**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**Quarterly Report Pursuant to Section13 or 15(d) of the SecuritiesExchange Act of 1934**

 

**For thequarterly period ended September 30, 2007**

 

**CommissionFile Number: 000-51444**

 

**KapStone Paper and PackagingCorporation**

(Exact name of registrant asspecified in its charter)

 

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

 

**KapStonePaper and Packaging Corporation, One Northfield Plaza, Suite 480**

**Northfield,IL 60093**

(Address of PrincipalExecutive Offices including zip code)

 

**(847)441-0929**

(Registrant’s TelephoneNumber, 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.

 

Yesx No 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 x |   | Non-Accelerated Filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

 

Yeso No x

 

Therewere 24,968,097 shares of the Registrant’s Common Stock, $0.0001 par value,outstanding at October 31, 2007, excluding 40,000 shares held as treasuryshares.

 

 

----

 

**KapStonePaper and Packaging Corporation Index to Form 10-Q**

 

**TABLE OFCONTENTS**

 
| PART I. — FINANCIAL INFORMATION |                                                                                                                                                      |
|--------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                 |                                                                                                                                                      |
|                                 | Item 1. — Condensed Consolidated  Financial Statements (Unaudited) and Notes to Condensed Consolidated  Financial     Statements | 1 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 2. — Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                | 14 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 3. —  Quantitative and Qualitative Disclosures about Market Risk                                                                                | 21 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 4. — Controls  and Procedures                                                                                                                   | 21 |
|                                 |                                                                                                                                                      |
| PART II. — OTHER  INFORMATION   |                                                                                                                                                      |
|                                 |                                                                                                                                                      |
|                                 | Item 1. — Legal  Proceedings                                                                                                                         | 22 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 1A. — Risk Factors                                                                                                                              | 22 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 2. —  Unregistered Sales of Equity Securities and Use of Proceeds                                                                               | 22 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 3. —  Defaults Upon Senior Securities                                                                                                           | 22 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 4. — Submission  of Matters to a Vote of Security Holders                                                                                       | 22 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 5. — Other  Information                                                                                                                         | 22 |
|                                 |                                                                                                                                                      |   |
|                                 | Item 6. — Exhibits                                                                                                                                   | 22 |
|                                 |                                                                                                                                                      |
| SIGNATURES                           |                                                                                                                                                      |

 

i

----

 

**Part 1.Financial Information**

 

**Item 1. Financial Statements**

 

**KapStonePaper and Packaging CorporationCondensed Consolidated Balance Sheets**

 

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

** **
| ** **                                                                                                                                                                                                                                                                | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | **Predecessor  KPB**  | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                                                                                                                                                | ** ** | **2007**               | ** ** | **2006**              | ** ** | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                                                                                | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                                                                |       |                   |       |                  |       |       |                  |       |
| Current assets:                                                                                                                                                                                                                                                           |       |                   |       |                  |       |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                 |       | $                      | 9,942      |                  | $          | —     |                  |       | $ | 1 |   |
| Restricted cash held in trust                                                                                                                                                                                                                                             |       | —                 |       | 115,239               |       |       | —                |       |
| Short-term investments                                                                                                                                                                                                                                                    |       | 35,379                 |       | —                |       |       | —                |       |
| Accounts receivable, less allowances of  $280 at September 30, 2007                                                                                                                                                                                                       |       | 31,586                 |       | —                |       |       | 25,824                |       |
| Inventories                                                                                                                                                                                                                                                               |       | 20,333                 |       | —                |       |       | 24,087                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                 |       | 1,782                  |       | 120                   |       |       | 1,425                 |       |
| Total current assets                                                                                                                                                                                                                                                      |       | 99,022                 |       | 115,359               |       |       | 51,337                |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |       |                  |       |
| Plant, property and equipment, net                                                                                                                                                                                                                                        |       | 105,354                |       | —                |       |       | 201,593               |       |
| Deferred income taxes                                                                                                                                                                                                                                                     |       | 934                    |       | 689                   |       |       | —                |       |
| Deferred acquisition costs                                                                                                                                                                                                                                                |       | 1,200                  |       | 3,058                 |       |       | —                |       |
| Other assets                                                                                                                                                                                                                                                              |       | 2,086                  |       | 151                   |       |       | 4,452                 |       |
| Intangible assets, net                                                                                                                                                                                                                                                    |       | 5,925                  |       | —                |       |       | —                |       |
| Goodwill                                                                                                                                                                                                                                                                  |       | 441                    |       | —                |       |       | —                |       |
| Total assets                                                                                                                                                                                                                                                              |       | $                      | 214,962    |                  | $          | 119,257    |                  |       | $ | 257,382 |   |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |       |                  |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                             |       |                   |       |                  |       |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                      |       |                   |       |                  |       |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                                          |       | $                      | 10,623     |                  | $          | 196        |                  |       | $ | 7,931 |   |
| Accrued expenses                                                                                                                                                                                                                                                          |       | 3,397                  |       | 2,786                 |       |       | 7,144                 |       |
| Accrued compensation costs                                                                                                                                                                                                                                                |       | 5,609                  |       | —                |       |       | —                |       |
| Accrued income taxes                                                                                                                                                                                                                                                      |       | 1,947                  |       | —                |       |       | —                |       |
| Current portion of long-term debt                                                                                                                                                                                                                                         |       | 9,750                  |       | —                |       |       | —                |       |
| Total current liabilities                                                                                                                                                                                                                                                 |       | 31,326                 |       | 2,982                 |       |       | 15,075                |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |       |                  |       |
| Other liabilities:                                                                                                                                                                                                                                                        |       |                   |       |                  |       |       |                  |       |
| Long-term debt                                                                                                                                                                                                                                                            |       | 46,500                 |       | —                |       |       | 22,357                |       |
| Asset retirement obligations                                                                                                                                                                                                                                              |       | 275                    |       | —                |       |       | 265                   |       |
| Pension and post retirement benefits                                                                                                                                                                                                                                      |       | 3,188                  |       | —                |       |       | —                |       |
| Total other liabilities                                                                                                                                                                                                                                                   |       | 49,963                 |       | —                |       |       | 22,622                |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |       |                  |       |
| Common stock, subject to redemption-40,000  shares at December 31, 2006                                                                                                                                                                                                   |       | —                 |       | 230                   |       |       | —                |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |       |                  |       |
| 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; 25,008,097 shares issued less 40,000 treasury shares  outstanding at September 30, 2007 and 25,000,000 at December 31, 2006  (including 40,000 shares subject to possible redemption at December 31, 2006) |       | 2                      |       | 3                     |       |       | —                |       |
| Additional paid-in capital                                                                                                                                                                                                                                                |       | 113,434                |       | 113,904               |       |       | —                |       |
| Divisional control                                                                                                                                                                                                                                                        |       | —                 |       | —                |       |       | 219,685               |       |
| Common stock held in treasury, at cost                                                                                                                                                                                                                                    |       | (230                   | )          | —                |       |       | —                |       |
| Retained earnings                                                                                                                                                                                                                                                         |       | 20,467                 |       | 2,138                 |       |       | —                |       |
| Total stockholders’ equity                                                                                                                                                                                                                                           |       | 133,673                |       | 116,275               |       |       | 219,685               |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                           |       | $                      | 214,962    |                  | $          | 119,257    |                  |       | $ | 257,382 |   |

 

See notes to condensedconsolidated financial statements.

 

1

----

 

**KapStonePaper and Packaging CorporationCondensed Consolidated Statements of Operations (In thousands, except share and per share amounts)**

 

**(unaudited)**

** **
| ** **                                                                                      | ** ** | ** **                                               | ** ** | ** ** | ** **                       | ** ** | **Predecessor  KPB**             | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                      | ** ** | **Three Months Ended September 30,** | ** ** | ** ** | **Three Months Ended** | ** ** |
| ** **                                                                                      | ** ** | **2007**                                                 | ** ** | **2006**   | ** **                       | ** ** | **September 30, 2006** | ** ** |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Net sales                                                                                       |       | $                                                        | 66,188     |       | $                                | —     |                             |       | $ | 64,318 |   |
| Cost of sales                                                                                   |       | 46,026                                                   |       | —     |                             |       | 46,774                           |       |
| Depreciation and amortization                                                                   |       | 3,178                                                    |       | —     |                             |       | 4,671                            |       |
| Gross profit                                                                                    |       | 16,984                                                   |       | —     |                             |       | 12,873                           |       |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Selling, general and administrative  expenses                                                   |       | 4,529                                                    |       | 373        |                             |       | 2,639                            |       |
| Other operating income                                                                          |       | 399                                                      |       | —     |                             |       | —                           |       |
| Operating income / (loss)                                                                       |       | 12,854                                                   |       | (373       | )                                |       | 10,234                           |       |
| Interest income                                                                                 |       | 585                                                      |       | 1,396      |                             |       | —                           |       |
| Interest expense                                                                                |       | (1,044                                                   | )          | —     |                             |       | (352                             | )          |
| Income before provision for income taxes                                                        |       | 12,395                                                   |       | 1,023      |                             |       | 9,882                            |       |
| Provision for income taxes                                                                      |       | 4,593                                                    |       | 351        |                             |       | 3,818                            |       |
| Net income                                                                                      |       | 7,802                                                    |       | 672        |                             |       | $                                | 6,064      |   |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Deferred interest, net of taxes,  attributable to common stock subject to possible redemption   |       | —                                                   |       | (183       | )                           |       | —                           |       |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Net income allocable to holders of  nonredeemable common stock                                  |       | $                                                        | 7,802      |       | $                                | 489        |                             |       | $ | — |   |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Weighted-average number of shares  outstanding:                                                 |       |                                                     |       |       |                             |       |                             |       |
| Basic                                                                                           |       | 24,968,097                                               |       | 25,000,000 |                             |       | —                           |       |
| Diluted                                                                                         |       | 36,674,697                                               |       | 29,539,007 |                             |       | —                           |       |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Net income per share:                                                                           |       |                                                     |       |       |                             |       |                             |       |
| Basic                                                                                           |       | $                                                        | 0.31       |       | $                                | 0.03       |                             |       | $ | — |   |
| Diluted                                                                                         |       | $                                                        | 0.21       |       | $                                | 0.02       |                             |       | $ | — |   |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Weighted-average shares outstanding  exclusive of shares subject to possible redemption:        |       |                                                     |       |       |                             |       |                             |       |
| Basic                                                                                           |       | 24,968,097                                               |       | 21,002,000 |                             |       | —                           |       |
| Diluted                                                                                         |       | 36,674,697                                               |       | 25,541,007 |                             |       | —                           |       |
|                                                                                            |       |                                                     |       |       |                             |       |                             |       |
| Net income per share exclusive of shares  and deferred interest subject to possible redemption: |       |                                                     |       |       |                             |       |                             |       |
| Basic                                                                                           |       | $                                                        | 0.31       |       | $                                | 0.02       |                             |       | $ | — |   |
| Diluted                                                                                         |       | $                                                        | 0.21       |       | $                                | 0.02       |                             |       | $ | — |   |
|                                                                                                 |            |                                                          |            |            |                                  |            |                                  |            |  |  |  |  |

 

See notes to condensedconsolidated financial statements.

 

2

----

 

**KapStonePaper and Packaging CorporationCondensed Consolidated Statements of Operations (In thousands, except share and per share amounts)**

 

**(unaudited)**

** **
| ** **                                                                                         | ** ** | ** **                                              | ** ** | ** ** | ** **                      | ** ** | **Predecessor  KPB**             | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **                                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** | ** ** | **Nine Months Ended** | ** ** |
| ** **                                                                                         | ** ** | **2007**                                                | ** ** | **2006**   | ** **                      | ** ** | **September 30, 2006** | ** ** |
|                                                                                               |       |                                                    |       |       |                            |       |                             |       |
| Net sales                                                                                          |       | $                                                       | 191,857    |       | $                               | —     |                             |       | $ | 189,164 |   |
| Cost of sales                                                                                      |       | 141,180                                                 |       | —     |                            |       | 142,688                          |       |
| Depreciation and amortization                                                                      |       | 8,272                                                   |       | —     |                            |       | 13,600                           |       |
| Gross profit                                                                                       |       | 42,405                                                  |       | —     |                            |       | 32,876                           |       |
|                                                                                               |       |                                                    |       |       |                            |       |                             |       |
| Selling, general and administrative  expenses                                                      |       | 12,552                                                  |       | 892        |                            |       | 8,924                            |       |
| Other operating income                                                                             |       | 987                                                     |       | —     |                            |       | —                           |       |
| Operating income / (loss)                                                                          |       | 30,840                                                  |       | (892       | )                               |       | 23,952                           |       |
| Interest income                                                                                    |       | 1,467                                                   |       | 3,923      |                            |       | —                           |       |
| Interest expense                                                                                   |       | (3,317                                                  | )          | —     |                            |       | (1,059                           | )          |
| Income before provision for income taxes                                                           |       | 28,990                                                  |       | 3,031      |                            |       | 22,893                           |       |
| Provision for income taxes                                                                         |       | 10,661                                                  |       | 1,028      |                            |       | 8,846                            |       |
| Net income                                                                                         |       | 18,329                                                  |       | 2,003      |                            |       | $                                | 14,047     |   |
| Deferred interest, net of taxes,  attributable to common stock subject to possible redemption      |       | —                                                  |       | (510       | )                               |       | —                           |       |
|                                                                                               |       |                                                    |       |       |                            |       |                             |       |
| Net income allocable to holders of  nonredeemable common stock                                     |       | $                                                       | 18,329     |       | $                               | 1,493      |                             |       | $ | — |   |
|                                                                                               |       |                                                    |       |       |                            |       |                             |       |
| Weighted-average number of shares  outstanding:                                                    |       |                                                    |       |       |                            |       |                             |       |
| Basic                                                                                              |       | 24,967,143                                              |       | 25,000,000 |                            |       | —                           |       |
| Diluted                                                                                            |       | 35,723,847                                              |       | 28,963,964 |                            |       | —                           |       |
|                                                                                               |       |                                                    |       |       |                            |       |                             |       |
| Net income per share:                                                                              |       |                                                    |       |       |                            |       |                             |       |
| Basic                                                                                              |       | $                                                       | 0.73       |       | $                               | 0.08       |                             |       | $ | — |   |
| Diluted                                                                                            |       | $                                                       | 0.51       |       | $                               | 0.07       |                             |       | $ | — |   |
|                                                                                               |       |                                                    |       |       |                            |       |                             |       |
| Weighted-average number of shares  outstanding exclusive of shares subject to possible redemption: |       |                                                    |       |       |                            |       |                             |       |
| Basic                                                                                              |       | 24,962,699                                              |       | 21,002,000 |                            |       | —                           |       |
| Diluted                                                                                            |       | 35,719,403                                              |       | 24,965,964 |                            |       | —                           |       |
|                                                                                               |       |                                                    |       |       |                            |       |                             |       |
| Net income per share exclusive of shares  and deferred interest subject to possible redemption:    |       |                                                    |       |       |                            |       |                             |       |
| Basic                                                                                              |       | $                                                       | 0.73       |       | $                               | 0.07       |                             |       | $ | — |   |
| Diluted                                                                                            |       | $                                                       | 0.51       |       | $                               | 0.06       |                             |       | $ | — |   |
|                                                                                                    |            |                                                         |            |            |                                 |            |                                  |            |  |  |  |  |

 

See notes to condensedconsolidated financial statements.

 

3

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**KapStonePaper and Packaging CorporationCondensed Consolidated Statements of Cash Flows (In thousands, except share and per share amounts)**

 

**(unaudited)**

 
| ** **                                              | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | **Predecessor KPB**         | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|----------------------------------|------------|
| ** **                                              | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | **Nine Months**             | ** ** |
| ** **                                              | ** ** | **Nine Months Ended September 30,** | ** ** | ** ** | **Ended**  | ** ** |
| ** **                                              | ** ** | **2007**                                                | ** ** | **2006**   | ** ** | ** ** | **September 30, 2006** | ** ** |
| **Operating activities**                                |       |                                                    |       |       |       |       |                             |       |
| Net income                                              |       | $                                                       | 18,329     |       | $          | 2,003      |                             |       | $ | 14,047 |   |
| Depreciation and amortization                           |       | 8,272                                                   |       | —     |       |       | 13,600                           |       |
| Stock based compensation expense                        |       | 459                                                     |       | —     |       |       | —                           |       |
| Amortization of debt issuance costs                     |       | 193                                                     |       | —     |       |       | —                           |       |
| Other                                                   |       | —                                                  |       | —     |       |       | (163                             | )          |
| Changes in operating assets and  liabilities:           |       |                                                    |       |       |       |       |                             |       |
| Accounts receivable, net                                |       | (5,089                                                  | )          | —     |       |       | (4,007                           | )          |
| Interest receivable on short-term  investments          |       | (379                                                    | )          | 24         |       |       | —                           |       |
| Inventories                                             |       | 5,280                                                   |       | —     |       |       | 2,219                            |       |
| Prepaid expenses and other current assets               |       | (573                                                    | )          | 95         |       |       | 328                              |       |
| Accounts payable                                        |       | 2,496                                                   |       | —     |       |       | 934                              |       |
| Accrued expenses                                        |       | (881                                                    | )          | 1,193      |       |       | 398                              |       |
| Accrued compensation costs                              |       | 5,609                                                   |       | —     |       |       | —                           |       |
| Accrued income taxes                                    |       | 1,927                                                   |       | 44         |       |       | —                           |       |
| Deferred income taxes                                   |       | 628                                                     |       | (281       | )          |       | —                           |       |
| Net cash provided by operating activities               |       | 36,271                                                  |       | 3,078      |       |       | 27,356                           |       |
|                                                    |       |                                                    |       |       |       |       |                             |       |
| **Investing activities**                                |       |                                                    |       |       |       |       |                             |       |
| Acquisition costs paid                                  |       | (1,200                                                  | )          | (1,829     | )          |       | —                           |       |
| KPB acquisition                                         |       | (150,303                                                | )          | —     |       |       | —                           |       |
| Capital expenditures                                    |       | (9,070                                                  | )          | —     |       |       | (5,288                           | )          |
| Purchase of short-term investments                      |       | (35,000                                                 | )          | —     |       |       | —                           |       |
| Restricted cash                                         |       | —                                                  |       | —     |       |       | 300                              |       |
| Purchase of U.S. government securities held  in trust   |       | —                                                  |       | (1,135,849 | )          |       | —                           |       |
| Maturities of U.S. government securities  held in trust |       | —                                                  |       | 1,133,216  |       |       | —                           |       |
| Net cash used in investing activities                   |       | (195,573                                                | )          | (4,462     | )          |       | (4,988                           | )          |
|                                                    |       |                                                    |       |       |       |       |                             |       |
| **Financing activities**                                |       |                                                    |       |       |       |       |                             |       |
| Proceeds from long-term debt                            |       | 60,000                                                  |       | —     |       |       | —                           |       |
| Debt issuance costs paid                                |       | (855                                                    | )          | —     |       |       | —                           |       |
| Repayments of long-term debt                            |       | (3,750                                                  | )          | —     |       |       | —                           |       |
| Receipt of funds held in trust                          |       | 115,239                                                 |       | —     |       |       | —                           |       |
| Redemption of shares                                    |       | (230                                                    | )          | —     |       |       | —                           |       |
| Investment banking fee paid                             |       | (1,200                                                  | )          | —     |       |       | —                           |       |
| Proceeds from exercise of common stock  warrants        |       | 40                                                      |       | —     |       |       | —                           |       |
| Distributed to International Paper Company              |       | —                                                  |       | —     |       |       | (22,368                          | )          |
| Net cash provided by financing activities               |       | 169,244                                                 |       | —     |       |       | (22,368                          | )          |
|                                                    |       |                                                    |       |       |       |       |                             |       |
| Net increase in cash and cash equivalents               |       | 9,942                                                   |       | (1,384     | )          |       | —                           |       |
| Cash and cash equivalents-beginning of  period          |       | —                                                  |       | 2,157      |       |       | 1                                |       |
| Cash and cash equivalents-end of period                 |       | $                                                       | 9,942      |       | $          | 773        |                             |       | $ | 1 |   |

 

See notes to condensedconsolidated financial statements.

 

4

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** **

**KAPSTONEPAPER AND PACKAGING CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts)**

 

**(UNAUDITED)**

 

# **1.**                                      Financial Statements

# ** **

Theaccompanying unaudited condensed consolidated financial statements of KapStonePaper and Packaging Corporation (the “Company,” “we,” “us,” “our” or “KapStone”)have been prepared in accordance with U.S. generally accepted accountingprinciples (U.S. GAAP) for interim financial information, the instructions toForm 10-Q and Article 10 of Regulation S-X. Accordingly, they do notinclude all of the information and footnotes required by US. GAAP 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 and nine months ended September30, 2007, are not necessarily indicative of the results that may be expectedfor the year ending December 31, 2007. For further information, refer tothe consolidated financial statements and related footnotes included in ourAnnual Report on Form 10-K for the year ended December 31, 2006.

 

KapStonePaper and Packaging Corporation (formerly Stone Arcade Acquisition Corporation)was incorporated in Delaware on April 15, 2005.  On May 25, 2006, theCompany formed a wholly-owned subsidiary, KapStone Kraft Paper Corporation, orKapStone Kraft.  The Company was formed to serve as a vehicle for theacquisition through a merger, capital stock exchange, asset acquisition, orother similar business combination (“Business Combination”) of an operatingbusiness in the paper, packaging, forest products and related industries.

 

OnJanuary 2, 2007, the Company acquired substantially all of the assets andassumed certain liabilities of the Kraft Papers Business (“KPB”) fromInternational Paper Company (“IP”). The accompanying condensed consolidatedfinancial statements include the results of KPB since the date of acquisition.Prior to the acquisition of KPB, the Company had no operations and wasconsidered a development stage enterprise.  For periods prior to theacquisition, KPB is deemed to be the “Predecessor” to the Company. As a result,for the period ended September 30, 2006, the statement of operations andstatement of cash flows of KPB are presented for comparative purposes. The accompanying condensed consolidated statements of operations and cash flowspresent the results of operations and cash flows for i) the period precedingthe acquisition of KPB, exclusive of KPB results of operations and cash flowsand ii) for the periods succeeding the acquisition our consolidated results ofoperations including KPB. The results of operations and cash flows on aconsolidated basis subsequent to the acquisition of KPB is not comparative tothe Predecessor KPB results of operations and cash flows as i) the basis of theacquired assets and liabilities from KPB have been adjusted to fair valuepursuant to Statement of Financial Accounting Standards (SFAS) No. 141, *Business Combinations* and ii) KPB was adivision of IP and not a stand alone business.

 

# **2.**                                      Summary ofSignificant Accounting Policies

# ** **

***Use of Estimates***—The preparation of financial statements inconformity with U.S. GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, disclosure ofcontingent assets and liabilities at the date of the condensed consolidatedfinancial statements, and the reported amounts of revenues and expenses duringthe reporting periods. Actual results could differ from these estimates.

 

***Revenue Recognition***—Revenue is recognized when the customertakes title and assumes the risks and rewards of ownership. Sales with termsdesignated f.o.b. (free on board) shipping point are recognized at the time ofshipment. For sales transactions designated f.o.b. destination, revenue isrecorded when the product is delivered to the customer’s site and when titleand risk of loss are transferred. Sales on consignment are recognized in revenueat the earlier of the month that the goods are consumed or after a period oftime subsequent to receipt by the customer as specified by contract terms. Cashincentive rebates are netted against revenue on an accrual basis as qualifyingpurchases are made by the customer to earn and thereby retain the rebate.

 

Prepaidrebates are recorded in prepaid expenses and other current assets in theaccompanying condensed consolidated balance sheets until earned. Discounts forprompt payments are accrued at the time of sale and adjusted when qualifyingpayments are made by customers and are netted against revenues. Accrueddiscounts are netted against account receivables, net in the accompanyingcondensed consolidated balance sheets and totaled $1.2 million at September 30,2007.

 

Freightcharged to customers is recognized in net sales.

 

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***Cost of Sales***— Cost of sales includes the following: thecost of inventory sold during the period, warehousing costs which includedistribution costs and distribution center occupancy costs, maintenance costs,property taxes and freight expenses to ship products to customers. Revenueearned from the sale of by-products generated from the paper manufacturingprocess is reflected as a reduction to cost of sales.

 

KPBcost of sales for the three months ended September 30, 2006, includes anunfavorable property tax settlement of $0.9 million.

 

***Annual Maintenance Costs***—The Company recognizes the cost of majormaintenance activities in the period in which they occur under the directexpense method of FSP No. AUG AIR-1, *Accountingfor Planned Major Maintenance Activities*. Other maintenance costsare expensed as incurred.

 

TheCompany completed its annual planned maintenance shutdown during the quarterended June 30, 2007. Costs of $4.6 million related to the shutdown are includedin cost of sales for the nine month periods ended September 30, 2007 and 2006.

 

***Net Income per Common Share***—Basic net income per share is based on theweighted average number of common shares outstanding during the period. Diluted income per share reflects the potential dilution assuming common shareswere issued for outstanding in-the-money warrants, stock options and restrictedstock awards and the proceeds thereof were used to purchase common shares atthe average market price during the period such awards were outstanding.

 

***Short-term Investments-*** At September 30, 2007, short-term investmentsconsisted of a bank certificate of deposit and included $0.4 million of accruedinterest.

 

***Concentrations of Credit Risk***—Financial instruments that potentiallyexpose the Company to concentrations of credit risk, as defined by SFASNo. 105, *Disclosure of Informationabout Financial Instruments with Off-Balance Sheet Risk and FinancialInstruments with Concentrations of Credit Risk*, consist primarily oftrade accounts receivable and short-term investments. Trade accounts receivablebalances (net of allowances) for net sales to unaffiliated customers wereapproximately $31.6 million at September 30, 2007 and $31.1 millionat September 30, 2006 (Predecessor).

 

TheCompany establishes its allowance for doubtful accounts based upon factorssurrounding the credit risks of specific customers, historical trends, andother information.

 

***Inventories***—Inventories are valued at the lower of costor market and include all costs associated with manufacturing products:materials, labor, and manufacturing overhead. These values are presented at thelower of cost or market. Costs of raw materials, work-in-process, and finishedgoods are determined using the first-in, first-out method. Replacement partsand other supplies are stated using the average cost method.

 

***Plant, Property, and Equipment, net***—Plant and equipment is stated at cost lessaccumulated depreciation. Plant and equipment acquired in the KPBacquisition was recorded at fair value on the date of acquisition (see Note 4).Depreciation is computed using the straight-line method over the assets’estimated useful lives.  The range of estimated useful lives is asfollows:

 
| ** **                     | ** ** | **Years**                                                     | ** ** |
|--------------------------------|------------|---------------------------------------------------------------|------------|
| Machinery and equipment        |       | 1-20                                                          |       |
| Building                       |       | 20-40                                                         |       |
| Computer hardware              |       | 3-6                                                           |       |
| Furniture and office equipment |       | 3-10                                                          |       |
| Leasehold improvements         |       | Lesser of life of leasehold improvements or term of the lease |       |

 

***Impairment of Long-Lived Assets***—Long-lived assets, excluding goodwill andindefinite-lived intangibles, are reviewed for impairment upon the occurrenceof events or changes in circumstances that indicate that the carrying value ofthe assets or group of assets may not be recoverable, as measured by comparingtheir net book value to the undiscounted estimated future cash flows generatedby their use. In the event undiscounted estimated future cash flows are lessthan the net book value, an impairment charge is recorded to reflect theestimated fair value of the assets, determined principally using discountedcash flows.

 

6

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***Income Taxes***—The Company accounts for income taxes underthe liability method in accordance with SFAS No. 109, *Accounting for Income Taxes*. Accordingly,deferred income taxes are provided for the future tax consequences attributableto differences between the carrying amounts of assets and liabilities forfinancial reporting and income tax purposes.  Deferred tax assets andliabilities are measured using tax rates in effect for the year in which thosetemporary differences are expected to be recovered or settled.  Avaluation allowance is established when necessary to reduce deferred tax assetsto the amount expected to be realized.

 

***Employee Defined Benefit Plan***—The Company established a defined benefitpension plan for its union employees in North Carolina and Arkansas inaccordance with the purchase agreement.  The Company has estimated thecurrent service costs which are being charged to operations as they accruebased on services rendered by employees during the year. An independent actuaryperformed an actuarial valuation based on management’s best estimate for keyassumptions.

 

***Deferred Acquisition Costs***—The Company capitalizes costs incurredrelating to planned acquisitions which include legal fees, due diligence andother costs. At September 30, 2007, $1.2 million of transaction costs have beencapitalized and will be included in the purchase price of the acquisition uponconsummation of the deal.

 

# **3.**                                      Reclassifications

# ** **

Certainprior period Predecessor balances have been reclassified to conform to thecurrent period presentation.

 

# **4.**                                      KPB Acquisition

# ** **

OnJanuary 2, 2007, the Company purchased substantially all of the assets andassumed certain liabilities of the Kraft Papers Business, or KPB, a division ofIP, consisting of an unbleached kraft paper manufacturing facility in RoanokeRapids, North Carolina and Ride Rite® Converting, an inflatable dunnage bagmanufacturer located in Fordyce, Arkansas, for a cash purchase price of $155.0million and less certain post-closing adjustments of $7.8 million plus twocontingent earn-out payments of up to $60.0 million (in aggregate), based onKPB’s annual earnings before interest, income taxes and depreciation andamortization, or EBITDA, during the five years immediately following theacquisition.  Any contingent earn-out payments will be accounted for asadditional purchase price consideration and be recorded as goodwill if suchperformance targets are achieved. KPB was deemed an attractive acquisitioncandidate based on meeting the objectives of being a North American basedprofitable operating company in the paper and packaging industry.

 

TheKPB acquisition was accounted for in accordance with the provisions of SFAS No.141, *Business Combinations* andSFAS No. 142, *Goodwill and Other IntangibleAssets.*

 

Thepreliminary purchase price allocation includes cash of $155.0 million lessworking capital adjustments of $7.8 million plus transaction costs of $3.1million. The following table summarizes the estimated fair value of the assetsacquired and the liabilities assumed at the date of the acquisition. TheCompany is in the process of reviewing third party valuations of tangible andintangible assets acquired and the allocation of income tax adjustments.  Therefore, the allocation of the purchaseprice and the valuation of the assets and liabilities are subject to refinement($ 000’s):

 
| Accounts receivable                       |   | $       | 26,498  |   |
|-------------------------------------------|--------|---------|---------|--------|
| Inventories                               |   | 25,613  |    |
| Prepaid expenses and other current assets |   | 1,089   |    |
| Plant, property and equipment             |   | 104,829 |    |
| Deferred income taxes                     |   | 853     |    |
| Other assets                              |   | 1,116   |    |
| Goodwill                                  |   | 441     |    |
| Intangible assets                         |   | 6,063   |    |
| Accounts payable                          |   | (7,931  | )       |
| Accrued expenses                          |   | (5,843  | )       |
| Other liabilities                         |   | (2,425  | )       |
| Allocated purchase price                  |   | $       | 150,303 |   |

 

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Theintangible assets represent the value of a long term building lease withfavorable terms compared to market rates, $3.1 million, the Ride Ritetrademark, $2.8 million and customer lists, $0.2 million. The favorable leaseasset is amortized over 19 years, the remaining lease term. Customer lists areamortized over 8 years. For the three and nine month periods ended September30, 2007, amortization expense totaled $0.1 million, and is included in cost ofsales in the accompanying Condensed Consolidated Statements of Operations.Trademarks were appraised with an indefinite life and as a result are not beingamortized, but are subject to an annual impairment review.

 

Inaccordance with SFAS No. 142, *Goodwilland Other Intangible Assets*, goodwill is not amortized, but insteadis tested annually for impairment, or more frequently, if circumstancesindicate a possible impairment may exist.  The impairment test will beconducted in the fourth quarter.  Goodwill will be deducted for federalincome tax purposes over 15 years.

 

Aspart of the KPB acquisition, the Company assumed liabilities for retireemedical/life obligation for employees not eligible to retire at December 31,2006, of $0.9 million. In addition, obligations for an increase in the hourlypension benefit level totaling $1.3 million were assumed by the Company. Pursuant to the purchase agreement with IP, in May 2007, the Companyestablished a defined benefit pension plan for its union employees providingbenefits beginning January 1, 2007. See Note 13.

 

Proforma financial information for the prior period has not been presented in thisreport as pro forma results would not be materially different than thePredecessor results presented in the accompanying Condensed ConsolidatedStatements of Operations.

 

# **5.**                                      Underwriter’s Fee

# ** **

TheCompany paid the underwriter $1.2 million in 2007 for services performedrelating to the Company’s initial public offering. The fee was payable upon asuccessful Business Combination, as defined. Accordingly, the fee was chargedagainst Additional paid-in capital in the accompanying Condensed ConsolidatedBalance Sheets.

 

# **6.**                                      Redemption Status ofCommon Stock

# ** **

Theregistration statement for the Company’s initial public offering indicatedthat, after signing a definitive agreement for the acquisition of a targetbusiness, the Company would submit such transaction for stockholderapproval. Based on the votes submitted on December 29, 2006, 40,000 sharesvoted against the proposed KPB Business Combination and sought to be redeemedfor cash. As a result, $0.2 million of the net proceeds from the initialoffering plus interest was classified as common stock subject to redemption atDecember 31, 2006. The stock redemption occurred in February 2007 and theredeemed shares were held in treasury at September 30, 2007.

 

**7.             Stock-Based Compensation**

 

OnApril 5, 2007, the Company’s Compensation Committee approved the issuance of174,000 shares of restricted stock and 620,750 stock options to directors,executive officers and employees of the Company. KapStone accounts for theseawards under SFAS No. 123R, *Share-BasedPayment*, which requires that the cost resulting from all share-basedpayment transactions be recognized as compensation cost over the vesting periodbased on the fair value of the instrument on the date of grant. As a result,the Company recognized $0.3 million and $0.5 million of compensation cost forthe three and nine months ended September 30, 2007, respectively.

 

AtSeptember 30, 2007, the Company reserved 3,000,000 shares of common stock forstock option and restricted stock awards.

 

SFASNo. 123R requires that cash flows relating to the benefits of taxdeductions in excess of recognized compensation cost be reported as financingcash flow, rather than as an operating cash flow, as previously required.

 

**Stock options**

 

Thestock options vest as follows: 50% after two years and the remaining 50% afterthree years.  The stock options have a contractual term of seven years.The stock options are subject to forfeiture should these employees terminatetheir employment with the Company for certain reasons prior to vesting in theirawards, or the occurrence of certain other events such as termination withcause. The exercise price of these stock options is based on closing marketprice of our common stock on the date of grant and compensation expense isrecorded on an accelerated basis over the awards’ vesting periods.

 

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Asummary of information related to stock options is as follows:

 
| ** **                             | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted**          | ** ** | **Intrinsic**        | ** ** |
|----------------------------------------|------------|------------|------------|--------------|------------|-----------------------|------------|----------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | **Average**  | ** ** | **Average**           | ** ** | **Value**            | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Remaining**         | ** ** | **(dollars in** | ** ** |
| **KapStone Stock Options**   | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Life (Years)** | ** ** | **Thousands)**       | ** ** |
| Outstanding at January 1, 2007         |       | —     |       | $            | —     |                  | —     |                 | —     |   |
| Granted                                |       | 620,750    |       | 6.76         |       | 6.5                   |       | 261                  |       |
| Exercised                              |       | —     |       | —       |       | —                |       | —               |       |
| Lapsed (forfeited or cancelled)        |       | —     |       | —       |       | —                |       | —               |       |
| Outstanding at September 30, 2007 |       | 620,750    |       | $            | 6.76       |                  | 6.5        |                 | $          | 261 |   |
| Exercisable at September 30, 2007 |       | —     |       | $            | —     |                  |       |                 |       |   |
|                                        |            |            |            |              |            |                       |            |                      |            |  |  |

 

Totalstock-based compensation recorded in the Condensed Consolidated Statement ofOperations related to the stock option grants was $0.2 million and $0.3 millionduring the three and nine months ended September 30, 2007, respectively.

 

Asof September 30, 2007, there was $1.1 million of total unrecognizedcompensation cost related to non-vested stock options. That cost is expected tobe recognized over a weighted average period of 2.5 years. No stock optionswere vested as of September 30, 2007.

 

Theweighted average fair value for the KapStone stock options granted in April2007 was $2.30 per option. The fair value was estimated using the Black-Scholesoption-pricing model based on the weighted average market price at the grantdate and the weighted average assumptions specific to the underlying options.Expected volatility assumptions are based on volatility of related industrystocks. The expected term is based on management’s estimate of the contractualterm of the options, or seven years, and employees’ expected exercise behavior.The risk-free interest rate was selected based upon yields of U.S. Treasuryissues with a term equal to the expected life of the stock option being valued.The assumptions utilized for stock options during the period are as follows:

 
| ** **                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                            | ** ** |
| KapStone Stock Options Black-Scholes  assumptions (weighted average): |       |                                                |       |
| Expected volatility                                                   |       | 28.6                                                | %          |
| Expected term (years)                                                 |       | 5.0                                                 |       |
| Risk-free interest rate                                               |       | 4.6                                                 | %          |
| Expected dividend yield                                               |       | 0.0                                                 | %          |
| Expected forfeitures                                                  |       | 2.0                                                 | %          |

# ** **

# **Restricted Stock**

# ** **

OnApril 5, 2007, the Company’s Compensation Committee granted 174,000 restrictedshares of common stock to executive officers and employees as compensation forservice. These common stock shares are restricted as to transferability untilthey vest three years from the grant date. These restricted shares are subjectto forfeiture should these employees terminate their employment with theCompany for certain reasons prior to vesting in their awards, or the occurrenceof certain other events. The value of these restricted shares is based on theclosing market price of our common stock on the date of grant and compensationexpense is recorded on a straight-line basis over the awards’ vesting periods.

 

Thefollowing table summarizes our restricted stock amounts and activity: 

 
| ** **                        | ** ** | ** ** | ** ** | **Weighted** | ** ** |
|-----------------------------------|------------|------------|------------|--------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Average**  | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Grant**    | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Price**    | ** ** |
| Outstanding at January 1, 2007    |       | —     |       | $            | —     |   |
| Granted                           |       | 174,000    |       | 6.76         |       |
| Vested                            |       | —     |       | —       |       |
| Forfeited                         |       | —     |       | —       |       |
| Outstanding at September 30, 2007 |       | 174,000    |       | $            | 6.76       |   |

 

Totalstock-based compensation recorded in the Condensed Consolidated Statement ofOperations related to the restricted stock awards was $0.1 million and $0.2million during the three and nine months ended September 30, 2007,respectively. As of September 30, 2007, there was $0.9 million of totalunrecognized compensation cost related to the restricted stock which will berecognized over the remaining vesting period.

# ** **

# **9**

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# ** **

# **8.**                                      Related-PartyTransactions

# ** **

Fromtime to time, the Company retains the services of White Oak Aviation (WhiteOak), an aviation services company solely owned by certain stockholders. The fees charged by White Oak to KapStone for these services are calculatedusing a discounted rate from the fees White Oak typically charges to outsideparties. For the nine month period ended September 30, 2007, the amount paid tothis entity was $0.2 million.

 

# **9.**                                      Common StockReserved for Issuance

# ** **

AtSeptember 30, 2007, and December 31, 2006, approximately 44 million shares ofcommon stock were reserved for issuance upon exercise of warrants, stockoptions and the underwriter’s option.

 

# **10.**                               Long-term Debt andCredit Facility

# ** **

OnJanuary 2, 2007 in connection with the KPB acquisition, the Company obtained asenior secured credit facility, which provides the Company the ability toborrow up to $95.0 million pursuant to a five year $35.0 million revolving lineof credit and a five year $60.0 million term loan, due December 31, 2011. Advances under the revolving line of credit are primarily based uponpercentages of eligible accounts receivable and inventories.  At September30, 2007, there were no advances under the revolving line of credit. Long-termdebt at September 30, 2007, is summarized as follows ($000’s):

 
| ** **                             | ** ** | **September 30, 2007** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **(Unaudited)**                  | ** ** |
| Term loan                              |       | $                                | 56,250     |   |
|                                   |       |                             |       |
| Less current portion of long-term debt |       | 9,750                            |       |
|                                   |       |                             |       |
| Long-term debt                         |       | $                                | 46,500     |   |

 

AtSeptember 30, 2007, the Company had one letter of credit outstanding totaling$0.3 million.

 

Borrowingsunder the term loan accrue interest, at our option, at either:  LIBOR plus1.25% to 2.00% depending on the Company’s total debt to EBITDA ratio (asdefined in the agreement); or the Base Rate (prime rate) plus 0% to .50%depending on the Company’s total debt to EBITDA ratio. At September 30, 2007the Base Rate and LIBOR rate, which adjust quarterly, were 7.75% for the amountof the term loan payable on October 2, 2007, ($1.9 million) and 6.34% for thebalance of the term loan ($54.4 million), respectively.

 

Debtissuance costs paid for the above credit facility totaled $0.9 million and arebeing amortized over five years using the effective interest method.Amortization expense was $0.1 million and $0.2 million for the three and ninemonths ended September 30, 2007 and is recorded in interest expense in theaccompanying Condensed Consolidated Statements of Operations.

 

TheCompany is required to make prepayments on the term loan under certaincircumstances from the net cash proceeds of certain asset dispositions,issuances of securities or debt, and within 100 days after the fiscal yearsending of December 31, 2007 and 2008, respectively, 50% of excess cashflow from such fiscal years.

 

# **11.**                               Inventories

# ** **

Inventoriesconsist of the following at September 30, 2007, and December 31, 2006,respectively ($000’s):

 
| ** **                     | ** ** | **September 30, 2007** | ** ** | ** ** | **Predecessor KPB**        | ** ** |
|--------------------------------|------------|----------------------------------|------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **(Unaudited)**                  | ** ** | ** ** | **December 31, 2006** | ** ** |
| Raw materials                  |       | $                                | 5,741      |       |                            | $          | 6,466 |   |
| Work in process                |       | 464                              |       |       | 321                             |       |
| Finished goods                 |       | 10,300                           |       |       | 13,352                          |       |
| Replacement parts and supplies |       | 3,828                            |       |       | 3,948                           |       |
| Inventories                    |       | $                                | 20,333     |       |                            | $          | 24,087 |   |

 

Aspart of the KPB acquisition, the Company revalued finished goods inventories inaccordance with SFAS No.141, *BusinessCombinations,*accordingly, at January 2, 2007, finished goodsinventories were revalued by $1.5 million to fair value. This amount wascharged to cost of sales in the accompanying Condensed Consolidated Statementsof Operations in the nine month period ended September 30, 2007.

 

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# **12.          Income taxes**

# ** **

TheCompany’s U.S. federal statutory tax rate is 35% for 2007 and 34% for2006. Our effective tax rate for the nine months ended September 30, 2007,was 36.8% compared with 38.6% for KPB for the same period in the prior year.Differences between the effective tax rate and the federal statutory tax rateare due to the impact of state tax, net of federal benefit, the domesticmanufacturing deduction, and changes in statutory federal and state tax rates.

 

InJuly 2006, the Financial Accounting Standards Board issued FIN 48, whichclarifies the application of SFAS No. 109. FIN 48 establishes a thresholdcondition that a tax position must meet for any part of the benefit of such aposition to be recognized in the financial statements. In addition, FIN 48provides guidance regarding measurement, de-recognition, classification, anddisclosure of tax positions. The Company adopted FIN 48 effective January 1,2007. The Company to date has no unrecognized tax benefit. In accordance withFIN 48, paragraph 19, the Company classifies interest and penalties as acomponent of tax expense. We do not have any uncertain income tax positions includedin the accompanying condensed consolidated financial statements at September30, 2007.

 

Inthe normal course of business, we are subject to examination by taxingauthorities. The Company’s open tax years are 2005 and 2006.

 

# **13.**                               Pension and post retirementbenefits

# ** **

Aspart of the KPB acquisition, the Company established a defined benefit plan toprovide benefits for approximately 550 union represented employees.  Thisplan is part of the collective bargaining agreement between Kapstone Kraft andthe United Steel, Paper and Forestry, Rubber, Manufacturing, Energy,Allied-Industrial, Chemical and Service Workers Union, AFL-CIO, CLC.  Theassumed liability for the pension benefit was $1.3 million at January 2, 2007,and employees accrue a benefit under the Kapstone Kraft plan as of January 1,2007.

 

Netpension cost recognized for the three and nine months ended September 30,2007and 2006 for the Company’s pension plan, is as follows ($ 000’s):

 
| ** **                                        | ** ** | ** **                                                                    | ** ** | ** **              | ** **                                                                    | ** ** | **Predecessor KPB** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|-------------------------|-------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                        | ** ** | **Three and  Nine Months Ended  September 30, 2007** | ** ** | ** **              | **Three and  Nine Months Ended  September 30, 2006** | ** ** |
| ** **                                        | ** ** | **Three  Months  Ended**                                                      | ** ** | **Nine  Months  Ended** | ** **                                                                    | ** ** | **Three  Months  Ended** | ** ** | **Nine  Months  Ended** | ** ** |
|                                              |       |                                                                          |       |                    |                                                                          |       |                     |       |   |   |
| Service cost for benefits earned during the  year |       | $                                                                             | 288        |                    | $                                                                             | 863        |                     |       | $ | — |   | $ | — |   |
| Interest cost on projected benefit  obligations   |       | 20                                                                            |       | 60                      |                                                                          |       | —                   |       | — |   |
| Expected return on plan assets                    |       | —                                                                        |       | —                  |                                                                          |       | —                   |       | — |   |
| Amortization of prior service cost                |       | 25                                                                            |       | 75                      |                                                                          |       | —                   |       | — |   |
| Allocation of pension cost from IP                |       | —                                                                        |       | —                  |                                                                          |       | 308                      |       | 925 |   |
| Net pension cost                                  |       | $                                                                             | 333        |                    | $                                                                             | 998        |                     |       | $ | 308 |   | $ | 925 |   |

 

KapStonewill fund its pension plan according to IRS funding limitations. Based on thoselimitations, KapStone does not expect to contribute to its pension plan in 2007and expects to contribute $1.1 million to its pension plan in 2008.

 

Aspart of the KPB acquisition, the Company assumed liabilities for retireemedical/life obligation for employees not eligible to retire at December 31,2006, of $0.9 million. Net postretirement cost recognized for the three andnine months ended September 30, 2007 and 2006 for the Company’s retiree medicaland life insurance plan is as follows ($ 000’s):

 

11

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| ** **                                        | ** ** | ** **                                                                    | ** ** | ** **              | ** **                                                                    | ** ** | **Predecessor KPB** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|-------------------------|-------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                        | ** ** | **Three and  Nine Months Ended  September 30, 2007** | ** ** | ** **              | **Three and  Nine Months Ended  September 30, 2006** | ** ** |
| ** **                                        | ** ** | **Three  Months  Ended**                                                      | ** ** | **Nine  Months  Ended** | ** **                                                                    | ** ** | **Three  Months  Ended** | ** ** | **Nine  Months  Ended** | ** ** |
|                                              |       |                                                                          |       |                    |                                                                          |       |                     |       |   |   |
| Service cost for benefits earned during the  year |       | $                                                                             | 7          |                    | $                                                                             | 20         |                     |       | $ | — |   | $ | — |   |
| Interest cost on projected benefit  obligations   |       | 12                                                                            |       | 36                      |                                                                          |       | —                   |       | — |   |
| Expected return on plan assets                    |       | —                                                                        |       | —                  |                                                                          |       | —                   |       | — |   |
| Amortization of prior service cost                |       | —                                                                        |       | —                  |                                                                          |       | —                   |       | — |   |
| Allocation of post retirement cost from IP        |       | —                                                                        |       | —                  |                                                                          |       | 56                       |       | 166 |   |
| Net periodic cost                                 |       | $                                                                             | 19         |                    | $                                                                             | 56         |                     |       | $ | 56 |   | $ | 166 |   |

 

TheCompany maintains defined contribution plans covering all eligible salariedemployees. Company contributions to the 401(k) plan are based on matching ofemployee contributions, vest immediately for salaried employees and vest afterthree years for union employees. For the three months and nine months endedSeptember 30, 2007, the expense of Company matching employee contributionstotaled $0.2 million and $0.8 million, respectively.

 

TheCompany’s Retirement Savings Plan, which provides for contributions based on asalaried employee’s salary and age, vests 100% after three years. For the threemonths and nine months ended September 30, 2007, the expense of the RetirementSavings Plan totaled $0.2 million and $0.5 million, respectively.

 

**14.          Netincome per share**

 

Basicand diluted net income per share is calculated as follows ($ 000’s except forshare and per share data):

 
| ** **                                                               | ** ** | **Three Months  Ended**     | ** ** | **Nine Months  Ended**      | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                               | ** ** | **September 30, 2007** | ** ** | **September 30, 2007** | ** ** |
| Net income as reported                                                   |       | $                                | 7,802      |                             | $          | 18,329 |   |
| Weighted-average number of common shares  for basic net income per share |       | 24,968,097                       |       | 24,967,143                       |       |
| Incremental effect of dilutive common stock  equivalents:                |       |                             |       |                             |       |
| Common stock warrants                                                    |       | 11,690,113                       |       | 10,747,228                       |       |
| Unvested restricted stock awards                                         |       | 16,487                           |       | 9,476                            |       |
|                                                                     |       |                             |       |                             |       |
| Weighted-average number of shares for  diluted                           |       | 36,674,697                       |       | 35,723,847                       |       |
|                                                                     |       |                             |       |                             |       |
| Net income per share – basic                                        |       | $                                | 0.31       |                             | $          | 0.73 |   |
|                                                                     |       |                             |       |                             |       |
| Net income per share – diluted                                      |       | $                                | 0.21       |                             | $          | 0.51 |   |

 

Stockoption grants totaling 620,750 were outstanding in the nine month period endedSeptember 30, 2007, but the weighted-average stock option grants were notincluded in the computation of diluted earnings per share because the effect ofincluding the stock option grants would be anti-dilutive.

 

**15.          Restatementof Predecessor Results**

 

TheCompany recognizes the cost of major maintenance activities in the period inwhich they occur under the direct expense method of FSP No. AUG AIR-1, *Accounting for Planned Major Maintenance Activities*.Previously, the Predecessor accrued major planned maintenance ratably over theyear for interim reporting.  Predecessor results have been restated toaccount for major maintenance activities under the direct expense method. Cost of sales has been lowered by $1.2 million while operating income has beenincreased by $1.2 million for the three months ended September 30, 2006. As a result, net income has been increased by $0.7 million for the threemonths ended September 30, 2006. For the nine months ended September 30, 2006,cost of sales has been increased by $1.2 million, operating income has beenlowered by $1.2 million and net income lowered by $0.7 million.

 

12

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# **16.**                               Segment Information

# ** **

TheCompany operates in one geographic segment, the United States. The Companyoperates in two operating segments: unbleached Kraft and dunnage bags. Theunbleached Kraft segment produces a variety of unbleached Kraft paper andlinerboard products. These products are sold to customers who convert the paperinto end-market finished products. The dunnage bags segment converts unbleachedKraft paper and film into inflatable dunnage products, which are used to securefreight to minimize movement and potential damage of goods and products duringtransport. The products are sold to distributors and on a direct basis for useby manufacturers, less-than-trailer-load carriers and retail regionaldistribution centers. Corporate represents expenses that benefit the entireorganization and are not charged to the operating segments. Corporate assetsrepresent mainly cash and cash equivalents, capital expenditures for a new ERPsystem and deferred acquisition costs.

 
| ** **                                           | ** ** | ** **                                                 | ** ** | ** **                                                | ** ** | ** ** | **Predecessor**

**KPB**                               | ** ** | **Predecessor  KPB**                                      | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **Operating Segment ($ 000’s):** | ** ** | **Three Months  Ended September 30,  2007** | ** ** | **Nine Months  Ended September 30,  2007** | ** ** | ** ** | **Three Months  Ended September  30,  2006** | ** ** | **Nine Months  Ended September 30,  2006** | ** ** |
| Net Sales:                                           |       |                                                       |       |                                                      |       |       |                                                   |       |                                                      |       |
| Unbleached kraft                                     |       | $                                                          | 58,967     |                                                      | $          | 169,968    |                                                   |       | 56,006                                                    |       | $ | 164,413 |   |
| Dunnage bags                                         |       | 8,254                                                      |       | 24,706                                                    |       |       | 9,558                                                  |       | 27,537                                                    |       |
| Elimination of intersegment sales                    |       | (1,033                                                     | )          | (2,817                                                    | )          |       | (1,246                                                 | )          | (2,786                                                    | )          |
| Total                                                |       | $                                                          | 66,188     |                                                      | $          | 191,857    |                                                   |       | $                                                         | 64,318     |   | $ | 189,164 |   |
| Operating income / (loss):                           |       |                                                       |       |                                                      |       |       |                                                   |       |                                                      |       |
| Unbleached kraft                                     |       | $                                                          | 15,297     |                                                      | $          | 36,703     |                                                   |       | 9,879                                                     |       | 24,308 |   |
| Dunnage bags                                         |       | 1,420                                                      |       | 4,732                                                     |       |       | 2,041                                                  |       | 5,779                                                     |       |
| Corporate                                            |       | (3,863                                                     | )          | (10,595                                                   | )          |       | (1,686                                                 | )          | (6,135                                                    | )          |
| Total                                                |       | $                                                          | 12,854     |                                                      | $          | 30,840     |                                                   |       | $                                                         | 10,234     |   | $ | 23,952 |   |
| Depreciation and amortization:                       |       |                                                       |       |                                                      |       |       |                                                   |       |                                                      |       |
| Unbleached kraft                                     |       | $                                                          | 3,009      |                                                      | $          | 8,002      |                                                   |       | $                                                         | 4,592      |   | $ | 13,363 |   |
| Dunnage bags                                         |       | 169                                                        |       | 270                                                       |       |       | 79                                                     |       | 237                                                       |       |
| Corporate                                            |       | —                                                     |       | —                                                    |       |       | —                                                 |       | —                                                    |       |
| Total                                                |       | $                                                          | 3,178      |                                                      | $          | 8,272      |                                                   |       | $                                                         | 4,671      |   | $ | 13,600 |   |

 
| ** **                                                                                         | ** ** | ** ** | ** ** | ** ** | **Predecessor  KPB** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------|------------|------------|----------------------|------------|
| Total assets (at September 30, 2007and December 31, 2006): |       |       |       |       |                 |       |
| Unbleached kraft                                                                                   |       | $          | 147,308    |       |                 | $          | 245,412 |   |
| Dunnage bags                                                                                       |       | 16,328     |       |       | 11,970               |       |
| Corporate                                                                                          |       | 51,326     |       |       | —               |       |
| Total                                                                                              |       | $          | 214,962    |       |                 | $          | 257,382 |   |

 
| ** **                                           | ** ** | ** **                                                 | ** ** | ** **                                                | ** ** | ** ** | **Predecessor  KPB**                                 | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------|------------------------------------------------------|------------|
| **Operating Segment ($ 000’s):** | ** ** | **Three Months  Ended September 30,  2007** | ** ** | **Nine Months  Ended September 30,  2007** | ** ** | ** ** | **Three Months  Ended September30,  2006** | ** ** | **Nine Months  Ended September 30,  2006** | ** ** |
| Capital Spending:                                    |       |                                                       |       |                                                      |       |       |                                                 |       |   |   |
| Unbleached kraft                                     |       | $                                                          | 1,978      |                                                      | $          | 4,916      |                                                 |       | $ | 2,458 |   | $ | 5,288 |   |
| Dunnage bags                                         |       | 146                                                        |       | 203                                                       |       |       | —                                               |       | — |   |
| Corporate                                            |       | 1,281                                                      |       | 3,951                                                     |       |       | —                                               |       | — |   |
| Total                                                |       | $                                                          | 3,405      |                                                      | $          | 9,070      |                                                 |       | $ | 2,458 |   | $ | 5,288 |   |

 

13

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** **
| **Item 2.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION** |
|-------------|-----------------------------------------------------------------------|
|        | **AND 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**

 

Wewere formed on April 15, 2005, to serve as a vehicle to effect a merger,capital stock exchange, asset acquisition or other similar business combination(“Business Combination”) with an operating business in the paper, packaging,forest products and related industries.

 

OnJanuary 2, 2007, the Company purchased substantially all of the assetsand assumed certain liabilities of the Kraft Papers Business, or KPB, adivision of International Paper Company (IP), consisting of an unbleached kraftpaper manufacturing facility in Roanoke Rapids, North Carolina and Ride Rite®Converting, an inflatable dunnage bag manufacturer located in Fordyce,Arkansas, for a cash purchase price of $155 million and less certainpost-closing adjustments of $7.8 million plus two contingent earn-outpayments of up to $60 million (in aggregate), based on KPB’s annual earningsbefore interest, income taxes, depreciation and amortization, or EBITDA, duringthe five years immediately following the acquisition.  Any contingentearn-out payments will be accounted for as additional purchase priceconsideration and recorded as goodwill. The purchase price payable on theclosing date was adjusted by $7.8 million, or dollar-for-dollar, for IP’sworking capital as of such date being less than $42.6 million.

 

Theaccompanying management discussion and analysis includes the results of KPBsince January 2, 2007. Prior to the acquisition of KPB, the Company had nooperations nor generated operating revenues and was considered a developmentstage enterprise.  For periods prior to the acquisition, KPB is deemed tobe the “Predecessor” to the Company. As a result, for the three and nine monthperiods ended September 30, 2006, the statement of operations and statement ofcash flows of KPB are presented for comparative purposes.  Theaccompanying consolidated statements of operations and cash flows present theresults of our operations and cash flows for i) the  period preceding theacquisition of KPB, exclusive of KPB results of operations and cash flows andii) for the periods succeeding the acquisition our consolidated results ofoperations including KPB. Our results of operations and cash flows on aconsolidated basis subsequent to the acquisition of KPB is not comparative tothe Predecessor KPB results of operations and cash flows as i) the basis of theacquired assets and liabilities from KPB have been adjusted to fair valuepursuant to SFAS No. 141, *BusinessCombinations* and ii) KPB was a division of IP and not a stand alonebusiness.

 

**Results of Operations**

 

Presentedbelow are results for the quarter and nine months ended September 30, 2007and 2006 as reported in accordance with accounting principles generallyaccepted in the United States (“GAAP”). All per share amounts are presented onan after-tax basis.

 
| ** **                                    | ** ** | **Quarter ended  September 30,** | ** ** | **Nine months ended  September 30****,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|----------------------------------------------------|------------|
| **In  thousands, except per share amounts**   | ** ** | **2007**                                   | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                     |       | $                                          | 66,188     |                                               | $          | 64,318 |   | $ | 191,857 |   | $ | 189,164 |   |
| Cost of sales                                 |       | 46,026                                     |       | 46,774                                             |       | 141,180 |   | 142,688 |   |
| Depreciation and amortization                 |       | 3,178                                      |       | 4,671                                              |       | 8,272 |   | 13,600 |   |
| Gross profit                                  |       | 16,984                                     |       | 12,873                                             |       | 42,405 |   | 32,876 |   |
| Selling, general and administrative  expenses |       | 4,529                                      |       | 2,639                                              |       | 12,552 |   | 8,924 |   |
| Other operating income                        |       | 399                                        |       | —                                             |       | 987 |   | — |   |
| Operating income                              |       | 12,854                                     |       | 10,234                                             |       | 30,840 |   | 23,952 |   |
| Interest income                               |       | 585                                        |       | —                                             |       | 1,467 |   | — |   |
| Interest expense                              |       | (1,044                                     | )          | (352                                               | )          | (3,317 | ) | (1,059 | ) |
| Provision for income taxes                    |       | 4,593                                      |       | 3,818                                              |       | 10,661 |   | 8,846 |   |
| Net income                                    |       | $                                          | 7,802      |                                               | $          | 6,064 |   | $ | 18,329 |   | $ | 14,047 |   |

 

14

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Allcomments and variances in the following commentary for the period endedSeptember 30, 2006 refer to the Predecessor, or KPB.

 

Netsales for the quarter ended September 30, 2007, were $66.2 million compared to$64.3 million for the third quarter of 2006, an increase of 2.9%. The increasein net sales was driven by 5.1% volume/mix increase of unbleached kraft paperpartially offset by an 11.4% decrease in dunnage bag volume. Net sales for thenine months ended September 30, 2007 were $191.9 million compared to $189.2million for the similar period in 2006, an increase of 1.4%. The increase wasdriven by higher prices and volume in unbleached kraft partially offset by a9.6% decrease in dunnage bag volume. Refer to the individual segmentdiscussions below for detailed sales information for each segment.

 

Costof sales for the quarter ended September 30, 2007, was $46.0 million comparedto $46.8 million for the third quarter of 2006, a 1.7% decrease. The decreasein cost of sales was due to productivity improvements and lower dunnage bagvolume partially offset by higher unbleached kraft volume. Cost of sales forthe 2006 period included a $0.9 million unfavorable property tax settlement.Cost of sales for the nine months ended September 30, 2007, was $141.2 millioncompared to $142.7 million for the similar period of 2006, a decrease of 1.1%.Decreased cost of sales for the nine months ended September 30, 2007, comparedto the respective period in 2006 was dueto productivity improvements and lower dunnage bag volume partially offset by a$1.5 million non-cash purchase accounting charge adjusting finished goodsinventory to fair value, a $1.0 million two day unplanned outage caused by anelectrical fire in June 2007 and higher unbleached kraft volume.

 

Depreciationand amortization for the quarter ended September 30, 2007, totaled $3.2 millioncompared to $4.7 million for the quarter ended September 30, 2006. The decreaseof $1.5 million reflects an appraisal of depreciable assets to their respectivefair values as of January 2, 2007. The fair value of assets acquired wasapproximately $100 million less than the basis being used for depreciation in the2006 period. In addition, amortization of intangible assets of $0.1 million isincluded in the current period quarter.

 

Depreciationand amortization for the nine months ended September 30, 2007, totaled $8.3million compared to $13.6 million for the nine months ended September 30, 2006.The decrease of $5.3 million reflects an appraisal of depreciable assets totheir respective fair values as of January 2, 2007. The fair value of assetsacquired was approximately $100 million less than the basis being used fordepreciation in the 2006 period.

 

Selling,general and administrative expenses for the quarter ended September 30, 2007,totaled $4.5 million compared to $2.6 million for the quarter ended September30, 2006. The increase of $1.9 million is due tothe KPB acquisition which was consummated on January 2, 2007.  Results forthe 2006 period reflect an allocation of corporate expenses from IP while theexpenses for the 2007 quarter reflect corporate expenses associated with anoperating company.

 

Selling,general and administrative expenses for the nine months ended September 30,2007 totaled $12.6 million compared to $8.9 million for the 2006 period. Theincrease of $3.7 million is due to the KPBacquisition which was consummated on January 2, 2007.  Results for the2006 period reflect an allocation of corporate expenses from IP while theexpenses for the 2007 period includes corporate expenses associated with anoperating company.

 

Otheroperating income for the quarter and nine months ended September 30, 2007totaled $0.4 million and $1.0 million, respectively. Other operating incomeincludes commissions the Company receives from IP for selling IP products toKapStone customers.

 

Interest income for the quarter and nine months endedSeptember 30, 2007 was $0.6 million and $1.5 million, respectively. Interestincome represents earnings on the Company’s short-term investments and cashequivalents.

 

Interest expense for the quarter and nine months endedSeptember 30, 2007 was $1.0 million and $3.3 million, respectively, compared tointerest expense of $0.4 million and $1.1 million for the similar periods in2006. Interest expense for the quarter and nine months ended September 30,2007, reflects interest on the Company’s long-term debt and amortization ofdebt issuance costs while interest expense in the 2006 period reflects intereston Industrial Development Bonds and Environmental Development Bonds. Thesebonds were not assumed by KapStone as part of the KPB acquisition.

 

Provision for income taxes for the quarter and nine monthsended September 30, 2007, reflects effective tax rates of 37.1% and 36.8%,respectively. The effective tax rate for the 2006 periods was 38.6%.

 

15

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**KapStone Paper and Packaging Corporation compared toPredecessor (KPB)**

 

***Unbleached Kraft***

 
| ** **                      | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                                 | ** ** | **2006**                                                | ** ** | **Change** | ** ** | **%** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| Net sales                       |       | $                                                        | 58,967     |                                                    | $          | 56,006 |   | $ | 2,961 |   | 5.3 | % | $ | 169,968 |   | $ | 164,413 |   | $ | 5,555 |   | 3.4 | % |
| Operating income                |       | 15,297                                                   |       | 9,879                                                   |       | 5,418 |   | 54.8 | % | 36,703 |   | 24,308 |   | 12,395 |   | 51.0 | % |
| Operating income % of net sales |       | 25.9                                                     | %          | 17.6                                                    | %          | 8.3 | % |   |   | 21.6 | % | 14.8 | % | 6.8 | % |   |   |
| Average revenue per ton         |       | $                                                        | 549.34     |                                                    | $          | 548.20 |   | $ | 1.14 |   | 0.2 | % | $ | 544.18 |   | $ | 532.49 |   | $ | 11.69 |   | 2.2 | % |
| Tons of paper sold              |       | 107,342                                                  |       | 102,164                                                 |       | 5,178 |   | 5.1 | % | 312,339 |   | 308,761 |   | 3,578 |   | 1.2 | % |

 

Forthe quarter ended September 30, 2007, unbleached kraft segment net salesincreased by $3.0 million, or 5.3%, to $59.0 million compared to $56.0 millionfor the quarter ended September 30, 2006. Average revenue per ton is up $1.14,or approximately $0.9 million of the sales increase, due to higher kraft paperprices, partially offset by higher sales of linerboard which has a lower thanaverage revenue per ton compared to kraft paper. Volume/mix of paper soldincreased by 5,178 tons, or $2.1 million, driven by a 15,324 tons increase inlinerboard partially offset by a 10,146 tons reduction in kraft paper.

 

Unbleachedkraft segment operating income increased by $5.4 million, or 54.8%, to $15.3million for the quarter ended September 30, 2007 compared to $9.9 million forthe quarter ended September 30, 2006. Higher sales volume, productivity gainsand lower depreciation costs of $1.6 million due to revaluing plant, propertyand equipment to fair values contributed to the improved operating performance.In addition, the quarter ended September 30, 2006 was negatively impacted by a$0.9 million unfavorable property tax settlement. Operating income as a percentof net sales improved to 25.9%.

 

Forthe nine months ended September 30, 2007, unbleached kraft segment net salesincreased by $5.6 million, or 3.4%, to $170.0 million compared to $164.4million for the nine months ended September 30, 2006. Average revenue per tonis up $11.69 due to the favorable impact of higher kraft paper prices in 2007and the full realization of price increases implemented in 2006, orapproximately $7.1 million of the sales increase. Volume/mix of paper soldincreased by 3,578 tons, or $1.5 million, driven by a 35,412 increase inlinerboard partially offset by a 31,834 tons reduction in kraft paper.

 

Unbleachedkraft segment operating income increased by $12.4 million, or 51.0%, to $36.7million for the nine months ended September 30, 2007 compared to $24.3 millionfor the nine months ended September 30, 2006. Higher sales volume/mix andaverage revenue per ton contributed $4.5 million to the increased operatingincome. In addition, lower depreciation costs of $5.4 million due to revaluingplant, property and equipment to fair values and productivity gains alsocontributed to the improved results, partially offset by a $1.2 millionnon-cash purchase accounting charge adjusting finished goods inventory to fairvalue and a $1.0 million two day unplanned outage caused by an electrical firein June 2007. In addition, operating income for the nine month periods endedSeptember 30, 2007 and 2006 includes $4.6 million of expenses relating to theCompany’s annual planned maintenance outage. Operating income as a percent ofnet sales improved to 21.6%.

 

***Dunnage Bags***

 
| ** **                      | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                                 | ** ** | **2006**                                                | ** ** | **Change** | ** ** | **%** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| Net sales                       |       | $                                                        | 8,254      |                                                    | $          | 9,558 |   | $ | (1,304 | ) | (13.6 | )% | $ | 24,706 |   | $ | 27,537 |   | $ | (2,831 | ) | (10.3 | )% |
| Operating income                |       | 1,420                                                    |       | 2,041                                                   |       | (621 | ) | (30.4 | )% | 4,732 |   | 5,779 |   | (1,047 | ) | (18.1 | )% |
| Operating income % of net sales |       | 17.2                                                     | %          | 21.4                                                    | %          | (4.2 | )% |   |   | 19.2 | % | 21.0 | % | (1.8 | )% |   |   |
|                            |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Average revenue per bag         |       | $                                                        | 3.62       |                                                    | $          | 3.72 |   | $ | (0.10 | ) | (2.7 | )% | $ | 3.78 |   | $ | 3.81 |   | $ | (0.03 | ) | (0.8 | )% |
| Bags sold (000’s)          |       | 2,278                                                    |       | 2,570                                                   |       | (292 | ) | (11.4 | )% | 6,533 |   | 7,226 |   | (693 | ) | (9.6 | )% |

 

16

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Forthe quarter ended September 30, 2007, net sales for the dunnage bag segmentsold under the Ride Rite® Converting brand name decreased by $1.3 million, or13.6%, to $8.3 million compared to $9.6 million for the three months endedSeptember 30, 2006 mainly due to an 11.4% decrease in unit volume. Average revenueper bag of $3.62 decreased by $0.10 or 2.7%, for the three months endedSeptember 30, 2007 compared to the similar period last year.   Bagsales have decreased due to reduced customer shipping activity particularly inthe less-than-truckload market, lower demand in the home construction industryand due to a distributor losing position with two key accounts.

 

Dunnagebag segment operating income decreased by $0.6 million, or 30.4%, to $1.4million for the three months ended September 30, 2007 compared to $2.0 millionfor the three months ended September 30, 2006. Lower sales volume and prices ofapproximately $0.5 million and higher amortization expense for intangibleassets of $0.1 million contributed to the lower operating income. Operatingincome as a percent of net sales declined to 17.2%.

 

Forthe nine months ended September 30, 2007, net sales for the dunnage bag segmentdecreased by $2.8 million, or 10.3%, to $24.7 million compared to $27.5 millionfor the nine months ended September 30, 2006 mainly due to a 9.6% decrease inunit volume. Average revenue per bag of $3.78 decreased by $0.03 or 0.8%, forthe nine months ended September 30, 2007 compared to the similar period lastyear.   Bag sales have decreased due to reduced customer shipping activityparticularly in the less-than-truckload market, lower demand in the homeconstruction industry and due to a distributor losing position with two keyaccounts.

 

Dunnagebag segment operating income decreased by $1.0 million, or 18.1%, to $4.7million for the nine months ended September 30, 2007 compared to $5.8 millionfor the nine months ended September 30, 2006. Lower sales volume and pricescontributed approximately $0.6 million of the shortfall. In addition, 40% ofthe shortfall was contributed by a non-cash purchase accounting charge of $0.3million adjusting finished goods inventories to fair value and higheramortization expense of intangible assets of $0.1 million. Operating income asa percent of net sales declined to 19.2%.

 

***Corporate***

 

Corporateexpenses for the quarter ended September 30, 2007, totaled $3.9 millioncompared to $1.7 million for the quarter ended September 30, 2006. The increaseof $2.2 million is due to the KPB acquisitionwhich was consummated on January 2, 2007.  Results for the 2006 periodreflect an allocation of corporate expenses from IP while the expenses for the2007 quarter reflect corporate expenses associated with an operating company.

 

Corporateexpenses for the nine months ended September 30, 2007 totaled $10.6 millioncompared to $6.1 million for the nine months ended September 30, 2006. Theincrease of $4.5 million is due to the KPBacquisition which was consummated on January 2, 2007.  Results for the2006 period reflect an allocation of corporate expenses from IP while theexpenses for the 2007 period reflect corporate expenses associated with anoperating company.

 

**KapStone Paper and Packaging Corporation compared toStone Arcade Acquisition Corporation**

 

***Operating income***

 

Operating income for the Company for the quarter endedSeptember 30, 2007 was $12.9 million compared to an operating loss of $0.4million for the similar period in 2006. The change in quarterly operatingincome is due to the KPB acquisition which was consummated on January 2,2007.  Results for the 2006 period reflect the Company as a developmentstage enterprise and as a result, the operating loss includes expenses incurredto identify and acquire a business. Expenses for the 2007 quarter reflectcorporate expenses associated with an operating company.

 

Operating income for the Company for the nine months endedSeptember 30, 2007 was $30.8 million compared to an operating loss of $0.9million for the similar period in 2006. The change in operating income is dueto the KPB acquisition which was consummated on January 2, 2007.  Resultsfor the 2006 period reflect the Company as a development stage enterprise andas a result, the operating loss includes expenses incurred to identify andacquire a business. Expenses for the 2007 period reflect corporate expensesassociated with an operating company.

 

17

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***Interest expense and interest income***

 

Interest expense and interest income for the quarter endedSeptember 30, 2007, were $1.0 and $0.6 million, respectively, compared tointerest income of $1.4 million for the quarter ended September 30, 2006.Interest expense for the quarter ended September 30, 2007 reflects interest onthe Company’s long-term debt while interest income reflects earnings on excesscash that is invested. Interest income in 2006 reflects interest earned onrestricted cash held in trust when the Company was a development stageenterprise.

 

Interest expense and interest income for the nine monthsended September 30, 2007, was $3.3 and $1.5 million, respectively, compared tointerest income of $3.9 million for the nine months ended September 30, 2006.Interest expense for the nine months ended September 30, 2007, reflectsinterest on the Company’s long-term debt while interest income reflects earningson excess cash that is invested in a combination of a bank certificate ofdeposit (maturity of 120 days), commercial paper (seven day maturity) andovernight deposits. Interest income in 2006 reflects interest earned onrestricted cash held in trust when the Company was a development stageenterprise.

 

**Liquidity and Capital Resources**

 

***KPB Acquisition***

 

OnJanuary 2, 2007, we consummated the purchase of substantially all of the assetsand assumed certain liabilities of KPB. The assets consist of an unbleachedkraft paper manufacturing facility in Roanoke Rapids, North Carolina and RideRite® Converting, an inflatable dunnage bag manufacturer located in Fordyce,Arkansas. The liabilities assumed consist of trade accounts payable, accruedexpenses and certain long-term liabilities. The purchase price for theacquisition was approximately $155.0 million in cash less certain post-closingadjustments of $7.8 million, plus contingent earn-out payments of up to$60.0 million (in aggregate) based on KPB’s annual earnings beforeinterest, income taxes, depreciation and amortization (“EBITDA”) during thefive year period immediately following the acquisition. The first contingentpayment will be equal to 5.3 times KPB’s average annual EBITDA for the fiveyear period immediately following the acquisition, less $165.0 million andsubject to a maximum of $35.0 million. The second contingent payment is an“all or nothing” payment and is payable if, and only if, KPB’s average annualEBITDA for the same five year period equals or exceeds $49.2 million.Generally, both payments, if earned, will be due and paid at the end of thefive year period.

 

Ifthese contingent earn-out payments are made, they will be accounted for asadditional purchase price consideration.

 

Fundingfor the acquisition came from funds held in trust at December 31, 2006,totaling $115.2 million and the establishment of a $60.0 million term loan.

 

***Credit Facility***

 

Inconnection with the acquisition, the Company’s subsidiary, KapStone Kraft,obtained a senior secured credit facility which provides us with the ability toborrow up to $95.0 million pursuant to a five year $35.0 millionrevolving line of credit and a five year $60.0 million term loan. Advances under the revolving line of credit are primarily based uponpercentages of eligible accounts receivable and inventories.  The facilityexpires on December 31, 2011. At September 30, 2007, there were noadvances under the revolving line of credit.

 

Theterm loan has scheduled principal payments of:  (a) $1.875 million onOctober 1 and December 31 of 2007; (b) $2.0 million onMarch 31, June 30, September 30 and December 31 of 2008;(c) $2.125 million on March 31, June 30, September 30and December 31 of 2009 and March 31, June 30, September 30and December 31 of 2010; (d) $2.25 million on March 31,June 30 and September 30 of 2011; and (e) $20.75 million onDecember 31, 2011.  We are also required to make prepayments on theterm loan under certain circumstances from the net cash proceeds of certainasset dispositions, issuances of securities or debt, and within 100 days afterthe end of fiscal years December 31, 2007 and 2008, respectively, 50% ofexcess cash flow from such fiscal years.

 

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Borrowingsunder the revolving line of credit accrue interest, at our option, ateither:  LIBOR plus 1.00% to 1.75% depending on KapStone Kraft’s totaldebt to EBITDA ratio; or the Base Rate (prime rate) plus 0% to .50% dependingon KapStone Kraft’s total debt to EBITDA ratio.  Borrowings under the termloan accrue interest, at our option, at either:  LIBOR plus 1.25% to 2.00%depending on KapStone Kraft’s total debt to EBITDA ratio; or the Base Rate(prime rate) plus 0% to .50% depending on KapStone Kraft’s total debt to EBITDAratio. The Base Rate margin and LIBOR margin shall adjust quarterly uponreceipt of quarterly financial statements.

 

Thecredit facility contains a number of significant covenants that, among otherthings, restrict KapStone’s ability to dispose of assets, incur additionalindebtedness, prepay other indebtedness, pay dividends, repurchase or redeemcapital stock, enter into certain investments, make certain acquisitions,engage in mergers and consolidations, create liens, or engage in certaintransactions with affiliates and otherwise restrict KapStone’s corporate andbusiness activities.  In addition, under the credit facility, KapStoneKraft is required to comply with a minimum EBITDA, fixed charge coverage ratioand total debt to EBITDA ratio.  The credit facility also restricts theaggregate amount of capital expenditures incurred by KapStone Kraft.

 

Eventsof default under the senior secured credit facility include, but are notlimited to:  (a) failure to pay principal or interest when due;(b) material breach of any representation or warranty; (c) covenantdefaults; (d) default with respect to any other debt with an outstandingprincipal amount in excess of $2.5 million if the effect thereof is toaccelerate or permit the acceleration of such debt; and (e) events ofbankruptcy.

 

Thecredit facility is secured by all of KapStone Kraft’s tangible and intangibleassets and a pledge of the capital stock of KapStone Kraft.

 

***Cash flow***

 

Cashflow from all activities during the nine months ended September 30, 2007,increased by $9.9 million from December 31, 2006, reflecting the receipt offunds held in trust at December 31, 2006, not used for the KPB acquisition of$28.3 million, and cash generated from operations of $36.3 million, partiallyoffset by purchase of short-term investments of $35.0 million, capitalexpenditures of $9.1 million, repayment of long-term debt of $3.8 million,acquisition costs paid of $1.2 million and an investment banking fee paid of$1.2 million.

 

Netcash inflow from operating activities was $36.3 million due to net income forthe period of $18.3 million and improved working capital of $9.0 million.

 

Netcash outflow from investing activities was $195.6 million and included paymentfor the KPB acquisition of $150.3 million, purchase of a short-term investmentof $35.0 million and capital expenditures of $9.1 million. Capital expendituresof $4.9 million were for the unbleached kraft segment and include equipmentupgrades and replacements at the paper mill in Roanoke Rapids, North Carolina.In addition, $3.1 million was paid for implementing a new ERP system and isincluded in corporate capital expenditures.

 

Netcash inflow generated from financing activities totaled $169.2 million duringthe period ended September 30, 2007, and includes proceeds from the term loanof $60.0 million, and receipt of funds held in trust for the KPB acquisition of$115.2 million. In addition, during the period, the Company made long-term debtrepayments of $3.8 million, paid its investment banker a $1.2 million feerelating to the Company’s Initial Public Offering and paid a $0.9 million feefor its credit facility.

 

**Off-Balance Sheet Arrangements**

 

Wehave not entered 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.

 

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**New Accounting Pronouncement**

 

**Fair Value Option for Financial Assets**

 

InFebruary 2007, the Financial Accounting Standards Board issued SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities*, including an amendment of SFAS No. 115. Thisstatement permits entities to choose to measure many financial instruments andcertain other items at fair value. The objective is to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions. Thisstatement is expected to expand the use of fair value measurement, which isconsistent with the FASB’s long-term measurement objectives for accounting forfinancial instruments. SFAS No. 159 is effective for our fiscal year beginningJanuary 1, 2008.

 

Weare in the process of evaluating this statement, but do not expect that theadoption of SFAS No. 159 will have a material impact on our condensedconsolidated financial statements.

 

**Contractual Obligations**

 

Welease various facilities, warehouses and equipment under non-cancelableoperating leases. In accordance with generally accepted accounting principles,some of these obligations are not recognized as liabilities in our accompanyingCondensed Consolidated Balance Sheets.

 

Thefollowing table summarizes our contractual obligations as of September 30, 2007($ 000’s):

 
| ** **                                | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | ** **                                | ** ** | **Less Than** | ** ** | **1-3** | ** ** | **3-5** | ** ** | **More than** | ** ** |
| **Contractual Obligations**          | ** ** | **Total**                                 | ** ** | **1 Year** | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** |
| Long-term debt obligations(1)             |       | $                                         | 56,250     |   | $ | 9,750 |   | $ | 25,750 |   | $ | 20,750 |   | $ | — |   |
| Interest on long-term debt obligations(2) |       | 11,121                                    |       | 4,155 |   | 6,637 |   | 329 |   | — |   |
| Operating lease obligations(3)            |       | 2,187                                     |       | 299 |   | 1,135 |   | 690 |   | 63 |   |
| Purchase obligations(4)                   |       | 496                                       |       | 496 |   | — |   | — |   | — |   |
| Other liabilities(5)                      |       | 3,463                                     |       | 1,099 |   | 2,089 |   | — |   | 275 |   |
| Total                                     |       | $                                         | 73,517     |   | $ | 15,799 |   | $ | 35,611 |   | $ | 21,769 |   | $ | 338 |   |

 

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| (1)    | These  obligations are reflected on our Condensed Consolidated Balance Sheets at  September 30, 2007 in Current portion of long-term debt and Long-term debt,  as appropriate.                                                                                                                                                                          |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                    |
| (2)    | Assumes  debt is carried to full term and excludes any mandatory prepayments. Debt  bears interest at variable rates. The amounts above assume future interest  will be incurred at the bank’s LIBOR rate on September 30, 2007 (6.34%).  These obligations are not reflected on our Condensed Consolidated Balance  Sheets at September 30, 2007. |
|   |                                                                                                                                                                                                                                                                                                                                                    |
| (3)    | These  obligations are not reflected on our Condensed Consolidated Balance Sheets at  September 30, 2007.                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                    |
| (4)    | Purchase  obligations are agreements to purchase goods or services that are enforceable  and legally binding on us and that specify all significant terms, including:  fixed or minimum quantities to be purchased. These obligations are not  reflected on our Condensed Consolidated Balance Sheets at September 30, 2007.                            |
|   |                                                                                                                                                                                                                                                                                                                                                    |
| (5)    | These  items are reflected on our Condensed Consolidated Balance Sheets at September  30, 2007 in Other liabilities.                                                                                                                                                                                                                                    |

 

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**Item 3. —QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Marketrisk is the sensitivity of income to changes in interest rates, commodityprices, equity prices, and other market-driven rates or prices.

 

UnderKapStone Kraft’s Credit Facility, we have a $60 million term loan and arevolving line of credit of $35 million. At September 30, 2007, the balance ofthe term loan was $56.3 million and there were no amounts drawn on therevolving line of credit. We had one letter of credit outstanding at September 30,2007 totaling $0.3 million. Advances under the revolving line of credit areprimarily based upon percentages of eligible accounts receivable andinventories.  The facility has a maturity date of December 31,2011.Borrowings under the term loan accrue interest, at our option, ateither:  LIBOR plus 1.25% to 2.00% depending on KapStone Kraft’s totaldebt to EBITDA ratio (as defined in the agreement); or the Base Rate (primerate) plus 0% to .50% depending on KapStone Kraft’s total debt to EBITDA ratio.The Base Rate margin and LIBOR margin shall adjust quarterly upon receipt ofquarterly financial statements.

 

Changesin market rates may impact the bank’s LIBOR rate. For instance, if the bank’sLIBOR rate was to increase or decrease by one percentage point (1.0%), ourannual interest expense would change by approximately $0.5 million based uponour expected future monthly loan balances per our existing repayment schedule.

 

Theprincipal market risk to which we are exposed is commodity and energy pricerisk. We are exposed to price fluctuations of certain commodities used inproduction as well as fluctuations in the price of its finished goods. Key rawmaterials and energy used in the production process include roundwood andwoodchips, coal, electricity and caustic soda. We purchase these raw materialsand energy at the market prices, and do not use forward contracts or otherfinancial instruments to hedge its exposure to price risk related to thesecommodities. Prices for paper and related products are subject to marketconditions. We have no long-term contracts to purchase raw materials or energyat fixed prices.

 

Exceptas described above, there have been no other material changes to our marketrisk exposure since December 31, 2006.

 

**Item 4. —CONTROLS AND PROCEDURES**

 

Asof the end of the period covered by this report, our Chief Executive Officerand our Chief Financial Officer carried out an evaluation of the effectivenessof the design and operation of our disclosure controls and procedures, asrequired by Rule 13a-15(b) under the Securities Exchange Act of 1934.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were designed,and were effective, to give reasonable assurance that information required tobe disclosed about us and our subsidiary is recorded, processed, summarized andreported within the time periods specified by the rules and forms of the SECand is accumulated and communicated to management as appropriate to allowtimely decisions regarding required disclosure in our filings under theSecurities Exchange Act of 1934.

 

Thefollowing changes were made to the Company’s internal control over financialreporting during the nine month period ended September 30, 2007, that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting:

 

•                  Upon the Company’s acquisition of KPB onJanuary 2, 2007, from International Paper Company (IP), the Company’sexisting financial reporting processes, which consisted of management of cashand investments, management of cash disbursements, management of period endclosing and management of external reporting, were all expanded and ormodified.

 

•                  Various functions, controls and financialreporting processes of KPB were combined to existing Company functions,controls and financial processes and the Company currently continues to dependon the information and reporting systems of IP to monitor the operation of theKPB business.

 

•                  The Company implemented significant businessprocesses, much of which were from KPB, addressing financial reporting,accounting close, revenue and receivables, purchasing and payables, plant,property and equipment, treasury and investment, inventory, payroll, employeebenefits, non-recurring transactions and information technology.

 

•                  In addition, in January 2007, an auditcommittee, compensation committee and nominating and governance committee ofthe board were formed, board committee charters were adopted and variouscorporate governance policies were implemented.

 

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**PART II. —OTHER INFORMATION**

 

**Item 1. — LEGAL PROCEEDINGS**

 

None.

 

**Item 1A. — RISK FACTORS**

 

Exceptas described below, there have been no material changes from the Risk Factorsdescribed in our Form 10-K for the year ended December 31, 2006 (“Form10-K”). The first risk factor below is an addition to our Risk Factors and theremainder are updates to existing risk factors that supersede the correspondingRisk Factors in our Form 10-K. Each of the Risk Factors below should be read inconjunction with the Risk Factors and information disclosed in our Form 10-K.

 

**The market price for our common stock may be highlyvolatile.**

 

Themarket price of our common stock may be volatile due to certain factors,including, but not limited to, quarterly fluctuations in our financial andoperating results; general conditions in the paper and packaging industries; orchanges in earnings estimates.

 

**Shares available for future issuance, conversion andexercise could have an adverse effect on the earnings per share and the marketprice of our common stock.**

 

Anyfuture issuance of equity securities, including exercise of stock options,could dilute the interests of our existing stockholders and could substantiallydecrease the trading price of our common stock.

 

**Item 2. — UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS**

 

None.

 

**Item 3. — DEFAULTS UPON SENIORSECURITIES**

 

None.

 

**Item 4. — SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

None.

 

**Item 5. — OTHER INFORMATION**

 

None.

 

**Item 6. — EXHIBITS**

 

(b)           Exhibits

 
| 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.                               |

 

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**SIGNATURES**

 

In accordance with the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|              | KAPSTONE  PAPER AND PACKAGING CORPORATION |
|-------------------|-------------------------------------------|
|              |                                      |   |
| November  5, 2007 | By:                                       | /s/  Andrea K. Tarbox |   |
|              |                                      | Andrea  K. Tarbox |
|              |                                      | Vice  President and Chief Financial Officer |

 

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