** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

** **

**x****       ****Quarterly Report Pursuant toSection 13 or 15(d) of the SecuritiesExchange Act of 1934**

**For the quarterly period endedSeptember 30, 2006.**

**or**

**o****          ****ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

**For the transition periodfrom                         to                          .**

**Commission File Number:000-51444**

** **

**Stone Arcade Acquisition Corporation**

(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.) |

 

**c/o Stone-KaplanInvestments, LLC, One Northfield Plaza, Suite 480**

**Northfield, IL 60093**

(Address of Principal Executive Offices including zipcode)

 

**(847) 441-0929**

(Registrant’s Telephone Number, Including Area Code)

 

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

Yes xNo o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of theExchange Act).
| Large Accelerated Filer  o | Accelerated  Filer o | Non-Accelerated  Filer x |
|----------------------------|----------------------|--------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).Yes x No o

There were 25,000,000 shares of the Registrant’sCommon Stock issued and outstanding on November 10, 2006.

 

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**Stone Arcade Acquisition Corporation Index to Form10-Q**

**TABLE OF CONTENTS**

| PART I. — FINANCIAL INFORMATION                                                         |   |
|----------------------------------------------------------------------------------------------|--------|
|                                                                                         |   |
| Item 1. —  FINANCIAL STATEMENTS (UNAUDITED) AND NOTES TO FINANCIAL STATEMENTS           | 2      |
|                                                                                         |   |
| Item 2. —  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS | 9      |
|                                                                                         |   |
| Item 3. —  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   | 12     |
|                                                                                         |   |
| Item 4. — CONTROLS  AND PROCEDURES                                                      | 12     |
|                                                                                         |   |
| PART II. — OTHER  INFORMATION                                                           |   |
|                                                                                         |   |
| Item 1. — LEGAL  PROCEEDINGS                                                            | 13     |
|                                                                                         |   |
| Item 1A. — RISK FACTORS                                                                 | 13     |
|                                                                                         |   |
| Item 2. —  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                  | 13     |
|                                                                                         |   |
| Item 3. —  DEFAULTS UPON SENIOR SECURITIES                                              | 14     |
|                                                                                         |   |
| Item 4. —  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                          | 14     |
|                                                                                         |   |
| Item 5. — OTHER  INFORMATION                                                            | 14     |
|                                                                                         |   |
| Item 6. — EXHIBITS                                                                      | 14     |
|                                                                                         |   |
| SIGNATURES                                                                                   |   |

 

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**Stone Arcade AcquisitionCorporation**

**(a development stage company)**

**Condensed Consolidated Balance Sheets**
| ** **                                                                                                                                                                      | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **2006**               | ** **  | **2005**              | ** ** |
| ** **                                                                                                                                                                      | ** ** | **(unaudited)**        | ** **  |
| **Assets**                                                                                                                                                                      |       |                   |        |                  |       |
| Current assets:                                                                                                                                                                 |       |                   |        |                  |       |
| Cash                                                                                                                                                                            |       | $                      | 773,016     |                  | $          | 2,157,611 |   |
| Restricted cash  and equivalents, held in trust                                                                                                                                 |       | 114,574,151            |        | 111,965,034           |       |
| Prepaid expenses                                                                                                                                                                |       | 33,626                 |        | 128,875               |       |
| Total current assets                                                                                                                                                            |       | 115,380,793            |        | 114,251,520           |       |
| Deferred acquisition  cost                                                                                                                                                      |       | 1,829,382              |        | —                |       |
| Deferred income taxes                                                                                                                                                           |       | 335,260                |        | 54,094                |       |
| Total assets                                                                                                                                                                    |       | $                      | 117,545,435 |                  | $          | 114,305,614 |   |
|                                                                                                                                                                            |       |                   |        |                  |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                  |       |                   |        |                  |       |
| Current liabilities:                                                                                                                                                            |       |                   |        |                  |       |
| Accrued expenses                                                                                                                                                                |       | $                      | 1,381,177   |                  | $          | 136,338 |   |
| Deferred income  taxes                                                                                                                                                          |       | 82,357                 |        | 90,521                |       |
| Total current  liabilities                                                                                                                                                      |       | 1,463,534              |        | 226,859               |       |
|                                                                                                                                                                            |       |                   |        |                  |       |
| Common stock, subject  to possible redemption-3,998,000 shares                                                                                                                  |       | 22,159,715             |        | 22,159,715            |       |
| Interest income  attributable to common stock subject to possible redemption (net of taxes of  $266,050 and $97,061 at September 30, 2006 and December 31, 2005,  respectively) |       | 699,266                |        | 189,462               |       |
|                                                                                                                                                                            |       | 22,858,981             |        | 22,349,177            |       |
| Commitments and  contingencies (Note E)                                                                                                                                         |       |                   |        |                  |       |
|                                                                                                                                                                            |       |                   |        |                  |       |
| 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; 25,000,000 shares issued and  outstanding (including 3,998,000 shares subject to possible redemption)            |       | 2,500                  |        | 2,500                 |       |
| Additional  paid-in capital                                                                                                                                                     |       | 91,098,761             |        | 91,098,761            |       |
| Income  accumulated during the development stage                                                                                                                                |       | 2,121,659              |        | 628,317               |       |
| Total stockholders’  equity                                                                                                                                                |       | 93,222,920             |        | 91,729,578            |       |
| Total liabilities and  stockholders’ equity                                                                                                                                |       | $                      | 117,545,435 |                  | $          | 114,305,614 |   |

 

See notes to condensed unauditedfinancial statements.

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**Stone Arcade Acquisition Corporation**

**(a development stage company)**

**Condensed Consolidated Statementsof Operations**

**(unaudited)**
| ** **                                                                                            | ** ** | ** **                        | ** ** | ** **             | ** ** | **Nine Months**   | ** ** | **(April 15,   2005)** | ** ** | **Accumulated  Inception** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|------------------------|------------|------------------------|------------|----------------------------------|------------|----------------------------|------------|
| ** **                                                                                            | ** ** | ** **                        | ** ** | ** **             | ** ** | **Ended**              | ** ** | **Through**                      | ** ** | **Through**                | ** ** |
| ** **                                                                                            | ** ** | **Ended September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,**           | ** ** |
| ** **                                                                                            | ** ** | **2006**                          | ** ** | **2005**               | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **2006**                   | ** ** |
| Cost and expenses:                                                                                    |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Operating  expenses                                                                                   |       | $                                 | 373,519    |                   | $          | 37,799                 |       | $                                | 891,687    |                       | $          | 38,799 |   | $ | 1,112,287 |   |
|                                                                                                  |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Other income:                                                                                         |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Bank interest                                                                                         |       | 10,130                            |       | 7,839                  |       | 58,493                 |       | 7,839                            |       | 82,633                     |       |
| Interest on  restricted cash and cash equivalents, held in trust                                      |       | 1,385,661                         |       | 422,341                |       | 3,864,094              |       | 422,341                          |       | 5,300,112                  |       |
| Total other income                                                                                    |       | 1,395,791                         |       | 430,180                |       | 3,922,587              |       | 430,180                          |       | 5,382,745                  |       |
| Income before provision  for income taxes:                                                            |       | 1,022,272                         |       | 392,381                |       | 3,030,900              |       | 391,381                          |       | 4,269,958                  |       |
| Provision (benefit) for  income taxes:                                                                |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Current                                                                                               |       | 423,545                           |       | 71,725                 |       | 1,297,017              |       | 71,725                           |       | 1,681,869                  |       |
| Deferred                                                                                              |       | (72,673                           | )          | 61,345                 |       | (269,263               | )          | 61,345                           |       | (232,836                   | )          |
| Total provision for  income taxes                                                                     |       | 350,872                           |       | 133,070                |       | 1,027,754              |       | 133,070                          |       | 1,449,033                  |       |
| Net income                                                                                            |       | 671,400                           |       | 259,311                |       | 2,003,146              |       | 258,311                          |       | 2,820,925                  |       |
| Deferred interest, net  of taxes, attributable to common stock subject to possible redemption         |       | (182,815                          | )          | (55,721                | )          | (509,804               | )          | (55,721                          | )          | (699,266                   | )          |
|                                                                                                  |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Net income allocable to  holders of nonredeemable common stock                                        |       | $                                 | 488,585    |                   | $          | 203,590                |       | $                                | 1,493,342  |                       | $          | 202,590 |   | $ | 2,121,659 |   |
|                                                                                                  |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Weighted-average number  of shares outstanding:                                                       |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Basic                                                                                                 |       | 25,000,000                        |       | 14,130,435             |       | 25,000,000             |       | 10,000,000                       |       | 20,272,045                 |       |
| Diluted                                                                                               |       | 29,539,007                        |       | 15,131,503             |       | 28,963,964             |       | 10,548,204                       |       | 23,348,428                 |       |
|                                                                                                  |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Net income per share:                                                                                 |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Basic                                                                                                 |       | $                                 | 0.03       |                   | $          | 0.02                   |       | $                                | 0.08       |                       | $          | 0.03 |   | $ | 0.14 |   |
| Diluted                                                                                               |       | $                                 | 0.02       |                   | $          | 0.02                   |       | $                                | 0.07       |                       | $          | 0.02 |   | $ | 0.12 |   |
|                                                                                                  |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Weighted-average number  of shares outstanding exclusive of shares subject to possible redemption:    |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Basic                                                                                                 |       | 21,002,000                        |       | 12,305,261             |       | 21,002,000             |       | 9,000,500                        |       | 17,219,163                 |       |
| Diluted                                                                                               |       | 25,541,007                        |       | 13,306,329             |       | 24,965,964             |       | 9,548,704                        |       | 20,295,546                 |       |
|                                                                                                  |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Net income per share  exclusive shares and related deferred interest subject to possible  redemption: |       |                              |       |                   |       |                   |       |                             |       |                       |       |
| Basic                                                                                                 |       | $                                 | 0.02       |                   | $          | 0.02                   |       | $                                | 0.07       |                       | $          | 0.02 |   | $ | 0.12 |   |
| Diluted                                                                                               |       | $                                 | 0.02       |                   | $          | 0.02                   |       | $                                | 0.06       |                       | $          | 0.02 |   | $ | 0.10 |   |

 

See notes to condensed unauditedfinancial statements.

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**Stone Arcade Acquisition Corporation**

**(a development stage company)**

**Condensed Consolidated Statements of Cash Flows**

**(unaudited)**

 
| ** **                                                                  | ** ** | ** **                       | ** ** | **Inception**                    | ** ** | **Accumulated**                  | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                  | ** ** | **Nine Months**             | ** ** | **(April 15, 2005)**   | ** ** | **(Inception)**                  | ** ** |
| ** **                                                                  | ** ** | **Ended**                        | ** ** | **Through**                      | ** ** | **Through**                      | ** ** |
| ** **                                                                  | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **September 30, 2006** | ** ** |
| **Operating activities**                                                    |       |                             |       |                             |       |                             |       |
| Net income                                                                  |       | $                                | 2,003,146  |                             | $          | 258,311                          |       | $ | 2,820,925 |   |
| Deferred income  taxes                                                      |       | (281,166                         | )          | —                           |       | (335,260                         | )          |
| Changes in                                                                  |       |                             |       |                             |       |                             |       |
| Interest  receivable on restricted cash and cash equivalents, held in trust |       | 24,013                           |       |                             |       | (242,226                         | )          |
| Prepaid expenses                                                            |       | 95,249                           |       | (180,425                         | )          | (33,626                          | )          |
| Accrued expenses                                                            |       | 1,192,756                        |       | 61,154                           |       | 1,269,241                        |       |
| Accrued income  taxes                                                       |       | 43,920                           |       | 133,070                          |       | 194,293                          |       |
|                                                                        |       |                             |       |                             |       |                             |       |
| Net cash provided by  operating activities                                  |       | 3,077,918                        |       | 272,110                          |       | 3,673,347                        |       |
|                                                                        |       |                             |       |                             |       |                             |       |
| **Investing activities**                                                    |       |                             |       |                             |       |                             |       |
| Acquisition cost paid                                                       |       | (1,829,382                       | )          | —                           |       | (1,829,382                       | )          |
| Purchase of U.S.  government securities held in trust                       |       | (1,135,849,131                   | )          | (111,276,341                     | )          | (1,582,658,925                   | )          |
| Maturities of U.S.  government securities held in trust                     |       | 1,133,216,000                    |       | —                           |       | 1,468,327,000                    |       |
| Net cash used in  investing activities                                      |       | (4,462,513                       | )          | (111,276,341                     | )          | (116,161,307                     | )          |
|                                                                        |       |                             |       |                             |       |                             |       |
| **Financing activities**                                                    |       |                             |       |                             |       |                             |       |
| Proceeds from public  offering, net of expenses                             |       | —                           |       | 113,243,061                      |       | 113,235,876                      |       |
| Proceeds from sale of  common stock to founding stockholders                |       | —                           |       | 25,000                           |       | 25,000                           |       |
| Proceeds from notes  payable to stockholders                                |       | —                           |       | 200,000                          |       | 200,000                          |       |
| Repayment of notes  payable to stockholders                                 |       | —                           |       | (200,000                         | )          | (200,000                         | )          |
| Proceeds from issuance  of underwriters’ option                        |       | —                           |       | 100                              |       | 100                              |       |
| Net cash provided by  financing activities                                  |       | —                           |       | 113,268,161                      |       | 113,260,976                      |       |
|                                                                        |       |                             |       |                             |       |                             |       |
| Net (decrease) increase  in cash                                            |       | (1,384,595                       | )          | 2,263,930                        |       | 773,016                          |       |
| Cash-beginning of  period                                                   |       | 2,157,611                        |       | —                           |       | —                           |       |
| Cash-end of period                                                          |       | $                                | 773,016    |                             | $          | 2,263,930                        |       | $ | 773,016 |   |

 

See notes to condensed unauditedfinancial statements.

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**STONE ARCADE ACQUISITION CORPORATION (A DEVELOPMENT STAGE COMPANY)NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS**

**Note A.    Organization and BusinessOperations**

StoneArcade Acquisition Corporation (the “Company”) was incorporated in Delaware onApril 15, 2005. On May 25, 2006, the Company formed a wholly-ownedsubsidiary, KapStone Kraft Paper Corporation, or KapStone Kraft. The Companywas formed to serve as a vehicle for the acquisition through a merger, capitalstock exchange, asset acquisition, or other similar business combination (“BusinessCombination”) of an operating business in the paper, packaging, forest productsand related industries. The Company has neither engaged in any operations norgenerated operating revenue. The Company is considered to be in the developmentstage and is subject to the risks associated with activities of developmentstage companies. The Company has selected December 31 as its fiscal yearend.

The registration statement for the Company’s initialpublic offering (the “Offering”) was declared effective on August 15,2005. The Company consummated the Offering on August 19, 2005 and receivednet proceeds of approximately $113,236,000 of which approximately $110,854,000was placed into a trust account (“Trust Account”). The Company’s management hasbroad discretion with respect to the specific application of the net proceedsof the Offering (as described in Note C), although substantially all ofthe net proceeds of the Offering are intended to be generally applied toward aBusiness Combination. Furthermore, there is no assurance that the Company willbe able to successfully effect a Business Combination. As of September 30,2006, of the net proceeds, $114,574,151, including interest earned of$5,300,112, net of taxes, is being held in the Trust Account and invested inU.S. Government securities until the earlier of (i) the consummation ofthe first Business Combination or (ii) the distribution of the TrustAccount as described below.  Although taxpayments are made from the Trust Account as required on the interest incomeearned by the Trust Account, the interest income is subject to additional taxesincurred, but not yet paid as of September 30, 2006.

Theremaining proceeds may be used to pay for business, legal and accounting duediligence on prospective business combinations and continuing general andadministrative expenses. The Company, after signing a definitive agreement fora Business Combination on June 30, 2006, will submit such transaction forstockholder approval. In the event that holders of 20 percent or more ofthe shares issued in the Offering (the “IPO Shares”) vote against the BusinessCombination and seek to have their shares redeemed, the Business Combinationwill not be consummated. If a majority of stockholders vote in favor of theBusiness Combination and holders of less than 20 percent of the sharesissued in the offering vote against the Business Combination and elect to havetheir shares redeemed, the Business Combination will be consummated.  Stockholders voting against the BusinessCombination will have their stock redeemed for approximately $5.54 per share,plus interest allocable to such shares, net of income taxes. The maximum numberof shares subject to possible redemption is approximately 3,998,000. AtSeptember 30, 2006, the Company has classified $22,858,981 of the net proceedsfrom the Offering, inclusive of interest but net of taxes, as common stocksubject to possible redemption in the accompanying balance sheet.

In theevent that the Company does not consummate a Business Combination within18 months from the effective date of the Offering, or 24 months fromthe effective date of the Offering if certain extension criteria have beensatisfied (the “Acquisition Period”), the proceeds held in the Trust Accountwill be distributed to the Company’s public stockholders (i.e. excluding thepersons who were stockholders prior to the Offering (the “Founding Stockholders”)to the extent of their initial stock holdings.) However, the Founding Stockholderswill participate in any liquidation distribution with respect to any shares ofcommon stock they acquired in connection with or following the Offering. In theevent of such distribution, it is likely that the per share value of theresidual assets remaining available for distribution (including Trust Accountassets) will be less than the initial public offering price per share in theOffering (assuming no value is attributed to the Warrants contained in theUnits in the Offering discussed in Note C).

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**Note B.    Basis of Presentation,Principles of Consolidation, Use of Estimates and Reclassifications**

Theaccompanying condensed unaudited interim financial statements have beenprepared in accordance with U.S. generally accepted accounting principles (“USGAAP”) pursuant to the rules and regulations of the Securities and ExchangeCommission (the”SEC”).  Accordingly, theydo not include all of the information and footnotes required by US GAAP forcomplete financial statements. In the opinion of management, all normalrecurring adjustments considered necessary for a fair presentation have beenincluded. The consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiary. The results of operations for the ninemonth period ended September 30, 2006 are not necessarily indicative ofthe results to be expected for the year ending December 31, 2006.

Thecondensed balance sheet at December 31, 2005 has been derived from theaudited financial statements at that date, but does not include all of theinformation and footnotes required by US GAAP for complete financialstatements.

Forfurther information, refer to the financial statements and footnotes theretoincluded in Stone Arcade Acquisition Corporation’s Annual Report onForm 10-K for the period from April 15, 2005 (date of inception) toDecember 31, 2005.

The preparation of financial statements inconformity with US GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities at the date of thefinancial statements and the reported amounts of expenses during the reportingperiod. Actual results could differ from those estimates.

**Note C.    Initial Public Offering**

OnAugust 19, 2005, the Company sold 20,000,000 units (“Units”) for a grossprice of $6.00 per Unit. Each Unit consists of one share of the Company’scommon stock, $.0001 par value, and two warrants (“Warrants”). Each Warrantentitles the holder to purchase from the Company one share of common stock atan exercise price of $5.00. Each warrant is exercisable on the later of(a) the completion of a Business Combination or (b) August 15,2006, and expires on August 15, 2009. The Warrants are redeemable at aprice of $.01 per Warrant upon 30 days notice after the Warrants becomeexercisable, only in the event that the last sale price of the common stock isat least $8.50 per share for any 20 trading days within a 30 trading day periodending on the third day prior to the date on which notice of redemption is given.

Thewarrants will be exercisable only if at the time of exercise a currentregistration statement covering the underlying shares is effective or, in theopinion of counsel, not required, and if the shares are qualified for sale orexempt from qualification under the applicable state securities laws of theexercising holder.  The Company isobligated to use its best efforts to maintain an effective registrationstatement during the term of the warrants; however, it may be unable to doso.  Holders of the warrants are notentitled to receive a net cash settlement or other settlement in lieu ofphysical settlement of the shares.

Inconnection with the Offering, the Company paid the underwriters an underwritingdiscount of five percent of the gross proceeds of the Offering. The Companyalso issued for $100 an option to the representative of the underwriters topurchase up to a total of 1,000,000 units at a price of $7.50 per unit. Theunits issuable upon the exercise of this option are identical to those offeredin the prospectus, except that the exercise price of the warrants included inthe underwriters’ purchase option is $6.25. This option is exercisablecommencing on the later of the consummation of a Business Combination or oneyear from the date of the Offering, expires five years from the date of theOffering, and may be exercised on a cashless basis. The option may not be sold,transferred, assigned, pledged or hypothecated until August 16, 2006.However, the option may be transferred to any underwriter or selected dealerparticipating in the Offering and their bona fide officers or partners.

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Theholders of the option have demand and piggy-back registration rights under theSecurities Act for periods of five and seven years, respectively, from the dateof the prospectus with respect to registration of the securities directly andindirectly issuable upon exercise of the option. The exercise price and numberof units issuable upon exercise of the option may be adjusted in certaincircumstances, including issuances of a stock dividend, recapitalization,reorganization, merger or consolidation. However, the option will not beadjusted for issuances at a price below its exercise price.

TheCompany has estimated, based upon a Black Scholes model, that the fair value ofthe purchase option on the date of sale was approximately $980,000. The Companyaccounted for this purchase option, inclusive of the receipt of the $100 cashpayment, as an expense of the Offering resulting in a charge directly tostockholders’ equity. Accordingly there was no impact in the Company’sfinancial position or results of operations except for the recording of the$100 proceeds from the sale.

Inaccordance with a commitment entered into in connection with the Offering, theFounding Stockholders have purchased 3,500,000 warrants in the publicmarketplace. They have further agreed that such warrants will not be sold ortransferred until the completion of a Business Combination.

**Note D.    Related-PartyTransactions**

TheCompany has agreed to pay Stone-Kaplan Investments, LLC, a company wherecertain of the Founding Stockholders serve in executive capacities, anadministrative fee of $7,500 per month for office space and general andadministrative services from August 15, 2005 through the date of aBusiness Combination. Stone-Kaplan Investments LLC has agreed to pay a portionof the aforementioned administration fee to Arcade Partners LLC, a companywhere certain of the Founding Stockholders serve in executive capacities. Fromtime to time the Company retains the services of White Oak Aviation, anaviation services company solely owned by certain Founding Stockholders. Forthe three and nine months ended September 30, 2006, the amount paid to thisentity was $34,787 and $61,537, respectively.

TheFounding Stockholders have agreed with the Company and the underwriters that ifthe Company liquidates prior to the consummation of a Business Combination, theFounding Stockholders will be personally liable to pay debts and obligations tovendors that are owed money by the Company for services rendered or productssold to the Company to the extent such debts were not paid from the netproceeds not held in the Trust Account at that time.

**Note E.    Commitments andContingencies**

TheCompany has engaged the representative of the underwriters to act as itsinvestment banker in connection with a Business Combination. The Company hasagreed to pay the representative a cash fee of $1,200,000 at the closing of theBusiness Combination for assisting the Company in structuring and negotiatingthe terms of the transaction.

**Note F.    Common Stock Reserved forIssuance**

AtSeptember 30, 2006, 43,000,000 shares of common stock were reserved forissuance upon exercise of warrants and the underwriter’s option.

**Note G.    Purchase Agreement forProposed Business Combination**

OnJune 23, 2006, Stone, KapStone Kraft, and International Paper Company, orIP, entered into a Purchase Agreement. The Purchase Agreement provides for theacquisition of substantially all of the assets and the assumption of certainliabilities of the Kraft Papers Business, or KPB, a division of IP, consistingof an unbleached kraft paper manufacturing facility in Roanoke Rapids, NorthCarolina and Ride Rite® Converting, an inflatable dunnage bag manufacturerlocated in Fordyce, Arkansas, for a cash purchase 

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price of$155 million plus two contingent earn-out payments of up to$35 million and $25 million, based on KPB’s annual earnings beforeinterest, income taxes, depreciation and amortization, or EBITDA, during thefive years immediately following the acquisition. The purchase price payable onthe closing date will be adjusted dollar-for-dollar to the extent IP’s workingcapital as of such date is greater or less than $42,637,709.

KPBgenerated approximately $189.2 million in sales and $25.1 million inoperating income for the nine months ended September 30, 2006 and approximately$222.0 million in sales and $9.5 million in operating income for theyear ended December 31, 2005.

TheCompany intends to use its proceeds of its initial public offering, whichincludes $114,574,151, including interest earned, currently held in the TrustAccount, together with borrowings from a $95,000,000 senior secured creditfacility to be obtained in connection with the acquisition to acquire the KPBassets, to pay transaction expenses, and to pay holders of the IPO Shares whoexercise their redemption rights.

Theproposed acquisition is subject to, among other things, the approval of thetransaction by the Company’s stockholders. There can be no assurance that thetransaction will be consummated.

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**Item 2.—  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

ThisQuarterly Report on Form 10-Q includes forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended. We have based theseforward-looking statements on our current expectations and projections aboutfuture events. These forward-looking statements are subject to known andunknown risks, uncertainties and assumptions about us that may cause our actualresults, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by such forward-looking statements. In somecases, you can identify forward-looking statements by terminology such as “may,”“should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,”“continue,” or the negative of such terms or other similar expressions. Factorsthat might cause or contribute to such a discrepancy include, but are notlimited to, those described in our other Securities and Exchange Commissionfilings. The following discussion should be read in conjunction with ourFinancial Statements and related Notes thereto included elsewhere in thisreport.

**Overview**

We wereformed on April 15, 2005 to serve as a vehicle to effect a merger, capitalstock exchange, asset acquisition or other similar business combination (“BusinessCombination”) with an operating business in the paper, packaging, forestproducts and related industries. Our initial Business Combination must be witha target business or businesses whose fair market value is at least equal to80% of our net assets at the time of such acquisition. We intend to utilizecash derived from the proceeds of our initial public offering (the “Offering”),our capital stock, debt or a combination of cash, capital stock and debt, ineffecting a Business Combination.

**Critical Accounting Policies**

***Use of Estimates***

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities at the date of the financial statements and the reported amounts ofexpenses during the reporting period. Actual results could differ from thoseestimates.

**Results of Operations for the Quarters EndingSeptember 30, 2006 and September 30, 2005**

For the quarter ending September 30, 2006 and 2005, our netincome attributed to nonredeemable common stock was $488,585 ($671,400 beforethe deduction of $182,815 of interest net of taxes attributable to common stocksubject to possible redemption) as compared to $203,590 ($259,311 before thededuction of $55,721 of interest net of taxes attributable to common stocksubject to possible redemption), respectively. Since we did not have any operations, all of our income wasderived from interest income, most of which was earned on funds held in a trustaccount.  Interest income earned for thequarter ended September 30, 2006 was higher than the prior year’s comparablequarter by $965,611, because the principal balance was not invested untilAugust 19, 2005, upon the completion of our initial public offering and receiptof $113,235,876 of net proceeds.  Ouroperating expenses for the quarter endingSeptember 30, 2006 and September 30, 2005 were $373,519 and $37,799,respectively.  The expenses for thequarter ended September 30, 2006 were higher than the previous year’scorresponding quarter by $335,720 primarily due to increased expenses relatedto pursuing a business combination, professional fees, insurance, andfranchise taxes.  We also expensed $350,872 and $133,070 for income taxes for the quartersending September 30, 2006 and 2005, respectively.

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**Results of Operations for the Nine Months EndingSeptember 30, 2006**

For the nine months ending September 30, 2006, our net incomeattributed to nonredeemable common stock was $1,493,342 ($2,003,146 before thededuction of $509,804 of interest net of taxes attributable to common stocksubject to possible redemption).  Sincewe did not have any operations, all of our income was derived from interestincome, most of which was earned on funds held in the trust account.  Our operating expenses for the nine months ending September 30, 2006 were$891,687.  The expenses consistedprimarily of expenses related to pursuing a business combination,professional fees, insurance, franchise taxes, and the monthly administrativefee of $7,500 paid to Stone-Kaplan Investments. We also expensed $1,027,754 of income taxexpense for the nine months ending September 30, 2006.

**Results of Operations for the Period from April 15, 2005(Date of Inception) to September 30, 2005**

For theperiod ended September 30, 2005, our net income attributedto nonredeemable common stock was $202,590 ($258,311 before thededuction of $55,721 of net income attributable to common stock subject topossible redemption). Since we did not have any operations, all of our incomewas derived from interest income, most of which was earned on funds held in thetrust account. Our operating expenses during the period were $38,799 andconsisted primarily of expenses related to pursuing a business combination,professional fees and the monthly administrative fee of $7,500 paid toStone-Kaplan Investments. We also provided for $133,070 in income taxes.

**Liquidity and Capital Resources**

AtSeptember 30, 2006, $114,574,151 of the proceeds from the Offering, togetherwith interest, was being held in a trust account. At such date, we had totalcurrent liabilities of $1,463,534 consisting of $1,000,000 in accrued legalfees, $269,241 in accrued operating expenses ($182,771 in franchise taxes, $25,000in accounting fees, $49,403 in insurance and $12,067 in miscellaneousexpenses), $111,936 in accrued income taxes and $82,357 in deferred incometaxes. In addition, in connection with the Business Combination, we havereceived a commitment from LaSalle Bank, N.A., with respect to a $95,000,000senior secured credit facility. KapStone Kraft, our wholly owned subsidiary,will be the borrower under the senior secured credit facility. At September 30,2006, we have incurred $1,829,382 of acquisition related costs recorded asdeferred acquisition cost consisting of due diligence, legal, accounting andother expenses attendant to the due diligence investigations, structuring andnegotiation of the KPB acquisition and the preparation of the proxy statement.  We estimate that costs of completing theBusiness Combination with KPB will total approximately $1,995,000,inclusive of the expenses incurred through September 30, 2006, but exclusive ofany investment banking and financing fees. Of such amount, approximately$345,000 relates to due diligence conducted with respect to prospectivebusiness targets and $1,650,000 represents legal, accounting and other expensesattendant to the due diligence investigations, structuring and negotiation ofthe KPB acquisition and the preparation of the proxy statement. This estimateexceeds the $1,450,000 estimate of such expenses ($750,000 for due diligence onprospective targets and $700,000 for legal, accounting and other BusinessCombination expenses) made by us at the time of the Offering.

Uponconsummation of the Business Combination with KPB, $90,000,000 of the fundsheld in the trust account will be used to fund the acquisition of KPB. Up toapproximately $22,859,000 will be paid to holders of IPO shares that electredemption and the balance (approximately $1,715,170 assuming redemption of19.99% of all holders of IPO shares and $24,574,151 assuming no redemption)will be added to our working capital. Proceeds of the credit facility will beused to pay the $65,000,000 balance of the purchase price, the acquisitioncosts and financing fees and the $1,200,000 investment banking fee to themanaging underwriter of our initial public offering, with the balance availablefor working capital. While it is anticipated that the borrowings from thecredit facility, together with funds generated from KPB operating activities,will be sufficient for our expected short-term and long-term operating needs,the ability to make payments on amounts outstanding under the credit facilitywill depend on KPB’s ability to generate cash from its operations. Followingthe acquisition, Kapstone Kraft’s expected debt service obligation is initiallyestimated to be approximately $4,000,000 in interest payments per annum, whichamount will be reduced each year in accordance with scheduled debt amortizationpayments, if made. In addition, debt service requirements will also includescheduled quarterly principal amortizations starting at $1,875,000 during thefirst year and rising to $2,250,000 in the final year of the facility.Management believes that 

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KapStoneKraft’s cash flow from operations will be sufficient to fund all suchredemption payments, and that such payments will not have a material adverseeffect on the Company’s business plans, liquidity and growth opportunities.

Stone hasmade informal arrangements with its professional advisors to defer payment ofany expenses, which exceed the amount currently held outside the trust, untilcompletion of the business combination,

**Off-Balance Sheet Arrangements**

We havenever entered into any off-balance sheet financing arrangements and have neverestablished any special purpose entities. We have not guaranteed any debt orcommitments of other entities or entered into any options on non-financialassets.

**ContractualObligations**

On June23, Stone and Kapstone Kraft entered into the Purchase Agreement with IP.  The Purchase Agreement provides for theacquisition of substantially all of the assets and the assumption of certainliabilities of the Kraft Papers Business, or KPB, a division of IP, consistingof an unbleached kraft paper manufacturing facility in Roanoke Rapids, NorthCarolina and Ride Rite® Converting, an inflatable dunnage bag manufacturerlocated in Fordyce, Arkansas, for a cash purchase price of $155 millionplus two contingent earn-out payments of up to $35 million and$25 million, based on KPB’s annual earnings before interest, income taxes,depreciation and amortization, or EBITDA, during the five years immediatelyfollowing the acquisition. The purchase price payable on the closing date willbe adjusted dollar-for-dollar to the extent IP’s working capital as of suchdate is greater or less than $42,637,709.

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**Item 3.—****    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

Marketrisk is the sensitivity of income to changes in interest rates, foreignexchanges, commodity prices, equity prices, and other market-driven rates orprices. We are not presently engaged in and, if a suitable business target isnot identified by us prior to the prescribed liquidation date of the TrustAccount, we may not engage in, any substantive commercial business.Accordingly, we are not and, until such time as we consummate a BusinessCombination, we will not be, exposed to risks associated with foreign exchangerates, commodity prices, equity prices or other market-driven rates or prices.The net proceeds of the Offering held in the Trust Account have been investedonly in money market funds meeting certain conditions under Rule 2a-7promulgated under the Investment Company Act of 1940. Given our limited risk inour exposure to money market funds, we do not view the interest rate risk to besignificant.

**Item 4.—****    CONTROLSAND PROCEDURES**

Anevaluation of the effectiveness of our disclosure controls and procedures as ofSeptember 30, 2006 was made under the supervision and with the participation ofour management, including our chief executive officer who also serves as ourprincipal financial officer. Based on that evaluation, he concluded that ourdisclosure controls and procedures are effective as of the end of the periodcovered by this report to ensure that information required to be disclosed byus in reports that we file or submit under the Securities Exchange Act of 1934is recorded, processed, summarized and reported within the time periodsspecified in Securities and Exchange Commission rules and forms. During themost recently completed fiscal quarter, there has been no significant change inour internal control over financial reporting that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

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**PART II.— OTHER INFORMATION**

**Item 1.—****    LEGALPROCEEDINGS**

None.

**Item 1A.— RISK FACTORS**

Inaddition to the other information set forth in this report, you shouldcarefully consider the factors discussed in Part I, “Item 1A. Risk Factors” inour Annual Report on Form 10-K for the year ended December 31, 2005, and inPart II, “Item 1A.  Risk Factors” in ourQuarterly Report on Form 10-Q for the quarter ended June 30, 2006, which couldmaterially affect our business, financial condition or future results. Therisks described in our Annual Report on Form 10-K and in our Quarterly Reportfor the quarter ended June 30, 2006, are not the only risks facing our Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.

**Item 2.—****    UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

On August 19, 2005, we consummated our initial publicoffering of 20,000,000 units. Each unit consists of one share of common stockand two redeemable common stock purchase warrants. Each warrant entitles theholder to purchase from us one share of our common stock at an exercise priceof $5.00. The units were sold at an offering price of $6.00 per unit,generating total gross proceeds of $120,000,000. Morgan Joseph & Co. Inc.acted as lead underwriter. The securities sold in the Offering were registeredunder the Securities Act of 1933 on a registration statement on Form S-1 (No.333-124601). The Securities and Exchange Commission declared the registrationstatement effective on August 15, 2005.

We paid a total of $6,000,000 in underwritingdiscounts and commissions, and approximately $764,000 was paid for costs andexpenses related to the Offering.

After deducting the underwriting discounts andcommissions and the offering expenses, the total net proceeds to us from theoffering were approximately $113,236,000, of which $110,854,000 (or $5.54 perunit sold in the Offering) was deposited into the Trust Account and theremaining proceeds are available to be used to provide for business, legal andaccounting due diligence on prospective business combinations and continuinggeneral and administrative expenses.

From inception through September 30, 2006, we used$1,112,787 of the net proceeds that were not deposited into the Trust Accountto pay operating expenses that consisted primarily of expenses related topursuing a business combination, professional fees, franchise taxes and monthlyadministrative fee of $7,500 paid to Stone-Kaplan Investments. As of September30, 2006, there was $114,574,151, including accrued interest receivable of$242,226, held in the Trust Account.

The net proceeds of the Offering in the amount of$110,854,000 deposited into the Trust Account have been invested in short-termU.S. Government Securities, specifically Treasury Bills, having a maturity dateof  90 days or less.

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**Item 3.—****    DEFAULTSUPON SENIOR SECURITIES**

None.

**Item 4.—****    SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**Item 5.—****    OTHERINFORMATION**

None.

**Item 6.—****    EXHIBITS**

(b)     Exhibits
| 4.7      |   | Unit Purchase Option Clarification Agreement, by and  between Stone Arcade Acquisition   Corporation and Morgan Joseph & Co. Inc. |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                  |
| 31  |   | Rule 13a-14(a) Certification of Principal Executive  Officer and Principal Financial Officer.                                         |
|     |   |                                                                                                                                  |
| 32  |   | 18 U.S.C Section 1350 Certification.                                                                                                  |

** **

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**SIGNATURES**

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized. 
|                   | STONE ARCADE ACQUISITION CORPORATION |
|-------------------|--------------------------------------|
|              |                                 |
| November 13, 2006 | By:                                  | /s/ Roger Stone |
|              |                                 | Roger Stone |
|              |                                 | Chairman of the Board  and Chief Executive Officer |

 

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