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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2008

Commission File Number: 001-33494

KapStone Paper and Packaging Corporation

(Exact name of registrant as specified in its charter)

KapStone Paper and Packaging Corporation, 1101 Skokie Blvd., Suite 300

Northbrook, IL 60062

(Address of Principal Executive Offices including zip code)

(847) 239-8800

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed 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 such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

There were 28,370,248 shares of the Registrant’s Common Stock, $0.0001 par value, outstanding at October 31, 2008, excluding 40,000 shares held as treasury shares.

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KapStone Paper and Packaging Corporation Index to Form 10-Q

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Part 1. Financial Information

Item 1. Financial Statements

KapStone Paper and Packaging Corporation

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

See notes to condensed consolidated financial statements

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KapStone Paper and Packaging Corporation

Condensed Consolidated Statements of Income

(In thousands, except share and per share amounts)

(unaudited)

See notes to condensed consolidated financial statements

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KapStone Paper and Packaging Corporation

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

See notes to condensed consolidated financial statements

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KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share amounts)

(unaudited)

1.                                      Financial Statements

The accompanying unaudited condensed consolidated financial statements of KapStone Paper and Packaging Corporation (the “Company,” “we,” “us,” “our” or “KapStone”) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of a normal recurring nature) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. For further information, refer to the consolidated financial statements and related footnotes included in our Annual Report on Form 10-K/A for the year ended December 31, 2007.

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

On January 2, 2007, the Company acquired substantially all of the assets and assumed certain liabilities of the Kraft Papers Business (“KPB”) from International Paper Company (“IP”).  Prior to the acquisition of KPB, the Company had no operations and was considered a development stage company.

On July 1, 2008, the Company consummated an asset purchase agreement with MeadWestvaco Corporation (“MWV”) to purchase substantially all of the assets and assume certain liabilities of the Charleston Kraft Division (“CKD”) for $485 million, subject to certain post-closing adjustments. The accompanying condensed consolidated financial statements include the results of CKD since the date of acquisition.

2.             Reclassification

Certain 2007 balances have been reclassified to conform to 2008 presentation, including freight and distribution from cost of sales, and amortization expense from selling, general and administrative expenses in the statements of income for the three and nine month periods ended September 30, 2007. In addition, deferred income taxes have been reclassified from accrued expenses in the statements of cash flows.

3.             Accounting Pronouncements

In April 2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”) 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal or extension assumptions used in determining the useful life of a recognized intangible asset. This FSP is effective for financial statements issued for fiscal years (and interim periods) beginning after December 15, 2008 (calendar year 2009). The Company is currently evaluating the impact of the provisions of this FSP on the consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements but does not change existing guidance as to whether or not an instrument is carried at fair value.  In February 2008, the FASB released a FASB Staff Position, which delayed the effective date of SFAS No. 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the condensed consolidated financial statements on a recurring basis. SFAS No. 157 was first effective for the Company on January 1, 2008.

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The impact of the adoption of SFAS No. 157 on our financial assets and liabilities, which are principally comprised of cash equivalents, did not have a significant impact on their fair value measurements or require expanded disclosures.

4.                                      CKD Acquisition

On July 1, 2008, the Company consummated an asset purchase agreement with MeadWestvaco Corporation (“MWV”) to purchase substantially all of the assets and assume certain liabilities of MWV’s Charleston Kraft Division (“CKD”), for $485 million, subject to certain adjustments. CKD consists of an unbleached kraft paper manufacturing facility in North Charleston, South Carolina, chip mills located in Elgin, Hampton, Andrews and Kinards, South Carolina and a lumber business located in Summerville, South Carolina.

The acquisition was financed by cash on hand and by a new  senior secured credit facility of $515 million consisting of a LIBOR based five-year term loan of $390 million, a LIBOR based seven-year term loan of $25 million and a $100 million revolving credit facility. In addition, $40 million of seven-year 8.30% senior notes were issued.  A portion of the proceeds were used to redeem the Company’s prior credit facility.

The CKD business was deemed an attractive acquisition candidate based upon meeting the Company’s objectives of being a North American-based, profitable company in the paper and packaging industry and for its synergies with the Company’s existing operations.

In connection with the CKD acquisition, the Company entered into a Long Term Fiber Supply Agreement (“Supply Agreement”) with MWV. Pursuant to the Supply Agreement, the Company will purchase, on a take or pay basis, certain amounts of pine pulpwood and saw timber at market prices for a period of 15 years. The purchases will be accounted for as raw materials.

The CKD acquisition was accounted for in accordance with the provisions of SFAS No. 141, Business Combinations and the accompanying condensed consolidated financial statements include the results of CKD since the date of acquisition.

The excess of the purchase price over the aggregate fair value of net assets acquired was allocated to goodwill. The following table summarizes the purchase price ($000’s):

The following table summarizes the preliminary estimated fair value of the assets acquired and liabilities assumed at the date of acquisition ($000’s):

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The appraisal process for determining the fair value of the acquired CKD assets, in accordance with SFAS No. 141, Business Combinations, included a valuation of the acquired assets with a consideration of the three traditional valuation approaches to fair value: cost, market and income. The preliminary appraisal was based on management’s estimates and assumptions.  As of September 30, 2008, the preliminary purchase accounting is still subject to final adjustment and could materially change in subsequent periods. The Company’s management has not finalized its review of all CKD plant and equipment, intangible assets, deferred income taxes and other liabilities.

Goodwill is allocated amongst reporting units in proportion to the fair value of their net assets acquired at July 1, 2008. Goodwill of $6.6 million was allocated to the unbleached kraft segment as a result of the CKD acquisition. See footnote 14 for additional discussion regarding the Company’s segments.

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but instead is tested annually for impairment, or more frequently, if circumstances indicate a possible impairment may exist.  The impairment test will be conducted in the fourth quarter.

The following table summarizes the acquired intangible assets and their estimated fair value ($000’s):

The fair value of the intangible assets will be amortized on a straight-line basis over the remaining useful lives.  Estimated amortization expense for the next five years is as follows ($000’s):

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The following unaudited pro forma consolidated results of operations assume that the acquisition of CKD occurred as of the beginning of the periods presented. This pro forma data is based on historical information and does not necessarily reflect the actual results that would have occurred, nor is it indicative of future results of operations ($000’s).

Certain corporate services were performed and allocated or charged by MWV to the historical CKD business. For the three and nine months ended September 30, 2007, and the nine months ended September 30, 2008, amounts allocated or charged by MWV to CKD were $5,304, $15,911 and $14,775, respectively, and are included in net pro forma income.

5.                                      Inventories

Inventories consist of the following at September 30, 2008, and December 31, 2007, respectively ($000’s):

6.                                      Accrued expenses

 Accrued expenses consist of the following at September 30, 2008, and December 31, 2007, respectively ($000’s):

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7.                                      Long-Term Debt and Credit Facility

Senior Credit Agreement

On June 12, 2008, the Company entered into a Credit Agreement, effective with the consummation of the acquisition of CKD, (the “Senior Credit Agreement”) which provides for an aggregate of up to $515 million in senior secured credit facilities (the “Senior Credit Facilities”), consisting of a $390 million term A loan facility, a $25 million term B loan facility and a $100 million revolving credit facility (including a letter of credit sub-facility).  The Senior Credit Agreement replaces the prior senior secured credit facility due on December 31, 2011. The Senior Credit Facilities are guaranteed by the Company and its domestic subsidiaries and are secured by substantially all of the Company’s assets.

The Senior Credit Facilities are required to be repaid in consecutive quarterly installments with final payments of all outstanding principal and interest on the maturity date. The maturity date is the earlier of:  (a) June 12, 2013 with respect to the term A loan facility and the revolving credit facility, and June 12, 2015 with respect to the term B loan facility, and (b) the date which is 90 days prior to the date on which any earn-out obligations to International Paper Company will become (or are reasonably expected to become) due (January 2, 2011); provided that the maturity date will not be so accelerated if, among other things, the total leverage ratio as of the end of the then most recent fiscal quarter is less than 2.0 to 1.0.

Outstanding principal under the term A loan facility and the revolving credit facility initially bears interest at a rate equal to, at the Company’s option, either (1) the base rate plus a margin of 1.50%, or (2) the reserve adjusted one, two, three or six-month LIBOR rate plus a margin of 3.00%.   Commencing six months after the closing of the Senior Credit Facilities, pricing under the term A loan facility and the revolving credit facility and the unused line fee for the revolving credit facility will be determined by reference to a pricing grid based on our total leverage ratio.  Under the pricing grid, the applicable margins for the term A loan facility and the revolving credit facility will range from 0.0% to 1.5% for base rate loans and from 1.50% to 3.00% for Eurodollar loans, and the unused line fee for the revolving credit facility will range from 0.375% to 0.50%.  At September 30, 2008, the revolving credit facility was a base rate loan at a rate of 6.5% and term loan A was a LIBOR loan with a 6.1225% rate. The unused line fee for the revolving credit facility was 0.50% at September 30, 2008.

Outstanding principal under the term B loan facility bears interest at a rate equal to, at the Company’s option, either (1) the base rate plus a margin of 2.00% or (2) the reserved adjusted one, two, three or six-month Eurodollar rate plus a margin of 3.50%.  At September 30, 2008, the term B loan was a LIBOR loan with a 6.6225% rate.

The term loan facilities and the revolving credit facility may be prepaid at any time without premium penalties.  The Senior Credit Facilities are subject to mandatory prepayment with specified percentages of the net cash proceeds of certain asset dispositions, casualty events, exercise of outstanding warrants, debt and equity issuances, and with excess cash flow, in each case subject to certain conditions. During the three months ended September 30, 2008, an $11.9 million mandatory prepayment was made reflecting proceeds from the exercises of common stock warrants.

Borrowings under the revolving credit facility may be used for working capital and other general corporate purposes.

Note Purchase Agreement

Pursuant to the Note Purchase Agreement dated July 1, 2008 (the “Note Purchase Agreement”) the Company issued senior secured promissory notes (the “Senior Notes”) with an aggregate principal amount of $40 million.  The Senior Notes are guaranteed by the Company and secured by substantially all of the Company’s assets.

The Senior Notes are required to be repaid in annual installments until the maturity date of July 1, 2015 and bear interest at the rate of 8.30%.

The Senior Notes may be prepaid at any time with the payment of an applicable yield-maintenance amount.  In the event that a mandatory prepayment event occurs under the Senior Credit Agreement (certain asset dispositions, casualty events, exercises of outstanding warrants, debt and equity issuances and excess cash flow, in each case subject to certain conditions), then the Company is required to offer to repay, without premium, a pro rata portion of

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the Senior Notes held by each holder who accepts the Company’s prepayment offer (such portion based on the product of (a) the net cash proceeds from the mandatory  prepayment event required to be prepaid pursuant to the Senior Credit Agreement multiplied by (b) a fraction, the numerator of which is the aggregate outstanding principal amount of the Senior Notes held by such holder and the denominator of which is the sum of (x) the aggregate outstanding principal amount under the Senior Credit Agreement and (y) the aggregate outstanding principal amount under all Senior Notes.)

Long-term debt and notes at September 30, 2008 and December 31, 2007, is summarized as follows ($000’s):

The Company recorded approximately $12.6 million of debt issuance costs associated with the new Senior Credit Agreement, which is being amortized over a five-year period using the effective interest method. In addition, in the three months ended September 30, 2008, $0.2 million of debt issuance costs from the prior credit facility were amortized.

The Senior Credit Agreement and Senior Notes contain, among other provisions, requirements for maintaining certain financial ratios and limitations on certain payments. As of September 30, 2008, the Company was in compliance with such provisions.

8.                                      Stockholder’s equity

In connection with the Company’s initial public 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 share of the company’s common stock, $0.0001 par value, and two warrants. Each warrant entitles the holder to purchase from the Company one share of common stock at an exercise price of $5.00 and expires on August 15, 2009.

The warrants are redeemable by the Company at a price of $0.01 per warrant upon 30 days notice after the warrants become exercisable, only in the event that the last sale price of the common stock is at least $8.50 per share for any 20 trading days within a 30 day trading period ending on the third day prior to the date on which notice of redemption is given.

For the nine months ended September 30, 2008, 3,029,180 common stock warrants were exercised with proceeds totaling $15.1 million.

9.                                      Income taxes

The Company’s U.S. federal statutory tax rate is 35% for 2008 and 2007. The Company’s effective tax rate for the nine months ended September 30, 2008 and 2007 was 39.3% and 36.8%, respectively. The effective tax rate for the three and nine months ended September 30, 2008 increased due to a lower benefit from the federal domestic manufacturing deduction.

In the normal course of business, we are subject to examination by taxing authorities. The Company’s open tax years are 2005 through 2007.

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10.                               Net income per share

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

Stock option grants were outstanding during all periods, but were not included in the computation of diluted earnings per share because the effect of including the stock option grants would be anti-dilutive.

Underwriter’s purchase option with respect to 1,000,000 Units was outstanding during the three and nine months ended September 30, 2007, but such Units were not included in the computation of diluted earnings per share because the effect of including the underwriter’s option would be anti-dilutive.

11.                               Pension plan and post retirement benefits

Defined Benefit Plan

As part of the Company’s acquisition of the Kraft Papers Business (KPB) in January 2007, the Company established the KapStone Paper and Packaging Corporation Defined Benefit Plan (“Plan”) to provide benefits for approximately 560 union represented employees.  This plan is part of the collective bargaining agreement between KapStone and the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied-Industrial, Chemical and Service Workers Union, AFL-CIO, and CLC.  The assumed liability for the retroactive benefits provided for prior service was $1.4 million at January 2, 2007, and employees began to accrue benefits under the Plan as of January 1, 2007.

As part of the CKD acquisition, the Company assumed certain liabilities of $1.4 million for defined benefit obligations for 615 union employees at July 1, 2008. CKD union employees began earning benefits under the KapStone Plan as of the acquisition date and has been considered in the determination of net pension cost for the three and nine months ended September 30, 2008.

Net pension cost recognized for the three and nine months ended September 30, 2008 and 2007 for the Company’s pension plan, is as follows ($000’s):

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KapStone funds its Plan according to IRS funding limitations. Based on those limitations, KapStone funded $1.0 million to the pension plan during the three months ended September 30, 2008.

Other Post-retirement Benefits

As part of the CKD acquisition, the Company assumed certain liabilities of $1.8 million for retiree medical/life obligations for employees not eligible to retire at June 30, 2008. Net postretirement cost recognized for each of the three and nine months ended September 30, 2008 for the Company’s retiree medical and life insurance plan was approximately $0.1 million.

Defined Contribution Plans

In January 2007, the Company established the KapStone’s Retirement Savings Plan, a defined contribution plan covering all eligible employees. Company contributions to the plan are based on matching of employee contributions, vest immediately for salaried employees and vest after three years for union employees. For the three months ended September 30, 2008 and 2007, the Company recognized expense of $0.8 million and $0.2 million, respectively, for matching contributions. For the nine months ended September 30, 2008 and 2007, the Company recognized expense of $1.5 million and $0.8 million, respectively.

The Company’s Retirement Savings Plan, which covers all eligible salaried employees, provides for contributions based on an employee’s salary and age.  The Company contributions vest 100% after three years. For the three months ended September 30, 2008 and 2007, the Company recognized expense for the Retirement Savings Plan of $0.5 million and $0.2 million, respectively. For the nine months ended September 30, 2008 and 2007, the Company recognized expense of $0.8 million and $0.5 million, respectively.  Retirement Savings Plan contributions are made to employees’ 401(k) accounts in January of each year.

12.                               Stock-Based Compensation

On December 29, 2006, the Company’s stockholders approved the 2006 Incentive Plan (“2006 Plan”).  A maximum of 3.0 million shares of our common stock, available for issuance pursuant to stock options, restricted stock awards or stock appreciation rights (collectively called “Awards”), may be granted under the 2006 Plan. If any Award is forfeited or expires without being exercised, or if restricted stock is repurchased by the Company, the shares of stock subject to the Award shall be available for additional grants under the 2006 Plan. The number of shares available under the 2006 Plan is subject to adjustment in the event of any stock split, stock dividend, recapitalization, spin-off or other similar action. Awards may be granted to employees, officers and directors of, and consultants or advisors to, the Company and any subsidiary corporations. Options intended to qualify, under the standards set forth in certain federal tax rules, as incentive stock options (“ISOs”) may be granted only to employees while actually employed the Company. Non-employee directors, consultants and advisors are not entitled to receive ISOs. Option Awards granted under the 2006 Plan are exercisable for a period fixed by the administrator, but not longer than 10 years from the date of grant, at an exercise price which is not less than the fair market value of the shares on the date of the grant.

KapStone accounts for these awards under SFAS No. 123(R), Share-Based Payment, which requires that the cost resulting from all share-based payment transactions be recognized as compensation cost over the vesting period based on the fair value of the instrument on the date of grant. The Company recognized $0.5 million and $1.2 million of compensation cost for the three and nine months ended September 30, 2008, respectively, and $0.3 million and $0.5 million for the three and nine months ended September 30, 2007, respectively.

At September 30, 2008, the Company had reserved 3.0 million shares of common stock for stock option and restricted stock awards.

Stock Options

In 2008, the Company’s Compensation Committee approved the issuance of 747,781 stock options to directors, executive officers and employees of the Company.  The stock options vest as follows: 50% after two years and the remaining 50% after three years.  The stock options awarded in 2008 have a contractual term of ten years. The stock options are subject to forfeiture should  recipients terminate their employment with the Company for certain reasons prior to vesting in their awards, or upon the occurrence of certain other events such as termination with cause. The

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exercise price of these stock options is based on the closing market price of our common stock on the date of grant and compensation expense is recorded on an accelerated basis over the awards’ vesting periods.

The weighted average fair value of the KapStone stock options granted in 2008 was $2.11. The fair value was calculated using the Black-Scholes option-pricing model based on the market price at the grant date and the weighted average assumptions specific to the underlying options. The expected volatility assumption is based on volatility of related industry stocks. The Company uses the “simplified method”, defined in SEC Staff Accounting Bulletin (“SAB”) No. 107, to determine the expected life assumption for all of its options.  The Company  uses the “simplified method”, as permitted by SAB No. 110, as it does not have any historical exercise data to provide a reasonable basis upon which to estimate expected life due to the limited time its equity shares have been publicly traded. The risk-free interest rate was selected based upon yields of U.S. Treasury issues with a term similar to the expected life of the stock options.

The assumptions utilized for determining the fair value of stock options awarded during the period are as follows:

A summary of information related to stock options is as follows:

Total stock-based compensation recorded in the Condensed Consolidated Statements of Income related to the stock option grants was $0.3 million and $0.7 million for the three and nine months ended September 30, 2008, respectively, and $0.2 million and $0.3 million for the three and nine months ended September 30, 2007, respectively.

As of September 30, 2008, there was $1.8 million of total unrecognized compensation cost related to non-vested stock options. That cost is expected to be recognized over the remaining vesting period of approximately two years   No stock options were vested as of September 30, 2008.

Restricted Stock

In 2008, the Company’s Compensation Committee granted 194,688 restricted stock units to executive officers and employees as compensation for service. These restricted stock units are restricted as to transferability until they vest three years from the grant date. These restricted stock units are subject to forfeiture should these employees terminate their employment with the Company for certain reasons prior to vesting in their awards, or the occurrence of certain other events. The value of these restricted stock units is based on the closing market price of our common stock on the date of grant and compensation expense is recorded on a straight-line basis over the awards’ vesting periods.

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The following table summarizes restricted stock amounts and activity:

Total stock-based compensation recorded in the Condensed Consolidated Statements of Income related to the restricted stock awards was $0.2 million and $0.5 million for the three and nine months ended September 30, 2008, respectively, and $0.1 million and $0.2 million for the three and nine month periods ended September 30, 2007, respectively. As of September 30, 2008, there was $1.6 million of total unrecognized compensation cost related to the restricted stock which, will be recognized over the remaining vesting period of approximately two years. No restricted stock awards were vested as of September 30, 2008.

13.                               Annual Planned Maintenance Outage

Cost of sales for the nine month periods ended September 30, 2008 and 2007 included approximately $6.0 million and $4.6 million, respectively, for the annual planned maintenance outage costs at the Company’s North Carolina unbleached kraft paper facility, which are expensed as incurred.  The annual planned maintenance outage occurred in the third quarter of 2008 and in the second quarter of 2007.

14.                               Segment Information

Prior to the acquisition of CKD, the Company had two reportable segments, unbleached kraft and dunnage bags.  After the CKD acquisition the Company determined, in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, that it has one reportable segment. The unbleached kraft reportable segment consists of the Company’s unbleached kraft paper mills in Roanoke Rapids, North Carolina and North Charleston, South Carolina, which produce unbleached kraft paper, linerboard products, unbleached kraft board and saturating kraft. These products are sold to customers who convert our products into end-market finished products. The all other category consists of the Company’s dunnage bag operating segment, based in Fordyce, Arkansas, which converts unbleached kraft paper and film into inflatable dunnage products, which are used to secure freight to minimize movement and potential damage of goods and products during transport, and the lumber business operating segment, based in Summerville, South Carolina, which produces dimensional softwood board lumber which is sold to regional lumber yards.

Corporate expenses that benefit the entire organization are not charged to the operating segments.

The Company operates in two geographic segments, the United States and International. For the nine months ended September 30, 2008 approximately 29% of consolidated net sales were to International customers.

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Segment disclosures have been revised to conform to the new presentation for all reporting periods.

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Item 2.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions 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 such forward-looking statements. In some cases, forward-looking statements can be identified by terminology such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” or the negative of such terms or other similar expressions. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those described in Item 1A in this Form 10-Q and in our other Securities and Exchange Commission filings.  The information contained in this Form 10-Q represents our best judgment at the date of this report based on information currently available.  In providing forward-looking statements, KapStone does not intend, and does not undertake any duty or obligations, to update such statements as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and related Notes thereto included elsewhere in this report.

Overview

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

On January 2, 2007, the Company purchased substantially all of the assets and  assumed certain liabilities of the Kraft Papers Business (“ KPB’’), a division of International Paper Company (“IP”), consisting of an unbleached kraft paper 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 in cash, less certain post-closing adjustments 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 years immediately following the acquisition.  Any contingent earn-out payments will be accounted for as additional purchase price consideration and recorded as goodwill.

On July 1, 2008, the Company consummated an asset purchase agreement with MeadWestvaco Corporation (“MWV”) to purchase substantially all of the assets and assume certain liabilities of MWV’s Charleston Kraft Division (“CKD”) for $485 million, subject to certain closing adjustments.  The acquisition consists of an unbleached kraft paper manufacturing facility in North Charleston, South Carolina, chip mills located in Elgin, Hampton, Andrews and Kinards, South Carolina and a lumber business located in Summerville, South Carolina.

The results reported below do not reflect any actual or pro forma adjustments related to the acquisition prior to the consummation of the acquisition on July 1, 2008. The results reported below include the results of CKD since the date of acquisition, July 1, 2008.

 See Liquidity and Capital Resources – CKD Acquisition for discussion of the financing of the CKD acquisition.

Comparison of Results of Operations for the Three Months Ended September 30, 2008 and the Three Months Ended September 30, 2007

The Company’s management uses a variety of financial measurements to analyze its performance. These measurements include (1) Operating Income, (2) Tons Sold, (3) Selling, General & Administrative (“SG&A”) expenses and (4) Average revenue per ton (for unbleached kraft).

Operating Income.    Operating income is used by the Company’s management primarily as a measure of its segments’ operating performance. The Company’s management defines operating income as sales minus costs associated with these sales. Sales include sales of unbleached kraft paper products, linerboard and dunnage bags net of term allowances and discounts. For purposes of calculating operating income, costs include the cost of raw

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materials, labor, maintenance, depreciation and amortization, freight and distribution expenses and selling, general and administrative expenses.

Selling, General and Administrative Expenses.   SG&A expenses include selling, customer service and corporate employee salaries and benefits, professional fees, and information technology expenses, including fees paid  for transitional services support.

Average Revenue per Ton.  Average revenue per ton represents gross revenue divided by the tons of unbleached kraft products sold.