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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to                    

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)

Registrant’s Telephone Number, including area code (847) 239-8800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 95,924,136 shares of the Registrant’s Common Stock, $0.0001 par value, outstanding at July 25, 2014.

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

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

See notes to consolidated financial statements.

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KAPSTONE PAPER AND PACKAGING CORPORATION

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(unaudited)

See notes to consolidated financial statements.

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KAPSTONE PAPER AND PACKAGING CORPORATION

Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

See notes to consolidated financial statements.

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KAPSTONE PAPER AND PACKAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share amounts)

(unaudited)

1.                                      Financial Statements

The accompanying unaudited 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 (“GAAP”) 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 notes required by GAAP 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 six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. For further information, refer to the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2013.

2.                                      Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB’) issued Accounting Standards Update (“ASU”) No. 2014-09 “Revenue from Contracts with Customers”.  The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts).  The guidance in this update supersedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition”, and most industry-specific guidance throughout the Industry Topics of the Codification. Additionally, this update supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition—Construction-Type and Production-Type Contracts”.  For a public entity, the amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The ASU allows for full or modified retrospective adoption.  Early application is not permitted.  The Company is currently evaluating the expected impact of adopting this standard.

In July 2013, the FASB issued ASU No. 2013-11 “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”.  ASU No. 2013-11 amends the guidance within ASC Topic 740, “Income Taxes”, to require entities to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The Company adopted ASU No. 2013-11 beginning in the first quarter of 2014 with no impact on the consolidated financial statements.

3.                                      Longview Acquisition

On July 18, 2013, the Company acquired 100 percent of the stock of Longview Fibre Paper and Packaging, Inc., (“Longview”) for $1.025 billion plus $41.5 million of working capital adjustments.  Longview is a leading manufacturer of high quality containerboard, kraft papers, and corrugated products. Longview’s operations include a paper mill located in Longview, Washington equipped with five paper machines which have the capacity to produce 1.3 million tons of containerboard and kraft paper annually.  Longview also owns seven converting facilities located in the Pacific Northwest.

The excess of the purchase price over the aggregate estimated fair value of net assets acquired was allocated to goodwill. The purchase price allocation is final.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed by major category of assets and liabilities as of December 31, 2013, as well as adjustments (referred to as “measurement period adjustments”):

(1)         As previously reported in the Notes to Consolidated Financial Statements included in our 2013 Form 10-K.

(2)         The measurement period adjustments include the following:

·                  Property, plant, and equipment were adjusted downward by $7.4 million to reflect the change in fair value estimates for certain acquired equipment.

·                  Inventories were adjusted downward to reflect better estimates for spare parts inventory.

·                  Deferred income taxes decreased primarily due to the change in property, plant, and equipment and inventories.

4.                                      Annual Planned Maintenance Outage

Annual planned maintenance outage costs for the three months ended June 30, 2014 and 2013 totaled $5.2 million and $8.5 million, respectively, and are included in cost of sales.  Outage costs for the three months ended June 30, 2014 included $4.3 million primarily for downtime and maintenance costs incurred during a paper machine upgrade at Longview with a related 4,064 reduction in tons produced.  Outage costs for the three months ended June 30, 2013 included $5.0 million and a 9,432 reduction in tons produced for the tri-annual planned maintenance outage at the Charleston, South Carolina mill.

Annual planned maintenance outage costs for the six months ended June 30, 2014 and 2013 totaled $20.0 million and $13.2 million, respectively.

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5.                                      Inventories

Inventories consist of the following at June 30, 2014 and December 31, 2013, respectively:

The cost for the Longview inventories is determined on a last-in, first-out method except for replacement parts and supplies inventories, which are valued using the average cost method.  As of June 30, 2014, Longview’s inventories included in the Consolidated Balance Sheets were $110.3 million.

6.                                      Short-term Borrowings and Long-term Debt

First Amendment to Amended and Restated Credit Agreement

In April 2014, the Company entered into a First Amendment to the Amended and Restated Credit Agreement dated as of July 18, 2013 (the “First Amendment”).  The First Amendment reduces the borrowing rates under our senior secured credit facility (the “Credit Facility”) for both term loans under the Credit Facility and for any future borrowings under the $400 million revolving credit facility (the “Revolver”) portion of the Credit Facility.  The interest rates are based on LIBOR rates plus margin determined from a pricing grid based on the Company’s debt to EBITDA ratio as defined in our Amended and Restated Credit Agreement, as amended by the First Amendment (the “Credit Agreement).  Accordingly, the weighted average interest rate on borrowings under the Credit Facility as of June 30, 2014 is 2.0 percent, compared to 2.25 percent as of March 31, 2014.  The First Amendment also reduced the unused commitment fees related to the Revolver by 5 to 10 basis points.

The Company incurred approximately $0.7 million of loan amendment costs associated with the First Amendment, which is being amortized using the effective interest method.

Credit Facility

As of June 30, 2014, the Company has current availability of $395.0 million under the Revolver.

As of June 30, 2014, the Credit Facility had two term loans outstanding totaling $1.221 billion with a weighted average interest rate of 2.0 percent.

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Debt Covenants

The Credit Agreement contains, among other provisions, covenants with which we must comply. The covenants limit our ability to, among other things, incur indebtedness, create additional liens on our assets, make investments, engage in mergers and acquisitions, pay dividends and sell any assets outside the normal course of business.

As of June 30, 2014, the Company was in compliance with all applicable covenants in the Credit Agreement.

Fair Value of Debt

As of June 30, 2014, the fair value of the Company’s debt approximates the carrying value of $1.2 billion as the variable interest rates re-price frequently at current market rates. The debt was valued using Level 2 inputs in the fair value hierarchy which are significant observable inputs including quoted prices for debt of similar terms and maturities.

Other Borrowing

In 2014 and 2013, the Company entered into short-term financing agreements of $6.3 million and $3.7 million, respectively, at an annual interest rate of 1.69 and 1.56 percent, respectively, for its annual property insurance premiums. The agreements require the Company to pay consecutive monthly payments through the term of each financing agreement ending on December 1st.  As of June 30, 2014 and June 30, 2013, there was $2.9 million and $1.7 million, respectively, outstanding under these agreements which is included in “Other current borrowings” on the Consolidated Balance Sheets.

7.                                      Income Taxes

The Company’s effective income tax rate for the six months ended June 30, 2014 and 2013 was 33.9 percent and 34.2 percent, respectively.  Our tax rate is affected by recurring items such as state income taxes. It is also affected by discrete items that may occur in any given period, but are not consistent from period to period. In addition to state income taxes, the domestic manufacturing deduction had the most significant impact on the difference between our statutory U.S. federal income tax rate of 35 percent and our effective tax rate for both years.

The Company is subject to examination by taxing authorities. The Company’s federal tax years are open beginning with 2010.  The Internal Revenue Service is currently examining the Company’s income tax return for 2012. For acquired companies, U.S. Corrugated Acquisition Inc.’s federal tax years 2009 through 2011 are open and are currently under examination. The Internal Revenue Service recently concluded their examination of Longview’s tax returns for 2011, 2012 and the period ending with our acquisition in July 2013. Accordingly, in the quarter ended June 30, 2014, the Company reversed a $0.3 million reserve for an uncertain tax position.  State income tax years are generally open beginning with 2010.

8.                                      Net Income per Share

Basic and diluted net income per share is calculated as follows (In thousands, except for share and per share data):

Approximately 78,000 shares and 10,000 of unexercised stock options were outstanding at June 30, 2014 and 2013, respectively, but were not included in the computation of diluted earnings per share because the options were anti-dilutive.

On December 11, 2013, the board of directors declared a two-for-one stock split in the form of a stock dividend on the Company’s common stock. To implement the stock split, shares of common stock were distributed on January 7, 2014 to all shareholders of record as of the close of business on December 23, 2013. All shares and earnings per share amounts for the three and six month periods ended June 30, 2013 have been restated to reflect this change.

9.                                      Pension Plan and Post-Retirement Benefits

Defined Benefit Plans

Net pension (benefit) / cost recognized for the three and six months ended June 30, 2014 and 2013 for the Pension Plans are as follows:

The year-over-year change in total net pension benefit is a result of two pension plans acquired as part of the Longview acquisition.

KapStone funds the Pension Plans according to IRS funding requirements. Based on those requirements, KapStone funded $2.3 million for the six months ended June 30, 2014 and expects to fund an additional $1.6 million to the Pension Plans in 2014.

Defined Contribution Plan

We offer a 401(k) Defined Contribution Plan (“Contribution Plan”) to eligible employees.  The Company’s monthly contributions are based on the matching of certain employee contributions or based on a union negotiated formula.  For the three months ended June 30, 2014 and 2013, the Company recognized expense of $4.0 million and $2.9 million, respectively, for the Company contributions to these plans.  For the six months ended June 30, 2014 and 2013, the Company recognized expense of $8.2 million and $5.8 million, respectively, for the Company contributions to these plans.

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10.                               Stock-Based Compensation

On May 15, 2014, stockholders of the Company approved the 2014 Incentive Plan (“2014 Plan”).

A maximum of 8,500,000 shares of our common stock will initially be available for all awards, subject to adjustment in the event of certain corporate transactions described in the 2014 Plan. Stock options, stock appreciation rights (“SAR”), restricted stock and restricted stock units may be granted under the 2014 Plan. To the extent the Company grants a stock option or SAR under the 2014 Plan, the number of shares of common stock that remain available for future grants will be reduced by an amount equal to the number of shares subject to such stock option or SAR. To the extent the Company grants restricted stock or a restricted stock unit (collectively, “Stock Awards”) under the 2014 Plan, the number of shares of common stock that remain available for future grants will be reduced by an amount equal to two times the number of shares subject to such Stock Award.

Under the 2014 Plan, awards may be granted to employees, officers and directors of, and consultants and advisors to, the Company.

In the quarter ended March 31, 2014, the compensation committee of the board of directors approved stock-based awards to executive officers, certain employees and directors. The 2014 awards included 441,415 stock option grants and 156,787 restricted stock units.

The Company accounts for stock-based awards in accordance with ASC 718, “Compensation — Stock Compensation,” 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.

Total stock-based compensation expense related to the stock option and restricted stock unit grants for the three and six months ended June 30, 2014 and 2013 is as follows:

Total unrecognized stock-based compensation cost related to the stock option grants and restricted stock units as of June 30, 2014 and December 31, 2013 is as follows:

As of June 30, 2014, total unrecognized compensation cost related to non-vested stock options and restricted stock units is expected to be recognized over a weighted average period of 2.0 years and 2.3 years, respectively.

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Stock Options

Stock option awards vest as follows: 50% after two years and the remaining 50% after three years or upon a grantee of such stock options attaining the age 65. The stock options awarded in 2014 have a contractual term of ten years and are subject to forfeiture should the recipient terminate his or her employment with the Company for certain reasons prior to vesting in his or her awards, or the occurrence of certain other events such as termination with cause. The exercise price of these stock options is based on the closing market price of our common stock on the date of grant ($30.40 is the weighted average price for the 2014 awards described above) and compensation expense is recorded on an accelerated basis over the awards’ vesting periods.

The weighted average fair value of the stock options granted in March 2014 and 2013 was $10.36 and $5.41, respectively. 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. In the quarter ended March 31, 2014, the expected term used by the Company is based on the historical average life of stock option awards.  The expected volatility assumption is based on the volatility of our common stock from the same time period as the expected term of the stock options. 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 calculating the fair value of stock options during the period are as follows:

The following table summarizes stock options amounts and activity:

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For the three and six months ended June 30, 2014, cash proceeds from the exercise of stock options totaled $0.2 million and $0.4 million, respectively. For the three and six months ended June 30, 2013, cash proceeds from the exercise of stock options totaled $0.6 million and $1.0 million, respectively.

Restricted Stock

Restricted stock units are restricted as to transferability until they vest three years from the grant date or upon a grantee of such restricted stock units attaining the age 65. These restricted stock units are subject to forfeiture should applicable 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.

The following table summarizes unvested restricted stock units amounts and activity:

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11.                               Commitments and Contingencies

We are subject to various legal proceedings arising from our operations. We establish reserves for claims and proceedings when it is probable that liabilities exist and reasonable estimates of loss can be made. While it is not possible to predict the outcome of these matters, based on our assessment of the facts and circumstances now known, we do not believe that these matters, individually or in the aggregate, will have a material adverse effect on our financial position. However, actual outcomes may be different from those expected and could have a material effect on our results of operations or cash flows in a particular period.

There have been no material changes in any of our legal proceedings since December 31, 2013.

12.                               Segment Information

The Company has one operating segment.  The Company produces containerboard, corrugated products, and specialty paper which are sold to customers who convert our products into end-market finished products or internally to corrugating plants which produce a wide variety of products ranging from basic corrugated shipping containers to specialized packaging.

The Company’s identification of one operating segment is based on financial information regularly evaluated by the chief operating decision maker in determining resource allocation and assessing performance, in accordance with Accounting Standards Codification 805, Segment Reporting.

Net sales for the three and six months ended June 30, 2014 and 2013 are as follows:

In the three and six months ended June 30, 2014, the increase in net sales was driven primarily by the Longview acquisition which accounted for $239.7 million and $467.2 million, respectively.

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13.                               Voluntary Separation Plan

In February 2014, the Company offered a voluntary separation plan to a specific identified group of employees.  The employees were given a limited timeframe to review the offer and to communicate their acceptance.  As of June 30, 2014, 32 employees have accepted the offer and the Company has reserved $4.8 million with respect to this separation plan.  Payments charged against the reserve during the quarter ended June 30, 2014 totaled $0.4 million.

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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, you can identify forward-looking statements by terminology such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” or the negative of such terms or other similar expressions. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those described in Part I Item 1A of our Form 10-K for the fiscal year ended December 31, 2013 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 obligation, to update its statements as a result of new information, future events or otherwise.

The Company has one reportable segment as of June 30, 2014. The Company manufactures and sells containerboard, corrugated products, and specialty paper.

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

Comparison of Results of Operations for the Three Months Ended June 30, 2014 and 2013

(In thousands)

Net sales for the quarter ended June 30, 2014 were $590.4 million compared to $326.3 million for the second quarter of 2013, an increase of $264.1 million. The increase in net sales was driven primarily by the Longview acquisition which accounted for $239.7 million of the increase.  Excluding the Longview acquisition, net sales increased by $24.4 million, or 7.5 percent, due to $13.9 million of higher sales volume, $9.6 million of higher average selling prices, and $0.9 million of other factors. Average selling prices increased primarily due to the realization of 2013 containerboard and corrugated products price increases along with 2013 specialty paper price increases and the 2014 kraft paper price increase. Average mill selling price per ton for the quarter ended June 30, 2014 was $685 compared to $664 for the second quarter 2013.

In February 2014, the Company announced a $50 per ton selling price increase for domestic kraft paper, which the Company expects to be fully implemented by the end of the third quarter of 2014.

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The following represents the Company’s sales by product line:

Tons of product sold for the quarter ended June 30, 2014 was 719,749 tons compared to 417,850 tons for the quarter ended June 30, 2013.  Excluding the Longview acquisition, tons of products sold for the quarter ended June 30, 2014 increased by 15,715 tons or 3.8 percent as follows:

·                  Containerboard / Corrugated products sales volume decreased 0.4 percent.  Containerboard sales decreased 4.0 percent reflecting volumes being redirected from outside sales to fulfill demand for internal converting.  Corrugated product sales volume increased 5.9 percent.

·                  Specialty paper sales volume increased by 12.2 percent, primarily due to higher kraft paper shipments prior to the domestic kraft paper price increase.

Cost of sales, excluding depreciation and amortization expense, for the quarter ended June 30, 2014 was $392.2 million compared to $225.8 million for the second quarter of 2013, an increase of $166.4 million. The increase in cost of sales was mainly due to the $155.0 million impact of the Longview acquisition.  Excluding the Longview acquisition, cost of sales increased by $11.4 million, or 5.0 percent, mainly due to $7.8 million of higher sales volume, $6.8 million of inflation on labor, benefits and input costs, and $4.5 million of voluntary severance plan charges, partially offset by lower planned maintenance outage costs of $7.7 million.  Planned maintenance outage costs, including Longview, of approximately $5.2 million and $8.5 million were included in cost of sales for the quarters ended June 30, 2014 and 2013, respectively.

Depreciation and amortization expense for the quarter ended June 30, 2014 totaled $33.9 million compared to $17.3 million for the quarter ended June 30, 2013.  The increase of $16.6 million was primarily due to the Longview acquisition and included $1.3 million of amortization expense for identified intangibles associated with the Longview acquisition.

Freight and distribution expenses for the quarter ended June 30, 2014 totaled $44.9 million compared to $27.8 million for the quarter ended June 30, 2013. The increase of $17.1 million was primarily due to $14.6 million associated with the Longview acquisition.  In addition, $2.5 million of additional expenses were driven by the 3.8 percent sales volume increase.

Selling, general and administrative expenses for the quarter ended June 30, 2014 totaled $34.1 million compared to $21.1 million for the quarter ended June 30, 2013. The increase of $13.0 million was primarily due to $11.7 million from the Longview acquisition.  Excluding the Longview acquisition, selling, general, and administrative expenses increased by $1.3 million due to $1.0 million of higher compensation related expenses, $0.3 million of voluntary severance plan charges, $0.4 million of IT related expenses, $0.6 million of higher professional fees, and $0.4 million of 2014 Longview integration related expenses, partially offset by $1.4 million of 2013 Longview acquisition related expenses.  For the quarter ended June 30, 2014, selling, general and administrative expenses as a percentage of net sales decreased to 5.8 percent from 6.5 percent in the quarter ended June 30, 2013.

Net interest expense for the quarters ended June 30, 2014 and 2013 was $8.0 million and $2.6 million, respectively. Interest expense reflects interest on the outstanding borrowings under the Credit Facility and amortization of debt issuance costs. Interest expense was $5.4 million higher in the quarter ended June 30, 2014 due to higher term loan balances used to fund the Longview acquisition and an increase in interest rates.

Provision for income taxes for the quarters ended June 30, 2014 and 2013 was $26.0 million and $11.1 million, respectively, reflecting an effective tax rate of 33.6 percent for the quarter ended June 30, 2014

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compared to 34.5 percent for the similar period in 2013. The higher provision for income taxes in 2014 primarily reflects higher pre-tax income of $45.4 million offset by $0.7 million of favorable discrete tax adjustments.

Comparison of Results of Operations for the Six Months Ended June 30, 2014 and 2013

(In thousands)

Net sales for the six months ended June 30, 2014 were $1,139.4 million compared to $646.1 million for the six months of 2013, an increase of $493.3 million. The increase in net sales was driven primarily by the Longview acquisition which accounted for $467.2 million of the increase.  Excluding the Longview acquisition, net sales increased by $26.1 million, or 4.0 percent, due to $23.3 million of higher average selling prices in the first half of 2014 compared to the first half of 2013 and $2.8 million of volume and mix changes. Average selling prices increased primarily due to the realization of 2013 containerboard and corrugated products price increases along with 2013 specialty paper price increases and the 2014 kraft paper price increase. Average mill selling price per ton for the six months ended June 30, 2014 was $685 compared to $658 for the prior year period.

The following represents the Company’s sales by product line: