**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

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**FORM 10-K**

 

| **(Mark One)**                                                                                                  | ** ** | ** **                                                                                                              |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| **x**                                                                                                           | ** ** | **ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
| ** **                                                                                                      | ** ** | ** **                                                                                                              |
| **For the fiscal year ended February 29, 2008**                                                            |
| ** **                                                                                                      | ** ** | ** **                                                                                                              |
| **or**                                                                                                          |
| ** **                                                                                                      | ** ** | ** **                                                                                                              |
| **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 333-118829**

 

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**Cellu Tissue Holdings, Inc.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **06-1346495**                    |
|-----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of incorporation or  organization) | ** ** | (IRS Employer Identification No.) |
|                                                            | ** ** |                              |
| **1855 Lockeway Drive,  Suite 501, Alpharetta, Georgia**   | ** ** | **30004**                         |
| (Address of principal executive offices)                        | ** ** | (Zip Code)                        |

 

**(678) 393-2651**

(Registrant’s telephone number, including areacode)

 

**Not Applicable**

(Former name, former address and former fiscalyear, if changed since last report)

 

                   Securitiesregistered pursuant to Section 12(b) of the Act:       **None**

 

                   Securitiesregistered pursuant to Section 12 (g) of the Act:      **None**

 

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Indicate by check markif the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.  Yes o No x

 

Indicate by check markif the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Exchange Act. Yes x  No o

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports) and (2) has been subject to such filing requirementsfor the past 90 days. Yes x No o

 

Indicate by check markif disclosure of delinquent filers pursuant to item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  o                     |   | Accelerated filer o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer x                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

 

There is no market forthe Registrant’s equity.  The number ofshares of issuer’s Common Stock, $.01 par value, outstanding on May 2,2008 was 100 shares.

 

Documents incorporatedby reference:  **None**

 

 

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**TABLE OF CONTENTS**

 
| PART 1   |                                                                                                                |   |
|---------------|---------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                                |   |
| ITEM 1.       | BUSINESS                                                                                                            |   |
|          |                                                                                                                |   |
| ITEM 1A.      | RISK FACTORS                                                                                                        |   |
|          |                                                                                                                |   |
| ITEM 1B.      | UNRESOLVED  STAFF COMMENTS                                                                                          |   |
|          |                                                                                                                |   |
| ITEM 2.       | PROPERTIES                                                                                                          |   |
|          |                                                                                                                |   |
| ITEM 3.       | LEGAL PROCEEDINGS                                                                                                   |   |
|          |                                                                                                                |   |
| ITEM 4.       | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |   |
|          |                                                                                                                |   |
| PART II  |                                                                                                                |   |
|          |                                                                                                                |   |
| ITEM 5.       | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES |   |
|          |                                                                                                                |   |
| ITEM 6.       | SELECTED  FINANCIAL DATA                                                                                            |   |
|          |                                                                                                                |   |
| ITEM 7.       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINCANCIAL CONDITION AND RESULTS OF OPERATIONS                        |   |
|          |                                                                                                                |   |
| ITEM 7A.      | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                         |   |
|          |                                                                                                                |   |
| ITEM 8.       | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                        |   |
|          |                                                                                                                |   |
| ITEM 9.       | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               |   |
|          |                                                                                                                |   |
| ITEM 9A(T).   | CONTROLS AND  PROCEDURES                                                                                            |   |
|          |                                                                                                                |   |
| ITEM 9B.      | OTHER INFORMATION                                                                                                   |   |
|          |                                                                                                                |   |
| PART III |                                                                                                                |   |
|          |                                                                                                                |   |
| ITEM 10.      | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                             |   |
|          |                                                                                                                |   |
| ITEM 11.      | EXECUTIVE  COMPENSATION                                                                                             |   |
|          |                                                                                                                |   |
| ITEM 12.      | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                    |   |
|          |                                                                                                                |   |
| ITEM 13.      | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE                                           |   |
|          |                                                                                                                |   |
| ITEM 14.      | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                                             |   |
|          |                                                                                                                |   |
| PART IV  |                                                                                                                |   |
|          |                                                                                                                |   |
| ITEM 15.      | EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES                                                                         |   |

 

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**PART I**

** **

**ITEM 1. BUSINESS**

** **

CelluTissue Holdings, Inc. (“we”, “us” or “the Company”) was incorporated inDelaware in 1984.  At the time of ourincorporation, we acquired the assets of our Connecticut facility and, in 1995,we purchased our Mississippi facility. Throughout 1998, we acquired the assets of each of our Michigan, NewYork and Ontario facilities and, in 2002 we purchased our Neenah Wisconsinfacility.   In March 2007, weacquired our Ladysmith Wisconsin facility.

 

On June 12, 2006,Cellu Paper Holdings, Inc., our parent, entered into an Agreement and Planof Merger with Cellu Parent Corporation (referred to herein as Cellu Parent), acorporation organized and controlled by Weston Presidio V, L.P. (referred toherein as Weston Presidio), and Cellu Acquisition Corporation, a newly formedwholly owned subsidiary of Cellu Parent, or Merger Sub.  Pursuant to the agreement, on June 12,2006, Merger Sub was merged with and into our parent, with our parent survivingand becoming a wholly owned subsidiary of Cellu Parent, or the Merger.   The aggregate merger consideration to bepaid to shareholders of our parent was $207.8 million, including assumption of$162.0 million in aggregate principal amount of our outstanding 9.75% seniorsecured notes.  In addition, during theearn-out period beginning on March 1, 2006 and ending on February 28,2010, the merger consideration is subject to an increase for certain contingentearn-out consideration of up to $35 million in the aggregate, not to exceed $15million for any fiscal year, payable within six months of the end of the priorfiscal year.  Weston Presidio willguaranty payment of any earn-out consideration. For the fiscal year ended February 28,2007, or fiscal year 2007, no payment was required.   For the fiscal year ended February 29,2008, or fiscal year 2008, $15.0 million payment will be required to be paid inthe fiscal year ending February 28, 2009, or fiscal year 2009.

 

Any references to fiscalyear 2007 operating results in the remainder of Item 1 Business, combines ouroperating results for the period March 1, 2006 to June 12, 2006(pre-merger) and June 13, 2006 to February 28, 2007(post-merger).  See Item 7. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS forfurther analysis thereof.

 

Wemanufacture and market a variety of specialty tissue hard rolls andmachine-glazed paper used in the manufacture of various end products, includingdiapers, facial and bath tissue, assorted paper towels and food wraps.  In addition, we produce a variety ofconverted tissue products.  Our customersinclude major North American producers of branded and unbranded disposableconsumer absorbent and tissue products for the personal and health care markets;consumer and away-from-home tissue products companies; national and regionaltissue products distributors; and third-party converters who sell theirproducts to food, bakery and confections companies.  We service a diverse group of high-qualitycustomers, with three of our top 10 customers belonging to the Fortune 150group of companies. For fiscal year 2008, we sold 317,080 tons of tissue andmachine-glazed paper products, generating net sales of $ 431.0 million.

 

Ourbusiness is comprised of two segments: tissue and machine-glazed paper.  We currently own and operate sevenstrategically located manufacturing facilities with an aggregate annualproduction capacity of approximately 315,000 tons of tissue and machine-glazedpaper hard rolls, currently consisting of approximately 236,000 tons of tissuehard roll production capacity and approximately 79,000 tons of machine-glazedpaper hard roll production capacity.  Inaddition, our tissue converting equipment and machine-glazed paper convertingequipment currently have annual converting production capacities ofapproximately 90,000 and 29,000 tons, respectively.

 

***Tissue***. Our tissue segment consists of two product lines: (1) hard rolltissue and (2) consumer and away-from-home converted tissue products.    For fiscal year 2008, our tissue segmentsold 235,395 tons of 

 

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tissue,generating net sales of $325.0 million, or approximately 75.4% of our netsales, and 83.8****% of our gross margin.

 

*Hard rolltissue*.  We producetissue hard rolls at all of our facilities other than our Michiganfacility.  Our hard roll tissue is soldas facial and bath tissue, specialty medical tissue, industrial wipers, napkinand paper towel stock, as well as absorbent cover stock.  We manufacture our hard roll tissue with avariety of pulps and recycled fibers and produce hard roll tissue to ourcustomers’ specifications by controlling such attributes as brightness,absorbency, bulk, strength, porosity and color. In addition, we produce our absorbent cover stock in a variety ofweights and widths for sale to consumer products companies or third-partyconverters.  Our customers then print,cut and process our absorbent cover stock hard rolls to be used in themanufacture of a variety of disposable absorbent products in the personal andhealth care markets, such as diapers, adult incontinence and feminine careproducts, surgical waddings and other medical and sanitary disposableproducts.  We also sell our absorbentcover stock to manufacturers of absorbent bed pads, disposable infant bibs anddisposable absorbent pet products.

 

*Consumerand away-from-home converted tissue*.  We convert consumer and away-from-home tissueproducts at our Neenah Wisconsin facility. Our converted tissue products include a variety of private labelconsumer and away-from-home bath and facial tissue, napkins and folded androlled towels.  We manufacture ourconverted tissue products according to our customers’ specifications forweight, softness, size, color, prints, embossing patterns, grade, fold, packageconfiguration and price.  We believe thatall of our products are recognized for their softness, strength andabsorbency.  We offer a complete range ofconverted facial tissue products as well as dispenser, dinner, cocktail andluncheon napkins.  In addition, we ship afull line of bath tissue products, in both jumbo and standard roll bath sizes,and a full line of consumer and away-from-home towel formats.  We sell our converted tissue products throughvarious channels that serve the consumer and away-from-home markets.

 

Weentered the consumer and away-from-home converted tissue products marketfollowing our August 2002 acquisition of a previously idle manufacturingand converting facility in Neenah Wisconsin. We began manufacturing at our Neenah Wisconsin facility in August 2002and began producing our full line of converted tissue products by March 2003.  We have significantly increased the sales ofproducts from the Neenah Wisconsin facility since its acquisition to in excessof $134 million in fiscal year 2008.

 

On March 21, 2007,we consummated a definitive merger agreement, or the CityForest MergerAgreement, with CityForest Corporation, or CityForest, Cellu City AcquisitionCorporation, our wholly owned subsidiary, or Cellu City Merger Sub, and WayneGullstad as the shareholders’ representative. Pursuant to the CityForest Merger Agreement and subject to the terms andconditions therein, Cellu City Merger Sub merged with and into CityForest, withCityForest surviving and becoming our wholly owned subsidiary.  The aggregate merger consideration paid(including assumption of $18.5 million in aggregate principal amount ofindustrial revenue bonds) was approximately $61.0 million subject to certainworking capital and net cash adjustments.  CityForest is a Ladysmith, Wisconsin-based manufacturer of tissue hardrolls for third-party converters that resize and convert the rolls intonapkins, towels, bath tissue, specialty medical tissue, industrial wipers andfacial tissue. The majority of CityForest’s sales are tothird-party converters serving the away-from-home market, the consumer market,as well as state and federal government agencies and the medical industry.  CityForest is solely focused on manufacturingtissue hard rolls and does not currently convert rolls into finishedproducts.   However, a portion ofCityForest production is transferred to our Neenah facility to be converted tofinished product.

 

***Machine-glazed paper***.  We produce machine-glazed paper hard rolls atour Michigan, Mississippi and Ontario facilities in a variety of weights,widths and surface characteristics. Machine-glazed paper is tissue paper with a glazed coating and, in somecases, other moisture and grease-resistant coatings.  We sell our machine-glazed paper hard rollsto third-party converters that manufacture fast food and commercial food wrap,as well as niche market products such as gum wrappers, coffee filters, tobaccopapers, wax paper and butter wraps.  Weuse the balance of our machine-glazed paper hard rolls at our Michigan facilityto produce converted wax paper products, including wet and dry wax paper,sandwich bags and microwavable wax paper.  The majority of our converted wax paper products manufactured at ourMichigan facility is sold as branded products to a single customer.  For fiscal year 2008, our machine-glazedpaper segment 

 

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sold81,685 tons of machine-glazed paper hard rolls and converted wax paperproducts, generating net sales of $106.0 million, or approximately 24.6****% of our net sales, and 16.2****%of our gross margin.

 

**Businessstrengths**

** **

Some of our key businessstrengths are as follows:

 

***Increased net sales and profitability potential in our convertingbusiness***.  Weentered into the consumer andaway-from-home converted tissue products market following the August 2002acquisition of our Neenah Wisconsin manufacturing and converting facility andrelated equipment for approximately $30.0 million.  We believe that the Neenah Wisconsin facilityis an efficient, low-cost producer of converted tissue products such as bathand facial tissue, napkins and folded and rolled towels.  The facility includes five light dry crepepaper machines with approximately 85,000 tons of annual tissue productioncapacity and 14 converting lines with approximately 90,000 tons of annualconverting capacity.  In addition, thefacility includes a complete distribution center with fully automated unitizingand wrapping capacities.  Sales of ourconverted tissue products in the consumer and away-from-home converted tissueproducts market generate significantly greater revenue per ton than sales ofhard roll tissue.  We believe that, as wecontinue to increase the utilization of our converting capacity, we willincrease our profits and generate higher margins on our consumer andaway-from-home converted tissue products.

 

***Low- cost manufacturing operations***.  Our strategic manufacturing facilitylocations and flexible production capacity, combined with our relatively lowoverhead costs, contribute to our competitive position in the marketplace.  We believe that our Neenah Wisconsin facilityis a low- cost tissue production facility and has helped us continue to improveour competitive position.  In addition,we have established ongoing cost-saving investments and productivityimprovement initiatives.

 

***Diversified and high-quality customer base***.  We sell to a highly diversified customerbase, thereby reducing our dependence on any single customer, with only onecustomer representing more than 10% of our net sales for fiscal year 2008.  Our customers include leading branded andprivate label tissue products companies, tissue and machine-glazed paperconverters, distributors of tissue products, fast food restaurants, third-partyconverters who sell their products to food, bakery and confections companiesand third-party converters serving state and federal government agencies andthe medical industry.   Notably, ourcustomers include all of the major producers in North America of branded andunbranded disposable consumer absorbent and tissue products for the personaland health care markets and three of our top 10 customers are Fortune 150companies.  Our customer base has becomeincreasingly diversified with our 10 largest customers accounting forapproximately 51.3% of gross sales for fiscal year 2008, down from 54.9% in thefiscal year ended February 28, 2007, or fiscal year 2007.

 

***Experienced and incentivized management team***.  We are managed by an experienced team ofexecutive officers that have an average of over 20 years of experience in thepaper products industry.  Russell C.Taylor has been our president and chief executive officer since 2001 and hasover 25 years of industry experience. Prior to coming to our company, he was a senior executive atKimberly-Clark Corporation, a leading personal care consumer productscompany.  Mr. Taylor leads a team ofsenior executives with expertise in the paper and paper products industry withproven management and strategic experience.

 

**Businessstrategy**

** **

Ouroverall strategy is to increase revenues, optimize our product mix and lowercosts to enhance our position within the paper industry.  We intend to implement this strategy throughour key initiatives set forth below:

 

***Maximize utilization of our converting capacity***.  Our Neenah Wisconsin facility began producingour full line of consumer and away-from-home converted tissue products in March 2003.    As part of our growth strategy, we continueto increase the production of converted tissue products across our 14converting lines by expanding our customer base for our consumer andaway-from-home converted tissue products. Toward that end, we continue to promote our “customer delight” program,producing quality products at competitive prices and providing customers withwhat management believes to be among the industry’s best on-time delivery ratesand complete shipment performance as well as building on past relationships 

 

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withcustomers in our hard roll tissue products line.  We have expanded our dedicated sales force inthe consumer and away-from-home converted tissue products market to capitalizeon these opportunities.  As a result, webelieve that we can continue to increase the utilization of the convertingcapacity at our Neenah Wisconsin facility and are adding retail-focusedconverting equipment.

 

***Continue to develop our “customer delight” program***.  We continually strive to establish andmaintain excellent relationships with our customers by providing a high levelof customer service and technical support. We focus on critical factors such as competitive pricing, productquality, on-time deliveries and complete shipments.  In addition, we provide a full line ofproducts designed to meet the various needs of each of our customers, includingthe unique capability to produce premium-quality level products with a recycledcost and fiber base.  Our manufacturingprocess is tailored to our customers’ specifications and allows us to offerthem flexibility in price, grade, softness, package configuration andsize.  For example, our products can bemanufactured completely with virgin pulp (for premium products) or recycledfiber (for value products) or any combination thereof.  We believe that our high-quality customerservice and technical support have helped us develop and maintain long-termrelationships with our customers that represent a majority of our sales.

 

***Continue to reduce manufacturing costs***.  We continually seek out opportunities to containand reduce our costs more effectively. As part of our cost management strategy, we benchmark our machines andmanufacturing operations against certain world class levels, including those ofleading paper manufacturers.  Ourbenchmarking is applied by business sector and by type of machine on a monthlyand year-to-date basis.  We reviewmetrics such as total machine efficiency, fiber loss and waste percentage, tonsproduced per machine per person per year, fixed and variable costs per tonproduced and total energy per ton produced. We use our benchmarking analyses to help us allocate our strategiccapital and non-capital investments in order to reduce our manufacturing costsmost effectively.  In addition, our costmanagement strategy focuses on reducing variable costs through increasedoperating efficiencies and reduced energy consumption, and allows us to bettermanage our costs and lessen the impact of fiber price cyclicality.   In an effort to reduce manufacturing costs,we have initiated a project to install a combined heat and power system at ourEast Hartford facility.   Furthermore, weintend to fully utilize the third-party gasification steam project at ourWiggins facility to reduce natural gas consumption that was started up in thefourth quarter of fiscal year 2008.

 

***Deliver greater earnings stability through enhanced fiber and energycost management***. We have developed and implemented a pulpcost management strategy that has been highly effective in reducing our pulpcosts.    Our supply agreements withvarious pulp suppliers enable us to purchase a majority of our anticipatedtotal pulp requirements for a given year at prices below published listprices.  These agreements further allowus to shift a portion of our pulp purchases to the spot market to takeadvantage of more favorable spot market prices when such prices fall.  We believe these supply agreements provide uswith significant protection against the risk of fluctuating pulp costs andoffer a substantial savings from purchasing pulp on the spot market duringperiods of tight supply.  Furthermore,approximately 50% of our sales are to customers with pulp price pass-throughcontracts.  These contracts track a publishedpulp benchmark price index and have various triggers and timing clauses thatdictate the price customers pay for our products.  We also continue to capitalize uponopportunities to establish greater fiber cost stability throughout ourplants.  We are actively expanding ourcapability to replace virgin fiber with recycled fiber at several of our millsites in order to continue manufacturing premium quality level products with amore stable and competitive cost position. Additionally, we have a targeted strategy in place that is designed toyield greater energy costs control, which includes utilizing gas strips orhedges to minimize price volatility, deploy capital to reduce consumption andimplement alternative energy sources.

 

**Manufacturing**

** **

Wecurrently own and operate six manufacturing facilities located in the UnitedStates and one manufacturing facility located in Ontario, Canada.  We produce hard roll tissue at ourConnecticut, Mississippi, New York, Ontario and both Wisconsin facilities forsale to consumer products companies and third-party converters and for use inthe production of converted tissue products at our Neenah Wisconsinfacility.  We produce machine-glazedpaper at our Michigan, Mississippi and Ontario facilities in a variety ofspecialty hard rolls.  We also produceconverted wax paper products at our Michigan facility.

 

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Ourhard roll tissue manufacturing process begins with wood pulp or recycledfiber.  These raw materials typically arepulped in large blenders or pulpers and moved via networks of pipes and pumpsto a tissue machine where sheets of tissue paper are formed according tocustomer or grade specifications.  Thetissue paper is then drawn through the machine and formed on wires as ittravels through various press rolls. Once the sheets are formed, they are transferred to a dryer section ofthe machine that dries the tissue. Following the drying process, the tissue paper is removed from thedrying cylinders and wound into hard roll tissue.  Hard roll tissue is either used internallyfor our converting operations at our Neenah Wisconsin facility or sold toconsumer products companies and third-party converters.  We undergo a similar process at each of ourMichigan, Mississippi and Ontario facilities in our machine-glazed paperoperations, which are designed to produce machine-glazed paper hard rolls.Also, at our Ladysmith, Wisconsin facility, we process the majority of fiberused in our products.  The fiberprocessing area consists of a new state-of-the art de-inking plant that isdirectly linked to the paper machines. Raw material is received in the form of bales of recycled paper (mostlyoffice paper).  The de-inking processremoves contaminants such as ink, staples, paper clips, plastic and papercoatings.  Non-chlorine whiteners areused to brighten the fiber and strip colors. The end product is clean, bright fiber pulp.

 

Ourconverting process at our Neenah Wisconsin facility involves loading hard rolltissue onto converting machines which unwind, perforate, emboss and printtissue as needed.  The convertingmachines then roll or fold the processed tissue into converted tissue products,such as bath or facial tissue, napkins or paper towels.  Similarly, our converting operations at ourMichigan facility are designed to convert our machine-glazed paper hard rollsinto converted wax paper products.

 

Thefollowing table illustrates the annual hard roll production capacity at each ofour manufacturing facilities based on current utilization and the type ofproducts produced at each of such facilities:

 
| ** **            | ** ** | **Total hard roll  capacity  (tons per year)** | ** ** | **Hard roll  tissue** | ** ** | **Hard roll  machine-  glazed paper** | ** ** | **Tissue  converting** | ** ** | **Machine-  glazed paper  converting** | ** ** |
|-----------------------|------------|--------------------------------------------------------------------|------------|----------------------------|------------|-------------------------------------------------|------------|------------------------|------------|---------------------------------------------|------------|
| Connecticut           |       | 29,000                                                             |       | X                          |       |                                            |       |                   |       |                                        |       |
| Michigan              |       | 33,000                                                             |       |                       |       | X                                               |       |                   |       | X                                           |       |
| Mississippi           |       | 48,000                                                             |       | X                          |       | X                                               |       |                   |       |                                        |       |
| New York              |       | 31,000                                                             |       | X                          |       |                                            |       |                   |       |                                        |       |
| Ontario               |       | 41,000                                                             |       | X                          |       | X                                               |       |                   |       |                                        |       |
| Wisconsin (Neenah)    |       | 85,000                                                             |       | X                          |       |                                            |       | X                      |       |                                        |       |
| Wisconsin (Ladysmith) |       | 48,000                                                             |       | X                          |       |                                            |       |                   |       |                                        |       |

*** ***

***Connecticut facility***

*** ***

OurConnecticut facility is a 59,000 square foot facility located in East Hartford,Connecticut.  The facility consists oftwo paper machines, each of which produces dry creped tissue that is used byconsumer products companies and third-party converters in the manufacture ofdisposable baby diapers, adult incontinence products, surgical waddings anddisposable bibs.   In addition, ourConnecticut facility has the capacity to produce base sheets for facial andbath tissue, napkins and paper towel products.

 

***Michigan facility***

*** ***

OurMichigan facility is a 397,000 square foot complex located along Lake Michigan’sBay of Green Bay in the City of Menominee. The facility consists of a paper machine for the manufacture ofmachine-glazed paper hard rolls and 20 converting line operations for both wetand dry wax papers.  We believe that thisfacility is a highly efficient, low-cost producer of machine-glazed paper hardrolls which are used by third-party converters to make food packaging,wrapping, laminating and moisture -resistant and grease- resistant paperproducts.  A portion of themachine-glazed paper hard rolls produced at the Michigan facility is convertedthrough our converting equipment into converted wax paper products, includingwet and dry wax paper, sandwich bags and microwavable wax paper.  The majority of our converted wax paperproducts manufactured at the Michigan facility is sold as branded products tothe facility’s largest customer.

 

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*** ***

***Mississippi facility***

*** ***

OurMississippi facility is located in Wiggins, Mississippi.  Our facility complex consists of a 163,200square foot manufacturing and warehousing facility in addition to a 6,800square foot office.  The facility is inclose proximity to major interstate highways and a railroad, with a rail spurthat runs directly to the facility.  Inaddition, the facility is strategically located near the Mississippi gulf coastand three major seaports, including the Port of Gulfport, through which we shipour exports.  Our Mississippi facility iscentrally located between Atlanta and Dallas, thereby allowing for optimalservice to many of our key customers.

 

Ourmanufacturing facilities at the Mississippi facility consists of two papermachines.  One machine producesmachine-glazed paper hard rolls for food packaging, wrapping, laminating andmoisture-resistant and grease-resistant paper products.  The second machine produces dry creped paperthat is used in the diaper and hygiene products market.  In addition, it produces tissue, napkin andtowel roll stock.

 

***New York facility***

*** ***

OurNew York facility is a 242,000 square foot complex located in Gouverneur, NewYork.  It consists of two light drycreped paper machines, each of which produces a variety of specialty tissueproducts, such as personal hygiene grades, medical and surgical drapes, facemask wadding, filtration grades and tissues used in the personal caremarkets.  In addition, the facilityproduces flexographic printed (a lower-cost, lower resolution graphic) colorednapkins for the party goods industry and premium facial tissue.  The facility is in close proximity to majorinterstate highways and a railroad, with a rail spur that runs directly to thefacility.

 

***Ontario facility***

*** ***

OurOntario facility is a 256,000 square foot complex located in St. Catharines,Ontario, Canada.  The facility currentlyconsists of two types of actively used machines: through-air dried andmachine-finished.

 

Bothof these types of machines have color capability. Our through-air dried machineproduces highly absorbent bulky sheets in basis weights from nine to 25 poundsused in the manufacture of folded and rolled towels, facial and bath tissue,napkins and absorbent tissues. Our machine-finished machine produces wax paperbase stock and wet creped tissue used in the manufacture of coffee filters,masking tape and washroom towel base papers. All of the products manufactured at our Ontario facility are produced injumbo rolls and sold to North American converters for further processing.

 

In November 2005,we made the decision to indefinitely idle our machine-glazed machine at ourOntario facility and in the fourth quarter of fiscal year 2007, we decided toshut down the machine-glazed machine permanently.

 

***Neenah Wisconsin facility***

 

OurNeenah Wisconsin facility is a 1.2 million square foot facility located inNeenah, Wisconsin.  We acquired thisfacility in August 2002 and added converting capacity to the facilitysubsequent to its acquisition.  Thefacility currently consists of five light dry creped paper machines with up to85,000 tons of annual hard roll tissue production capacity and 14 convertinglines with approximately 90,000 tons of annual converting capacity.  A complete distribution center with fullyautomated unitizing and wrapping capabilities is located adjacent to the facility.  This facility produces converted tissueproducts such as facial and bath tissue, napkins and paper towels, as well asunconverted hard roll tissue, and enables us to offer our customers flexibilityin the price, grade, softness, package configuration and size of our products.  For example, our products can be manufacturedcompletely with virgin pulp (for premium products) or recycled fiber (for valueproducts) or any combination thereof. Our machines have color and multi-ply capacity.  The facility contains full-width BrettingM-fold towel, kitchen roll towel and napkin machines.  We also utilize a multi-fold facial line.

 

Thefacility is in close proximity to major interstate highways and supports a railspur that runs directly to the facility. In addition, the facility enjoys a strategic geographic advantage inservicing the midwestern U.S. markets.

 

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***Ladysmith Wisconsin facility***

 

Our Ladysmith Wisconsinfacility is a 259,000 square foot facility located in Ladysmith, Wisconsin. Weacquired this facility in March 2007. CityForest is a Ladysmith, Wisconsin-based manufacturer of tissue hardrolls for third-party converters that resize and convert the rolls intonapkins, towels, bath tissue, specialty medical tissue, industrial wipers andfacial tissue. The majority of CityForest’s sales are to third-party convertersserving the away-from-home market, the consumer market, as well as state andfederal government agencies and the medical industry.  CityForest is solely focused on manufacturingtissue hard rolls and does not currently convert rolls into finishedproducts.   CityForest’s manufacturingprocess includes a de-inking facility, two light dry crepe paper machines witha combined annual capacity of over 48,000 tons used to manufacture tissue hardrolls and water and wastewater treatment capabilities.  The facility processes over 98% of the fiberused in its product.  This pulp can beused to make 100 percent recycled tissue or can be combined with other fiber,such as virgin pulp, at the paper machine,  The ability to combine fibers of different types allows the facility toprecisely match the specific requirements for a customer’s existing or newproducts.

 

**Rawmaterial and energy sources and supply**

** **

Theprimary raw material used in our various facilities is wood pulp (both virginpulp and recycled fiber).  Other costsinclude natural gas, electricity, fuel oil and, in our Michigan facility,coal.   We have developed and implementeda pulp cost management strategy that has been highly effective in controllingour pulp costs.    Our supply agreementswith various pulp suppliers enable us to purchase a majority of our anticipatedtotal pulp requirements for a given year at prices below published list prices.  These agreements further allow us to shift aportion of our pulp purchases to the spot market to take advantage of morefavorable spot market prices when such prices fall.  We believe these supply agreements provide uswith significant protection against the risk of fluctuating pulp costs andoffer a substantial savings from purchasing pulp on the spot market duringperiods of tight supply.  In addition,our Ladysmith, Wisconsin facility processes over 98% of the fiber used in itsproduct.  We satisfy all of our energyrequirements through purchases of natural gas (other than for our Michiganfacility) and electricity from local utility companies.   At our Michigan facility, our power boilersgenerate most of our energy requirements through the use of coal, with thebalance being supplied through the purchase of natural gas by contract.

 

**Salesand customer support**

** **

***Tissue***

*** ***

*Hard rolltissue*.  Our hard rollsales group markets and sells our tissue hard rolls and specialty products toconsumer and away-from-home products companies and third-party converters.

 

*Consumerand away-from-home converted tissue*.  Our converted products sales group marketsand sells our converted tissue products to a variety of retail andaway-from-home customers, directly to retailers or to distributors, which inturn sell to end-users.

 

***Machine-glazed paper***

*** ***

Ourmachine-glazed sales group markets and sells our machine-glazed paper in avariety of specialty hard rolls from each of our Michigan, Mississippi andOntario facilities.  In addition, at ourMichigan facility, our machine-glazed sales group markets and sells convertedwax paper products.  The productsmanufactured in our machine-glazed paper segment are sold to third-partyconverters, consumer products companies and, in certain instances, directly todistributors.

 

**Competition**

** **

Thehard roll tissue market and consumer and away-from-home converted tissueproducts market are highly competitive and are dominated by a number of large,international corporations, as well as smaller, regional corporations.  Among the larger corporations, there is agrowing trend to engage in contract manufacturing with smaller, morecost-effective manufacturers, such as ourselves.  In such instances, major corporations find itmore cost-effective to outsource their manufacturing needs rather than build orrebuild 

 

9

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paperand converting machines or increase their production capacity.  We believe that we offer an alternative tovarious major corporations by producing quality hard roll tissue and convertedtissue products at attractive prices.

 

Wealso compete in the machine-glazed paper market.  Our primary competitors in the machine-glazedpaper market are medium-sized North American-based independent organizations.

 

In allareas, we believe that we compete on the basis of product quality andperformance, price, service, sales and distribution.  See “Item 1A. Risk Factors-”Excess supply inthe markets we serve may reduce the prices we are able to charge for ourproducts.”

 

**Majorcustomers**

** **

Ourcustomer base is comprised of leading tissue consumer products companies,tissue and machine-glazed paper converters, manufacturers of private labelproducts and distributors of tissue products. Three of our top 10 customers are Fortune 150 companies.  Our 10 largest customers represented 56.8% ofsales for the fiscal year ended February 28, 2006, or fiscal year 2006,54.9% of sales for fiscal year 2007 and 51.3% of sales for fiscal year2008.   Kimberly-Clark Corporation, ourcurrent largest single customer, represented 13.4% and 12.3% of sales in fiscalyear 2008 and fiscal year 2006, respectively. No customer accounted for more than 10% of our sales in fiscal year 2007and no other customer accounted for more than 10% of our sales in fiscal year2008 or fiscal year 2006.

 

**Employeesand labor relations**

** **

As of February 29,2008, we employed approximately****942 activefull-time employees, consisting of****784****hourly employees and 158 salaried employees.  We have collective bargaining agreements withthe United Steelworkers of America, referred to as USWcovering approximately 473 of our hourly employees in our Michigan, NewYork and Wisconsin facilities, collectively. In addition, we have a collective bargaining agreement with IndependentPaperworkers of Canada covering approximately 77****employeesin our Ontario facility.  Our collectivebargaining agreements expire between June 2008 and June 2012.

 

In July 2005,the USW was elected to represent 76 hourly employees at our Mississippifacility and was certified by the National Labor Relations Board as theexclusive collective bargaining representative of such employees.  On June 29, 2007, a collectivebargaining agreement with USW was ratified.

 

Ourfacilities have active health and safety programs in place.  We have not experienced any work stoppages orsignificant labor disputes and we consider relations with our employees to besatisfactory.  All of our facilities aresituated in areas where adequate labor pools exist.

 

**Intellectualproperty**

** **

We arethe owner of certain trademarks relating to our products.  We are not aware of any existing infringinguses that could materially affect our business. We believe that our trademarks are valuable to our operations in ourtissue and machine-glazed paper segments and are important to our overallbusiness strategy.

 

We ownthe trademark WaxtexTM which is used in connection with our machine-glazed paperproducts brand produced at our Michigan facility.  We also own the trademark Magic SoftTM used inassociation with the converted facial and bath tissue, paper towel and napkinproducts manufactured at our Wisconsin facility and the trademarks InterlakeTMand Interlake PaperTM.

 

**Environmentallaws**

** **

We aresubject to comprehensive and frequently changing federal, state, local andforeign environmental, health and safety laws and regulations, including lawsand regulations governing emissions of air pollutants, discharges of wastewaterand storm water, storage, treatment and disposal of materials and waste, siteremediation and liability for damage to natural resources.  We are also subject to frequent inspectionsand monitoring by government enforcement authorities.  Compliance with these laws and regulations isan important factor in our business.  Fromtime to time, we incur significant capital and 

 

10

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operatingexpenditures to comply with applicable federal, state and local environmentallaws and regulations and to meet new statutory and regulatoryrequirements.  We have implementedpractices and procedures at our operating facilities that are intended topromote compliance with environmental laws, regulations and permitrequirements.  We believe that ourfacilities and manufacturing operations are currently in material compliancewith such laws, regulations and requirements; however, we may not always be incompliance with all such laws, regulations or requirements.

 

We maybe subject to strict liability for the investigation and remediation ofenvironmental contamination (including contamination that may have been causedby other parties) at properties that we own or operate and at other third-partyowned properties where we or our predecessors have disposed of or arranged forthe disposal of regulated materials.  Asa result, we may be involved in administrative and judicial proceedings andinquiries in the future relating to environmental matters.  The total of such environmental compliancecosts and liabilities cannot be determined at this time and may be material.

 

**Othergovernmental regulation**

** **

We arealso regulated by the U.S. Food and Drug Administration and the U.S.Occupational Safety and Health Administration. We believe that our manufacturing facilities are in compliance, in allmaterial respects, with these laws and regulations.

 

We arecommitted to ensuring that safe operating practices are established,implemented and maintained throughout our organization.  In addition, we have instituted active healthand safety programs throughout our company.

 

**Forward-lookingstatements**

** **

This Annual Report on Form 10-Kincludes “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements are those that do not relate solely tohistorical fact.  They include, but arenot limited to, any statement that may predict, forecast, indicate or implyfuture results, performance, achievements or events.  They may contain words such as “believe,” “anticipate,”“expect,” “estimate,” “intend,” “project,” “plan,” “will” or words or  phrases of similar meaning.  Forward-looking statements are subject tomany uncertainties and other variable circumstances, including those discussedin this Annual Report under the heading “Item 1A. Risk Factors,” many of whichare outside of our control, that could cause our actual results and experienceto differ materially from those we thought would occur.  Other risks besides those listed in “Item 1A.Risk Factors” can adversely affect us. New risk factors can emerge from time to time.  It is not possible for us to predict all ofthese risks, nor can we assess the extent to which any factor, or combinationof factors, may cause actual results to differ from those contained in theforward-looking statements.  Given theserisks and uncertainties, we urge you to read this Annual Report completely andwith the understanding that actual future results may be materially differentfrom what we plan or expect.  We will notupdate these forward-looking statements even if our situation changes in thefuture.

 

The following listingrepresents some, but not necessarily all, of the factors that may cause actualresults to differ from those anticipated or predicted:

 

·                  the cyclicality of the paperindustry;

 

·                  changes in the cost and availabilityof raw materials, including future demand for pulp in domestic and exportmarkets;

 

·                  the effects on us from competition;

 

·                  increases in our energy costs;

 

·                  operational problems at ourfacilities causing significant lost production;

 

·                  the maintenance of relationships withcustomers;

 

·                  our ability to realize operatingimprovements and anticipated cost savings;

 

11

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·                  changes in our regulatoryenvironment, including environmental regulations;

 

·                  a change in control relating to us;

 

·                  increases in interest rates;

 

·                  fluctuations in foreign currencyrelated to our Canadian subsidiary;

 

·                  assessment of market and industryconditions;

 

·                  general economic conditions and theireffects on our business;

 

·                  our ability to service our debtobligations and  fund our working capitalrequirements; and

 

·                  increased general and administrativecosts arising out of or resulting from achieving compliance withSarbanes-Oxley.

 

**Item 1A. Risk Factors**

** **

***The cyclical nature of thespecialty paper, packaging and tissue industry could have a material adverseeffect on our business, financial condition and operating results.***

* *

The market forspecialty paper, packaging and tissue products is highly cyclical and sensitiveto changes in general business conditions, industry capacity, consumerpreferences and other factors.  Demand is alsoinfluenced by fluctuations in inventory levels held by customers and consumerpreferences.  Supply depends primarily onindustry capacity and capacity utilization rates.  In periods of economic weakness reducedspending by consumers and businesses results in decreased demand, potentiallycausing downward price pressure.  Industryparticipants may also, at times, add new capacity or increase capacityutilization rates, potentially causing supply to exceed demand and exertingdownward price pressure.  We have nocontrol over these factors and they can heavily influence our financialperformance.

 

***Our operating results depend upon our wood pulpcosts.***

*** ***

Pulpis the principal raw material used in the manufacture of our specialty paperand tissue products.  It is purchased inhighly competitive, price sensitive markets. We buy a significant amount of pulp and other raw materials eitherthrough supply agreements or on the spot market.  For fiscal year 2008, we purchasedapproximately 315,000****metric tons ofpulp and recycled fiber.

 

We have agreementswith various pulp vendors to purchase various amounts of pulp over the next twoto three years.  These commitments require purchases ofpulp up to approximately 169,000 metric tons per year at pulp prices belowpublished list prices and allow us to shift a portion of our pulp purchases tothe spot market to take advantage of more favorable spot market prices whensuch prices fall.  We believethatourcurrent commitment under these arrangements or theirequivalent approximates 50% of our current budgeted pulp needs.   If upon expiration of these agreements, orupon failure of our suppliers to fulfill their obligations under theseagreements, we are unable to obtain wood pulp on terms as favorable as thosecontained in these agreements, our cost of goods sold may increase and resultsof operations will be impaired.  As aresult, our ability to satisfy customer demands and to manufacture products ina cost-effective manner may be materially adversely affected.

 

In addition, thecosts and availability of wood pulp have at times fluctuated greatly because ofweather, economic global buying behaviors or general industry conditions.  From time to time, timber harvesting may be limited bynatural events, such as fire, insect infestation, disease, ice storms,excessive rainfall and wind storms or by harvesting restrictions.  Production levels within the forest productsindustry are also affected by such factors as currency fluctuations, duties andfinished lumber prices.  These factorscan increase the price we may have to pay to our existing suppliers or from anynew suppliers.  In the presence ofoversupply in the markets we serve, selling prices of our finished products maynot increase in response to raw material price increases.  If we are unable to pass any raw materialprice increases through to our customers, our business financial condition andoperating results may be materially adversely affected.

 

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***Our energy costs may behigher than we anticipated, which could have a material adverse effect on ourbusiness, financial condition and operating results.***

*** ***

We use energy, mainly natural gas, electricity andfuel oil, to operate machinery and to generate steam, which we use in ourproduction process.  Energy prices,particularly for natural gas and fuel oil, have continued to increase since2000, with a corresponding effect on our production costs.  We spent approximately $50.9 million infiscal year 2008 on electricity, natural gas, oil and coal.  Our Mississippi and Wisconsin facilitiesoperate in regulated electric markets. Our other four facilities operate in deregulated electric markets.  All of our facilities operate in deregulatednatural gas markets.  If our energy costsare greater than anticipated, our business, financial condition and operatingresults may be materially adversely affected.

 

***Unforeseen or recurringoperational problems and maintenance outages at any of our facilities may causesignificant lost production.***

 

Our manufacturing process could be affected byoperational problems that could impair our production capability.  Each of our facilities contains complex andsophisticated machines that are used in our manufacturing process.  Disruptions or shutdowns at any of ourfacilities could be caused by:

 

·      maintenance outage toconduct maintenance operations that cannot be performed safely duringoperations;

 

·      prolonged power failures orreductions, including the effect of lightning strikes on our electrical supply;

 

·      breakdown, failure orsubstandard performance of any of our pulping machines, paper machines,recovery boilers, converting machines, de-inking facility or other equipment;

 

·      noncompliance with materialenvironmental requirements or permits;

 

·      shortages of raw materials,a drought or lower than expected rainfall on our water supply;

 

·      disruptions in thetransportation infrastructure, including railroad tracks, bridges, tunnels orroads;

 

·      fires, floods, tornados,hurricanes, earthquakes or other catastrophic disasters;

 

·      labor difficulties; or

 

·      other operational problems.

 

If our facilities are shut down, they may experienceprolonged startup periods, regardless of the reason for the shutdown.  Those startup periods could range fromseveral days to several weeks, depending on the reason for the shutdown andother factors.  Any prolonged disruptionin operations of any of our facilities could cause significant lost production,which would have a material adverse effect on our business, financial conditionand operating results.

 

***Labor disputes orincreased labor costs could disrupt our business and have a material adverseeffect on our financial condition and operating results.***

*** ***

As of February 29, 2008, approximately****66% of our active full-time employees were represented byeither the USW or the Independent Paper Workers of Canada through variouscollective bargaining agreements.

 

InJuly 2005, the USW was elected to represent 76 hourly employees at ourMississippi facility and was certified by the National Labor Relations Board asthe exclusive collective bargaining representative of such employees.  On June 29, 2007, a collectivebargaining agreement with USW was ratified.

 

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Thecollective bargaining agreements for our facilities expire between June 2008and June 2012.  It is likely thatour workers will seek an increase in wages and benefits at the expiration ofeach of those contracts.

 

Anysignificant work stoppage in the future or any significant increase inlabor costs could have a material adverse effect on our business, financialcondition and operating results.

 

***We are dependent uponcontinued demand from our large customers.***

*** ***

Our largest customers account for a significantportion of our sales.  Our ten largestcustomers represented  56.8% of our salesfor fiscal year 2006, 54.9%****of our salesfor fiscal year 2007 and 51.3% of our sales for fiscal year 2008.    Some of our large customers (including fourof our 10 largest customers) have the capability of producing the products thatthey currently buy from us.  The loss orsignificant reduction of orders from any of our large customers could have amaterial adverse effect on our business, financial condition and operatingresults.

 

***We are subject tosignificant environmental, health and safety laws and regulations andcompliance expenditures.***

*** ***

Our business is subject to a wide range of federal,state, local and foreign general and industry specific environmental, healthand safety laws and regulations, including those relating to air emissions,wastewater discharges, solid and hazardous waste management and disposal andsite remediation.  We are also subject tofrequent inspections and monitoring by government enforcement authorities.  Compliance with these laws and regulations isa significant factor in our business. From time to time, we incur significant capital and operatingexpenditures to achieve and maintain compliance with applicable environmentallaws and regulations.  Our failure tocomply with applicable environmental laws and regulations or permitrequirements could result in substantial civil or criminal fines or penaltiesor enforcement actions, including regulatory or judicial orders enjoining orcurtailing operations or requiring remedial or corrective measures, installationof pollution control equipment or other actions, which could have a materialadverse effect on our business, financial condition and operating results.

 

Certain of our operations also require environmentalpermits or other approvals from governmental authorities, and certain of thesepermits and approvals are subject to expiration, denial, revocation ormodification under various circumstances. Failure to obtain or comply with these permits and approvals, or withother environmental requirements, may subject us to civil or criminalenforcement proceedings that can lead to substantial fines and penalties beingimposed against us, orders requiring us to take certain actions or temporary orpermanent shutdown of our affected operations. Such enforcement proceedings could also have a material adverse effecton our business, financial condition and operating results.

 

In addition, as an owner and operator of real estate,we may be responsible under environmental laws and regulations for theinvestigation, remediation and monitoring, as well as associated costs,expenses and third-party damages, including tort liability and natural resourcedamages, relating to past or present releases of hazardous substances on orfrom our properties.  Liability underthese laws may be imposed without regard to whether we knew of, or wereresponsible for, the presence of those substances on our property, may be jointand several, meaning that the entire liability may be imposed on each partywithout regard to contribution, and retroactive and may not be limited to thevalue of the property.  In addition, weor others may discover new material environmental liabilities, includingliabilities related to third-party owned properties that we or our predecessorsformerly owned or operated, or at which we or our predecessors have disposedof, or arranged for the disposal of, certain materials.  We may be involved in administrative orjudicial proceedings and inquiries in the future relating to such environmentalmatters which could have a material adverse effect on our business, financialcondition and operating results.

 

New environmental laws or regulations (or changes inexisting laws or regulations or their enforcement) may be enacted that requiresignificant expenditures by us.  If theresulting expenses significantly exceed our expectations, our business,financial condition and operating results could be materially and adverselyaffected.

 

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We are also subject to various federal, state, localand foreign requirements concerning safety and health conditions at ourmanufacturing facilities.  We may also besubject to material financial penalties or liabilities for noncompliance withthose safety and health requirements, as well as potential business disruption,if any of our facilities or a portion of any facility is required to betemporarily closed as a result of any noncompliance with thoserequirements.  Such financial penaltiesor liabilities or business disruptions could have a material adverse effect onour business, financial condition and operating results.

 

***If we are unable toimplement our business strategies, our business, financial condition andoperating results could be materially and adversely affected.***

*** ***

Our future operating results will depend in part onthe extent to which we can successfully implement our business strategies on acost-effective basis.  However, ourstrategies are subject to significant business, economic and competitiveuncertainties and contingencies, many of which are beyond our control.  If we are unable to successfully implementour business strategies, our business, financial condition and operatingresults could be materially and adversely affected.

 

***We face many competitors, severalof which have greater financial and other resources.***

 

We face competition in each of our markets fromcompanies that produce the same type of products that we produce or thatproduce alternative products that customers may use instead of ourproducts.  We currently compete in thespecialty paper, packaging, tissue and converted paper markets.  Some of our competitors may be able toproduce certain of our products at lower cost than us.  Additionally, many of our competitors arelarge, vertically integrated companies that are more strongly capitalized thanus or have more financial resources than us. Any of the foregoing factors may enable our competitors to betterwithstand periods of declining process and adverse operating conditions.  In addition, changes within the paperindustry, including the consolidation of our competitors and consolidation ofcompanies in the distribution channels for our products, have occurred and maycontinue to occur and may have a material adverse effect on our business,financial condition and operating results.

 

***Excess supply in the markets weserve may reduce the prices we are able to charge for our products.***

 

We compete on the basis of product quality andperformance, price, service, sales and distribution.  Competing in our markets involves thefollowing key risks:

 

·      our failure to anticipate and respond to changingcustomer preferences and demographics;

 

·      our failure to develop new and improved products;

 

·      aggressive pricing by competitors, which mayforce us to decrease prices in an attempt to maintain market share;

 

·      consolidation of our customer base thatdiminishes our negotiating leverage;

 

·      the decision by our large customers todiscontinue outsourcing the production of their products to us and to producetheir products themselves;

 

·      acquisition of a customer by one of ourcompetitors, who thereafter replaces us as a supplier for that customer; and

 

·      our failure to control costs.

 

These competitive factors could cause our customers toshift to other products or attempt to produce products themselves.  Additional competition could result in lostmarket share or reduced prices for our products.

 

New machines may be built or idle machines may beactivated, which would add more capacity to the specialty paper, packaging,tissue and converted paper and tissue product markets.  Increased production capacity in any of thesemarkets could cause an oversupply resulting in lower market prices for ourproducts and increased competition, either of which could have a materialadverse effect on our business, financial condition and operating results.

 

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***We may lose business tocompetitors who underbid us, and we may be otherwise unable to competefavorably under declining market conditions.***

 

Demand for specialty paper, packaging, tissue andconverted paper and tissue products tends to be more price-sensitive duringdeclining market conditions than during normal market conditions.  When market conditions decline, ourcompetitors are more likely to try to underbid our prices in markets where weenjoy a leading position to target some of our market share in thosemarkets.  This competitive behavior coulddrive market prices down and hinder our ability to pass on increases in rawmaterial costs to our customers.  Becauseof the fixed-cost nature of our business, our overall profitability issensitive to minor shifts in the balance between supply and demand.  Competitors having lower operating costs thanwe do will have a competitive advantage over us with respect to products thatare particularly price-sensitive.

 

***The loss of our keymanagers could materially and adversely affect our business, financialcondition and operating results.***

*** ***

Our future success depends, in significant part, uponthe continued services of our management personnel.  Our chief executive officer, Russell C.Taylor, has over 25 years experience in the paper and paper productsindustry.  Our senior executives have anaverage of over 20 years experience in the paper and paper productsindustry.   The market for qualifiedindividuals is highly competitive and we may not be able to attract and retainqualified personnel to replace or succeed members of our senior management orother key employees, should the need arise. Therefore, the loss of services of one or more of our key seniormanagement could materially and adversely affect our business, financialcondition and operating results.

 

***Exposure to interestrate changes and other types of capital market volatility could increase ourfinancing costs.***

*** ***

We require both short-term and long-term financing tofund our operations, including capital expenditures.  We are exposed to changes in interest rateswith respect to our working capital facility and any new debt issues.  Changes in the capital markets, our creditrating or prevailing interest rates can increase or decrease the cost oravailability of financing which may have an adverse effect on our financialcondition and operating results.  Inaddition, because some of our operations and sales are in internationalmarkets, we could be adversely affected by unfavorable fluctuations in foreigncurrency exchange rates.

 

***Changes in the politicalor economic conditions in the United States, Canada and, to a lesser extent,other countries in which our products are sold, could materially and adverselyaffect our business, financial condition and operating results.***

*** ***

We sell our products in the United States, Canada,Mexico and South America.  The economicand political climate of each of these regions has a significant impact oncosts, prices and demand for our products in these areas.  Changes in regional economies or politicalstability, including acts of war or terrorism, and changes in trade restrictionsor laws (including tax laws and regulations, increased tariffs or other tradebarriers) can affect the cost of manufacturing and distributing our productsand the price and sales volume of our products, which could materially andadversely affect our business, financial condition and operating results.

 

***We may not be able to generate sufficient cashflows to meet our debt service obligations.***

 

Ourability to make scheduled payments on, or to refinance our obligations withrespect to, our indebtedness, including the $162,000,000 aggregate principalamount of our 9 3⁄4% senior secured notes due 2010 that we issued in March 2004,referred to as the Original Notes, and the approximately $20 million aggregateprincipal amount of our 9 3⁄4% senior secured notes in conjunction with theCityForest purchase due 2010 that we issued in March 2007, referred to asthe Additional Notes (and together with the Original Notes, referred to hereinas the Notes), or to fund our other liquidity needs will depend on ourfinancial and operational performance which in turn will be affected by generaleconomic conditions and by financial, competitive, regulatory and other factorsbeyond our control.  If we are unable togenerate sufficient cash flow to satisfy our debt obligations, we may have toundertake alternative financing plans, such as refinancing or restructuring ourdebt, selling assets, reducing or delaying capital investments or seeking toraise additional capital.  We cannotassure you that any refinancing would be possible, that any assets could

 

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besold, or, if sold, of the timing of sales and the amount of proceeds that maybe realized from those sales, or that additional financing could be obtained onacceptable terms, if at all.  Ourinability to generate sufficient cash flows to satisfy our debt obligations, or to refinance our indebtedness oncommercially reasonable terms, would materially and adversely affect ourfinancial condition and results of operations and our ability to satisfy ourobligations under the Notes.

 

***Our significant debt obligationscould limit our flexibility in managing our business and expose us to certainrisks***.

 

Weare highly leveraged.  As of February 29,2008, we had $198.8 million of indebtedness outstanding, which includes the Notesand $17.9 million of industrial revenue bonds assumption in connection with theacquisition of CityForest.  In addition,we are permitted under our working capital facility and the indenture governingthe Notes to incur additional debt, subject to certain limitations.  Furthermore, we borrowed $9.8 million underour working capital facility.  Our highdegree of leverage may have important consequences to investors, including thefollowing:

 

·      we may have difficulty satisfying our obligations under the Notes orother indebtedness and, if we fail to comply with these requirements, an eventof default could result;

 

·      we may be required to dedicate a substantial portion of our cash flowfrom operations to required payments on indebtedness, thereby reducing theavailability of cash flow for working capital, capital expenditures and othergeneral corporate activities;

 

·      covenants relating to our debt may limit our ability to obtainadditional financing for working capital, capital expenditures and othergeneral corporate activities;

 

·      covenants relating to our debt may limit our flexibility in planningfor, or reacting to, changes in our business and the industry in which weoperate;

 

·      we may be more vulnerable than our competitors to the impact ofeconomic downturns and adverse developments in our business; and

 

·      we may be placed at a competitive disadvantage against any lessleveraged competitors.

 

Theoccurrence of any one of these events could have a material adverse effect onour business, financial condition, results of operations, prospects and abilityto satisfy our obligations under the Notes.

 

**ITEM 1B.    UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM 2.  PROPERTIES**

 

**Properties**

 

We own and operate seven facilities located in EastHartford, Connecticut; Menominee, Michigan; Wiggins, Mississippi; Governeur,New York; St. Catharines, Ontario, Canada; Neenah, Wisconsin; and Ladysmith,Wisconsin.  In addition, we maintain ourcorporate headquarters in Alpharetta, Georgia.

 

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The following table lists each of our facilities and its location, use,approximate square footage and status:

 
| **Facility**                    | ** ** | **Location**       | ** ** | **Use**                                                   | ** ** | **Approximate  square  footage** | ** ** | **Owned or  leased** | ** ** |
|---------------------------------|------------|--------------------|------------|-----------------------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|
| Connecticut  facility           |       | East  Hartford, CT |       | Tissue  manufacturing                                     |       | 59,000                           |       | Owned                     |       |
|                            |       |               |       |                                                      |       |                             |       |                      |       |
| Georgia  administrative offices |       | Alpharetta,  GA    |       | Corporate  Headquarters Administrative offices            |       | 5,000                            |       | Leased                    |       |
|                            |       |               |       |                                                      |       |                             |       |                      |       |
| Michigan  facility              |       | Menominee,  MI     |       | Machine-glazed  paper manufacturing and converting        |       | 397,000                          |       | Owned                     |       |
|                            |       |               |       |                                                      |       |                             |       |                      |       |
| Mississippi  facility           |       | Wiggin, MS         |       | Tissue and  machine-glazed paper manufacturing            |       | 170,000                          |       | Owned                     |       |
|                            |       |               |       |                                                      |       |                             |       |                      |       |
| New York  facility              |       | Gouverneur,  NY    |       | Tissue  manufacturing                                     |       | 242,000                          |       | Owned                     |       |
|                            |       |               |       |                                                      |       |                             |       |                      |       |
| Ontario  facility               |       | Ontario,  Canada   |       | Tissue and  machine-glazed paper manufacturing            |       | 256,000                          |       | Owned                     |       |
|                            |       |               |       |                                                      |       |                             |       |                      |       |
| Wisconsin  facility             |       | Neenah, WI         |       | Tissue  manufacturing, converting and distribution center |       | 1,200,000                        |       | Owned                     |       |
|                            |       |               |       |                                                      |       |                             |       |                      |       |
| Wisconsin  facility             |       | Ladysmith,  WI     |       | Tissue  manufacturing,  de-inking facility                |       | 259,000                          |       | Owned                     |       |

 

**ITEM 3. LEGAL PROCEEDINGS**

 

Weare, from time to time, party to various routine legal proceedings arising outof our business.  These proceedings,primarily involve commercial claims, personal injury claims and workers’compensation claims.  We cannot predictthe outcome of these lawsuits, legal proceedings and claims with certainty.Nevertheless, we believe that the outcome of any currently existingproceedings, even if determined adversely, would not have a material adverseeffect on our business, financial condition and operating results.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Notapplicable.

 

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**PART II**

 

**ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERSAND ISSUER PURCHASES OF EQUITY SECURITIES.**

 

Notapplicable.

 

**ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA**

 

Thefollowing table contains our selected consolidated financial data for fiscalyear 2008, for the period from March 1, 2006 to June 12, 2006(pre-merger), for the period from June 13, 2006 to February 28, 2007(post-merger) and for fiscal year 2006 and for the fiscal year ended February 28,2005, or fiscal year 2005 (pre-merger), and the fiscal year ended February 29,2004, or fiscal year 2004 (pre-merger). Our selected consolidated results of operations and other data forfiscal year 2008, for the period from March 1, 2006 to June 12, 2006(pre-merger) and for the period from June 13, 2006 to February 28,2007 (post-merger) and fiscal year 2006, and our selected consolidated balancesheet data at February 29, 2008 and February 28, 2007 have beenderived from audited consolidated financial statements included elsewhere in thisAnnual Report.  Our selected consolidatedresults of operations and other data for fiscal year 2005 and fiscal year 2004and our selected consolidated balance sheet data at February 28, 2005 and February 29,2004 have been derived from audited consolidated financial statements notincluded in this Annual Report.  Youshould read the information set forth below in conjunction with our “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andour consolidated financial statements and related notes included elsewhere inthis Annual Report.

** **
| ** **                                           | ** ** | **Feb. 29,  2004** | ** ** | **Feb. 28,  2005** | ** ** | **Feb. 28,  2006** | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  February 28, 2007** | ** ** | **Feb. 29,  2008** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------|------------|
| **(Dollars in thousands)**                 | ** ** | **(Pre-merger)**        | ** ** | **(Post-merger)**       | ** ** |
| Statement of operations data:                        |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Net sales:                                           |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Tissue segment                                       |       | $                       | 189,744    |                    | $          | 230,370                 |       | $                                                     | 232,865    |                                                      | $          | 67,200                  |       | $ | 170,311 |   | $ | 325,030 |   |
| Machine-glazed paper segment                         |       | 100,519                 |       | 102,523                 |       | 95,968                  |       | 27,042                                                |       | 70,926                                                    |       | 105,992                 |       |
| Total net sales                                      |       | 290,263                 |       | 332,893                 |       | 328,833                 |       | 94,242                                                |       | 241,237                                                   |       | 431,022                 |       |
| Cost of goods sold                                   |       | 256,930                 |       | 292,051                 |       | 301,111                 |       | 86,054                                                |       | 228,318                                                   |       | 388,258                 |       |
| Gross profit                                         |       | 33,333                  |       | 40,842                  |       | 27,722                  |       | 8,188                                                 |       | 12,919                                                    |       | 42,764                  |       |
| Income (loss) from operations                        |       | 19,948                  |       | 21,955                  |       | 11,433                  |       | (3,330                                                | )          | 1,015                                                     |       | 20,665                  |       |
| Net income (loss)                                    |       | $                       | 7,147      |                    | $          | 3,096                   |       | $                                                     | (2,569     | )                                                         | $          | (6,535                  | )          | $ | (6,192 | ) | $ | 3,993 |   |
|                                                 |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Other financial data:                                |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Net cash provided by (used in) operating  activities |       | $                       | 20,259     |                    | $          | 32,235                  |       | $                                                     | 8,600      |                                                      | $          | (6,540                  | )          | $ | 10,139 |   | $ | 19,233 |   |
| Net cash (used in) provided by investing  activities |       | (10,547                 | )          | (7,416                  | )          | (13,050                 | )          | (1,938                                                | )          | 38,085                                                    |       | (64,173                 | )          |
| Net cash (used in) provided by financing  activities |       | (10,241                 | )          | 1,437                   |       | (282                    | )          | (290                                                  | )          | (45,762                                                   | )          | 29,225                  |       |
| Depreciation and amortization                        |       | 14,935                  |       | 16,264                  |       | 16,277                  |       | 4,632                                                 |       | 16,133                                                    |       | 23,106                  |       |
| Capital expenditures                                 |       | 10,547                  |       | 11,419                  |       | 13,050                  |       | 1,938                                                 |       | 7,677                                                     |       | 20,477                  |       |
| EBITDA (1)                                           |       | 33,341                  |       | 35,387                  |       | 26,077                  |       | 739                                                   |       | 17,738                                                    |       | 43,427                  |       |
|                                                 |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Balance sheet data:                                  |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Cash and cash equivalents                            |       | $                       | —     |                    | $          | 26,959                  |       | $                                                     | 22,824     |                                                      | N/A        |                    | $          | 16,261 |   | $ | 883 |   |
| Total assets                                         |       | 186,943                 |       | 210,843                 |       | 210,232                 |       | N/A                                                   |       | 325,269                                                   |       | 404,312                 |       |
| Total debt                                           |       | 55,787                  |       | 161,060                 |       | 161,080                 |       | N/A                                                   |       | 160,356                                                   |       | 208,647                 |       |
| Stockholders’ equity (deficit)                  |       | 84,482                  |       | (7,586                  | )          | (6,906                  | )          | N/A                                                   |       | 38,991                                                    |       | 47,338                  |       |

 

19

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(1)  EBITDArepresents earnings before interest expense, income taxes and depreciation andamortization.  EBITDA does not representand should not be considered as an alternative to net income or cash flow fromoperations, as determined by U.S. generally accepted accounting principles, orU.S. GAAP, and our calculation thereof may not be comparable to that reportedby other companies.  We present EBITDAbecause we believe that it is widely accepted that EBITDA provides usefulinformation regarding a company’s ability to service and/or incurindebtedness.   EBITDA has limitations asan analytical tool, and you should not consider it in isolation, or as asubstitute for analysis of our results as reported under U.S. GAAP.  Some of the limitations are:

 

·      EBITDA does not reflect ourcash expenditures, or future requirements for capital expenditures orcontractual commitments;

 

·      EBITDA does not reflectchanges in, or cash requirements for, our working capital needs;

 

·      EBITDA does not reflect thesignificant interest expense, or the cash requirements necessary to serviceinterest or principal payments, on our debts;

 

·      although depreciation andamortization are non-cash charges, the assets being depreciated and amortizedwill often have to be replaced in the future, and EBITDA does not reflect anycash requirements for such replacements; and

 

·      other companies in ourindustry may calculate EBITDA differently than we do, limiting its usefulnessas a comparative measure.

 

Because of these limitations, EBITDA should not beconsidered as a measure of discretionary cash available to us to invest in thegrowth of our business.  We compensatefor these limitations by relying primarily on our U.S. GAAP results and usingEBITDA only supplementally.  See theconsolidated statements of cash flow included in our financial statementsincluded elsewhere in this Annual Report. The following is a reconciliation of EBITDA to net income (loss) and netcash provided by operating activities:

 
| ** **                                                 | ** ** | **Feb. 29,  2004** | ** ** | **Feb. 28,  2005** | ** ** | **Feb. 28,  2006** | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  February 28, 2007** | ** ** | **Feb. 29,  2008** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------|------------|
| **(Dollars in thousands)**                       | ** ** | **(Pre-merger)**        | ** ** | **(Post-merger)**       | ** ** |
| EBITDA                                                     |       | $                       | 33,341     |                    | $          | 35,387                  |       | $                                                     | 26,077     |                                                      | $          | 739                     |       | $ | 17,738 |   | $ | 43,427 |   |
| (Add) subtract:                                            |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Interest expense                                           |       | 7,085                   |       | 17,507                  |       | 17,367                  |       | 5,001                                                 |       | 11,685                                                    |       | 20,057                  |       |
| Provision for (benefit from) income taxes                  |       | 5,151                   |       | (74                     | )          | (3,575                  | )          | (1,953                                                | )          | (3,888                                                    | )          | (3,729                  | )          |
| Depreciation                                               |       | 13,958                  |       | 14,858                  |       | 14,854                  |       | 4,227                                                 |       | 16,133                                                    |       | 23,106                  |       |
| Net income (loss)                                          |       | $                       | 7,147      |                    | $          | 3,096                   |       | $                                                     | (2,569     | )                                                         | $          | (6,536                  | )          | $ | (6,192 | ) | $ | 3,993 |   |
| Add (subtract):                                            |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |                    |       |
| Depreciation and amortization                              |       | 14,935                  |       | 16,264                  |       | 16,277                  |       | 4,632                                                 |       | 16,133                                                    |       | 23,106                  |       |
| Write-off of debt issuance costs and  prepayment penalties |       | —                  |       | 2,895                   |       | —                  |       | —                                                |       | —                                                    |       | —                  |       |
| Stock-based compensation                                   |       | —                  |       | 922                     |       | 82                      |       | 924                                                   |       | 497                                                       |       | 808                     |       |
| Provision for deferred income taxes                        |       | 2,821                   |       | 1,431                   |       | (2,955                  | )          | (396                                                  | )          | (6,651                                                    | )          | (6,567                  | )          |
| Other non-cash charges                                     |       | 667                     |       | (2,074                  | )          | 290                     |       | 85                                                    |       | 1,778                                                     |       | 616                     |       |
| Net changes in working capital                             |       | (5,311                  | )          | 9,701                   |       | (2,525                  | )          | (5,249                                                | )          | 4,574                                                     |       | (2,723                  | )          |
| Net cash provided by (used in) operating  activities       |       | $                       | 20,259     |                    | $          | 32,235                  |       | $                                                     | 8,600      |                                                      | $          | (6,540                  | )          | $ | 10,139 |   | $ | 19,233 |   |

 

20

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**ITEM 7.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The financial and businessanalysis below provides information which we believe is relevant to anassessment and understanding of our consolidated financial position, results ofoperations and cash flows.  Thisfinancial and business analysis should be read in conjunction with theconsolidated financial statements and related notes.

 

# **Overview**

# ** **

We manufacture and market specialty tissue andmachine-glazed paper used in the manufacture of various end products, includingdiapers, facial and bath tissue, assorted paper towels and food wraps.  In addition, we manufacture and market abroad range of converted tissue products. Our business is comprised of two segments: tissue and machine-glazedpaper.  In addition, our tissue segmentconsists of two product lines: (1) hard roll tissue and (2) consumerand away-from-home converted tissue products. We own and operate six facilities in the United States, located inConnecticut, Michigan, Mississippi, New York, two facilities in Wisconsin andone facility located in Ontario, Canada.

 

OnJune 12, 2006, our parent entered into an Agreement and Plan of Mergerwith Cellu Parent, a corporation organized and controlled by Weston Presidio,and Cellu Acquisition Corporation, a newly formed wholly owned subsidiary ofCellu Parent, or Merger Sub.  Pursuant tothe agreement, on June 12, 2006, Merger Sub was merged with and into ourparent, with our parent surviving and becoming a wholly owned subsidiary ofCellu Parent, or the Merger.

 

Weaccounted for the Merger as a purchase in accordance with the provisions ofStatement of Financial Accounting Standards No. 141 (“SFAS 141”), *Business Combinations*, which resulted in a new valuation forour assets and liabilities based upon fair values as of the date of theMerger.  As allowed under SEC StaffAccounting Bulletin No. 54, *Push Down Basis ofAccounting Required in Certain Limited Circumstances*(“Push DownAccounting”), we have reflected all applicable purchase accounting adjustmentsin our consolidated financial statements for all periods subsequent to theMerger date.  Push Down Accountingrequires us to establish a new basis for our assets and liabilities based onthe amount paid for our equity at the close of business on June 12,2006.  Accordingly, our parent’sownership basis is reflected in our consolidated financial statements beginningupon completion of the Merger.  In orderto apply Push Down Accounting, our parent’s purchase price of $207.8 million,including assumption of $162.0 million in aggregate principal amount of ouroutstanding 9.75% senior secured notes (referred to herein as the OriginalNotes), was allocated to the assets and liabilities based on their relativefair values.  The total consideration is subjectto adjustment for up to an additional $35.0 million in contingent earn-outconsideration based upon the achievement of certain financial targets.  If any portion of the earned contingentpayments is unable to be made by us, then Weston Presidio has agreed to providethe necessary funds to former holders of our parent’s capital stock, optionsand warrants through an equity investment in our parent or otherwise.  In accordance with SFAS 141, the $35.0million has been recognized as a liability as of February 29, 2008.  For the fiscal year ended February 28,2007, no payment was required.  Forfiscal year 2008, a $15.0 million payment will be made in fiscal year 2009.

 

Wehave allocated the excess of purchase price over the net assets acquired in theMerger based on our estimates of the fair value of assets and liabilities asfollows:

 

21

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| ** **                    | ** ** | **Excess purchase price  allocated to:** | ** **       |
|-------------------------------|------------|---------------------------------------------------------|------------------|
| Inventories                   |       | $                                                       | 909,264          |   |
| Property, plant and equipment |       | 142,292,525                                             |             |
| Trademarks                    |       | 6,550,314                                               |             |
| Long-term debt                |       | (900,729                                                | )                |
| Contingent consideration      |       | (35,000,000                                             | )                |
| Deferred income taxes         |       | (50,830,323                                             | )                |
| Total                         |       | $                                                       |  63,021,051 |   |
|                               |            |                                                         |                  |  |  |

 

Thefollowing discussion relative to the prior year combines our operating resultsfor the period March 1, 2006 to June 12, 2006 (pre-merger) and June 13,2006 to February 28, 2007 (post-merger). See RESULTS OF OPERATIONS below for further analysis thereof.

 

In our tissue segment, we derive our revenues from thesale of (1) tissue hard rolls sold as facial and bath tissue, specialtymedical tissue, industrial wipers, napkin and paper towel stock, as well asabsorbent cover stock and (2) converted tissue products, including avariety of private label consumer and away-from-home bath and facial tissue,napkins and folded and rolled towels.  Wederive our revenues in our machine-glazed paper segment from the sale of (1) machine-glazedpaper hard rolls to third-party converters that manufacture fast food andcommercial food wrap, as well as niche market products such as gum wrappers,coffee filters, tobacco papers, wax paper and butter wraps and (2) convertedwax paper products, including wet and dry wax paper, sandwich bags and waxpaper.  For fiscal year 2008, our tissuesegment generated net sales of $325.0****million orapproximately 75.4% of our net sales, and our machine-glazed paper segmentgenerated net sales of $106.0 million or approximately 24.6% of our netsales.  For fiscal year 2007 and fiscalyear 2006, our tissue segment generated $237.5****millionand $232.9 million, respectively, of net sales, or approximately 70.8% of ourtotal net sales in each of fiscal year 2007 and fiscal year 2006, and ourmachine-glazed paper segment generated $98.0 million and $95.9 million, respectively,of net sales, or approximately 29.2% of our total net sales in each of fiscalyear 2007 and fiscal year 2006.

 

We entered the consumer and away-from-home convertedtissue products market following the August 2002 acquisition of our NeenahWisconsin manufacturing and converting facility.  Our Neenah Wisconsin facility has addedapproximately 85,000 tons of annual hard roll tissue production capacity and 14converting lines with approximately 90,000 tons of annual converting productioncapacity.  Sales of our converted tissueproducts in the consumer and away-from-home converted tissue products marketgenerate significantly greater revenue per ton than sales of hard rolltissue.  Our Neenah Wisconsin facility beganproducing our full line of consumer and away-from-home converted tissueproducts in March 2003.  We believethat, as we continue to increase the utilization of our converting capacity andadd retail focused converting equipment, we will increase our profits andgenerate higher margins on our consumer and away-from-home converted tissueproducts.

 

OnMarch 21, 2007, we consummated a definitive merger agreement withCityForest, Cellu City Merger Sub, our wholly owned subsidiary, and WayneGullstad as the shareholders’ representative. Pursuant to the agreement, and subject to the terms and conditionstherein, Cellu City Merger Sub merged with and into CityForest, with CityForestsurviving and becoming our wholly owned subsidiary (referred to herein as theCityForest Acquisition).  The aggregate mergerconsideration paid (including assumption of $18.4 million in aggregateprincipal amount of industrial revenue bonds) was approximately $61 millionsubject to certain working capital and net cash adjustments.   Total cash paid for the acquisition of $46.8million (purchase price of $61.0 million less assumed indebtedness of $18.4million plus restricted cash and other miscellaneous adjustments of $1.6million and acquisition costs of $2.6 million), was financed in part byissuance of unregistered 9 3⁄4% Senior Secured Notes due 2010 (referred to hereinas the Additional Notes and, together with the Original Notes, referred toherein as the Notes) of approximately $20.0 million, borrowing on a revolvingline of credit ($17.4 million) and available cash on hand.

 

22

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The CityForest Acquisition has been accounted for as a purchase inaccordance with the provisions of SFAS 141 and, accordingly, the consolidatedstatements of operations includes the results of CityForest for fiscal year2008 from the date of acquisition. Purchase price allocations are subject to refinement until all pertinentinformation is obtained.  We haveallocated the excess of purchase price over the net assets acquired in theacquisition based on its estimates of the fair value of assets and liabilitiesas follows:

** **
| ** **                     | ** ** | **Excess purchase price allocated to:** | ** **       |
|--------------------------------|------------|-------------------------------------------------------------|------------------|
| Property,  plant and equipment |       | $                                                           | 32,854,514       |   |
| Trademarks                     |       | 2,200,000                                                   |             |
| Goodwill                       |       | 6,970,001                                                   |             |
| Long-term  debt                |       | (1,724,684                                                  | )                |
| Deferred  income taxes         |       | (17,238,509                                                 | )                |
| Total                          |       | $                                                           |  23,061,322 |   |

 

The results of CityForest’soperations from the date of acquisition (March 21, 2007) are included inour tissue segment.  Unaudited pro formaresults of operations for fiscal year 2008, for the period June 13, 2006-November 23,2006 and  for the period March 1, 2006-June 12,2006, as if we and CityForest had been combined as of March 1, 2006, arepresented below.  The pro forma resultsinclude estimates and assumptions, which our management believes arereasonable.  However, the pro formaresults do not include any cost savings or other effects of the plannedintegration of CityForest and are not necessarily indicative of the resultswhich would have occurred if the business combination had been in effect on thedates indicated, or which may result in the future.

 

23

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| ** **               | ** ** | **Year Ended  February  29, 2008  (1)** | ** ** | **June 13, 2006-  February 28, 2007  (2)** | ** ** | **March 1, 2006-  June 12, 2006  (2)** | ** ** |
|--------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **               | ** ** | **As Filed**                                           | ** ** | **Pro Forma**                                             | ** ** | **As Filed**                                          | ** ** | **Pro Forma** | ** ** | **As Filed** | ** ** | **Pro Forma** | ** ** |
| ** **               | ** ** | **(in thousands)**                                     | ** ** | **(in thousands)**                                        | ** ** | **(in thousands)**                                    | ** ** |
| Net sales                |       | $                                                           | 431,022    |                                                           | $          | 433,733                                                    |       | $ | 241,237 |   | $ | 275,319 |   | $ | 94,242 |   | $ | 107,823 |   |
|                     |       |                                                        |       |                                                           |       |                                                       |       |   |   |   |   |   |   |
| Operating  income (loss) |       | $                                                           | 20,665     |                                                           | $          | 21,251                                                     |       | $ | 1,015 |   | $ | 9,620 |   | $ | (3,330 | ) | $ | 99 |   |
|                     |       |                                                        |       |                                                           |       |                                                       |       |   |   |   |   |   |   |
| Net income  (loss)       |       | $                                                           | 3,993      |                                                           | $          | 4,553                                                      |       | $ | (6,192 | ) | $ | (562 | ) | $ | (6,535 | ) | $ | (4,292 | ) |

 

----

(1) Pro forma operating results include theoperating results for CityForest for fiscal year 2008.  The “as filed” operating results include theoperating results for CityForest for the period from the acquisition date (March 21,2007) to February 29, 2008.

 

(2) Pro forma operating results include the operating results for CityForest forfiscal year 2006, prorated between the two reporting periods presented for us,as CityForest was previously a calendar year-end company.

 

The primary component of cost of goods sold for eachof our segments is pulp, which represented approximately 47%, 43% and 43% ofour cost of goods sold in fiscal year 2008, fiscal year 2007 and fiscal year2006, respectively. ** **We have supply agreements withvarious pulp suppliers over the next two to three years.  We believe under these agreements or theirequivalents, we will purchase approximately 50% of our total annual pulprequirements.  These supply agreementspermit us to purchase pulp at prices that are discounted from published listprices and allow us to shift a portion of our pulp purchases to the spot marketto take advantage of more favorable spot market prices when such pricesfall.  In addition, our Ladysmith, Wisconsinfacility processes over 98% of the fiber used in its product.  The balance of our pulp requirements arepurchased on the open market.

 

Our labor, manufacturing, energy, other materials anddepreciation costs in the aggregate represented approximately 53%, 57% and 57%of our cost of goods sold for fiscal year 2008, fiscal year 2007 and fiscalyear 2006, respectively.  Those costs arebroken down as follows: (1) wages and benefits made up approximately****10% for each of fiscal year 2008, fiscal year 2007 andfiscal year 2006; (2) manufacturing overhead represented approximately15%, 17% and 17% for fiscal year 2008, fiscal year 2007 and fiscal year 2006,respectively; (3) energy costs represented approximately 13%, 13% and 15%,for fiscal year 2008, fiscal year 2007 and fiscal year 2006, respectively; (4) othermaterials (including chemicals, wax, dye and packaging) representedapproximately 9%, 11% and 11%, for fiscal year 2008, fiscal year 2007 and fiscal year 2006, respectively;and (5) depreciation represented approximately 6%, 6% and  4% for fiscal year 2008,  fiscal year 2007 and fiscal year 2006,respectively.

 

Wehave collective bargaining agreements with the USW in each of our Michigan, NewYork and Neenah Wisconsin facilities covering 473****ofour hourly employees.  In addition, wehave a collective bargaining agreement with Independent Paper Workers of Canadacovering****77****hourlyemployees in our Ontario facility.  Ouragreements expire between June 2008 and June 2012.  In July 2005, the USW was elected torepresent 76 hourly employees at our Mississippi facility and was certified bythe National Labor Relations Board as the exclusive collective bargainingrepresentative of such employees.  On June 29,2007, a 

 

24

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collectivebargaining agreement with USW was ratified. Historically, we have not experienced any significant labor disputes orwork stoppages.

 

We satisfy all of our energy requirements throughpurchases of natural gas (other than for our Michigan facility) and electricityfrom local utility companies.  We utilizegas strips or hedges to minimize price volatility with respect to natural gaspurchases.   At our Michigan facility,our power boilers generate most of our energy requirements through the use ofcoal, with the balance being supplied through the purchase of natural gas bycontract.

 

**Resultsof operations**

 

Fiscalyear 2008 has been compared to the combined periods from March 1, 2006 to June 12,2006 (pre- merger) and from June 13, 2006 to February 28, 2007 (post-merger) and fiscal year 2006 for purposes of management’s discussion andanalysis of the results of operations. Any references below to fiscal year 2007 shall refer to the combinedperiods.  Material fluctuations inoperations resulting from the effect of purchase accounting have beenhighlighted.

 

The following table sets forth certain sales andoperating data for our business segments for the periods indicated:

 
| ** **                          | ** ** | **Fiscal Year**               | ** ** | **For the Period**                          | ** ** | ** **                                                | ** ** | **Fiscal Year**                  | ** ** |
|-------------------------------------|------------|------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|
| **(Dollars in millions)** | ** ** | **Ended  Feb. 28, 2006** | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  February 28, 2007** | ** ** | **Combined  Feb. 28, 2007** | ** ** | **Ended  Feb. 29, 2008** | ** ** |
|                                | ** ** | **(Pre-merger)**                   | ** ** | **(Post-merger)**                                     | ** ** |
| Net sales:                          | ** ** | ** **                         | ** ** | ** **                                            | ** ** | ** **                                                | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Tissue segment                      |       | $                                  | 232.9      |                                                  | $          | 67.2                                                      |       | $                                     | 170.3      |   | $ | 237.5 |   | $ | 325.0 |   |
| Machine-glazed paper segment        |       | 95.9                               |       | 27.1                                                  |       | 70.9                                                      |       | 98.0                                  |       | 106.0 |   |
| Total                               |       | $                                  | 328.8      |                                                  | $          | 94.3                                                      |       | $                                     | 241.2      |   | $ | 335.5 |   | $ | 431.0 |   |
|                                |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Gross profit:                       |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Tissue segment                      |       | $                                  | 18.8       |                                                  | $          | 6.4                                                       |       | $                                     | 10.0       |   | $ | 16.4 |   | $ | 35.9 |   |
| Machine-glazed paper segment        |       | 8.9                                |       | 1.8                                                   |       | 2.9                                                       |       | 4.7                                   |       | 6.9 |   |
| Total                               |       | $                                  | 27.7       |                                                  | $          | 8.2                                                       |       | $                                     | 12.9       |   | $ | 21.1 |   | $ | 42.8 |   |
|                                |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Percentage of net sales:            |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Tissue segment                      |       | 70.8                               | %          | 71.3                                                  | %          | 70.6                                                      | %          | 70.8                                  | %          | 75.4 | % |
| Machine-glazed paper segment        |       | 29.2                               | %          | 28.7                                                  | %          | 29.4                                                      | %          | 29.2                                  | %          | 24.6 | % |
| Total                               |       | 100.0                              | %          | 100.0                                                 | %          | 100.0                                                     | %          | 100.0                                 | %          | 100.0 | % |
|                                |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Gross margin:                       |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Tissue segment                      |       | 8.1                                | %          | 9.5                                                   | %          | 5.9                                                       | %          | 6.9                                   | %          | 11.0 | % |
| Machine-glazed paper segment        |       | 9.3                                | %          | 6.6                                                   | %          | 4.1                                                       | %          | 4.8                                   | %          | 6.5 | % |
| Total                               |       | 8.4                                | %          | 8.7                                                   | %          | 5.3                                                       | %          | 6.3                                   | %          | 9.9 | % |
|                                |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Shipments (tons):                   |       |                               |       |                                                  |       |                                                      |       |                                  |       |   |   |
| Tissue segment                      |       | 179,401                            |       | 50,406                                                |       | 124,012                                                   |       | 174,418                               |       | 235,395 |   |
| Machine-glazed paper segment        |       | 81,783                             |       | 23,108                                                |       | 57,231                                                    |       | 80,339                                |       | 81,685 |   |
| Total                               |       | 261,184                            |       | 73,514                                                |       | 181,243                                                   |       | 254,757                               |       | 317,080 |   |

 

25

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***Fiscal year ended February 29,2008 (fiscal year 2008) compared to fiscal year ended February 28, 2007(fiscal year 2007)***

*** ***

**Net sales** for fiscal year 2008increased $95.5 million, or 28.5%, to $431.0 million from $335.5 for fiscalyear 2007.  On a company-wide basis, tonssold increased for fiscal year 2008 compared to fiscal year 2007.  For fiscal year 2008, we sold 317,080 tons oftissue hard rolls, machine-glazed paper hard rolls and converted paper products,an increase of 62,323, or 24.5%, compared to fiscal year 2007.  Furthermore, net selling price per tonincreased from $1,317 for fiscal year 2007 to $1,359 for fiscal year 2008.

 

Net sales for our tissue segment for fiscal year 2008increased $87.5 million, or 36.8%, to $325.0 million from $237.5 for fiscalyear 2007. This increase is attributable to the CityForest Acquisition, anincrease in net selling price per ton and an increase in tonnage sold.  Net selling price per ton increased from$1,362 for fiscal year 2007 to $1,381 for fiscal year 2008.   For fiscal year 2008, we sold 235,395 tonsof tissue, compared to 174,418 tons sold in fiscal year 2007.  Net sales for our machine-glazed segment forfiscal year 2008 increased $8.0 million, or 8.2%, to $106.0 million from $98.0million for fiscal year 2007.  Thisincrease is also attributable to an increase in net selling price per ton andan increase in tonnage sold.  Net sellingprice per ton increased from $1,219 for fiscal year 2007 to $1,298 for fiscalyear 2008.  For fiscal year 2008, we sold81,685 tons of machine-glazed products, compared to 80,339 tons sold in fiscalyear 2007.

 

**Gross profit** for fiscal year2008 increased to $42.8 million from $21.1 million for fiscal year 2007, anincrease of $21.7 million, or 102.6%, from fiscal year 2007.  As a percentage of net sales, gross profitincreased to 9.9% for fiscal year 2008, compared to 6.3% for fiscal year2007.  The increases in gross profit areattributable to the City Forest Acquisition, continued improvement in productmix and the strong market for tissue hard rolls, compared to the comparableperiod in the prior year.

 

Gross profit for our tissue segment for fiscal year2008 was $35.9 million, an increase of $19.5 million, or 118.4%, from fiscalyear 2007.   Gross profit for ourmachine-glazed segment for fiscal year 2008 was $6.9 million, an increase of$2.2 million, or 47.4%, from fiscal year 2007. As a percentage of net sales, gross profit for the tissue segmentincreased to 11.0% for fiscal year 2008 from 6.9% in fiscal year 2007.  As a percentage of net sales, gross profitfor the machine-glazed segment increased to 6.5% for fiscal year 2008 from 4.8%in fiscal year 2007.

 

**Selling, general and administrative expenses**for fiscal year 2008 increased $6.8 million, or 57.2%, to $18.7 million from$11.9 million for fiscal year 2007.  As apercentage of net sales, selling, general and administrative expenses increasedto 4.3% in fiscal year 2008 from 3.5% for fiscal year 2007. Included in fiscalyear 2008 are $1.6 million of ongoing CityForest administrative expenses. Also, included in fiscal year 2008 are additional costs incurred in connectionwith Sarbanes-Oxley compliance and increases in incentive compensation expenseassociated with strong business performance.

 

**Restructuring costs** for fiscalyear 2007 were $.2 million related to severance costs associated with theelimination of a corporate position.

 

**Merger-related transaction costs**forfiscal year 2007 were $6.1 million.

 

**Terminated acquisition related transaction costs**forfiscal year 2008 were $2.1 million related to costs incurred related to anacquisition that did not transpire.

 

26

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**Stock and related compensationexpense**for fiscalyear 2008 were $.6 million compared to $3.3 million for fiscal year 2007.  The $.6 million for fiscal year 2008 wasprimarily related to compensation expense related to the payment of taxesassociated with a restricted stock award grant. The $3.3 million for fiscal year 2007was related to non-cashcompensation expense related to the vesting of restricted stock awards, paymentof taxes associated with such awards and other compensation expense related tothe Merger.

 

**Vesting of stock option/restrictedstock grants**forfiscal year 2008 was $.8 million compared to $1.4 million for fiscal year 2007.

 

**Impairment of property, plant and equipment**forfiscal year 2007 resulted in a charge of $.5 million related to our decision inthe fourth quarter of fiscal year 2007 to shut down permanently the papermachine at our Ontario facility, which we had idled in the third quarter offiscal year 2006.

 

**Foreign currency gain (loss)**forfiscal year 2008 was a loss of $.7 million compared to a gain of $.1 millionfor fiscal year 2007.  The decrease infiscal year 2008 is due to the fluctuations in the foreign currency (theCanadian dollar).

 

**Income tax benefit**for fiscalyear 2008 was $3.7 million compared to $5.8 million for fiscal year 2007.  Included in the income tax benefit for fiscalyear 2008 is $1.5 million and $1.4 million, respectively, of benefit associatedwith future changes in Canadian tax rates due to legislative changes andchanges in our effective state tax rates which are expected to be realized inthe future.  The effective income taxrate for fiscal year 2007 differs from the federal statutory rate primarily dueto non-deductible transaction costs expensed for book purposes.

 

**Net income**for fiscal year 2008was $4.0 million compared to a net loss of $12.7 million for fiscal year2007.  Included in fiscal year 2008 netincome is $2.1 million of terminated acquisition-related costs and $1.4 millionof cash and non-cash stock compensation charges.  Also, included in fiscal year 2008 net incomeis a tax benefit of $3.7 million.  Included in fiscal year 2007 net loss is $.2 million of restructuring costs, $6.1 million of merger-related transactioncosts, $3.8 million of merger-related and other compensation charges and $.5million related to an impairment charge for our paper machine at our Ontariofacility.

 

***Fiscal year ended February 28,2007 (fiscal year 2007) compared to fiscal year ended February 28, 2006(fiscal year 2006)***

*** ***

**Net sales** for fiscal year 2007increased $6.7 million, or 2.0%, to $335.5 million from $328.8 for fiscal year2006.  On a company-wide basis, tons solddecreased for fiscal year 2007 compared to fiscal year 2006.  For fiscal year 2007, we sold 254,757 tons oftissue hard rolls, machine-glazed paper hard rolls and converted paperproducts, a decrease of 6,427, or 2.5%, compared to fiscal year 2006.  Included in this decrease is the effect ofthe shutdown of our machine-glazed machine at our Ontario facility, which weidled in the third quarter of fiscal year 2006, and which represented adecrease of 5,925 tons.  Net of theeffect of this, tons sold decreased 502, or .2%, for fiscal year 2007 from thecomparable period in the prior year. Offsetting the decrease in volume sold for fiscal year 2007 from theprior fiscal year was an increase in net selling price per ton from $1,259 forfiscal year 2006 to $1,317 for fiscal year 2007.

 

Net sales for our tissue segment for fiscal year 2007increased $4.6 million, or 2.0%, to $237.5 million from $232.9 for fiscal year2006. This increase is attributable to an increase in net selling price perton, which was partially offset by a decrease in tonnage sold.  Net selling price per ton increased from$1,298 for fiscal year 2006 to $1,362 for fiscal year 2007.   For fiscal year 2007, we sold 174,418 tonsof tissue, compared to 179,401 tons sold in fiscal year 2006.  Net sales for our machine-glazed segment forfiscal year 2007 increased $2.1 million, or 2.1%, to $98.0 million from $95.9million for fiscal year 2006.  Thisincrease is also attributable to an increase in net selling price per ton,which was partially offset by a decrease in tonnage sold due in part to theshutdown of our machine-glazed machine at our Ontario facility.  Net selling price per ton increased from$1,173 for fiscal year 2006 to $1,219 for fiscal year 2007.  For fiscal year 2007, we sold 80,339 tons ofmachine-glazed products, compared to 81,783 tons sold in fiscal year 2006.

 

27

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**Gross profit** for fiscal year2007 decreased to $21.1 million from $27.7 million for fiscal year 2006, adecrease of $6.6 million, or 23.9%, from fiscal year 2006.  As a percentage of net sales, gross profitdecreased to 6.3% for fiscal year 2007, compared to 8.4% for fiscal year2006.  Included in fiscal year 2007 is$5.4 million of additional depreciation expense in cost of goods sold ascompared to our historical basis of accounting prior to the Merger.  Also, included in fiscal year 2007 is anon-cash charge to cost of goods sold reflecting $.9 million of excess purchaseprice allocated to inventory.

 

Gross profit for our tissue segment for fiscal year2007 was $16.4 million, a decrease of $2.4 million, or 12.8%, from fiscal year2006.  Included in fiscal year 2007 isthe impact of the additional charges noted above on the tissue segment of $3.5million and $.6 million, respectively. Gross profit for our machine-glazed segment for fiscal year 2007 was$4.7 million, a decrease of $4.2 million, or 47.2%, from fiscal year 2006.  Included in fiscal year 2007 is the impact ofthe additional charges noted above on the machine-glazed segment of $1.9million and $.3 million, respectively.  Asa percentage of net sales, gross profit for the tissue segment decreased to6.9% for fiscal year 2007 from 8.1% in fiscal year 2006.  As a percentage of net sales, gross profitfor the machine-glazed segment decreased to 4.8% for fiscal year 2006 from 9.3%in fiscal year 2006

 

**Selling, general and administrative expenses**for fiscal year 2007 decreased $1.0 million, or 7.8%, to $11.9 million from $12.9 million for fiscal year 2006.  As a percentage of net sales, selling,general and administrative expenses decreased to 3.5% in fiscal year 2007 from3.9% for fiscal year 2006.

 

**Restructuring costs** for fiscalyear 2007 were $.2 million related to severance costs associated with theelimination of a corporate position. Restructuring costs for fiscal year 2006 were $1.0 million, of which $.7million related to our fiscal year 2006 decision to indefinitely idle one ofour machine-glazed paper machines at our Ontario facility and the relatedseverance costs and $.3 million related to severance costs associated with acorporate organizational restructuring.

 

**Merger-related transaction costs**forfiscal year 2007 were $6.1 million.  Themerger-related transaction costs for fiscal year 2006 were $2.3 million relatedto a previously announced terminated transaction.

 

**Stock and related compensation expense**forfiscal year 2007 were $3.3 million related to non-cash compensation expenserelated to the vesting of restricted stock awards, payments of taxes associatedwith such awards and other compensation expense related to the Merger.

 

**Vesting of stock option/restricted stock grants**forfiscal year 2007 was $1.4 million compared to less than $.1 million for fiscalyear 2006.  The $1.4 million for fiscalyear 2007 consists of $.9 million related primarily to restricted stock grantsprior to the Merger that vested immediately upon the Merger and $.5 million ofvesting related to restricted stock grants made after the Merger.

 

**Impairment of property, plant and equipment**forfiscal year 2007 resulted in a charge of $.5 million related to our decision inthe fourth quarter of fiscal year 2007 to shut down permanently themachine-glazed paper machine at our Ontario facility, which we had idled in thethird quarter of fiscal year 2006.

 

**Foreign currency gain (loss)**forfiscal year 2007 was a gain of $.1 million compared to a loss of $.5 millionfor fiscal year 2006.  The increase infiscal year 2007 is due to the fluctuations in the foreign currency (theCanadian dollar).

 

**Income tax benefit**for fiscalyear 2007 was $5.8 million, or an effective tax rate of 31.5%, compared to $3.6million, or an effective tax rate of 58.2%, for fiscal year 2006.  The effective income tax rate for fiscal year2007 differs from the federal statutory rate primarily due to non-deductibletransaction costs expensed for book purposes. Included in the 58.2% effective tax rate for fiscal year 2006 isapproximately $1.2 million of benefit related to the different book and taxtreatment of deductions related to stock compensation matters.  This benefit was recorded in fiscal year 2006upon completion of our fiscal year 2005 tax returns.  Also included in the 58.2% effective tax ratewas $.1 million of tax expense related to Canadian withholding tax.  Without these items, the effective tax ratefor fiscal year 2006 was 40.6% (benefit of $2.5 million).

 

**Net loss**for fiscal year 2007was $12.7 million,****compared tonet loss of $2.6 million for fiscal year 2006. Included in fiscal year 2007 net loss is $6.3 million related toadditional depreciation and a non-cash charge 

 

28

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to cost of goods sold resulting from purchaseaccounting, $.2 million of restructuring costs, $6.1 million of merger-relatedtransaction costs, $3.8 million of merger-related and other compensationcharges and $.5 million related to an impairment charge for our machine-glazedpaper machine at our Ontario facility. Included in fiscal year 2006 net loss is $1.1 million of restructuringcosts and $2.2 million of merger-related transaction costs related to aterminated transaction.

 

**Liquidityand capital resources**

 

Our principal liquidity requirements are to servicedebt and meet working capital, tax and capital expenditure needs.  Our total debt at February 29, 2008 was$208.6 million.

 

In March 2004, we completed a private offering ofthe Original Notes.   We raised $152.2 million,net of debt issuance costs of $8.0 million and original issuance discount of$1.8 million.  At the same time, weentered into a $30.0 million revolving working capital facility with CITGroup/Business Inc.   A portion of theproceeds, along with a drawdown from the working capital facility, were used topay off existing debt of approximately $56.0 million.  In addition, we used an aggregate $100.2million of the proceeds to fund a stockholder dividend in the amount of $96.8million to Cellu Paper Holdings, Inc., our parent, to repurchase a portionof its outstanding common stock and warrants at that time, and to fundcompensation from the redemption of stock options of our parent in the amountof $3.4 million.

 

In connection with the CityForest Acquisition in March 2007,we issued and sold approximately $20 million of Additional Notes.

 

Furthermore, at February 29, 2008 we hadoutstanding borrowings of $9.8 million under our working capital facility andexcess availability was $27.0 million.

 

The Notes mature on March 15, 2010 and requiresemi-annual interest payments on March 15th and September 15th.

 

Inconnection with the Merger, we solicited consents with respect to the OriginalNotes.   Consents were received withrespect to 100% of the aggregate outstanding principal amount of the OriginalNotes. We accepted all of the consents delivered in the consent solicitationand paid to the consenting noteholders a consent fee of $40 per $1,000principal amount of Original Notes for which they delivered consents.  These payments were made in the secondquarter of fiscal year 2007.  As a resultof our acceptance of the consents delivered by noteholders and the completionof the consent solicitation, the amendments to the Indenture governing theNotes described in the Consent Solicitation Statement dated May 9, 2006and related Supplement dated May 24, 2006 became operative and we were notrequired to make a change of control offer to purchase any Notes in connectionwith the Merger.

 

Weentered into a Credit Agreement, dated as of June 12, 2006 (referred toherein as the Credit Agreement), among us, as U.S. Borrower, InterlakeAcquisition Corporation Limited, one of our subsidiaries, as Canadian Borrower,our parent, the other loan guarantors party thereto, JPMorgan Chase Bank, N.A.,as U.S. Administrative Agent, JPMorgan Chase Bank, N.A., Toronto Branch, asCanadian Administrative Agent, and the other lenders party thereto.  The Credit Agreement provides for a $35.0million working capital facility, including a letter of credit sub-facility andswing-line loan sub-facility. The Credit Agreement provides that amounts underthe facility may be borrowed, repaid and re-borrowed, subject to a borrowingbase test, until the maturity date, which is June 12, 2011. An amountequal to $32.0 million is available, in U.S. dollars, to the U.S. Borrowerunder the facility, and an amount equal to $3.0 million is available, in U.S.or Canadian dollars, to the Canadian Borrower under the facility.  Borrowings of $17.4 million were made tofinance a portion of the CityForest Acquisition.   As of February 29, 2008, $9.8 millionof borrowings remained outstanding under the working capital facility.

 

Inconnection with the CityForest purchase agreement, the following agreementswere entered into:

 

29

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***Second Supplemental Indenture***

 

We,certain of our subsidiaries, the Trustee and CityForest have executed a SecondSupplemental Indenture, dated March 21, 2007, or the Second SupplementalIndenture, pursuant to which CityForest became a party to our Indenture as asubsidiary guarantor.  As a subsidiaryguarantor, CityForest, on a joint and several basis with all the existingsubsidiary guarantors, fully, unconditionally and irrevocably guarantees toeach holder of the Notes and the Trustee our obligations under our Indentureand the Notes.

 

***Amendment to Credit Agreement***

 

Weentered into a First Amendment, dated March 21, 2007 (referred to hereinas the First Amendment), to the Credit Agreement dated June 12, 2006 (asamended by the First Amendment, the Amended Credit Agreement) among us, as U.S.Borrower, Interlake Acquisition Corporation Limited, one of our subsidiaries,as Canadian Borrower, certain other of our subsidiaries, our parent, JPMorganChase Bank, N.A. and JPMorgan Chase Bank, N.A., Toronto Branch.  The maturity date of the Credit Agreement is June 12,2011.

 

TheFirst Amendment (1) increased the working capital facility from $35.0million to $40.0 million, (2) permitted the issuance and sale by us of theNotes, (3) provided  for theconsummation of the CityForest acquisition and the conversion by CityForestfrom a Minnesota corporation to a Minnesota limited liability company, (4) permittedthe assumption of approximately $18.5 million in aggregate principal amount ofindebtedness of CityForest in connection with the CityForest Acquisition inaccordance with the terms of the CityForest Bond Documents (as defined belowunder “CityForest Bond Documents”) and (5) permitted the guarantee by usof certain obligations of CityForest under the CityForest Bond Documents.  In connection with the First Amendment,CityForest became a guarantor of the obligations of the borrowers under theAmended Credit Agreement.

 

***CityForest Bond Documents***

 

CityForestis party to a Loan Agreement, dated March 1, 1998, the Loan Agreement,with the City of Ladysmith, Wisconsin (referred to herein as the Issuer).  Pursuant to the Loan Agreement, the Issuerloaned the proceeds of the Issuer’s Variable Rate Demand Solid Waste DisposalFacility Revenue Bonds, Series 1998 (CityForest Corporation Project, orthe Bonds) to CityForest to finance the construction by CityForest of a solidwaste disposal facility.  Approximately$18.5 million in aggregate principal amount of the Bonds was outstanding as ofthe date of the CityForest Acquisition. CityForest is required, under the terms of the Indenture of Trustgoverning the Bonds, or the CityForest Indenture, to provide a letter of creditin favor of the trustee under the CityForest Indenture, or the BondsTrustee.  CityForest has entered into anAmended and Restated Reimbursement Agreement, dated March 21, 2007, or theReimbursement Agreement and, together with the CityForest Indenture and theLoan Agreement, or the CityForest Bond Documents, with Associated Bank,National Association , or Associated Bank, pursuant to which Associated Bankhas extended the required letter of credit, or the Associated Bank Letter ofCredit and has provided a revolving credit facility to CityForest in anaggregate principal amount of up to $3.5 million, or the Associated BankRevolving Credit Facility.

 

TheBonds Trustee is permitted to draw upon the Associated Bank Letter of Credit topay principal and interest due on the Bonds, and to provide liquidity topurchase the Bonds put to CityForest by bondholders and not remarketed; andCityForest is obligated under the Reimbursement Agreement to reimburseAssociated Bank for any such draws. CityForest is also obligated to pay a feein respect of the aggregate amount available to be drawn under the AssociatedBank Letter of Credit at a rate per annum initially equal to 1.25%, subject toadjustment on a quarterly basis based on CityForest’s leverage.  The expiration date of the Associated BankLetter of Credit is February 15, 2011.

 

Amounts borrowed by CityForest under the AssociatedBank Revolving Credit Facility bear interest at a rate per annum equal to theLIBOR Rate (as defined in the Reimbursement Agreement), plus an applicablemargin. The applicable margin percentage initially is 1.75%, subject toadjustment on a quarterly basis based upon CityForest’s leverage.  During the continuance of an event ofdefault, the outstanding principal balance bears interest at a rate per annumequal to the then applicable interest rate plus 2.00%.  CityForest 

 

30

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is also obligated to pay a commitment fee in respectof any unused commitment under the Associated Bank Revolving Credit Facility inan amount equal to 0.50% per annum.  Inaddition, subject to certain exceptions, if CityForest terminates theAssociated Bank Revolving Credit Facility prior to February 15, 2009,CityForest is obligated to pay to Associated Bank a fee equal to 1.00% of thecommitment then being terminated. The maturity date of the Associated BankRevolving Credit Facility is February 15, 2011.

 

The Reimbursement Agreement requires scheduledsemi-annual payments of principal of the Bonds equal to approximately 2% of theprincipal amount outstanding as of the date of the Acquisition, with thebalance payable at maturity of the Bonds on March 1, 2028. TheReimbursement Agreement also contains a number of other provisions regardingreserve funds and other mandatory and optional repayments in connection withthe Bonds.  In addition, theReimbursement Agreement provides that in certain circumstances where theCompany incurs Indebtedness in excess of amounts currently permitted under itsIndenture or refinances the indebtedness issued under its Indenture, AssociatedBank may require CityForest to repay all of its obligations to Associated Bankunder the Reimbursement Agreement and either to cause the Bonds to be redeemedor to replace the Associated Bank Letter of Credit with a Substitute CreditFacility, as such term is defined in the CityForest Indenture.

 

TheReimbursement Agreement contains various affirmative and negative covenantscustomary for working capital and term credit facilities, as well as additionalcovenants relating to the Bonds.  Thenegative covenants include limitations on: indebtedness; liens; acquisitions,mergers and consolidations; investments; guarantees; asset sales; sale andleaseback transactions; dividends and distributions; transactions withaffiliates; capital expenditures; and changes to the status of the Bonds.CityForest is also required to comply on a quarterly basis with a maximumleverage covenant and a minimum fixed charge coverage covenant.

 

TheReimbursement Agreement also contains customary events of default, including:  payment defaults; breaches of representationsand warranties; covenant defaults; cross-defaults to certain other debt,including the Notes and indebtedness under the Amended Credit Agreement;certain events of bankruptcy and insolvency; judgment defaults; certaindefaults related to the Employee Retirement Income Security Act of 1974, asamended; and a change of control of CityForest or us.

 

Wehave guaranteed all of the obligations of CityForest under the ReimbursementAgreement, pursuant to a Guaranty, dated March 21, 2007 (the “Cellu TissueGuaranty”), executed by us in favor of Associated Bank. In addition, theobligations of CityForest under the Reimbursement Agreement are secured byfirst-priority liens in favor of Associated Bank in all of CityForest’sassets.  The U.S. Administrative Agent,the Canadian Administrative Agent, Associated Bank and CityForest have enteredinto an Intercreditor Agreement, dated March 21, 2007, which sets forththe respective rights and priorities of Associated Bank, on the one hand, andthe U.S. Administrative Agent and the Canadian Administrative Agent, on theother hand, as to the collateral of CityForest securing the ReimbursementAgreement and the Amended Credit Agreement.

 

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The table that follows presents cash flows informationfor fiscal year 2008, combined fiscal year 2007 and fiscal year 2006:

 
| ** **                                               | ** ** | **Pre-Merger**                                               | ** **  | **Pre-Merger**                                        | ** ** | **Post-Merger**                                           | ** ** | **Combined**                                                 | ** **  | **Post-Merger**                                              | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------|-------------|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------------------|-------------|--------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Fiscal Year Ended  February 28, 2006** | ** **  | **March 1, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  February 28, 2007** | ** ** | **Fiscal Year Ended  February 28, 2007** | ** **  | **Fiscal Year Ended  February 29, 2008** | ** ** |
| **Net Cash Provided by (Used in) Operating  Activities** |       |                                                         |        |                                                  |       |                                                      |       |                                                         |        |                                                         |       |
| Net (loss) income                                        |       | $                                                            | (2,569,354  | )                                                     | $          | (6,534,964                                                | )          | $                                                            | (6,192,366  | )                                                            | $          | (12,727,330 | ) | $ | 3,992,751 |   |
| Non-cash items                                           |       | 13,694,780                                                   |        | 5,245,238                                             |       | 11,757,574                                                |       | 17,002,812                                                   |        | 17,963,909                                                   |       |
| Changes in working capital                               |       | (2,525,660                                                   | )           | (5,250,094                                            | )          | 4,574,243                                                 |       | (675,851                                                     | )           | (2,724,132                                                   | )          |
| Net cash provided by (used in) operating  activities     |       | $                                                            | 8,599,766   |                                                  | $          | (6,539,820                                                | )          | $                                                            | 10,139,451  |                                                         | $          | 3,599,631 |   | $ | 19,232,528 |   |
|                                                     |       |                                                         |        |                                                  |       |                                                      |       |                                                         |        |                                                         |       |
| **Net Cash (Used in) Provided by Investing  Activities** |       | $                                                            | (13,050,166 | )                                                     | $          | (1,937,610                                                | )          | $                                                            | 38,084,856  |                                                         | $          | 36, 147,246 |   | $ | (64,172,696 | ) |
|                                                     |       |                                                         |        |                                                  |       |                                                      |       |                                                         |        |                                                         |       |
| **Net Cash (Used in) Provided by Financing  Activities** |       | $                                                            | (281,653    | )                                                     | $          | (290,000                                                  | )          | $                                                            | (45,761,997 | )                                                            | $          | (46, 051,997 | ) | $ | 29,225,000 |   |
|                                                     |       |                                                         |        |                                                  |       |                                                      |       |                                                         |        |                                                         |       |
| **Effect of foreign currency**                           |       | $                                                            | 597,086     |                                                  | $          | 362,212                                                   |       | $                                                            | (620,553    | )                                                            | $          | (258,341 | ) | $ | 337,955 |   |
|                                                     |       |                                                         |        |                                                  |       |                                                      |       |                                                         |        |                                                         |       |
| **Net increase (decrease) in cash**                      |       | $                                                            | (4,134,967  | )                                                     | $          | (8,405,218                                                | )          | $                                                            | 1,841,757   |                                                         | $          | (6,563,461 | ) | $ | (15,377,213 | ) |

 

**Net cashprovided by (used in) operations** was $19.2 million for fiscalyear 2008, $3.6 million for fiscal year 2007 and $8.6 million for fiscal year2006.   Non-cash items for fiscal year2008, fiscal year 2007 and fiscal year 2006 totaled $18.0 million, $17.0million and $13.7 million, respectively, and consisted primarily ofamortization, depreciation and deferred income taxes.  Cash flows used by changes in working capitaltotaled $2.7 million, $.7 million and $2.5 million for fiscal year 2008, fiscalyear 2007 and fiscal year 2006, respectively. With respect to changes inaccounts receivable and inventory, cash used by these items was $8.6 millionfor fiscal year 2008, cash provided by these items was $.1 for fiscal year 2007and 

 

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cash used by these items was $2.6 million for fiscalyear 2006.  Cash provided by changes inprepaid expenses, income tax receivable and other current assets was $1.9million for fiscal year 2008, $.9 million for fiscal year 2007 and $.1 millionfor fiscal year 2006.  Cash provided bychanges in accounts payable, accrued expenses, accrued interest and otherliabilities was $4.0 million for fiscal year 2008, cash used by changes inaccounts payable, accrued expenses, accrued interest and other liabilities was$1.7 million for fiscal year 2007 and cash provided by changes in accountspayable, accrued expense, accrued interest and other liabilities was less than$.1 million for fiscal year 2006.

 

** Net cashprovided by (used in) investing activities**was cash used ininvesting activities of $64.2 million for fiscal year 2008, cash provided byinvesting activities of $36.1 million in fiscal year 2007 and cash used ininvesting****activities of $13.1 million in fiscalyear 2006.  Included in fiscal year 2008is the cash paid for the CityForest Acquisition, net of cash received, of $43.7million.  Included in fiscal year 2007 is$45.8 million related to the equity investment by Weston Presidio.  The remaining change related to the level ofcapital spending year over year.

 

**Net cash (used in) provided by financing**was cash provided by financing activities of $29.2 million for fiscal year2008, which includes proceeds from issuance of the Additional Notes of $20.0million, $9.8 million of net borrowings on the working capital facility and $.6million payment on the industrial revenue bond assumed in the CityForestAcquisition.   Cash used in financingactivities of $46.1 million for fiscal year 2007 includes $45.8 million relatedto merger consideration paid to former shareholders of our parent.  The remaining $.3 million for fiscal year2007 relates to payments on our industrial revenue bond.  Our final payment was made in the firstquarter of fiscal year 2007.  Cash usedin financing activities for fiscal year 2006 related primarily to payments onour industrial revenue bond.

 

**Cash** as of February 29,2008 decreased to $.9 million from $16.3 million as of the end of the priorfiscal year as a result of the items described above.

 

**Receivables, net** as of February 29,2008 increased to $44.5 million from $34.1 million as of the end of the priorfiscal year.  Included in the $44.5million is $5.3 million of receivables related to CityForest.  Without the effect of the acquisition,receivables increased $5.1 million, primarily due to increased net sales.

 

**Inventories**as of February 29,2008 increased to $34.0 million from $28.7 million as of the end of the priorfiscal year.  Included in the $34.0million is $1.4 million of inventories related to CityForest.  Without the effect of the acquisition,inventories increased $3.9 million in support of increased net sales.

 

**Deferred income taxes**as of February 29,2008 increased to $7.2 million from $6.5 million as of the end of the priorfiscal year.  This increase is primarilyattributable to the recording of the benefit of net operating losscarryforwards, or NOLs, generated during fiscal year 2008 for federal and statetax purposes.

 

**Property, plant and equipment, net**asof February 29, 2008 increased to $296.6 million from $228.9 million as ofthe prior fiscal year.  Included in the$296.6 million of property, plant and equipment, net is $66.8 million relatedto CityForest.  Without the effect of theacquisition, property plant and equipment increased $.9 million from the end ofthe prior fiscal year.  This increaserelates to capital expenditures offset partially by depreciation expense forthe period.  Included in the capitalexpenditures for fiscal year 2008 is $5.4 million of purchased machinery andequipment that had been leased previously.

 

**Goodwill**of $7.0 million as of February 29,2008 arose due to the City Forest Acquisition.

 

**Trademarks**as of February 29,2008 increased to $8.8 million from $6.6 million as of the end of the priorfiscal year.  The additions to trademarksrelate to the CityForest Acquisition.

 

**Reserved cash**as of February 29,2008 of $1.2 million relates to reserve funds in connection with the industrialrevenue bond assumed in the CityForest Acquisition.

 

**Revolving line of credit**as of February 29,2008 represents $17.4 million of borrowings to finance a portion of theCityForest Acquisition, offset by net payments through February 29, 2008of $7.6 million.

 

**Accounts payable**as of February 29,2008 increased to $24.1 million from $16.5 million as of the end of the priorfiscal year.  Included in the $24.1million of accounts payable is $3.2 million related to CityForest.  

 

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Without the effect of the acquisition, accountspayable increased $4.4 million due to increased pulp purchases and timing ofpayments.

 

**Accrued expenses**as of February 29,2008 increased to $18.9 million from $16.3 million as of the end of the priorfiscal year.  Included in the $18.9million of accrued expenses is $.9 million related to CityForest.

 

**Accrued interest**as of February 29,2008 increased to $8.3 million from $7.2 million as of the end of the priorfiscal year.  The increase is due to theadditional borrowings to finance the CityForest Acquisition and the debtassumed in the transaction.

 

**Other current liabilities**as of February 29,2008 of $15.0 million represents the amount to be paid in fiscal year 2009related to the contingent earnout consideration in connection with the Merger.

 

**Long-term debt**as of February 29,2008 increased to $198.8 million from $160.4 million as of the end of the priorfiscal year due to the assumption of CityForest debt and debt incurred tofinance the acquisition.

 

**Deferred income taxes**as of February 29,2008 increased to $62.0 million from $50.7 million as of the end of the priorfiscal year primarily due to the deferred taxes recorded in purchase accountingfor CityForest.

 

**Other liabilities**as of February 29,2008 decreased to $20.1 million from $35.2 as of the end of the prior fiscalyear primarily due to the reclassification of $15.0 million to other currentliabilities reflecting the amount to be paid in fiscal year 2009 related to thecontingent earnout consideration in connection with the Merger.

 

**Stockholders’ equity** as of February 29, 2008 increased to $47.3 million compared toequity of $39.0 million as of the end of the prior fiscal year.  The equity as of February 29, 2008 is reflectiveof the net income generated for fiscal year 2008 and the increase in theforeign currency translation charge to equity.

 

**Capitalspending summary**

 

Capital expenditures were $20.5 million, $9.6 millionand $13.1 million for fiscal year 2008, fiscal year 2007 and fiscal year 2006,respectively.  We have increased capitalexpenditures since fiscal year 2002 to support ongoing cost savings programs(cost improvements) and growth in our manufacturing capacity.  We have concentrated the growth in our manufacturingcapacity since fiscal year 2003 on our converting operations at our Wisconsinfacility for the production of value-added converted tissue products.

 

**Contractualobligations**

 

At February 29, 2008, our material obligationsunder firm contractual arrangements, including commitments for future paymentsunder long-term debt arrangements, operating lease arrangements and otherlong-term obligations, are summarized below.

 

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| ** **                           | ** ** | **Cash payments due by period** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Total**                                           | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Long-term debt obligations (1)       |       | $                                                   | 200,131    |   | $ | 760 |   | $ | 184,536 |   | $ | 2,280 |   | $ | 12,555 |   |
| Operating lease obligations          |       | 2,830                                               |       | 1,141 |   | 1,689 |   | — |   | — |   |
| Purchase obligations                 |       | 106,119                                             |       | 53,059 |   | 53,060 |   | — |   | — |   |
| Total                                |       | $                                                   | 309,080    |   | $ | 54,960 |   | $ | 239,285 |   | $ | 2,280 |   | $ | 12,555 |   |

 

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(1)  Interest incurred at 9 3/4%,payable semi-annually for the Notes and varying from 1.38% to 4.15% for theindustrial revenue bond.

 

**Net operatingloss carryforwards**

 

At February 29, 2008, we had federal NOLs ofapproximately $9,804,000, which begin to expire in 2021 and state NOLs ofapproximately $14,506,000, which begin to expire in 2019.   We currently anticipate fully utilizingrecorded federal and state NOLs prior to their expiration.

 

In assessing the realizability of deferred tax assets,we consider whether it is more likely than not that some portion or all of thedeferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon thegeneration of future taxable income during the periods in which those temporarydifferences become deductible.  Weconsider the scheduled reversal of deferred tax liabilities, projected futuretaxable income and tax planning strategies in making this assessment.  Based on the level of historical taxableincome and projections for future taxable income over the periods in which thedeferred tax assets are deductible, we believe it is more likely than not thatwe will realize the benefits of these deductible differences.

 

**Newaccounting standards**

 

Referto Note 2 (Summary of Significant Accounting Policies) of the notes to ourconsolidated financial statements included elsewhere in this Annual Report fora discussion of new accounting pronouncements and the potential impact to ourconsolidated results of operations and financial position.

 

***Critical accounting policies and estimates***

*** ***

Preparationof our financial statements requires management to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenues andexpenses.  Significant accountingpolicies used in the preparation of our consolidated financial statements aredescribed in Note 2 (Summary of Significant Accounting Policies), includedelsewhere in this Annual Report. Management believes the most complex and sensitive judgments, because oftheir critical nature, result primarily from the need to make estimates aboutthe effects of matters with inherent uncertainty.  The most critical areas involving managementestimates are described below.  Actualresults in these areas could differ from management’s estimates.

 

***Allowancefor doubtful accounts***

*** ***

Weestimate our allowance for doubtful accounts using two methods.  First, we determine a specific reserve forindividual accounts where information is available that the customer may havean inability to meet its financial obligation. Second, we estimate additional reserves for all customers based on historicalwrite-offs.  Accounts are charged-offagainst the allowance for doubtful accounts when we have exhausted allcollection efforts and have deemed the accounts uncollectible.

 

***Goodwilland Trademarks***

*** ***

Goodwillis not amortized but tested for impairment annually at year-end, and at any timewhen events suggest impairment may have occurred. Our goodwill impairment testis performed by comparing the net 

 

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presentvalue of projected cash flows to the carrying value of goodwill.  We incorporate assumptions involving futuregrowth rates, discount rates and tax rates in projecting the future cashflows.  In the event the carrying valueof a reporting unit exceeds its fair value, an impairment loss would berecognized to the extent the carrying amount of the reporting unit’s goodwillexceeds its implied fair value.  Goodwillas of February 29, 2008 of $7.0 million was recorded in connection with anacquisition in the current year.  Nogoodwill impairment has been noted subsequent to the acquisition through February 29,2008.

 

Trademarksare not amortized but tested for impairment annually at the end of our secondquarter, and at any time when events suggest impairment may have occurred.  Our impairment test is performed by comparingthe net present value of projected cash flows to the carrying value of thetrademarks.  We incorporate assumptionsinvolving future growth rates, discount rates and tax rates in projecting thefuture cash flows.  In the event thecarrying value of a reporting unit exceeds its fair value, an impairment losswould be recognized to the extent the carrying amount of the reporting unit’strademarks exceed their implied fair value. No trademark impairments were recorded during fiscal year 2008 or theperiod from June 13, 2006 to February 28, 2007 (post-merger).

 

***Incometaxes***

*** ***

Werecognize deferred tax assets and liabilities for expected future taxconsequences of events that have been included in the financial statements orincome tax returns.  Under thismethodology, deferred tax assets and liabilities are determined based on thedifference between the financial statements and the tax basis of assets andliabilities using enacted tax rates in effect for the year in which thedifferences are expected to reverse.

 

**ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

InMarch 2004, we completed a private offering of the Original Notes.  At the same time, we entered into a $30.0million revolving working capital facility. We raised approximately $152.0 million, net of debt issuance costs andoriginal discount on the Original Notes. The proceeds, along with a drawdown from the revolver, were used to payoff existing debt of approximately $56.0 million and to fund a stockholderdividend to our parent to purchase shares of its common stock and warrants andfund compensation from the redemption of stock options of our parent, in theamount of $100.2 million.  In connectionwith the CityForest Acquisition in March 2007, we issued and soldapproximately $20 million of Additional Notes. Furthermore, we borrowed $17.4 million under our working capitalfacility.  As a result of thesetransactions, we are highly leveraged. As of February 29, 2008, $9.8 million of borrowings remainedoutstanding under the working capital facility and excess availability was$27.0 million.

 

Wehave minimal foreign currency translation risk. All international sales other than sales originating from our Canadiansubsidiary are denominated in U. S. dollars. Due to our Canadian operations, however, we could be adversely affectedby unfavorable fluctuations in foreign currency exchange rates.

 

**ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

SeeItem 15 for an index to financial statements and financial statementschedules.  Such financial statements andfinancial statement schedules are incorporated herein by reference.

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE**

 

None.

 

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**ITEM 9A(T).  CONTROLS AND PROCEDURES**

 

**EVALUATIONS OF INTERNAL CONTROLS ANDPROCEDURES**

 

Wecarried out an evaluation, under the supervision and with the participation ofour management, including our chief executive officer and principal financialofficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rule 13a-15(e) and 15d-15(e)),under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), asof the end of the period covered by this report.  Our chief executive officer and chieffinancial officer have concluded that, as of the end of such period, ourdisclosure controls and procedures were effective in ensuring them that allmaterial information required to be disclosed by us in this Annual Report on Form 10-Kwas recorded, processed, summarized, reported and properly disclosed in thetime period specified in the rules and regulations of the Securities andExchange Commission, and that such information was accumulated and communicatedto our management (including our chief executive officer and chief financialofficer) to allow timely decisions regarding required disclosure.  Based on such evaluation, our chief executiveofficer and chief financial officer have concluded that we are in compliancewith Rule 13a-15(e) of the Exchange Act.

 

**MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

Management of the Company is responsible for establishing andmaintaining adequate internal control over financial reporting. The Company’sinternal control over financial reporting is designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles in the United States of America. The Company’sinternal control over financial reporting includes those policies andprocedures that: (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples in the United States of America, and that receipts and expendituresof the Company are being made only in accordance with authorizations ofmanagement and directors of the Company; and (iii) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of the Company’s assets that could have a material effect onthe financial statements.

 

Any system of internal control, no matter how well designed, hasinherent limitations, including the possibility that a control can becircumvented or overridden and misstatements due to error or fraud may occurand not be detected in a timely manner. Also, because of changes in conditions,internal control effectiveness may vary over time. Accordingly, even aneffective system of internal control will provide only reasonable assurancewith respect to financial statement preparation.

 

Management assessed the effectiveness of the Company’s internal controlover financial reporting as of February 29, 2008. In making thisassessment, management used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in “InternalControl-Integrated Framework.” Based on management’s assessment using the COSOcriteria, management has concluded that the Company’s internal control overfinancial reporting was effective as of February 29, 2008.

 

This Annual Report does not include an attestation report of theCompany’s registered public accounting firm regarding internal control overfinancial reporting. Management’s report was not subject to attestation by theCompany’s registered public accounting firm pursuant to temporary rules ofthe Securities and Exchange Commission that permit the Company to provide onlymanagement’s report in this Annual Report.

 

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**CHANGES IN INTERNAL CONTROL OVER FINANCIALREPORTING**

 

Duringthe quarter ended February 29, 2008, there were no significant changes inour internal controls over financial reporting that have materially affected orare reasonably likely to materially affect our internal control over financialreporting.

 

**ITEM 9B. OTHER INFORMATION**

 

None.

 

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**PART III**

 

**ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

 

The following table sets forth certain informationregarding the members of our board of directors and our executiveofficers.  Each of our directors willhold office until removal by our parent as sole stockholder.  Our officers serve at the discretion of ourboard of directors.

 
| **Name**           | ** ** | **Age** | ** ** | **Position**                                                             |
|--------------------|------------|---------|------------|--------------------------------------------------------------------------|
| Russell C. Taylor  |       | 51      |       | President, Chief Executive  Officer and Director                         |
| David J. Morris    |       | 52      |       | Senior Vice President,  Finance and Chief Financial Officer              |
| W. Edwin Litton    |       | 44      |       | General Counsel, Senior  Vice President, Human Resources and Secretary   |
| Steven D. Ziessler |       | 48      |       | President,  Tissue & Machine-Glazed and Chief Operating Officer |
| R. Sean Honey      |       | 37      |       | Chairman  of the Board                                                   |
| Scott M. Bell      |       | 32      |       | Director                                                                 |
| David L. Ferguson  |       | 53      |       | Director                                                                 |

 

*Russell C. Taylor* has been ourpresident and chief executive officer since October 2001.  Mr. Taylor became a member of our boardof directors upon assuming his role as chief executive officer in October 2001.  Prior to that, he was employed by KimberlyClark Corporation, a manufacturer of personal care paper products, from May 1997to January 1999 as president, Kimberly Clark, Professional/Pulp, NorthAmerica/Europe, and from January 1999 to October 2001 as grouppresident, Kimberly Clark, Professional Pulp/Tissue Paper/Environmental, NorthAmerica/Europe.

 

*David J. Morris* has been ourchief financial officer and senior vice president, finance since August 2007.  Previously, Mr. Morris was employed byBlueLinx Holdings, Inc. as Chief Financial Officer and Treasurer from May 2004to December 2006.  Prior to thattime, Mr. Morris spent 14 years with Georgia-Pacific Corporation, mostrecently as Vice President of Finance for the distribution division since 1999.

 

*W. Edwin Litton* has been ourgeneral counsel and senior vice president of human resources since July 2006and secretary since December 2006. From August 2003 to July 2006, Mr. Litton was retained byus as outside counsel.  Mr. Littonserved as in-house legal counsel for Lacerte Technologies, Inc. from May 2002until May 2003 and was employed in the private practice of law from September 1990until April 2002.

 

*Steven D. Ziessler* has been ourpresident, tissue & machine-glazed and chief operating officer since August 2005.   Previously, Mr. Ziessler was employedby Kimberly Clark Corporation as (i) vice president, Global Health CareSales from January 2005 to April 2005; (ii) president, KimberlyClark Professional Europe from 2003 to 2004; and (iii) vice president ofsales, marketing and general manager from 1997 to 2003.

 

*R. Sean Honey*was appointed toour board of directors in June 2006 and has served as chairman since thatdate.  Mr. Honey is a partner withWeston Presidio, which he joined in 1999. Prior to that, Mr. Honey was with J.P. Morgan Capital (thepredecessor to JP Morgan Partners).

 

*Scott M. Bell*was appointed toour board of directors in January 2007. Mr. Bell joined Weston Presidio in 2004.  Prior to that, Mr. Bell worked as anassociate for Goldman, Sachs & Company.

 

*David L. Ferguson*was appointedto our board of directors in June 2006. Mr. Ferguson is a partner with Weston Presidio, which he joined in2003.  Prior to that, Mr. Fergusonwas a general partner of JP Morgan Partners. His prior work experience includes Bankers Trust New York Corporationand Prudential Securities, as well as the audit departments of KPMG PeatMarwick and Deloitte & Touche.

 

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**Shareholders’Agreement**

 

Cellu Parent, our indirect parent, has entered into aShareholders’ Agreement, dated as of June 12, 2006, with certain of itsstockholders, including Russell C. Taylor, our chief executive officer andpresident and a member of our board of directors, and Steven Ziessler,president, tissue & machine-glazed and chief operating officer.   Upon employment of David J. Morris in August 2007,this agreement was also executed with Mr. Morris, senior vice president,finance and chief financial officer.  Theagreement created certain rights and restrictions with respect to Cellu Parent’scommon stock, including restrictions on the transfer of stock, tag-alongrights, pre-emptive rights, call rights, co-sale rights, registration rightsand the right of Weston Presidio, in certain circumstances, to compel otherstockholders to sell their stock.

 

**CompensationCommittee Interlocks and Insider Participation**

 

Thereare no compensation committee interlocks (none of our executive officers servesas a member of the board of directors or the compensation committee of anotherentity that has an executive officer serving on our board of directors).

 

**Board ofDirectors and Committees**

 

Theboard of directors held four****meetingsduring fiscal year 2008.  During fiscalyear 2008, each director then in office attended 100% of the aggregate totalnumber of meetings of the board of directors held during the period in which hewas a director and the total number of meetings held by all of the committeesof the board of directors on which he served. The only standing committees of the board of directors are an auditcommittee and a compensation committee.

 

*Audit Committee*

 

R.Sean Honey, David L. Ferguson, and Scott Bell are members of the auditcommittee.  The audit committee isempowered to: (i)  appoint, fix the compensation of and oversee the workof our independent auditors (including the power to resolve any disagreementsbetween management and the independent auditors), with the independent auditorsreporting directly to the audit committee; (ii) pre-approve all auditservices and permissible non-audit services; (iii) establish proceduresfor whistleblower complaints; and (iv) engage and determine funding forindependent counsel and other advisors. The board of directors has determined that it currently does not have anaudit committee financial expert within the meaning of the rules of theSecurities and Exchange Commission serving on its audit committee.  In connection with the acquisition of ourparent by Weston Presidio in June 2006, the former director who served asan audit committee financial expert resigned as a member of the board ofdirectors.

 

*Compensation Committee*

 

R.Sean Honey and David L. Ferguson are members of the compensationcommittee.  The compensation committee isresponsible for (i) compensation of our executives; (ii) equity-basedcompensation plans, including, without limitation, stock option plans in whichofficers or employees participate; and (iii) arrangements with executiveofficers, relating to their employment relationships with us, including,without limitation, employment agreements and restrictive covenants.  The compensation committee has overall responsibilityfor approving and evaluating our executive officer compensation plans, policiesand programs, as well as all equity-based compensation plans and policies.  In addition, the compensation committeeoversees, reviews and approves all of our ERISA and other employee benefitplans.

 

**Code ofEthics**

 

Wehave adopted a Code of Ethics that applies to our chief executive officer,senior financial officer and other senior officers (as that term is defined inthe Code of Ethics).  A copy of the Codeof Ethics was filed with the Securities and Exchange Commission as Exhibit 14.1to our Annual Report on Form 10-K for the fiscal year ended February 28,2005.

 

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**ITEM 11.  EXECUTIVE COMPENSATION**

 

**COMPENSATION DISCUSSION ANDANALYSIS**

 

In this section, we will give an overview and analysisof our compensation program and policies, the material compensation decisionswe have made under those programs and policies, and the material factors thatwe considered in making those decisions. Later in this Part III under the heading “Additional InformationRegarding Executive Compensation,” you will find tables containing specificinformation about the compensation earned by the following individuals, all ofwhom received compensation in excess of $100,000 in fiscal year 2008, whom werefer to as our “named executive officers”:

 

·                  Russell C. Taylor, president, chiefexecutive officer and director

 

·                  David J. Morris, senior vicepresident, finance and chief financial officer since August 2007

 

·                  Dianne M. Scheu, who was senior vicepresident, finance and chief financial officer until July 31, 2007

 

·                  W. Edwin Litton, general counsel,senior vice president, human resources and secretary

 

·                  Steven D. Ziessler, president andchief operating officer

 

The discussion below is intended to help youunderstand the detailed information provided in those tables and put thatinformation into context within our overall compensation program.

 

**Compensation Philosophy**

 

Our compensation programs are designed to attract,motivate and retain key employees, rewarding them for the achievement ofsignificant goals that continuously improve our business performance andincrease our value.  Performance andcompensation are evaluated annually****to ensure thatwe maintain our ability to attract and retain outstanding employees in keypositions and that compensation provided to our key employees is competitiverelative to the compensation paid to similarly situated employees of comparablecompanies.

 

Our compensation decisions with respect to executiveofficer salaries and annual incentives, as well as long-term incentives such asrestrictive stock awards and stock option grants, are influenced by (a) theexecutive’s level of responsibility and function, (b) our overallperformance and profitability and (c) our assessment of the competitivemarketplace, including other peer companies. As discussed below in more detail, our philosophy is to focus on totaldirect compensation opportunities through a mix of base salary and annual cashbonus, as applicable, and long-term incentives, including stock-based awards.

 

**Overview of Compensation Committee**

 

Our executive compensation philosophy, policies, plansand programs are under the supervision of the compensation committee of ourboard of directors.  The compensationcommittee’s responsibilities include (i) compensation of our executives; (ii) administrationand overview of equity-based compensation plans, including, without limitation,the 2006 Stock Option and Restricted Stock Plan, in which officers andemployees may participate and (iii) arrangements with executive officersrelated to their employment relationships with us, including, withoutlimitation, employment agreements and restrictive covenants.  The compensation committee has overallresponsibility for approving and evaluating our executive officer compensationplans, policies and programs, as well as all equity-based compensation plansand policies.

 

**Overview of Compensation Program**

 

Throughout this narrative discussion and in theaccompanying tables, we refer to our named executive officers.  The key compensation package provided to ournamed executive officers includes:

 

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·                  base salary, which provides fixedcompensation based on competitive market practice and, except for W. EdwinLitton, in accordance with the terms of each individual’s employment agreement;

 

·                  bonus/performance-based incentivecompensation, which provides focus on meeting corporate****annualgoals that lead to our long-term success and motivates achievement of criticalannual performance metrics;

 

·                  equity compensation, as applicable,in the form of restrictive stock awards or stock option grants by Cellu Parent,our indirect parent, which is designed to reward and motivate employees byaligning their interests with those of the stockholders of Cellu Parent andprovide an opportunity to acquire an indirect proprietary interest in theCompany;

 

·                  our matching cash contributions toour named executive officers who participate in our 401(k) Plan; and

 

·                  other benefits.

 

**Determination of Appropriate Pay Levels**

 

We compete with many other companies for experiencedand talented executives.  As such, marketinformation  is reviewed to assist indetermining the reasonableness of our compensation and ensuring thatcompensation levels remain competitive in the marketplace.  As described elsewhere in this Annual Report,three of our executive officers entered into employment agreements with us thatestablish various terms and conditions of their employment  For a further description of theseagreements, see “Additional Information Regarding Executive Compensation–EmploymentAgreements; Restricted Stock Award Agreements”

 

Each element of compensation (including any baseadjustments to the terms and conditions set forth in the employment agreements)is reviewed so that the overall compensation package will attract, motivate andretain our key employees, including our named executive officers, by rewardingsuperior performance and providing an incentive for the achievement of ourstrategic goals.  The following factorsare considered to determine the amount of compensation paid to each executiveofficer:

 

·                  overall job performance, includingperformance against corporate and individual objectives;

 

·                  job responsibilities, includingunique skills necessary to support our long-term corporate performance;

 

·                  teamwork, both contributions as amember of the executive management team and fostering an environment ofpersonal and professional growth for the entire work force;

 

·                  performance of general managementresponsibilities, execution of our objectives and contributions to ourcontinuing success; and

 

·                  our overall financial position andproviding for an equitable distribution of compensation.

 

**Allocation of Compensation**

 

There is no pre-established policy or target for theallocation of compensation, other than the employment agreements as previouslyreferenced.  The factors described above,as well as the overall compensation philosophy, and compensation is reviewed todetermine appropriate level and mix of compensation.

 

**Timing of Compensation**

 

As discussed elsewhere, compensation for our namedexecutive officers is reviewed annually, including incentive plan goalspecifications and incentive plan payments for our named executive officers.

 

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**Minimum Stock Ownership Requirements**

 

We do not have any minimum stock ownershipguidelines.  All of our shares arebeneficially owned by our parent, and all of the shares of our parent arebeneficially owned by Cellu Parent, our indirect parent.  All of the named executive officers, however,currently beneficially own shares of restrictive stock, or stock options topurchase common stock, of Cellu Parent.

 

**Compensation Components for Fiscal Year 2008**

 

For fiscal year 2008, the principal components ofcompensation for the named executive officers were:

 

·                  base salary;

 

·                  bonus;

 

·                  equity awards under the 2006 StockOption and Restricted Stock Plan of Cellu Parent and the 2001 Stock IncentivePlan of Cellu Holdings; and

 

·                  401(k) and other benefits.

 

*Base Salary*

 

We provided our named executive officers and otherofficers with a base salary to compensate them for services rendered during thefiscal year.  In general, base salaryranges are determined for each executive based on his or her position andresponsibility.  Base salary levels arereviewed annually, as part of our performance review process, and adjustmentsare made.

 

On July 12, 2006 in connection with the Merger,we entered into employment agreements with each of Russell C. Taylor, Dianne M.Scheu (former Senior Vice President, Finance and Chief Financial Officer), and Steven Ziessler.   On August 2, 2007, we entered into anemployment agreement with David J. Morris, Senior Vice President, Finance and Chief Financial Officer.  We discuss the terms and conditions of theseagreements elsewhere in this Part III under “Additional InformationRegarding Executive Compensation–Employment Agreements; Restricted Stock AwardAgreements.”

 

*Annual Bonus Compensation*

 

On March 27, 2006, we entered into bonusagreements with Messrs. Taylor and Ziessler and Ms. Scheu pursuant towhich each such executive officer was entitled to receive a fixed amountone-time stay cash bonus as an incentive to continue employment with us upthrough and including the effective date of the Merger.  Pursuant to the bonus agreements for fiscalyear 2007, each of the applicable executive officers received a lump sum cashpayment equal to one year’s current base salary.   The bonus payments are reflected in Column (d) ofthe Summary Compensation Table.

 

For fiscal year 2008, and for each fiscal yearthereafter, named executive officers are eligible to receive an annualincentive-based cash bonus of up to 100% of base salary, subject to theachievement by us of certain EBITDA targets set by the chairman of our board ofdirectors and approved by the Compensation Committee.   It is anticipated that, for each fiscalyear, a range of EBITDA targets will be set for each executive officer, usuallyin the first quarter of such fiscal year. Each EBITDA target will be expressed as a percentage of base salary,ranging from 0% to 100%.  Performancemeasures for each fiscal year will be reviewed and performance incentive awardsgranted by the Compensation Committee to executive officers, as applicable.

 

For fiscal year 2008, the bonus pool is subject to usachieving minimum adjusted EBITDA of at least $44.0 million.  The maximum bonus pool amount is realized iffiscal year 2008 adjusted EBITDA of $49 million is achieved.  If fiscal year 2008 adjusted EBITDA isbetween $44.0 and $49.0 million, then the bonus pool will be prorated, between50% and 100% based on the fiscal year 2008 adjusted EBITDA achieved.  If the bonus pool is earned, then it will bedistributed to executive officers, based on their respective base salaries,with a maximum paid out of 50% or 100% of their respective base salaries,dependent upon the executive’s position. The bonus pool payout for fiscal year 2008 was 85.5% of target, whichwill be paid in the first quarter of fiscal year 2009.

 

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*Equity Awards*

 

OnJune 12, 2006, the board of directors of Cellu Parent adopted the 2006Stock Option and Restricted Stock Plan, or the Plan.  Under the Plan, the board of directors ofCellu Parent or its delegate (referred to as the plan administrator) may grantto participants, including named executive officers, stock option awards topurchase shares of common stock of Cellu Parent and/or awards of restrictedshares of common stock of Cellu Parent. A maximum of 8,095 shares of common stock of Cellu Parent may bedelivered in satisfaction of awards under the Plan, determined net of shares ofcommon stock withheld by Cellu Parent in payment of the exercise price of anaward or in satisfaction of tax-withholding requirements.  Key employees and directors of, andconsultants and advisors to, Cellu Parent or its affiliates who, in the opinionof the plan administrator, are in a position to make a significant contributionto the success of Cellu Parent and its affiliates are eligible to participatein the Plan.   Stock options are grantedat the fair market value as determined by the plan administrator in accordancewith the applicable regulations of the Code on the date of grant and have a10-year term.  Generally, stock optiongrants vest ratably over four years from the date of grant.

 

*401(k) and Other Benefits*

 

401(k) Plan

 

We have a Savings Incentive and Profit-Sharing Planqualified under Section 401(k) of the Code, which is available to allour employees who are 21 years of age or older with one or more years ofservice.  Employees may contribute up to20% of their annual compensation (subject to certain statutory limitations) tothe plan through voluntary salary deferred payments.  We match 100% of each employee’s contributionup to 2% of the employee’s salary and 70% of the employee’s remainingcontribution up to 6% of the employee’s salary. Eligible named executive officers participated in the 401(k) Planin fiscal year 2008 and 2007 and received matching contributions from us underthe 401(k) Plan as follows:

 
| **Named Executive** | ** ** | **2008 Matching Contributions  under the 401(K) Plan** | ** ** | **2007 Matching Contributions  under the 401(K) Plan** | ** ** |
|--------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| Russell C. Taylor        |       | $                                                                               | 10,812     |                                                                            | $          | 4,562 |   |
| David J. Morris          |       | $                                                                               | 2,308      |                                                                            | N/A        |   |
| Dianne M. Scheu          |       | $                                                                               | 4,390      |                                                                            | $          | 4,100 |   |
| Steven D. Ziessler       |       | N/A                                                                             |       | N/A                                                                             |       |
| W. Edwin Litton          |       | $                                                                               | 8,630      |                                                                            | $          | 1,328 |   |

 

Other Benefits

 

Each of the named executive officers receives medicaland dental insurance coverage on the same terms as other employees.

 

**Accounting and Tax Considerations**

 

We adopted the provisions of SFAS 123R using theprospective method effective March 1, 2006.  There was no accounting effect on any of theoutstanding awards of restricted common stock units.

 

44

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**COMPENSATION COMMITTEE REPORT**

** **

The compensation committee of our board of directorshas reviewed and discussed the Compensation Discussion and Analysis required byItem 402(b) of Regulation S-K with management and, based on such reviewand discussions, the compensation committee recommended to the board ofdirectors that the Compensation Discussion and Analysis be included in thisAnnual Report onForm 10-K.

 

 
|   | THE COMPENSATION COMMITTEE |
|--------|----------------------------|
|   |                       |
|   | R. Sean Honey              |
|   | David L. Ferguson          |

 

**ADDITIONAL INFORMATION REGARDINGEXECUTIVE COMPENSATION**

** **

**Summary Compensation Table**

** **

The following table shows the compensation earned forservices rendered to us and our subsidiaries in fiscal year 2008 and fiscalyear 2007 by each of our named executive officers.

 
| **Name and  principal  position  (a)**                               | ** ** | **Fiscal  Year  (b)** | ** ** | **Salary  (c)** | ** ** | **Bonus (1)  (d)** | ** ** | **Stock  Award (2)  (e)** | ** ** | **Option  Awards  (3)  (f)** | ** ** | **Non-Equity  Incentive Plan  Compensation  (4)  (g)** | ** ** | **Change in  Pension  Value and  Nonquali-  fied  Deferred  Compen-  sation  Earnings  (h)** | ** ** | **All Other  Compensation  (i)** | ** ** | **Total  (j)** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|-------------------------|------------|--------------------------------|------------|------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|----------------|------------|
| Russell C.  Taylor, President and                                         |       | 2008                  |       | $               | 475,000    |                    | $          | —                         |       | $                            | 403,009    |                                                        | $          | —                                                                                                 |       | $                                     | 406,125    |           | $          | — |   | $ | 10,812 | (5) | $ | 1,294,946  |   |
| Chief Executive  Officer                                                  |       | 2007                  |       | $               | 469,428    |                    | $          | 425,000                        |       | $                            | 287,075    |                                                        | $          | —                                                                                                 |       | $                                     | —     |           | $          | — |   | $ | 4,562 | (5) | $ | 1,186,065 |   |
|                                                                      |       |                  |       |            |       |                    |       |                           |       |                         |       |                                                        |       |                                                                                                   |       |                                  |       |           |       |
| David J. Morris,  Senior Vice President, Finance, and Chief               |       | 2008                  |       | $               | 144,231    |                    | $          | —                         |       | $                            | 611,170    |                                                        | $          | —                                                                                                 |       | $                                     | 60,738     |           | $          | — |   | $ | 2,308 | (5) | $ | 818,447 |   |
| Financial  Officer  (6)                                              |       | 2007                  |       | $               | —     |                    | $          | —                         |       | $                            | —     |                                                        | $          | —                                                                                                 |       | $                                     | —     |           | $          | — |   | $ | — |   | $ | — |   |
|                                                                      |       |                  |       |            |       |                    |       |                           |       |                         |       |                                                        |       |                                                                                                   |       |                                  |       |           |       |
| Dianne M. Scheu,  Senior Vice President, Finance, and Chief               |       | 2008                  |       | $               | 97,308     |                    | $          | —                         |       | $                            | 41,002     |                                                        | $          | —                                                                                                 |       | $                                     | 81,938     |           | $          | — |   | $ | 4,390 | (5) | $ | 224,638 |   |
| Financial Officer  (7)                                                    |       | 2007                  |       | $               | 228,654    |                    | $          | 230,000                        |       | $                            | 858,380    |                                                        | $          | —                                                                                                 |       | $                                     | —     |           | $          | — |   | $ | 4,100 | (5) | $ | 1,321,134 |   |
|                                                                      |       |                  |       |            |       |                    |       |                           |       |                         |       |                                                        |       |                                                                                                   |       |                                  |       |           |       |
| Steven Ziessler,  President, Tissue and Machine-Glazed  & Chief  |       | 2008                  |       | $               | 267,127    |                    | $          | —                         |       | $                            | 143,901    |                                                        | $          | —                                                                                                 |       | $                                     | 235,125    |           | $          | — |   | $ | — |   | $ | 646,153 |   |
| Operating Officer                                                         |       | 2007                  |       | $               | 247,885    |                    | $          | 250,000                        |       | $                            | 892,432    |                                                        | $          | —                                                                                                 |       | $                                     | —     |           | $          | — |   | $ | — |   | $ | 1,390,317 |   |
|                                                                      |       |                  |       |            |       |                    |       |                           |       |                         |       |                                                        |       |                                                                                                   |       |                                  |       |           |       |
| W. Edwin Litton,  General Counsel, Senior Vice President, Human Resources |       | 2008                  |       | $               | 172,000    |                    | $          | —                         |       | $                            | —     |                                                        | $          | 8,234                                                                                                  |       | $                                     | 73,530     |           | $          | — |   | $ | 8,630 | (5) | $ | 262,403 |   |
| and Secretary                                                             |       | 2007                  |       | $               | 102,314    |                    | $          | —                         |       | $                            | —     |                                                        | $          | 3,139                                                                                                  |       | $                                     | —     |           | $          | — |   | $ | 1,328 | (5) | $ | 106,781 |   |

 

45

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----

(1)                                  Amountsfor fiscal year 2007 represent one-time stay bonuses in fixed amounts pursuantto bonus agreements entered into with certain named executives in connectionwith the Merger.  See further discussionunder “Bonus Agreements.”  Amounts forfiscal year 2008 represent incentive-based cash awards and are reported undercolumn (g) of this Summary Compensation Table.

** **

(2)                                  Reflectsshares of restricted stock of (i) our parent granted under the Cellu PaperHoldings, Inc. 2001 Incentive Plan that fully vested at the effective dateof the Merger and were repurchased by our parent in fiscal year 2007 (Mr. Ziessler–$478,816;and Ms. Scheu–$444,764); and (ii) Cellu Parent granted under the 2006Stock Option and Restricted Stock Plan in fiscal year 2008 and fiscal year2007, respectively,  (Mr. Taylor–$403,009and $287,075; Mr. Morris - $97,188 and $0; Mr. Ziessler–$143,901 and$102,505; and Ms. Scheu–$41,002 and $102,505) and the gross-up amount paidrelated thereto in fiscal year 2007 (each of Mr. Ziessler and Ms. Scheu–$311,111)  and in fiscal year 2008 (Mr. Morris-$513,982).  The amounts in column (e) represent theproportionate amount of the total fair value of restricted stock recognized byus as an expense in fiscal year 2008 and fiscal year 2007 for financialaccounting purposes, disregarding for this purpose the estimate of forfeituresrelated to service-based vesting conditions. The fair values of these awards and the amounts expensed in fiscal year2007 and fiscal year 2008 were determined in accordance with FAS No. 123R.  The awards for which expense is shown incolumn (e) include the awards described in the Grants of Plan-Based Awardsincluded elsewhere in this section.  Theassumptions used in determining the grant date fair values of these awards areset forth in Note 2 to our consolidated financial statements included elsewherein this Annual Report.

 

(3)                               Reflectsoptions granted under the 2006 Stock Option and Restricted Stock Plan topurchase shares of common stock of Cellu Parent upon exercise of such options.The amounts in column (f) represent the proportionate amount of the totalfair value of options recognized by us as an expense in fiscal year 2007andfiscal year 2008 for financial accounting purposes, disregarding for thispurpose the estimate of forfeitures related to service-based vestingconditions.  The fair values of theseawards and the amounts expensed in fiscal year 2007and fiscal year 2008 weredetermined in accordance with FAS No. 123R.  The awards for which expense is shown incolumn (f) include the awards described in the Grants of Plan-Based Awardsincluded elsewhere in this section.   Theassumptions used in determining the grant date fair values of these awards areset forth in Note 2 to our consolidated financial statements included elsewherein this Annual Report.

 

(4)                               Theamounts in column (g) represent the incentive-based cash awards earned infiscal year 2008 and payable in the fiscal year ending February 28, 2009,which are further discussed under “Compensation Discussion andAnalysis-Compensation Components for Fiscal Year 2008-Annual Bonus Compensation”and, which, for purposes of this Summary Compensation Table, have beencharacterized as “Non-Equity Incentive Plan Compensation” under this column (g) ratherthan “Bonus” under column (d).

 

(5)                               Reflectsmatching contributions to the 401(k) plan.

 

46

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(6)                               Mr. Morriscommenced employment with us as chief financial officer and senior vicepresident, finance on August 6, 2007.

 

(7)                               Ms. Scheuresigned as senior vice president, finance and chief financial officer on July 31,2007.

 

**EmploymentAgreements; Restricted Stock Award Agreements**

** **

We have enteredinto an employment agreement with Russell Taylor, dated June 12, 2006,pursuant to which Mr. Taylor will continue to serve as our chief executiveofficer and president.  The agreement isfor a term of four years, commencing on June 12, 2006, and will automaticallyextend for successive terms of one year each, unless either Mr. Taylor orwe provide notice to the other at least 60 days prior to the expiration of theoriginal or any extension term that the agreement is not to be extended.  The agreement provides Mr. Taylor withan annual base salary of $475,000, a bonus opportunity of up to 100% of basesalary and certain severance benefits under the following circumstances:

 

(A)          If Mr. Taylor’s employment isterminated due to death or disability, he will be entitled to (i) anyearned, but unpaid, base salary through the date of termination; (ii) anyearned, but unpaid, annual bonus for any fiscal year prior to the fiscal yearof his termination; (iii) a pro rata portion of his Target Bonus (asdefined); (iv) a lump sum payment equal to the lesser of (A) 12months of base salary or (B) base salary for a period equal to theremainder of the term of the employment agreement; and (v) any reimbursedbusiness expenses.

 

(B)           If Mr. Taylor’s employment istermination by us without cause (as defined) or by him with good reason (asdefined), he will be entitled to (i) any earned, but unpaid, base salarythrough the date of termination; (ii) any earned, but unpaid, annual bonusfor any fiscal year prior to the fiscal year of his termination; (iii) apro rata portion of his Target Bonus; (iv) a lump sum payment equal to thegreater of (a) 24 months of base salary or (b) base salary for aperiod equal to the remainder of the term of the employment agreement; (v) alump sum equal to the greater of (x) one times the Target Bonus or (y) paymentof the Target Bonus with respect to a period equal to the remainder of theterm; and (vi) any reimbursed business expenses.

 

(C)           If Mr. Taylor’s employment isterminated by non-renewal of his employment agreement by us for any reason(other than for cause), he will be entitled to (i) any earned, but unpaid,base salary through the date of termination; (ii) any earned, but unpaid,annual bonus for any fiscal year prior to the fiscal year of his termination; (iii) apro rata portion of his Target Bonus; (iv) a lump sum payment equal to 24months of base salary; and (v) any reimbursed business expenses.

 

If a change of control (asdefined) occurs and, within three months before and two years following suchchange of control, we terminate Mr. Taylor’s employment other than forcause or by reason of death or disability, or Mr. Taylor terminates hisemployment for good reason, then, in lieu of any payments otherwise due underClauses (B) or (C) he will be entitled to (i) any earned, butunpaid, base salary through the date of termination; (ii) any earned, butunpaid, annual bonus for any fiscal year prior to the fiscal year of histermination; (iii) a pro rata portion of his Target Bonus; (iv) alump sum payment equal to the greater of (a) 36 months of base salary or (b) basesalary for a period equal to the remainder of the term of the employmentagreement; (v) a lump sum equal to the greater of (x) one times theTarget Bonus or (y) payment of the Target Bonus with respect to a periodequal to the remainder of the term of the employment agreement; and (vi) anyreimbursed business expenses.

 

In addition, the agreementalso provides that, during the term and for a period of one year after the endof the term, we will pay the premium for a term life insurance policy covering Mr. Taylorin the amount of $1,000,000.  Theagreement includes a non-competition and non-solicitation covenant by Mr. Taylorthat extends during the term of his employment and for two yearsthereafter.  The agreement also providesthat Mr. Taylor will receive an award of restricted shares of Cellu Parent’scommon stock, or the Cellu Parent Shares, pursuant to the 2006 Stock Option andRestricted Stock Plan, and a Restricted Stock Award Agreement.  On June 12,2006, Cellu Parent awarded Mr. Taylor 3,778 Cellu Parent Shares.  The Cellu Paent Shares are subject to vestingin accordance with the following vesting schedule:  (1) 25% of the Cellu 

 

47

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Parent Shares are vested onand after June 12, 2007; (2) an additional 25% of the Cellu ParentShares are vested on and after June 12, 2008; (3) an additional 25%of the Cellu Parent Shares are vested on and after June 12, 2009; and (4) anadditional 25% of the Cellu Parent Shares are vested on and after June 12,2010.  None of the Cellu Parent Shareswill vest on any vesting date unless Mr. Taylor is then, and since thedate of the award has continuously been, employed by Cellu Parent or itssubsidiaries (including the Company).  IfMr. Taylor ceases to be employed by Cellu Parent or its subsidiaries, anythen outstanding and unvested Cellu Parent Shares will be automatically andimmediately forfeited, unless employment ceases due to death or disability, inwhich case 50% of the Cellu Parent Shares that are not then already vested willvest, or unless employment ceases by reason of Cellu Parent’s election not torenew the employment agreement (and, at the time of such election, there existsno cause for the termination), in which case one hundred percent 100% of theCellu Parent Shares that are not then already vested will vest.  The foregoing description is qualified in itsentirety by reference to the actual employment agreement executed with Mr. Taylor.

 

We have entered into anemployment agreement with David Morris, dated August 6, 2007, pursuant towhich Mr. Morris will continue to serve as our chief financialofficer.  The agreement is for a term offour years, commencing on August 6, 2007, and will automatically extendfor successive terms of one year each, unless either Mr. Morris or weprovide notice to the other at least 60 days prior to the expiration of theoriginal or any extension term that the agreement is not to be extended.  The agreement provides Mr. Morris withan annual base salary of $250,000, a bonus opportunity of up to 100% of basesalary, and certain severance benefits under the following circumstances:

 

(A)          If Mr. Morris’ employment isterminated due to death or disability, he will be entitled to (i) anyearned, but unpaid, base salary through the date of termination; (ii) anyearned, but unpaid, annual bonus for any fiscal year prior to the fiscal yearof his termination; (iii) a pro rata portion of his Target Bonus; (iv) alump sum payment equal to the lesser of (A) 12 months of base salary orbase salary for a period equal to the remainder of the term of the employmentagreement; and (v) any reimbursed business expenses.

 

(B)           IfMr. Morris’ employment is termination by us without cause or by him withgood reason, he will be entitled to (i) any earned, but unpaid, basesalary through the date of termination; (ii) any earned, but unpaid,annual bonus for any fiscal year prior to the fiscal year of his termination; (iii) apro rata portion of his Target Bonus; (iv) a lump sum payment equal to 24months of base salary; (v) a lump sum equal to one times the Target Bonus;and (vi) any reimbursed business expenses.

 

(C)           If Mr. Morris’ employment isterminated by non-renewal of his employment agreement by us for any reason(other than for cause), he will be entitled to (i) any earned, but unpaid,base salary through the date of termination; (ii) any earned, but unpaid,annual bonus for any fiscal year prior to the fiscal year of his termination; (iii) apro rata portion of his Target Bonus; (iv) a lump sum payment equal to 24months of base salary; and (v) any reimbursed business expenses.

 

The agreementalso provides that Mr. Morris will receive an award of Cellu ParentShares, pursuant to the 2006 Stock Option and Restricted Stock Plan, and aRestricted Stock Award Agreement.  On August 6, 2007, Cellu Parent awarded Mr. Morris700 Cellu Parent Shares.  The vesting and forfeiture terms applicableto Mr. Morris’ award are the same as those applicable to Mr. Taylor’saward as described above.  Theforegoing description is qualified in its entirety by reference to the actualemployment agreement executed with Mr. Morris.

 

We have entered into anemployment agreement with Steven Ziessler, dated June 12, 2006, pursuantto which Mr. Ziessler will continue to serve as our chief operatingofficer.  The agreement is for a term offour years, commencing on June 12, 2006, and will automatically extend forsuccessive terms of one year each, unless either Mr. Ziessler or weprovide notice to the other at least 60 days prior to the expiration of theoriginal or any extension term that the agreement is not to be extended.  The agreement provides Mr. Ziessler withan annual base salary of $250,000, a bonus opportunity of up to 100% of basesalary, and certain severance benefits under the following circumstances:

 

48

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(A)          If Mr. Ziessler’s employment isterminated due to death or disability, he will be entitled to (i) anyearned, but unpaid, base salary through the date of termination; (ii) anyearned, but unpaid, annual bonus for any fiscal year prior to the fiscal yearof his termination; (iii) a pro rata portion of his Target Bonus; (iv) alump sum payment equal to the lesser of (A) 12 months of base salary orbase salary for a period equal to the remainder of the term of the employmentagreement; and (v) any reimbursed business expenses.

 

(B)           IfMr. Ziessler’s employment is termination by us without cause or by himwith good reason, he will be entitled to (i) any earned, but unpaid, basesalary through the date of termination; (ii) any earned, but unpaid,annual bonus for any fiscal year prior to the fiscal year of his termination; (iii) apro rata portion of his Target Bonus; (iv) a lump sum payment equal to 24months of base salary; (v) a lump sum equal to one times the Target Bonus;and (vi) any reimbursed business expenses.

 

(C)           If Mr. Ziessler’s employment isterminated by non-renewal of his employment agreement by us for any reason(other than  for cause), he will beentitled to (i) any earned, but unpaid, base salary through the date oftermination; (ii) any earned, but unpaid, annual bonus for any fiscal yearprior to the fiscal year of his termination; (iii) a pro rata portion ofhis Target Bonus; (iv) a lump sum payment equal to 24 months of basesalary; and (v) any reimbursed business expenses.

 

In addition, the agreementalso provides that, during the term and for a period of one year after the endof the term, we will pay the premium for a term life insurance policy covering Mr. Ziesslerin the amount of $1,000,000.  Theagreement includes a non-competition and non-solicitation covenant by Mr. Ziessler that extends duringthe term of his employment and for two years thereafter.  The agreement also provides that Mr. Ziesslerwill receive an award of Cellu Parent Shares, pursuant to the 2006 Stock Optionand Restricted Stock Plan, and a Restricted Stock Award Agreement.  On June 12,2006, Cellu Parent awarded Mr. Ziessler 1,349 Cellu Parent Shares.  Thevesting and forfeiture terms applicable to Mr. Ziessler’s award are thesame as those applicable to Mr. Taylor’s award as described above.  The foregoing description is qualifiedin its entirety by reference to the actual employment agreement executed with Mr. Ziessler.

 

Inthe case of termination for any of the above-referenced reasons, for each ofthe named executive officers (x) we shall continue the insurance coveragebenefits for the period contemplated therein, and (y) subject to anyemployee contribution applicable to employees and their dependents, generallyfor the period following termination of 24 months (36 months in the case of achange in control for Mr. Taylor), or if earlier, until the date that theexecutive becomes eligible for coverage with a subsequent employer, we willcontinue to contribute to the premium cost of coverage for the executive andthe executive’s dependents under our medical and dental plans provided that atimely election is made pursuant to the Consolidated Omnibus BudgetReconciliation Act of 1985, as amended, or COBRA, at the executive’sexpense.  Each of the executives may alsobe entitled to receive a gross-up payment in certain circumstances if paymentsor benefits provided trigger an excise tax under Section 4999 of the Code,but only if the payments and benefits provided exceed 105% of the greatestamount that could be paid without triggering the excise tax.  If the payments and benefits provided do notexceed 105% of the greatest amount that could be paid without triggering theexcise tax, then the payments and benefits will be reduced to the greatestamount that could be paid without triggering the excise tax.

** **

***2006Stock Option and Restricted Stock Plan***

*** ***

Theboard of directors of Cellu Parent has adopted the 2006 Stock Option andRestricted Stock Plan.  The 2006 StockOption and Restricted Stock Plan authorizes the award of incentive stockoptions, which are stock options that qualify for special federal income taxtreatment.  The exercise price of anystock option granted under the 2006 Stock Option and Restricted Stock Plan maynot be less than the fair market value of the common stock on the date ofgrant.  In general, each option grantedunder the 2006 Stock Option and Restricted Stock Plan vests annually in fourequal installments and expires ten years from the date of grant, subject toearlier expiration in case of termination of employment.   The vesting period is subject tocertain acceleration provisions if a change in control occurs.   The Plan also authorizes awards ofrestricted stock.  On June 12, 2006,in connection with the Merger, Cellu Parent entered into Restricted StockAgreements 

 

49

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withMessrs Taylor and Ziessler and Ms. Scheu, pursuant to which Cellu Parentgranted 3,778 restricted shares of its common stock to Mr. Taylor and1,349 restricted shares of its common stock to each of Mr. Ziessler and Ms. Scheu.  Effective July 31, 2007, Ms. Scheuresigned and forfeited three-fourths of her restricted stock grant.

 

OnAugust 6, 2007, David Morris received a restricted stock grant of 700shares.

 

***2001Stock Incentive Plan***

*** ***

Prior to the merger, theboard of directors of our parent, Cellu Paper, adopted the 2001 Stock IncentivePlan, or the 2001 Plan.  The 2001 Planauthorized the award of incentive stock options, which are stock options thatqualify for special federal income tax treatment, to purchase shares of commonstock of Cellu Paper.  The 2001 Plan alsoauthorized awards of restricted stock of Cellu Paper.  On March 27, 2006, prior to the Merger,our parent entered into Restricted Stock Agreements with Dianne Scheu andSteven Ziessler, pursuant to which our parent granted 170.65 restricted sharesof its common stock to each of Dianne Scheu and Steven Ziessler pursuant to the2001 Plan.  In accordance with the termsof the 2001 Plan, the shares of restricted stock fully vested at the effectivedate of the Merger and were repurchased by our parent.  In addition, our parent paid an additionalamount to Ms. Scheu and Mr. Ziessler, as the case may be, to fullygross up her or him, as applicable, for the amount included in gross income forincome tax purposes as a result of making a Section 83(b) electionunder the Code.  The 2001 Plan wasterminated at the effective date of the Merger.

 

**BonusAgreements**

 

On March 27, 2006, we entered into bonusagreements with each of Russell Taylor, Dianne Scheu and Steven Ziessler.  Pursuant to the bonus agreements, each of theexecutive officers was entitled to receive a fixed amount one-time stay bonusas an incentive to continue employment with us up through and including theeffective date of the Merger.  Pursuantto the bonus agreements, each of the executive officers was entitled to receivea lump sum cash payment equal to one year’s current base salary upon theexecution of the applicable agreement. The bonus payments, as reflected in Column (d) of the SummaryCompensation Table, were $425,000 for Mr. Taylor, $230,000 for Ms. Scheuand $250,000 for Mr. Ziessler.

 

50

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**GRANTSOF PLAN-BASED AWARDS FOR FISCAL YEAR 2008**

 
| **Name (a)** | ** ** | **Grant  Date  (b)** | ** ** | **Estimated  Potential/  Future  Payouts  Under  Non-  Equity  Incentive  Plan  Awards  Threshold  ($) (c)** | ** ** | **Estimated  Potential/  Future  Payouts  Under  Non-  Equity  Incentive  Plan  Awards  Target  ($)(d)** | ** ** | **Estimated  Potential/  Future  Payouts  Under  Non-  Equity  Incentive  Plan  Awards  Max  ($)(e)** | ** ** | **Threshold  ($) (f)** | ** ** | **Target  ($)(g)** | ** ** | **Max  ($)(h)** | ** ** | **All Other  Stock  Awards  Number  of Shares  of Stock  or Units  (#)(i)** | ** ** | **All Other  Option  Awards:  Number  of  Securities  Underlying  Options  (#) (j)** | ** ** | **Exercise  or Base  Price of  Option  Awards  ($/SH) (k)** | ** ** | **Grant Date  Fair Value of  Stock and  Option  Awards (1)  (l)** | ** ** |
|-------------------|------------|----------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------|------------|-----------------|------------|-------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| Russell Taylor    |       | —               |       | —                                                                                                            |       | —                                                                                                   |       | —                                                                                                |       | —                      |       | —             |       | —          |       | —                                                                                          |       | —                                                                                         |       | —                                                                     |       | —                                                                                     |       |
|              |       |                 | (2)        | $                                                                                                                 | 237,500    |                                                                                                     | $          | 406,125                                                                                               |       | $                           | 475,000    |               | —     |            | —     |                                                                                            | —     |                                                                                           | —     |                                                                       | —     |                                                                                       | —     |   | — |   |
|              |       |                 |       |                                                                                                              |       |                                                                                                     |       |                                                                                                  |       |                        |       |               |       |            |       |                                                                                            |       |                                                                                           |       |                                                                       |       |                                                                                       |       |
| David Morris      |       | 8/07                 |       | —                                                                                                            |       | —                                                                                                   |       | —                                                                                                |       | —                      |       | —             |       | —          |       | 700                                                                                             | (3)        | —                                                                                         |       | $                                                                          | 979.25     |                                                                                       | $          | 685,475 |   |
|              |       |                 | (2)        | $                                                                                                                 | 35,519     |                                                                                                     | $          | 60,738                                                                                                |       | $                           | 71,038     |               | —     |            | —     |                                                                                            | —     |                                                                                           | —     |                                                                       | —     |                                                                                       | —     |   | — |   |
|              |       |                 |       |                                                                                                              |       |                                                                                                     |       |                                                                                                  |       |                        |       |               |       |            |       |                                                                                            |       |                                                                                           |       |                                                                       |       |                                                                                       |       |
| Steven. Ziessler  |       | —               |       | —                                                                                                            |       | —                                                                                                   |       | —                                                                                                |       | —                      |       | —             |       | —          |       | —                                                                                          |       | —                                                                                         |       | —                                                                     |       | —                                                                                     |       |
|              |       |                 | (2)        | $                                                                                                                 | 137,500    |                                                                                                     | $          | 235,125                                                                                               |       | $                           | 275,000    |               | —     |            | —     |                                                                                            | —     |                                                                                           | —     |                                                                       | —     |                                                                                       | —     |   | — |   |
|              |       |                 |       |                                                                                                              |       |                                                                                                     |       |                                                                                                  |       |                        |       |               |       |            |       |                                                                                            |       |                                                                                           |       |                                                                       |       |                                                                                       |       |
| Edwin Litton      |       | 4/07                 |       | —                                                                                                            |       | —                                                                                                   |       | —                                                                                                |       | —                      |       | —             |       | —          |       | —                                                                                          |       | 25                                                                                             |       | $                                                                          | 704.25     |                                                                                       | $          | 17,606 |   |
|              |       |                 | (2)        | $                                                                                                                 | 43,000     |                                                                                                     | $          | 73,530                                                                                                |       | $                           | 86,000     |               | —     |            | —     |                                                                                            | —     |                                                                                           | —     |                                                                       | —     |                                                                                       | —     |   | — |   |

 

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(1)                                  Thiscolumn reflects the full grant date value of stock and option awards under FAS No. 123Rgranted to the named executive officers in fiscal year 2008.  We use the Black-Scholes option pricing modelto estimate the fair value of options on the date of grant which requirescertain estimates to be made by management including the expected forfeiturerate and expected term of 

 

51

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the options.  The actual value, if any, that a namedexecutive officer may realize upon exercise of stock options will depend on theexcess of the stock price over the base value on the date of exercise, so thereis no assurance that the value realized by a named executive officer will be ator near the value estimated by the Black-Scholes model.  The assumptions used in determining the grantdate fair values of these stock and option awards are set forth in the notes toour consolidated financial statements included elsewhere in this Annual Report

 

(2)                                  Theamounts reflected in columns (c), (d) and (e) represent the potentialminimum and maximum payouts of the incentive-based cash wards granted in fiscalyear 2008 to each of the named executive officers.  See footnote 4 to Summary Compensation Tablefor actual amounts earned in fiscal year 2008 and payable in fiscal year 2009.

 

(3)                                  OnAugust 6, 2007, upon employment, Cellu Parent entered into a RestrictedStock Agreement with our chief financial officer, pursuant to which CelluParent granted 700 restricted shares of its to the named individual under the2006 Stock Option and Restricted Stock Plan.   See further discussion under “Employment Agreements; Restricted StockAgreements.”

 

**OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END**

 
| ** **       | ** ** | **Options Awards**                                                                      | ** ** | **Stock Awards**                                                                          | ** ** |
|------------------|------------|----------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|
| **Name**         | ** ** | **Number of  Securities   Underlying  Unexercised  Options (#)  Exercisable** | ** ** | **Number of  Securities   Underlying  Unexercised  Options (#)  Unexercisable** | ** ** | **Equity  Incentive  Plan  Awards:  Number of  Securities   Underlying  Unexercised  Unearned   Options (#)** | ** ** | **Option  Exercise  Price ($)** | ** ** | **Option  Expiration  Date** | ** ** | **Number  of Shares  or Units  of Stock  That Have  Not  Vested (#)** | ** ** | **Market  Value of  Shares or   Units of  Stock  That Have  Not  Vested ($)** | ** ** | **Equity  Incentive   Plan  Awards:  Number  of Shares,   Units, or  Other  Rights  That Have  Not  Vested (#)** | ** ** | **Equity  Incentive  Plan  Awards:  Market or  Payout  Value of  Unearned   Shares,  Unites or  Other Rights  That Have  Not Vested  ($)** | ** ** |
| Russell Taylor   |       | —                                                                                       |       | —                                                                                         |       | — |   | — |   | — |   | 2,833 |   | 1,208,813 |   | — |   | — |   |
|             |       |                                                                                         |       |                                                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| David Morris     |       | —                                                                                       |       | —                                                                                         |       | — |   | — |   | — |   | 700 |   | 685,475 |   | — |   | — |   |
|             |       |                                                                                         |       |                                                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Steven. Ziessler |       | —                                                                                       |       | —                                                                                         |       | — |   | — |   | — |   | 1,012 |   | 431,810 |   | — |   | — |   |
|             |       |                                                                                         |       |                                                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Edwin            |       | —                                                                                       |       | 25                                                                                             |       | — |   | $ | 704.25 |   | 2017 |   | — |   | — |   | — |   | — |   |
| Litton           |       | —                                                                                       |       | 50                                                                                             |       | — |   | $ | 426.69 |   | 2016 |   | — |   | — |   | — |   | — |   |

 

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**OPTION EXERCISES ANDSTOCK VESTED**

 

**The following table includes certain information withrespect to restricted stock awards and options that vested during the fiscalyear 2008:**

 
| ** **        | ** ** | **Option Award**              | ** ** | **Stock Awards** | ** ** |
|-------------------|------------|------------------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **Shares  Acquired  on  Exercise** | ** ** | **Value  Realized**   | ** ** | **Number of Shares  Acquired   on Vesting** | ** ** | **Value Realized on  Vesting** | ** ** |
| **Name**          | ** ** | **(#)**                            | ** ** | **($)**               | ** ** | **(#)** | ** ** | **($) (1)** | ** ** |
| Russell C. Taylor |       | —                             |       | —                |       | — |   | $ | 403,222 |   |
| David J. Morris   |       | —                             |       | —                |       | — |   | — |   |
| Steve D. Ziessler |       | —                             |       | —                |       | — |   | $ | 143,795 |   |
| W. Edwin Litton   |       | —                             |       | —                |       | — |   | — |   |

 

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(1)                      Representsrestricted shares of our parent’s common stock, which became vested duringfiscal year 2008.  Restricted sharesvested in four equal annual installments beginning on June 12, 2006.  The value realized when the restricted sharedvested represents the valuation of our parent’s common stock of $426.69.

 

**Potential Payments UponTermination or Change in Control**

 

The following tables summarize the value of thetermination payments and benefits that Messrs. Taylor, Ziessler and Morriswould receive if they had terminated employment on February 29, 2008 underthe circumstances shown, pursuant to employmentagreements and restricted stock agreements we have entered into with each ofthem.  For further description ofthe employment agreements and restrictive stock agreements governing thesepayments, see “Employment Agreements; Restricted Stock Award Agreements.”  The tables exclude (i) amounts accruedthrough February 29, 2008 that would be paid in the normal course ofcontinued employment, such as accrued but unpaid salary and earned annual bonusfor fiscal year 2008 and reimbursed business expenses and (ii) vestedaccount balances under our 401(k) Plan that is generally available to allof our employees.

 

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**Russell C. Taylor**

 
| ** **

**Benefit**            | ** ** | **Retirement ($)** | ** ** | **Death ($)** |   | **Disability ($)** |   | **Termination  by Company  without Cause  or Executive   with Good  Reason ($)** |      | **Termination  due to Non-  Renewal by  Company  (Other Than  for Cause) ($)** |   | **Termination  Within Two  Years  Following or  Three Months  Prior to a  Change in  Control ($) (1)** |   |
|------------------------------------|------------|-------------------------|------------|--------------------|--------|-------------------------|--------|----------------------------------------------------------------------------------------------------------------|-----------|--------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Cash Severance                     | ** ** | **$**                   | **—** |               | $      | 475,000                 | (2)    | $                                                                                                              | 475,000   | (2)                                                                                                          | $      | 2,170,685                                                                                                                                 | (3)    | $ | 950,000 | (4) | $ | 2,170,685 | (5) |
| Acceleration of Restricted Stock   | ** ** | **$**                   | **—** |               | $      | 1,387,108               | (6)    | $                                                                                                              | 1,387,108 | (6)                                                                                                          | **$**  | **—**                                                                                                                                |   | $ | 2,774,215 | (7) | $ | — |   |
| Health & Welfare Benefits |       | $                       | —     | (8)                | $      | —                  | (8)    | $                                                                                                              | —    | (8)                                                                                                          | $      | —                                                                                                                                    | (8)    | $ | — | (8) | $ | — | (8) |
| Total                              |       | $                       | —     |               | $      | 1,862,108               |   | $                                                                                                              | 1,862,108 |                                                                                                         | $      | 2,170,685                                                                                                                                 |   | $ | 3,724,215 |   | $ | 2,170,685 |   |

 

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(1)                                        Excludinga termination for cause or by reason of death or disability.

 

(2)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a lump sum payment equal to the lesser of (A) 12 months of basesalary or (B) base salary for a period equal to the remainder of the termof the employment agreement.

 

(3)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a (i) lump sum payment equal to the greater of (A) 24 monthsof base salary or (B) base salary for a period equal to the remainder ofthe term of the employment; and (ii) lump sump equal to the greater of (x) onetimes the Target Bonus or (y) payment of the Target Bonus with respect toa period equal to the remainder of the term of the employment agreement.

 

(4)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a  lump sum payment equal to 24months of base salary.

 

(5)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a (i) lump sum payment equal to the greater of (A) 36 monthsof base salary or (B) base salary for a period equal to the remainder ofthe term of the employment agreement; and (ii) lump sump equal to onetimes the Target Bonus.  Payments inrespect of a change in control are in lieu of payments for termination byreason of death or disability or by the Company without cause or the Executivefor good reason or non-renewal of the employment agreement.

 

(6)                                        Reflectsthe value of 50% of the restricted shares not yet vested which accelerates inconnection with a termination due to death or disability, calculated inaccordance with the fair market value of the common stock of Cellu Parent as ofFebruary 29, 2008.

 

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(7)                                        Reflectsthe value of 100% of the restricted shares not yet vested which accelerates inconnection with a termination due to non-renewal of the executive’s employmentagreement (other than for cause), calculated in accordance with the fair marketvalue of the common stock of Cellu Parent as of February 29, 2008.

 

(8)                                        Executive is entitled to continuedparticipation in our group health plan, assuming he makes a timely election ofcontinuation coverage under COBRA, at the executive’s expense.

 

**David J. Morris**

 
| **Benefit**                        | ** ** | **Retirement ($)** | ** ** | **Death ($)** | ** ** | **Disability ($)** |   | **Termination  by Company  without Cause  or Executive  with Good  Reason ($)** | ** ** | **Termination  due to Non-  Renewal by  Company  (Other Than  for Cause) ($)** | ** ** | **Termination  Within Two  Years  Following or  Three Months  Prior to a  Change in  Control $(1)** | ** ** |
|------------------------------------|------------|-------------------------|------------|--------------------|------------|-------------------------|--------|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
| Cash Severance                     | ** ** | **$**                   | **—** |               | $          | 250,000                 | (2)    | $                                                                                                        | 250,000    | (2)                                                                                                          | $          | 750,000                                                                                                                                | (3)        | $ | 500,000 | (4) | $ | — | (5) |
| Acceleration of Restricted Stock   | ** ** | **$**                   | **—** |               | $          | 342,738                 | (6)    | $                                                                                                        | 342,738    | (6)                                                                                                          | **$**      | **—**                                                                                                                             |       | $ | 685,475 | (7) | $ | — |   |
| Health & Welfare Benefits |       | $                       | —     | (8)                | $          | —                  | (8)    | $                                                                                                        | —     | (8)                                                                                                          | $          | —                                                                                                                                 | (8)        | $ | — | (8) | $ | — | (8) |
| Total                              |       | $                       | —     |               | $          | 592,738                 |   | $                                                                                                        | 592,738    |                                                                                                         | $          | 750,000                                                                                                                                |       | $ | 1,185,475 |   | $ | — |   |

 

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(1)                                        Excludinga termination for cause or by reason of death or disability.

 

(2)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a lump sum payment equal to the lesser of (A) 12 months of basesalary or (B) base salary for a period equal to the remainder of the termof the employment agreement.

 

(3)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a (i) lump sum payment equal to 24 months of base salary; and (ii) lumpsump equal to one times the Target Bonus.

 

(4)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a  lump sum payment equal to 24months of base salary.

 

(5)                                        Executiveis not entitled to any specific payments upon a change in control, other thansuch payments that executive would otherwise be entitled to if termination upona change in control is by reason of death or disability or by the Company forcause or the Executive for good reason or non-renewal of the employmentagreement, as provided in the related columns.

 

(6)                                        Reflectsthe value of 50% of the restricted shares not yet vested which accelerates inconnection with a termination due to death or disability, calculated inaccordance with the fair market value of the common stock of Cellu Parent as ofFebruary 29, 2008.

 

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(7)                                        Reflectsthe value of 100% of the restricted shares not yet vested which accelerates inconnection with a termination due to non-renewal of the executive’s employmentagreement (other than for cause), calculated in accordance with the fair marketvalue of the common stock of Cellu Parent as of February 29, 2008.

 

(8)                                        Executive is entitled to continuedparticipation in our group health plan, assuming he makes a timely election ofcontinuation coverage under COBRA, at the executive’s expense.

 

**Steven D. Ziessler**

 
| **Benefit**                        | ** ** | **Retirement ($)** | ** ** | **Death ($)** | ** ** | **Disability ($)** |   | **Termination  by Company  without Cause  or Executive  with Good  Reason ($)** | ** ** | **Termination  due to Non-  Renewal by  Company  (Other Than  for Cause) ($)** |   | **Termination  Within Two  Years  Following or  Three Months  Prior to a  Change in  Control $ (1)** | ** ** |
|------------------------------------|------------|-------------------------|------------|--------------------|------------|-------------------------|--------|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Cash Severance                     | ** ** | **$**                   | **—** |               | $          | 275,000                 | (2)    | $                                                                                                        | 275,000    | (2)                                                                                                          | $      | 825,000                                                                                                                                      | (3)        | $ | 550,000 | (4) | **$** | — | (5) |
| Acceleration of Restricted Stock   |       | $                       | —     |               | $          | 495,501                 | (6)    | $                                                                                                        | 495,501    | (6)                                                                                                          | **$**  | **—**                                                                                                                                   |       | $ | 991,001 | (7) | $ | — |   |
| Health & Welfare Benefits |       | $                       | —     | (8)                | $          | —                  | (8)    | $                                                                                                        | —     | (8)                                                                                                          | $      | —                                                                                                                                       | (8)        | $ | — | (8) | $ | — | (8) |
| Total                              |       | $                       | —     |               | $          | 770,501                 |   | $                                                                                                        | 770,501    |                                                                                                         | $      | 825,000                                                                                                                                      |       | $ | 1,541,001 |   | $ | — |   |

 

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(1)                                        Excludinga termination for cause or by reason of death or disability.

 

(2)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a lump sum payment equal to the lesser of (A) 12 months of basesalary or (B) base salary for a period equal to the remainder of the termof the employment agreement.

 

(3)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a (i) lump sum payment equal to 24 months of base salary; and (ii) lumpsump equal to one times the Target Bonus.

 

(4)                                        Excludingaccrued, but unpaid, base salary and annual bonus, executive is entitled toreceive a  lump sum payment equal to 24months of base salary.

 

(5)                                        Executiveis not entitled to any specific payments upon a change in control, other thansuch payments that executive would otherwise be entitled to if termination upona change in control is by reason of death or disability or by the Company forcause or the Executive for good reason, or non-renewal of the employmentagreement, as provided in the related columns.

 

(6)                                        Reflectsthe value of 50% of the restricted shares not yet vested which accelerates inconnection with a termination due to death or disability, calculated in accordancewith the fair market value of the common stock of Cellu Parent as of February 29,2008.

 

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(7)                                        Reflectsthe value of 100% of the restricted shares not yet vested which accelerates inconnection with a termination due to non-renewal of the executive’s employmentagreement (other than for cause), calculated in accordance with the fair marketvalue of the common stock of Cellu Parent as of February 29, 2008.

 

(8)                                        Executive is entitled to continued participationin our group health plan, assuming he makes a timely election of continuationcoverage under COBRA, at the executive’s expense.

 

**W. Edwin Litton**

 

Mr. Litton is notentitled to any payments in connection with any termination, including, withoutlimitation, resignation, severance, retirement, death, disability, withoutcause or as a result of a change in control (nor is he entitled to any gross-uppayments under Section 4999 of the Code), except that, in the event of achange in control, any unvested stock options held by Mr. Litton topurchase shares of common stock of Cellu Parent would be fullyaccelerated.  Accordingly, if Mr. Litton’semployment was terminated on February 29, 2008 due to a change in control,he would have received $27,628, representing the difference between theexercise price and the fair market value of 50 shares of common stock of CelluParent as of February 29, 2008.  Mr. Littonholds 25 other stock options for which the fair market value as of February 29,2008 equaled the exercise price of his unvested options which would acceleratein connection with a change in control. Notwithstanding the foregoing, Mr. Litton is entitled to (i) amountsaccrued through the date of termination that would be paid in the normal courseof continued employment, such as accrued but unpaid salary and earned annualbonus, (ii) vested account balances under our 401(k) Plan that isgenerally available to all of our employees and (iii) any post-employmentbenefits that are available to all of our salaried employees and do notdiscriminate in favor of Mr. Litton. Furthermore, under the provisions of ERISA, he would be entitled to oneyear’s salary.

 

**Compensationof Directors**

 

Membersof our board of directors (including Russell C. Taylor, our president and chiefexecutive officer) do not receive director’s fees or other compensation forserving as directors.  All members of ourboard of directors are reimbursed for actual expenses incurred in connectionwith attendance at board meetings. Compensation payable to Mr. Taylor as a named executive officer forfiscal year 2008 and fiscal year 2007 is reported in the Summary CompensationTable included elsewhere in this section.

 

**ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFCIALOWNERS AND MANAGEMENT**

 

We are a wholly owned subsidiary of Cellu PaperHoldings, Inc (referred to herein as our parent) and a wholly owned indirectsubsidiary of Cellu Parent Corporation (referred to herein as CelluParent).  As of the date of this report,our parent’s outstanding capital stock consisted of 11,127 shares of commonstock, par value $0.01 per share, all of which was beneficially owned by CelluParent.  As of the date of this report,Cellu Parent’s outstanding capital stock consisted of 45,730 shares of Series Apreferred stock and 6,164 shares of common stock, par value $0.01 per share.The following table sets forth information with respect to the beneficialownership of Cellu Parent’s common stock as of May 2, 2008 by:

 

·                  each person whois known by us to beneficially own more than 5% of the outstanding shares ofcommon stock;

 

·                  each executiveofficer named in the summary compensation table;

 

·                  each member ofour board of directors; and

 

·                  all members ofour board of directors and executive officers as a group.

 

To our knowledge, each of the holders of common stocklisted below has sole voting and investment power as to the shares of commonstock beneficially owned by such holder, unless otherwise noted.  Shares of common stock subject to optionsthat are currently exercisable or exercisable within 60 days of May 1, 

 

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2007 are deemed outstanding for computing theownership percentage of the stockholder holding such options, but are notdeemed outstanding for computing the ownership of any other stockholder.

 
| **Name and address of  beneficial owner** | ** ** | **Number of Shares  of Series A  Preferred Stock** | ** ** | **Percentage of  Class** | ** ** | **Number of  Shares of  Common  Stock** | ** ** | **Percentage  of Class** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------|------------|---------------------------------------------------|------------|-------------------------------|------------|
| Weston Presidio (1)                                           |       | 42,502                                                                      |       | 92.9                          | %          | —                                            |       | —                        |       |
| Russell C. Taylor (2) (3)                                |       | 2,559                                                                       |       | 5.6                           | %          | 3,778                                             |       | 61.3                          | %          |
| David J. Morris (2) (3)                                  |       | —                                                                      |       | —                        |       | 700                                               |       | 11.4                          | %          |
| Steven D. Ziessler (2)(3)                                     |       | 96                                                                          |       | Less than 1                   | %          | 1,349                                             |       | 21.9                          | %          |
| W. Edwin Litton (2)                                           |       |                                                                        |       | —                        |       | —                                            |       | —                        |       |
| R. Sean Honey (1)                                             |       | 42,502                                                                      | (5)        | 92.9                          | %          | —                                            |       | —                        |       |
| David L. Ferguson (1)                                         |       | 42,502                                                                      | (5)        | 92.9                          | %          | —                                            |       | —                        |       |
| Scott M. Bell (1)                                             |       | —                                                                      |       | —                        |       | —                                            |       | —                        |       |
| All directors and executive officers as a  group (7 persons)  |       | 45,157                                                                      |       | 98.7                          | %          | 5,827                                             |       | 94.6                          | %          |

 

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(1)                                  Theaddress for Weston Presidio and for each of Messrs. Honey, Ferguson andBell is Pier 1 Bay 2, San Francisco, California 94111.

 

(2)                                  Theaddress for each officer is c/o Cellu Tissue Holdings, Inc., 1855 LockewayDrive, Alpharetta, Georgia 30004.

 

(3)                                  Commonstock ownership represents restricted stock that vests ratably over 4years.  As of February 29, 2008,2,834, 700 and 1,012 for Messrs. Taylor, Morris and Ziessler,respectively, have not vested.

 

(5)                                  Eachof Messrs. Honey and Ferguson is a partner of Weston Presidio and, assuch, is deemed to have shared voting and investment power (along with otherpartners of Weston Presidio) as to the shares of common stock beneficiallyowned directly by Weston Presidio. Each of Messrs. Honey and Fergusondisclaims beneficial ownership with respect to the shares beneficially owned byWeston Presidio.

 

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The following table summarizes shares of common stockof our Cellu Parent, our indirect parent, to be issued upon exercise ofoptions, the weighted-average exercise price of outstanding options and optionsavailable for future issuance as of February 28, 2007.

 
| **PLAN CATEGORY**                                      | ** ** | **NUMBER OF  SECURITIES TO BE  ISSUED UPON  EXERCISE OF  OUTSTANDING  OPTIONS,  WARRANTS AND  RIGHTS  (a)** | ** ** | **WEIGHTED-AVERAGE  EXERCISE PRICE OF  OUTSTANDING  OPTIONS, WARRANTS  AND RIGHTS  (b)** | ** ** | **REMAINING AVAILABLE  NUMBER OF SECURITIES  FOR FUTURE ISSUANCE  UNDER EQUITY  COMPENSATION PLANS  (EXCLUDING  SECURITIES REFLECTED  IN COLUMN (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders     |       | 1,125                                                                                                                                     |       | $                                                                                                            | 733.67     |                                                                                                                                                                                                          | 806        |   |
| Equity compensation plans not approved by  security holders |       | —                                                                                                                                    |       | —                                                                                                       |       | —                                                                                                                                                                                                        |       |
| Total                                                       |       | 1,125                                                                                                                                     |       | $                                                                                                            | 733.67     |                                                                                                                                                                                                          | 806        |   |

 

The2006 Stock Option and Restricted Stock Plan authorizes the award of incentivestock options, which are stock options that qualify for special federal incometax treatment.  The exercise price of anystock option granted under the 2006 Stock Option and Restricted Stock Plan maynot be less than the fair market value of the common stock on the date ofgrant.  In general, each option grantedunder the 2006 Stock Option and Restricted Stock Plan vests annually in fourequal installments and expires ten years from the date of grant, subject toearlier expiration in case of termination of employment. **  **The vesting period is subject tocertain acceleration provisions if a change in control occurs.   The Plan also authorizes awards of restrictedstock.

 

**ITEM 13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

**ManagementAgreement**

 

On June 12, 2006, theCompany, Cellu Parent, and Cellu Acquisition Corporation entered into aManagement Agreement with Weston Presidio Service Company, LLC (“WestonPresidio Service Company”), pursuant to which Weston Presidio Service Companyhas agreed to provide the Company with certain management, consulting andfinancial and other advisory services. Weston Presidio Service Company is an affiliate of Weston Presidio,which is the controlling shareholder of Cellu Parent, which is the soleshareholder of the Company’s parent corporation, Cellu Paper.  In consideration for such services, theCompany, Cellu Parent and Cellu Acquisition Corporation have jointly andseverally agreed to pay Weston Presidio Service Company an annual fee of$450,000, to be paid in equal quarterly installments, and to reimburse expensesof Weston Presidio Service Company and its affiliates.  In addition, in connection with theconsummation of the Merger and as required by the Management Agreement, theCompany paid Weston Presidio Service Company a fee in the amount of$2,000,000.  The Management Agreementexpires on June 12, 2016 but will be automatically extended on eachanniversary of such date for an additional year unless one of the partiesprovides written notice of its desire not to automatically extend the term atleast 90 days prior to such anniversary. Weston Presidio Service Company may terminate the Management Agreementupon not less than 10 days written notice to the Company, and the ManagementAgreement will terminate upon the consummation of an initial public offering ora change of 

 

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control.  The Management Agreement also provides thatthe Company, Cellu Parent and Cellu Acquisition Corporation will jointly andseverally indemnify Weston Presidio Service Company and its affiliates andtheir related persons from and against any and all actions, causes of action,suits, claims, liabilities, losses, damages and costs and expenses incurred asa result of, arising out of, or in any way relating to the ManagementAgreement, the services provided under the Management Agreement, the Merger orits equity interest in and ownership of the Company or Cellu Parent, except forany such indemnified liabilities arising on account of gross negligence orwillful misconduct of the party seeking indemnification.  If and to the extent that indemnification maybe unavailable or unenforceable for any reason, the Company, Cellu Parent andCellu Acquisition Corporation agree to make the maximum contribution to thepayment and satisfaction of each of the indemnified liabilities that ispermissible under applicable law.  Theforegoing description is qualified in its entirety by reference to the actualManagement Agreement.

 

**ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

Aggregatefees for professional services rendered to us by Ernst & Young LLP asof or for the fiscal years ended February 29, 2008 and February 28,2007 are set forth below.  The aggregatefees included in the Audit category are fees billed for the fiscal years forthe audit of our annual financial statements and review of regulatory filings.  The aggregate fees included in each of theother categories are for fees billed in the fiscal years.

 
| ** **         | ** ** | **February 29, 2008** | ** **    | **February 28, 2007** | ** ** |
|--------------------|------------|---------------------------------|---------------|---------------------------------|------------|
| Audit Fees    |       | $                               |  527,000 |                            | $          |  400,000 |   |
| Audit-Related Fees |       | 95,700                          |          | 285,056                         |       |
| Tax Fees           |       | 418,935                         |          | 162,794                         |       |
| Total Fees         |       | $                               | 1,041,635     |                            | $          | 847,850 |   |

 

*Audit Fees: *Fees for audit services include feesassociated with the annual audits and reviews of our quarterly reports on Form 10-Qand annual report on Form 10-K.

 

*Audit- Related Fees: *Fees for audit-related services in fiscal year2008 also relate to the acquisition related audit.  Fees for audit-related services in fiscalyear 2007 relate to the merger transaction and acquisition related audit work.

 

*Tax Fees: *Fees for tax services relate to thepreparation of U.S. and Canadian tax returns, other miscellaneous compliancematters and foreign tax planning.

 

**PART IV**

 

**ITEM 15. EXHIBITS and FINANCIAL STATEMENT SCHEDULES**

 

(a)           Index to documents filed as part of this report:

 

1.               and 2. Financial Statements and Financial Statement Schedules

 

The response to this portion of Item 15 is submittedas a separate section of this report beginning with an index thereto on page F-1.

 

(b)          Exhibits

 

The following exhibits are filed with this report orincorporated by reference:

 

60

----

 

**INDEX TO EXHIBITS**

 
| **Exhibit  No.** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.1              |       | Certificate of Incorporation of Cellu Tissue  Holdings, Inc. (the “Company”) (incorporated by reference to  Exhibit 3.1 of the Company’s Registration Statement on Form S-4  dated September 3, 2004 (No. 333-118829))                                                                                                                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 3.2              |       | By-Laws of the Company (incorporated by reference to  Exhibit 3.2 of the Company’s Registration Statement on Form S-4  dated September 3, 2004 (No. 333-118829))                                                                                                                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.1A             |       | Indenture, dated as of  March 12, 2004, by and among the Company, the Subsidiary Guarantors (as  defined therein) and The Bank of New York, as trustee (incorporated by  reference to Exhibit 4.1 of the Company’s Registration Statement on  Form S-4 dated September 3, 2004 (No. 333-118829))                                                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.1B             |       | First Supplemental  Indenture, dated as of June 2, 2006, by and among the Company, the  subsidiary guarantors, and the Bank of New York Trust Company, N.A., as  successor trustee to the Bank of New York (incorporated by reference to  Exhibit 10.4 of the Company’s Current Report on Form 8-K, filed  with the SEC on June 16, 2006)                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.1C             |       | Second Supplemental  Indenture, dated March 21, 2007, by and among the Company, the  subsidiary guarantors, and The Bank of New York Trust Company, N.A., as  successor trustee to the Bank of New York (incorporated by reference to  Exhibit 10.2 of the Company’s Current Report on Form 8-K/A, filed  with the SEC on March 27, 2007)                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.2              |       | Form of 9 3⁄4%  Senior Secured Exchange Note due 2010 (incorporated by reference to  Exhibit 4.2 of the Company’s Registration Statement on Form S-4  dated September 3, 2004 (No. 333-118829))                                                                                                                                                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.3              |       | Notation of Guarantee,  Natural Dam, Neenah, Cellu Tissue LLC, Coastal, Interlake, Menominee, Van  Paper and Van Timber as Guarantors (incorporated by reference to  Exhibit 4.3 of the Company’s Registration Statement on Form S-4  dated September 3, 2004 (No. 333-118829))                                                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.5              |       | Registration Rights  Agreement, dated as of March 12, 2004, by and among the Company and The  Bank of New York (incorporated by reference to Exhibit 4.5 of the  Company’s Registration Statement on Form S-4 dated September 3,  2004 (No. 333-118829))                                                                                                                                                                          |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.6              |       | Indenture, dated  March 1, 1998, between City of Ladysmith, Wisconsin and Norwest Bank  Wisconsin, N.A. (incorporated by reference to Exhibit 10.6 of the  Company’s Current Report on Form 8-K/A, filed with the SEC on  March 21, 2007)                                                                                                                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.1             |       | Financing Agreement,  dated as of March 12, 2004, by and among the Company, Natural Dam,  Neenah, Cellu Tissue LLC, Coastal, Interlake, Menominee, Van Paper and Van  Timber, Cellu Paper Holdings, Inc., the Lenders party thereto and The  CIT Group/Business Credit, Inc. (incorporated by reference to  Exhibit 10.1 of the Company’s Registration Statement on Form S-4  dated September 3, 2004 (No. 333-118829)) |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.2             |       | Purchase Agreement,  dated as of March 5, 2004, by and among the Company and Initial  Purchasers named therein (incorporated by reference to Exhibit 10.2 of  the Company’s Registration Statement on Form S-4 dated September 3,  2004 (No. 333-118829))                                                                                                                                                                         |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.3             |       | Employment Agreement,  dated June 12, 2006, between Russell Taylor and the Company  (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly  Report on Form 10-Q for the quarter ended May 25, 2006)                                                                                                                                                                                                                     |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.4             |       | Employment Agreement,  dated June 12, 2006, between Dianne Scheu and the Company (incorporated  by reference to Exhibit 10.2 of the Company’s Quarterly Report on  Form 10-Q for the quarter ended May 25, 2006)                                                                                                                                                                                                                       |

 

61

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| 10.5   |   | Employment Agreement,  dated June 12, 2006, between Steven Ziessler and the Company  (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly  Report on Form 10-Q for the quarter ended May 25, 2006)                                                                                                                                                                                                                                                                                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.6   |   | Cellu Parent  Corporation 2006 Stock Option and Restricted Stock Plan (incorporated by  reference to Exhibit 10.1 of the Company’s Current Report on  Form 8-K, filed with the SEC on June 16, 2006)                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.7   |   | Management Agreement,  dated June 12, 2006, by and among Cellu Parent Corporation, Cellu  Acquisition Corporation, the Company and Weston Presidio Service Company, LLC  (incorporated by reference to Exhibit 10.2 of the Company’s Current  Report on Form 8-K, filed with the SEC on June 16, 2006)                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.8   |   | Financial Advisory and  Management Services Agreement, dated as of September 30, 2002, between  Cellu Tissue Holdings, Inc. and Charterhouse Group  International, Inc. (incorporated by reference to Exhibit 10.5 of  the Company’s Registration Statement on Form S-4 dated September 3,  2004 (No. 333-118829))                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.9   |   | Shareholders Agreement,  dated as of June 12, 2006, among Cellu Parent Corporation and each of  the Security Holders.                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.10  |   | Cellu Paper Holdings  2001 Stock Incentive Plan (incorporated by reference to Exhibit 10.7 of  the Company’s Registration Statement on Form S-4 dated September 3,  2004 (No.333-118829))                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.11  |   | Bonus Agreement, dated  as of March 27, 2006, between Cellu Tissue Holdings, Inc. and  Russell C. Taylor (incorporated by reference to Exhibit 10.8 of the  Company’s Annual Report on Form 10-K for the fiscal year ended  February 28, 2006)                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.12  |   | Bonus Agreement, dated  as of March 27, 2006, between Cellu Tissue Holdings, Inc. and  Dianne M. Scheu (incorporated by reference to Exhibit 10.9 of the  Company’s Annual Report on Form 10-K for the fiscal year ended  February 28, 2006)                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.13  |   | Bonus Agreement, dated  as of March 27, 2006, between Cellu Tissue Holdings, Inc. and  Steven Ziessler (incorporated by reference to Exhibit 10.10of the  Company’s Annual Report on Form 10-K for the fiscal year ended February 28,  2006)                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.14  |   | Restricted Stock  Agreement, dated as of March 27, 2006, between Cellu Paper  Holdings, Inc. and Dianne M. Scheu (incorporated by reference to  Exhibit 10.11 of the Company’s Annual Report on Form 10-K for the  fiscal year ended February 28, 2006)                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15  |   | Restricted Stock  Agreement, dated as of March 27, 2006, between Cellu Paper  Holdings, Inc. and Steven Ziessler (incorporated by reference to  Exhibit 10.12 of the Company’s Annual Report on Form 10-K for the  fiscal year ended February 28, 2006)                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.16  |   | Cellu Tissue  Holdings, Inc. Severance Pay Plan (incorporated by reference to  Exhibit 10.8 of the Company’s Annual Report on Form 10-K for the  fiscal year ended February 28, 2005)                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.17  |   | Agreement and Plan of  Merger by and among Cellu Parent Corporation, Cellu Acquisition Corporation  and Cellu Paper Holdings, Inc. (incorporated by reference to  Exhibit 10.14 of the Company’s Annual Report on Form 10-K, filed  with the SEC on May 9, 2006)                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.18  |   | Credit Agreement, dated  as of June 12, 2006, among Cellu Paper, the Company, as U.S. Borrower,  Interlake Acquisition Corporation Limited, a subsidiary of the Company, as  Canadian Borrower, the loan guarantors party thereto, JPMorgan Chase Bank,  N.A., as U.S. Administrative Agent, JPMorgan Chase Bank, N.A. Toronto Branch,  as Canadian Administrative Agent,, and the lenders party thereto  (incorporated by reference to Exhibit 10.3 of the Company’s Current  Report on Form 8-K, filed with the SEC on June 16, 2006) |

 

62

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| 10.19  |   | Merger Agreement among  the Company, Cellu City Acquisition Corporation, Wayne Gullstad as the  Shareholders’ Representative and CityForest Corporation, dated  February 26, 2007 (incorporated by reference to Exhibit 10.1 of the  Company Current Report on Form 8-K, filed with the SEC on March 1,  2007                                                                                                                                                                                                                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.20  |   | Note Purchase  Agreement, dated March 21, 2007, between the Company and Wingate Capital  Ltd. (incorporated by reference to Exhibit 10.1 of the Company’s Current  Report on Form 8-K/A, filed with the SEC on March 27, 2007)                                                                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.21  |   | First Amendment, dated  March 21, 2007, to Credit Agreement dated June 12, 2006 (as amended  by the Amendment, the “Amended Credit Agreement”) among the Company, as U.S.  Borrower, Interlake Acquisition Corporation Limited, a subsidiary of the  Company, as Canadian Borrower, certain subsidiaries of the Company, Cellu  Paper Holdings, Inc. , the parent corporation of the Company, JPMorgan  Chase Bank, N.A. and JPMorgan Chase Bank, N.A., Toronto Branch (incorporated  by reference to Exhibit 10.3 of the Company’s Current Report on  Form 8-K/A, filed with the SEC on March 27, 2007) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.22  |   | Amended and Restated  Reimbursement Agreement, dated March 21, 2007, between Cellu  Tissue-CityForest LLC and Associated Bank, National Association (incorporated  by reference to Exhibit 10.4 of the Company’s Current Report on  Form 8-K/A, filed with the SEC on March 27, 2007)                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.23  |   | Loan Agreement, dated  March 1, 1998, between CityForest Corporation and City of Ladysmith,  Wisconsin (incorporated by reference to Exhibit 10.5 of the Company’s  Current Report on Form 8-K/A, filed with the SEC on March 27, 2007)                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.24  |   | Guaranty, dated  March 1, 1998, executed by the Company in favor of Associated Bank,  National Association (incorporated by reference to Exhibit 10.7 of the  Company’s Current Report on Form 8-K/A, filed with the SEC on  March 27, 2007)                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.25  |   | Employment Agreement,  dated August 6, 2007, between David Morris and the Company (incorporated  by reference to Exhibit 10.1 of the Company’s Quarterly Report on  Form 10-Q for the quarter ended August 30, 2007)                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.26* |   | Corporate Bonus Plan,  dated June 21, 2007                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 14.1   |   | Code of Ethics  (incorporated by reference to Exhibit 14.1 of the Company’s Annual  Report on Form 10-K for the fiscal year ended February 28, 2005)                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 21.1*  |   | List of subsidiaries of  the Company                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 31.1*  |   | Certification of CEO  pursuant to Section 302 of Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 31.2*  |   | Certification of CFO  pursuant to Section 302 of Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

 

----

*Filed herewith.

 

(c) See Financial Statements immediatelyfollowing Index to Consolidated Financial Statements and Consolidated FinancialStatement Schedule.

 

63

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Company has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
| ** **         |       | **Cellu Tissue Holdings, Inc.**                       |
|--------------------|------------|------------------------------------------------------------|
| ** **         | ** ** | ** **                                                 |
|               |       | By:                                                        | /s/ Russell C. Taylor |
|               |       | Russell C.  Taylor, President and Chief Executive  Officer |
|               |       |                                                       |
| May 19,  2008 |       |                                                       |
|                    |            |                                                            |  |  |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| /s/ Russell C. Taylor          |   | /s/ David J. Morris                |
|--------------------------------|--------|------------------------------------|
| Russell C. Taylor, President   |   | Chief Financial Officer (Principal |
| (Principal Executive Officer), |   | Financial and Accounting Officer)  |
| Director                       |   |                               |
|                           |   |                               |
| /s/ Sean Honey                 |   | /s/ David Ferguson                 |
| Chairman and Director          |   | Director                           |
|                           |   |                               |
| /s/ Scott Bell                 |   |                               |
| Director                       |   |                               |

 

64

----

 

**FORM 10-K**

**ITEM 15(a) (1) and(2)**

**CELLUTISSUE HOLDINGS, INC.**

 

**INDEXTO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE**

 

Report ofIndependent Registered Public Accounting Firm

 

ConsolidatedBalance Sheets-February 29, 2008 and February 28, 2007

 

ConsolidatedStatements of Operations-for the fiscal year ended February 29, 2008(post-merger), for the periods from June 13, 2006 to February 28,2007 (post-merger), from March 1, 2006 to June 12, 2006 (pre-merger)and for the fiscal year ended February 28, 2006 (pre-merger)

 

ConsolidatedStatements of Changes in Stockholders’ Equity (Deficiency)-for the fiscal yearended February 29, 2008 (post-merger), for the periods from June 13,2006 to February 28, 2007 (post-merger), from March 1, 2006 to June 12,2006 (pre-merger) and for the fiscal year ended February 28, 2006(pre-merger)

 

ConsolidatedStatements of Cash Flows-for the fiscal year ended February 29, 2008(post-merger), for the periods from June 13, 2006 to February 28,2007 (post-merger), from March 1, 2006 to June 12, 2006 (pre-merger)and for the fiscal year ended February 28, 2006 (pre-merger)

 

Notes toConsolidated Financial Statements

 

Schedule II –Valuationand Qualifying Accounts of Cellu Tissue Holdings, Inc. is included in Item15

 

All other schedulesfor which provision is made in the applicable accounting regulation of theSecurities and Exchange Commission are not required under the relatedinstructions or are inapplicable, and therefore have been omitted.

 

F-1

----

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors

Cellu Tissue Holdings, Inc.and Subsidiaries

 

We have audited theaccompanying consolidated balance sheets of Cellu Tissue Holdings, Inc.and Subsidiaries (the “Company”) as of February 29, 2008 and February 28,2007, and the related consolidated statements of operations, changes instockholders’ equity (deficiency), and cash flows for the fiscal year ended February 29,2008 (post-merger), for the periods from June 13, 2006 to February 28,2007 (post-merger), from March 1, 2006 to June 12, 2006 (pre-merger)and for the fiscal year ended February 28, 2006 (pre-merger). Our auditsalso include the financial statement schedule listed in the Index at Item 15(a).  These financial statements and schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements and schedule based on ouraudits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. We were not engaged to perform an audit of theCompany’s internal control over financial reporting.  Our audits included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting.  Accordingly, we express nosuch opinion.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Cellu Tissue Holdings, Inc.and Subsidiaries at February 29, 2008 and February 28, 2007, and theconsolidated results of their operations and their cash flows for the fiscalyear ended February 29, 2008 (post-merger),  for the periods from June 13, 2006 to February 28,2007 (post-merger), from March 1, 2006 to June 12, 2006 (pre-merger)and for the  fiscal year ended February 28,2006 (pre-merger) in conformity with U. S. generally accepted accountingprinciples.  Also, in our opinion, therelated financial statement schedule, when considered in relation to the basicfinancial statements taken as a whole, presents fairly in all material respectsthe information set forth therein.

 

As discussed in Note 2 tothe Consolidated Financial Statements, the Company adopted the Statement ofFinancial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-BasedPayment” effective March 1, 2006. As discussed in Note 7 to the Consolidated Financial Statements, theCompany adopted Financial Accounting Standards Board Interpretation No. 48,“Accounting for Uncertainty in Income Taxes-an Interpretation of SFAS No. 109”,effective March 1, 2007.

 
| /s/ Ernst &  Young |
|-----------------------------|
| Hartford, Connecticut       |
| May 7, 2008            |

 

F-2

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

ConsolidatedBalance Sheets

 
| ** **                                                                                                                                                       | ** ** | **February 29** | ** **  | **February 28** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2008**             | ** **  | **2007**             | ** ** |
| **Assets**                                                                                                                                                       |       |                 |        |                 |       |
| Current assets:                                                                                                                                                  |       |                 |        |                 |       |
| Cash and cash  equivalents                                                                                                                                       |       | $                    | 883,388     |                 | $          | 16,260,601 |   |
| Receivables, net  of allowance of $169,811 in 2008 and $408,314 in 2007                                                                                          |       | 44,542,337           |        | 34,140,844           |       |
| Inventories                                                                                                                                                      |       | 33,996,439           |        | 28,715,495           |       |
| Prepaid expenses  and other current assets                                                                                                                       |       | 3,745,989            |        | 3,697,328            |       |
| Income tax  receivable                                                                                                                                           |       | 177,281              |        | 329,861              |       |
| Deferred income  taxes                                                                                                                                           |       | 7,157,191            |        | 6,498,098            |       |
| Total current assets                                                                                                                                             |       | 90,502,625           |        | 89,642,227           |       |
|                                                                                                                                                             |       |                 |        |                 |       |
| Property, plant and equipment, net                                                                                                                               |       | 296,597,888          |        | 228,851,765          |       |
| Goodwill                                                                                                                                                         |       | 6,970,001            |        | —               |       |
| Trademarks                                                                                                                                                       |       | 8,750,314            |        | 6,550,314            |       |
| Reserved cash                                                                                                                                                    |       | 1,243,956            |        | —               |       |
| Other assets                                                                                                                                                     |       | 247,262              |        | 224,438              |       |
| Total assets                                                                                                                                                     |       | $                    | 404,312,046 |                 | $          | 325,268,744 |   |
| **Liabilities and stockholders’ equity**                                                                                                                    | ** ** | ** **           | ** **  | ** **           | ** ** |
| Current liabilities:                                                                                                                                             |       |                 |        |                 |       |
| Revolving line  of credit                                                                                                                                        |       | $                    | 9,800,000   |                 | $          | — |   |
| Accounts payable                                                                                                                                                 |       | 24,055,782           |        | 16,523,755           |       |
| Accrued expenses                                                                                                                                                 |       | 18,860,526           |        | 16,315,163           |       |
| Accrued interest                                                                                                                                                 |       | 8,253,915            |        | 7,226,753            |       |
| Other current  liabilities                                                                                                                                       |       | 15,000,000           |        | —               |       |
| Current portion  of long-term debt                                                                                                                               |       | 760,000              |        | —               |       |
| Total current liabilities                                                                                                                                        |       | 76,730,223           |        | 40,065,671           |       |
|                                                                                                                                                             |       |                 |        |                 |       |
| Long-term debt, less current portion                                                                                                                             |       | 198,086,944          |        | 160,355,507          |       |
| Deferred income taxes                                                                                                                                            |       | 62,008,004           |        | 50,677,332           |       |
| Other liabilities                                                                                                                                                |       | 20,148,590           |        | 35,179,252           |       |
| Stockholders’ equity:                                                                                                                                       |       |                 |        |                 |       |
| Common stock,  Class A, $.01 par value, 1,000 shares authorized, 100 shares issued and  outstanding as of February 29, 2008 and February 28, 2007 |       | 1                    |        | 1                    |       |
| Capital in  excess of par value                                                                                                                                  |       | 47,035,214           |        | 46,259,101           |       |
| Accumulated  deficit                                                                                                                                             |       | (2,199,615           | )           | (6,192,366           | )          |
| Accumulated  other comprehensive income (loss)                                                                                                                   |       | 2,502,685            |        | (1,075,754           | )          |
| Total stockholders’ equity                                                                                                                                  |       | 47,338,285           |        | 38,990,982           |       |
| Total liabilities and stockholders’ equity                                                                                                                  |       | $                    | 404,312,046 |                 | $          | 325,268,744 |   |

 

*See accompanying notes toconsolidated financial statements.*

 

F-3

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

ConsolidatedStatements of Operations

 
| ** **                                        | ** ** | **Fiscal Year Ended  February 29, 2008** | ** **  | **For the Period  June 13, 2006-  February 28, 2007** | ** ** | **For the Period  March 1, 2006-  June 12, 2006** | ** ** | **Fiscal Year Ended  February 28, 2006** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------|-------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                        | ** ** | **(Post-Merger)**                                            | ** **  | **(Pre-Merger)**                                                                    | ** ** |
| Net sales                                         |       | $                                                            | 431,022,429 |                                                                                | $          | 241,236,592                                                                     |       | $                                                            | 94,241,932 |   | $ | 328,832,864 |   |
| Cost of goods  sold                               |       | 388,258,498                                                  |        | 228,318,155                                                                         |       | 86,053,812                                                                      |       | 301,111,146                                                  |       |
| Gross profit                                      |       | 42,763,931                                                   |        | 12,918,437                                                                          |       | 8,188,120                                                                       |       | 27,721,718                                                   |       |
| Selling, general  and administrative expenses     |       | 18,661,904                                                   |        | 7,207,057                                                                           |       | 4,661,285                                                                       |       | 12,872,052                                                   |       |
| Restructuring  costs                              |       | —                                                       |        | 240,218                                                                             |       | —                                                                          |       | 1,050,363                                                    |       |
| Merger-related  transaction costs                 |       | —                                                       |        | 142,079                                                                             |       | 5,933,265                                                                       |       | 2,284,475                                                    |       |
| Terminated  acquisition-related transaction costs |       | 2,078,212                                                    |        | —                                                                              |       | —                                                                          |       | —                                                       |       |
| Stock and  related compensation expense           |       | 550,804                                                      |        | 3,328,834                                                                           |       | —                                                                          |       | —                                                       |       |
| Vesting of stock  option/restricted stock grants  |       | 808,111                                                      |        | 497,105                                                                             |       | 923,580                                                                         |       | 81,787                                                       |       |
| Impairment of  property, plant and equipment      |       | —                                                       |        | 488,274                                                                             |       | —                                                                          |       | —                                                       |       |
| Income (loss)  from operations                    |       | 20,664,900                                                   |        | 1,014,870                                                                           |       | (3,330,010                                                                      | )          | 11,433,041                                                   |       |
| Interest  expense, net                            |       | (19,870,029                                                  | )           | (11,468,975                                                                         | )          | (4,896,355                                                                      | )          | (17,076,757                                                  | )          |
| Foreign currency  (loss) gain                     |       | (663,686                                                     | )           | 359,236                                                                             |       | (289,010                                                                        | )          | (503,262                                                     | )          |
| Other income                                      |       | 132,623                                                      |        | 14,527                                                                              |       | 27,049                                                                          |       | 2,492                                                        |       |
| Income (loss)  before income tax benefit          |       | 263,808                                                      |        | (10,080,342                                                                         | )          | (8,488,326                                                                      | )          | (6,144,486                                                   | )          |
| Income tax  benefit                               |       | (3,728,943                                                   | )           | (3,887,976                                                                          | )          | (1,953,362                                                                      | )          | (3,575,132                                                   | )          |
| Net income  (loss)                                |       | $                                                            | 3,992,751   |                                                                                | $          | (6,192,366                                                                      | )          | $                                                            | (6,534,964 | ) | $ | (2,569,354 | ) |

 

*See accompanying notes toconsolidated financial statements.*

 

F-4

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

**ConsolidatedStatements of Changes in Stockholders’ Equity (Deficiency)**

 
| ** **                                           | ** ** | **Class A  Common  Stock** | ** ** | **Capital in  Excess of Par  Value** | ** ** | **Accumulated  Earnings  (Deficit)** | ** ** | **Accumulated Other  Comprehensive  Income (Loss)** | ** ** | **Total Stockholders’  Equity (Deficiency)** | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Balance,  February 28, 2005                     |       | $                               | 1          |                                                | $          | 533,551                              |       | $                                                             | (9,056,405 | )                                                           | $          | 937,063 |   | $ | (7,585,790 | ) |
| Accelerated  vesting-stock options                   |       |                            |       | 81,787                                              |       |                                 |       |                                                          |       | 81,787                                                      |       |
| Net loss                                             |       |                            |       |                                                |       | (2,569,354                           | )          |                                                          |       | (2,569,354                                                  | )          |
| Foreign currency  translation                        |       |                            |       |                                                |       |                                 |       | 3,167,797                                                     |       | 3,167,797                                                   |       |
| Comprehensive  income                                |       |                            |       |                                                |       |                                 |       |                                                          |       | 598,443                                                     |       |
| Balance,  February 28, 2006                     |       | 1                               |       | 615,338                                             |       | (11,625,759                          | )          | 4,104,860                                                     |       | (6,905,560                                                  | )          |
| Net loss  3/1/06-6/12/06                             |       |                            |       |                                                |       | (6,534,964                           | )          |                                                          |       | (6,534,964                                                  | )          |
| Foreign currency  translation                        |       |                            |       |                                                |       |                                 |       | 586,186                                                       |       | 586,186                                                     |       |
| Comprehensive  loss 3/1/06-6/12/06                   |       |                            |       |                                                |       |                                 |       |                                                          |       | (5,948,778                                                  | )          |
| Vesting-stock  awards 3/1/06-6/12/06                 |       |                            |       | 52,658                                              |       |                                 |       |                                                          |       | 52,658                                                      |       |
| Accelerated  vesting-stock awards                    |       |                            |       | 870,922                                             |       |                                 |       |                                                          |       | 870,922                                                     |       |
| Recapitalization-June 12,  2006                 |       |                            |       | 44,223,078                                          |       | 18,160,723                           |       | (4,691,046                                                    | )          | 57,692,755                                                  |       |
| Balance,  June 12, 2006, after recapitalization |       | 1                               |       | 45,761,996                                          |       | —                               |       | —                                                        |       | 45,761,997                                                  |       |
| Vesting-stock  awards 6/13/06-2/28/07                |       |                            |       | 497,105                                             |       |                                 |       |                                                          |       | 497,105                                                     |       |
| Net loss  6/13/06-2/28/07                            |       |                            |       |                                                |       | (6,192,366                           | )          |                                                          |       | (6,192,366                                                  | )          |
| Foreign currency  translation and derivative         |       |                            |       |                                                |       |                                 |       | (1,075,754                                                    | )          | (1,075,754                                                  | )          |
| Comprehensive  loss 6/13/06-2/28/07                  |       |                            |       |                                                |       |                                 |       |                                                          |       | (7,268,120                                                  | )          |
| Balance,  February 28, 2007                     |       | 1                               |       | 46,259,101                                          |       | (6,192,366                           | )          | (1,075,754                                                    | )          | 38,990,982                                                  |       |
| Vesting-stock  awards                                |       |                            |       | 776,113                                             |       |                                 |       |                                                          |       | 776,113                                                     |       |
| Net income                                           |       |                            |       |                                                |       | 3,992,751                            |       |                                                          |       | 3,992,751                                                   |       |
| Foreign currency  translation and derivative         |       |                            |       |                                                |       |                                 |       | 3,578,439                                                     |       | 3,578,439                                                   |       |
| Comprehensive  income                                |       |                            |       |                                                |       |                                 |       |                                                          |       | 7,571,190                                                   |       |
| Balance,  February 29, 2008                     |       | $                               | 1          |                                                | $          | 47,035,214                           |       | $                                                             | (2,199,615 | )                                                           | $          | 2,502,685 |   | $ | 47,338,285 |   |

 

*See accompanying notes toconsolidated financial statements.*

 

F-5

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

ConsolidatedStatements of Cash Flows

 
| ** **                                                                                           | ** ** | **Fiscal Year Ended  February 29, 2008** | ** ** | **For the Period  June 13, 2006-  February 28, 2007** | ** ** | **For the Period  March 1, 2006-  June 12, 2006** | ** ** | **Fiscal Year Ended  February 28, 2006** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **(Post-Merger)**                                            | ** ** | **(Pre-Merger)**                                                                    | ** ** |
| **Cash  flows from operating activities**                                                            | ** ** | ** **                                                   | ** ** | ** **                                                                          | ** ** | ** **                                                                      | ** ** | ** **                                                   | ** ** |
| Net income  (loss)                                                                                   |       | $                                                            | 3,992,751  |                                                                                | $          | (6,192,366                                                                      | )          | $                                                            | (6,534,964 | ) | $ | (2,569,354 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                                                         |       |                                                                                |       |                                                                            |       |                                                         |       |
| Noncash  inventory charge                                                                            |       | —                                                       |       | 909,264                                                                             |       | —                                                                          |       | —                                                       |       |
| Amortization of  debt issuance costs                                                                 |       | —                                                       |       | —                                                                              |       | 405,568                                                                         |       | 1,423,388                                                    |       |
| Depreciation                                                                                         |       | 23,106,291                                                   |       | 16,133,460                                                                          |       | 4,226,643                                                                       |       | 14,854,021                                                   |       |
| Deferred income  taxes                                                                               |       | (6,566,930                                                   | )          | (6,651,089                                                                          | )          | (396,024                                                                        | )          | (2,955,381                                                   | )          |
| Accretion of  debt discount                                                                          |       | 616,437                                                      |       | 380,560                                                                             |       | 85,471                                                                          |       | 299,970                                                      |       |
| Stock-based  compensation                                                                            |       | 808,111                                                      |       | 497,105                                                                             |       | 923,580                                                                         |       | 81,787                                                       |       |
| Impairment of  fixed assets                                                                          |       | —                                                       |       | 488,274                                                                             |       | —                                                                          |       | —                                                       |       |
| Gain on disposal  of equipment                                                                       |       | —                                                       |       | —                                                                              |       | —                                                                          |       | (9,005                                                       | )          |
| Changes in  operating assets and liabilities:                                                        |       |                                                         |       |                                                                                |       |                                                                            |       |                                                         |       |
| Receivables                                                                                          |       | (4,829,995                                                   | )          | 2,908,202                                                                           |       | (1,994,674                                                                      | )          | 732,294                                                      |       |
| Inventories                                                                                          |       | (3,735,511                                                   | )          | 1,413,120                                                                           |       | (2,208,757                                                                      | )          | (3,318,880                                                   | )          |
| Prepaid expenses  and other current assets                                                           |       | 1,124,858                                                    |       | 1,696,689                                                                           |       | (683,329                                                                        | )          | 427,048                                                      |       |
| Other assets                                                                                         |       | 552,555                                                      |       | (48,517                                                                             | )          | (5,328                                                                          | )          | (11,470                                                      | )          |
| Income tax  receivable                                                                               |       | 137,153                                                      |       | —                                                                              |       | —                                                                          |       | (362,122                                                     | )          |
| Accounts  payable, accrued expenses, accrued interest and other liabilities                          |       | 4,026,808                                                    |       | (1,395,251                                                                          | )          | (358,006                                                                        | )          | 7,470                                                        |       |
| Total  adjustments                                                                                   |       | 15,239,777                                                   |       | 16,331,817                                                                          |       | (4,856                                                                          | )          | 11,169,120                                                   |       |
| Net cash  provided by (used in) operating activities                                                 |       | 19,232,528                                                   |       | 10,139,451                                                                          |       | (6,539,820                                                                      | )          | 8,599,766                                                    |       |
|                                                                                                      |            |                                                              |            |                                                                                     |            |                                                                                 |            |                                                              |            |  |  |  |  |

 

F-6

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

ConsolidatedStatements of Cash Flows (continued)

 
| ** **                                               | ** ** | **Fiscal Year Ended  February 29, 2008** | ** ** | **For the Period  June 13, 2006-  February 28, 2007** | ** ** | **For the Period  March 1, 2006-  June 12, 2006** | ** ** | **Fiscal Year Ended  February 28, 2006** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                               | ** ** | **(Post-Merger)**                                            | ** ** | **(Pre-Merger)**                                                                    | ** ** |
| **Cash  flows from investing activities**                |       |                                                         |       |                                                                                |       |                                                                            |       |                                                         |       |
| Equity  investment by Weston Presidio/Other Stockholders |       | (32,000                                                      | )          | 45,761,997                                                                          |       | —                                                                          |       | —                                                       |       |
| Cash paid for  acquisition, net of cash received         |       | (43,663,270                                                  | )          | —                                                                              |       | —                                                                          |       | —                                                       |       |
| Capital  expenditures                                    |       | (20,477,426                                                  | )          | (7,677,141                                                                          | )          | (1,937,610                                                                      | )          | (13,050,166                                                  | )          |
| Net cash (used  in) provided by investing activities     |       | (64,172,696                                                  | )          | 38,084,856                                                                          |       | (1,937,610                                                                      | )          | (13,050,166                                                  | )          |
| **Cash  flows from financing activities**                | ** ** | ** **                                                   | ** ** | ** **                                                                          | ** ** | ** **                                                                      | ** ** | ** **                                                   | ** ** |
| Merger  consideration paid to former shareholders        |       | —                                                       |       | (45,761,997                                                                         | )          | —                                                                          |       | —                                                       |       |
| Payments of  long-term debt                              |       | (575,000                                                     | )          | —                                                                              |       | (290,000                                                                        | )          | (280,000                                                     | )          |
| Borrowings on  revolving credit facility, net            |       | 9,800,000                                                    |       | —                                                                              |       | —                                                                          |       | —                                                       |       |
| Proceeds from  note offering                             |       | 20,000,000                                                   |       | —                                                                              |       | —                                                                          |       | —                                                       |       |
| Debt refinancing  costs                                  |       | —                                                       |       | —                                                                              |       | —                                                                          |       | (1,653                                                       | )          |
| Net cash  provided by (used in) financing activities     |       | 29,225,000                                                   |       | (45,761,997                                                                         | )          | (290,000                                                                        | )          | (281,653                                                     | )          |
| Effect of  foreign currency                              |       | 337,955                                                      |       | (620,553                                                                            | )          | 362,212                                                                         |       | 597,086                                                      |       |
| Net (decrease)  increase in cash and cash equivalents    |       | (15,377,213                                                  | )          | 1,841,757                                                                           |       | (8,405,218                                                                      | )          | (4,134,967                                                   | )          |
| Cash and cash  equivalents at beginning of period        |       | 16,260,601                                                   |       | 14,418,844                                                                          |       | 22,824,062                                                                      |       | 26,959,029                                                   |       |
| Cash and cash  equivalents at end of period              |       | $                                                            | 883,388    |                                                                                | $          | 16,260,601                                                                      |       | $                                                            | 14,418,844 |   | $ | 22,824,062 |   |
| **Supplemental  disclosure of cash flow information**    | ** ** | ** **                                                   | ** ** | ** **                                                                          | ** ** | ** **                                                                      | ** ** | ** **                                                   | ** ** |
| Cash paid during  the year for Interest                  |       | $                                                            | 18,397,690 |                                                                                | $          | 8,000,787                                                                       |       | $                                                            | 8,000,000  |   | $ | 16,128,129 |   |
| Cash paid during  the year for Income taxes              |       | $                                                            | 2,828,444  |                                                                                | $          | 248,476                                                                         |       | $                                                            | 20,804     |   | $ | 266,366 |   |

 

F-7

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements

 

February 29, 2008

 

**1. Organization and Nature ofOperations**

 

The consolidatedfinancial statements include the accounts of Cellu Tissue Holdings, Inc.(the “Company”) and its wholly owned subsidiaries. The Company, a wholly ownedsubsidiary of Cellu Paper Holdings, Inc. (the “Parent”), operatesfacilities in the United States and Canada. The Company manufactures specialtytissue paper for use in personal care products such as baby and adult diapers,incontinent products, surgical waddings and sanitary napkins and for use infast food wrapping, gift wrapping and food service products. The Parentconducts no operating activities.

 

On June 12, 2006,the Parent consummated an Agreement and Plan of Merger with Cellu ParentCorporation (“Cellu Parent”), a corporation organized and controlled by WestonPresidio V, L.P. (“Weston Presidio”), and Cellu Acquisition Corporation (“MergerSub”), a wholly owned subsidiary of Cellu Parent and a newly formed corporationindirectly controlled by Weston Presidio. Pursuant to the agreement, on June 12, 2006, Merger Sub was mergedwith and into Parent, with the Parent surviving (the “Merger”).  Accordingly, the operating results and cashflows for the prior year are presented in the accompanying financial statementson a pre-merger (period from March 1, 2006 to June 12, 2006) andpost-merger (period from June 13, 2006 to February 28, 2007)basis.   The current year operatingresults and cash flows are post-merger.

 

The Company accounted forthe Merger as a purchase in accordance with the provisions of Statement ofFinancial Accounting Standards No. 141 (“SFAS 141”), *BusinessCombinations*, which resulted in a new valuation for the assets and liabilitiesof the Company based upon fair values as of the date of the Merger.  As allowed under SEC Staff AccountingBulletin No. 54, *Push Down Basis ofAccounting Required in Certain Limited Circumstances*(“Push DownAccounting”), the Company has reflected all applicable purchase accountingadjustments in the Company’s consolidated financial statements for all periodssubsequent to the Merger date.  Push DownAccounting requires the Company to establish a new basis for its assets andliabilities based on the amount paid for its equity at the close of business onJune 12, 2006.  Accordingly, CelluParent’s ownership basis is reflected in the Company’s consolidated financialstatements beginning upon completion of the Merger.  In order to apply Push Down Accounting, CelluParent’s purchase price of $207.8 million, including assumption of $162.0million in aggregate principal amount of the Company’s outstanding 9.75% seniorsecured notes (the “Original Notes”), was allocated to the assets andliabilities based on their relative fair values.  The total consideration is subject toadjustment for up to an additional $35.0 million in contingent earnoutconsideration based upon the achievement of certain financial targets.  If any portion of the earned contingent paymentsis unable to be made, then Weston Presidio has agreed to provide the necessaryfunds to former holders of the Parent’s capital stock,

 

F-8

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**1. Organization and Nature ofOperations (continued)**

 

options and warrantsthrough an equity investment in the Parent or otherwise.  In accordance with SFAS 141, the $35.0million has been recognized as a liability, of which $15.0 million will be paidin fiscal year 2009 and is recorded in other current liabilities as of February 29,2008.  The remaining $20.0 million isrecorded in other liabilities as of February 29, 2008.

 

The Company has allocatedthe excess purchase price over the net assets acquired in the Merger based onits estimates of the fair value of assets and liabilities as follows:

 
| ** **                     | ** ** | **Excess purchase  price allocated to:** | ** ** |
|--------------------------------|------------|---------------------------------------------------------|------------|
| Inventories                    |       | $                                                       | 909,264    |   |
| Property, plant  and equipment |       | 142,292,525                                             |       |
| Trademarks                     |       | 6,550,314                                               |       |
| Long-term debt                 |       | (900,729                                                | )          |
| Contingent  consideration      |       | (35,000,000                                             | )          |
| Deferred income  taxes         |       | (50,830,323                                             | )          |
| Total                          |       | $                                                       | 63,021,051 |   |

 

In conjunction with thevaluation of the Company’s property, plant and equipment, the lives over whichthe assets are depreciated were re-evaluated and the resulting estimated usefullives of the principal classifications of depreciable assets are as follows:

 
| ** **                  | ** ** | **Life in Years** | ** ** |
|-----------------------------|------------|-----------------------------|------------|
| Buildings and  improvements |       | 20-30                       |       |
| Machinery and  equipment    |       | 15-30                       |       |
| Furniture and  fixtures     |       | 10                          |       |
| Land  improvements          |       | 5                           |       |
| Computer  software          |       | 5                           |       |

 

**2. Summary of SignificantAccounting Policies**

 

**Principlesof Consolidation**

 

The accompanyingfinancial statements include the accounts of the Company and its wholly ownedsubsidiaries. All significant intercompany transactions and balances areeliminated in consolidation.

 

F-9

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

**CashEquivalents**

 

TheCompany considers all investments with an original maturity of three months orless at the date of purchase cash equivalents.

 

**RevenueRecognition**

 

The Company recognizesrevenue when persuasive evidence of an arrangement exists, delivery hasoccurred, the fee is fixed and determinable and collection is reasonablyassured. Typically, revenue is recognized from product sales when title andrisk of loss has passed to the customer in accordance with the related shippingterms, which is generally at the time products are shipped. Certain sales havefreight-on-board destination terms, in which case, revenue is recognized whenthe product is received by the customer. The Company records a provision forestimated sales returns and other allowances as a reduction of revenue at thetime of revenue recognition.

 

**TradeReceivables and Allowance for Doubtful Accounts**

 

Trade receivables arestated at gross invoice amount, less discounts and provision for uncollectibleaccounts. The Company performs periodic credit evaluations of its customers’financial condition and generally does not require collateral. The Companyestimates its allowance for doubtful accounts using two methods. First, theCompany determines a specific reserve for individual accounts where informationis available that the customer may have an inability to meet its financialobligation. Second, the Company estimates additional reserves for all customersbased on historical write-offs. Accounts are charged-off against the allowancefor doubtful accounts when the Company has exhausted all collection efforts andhas deemed the accounts uncollectible.

 

**Inventories**

 

Inventories are stated atthe lower of cost (average-cost method) or market. The Company providesallowances for materials or products that are determined to be obsolete, or forquantities on hand in excess of expected normal, future requirements. Includedin packaging materials and supplies are felts and wires. These component partsare kept in inventory until they are installed on the machines. Once installed,felts and wires are amortized over their useful lives of approximately threemonths.

 

F-10

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

**Maintenance and Repairs**

 

Maintenance and repairexpenses that do not qualify to be capitalized are expensed as incurred.

 

**Property, Plant and Equipment**

 

Property, plant andequipment acquired in connection with the Merger and the CityForest Acquisitionare valued at fair value.  All otherproperty, plant and equipment acquired is stated at cost. Depreciation of equipmentand amortization of leasehold improvements are computed using the straight-linemethod over the estimated useful lives of the related assets or the life of thelease term, whichever is shorter. The estimated useful lives of the principalclassifications of depreciable assets are as follows:

 
| ** **                  | ** ** | **Life in Years** | ** ** |
|-----------------------------|------------|-----------------------------|------------|
|                        |       |                        |       |
| Buildings and  improvements |       | 20-30                       |       |
| Machinery and  equipment    |       | 15-30                       |       |
| Furniture and  fixtures     |       | 10                          |       |
| Land  improvements          |       | 5                           |       |
| Computer  software          |       | 5                           |       |

 

**AssetImpairment**

 

The Company evaluates theappropriateness of the carrying amounts of its long-lived assets at leastannually, or whenever indicators of impairment are deemed to exist. In thefourth quarter fiscal year 2007, the Company shut down its machine-glazed papermachine at its Interlake facility permanently (see Note 13) and, accordingly,recorded an impairment charge of $488,274, which is reflected as a separate line item in the Company’sstatements of operations for fiscal year 2007. The Company believes that, as of February 29, 2008, there are nosignificant impairments of the carrying amounts of such assets and no reductionin their estimated useful life is warranted.

 

**Goodwilland Trademarks**

 

Goodwill represents costsin excess of fair values assigned to the underlying net assets of acquiredbusinesses.  Goodwill is not amortized,but tested for impairment annually at year-end, and at any time when eventssuggest impairment may have occurred. The Company’s goodwill impairment test is performed by comparing the netpresent value of projected cash flows to the carrying value of goodwill.  The Company incorporates assumptionsinvolving future growth rates, discount rates and tax rates in projecting thefuture cash flows.  In the event thecarrying value of a reporting unit exceeds its fair value, an impairment losswould be recognized to the extent the carrying amount of the reporting unit’sgoodwill exceeds its implied fair value.

 

F-11

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

Goodwill as of February 29,2008 of $7.0 million was recorded in connection with an acquisition in thecurrent year (see Footnote 3).  Nogoodwill impairment has been noted subsequent to the acquisition through thecurrent date.

 

Trademarksare not amortized but tested for impairment annually at the end of our secondquarter and at any time when events suggest impairment may have occurred.  Our impairment test is performed by comparingthe net present value of projected cash flows to the carrying value of thetrademarks.  We incorporate assumptionsinvolving future growth rates, discount rates and tax rates in projecting thefuture cash flows.  In the event thecarrying value of a reporting unit exceeds our fair value, an impairment losswould be recognized to the extent the carrying amount of the reporting unit’strademarks exceeds their implied fair value. No trademark impairments were recorded during fiscal year 2008 or theperiod from June 13, 2006 to February 28, 2007 (post-merger).

 

**Stock-Based Compensation**

 

In December 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 123R (“SFAS 123R”), *Share-BasedPayment*, which requires the measurement of all employee share-basedpayments to employees, including grants of employee stock options, using thefair-value-based method and the recording of such expense in the Company’sconsolidated statement of operations.  TheCompany adopted the provisions of SFAS 123R using the prospective methodeffective March 1, 2006.  As such,there was no accounting effect on any awards outstanding at the date ofadoption.  Upon adoption of SFAS 123R,the Company had only one share-based payment arrangement, the Cellu PaperHoldings, Inc. 2001 Stock Incentive Plan (the “Old Plan”), under which theParent granted stock options to certain members of the Company’smanagement.  In accordance with the OldPlan, each option outstanding at the time of a change in control immediatelyvested and became exercisable. Furthermore, in accordance with the terms of the Merger, all outstandingoptions were cancelled and automatically converted into the right to receivethe per share merger consideration for any in-the-money options.

 

On June 12, 2006,the Board of Directors of Cellu Parent adopted the 2006 Stock Option andRestricted Stock Plan (the “Plan”). Under the Plan, the Plan Administrator may make awards of options topurchase shares of common stock of Cellu Parent and/or awards of restrictedshares of common stock of Cellu Parent. A maximum of 8,095 shares of common stock of Cellu Parent may bedelivered in satisfaction of awards under the Plan, determined net of shares ofcommon stock withheld by Cellu Parent in payment of the exercise price of anaward or in satisfaction of tax withholding requirements.  Key employees and directors of, andconsultants and advisors to, Cellu Parent or its affiliates who, in the opinionof the Plan Administrator, are in a position to make a significant contributionto the success of Cellu Parent and its affiliates are eligible to

 

F-12

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

participate in thePlan.   Stock options are granted at thefair market value of the Cellu Parent’s stock on the date of grant and have a10-year term.  Generally, stock optiongrants vest ratably over four years from the date of grant.  The following describes how certainassumptions affecting the estimated fair value of stock options aredetermined.  The dividend yield is zero;the volatility is based on historical market value of the Company’s stock; andthe risk-free interest rate is based on U.S. Treasury securities withmaturities equal to the expected life of the option.  The Company uses historical data in order toestimate exercise, termination and holding period behavior for valuationpurposes.  A summary of the optionactivity as of February 29, 2008 and for the fiscal year then ended is asfollows:

 
| ** **                      | ** ** | **Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** |
|---------------------------------|------------|-------------|------------|--------------------------------------------|------------|---------------------------------------------------------|------------|
| Outstanding,  beginning of year |       | 575         |       | $                                          | 426.69     |                                                    | 9.5 Years  |   |
| Forfeited                       |       | (100        | )          | $                                          | 426.69     |                                                    | 9.5 Years  |   |
| Granted                         |       | 650         |       | $                                          | 979.25     |                                                    | 9.1 Years  |   |
| Outstanding, end  of year       |       | 1,125       |       | $                                          | 733.67     |                                                    | 8.9 Years  |   |
| Exercisable, end  of year       |       | 125         |       | $                                          | 426.69     |                                                    | 8.5 Years  |   |

 

The fair value of thestock option grant was estimated on the date of grant using the Black-Scholesoption pricing model.  The weightedaverage assumptions used to value the grants were: no dividend yield; 57%volatility; 4.9% risk-free interest rate; and 10-year expected life.  The weighted average fair value of stockoptions granted was $478.82 per share and the unrecognized total compensationcost as of February 29, 2008 related to non-vested awards was $402,564**.**

 

On August 6, 2007,Cellu Parent entered into a Restricted Stock Agreement with the Company’s newlyappointed Chief Financial Officer, pursuant to which Cellu Parent granted 700restricted shares of its common stock to the named individual pursuant to thePlan.  The shares will vest and cease tobe restricted in four equal annual installments commencing on August 6,2007, as long as the named individual is continuously employed by the Companyuntil such vesting date with respect to his shares.  Any restricted stock outstanding at the timeof a Covered Transaction (as defined in the Plan) shall become vested and ceaseto be restricted stock at the time of a change in control.  Additionally, the Parent has agreed to pay anamount to the named individual equal to an amount that would be included insuch individual’s gross income and payable as income tax as a result of makinga Section 83(b) election under the Internal Revenue Code of 1986, asamended (the “Code”).  The namedindividual has made a timely Section 83(b) election.  In connection with this election, the Companyhas recorded compensation expense of $501,853 in the third quarter fiscal year2008.

 

F-13

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

On June 12, 2006,Cellu Parent entered into Restricted Stock Agreements with the Company’s ChiefExecutive Officer, Chief Operating Officer and the then Chief FinancialOfficer, pursuant to which Cellu Parent granted 3,778 restricted shares of itscommon stock to its Chief Executive Officer and 1,349 restricted shares of itscommon stock to each of the other two named individuals pursuant to thePlan.  The shares will vest and cease tobe restricted in four equal annual installments commencing on June 12,2007, as long as the named individual, as the case may be, is continuouslyemployed by the Company until each such vesting date with respect to his or hershares.  Any restricted stock outstandingat the time of a Covered Transaction shall become vested and cease to berestricted stock at the time of a change in control.  Additionally, the Parent has agreed to pay anadditional amount to each of the named individuals equal to an amount thatwould be included in such individual’s gross income and payable as income taxas a result of making a Section 83(b) election under the Code.  All named individuals have made a timely Section 83(b) election.

 

EffectiveJuly 31, 2007, the then Chief Financial Officer resigned and forfeitedthree-fourths of the individual’s restricted stock grant and, accordingly, theCompany only recorded compensation expense associated with this individual’sgrant through June 12, 2007, as all other shares were forfeited and nocompensation expense was required to be recognized for forfeited shares.

 

For fiscal year 2008 andfor the period from June 13, 2006 to February 28, 2007, the Companyhas recorded $685,100 and $489,661, respectively, of compensation expenserelated to the vesting of the above grants in accordance with SFAS 123R.  Immediately prior to consummation of theMerger, there were 341.3 restricted shares of Parent’s common stock.  In accordance with the terms of the Old Plan,the restricted stock immediately vested. Accordingly, for the period from March 1, 2006 to June 12,2006, the Company recorded $923,580 of compensation expense related to thevesting of the above restricted stock in accordance with SFAS 123R.

 

**Derivativesand Hedging**

 

The Company usesderivative financial instruments to offset a substantial portion of itsexposure to market risk arising from changes in the price of natural gas.  Hedging of this risk is accomplished byentering into forward swap contracts, which are designated as hedges ofspecific quantities of natural gas expected to be purchased in futuremonths.    These contracts are held forpurposes other than trading and are designated as cash flow hedges.  The Company

 

F-14

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

measures hedgeeffectiveness by formally assessing, at least quarterly, the correlation of theexpected future cash flows of the hedged item and the derivative hedginginstrument.  The ineffective portions ofthe hedges, which are not material for any period presented, are immediatelyrecognized in earnings.  The fair valueof these cash flow hedging instruments was an asset of $.2 million and lessthan $.1 million as of February 29, 2008 and February 28, 2007,respectively.  During the next 12 months,the entire $.2 million will be reclassified to earnings consistent with thetiming of the underlying hedged transaction. The accumulated derivative gain as of February 29, 2008 and February 28,2007 was $.2 million and less than $.1 million, respectively.

 

**ForeignCurrency Translation**

 

The financial statementsof the Company’s foreign subsidiary have been translated into U.S. dollars inaccordance with SFAS No. 52, “*Foreign CurrencyTranslatio*n.” All balance sheet accounts are translated at currentexchange rates; income and expenses are translated using weighted averageexchange rates during the applicable fiscal year. Resulting translationadjustments are reported in other comprehensive income (loss).

 

Included in foreigncurrency translation adjustments for fiscal year 2006 is a one-time adjustmentof $2.6 million to correct the cumulative effect of improperly translating thevalue of property, plant and equipment. The translation of these assets from Canadian dollars to U.S. dollarshad been occurring at historical rates, as opposed to actual month-end rates,as required under SFAS 52, “*Foreign CurrencyTranslation.”*

 

**Concentrations**

 

For fiscal year 2008, onecustomer comprised 13.4% of sales.   Forthe period from June 13, 2006 to February 28, 2007, no customercomprised more than 10% of sales.  Forthe period March 1, 2006 to June 12, 2006 and fiscal year 2006, onecustomer comprised 10.3% and 12.3%, respectively, of sales. These sales were inthe Company’s tissue segment for fiscal year 2008, the period from March 1,2006 to June 12, 2006 and for fiscal year 2006.

 

**Labor Concentration**

 

At February 29,2008, approximately****66% of theCompany’s active full-time employees were represented by either the UnitedSteel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied-Industrial andService Workers International Union (the “USW”) or Independent Paper Workers ofCanada through various collective bargaining agreements that expire between June 2008and June 2012**.**  In July 2005, the USW was elected torepresent 76 hourly employees at

 

F-15

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

the Company’s Mississippifacility and was certified by the National Labor Relations Board as theexclusive collective bargaining representative of such employees.  On June 29, 2007, a collectivebargaining agreement with USW was ratified.

 

**Shipping and Handling Costs**

 

The Company classifiesthird-party inbound shipping and handling costs as a component of cost of goodssold.  The Company classifies outboundshipping and handling costs as a reduction of sales.  The outbound costs were $12,058,701,****$6,175,268, $2,501,880 and $8,530,418 for fiscal year 2008,for the periods from June 13, 2006 to February 28, 2007, from March 1,2006 to June 12, 2006 and for fiscal year 2006, respectively.

 

**Considerations Paid to Resellers**

 

TheCompany recognizes consideration paid to a reseller of its products as areduction of the selling price of its products sold and, therefore, reduces netsales in the Company’s statement of operations.

 

**Use of Estimates**

 

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

 

**Financial Instruments**

 

The Company estimates thefair value of financial instruments for financial statement disclosure.  For these purposes, the carrying amounts forcash and cash equivalents, accounts receivable and accounts payable approximatefair value.  The carrying amount of theCompany’s borrowings under its revolving line of credit approximates its fairvalue.  The Company’s long-term debt hasbeen recorded at its fair value.

 

**Reclassifications**

 

Certain prior yearamounts have been reclassified to conform to the fiscal year 2008 presentation.

 

F-16

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

**2. Summary of SignificantAccounting Policies (continued)**

 

**New Accounting Standards**

 

In September 2006,the FASB issued FAS No. 157,”*Fair Value Measurements*”(“SFAS 157”).  SFAS 157 defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value measurements.  This statement applies under other accountingpronouncements that require or permit fair value measurements.  In February 2008, the FASB issued FSP157-2, “*Effective Date of FASB Statement No. 157*”, which delays the effective date ofSFAS No. 157 to fiscal years beginning after November 15, 2008 andinterim periods within those fiscal years. The Company does not expect the adoption of this statement to have amaterial impact on its financial statements.

 

In February 2007,the FASB issued SFAS No. 159, “*The Fair Value Option forFinancial Assets and Financial Liabilities; Including an Amendment of FASBStatement No. 115*” (“SFAS 159”)  SFAS 159 provides an option to measureeligible items at fair value at specified dates.  Unrealized gains and losses on the eligibleitems for which the fair value option has been elected should be reported inearnings.  SFAS 159 is effective for theCompany’s fiscal year ending February 28, 2009.  The Company expects that the adoption of SFAS159 will not have a material effect on its financial statements.

 

In December 2007,the FASB issued SFAS No. 141R, “*Business Combinations*”(“SFAS No. 141R”), and SFAS No. 160, “*Noncontrolling Interests inConsolidated Financial Statements” (“SFAS 160*”).  SFAS 141R requires an acquirer to measure theidentifiable assets acquired, the liabilities assumed and any noncontrollinginterest in the acquiree at their fair values on the acquisition date, withgoodwill being measured and recorded at the excess value over the netidentifiable assets acquired.  SFAS 160clarifies that a noncontrolling interest in a subsidiary should be reported asequity in the consolidated financial statements.  SFAS 141R and SFAS 160 are effective forfinancial statements issued for fiscal years beginning after December 15,2008.  Early adoption is prohibited.  The Company is currently assessing the impactthat SFAS 141R and SFAS 160 will have on its results of operations andfinancial position.

 

**3. Acquisitions**

 

On March 21, 2007,the Company executed a definitive merger agreement (the “Acquisition Agreement”)with CityForest Corporation (“CityForest”), Cellu City Acquisition Corporation(“Cellu City Merger Sub”) and Wayne Gullstad as the shareholders’representative.  Pursuant to theAcquisition Agreement, and subject to the terms and conditions therein, CelluCity Merger Sub, a wholly owned subsidiary of the Company, merged with and intoCityForest, with CityForest surviving and becoming a wholly owned subsidiary ofthe Company (the “CityForest Acquisition”). The aggregate merger consideration (including assumption of $18.4million in

 

F-17

----

 

Cellu TissueHoldings, Inc. and Subsidiaries

 

Notes toConsolidated Financial Statements (continued)

 

** 3. Acquisition (continued)**

 

aggregate principalamount of industrial revenue bonds) was approximately $61.0 million subject tocertain working capital and net cash adjustments.  Total cash paid for the acquisition of $46.8million (purchase price of $61.0 million less assumed indebtedness of $18.4million plus restricted cash and other miscellaneous adjustments of $1.6million and acquisition costs of $2.6 million) was financed in part by issuanceof unregistered 9 3/4% Senior Secured Notes due 2010 (the “Additional Notes”)of approximately $20.0 million, borrowings on a revolving line of credit ($17.4million) and available cash on hand.

 

The CityForestAcquisition has been accounted for as a purchase in accordance with theprovisions of SFAS 141 and, accordingly, the consolidated statements ofoperations includes the results of CityForest for fiscal year 2008 from thedate of acquisition.  Purchase priceallocations are subject to refinement until all pertinent information isobtained.  The Company has allocated theexcess of purchase price over the net assets acquired in the acquisition basedon its estimates of the fair value of assets and liabilities as follows:

** **
| ** **                     | ** ** | **Excess purchase price allocated to:** | ** ** |
|--------------------------------|------------|-------------------------------------------------------------|------------|
| Property, plant  and equipment |       | $                                                           | 32,854,514 |   |
| Trademarks                     |       | 2,200,000                                                   |       |
| Goodwill                       |       | 6,970,001                                                   |       |
| Long-term debt                 |       | (1,724,684                                                  | )          |
| Deferred income  taxes         |       | (17,238,509                                                 | )          |
| Total                          |       | $                                                           | 23,061,322 |   |

 

The results ofCityForest’s operations from the date of acquisition (March 21, 2007) areincluded in the Company’s tissue segment. Unaudited pro forma results of operations for fiscal year 2008, for theperiod June 13, 2006-November 23, 2006 and for the period March 1,2006-June 12, 2006, as if the Company and CityForest had been combined asof March 1, 2006, are presented below. The pro forma results include estimates and assumptions, which theCompany’s management believes are reasonable. However, the pro forma results do not include any cost savings or othereffects of the planned integration of CityForest and are not necessarilyindicative of the results which would have occurred if the business combinationhad been in effect on the dates indicated, or which may result in the future.

 

F-18

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**3.   Acquisition (continued)**

 
| ** **               | ** ** | **Year Ended  February  29, 2008  (1)** | ** ** | **June 13, 2006-  February 28, 2007  (2)** | ** ** | **March 1, 2006-  June 12, 2006  (2)** | ** ** |               |
|--------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|--------------------|
| ** **               | ** ** | **As Filed**                                           | ** ** | **Pro Forma**                                             | ** ** | **As Filed**                                          | ** ** | **Pro Forma** | ** ** | **As Filed** | ** ** | **Pro Forma** | ** ** |   |
| ** **               | ** ** | ** **                                                  | ** ** | **(Unaudited)**                                                | ** ** | ** **                                                 | ** ** | **(Unaudited)**    | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |   |
| ** **               | ** ** | **(in thousands)**                                     | ** ** | **(in thousands)**                                        | ** ** | **(in thousands)**                                    | ** ** |               |
|                     |       |                                                        |       |                                                           |       |                                                       |       |               |   |   |   |   |   |   |
| Net sales                |       | $                                                           | 431,022    |                                                           | $          | 433,733                                                    |       | $                  | 241,237 |   | $ | 275,319 |   | $ | 94,242 |   | $ | 107,823 |   |
|                     |       |                                                        |       |                                                           |       |                                                       |       |               |   |   |   |   |   |   |
| Operating income  (loss) |       | $                                                           | 20,665     |                                                           | $          | 21,251                                                     |       | $                  | 1,015 |   | $ | 9,620 |   | $ | (3,330 | ) | $ | 99 |   |
|                     |       |                                                        |       |                                                           |       |                                                       |       |               |   |   |   |   |   |   |
| Net income  (loss)       |       | $                                                           | 3,993      |                                                           | $          | 4,553                                                      |       | $                  | (6,192 | ) | $ | (562 | ) | $ | (6,535 | ) | $ | (4,292 | ) |
|                          |            |                                                             |            |                                                                |            |                                                            |            |                    |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) Pro forma operating results include the operating results forCityForest for fiscal year 2008.  The “asfiled” operating results include the operating results for CityForest for theperiod from the acquisition date (March 21, 2007) to February 29,2008.

 

(2)  Pro forma operating results include the operating results forCityForest for the year ended December 31, 2006, prorated between the tworeporting periods presented for the Company, as CityForest was previously acalendar year-end company.

 

**4. Inventories**

 

Components of inventoriesare as follows:

 
| ** **                        | ** ** | **February 29** | ** ** | **February 28** | ** ** |
|-----------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                        | ** ** | **2008**             | ** ** | **2007**             | ** ** |
|                              |       |                 |       |                 |       |
| Finished goods                    |       | $                    | 17,961,802 |                 | $          | 18,896,790 |   |
| Raw materials                     |       | 7,073,131            |       | 2,742,025            |       |
| Packaging  materials and supplies |       | 9,082,592            |       | 7,210,268            |       |
|                              |       | 34,117,525           |       | 28,849,083           |       |
|                              |       |                 |       |                 |       |
| Reserve for  obsolescence         |       | (121,086             | )          | (133,588             | )          |
|                              |       | $                    | 33,996,439 |                 | $          | 28,715,495 |   |

 

F-19

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**5. Property, Plant and Equipment**

 

Property, plant andequipment consist of the following:

 
| ** **                      | ** ** | **February 29, 2008** | ** **  | **February 28, 2007** | ** ** |
|---------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Land and  improvements          |       | $                               | 3,717,906   |                            | $          | 4,129,581 |   |
| Buildings and  improvements     |       | 34,499,830                      |        | 22,464,389                      |       |
| Machinery and  equipment        |       | 288,166,437                     |        | 212,598,587                     |       |
| Furniture and  fixtures         |       | 91,723                          |        | 37,610                          |       |
| Computer  hardware and software |       | 4,420,076                       |        | 2,892,082                       |       |
| Construction-in-progress        |       | 5,620,003                       |        | 2,862,976                       |       |
|                            |       | 336,515,975                     |        | 244,985,225                     |       |
| Less accumulated  depreciation  |       | (39,918,087                     | )           | (16,133,460                     | )          |
|                            |       | $                               | 296,597,888 |                            | $          | 228,851,765 |   |

 

**6. Long-Term Debt**

 

Long-term debt consistsof the following:

 
| ** **                                                                                                        | ** ** | **February 29, 2008** | ** **  | **February 28, 2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Senior secured 9 3⁄4% notes due 2010                                                                           |       | $                               | 182,255,572 |                            | $          | 162,000,000 |   |
| Less discount                                                                                                     |       | (1,283,628                      | )           | (1,644,493                      | )          |
|                                                                                                              |       | 180,971,944                     |        | 160,355,507                     |       |
| Industrial  revenue bond payable, in annual installments, plus interest ranging from 1.38%  to 4.15%, due in 2028 |       | 17,875,000                      |        | —                          |       |
|                                                                                                              |       | 198,846,944                     |        | 160,355,507                     |       |
|                                                                                                              |       |                            |        |                            |       |
| Less current  portion of debt                                                                                     |       | 760,000                         |        | —                          |       |
|                                                                                                              |       | $                               | 198,086,944 |                            | $          | 160,355,507 |   |

 

The maturities oflong-term debt for the next five years follow: 2009-$760,000; 2010-$183,015,572; 2011-$760,000; 2012-$760,000; 2013 andthereafter-$14,835,000.

 

In March 2004, theCompany completed a private offering of $162.0 million aggregate principalamount of 93⁄4% senior secured notes due 2010 (the “Original Notes” and togetherwith the Additional Notes, the “Notes”). In connection with the CityForest Acquisition (see Note 3), the Companyentered into a Note Purchase Agreement (the “Note Purchase Agreement”) withWingate Capital Ltd. (“Wingate”), dated March 21, 2007, pursuant to whichit issued and sold

 

F-20

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**6. Long-Term Debt (continued)**

 

$20.3 million aggregate principal amount of the Additional Notes toWingate for the purchase price of approximately $20.0 million, which is equalto 98.7383% of the aggregate principal amount of the Additional Notes.  The Notes (including the Original Notes andthe Additional Notes) were issued pursuant to and will be governed by theIndenture, dated as of March 12, 2004 (as amended and supplemented, the “CelluTissue Indenture”) among the Company, the subsidiary guarantors party theretoand The Bank of New York Trust Company, N.A., as successor trustee to the Bankof New York (the “Trustee”).

 

The Notes mature on March 15, 2010 and require semi-annualinterest payments on March 15 and September 15.  The Notes are collateralized by a seniorsecured interest in substantially all of the Company’s assets.  Terms of the Indenture under which the Noteshave been issued contain certain covenants, including limitations on certainrestricted payments and the incurrence of additional indebtedness.  The Notes are unconditionally guaranteed byall of the Company’s subsidiaries.

 

In connection with the Merger (see Note 1), the Company solicitedconsents with respect to the Original Notes.  Consents were received with respect to 100% of the aggregate outstandingprincipal amount of the Original Notes. The Company accepted all of theconsents delivered in the consent solicitation and paid to the consentingnoteholders a consent fee of $40 per $1,000 principal amount of Original Notesfor which they delivered consents.  Thesepayments were made in the Company’s second quarter of fiscal year 2007.  These payments, along with other transactioncosts totaling $5.9 million, are reflected as merger-related transaction costson the statement of operations for the prior year.  The Company had previously incurred $.1million in the first quarter of fiscal year 2007.   As a result of the acceptance by the Companyof the consents delivered by noteholders and the completion of the consent solicitation,the amendments to the Cellu Tissue Indenture described in the ConsentSolicitation Statement dated May 9, 2006 and related Supplement dated May 24,2006 became operative and the Company was not required to make a change ofcontrol offer to purchase any Notes in connection with the Merger.

 

The Company entered into a Credit Agreement, dated as of June 12,2006 (the “Credit Agreement”), among the Company, as U.S. Borrower, InterlakeAcquisition Corporation Limited, a subsidiary of the Company, as CanadianBorrower, the Parent, the other loan guarantors party thereto, JPMorgan ChaseBank, N.A., as U.S. Administrative Agent, JPMorgan Chase Bank, N.A., TorontoBranch, as Canadian Administrative Agent, and the other lenders party thereto.  The Credit Agreement provides for a $35.0million working capital facility, which was subsequently increased to $40.0million (see discussion following), including a letter of credit sub-facilityand swing-line loan sub-facility. The Credit Agreement provides that amountsunder the facility may be borrowed, repaid and re-borrowed, subject to aborrowing base test, until the maturity date, which is June 12, 2011. Anamount equal to $32.0 million, which was subsequently increased to $37.0million (see discussion following), is available, in U.S. dollars, to the U.S.Borrower under the facility, and an amount equal

 

F-21

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**6. Long-TermDebt (continued)**

 

to $3.0 million is available, in U.S. or Canadian dollars, to theCanadian Borrower under the facility. Borrowings of $17.4 million were made to finance a portion of theCityForest Acquisition.  As of February 29,2008, $9.8 million of borrowings remained outstanding under the working capitalfacility and excess availability was $27.0 million.  In addition to the Note Purchase Agreement,the following agreements were entered into in connection with the CityForestAcquisition:

 

***Second Supplemental Indenture***

 

The Company, certain of its subsidiaries, the Trustee and CityForesthave executed the Second Supplemental Indenture, dated March 21, 2007 (the“Second Supplemental Indenture”), pursuant to which CityForest became a partyto the Cellu Tissue Indenture as a subsidiary guarantor.  As a subsidiary guarantor, CityForest, on ajoint and several basis with all the existing subsidiary guarantors, fully,unconditionally and irrevocably guarantees to each holder of the Notes and theTrustee the obligations of Company under its Indenture and the Notes.

 

***Amendment to Credit Agreement***

 

The Company has entered into a First Amendment, dated March 21,2007 (the “Amendment”), to the Credit Agreement dated June 12, 2006 (asamended by the Amendment, the “Amended Credit Agreement”) among Cellu Tissue,as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary ofCellu Tissue, as Canadian Borrower, certain subsidiaries of Cellu Tissue, CelluPaper Holdings, Inc., the parent corporation of Cellu Tissue, JPMorganChase Bank, N.A. (the “U.S. Administrative Agent”) and JPMorgan Chase Bank,N.A., Toronto Branch (the “Canadian Administrative Agent”).

 

The Amendment (1) increases the working capital facility from$35.0 million to $40.0 million, (2) permits the issuance and sale by theCompany of the Additional Notes, (3) provides for the consummation of theCityForest Acquisition and the conversion by CityForest from a Minnesotacorporation to a Minnesota limited liability company, (4) permits theassumption of approximately $18.4 million in aggregate principal amount ofindebtedness of CityForest in connection with the CityForest Acquisition inaccordance with the terms of the CityForest Bond Documents (as defined belowunder “CityForest Bond Documents”) and (5) permits the guarantee by CelluTissue of certain obligations of CityForest under the CityForest BondDocuments.  In connection with theAmendment, CityForest became a guarantor of the obligations of the borrowersunder the Amended Credit Agreement.

 

***CityForest Bond Documents***

 

CityForest is party to a Loan Agreement, dated March 1, 1998 (the “LoanAgreement”), with the City of Ladysmith, Wisconsin (the “Issuer”).  Pursuant to the Loan Agreement,

 

F-22

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**6.Long-Term Debt (continued)**

 

the Issuer loaned the proceeds of the Issuer’s Variable Rate DemandSolid Waste Disposal Facility Revenue Bonds, Series 1998 (CityForestCorporation Project) (the “Bonds”) to CityForest to finance the construction byCityForest of a solid waste disposal facility. Approximately $18.4 million in aggregate principal amount of the Bondswas outstanding as of the date of the CityForest Acquisition.  CityForest is required, under the terms ofthe Indenture of Trust governing the Bonds (the “CityForest Indenture”), toprovide a letter of credit in favor of the trustee under the CityForestIndenture (the “Bonds Trustee”). CityForest has entered into an Amended and Restated ReimbursementAgreement, dated March 21, 2007 (the “Reimbursement Agreement” and,together with the CityForest Indenture and the Loan Agreement, the “CityForestBond Documents”), with Associated Bank, National Association (“Associated Bank”),pursuant to which Associated Bank has extended the required letter of credit(the “Associated Bank Letter of Credit”) and has provided a revolving creditfacility to CityForest in an aggregate principal amount of up to $3.5 million(the “Associated Bank Revolving Credit Facility”).

 

The Bonds Trustee is permitted to draw upon the Associated Bank Letterof Credit to pay principal and interest due on the Bonds, and to provideliquidity to purchase Bonds put to CityForest by bondholders and notremarketed; and CityForest is obligated under the Reimbursement Agreement toreimburse Associated Bank for any such draws. CityForest is also obligated topay a fee in respect of the aggregate amount available to be drawn under theAssociated Bank Letter of Credit at a rate per annum initially equal to 1.25%,subject to adjustment on a quarterly basis based on CityForest’s leverage.  The expiration date of the Associated BankLetter of Credit is February 15, 2011.

 

Amounts borrowed by CityForest under the Associated Bank RevolvingCredit Facility bear interest at a rate per annum equal to the LIBOR Rate (asdefined in the Reimbursement Agreement), plus an applicable margin. Theapplicable margin percentage initially is 1.75%, subject to adjustment on aquarterly basis based upon CityForest’s leverage.  During the continuance of an event ofdefault, the outstanding principal balance bears interest at a rate per annumequal to the then applicable interest rate plus 2.00%.  CityForest is also obligated to pay acommitment fee in respect of any unused commitment under the Associated BankRevolving Credit Facility in an amount equal to 0.50% per annum.  In addition, subject to certain exceptions,if CityForest terminates the Associated Bank Revolving Credit Facility prior toFebruary 15, 2009, CityForest is obligated to pay to Associated Bank a feeequal to 1.00% of the commitment then being terminated. The maturity date ofthe Associated Bank Revolving Credit Facility is February 15, 2011.

 

The Reimbursement Agreement requires scheduled semi-annual payments ofprincipal of the Bonds equal to approximately 2.00% of the principal amountoutstanding as of the date of the CityForest Acquisition, with the balancepayable at maturity of the Bonds on March 1, 2028. The

 

F-23

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**6.Long-Term Debt (continued)**

 

Reimbursement Agreement also contains a number of other provisionsregarding reserve funds and other mandatory and optional repayments inconnection with the Bonds.  In connectiontherewith, the Company has $1.2 million of reserved cash as of February 29,2008, which is separately stated on the balance sheet.  In addition, the Reimbursement Agreementprovides that in certain circumstances where the Company incurs indebtedness,as defined, in excess of amounts currently permitted under the CityForestIndenture or refinances the indebtedness issued under the Indenture, AssociatedBank may require CityForest to repay all of its obligations to Associated Bankunder the Reimbursement Agreement and either to cause the Bonds to be redeemedor to replace the Associated Bank Letter of Credit with a Substitute CreditFacility, as such term is defined in the CityForest Indenture.

 

The Reimbursement Agreement contains various affirmative and negativecovenants customary for working capital and term credit facilities, as well asadditional covenants relating to the Bonds. The negative covenants include limitations on: indebtedness; liens;acquisitions, mergers and consolidations; investments; guarantees; asset sales;sale and leaseback transactions; dividends and distributions; transactions withaffiliates; capital expenditures; and changes to the status of the Bonds.CityForest is also required to comply on a quarterly basis with a maximumleverage covenant and a minimum fixed charge coverage covenant.

 

The Reimbursement Agreement also contains customary events of default,including:  payment defaults; breaches ofrepresentations and warranties; covenant defaults; cross-defaults to certainother debt, including the Additional Notes and indebtedness under the AmendedCredit Agreement; certain events of bankruptcy and insolvency; judgmentdefaults; certain defaults related to the Employee Retirement Income SecurityAct of 1974, as amended; and a change of control of CityForest or the Company.

 

The Company has guaranteed all of the obligations of CityForest underthe Reimbursement Agreement, pursuant to a Guaranty, dated March 21, 2007(the “Cellu Tissue Guaranty”), executed by the Company in favor of AssociatedBank. In addition, the obligations of CityForest under the ReimbursementAgreement are secured by first-priority liens in favor of Associated Bank inall of CityForest’s assets.  The U.S.Administrative Agent, the Canadian Administrative Agent, Associated Bank andCityForest have entered into an Intercreditor Agreement, dated March 21,2007, which sets forth the respective rights and priorities of Associated Bank,on the one hand, and the U.S. Administrative Agent and the CanadianAdministrative Agent, on the other hand, as to the collateral of CityForestsecuring the Reimbursement Agreement and the Amended Credit Agreement.

 

F-24

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**7. Income Taxes**

 

The components of pretax income (loss) consist of the following:

 
| ** **                  | ** ** | **Year Ended  February 29, 2008** | ** ** | **For the Period  June 12, 2006-  February 28, 2007** | ** ** | **For the Period  March 1, 2006-  June 12, 2006** | ** ** | **Year Ended  February 28,  2006** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                  | ** ** | **(Post-Merger)**                                | ** ** | **(Pre-Merger)**                                                                    | ** ** |
| United States               |       | $                                                | (2,279,249 | )                                                                                   | $          | (12,100,807                                                                     | )          | $                                            | (8,390,310 | ) | $ | (6,349,474 | ) |
| Foreign                     |       | 2,543,057                                        |       | 2,020,465                                                                           |       | (98,016                                                                         | )          | 204,988                                      |       |
| Total pretax  income (loss) |       | $                                                | 263,808    |                                                                                | $          | (10,080,342                                                                     | )          | $                                            | (8,488,326 | ) | $ | (6,144,486 | ) |

 

The provision for incometaxes (benefit) consisted of the following:

 
| ** **           | ** ** | **Year Ended  February 29, 2008** | ** ** | **For the Period  June 13, 2006-  February  28, 2007** | ** ** | **For the Period  March 1, 2006-  June 12, 2006** | ** ** | **Year Ended  February 28, 2006** | ** ** |
|----------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **           | ** ** | **(Post-Merger)**                                | ** ** | **(Pre-Merger)**                                                                          | ** ** |
| Current:             | ** ** | ** **                                       | ** ** | ** **                                                                                | ** ** | ** **                                                                      | ** ** | ** **                                       | ** ** |
| Federal              |       | $                                                | 1,536,448  |                                                                                      | $          | 1,398,110                                                                       |       | $                                                | (1,509,493 | ) | $ | (1,029,216 | ) |
| State                |       | 49,000                                           |       | 27,750                                                                                    |       | 9,250                                                                           |       | 177,000                                          |       |
| Foreign              |       | 1,282,657                                        |       | 1,337,253                                                                                 |       | (57,095                                                                         | )          | 232,465                                          |       |
|                 |       | 2,868,105                                        |       | 2,763,113                                                                                 |       | (1,557,338                                                                      | )          | (619,751                                         | )          |
| Deferred:            |       |                                             |       |                                                                                      |       |                                                                            |       |                                             |       |
| Federal              |       | (2,786,114                                       | )          | (5,645,456                                                                                | )          | (404,831                                                                        | )          | (2,569,061                                       | )          |
| State                |       | (2,053,590                                       | )          | (362,209                                                                                  | )          | (14,288                                                                         | )          | (387,963                                         | )          |
| Foreign              |       | (1,757,344                                       | )          | (643,424                                                                                  | )          | 23,095                                                                          |       | 36,459                                           |       |
|                 |       | (6,597,048                                       | )          | (6,651,089                                                                                | )          | (396,024                                                                        | )          | (2,920,565                                       | )          |
| Valuation  allowance |       | —                                           |       | —                                                                                    |       | —                                                                          |       | (34,816                                          | )          |
|                 |       | $                                                | (3,728,943 | )                                                                                         | $          | (3,887,976                                                                      | )          | $                                                | (1,953,362 | ) | $ | (3,575,132 | ) |

 

The foreign portion of the provision for income taxes is a result ofoperations at one of the Company’s subsidiaries, Interlake AcquisitionCorporation Limited, in Canada.  TheCompany provides tax on foreign earnings that are remitted or deemed to beremitted.

 

F-25

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**7. Income Taxes (continued)**

 

The reconciliation of income tax benefit on income (loss) at the U.S.federal statutory tax rates to the effective income tax rates is as follows:

 
| ** **                           | ** ** | **Year Ended  February 29, 2008** | ** ** | **For the Period  June 12, 2006-  February 28,2007** | ** ** | **For the Period  March 1, 2006-  June 12, 2006** | ** ** | **Year Ended  February 28, 2006** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **(Post-Merger)**                                | ** ** | **(Pre-Merger)**                                                              | ** ** |
| Tax at U.S. statutory  rate          |       | $                                                | (774,945   | )                                                                             | $          | (4,114,274                                                                      | )          | $                                                | (2,852,705 | ) | $ | (2,089,125 | ) |
| Tax at foreign  statutory rate       |       | 867,691                                          |       | 707,163                                                                       |       | (34,306                                                                         | )          |                                             |       |
| State taxes, net  of federal benefit |       | (521,065                                         | )          | (377,954                                                                      | )          | 24,994                                                                          |       | (210,963                                         | )          |
| Foreign non-deductible  expense      |       | 1,024                                            |       | 525                                                                           |       | 175                                                                             |       | 680                                              |       |
| U.S. non-deductible  items           |       | (148,240                                         | )          | 2,060                                                                         |       | 908,480                                                                         |       | 38,643                                           |       |
| Change in  valuation allowance       |       | —                                           |       | —                                                                        |       | —                                                                          |       | (34,816                                          | )          |
| Provision to  return changes         |       | (867,460                                         | )          | —                                                                        |       | —                                                                          |       | (1,215,247                                       | )          |
| Canadian  withholding tax            |       |                                             |       | —                                                                        |       | —                                                                          |       | 136,917                                          |       |
| AMT credit                           |       | (290,979                                         | )          | —                                                                        |       | —                                                                          |       | —                                           |       |
| FIN 48 Provision                     |       | 845,668                                          |       | —                                                                        |       | —                                                                          |       | —                                           |       |
| State deferred  rate change          |       | (1,500,184                                       | )          | —                                                                        |       | —                                                                          |       | —                                           |       |
| Canadian  deferred rate change       |       | (1,383,386                                       | )          |                                                                          |       |                                                                            |       |                                             |       |
| Other                                |       | 42,933                                           |       | (105,496                                                                      | )          | —                                                                          |       | (201,221                                         | )          |
| Income tax  benefit                  |       | $                                                | (3,728,943 | )                                                                             | $          | (3,887,976                                                                      | )          | $                                                | (1,953,362 | ) | $ | (3,575,132 | ) |

 

Included in the income tax benefit for fiscal year 2008 is $1.4 millionand $1.5 million, respectively, of benefit associated with future changes inCanadian tax rates due to legislative changes and changes in the Company’seffective state tax rates which are expected to be realized in the future.

 

The reduction in the valuation allowance during fiscal year 2006relates to the utilization of Canadian NOLs, as the subsidiary was profitablein fiscal year 2006.

 

F-26

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to ConsolidatedFinancial Statements (continued)

 

**7. Income Taxes (continued)**

 

Significantcomponents of the Company’s deferred tax assets and liabilities are as follows:

 
| ** **                      | ** ** | **February 29** | ** **  | **February 28** | ** ** |
|---------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                      | ** ** | **2008**             | ** **  | **2007**             | ** ** |
|                            |       |                 |        |                 |       |
| Deferred tax  assets:           |       |                 |        |                 |       |
| Compensation and  benefits      |       | $                    | 1,237,579   |                 | $          | 565,512 |   |
| NOL carryforward                |       | 4,612,901            |        | 5,574,218            |       |
| Accounts  receivable            |       | 133,646              |        | 189,630              |       |
| Contingent consideration        |       | 14,206,500           |        | 13,979,000           |       |
| Refinancing  costs              |       | 2,484,857            |        | 2,199,924            |       |
| Capitalized  transaction costs  |       | 670,678              |        | —               |       |
| AMT credit                      |       | 334,979              |        | —               |       |
| Other                           |       | 196,663              |        | 253,710              |       |
| Total deferred  tax assets      |       | 23,877,803           |        | 22,761,994           |       |
|                            |       |                 |        |                 |       |
| Deferred tax  liabilities:      |       |                 |        |                 |       |
| Goodwill/trademarks             |       | (900,216             | )           | —               |       |
| Restricted stock                |       | (918,469             | )           | (908,299             | )          |
| Property, plant  and equipment  |       | (76,786,150          | )           | (65,826,158          | )          |
| Other                           |       | (123,781             | )           | (206,771             | )          |
| Total deferred  tax liabilities |       | (78,728,616          | )           | (66,941,228          | )          |
|                            |       |                 |        |                 |       |
| Valuation  allowance            |       | —               |        | —               |       |
| Net deferred tax  liability     |       | $                    | (54,850,813 | )                    | $          | (44,179,234 | ) |

 

Deferred income taxes areincluded in the balance sheets as follows:

 
| ** **                                  | ** ** | **February 29** | ** **  | **February 28** | ** ** |
|---------------------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                                  | ** ** | **2008**             | ** **  | **2007**             | ** ** |
| Current deferred  income tax assets         |       | $                    | 7,157,191   |                 | $          | 6,498,098 |   |
| Noncurrent  deferred income tax liabilities |       | (62,008,004          | )           | (50,677,332          | )          |
|                                        |       | $                    | (54,850,813 | )                    | $          | (44,179,234 | ) |

 

F-27

----

 

Cellu Tissue Holdings, Inc.and Subsidiaries

 

Notes to Consolidated FinancialStatements (continued)

 

**7. Income Taxes (continued)**

 

The temporary differencesthat give rise to significant portions of the deferred tax assets and deferredtax liabilities are net operating loss carryforwards, differences betweenfinancial statement and tax bases of property, plant and equipment, theallowance for doubtful accounts and other miscellaneous reserves.

 

As of February 29,2008, the Company had federal NOLs of approximately $9,804,000**,** which begin to expire in****2021****and state net NOLs of approximately $14,506,000, whichbegin to expire in 2019.

 

The Company adopted FASBInterpretation 48, “*Accounting for Uncertaintyin Income Taxes*” (“FIN 48”), at the beginning of fiscal year2008.  The implementation of FIN 48 didnot have a material impact on the Company’s results of operations and financialposition.

 

The Company recognizesinterest and penalties related to uncertain tax positions in income taxexpense.  As of February 29, 2008,the Company had accrued $1,552,000 related to uncertain tax positions.

 

The fiscal tax years 2004through 2008 remain open to examination by the major taxing jurisdictions towhich the Company is subject.  As of February 29,2008, the Company does not expect any material changes to unrecognized taxpositions within the next 12 months.

 

**8. Retirement Plan**

 

The Company has a SavingsIncentive and Profit-Sharing Plan (the “Plan”) qualified under Section 401(k) ofthe Code. The Plan covers all employees who are 21 years of age or older withone or more years of service. Employees may contribute up to 20% of theirannual compensation (subject to certain statutory limitations) to the Planthrough voluntary salary deferred payments. The Company matches 100% of theemployees’ contribution up to 2% of the employees’ salary and 70% of theremaining employees’ contribution up to 6% of the employees’ salary. TheCompany contributed $1,620,998, $1,096,118, $471,808 and $1,782,923 to the Planfor fiscal year 2008, from June 13, 2006 to February 28, 2007, from March 1,2006 to June 12, 2006 and for fiscal year 2006, respectively.

 

F-28

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

 

**9. Commitments and Contingencies**

 

The Company leases certain warehouses, vehicles and equipment undernoncancelable operating leases, which expire at varying times through February 2012**.** Future minimum lease obligations at February 29, 2008are as follows:

 
| **Year ending:** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| 2009                  |       | $          | 1,140,500  |   |
| 2010                  |       | 668,139    |       |
| 2011                  |       | 593,551    |       |
| 2012                  |       | 427,441    |       |
|                  |       | $          | 2,829,631  |   |

 

Operating lease and rental expenses aggregated $2,667,485, $1,918,784,$764,573 and $3,160,316 for fiscal year 2008, from June 13, 2006 to February 28,2007, from March 1, 2006 to June 12, 2006 and for fiscal year 2006,respectively.

 

In December 2007, the Company purchased machinery and equipment for$5.5 million that it had been leasing under a 10-year operating lease.  The lease had a remaining term of two yearsand lease payments were approximately $1.5 million a year.

 

In the normal course of business, the Company is involved in variousclaims. The Company’s policy is toaccrue environmental investigatory and remediation costs for identified siteswhen it is probable that a liability has been incurred and the amount of theloss can be reasonably estimated. The amount recorded for identified contingentliabilities is based on estimates and is not material.

 

The Company enters into agreements with various pulp vendors topurchase various amounts of pulp over the next two to three years.  These commitments require purchases of pulpup to approximately 169,000 metric tons per year, at pulp prices belowpublished list prices and allow the Company to shift a portion of its pulppurchases to the spot market to take advantage of more favorable spot marketprices when such prices fall. The Company believes that its current commitmentunder these arrangements or their equivalent approximates****50%of its annual budgeted pulp needs.  Thefuture purchase value of the contracts, valued at the February 29, 2008price, is $106,119,300.

 

**10. Related Party Transactions**

 

On June 12, 2006, the Company, Cellu Parent and Merger Sub enteredinto a Management Agreement with Weston Presidio Service Company, LLC (“WestonPresidio Service Company”),

 

F-29

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

 

**10. Related Party Transactions (continued)**

 

pursuant to which Weston Presidio Service Company has agreed to providethe Company with certain management, consulting and financial and otheradvisory services.  Weston PresidioService Company is an affiliate of Weston Presidio, which is the controllingshareholder of Cellu Parent, which is the sole shareholder of the Parent.   In consideration for such services, theCompany and Cellu Parent have jointly and severally agreed to pay WestonPresidio Service Company an annual fee of $450,000, to be paid in equalquarterly installments, and to reimburse out-of-pocket expenses of WestonPresidio Service Company and its affiliates. In addition, in connection with the consummation of the Merger and asrequired by the Management Agreement, the Company paid Weston Presidio ServiceCompany a fee in the amount of $2,000,000. This amount has been capitalized through purchase accounting as part oftotal merger consideration.  TheManagement Agreement expires on June 12, 2016, but will be automaticallyextended on each anniversary of such date for an additional year, unless one ofthe parties provides written notice of its desire not to automatically extendthe term at least 90 days prior to such anniversary.

 

Management fees paid to Weston Presidio Service Company of $450,000 forfiscal year 2008 and $302,812 for the period June 13, 2006 to February 28,2007 are reflected in selling, general and administrative expenses.

 

Management fees and out-of-pocket expenses paid to Charterhouse GroupInternational, Inc. (“Charterhouse”) (the former majority stockholder ofthe Parent) of $153,482 and $450,768 for the period March 1, 2006 to June 12,2006 and in fiscal year 2006, respectively, are reflected in selling, generaland administrative expenses.

 

**11. Business Segments**

 

The Company operates in two reportablebusiness segments: tissue and machine-glazed paper. The Company assesses theperformance of its reportable business segments using income from operations.Income from operations excludes interest income, interest expense, income taxexpense (benefit), the impact of foreign currency gains and losses and gain andloss on sale of equipment. A portion of corporate and shared expenses isallocated to each segment. Included in income from operations for fiscal year2008 is $2,078,212 of terminated acquisition related costs, of which $1,350,838impacts the tissue segment and $727,374 impacts the machine-glazed papersegment.  Also, included in income fromoperations for fiscal year 2008 is $808,111 of compensation charges related tonon-cash compensation expense related to the vesting of restricted stock andstock option awards.  Of this amount,$525,272 and $282,839 impacts the tissue segment and machine-glazed papersegment, respectively.  Included in lossfrom operations for the period June 13, 2006 to February 28, 2007 is$142,079 of merger-related transaction costs, $240,218 of restructuring costsand $909,264 for a non-cash charge to cost of goods sold related to excesspurchase price allocated to inventory.

 

F-30

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

 

**11. Business Segments (continued)**

 

Of these amounts, $92,351, $156,142 and$591,022, respectively, impacts the tissue segment and $49,728, $84,076 and$318,242, respectively impacts the machine-glazed paper segment.  Included in loss from operations for theperiod June 13, 2006 to February 28, 2007 are compensation charges of$3,825,939 related to non-cash compensationexpense related to the vesting of restrictedstock awards, payments of taxes associated with such awards and othercompensation expense related to the Merger. Of this amount, $2,486,867 impacts the tissue segment and $1,339,072impacts the machine-glazed paper segment. Included in loss from operations for the period March 1, 2006 to June 12,2006 is $5,933,265 of merger-related transaction costs.  Of this amount, $3,856,622 impacts the tissuesegment and $2,076,643 impacts the machine-glazed paper segment.  Also included in loss from operations for theperiod March 1, 2006 to June 12, 2006 are compensation charges of$923,580 related to restricted stock grants prior to the Merger that vestedimmediately upon the Merger and normal vesting related to restricted stockgrants made after the Merger.  Of thisamount, $323,253 impacts the machine-glazed paper segment and $600,327 impactsthe tissue segment.

 

Segment assets primarilyinclude mill property, plant and equipment, raw material, packaging andfinished product inventories and accounts receivable. Corporate assetsprimarily include prepaid expenses and other current assets, income taxes andtrademarks.

 

F-31

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

 

**11. Business Segments (continued)**

 
| ** **                                    | ** ** | **Year Ended  February 28, 2008** | ** **  | **For the Period  June 13, 2006-February 28, 2007** | ** ** | **For the Period  March 1, 2006-June 12, 2006** | ** ** | **Year Ended  February 28, 2006** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|-------------|-----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Net  Sales**                                |       |                                             |        |                                                                              |       |                                                                          |       |                                             |       |
| Tissue                                        |       | $                                                | 325,029,766 |                                                                              | $          | 170,310,446                                                                   |       | $                                                | 67,199,611 |   | $ | 232,864,518 |   |
| Machine-glazed  paper                         |       | 105,992,663                                      |        | 70,926,146                                                                        |       | 27,042,321                                                                    |       | 95,968,346                                       |       |
| Consolidated                                  |       | $                                                | 431,022,429 |                                                                              | $          | 241,236,592                                                                   |       | $                                                | 94,241,932 |   | $ | 328,832,864 |   |
| **Income  (Loss) from Operations**            |       |                                             |        |                                                                              |       |                                                                          |       |                                             |       |
| Tissue                                        |       | $                                                | 20,550,257  |                                                                              | $          | 2,165,197                                                                     |       | $                                                | (1,210,487 | ) | $ | 8,372,803 |   |
| Machine-glazed  paper                         |       | 114,643                                          |        | (1,150,327                                                                        | )          | (2,119,523                                                                    | )          | 3,060,238                                        |       |
| Consolidated                                  |       | 20,664,900                                       |        | 1,014,870                                                                         |       | (3,330,010                                                                    | )          | 11,433,041                                       |       |
| Interest  expense, net                        |       | (19,870,029                                      | )           | (11,468,975                                                                       | )          | (4,896,355                                                                    | )          | (17,076,757                                      | )          |
| Net foreign  currency transaction (loss) gain |       | (663,686                                         | )           | 359,236                                                                           |       | (289,010                                                                      | )          | (503,262                                         | )          |
| Other income                                  |       | 132,623                                          |        | 14,527                                                                            |       | 27,049                                                                        |       | 2,492                                            |       |
| Pretax income  (loss)                         |       | $                                                | 263,808     |                                                                              | $          | (10,080,342                                                                   | )          | $                                                | (8,488,326 | ) | $ | (6,144,486 | ) |
|                                          |       |                                             |        |                                                                              |       |                                                                          |       |                                             |       |
| **Capital  Expenditures**                     |       |                                             |        |                                                                              |       |                                                                          |       |                                             |       |
| Tissue                                        | ** ** | 18,415,312                                       |        | $                                                                                 | 6,079,263  |                                                                          | $          | 1,355,009                                        |       | $ | 11,770,818 |   |
| Machine-glazed  paper                         |       | 2,062,114                                        |        | 1,597,878                                                                         |       | 582,601                                                                       |       | 1,279,348                                        |       |
| Consolidated                                  |       | $                                                | 20,477,426  |                                                                              | $          | 7,677,141                                                                     |       | $                                                | 1,937,610  |   | $ | 13,050,166 |   |
|                                          |       |                                             |        |                                                                              |       |                                                                          |       |                                             |       |
| **Depreciation**                              |       |                                             |        |                                                                              |       |                                                                          |       |                                             |       |
| Tissue                                        | ** ** | $                                                | 16,732,593  |                                                                              | $          | 11,186,520                                                                    |       | $                                                | 2,981,837  |   | $ | 9,686,799 |   |
| Machine-glazed  paper                         |       | 5,717,200                                        |        | 4,621,292                                                                         |       | 1,129,705                                                                     |       | 4,757,120                                        |       |
| Corporate                                     |       | 656,498                                          |        | 325,648                                                                           |       | 115,101                                                                       |       | 410,102                                          |       |
| Consolidated                                  | ** ** | $                                                | 23,106,291  |                                                                              | $          | 16,133,460                                                                    |       | $                                                | 4,226,643  |   | $ | 14,854,021 |   |

 

F-32

----

 

Cellu Tissue Holdings, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

 

**11. Business Segments (continued)**

** **
| ** **            | ** ** | **February 29** | ** **  | **February 28** | ** ** |
|-----------------------|------------|----------------------|-------------|----------------------|------------|
| ** **            | ** ** | **2008**             | ** **  | **2007**             | ** ** |
| **Segment  assets**   |       |                 |        |                 |       |
| Tissue                |       | $                    | 310,769,171 |                 | $          | 214,039,270 |   |
| Machine-glazed paper  |       | 84,660,190           |        | 79,277,799           |       |
| Corporate assets      |       | 8,882,685            |        | 31,951,675           |       |
| Consolidated          |       | $                    | 404,312,046 |                 | $          | 325,268,744 |   |
|                  |       |                 |        |                 |       |
| **Goodwill**          |       |                 |        |                 |       |
| Tissue                |       | $                    | 6,970,001   |                 |       |   |
| Machine-glazed  paper |       | —               |        |                 |       |
| Consolidated          |       | $                    | 6,970,001   |                 |       |   |

 

**12. Geographic Data**

 

Netsales and long-lived assets by geographic area are as follows:

 
| ** **       | ** ** | **Year Ended  February 29, 2008** | ** ** | **For the Period  June 13, 2006-February 28, 2007** | ** ** | **For the Period  March 1, 2006- June 12, 2006** | ** ** | **Year Ended  February 28, 2006** | ** ** |
|------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
|             |       |                                             |       |                                                                              |       |                                                                                |       |                                             |       |
| **Net  Sales**   |       |                                             |       |                                                                              |       |                                                                                |       |                                             |       |
| United States    |       | $394,019,201                                     |       | $208,880,170                                                                      |       | $80,395,283                                                                         |       | $284,737,873                                     |       |
| Other            |       | 56,994,578                                       |       | 42,990,743                                                                        |       | 17,787,863                                                                          |       | 58,461,671                                       |       |
| Sub-total        |       | 451,013,779                                      |       | 251,870,913                                                                       |       | 98,183,146                                                                          |       | 343,199,544                                      |       |
|             |       |                                             |       |                                                                              |       |                                                                                |       |                                             |       |
| Sales deductions |       | 19,991,350                                       |       | 10,634,321                                                                        |       | 3,941,214                                                                           |       | 14,366,680                                       |       |
| Consolidated     |       | $431,022,429                                     |       | $241,236,592                                                                      |       | $94,241,932                                                                         |       | $328,832,864                                     |       |

 
| ** **                         | ** ** | ** ** | ** ** | **February 29** | ** **  | **February 28** | ** ** |
|------------------------------------|------------|------------|------------|----------------------|-------------|----------------------|------------|
| ** **                         | ** ** | ** ** | ** ** | **2008**             | ** **  | **2007**             | ** ** |
| **Property,  Plant and Equipment** |       |       |       |                 |        |                 |       |
| United States                      | ** ** |       |       | $                    | 266,720,192 |                 | $          | 200,839,945 |   |
| Other                              |       |       |       | 29,877,696           |        | 28,011,820           |       |
| Consolidated                       | ** ** |       |       | $                    | 296,597,888 |                 | $          | 228,851,765 |   |

 

F-33

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Cellu Tissue Holdings, Inc. andSubsidiaries

 

Notes to Consolidated Financial Statements(continued)

 

**13.   OtherCosts**

 

During fiscal year 2008, the Company incurred $2.1 million in costsassociated with a potential acquisition that did not transpire.  This amount is shown as a separate line itemon the fiscal year 2008 statement of operations.

 

During fiscal year 2006, the Company idled one of its paper machines atits Interlake facility in Ontario, Canada. This decision was due to significant increases in manufacturing coststhat the Company was unable to pass on to the machine-glazed segmentmarket.  As a result, 48 employees wereterminated and the Company recorded $625,476 of severance costs.  Also during fiscal year 2006, the Companyrecorded $424,887 related to severance costs associated with a change in thecorporate organizational structure of the Company. Accordingly, for fiscal year2006 restructuring costs of $1,050,363 million were recorded as a separate lineitem in the Company’s statement of operations.

 

In the fourth quarter of fiscal year 2007, the Company shut down theInterlake paper machine permanently and, accordingly, has recorded animpairment charge of $488,274, which is reflected as a separate line item inthe Company’s statement of operations for fiscal year 2007.

 

**14. Quarterly Results of Operations (Unaudited)**

** **
| **Year Ended  February 29,  2008** | ** ** | **First Quarter** | ** **  | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter  (1)** | ** **  | **Year** | ** ** |
|----------------------------------------------|------------|------------------------|-------------|-------------------------|------------|------------------------|------------|------------------------------|-------------|----------|------------|
| Net sales                                    |       | $                      | 103,200,786 |                    | $          | 109,000,321            |       | $                            | 109,161,988 |     | $          | 109,659,334 |   | $ | 431,022,429 |   |
| Gross profit                                 |       | $                      | 8,292,118   |                    | $          | 11,766,537             |       | $                            | 11,515,878  |     | $          | 11,189,398 |   | $ | 42,763,931 |   |
| Income from operations                       |       | $                      | 3,576,262   |                    | $          | 7,060,342              |       | $                            | 5,965,851   |     | $          | 4,062,445 |   | $ | 20,664,900 |   |
| Net (loss)  income                           |       | $                      | (1,110,484  | )                       | $          | 1,069,830              |       | $                            | 1,375,672   |     | $          | 2,657,733 |   | $ | 3,992,751 |   |

 

----

(1)  Income from operations for fiscal year 2008includes $2.1 million related to the write-off of terminatedacquisition-related transaction costs. Net income for fiscal year 2008 includes an income tax benefit of $3.7million.

 

F-34

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Cellu Tissue Holdings, Inc. andSubsidiaries

 

Notes to Consolidated Financial Statements(continued)

 

**14. Quarterly Results of Operations (Unaudited) (continued)**

 
| **Year Ended  February 28,  2007** | ** ** | **First Quarter** | ** ** | **May 26, 2006-June 12, 2006** | ** ** | **June 13, 2006-August 23 ,2006** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** | **Year**   | ** ** |
|----------------------------------------------|------------|------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|------------|------------|
| Net sales                                    |       | $                      | 78,641,977 |                                               | $          | 15,599,955                                            |       | $                      | 68,562,386 |                    | $          | 83,281,206 |       | $ | 89,393,000 |   | $ | 335,478,524 |   |
| Gross profit (1)                             |       | $                      | 6,850,819  |                                               | $          | 1,337,301                                             |       | $                      | 3,344,627  |                    | $          | 5,890,779  |       | $ | 3,683,031 |   | $ | 21,106,557 |   |
| Income(loss) from operations (2)             |       | $                      | 3,576,308  |                                               | $          | (6,906,318                                            | )          | $                      | (912,630   | )                       | $          | 2,426,928  |       | $ | (499,428 | ) | $ | (2,315,140 | ) |
| Net loss                                     |       | $                      | (475,652   | )                                                  | $          | (6,059,312                                            | )          | $                      | (2,619,388 | )                       | $          | (1,074,735 | )          | $ | (2,498,243 | ) | $ | (12,727,330 | ) |

 

----

(1)                                  GrossprofitfortheperiodfromJune13,2006toAugust23,2006andforthethirdandfourthquartersoffiscalyear2007includes$1.5million,$1.9millionand$2.0million,respectively,foradditionaldepreciationexpenserelatedtoexcesspurchasepriceallocatedtoproperty,plantandequipment.  Also,includedingrossprofitfortheperiodfromJune13,2006toAugust23,2006isa$.9millionnon-cashchargetocostofgoodssoldrelatedtoexcesspurchasepriceallocatedtoinventory.

 

(2)                                  Incomefrom operations for the period March 1, 2006 to June 12, 2006, for theperiod June 13, 2006 to August 23, 2006, for the third and fourthquarters of fiscal year 2007 includes $1.3 million, $1.8 million, $.4 millionand $.3 million, respectively, related to non-cash compensation expense relatedto the vesting of restricted stock awards, payments of taxes associated withsuch awards and other compensation expense related to the Merger.

 

F-35

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**Schedule II—Valuation and QualifyingAccounts**

**Cellu Tissue Holdings, Inc.**

**Fiscal years ended February 29,2008 and February 28, 2007 and 2006**

** **
| **Description**                   | ** ** | **Balance at  Beginning  of Year** | ** ** | **Charged  to Costs  and  Expenses** | ** ** | **Deductions** | ** ** | **Balance at  End of  Year** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|-------------------------------------------|------------|----------------|------------|----------------------------------------|------------|
| Allowance for  Doubtful Accounts: |       |                                         |       |                                      |       |           |       |                                   |       |
| February 29,  2008           |       | $                                            | 408,314    |                                      | $          | 202,064        |       | $                                      | 440,567    |   | $ | 169,811 |   |
| February 28,  2007           |       | 300,314                                      |       | 328,405                                   |       | 220,405        |       | 408,314                                |       |
| February 28,  2006           |       | 398,749                                      |       | 115,269                                   |       | 213,704        |       | 300,314                                |       |
| ** **                        | ** ** | ** **                                   | ** ** | ** **                                | ** ** | ** **     | ** ** | ** **                             | ** ** |
| Inventory  Obsolescence Reserve:  |       |                                         |       |                                      |       |           |       |                                   |       |
| February 29,  2008           |       | $                                            | 133,588    |                                      | $          | 113,996        |       | $                                      | 126,498    |   | $ | 121,086 |   |
| February 28,  2008           |       | 223,218                                      |       | 50,841                                    |       | 140,471        |       | 133,588                                |       |
| February 28,  2006           |       | 114,015                                      |       | 144,427                                   |       | 35,224         |       | 223,218                                |       |

 

S-1

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