaries and up to 66% of the capital stockof our foreign subsidiaries.

 

At March 31, 2009, the Company had $29.3million outstanding against the revolver, or a net increase of $16.9 millionduring the quarter ended March 31, 2009.

 

In addition, $40 millionof 8.3% seven year senior notes were issued as part of the financing for theCKD acquisition.

 

***Debt Covenants***

 

Under the financialcovenants of the Senior Credit Agreement, KapStone must comply on a quarterlybasis with a maximum permitted leverage ratio that is currently 3.5 to 1. TheSenior Credit agreement also includes a financial covenant requiring a minimumfixed charge coverage ratio that is 1.1 to 1. As of March 31, 2009 the Company was in compliance with the SeniorCredit Agreement with a leverage ratio of 3.26 to 1.00 and a fixed chargecoverage ratio of 1.70 to 1.00.

 

***Alternative Fuel Tax Credit***

 

On March 31, 2009, the Company receivedapproval from the IRS for its registration as an alternative fuel mixer, whichprovides for a refund of $0.50 per gallon of alternate fuel used in the Company’spulp making process. As a result, for the three months ending March 31,2009, the Company recorded a refund totaling $23.9 million which wassubsequently received on April 20, 2009. The Company expects future quarterly refunds in 2009 to approximate $44million.

 

The alternative fuel tax credit expires on December 31,2009.

 

***Sale of Dunnage Bag Business***

 

On March 31, 2009 the Company sold its dunnagebag business to Illinois Tool Works Inc. for $36.0 million. Of the net cash proceeds,$32.8 million was required to pay down the Company’s long-term debt and notesunder the terms of the Senior Credit Agreement. Pursuant to the terms of the sale, $2.5 million of the proceeds arebeing held in escrow for 18 months.

 

***IncomeTaxes***

 

In the quarter ended March 31,2009, the Company received a $9.3 million federal income tax refund. Anadditional federal income tax refund of $4.3 million is expected later in 2009.

 

***Sources and Uses of Cash***

 
| **Three months ended March 31 ($000’s)** | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating activities                                                   |       | $          | (3,594     | )          | $          | 9,916 |   |
| Investing activities                                                   |       | 27,260     |       | (2,770     | )          |
| Financing activities                                                   |       | (26,311    | )          | (3,521     | )          |
|                                                                        |            |            |            |            |            |  |  |

 

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Cash flow from allactivities during the quarter ended March 31, 2009 decreased cash by $2.6million from December 31, 2008, reflecting cash used in operations of $3.6million, net cash provided by investing activities of $27.3 million and netcash used in financing activities of $26.3 million.

 

Net cash used inoperating activities was $3.6 million due to net income for the quarter of$11.1 million and non-cash charges of $22.5 million offset by the gain on saleof the dunnage bag business of $17.4 million. Changes in operating assets andliabilities used $19.8 million of cash reflecting a $23.8 million increase inother receivables, primarily for the alternate fuel tax credit; $14.5 millionof lower accrued expenses, reflecting payment of annual property taxes andinterest and $5.3 million of lower accrued compensation costs. Partiallyoffsetting these items were lower trade receivables of $12.0 million due tolower sales volume and lower refundable and prepaid taxes due to receipt of a$9.3 million federal income tax refund.

 

Net cash provided byinvesting activities was $27.3 million reflecting proceeds from the sale of thedunnage bag business of $36.1 million partially offset by capital expendituresof $6.3 million and $2.5 million of proceeds from the sale of the dunnage bagbusiness held in escrow. For the quarter ended March 31, 2009, capitalexpenditures include $5.9 million for the unbleached kraft segment forequipment upgrades and replacements at the paper mills. In addition, $0.4million was spent on IT systems projects.

 

Net cash used infinancing activities totaled $26.3 million during the quarter ended March 31,2009, and reflects $63.8 million of repayments on long-term debt, notes andrevolver offset by borrowings under the revolving credit facility of $37.9million and $0.4 million in expenses paid in connection with an amendment tothe Senior Credit Agreement.

 

***Future Cash Needs***

 

We expect that cashgenerated from operating activities, and if needed, the ability to draw fromour revolving credit facility will be sufficient to meet the anticipated 2009cash needs. The Company expects to spend approximately $27.0 million on capitalexpenditures in 2009. In addition, the Company has $25.4 million of requiredlong-term debt repayments for the balance of 2009.

 

**Off-BalanceSheet Arrangements**

 

We have not entered intoany off-balance sheet financing arrangements and have not established anyspecial purpose entities. We have not guaranteed any debt or commitments ofother entities or entered into any options on non-financial assets.

 

**Item 3. —    QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Market risk is thesensitivity of income to changes in interest rates, commodity prices, equityprices, and other market-driven rates or prices.

 

Under KapStone Kraft’s new Senior Credit Facilities, we have two termloans totaling $348.5 million and a revolving loan of $29.3 million outstandingat March 31, 2009.  The maturitydate is the earlier of:  (a) June 12,2013 with respect to the term A loan facility and the revolving creditfacility, and June 12, 2015 with respect to the term B loan facility, and (b) thedate which is 90 days prior to the date on which any earn-out, obligations toIP will become (or are reasonably expected to become) due, excluding theearn-out as a result of the sale of the dunnage bag business; provided that thematurity date will not be so accelerated if, among other things, the totalleverage ratio as of the end of the then most recent fiscal quarter, is lessthan 2.0 to 1.0.

 

Changes in market ratesmay impact the base rate in our Senior Credit Agreement. For instance, if thebank’s LIBOR rate was to increase or decrease by one percentage point (1.0%),our annual interest expense would change by approximately $3.4 million basedupon our expected future monthly loan balances per our existing repaymentschedule.

 

We are exposed to pricefluctuations of certain commodities used in production. Key raw materials andenergy used in the production process include roundwood and woodchips, fueloil, electricity and caustic soda.  Wepurchase these raw materials and energy at market prices, and do not useforward contracts or other financial instruments to hedge our exposure to pricerisk related to these commodities.  Wehave two contracts to purchase coal at fixed prices that expire on December 31,2009.

 

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We are exposed tocurrency fluctuations as we invoice certain European customers in euros. Attimes, the Company has used forward contracts to reduce the impact of currencyfluctuations. No such contracts were outstanding at March 31, 2009.

 

 **Item 4. —CONTROLS ANDPROCEDURES**

 

As of the end of theperiod covered by this report, our Chief Executive Officer and our ChiefFinancial Officer carried out an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures, as required by Rule 13a-15(b) underthe Securities Exchange Act of 1934. Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures were effective as of March 31, 2009.

 

There were no changes inour internal control over financial reporting during the three months ended March 31,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II. — OTHER INFORMATION**

 

**Item 1. —    LEGAL PROCEEDINGS**

 

None.

 

**Item 1A. — RISK FACTORS**

 

With the exception of thefollowing update to the risk factors relating to the alternative fuel mixturetax credit, there have been no material changes from the Risk Factors describedin our Form 10-K for the year ended December 31, 2008 (“Form 10-K”). The Risk Factor below should be read in conjunction with the Risk Factors andinformation disclosed in our Form 10-K.

 

Thealternative fuel mixture tax credit provided by the U.S. government is beingchallenged in Congress and may be amended in a manner that eliminates orreduces the benefits of the tax credit for pulp and paper companies.

 

The U.S. governmentprovides an excise tax credit to taxpayers for the use of alternative fuelmixtures.  The alternative fuel mixture tax credit, as it relates toliquid fuel derived from biomass, is scheduled to expire on December 31,2009.  In recent weeks, certain members of Congress and others haveindicated their opposition to pulp and paper companies receiving the taxcredit.  They have called for the amendment of the tax credit in amanner that would eliminate or reduce its benefits for pulp and papercompanies.  In response, other members of Congress and interestedparties have voiced their support for maintaining the tax credit and itsavailability to all taxpayers, including pulp and paper companies.  Wedo not know whether the U.S. government will amend the tax credit to eliminateor reduce its benefits for pulp and paper companies, but there is thepossibility that such action may be taken.  Any such amendment of thetax credit could have a material adverse effect on our financial condition andresults of operations.

 

**Item 2. —    UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None.

 

**Item 3. —    DEFAULTS UPON SENIORSECURITIES**

 

None.

 

**Item 4. —    SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

None.

 

**Item 5. —    OTHER INFORMATION**

 

None.

 

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**Item 6. —    EXHIBITS**

 

The following Exhibitsare filed as part of this report.

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                           |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                      |
| 10.1             |       | Second Amendment and  Limited Waiver Agreement dated as of March 30, 2009 by and amongKapstone Kraft Paper Corporation,  KapStone Paper and Packaging Corporation, the lenders who are a party thereto  and Bank of America N.A. (1) |
|             |       |                                                                                                                                                                                                                                      |
| 10.2             |       | Limited Waiver and  Amendment Number 2 to Note Agreement dated as of March 27, 2009 among  KapStone Kraft Paper Corporation, KapStone Paper and Packaging Corporation  and The Prudential Insurance Company of America. (1)          |
|             |       |                                                                                                                                                                                                                                      |
| 31.1             |       | Certification of Chief  Executive Officer Pursuant to Rule 13a-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 of Chief  Financial Officer Pursuant to Rule 13a-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 of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                            |
|             |       |                                                                                                                                                                                                                                      |
| 32.2             |       | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                            |
|             |       |                                                                                                                                                                                                                                      |
|                  |
| (1)              |       | Incorporated by  reference to the Registrant’s Current Report on Form 8-K dated March 27,  2009.                                                                                                                           |

 

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**SIGNATURES**

 

In accordance withthe requirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|              | KAPSTONE PAPER AND  PACKAGING CORPORATION |
|-------------------|-------------------------------------------|
|              |                                      |
|              |                                      |
| May 11, 2009 | By:                                       | /s/ Andrea K. Tarbox |
|              |                                      | Andrea K. Tarbox |
|              |                                      | Vice President and  Chief Financial Officer |

 

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