Form 10-Q KAPSTONE PAPER & PACKAGI For: Sep 30

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UNITED STATES

�SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM�10-Q

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

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For the quarterly period ended September�30, 2014

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

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For the transition period from�����������������������������to�����������������������������

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Commission File Number: 001-33494

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KapStone Paper and Packaging Corporation

(Exact Name of Registrant as Specified in its Charter)

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KapStone Paper and Packaging Corporation

1101 Skokie Blvd., Suite�300

Northbrook,�IL 60062

(Address of Principal Executive Offices including zip code)

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

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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

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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

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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):

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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

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There were 96,000,356 shares of the Registrant�s Common Stock, $0.0001 par value, outstanding at October�23, 2014.

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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

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

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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)

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See notes to consolidated financial statements.

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KAPSTONE PAPER AND PACKAGING CORPORATION

Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

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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)

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(unaudited)

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1.������������������������������������� Financial Statements

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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 nine months ended September�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.

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2.������������������������������������� Recent Accounting Pronouncements

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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.

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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.

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3.������������������������������������� Longview Acquisition

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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.

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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�):

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

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(2)�������� The measurement period adjustments include the following:

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������������������ 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 by $2.0 million downward to reflect better estimates for replacement parts and supplies.

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

4.������������������������������������� Annual Planned Maintenance Outages

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Annual planned maintenance outage costs for the three months ended September�30, 2014 and 2013 totaled $5.2 million and $1.1 million, respectively, and are included in cost of sales.

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Annual planned maintenance outage costs for the nine months ended September�30, 2014 and 2013 totaled $25.1 million and $14.3 million, respectively.� Outage costs for the nine months ended September�30, 2014 included $5.6 million at the North Charleston, South Carolina paper mill for downtime incurred during the upgradge of the No.�3 paper machine and $10.0 million at the Longview, Washington mill for the upgrade of the No.�10 paper machine and other outages.�� As a result of these outages, production tons were reduced by 19,700 tons and 9,400 tons, respectively, for the nine months ended September�30, 2014 and 2013.

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Outage costs for the nine months ended September�30, 2013 included $5.0 million for the tri-annual planned maintenance outage at the North Charleston, South Carolina mill.

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5.������������������������������������� Inventories

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

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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 September�30, 2014, Longview�s inventories included in the Consolidated Balance Sheets were $112.6 million.

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6.������������������������������������� Short-term Borrowings and Long-term Debt

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Receivables Credit Facility

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In September�2014, certain wholly-owned subsidiaries of the Company (�Originators�) entered into a one-year agreement to sell all domestic receivables (the �Receivables�) on a non-recourse basis (subject to purchase price credits for breaches of certain representations and warranties with respect to the Receivables), to a wholly-owned subsidiary of the Company that is a bankruptcy remote special purpose entity (the �SPE�).� Sales of Receivables to the SPE occur daily and are settled on a monthly basis. The SPE finances its purchases of the Receivables in part with proceeds of draws under a one-year facility (�Receivables Credit Facility�), subject to a maximum of $175 million. The actual amount available to draw upon varies based on eligible receivables (as defined in the documents establishing the Receivables Credit Facility).� The SPE pays a fee for the drawn and undrawn portions of the Receivables Credit Facility, respectively.

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The SPE�s sole business consists of the purchase of the Receivables from the Originators, through a combination of draws under the Receivables Credit Facility, draws on subordinated notes payable to the Originators and capital contributions from one of the Originators, and the subsequent sale of undivided ownership interests in, or granting of a security interest in, such Receivables to the bank agent under the Receivables Credit Facility.� In addition, the SPE is a separate legal entity with its own separate creditors who will be entitled, upon liquidation, to be satisfied out of the SPE�s assets prior to any assets or value in the SPE becoming available to the Originators or the Company, and the assets of the SPE are not available to pay creditors of the Company or any of its affiliates (other than the SPE).

The Company will service the Receivables in exchange for a servicing fee and guarantees the performance by the Originators of their payment obligations in respect of purchase price credits under the Receivables Credit Facility. At September�30, 2014, $175.0 million was outstanding and included in Long-term debt on the Consolidated Balance Sheets. All of the Receivables at September�30, 2014 have been sold to the SPE and are included in Trade accounts receivable, net of allowance on the Consolidated Balance Sheets.

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This transaction created an on-balance sheet securitization program for KapStone�s trade accounts receivables that is accounted for as a secured borrowing under Accounting Standards Codification (�ASC�) 860, �Transfers and Servicing.�

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The Company included the Receivables Credit Facility in Long-term debt on the Consolidated Balance Sheets based on management�s intent to continue to refinance this agreement until the maturity of the Term loan A-1 which is July�18, 2018.� In addition, the Company also has the ability to refinance this short-term obligation on a long-term basis using its Revolving Credit Facility.� There are no additional requirements as to when borrowings under the Revolver would need to be repaid.� The Revolver�s maturity date is July�18, 2018.

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The Company incurred approximately $0.4 million of fees associated with the Receivable Credit Facility, which have been deferred and will be amortized as interest expense using the effective interest method.

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Proceeds from the Receivables Credit Facility were used to prepay $175.0 million of the term loans and as a result, $3.0 million of unamortized debt issuance costs were written-off as a loss on debt extinguishment.

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Long-term debt consists of the following at September�30, 2014 and December�31, 2013, respectively:

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The Company�s weighted average interest rate on all borrowings was 1.83 percent as of September�30, 2014.

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Amendments to the Amended and Restated Credit Agreement

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In April�2014, the Company entered into a First Amendment (the �First Amendment�) to the Amended and Restated Credit Agreement dated as of July�18, 2013 (as amended; the �Credit Agreement�).� The First Amendment reduced 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 a margin determined from a pricing grid based on the Company�s debt to EBITDA ratio as defined in our Credit Agreement.� Accordingly, the weighted average interest rate on borrowings under the Credit Facility as of September�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 fees associated with the First Amendment, which have been deferred and are being amortized as interest expense using the effective interest method.

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In August�2014, the Company entered into a Second Amendment to the Amended and Restated Credit Agreement, which included certain technical amendments to the Credit Agreement in connection with the Receivables program and the related Receivables Credit Facility.

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Revolver

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

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Debt Covenants

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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.

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

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Fair Value of Debt

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As of September�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.

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Other Borrowing

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In 2014 and 2013, the Company entered into short-term financing agreements of $6.3 million and $5.1 million, respectively, at an annual interest rate of 1.69 and 1.61 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 September�30, 2014 and September�30, 2013, there was $1.2 million and $1.4 million, respectively, outstanding under these agreements which is included in �Other current borrowings� on the Consolidated Balance Sheets.

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7.������������������������������������� Income Taxes

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The Company�s effective income tax rate for both the three and nine months ended September�30, 2014 was 33.9 percent, compared to 37.9 percent and 36.2 percent for the three and nine months ended September�30, 2013, respectively.� Our tax rate is affected by recurring items such as state income taxes and 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 income tax rate for both years.� The effective income tax rate in the third quarter of 2014 includes a $0.5 million favorable discrete adjustment relating to filing the 2013 federal income tax return, whereas the tax return filing adjustment was unfavorable in the prior year. The effective income tax rate for the nine months ended September�30, 2014 includes $1.3 million of favorable discrete adjustments from the resolution of tax audits, the effects from tax legislation and a favorable tax return filing adjustment.

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In the normal course of business, the Company is subject to examination by taxing authorities. The Internal Revenue Service (IRS) recently completed their examination of the Company�s income tax return for 2012. An IRS examination of U.S. Corrugated�s (a business acquired by the Company in October�2011) tax returns for 2009 through 2011 is nearing completion.� No adjustments are anticipated from these examinations.� State income tax years are generally open beginning with 2010.

8.������������������������������������� Net Income per Share

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

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Approximately 42,000 and 23,000 of unexercised stock options were outstanding at September�30, 2014 and 2013, respectively, but were not included in the computation of diluted earnings per share because the options were anti-dilutive.

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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 nine month periods ended September�30, 2013 have been restated to reflect this change.

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9.������������������������������������� Pension Plan and Post-Retirement Benefits

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Defined Benefit Plans

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

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

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KapStone funds the Pension Plans according to IRS funding requirements. Based on those requirements, KapStone funded $3.2 million for the nine months ended September�30, 2014 and expects to fund an additional $0.4 million to the Pension Plans in 2014.

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Defined Contribution Plan

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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 September�30, 2014 and 2013, the Company recognized expense of $3.6 million and $3.3 million, respectively, for the Company contributions to the Contribution Plan.� For the nine months ended September�30, 2014 and 2013, the Company recognized expense of $11.8 million and $9.1 million, respectively, for the Company contributions to this plan.

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10.������������������������������ Stock-Based Compensation

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On May�15, 2014, stockholders of the Company approved the 2014 Incentive Plan (�2014 Plan�).� The major changes included in the 2014 Plan are:

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������������������ An increase in the maximum number of shares to 8,500,000 of our common stock which will initially be available for all awards, subject to adjustment in the event of certain corporate transactions described in 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.

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

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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.

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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.

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

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

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As of September�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 1.8 years and 2.0 years, respectively.

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Stock Options

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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

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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.

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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. For the nine months ended September�30, 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:

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The following table summarizes stock options amounts and activity:

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For the three and nine months ended September�30, 2014, cash proceeds from the exercise of stock options totaled $0.2 million and $0.6 million, respectively. For the three and nine months ended September�30, 2013, cash proceeds from the exercise of stock options totaled $0.6 million and $1.6 million, respectively.

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Restricted Stock

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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.

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

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11.������������������������������ Commitments and Contingencies

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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.

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

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12.������������������������������ Segment Information

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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.

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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.

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Net sales by product line for the three and nine months ended September�30, 2014 and 2013 are as follows:

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In the three and nine months ended September�30, 2014, the increase in net sales was driven primarily by the Longview acquisition which accounted for $43.0 million and $510.2 million of net sales, respectively.

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13.����������������������������� Voluntary Separation Plan

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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 September�30, 2014, 41 employees have accepted the offer and the Company has reserved $6.3 million with respect to this separation plan.� Payments charged against the reserve for the three and nine months ended September�30, 2014 totaled $1.0 million and $1.4 million, respectively.

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14.������������������������������ Subsequent Event

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The Company�s paper mill in Roanoke Rapids, North Carolina completed its annual planned maintenance outage in October�2014. The outage lasted approximately 9 days with an estimated cost of $8.5 million primarily for annual maintenance and inspections, and the fixed cost impact associated with lost paper production and a 11,200 reduction in tons produced. In October�2013, the annual planned maintenance outage lasted 9 days with a cost of $8.0 million primarily for annual maintenance and inspections, and the fixed cost impact associated with lost paper production and a 10,500 reduction in tons produced.

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ITEM 2.

MANAGEMENT�S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

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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.

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

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

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

(In thousands)

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Net sales for the quarter ended September�30, 2014 were $598.1 million compared to $538.6 million for the third quarter of 2013, an increase of $59.5 million or 11.0 percent. The increase in net sales was primarily driven by the benefit of a full quarter of owning Longview in 2014 as compared to a partial quarter in 2013, which accounted for approximately $43.0 million of the increase.� In addition to the Longview acquisition, net sales increased due to $11.7 million of higher sales volume, $3.5 million of higher average selling prices, and $1.3 million of other increases.� Average selling prices increased primarily due to the partial realization of the 2014 kraft paper price increase partially offset by lower export containerboard prices.� Average mill selling price per ton for the quarter ended September�30, 2014 was $689 compared to $682 for the prior year�s quarter.

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

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