** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

** **

x        Quarterly Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934

** **

**For the quarterly periodended June 30, 2006.**

** **

**or**

** **

o        Report Pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934

** **

**For the transition periodfrom                         to                         .**

** **

**Commission File Number:000-51444**

** **

**Stone Arcade Acquisition 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.) |
|                                                                                          |                 |
| **c/o  Stone-Kaplan Investments, LLC, One Northfield Plaza, Suite 480  Northfield, IL 60093** |
| (Address of  Principal Executive Offices including zip code)                                  |
|                                                                                          |
| **(847)  441-0929**                                                                           |
| (Registrant’s  Telephone Number, Including Area Code)                                    |

 

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes xNo o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
| Large Accelerated Filer o | Accelerated  Filer o | Non-Accelerated Filer x |
|---------------------------|----------------------|-------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes xNo o

There were 25,000,000 shares of the Registrant’sCommon Stock issued and outstanding on August 11, 2006.

 

 

----

**Stone ArcadeAcquisition Corporation Index to Form 10-Q**

**TABLE OF CONTENTS**
| PART I. — FINANCIAL  INFORMATION                                                        |
|----------------------------------------------------------------------------------------------|
|                                                                                         |
| Item 1. —  FINANCIAL STATEMENTS (UNAUDITED)                                             |
|                                                                                         |
| Item 2. —  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS |
|                                                                                         |
| 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

----

**Stone ArcadeAcquisition Corporation(a development stage company)Condensed Consolidated Balance Sheet**
| ** **                                                                                                                                                                | ** ** | **June 30,  2006** | ** **  | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                                                                | ** ** | **(unaudited)**         | ** **  | ** **                  | ** ** |
| **Assets**                                                                                                                                                                | ** ** | ** **              | ** **  | ** **                  | ** ** |
| Current assets:                                                                                                                                                           |       |                    |        |                        |       |
| Cash                                                                                                                                                                      |       | $                       | 1,427,509   |                        | $          | 2,157,611 |   |
| Cash and investments, held in trust                                                                                                                                       |       | 113,608,480             |        | 111,965,034                 |       |
| Prepaid expenses                                                                                                                                                          |       | 24,500                  |        | 128,875                     |       |
| Total current  assets                                                                                                                                                     |       | 115,060,489             |        | 114,251,520                 |       |
| Acquisition cost                                                                                                                                                          |       | 1,046,450               |        | —                      |       |
| Deferred income  taxes                                                                                                                                                    |       | 222,288                 |        | 54,094                      |       |
| Total assets                                                                                                                                                              |       | $                       | 116,329,227 |                        | $          | 114,305,614 |   |
|                                                                                                                                                                      |       |                    |        |                        |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                            | ** ** | ** **              | ** **  | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                      |       |                    |        |                        |       |
| Accrued expenses                                                                                                                                                          |       | $                       | 876,668     |                        | $          | 136,338 |   |
| Deferred income taxes                                                                                                                                                     |       | 42,058                  |        | 90,521                      |       |
| Total current  liabilities                                                                                                                                                |       | 918,726                 |        | 226,859                     |       |
|                                                                                                                                                                      |       |                    |        |                        |       |
| Common stock,  subject to possible redemption-3,998,000 shares                                                                                                            |       | 22,159,715              |        | 22,159,715                  |       |
| Interest income  attributable to common stock subject to possible redemption (net of taxes of  $266,050 and $97,061 at June 30, 2006 and December 31, 2005, respectively) |       | 516,451                 |        | 189,462                     |       |
|                                                                                                                                                                      |       | 22,676,166              |        | 22,349,177                  |       |
| Commitments and  contingencies (Note E)                                                                                                                                   |       |                    |        |                        |       |
|                                                                                                                                                                      |       |                    |        |                        |       |
| Stockholders’ equity                                                                                                                                                 |       |                    |        |                        |       |
| Preferred stock $.0001 par value; 1,000,000 shares  authorized; 0 shares issued and outstanding                                                                           |       | —                  |        | —                      |       |
| Common stock $.0001 par value, 175,000,000 shares  authorized; 25,000,000 shares issued and outstanding (including 3,998,000  shares subject to possible redemption)      |       | 2,500                   |        | 2,500                       |       |
|                                                                                                                                                                      |       |                    |        |                        |       |
| Additional paid-in capital                                                                                                                                                |       | 91,098,761              |        | 91,098,761                  |       |
| Income accumulated during the development stage                                                                                                                           |       | 1,633,074               |        | 628,317                     |       |
| Total stockholders’  equity                                                                                                                                          |       | 92,734,335              |        | 91,729,578                  |       |
| Total liabilities and  stockholders’ equity                                                                                                                          |       | $                       | 116,329,227 |                        | $          | 114,305,614 |   |

 

See notes tocondensed unaudited financial statements.

1

----

**Stone ArcadeAcquisition Corporation(a development stage company)Condensed Consolidated Statement of Operations(unaudited)**
| ** **                                                                                          | ** ** | ** **                  | ** ** | ** **                  | ** ** | **Inception**                 | ** ** | **Accumulated**             | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** **                                                                                          | ** ** | **Three Months**       | ** ** | **Six Months**         | ** ** | **(April 15, 2005** | ** ** | **Inception**               | ** ** |
| ** **                                                                                          | ** ** | **Ended**                   | ** ** | **Ended**                   | ** ** | **Through**                   | ** ** | **Through**                 | ** ** |
| ** **                                                                                          | ** ** | **June 30, 2006** | ** ** | **June 30, 2006** | ** ** | **June 30, 2005)**  | ** ** | **June 30, 2006** | ** ** |
| Cost and expenses:                                                                                  |       |                        |       |                        |       |                          |       |                        |       |
| Operating  expenses                                                                                 |       | $                           | 363,711    |                        | $          | 518,168                       |       | $                           | 1,000      |   | $ | 739,268 |   |
|                                                                                                |       |                        |       |                        |       |                          |       |                        |       |
| Other income:                                                                                       |       |                        |       |                        |       |                          |       |                        |       |
| Bank interest                                                                                       |       | 21,128                      |       | 48,363                      |       | —                        |       | 72,503                      |       |
| Interest on cash  and cash equivalents held in trust                                                |       | 1,298,603                   |       | 2,478,433                   |       | —                        |       | 3,914,451                   |       |
| Total other income                                                                                  |       | 1,319,731                   |       | 2,526,796                   |       | —                        |       | 3,986,954                   |       |
| Income (loss) before  provision for income taxes:                                                   |       | 956,020                     |       | 2,008,628                   |       | (1,000                        | )          | 3,247,686                   |       |
| Provision for income  taxes:                                                                        |       |                        |       |                        |       |                          |       |                        |       |
| Current                                                                                             |       | 378,601                     |       | 873,472                     |       | —                        |       | 1,258,324                   |       |
| Deferred                                                                                            |       | (62,905                     | )          | (196,590                    | )          | —                        |       | (160,163                    | )          |
| Total provision for  income taxes                                                                   |       | 315,696                     |       | 676,882                     |       | —                        |       | 1,098,161                   |       |
| Net income (loss)                                                                                   |       | 640,324                     |       | 1,331,746                   |       | (1,000                        | )          | 2,149,525                   |       |
| Deferred interest, net  of taxes, attributable to common stock subject to possible redemption       |       | (171,330                    | )          | (326,989                    | )          | —                        |       | (516,451                    | )          |
|                                                                                                |       |                        |       |                        |       |                          |       |                        |       |
| Net income (loss)  allocable to holders of nonredeemable common stock                               |       | $                           | 468,994    |                        | $          | 1,004,757                     |       | $                           | (1,000     | ) | $ | 1,633,074 |   |
| Weighted-average number  of shares outstanding:                                                     |       |                        |       |                        |       |                          |       |                        |       |
| Basic                                                                                               |       | 25,000,000                  |       | 25,000,000                  |       | 5,000,000                     |       | 19,285,714                  |       |
| Diluted                                                                                             |       | 29,221,825                  |       | 29,028,777                  |       | 5,000,000                     |       | 21,788,321                  |       |
| Earnings per share:                                                                                 |       |                        |       |                        |       |                          |       |                        |       |
| Basic                                                                                               |       | $                           | 0.03       |                        | $          | 0.05                          |       | $                           | —     |   | $ | 0.11 |   |
| Diluted                                                                                             |       | $                           | 0.02       |                        | $          | 0.05                          |       | $                           | —     |   | $ | 0.10 |   |
| Weighted-average number  of shares outstanding exclusive of shares subject to possible redemption:  |       |                        |       |                        |       |                          |       |                        |       |
| Basic                                                                                               |       | 21,002,000                  |       | 21,002,000                  |       |                          |       | 16,430,000                  |       |
| Diluted                                                                                             |       | 25,223,825                  |       | 25,030,777                  |       |                          |       | 18,932,607                  |       |
| Earnings per share  exclusive shares and related deferred interest subject to possible  redemption: |       |                        |       |                        |       |                          |       |                        |       |
| Basic                                                                                               |       | $                           | 0.02       |                        | $          | 0.05                          |       |                        |       | $ | 0.10 |   |
| Diluted                                                                                             |       | $                           | 0.02       |                        | $          | 0.04                          |       |                        |       | $ | 0.09 |   |

 

See notes tocondensed unaudited financial statements.

2

----

**Stone ArcadeAcquisition Corporation(a development stage company)Condensed Consolidated Statement of Cash Flows(unaudited)**
| ** **                                                   | ** ** | ** **                  | ** ** | **Inception**                 | ** ** | **Accumulated**             | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** **                                                   | ** ** | **Six Months**         | ** ** | **(April 15, 2005** | ** ** | **(Inception)**             | ** ** |
| ** **                                                   | ** ** | **Ended**                   | ** ** | **Through**                   | ** ** | **Through**                 | ** ** |
| ** **                                                   | ** ** | **June 30, 2006** | ** ** | **June 30, 2005)**  | ** ** | **June 30, 2006** | ** ** |
| **Operating activities:**                                    |       |                        |       |                          |       |                        |       |
| Net income (loss)                                            |       | $                           | 1,331,746  |                          | $          | (1,000                      | )          | $ | 2,149,525 |   |
| Changes in                                                   |       |                        |       |                          |       |                        |       |
| Interest  receivable on short term investments               |       | 142,540                     |       | —                        |       | (123,699                    | )          |
| Prepaid expenses                                             |       | 104,375                     |       | —                        |       | (24,500                     | )          |
| Accrued expenses                                             |       | 686,792                     |       | 1,000                         |       | 763,277                     |       |
| Accrued income  taxes                                        |       | 53,539                      |       | —                        |       | 113,391                     |       |
| Deferred income  taxes                                       |       | (216,657                    | )          | —                        |       | (180,230                    | )          |
| Net cash provided by  operating activities                   |       | 2,102,335                   |       | —                        |       | 2,697,764                   |       |
|                                                         |       |                        |       |                          |       |                        |       |
| **Investing activities:**                                    |       |                        |       |                          |       |                        |       |
| Acquisition cost                                             |       | (1,046,450                  | )          | —                        |       | (1,046,450                  | )          |
| Purchase of U.S.  government securities held in trust        |       | (792,063,023                | )          | —                        |       | (1,348,828,031              | )          |
| Maturities of U.S.  government securities held in trust      |       | 790,277,036                 |       | —                        |       | 1,235,343,250               |       |
| Net cash used in  investing activities                       |       | (2,832,437                  | )          | —                        |       | (114,531,231                | )          |
|                                                         |       |                        |       |                          |       |                        |       |
| **Financing activities:**                                    |       |                        |       |                          |       |                        |       |
| Proceeds from public  offering, net of expenses              |       | —                      |       | —                        |       | 113,235,876                 |       |
| Proceeds from sale of  common stock to founding stockholders |       | —                      |       | 25,000                        |       | 25,000                      |       |
| Proceeds from notes  payable to stockholders                 |       | —                      |       | 200,000                       |       | 200,000                     |       |
| Repayment of notes to  stockholders                          |       | —                      |       | —                        |       | (200,000                    | )          |
| Payments of deferred  offering costs                         |       | —                      |       | (186,976                      | )          | —                      |       |
| Proceeds from issuance  of underwriters’ option         |       | —                      |       | —                        |       | 100                         |       |
| Net cash provided by  financing activities                   |       | —                      |       | 38,024                        |       | 113,260,976                 |       |
|                                                         |       |                        |       |                          |       |                        |       |
| Net (decrease) increase  in cash                             |       | (730,102                    | )          | 38,024                        |       | 1,427,509                   |       |
| Cash-beginning of  period                                    |       | 2,157,611                   |       | —                        |       | —                      |       |
| Cash-end of period                                           |       | $                           | 1,427,509  |                          | $          | 38,024                      |       | $ | 1,427,509 |   |

 

See notes tocondensed unaudited financial statements.

3

----

**Stone ArcadeAcquisition Corporation(a development stage company)Notes to Condensed Consolidated Unaudited Financial Statements**

**Note A. Basis ofPresentation, Principles of Consolidation, Use of Estimates andReclassifications**

The accompanying unaudited financial statements havebeen prepared in accordance with U.S. generally accepted accounting principlesfor interim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of the informationand footnotes required by generally accepted accounting principles for completefinancial statements. In the opinion of management, all normal recurringadjustments considered necessary for a fair presentation have been included. Theconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiary and are prepared in conformity with U.S. generallyaccepted accounting principles. The results of operations for the six monthperiod ended June 30, 2006 are not necessarily indicative of the results to beexpected for the year ending December 31, 2006.

The condensed balance sheet at December 31, 2005 hasbeen derived from the audited financial statements at that date, but does notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements.

For further information, refer to the financialstatements and footnotes thereto included in Stone Arcade AcquisitionCorporation’s annual report on Form 10-K for the period ended December 31,2005.

**The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of expenses during the reporting period.Actual results could differ from those estimates.**

**Note B. Organizationand Business Operations**

Stone Arcade Acquisition Corporation (the “Company”)was incorporated in Delaware on April 15, 2005. On May 25, 2006, theCompany formed a wholly-owned subsidiary, KapStone Kraft Paper Corporation, orKapStone Kraft. The Company was formed to serve as a vehicle for theacquisition through a merger, capital stock exchange, asset acquisition, orother similar business combination (“Business Combination”) of an operatingbusiness in the paper, packaging, forest products and related industries. TheCompany has neither engaged in any operations nor generated operating revenue. TheCompany is considered to be in the development stage and is subject to therisks associated with activities of development stage companies. The Companyhas selected December 31 as its fiscal year end.

The registration statement for the Company’s initialpublic offering (the “Offering”) was declared effective on August 15, 2005. TheCompany consummated the Offering on August 19, 2005 and received net proceedsof approximately $113,236,000. The Company’s management has broad discretionwith respect to the specific application of the net proceeds of the Offering(as described in Note C), although substantially all of the net proceeds of theOffering are intended to be generally applied toward a Business Combination. Furthermore,there is no assurance that the Company will be able to successfully effect aBusiness Combination. As of June 30, 2006, of the net proceeds, $113,608,480,including interest earned of $3,914,451, net of taxes, is being held in a trustaccount (“Trust Fund”) and invested in U.S. Government securities until theearlier of (i) the consummation of the first Business Combination or (ii) thedistribution of the Trust Fund as described below.

The interest income is subject to additional taxes incurred,but not yet paid as of June 30, 2006. The remaining proceeds may be used to payfor business, legal and accounting due diligence on prospective businesscombinations and continuing general and administrative expenses. The Company,after signing a definitive agreement for the acquisition of a target business,will submit such transaction for stockholder approval. In the event thatholders of 20 percent or more of the shares issued in the Offering vote againstthe Business Combination and seek to have their shares redeemed, the BusinessCombination will not be consummated. If a majority of the shares voted at themeeting by public stockholders are voted in favor of the Business Combinationand holders of less than 20 percent of the shares issued in the offering voteagainst the Business Combination and elect to have their shares redeemed, theBusiness Combination will be consummated and the shares of such holders will beredeemed for approximately $5.54 per share, plus interest allocable to suchshares, net of income taxes. The number of shares subject to possibleredemption is approximately 3,998,000. At June 30, 2006, the Company hasclassified $22,676,166 of the net proceeds from the Offering, inclusive ofinterest but net of taxes, as common stock subject to possible redemption inthe accompanying balance sheet.

4

----

In the event that the Company does not consummate aBusiness Combination within 18 months from the effective date of the Offering,or 24 months from the effective date of the Offering if certain extensioncriteria have been satisfied (the “Acquisition Period”), the proceeds held inthe Trust Fund will be distributed to the Company’s public stockholders (i.e.excluding the persons who were stockholders prior to the Offering (the “FoundingStockholders”) to the extent of their initial stock holdings.) However, theFounding Stockholders will participate in any liquidation distribution withrespect to any shares of common stock they acquired in connection with orfollowing the Offering. In the event of such distribution, it is likely thatthe per share value of the residual assets remaining available for distribution(including Trust Fund assets) will be less than the initial public offeringprice per share in the Offering (assuming no value is attributed to theWarrants contained in the Units in the Offering discussed in Note C).

**Note C. InitialPublic Offering**

On August 19, 2005, the Company sold 20,000,000 units(“Units”) for a gross price of $6.00 per Unit. Each Unit consists of one shareof the Company’s common stock, $.0001 par value, and two warrants (“Warrants”).Each Warrant entitles the holder to purchase from the Company one share ofcommon stock at an exercise price of $5.00. Each warrant is exercisable on thelater of (a) the completion of a Business Combination or (b) August 15, 2006,and expires on August 15, 2009. The Warrants are redeemable at a price of $.01per Warrant upon 30 days notice after the Warrants become exercisable, only inthe event that the last sale price of the common stock is at least $8.50 pershare for any 20 trading days within a 30 trading day period ending on thethird day prior to the date on which notice of redemption is given.

In connection with the Offering, the Company paid theunderwriters an underwriting discount of five percent of the gross proceeds ofthe Offering. The Company also issued for $100 an option to the representativeof the underwriters to purchase up to a total of 1,000,000 units at a price of$7.50 per unit. The units issuable upon the exercise of this option areidentical to those offered in the prospectus, except that the exercise price ofthe warrants included in the underwriters’ purchase option is $6.25. Thisoption is exercisable commencing on the later of the consummation of a BusinessCombination or one year from the date of the Offering, expires five years fromthe date of the Offering, and may be exercised on a cashless basis. The optionmay not be sold, transferred, assigned, pledged or hypothecated until August 16,2006. However, the option may be transferred to any underwriter or selecteddealer participating in the Offering and their bona fide officers or partners.

The holders of the option have demand and piggy-backregistration rights under the Securities Act for periods of five and sevenyears, respectively, from the date of the prospectus with respect toregistration of the securities directly and indirectly issuable upon exerciseof the option. The exercise price and number of units issuable upon exercise ofthe option may be adjusted in certain circumstances, including issuances of astock dividend, recapitalization, reorganization, merger or consolidation. However,the option will not be adjusted for issuances at a price below its exerciseprice.

The Company has estimated, based upon a Black Scholesmodel, that the fair value of the purchase option on the date of sale wasapproximately $980,000. The Company accounted for this purchase option,inclusive of the receipt of the $100 cash payment, as an expense of theOffering resulting in a charge directly to stockholders’ equity. Accordinglythere was no impact in the Company’s financial position or results ofoperations except for the recording of the $100 proceeds from the sale.

In accordance with a commitment entered into in connectionwith the Offering, the Founding Stockholders have purchased 3,500,000 warrantsin the public marketplace. They have further agreed that such warrants will notbe sold or transferred until the completion of a Business Combination.

**Note D. Related-PartyTransactions**

The Company has agreed to pay Stone-KaplanInvestments, LLC, a company where certain of the Founding Stockholders serve inexecutive capacities, an administrative fee of $7,500 per month for office spaceand general 

5

----

and administrative services from August 15, 2005through the acquisition date of a target business. Stone-KaplanInvestments LLC has agreed to pay a portion of the aforementionedadministration fee to Arcade Partners LLC, a company where certain of theFounding Stockholders serve in executive capacities. From time to time theCompany retains the services of White Oak Aviation, an aviation servicescompany solely owned by certain Founding Stockholders. For the three and sixmonths ended June 30, 2006, the amount paid to this entity was $18,295 and$38,579, respectively.

The Founding Stockholders have agreed with the Companyand the underwriters that if the Company liquidates prior to the consummationof a Business Combination, they will be personally liable to pay debts andobligations to vendors that are owed money by the Company for services renderedor products sold to us in excess of the net proceeds not held in the Trust Fundat that time.

**Note E. Commitmentsand Contingencies**

The Company has engaged the representative of theunderwriters to act as its investment banker in connection with a BusinessCombination. The Company has agreed to pay the representative a cash fee of$1,200,000 at the closing of the Business Combination for assisting the Companyin structuring and negotiating the terms of the transaction.

**Note F. CommonStock Reserved for Issuance**

At June 30, 2006, 43,000,000 shares of common stockwere reserved for issuance upon exercise of warrants and the underwriter’soption.

**Note G. PurchaseAgreement for Proposed Business Combination**

On June 23, 2006, Stone, KapStone Kraft, andInternational Paper Company, or IP, entered into a Purchase Agreement. ThePurchase Agreement provides for the acquisition of substantially all of theassets and the assumption of certain liabilities of the Kraft Papers Business,or KPB, a division of IP, consisting of an unbleached kraft paper manufacturingfacility in Roanoke Rapids, North Carolina and Ride Rite® Converting, aninflatable dunnage bag manufacturer located in Fordyce, Arkansas, for a cashpurchase price of $155 million plus two contingent earn-out payments of up to$35 million and $25 million, based on KPB’s annual earnings before interest,income taxes, depreciation and amortization, or EBITDA, during the five yearsimmediately following the acquisition. The purchase price payable on theclosing date will be adjusted dollar-for-dollar to the extent IP’s workingcapital as of such date is greater or less than $42,637,709.

KPB generated approximately $64 million in sales and$6.7 million in operating income for the three months ended March 31, 2006 andapproximately $223.4 million in sales and $10.9 million in operating income forthe year ended December 31, 2005.

The Company intends to use its proceeds of its initialpublic offering, which includes $113,608,480, including interest earned,currently held in the Trust Fund, together with borrowings from a $95,000,000senior secured credit facility to be obtained in connection with theacquisition to acquire the KPB assets, to pay transaction expenses, and to payholders of IPO shares who exercise their redemption rights.

The proposed acquisition is subject to, among other things,the approval of the transaction by the Company’s stockholders. There can be noassurance that the transaction will be consummated.

6

----

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

This Quarterly Report on Form 10-Q includesforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Exchange Act of1934, as amended. We have based these forward-looking statements on our currentexpectations and projections about future events. These forward-lookingstatements are subject to known and unknown risks, uncertainties andassumptions about us that may cause our actual results, levels of activity,performance or achievements to be materially different from any future results,levels of activity, performance or achievements expressed or implied by suchforward-looking statements. In some cases, you can identify forward-lookingstatements by terminology such as “may,” “should,” “could,” “would,” “expect,” “plan,”“anticipate,” “believe,” “estimate,” “continue,” or the negative of such termsor other similar expressions. Factors that might cause or contribute to such adiscrepancy include, but are not limited to, those described in our otherSecurities and Exchange Commission filings. The following discussion should beread in conjunction with our Financial Statements and related Notes theretoincluded elsewhere in this report.

**Overview**

We were formed on April 15, 2005 to serve as a vehicleto effect a merger, capital stock exchange, asset acquisition or other similarbusiness combination with an operating business in the paper, packaging, forestproducts and related industries. Our initial Business Combination must be witha target business or businesses whose fair market value is at least equal to80% of our net assets at the time of such acquisition. We intend to utilize cashderived from the proceeds of the Offering, our capital stock, debt or acombination of cash, capital stock and debt, in effecting a BusinessCombination.

**CriticalAccounting Policies**

*Use of Estimates*

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities at the date of the financial statements andthe reported amounts of expenses during the reporting period. Actual resultscould differ from those estimates.

**Results ofOperations**

For the quarter ending June 30, 2006,we earned net income after taxes of $468,994 ($640,324 before the deduction of$171,330 of net interest attributable to common stock subject to possibleredemption). For the six months ending June 30, 2006, we earned net incomeafter taxes of $1,004,757 ($1,331,746 before the deduction of $326,989 of netinterest attributable to common stock subject to possible redemption). Since wedid not have any operations, all of our income was derived from interestincome, most of which was earned on funds held in the Trust Fund. Our operatingexpenses for the three months and the six months ending June 30, 2006 were $363,711and $518,168, respectively, and consisted primarily of expenses related topursuing a business combination, professional fees, franchise taxes and themonthly administrative fee of $7,500 paid to Stone-Kaplan Investments. We alsoprovided for $315,696 and $676,882 in income taxes for the three months and sixmonths ending June 30, 2006, respectively.

7

----

**Liquidity andCapital Resources**

On June 23, 2006, Stone and Stone’s wholly-ownedsubsidiary, Kapstone Kraft Paper Corporation, or Kapstone Kraft, entered intoan agreement to acquire substantially all of the assets and the assume certainliabilities of the Kraft Papers Business, or KPB, a division of InternationalPaper, or IP, for a cash purchase price of $155 million plus two contingentearn-out payments of up to $35 million and $25 million. The purchase pricepayable on the closing date will be adjusted dollar-for-dollar to the extent IP’sworking capital as of such date is greater or less than $42,637,709.

The Company intends to use the proceeds of its initialpublic offering, which includes $113,608,480, including interest earned,currently held in the Trust Fund, together with borrowings from a $95,000,000senior secured credit facility to be obtained in connection with theacquisition to acquire the KPB assets, to pay transaction expenses, and to payholders of IPO shares who exercise their redemption rights.

**Off-Balance SheetArrangements**

We have never entered into any off-balance sheetfinancing arrangements and have never established any special purpose entities.We have not guaranteed any debt or commitments of other entities or enteredinto any options on non-financial assets.

**ContractualObligations**

On June 23, 2006, Stone and KapStone Kraft enteredinto an agreement to acquire substantially all of the assets and assume certainliabilities of the Kraft Papers Business division of IP.

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

Market risk is the sensitivity of income to changes ininterest rates, foreign exchanges, commodity prices, equity prices, and othermarket-driven rates or prices. We are not presently engaged in and, if asuitable business target is not identified by us prior to the prescribedliquidation date of the trust fund, we may not engage in, any substantive commercialbusiness. Accordingly, we are not and, until such time as we consummate aBusiness Combination, we will not be, exposed to risks associated with foreignexchange rates, commodity prices, equity prices or other market-driven rates orprices. The net proceeds of the Offering held in the Trust Fund have beeninvested only in money market funds meeting certain conditions under Rule 2a-7promulgated under the Investment Company Act of 1940. Given our limited risk inour exposure to money market funds, we do not view the interest rate risk to besignificant.

**Item 4. —**          CONTROLS AND PROCEDURES

An evaluation of the effectiveness of our disclosurecontrols and procedures as of June 30, 2006 was made under the supervision andwith the participation of our management, including our chief executive officerwho also serves as our principal financial officer. Based on that evaluation,he concluded that our disclosure controls and procedures are effective as ofthe end of the period covered by this report to ensure that informationrequired to be disclosed by us in reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rules andforms. During the most recently completed fiscal quarter, there has been nosignificant change in our internal control over financial reporting that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

8

----

**PART II. — OTHERINFORMATION**

**Item 1. —**          LEGAL PROCEEDINGS

None.

**Item1A. — RISK FACTORS**

In addition to the other information set forth in thisreport, you should carefully consider the factors discussed in Part I, “Item1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December31, 2005, which could materially affect our business, financial condition orfuture results. The risks described in our Annual Report on Form 10-K are notthe only risks facing our Company. Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also may materiallyadversely affect our business, financial condition and/or operating results.

**We may choose toredeem our outstanding warrants at a time that is disadvantageous to ourwarrant holders.**

Subject to there being a current prospectus under theSecurities Act of 1933 with respect to the shares of common stock issuable uponexercise of the warrants issued as a part of the units in the Offering, we mayredeem all our outstanding warrants at any time after they become exercisableat a price of $.01 per warrant, upon a minimum of 30 days prior written noticeof redemption, if and only if, the last sale price of our common stock equalsor exceeds $8.50 per share for any 20 trading days within a 30 trading dayperiod ending three business days before we send the notice of redemption. Callingall of our warrants for redemption could force the warrant holders:

·              To exercise the warrantsand pay the exercise price therefor at a time when it may be disadvantageous forthe holders to do so,

·              tosell the warrants at the then current market price when they might otherwisewish to hold the warrants, or

·               to accept the nominal redemption pricewhich, at the time the warrants are called for redemption, is likely to besubstantially less than the market value of the warrants.

**Our warrantholders may not be able to exercise their warrants, which may create liabilityfor us.**

Holders of the warrants we issued in the Offering willbe able to receive shares upon exercise of the warrants only if (i) a currentregistration statement under the Securities Act of 1933 relating to the sharesof our common stock underlying the warrants is then effective and (ii) suchshares are qualified for sale or exempt from qualification under the applicablesecurities laws of the states in which the various holders of warrants reside.Although we have agreed to use our best efforts to maintain a current registrationstatement covering the shares underlying the warrants to the extent required byfederal securities laws, and we intend to comply with such agreement, we cannotgive assurance that we will be able to do so. In addition, some states may notpermit us to register the shares issuable upon exercise of our warrants forsale. The value of the warrants will be greatly reduced if a registrationstatement covering the shares issuable upon the exercise of the warrants is notkept current or if the securities are not qualified, or exempt fromqualification, in the states in which the holders of warrants reside. Holdersof warrants who reside in jurisdictions in which the shares underlying thewarrants are not qualified and in which there is no exemption will be unable toexercise their warrants and would either have to sell their warrants in theopen market or allow them to expire unexercised. Since our obligations in thisregard are subject to a “best efforts” standard, it is possible that, even ifwe are able to successfully assert a defense to a claim by warrant holders dueto impossibility, a court may impose monetary damages on us to compensate warrantholders due to the change in circumstances that led to us being unable to fulfillour obligations. If and when the warrants become redeemable by us, we mayexercise our redemption right even if we are unable to qualify the underlyingsecurities for sale under all applicable state securities laws.

9

----

**If we liquidate,the procedures we must follow under Delaware law are time-consuming and mayresult in residual liabilityfor our stockholders.**

If we do not consummate a Business Combination by thelater of February 19, 2007, or August 19, 2007 in the event that a letter ofintent, an agreement in principle or a definitive agreement to complete aBusiness Combination was executed but not consummated by February 19, 2007,then, pursuant to Article SIXTH of our certificate of incorporation, and inaccordance with Section 281(b) of the Delaware General Corporation Law , wewill adopt a plan of dissolution, and as soon as reasonably possible afterdissolution, make liquidating distributions to our stockholders.

Under the Delaware General Corporation Law,stockholders may be held liable for claims by third parties against acorporation to the extent of distributions received by them in a dissolution. Tomitigate against this possibility, we have received executed agreements fromour vendors waiving any right, title, interest or claim of any kind in or toany monies held in the Trust Fund. As a result of this, the claims that couldbe made against us are significantly limited and the likelihood that any claimwould result in any liability extending to the Trust Fund is minimal. If wewind up our affairs in compliance with either Section 280 or 281(b) of theDelaware General Corporation Law following a dissolution, pursuant to Section282 of the Delaware General Corporation Law, the potential liability of ourstockholders will be limited to the lesser of the stockholder’s pro-rata shareof any claim or the amount distributed to the stockholder. As we do notanticipate seeking dissolution under the complex procedures of Section 280, weexpect that, in accordance with Section 281(b), we will be required to seekstockholder approval of a plan of dissolution to provide for our payment, basedon facts known to us at such time, of existing and pending claims, and claimsthat may be potentially brought against us within the subsequent 10 years. Weestimate the costs associated with the implementation and completion of such aplan of dissolution and liquidation, to be approximately $50,000 to $75,000,which would be funded by any funds not held in our Trust Fund and fundsreleased to Stone to fund working capital.

The procedures required for us to liquidate under theDelaware General Corporation Law, or a vote to reject any plan of dissolutionand distribution by our stockholders, may result in substantial delays in theliquidation of our Trust Fund to our public stockholders as part of our plan ofdissolution and distribution.

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

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

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

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

From January 1, 2006 through June 30, 2006, we usedapproximately $518,168 of the net proceeds that were not deposited into theTrust Fund to pay operating expenses that consisted primarily of expensesrelated to pursuing a business combination, professional fees, franchise taxesand monthly administrative fee of $7,500 paid to Stone-Kaplan Investments. Asof June 30, 2006, there was $113,608,480, including accrued interest receivableof $123,699, held in the Trust Fund.

The net proceeds of the Offering in the amount of$110,854,000 deposited into the Trust Fund have been invested in short-termU.S. Government Securities, specifically Treasury Bills, having a maturity dateof 180 days or less.

10

----

**Item 3. —**          DEFAULTS UPON SENIORSECURITIES

None.

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

None.

**Item 5. —**          OTHER INFORMATION

None.

**Item 6. —**          EXHIBITS

**(b)**            Exhibits

4.6           WarrantClarification Agreement, by and between Stone Arcade Acquisition Corp. andContinental Stock Transfer & Trust Company

31              Rule13a-14(a) Certification of Principal Executive Officer and Principal FinancialOfficer.

32              18U.S.C Section 1350 Certification.

11

----

**SIGNATURES**

In accordance with the requirements of the Exchange Act,the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|                 | STONE ARCADE ACQUISITION CORPORATION |
|-----------------|--------------------------------------|
|            |                                 |
| August 14, 2006 | By:                                  | /s/ Roger Stone |
|            |                                 | Roger Stone |
|            |                                 | Chairman of the Board and Chief Executive Officer |

 

12

----