Table ofContents

 

 

 

**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, 2010** |
|                                                         |       |                                                                                                        |
| **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 No o

 

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, an acceleratedfiler, a non-accelerated filer, or a smaller reporting company. See definitionsof “large accelerated filer,” “accelerated filer,” and “smaller reportingcompany” 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

 

Therewere 45,865,857 shares of the Registrant’s Common Stock, $0.0001 par value,outstanding at April 30, 2010, excluding 40,000 shares held as treasuryshares.

 

 

 

----

Table ofContents

 

**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    |   | 9      |
|                                                                                                          |   |   |
| Item 3. — Quantitative and Qualitative  Disclosures about Market Risk                                    |   | 14     |
|                                                                                                          |   |   |
| Item 4. — Controls and Procedures                                                                        |   | 15     |
|                                                                                                          |   |   |
| PART II. — OTHER  INFORMATION                                                                       |   |   |
|                                                                                                          |   |   |
| Item 1. — Legal Proceedings                                                                              |   | 16     |
|                                                                                                          |   |   |
| Item 1A. — Risk Factors                                                                                  |   | 16     |
|                                                                                                          |   |   |
| Item 2. — Unregistered Sales of Equity  Securities and Use of Proceeds                                   |   | 16     |
|                                                                                                          |   |   |
| Item 3. — Defaults Upon Senior Securities                                                                |   | 16     |
|                                                                                                          |   |   |
| Item 4. — Reserved                                                                                       |   | 16     |
|                                                                                                          |   |   |
| Item 5. — Other Information                                                                              |   | 16     |
|                                                                                                          |   |   |
| Item 6. — Exhibits                                                                                       |   | 17     |
|                                                                                                          |   |   |
| SIGNATURE                                                                                                     |   | 18     |

 

i

----

Table of Contents

** **

**PART 1.FINANCIAL INFORMATION**

 

**ITEM 1.**

 

**FINANCIALSTATEMENTS**

 

**KapStonePaper and Packaging Corporation**

**ConsolidatedBalance Sheets**

**(Inthousands, except share and per share amounts)**

 
| ** **                                                                                                                                                                                                                                                                  | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                  | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                                                                  |       |                     |       |                        |       |
| Current  assets:                                                                                                                                                                                                                                                            |       |                     |       |                        |       |
| Cash  and cash equivalents                                                                                                                                                                                                                                                  |       | $                        | 3,851      |                        | $          | 2,440 |   |
| Trade  accounts receivable, less allowances of $1,256 in 2010 and $1,217 in 2009                                                                                                                                                                                            |       | 59,187                   |       | 58,408                      |       |
| Other  receivables                                                                                                                                                                                                                                                          |       | 10,497                   |       | 16,487                      |       |
| Inventories                                                                                                                                                                                                                                                                 |       | 69,715                   |       | 61,377                      |       |
| Refundable  and prepaid income taxes                                                                                                                                                                                                                                        |       | 18,008                   |       | 13,757                      |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                                                                  |       | 5,860                    |       | 1,690                       |       |
| Restricted  cash                                                                                                                                                                                                                                                            |       | 2,500                    |       | 2,500                       |       |
| Deferred  income taxes                                                                                                                                                                                                                                                      |       | 5,603                    |       | 5,604                       |       |
| Total  current assets                                                                                                                                                                                                                                                       |       | 175,221                  |       | 162,263                     |       |
|                                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| Plant,  property and equipment, net                                                                                                                                                                                                                                         |       | 466,668                  |       | 470,278                     |       |
| Other  assets                                                                                                                                                                                                                                                               |       | 5,471                    |       | 4,935                       |       |
| Intangible  assets, net                                                                                                                                                                                                                                                     |       | 25,315                   |       | 26,198                      |       |
| Goodwill                                                                                                                                                                                                                                                                    |       | 4,811                    |       | 5,449                       |       |
|                                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| Total  assets                                                                                                                                                                                                                                                               |       | $                        | 677,486    |                        | $          | 669,123 |   |
|                                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                               |       |                     |       |                        |       |
| Current  liabilities:                                                                                                                                                                                                                                                       |       |                     |       |                        |       |
| Current  portion of long-term debt                                                                                                                                                                                                                                          |       | $                        | 18,267     |                        | $          | 18,630 |   |
| Borrowings  under revolving credit facility                                                                                                                                                                                                                                 |       | 4,500                    |       | 7,400                       |       |
| Other  current borrowings                                                                                                                                                                                                                                                   |       | 1,712                    |       | —                      |       |
| Accounts  payable                                                                                                                                                                                                                                                           |       | 57,664                   |       | 52,147                      |       |
| Accrued  expenses                                                                                                                                                                                                                                                           |       | 21,053                   |       | 20,800                      |       |
| Accrued  compensation costs                                                                                                                                                                                                                                                 |       | 9,015                    |       | 7,719                       |       |
| Total  current liabilities                                                                                                                                                                                                                                                  |       | 112,211                  |       | 106,696                     |       |
|                                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| Other  liabilities:                                                                                                                                                                                                                                                         |       |                     |       |                        |       |
| Long-term  debt, net of current portion                                                                                                                                                                                                                                     |       | 107,929                  |       | 121,031                     |       |
| Pension  and post-retirement benefits                                                                                                                                                                                                                                       |       | 6,141                    |       | 5,949                       |       |
| Deferred  income taxes                                                                                                                                                                                                                                                      |       | 41,475                   |       | 38,577                      |       |
| Other  liabilities                                                                                                                                                                                                                                                          |       | 53,644                   |       | 48,080                      |       |
| Total  other liabilities                                                                                                                                                                                                                                                    |       | 209,189                  |       | 213,637                     |       |
|                                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| 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; 45,814,917 shares  issued and outstanding (40,000 treasury shares outstanding) at March 31,  2010 and 45,418,074 issued and outstanding (40,000 treasury shares  outstanding) at December 31, 2009 |       | 5                        |       | 5                           |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                 |       | 220,821                  |       | 219,828                     |       |
| Retained  earnings                                                                                                                                                                                                                                                          |       | 135,437                  |       | 129,046                     |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                                       |       | (177                     | )          | (89                         | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                            |       | 356,086                  |       | 348,790                     |       |
|                                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                            |       | $                        | 677,486    |                        | $          | 669,123 |   |

 

See notes to consolidated financial statement

 

1

----

Table ofContents

 

**KapStone Paper and PackagingCorporation**

**Consolidated Statements of Income**

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

 

**(unaudited)**

 
| ** **                                              | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                              | ** ** | **2010**                              | ** ** | **2009** | ** ** |
|                                                    |       |                                  |       |   |   |
| Net  sales                                              |       | $                                     | 176,499    |   | $ | 140,584 |   |
| Cost  of sales, excluding depreciation and amortization |       | 130,301                               |       | 96,484 |   |
| Freight  and distribution expenses                      |       | 16,070                                |       | 13,328 |   |
| Selling,  general and administrative expenses           |       | 7,099                                 |       | 8,557 |   |
| Depreciation  and amortization                          |       | 11,346                                |       | 13,609 |   |
| Gain  on sale of business                               |       | —                                |       | 17,399 |   |
| Other  operating income                                 |       | 283                                   |       | 232 |   |
| Operating  income                                       |       | 11,966                                |       | 26,237 |   |
| Foreign  exchange losses                                |       | 366                                   |       | 298 |   |
| Interest  income                                        |       | 9                                     |       | 1 |   |
| Interest  expense                                       |       | 1,637                                 |       | 5,733 |   |
| Income  before provision for income taxes               |       | 9,972                                 |       | 20,207 |   |
| Provision  for income taxes                             |       | 3,581                                 |       | 9,095 |   |
| Net  income                                             |       | $                                     | 6,391      |   | $ | 11,112 |   |
|                                                    |       |                                  |       |   |   |
| Weighted-average  number of shares outstanding:         |       |                                  |       |   |   |
| Basic                                                   |       | 45,483,293                            |       | 28,370,248 |   |
| Diluted                                                 |       | 46,622,595                            |       | 28,480,055 |   |
| Net  income per share:                                  |       |                                  |       |   |   |
| Basic                                                   |       | $                                     | 0.14       |   | $ | 0.39 |   |
| Diluted                                                 |       | $                                     | 0.14       |   | $ | 0.39 |   |

 

See notes to consolidated financial statements

 

2

----

Table ofContents

 

**KapStonePaper and Packaging Corporation**

**Consolidated Statements of Cash Flows**

**(In thousands)**

** **

**(unaudited)**

 
| ** **                                                                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                    | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **Operating activities**                                                                      |       |                                  |       |   |   |
| Net  income                                                                                   |       | $                                     | 6,391      |   | $ | 11,112 |   |
| Adjustments  to reconcile net income to net cash (used in) provided by operating  activities: |       |                                  |       |   |   |
| Depreciation  and amortization                                                                |       | 11,346                                |       | 13,609 |   |
| Stock  based compensation expense                                                             |       | 637                                   |       | 506 |   |
| Amortization  of debt issuance costs                                                          |       | 776                                   |       | 823 |   |
| Loss  on disposal of fixed assets                                                             |       | 153                                   |       | 375 |   |
| Deferred  income taxes                                                                        |       | 2,899                                 |       | 7,165 |   |
| Gain  on sale of dunnage bag business                                                         |       | —                                |       | (17,399 | ) |
| Changes  in operating assets and liabilities:                                                 |       |                                  |       |   |   |
| Trade  accounts receivable, net                                                               |       | (779                                  | )          | 11,992 |   |
| Other  receivables                                                                            |       | 5,990                                 |       | (23,773 | ) |
| Inventories                                                                                   |       | (8,338                                | )          | 5,586 |   |
| Refundable  and prepaid income taxes                                                          |       | (4,279                                | )          | 11,224 |   |
| Prepaid  expenses and other current assets                                                    |       | (4,170                                | )          | (2,507 | ) |
| Other  assets                                                                                 |       | (635                                  | )          | — |   |
| Accounts  payable                                                                             |       | 5,517                                 |       | (2,575 | ) |
| Accrued  expenses and other                                                                   |       | 6,191                                 |       | (14,451 | ) |
| Accrued  compensation costs                                                                   |       | 1,296                                 |       | (5,281 | ) |
| Net  cash provided by (used in) operating activities                                          |       | 22,995                                |       | (3,594 | ) |
|                                                                                          |       |                                  |       |   |   |
| **Investing activities**                                                                      |       |                                  |       |   |   |
| CKD  acquisition                                                                              |       | 638                                   |       | — |   |
| Proceeds  from sale of dunnage bag business                                                   |       | —                                |       | 36,083 |   |
| Restricted  cash                                                                              |       | —                                |       | (2,500 | ) |
| Capital  expenditures                                                                         |       | (7,248                                | )          | (6,323 | ) |
| Net  cash provided by (used in) investing activities                                          |       | (6,610                                | )          | 27,260 |   |
|                                                                                          |       |                                  |       |   |   |
| **Financing activities**                                                                      |       |                                  |       |   |   |
| Proceeds  from revolving credit facility                                                      |       | 51,800                                |       | 37,900 |   |
| Repayments  on revolving credit facility                                                      |       | (54,700                               | )          | (21,000 | ) |
| Repayments  of long-term debt                                                                 |       | (14,141                               | )          | (42,806 | ) |
| Proceeds  from the exercises of stock options, including tax benefits                         |       | 355                                   |       | — |   |
| Proceeds  from other current borrowings                                                       |       | 2,564                                 |       | — |   |
| Repayments  on other current borrowings                                                       |       | (852                                  | )          | — |   |
| Debt  issuance costs                                                                          |       | —                                |       | (405 | ) |
| Net  cash provided by (used in) financing activities                                          |       | (14,974                               | )          | (26,311 | ) |
|                                                                                          |       |                                  |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                                         |       | 1,411                                 |       | (2,645 | ) |
| Cash  and cash equivalents-beginning of period                                                |       | 2,440                                 |       | 4,165 |   |
| Cash  and cash equivalents-end of period                                                      |       | $                                     | 3,851      |   | $ | 1,520 |   |

 

See notes to consolidated financial statements

 

3

----

Table of Contents

** **

**KAPSTONE PAPER AND PACKAGINGCORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

** **

**(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 information andfootnotes 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, 2010are not necessarily indicative of the results that may be expected for the yearending December 31, 2010. 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, 2009.

 

# **2.**                                      Recent Accounting Pronouncement

# ** **

In January 2010,the Financial Accounting Standards Board (“FASB”) issued Accounting StandardUpdate (“ASU”) No. 2010-06, “Fair Value Measurements and Disclosures,”which amends the disclosure requirements related to recurring and nonrecurringfair value measurements.  The guidance requires disclosure of transfers ofassets and liabilities between Level 1 and Level 2 of the fair valuemeasurement hierarchy, including the reasons and the timing of the transfersand information on purchases, sales, issuance, and settlements on a gross basisin the reconciliation of the assets and liabilities measured under Level 3 ofthe fair value measurement hierarchy. The guidance is effective for annual andinterim reporting periods beginning after December 15, 2009, except forLevel 3 reconciliation disclosures which are effective for annual and interimperiods beginning after December 15, 2010. The implementation of thisstandard did not have a material impact on the consolidated financialstatements.

 

In December 2007,the FASB issued SFAS No. 141(R), *BusinessCombinations* (“SFAS No. 141(R)”). This guidance is included inFASB ASC 805, *Business Combinations*.This guidance requires the Company to continue to follow the guidance in SFAS No. 141(also included in FASB ASC 805) for certain aspects of business combinations,and provides additional guidance defining the acquirer, recognizing andmeasuring the identifiable assets acquired, the liabilities assumed, anynoncontrolling interest in the acquiree, assets and liabilities arising fromcontingencies, defining a bargain purchase and recognizing and measuringgoodwill or a gain from a bargain purchase. This guidance also requirestransaction costs to be charged to earnings and requires contingentconsideration to be recorded at its fair value on the acquisition date. Inaddition, under this guidance, adjustments associated with changes in taxcontingencies that occur after the measurement period, not to exceed one year,are recorded as adjustments to income. This guidance is effective for allbusiness combinations for which the acquisition date is on or after thebeginning of an entity’s first fiscal year that begins after December 15,2008; however, the guidance regarding the treatment of income tax contingenciesis retrospective to business combinations completed prior to 2009.  Nobusiness combinations occurred during the three months ended March 31,2010.

 

4

----

# **Table of Contents**

# ** **

# **3.**                                      Alternative Fuel Mixture Tax Credit

# ** **

A summary ofalternative fuel mixture tax credits recognized in the consolidated financialstatements for the quarters ended March 31, 2010 and March 31, 2009is as follows:

 
| ** **                                                                                                                                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Gallons  of fuel burned (000’s) (unaudited)                                                                                                     |       | —   |       | 47,818   |       |
| Tax  credit for each gallon burned                                                                                                                   |       | —   |       | $        | 0.50       |   |
|                                                                                                                                                 |       |     |       |     |       |
| Total  alternative fuel mixture tax credit generated (1)                                                                                             |       | $        | —     |     | $          | 23,909 |   |
|                                                                                                                                                 |       |     |       |     |       |
| Recognition  of tax credit deferred in December 31, 2009 inventory                                                                                   |       | 14,260   |       | —   |       |
|                                                                                                                                                 |       |     |       |     |       |
| Tax  credit related to inorganic content burned in 2009                                                                                              |       | 7,895    |       | —   |       |
|                                                                                                                                                 |       |     |       |     |       |
| Tax  credit included in ending inventory                                                                                                             |       | —   |       | (18,465  | )          |
|                                                                                                                                                 |       |     |       |     |       |
| Total  alternative fuel mixture tax credits included as a reduction to cost of sales  for quarter ending March 31, 2010 and March 31, 2009 |       | $        | 22,155     |     | $          | 5,444 |   |

 

(1) Thealternate fuel mixture tax credit expired on December 31, 2009.

 

The Companyrecognized $14.3 million of the tax credits in the quarter ended March 31,2010 as a reduction of cost of goods sold that had been included as a reductionto the cost of inventory at December 31, 2009.

 

The Companybelieves it is eligible to receive an additional $7.9 million credit based onan U.S. Internal Revenue Service Advice Memorandum released on March 12,2010 which indicates that the portion of inorganic content included in the fuelburned is eligible for a $0.50 per gallon refund. The Company had excluded thisamount when submitting refunds during 2009. Inorganic content represented about4% of the total gallons burned in 2009.

 

**4.****                                     ****PlannedMaintenance Outage**

 

Cost of sales forthe three months ended March 31, 2010 included approximately $6.5 millionfor the tri-annual planned maintenance outage for the Company’s South Carolinaunbleached kraft paper facility.

 

# **5.**                                      Inventories

# ** **

Inventoriesconsist of the following at March 31, 2010 and December 31, 2009,respectively:

 
| ** **                      | ** ** | **(Unaudited)  March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|-----------------------------|------------|
| Raw  materials                  |       | $                                     | 16,199     |                        | $          | 13,082 |   |
| Work  in process                |       | 473                                   |       | 980                         |       |
| Finished  goods                 |       | 33,644                                |       | 27,475                      |       |
| Replacement  parts and supplies |       | 19,399                                |       | 19,840                      |       |
| Inventories                     |       | $                                     | 69,715     |                        | $          | 61,377 |   |

# ** **

# **5**

# ****

# **Table of Contents**

# ** **

# **6.**                                      Goodwill

# ** **

Goodwill at March 31,2010 and December 31, 2009 was $4.8 million and $5.4 million,respectively.  In March 2010, theCompany received $0.6 million from MeadWestvaco Corporation (“MWV”)representing proceeds from a tax benefit MWV received pursuant to the terms ofthe Asset Purchase Agreement dated April 4, 2008.  The offset to the cash received was adecrease of $0.6 million to goodwill within the unbleached kraft segment.

 

**7.****                                     ****Long-termDebt and Other Borrowings**

 

In the quarterended March 31, 2010, the Company made a $10.0 million voluntary term loanrepayment on its Senior Credit Facility in addition to its mandatory payment of$4.1 million. In connection with the voluntaryterm loan repayment, the Company recognized $0.3 million of acceleratedamortization expense of its debt issuance costs.

 

On January 5,2010, the Company entered into a twelve month financing agreement of $2.6million at an annual interest rate of 1.62% for the Company’s annual propertyinsurance premium. The agreement requires the Company to pay consecutivemonthly payments of $0.2 million through the term of the financingagreement ending on December 1, 2010. As of March 31, 2010, $1.7 million was outstanding.

 

# **8.**                                      Income Taxes

# ** **

The Company’s U.S.federal statutory income tax rate is 35% for 2010 and 2009. The Company’seffective tax rate for the three months ended March 31, 2010 and 2009 was35.9% and 45.0%, respectively.  Thedifferences between the effective tax rate and the federal statutory tax ratefor the quarter ended March 31, 2010 are due to the impact of state taxnet of federal benefit. Differences between the effective tax rate and thefederal statutory tax rate for the quarter ended March 31, 2009 are due tothe impact of state tax net of federal benefit, the domestic manufacturing taxdeduction and a discrete item relating to the sale of the dunnage bag business.

 

The grossunrecognized tax benefits, including interest as of March 31, 2010increased by $5.8 million from December 31, 2009 to $68.7 million. Unrecognized tax benefits of $68.7 million are included in other long termliabilities in the accompanying Consolidated Balance Sheets.

 

In the normalcourse of business, we are subject to examination by taxing authorities. TheCompany’s open tax years are 2006 through 2009. The Company’s tax returns for2007 and 2008 are currently under examination by the Internal Revenue Service.

 

# **9.**                                      Net Income per Share

# ** **

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

 
| ** **                                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Net  income as reported                                                  |       | $                                     | 6,391      |   | $ | 11,112 |   |
| Weighted-average  number of common shares for basic net income per share |       | 45,483,393                            |       | 28,370,248 |   |
| Incremental  effect of dilutive common stock equivalents:                |       |                                  |       |   |   |
| Unexercised  stock options                                               |       | 357,040                               |       | — |   |
| Unvested  restricted stock awards                                        |       | 565,315                               |       | 109,807 |   |
| Underwriter’s  purchase option                                      |       | 216,847                               |       | — |   |
| * *                                                                 | * *   | * *                              | * *   | * * | * * |
| Weighted-average  number of shares for diluted net income per share      |       | 46,622,595                            |       | 28,480,055 |   |
|                                                                     |       |                                  |       |   |   |
| Net  income per share — basic                                       |       | $                                     | 0.14       |   | $ | 0.39 |   |
|                                                                     |       |                                  |       |   |   |
| Net  income per share — diluted                                     |       | $                                     | 0.14       |   | $ | 0.39 |   |

 

6

----

Table of Contents

 

Unexercised stockoptions totaling 1.3 million were outstanding during the three month periodended March 31, 2009, but were not included in the computation of dilutedearnings per share because the options were not-in-the money. 

 

In March 2010,the underwriter’s purchase option was exercised and converted into 348,393shares of common stock. The underwriter’s purchase option was outstandingduring the three month period ended March 31, 2009, but was not includedin the computation of diluted earnings per share because the option wasnot-in-the money.

 

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

# ** **

**DefinedBenefit Plan**

 

The KapStone Paperand Packaging Corporation Defined Benefit Plan (“Pension Plan”) providesbenefits for approximately 1,000 union employees.

 

Net pension costrecognized for the three months ended March 31, 2010 and 2009 for thePension Plan, is as follows:

 
| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                           | ** ** | **2010**                              | ** ** | **2009** | ** ** |
|                                                 |       |                                  |       |   |   |
| Service  cost for benefits earned during the quarter |       | $                                     | 715        |   | $ | 739 |   |
| Interest  cost on projected benefit obligations      |       | 141                                   |       | 93 |   |
| Expected  return on plan assets                      |       | (129                                  | )          | (38 | ) |
| Amortization  of actuarial gain                      |       | 10                                    |       | — |   |
| Net  pension cost                                    |       | $                                     | 737        |   | $ | 794 |   |

 

KapStone funds itsPension Plan according to Internal Revenue Service funding requirements. Basedon those limitations, KapStone expects to fund $4.1 million to the Pension Planin 2010.

 

**OtherPost-retirement Benefits**

 

Netpost-retirement cost recognized for each of the three months ended March 31,2010 and 2009 for the Company’s retiree medical and life insurance plan wasless than $0.1 million.

 

**DefinedContribution Plans**

 

The KapStoneDefined Contribution Plan (“Contribution Plan”) covers all eligible employees.Company monthly contributions to the Contribution Plan are based on thematching of employee contributions, vest immediately for salaried,non-bargained hourly and Charleston union employees, and vest after three yearsfor Roanoke Rapids union employees. For the three months ended March 31,2010 and 2009, the Company recognized expense of $1.0 million and $0.8 million,respectively, for matching contributions.

 

The Company’sRetirement Savings Plan (“Savings Plan”), which covers all eligible salariedand non-bargained hourly employees, provides for an annual contribution basedon an employee’s salary and age.  TheCompany contributions vest 100% after three years. For the three months ended March 31,2010, the Company recognized expense of $0.5 million. Effective February 1,2009, the Company temporarily suspended contributions to the Savings Plan dueto economic conditions, and as a result, no expense was recognized in thequarter ended March 31, 2009. The Company reinstated contributions to theSavings Plan in November 2009.

 

# **11.**                               Stockholder’s Equity

# ** **

In connection withthe Company’s initial public offering on August 19, 2005, the Companyissued for $100 an option to the representative of the underwriters to purchaseup to a total of 1,000,000 units at a price of $7.50 per unit. Each Unit consisted of one share of theCompany’s common stock, $0.0001 par value, and two warrants. The warrantsexpired on August 17, 2009, but were not exercised. In March 2010,the purchase option was exercised at a market price of $11.51 per share.  The purchase option was exercised on acashless basis and therefore no cash proceeds were received by theCompany.  Accordingly, 348,393 shares ofcommon

 

7

----

Table of Contents

 

stock were issued.

 

For the quarterended March 31, 2010, 48,450 employee stock options were exercised withcash proceeds to the Company of $0.4 million.

 

# **12.**                               Segment Information

# ** **

The Company hasone reportable segment, unbleached kraft. The unbleached kraft segment consistsof the Company’s paper mills in Roanoke Rapids, North Carolina and NorthCharleston, South Carolina, which produce kraft paper, linerboard, saturatingkraft and unbleached folding carton board. These products are sold to customerswho convert our products into end market finished products.

 

In the table below“other” represents the Company’s dunnage bag business, which was sold on March 31,2009.

 

The Company’sreportable and operating segment is based on financial information regularlyevaluated by the chief operating decision maker in determining resourceallocation and assessing performance, in accordance with ASC 805, “*Segment Reporting*.” In the third quarter2009, the Company revised its reporting structure. Segment disclosures havebeen revised to conform to the current presentation for all reporting periods.

 
| ** **                                            | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|
| **Operating Segment (in thousands of U.S. dollars):** | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Net  sales:                                           |       |                                  |       |   |   |
| Unbleached  kraft                                     |       | $                                     | 176,499    |   | $ | 134,556 |   |
| Other                                                 |       | —                                |       | 6,927 |   |
| Intersegment  sales                                   |       | —                                |       | (899 | ) |
|                                                  |       |                                  |       |   |   |
| Total                                                 |       | $                                     | 176,499    |   | $ | 140,584 |   |
|                                                  |       |                                  |       |   |   |
| Net  sales to external customers:                     |       |                                  |       |   |   |
| Unbleached  kraft                                     |       | $                                     | 176,499    |   | $ | 133,701 |   |
| Other                                                 |       | —                                |       | 6,883 |   |
|                                                  |       |                                  |       |   |   |
| Total                                                 |       | $                                     | 176,499    |   | $ | 140,584 |   |
|                                                  |       |                                  |       |   |   |
| Operating  income / (loss):                           |       |                                  |       |   |   |
| Unbleached  kraft                                     |       | $                                     | 16,755     |   | $ | 13,897 |   |
| Other                                                 |       | —                                |       | 748 |   |
| Gain  on sale of business                             |       | —                                |       | 17,399 |   |
| Corporate                                             |       | (4,789                                | )          | (5,807 | ) |
|                                                  |       |                                       |       |   |   |
| Total                                                 |       | $                                     | 11,966     |   | $ | 26,237 |   |

 
| ** **                                                                          | ** ** | **(Unaudited)**    | ** **    | ** **            | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------|---------------|-----------------------|------------|
| ** **                                                                          | ** ** | **March 31,** | ** **    | **December 31,** | ** ** |
| **Operating Segment (in thousands of U.S. dollars):** | ** ** | **2010**           | ** **    | **2009**              | ** ** |
| Total assets:                                                                       |       | ** **         |          | ** **            |       |
| Unbleached kraft                                                                    |       | $                  |  637,388 |                  | 638,050    |   |
| Corporate                                                                           |       | 40,098             |          | 31,073                |       |
|                                                                                |       |               |          |                  |       |
| Total                                                                               |       | $                  | 677,486       |                  | $          | 669,123 |   |
|                                                                                     |            |                    |               |                       |            |  |  |

 

8

----

Table of Contents

 

**ITEM 2.**

 

**MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION**

**AND RESULTS OF OPERATIONS**

 

This QuarterlyReport on Form 10-Q includes forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, as amended, and Section 21Eof 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 materially differentfrom any future results, levels of activity, performance or achievementsexpressed or implied by such forward-looking statements. In some cases, you canidentify forward-looking statements by terminology such as “may,” “should,” “could,”“would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” orthe negative of such terms or other similar expressions. Factors that mightcause or contribute to such a discrepancy include, but are not limited to,those described in Part I Item 1A of our Form 10-K for the fiscalyear ended December 31, 2009 and in our other Securities and ExchangeCommission filings.  The informationcontained in this Form 10-Q represents our best judgment at the date ofthis report based on information 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 followingdiscussion should be read in conjunction with our Consolidated FinancialStatements and related Notes thereto included elsewhere in this report.

 

9

----

Table of Contents

 

**Comparison of Results of Operationsfor the Three Months Ended March 31, 2010**

**and the Three Months Ended March 31,2009**

 
| ** **                                              | ** ** | **Three Months Ended March 31,** | ** ** | **Increase/** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|---------------|------------|
| **(in thousands of U.S. dollars):**                     | ** ** | **2010**                              | ** ** | **2009**      | ** ** | **(Decrease)** | ** ** |
| Net  sales                                              |       | $                                     | 176,499    |          | $          | 140,584 |   | $ | 35,915 |   |
| Cost  of sales, excluding depreciation and amortization |       | 130,301                               |       | 96,484        |       | 33,817 |   |
| Freight  and distribution expenses                      |       | 16,070                                |       | 13,328        |       | 2,742 |   |
| Selling,  general and administrative expenses           |       | 7,099                                 |       | 8,557         |       | (1,458 | ) |
| Depreciation  and amortization                          |       | 11,346                                |       | 13,609        |       | (2,263 | ) |
| Gain  on sale of business                               |       | —                                |       | 17,399        |       | (17,399 | ) |
| Other  operating income                                 |       | 283                                   |       | 232           |       | 51 |   |
| Operating  income                                       |       | 11,966                                |       | 26,237        |       | (14,271 | ) |
| Foreign  exchange loss                                  |       | 366                                   |       | 298           |       | 68 |   |
| Interest  income                                        |       | 9                                     |       | 1             |       | 8 |   |
| Interest  expense                                       |       | 1,637                                 |       | 5,733         |       | (4,096 | ) |
| Income  before provision for income taxes               |       | 9,972                                 |       | 20,207        |       | (10,235 | ) |
| Provision  for income taxes                             |       | 3,581                                 |       | 9,095         |       | (5,514 | ) |
| Net  income                                             |       | $                                     | 6,391      |          | $          | 11,112 |   | $ | (4,721 | ) |

 

Net sales for thequarter ended March 31, 2010 were $176.5 million compared to $140.6million for the first quarter of 2009, an increase of $35.9 million or 25.5%.The increase in net sales was driven by $57.8 million of increased sales volumein the first quarter of 2010 compared to the first quarter of 2009, mainly dueto increased demand reflecting improving economic conditions.  Partially offsetting the sales volume gain isan $11.5 million decrease due to lower average revenue per ton, $4.4 million ofless favorable product mix due to a higher percentage of linerboard sales and$6.0 million due to the sale of the dunnage bag business.

 

Cost of sales,excluding depreciation and amortization expense, for the quarter ended March 31,2010 was $130.3 million compared to $96.5 million for the first quarter of2009, an increase of $33.8 million, or 35.0%. The increase in cost of sales wasmainly due to $41.0 million from increased sales volume, $6.5 million relatedto the Charleston mill planned maintenance outage, $4.2 million due toinflation on input costs and a $1.6 million increase in compensation andbenefit costs as the Company reinstated certain benefits in November 2009and January 2010. Partially offsetting the increase in cost of sales is a$16.7 million increase in alternative fuel mixture tax credits and $4.5 milliondue to the sale of the dunnage bag business.

 

Freight anddistribution expenses for the quarter ended March 31, 2010 totaled $16.1million compared to $13.3 million for the quarter ended March 31, 2009.The increase of $2.8 million was primarily due to a 45.5% increase in salesvolume, partially offset by $0.4 million due to the sale of the dunnage bagbusiness.

 

Selling, generaland administrative expenses for the quarter ended March 31, 2010 totaled$7.1 million compared to $8.6 million for the quarter ended March 31, 2009.The decrease of $1.5 million reflects $1.6 million for the termination of transitional services provided by MeadWestvaco, $0.4million of lower bad debts and $0.3 million related to the sale of the dunnagebag business.  Partially offsetting thedecrease in selling, general and administrative expense was $0.8 millionof higher compensation and benefit expenses as the Company reinstated certainbenefits in November 2009 and January 2010 that were previously suspended as aresult of poor economic conditions in early 2009.

 

Depreciation andamortization for the quarter ended March 31, 2010 totaled $11.3 millioncompared to $13.6 million for the quarter ended March 31, 2009. Thedecrease of $2.3 million is primarily due to $2.4 million of lower intangible assetamortization. The Company acquired a coal contract with below market prices inconjunction with the Charleston Kraft Division (“CKD”) acquisition. Thecontract and related amortization expired on December 31, 2009.

 

The $17.4 milliongain on sale of a business in the first quarter of 2009 is the result of thesale of the dunnage bag business to Illinois Tool Works Inc.

 

10

----

Table of Contents

 

Interestexpense for the quarters ended March 31, 2010 and 2009 was $1.6 millionand $5.7 million, respectively. Interest expense reflects interest on theCompany’s senior credit agreement and amortization of debt issuance costs.Interest expense was $4.1 million lower in the quarter ended March 31,2010 primarily due to lower debt balances and interest rates.

 

Provisionfor income taxes for the quarters ended March 31, 2010 and 2009 was $3.6million and $9.1 million, respectively, reflecting an effective tax rate of35.9% for the quarter ended March 31, 2010 compared to 45.0% for thesimilar period in 2009. The higher rate in 2009 reflects a discrete adjustmentfor the sale of the dunnage bag business and the alternative fuel mixture taxcredits.

 

**S****egment Results**

 

The followingtable presents a reconciliation of consolidated net sales and operating incometo amounts reported by operating segment:

 
| ** **                           | ** ** | **Three Months Ended March 31,** | ** **  |
|--------------------------------------|------------|---------------------------------------|-------------|
| **Operating Segment ($000’s):** | ** ** | **2010**                              | ** **  | **2009** | ** ** |
| Consolidated  net sales:             |       |                                  |        |   |   |
| Unbleached  kraft                    |       | $                                     | 176,499     |   | $ | 134,556 |   |
| Other                                |       | —                                |        | 6,927 |   |
| Intersegment  sales                  |       | —                                |        | (899 | ) |
|                                 |       |                                  |        |   |   |
| **Total net sales**                  | ** ** | **$**                                 | **176,499** | ** ** | **$** | **140,584** | ** ** |
|                                 |       |                                  |        |   |   |
| Operating  income / (loss):          |       |                                  |        |   |   |
| Unbleached  kraft                    |       | $                                     | 16,755      |   | $ | 13,897 |   |
| Other                                |       | —                                |        | 748 |   |
| Gain  on sale of business            |       | —                                |        | 17,399 |   |
| Corporate                            |       | (4,789                                | )           | (5,807 | ) |
|                                 |       |                                  |        |   |   |
| **Total operating income**           | ** ** | **$**                                 | **11,966**  | ** ** | **$** | **26,237** | ** ** |

 

The followingrepresents analysis and commentary for results of operations for the Company’soperating segment.

 

***Unbleached Kraft***

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Net  sales                       |       | $                                     | 176,499    |   | $ | 134,556 |   |
| Operating  income                |       | $                                     | 16,755     |   | $ | 13,897 |   |
| Operating  income % of net sales |       | 9.5                                   | %          | 10.3 | % |
|                             |       |                                  |       |   |   |
| Average  revenue per ton         |       | $                                     | 535        |   | $ | 595 |   |
| Tons  of paper sold              |       | 316,305                               |       | 217,412 |   |

 

For the threemonths ended March 31, 2010, unbleached kraft segment net sales increasedby $41.9 million, or 31.1%, to $176.5 million compared to $134.6 million forthe three months ended March 31, 2009. The increase in net sales is mainlydue to $57.8 million of higher sales volume, resulting from an increase of98,893 tons of paper sold, partially offset by $11.5 million of lower averagerevenue per ton and $4.4 million due to a less favorable product mix from ahigher percentage of linerboard sales. Average selling prices in the firstquarter of 2010 of $535 per ton are $60 per ton lower than average sellingprices in the first quarter of 2009, reflecting market driven reductions in thefirst nine months of 2009 for kraft paper and linerboard. In the quarter ended March 31,2010, the Company realized some price recovery for both of these products andexpects additional price recovery in 2010.

 

11

----

Table of Contents

 

Unbleached kraftsegment operating income increased by $2.9 million, or 20.9%, to $16.8 millionfor the three months ended March 31, 2010 compared to $13.9 million forthe three months ended March 31, 2009. Operating income increased primarily due to $14.4 million from highersales volume, $16.7 million from alternate fuel mixture tax credits, $2.4million related to decreased amortization expense related to an expiredintangible asset and $0.4 million of lower bad debts.  The increase in operating income is partiallyoffset by $11.5 million of lower average revenue per ton, $6.5 million relatedto the Charleston mill planned maintenance outage, $4.4 million of a lessfavorable product mix due to a higher percentage of linerboard sales, $4.2million of inflation on input costs, and $4.4 million of other cost increases.

 

For the quarterending March 31, 2010, operating income as a percentage of net salesdeclined to 9.5% from 10.3% for the first quarter of 2009, mainly due to lowermargin on sales and the Charleston mill planned maintenance outage partiallyoffset by a higher alternative fuel mixture tax credit.

 

***Other***

 

Other includes theCompany’s former dunnage bag business which was sold on March 31, 2009 toIllinois Tool Works, Inc.

 

***Corporate***

 

Corporateoperating expense for the three months ended March 31, 2010 totaled $4.8million compared to $5.8 million for the three months ended March 31,2009. The decrease of $1.0 million is due to $1.6 million for the terminationof transitional services provided byMeadWestvaco partially offset by $0.6 million of higher compensation andbenefit expenses as the Company reinstated certain benefits in November 2009and January 2010 that were temporarily suspended in 2009 as a result of pooreconomic conditions.

 

**Liquidityand Capital Resources**

 

***Senior Credit Agreement***

 

We entered into aSenior Credit Agreement, dated as of June 12, 2008. The Senior CreditAgreement provides for an aggregate of up to $515 million consisting of a $390million term A loan facility, a $25 million term B loan facility and a $100million revolving credit facility, including a letter of credit subfacility(collectively, the “Senior Credit Facilities”). The Senior Credit Facilities are guaranteed by KapStone Kraft and ourother domestic subsidiaries and are secured by substantially all of our assets,including all of our capital stock, the capital stock of our guarantorsubsidiaries and up to 66% of the capital stock of our foreign subsidiaries.

 

In addition, $40 millionof 8.3% seven year senior notes were issued in July 2008 as part of thefinancing for the CKD acquisition and were extinguished in July 2009 usingcash from operations.

 

In the quarter ended March 31,2010, the Company made a $10.0 million voluntary loan repayment on the termloan facility.

 

***Debt Covenants***

 

Under the financialcovenants of the Senior Credit Agreement, KapStone must comply on a quarterlybasis with a maximum permitted leverage ratio of 3.0 to 1. The Senior Credit Agreementalso includes a financial covenant requiring a minimum fixed charge coverageratio that is 1.1 to 1.  As of March 31,2010 the Company was in compliance with the Senior Credit Agreement with aleverage ratio of 0.76 to 1 and a fixed charge coverage ratio of 5.20 to 1.

 

At March 31, 2010,the Company was in compliance with all other applicable covenants in the SeniorCredit Agreement.

 

***Other Borrowings***

 

For the quarter ended March 31, 2010, theCompany reduced its revolving credit facility by $2.9 million to $4.5 millionfrom December 31, 2009. The Company utilizes its revolving credit faciltyfor working capital needs.

 

12

----

Table ofContents

 

On January 5,2010, the Company entered into a twelve month financing agreement of $2.6million at an annual interest rate of 1.62% for the Company’s annual propertyinsurance premium. The agreement requires the Company to make consecutivemonthly repayments of $0.2 million through the term of the financingagreement ending on December 1, 2010. As of March 31, 2010, $1.7million was outstanding.

 

***Restricted Cash***

 

On March 31,2009, the Company consummated the sale of its dunnage bag business to IllinoisTool Works Inc. for $36.0 million less $1.1 million of workingcapital adjustments. As a condition of sale, $2.5 million of the saleproceeds are being held in escrow until September 30, 2010 to be availableto satisfy any losses or indemnity claims that may arise against the Company inconnection with the sale. The Company expects the full $2.5 million held inescrow to be returned on September 30, 2010.

 

***Alternative Fuel Mixture Tax Credit***

 

Based on an U.S. Internal Revenue ServiceAdvice Memorandum released on March 12, 2010, the Company believes it iseligible to receive an additional $7.9 million tax credit related to inorganiccontent burned in 2009. The inorganic content, which represented about 4% ofthe total gallons burned, was excluded from refunds submitted in 2009. TheCompany expects to receive this tax credit in 2010.

 

***Incometaxes***

 

The Company hasrecorded a $68.7 million tax contingency reserve at March 31, 2010for an unrecognized tax benefit relating to the taxability of alternative fuelmixture tax credits (“AFTC”). The Company has taken the position that the AFTCis similar to a federal excise tax and as a result is not taxable. To date, theInternal Revenue Service has issued no guidance concerning this issue.

 

The Company expects to receive a $13.2 millionfederal tax refund in 2010. The Company expects to use these proceeds to makevoluntary debt repayments.

 

In December 2009,the Company filed its registration as a cellulosic biofuel producer for theyear 2009. The cellulosic biofuel tax credit, under Section 40(b)(6) ofthe Internal Revenue Service (“IRS”) Code, is a $0.51 per gallon credit forcellulosic biofuel producers. The Company will not recognize any benefitassociated with this tax credit until it is approved by the IRS.  If approved, the Company can apply for thetax credit related to cellulosic biofuel produced during 2009 and it would berealized by reducing future income tax payable.

 

***Exercisesof Employee Stock Options***

 

In the quarterended March 2010, the Company received $0.4 million from exercises ofemployee stock options.

 

***Sources and Uses of Cash***

 
| **Three months ended March 31 ($000’s)** | ** ** | **2010**   | ** ** | **2009**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating  activities                              |       | $          | 22,995     |       | $          | (3,594 | ) |
| Investing  activities                              |       | (6,610     | )          | 27,260     |       |
| Financing  activities                              |       | (14,974    | )          | (26,311    | )          |
|                                                    |            |            |            |            |            |  |  |

 

Cash and cashequivalents increased by $1.4 million from December 31, 2009, reflecting$23.0 million of net cash provided by operating activities, $6.6 million of netcash used in investing activities and $15.0 million of net cash used infinancing activities.

 

Net cash providedby operating activities was $23.0 million primarily due to net income for thequarter of $6.4 million and $15.8 million of non-cash charges. Changes inoperating assets and liabilities provided $0.8 million. Net cash provided byoperating activities increased by $26.6 million in the quarter ended March 31,2010 compared to the quarter ended March 31, 2009 due to $23.9 million forthe alternative fuel mixture tax credit receivable, a $20.6 million increase ofaccrued expenses and other and $17.4 million

 

13

----

Table ofContents

 

related to gain on thesale of the dunnage bag business in the first quarter of 2009. Accrued expensesand other increased due to a $6.1 million property tax and $5.1 interestpayment made in the first quarter of 2009 and a $4.9 million increase of theCompany’s unrecognized tax benefit relating to the taxability of thealternative fuel mixture tax credit in 2010.

 

Net cash used ininvesting activities was $6.6 million reflecting $7.2 million of capitalexpenditures partially offset by $0.6 million received from MeadWestvacorelating to the CKD acquisition. For the quarter ended March 31, 2010,capital expenditures included $5.9 million for the unbleached kraft segment forequipment upgrades and replacements at the paper mills. In addition, $1.3million was spent on IT systems projects. Net cash provided by investing activities decreased by $33.9 million inthe quarter ended March 31, 2010 compared to the quarter ended March 31,2009 mainly due to $36.1 million of proceeds received from the sale of thedunnage bag business in the first quarter of 2009.

 

Net cash used infinancing activities was $15.0 million and reflects $17.0 million of term loanrepayments including a $10.0 million voluntary repayment and $2.9 million ofnet repayments on the revolving credit facility partially offset by $1.7million of net other borrowings and $0.4 million of proceeds from exercises ofstock options. Net cash used in financing activities decreased by $11.3 millionin the quarter ended March 31, 2010 compared to the quarter ended March 31,2009 due to a lower amount of debt repayments in the first quarter of 2010.

 

***Future Cash Needs***

 

We expect thatcash generated from operating activities, and if needed, the ability to drawfrom our revolving credit facility will be sufficient to meet the anticipated2010 cash needs. The Company expects to spend approximately $25.0 million oncapital expenditures for the balance of 2010. In addition, the Company has$13.5 million of required long-term debt repayments for the balance of 2010 andexpects to fund an additional $3.5 million to its pension plan.

 

**Off-BalanceSheet Arrangements**

 

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

 

**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 Senior Credit Facilities, wehave two term loans totaling $130.8 million and a revolving loan of $4.5million outstanding at March 31, 2010. The maturity date is the earlier of: (a) June 12, 2013 withrespect to the term A loan facility and the revolving credit facility, and June 12,2015 with respect to the term B loan facility, and (b) the date which is90 days prior to the date on which any earn-out, obligations to InternationalPaper Company will become (or are reasonably expected to become) due, providedthat the maturity date will not be so accelerated if, among other things, thetotal leverage ratio as of the end of the then most recent fiscal quarter, isless than 2.0 to 1.0.

 

Changes in marketrates may impact the base rate in our Senior Credit Agreement. For instance, ifthe bank’s LIBOR rate was to increase or decrease by one percentage point(1.0%), our annual interest expense would change by approximately $1.3 millionbased upon our expected future monthly loan balances per our existing repaymentschedule.

 

We are exposed toprice fluctuations of certain commodities used in production. Key raw materialsand energy 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

 

14

----

Table ofContents

 

these commodities.  We have two contracts to purchase coal atfixed prices that expire on December 31, 2010.

 

We are exposed toprice fluctuations in the price of our finished goods. The prices we charge forour products are primarily based on market conditions.

 

We are exposed tocurrency fluctuations as we invoice certain European customers in euros. TheCompany did not use forward contracts to reduce the impact of currencyfluctuations. No such contracts were outstanding at March 31, 2010.

 

**ITEM 4**

 

**CONTROLS AND PROCEDURES**

 

As of the end ofthe period 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, 2010.

 

There were nochanges in our internal control over financial reporting during the threemonths ended March 31, 2010 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

15

----

Table ofContents

 

**PART II. — OTHER INFORMATION**

 

**ITEM 1**

 

**LEGAL PROCEEDINGS**

 

None.

 

**ITEM 1A**

 

**RISK FACTORS**

 

There have been nomaterial changes from the Risk Factors described in our Form 10-K for theyear ended December 31, 2009.

 

**ITEM 2**

 

**UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 3**

 

**DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4**

 

**RESERVED**

 

**ITEM 5**

 

**OTHER INFORMATION**

 

None.

 

16

----

Table ofContents

 

**ITEM 6**

 

**EXHIBITS**

 

The following Exhibitsare filed as part of this report.

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                        |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                   |
| 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.                                         |

 

17

----

Table ofContents

 

**SIGNATURE**

 

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 5, 2010 |   | By:                                       | /s/ Andrea K. Tarbox |
|             |   |                                      | Andrea K. Tarbox |
|             |   |                                      | Vice President and  Chief Financial Officer |

 

18

----