**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-Q**

**Quarterly Report Pursuant to Section 13 or15(d) of the SecuritiesExchange Act of 1934**

**Forthe quarterly period ended June 30, 2007**

**CommissionFile Number: 000-51444**

**KapStonePaper and Packaging Corporation**

(Exact name of registrantas specified in its charter)

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

 

**KapStone Paper andPackaging 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.

Yes xNo o

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

| Large Accelerated Filer o |   | Accelerated  Filer x |   | Non-Accelerated  Filer o |
|---------------------------|--------|----------------------|--------|--------------------------|

 

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

Yes oNo x

Therewere 24,968,097 shares of the Registrant’s Common Stock, $0.0001 par value,outstanding at August 1, 2007, excluding 40,000 shares held as treasuryshares.

 

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

 

i

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**Part 1. FinancialInformation**

**Item 1. FinancialStatements**

**KapStone Paper andPackaging CorporationCondensed Consolidated Balance Sheets**

**(In thousands,except share and per share amounts)**
| ** **                                                                                                                                                                                                                                                            | ** ** | ** **        | ** ** | ** **            | ** ** | ** ** | ** ** | **Predecessor  KPB**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | ** ** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                                                                                                                                            | ** ** | **2007**          | ** ** | **2006**              | ** ** | ** ** | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                                                                            | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** | ** ** | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                                                            |       |              |       |                  |       |       |       |                  |       |
| Current assets:                                                                                                                                                                                                                                                       |       |              |       |                  |       |       |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                            |       | $                 | 42,930     |                  | $          | —     |       |                  |       | $ | 1 |   |
| Restricted cash  held in trust                                                                                                                                                                                                                                        |       | —            |       | 115,239               |       |       |       | —                |       |
| Accounts  receivable, less allowances of $884 at June 30, 2007                                                                                                                                                                                                        |       | 26,952            |       | —                |       |       |       | 25,824                |       |
| Inventories                                                                                                                                                                                                                                                           |       | 21,329            |       | —                |       |       |       | 24,087                |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                            |       | 2,337             |       | 120                   |       |       |       | 1,425                 |       |
| Total current assets                                                                                                                                                                                                                                                  |       | 93,548            |       | 115,359               |       |       |       | 51,337                |       |
|                                                                                                                                                                                                                                                                  |       |              |       |                  |       |       |       |                  |       |
| Plant, property and  equipment, net                                                                                                                                                                                                                                   |       | 110,982           |       | —                |       |       |       | 201,593               |       |
| Deferred income taxes                                                                                                                                                                                                                                                 |       | 1,006             |       | 689                   |       |       |       | —                |       |
| Deferred acquisition  costs                                                                                                                                                                                                                                           |       | 1,197             |       | 3,058                 |       |       |       | —                |       |
| Other assets                                                                                                                                                                                                                                                          |       | 3,156             |       | 151                   |       |       |       | 4,452                 |       |
| Goodwill                                                                                                                                                                                                                                                              |       | 677               |       | —                |       |       |       | —                |       |
| Total assets                                                                                                                                                                                                                                                          |       | $                 | 210,566    |                  | $          | 119,257    |       |                  |       | $ | 257,382 |   |
|                                                                                                                                                                                                                                                                  |       |              |       |                  |       |       |       |                  |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                                                                        |       |              |       |                  |       |       |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                  |       |              |       |                  |       |       |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                                      |       | $                 | 11,864     |                  | $          | 196        |       |                  |       | $ | 7,931 |   |
| Accrued expenses                                                                                                                                                                                                                                                      |       | 4,435             |       | 2,562                 |       |       |       | 7,144                 |       |
| Accrued  compensation costs                                                                                                                                                                                                                                           |       | 5,632             |       | —                |       |       |       | —                |       |
| Accrued taxes  other than income                                                                                                                                                                                                                                      |       | 1,008             |       | 224                   |       |       |       | —                |       |
| Deferred income  taxes                                                                                                                                                                                                                                                |       | 255               |       | —                |       |       |       | —                |       |
| Current portion  of long-term debt                                                                                                                                                                                                                                    |       | 9,625             |       | —                |       |       |       | —                |       |
| Total current  liabilities                                                                                                                                                                                                                                            |       | 32,819            |       | 2,982                 |       |       |       | 15,075                |       |
|                                                                                                                                                                                                                                                                  |       |              |       |                  |       |       |       |                  |       |
| Other liabilities:                                                                                                                                                                                                                                                    |       |              |       |                  |       |       |       |                  |       |
| Long-term debt                                                                                                                                                                                                                                                        |       | 48,500            |       | —                |       |       |       | 22,357                |       |
| Asset retirement  obligations                                                                                                                                                                                                                                         |       | 272               |       | —                |       |       |       | 265                   |       |
| Pension and post  retirement benefits                                                                                                                                                                                                                                 |       | 3,362             |       | —                |       |       |       | —                |       |
| Total other liabilities                                                                                                                                                                                                                                               |       | 52,134            |       | —                |       |       |       | 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; 25,000,000 shares issued  less 40,000 treasury shares outstanding at June 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                                                                                                                                                                                                                                           |       | 113,176           |       | 113,904               |       |       |       | —                |       |
| Divisional  control                                                                                                                                                                                                                                                   |       | —            |       | —                |       |       |       | 219,685               |       |
| Common stock  held in treasury                                                                                                                                                                                                                                        |       | (230              | )          | —                |       |       |       | —                |       |
| Retained  earnings                                                                                                                                                                                                                                                    |       | 12,665            |       | 2,138                 |       |       |       | —                |       |
| Total stockholders’  equity                                                                                                                                                                                                                                      |       | 125,613           |       | 116,275               |       |       |       | 219,685               |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                       |       | $                 | 210,566    |                  | $          | 119,257    |       |                  |       | $ | 257,382 |   |

 

See notes to condensedconsolidated financial statements.

1

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**KapStone Paper andPackaging CorporationCondensed Consolidated Statements of Operations(In thousands, except share and per share amounts)**

**(unaudited)**
| ** **                                                                                               | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** **                       | ** ** | **Predecessor  KPB**        | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                                                                                               | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** | **Three Months Ended** | ** ** |
| ** **                                                                                               | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | ** **                       | ** ** | **June 30, 2006** | ** ** |
|                                                                                                     |       |                                                |       |       |       |                             |       |                        |       |
| Net sales                                                                                                |       | $                                                   | 60,242     |       | $          | —                           |       |                        |       | $ | 61,010 |   |
| Cost of sales                                                                                            |       | 47,029                                              |       | —     |       |                             |       | 47,618                      |       |
| Depreciation and  amortization, excluding amortization of intangible assets                              |       | 2,924                                               |       | —     |       |                             |       | 4,198                       |       |
| Gross profit                                                                                             |       | 10,289                                              |       | —     |       |                             |       | 9,194                       |       |
|                                                                                                     |       |                                                |       |       |       |                             |       |                        |       |
| Selling, general  and administrative expenses                                                            |       | 4,295                                               |       | 364        |       |                             |       | 3,191                       |       |
| Other operating  income                                                                                  |       | 127                                                 |       | —     |       |                             |       | —                      |       |
| Operating income  / (loss)                                                                               |       | 6,121                                               |       | (364       | )          |                             |       | 6,003                       |       |
| Interest income                                                                                          |       | 485                                                 |       | 1,320      |       |                             |       | —                      |       |
| Interest expense                                                                                         |       | (1,117                                              | )          | —     |       |                             |       | (352                        | )          |
| Income before  provision for income taxes                                                                |       | 5,489                                               |       | 956        |       |                             |       | 5,651                       |       |
| Provision for  income taxes                                                                              |       | 2,040                                               |       | 316        |       |                             |       | 2,184                       |       |
| Net income                                                                                               |       | 3,449                                               |       | 640        |       |                             |       | 3,467                       |       |
| Deferred  interest, net of taxes, attributable to common stock subject to possible  redemption           |       | —                                              |       | (171       | )          |                             |       | —                      |       |
|                                                                                                     |       |                                                |       |       |       |                             |       |                        |       |
| Net income  allocable to holders of nonredeemable common stock                                           |       | $                                                   | 3,449      |       | $          | 469                              |       |                        |       | $ | 3,467 |   |
|                                                                                                     |       |                                                |       |       |       |                             |       |                        |       |
| Weighted-average  number of shares outstanding:                                                          |       |                                                |       |       |       |                             |       |                        |       |
| Basic                                                                                                    |       | 24,960,000                                          |       | 25,000,000 |       |                             |       | —                      |       |
| Diluted                                                                                                  |       | 36,627,912                                          |       | 29,221,825 |       |                             |       | —                      |       |
|                                                                                                     |       |                                                |       |       |       |                             |       |                        |       |
| Net income per  share:                                                                                   |       |                                                |       |       |       |                             |       |                        |       |
| Basic                                                                                                    |       | $                                                   | 0.14       |       | $          | 0.03                             |       |                        |       | $ | — |   |
| Diluted                                                                                                  |       | $                                                   | 0.09       |       | $          | 0.02                             |       |                        |       | $ | — |   |
|                                                                                                     |       |                                                |       |       |       |                             |       |                        |       |
| Weighted-average  number of shares outstanding exclusive of shares subject to possible  redemption:      |       |                                                |       |       |       |                             |       |                        |       |
| Basic                                                                                                    |       | 24,960,000                                          |       | 21,002,000 |       |                             |       | —                      |       |
| Diluted                                                                                                  |       | 36,627,912                                          |       | 25,223,825 |       |                             |       | —                      |       |
|                                                                                                     |       |                                                |       |       |       |                             |       |                        |       |
| Net income per  share exclusive of shares and related deferred interest subject to possible  redemption: |       |                                                |       |       |       |                             |       |                        |       |
| Basic                                                                                                    |       | $                                                   | 0.14       |       | $          | 0.02                             |       |                        |       | $ | — |   |
| Diluted                                                                                                  |       | $                                                   | 0.09       |       | $          | 0.02                             |       |                        |       | $ | — |   |

 

See notes to condensedconsolidated financial statements.

2

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**KapStone Paper andPackaging CorporationCondensed Consolidated Statements of Operations(In thousands, except share and per share amounts)**

**(unaudited)**
| ** **                                                                                               | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** **                     | ** ** | **Predecessor  KPB**        | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                                                                                               | ** ** | **Six Months Ended June 30,** | ** ** | ** ** | ** ** | **Six Months Ended** | ** ** |
| ** **                                                                                               | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | ** **                     | ** ** | **June 30, 2006** | ** ** |
|                                                                                                     |       |                                              |       |       |       |                           |       |                        |       |
| Net sales                                                                                                |       | $                                                 | 125,669    |       | $          | —                         |       |                        |       | $ | 124,846 |   |
| Cost of sales                                                                                            |       | 95,154                                            |       | —     |       |                           |       | 95,914                      |       |
| Depreciation and  amortization, excluding amortization of intangible assets                              |       | 5,094                                             |       | —     |       |                           |       | 8,929                       |       |
| Gross profit                                                                                             |       | 25,421                                            |       | —     |       |                           |       | 20,003                      |       |
|                                                                                                     |       |                                              |       |       |       |                           |       |                        |       |
| Selling, general  and administrative expenses                                                            |       | 8,023                                             |       | 518        |       |                           |       | 6,285                       |       |
| Other operating  income                                                                                  |       | 588                                               |       | —     |       |                           |       | —                      |       |
| Operating income  / (loss)                                                                               |       | 17,986                                            |       | (518       | )          |                           |       | 13,718                      |       |
| Interest income                                                                                          |       | 882                                               |       | 2,527      |       |                           |       | —                      |       |
| Interest expense                                                                                         |       | (2,273                                            | )          | —     |       |                           |       | (707                        | )          |
| Income before  provision for income taxes                                                                |       | 16,595                                            |       | 2,009      |       |                           |       | 13,011                      |       |
| Provision for  income taxes                                                                              |       | 6,068                                             |       | 677        |       |                           |       | 5,027                       |       |
| Net income                                                                                               |       | 10,527                                            |       | 1,332      |       |                           |       | 7,984                       |       |
| Deferred  interest, net of taxes, attributable to common stock subject to possible  redemption           |       | —                                            |       | (327       | )          |                           |       | —                      |       |
|                                                                                                     |       |                                              |       |       |       |                           |       |                        |       |
| Net income  allocable to holders of nonredeemable common stock                                           |       | $                                                 | 10,527     |       | $          | 1,005                          |       |                        |       | $ | 7,984 |   |
|                                                                                                     |       |                                              |       |       |       |                           |       |                        |       |
| Weighted-average  number of shares outstanding:                                                          |       |                                              |       |       |       |                           |       |                        |       |
| Basic                                                                                                    |       | 24,966,667                                        |       | 25,000,000 |       |                           |       | —                      |       |
| Diluted                                                                                                  |       | 35,248,423                                        |       | 29,028,777 |       |                           |       | —                      |       |
|                                                                                                     |       |                                              |       |       |       |                           |       |                        |       |
| Net income per  share:                                                                                   |       |                                              |       |       |       |                           |       |                        |       |
| Basic                                                                                                    |       | $                                                 | 0.42       |       | $          | 0.05                           |       |                        |       | $ | — |   |
| Diluted                                                                                                  |       | $                                                 | 0.30       |       | $          | 0.05                           |       |                        |       | $ | — |   |
|                                                                                                     |       |                                              |       |       |       |                           |       |                        |       |
| Weighted-average  number of shares outstanding exclusive of shares subject to possible  redemption:      |       |                                              |       |       |       |                           |       |                        |       |
| Basic                                                                                                    |       | 24,960,000                                        |       | 21,002,000 |       |                           |       | —                      |       |
| Diluted                                                                                                  |       | 35,241,756                                        |       | 25,030,777 |       |                           |       | —                      |       |
|                                                                                                     |       |                                              |       |       |       |                           |       |                        |       |
| Net income per  share exclusive of shares and related deferred interest subject to possible  redemption: |       |                                              |       |       |       |                           |       |                        |       |
| Basic                                                                                                    |       | $                                                 | 0.42       |       | $          | 0.05                           |       |                        |       | $ | — |   |
| Diluted                                                                                                  |       | $                                                 | 0.30       |       | $          | 0.04                           |       |                        |       | $ | — |   |

 

See notes to condensed consolidated financialstatements.

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**    | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|------------|------------|-----------------------------|------------|
| ** **                                              | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months**         | ** ** |
| ** **                                              | ** ** | **Six Months Ended June 30,** | ** ** | ** ** | ** ** | **Ended**  | ** ** |
| ** **                                              | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | ** ** | ** ** | **June 30, 2006** | ** ** |
| **Operating activities**                                |       |                                              |       |       |       |       |       |                        |       |
| Net income                                              |       | $                                                 | 10,527     |       | $          | 1,332      |       |                        |       | $ | 7,984 |   |
| Depreciation and  amortization                          |       | 5,110                                             |       | —     |       |       |       | 8,929                       |       |
| Stock based  compensation expense                       |       | 223                                               |       | —     |       |       |       | —                      |       |
| Amortization of  debt issuance costs                    |       | 129                                               |       | —     |       |       |       | —                      |       |
| Other                                                   |       | —                                            |       | —     |       |       |       | (279                        | )          |
| Changes in operating  assets and liabilities:           |       |                                              |       |       |       |       |       |                        |       |
| Accounts  receivable, net                               |       | (1,128                                            | )          | —     |       |       |       | (3,222                      | )          |
| Interest  receivable on short-term investments          |       | —                                            |       | 143        |       |       |       | —                      |       |
| Inventories                                             |       | 4,284                                             |       | —     |       |       |       | 1,326                       |       |
| Prepaid expenses  and other current assets              |       | (1,128                                            | )          | 104        |       |       |       | (1,100                      | )          |
| Accounts payable                                        |       | 3,737                                             |       | —     |       |       |       | (116                        | )          |
| Accrued expenses                                        |       | (993                                              | )          | 687        |       |       |       | 1,501                       |       |
| Accrued  compensation costs                             |       | 5,632                                             |       | —     |       |       |       | —                      |       |
| Accrued taxes  other than income                        |       | 784                                               |       | —     |       |       |       | —                      |       |
| Accrued income  taxes                                   |       | —                                            |       | 53         |       |       |       | —                      |       |
| Deferred income  taxes                                  |       | 963                                               |       | (217       | )          |       |       | —                      |       |
|                                                    |       |                                              |       |       |       |       |       |                        |       |
| Net cash provided by  operating activities              |       | 28,140                                            |       | 2,102      |       |       |       | 15,023                      |       |
|                                                    |       |                                              |       |       |       |       |       |                        |       |
| **Investing activities**                                |       |                                              |       |       |       |       |       |                        |       |
| Acquisition costs paid                                  |       | (340                                              | )          | (1,046     | )          |       |       | —                      |       |
| KPB acquisition, net of  cash acquired                  |       | (150,303                                          | )          | —     |       |       |       | —                      |       |
| Capital expenditures                                    |       | (5,665                                            | )          | —     |       |       |       | (2,830                      | )          |
| Restricted cash                                         |       | —                                            |       | —     |       |       |       | 311                         |       |
| Purchase of U.S.  government securities held in trust   |       | —                                            |       | (792,063   | )          |       |       | —                      |       |
| Maturities of U.S.  government securities held in trust |       | —                                            |       | 790,277    |       |       |       | —                      |       |
| Net cash used in  investing activities                  |       | (156,308                                          | )          | (2,832     | )          |       |       | (2,519                      | )          |
|                                                    |       |                                              |       |       |       |       |       |                        |       |
| **Financing activities**                                |       |                                              |       |       |       |       |       |                        |       |
| Proceeds from long-term  debt                           |       | 60,000                                            |       | —     |       |       |       | —                      |       |
| Debt issuance costs  paid                               |       | (855                                              | )          | —     |       |       |       | —                      |       |
| Repayment of long-term  debt                            |       | (1,875                                            | )          | —     |       |       |       | —                      |       |
| 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        |       | 19                                                |       | —     |       |       |       | —                      |       |
| Distributed to  International Paper Company             |       | —                                            |       | —     |       |       |       | (12,504                     | )          |
| Net cash provided by  financing activities              |       | 171,098                                           |       | —     |       |       |       | (12,504                     | )          |
|                                                    |       |                                              |       |       |       |       |       |                        |       |
| Net increase in cash  and cash equivalents              |       | 42,930                                            |       | (730       | )          |       |       | —                      |       |
| Cash and cash  equivalents-beginning of period          |       | —                                            |       | 2,157      |       |       |       | 1                           |       |
| Cash and cash equivalents-end of period                 |       | $                                                 | 42,930     |       | $          | 1,427      |       |                        |       | $ | 1 |   |

 

See notes to condensed consolidated financialstatements.

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.****                                      FinancialStatements**

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 generally acceptedaccounting principles for complete financial statements. In the opinion ofmanagement, all adjustments (consisting of a normal recurring nature)considered necessary for a fair presentation have been included. Operatingresults for the three and six months ended June 30, 2007 are not necessarilyindicative of the results that may be expected for the year endingDecember 31, 2007. For further information, refer to the consolidatedfinancial statements and related footnotes included in our Annual Report onForm 10-K for the year ended December 31, 2006.

KapStonePaper and Packaging Corporation (formerly Stone Arcade Acquisition Corporation)or the “Company” was incorporated in Delaware on April 15, 2005.  On May25, 2006, the Company formed a wholly-owned subsidiary, KapStone Kraft PaperCorporation, or KapStone Kraft.  The Company was formed to serve as avehicle for the acquisition through a merger, capital stock exchange, assetacquisition, or other similar business combination (“Business Combination”) ofan operating business in the paper, packaging, forest products and relatedindustries.

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 this date. Prior to theacquisition of KPB, the Company had no operations and was considered adevelopment stage enterprise.  For periods prior to the acquisition, KPBis deemed to be the “Predecessor” to the Company. As a result, for the periodended June 30, 2006, the statement of operations and statement of cash flows ofKPB are presented for comparative purposes.  The accompanying condensedconsolidated statements of operations and cash flows present the results ofoperations and cash flows for i) the period preceding the acquisition of KPB,exclusive of KPB results of operations and cash flows and ii) for the periodssucceeding the acquisition our consolidated results of operations includingKPB. The results of operations and cash flows on a consolidated basissubsequent to the acquisition of KPB is not comparative to the Predecessor KPBresults of operations and cash flows as i) the basis of the acquired assets andliabilities from KPB have been adjusted to fair value pursuant to Statement ofFinancial Accounting Standards (SFAS) No. 141, *BusinessCombinations* and ii) KPB was a division of IP and not a stand alonebusiness.

# **2.****                                      Summaryof Significant Accounting Policies**

***Use of Estimates***—Thepreparation of financial statements in conformity with U.S. GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, disclosure of contingent assets and liabilities atthe date of the condensed consolidated financial statements, and the reportedamounts of revenues and expenses during the reporting periods. Actual resultscould differ from these estimates.

***Revenue Recognition***—Revenueis recognized when the customer takes title and assumes the risks and rewardsof ownership. Sales with terms designated f.o.b. (free on board) shipping pointare recognized at the time of shipment. For sales transactions designatedf.o.b. destination revenue is recorded when the product is delivered to thecustomer’s site and when title and risk of loss are transferred. Sales on consignmentare recognized in revenue at the earlier of the month that the goods areconsumed or after a period of time subsequent to receipt by the customer asspecified by contract terms. Cash incentive rebates 

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arenetted against revenue on an accrual basis as qualifying purchases are made bythe customer to earn and thereby retain the rebate. Prepaid rebates arerecorded in prepaid expenses and other current assets in the accompanyingcondensed consolidated balance sheets until earned. Discounts for promptpayments are accrued at the time of sale and adjusted when qualifying paymentsare made by customers. Accrued discounts are netted against accountreceivables, net in the accompanying condensed consolidated balance sheets andtotaled $1.1 million at June 30, 2007.

Freightcharged to customers is recognized in net sales.

***Cost of sales***— Costof sales includes the following: the cost of inventory sold during the period,warehousing costs which include distribution costs and distribution centeroccupancy costs, maintenance costs, property taxes and freight expenses to shipproducts to customers.

Revenueearned from the sale of by-products generated from the paper manufacturingprocess is reflected as a reduction to cost of sales. 

Cost ofsales for the period ended June 30, 2006, includes a gain of $1.1 millionrelated to the settlement of a property tax dispute.

***Annual Maintenance Costs***—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*. Othermaintenance costs are 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 periods ended June 30, 2007 and 2006.

***Net Income per common share***—Basicnet income per share is based on the weighted average number of common sharesoutstanding during the period.  Diluted income per share reflects thepotential dilution assuming common shares were issued upon the exercise ofoutstanding in-the-money warrants, stock options and restricted stock awardsand the proceeds thereof were used to purchase common shares at the average marketprice during the period.

***Concentrations of Credit Risk***—Financialinstruments that potentially expose the Company to concentrations of creditrisk, as defined by SFAS No. 105, *Disclosureof Information about Financial Instruments with Off-Balance Sheet Risk andFinancial Instruments with Concentrations of Credit Risk*, consistprimarily of trade accounts receivable. Trade accounts receivable balances (netof allowances) for net sales to unaffiliated customers were approximately$27.0 million at June 30, 2007 and $31.2 million at June 30, 2006(Predecessor).

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

***Inventories***—Inventoriesare valued at the lower of cost or market and include all costs directlyassociated with manufacturing products: materials, labor, and manufacturingoverhead. These values are presented at the lower of cost or market. Costs ofraw materials, work-in-process, and finished goods are determined using thefirst-in, first-out method. Replacement parts and other supplies are statedusing the average cost method.

***Plant, Property, and Equipment, net***—Plantand equipment is stated at cost less accumulated depreciation. Plant andequipment acquired in the KPB acquisition is originally recorded at fair value(see note 4) and depreciated.

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Depreciationis computed using the straight-line method over the assets’ estimated usefullives.  Estimated useful lives are as follows: 

|                                 | ** ** | **Years**                                                       | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------|------------|
| Machinery and  equipment        |       | 10-20                                                           |       |
| 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-livedassets, excluding goodwill, are reviewed for impairment upon the occurrence ofevents or changes in circumstances that indicate that the carrying value of theassets 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 is lessthan the net book value, an impairment charge is recorded to reflect theestimated fair value of the assets, determined principally using discountedcash flows.

***Income Taxes***— TheCompany accounts for income taxes under the liability method in accordance withStatement of Financial Accounting Standards (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 benefit plan***—TheCompany established a defined benefit pension plan for its union employees inNorth Carolina and Arkansas in accordance with the purchase agreement. The Company has estimated the current service costs which are being charged tooperations as they accrue based on services rendered by employees during theyear. An independent actuary performed an actuarial valuation based onmanagement’s best estimate for key assumptions.

***Deferred acquisition costs***—TheCompany capitalizes costs incurred relating to planned acquisitions whichinclude legal fees, due diligence and other costs. At June 30, 2007, $1.2million of transaction costs has been capitalized and will be included in thepurchase price of the acquisition upon consummation of the deal.

# **3.****                                      Reclassifications**

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

# **4.****                                      KPBAcquisition**

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 when suchperformance targets are achieved. KPB was deemed an attractive acquisitioncandidate 

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basedon meeting the objectives of being a North American based profitable operatingcompany in the paper and packaging industry.

The KPBacquisition was accounted for in accordance with the provisions of SFAS No. 141,*Business Combinations* and SFASNo. 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 $3.1million. The following table summarizes the estimated fair value of the assetsacquired and the liabilities assumed at the date of the acquisition. TheCompany is in the process of reviewing third party valuations of tangible andintangible assets acquired, thus the allocation of the purchase price ispreliminary ($ 000’s):

| Accounts receivable                        |   | $       | 25,824  |   |
|--------------------------------------------|--------|---------|---------|--------|
| Inventories                                |   | 25,613  |    |
| Prepaid expenses  and other current assets |   | 1,089   |    |
| Plant, property  and equipment             |   | 110,359 |    |
| Deferred income  taxes                     |   | 1,023   |    |
| Other assets                               |   | 1,672   |    |
| Goodwill                                   |   | 677     |    |
| Intangible  assets                         |   | 673     |    |
| Accounts payable                           |   | (7,931  | )       |
| Accrued expenses                           |   | (5,843  | )       |
| Other  liabilities                         |   | (2,853  | )       |
| Allocated purchase  price                  |   | $       | 150,303 |   |

 

Theintangible assets represent the value of customer lists, $0.3 million andtrademarks, $0.4 million. Customer lists are amortized over 8 years. For thethree and six month periods ended June 30, 2007, amortization expense totaled$8 and $16, respectively, and is included in selling, general andadministrative expenses in the accompanying Condensed Consolidated Statementsof Operations. Trademarks were appraised with an indefinite life and as aresult are not being amortized, 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 has not yet been allocated tothe operating segments. Goodwill will be deducted for federal income taxpurposes over 15 years.

As partof the KPB acquisition, the Company assumed liabilities for retireemedical/life obligation for employees not eligible to retire at December 31,2006, of $1.3 million. In addition, obligations for an increase in the hourlypension benefit level totaling $1.3 million were assumed by the Company. Employees no longer accrue benefits under these plans. Pursuant to thepurchase agreement with IP, in May 2007, the Company established a definedbenefit pension plan for its union employees providing benefits beginningJanuary 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’sFee**

TheCompany paid the underwriter $1.2 million in 2007 for services performed relatingto the Company’s initial public offering. The fee was payable upon a successfulBusiness Combination, as defined. 

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Accordingly,the fee was charged against Additional paid-in capital in the accompanyingCondensed Consolidated Balance Sheets.

# **6.****                                      RedemptionStatus of Common 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 stockholder approval. Basedon the votes submitted on December 29, 2006, 40,000 shares voted against theproposed KPB Business Combination and sought to be redeemed for cash. As aresult, $0.2 million of the net proceeds from the initial offering plusinterest was classified as common stock subject to redemption at December 31,2006. The stock redemption occurred in February 2007 and the redeemed shareswere held in treasury at June 30, 2007.

# **7.****                                      Stock-BasedCompensation**

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 these awards under SFAS No. 123R, *Share-Based Payment*, which requires that the cost resultingfrom all share-based payment transactions be recognized as compensation costover the vesting period based on the fair value of the instrument on the dateof grant. As a result, the Company recognized $0.2 million and $0.1million on a pre tax and after tax basis, respectively, of compensation costfor the three and six months ended June 30, 2007. *      *

At June 30, 2007, the Company reserved 3,000,000shares of common stock for stock option and restricted stock awards.** 

SFAS No. 123R requires that cash flows relating tothe benefits of tax deductions in excess of recognized compensation cost bereported as financing cash flow, rather than as an operating cash flow, aspreviously required. For the six month periods ended June 30, 2007, thisexcess tax benefit was $0.

Stock options

Thestock options vest as follows: 50% after two years and the remaining 50% afterthree years.  The stock options have aterm of seven years. The stock options are subject to forfeiture shouldthese employees terminate their employment with the Company for certain reasonsprior to vesting in their awards, or the occurrence of certain other eventssuch as termination with cause. The exercise price of these stock options isbased on closing market price of our common stock on the date of grant andcompensation expense is recorded on an accelerated basis over the awards’vesting periods. 

A summary of information related to stock options is asfollows:
| ** **                           | ** ** | ** ** | ** ** | **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         |       | 6.7                   |       | 515                  |       |
| Exercised                            |       | —     |       | —       |       | —                |       | —               |       |
| Lapsed  (forfeited or cancelled)     |       | —     |       | —       |       | —                |       | —               |       |
| Outstanding at  June 30, 2007   |       | 620,750    |       | $            | 6.76       |                  | 6.7        |                 | $          | 515 |   |
| Exercisable at  June 30, 2007   |       | —     |       | $            | —     |                  |       |                 |       |   |
|                                      |            |            |            |              |            |                       |            |                      |            |  |  |

 

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Totalstock-based compensation recorded in the Condensed Consolidated Statement ofOperations related to the stock option grants was $0.1 million during the threeand six months ended June 30, 2007.

As of June 30, 2007, there was $1.2 million of totalunrecognized compensation cost related to non-vested stock options. That costis expected to be recognized over a weighted average period of 2.7 years. Nostock options were vested as of June 30, 2007.

The weighted average fair value for the KapStone stockoptions granted in April 2007 was $2.30. The fair value was estimated using theBlack-Scholes option-pricing model based on the weighted average market priceat the grant date and the weighted average assumptions specific to theunderlying options. Expected volatility assumptions are based on volatility ofrelated industry stocks. The expected term is based on management’s estimate ofthe contractual term of the options, or seven years, and employees’ expectedexercise behavior. The risk-free interest rate was selected based upon yieldsof U.S. Treasury issues with a term equal to the expected life of the stockoption being valued. The assumptions utilized for stock options during theperiod are as follows:
| ** **                                                            | ** ** | **Three Months  Ended June 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**

On April 5, 2007, theCompany’s Compensation Committee granted 174,000 restricted shares of commonstock to executive officers and employees as compensation for service. Thesecommon stock shares are restricted as to transferability until they vest threeyears from the grant date. These restricted shares are subject to forfeitureshould these employees terminate their employment with the Company for certainreasons prior to vesting in their awards, or the occurrence of certain otherevents. The value of these restricted shares is based on the closing marketprice of our common stock on the date of grant and compensation expense isrecorded on a straight-line basis over the awards’ vesting periods. 

The following tablesummarizes 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  June 30, 2007 |       | 174,000    |       | 6.76         |       |
|                                    |            |            |            |              |            |  |

 

Total stock-basedcompensation recorded in the Condensed Consolidated Statement of Operationsrelated to the restricted stock awards was $0.1 million during the three andsix months ended June 30, 2007, respectively. As of June 30, 2007, there was $1.0 million of total unrecognizedcompensation cost related to the restricted stock which will be recognized overthe remaining vesting period.

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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 FoundingStockholders.  The fees charged by White Oak to KapStone for theseservices are calculated using a discounted rate from the fees White Oaktypically charges to outside parties. For the six month period ended June 30,2007, the amount paid to this entity was $0.1 million.

# **9.****                                      CommonStock Reserved for Issuance**

At June30, 2007 and December 31, 2006, 44,000,000 shares of common stock were reservedfor issuance upon exercise of warrants, stock options and the underwriter’soption.

# **10.****                               Long-termDebt and Credit 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 June 30,2007, there were no advances under the revolving line of credit. The creditfacility expires on December 31, 2011.

Long-termdebt at June 30, 2007 is summarized as follows ($000’s):
| ** **                              | ** ** | **June 30, 2007** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| Term loan                               |       | $                           | 58,125     |   |
|                                    |       |                        |       |
| Less current  portion of long-term debt |       | 9,625                       |       |
|                                    |       |                        |       |
|                                    |       |                        |       |
| Long-term debt                          |       | $                           | 48,500     |   |

 

At June30, 2007, the Company had one letter of credit outstanding totaling $0.3million.

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 June 30, 2007 theBase Rate and LIBOR rate, which adjust quarterly, were 8.25% for the amount ofthe term loan payable on July 2, 2007 ($1.9 million) and 6.59% for the balanceof the term loan ($56.2 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 for the three and six months ended June30, 2007 and is recorded in interest expense in the accompanying CondensedConsolidated Statements of Operations.

# **11.****                               Inventories**

Inventoriesconsist of the following at June 30, 2007, and December 31, 2006, respectively($000’s):
| ** **                      | ** ** | **June 30, 2007** | ** ** | ** ** | ** ** | **Predecessor KPB**        | ** ** |
|---------------------------------|------------|-----------------------------|------------|------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **(Unaudited)**             | ** ** | ** ** | ** ** | **December 31, 2006** | ** ** |
| Raw materials                   |       | 6,319                       |       |       |       | 6,466                           |       |
| Work in process                 |       | 516                         |       |       |       | 321                             |       |
| Finished goods                  |       | 10,823                      |       |       |       | 13,352                          |       |
| Replacement  parts and supplies |       | 3,671                       |       |       |       | 3,948                           |       |
| Inventories                     |       | $                           | 21,329     |       |       |                            | $          | 24,087 |   |
|                                 |            |                             |            |            |            |                                 |            |  |  |

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As partof 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 six month period ended June 30, 2007.

# **12.****                               Incometaxes**

TheCompany’s U.S. federal statutory tax rate is 35% for 2007 and 34% for2006. Our effective tax rate for the six months ended June 30, 2007, was36.6% 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.

In July2006, the Financial Accounting Standards Board issued FIN No. 48, whichclarifies the application of SFAS No. 109. FIN No. 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 No. 48provides guidance regarding measurement, de-recognition, classification, anddisclosure of tax positions. The Company adopted FIN No. 48 effective January1, 2007. The Company to date has no unrecognized tax benefit. In accordancewith FIN No.48, paragraph 19, the Company classifies interest and penalties asa component of tax expense. We do not have any uncertain income tax positionsincluded in the accompanying condensed consolidated financial statements atJune 30, 2007.

In thenormal course of business, we are subject to examination by taxing authorities.The Company’s open tax years are 2005 and 2006.

# **13.****                               Pensionplan and post retirement benefits**

In June2007, the Company established a defined benefit plan to provide benefits forapproximately 550 union represented employees.  This plan is part of thecollective bargaining agreement between Kapstone Kraft and the United Steel,Paper and Forestry, Rubber, Manufacturing, Energy, Allied-Industrial, Chemicaland Service Workers Union, AFL-CIO, CLC.  Union employees began to accruea benefit under the Kapstone Kraft plan as of January 1, 2007.  

Net pension cost recognized for the three and sixmonths ended June 30, 2007 and 2006 for the Company’s pension plan, is asfollows ($ 000’s):
| ** **                                        | ** ** | ** **                                                               | ** ** | ** **             | ** ** | **Predecessor KPB**                                           | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **Three and   Six Months Ended  June 30, 2007** | ** ** | ** **             | ** ** | **Three and  Six Months Ended  June 30, 2006** | ** ** |
| ** **                                        | ** ** | **Three  Months  Ended**                                                 | ** ** | **Six  Months  Ended** | ** ** | ** **                                                         | ** ** | **Three  Months  Ended** | ** ** | **Six  Months  Ended** | ** ** |
| ** **                                        | ** ** |                                                                     |       |                   |       |                                                               |       | ** ** | ** ** | ** ** | ** ** |
| Service cost for  benefits earned during the year |       | $                                                                        | 288        |                   | $          | 575                                                                |       |   |   | $ | — |   | $ | — |   |
| Interest cost on  projected benefit obligations   |       | 20                                                                       |       | 40                     |       |                                                               |       | — |   | — |   |
| Expected return  on plans’ assets            |       | —                                                                   |       | —                 |       |                                                               |       | — |   | — |   |
| Amortization of  prior service cost               |       | 25                                                                       |       | 50                     |       |                                                               |       | — |   | — |   |
| Allocation of  pension cost from IP               |       | —                                                                   |       | —                 |       |                                                               |       | 363 |   | 727 |   |
| Net pension cost                                  |       | $                                                                        | 333        |                   | $          | 665                                                                |       |   |   | $ | 363 |   | $ | 727 |   |

 

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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.

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, while theCompany’s Retirement Savings Plan, which provides for contributions based on asalaried employee’s salary and age, vests 100% after three years. Companycontributions to the 401(k) plan are based on matching of employeecontributions and vest after three years for union employees. For the three monthsand six months ended June 30, 2007, the expense of Company matching employeecontributions totaled $0.3 million and $0.6 million, respectively.

**14.          Net income per share**

Basicand diluted net income per share are calculated as follows:

|                                                                          | ** ** | **Three Months  Ended** | ** ** | **Six Months  Ended**  | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                               | ** ** | **June 30, 2007**  | ** ** | **June 30, 2007** | ** ** |
| Net income as reported                                                   |       | $                            | 3,449      |                        | $          | 10,527 |   |
| Weighted-average number  of common shares for basic net income per share |       | 24,960,000                   |       | 24,966,667                  |       |
| Incremental effect of  dilutive common stock equivalents:                |       |                         |       |                        |       |
| Common stock warrants                                                    |       | 11,655,972                   |       | 10,275,786                  |       |
| Unvested restricted  stock awards                                        |       | 11,940                       |       | 5.970                       |       |
|                                                                     |       |                         |       |                        |       |
| Weighted-average number  of shares for diluted                           |       | 36,627,912                   |       | 35,248,423                  |       |
|                                                                     |       |                         |       |                        |       |
| Net income per share -  basic                                            |       | $                            | 0.14       |                        | $          | 0.42 |   |
|                                                                     |       |                         |       |                        |       |
| Net income per share - diluted                                           |       | $                            | 0.09       |                        | $          | 0.30 |   |

 

Stockoption grants totaling 620,750 were outstanding in the three and six monthperiods ended June 30, 2007, but the weighted-average stock option grants werenot included in the computation of diluted earnings per share because theeffect of including 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 increased by $3.5 million while operating income hasbeen lowered by $3.5 million for the three months ended June 30, 2006.  Asa result, net income has been lowered by $2.1 million for the three monthsended June 30, 2006. For the six months ended June 30, 2006, cost of sales hasbeen increased by $2.3 million, operating income has been lowered by $2.3million and net income lowered by $1.4 million. 

ThePredecessor results for the quarter ended March 31, 2006 have been restatedwithin the results for the six-month period ended June 30, 2006 from thosepreviously reported within the Company’s Form 10-Q for the three month periodending March 31, 2007. The restatement corrects errors related to cashdiscounts and the book to fair value adjustments for Industrial DevelopmentBonds, related to the 

13

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acquisitionof one of KPB’s facilities, was incorrectly recorded as a premium rather than adiscount. The impact of this correction was a decrease to net sales and netincome of $0.2 million and $0.1 million, respectively. 

# **16.****                               SegmentInformation**

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 goodwill (not yet allocated to the operating segments).
| ** **                                           | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** **                                          | ** ** | ** ** | ** ** | **Predecessor  KPB**                                  | ** ** | **Predecessor  KPB**                                | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|-----------------------------------------------------|------------|------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Operating Segment ($ 000’s):** | ** ** | **Three Months  Ended June 30,  2007** | ** ** | ** ** | ** ** | **Six Months  Ended June 30,  2007** | ** ** | ** ** | ** ** | **Three Months  Ended June 30,  2006** | ** ** | **Six Months  Ended June 30,  2006** | ** ** |
| Net Sales:                                           |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Unbleached kraft                                     |       | $                                                     | 52,519     |       |       |                                                | $          | 111,001    |       |                                                  |       | 52,436                                              |       | $ | 108,407 |   |
| Dunnage bags                                         |       | 8,684                                                 |       |       |       | 16,452                                              |       |       |       | 8,945                                                 |       | 17,979                                              |       |
| Elimination of  intersegment sales                   |       | (961                                                  | )          |       |       | (1,784                                              | )          |       |       | (371                                                  | )          | (1,540                                              | )          |
|                                                 |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Total                                                |       | $                                                     | 60,242     |       |       |                                                | $          | 125,669    |       |                                                  |       | $                                                   | 61,010     |   | $ | 124,846 |   |
|                                                 |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Operating income /  (loss):                          |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Unbleached kraft                                     |       | $                                                     | 7,919      |       |       |                                                | $          | 21,406     |       |                                                  |       | 6,310                                               |       | 14,418 |   |
| Dunnage bags                                         |       | 1,790                                                 |       |       |       | 3,312                                               |       |       |       | 1,790                                                 |       | 3,749                                               |       |
| Corporate                                            |       | (3,588                                                | )          |       |       | (6,732                                              | )          |       |       | (2,247                                                | )          | (4,449                                              | )          |
|                                                 |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Total                                                |       | $                                                     | 6,121      |       |       |                                                | $          | 17,986     |       |                                                  |       | $                                                   | 6,003      |   | $ | 13,718 |   |
|                                                 |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Depreciation and  amortization:                      |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Unbleached kraft                                     |       | $                                                     | 2,863      |       |       |                                                | $          | 4,993      |       |                                                  |       | 4,120                                               |       | 8,771 |   |
| Dunnage bags                                         |       | 61                                                    |       |       |       | 101                                                 |       |       |       | 78                                                    |       | 158                                                 |       |
| Corporate                                            |       | 8                                                     |       |       |       | 16                                                  |       |       |       | —                                                |       | —                                              |       |
|                                                 |       |                                                  |       |       |       |                                                |       |       |       |                                                  |       |                                                |       |
| Total                                                |       | $                                                     | 2,932      |       |       |                                                | $          | 5,110      |       |                                                  |       | $                                                   | 4,198      |   | $ | 8,929 |   |

 
| ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | **Predecessor  KPB** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|------------|------------|------------|------------|------------|------------|
| Total assets (at June  30, 2007 and December 31, 2006): |       |       |       |       |       |                 |       |       |       |       |       |       |       |
| Unbleached kraft                                        |       | $          | 147,179    |       |       |                 | $          | 245,412    |       |       |       |       |       |   |   |
| Dunnage bags                                            |       | 12,044     |       |       |       | 11,970               |       |       |       |       |       |       |       |
| Corporate                                               |       | 51,343     |       |       |       | —               |       |       |       |       |       |       |       |
|                                                    |       |       |       |       |       |                 |       |       |       |       |       |       |       |
| Total                                                   |       | $          | 210,566    |       |       |                 | $          | 257,382    |       |       |       |       |       |   |   |

 

14

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| ** **                                           | ** ** | ** **                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** | **Predecessor  KPB**                                  | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|-------------------------------------------------------|------------|
| **Operating Segment ($ 000’s):** | ** ** | **Three Months  Ended June 30,  2007** | ** ** | **Six Months  Ended June 30,  2007** | ** ** | ** ** | ** ** | **Three Months  Ended June 30,  2006** | ** ** | **Six Months  Ended June 30,  2006** | ** ** |
| Capital Spending:                                    |       |                                                  |       |                                                |       |       |       |                                                  |       |   |   |
| Unbleached kraft                                     |       | $                                                     | 889        |                                                | $          | 2,938      |       |                                                  |       | $ | 1,594 |   | $ | 2,830 |   |
| Dunnage bags                                         |       | 28                                                    |       | 57                                                  |       |       |       | —                                                |       | — |   |
| Corporate                                            |       | 2,670                                                 |       | 2,670                                               |       |       |       | —                                                |       | — |   |
|                                                 |       |                                                  |       |                                                |       |       |       |                                                  |       |   |   |
| Total                                                |       | $                                                     | 3,587      |                                                | $          | 5,665      |       |                                                  |       | $ | 1,594 |   | $ | 2,830 |   |

 

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

ThisQuarterly Report on Form 10-Q includes forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended. We have based theseforward-looking statements on our current expectations and projections aboutfuture events. These forward-looking statements are subject to known andunknown risks, uncertainties and assumptions about us that may cause our actualresults, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance or achievementsexpressed or implied by such forward-looking statements. In some cases, you canidentify forward-looking statements by terminology such as “may,” “should,” “could,”“would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” orthe negative of such terms or other similar expressions. Factors that mightcause or contribute to such a discrepancy include, but are not limited to,those described in our other Securities and Exchange Commission filings. Thefollowing discussion should be read in conjunction with our FinancialStatements and related Notes thereto included elsewhere in this report.

**Overview**

We wereformed on April 15, 2005 to serve as a vehicle to effect a merger, capitalstock exchange, asset acquisition or other similar business combination (“BusinessCombination”) with an operating business in the paper, packaging, forestproducts and related industries.

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 certain post closingadjustments of $7.8 million plus two contingent earn-out payments of up to$60 million (in aggregate), based on KPB’s annual earnings before interest,income taxes, depreciation and amortization, or EBITDA, during the five yearsimmediately following the acquisition.  Any contingent earn-out paymentswill be accounted for as additional purchase price consideration and recordedas goodwill. The purchase price payable on the closing date was adjusted by$7.8 million, or dollar-for-dollar, for IP’s working capital as of such datebeing 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 six month periodsended June 30, 2006, the statement of operations and statement of cash flows ofKPB are presented for comparative purposes.  The accompanying consolidatedstatements of operations and cash flows present the results of our operationsand cash flows for i) the  period preceding the acquisition of KPB,exclusive of KPB results of operations and cash flows and ii) for the periodssucceeding the acquisition our consolidated results of operations includingKPB. Our results of operations and cash flows on a consolidated basissubsequent to the acquisition of KPB is not comparative to the Predecessor KPBresults of operations and cash flows as i) the basis of the acquired assets andliabilities from KPB have been adjusted to fair value pursuant to SFAS No. 141,*Business Combinations* and ii) KPBwas a division of IP and not a stand alone business.

**Results of Operations**

TheCompany’s management uses a variety of financial measurements to analyze itsperformance. These measurements include (1) Operating Income, (2) Productivity(3) Selling, General & Administrative (“SG&A”) expenses and(4) Average revenue per ton (for unbleached kraft) and average revenue perdunnage bag (for Ride Rite® Converting).

*Operating Income.*    Operatingincome is used by the Company’s management primarily as a measure of itssegments’ operating performance. The Company’s management defines operatingincome as net sales minus costs associated with these sales. Net sales includesales of unbleached kraft paper products, 

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linerboardand dunnage bags net of term allowances and discounts. For purposes ofcalculating operating income, costs include the cost of raw materials, labor,maintenance, depreciation and amortization, distribution expenses and selling,general and administrative expenses.

*Selling, General and Administrative Expenses.*   SG&Aexpenses include selling, customer service and corporate employee salaries andbenefits, professional fees, and information technology expenses, includingfees paid to IP for transitional services support.

*Average Revenue per Ton/Dunnage Bag.* Average revenue per ton/bag represents the revenue divided by the tons ofunbleached kraft paper and linerboard sold or the units of dunnage bags sold,as applicable.

Allcomments and variances in the following commentary for the period ended June30, 2006 refer to the Predecessor, or KPB.

**Three Months Ended June 30, 2007 Compared with Three MonthsEnded June 30, 2006**

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

***Net sales***
| ** **                      | ** ** | **Three Months ended June 30,**            | ** ** |
|---------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                      | ** ** | **Net Sales in Thousands of Dollars** | ** ** | **Tons/Bags Sold** | ** ** |
| ** **                      | ** ** | **2007**                                                       | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| Unbleached kraft                |       | $                                                              | 52,519     |   | $ | 52,436 |   | $ | 83 |   | 0.2 | % | 96,044 |   | 95,277 |   | 767 |   | 0.8 | % |
| Dunnage bags                    |       | 8,684                                                          |       | 8,945 |   | (261 | ) | (2.9 | )% | 2,211,000 |   | 2,401,000 |   | (190,000 | ) | (7.9 | )% |
| Intersegment  elimination       |       | (961                                                           | )          | (371 | ) | (590 | ) | (159.0 | )% | (1,541 | ) | (1,885 | ) | 344 |   | 18.2 | % |
|                            |       | $                                                              | 60,242     |   | $ | 61,010 |   | $ | (768 | ) | (1.3 | )% |   |   |   |   |   |   |   |   |
|                            |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average revenue per ton         |       | $                                                              | 546.82     |   | $ | 550.35 |   | $ | (3.53 | ) | (0.6 | )% |   |   |   |   |   |   |   |   |
| Average revenue per dunnage bag |       | $                                                              | 3.93       |   | $ | 3.73 |   | $ | 0.20 |   | 5.4 | % |   |   |   |   |   |   |   |   |

 

KapStone’snet sales decreased by $0.8 million, or 1.3%, to $60.2 million for the quarterended June 30, 2007 compared with $61.0 million for the quarter ended June 30,2006.  A two day unplanned mill outage in June 2007 resulting from anelectrical fire reduced production by 2,300 tons and negatively impacted salesby approximately $1.3 million. In addition, dunnage bag volume was down 7.9%compared to 2006.

Unbleachedkraft segment net sales increased by $0.1 million, or 0.2%, to $52.5 millionfor the quarter ended June 30, 2007 compared with $52.4 million for the quarterended June 30, 2006. Both quarters ended June 30, 2007 and 2006 were impactedby planned annual maintenance shutdowns resulting in nine days of lostproduction and sales revenue. In addition, a two day unplanned mill outage inJune 2007 caused by an electrical fire interrupted production and had theeffect of reducing sales in the period by approximately 2,300 tons or $1.3million. Average revenue per ton is down $3.53 due to increased volume oflinerboard, a lower priced product, partially offset by the favorable impact ofa $50/ton 2006 price increase. 

Netsales for the dunnage bag segment sold under the Ride Rite® Converting brandname decreased by $0.3 million, or 2.9%, to $8.7 million for the three monthsended June 30, 2007 compared with $8.9 million for the three months ended June30, 2006 mainly due to a 7.9% drop in unit volume. Average revenue per bag of $3.93,increased by $0.20 or 5.4%, for the three months ended June 30, 2007 comparedto the similar period last year.   Bag sales have decreased due toreduced customer shipping activity particularly in the less-than-truckloadmarket and due to a distributor losing position with two key accounts.

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***Cost of sales***
| ** **                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase/(Decrease)** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------|------------|
| **$ 000’s**                           | ** ** | **2007**                                        | ** ** | **2006**                | ** ** | **Change** | ** ** | **%** | ** ** |
| Unbleached kraft                                |       | $                                               | 41,515     |                    | $          | 41,433 |   | $ | 82 |   | 0.2 | % |
| Dunnage bags                                    |       | 6,475                                           |       | 6,556                   |       | (81 | ) | (1.2 | )% |
| Intersegment elimination  from unbleached kraft |       | (961                                            | )          | (371                    | )          | (590 | ) | (159.0 | )% |
|                                            |       | $                                               | 47,029     |                    | $          | 47,618 |   | $ | (589 | ) | (1.2 | )% |

 

Cost ofsales for the period ended June 30, 2007 decreased by $0.6 million or 1.2%compared to 2006 due to lower dunnage bag volume and favorable unbleached kraftpaper raw material prices partially offset by $0.6 million for an unplannedmill outage in June 2007 caused by an electrical fire and higher utility costs.A $1.1 million favorable property tax settlement reduced 2006 cost of sales. 

Unbleachedkraft segment cost of sales increased by $0.1 million for the quarter endedJune 30, 2007 to $41.5 million. Cost of sales as a percent of net sales was79.0% for the quarters ended June 30, 2007 and 2006. A favorable $1.1 millionproperty tax settlement in 2006, $0.6 million for an unplanned mill outage inJune 2007, caused by an electrical fire which reduced production by 2,300 tons,and $0.4 million for higher utility costs were mostly offset by productivitygains and lower caustic soda and coal costs. During the quarters ended June 30,2007 and 2006, the Roanoke Rapids mill completed its annual planned maintenanceshutdowns at a cost of $4.6 million for each year. 

Dunnagebag segment cost of sales decreased by $0.1 million, or 1.2% from 2006 due to a7.9% drop in bag sales volume partially offset by distribution expenses. As aresult, cost of sales as a percent of net sales was 74.6% for the quarter endedJune 30, 2007 compared with 73.3% for the quarter ended June 30, 2006.

***Depreciation and amortization***

Depreciationand amortization for the quarter ended June 30, 2007, totaled $2.9 millioncompared to $4.2 million for the quarter ended June 30, 2006. The decrease of$1.3 million reflects an appraisal of depreciable assets to their respectivefair values as of January 2, 2007. The fair value of assets acquired wasapproximately $91 million less than the basis being used for depreciation inthe 2006 period.

Depreciationand amortization for the quarter ended June 30, 2007 includes $8 for intangibleassets amortization which is included in Corporate.

***Operating income***
| ** **            | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase/(Decrease)** | ** ** |
|-----------------------|------------|-------------------------------------------------|------------|-------------------------|------------|
| **$ 000’s** | ** ** | **2007**                                        | ** ** | **2006**                | ** ** | **Change** | ** ** | **%** | ** ** |
| Unbleached kraft      |       | $                                               | 7,919      |                    | $          | 6,310 |   | $ | 1,609 |   | 25.5 | % |
| Dunnage bags          |       | 1,790                                           |       | 1,940                   |       | (150 | ) | (7.7 | )% |
| Corporate             |       | (3,588                                          | )          | (2,247                  | )          | (1,341 | ) | (59.7 | )% |
|                  |       | $                                               | 6,121      |                    | $          | 6,003 |   | $ | 118 |   | 2.0 | % |

 

Operatingincome of $6.1 million for the quarter ended June 30, 2007 was $0.1 million or2.0% above the $6.0 million for the quarter ended June 30, 2006. Operatingincome for the quarter ended June 30, 2006 benefited from a favorable $1.1million property tax settlement. Improved product pricing for unbleached kraftpaper and lower depreciation costs were partially offset by higher corporateexpenses and a two day unplanned mill outage caused by an electrical fire.

18

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Unbleachedkraft segment operating income increased by $1.6 million, or 25.5%, to $7.9million for the quarter ended June 30, 2007 compared with $6.3 million for thequarter June 30, 2006. Operating income for the quarter ended June 30, 2006 wasfavorably impacted by a $1.1 million property tax settlement.  Higherselling prices and lower depreciation costs were the main reasons for theimprovement partially offset by a two day unplanned mill outage in June 2007which negatively impacted operating income by approximately $1.0 million. Bothquarters ended June 30, 2007 and 2006, were negatively impacted by $4.6 millionfor planned annual maintenance shutdowns resulting in nine days of lostproduction and related sales revenue as well as additional maintenanceexpenses.

Dunnagebag segment operating income decreased by $0.2 million, or 7.7%, to $1.8million for the quarter ended June 30, 2007 compared with $1.9 million for thequarter ended June 30, 2006. The reduction was driven by lower sales volumepartially offset by lower operating costs.

Corporateexpenses of $3.6 million for the quarter ended June 30, 2007 were $1.3 millionor 59.7% higher than the comparable quarter of 2006 and reflect expenses forthe Company’s headquarters while the amount for the quarter ended June 30, 2006reflects an allocation of corporate expenses when KPB was owned by IP. Includedin corporate expenses for the quarter ended June 30, 2007 are charges ofapproximately $0.6 million for transitional services support provided by IP.These support services are expected to end when the Company converts to its ERPsystem planned for the fourth quarter of, 2007. 

**KapStone Paper and Packaging Corporation compared to StoneArcade Acquisition Corporation**

***Operating income***

Operating income for the Company for the quarter ended June30, 2007 was $6.1 million compared to an operating loss of $0.4 million for thesimilar period in 2006. The change in quarterly operating income is due to theKPB acquisition which was consummated on January 2, 2007.  Results for the2006 period reflect the Company as a development stage enterprise and as aresult, the operating loss includes expenses incurred to identify and acquire abusiness. Expenses for the 2007 quarter reflect corporate expenses associatedwith an operating company.

***Interest expense and interest income***

Interest expense and interest income for the quarter endedJune 30, 2007 was $1.1 and $0.5 million, respectively, compared to interestincome of $1.3 million for the quarter ended June 30, 2006. Interest expensefor the quarter ended June 30, 2007 reflects interest on the Company’slong-term debt while interest income reflects earnings on excess cash that isinvested in maturities generally of seven days. Interest income in 2006reflects interest earned on restricted cash held in trust when the Company wasa development stage enterprise.

**Six Months Ended June 30, 2007 Compared with Six Months EndedJune 30, 2006**

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

***Net sales***
| ** **                      | ** ** | **Six Months ended June 30,**              | ** ** |
|---------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                      | ** ** | **Net Sales in Thousands of Dollars** | ** ** | **Tons/Bags Sold** | ** ** |
| ** **                      | ** ** | **2007**                                                       | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** | **%** | ** ** |
| Unbleached kraft                |       | $                                                              | 111,001    |   | $ | 108,407 |   | $ | 2,594 |   | 2.4 | % | 204,997 |   | 206,596 |   | (1,599 | ) | (0.8 | )% |
| Dunnage bags                    |       | 16,452                                                         |       | 17,979 |   | (1,527 | ) | (8.5 | )% | 4,255,000 |   | 4,656,000 |   | (401,000 | ) | (8.6 | )% |
| Intersegment  elimination       |       | (1,784                                                         | )          | (1,540 | ) | (244 | ) | (15.8 | )% | (2,897 | ) | (2,911 | ) | 14 |   | 0.5 | % |
|                            |       | $                                                              | 125,669    |   | $ | 124,846 |   | $ | 823 |   | 0.7 | % |   |   |   |   |   |   |   |   |
|                            |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average revenue per ton         |       | $                                                              | 541.48     |   | $ | 524.73 |   | $ | 16.75 |   | 3.2 | % |   |   |   |   |   |   |   |   |
| Average revenue per dunnage bag |       | $                                                              | 3.87       |   | $ | 3.86 |   | $ | 0.01 |   | 0.3 | % |   |   |   |   |   |   |   |   |

 

19

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KapStone’snet sales increased by $0.8 million, or 0.7%, to $125.7 million for the sixmonths ended June 30, 2007 compared with $124.8 million for the six monthsended June 30, 2006.  Higher unbleached kraft paper prices were partiallyoffset by lower unbleached kraft paper and dunnage bag volume. In addition, atwo day unplanned mill outage in June 2007 resulting from an electrical firereduced production by 2,300 tons and negatively impacted sales by approximately$1.3 million.

Unbleachedkraft segment net sales increased by $2.6 million, or 2.4%, to $111.0 millionfor the six months ended June 30, 2007 compared with $108.4 million for the sixmonths ended June 30, 2006. Both periods ended June 30, 2007 and 2006 wereimpacted by planned annual maintenance shutdowns resulting in nine days of lostproduction and sales revenue. Kraft paper volume was down 1,599 tons comparedto 2006 reflecting lower sales of kraft paper (21,686 tons) partially offset byhigher sales of linerboard (20,087 tons). In addition, a two day unplannedmill outage caused by an electrical fire in June 2007 reduced production andnegatively impacted sales by approximately 2,300 tons, or $1.3 million.

Averagerevenue per ton for the six months ended June 30, 2007 increased to $541.48 perton, a $16.75 per ton increase or 3.2%, due to full realization of 2006 priceincreases. The Company implemented a $40/ton price increase for certaingrades of kraft paper in May 2007 which should be realized during the thirdquarter of 2007.

Netsales for the dunnage bag segment sold under the Ride Rite® Converting brandname decreased by $1.5 million, or 8.5%, to $16.5 million for the six monthsended June 30, 2007 compared with $18.0 million for the six months ended June30, 2006 mainly due to an 8.6% drop in unit volume.  Bag sales havedecreased due to reduced customer shipping activity particularly in theless-than-truckload market and due to a distributor losing position with twokey accounts.

***Cost of sales***
| ** **                | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase/(Decrease)** | ** ** |
|---------------------------|------------|-----------------------------------------------|------------|-------------------------|------------|
| **$ 000’s**     | ** ** | **2007**                                      | ** ** | **2006**                | ** ** | **Change** | ** ** | **%** | ** ** |
| Unbleached kraft          |       | $                                             | 84,554     |                    | $          | 84,105 |   | $ | 449 |   | 0.5 | % |
| Dunnage bags              |       | 12,384                                        |       | 13,349                  |       | (965 | ) | (7.2 | )% |
| Intersegment  elimination |       | (1,784                                        | )          | (1,540                  | )          | (244 | ) | (15.8 | )% |
|                      |       | $                                             | 95,154     |                    | $          | 95,914 |   | $ | (760 | ) | (0.8 | )% |

 

Cost ofsales for the six months ended June 30, 2007 decreased by $0.8 million or 0.8%compared to 2006 due to lower sales volume and lower raw material costspartially offset by a $1.5 million non-cash purchase accounting chargeadjusting the finished goods inventory to fair value, a two day unplanned milloutage caused by an electrical fire and higher utility costs. In addition, a$1.1 million property tax settlement favorably impacted 2006 cost of sales. 

Unbleachedkraft segment cost of sales increased by $0.4 million for the six months endedJune 30, 2007 to $84.6 million. Cost of sales as a percent of net sales was76.2% for the six months ended June 30, 2007 compared with 77.6% for the 2006period. A $1.2 million non-cash purchase accounting charge adjusting thefinished goods inventory to fair value, a favorable $1.1 million property tax settlementin 2006, $0.6 million for a two day unplanned mill outage caused by anelectrical fire and $0.7 million for higher utility costs were partially offsetby lower volume, productivity gains and lower costs for caustic soda and coal.During the periods ended June 30, 2007 and 2006, the Roanoke Rapids millsuccessfully completed its annual planned maintenance shutdowns at a cost of$4.6 million for each year.

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Dunnagebag segment cost of sales decreased by $1.0 million or 7.2%, from 2006 due toan 8.6% drop in bag sales volume partially offset by a $0.3 million non-cashpurchase accounting charge adjusting the finished goods inventory to fair valueand higher distribution expenses. Cost of sales as a percent of net sales was75.3% for the six months ended June 30, 2007 compared with 74.2% for the 2006period.

***Depreciation and amortization***

Depreciationand amortization for the six months ended June 30, 2007, totaled $5.1 millioncompared to $8.9 million for the six months ended June 30, 2006. The decreaseof $3.8 million reflects an appraisal of depreciable assets to their respectivefair values as of January 2, 2007. The fair value of assets acquired wasapproximately $91 million less than the basis being used for depreciation inthe 2006 period.

Depreciationand amortization for the period ended June 30, 2007 includes $16 for intangibleassets amortization which is included in corporate.

***Operating income***
| ** **            | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase/(Decrease)** | ** ** |
|-----------------------|------------|-----------------------------------------------|------------|-------------------------|------------|
| **$ 000’s** | ** ** | **2007**                                      | ** ** | **2006**                | ** ** | **Change** | ** ** | **%** | ** ** |
| Unbleached kraft      |       | $                                             | 21,406     |                    | $          | 14,418 |   | $ | 6,988 |   | 48.5 | % |
| Dunnage bags          |       | 3,312                                         |       | 3,749                   |       | (437 | ) | (11.7 | )% |
| Corporate             |       | (6,732                                        | )          | (4,449                  | )          | (2,283 | ) | (51.3 | )% |
|                  |       | $                                             | 17,986     |                    | $          | 13,718 |   | $ | 4,268 |   | 31.1 | % |

 

Operatingincome of $18.0 million for the six months ended June 30, 2007 increased by$4.3 million, or 31.1%, compared with $13.7 million for the six months endedJune 30, 2006. Improved product pricing for unbleached kraft paper andlower depreciation costs were partially offset by higher corporate expenses, afavorable 2006 $1.1 million property tax settlement, $1.0 million for a two dayunplanned mill outage caused by an electrical fire and $0.7 million for higherutility costs.

Unbleachedkraft segment operating income increased by $7.0 million, or 48.5%, to $21.4million for the six months ended June 30, 2007 compared with $14.4 million forthe six months ended June 30, 2006.   Improved product pricing and lowerdepreciation costs were partially offset by a favorable 2006 $1.1 millionproperty tax settlement and $1.0 million for a two day unplanned mill outage inJune 2007. Both periods ended June 30, 2007 and 2006, were negatively impactedby planned annual maintenance shutdowns resulting in nine days of lostproduction and related sales revenue as well as recognition of maintenance expensesof approximately $4.6 million.

Dunnagebag segment operating income decreased by $0.4 million, or 11.7%, to $3.3million for the six months ended June 30, 2007 compared with $3.7 million forthe six months ended June 30, 2006 due to a $0.3 million non-cash purchaseaccounting charge adjusting the finished goods inventory to fair value.

Corporateexpenses of $6.7 million for the six months ended June 30, 2007 were $2.3million or 51.3% higher than the 2006 period and reflect expenses for theCompany’s headquarters while the amount for the 2006 period reflects anallocation of corporate expenses when KPB was owned by IP. Included incorporate expenses for the six months ended June 30, 2007 are charges ofapproximately $1.2 million for transitional services support provided by IP.These support services are expected to end when the Company converts to its ERPsystem planned for the fourth quarter of 2007.

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**KapStone Paper and Packaging Corporation compared to StoneArcade Acquisition Corporation**

***Operating income***

Operating income for the Company for the six months endedJune 30, 2007 was $18.0 million compared to an operating loss of $0.5 millionfor the similar period in 2006. The change in operating income is due to theKPB acquisition which was consummated on January 2, 2007.  Results for the2006 period reflect the Company as a development stage enterprise and as aresult, the operating loss includes expenses incurred to identify and acquire abusiness. Expenses for the 2007 period reflect corporate expenses associatedwith an operating company.

***Interest expense and interest income***

Interest expense and interest income for the six months endedJune 30, 2007 was $2.3 and $0.9 million, respectively compared to interestincome of $2.5 million for the six months ended June 30, 2006. Interest expensefor the six months ended June 30, 2007 reflects interest on the Company’slong-term debt while interest income reflects earnings on excess cash that isinvested in maturities generally of seven days. Interest income in 2006reflects interest earned on restricted cash held in trust when the Company wasa development stage enterprise.

**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 June 30, 2007, there were no advancesunder the revolving line of credit.

Theterm loan has scheduled principal payments of:  (a) $1.875 million onJuly 2, September 30 and December 31 of 2007;(b) $2.0 million on March 31, June 30, September 30and December 31 of 2008; (c) $2.125 million on March 31,June 30, September 30 and December 31 of 2009 and March 31,June 30, September 30 and December 31 of 2010;(d) $2.25 million on March 31, June 30 andSeptember 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 and issuances 

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ofsecurities or debt and, within 100 days after the end of December 31, 2007and 2008, respectively, 50% of excess cash flow from such fiscal years.

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 six months ended June 30, 2007, increasedby $42.9 million from December 31, 2006, reflecting the receipt of funds heldin trust at December 31, 2006 not used for the KPB acquisition of $23.7million, and cash generated from operations of $28.1 million, partially offsetby capital expenditures of $5.7 million, repayment of long-term debt of $1.9million, and an investment banking fee paid of $1.2 million.

Netcash inflow from operating activities was $28.1 million due to net income forthe period of $10.5 million and improved working capital of $12.2 million.

Netcash outflow from investing activities was $156.3 million and included paymentfor the KPB acquisition of $150.3 million and capital expenditures of $5.7million. Capital expenditures of $2.9 million were for the unbleached kraftsegment and include equipment upgrades and replacements at the paper mill inRoanoke Rapids, North Carolina. In addition, $2.1 million was paid forimplementing a new ERP system and is included in corporate capitalexpenditures.

Netcash inflow generated from financing activities totaled $171.1 million duringthe period ended June 30, 2007, and includes proceeds from the term loan of$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 a long-termdebt repayment of $1.9 million, paid its investment banker a $1.2 million feerelating to the IPO and paid a $0.9 million fee for its credit facility.

**Off-BalanceSheet Arrangements**

We havenot 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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**NewAccounting 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 and Financial Liabilities*,including an amendment of SFAS No. 115. This statement permits entities tochoose to measure many financial instruments and certain other items at fairvalue. The objective is to improve financial reporting by providing entitieswith the opportunity to mitigate volatility in reported earnings caused bymeasuring related assets and liabilities differently without having to applycomplex hedge accounting provisions. This statement is expected to expand theuse of fair value measurement, which is consistent with the FASB’s long-termmeasurement objectives for accounting for financial instruments. SFAS No. 159is effective for our fiscal year beginning January 1, 2008.

We arein 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-cancelable operatingleases. In accordance with generally accepted accounting principles, some ofthese obligations are not recognized as liabilities in our accompanyingCondensed Consolidated Balance Sheets.

Thefollowing table summarizes our contractual obligations as of June 30, 2007 (inthousands):

 
| ** **                                 | ** ** | **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)             |       | $                                         | 58,125     |   | $ | 9,625 |   | $ | 25,500 |   | $ | 23,000 |   | $ | — |   |
| Interest on long-term  debt obligations(2) |       | 11,559                                    |       | 3,519 |   | 7,319 |   | 721 |   | — |   |
| Operating lease  obligations(3)            |       | 1,052                                     |       | 317 |   | 595 |   | 70 |   | 70 |   |
| Purchase  obligations(4)                   |       | 496                                       |       | 496 |   | — |   | — |   | — |   |
| Other  liabilities(5)                      |       | 4,061                                     |       | 25 |   | 1,099 |   | 2,665 |   | 272 |   |
| Total                                      |       | $                                         | 75,293     |   | $ | 13,982 |   | $ | 34,513 |   | $ | 26,456 |   | $ | 342 |   |

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(1)             Theseobligations are reflected on our Condensed Consolidated Balance Sheets at June30, 2007 in Current portion of long-term debt and Long-term debt, asappropriate.

(2)             Assumesdebt is carried to full term. Debt bears interest at variable rates. Theamounts above assume future interest will be incurred at the bank’s LIBOR rateon June 30, 2007 (6.59%). These obligations are not reflected on our CondensedConsolidated Balance Sheets at June 30, 2007.

(3)             Theseobligations are not reflected on our Condensed Consolidated Balance Sheets atJune 30, 2007.

(4)             Purchaseobligations are agreements to purchase goods or services that are enforceableand legally binding on us and that specify all significant terms, including:fixed or minimum quantities to be purchased. These obligations are notreflected on our Condensed Consolidated Balance Sheets at June 30, 2007.

(5)             Theseitems are reflected on our Condensed Consolidated Balance Sheets at June 30,2007 in other liabilities.

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**Item 3.—QUANTITATIVE AND QUALITATIVE 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 June 30, 2007, the balance of theterm loan was $58.1 million and there were no amounts drawn on the revolvingline of credit. We had one letter of credit outstanding at June 30, 2007totaling $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.

Borrowingsunder the term loan accrue interest, at our option, at either:  LIBOR plus1.25% to 2.00% depending on KapStone Kraft’s total debt to EBITDA ratio (asdefined in the agreement); or the Base Rate (prime rate) plus 0% to .50%depending on KapStone Kraft’s total debt to EBITDA ratio. The Base Rate marginand LIBOR margin shall adjust quarterly upon receipt of quarterly financialstatements.

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**

As ofthe end of the period covered by this report, our Chief Executive Officer andour Chief Financial Officer carried out an evaluation of the effectiveness ofthe design and operation of our disclosure controls and procedures, as requiredby Rule 13a-15(b) under the Securities Exchange Act of 1934. Based uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were designed, and wereeffective, to give reasonable assurance that information required to bedisclosed 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 six month period ended June 30, 2007 that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting:

·                  Upon the Company’sacquisition of KPB on January 2, 2007 from International Paper Company(IP), the Company’s existing financial reporting processes, which consisted ofmanagement of cash and investments, management of cash disbursements,management of period end closing and management of external reporting, were allexpanded and or modified.

·                  Variousfunctions, controls and financial reporting processes of KPB were combined toexisting Company functions, controls and financial processes and the Companycurrently continues to depend on the information and reporting systems of IP tomonitor the operation of the KPB business.

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·                  The Companyimplemented significant business processes, much of which were from KPB,addressing financial reporting, accounting close, revenue and receivables,purchasing and payables, plant, property and equipment, treasury andinvestment, inventory, payroll, employee benefits, non-recurring transactionsand information technology.

·                  In addition, inJanuary 2007, an audit committee, compensation committee and nominating andgovernance committee of the board were formed, board committee charters wereadopted and various corporate 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 Factor 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 highly volatile.**

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 and exercisecould have an adverse effect on the earnings per share and the market price ofour 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 SENIOR SECURITIES**

None.

**Item 4. — SUBMISSION OF MATTERS TO AVOTE 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.                              |

 

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|      | ** ** | ** **                                                                                                                                                     |
|------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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 |
|----------------|--------|--------|--------|------------------------------------------|
|           |   |   |   |                                     |
| August 8, 2007 |   |   |   | By:                                      | /s/ Andrea K. Tarbox |
|           |   |   |   |                                     | Andrea K. Tarbox |
|           |   |   |   |                                     | Vice President and Chief Financial Officer |

 

 

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