**UNITED STATES**

**SECURITIES ANDEXCHANGE 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 28, 2007**                                                                                                                                                                                        |
| ** **                                                                                                                                                                                                                              |       | ** **                                                                                                        |
| **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.**

(Exact name of registrant asspecified 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 area code)                          |
|                                                                                |
| **Not  Applicable**                                                                 |
| (Former name,  former address and former fiscal year, if changed since last report) |

 

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

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

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Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.  Yes   o   No  x

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section15(d) of the Exchange Act.  Yes  x    No  o

Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.  Yes  x   No  o

Indicate by check mark ifdisclosure of delinquent filers pursuant to item 405 of Regulation S-K is notcontained 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

Indicate by check mark whetherthe registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer”in Rule 12b-2 of theExchange Act.

Large accelerated filer  o          Acceleratedfiler  o          Non-acceleratedfiler  x

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

There is no market for theRegistrant’s equity.  The number ofshares of issuer’s Common Stock, $.01 par value, outstanding on May 1, 2007 was100 shares.

Documents incorporated by reference: None

 

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**TABLE OFCONTENTS**
| 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 STOCKHOLDERS 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.  |   | 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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**PARTI**

**ITEM 1.  BUSINESS**

Cellu Tissue Holdings,Inc. (“we”, “us” or “the Company”) was incorporated in Delaware in 1984. At thetime of our incorporation, we acquired the assets of our Connecticut facilityand, in 1995, we purchased our Mississippi facility. Throughout 1998, weacquired the assets of each of our Michigan, New York and Ontario facilitiesand, in 2002 we purchased our Neenah Wisconsin facility. Recently, in March2007, we acquired our Ladysmith Wisconsin facility.

On June 12, 2006, CelluPaper Holdings, Inc., our parent, entered into an Agreement and Plan of Mergerwith 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 wholly-ownedsubsidiary of Cellu Parent, newly-formed or Merger Sub. Pursuant to theagreement, on June 12, 2006, Merger Sub was merged with and into our parent,with our parent surviving and becoming a wholly-owned subsidiary of CelluParent, or the Merger. The aggregate merger consideration to be paid toshareholders of our parent was $205 million, subject to certain working capitaland net cash adjustments as described below and up to an additional $35 millionin contingent consideration.

The merger considerationwas subject to certain net working capital and cash adjustments. If the actualnet working capital and/or cash were less than estimated amounts, then themerger consideration was to be reduced dollar-for-dollar by the amount of suchshortfall. If the actual net working capital and/or cash were greater thanestimated amounts, then the merger consideration would be increaseddollar-for-dollar by the amount of such difference. As a result thereof, themerger consideration was increased by approximately $1.0 million, which hasbeen paid. In addition, during the earn-out period beginning on March 1, 2006and ending on February 28, 2010, the merger consideration is subject to anincrease for certain contingent earn-out consideration of up to $35 million inthe aggregate, not to exceed $15 million for any fiscal year, payable withinsix months of the end of the prior fiscal year. Weston Presidio will guarantypayment of any earn-out consideration.

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-acquisition) and June 13, 2006 to February 28, 2007 (post-acquisition). SeeItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS for further analysis thereof.

We manufacture and marketa variety of specialty tissue hard rolls and machine-glazed paper used in themanufacture of various end products, including diapers, facial and bath tissue,assorted paper towels and food wraps. In addition, we produce a variety ofconverted tissue products. Our customers include major North American producersof branded and unbranded disposable consumer absorbent and tissue products forthe personal and health care markets; consumer and away-from-home tissueproducts companies; national and regional tissue products distributors; andthird-party converters who sell their products to food, bakery and confectionscompanies. We service a diverse group of high-quality customers, with three ofour top 10 customers belonging to the Fortune 150 group of companies. For thefiscal year ended February 28, 2007, or fiscal year 2007, we sold 254,757 tonsof tissue and machine-glazed paper products, generating net sales of $ 335.5million.

Our business is comprisedof two segments: tissue and machine-glazed paper. We currently own and operateseven strategically 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. In addition, our tissue convertingequipment and

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machine-glazed paperconverting equipment currently have annual converting production capacities ofapproximately 90,000 and 29,000 tons, respectively.

***Tissue***.  Our tissue segment consists of two productlines: (1) hard roll tissue and (2) consumer and away-from-home convertedtissue products. For fiscal year 2007, our tissue segment sold 174,418 tons oftissue, generating net sales of $237.5 million, or approximately 70.8% of ournet sales, and 77.7****% of our grossmargin.

*Hard roll tissue*.  We produce tissue hard rolls at all of ourfacilities other than our Michigan facility. Our hard roll tissue is sold asfacial and bath tissue, specialty medical tissue, industrial wipers, napkin andpaper towel stock, as well as absorbent cover stock. We manufacture our hardroll tissue with a variety of pulps and recycled fibers and produce hard rolltissue to our customers’ specifications by controlling such attributes asbrightness, absorbency, bulk, strength, porosity and color. In addition, weproduce our absorbent cover stock in a variety of weights and widths for saleto consumer products companies or third-party converters. Our customers thenprint, 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 disposable products.We also sell our absorbent cover stock to manufacturers of absorbent bed pads,disposable infant bibs and disposable absorbent pet products.

*Consumer and away-from-homeconverted tissue*.  Weconvert consumer and away-from-home tissue products at our Neenah Wisconsinfacility. 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 our converted tissue products according to ourcustomers’ specifications for weight, softness, size, color, prints, embossingpatterns, grade, fold, package configuration and price. We believe that all ofour products are recognized for their softness, strength and absorbency. Weoffer a complete range of converted facial tissue products as well asdispenser, dinner, cocktail and luncheon napkins. In addition, we ship a fullline of bath tissue products, in both jumbo and standard roll bath sizes, and afull line of consumer and away-from-home towel formats. We sell our convertedtissue products through various channels that serve the consumer andaway-from-home markets.

We entered the consumerand away-from-home converted tissue products market following our August 2002acquisition of a previously idle manufacturing and converting facility inNeenah Wisconsin. We began manufacturing at our Neenah Wisconsin facility inAugust 2002 and began producing our full line of converted tissue products byMarch 2003. We have significantly increased the sales of products from theNeenah Wisconsin facility since its acquisition to in excess of $108 million infiscal year 2007.

***Machine-glazedpaper***.  We producemachine-glazed paper hard rolls at our Michigan, Mississippi and Ontariofacilities in a variety of weights, widths and surface characteristics. Machine-glazedpaper is tissue paper with a glazed coating and, in some cases, other moistureand grease-resistant coatings. We sell our machine-glazed paper hard rolls tothird-party converters that manufacture fast food and commercial food wrap, aswell as niche market products such as gum wrappers, coffee filters, tobaccopapers, wax paper and butter wraps. We use the balance of our machine-glazedpaper hard rolls at our Michigan facility to produce converted wax paperproducts, including wet and dry wax paper, sandwich bags and microwavable waxpaper. The majority of our converted wax paper products manufactured at ourMichigan facility is sold as branded products to a single customer. For fiscalyear 2007, our machine-glazed paper segment sold 80,339 tons of machine-glazedpaper hard rolls and converted wax paper products, generating net sales of$98.0 million, or approximately 29.2****% of our netsales, and 22.3****% of our gross margin.

***SubsequentEvent. ***On March21, 2007, we consummated a definitive merger agreement, or the CityForestMerger Agreement, with CityForest Corporation, or CityForest, Cellu CityAcquisition Corporation, a wholly-owned subsidiary of the Company or Cellu CityMerger Sub and Wayne Gullstad as the shareholders’ representative. Pursuant tothe CityForest Merger 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. The aggregate mergerconsideration paid (including assumption of $18.5 million in aggregateprincipal amount of industrial revenue bonds) was approximately

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$61.0 million subject tocertain working capital and net cash adjustments. CityForest is a Ladysmith,Wisconsin-based manufacturer of tissue hard rolls for third-party convertersthat resize and convert the rolls into napkins, towels, bath tissue, specialtymedical tissue, industrial wipers and facial tissue. The majority of CityForest’ssales are to third-party converters serving the away-from-home market, theconsumer market, as well as state and federal government agencies and themedical industry. CityForest is solely focused on manufacturing tissue hardrolls and does not currently convert rolls into finished products.

**Business strengths**

Some of our key businessstrengths are as follows:

***Increasednet sales and profitability potential in our converting business***.  We entered 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 NeenahWisconsin facility is an efficient, low-cost producer of converted tissueproducts such as bath and facial tissue, napkins and folded and rolled towels. Thefacility includes five light dry crepe paper machines with approximately 85,000tons of annual tissue production capacity and 12 converting lines withapproximately 90,000 tons of annual converting capacity. In addition, thefacility includes a complete distribution center with fully automated unitizingand wrapping capacities. Sales of our converted tissue products in the consumerand away-from-home converted tissue products market generate significantlygreater revenue per ton than sales of hard 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. Webelieve that our Neenah Wisconsin facility acquired in August 2002 is a low-cost tissue production facility and has helped us continue to improve ourcompetitive position. In addition, since 2001, we have established ongoingcost-saving investments and productivity improvement initiatives.

***Diversifiedand high-quality customer base***.  We sell to a highly diversified customerbase, thereby reducing our dependence on any single customer, with no customerrepresenting more than 10% of our net sales for fiscal year 2007. Our customersinclude leading branded and private label tissue products companies, tissue andmachine-glazed paper converters, distributors of tissue products, fast foodrestaurants, third-party converters who sell their products to food, bakery andconfections companies and third-party converters serving state and federalgovernment agencies and the medical industry, upon the CityForest acquisition. Notably,our customers include all of the major producers in North America of brandedand unbranded 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 become increasingly diversified with our 10largest customers accounting for approximately 54.9% of gross sales for fiscalyear 2007, down from 56.8% in the fiscal year ended February 28, 2006, orfiscal year 2006.

***Experiencedand 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 chiefexecutive officer since 2001 and has over 25 years of industry experience. Priorto coming to our company, he was a senior executive at Kimberly-ClarkCorporation, a leading personal care consumer products company. Mr. Taylorleads a team of senior executives with expertise in the paper and paperproducts industry with proven management and strategic experience.

**Business strategy**

Our overall strategy isto increase revenues, optimize our product mix and lower costs to enhance ourposition within the paper industry. We intend to implement this strategythrough our key initiatives set forth below:

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***Maximizeutilization of our converting capacity***.  Our Neenah Wisconsin facility began producingour full line of consumer and away-from-home converted tissue products in March2003. As part of our growth strategy, we continue to increase the production ofconverted tissue products across our 12 converting lines by expanding ourcustomer base for our consumer and away-from-home converted tissue products. Towardthat end, we continue to promote our “customer delight” program, producingquality products at competitive prices and providing customers with whatmanagement believes to be among the industry’s best on-time delivery rates andcomplete shipment performance as well as building on past relationships withcustomers in our hard roll tissue products line. We have expanded our dedicatedsales force in the consumer and away-from-home converted tissue products marketto capitalize on these opportunities. As a result, we believe that we cancontinue to increase the utilization of the converting capacity at our NeenahWisconsin facility.

***Continueto 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 ascompetitive pricing, product quality, on-time deliveries and completeshipments. In addition, we provide a full line of products designed to meet thevarious needs of each of our customers, including the unique capability toproduce premium-quality level products with a recycled cost and fiber base. Ourmanufacturing process is tailored to our customers’ specifications and allowsus to offer them flexibility in price, grade, softness, package configurationand size. For example, our products can be manufactured completely with virginpulp (for premium products) or recycled fiber (for value products) or anycombination thereof. We believe that our high-quality customer service andtechnical support have helped us develop and maintain long-term relationshipswith our customers that represent a majority of our sales.

***Continueto reduce manufacturing costs***.  We continually seek out opportunities tocontain and reduce our costs more effectively. As part of our cost managementstrategy, we benchmark our machines and manufacturing operations againstcertain world class levels, including those of leading paper manufacturers. Ourbenchmarking is applied by business sector and by type of machine on a monthlyand year-to-date basis. We review metrics such as total machine efficiency,fiber loss and waste percentage, tons produced per machine per person per year,fixed and variable costs per ton produced and total energy per ton produced. Weuse our benchmarking analyses to help us allocate our strategic capital andnon-capital investments in order to reduce our manufacturing costs mosteffectively. In addition, our cost management strategy focuses on reducingvariable costs through increased operating efficiencies and reduced energyconsumption, and allows us to better manage our costs and lessen the impact offiber price cyclicality. In an effort to reduce manufacturing costs, we haveinitiated a project to install a combined heat & power system at our EastHartford facility.

***Delivergreater earnings stability through enhanced fiber and energy cost management***.We have developed and implemented a pulp cost management strategy that has beenhighly effective in reducing our pulp costs. Our supply agreements with variouspulp suppliers enable us to purchase a majority of our anticipated total pulprequirements for a given year at prices below published list prices. Theseagreements further allow us to shift a portion of our pulp purchases to thespot market to take advantage of more favorable spot market prices when suchprices fall. We believe these supply agreements provide us with significantprotection against the risk of fluctuating pulp costs and offer a substantialsavings from purchasing pulp on the spot market during periods of tight supply.Furthermore, approximately 50% of our sales are to customers with pulp pricepass-through contracts. These contracts track a published pulp benchmark priceindex and have various triggers and timing clauses that dictate the pricecustomers pay for our products. We also continue to capitalize uponopportunities to establish greater fiber cost stability throughout our plants. Weare actively expanding our capability to replace virgin fiber with recycledfiber at several of our mill sites in order to continue manufacturing premiumquality level products with a more stable and competitive cost position. Additionally,we have a targeted strategy in place that is designed to yield greater energycosts control, which includes utilizing gas strips or hedges to minimize pricevolatility, deploy capital to reduce consumption, and implement alternativeenergy sources.

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**Manufacturing**

We currently own andoperate six manufacturing facilities located in the United States and onemanufacturing facility located in Ontario, Canada. We produce hard roll tissueat our Connecticut, Mississippi, New York, Ontario and both Wisconsin facilitiesfor sale to consumer products companies and third-party converters and for usein the production of converted tissue products at our Neenah Wisconsinfacility. We produce machine-glazed paper at our Michigan, Mississippi andOntario facilities in a variety of specialty hard rolls. We also produceconverted wax paper products at our Michigan facility.

Our hard roll tissuemanufacturing process begins with wood pulp or recycled fiber. These rawmaterials typically are pulped in large blenders or pulpers and moved vianetworks of pipes and pumps to a tissue machine where sheets of tissue paperare formed according to customer or grade specifications. The tissue paper isthen drawn through the machine and formed on wires as it travels throughvarious press rolls. Once the sheets are formed, they are transferred to adryer section of the machine that dries the tissue. Following the dryingprocess, the tissue paper is removed from the drying cylinders and wound intohard roll tissue. Hard roll tissue is either used internally for our convertingoperations at our Neenah Wisconsin facility or sold to consumer productscompanies and third-party converters. We undergo a similar process at each ofour Michigan, 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 fiber processing area consists of a new state-of-theart de-inking plant that is directly linked to the paper machines. Raw materialis received in the form of bales of recycled paper (mostly office paper). Thede-inking process removes contaminants such as ink, staples, paper clips,plastic and paper coatings. Non-chlorine whiteners are used to brighten thefiber and strip colors. The end product is clean, bright fiber pulp.

Our converting process atour Neenah Wisconsin facility involves loading hard roll tissue onto convertingmachines which unwind, perforate, emboss and print tissue as needed. Theconverting machines then roll or fold the processed tissue into convertedtissue products, such as bath or facial tissue, napkins or paper towels. Similarly,our converting operations at our Michigan facility are designed to convert ourmachine-glazed paper hard rolls into converted wax paper products.

The following tableillustrates the annual hard roll production capacity at each of ourmanufacturing facilities based on current utilization and the type of productsproduced 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                          |       |                                            |       |                   |       |                                        |       |

 

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***Connecticutfacility***

Our Connecticut facilityis a 59,000 square foot facility located in East Hartford, Connecticut. Thefacility consists of two paper machines, each of which produces dry crepedtissue that is used by consumer products companies and third-party convertersin the manufacture of disposable baby diapers, adult incontinence products,surgical waddings and disposable bibs. The tissue paper is produced with 100%virgin pulp to insure absolute cleanliness. In addition, our Connecticutfacility has the capacity to produce base sheets for facial and bath tissue,napkins and paper towel products.

***Michiganfacility***

Our Michigan facility isa 397,000 square foot complex located along Lake Michigan’s Bay of Green Bay inthe City of Menominee. The facility consists of a paper machine for themanufacture of machine-glazed paper hard rolls and 20 converting lineoperations for both wet and dry wax papers. We believe that this facility is ahighly efficient, low-cost producer of machine-glazed paper hard rolls whichare used by third-party converters to make food packaging, wrapping, laminatingand moisture -resistant and grease- resistant paper products. 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 majorityof our converted wax paper products manufactured at the Michigan facility issold as branded products to the facility’s largest customer.

***Mississippifacility***

Our Mississippi facilityis 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 in close proximity to major interstatehighways and a railroad, with a rail spur that runs directly to the facility. Inaddition, the facility is strategically located near the Mississippi gulf coastand three major seaports, including the Port of Gulfport, from each of which weship our exports. Our Mississippi facility is centrally located between Atlantaand Dallas, thereby allowing for optimal service to many of our key customers.

Our manufacturingfacilities at the Mississippi facility consists of two paper machines. Onemachine produces machine-glazed paper hard rolls for food packaging, wrapping, laminatingand moisture-resistant and grease-resistant paper products. The second machineproduces dry creped paper that is used in the diaper and hygiene productsmarket. In addition, it produces tissue, napkin and towel roll stock.

***NewYork facility***

Our New York facility isa 242,000 square foot complex located in Gouverneur, New York. It consists oftwo light dry creped paper machines, each of which produces a variety ofspecialty tissue products, such as personal hygiene grades, medical andsurgical drapes, face mask wadding, filtration grades and tissues used in thepersonal care markets. In addition, the facility produces flexographic printed(a lower-cost, lower resolution graphic) colored napkins for the party goodsindustry 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.

***Ontariofacility***

Our Ontario facility is a256,000 square foot complex located in St. Catharines, Ontario, Canada. The facilitycurrently consists of two types of actively used machines: through-air driedand machine-finished.

Both of these types ofmachines have color capability. Our through-air dried machine produces highlyabsorbent bulky sheets in basis weights from nine to 25 pounds used in themanufacture of folded and rolled towels, facial and bath tissue, napkins andabsorbent tissues. Our machine-finished machine produces wax paper base stockand wet creped tissue used in the manufacture of coffee filters, masking tapeand washroom towel base papers. All of the products manufactured at our Ontariofacility are produced in jumbo rolls and sold to North American converters forfurther processing.

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In November 2005, we madethe decision to indefinitely idle our machine-glazed machine at our Ontariofacility and in the fourth quarter of fiscal year 2007, we decided to shut downthe machine-glazed machine permanently.

***NeenahWisconsin facility***

Our Neenah Wisconsinfacility is a 1.2 million square foot facility located in Neenah, Wisconsin. Weacquired this facility in August 2002 and added converting capacity to thefacility subsequent to its acquisition. The facility currently consists of fivelight dry creped paper machines with up to 85,000 tons of annual hard rolltissue production capacity and 12 converting lines with approximately 90,000tons of annual converting capacity. A complete distribution center with fullyautomated unitizing and wrapping capabilities is located adjacent to thefacility. This facility produces converted tissue products such as facial andbath tissue, napkins and paper towels, as well as unconverted hard roll tissue,and enables us to offer our customers flexibility in the price, grade,softness, package configuration and size of our products. For example, ourproducts can be manufactured completely with virgin pulp (for premium products)or recycled fiber (for value products) or any combination thereof. Our machineshave color and multi-ply capacity. The facility contains full-width BrettingM-fold towel, kitchen roll towel and napkin machines. We also utilize amulti-fold facial line.

The facility is in closeproximity to major interstate highways and supports a rail spur that runsdirectly to the facility. In addition, the facility enjoys a strategicgeographic advantage in servicing the midwestern U.S. markets.

***LadysmithWisconsin facility***

Our Ladysmith Wisconsinfacility is a 259,000 square foot facility located in Ladysmith, Wisconsin. Weacquired this facility in March 2007. CityForest’s manufacturing processincludes a de-inking facility, two light dry crepe paper machines with acombined annual capacity of over 48,000 tons used to manufacture tissue hardrolls and water and wastewater treatment capabilities. The facility processesover 94% of the fiber used in its product. This pulp can be used to make 100percent recycled tissue or can be combined with other fiber, such as virginpulp, at the paper machine, The ability to combine fibers of different typesallows the facility to precisely match the specific requirements for a customer’sexisting or new products.

**Raw material and energy sources and supply**

The primary raw materialused in our various facilities is wood pulp (both virgin pulp and recycledfiber). Other costs include natural gas, electricity, fuel oil and, in ourMichigan facility, coal. We have developed and implemented a pulp costmanagement strategy that has been highly effective in reducing our pulp costs. Oursupply agreements with various pulp suppliers enable us to purchase a majorityof our anticipated total pulp requirements for a given year at prices belowpublished list prices. These agreements further allow us to shift a portion ofour pulp purchases to the spot market to take advantage of more favorable spotmarket prices when such prices fall. We believe these supply agreements provideus with 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 facilityprocesses over 94% of the fiber used in its product. We satisfy all of ourenergy requirements through purchases of natural gas (other than for ourMichigan facility) and electricity from local utility companies. At ourMichigan facility, our power boilers generate most of our energy requirementsthrough the use of coal, with the balance being supplied through the purchaseof natural gas by contract.

**Sales and customer support**

***Tissue***

*Hard roll tissue*.At six of our facilities, our sales group sells our hard roll tissue toconsumer products companies and third-party converters. In addition, we haveexpanded the role of our sales force, which previously focused exclusively onhard roll tissue sales to focus additional efforts on the sale of consumer andaway-from-home converted tissue products.

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*Consumer and away-from-homeconverted tissue*. At our Neenah Wisconsin facility, we have adedicated sales group for our converted tissue products. We sell our convertedtissue products to a variety of industry customers, directly to end-users or todistributors, which in turn sell to end-users.

***Machine-glazedpaper***

Our sales group sells ourmachine-glazed paper in a variety of specialty hard rolls from each of ourMichigan, Mississippi and Ontario facilities. In addition, at our Michiganfacility, our sales group sells converted wax 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**

The hard roll tissuemarket and consumer and away-from-home converted tissue products market arehighly competitive and are dominated by a number of large, internationalcorporations, as well as smaller, regional corporations. Among the largercorporations, there is a growing trend to engage in contract manufacturing withsmaller, more cost-effective manufacturers, such as ourselves. In suchinstances, major corporations find it more cost-effective to outsource theirmanufacturing needs rather than build or rebuild paper and converting machinesor increase their production capacity. We believe that we offer an alternativeto various major corporations by producing quality hard roll tissue andconverted tissue products at attractive prices.

We also compete in themachine-glazed paper market. Our primary competitors in this market are large,international corporations.

In all areas, we believethat we compete on the basis of product quality and performance, 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.”

**Major customers**

Our customer base iscomprised of leading tissue consumer products companies, tissue andmachine-glazed paper converters, manufacturers of private label products anddistributors of tissue products. Three of our top 10 customers are Fortune 150companies. Our 10 largest customers represented 64.2% of sales for the fiscalyear ended February 28, 2005, or fiscal year 2005, 56.8% of sales for fiscalyear 2006 and****54.9% of sales for fiscal year2007. Kimberly-Clark Corporation, our current largest single customer,represented 17.6% and 12.3% of sales in fiscal year 2005 and fiscal year 2006,respectively. No customer accounted for more than 10% of our sales in fiscalyear 2007 and no other customer accounted for more than 10% of our sales infiscal year 2005 or fiscal year 2006.

**Employees and labor relations**

As of February 28, 2007,we employed approximately****864 activefull-time employees, consisting of****710****hourly employees and 154 salaried employees. We havecollective bargaining agreements with the UnitedSteelworkers of America, referred to as USW, (formerly represented by the Paper,Allied – Industrial, Chemical & Energy Workers International Union,referred to as PACE prior to PACE’s merger with and into USW) coveringapproximately 465 of our hourly employees in our Michigan, New York andWisconsin facilities, collectively. In addition, we have a collectivebargaining agreement with Independent Paperworkers of Canada coveringapproximately 76****employees in our Ontariofacility. Our collective bargaining agreements expire between 2008 and February2010.

In July 2005, the USW waselected to represent 84 hourly employees at our Mississippi facility, and wascertified by the National Labor Relations Board as the exclusive collectivebargaining representative of such employees. We are in the process ofnegotiating a collective bargaining agreement with USW.

At our LadysmithWisconsin facility we currently employ approximately 82 nonunion employees,consisting of 67 hourly employees and 15 salaried employees.

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Our facilities haveactive health and safety programs in place. We have not experienced any workstoppages or significant labor disputes and we consider relations with ouremployees to be satisfactory. All of our facilities are situated in areas whereadequate labor pools exist.

**Intellectual property**

We are the owner ofcertain trademarks relating to our products. We are not aware of any existinginfringing uses that could materially affect our business. We believe that ourtrademarks are valuable to our operations in our tissue and machine-glazedpaper segments and are important to our overall business strategy.

We own the trademarkWaxtexTM which is used in connection with our machine-glazed paper productsbrand produced at our Michigan facility. We also own the trademark Magic SoftTMused in association with the converted facial and bath tissue, paper towel andnapkin products manufactured at our Wisconsin facility and the trademarksInterlakeTM and Interlake PaperTM.

**Environmental laws**

We are subject tocomprehensive and frequently changing federal, state, local and foreignenvironmental, health and safety laws and regulations, including laws andregulations governing emissions of air pollutants, discharges of wastewater andstorm water, storage, treatment and disposal of materials and waste, siteremediation and liability for damage to natural resources. We are also subjectto frequent inspections and monitoring by government enforcement authorities. Compliancewith these laws and regulations is an important factor in our business. Fromtime to time, we incur significant capital and operating expenditures to complywith applicable federal, state and local environmental laws and regulations andto meet new statutory and regulatory requirements. We have implementedpractices and procedures at our operating facilities that are intended topromote compliance with environmental laws, regulations and permitrequirements. We believe that our facilities and manufacturing operations arecurrently in material compliance with such laws, regulations and requirements;however, we may not always be in compliance with all such laws, regulations orrequirements.

We may be subject tostrict liability for the investigation and remediation of environmentalcontamination (including contamination that may have been caused by otherparties) at properties that we own or operate and at other third-party ownedproperties where we or our predecessors have disposed of or arranged for thedisposal of regulated materials. As a result, we may be involved inadministrative and judicial proceedings and inquiries in the future relating toenvironmental matters. The total of such environmental compliance costs andliabilities cannot be determined at this time and may be material.

**Other governmental regulation**

We are also regulated bythe U.S. Food and Drug Administration and the U.S. Occupational Safety andHealth Administration. We believe that our manufacturing facilities are incompliance, in all material respects, with these laws and regulations.

We are committed toensuring that safe operating practices are established, implemented andmaintained throughout our organization. In addition, we have instituted activehealth and safety programs throughout our company.

**Forward-looking statements**

This Annual Report onForm 10-K includes “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995. Forward-looking statementsare those that do not relate solely to historical fact. They include, but arenot limited to, any statement that may predict, forecast, indicate or implyfuture results, performance, achievements or events. They may contain wordssuch as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,” “plan,”“will” or words or phrases of similar meaning. Forward-looking statements aresubject to many uncertainties and other variable circumstances, including thosediscussed in this Annual Report under the heading “Item 1A. Risk Factors” ,many of which are outside of our control, that could cause our actual resultsand experience to differ

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materially from those wethought 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 isnot possible for us to predict all of these risks, nor can we assess the extentto which any factor, or combination of factors, may cause actual results todiffer from those contained in the forward-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 not update these forward-lookingstatements even if our situation changes in the future.

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;

·                  changes in our regulatoryenvironment, including environmental regulations;

·                  a change in control relating to ourCompany;

·                  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 capital requirements; and

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

**Item 1A.  Risk Factors**

***The cyclical nature of the specialty paper,packaging and tissue industry could have a material adverse effect on ourbusiness, 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 also influencedby fluctuations in inventory levels held by customers and consumer preferences.Supply depends primarily on industry capacity and capacity utilization rates. Inperiods of economic weakness reduced spending by consumers and businessesresults in decreased demand, potentially causing downward price pressure. Inparticular, in recent years the away-from-home converted tissue products markethas been adversely impacted by reduced consumer and business spending on traveland entertainment. Industry participants may also, at times, add new capacityor increase capacity utilization rates, potentially causing supply to exceeddemand and exerting downward price pressure. We have no control over thesefactors and they can heavily influence our financial performance.

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***Ouroperating results depend upon our wood pulp costs.***

Pulp is the principal rawmaterial used in the manufacture of our specialty paper and tissue products. Itis purchased in highly competitive, price sensitive markets. We buy asignificant amount of pulp and other raw materials either through supplyagreements or on the spot market. For fiscal year 2007 we purchasedapproximately 227,000****metric tons ofpulp.

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 114,000 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 believe that our current commitment under thesearrangements or their equivalent approximates 70% of our current budgeted pulpneeds. If upon expiration of these agreements or upon failure of our suppliesto fulfill their obligations under these agreements, we are unable to obtainwood pulp on terms as favorable as those contained in these agreements, ourcost of goods sold may increase and results of operations will be impaired. Asa result, our ability to satisfy customer demands and to manufacture productsin a 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. Fromtime to time, timber harvesting may be limited by natural events, such as fire,insect infestation, disease, ice storms, excessive rainfall and wind storms orby harvesting restrictions. Production levels within the forest productsindustry are also affected by such factors as currency fluctuations, duties andfinished lumber prices. These factors can increase the price we may have to payto our existing suppliers or from any new 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 topass any raw material price increases through to our customers, our businessfinancial condition and operating results may be materially adversely affected.

***Ourenergy costs may be higher than we anticipated, which could have a materialadverse effect on our business, financial condition and operating results.***

We use energy, mainlynatural gas, electricity and fuel oil, to operate machinery and to generatesteam, which we use in our production process. Energy prices, particularly fornatural gas and fuel oil, have continued to increase since 2000, with acorresponding effect on our production costs. We spent approximately $41.3million in fiscal year 2007 on electricity, natural gas, oil and coal. Our Mississippiand Wisconsin facilities operate in regulated energy markets. Our other fourfacilities operate in deregulated energy markets. If our energy costs aregreater than anticipated, our business, financial condition and operatingresults may be materially adversely affected.

***Unforeseenor recurring operational problems and maintenance outages at any of ourfacilities may cause significant lost production.***

Our manufacturing processcould be affected by operational problems that could impair our productioncapability. Each of our facilities contains complex and sophisticated machinesthat are used in our manufacturing process. Disruptions or shutdowns at any ofour facilities could be caused by:

·                  maintenance outage to conductmaintenance operations that cannot be performed safely during operations;

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

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

·                  noncompliance with materialenvironmental requirements or permits;

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

·                  disruptions in the transportationinfrastructure, including railroad tracks, bridges, tunnels or roads;

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

·                  labor difficulties; or

·                  other operational problems.

If our facilities areshut down, they may experience prolonged startup periods, regardless of thereason for the shutdown. Those startup periods could range from several days toseveral weeks, depending on the reason for the shutdown and other factors. Anyprolonged disruption in operations of any of our facilities could causesignificant lost production, which would have a material adverse effect on ourbusiness, financial condition and operating results.

***Labordisputes or increased labor costs could disrupt our business and have a materialadverse effect on our financial condition and operating results.***

As of February 28,2007, approximately****72% of ouractive full-time employees are represented by either the USW or the IndependentPaper Workers of Canada through various collective bargaining agreements.

In July 2005, the USW waselected to represent 84 hourly employees at our Mississippi facility, and wascertified by the National Labor Relations Board as the exclusive collectivebargaining representative of such employees. We are in the process ofnegotiating a collective bargaining agreement with USW.

The collective bargainingagreements for our facilities expire between August 2008 and February 2010. Itis likely that our workers will seek an increase in wages and benefits at theexpiration of each of those contracts.

Any significant workstoppage in the future or any significant increase in labor costs could have amaterial adverse effect on our business, financial condition and operatingresults.

***Weare dependent upon continued demand from our large customers.***

Our largest customersaccount for a significant portion of our sales. Our ten largest customersrepresented 64.2% of our sales for fiscal year 2005, 56.8% of our sales forfiscal year 2006 and 54.9%****of our salesfor fiscal year 2007. Some of our large customers (including four of our 10largest customers) have the capability of producing the products that theycurrently buy from us. The loss or significant reduction of orders from any ofour large customers could have a material adverse effect on our business,financial condition and operating results.

***Weare subject to significant environmental, health and safety laws andregulations and compliance expenditures.***

Our business is subjectto a wide range of federal, state, local and foreign general and industryspecific environmental, health and safety laws and regulations, including thoserelating to air emissions, wastewater discharges, solid and hazardous wastemanagement and disposal and site remediation. We are also subject to frequentinspections and monitoring by government enforcement authorities. Compliancewith these laws and regulations is a significant factor in our business. Fromtime to time, we incur significant capital and operating expenditures toachieve and maintain compliance with applicable environmental laws andregulations. Our failure to comply with applicable environmental laws andregulations or permit requirements could result in substantial civil orcriminal fines or penalties or enforcement actions, including regulatory orjudicial orders enjoining or curtailing operations or requiring remedial orcorrective measures, installation of pollution control equipment or otheractions, which could have a material adverse effect on our business, financialcondition and operating results.

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Certain of our operationsalso require environmental permits or other approvals from governmentalauthorities, and certain of these permits and approvals are subject toexpiration, denial, revocation or modification under various circumstances. Failureto obtain or comply with these permits and approvals, or with otherenvironmental requirements, may subject us to civil or criminal enforcementproceedings that can lead to substantial fines and penalties being imposedagainst us, orders requiring us to take certain actions or temporary orpermanent shutdown of our affected operations. Such enforcement proceedingscould also have a material adverse effect on our business, financial conditionand operating results.

In addition, as an ownerand operator of real estate, we may be responsible under environmental laws andregulations for the investigation, remediation and monitoring, as well asassociated costs, expenses and third-party damages, including tort liabilityand natural resource damages, relating to past or present releases of hazardoussubstances on or from our properties. Liability under these laws may be imposedwithout regard to whether we knew of, or were responsible for, the presence ofthose substances on our property, may be joint and several, meaning that theentire liability may be imposed on each party without regard to contribution,and retroactive and may not be limited to the value of the property. Inaddition, we or others may discover new material environmental liabilities,including liabilities related to third-party owned properties that we or ourpredecessors formerly owned or operated, or at which we or our predecessorshave disposed of, or arranged for the disposal of, certain materials. We may beinvolved in administrative or judicial proceedings and inquiries in the futurerelating to such environmental matters which could have a material adverseeffect on our business, financial condition and operating results.

New environmental laws orregulations (or changes in existing laws or regulations or their enforcement)may be enacted that require significant expenditures by us. If the resultingexpenses significantly exceed our expectations, our business, financialcondition and operating results could be materially and adversely affected.

We are also subject tovarious federal, state, local and foreign requirements concerning safety andhealth conditions at our manufacturing facilities. We may also be subject tomaterial financial penalties or liabilities for noncompliance with those safetyand health requirements, as well as potential business disruption, if any ofour facilities or a portion of any facility is required to be temporarilyclosed as a result of any noncompliance with those requirements. Such financialpenalties or liabilities or business disruptions could have a material adverseeffect on our business, financial condition and operating results.

***Ifwe are unable to implement our business strategies, our business, financialcondition and operating results could be materially and adversely affected.***

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

***Weface many competitors, several of which have greater financial and otherresources.***

We face competition ineach of our markets from companies that produce the same type of products thatwe produce or that produce alternative products that customers may use insteadof our products. We currently compete in the specialty paper, packaging, tissueand converted paper markets. Some of our competitors may be able to producecertain of our products at lower cost than us. Additionally, many of our competitorsare large, vertically integrated companies that are more strongly capitalizedthan us or have more financial resources than us. Any of the foregoing factorsmay enable our competitors to better withstand periods of declining process andadverse operating conditions. In addition, changes within the paper industry,including the consolidation of our competitors and consolidation of companiesin the distribution channels for our products, have occurred and may continueto occur and may have a material adverse effect on our business, financialcondition and operating results.

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***Excesssupply in the markets we serve may reduce the prices we are able to charge forour products.***

We compete on the basisof product quality and performance, price, service, sales and distribution. Competingin our markets involves the following key risks:

·                  our failure toanticipate and respond to changing customer preferences and demographics;

·                  our failure todevelop new and improved products;

·                  aggressivepricing by competitors, which may force us to decrease prices in an attempt tomaintain market share;

·                  consolidation ofour customer base that diminishes our negotiating leverage;

·                  the decision byour large customers to discontinue outsourcing the production of their productsto us and to produce their products themselves;

·                  acquisition of acustomer by one of our competitors, who thereafter replaces us as a supplierfor that customer; and

·                  our failure tocontrol costs.

These competitive factorscould cause our customers to shift to other products or attempt to produceproducts themselves. Additional competition could result in lost market shareor reduced prices for our products.

New machines may be builtor idle machines may be activated, which would add more capacity to thespecialty paper, packaging, tissue and converted paper and tissue productmarkets. Increased production capacity in any of these markets could cause anoversupply resulting in lower market prices for our products and increasedcompetition, either of which could have a material adverse effect on ourbusiness, financial condition and operating results.

***Wemay lose business to competitors who underbid us, and we may be otherwiseunable to compete favorably under declining market conditions.***

Demand for specialtypaper, packaging, tissue and converted paper and tissue products tends to bemore price-sensitive during declining market conditions than during normalmarket conditions. When market conditions decline, our competitors are morelikely to try to underbid our prices in markets where we enjoy a leadingposition to target some of our market share in those markets. This competitivebehavior could drive market prices down and hinder our ability to pass onincreases in raw material costs to our customers. Because of the fixed-costnature of our business, our overall profitability is sensitive to minor shiftsin the balance between supply and demand. Competitors having lower operatingcosts than we do will have a competitive advantage over us with respect to productsthat are particularly price-sensitive.

***Theloss of our key managers could materially and adversely affect our business,financial condition and operating results.***

Our future successdepends, in significant part, upon the continued services of our managementpersonnel. Our chief executive officer, Russell C, Taylor, has over 25 yearsexperience in the paper and paper products industry. Our senior executives havean average of over 20 years experience in the paper and paper productsindustry. The market for qualified individuals is highly competitive and we maynot be able to attract and retain qualified personnel to replace or succeedmembers of our senior management or other key employees, should the need arise.Therefore, the loss of services of one or more of our key senior managementcould materially and adversely affect our business, financial condition andoperating results.

***Exposureto interest rate changes and other types of capital market volatility couldincrease our financing costs.***

We require bothshort-term and long-term financing to fund our operations, including capitalexpenditures. We are exposed to changes in interest rates with respect to ourworking capital facility and any new debt

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issues. Changes in thecapital markets, our credit rating or prevailing interest rates can increase ordecrease the cost or availability of financing which may have an adverse effecton our financial condition and operating results. In addition, because some ofour operations and sales are in international markets, we could be adverselyaffected by unfavorable fluctuations in foreign currency exchange rates.

***Changesin the political or economic conditions in the United States, Canada and, to alesser extent, other countries in which our products are sold, could materiallyand adversely affect our business, financial condition and operating results.***

We sell our products inthe United States, Canada, Mexico and South America. The economic and politicalclimate of each of these regions has a significant impact on costs, prices anddemand for our products in these areas. Changes in regional economies orpolitical stability, including acts of war or terrorism, and changes in traderestrictions or laws (including tax laws and regulations, increased tariffs orother trade barriers) can affect the cost of manufacturing and distributing ourproducts and the price and sales volume of our products, which could materiallyand adversely affect our business, financial condition and operating results.

***Wemay not be able to generate sufficient cash flows to meet our debt serviceobligations.***

Our ability to makescheduled payments on, or to refinance our obligations with respect to, ourindebtedness, including the $162,000,000 aggregate principal amount of our 9 3⁄4%senior secured notes due 2010 that we issued in March 2004, referred to as theNotes, or to fund our other liquidity needs will depend on our financial andoperational performance which in turn will be affected by general economicconditions and by financial, competitive, regulatory and other factors beyondour control. In addition, the guarantee of the Notes by our Canadian subsidiaryresulted in the inclusion of the earnings of that subsidiary in our U.S.taxable income and an increase in our U.S. income taxes that was substantial. Ifwe are unable to generate sufficient cash flow to satisfy our debt obligations,we may have to undertake alternative financing plans, such as refinancing orrestructuring our debt, selling assets, reducing or delaying capitalinvestments or seeking to raise additional capital. We cannot assure you thatany refinancing would be possible, that any assets could be sold, or, if sold,of the timing of sales and the amount of proceeds that may be realized fromthose sales, or that additional financing could be obtained on acceptableterms, if at all. Our inability to generate sufficient cash flows to satisfyour debt obligations, or to refinance our indebtedness on commerciallyreasonable terms, would materially and adversely affect our financial conditionand results of operations and our ability to satisfy our obligations under theNotes.

***Our significant debt obligations could limit our flexibilityin managing our business and expose us to certain risks***.

We are highly leveraged. Asof February 28, 2007, we had $160.4 million of indebtedness outstanding. Inaddition, we are permitted under our working capital facility and the indenturegoverning the Notes to incur additional debt, subject to certain limitations. Inconnection with the acquisition of CityForest in March 2007, we issued and soldapproximately $20 million of additional aggregate principal amount Notes. Furthermore,we borrowed $17.4 million under our working capital facility. Our high degreeof leverage may have important consequences to investors, including thefollowing:

·                  we may havedifficulty satisfying our obligations under the Notes or other indebtednessand, if we fail to comply with these requirements, an event of default couldresult;

·                  we may berequired to dedicate a substantial portion of our cash flow from operations torequired payments on indebtedness, thereby reducing the availability of cashflow for working capital, capital expenditures and other general corporateactivities;

·                  covenantsrelating to our debt may limit our ability to obtain additional financing forworking capital, capital expenditures and other general corporate activities;

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·                  covenantsrelating to our debt may limit our flexibility in planning for, or reacting to,changes in our business and the industry in which we operate;

·                  we may be morevulnerable than our competitors to the impact of economic downturns and adversedevelopments in our business; and

·                  we may be placedat a competitive disadvantage against any less leveraged competitors.

The occurrence of any oneof these events could have a material adverse effect on our business, financialcondition, results of operations, prospects and ability to satisfy ourobligations under the Notes.

**ITEM 1B.   UNRESOLVED STAFF COMMENTS**

None.

**ITEM2.  PROPERTIES**

**Properties**

We own and operate sevenfacilities located in East Hartford, Connecticut; Menominee, Michigan; Wiggins,Mississippi; Governeur, New York; St. Catharines, Ontario, Canada; Neenah,Wisconsin; and Ladysmith, Wisconsin. In addition, we maintain our corporateheadquarters in Alpharetta, Georgia.

The following table listseach of our facilities and its location, use, approximate square footage andstatus: 
| **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                |

 

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**ITEM3.  LEGAL PROCEEDINGS**

We are, from time totime, party to various routine legal proceedings arising out of our business. Theseproceedings, primarily involve commercial claims, personal injury claims andworkers’ compensation claims. We cannot predict the outcome of these lawsuits,legal proceedings and claims with certainty. Nevertheless, we believe that theoutcome of any currently existing proceedings, even if determined adversely,would not have a material adverse effect on our business, financial conditionand operating results.

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

Not applicable.

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**PART II**

**ITEM5.  MARKET FOR THE REGISTRANT’S COMMONEQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.**

Not applicable.

**ITEM6.  SELECTED CONSOLIDATED FINANCIAL DATA**

The following tablecontains our selected consolidated financial data for the period from March 1,2006 to June 12, 2006 (pre-acquisition), for the period June 13, 2006 toFebruary 28, 2007 (post-acquisition) and for the fiscal years ended February28, 2006 and 2005 (pre-acquisition), February 29, 2004, or fiscal year 2004(pre-acquisition), and February 28, 2003, or fiscal year 2003(pre-acquisition). Our selected consolidated results of operations and other datafor the period from March 1, 2006 to June 12, 2006 (pre-acquisition) and forthe period from June 13, 2006 to February 28, 2007 (post-acquisition), fiscalyear 2006 and fiscal year 2005, and our selected consolidated balance sheetdata at February 28, 2007 and 2006, have been derived from audited consolidatedfinancial statements included elsewhere in this Annual Report. Our selectedconsolidated results of operations and other data for fiscal year 2004 andfiscal year 2003, and our selected consolidated balance sheet data at February28, 2005, February 29, 2004 and February 28, 2003, have been derived fromaudited consolidated financial statements not included 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.
| **(Dollars in thousands)**                 | ** ** | **Feb. 28,  2003** | ** ** | **Feb. 29,  2004** | ** ** | **Feb. 28,  2005** | ** ** | **Feb. 28,  2006** | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  February 28, 2007** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                           | ** ** | **(Pre-acquisition)**   | ** ** | **(Post-acquisition)**  | ** ** |
| Statement of  operations data:                       |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |
| Net sales:                                           |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |
| Tissue segment                                       |       | $                       | 134,889    |                    | $          | 189,744                 |       | $                       | 230,370    |                                                  | $          | 232,865                                                   |       | $ | 67,200 |   | $ | 170,311 |   |
| Machine-glazed paper segment                         |       | 97,549                  |       | 100,519                 |       | 102,523                 |       | 95,968                  |       | 27,042                                                |       | 70,926                                                    |       |
| Total net sales                                      |       | 232,438                 |       | 290,263                 |       | 332,893                 |       | 328,833                 |       | 94,242                                                |       | 241,237                                                   |       |
| Cost of goods  sold                                  |       | 200,909                 |       | 256,930                 |       | 292,051                 |       | 301,111                 |       | 86,054                                                |       | 228,318                                                   |       |
| Gross profit                                         |       | 31,529                  |       | 33,333                  |       | 40,842                  |       | 27,722                  |       | 8,188                                                 |       | 12,919                                                    |       |
| Income (loss)  from operations                       |       | 18,358                  |       | 19,948                  |       | 21,955                  |       | 11,433                  |       | (3,330                                                | )          | 1,015                                                     |       |
| Net income (loss)                                    |       | $                       | 15,727     |                    | $          | 7,147                   |       | $                       | 3,096      |                                                  | $          | (2,569                                                    | )          | $ | (6,535 | ) | $ | (6,192 | ) |
|                                                 |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |
| Other financial  data:                               |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |
| Net cash provided  by (used in) operating activities |       | $                       | 21,312     |                    | $          | 20,259                  |       | $                       | 32,235     |                                                  | $          | 8,600                                                     |       | $ | (6,540 | ) | $ | 10,139 |   |
| Net cash (used  in) provided by investing activities |       | (42,096                 | )          | (10,547                 | )          | (7,416                  | )          | (13,050                 | )          | (1,938                                                | )          | 38,085                                                    |       |
| Net cash provided  by (used in) financing activities |       | 16,875                  |       | (10,241                 | )          | 1,437                   |       | (282                    | )          | (290                                                  | )          | (45,762                                                   | )          |
| Depreciation and  amortization                       |       | 12,144                  |       | 14,935                  |       | 16,264                  |       | 16,277                  |       | 4,632                                                 |       | 16,133                                                    |       |
| Capital  expenditures (1)                            |       | 16,080                  |       | 10,547                  |       | 11,419                  |       | 13,050                  |       | 1,938                                                 |       | 7,677                                                     |       |
| EBITDA (2)                                           |       | 41,353                  |       | 33,341                  |       | 35,387                  |       | 26,077                  |       | 739                                                   |       | 17,738                                                    |       |
|                                                 |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |
| Balance sheet  data:                                 |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                      |       |
| Cash and cash  equivalents                           |       | $                       | —     |                    | $          | —                  |       | $                       | 26,959     |                                                  | $          | 22,824                                                    |       | N/A |   | $ | 16,261 |   |
| Total assets                                         |       | 186,627                 |       | 186,943                 |       | 210,843                 |       | 210,232                 |       | N/A                                                   |       | 325,269                                                   |       |
| Total debt                                           |       | 67,575                  |       | 55,787                  |       | 161,060                 |       | 161,080                 |       | N/A                                                   |       | 160,356                                                   |       |
| Stockholders’ equity  (deficit)                 |       | 76,139                  |       | 84,482                  |       | (7,586                  | )          | (6,906                  | )          | N/A                                                   |       | 38,991                                                    |       |

 

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(1)          Excludes capitalexpenditures relating to the acquisition of our Neenah Wisconsin facility infiscal 2003.

(2)               EBITDArepresents earnings before interest expense, income taxes and depreciation andamortization. EBITDA does not represent and should not be considered as analternative to net income or cash flow from operations, as determined by U.S.generally accepted accounting principles, or U.S. GAAP, and our calculationthereof may not be comparable to that reported by other companies. We presentEBITDA because we believe that it is widely accepted that EBITDA providesuseful information regarding a company’s ability to service and/or incur indebtedness.EBITDA has limitations as an analytical tool, and you should not consider it inisolation, or as a substitute for analysis of our results as reported underU.S. GAAP. Some of the limitations are:

·                  EBITDA does not reflect our cashexpenditures, or future requirements for capital expenditures or contractualcommitments;

·                  EBITDA does not reflect changes 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 our industry maycalculate EBITDA differently than we do, limiting its usefulness as acomparative measure.

Because of theselimitations, EBITDA should not be considered as a measure of discretionary cashavailable to us to invest in the growth of our business. We compensate forthese limitations by relying primarily on our U.S. GAAP results and usingEBITDA only supplementally. See the consolidated statements of cash flowincluded in our financial statements included elsewhere in this Annual Report. Thefollowing is a reconciliation of EBITDA to net income (loss) and net cashprovided by operating activities: 
| **(Dollars in thousands)**                      | ** ** | **Feb. 28,  2003** | ** ** | **Feb. 29,  2004** | ** ** | **Feb. 28,  2005** | ** ** | **Feb. 28,  2006** | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  February 28, 2007** | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                | ** ** | **(Pre-acquisition)**   | ** ** | **(Post-acquisition)**  | ** ** |
| EBITDA                                                    |       | $                       | 41,353     |                    | $          | 33,341                  |       | $                       | 35,387     |                                                  | $          | 26,077                                               |       | $ | 739 |   | $ | 17,738 |   |
| (Add) subtract:                                           |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                 |       |
| Interest expense                                          |       | 2,621                   |       | 7,085                   |       | 17,507                  |       | 17,367                  |       | 5,001                                                 |       | 11,685                                               |       |
| Provision for (benefit from) income taxes                 |       | 10,989                  |       | 5,151                   |       | (74                     | )          | (3,575                  | )          | (1,953                                                | )          | (3,888                                               | )          |
| Depreciation                                              |       | 12,016                  |       | 13,958                  |       | 14,858                  |       | 14,854                  |       | 4,227                                                 |       | 16,133                                               |       |
| Net income (loss)                                         |       | $                       | 15,727     |                    | $          | 7,147                   |       | $                       | 3,096      |                                                  | $          | (2,569                                               | )          | $ | (6,536 | ) | $ | (6,192 | ) |
| Add (subtract):                                           |       |                    |       |                    |       |                    |       |                    |       |                                                  |       |                                                 |       |
| Depreciation and amortization                             |       | 12,144                  |       | 14,935                  |       | 16,264                  |       | 16,277                  |       | 4,632                                                 |       | 16,133                                               |       |
| Gain on early extinguishment of debt                      |       | (11,244                 | )          | —                  |       | —                  |       | —                  |       | —                                                |       | —                                               |       |
| Write-off of debt  issuancecosts and prepayment penalties |       | —                  |       | —                  |       | 2,895                   |       | —                  |       | —                                                |       | —                                               |       |
| Stock based compensation                                  |       | —                  |       | —                  |       | 922                     |       | 82                      |       | 924                                                   |       | 497                                                  |       |
| Provision for deferred income taxes                       |       | 9,347                   |       | 2,821                   |       | 1,431                   |       | (2,955                  | )          | (396                                                  | )          | (6,651                                               | )          |
| Other non-cash charges                                    |       | 684                     |       | 667                     |       | (2,074                  | )          | 290                     |       | 85                                                    |       | 1,778                                                |       |
| Net changes in  working capital                           |       | (5,346                  | )          | (5,311                  | )          | 9,701                   |       | (2,525                  | )          | (5,249                                                | )          | 4,574                                                |       |
| Net cash provided by  operating activities                |       | $                       | 21,312     |                    | $          | 20,259                  |       | $                       | 32,235     |                                                  | $          | 8,600                                                |       | $ | 6,540 |   | $ | 10,139 |   |

 

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**ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

Thefinancial and business analysis below provides information which we believe isrelevant to an assessment and understanding of our consolidated financialposition, results of operations and cash flows. This financial and businessanalysis should be read in conjunction with the consolidated financialstatements and related notes.

# **Overview**

We manufacture and marketspecialty tissue and machine-glazed paper used in the manufacture of variousend products, including diapers, facial and bath tissue, assorted paper towelsand food wraps. In addition, we manufacture and market a broad range ofconverted tissue products. Our business is comprised of two segments: tissueand machine-glazed paper. In addition, our tissue segment consists of twoproduct lines: (1) hard roll tissue and (2) consumer and away-from-homeconverted tissue products. We own and operate seven facilities in the UnitedStates, located in Connecticut, Michigan, Mississippi, New York, two facilitiesin Wisconsin and one facility located in Ontario, Canada.

On June 12, 2006, ourparent, entered into an Agreement and Plan of Merger with Cellu Parent, acorporation organized and controlled by Weston Presidio, and Cellu AcquisitionCorporation, a wholly owned subsidiary of Cellu Parent, newly-formed or MergerSub. Pursuant to the agreement, on June 12, 2006, Merger Sub was merged withand into our parent, with our parent surviving and becoming a wholly-ownedsubsidiary of Cellu Parent, or the Merger.

Beginning on June 13,2006, we accounted for the Merger as a purchase in accordance with the provisionsof Statement 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 the Merger.As allowed under SEC Staff Accounting Bulletin No. 54, *Push DownBasis of Accounting Required in Certain Limited Circumstances*(“PushDown Accounting”), we have reflected all applicable purchase accountingadjustments in our consolidated financial statements for all periods subsequentto the Merger date. Push Down Accounting requires us to establish a new basisfor our assets and liabilities based on the amount paid for our equity at theclose of business on June 12, 2006. Accordingly, our parent’s ownership basisis reflected in our consolidated financial statements beginning upon completionof the Merger. In order to apply Push Down Accounting, our parent’s purchaseprice of $207.8 million, including assumption of $162.0 million in aggregateprincipal amount of our outstanding 9.75% senior secured notes (the “Notes”),was allocated to the assets and liabilities based on their relative fairvalues. The purchase price is subject to adjustment for certain tax benefits wemay realize. In addition, total consideration is subject to adjustment for upto an additional $35.0 million in contingent earnout consideration based uponthe achievement of certain financial targets. If any portion of the earnedcontingent payments is unable to be made by us, then Weston Presidio has agreedto provide the necessary funds to former holders of our parent’s capital stock,options and warrants through an equity investment in our parent or otherwise. Inaccordance with SFAS 141, the $35.0 million has been recognized as a liabilityand is recorded in other liabilities as of February 28, 2007.

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Purchase priceallocations are subject to refinement until all pertinent information isobtained. We have allocated the excess of purchase price over the net assetsacquired in the Merger based on our estimates of the fair value of assets andliabilities 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 |   |

 

During the period from June 13, 2006 through February 28, 2007 andsubsequent to the CityForest acquisition, we reflected $909,264 of excesspurchase price allocated to inventory as a non-cash charge to cost of goodssold and $5,428,800 of additional depreciation expense in cost of goods sold ascompared to our historical basis of accounting prior to the Merger.

We have estimatedthe fair value of our assets and liabilities as of the Merger, utilizinginformation available at the time our unaudited interim financial statementssubsequent to the Merger were prepared and these estimates are subject torefinement until all pertinent information has been obtained. At that time, wewere in the process of obtaining outside third party appraisals of ourintangible assets and finalizing the allocation within property, plant andequipment categories. In the fourth quarter of the current fiscal year, weobtained a third party appraisal of our intangible assets. As a result thereof,identifiable intangible assets of $6.5 million have been recorded with acorresponding reduction in property, plant and equipment. The purchase priceallocation depicted in the table above reflects this adjustment.

The following discussioncombines our operating results for the period March 1, 2006 to June 12, 2006(pre-acquisition) and June 13, 2006 to February 28, 2007 (post-acquisition). SeeRESULTS OF OPERATIONS below for further analysis thereof.

In our tissue segment, wederive our revenues from the sale of (1) tissue hard rolls sold as facial andbath tissue, specialty medical tissue, industrial wipers, napkin and papertowel stock, as well as absorbent cover stock, and (2) converted tissueproducts, including a variety of private label consumer and away-from-home bathand facial tissue, napkins and folded and rolled towels. We derive our revenuesin our machine-glazed paper segment from the sale of (1) machine-glazed paperhard rolls to third-party converters that manufacture fast food and commercialfood wrap, as well as niche market products such as gum wrappers, coffeefilters, tobacco papers, wax paper and butter wraps and (2) converted wax paperproducts, including wet and dry wax paper, sandwich bags and wax paper. Forfiscal year 2007 and fiscal year 2006, our tissue segment generated $237.5****million and $232.9 million, respectively, of net sales, orapproximately 70.8% of our total net sales in fiscal year 2007 and fiscal year2006, and our machine-glazed paper segment generated $98.0 million and $95.9million, respectively, of net sales, or approximately 29.2% of our total netsales in each of fiscal year 2007 and fiscal year 2006. For fiscal year 2005,our tissue segment generated net sales of $230.4 million or approximately 69.2%of our net sales, and our machine-glazed paper segment generated net sales of$102.5 million, or approximately 30.8% of our net sales.

We entered the consumerand away-from-home converted tissue products market following the August 2002 acquisitionof our Neenah Wisconsin manufacturing and converting facility. Our NeenahWisconsin facility has added approximately 85,000 tons of annual hard rolltissue production capacity and 12 converting lines with approximately 90,000tons of annual converting production capacity. 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 roll tissue. OurNeenah Wisconsin facility began

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producing our full lineof consumer and away-from-home converted tissue products in March 2003. Webelieve that, as we continue to increase the utilization of our convertingcapacity, we will increase our profits and generate higher margins on ourconsumer and away-from-home converted tissue products.

The primary component ofcost of goods sold for each of our segments is pulp, which representedapproximately 43%, 43% and 46% of our cost of goods sold in fiscal year 2007,fiscal year 2006 and fiscal year 2005, respectively. We have supply agreementswith various pulp suppliers over the next two to three years. We believe underthese agreements or their equivalents, we will purchase in excess of 70% of ourtotal annual pulp requirements. These supply agreements permit us to purchasepulp at prices that are discounted from published list prices and allow us toshift a portion of our pulp purchases to the spot market to take advantage ofmore favorable spot market prices when such prices fall. In addition, ourLadysmith, Wisconsin facility processes over 94% of the fiber used in itsproduct. The balance of our pulp requirements are purchased on the open market.

Our labor, manufacturing,energy, other materials and depreciation costs in the aggregate representedapproximately 57%, 57% and 54% of our cost of goods sold for fiscal year 2007,fiscal year 2006 and fiscal year 2005, respectively. Those costs are brokendown as follows: (1) wages and benefits made up approximately****10% for each of fiscal year 2007, fiscal year 2006 andfiscal year 2005; (2) manufacturing overhead represented approximately 17%, 17%and 18% for fiscal year 2007, fiscal year 2006 and fiscal year 2005,respectively; (3) energy costs represented approximately 13%, 15% and 11%, forfiscal year 2007, fiscal year 2006 and fiscal year 2005, respectively; (4)other materials (including chemicals, wax, dye and packaging) representedapproximately 11%, 11% and 10%, for fiscal year 2007, fiscal year 2006 andfiscal year 2005, respectively; and (5) depreciation represented approximately6%, 4% and 5% for fiscal year 2007, fiscal year 2006 and fiscal year 2005,respectively.

We have collectivebargaining agreements with the USW in each of our Michigan, New York and NeenahWisconsin facilities covering 465****of our hourlyemployees. In addition, we have a collective bargaining agreement withIndependent Paper Workers of Canada covering****76****hourly employees in our Ontario facility. Our agreementsexpire between August 2008 and February 2010. In July 2005, the USW was electedto represent 84 hourly employees at our Mississippi facility, and was certifiedby the National Labor Relations Board as the exclusive collective bargainingrepresentative of such employees. We are in the process of negotiating acollective bargaining agreement with USW. Historically, we have not experiencedany significant labor disputes or work stoppages.

We satisfy all of ourenergy requirements through purchases of natural gas (other than for ourMichigan facility) and electricity from local utility companies. We utilize gasstrips or hedges to minimize price volatility with respect to natural gaspurchases. At our Michigan facility, our power boilers generate most of ourenergy requirements through the use of coal, with the balance being suppliedthrough the purchase of natural gas by contract.

On March 21, 2007, weconsummated a definitive merger agreement with CityForest, Cellu City MergerSub, a wholly-owned subsidiary of the Company and Wayne Gullstad as theshareholders’ representative. Pursuant to the agreement, and subject to theterms and conditions therein, Cellu City Merger Sub merged with and intoCityForest, with CityForest surviving and becoming our wholly-owned subsidiary.The aggregate merger consideration paid (including assumption of $18.5 millionin aggregate principal amount of industrial revenue bonds) was approximately$61 million subject to certain working capital and net cash adjustments. CityForestis a Ladysmith, Wisconsin-based manufacturer of tissue hard rolls for third-partyconverters that resize and convert the rolls into napkins, towels, bath tissue,specialty medical tissue, industrial wipers and facial tissue. The majority ofCityForest’s sales are to third-party converters serving the away-from-homemarket, the consumer market, as well as state and federal government agenciesand the medical industry. CityForest is solely focused on manufacturing tissuehard rolls and does not currently convert rolls into finished products.

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**Results of operations**

The combined periods fromMarch 1, 2006 to June 12, 2006 (pre- acquisition) and from June 13, 2006 toFebruary 28, 2007 (post- acquisition) have been compared to the fiscal year2006 and fiscal year 2005 for purposes of management’s discussion and analysisof the results of operations. Any references below to fiscal year 2007 shallrefer to the combined periods. Material fluctuations in operations resultingfrom the effect of purchase accounting have been highlighted.

The following table setsforth certain sales and operating data for our business segments for theperiods indicated: 
| ** **                          | ** ** | **Fiscal Year Ended** | ** ** | **For the Period** | ** ** | **Combined**                                          | ** ** |
|-------------------------------------|------------|---------------------------------|------------|------------------------------|------------|-------------------------------------------------------|------------|
| **(Dollars in millions)** | ** ** | **Feb. 28, 2005**     | ** ** | **Feb. 28, 2006**  | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  February 28, 2007** | ** ** | **Feb. 28, 2007** | ** ** |
| ** **                          | ** ** | ** **                      | ** ** | **(Pre-Acquisition)**        | ** ** | ** **                                            | ** ** | **(Post-Acquisition)** | ** ** | ** ** | ** ** |
| Net sales:                          | ** ** | ** **                      | ** ** | ** **                   | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Tissue segment                      |       | $                               | 230.4      |                         | $          | 232.9                                                 |       | $ | 67.2 |   | $ | 170.3 |   | $ | 237.5 |   |
| Machine-glazed paper segment        |       | 102.5                           |       | 95.9                         |       | 27.1                                                  |       | 70.9 |   | 98.0 |   |
| Total                               |       | $                               | 332.9      |                         | $          | 328.8                                                 |       | $ | 94.3 |   | $ | 241.2 |   | $ | 335.5 |   |
| ** **                          | ** ** | ** **                      | ** ** | ** **                   | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross profit:                       | ** ** | ** **                      | ** ** | ** **                   | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Tissue segment                      |       | $                               | 27.0       |                         | $          | 18.8                                                  |       | $ | 6.4 |   | $ | 10.0 |   | $ | 16.4 |   |
| Machine-glazed paper segment        |       | 13.8                            |       | 8.9                          |       | 1.8                                                   |       | 2.9 |   | 4.7 |   |
| Total                               |       | $                               | 40.8       |                         | $          | 27.7                                                  |       | $ | 8.2 |   | $ | 12.9 |   | $ | 21.1 |   |
| ** **                          | ** ** | ** **                      | ** ** | ** **                   | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Percentage of  net sales:           | ** ** | ** **                      | ** ** | ** **                   | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Tissue segment                      |       | 69.2                            | %          | 70.8                         | %          | 71.3                                                  | %          | 70.6 | % | 70.8 | % |
| Machine-glazed paper segment        |       | 30.8                            | %          | 29.2                         | %          | 28.7                                                  | %          | 29.4 | % | 29.2 | % |
| Total                               |       | 100.0                           | %          | 100.0                        | %          | 100.0                                                 | %          | 100.0 | % | 100.0 | % |
|                                |       |                            |       |                         |       |                                                  |       |   |   |   |   |
| Gross margin:                       |       |                            |       |                         |       |                                                  |       |   |   |   |   |
| Tissue segment                      |       | 11.6                            | %          | 8.1                          | %          | 9.5                                                   | %          | 5.9 | % | 6.9 | % |
| Machine-glazed paper segment        |       | 13.4                            | %          | 9.3                          | %          | 6.6                                                   | %          | 4.1 | % | 4.8 | % |
| Total                               |       | 12.3                            | %          | 8.4                          | %          | 8.7                                                   | %          | 5.3 | % | 6.3 | % |
|                                |       |                            |       |                         |       |                                                  |       |   |   |   |   |
| Shipments  (tons):                  |       |                            |       |                         |       |                                                  |       |   |   |   |   |
| Tissue segment                      |       | 182,192                         |       | 179,401                      |       | 50,406                                                |       | 124,012 |   | 174,418 |   |
| Machine-glazed paper segment        |       | 87,642                          |       | 81,783                       |       | 23,108                                                |       | 57,231 |   | 80,339 |   |
| Total                               |       | 269,834                         |       | 261,184                      |       | 73,514                                                |       | 181,243 |   | 254,757 |   |

 

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

**Net sales** forfiscal year 2007 increased $6.7 million, or 2.0%, to $335.5 million from $328.8for fiscal year 2006. On a company-wide basis, tons sold decreased for fiscalyear 2007 compared to fiscal year 2006. For fiscal year 2007, we sold 254,757tons of tissue hard rolls, machine-glazed paper hard rolls and converted paperproducts, a decrease of 6,427, or 2.5%, compared to fiscal year 2006. Includedin this decrease is the effect of the shutdown of our machine-glazed machine atour Ontario facility, which we idled in the third quarter of fiscal year 2006and represented a decrease of 5,925 tons. Net of the effect of this, tons solddecreased 502, or .2%, for fiscal year 2007 from the comparable period in theprior year. Offsetting the decrease in volume sold for fiscal year 2007 fromthe prior fiscal year was an increase in net selling price per ton from $1,259for fiscal year 2006 to $1,318 for fiscal year 2007.

Net sales for our tissuesegment for fiscal year 2007 increased $4.6 million, or 2.0%, to $237.5 millionfrom $232.9 for fiscal year 2006. This increase is attributable to an increasein net selling price per ton, which was partially offset by a decrease intonnage sold. Net selling price per ton increased from $1,298 for fiscal year2006 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 ourmachine-glazed segment for fiscal year 2007 increased $2.1 million, or 2.1%, to$98.0 million from $95.9 million for fiscal year 2006. This increase is alsoattributable to an increase in net selling price per ton, which was partiallyoffset by a decrease in tonnage sold due in part to the shutdown of ourmachine-glazed machine at our Ontario facility. Net selling price per tonincreased from $1,173 for fiscal year 2006 to $1,219 for fiscal year 2007. Forfiscal year 2007, we sold 80,339 tons of machine-glazed products, compared to81,783 tons sold in fiscal year 2006.

**Gross profit**for fiscal year 2007 decreased to $21.1 million from $27.7 million for fiscalyear 2006, a decrease of $6.6 million, or 23.9% from fiscal year 2006. As apercentage of net sales, gross profit decreased to 6.3% for fiscal year 2007,compared to 8.4% for fiscal year 2006. Included in fiscal year 2007 is $5.4million of additional depreciation expense in cost of goods sold as compared toour historical basis of accounting prior to the Merger. Also, included infiscal year 2007 is a non-cash charge to cost of goods sold reflecting $.9million of excess purchase price allocated to inventory.

Gross profit for ourtissue segment for fiscal year 2007 was $16.4 million, a decrease of $2.4million, or 12.8%, from fiscal year 2006. Included in fiscal year 2007 is theimpact of the additional charges noted above on the tissue segment of $3.5million and $.6 million, respectively. Gross profit for our machine-glazedsegment for fiscal year 2007 was $4.7 million, a decrease of $4.2 million, or47.2%, from fiscal year 2006. Included in fiscal year 2007 is the impact of theadditional charges noted above on the machine-glazed segment of $1.9 millionand $.3 million, respectively. As a percentage of net sales, gross profit forthe tissue segment decreased to 6.9% for fiscal year 2007 from 8.1% in fiscalyear 2006. As a percentage of net sales, gross profit for the machine-glazedsegment decreased to 4.8% for fiscal year 2006 from 9.3% in fiscal year 2006

**Selling, general andadministrative expenses** for fiscal year 2007 decreased $1.0million, or 7.8%, to $11.9 million from $12.9 million for fiscal year 2006. Asa percentage of net sales, selling, general and administrative expensesdecreased to 3.5% in fiscal year 2007 from 3.9% for fiscal year 2006.

**Restructuring costs**for fiscal year 2007 were $.2 million related to severance costs associatedwith the elimination of a corporate position. Restructuring costs for fiscalyear 2006 were $1.0 million, of which $.7 million related to our fiscal year2006 decision to indefinitely idle one of our paper machines at our Ontariofacility and the related severance costs and $.3 million related to severancecosts associated with a corporate organizational restructuring.

**Merger-related transaction costs**forfiscal year 2007 were $6.1 million. The merger-related transaction costs forfiscal year 2006 were $2.3 million related to a previously announced terminatedtransaction.

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**Stock and related compensationexpense**for fiscal year 2007 were $3.3 million related tonon-cash compensation expense related to the vesting of restricted stockawards, payments of taxes associated with such awards and other compensationexpense related to the Merger.

**Vesting of stockoption/restricted stock grants**for fiscal year 2007 was $1.4million compared to $.9 million for fiscal year 2006. The $1.4 million forfiscal year 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 fixed assets**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 2007 was a gain of $.1 million compared to a loss of $.5 millionfor fiscal year 2006. The fluctuation over the prior fiscal year is due to thefluctuations in the foreign currency (the Canadian dollar).

**Income tax benefit**forfiscal year 2007 was $5.8 million, or an effective tax rate of 31.5%, comparedto $3.6 million, or an effective tax rate of 58.2%, for fiscal year 2006. Theeffective income tax rate for fiscal year 2007 differs from the federalstatutory rate primarily due to non-deductible transaction costs expensed forbook 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 wasrecorded in fiscal year 2006 upon completion of our fiscal year 2005 taxreturns. Also included in the 58.2% effective tax rate was $.1 million of taxexpense related to Canadian withholding tax. Without these items, the effectivetax rate for fiscal year 2006 was 40.6% (benefit of $2.5 million).

**Net loss**forfiscal year 2007 was $12.7 million,****compared tonet loss of $2.6 million for fiscal year 2006. Included in fiscal year 2007 netloss is $6.3 million related to additional depreciation and a non-cash chargeto cost of goods sold resulting from purchase accounting, $.2 million ofrestructuring costs, $6.1 million of merger-related transaction costs, $3.8million of merger-related and other compensation charges and $.5 millionrelated to an impairment charge for our paper machine at our Ontario facility. Includedin fiscal year 2006 net loss is $1.1 million of restructuring costs and $2.2million of merger-related transaction costs related to a terminated transaction

***Fiscalyear ended February 28, 2006 (fiscal year 2006) compared to fiscal year endedFebruary 28, 2005 (fiscal year 2005)***

**Net sales** forfiscal year 2006 decreased approximately $4.1 million, or 1.2%, to $328.8million from $332.9 million for fiscal year 2005. The decrease is attributableto a decrease in tonnage sold for fiscal year 2006 compared to the comparableperiod in the prior year. For fiscal year 2006, we sold 261,184 tons of tissueand machine-glazed products, compared to 269,834 tons sold in fiscal year 2005.Contributing to the decrease in volume sold for fiscal 2006 was the reducedoperating schedule and ultimate idling of our machine-glazed machine at ourOntario facility in the third quarter of fiscal year 2006. Additionally, volumesold at our Mississippi facility was lower in fiscal year 2006 due to theshutdown of the mill for a week due to Hurricane Katrina. Furthermore, weexperienced a shortfall in our machine-glazed segment volume in the firstquarter of fiscal year 2006. Partially offsetting the decrease in volume soldfor fiscal year 2006 from the comparable period in the prior year was anincrease in net selling price per ton from $1,234 to $1,259 for fiscal year2006.

Net sales for our tissuesegment for fiscal year 2006 increased $2.4 million, or 1.1%, to $232.9 millionfrom $230.4 million for fiscal year 2005. The increase in net sales for thetissue segment is primarily attributable to growth in tissue converted productsales offset by unfavorable tissue hard roll mix. For fiscal year 2006, we sold179,401 tons of tissue, compared to 182,192 tons sold in fiscal year 2005. Netsales for our machine-glazed segment for fiscal year 2006 decreased $6.5million, or 6.4%, to $95.9 million from $102.5 million for fiscal year 2005. Thedecrease in net sales for the machine-glazed segment is attributable to lowervolume experienced in fiscal year 2006. For fiscal year 2006, we sold 81,783tons of

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combined hard rollmachine-glazed paper and converted wax paper products, compared to 87,642 tonsfor fiscal year 2005.

**Gross profit**for fiscal year 2006 decreased to $27.7 million from $40.8 million, a decreaseof $13.1 million, or 32.1%, from fiscal year 2005. As a percentage of netsales, gross profit decreased to 8.4% for fiscal year 2006, compared to 12.3%for fiscal year 2005. The decrease in gross profit in fiscal year 2006 wasprimarily attributable to significant market price increases for both naturalgas and electricity. The effect of the increase in energy prices for fiscalyear 2006 was $11.4****million. Absentthese energy price increases, gross margin for fiscal year 2006 would have been11.9% compared to 12.3% for the comparable period in the prior year. Otherfactors which negatively impacted gross profit in fiscal year 2006 wereunfavorable volume and expenses related to Hurricane Katrina. These negativefactors were partially offset by the growth in gross profit of the tissueconverting business.

Gross profit for ourtissue segment for fiscal year 2006 was $18.8 million, a decrease of $8.2million, or 30.4%, from fiscal year 2005. Gross profit for our machine-glazedsegment for fiscal year 2006 was $8.9 million, a decrease of $4.9 million, or35.5%, over fiscal year 2005. The decrease in gross profit for the tissuesegment was attributable to the increase in market energy prices as describedabove, unfavorable volume and unfavorable hard roll mix, all of which offsetthe improved gross profit in tissue converting. The decrease in gross profitfor the machine-glazed segment was attributable to the increase in marketenergy prices and the decrease in tons sold. As a percentage of net sales,gross profit for the tissue segment decreased to 8.1% for fiscal year 2006 from11.6% in fiscal year 2005. As a percentage of net sales, gross profit for themachine-glazed segment decreased to 9.3% for fiscal year 2006 from 13.4% infiscal year 2005.

**Selling, general andadministrative expenses** for fiscal year 2006 decreased $1.7million, or 11.5%, to $12.9 million from $14.6 million in fiscal year 2005. Asa percentage of net sales, selling, general and administrative expenses decreasedto 3.9% for fiscal year 2006 from 4.4% for fiscal year 2005. Included in fiscalyear 2005 is the accrual of business performance bonuses. There was no accrualof business performance bonuses in fiscal year 2006.

**Restructuring costs**infiscal year 2006 were $1.1 million, of which $.7 million related to our fiscal2006 decision to indefinitely idle one of our paper machines at our Ontariofacility and the resulting severance costs thereof. Furthermore, we alsorecorded approximately $.4 million related to severance costs associated with acorporate organizational restructuring.

**Terminated merger-relatedtransaction costs**in fiscal year 2006 were $2.3 millionassociated with a proposed transaction which was subsequently terminated.

**Stock and related compensationexpense and vesting of stock option/restricted stock grants**includedin fiscal year 2005 income from operations is $4.3 million; $3.4 millionrelated to compensation from the redemption of stock options, $.5 millionrelated to accelerated vesting of certain stock options, both triggered by theoffering of the Notes completed in March 2004, and $.4 million related to thevesting of a restricted common stock award to our chief executive officer thatwas fully vested at the end of fiscal year 2005. Furthermore, we recorded $.1million in fiscal year 2006 related to accelerated vesting of certain stockoptions. No additional expense will need to be recognized as the originalvesting period associated with the options has expired.

**Write-off of debt issuance costsand prepayment penalties**of $3.3 million included in fiscalyear 2005 income from operations was an expense incurred primarily related tothe write-off of debt issuance costs (non-cash) previously capitalized andassociated with debt that was extinguished in March 2004 with proceeds from theoffering of the Notes. No such expense was recognized in fiscal year 2006.

**Other income**of$2.4 million included in fiscal year 2005 relates to a gain on sale ofequipment generated by the sale of a paper machine at our Menominee mill. Netproceeds from the sale were $4.0 million (gross proceeds of $5.2 million lessbrokerage fees and other direct costs of $1.2 million).

**Income tax benefit**forfiscal year 2006 was $3.6 million, or an effective tax rate of 58.2%, comparedto less than $.1 million, or an effective tax rate of 2.4% for fiscal year2005. Included in the 58.2% effective tax rate for fiscal year 2006 isapproximately $1.2 million of benefit related to the different book and tax

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treatment of deductionsrelated to stock compensation matters. Also, included in this effective taxrate is $.1 million of tax expense related to Canadian withholding tax. Excludingthese items, the effective tax rate for fiscal year 2006 was 40.6% (benefit of$2.5 million). Included in the fiscal year 2005 benefit was $1.0 millionrelated to the reversal of a valuation allowance against foreign deferred taxesresulting from net operating loss carryforwards. As our foreign operations wereprofitable in fiscal year 2005, we utilized our foreign net operation lossesand, accordingly, the valuation allowance was no longer necessary. Without this$1.0 million benefit, income tax expense for fiscal year 2005 was 31%.

**Net (loss) income**forfiscal year 2006 was a net loss of $2.6 million,****comparedto net income of $3.1 million for fiscal year 2005. The decrease in net incomewas attributable to the decrease in gross profit as discussed above, costsassociated with Hurricane Katrina, the restructuring costs, and the terminatedmerger-related transaction costs.

**Liquidity and capital resources**

Our principal liquidityrequirements are to service debt and meet working capital, tax and capitalexpenditure needs. Our total debt at February 28, 2007 was $160.4 million. Inconnection with the acquisition of CityForest in March 2007, we issued and soldapproximately $20 million of additional aggregate principal amount Notes. Furthermore,we borrowed $17.4 million under our working capital facility. Although weexpect to be able to meet our liquidity requirements for fiscal year 2008through cash provided by operations, we cannot provide assurance that this willbe the case.

In March 2004, wecompleted a private offering of the Notes. We raised $152.2 million, net ofdebt issuance costs of $8.0 million and original issuance discount of $1.8million. At the same time, we entered into a $30.0 million revolving workingcapital facility with CIT Group/Business Inc. A portion of the proceeds, alongwith a drawdown from the working capital facility, were used to pay offexisting debt of approximately $56.0 million. In addition, we used an aggregate$100.2 million of the proceeds to fund a stockholder dividend in the amount of$96.8 million to Cellu Paper Holdings, Inc., our parent, to repurchase aportion of 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.

The Notes mature on March15, 2010 and require semi-annual interest payments on March 15th and September15th.

In connection with theMerger, we solicited consents with respect to the Notes. Consents were receivedwith respect to 100% of the aggregate outstanding principal amount of theNotes. 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 Notes for which they delivered consents. These paymentswere made in the second quarter of fiscal year 2007. As a result of ouracceptance of the consents delivered by noteholders and the completion of theconsent solicitation, the amendments to the indenture governing the Notesdescribed in the Consent Solicitation Statement dated May 9, 2006 and relatedSupplement dated May 24, 2006 have become operative and we will not be requiredto make a change of control offer to purchase any Notes in connection with theMerger.

We entered into a CreditAgreement, dated as of June 12, 2006 (referred to herein as the CreditAgreement), among us, as U.S. Borrower, Interlake Acquisition CorporationLimited, one of our subsidiaries, as Canadian Borrower, our parent, the otherloan guarantors party thereto, JPMorgan Chase Bank, N.A., as U.S.Administrative Agent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian AdministrativeAgent, and the other lenders party thereto. The Credit Agreement provides for a$35.0 million working capital facility, including a letter of creditsub-facility and swing-line loan sub-facility. The Credit Agreement providesthat amounts under the facility may be borrowed, repaid and re-borrowed,subject to a borrowing base test, until the maturity date, which is June 12,2011. An amount equal to $32.0 million is available, in U.S. dollars, to theU.S. Borrower under the facility, and an amount equal to $3.0 million isavailable, in U.S. or Canadian dollars, to the Canadian Borrower under thefacility. As of February 28, 2007, there were no outstanding borrowings underthe working capital facility.

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On March 21, 2007, weconsummated a definitive merger agreement with CityForest, Cellu City MergerSub, a wholly-owned subsidiary of the Company and Wayne Gullstad as theshareholders’ representative. Pursuant to the agreement, and subject to theterms and conditions therein, Cellu City Merger Sub merged with and intoCityForest, with CityForest surviving and becoming our wholly-owned subsidiary.The aggregate merger consideration paid (including assumption of $18.5 millionin aggregate principal amount of industrial revenue bonds) was approximately$61 million subject to certain working capital and net cash adjustments.

In connection with theCityForest Merger Agreement, the following agreements were entered into:

***NotePurchase Agreement***

We entered into a Note Purchase Agreement, or the NotePurchase Agreement, with Wingate Capital Ltd., or Wingate, dated March 21, 2007,pursuant to which we issued and sold $20,255,572 an additional aggregateprincipal amount of unregistered 9 3/4% Notes due 2010 to Wingate for thepurchase price of $20,000,007 which is equal to 98.7383% of the aggregateprincipal amount of the Notes. The Notes were issued pursuant to and will begoverned by the Indenture, dated as of March 12, 2004 (as amended andsupplemented, the Cellu Tissue Indenture) among us, our subsidiary guarantorsparty thereto and The Bank of New York Trust Company, N.A., as successortrustee to the Bank of New York , or the Trustee. The proceeds of the sale wereused to finance a portion of the acquisition.

***SecondSupplemental Indenture***

We, certain of our subsidiaries, the Trustee andCityForest have executed a Second Supplemental Indenture, dated March 21, 2007,or the Second Supplemental Indenture, pursuant to which CityForest became aparty to our Indenture as a subsidiary guarantor. As a subsidiary guarantor,CityForest, on a joint and several basis with all the existing subsidiaryguarantors, fully, unconditionally and irrevocably guarantees to each holder ofthe Notes and the Trustee our obligations under our Indenture and the Notes.

***Amendmentto Credit Agreement***

We entered into a First Amendment, dated March 21,2007 (referred to herein as the First Amendment), to the Credit Agreement datedJune 12, 2006 (as amended by the First Amendment, the Amended Credit Agreement)among us, as U.S. Borrower, Interlake Acquisition Corporation Limited, one ofour subsidiaries, as Canadian Borrower, certain other of our subsidiaries, ourparent, JPMorgan Chase Bank, N.A. and JPMorgan Chase Bank, N.A., TorontoBranch. The maturity date of the credit agreement is June 12, 2011.

The First Amendment (1) increased the working capitalfacility from $35.0 million to $40.0 million, (2) permitted the issuance andsale by us of the Notes, (3) provided for the consummation of the CityForestacquisition and the conversion by CityForest from a Minnesota corporation to aMinnesota limited liability company, (4) permitted the assumption ofapproximately $18.5 million in aggregate principal amount of indebtedness ofCityForest in connection with the CityForest acquisition in accordance with theterms of the CityForest Bond Documents (as defined below under “CityForest BondDocuments”), and (5) permitted the guarantee by us of certain obligations ofCityForest under the CityForest Bond Documents. In connection with theAmendment, CityForest became a guarantor of the obligations of the borrowersunder the Amended Credit Agreement.

***CityForestBond Documents***

CityForest is party to a Loan Agreement, dated March1, 1998, the Loan Agreement, with the City of Ladysmith, Wisconsin (referred toherein as the Issuer). Pursuant to the Loan Agreement, the Issuer loaned theproceeds of the Issuer’s Variable Rate Demand Solid Waste Disposal FacilityRevenue Bonds, Series

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1998 (CityForest Corporation Project), or the Bonds)to CityForest to finance the construction by CityForest of a solid wastedisposal facility. Approximately $18.5 million in aggregate principal amount ofthe Bonds was outstanding as of the date of the CityForest acquisition. CityForestis required, under the terms of the Indenture of Trust governing the Bonds, orthe CityForest Indenture, to provide a letter of credit in favor of the trusteeunder the CityForest Indenture, or he Bonds Trustee. CityForest has enteredinto an Amended and Restated Reimbursement Agreement, dated March 21, 2007, orthe Reimbursement 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.

The Bonds Trustee is permitted to draw upon theAssociated Bank Letter of Credit to pay principal and interest due on theBonds, and to provide liquidity to purchase the Bonds put to CityForest bybondholders and not remarketed; and CityForest is obligated under theReimbursement Agreement to reimburse Associated Bank for any such draws.CityForest is also obligated to pay a fee in respect of the aggregate amountavailable to be drawn under the Associated Bank Letter of Credit at a rate perannum initially equal to 1.25%, subject to adjustment on a quarterly basisbased on CityForest’s leverage. The expiration date of the Associated BankLetter of Credit is February 15, 2011.

Amounts borrowed byCityForest under the Associated Bank Revolving Credit Facility bear interest ata rate per annum equal to the LIBOR Rate (as defined in the ReimbursementAgreement), plus an applicable margin. The applicable margin percentageinitially is 1.75%, subject to adjustment on a quarterly basis based uponCityForest’s leverage. During the continuance of an event of default, theoutstanding principal balance bears interest at a rate per annum equal to thethen 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 BankRevolving Credit Facility prior to February 15, 2009, CityForest is obligatedto pay to Associated a Bank a fee equal to 1.00% of the commitment then beingterminated. The maturity date of the Associated Bank Revolving Credit Facilityis February 15, 2011.

The ReimbursementAgreement requires scheduled semi-annual payments of principal of the Bondsequal to approximately 2% of the principal amount outstanding as of the date ofthe Acquisition, with the balance payable at maturity of the Bonds on March 1,2028. The Reimbursement Agreement also contains a number of other provisionsregarding reserve funds and other mandatory and optional repayments inconnection with the Bonds. In addition, the Reimbursement Agreement providesthat in certain circumstances where the Company incurs Indebtedness in excessof amounts currently permitted under its Indenture or refinances theindebtedness issued under its Indenture, Associated Bank may require CityForestto repay all of its obligations to Associated Bank under the ReimbursementAgreement and either to cause the Bonds to be redeemed or to replace the AssociatedBank Letter of Credit with a Substitute Credit Facility, as such term isdefined in the CityForest Indenture.

The Reimbursement Agreement contains variousaffirmative and negative covenants customary for working capital and termcredit facilities, as well as additional covenants 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.

The Reimbursement Agreement also contains customaryevents of default, including: payment defaults; breaches of representations andwarranties; covenant defaults; cross-defaults to certain other debt, includingthe Notes and indebtedness under the Amended Credit Agreement; certain eventsof bankruptcy and insolvency; judgment defaults; certain defaults related tothe Employee Retirement Income Security Act of 1974, as amended; and a changeof control of CityForest or us.

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We have guaranteed all of the obligations ofCityForest under the Reimbursement Agreement, pursuant to a Guaranty, datedMarch 21, 2007 (the “Cellu Tissue Guaranty”), executed by us in favor ofAssociated Bank. In addition, the obligations of CityForest under theReimbursement Agreement are secured by first-priority liens in favor ofAssociated Bank in all of CityForest’s assets. The U.S. Administrative Agent,the Canadian Administrative Agent, Associated Bank and CityForest have enteredinto an Intercreditor Agreement, dated March 21, 2007, which sets forth therespective rights and priorities of Associated Bank, on the one hand, and theU.S. Administrative Agent and the Canadian Administrative Agent, on the otherhand, as to the collateral of CityForest securing the Reimbursement Agreementand the Amended Credit Agreement.

The table that followspresents cash flows information for the combined fiscal year 2007:
| ** **                                               | ** ** | **Post-Acquisition**                                      | ** **  | **Pre-Acquisition**                                    | ** ** | **Combined**                                                 | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------------|-------------|--------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                               | ** ** | **June 13, 2006-  February 28, 2007** | ** **  | **March 1, 2006-  June 12, 2006-** | ** ** | **Fiscal Year Ended  February 28, 2007** | ** ** |
| **Net  Cash Provided by (Used in) Operating Activities** | ** ** | ** **                                                | ** **  | ** **                                             | ** ** | ** **                                                   | ** ** |
| Net Loss                                                 |       | $                                                         | (6,192,366  | )                                                      | $          | (6,534,964                                                   | )          | $ | (12,727,330 | ) |
| Non-cash items                                           |       | 11,757,574                                                |        | 5,245,238                                              |       | 17,002,812                                                   |       |
| Changes in  working capital                              |       | 4,574,243                                                 |        | (5,250,094                                             | )          | (675,851                                                     | )          |
| Net cash  provided by (used in) operating activities     |       | $                                                         | 10,139,451  |                                                   | $          | (6,539,820                                                   | )          | $ | 3,599,631 |   |
|                                                     |       |                                                      |        |                                                   |       |                                                         |       |
| **Net  Cash Provided by (Used in) Investing Activities** |       | $                                                         | 38,084,856  |                                                   | $          | (1,937,610                                                   | )          | $ | 36, 147,246 |   |
|                                                     |       |                                                      |        |                                                   |       |                                                         |       |
| **Net  Cash Used in Financing Activities**               |       | $                                                         | (45,761,997 | )                                                      | $          | (290,000                                                     | )          | $ | (46, 051,997) |   |
| ** **                                               | ** ** | ** **                                                | ** **  | ** **                                             | ** ** | ** **                                                   | ** ** |
| **Effect  of foreign currency**                          |       | $                                                         | (620,553    | )                                                      | $          | 362,212                                                      |       | $ | (258,341 | ) |
| ** **                                               | ** ** | ** **                                                | ** **  | ** **                                             | ** ** | ** **                                                   | ** ** |
| **Net increase (decrease) in cash**                      |       | $                                                         | 1,841,757   |                                                   | $          | (8,405,218                                                   | )          | $ | (6,563,461 | ) |

 

**Net cash provided by operations**was $ 3.6 million for fiscal year 2007, $8.6 million for fiscal year 2006, and$32.2 million for fiscal year 2005. Noncash items for fiscal year 2007 and 2006totaled $17.0 million

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and $13.7 million,respectively, and consisted primarily of amortization, depreciation anddeferred income taxes. Significant noncash items included in fiscal year 2005were $2.9 million for the write-off of debt issuance costs and $.5 millionrelated to accelerated vesting of stock options, both of which are related tothe issuance of the Notes in March 2004. These charges are offset by a gain onsale of equipment of $2.4 million. Net of these items, noncash items for fiscalyear 2005 totaled $18.4 million. The fluctuation from $18.4 million in fiscalyear 2005 to $13.7 million in fiscal year 2006 relates primarily in the changein deferred taxes from the prior fiscal year. Cash flows used by changes inworking capital totaled $.7 million for fiscal year 2007, cash flows used bychanges in working capital totaled $2.5 million for fiscal year 2006 and cashflows provided by changes in working capital totaled $9.7 million for fiscalyear 2005. With respect to changes in accounts receivable and inventory, cashprovided by these items was $.1 for fiscal year 2007, cash used by these itemswas $2.6 million for fiscal year 2006 and cash provided by these items was $1.6million for fiscal year 2005. Cash provided by changes in prepaid expenses,income tax receivable and other current assets was $.9 million for fiscal year2007, cash provided by changes in prepaid expenses and other current assets was$.1 million for fiscal year 2006 and cash used by changes in prepaid expenses,income tax receivable and other current assets was $1.0 million for fiscal year2005. Cash used by changes in accounts payable, accrued expenses, accrued interestand other liabilities was $1.7 million for fiscal year 2007. Cash provided bychanges in accounts payable, accrued expense, accrued interest and otherliabilities was less than $.1 million and $9.1 million, respectively, forfiscal year 2006 and 2005.

** Net cash provided by (used in) investingactivities**was cash provided by investing activities of $36.1million in fiscal year 2007, cash used in investing****activitiesof $13.1 million in fiscal year 2006 and $7.4 million in fiscal year 2005. Includedin fiscal year 2007 is $45.8 million related to the equity investment by WestonPresidio. The remaining change related to the level of capital spending yearover year. The increase in net cash used in investing activities for fiscalyear 2006 compared to fiscal year 2005 relates to the level of capital spendingperiod over period and machine sale proceeds in fiscal year 2005.

**Net cash (used in) provided byfinancing** was cash used in financing activities of $46.1million for fiscal year 2007, which includes $45.8 million related to mergerconsideration paid to former shareholders of our parent. The remaining $.3million for fiscal year 2007 relates to payments on our industrial revenuebond. Our final payment was made in the first quarter of fiscal year 2007. Cashused in financing activities was $.3 million for fiscal year 2006 and cashprovided by financing activities was $1.4 million in fiscal year 2005. Cashused in fiscal year 2006 related primarily to payments on our industrialrevenue bond. In fiscal year 2005, proceeds of $160.2 million from issuance ofthe Notes (as discussed above) were offset by (i) net payments on long-termdebt and revolving line of credit of $43.9 million and $11.0 million,respectively; (ii) a stockholder dividend to our parent in the amount of $96.8to purchase shares of its common stock and warrants; (iii) prepayment penaltiesof $.4 million; and (iv) payment of fees and expenses related to the issuanceof the Notes in the amount of $6.7 million.

**Cash** as ofFebruary 28, 2007 decreased to $16.3 million from $22.8 million as of the endof the prior fiscal year as a result of the items described above.

**Receivables, net**as of February 28, 2007 decreased to $34.1 million from $35.1 million as of theend of the prior fiscal year.

**Inventories**asof February 28, 2007 increased to $28.7 million from $27.9 million as of theend of the prior fiscal year. This increase is primarily attributable to anincrease in finished goods and raw materials inventory valuations over theprior fiscal year.

**Deferred income taxes**asof February 28, 2007 increased to $6.5 million from $2.9 million as of the endof the prior fiscal year. This increase is primarily attributable to therecording of the benefit of net operating loss carryforwards, or NOLs,generated during fiscal year 2007 for federal and state tax purposes.

**Property, plant and equipment,net**as of February 28, 2007 increased to $228.9 million from$98.1 million as of the prior fiscal year primarily due to the excess purchaseprice associated with the merger allocated to property, plant and equipment.

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**Debt issuance costs**havebeen reduced to zero as of February 28, 2007 from $5.7 million as of the end ofthe prior fiscal year due to purchase accounting adjustments resulting from themerger.

**Goodwill**hasbeen reduced to zero as of February 28, 2007 from $13.7 million as of the endof the prior fiscal year due to purchase accounting adjustments resulting fromthe merger.

**Trademarks**asof February 28, 2007 of $6.6 million have been recorded as a result of anintangible appraisal performed in conjunction with the merger.

**Accounts payable**asof February 28, 2007 decreased to $16.5 million from $18.6 million as of theend of the prior fiscal year primarily due to timing of payments.

**Deferred income taxes**asof February 28, 2007 increased to $50.7 million from $14.0 million as of theend of the prior fiscal year primarily due to purchase accounting adjustmentsresulting from the merger consisting mainly of differences between book and taxtreatment of property, plant and equipment.

**Other liabilities**asof February 28, 2007 increased to $35.2 million from $.2 million as of the endof the prior fiscal year due to the recording of $35.0 million related tocontingent earnout consideration in connection with the merger.

**Stockholders’ equity (deficiency)**as of February 28, 2007 increased to equity of $39.0 million compared to adeficit of $6.9 million as of the end of the prior fiscal year.  The equity as of February 28, 2007 isreflective of the equity invested in us relative to the Merger, the net lossgenerated for the period June 13, 2006 to February 28, 2007 and other equityactivity for this period.

**Capital spending summary**

Capital expenditures were$9.6 million, $13.1 million and $11.4 million for fiscal year 2007, fiscal year2006 and fiscal year 2005, respectively. We have increased capital expenditures since fiscal year 2002 to supportongoing cost savings programs (cost improvements) and growth in ourmanufacturing capacity.  We have concentratedthe growth in our manufacturing capacity since fiscal year 2003 on ourconverting operations at our Wisconsin facility for the production ofvalue-added converted tissue products.

**Contractual obligations**

At February 28, 2007, ourmaterial obligations under firm contractual arrangements, including commitmentsfor future payments under long-term debt arrangements, operating leasearrangements and other long-term obligations, are summarized below. 
| ** **                                                         | ** ** | **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)                                    |       | $                                                   | 162,000    |   | $ |        — |   | $ |   — |   | $ |    162,000 |   | — |   |
|                                                               |       |                                                |       |   |   |   |   |   |   |   |   |
| Operating lease  obligations                                       |       | 5,941                                               |       | 2,357 |   | 3,584 |   | — |   | — |   |
| Purchase  obligations                                              |       | 190,691                                             |       | 88,881 |   | 101,810 |   | — |   | — |   |
| Other long-term  liabilities reflected on balance sheet under GAAP |       | —                                              |       | — |   | — |   | — |   | — |   |
| Total                                                              |       | $                                                   | 358,632    |   | $ | 91,238 |   | $ | 105,394 |   | $ | 162,000 |   | $ | — |   |
|                                                                    |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**(1)Interest incurred at 9 3/4%, payable semi-annually**

**Net operating loss carryforwards**

At February 28, 2007, wehad federal NOLs of approximately $14,245,000 which begin to expire in 2021 andstate NOLs of approximately $12,305,000, which begin to expire in 2019.   We currently anticipate fully utilizingrecorded federal and state NOLs prior to their expiration.

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In assessing therealizability of deferred tax assets, we consider whether it is more likelythan not that some portion or all of the deferred tax assets will not berealized.  The ultimate realization ofdeferred tax assets is dependent upon the generation of future taxable incomeduring the periods in which those temporary differences become deductible.  We consider the scheduled reversal ofdeferred tax liabilities, projected future taxable income and tax planningstrategies in making this assessment. Based on the level of historical taxable income and projections forfuture taxable income over the periods in which the deferred tax assets aredeductible, we believe it is more likely than not that we will realize thebenefits of these deductibles differences.

**New accounting standards**

Refer to Note 2 (Summaryof Significant Accounting Policies) of the notes to our consolidated financialstatements included elsewhere in this Annual Report for a discussion of newaccounting pronouncements and the potential impact to our consolidated resultsof operations and financial position.

***Critical accounting policies and estimates***

Preparation of ourfinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses.  Significant accounting policies used in thepreparation of our consolidated financial statements are described in Note 2(Summary of Significant Accounting Policies), included elsewhere in this AnnualReport.  Management believes the most complexand sensitive judgments, because of their critical nature, result primarilyfrom the need to make estimates about the effects of matters with inherentuncertainty.  The most critical areasinvolving management estimates are described below.  Actual results in these areas could differfrom management’s estimates.

***Allowancefor doubtful accounts***

We estimate our allowancefor doubtful accounts using two methods. First, we determine a specific reserve for individual accounts whereinformation is available that the customer may have an inability to meet itsfinancial obligation.  Second, weestimate 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***

Goodwill is not amortizedbut tested for impairment annually at year-end, and at any time when eventssuggest impairment may have occurred. Our goodwill impairment test is performedby comparing the net present value of projected cash flows to the carryingvalue of goodwill.  We incorporateassumptions involving future growth rates, discount rates and tax rates inprojecting the future cash flows.  In theevent the carrying value of a reporting unit exceeds our fair value, animpairment loss would be recognized to the extent the carrying amount of thereporting unit’s goodwill exceeds their implied fair value.  No goodwill impairments were recorded duringthe period from March 1, 2006 to June 12, 2006 (pre-acquisition), fiscal year2006 or 2005.  The goodwill balance as ofJune 12, 2006 of $13,723,935 has been eliminated through the Merger purchaseprice allocation.

Trademarks are notamortized but tested for impairment annually at the end of our second quarter,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 exceed their implied fair value. No trademark impairments were recorded during the period from June 13,2006 to February 28, 2007 (post-acquisition).

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***Incometaxes***

We recognize deferred taxassets and liabilities for expected future tax consequences of events that havebeen included in the financial statements or income tax returns.  Under this methodology, deferred tax assetsand liabilities are determined based on the difference between the financialstatements and the tax basis of assets and liabilities using enacted tax ratesin effect for the year in which the differences are expected to reverse.

**ITEM7A.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

In March 2004, wecompleted a private offering of the Notes. At the same time, we entered into a $30.0 million revolving workingcapital facility.  We raisedapproximately $152.0 million, net of debt issuance costs and original discounton the Notes.  The proceeds, along with adrawdown from the revolver, were used to pay off existing debt of approximately$56.0 million and to fund a stockholder dividend to our parent to purchaseshares of its common stock and warrants and fund compensation from theredemption of stock options of our parent, in the amount of $100.2 million.  As a result of these transactions, we arehighly leveraged.  As of February 28,2007 there were no borrowings under our current working capital facility but wehave the ability to borrow funds under this facility up to an aggregate of$35.0 million and could be adversely affected by a significant increase ininterest rates.  In connection with theacquisition of CityForest in March 2007, we issued and sold approximately $20million of additional aggregate principal amount Notes.  Furthermore, we borrowed $17.4 million underour working capital facility.

We have minimal foreigncurrency translation risk.  Allinternational sales other than sales originating from our Canadian subsidiaryare denominated in U. S. dollars.  Due toour Canadian operations, however, we could be adversely affected by unfavorablefluctuations in foreign currency exchange rates.

**ITEM8.  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

See Item 15 for an indexto financial statements and financial statement schedules.  Such financial statements and financialstatement schedules are incorporated herein by reference.

**ITEM9.    CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

None.

**ITEM9A.   CONTROLS AND PROCEDURES**

(A) We carried out anevaluation, under the supervision and with the participation of our management,including our chief executive officer and principal financial officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rule 13a-15(e) and 15d-15(e)), under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of the end of theperiod covered by this report.  Our chiefexecutive officer and chief financial officer have concluded that, as of theend of such period, our disclosure controls and procedures were effective inensuring them that all material information required to be disclosed by us inthis Annual Report on Form 10-K was recorded, processed, summarized, reportedand properly disclosed in the time period specified in the rules andregulations of the Securities and Exchange Commission, and that suchinformation was accumulated and communicated to our management (including ourchief executive officer and chief financial officer) to allow timely decisionsregarding required disclosure.  Based onsuch evaluation, our chief executive officer and chief financial officer haveconcluded that we are in compliance with Rule 13a-15(e) of the Exchange Act.

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(B)  There have been no significant changes in ourinternal controls over financial reporting or in other factors during thefiscal year ended February 28, 2007 that have materially affected or arereasonably likely to materially affect our internal control over financialreporting.

**ITEM9B.  OTHER INFORMATION**

None.

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**PART III**

**ITEM10.  DIRECTORS, EXECUTIVE OFFICERS ANDCORPORATE GOVERNANCE**

The following table setsforth certain information regarding the members of our board of directors andour executive officers.  Each of ourdirectors will hold office until removal by our parent as solestockholder.  Our officers serve at thediscretion of our board of directors. 
| **Name**            | ** ** | **Age** | ** ** | **Position**                                                           |
|---------------------|------------|---------|------------|------------------------------------------------------------------------|
| Russell C.  Taylor  |       | 50      |       | President, Chief Executive Officer and Director                        |
| Dianne M. Scheu     |       | 43      |       | Senior Vice President, Finance and Chief Financial Officer             |
| W. Eddie Litton     |       | 43      |       | General Counsel, Senior Vice President, Human Resources  and Secretary |
| Steven D.  Ziessler |       | 47      |       | President, Tissue & Machine-Glazed and Chief Operating  Officer    |
| R. Sean Honey       |       | 36      |       | Chairman of the Board                                                  |
| Scott M. Bell       |       | 31      |       | Director                                                               |
| David L.  Ferguson  |       | 52      |       | Director                                                               |

 

*Russell C. Taylor*has been our president and chief executive officer since October 2001.  Mr. Taylor became a member of our board ofdirectors 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 May1997 to January 1999 as president, Kimberly Clark, Professional/Pulp, NorthAmerica/Europe, and from January 1999 to October 2001 as group president, KimberlyClark, Professional Pulp/Tissue Paper/Environmental, North America/Europe.

*Dianne M. Scheu*has been our chief financial officer and senior vice president, finance sinceJuly 2003.  From March 2003 to July 2003,she served as our senior vice president, finance.  She was self-employed as a financialconsultant from September 2002 to March 2003. From September 2001 to September 2002, Ms. Scheu was employed byKimberly Clark Corporation on the “go-to-market” project team.  From May 2001 to September 2001, Ms. Scheuwas on a leave of absence.  From April2000 to May 2001, Ms. Scheu was employed by Kimberly Clark Corporation asdirector of K C Professional Worldwide/Napkins/Private Label.  From March 1999 to March 2000, Ms. Scheu wasemployed by Kimberly Clark Corporation as director of AFH Sales.

*W. Eddie Litton*has been our general counsel and senior vice president of human resources sinceJuly 2006 and secretary since December 2006. From August 2003 to July 2006, Mr. Litton was retained by us as outsidecounsel.  Mr. Litton served as in-houselegal counsel for Lacerte Technologies, Inc. from May 2002 until May 2003 andwas employed in the private practice of law from September 1990 until April2002.

*Steven D. Ziessler*has been our president, tissue & machine-glazed and chief operating officersince August 2005.   Previously, Mr.Ziessler was employed by Kimberly Clark Corporation as (i) vice president,Global Health Care Sales from January 2005 to April 2005; (ii) president,Kimberly Clark Professional Europe from 2003 to 2004; and (iii) vice presidentof sales, marketing and general manager from 1997 to 2003.

*R. Sean Honey*wasappointed to our board of directors in June 2006 and has served as chairmansince that date.  Mr. Honey is a partnerwith Weston Presidio, which he joined in 1999. Prior to that, Mr. Honey was with J.P. Morgan Capital (the predecessorto JP Morgan Partners).

*Scott M. Bell*wasappointed to our 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.

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*David L. Ferguson*wasappointed to our board of directors in June 2006.  Mr. Ferguson is a partner with WestonPresidio, which he joined in 2003.  Priorto that, Mr. Ferguson was a general partner of JP Morgan Partners.  His prior work experience includes BankersTrust New York Corporation and Prudential Securities, as well as the auditdepartments of KPMG Peat Marwick and Deloitte & Touche.

**Shareholders’ Agreement**

Cellu Parent, ourindirect parent, has entered into a Shareholders’ Agreement, dated as of June12, 2006, with certain of its stockholders, including Russell C. Taylor, ourchief executive officer and president and a member of our board of directors,Dianne M. Scheu, chief financial officer and Steven Ziessler, president, tissueand machine-glazed and chief operating officer.   The agreement created certain rights andrestrictions with respect to Cellu Parent’s common stock, includingrestrictions on the transfer of stock, tag-along rights, pre-emptive rights,call rights, co-sale rights, registration rights and the right of WestonPresidio, in certain circumstances, to compel other stockholders to sell theirstock.

**Compensation Committee Interlocks and InsiderParticipation**

There are no compensationcommittee interlocks (none of our executive officers serves as a member of theboard of directors or the compensation committee of another entity that has anexecutive officer serving on our board of directors).

**Board of Directors and Committees**

The board of directorsheld two****meetings during fiscal year 2007.  During fiscal year 2007, each director thenin office attended 100% of the aggregate total number of meetings of the boardof directors held during the period in which he was a director and the totalnumber of meetings held by all of the committees of the board of directors onwhich he served.  The only standingcommittees of the board of directors are an audit committee and a compensationcommittee.

*Audit Committee*

R. Sean Honey and DavidL. Ferguson are members of the audit committee. The audit committee is empowered to: (i) appoint, fix the compensation of and oversee the work of our independentauditors (including the power to resolve any disagreements between managementand the independent auditors), with the independent auditors reporting directlyto the audit committee; (ii) pre-approve all audit services and permissiblenon-audit services; (iii) establish procedures for whistleblower complaints;and (iv) engage and determine funding for independent counsel and otheradvisors.  The board of directors hasdetermined that it currently does not have an audit committee financial expertwithin the meaning of the rules of the Securities and Exchange Commissionserving on its audit committee.  Inconnection with the acquisition of our parent by Weston Presidio in June 2006,the former director who served as an audit committee financial expert resignedas a member of the board of directors.

*Compensation Committee*

R. Sean Honey and DavidFerguson are members of the compensation committee.  The compensation committee is responsible for(i) compensation of our executives; (ii) equity-based compensation plans,including, without limitation, stock option plans, in which officers oremployees participate; and (iii) arrangements with executive officers, relatingto 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.

**Code of Ethics**

We have adopted a Code ofEthics that applies to our chief executive officer, senior financial officerand other senior officers (as that term is defined in the Code of Ethics).

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**ITEM11.  EXECUTIVE COMPENSATION**

**COMPENSATIONDISCUSSION AND ANALYSIS**

In this section, we willgive an overview and analysis of our compensation program and policies, thematerial compensation decisions we have made under those programs and policies,and the material factors that we considered in making those decisions.  Later in this Part III under the heading “AdditionalInformation Regarding Executive Compensation,” you will find tables containingspecific information about the compensation earned by the following, all ofwhom received compensation in excess of $100,000 in fiscal year 2007, whom werefer to as our “named executive officers”:

·                  RussellC. Taylor, president, chief executive officer and director

·                  DianneM. Scheu, senior vice president, finance and chief financial officer

·                  W.Eddie Litton, general counsel, senior vice president, human resources andsecretary

·                  StevenD. Ziessler, president, tissue & machine-glazed and chief operating officer

·                  HugoE. Vivero, who was senior vice president and secretary until July 21, 2006

The discussion below isintended to help you understand the detailed information provided in thosetables and put that information into context within our overall compensationprogram.

**Compensation Philosophy**

Our compensation programsare designed to attract, motivate and retain key employees, rewarding them forthe achievement of significant goals that continuously improve our businessperformance and increase our value. Performance and compensation are evaluated annually****toensure that we maintain our ability to attract and retain outstanding employeesin key positions and that compensation provided to our key employees iscompetitive relative to the compensation paid to similarly situated employeesof comparable companies.

Our compensationdecisions with respect to executive officer salaries and annual incentives, aswell as long-term incentives such as restrictive stock awards and stock optiongrants, are influenced by (a) the executive’s level of responsibility andfunction, (b) our overall performance and profitability and (c) our assessmentof the competitive marketplace, including other peer companies.  As discussed below in more detail, ourphilosophy is to focus on total direct compensation opportunities through a mixof base salary and annual cash bonus, as applicable, and long-term incentives,including stock-based awards.

**Overview of CompensationCommittee**

Our executivecompensation philosophy, policies, plans and programs are under the supervisionof the compensation committee of our board of directors.  The compensation committee’s responsibilitiesinclude (i) compensation of our executives; (ii) equity-based compensationplans, including, without limitation, the 2006 Stock Option and RestrictedStock Plan, in which officers or employees may participate, and (iii) arrangementswith executive officers related to their employment relationships with us,including, without limitation, employment agreements and restrictivecovenants.  The compensation committeehas overall responsibility for approving and evaluating our executive officercompensation plans, policies and programs, as well as all equity-basedcompensation plans and policies.

**Overview of Compensation Program**

Throughout this narrativediscussion and in the accompanying tables, we refer to our named executive officers.  The key compensation package provided to ournamed executive officers includes:

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·                  basesalary, which provides fixed compensation based on competitive market practiceand, except for W. Eddie Litton, in accordance with the terms of each individual’semployment agreement or severance agreement;

·                  bonus/performance-basedincentive compensation, which provides focus on meeting corporate****annual goals that lead to our long-term success andmotivates achievement of critical annual performance metrics;

·                  equitycompensation, as applicable, in the form of restrictive stock awards or stockoption grants by Cellu Parent, our indirect parent, which is designed to rewardand motivate employees by aligning their interests with those of thestockholders of Cellu Parent and provide an opportunity to acquire an indirectproprietary interest in the Company;

·                  ourmatching cash contributions to our named executive officers who participate inour 401(k) Plan; and

·                  401(K)and other benefits.

**Determination of Appropriate PayLevels**

We compete with manyother companies for experienced and talented executives.  As such, market information regarding paypractices at peer companies (as provided in the public reports filed by suchcompanies with the Securities and Exchange Commission) is reviewed andconsidered in assessing the reasonableness of compensation and ensuring thatcompensation levels remain competitive in the marketplace.  As described elsewhere in this Annual Report,for fiscal year 2007, three of our executive officers have entered intoemployment agreements with us that establish various terms and conditions oftheir employment.  Hugo E. Vivero, whoretired on July 21, 2006, entered into a severance agreement with us establishingthe terms and conditions of his termination. For a further description of these agreements, see “AdditionalInformation Regarding Executive Compensation–Employment Agreements; RestrictedStock Award Agreements and Severance Agreement.”

Each element ofcompensation [(including any base adjustments to the terms and conditions setforth in the employment agreements) is reviewed so that the overallcompensation package will attract, motivate and retain our key employees,including our named executive officers, by rewarding superior performance andproviding an incentive for the achievement of our strategic goals.  The following factors are considered todetermine the amount of compensation paid to each executive officer:

·                  overalljob performance, including performance against corporate and individualobjectives;

·                  jobresponsibilities, including unique skills necessary to support the long-termperformance of the Company;

·                  teamwork,both contributions as a member of the executive management team and fosteringan environment of personal and professional growth for the entire work force;

·                  performanceof general management responsibilities, execution of Company objectives andcontributions to the continuing success of the Company; and

·                  theCompany’s overall financial position and providing for an equitabledistribution of compensation through the Company.

**Allocation of Compensation**

There is nopre-established policy or target for the allocation of compensation, other thanthe employment agreements and the severance agreement as previously referenced.  The factors described above, as well as theoverall compensation philosophy and compensation is reviewed to determineappropriate level and mix of compensation.

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**Timing of Compensation**

As discussed elsewhere,compensation for our named executive officers are reviewed annually.  Going forward, incentive plan goalspecifications and incentive plan payments for our neamed executive officerswill also be reviewed annually.

**Minimum Stock Ownership Requirements**

There are no minimumstock ownership guidelines for the Company. All of the shares of the Company are beneficially owned by our parent,and all of the shares of our parent are beneficially owned by Cellu Parent, ourindirect parent.  All of the namedexecutive officers (other than Hugo E. Vivero), however, currently beneficiallyown shares of restrictive stock, or stock options to purchase common stock, ofCellu Parent.

**Compensation Components forFiscal Year 2007**

For fiscal year 2007, theprincipal components of compensation for the named executive officers were:

·                  basesalary;

·                  one-timestay bonuses in fixed amounts pursuant to bonus agreements entered into withcertain named executives in connection with the Merger;

·                  equityawards under the 2006 Stock Option and Restricted Stock Plan of Cellu Parentand the 2001 Stock Incentive Plan 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, weentered into employment agreements with each of Russell C. Taylor, Dianne M.Scheu and Steven Ziessler.  On July 5,2007, we entered into a severance agreement with Hugo E. Vivero.  We discuss the terms and conditions of theseagreements elsewhere in this Part III under “Additional Information RegardingExecutive Compensation–Employment Agreements; Restricted Stock Award Agreementsand Severance Agreement”..

*Annual Bonus Compensation*

For fiscal year 2007, weentered into bonus agreements with Messrs. Taylor and Ziessler and Ms. Scheupursuant to which each such executive officer was entitled to receive a fixedamount one-time stay cash bonus as an incentive to continue employment with usup through and including the effective date of the Merger.  Pursuant to the bonus agreements, each of theexecutive officers was entitled to receive a lump sum cash payment equal to oneyear’s current base salary upon the execution of the applicable agreement.   The bonus payments are reflected in Column(d) of the Summary Compensation Table.

For the fiscal yearending February 29, 2008, and for each fiscal year thereafter, named executiveofficers will be eligible to receive an annual incentive-based cash bonus of upto 100% of base salary, subject to the achievement by the Company of certainEBITDA targets set by the chairman of our board of directors and approved bythe Compensation Committee.   It isanticipated that, for each fiscal year, a range of EBITDA targets will be setfor each executive officer, usually in the first quarter of such fiscalyear.  Each EBITDA target will beexpressed as a percentage of base salary, ranging from 0% to 100%.  Performance measures for each fiscal yearwill be reviewed and performance incentive awards granted by the CompensationCommittee to executive officers, as applicable.

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*Equity Awards*

On June 12, 2006, theboard of directors of Cellu Parent adopted the 2006 Stock Option and RestrictedStock Plan, or the Plan.  Under the Plan,the board of directors of Cellu Parent or its delegate (referred to as the planadministrator) may grant to participants, including named executive officers,stock option awards to purchase shares of common stock of Cellu Parent and/orawards of restricted shares of common stock of Cellu Parent.  A maximum of 8,095 shares of common stock ofCellu Parent may be delivered in satisfaction of awards under the Plan,determined net of shares of common stock withheld by Cellu Parent in payment ofthe exercise price of an award or in satisfaction of tax withholdingrequirements.  Key employees anddirectors of, and consultants and advisors to, Cellu Parent or its affiliateswho, in the opinion of the plan administrator, are in a position to make asignificant contribution to the success of Cellu Parent and its affiliates areeligible to participate in the Plan.  Stock options are granted at the fair market value as determined by theplan administrator in accordance with the applicable regulations of theInternal Revenue Code, as amended, or 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 SavingsIncentive and Profit-Sharing Plan qualified under Section 401(k) of the Code, whichis available to all our employees who are 21 years of age or older with one ormore years of service.  Employees maycontribute up to 20% of their annual compensation (subject to certain statutorylimitations) to the 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) Plan infiscal year 2007 and received matching contributions from us under the 401(k)Plan as follows:
| Named Executive | ** ** | **2007 Matching Contributions  under the 401(K) Plan** | ** ** |
|----------------------|------------|---------------------------------------------------------------------------------|------------|
| Russell C.  Taylor   |       | $                                                                               | 2,410      |   |
| Dianne M. Scheu      |       | $                                                                               | 1,317      |   |
| Steven D.  Ziessler  |       | N/A                                                                             |       |
| W. Eddie Litton      |       | $                                                                               | 996        |   |
| Hugo E. Vivero       |       | $                                                                               | 2,286      |   |

 

Other Benefits

Each of the namedexecutive officers receives medical and dental insurance coverage on the sameterms as other employees.  We providemedical and dental insurance coverage to Mr. Vivero pursuant to the terms andconditions of the severance plan entered into between us and Mr. Vivero on July5, 2006 (referred to herein as the Severance Agreement), consistent with suchcoverage received by the other named executive officers and employees.

**Accounting and Tax Considerations**

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

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**COMPENSATIONCOMMITTEE REPORT**

The compensationcommittee of our board of directors has reviewed and discussed the CompensationDiscussion and Analysis required by Item 402(b) of Regulation S-K withmanagement and, based on such review and discussions, the compensationcommittee recommended to the board of directors that the CompensationDiscussion and Analysis be included in this Annual Report on Form 10-K.
|        | THE COMPENSATION  COMMITTEE |
|--------|-----------------------------|
|   |                        |
|   | R. Sean Honey               |
|   | David L.  Ferguson          |

 

**ADDITIONALINFORMATION REGARDING EXECUTIVE COMPENSATION**

**Summary Compensation Table**

The following table showsthe compensation earned for services rendered to the Company and itssubsidiaries in fiscal year 2007 by each of our named executive officers.  

| Name and  principal  position                                                      | ** ** | **Fiscal  Year** | ** ** | **Salary** | ** ** | **Bonus (1)** | ** ** | **Stock  Award(2)** | ** ** | **Option  Awards(3)** | ** ** | **Non-Equity  Incentive Plan  Compensation** | ** ** | **Change in  Pension  Value and  Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------|------------|------------|------------|--------------------|------------|---------------------|------------|-----------------------|------------|---------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|-----------|------------|
| **(a)**                                                                                 | ** ** | **(b)**          | ** ** | **(c)**    | ** ** | **(d)**            | ** ** | **(e)**             | ** ** | **(f)**               | ** ** | **(g)**                                           | ** ** | **(h)**                                                                                     | ** ** | **(i)**                          | ** ** | **(j)**   | ** ** |
| Russell C. Taylor,   President and Chief Executive Officer                              |       | 2007             |       | $          | 469,428    |               | $          | 425,000             |       | $                     | 287,075    |                                              | $          | —                                                                                      |       | $                                | —     |      | $          | — |   | $  | 2,410 | (4) | $ | 1,183,913 |   |
|                                                                                    |       |             |       |       |       |               |       |                |       |                  |       |                                              |       |                                                                                        |       |                             |       |      |       |
| Dianne M.Scheu,   Senior Vice President, Finance, and Chief Financial Officer           |       | 2007             |       | $          | 228,654    |               | $          | 230,000             |       | $                     | 858,380    |                                              | $          | —                                                                                      |       | $                                | —     |      | $          | — |   | $  | 1,317 | (4) | $ | 1,318,351 |   |
|                                                                                    |       |             |       |       |       |               |       |                |       |                  |       |                                              |       |                                                                                        |       |                             |       |      |       |
| Steven Ziessler,  President, Tissue and Machine-Glazed & Chief Operating Officer    |       | 2007             |       | $          | 247,885    |               | $          | 250,000             |       | $                     | 892,432    |                                              | $          | —                                                                                      |       | $                                | —     |      | $          | — |   | $ | — |   | $ | 1,390,317 |   |
|                                                                                    |       |             |       |       |       |               |       |                |       |                  |       |                                              |       |                                                                                        |       |                             |       |      |       |
| W. Eddie Litton,  General Counsel, Senior Vice President, Human Resources and Secretary |       | 2007             |       | $          | 102,314    |               | $     | —              |       | $                     | —     |                                              | $          | 3,139                                                                                       |       | $                                | —     |      | $          | — |   | $  | 996 | (4) | $ | 106,449 |   |
|                                                                                    |       |             |       |       |       |               |       |                |       |                  |       |                                              |       |                                                                                        |       |                             |       |      |       |
| Hugo E.  Vivero(5)                                                                      |       | 2007             |       | $          | 195,572    | (6)                | $          | —              |       | $                     | —     |                                              | $          | —                                                                                      |       | $                                | —     |      | $          | — |   | $ | 20,519 | (7) | $ | 216,091 |   |

 

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(1)                                  Representsone-time stay bonuses in fixed amounts pursuant to bonus agreements enteredinto with certain named executives in connection with the Merger.  See further discussion under “BonusAgreements.”

(2)                                  Reflectsshares of restricted stock of (i) our parent granted under the Cellu PaperHoldings, Inc. 2001 Incentive Plan that fully vested at the effective date ofthe Merger and were repurchased by our parent (Mr. Ziessler–$478,816; and Ms.Scheu–$444,764); and (ii) Cellu Parent granted under the 2006 Stock Option andRestricted Stock Plan (Mr. Taylor–$287,075; Mr. Ziessler–$102,505; and Ms.Scheu–$102,505) and the gross up amount paid related thereto (each of Mr.Ziessler and Ms. Scheu–$311, 111).  Theamounts in column (e) represent the proportionate amount of the total fairvalue of restricted stock recognized by us as an expense in fiscal year 2007for financial accounting purposes, disregarding for this purpose the estimateof forfeitures related to service-based vesting conditions.  The fair values of these awards and theamounts expensed in fiscal year 2007 were determined in accordance with FAS No.123R.  The awards for which expense isshown in column (e) include the awards described in the Grants of Plan-BasedAwards included elsewhere in this section. The assumptions used in determining the grant date fair values of theseawards are set forth in Note 2 to our consolidated financial statementsincluded elsewhere in 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 total fairvalue of restricted stock recognized by us as an expense in fiscal year 2007for financial accounting purposes, disregarding for this purpose the estimateof forfeitures related to service-based vesting conditions.  The fair values of these awards and theamounts expensed in fiscal year 2007 were determined in accordance with FAS No.123R.  The awards for which expense isshown in column (f) include the awards described in the Grants of Plan-BasedAwards included elsewhere in this section.  The assumptions used in determining the grant date fair values of theseawards are set forth in Note 2 to our consolidated financial statementsincluded elsewhere in this Annual Report.

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

(5)                                  Mr.Vivero resigned as senior vice president and secretary on July 21, 2006.

(6)                                  Reflects(i) salary payments received for fiscal year 2007 prior to termination in theamount of $82,742 and (ii) severance payments received for fiscal year 2007pursuant to the Severance Agreement subsequent to termination in the amount of$112,830.  See further discussion under “SeveranceAgreement.”

(7)                                  Includes(i) matching contributions under our 401(k) Plan in the amount of $2,886; (ii)dollar value of premiums paid with respect to supplemental life insurance anddisability in the amount of $11,842; and (iii) monthly automobile leasepayments in the amount of $4,718; (iv) a lump sum payment in the amount of$1,073 in respect of monthly cellular phone fee and surcharges, in the case ofclauses (ii) through (iv) pursuant to the Severance Agreement.

**Employment Agreements; Restricted Stock AwardAgreements**

We have entered into an employment agreement withRussell Taylor, dated June 12, 2006, pursuant to which Mr. Taylor will continueto serve as our chief executive officer and president The agreement is for aterm of four years, commencing on June 12, 2006, and will automatically extendfor successive terms of one year each, unless either Mr. Taylor or we providenotice to the other at least 60 days prior to the expiration of the original orany 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)          IfMr. Taylor’s employment is terminated due to death or disability, 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 of hisTarget

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Bonus (as defined); (iv) a lump sum payment equal tothe lesser of (A) 12 months of base salary or (B) base salary for a periodequal to the remainder of the term of the employment agreement; and (v) anyreimbursed business expenses.

(B)        IfMr. Taylor’s employment is termination by us without cause (as defined) or byhim with good reason (as defined), 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) a lump sumpayment equal to the greater of (a) 24 months of base salary or (b) base salaryfor a period equal to the remainder of the term of the employment agreement;(v) a lump sum equal to the greater of (x) one times the Target Bonus or (y)payment of the Target Bonus with respect to a period equal to the remainder ofthe term; and (vi) any reimbursed business expenses.

(C)        IfMr. Taylor’s employment is terminated by non-renewal of his employmentagreement 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 fiscalyear of his termination; (iii) a pro rata portion of his Target Bonus; (iv) alump sum payment equal to 24 months of base salary; and (v) any reimbursedbusiness expenses.

iv.                            Ifa change of control (as defined) occurs and, within three months before and twoyears following such change of control, we terminate Mr. Taylor’s employmentother than for cause or by reason of death or disability, or Mr. Taylorterminates his employment for good reason, then, in lieu of any paymentsotherwise due under Clauses (B) or (C) he will be entitled to (i) any earned,but unpaid, 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) a lump sumpayment equal to the greater of (a) 36 months of base salary or (b) base salaryfor a period equal to the remainder of the term of the employment agreement;(v) a lump sum equal to the greater of (x) one times the Target Bonus or (y)payment of the Target Bonus with respect to a period equal to the remainder ofthe term of the employment agreement; and (vi) any reimbursed businessexpenses.

In addition, the agreement also provides that, duringthe term and for a period of one year after the end of the term, we will paythe premium for a term life insurance policy covering Mr. Taylor in the amountof $1,000,000.  The agreement includes anon-competition and non-solicitation covenant by Mr. Taylor that extends duringthe term of his employment and for two years thereafter.  The agreement also provides that Mr. Taylorwill receive an award of restricted shares of Cellu Parent’s common stock, orthe Cellu Parent Shares, pursuant to the 2006 Stock Option and Restricted StockPlan, 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 Parent Shares are vestedon and after June 12, 2007; (2) an additional 25% of the Cellu Parent Sharesare vested on and after June 12, 2008; (3) an additional 25% of the CelluParent Shares are vested on and after June 12, 2009; and (4) an additional 25%of the Cellu Parent Shares are vested on and after June 12, 2010.  None of the Cellu Parent Shares will vest onany vesting date unless Mr. Taylor is then, and since the date of the award hascontinuously been, employed by Cellu Parent or its subsidiaries (including theCompany).  If Mr. Taylor ceases to beemployed by Cellu Parent or its subsidiaries, any then outstanding and unvestedCellu Parent Shares will be automatically and immediately forfeited, unlessemployment ceases due to death or disability, in which case 50% of the CelluParent Shares that are not then already vested will vest, or unless employmentceases by reason of Cellu Parent’s election not to renew the employmentagreement (and, at the time of such election, there exists no cause for thetermination), in which case one hundred percent 100% of the Cellu Parent Sharesthat are not then already vested will vest. The foregoing description is qualified in its entirety by reference tothe actual employment agreement executed with Mr. Taylor.

We have entered into an employment agreement withDianne Scheu, dated June 12, 2006, pursuant to which Ms. Scheu will continue toserve as our chief financial officer. The agreement is for a term of four years, commencing on June 12, 2006,and will automatically extend for successive terms of one year each, unlesseither Ms. Scheu or we provide notice to the other at least 60 days prior tothe expiration of the

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original or any extension term that the agreement isnot to be extended.  The agreementprovides Ms. Scheu with an annual base salary of $230,000, a bonus opportunityof up to 100% of base salary, and certain severance benefits under thefollowing circumstances:

(A)          IfMs. Scheu’s employment is terminated due to death or disability, she 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 her termination; (iii) a pro rata portion of herTarget Bonus; (iv) a lump sum payment equal to the lesser of (A) 12 months ofbase salary or base salary for a period equal to the remainder of the term ofthe employment agreement; and (v) any reimbursed business expenses.

(B)           IfMs. Scheu’s employment is termination by us without cause or by her with goodreason, she will be entitled to (i) any earned, but unpaid, base salary throughthe date of termination; (ii) any earned, but unpaid, annual bonus for any fiscalyear prior to the fiscal year of her termination; (iii) a pro rata portion ofher Target Bonus; (iv) a lump sum payment equal to 24 months of base salary;(v) a lump sum equal to one times the Target Bonus; and (vi) any reimbursedbusiness expenses.

(C)           IfMs. Scheu’s employment is terminated by non-renewal of her employment agreementby us for any reason (other than for cause), she 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 her termination; (iii) a pro rata portion of her Target Bonus; (iv) a lumpsum payment equal to 24 months of base salary; and (v) any reimbursed businessexpenses.

In addition, the agreement also provides that, duringthe term and for a period of one year after the end of the term, we will paythe premium for a term life insurance policy covering Ms. Scheu in the amountof $1,000,000.  The agreement includes anon-competition and non-solicitation covenant by Ms. Scheu that extends duringthe term of her employment and for two years thereafter.  The agreement also provides that Ms. Scheuwill 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 Ms.Scheu 1,349 Cellu Parent Shares.  Thevesting and forfeiture terms applicable to Ms. Scheu’s award are the same asthose applicable to Mr. Taylor’s award as described above.  The foregoing description is qualified in itsentirety by reference to the actual employment agreement executed with Ms.Scheu.

We have entered into an employment agreement withSteven Ziessler, dated June 12, 2006, pursuant to which Mr. Ziessler will continueto serve as our chief operating officer. The agreement is for a term of four years, commencing on June 12, 2006,and will automatically extend for successive terms of one year each, unlesseither Mr. Ziessler or us provides notice to the other at least 60 days priorto the expiration of the original or any extension term that the agreement isnot to be extended.  The agreementprovides Mr. Ziessler with an annual base salary of $250,000, a bonusopportunity of up to 100% of base salary, and certain severance benefits under the following circumstances:

(A)          IfMr. Ziessler’s employment is terminated due to death or disability, 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 of hisTarget Bonus; (iv) a lump sum payment equal to the lesser of (A) 12 months ofbase salary or base salary for a period equal to the remainder of the term ofthe employment agreement; and (v) any reimbursed business expenses.

(B)           IfMr. Ziessler’s employment is termination by us without cause or by him withgood reason, he will be entitled to (i) any earned, but unpaid, base salarythrough the date of termination; (ii) any earned, but unpaid, annual bonus forany fiscal year prior to the fiscal year of his termination; (iii) a pro rataportion of his Target Bonus; (iv) a lump sum payment equal to 24 months of basesalary; (v) a lump sum equal to one times the Target Bonus; and (vi) anyreimbursed business expenses.

(C)           IfMr. Ziessler’s employment is terminated by non-renewal of his employmentagreement by us for any reason (other than for cause), he will be entitled to(i) any earned, but unpaid, base salary

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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) a lump sumpayment equal to 24 months of base salary; and (v) any reimbursed businessexpenses.

In addition, the agreement also provides that, duringthe term and for a period of one year after the end of the term, we will paythe premium for a term life insurance policy covering Mr. Ziessler in theamount of $1,000,000.  The agreementincludes a non-competition and non-solicitation covenant by Mr. Ziessler thatextends during the 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 the same asthose applicable to Mr. Taylor’s award as described above.  The foregoing description is qualified in itsentirety by reference to the actual employment agreement executed with Mr.Ziessler.

In the case oftermination for any of the above-referenced reasons, for each of the namedexecutive officers (x) we shall continue the insurance coverage benefits forthe period contemplated therein, and (y) subject to any employee contributionapplicable to employees and their dependents, generally for the periodfollowing termination of 24 months (36 months in the case of a change incontrol for Mr. Taylor), or if earlier, until the date that the executivebecomes eligible for coverage with a subsequent employer, we will continue tocontribute to the premium cost of coverage for the executive and the executive’sdependents under our medical and dental plans provided that a timely electionis made pursuant to the Consolidated Omnibus Budget Reconciliation Act of 1985,as amended, or COBRA, at the executive’s expense.  Each of the executives may also be entitledto receive a gross-up payment in certain circumstances if payments or benefitsprovided trigger an excise tax under Section 4999 of the Cod[, but only if thepayments and benefits provided exceed 105% of the greatest amount that could bepaid without triggering the excise tax. If the payments and benefits provided do not exceed 105% of the greatestamount that could be paid without triggering the excise tax, then the paymentsand benefits will be reduced to the greatest amount that could be paid withouttriggering the excise tax.

***2006 Stock Option and RestrictedStock Plan***

The board of directors ofCellu Parent has adopted the 2006 Stock Option and Restricted Stock Plan.  The 2006 Stock Option and Restricted StockPlan authorizes the award of incentive stock options, which are stock optionsthat qualify for special federal income tax treatment.  The exercise price of any stock optiongranted under the 2006 Stock Option and Restricted Stock Plan may not be lessthan the fair market value of the common stock on the date of grant.  In general, each option granted under the2006 Stock Option and Restricted Stock Plan vests annually in four equalinstallments and expires ten years from the date of grant, subject to earlierexpiration 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, inconnection with the Merger, Cellu Parent entered into Restricted StockAgreements with Messrs Taylor and Ziessler and Ms. Scheu, pursuant to whichCellu Parent granted 3,778 restricted shares of its common stock to Mr. Taylorand 1,349 restricted shares of its common stock to each of Mr. Ziessler and Ms.Scheu.

***2001 Stock 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.  Immediately priorto the Merger, Hugo E. Vivero held options to purchase 109 shares of commonstock of Cellu Paper.  In accordance withthe terms of 2001 Plan, the options fully vested at the effective time of theMerger and were repurchased by our parent. The 2001 Plan also authorized awards of restricted stock of Cellu Paper.  On March 27, 2006, prior to the Merger, ourparent entered into Restricted Stock Agreements with Dianne Scheu and StevenZiessler, pursuant to which our parent granted 170.65 restricted shares of itscommon stock to each of Dianne Scheu and Steven Ziessler pursuant to the 2001Plan.  In accordance with the terms ofthe 2001 Plan, the shares of restricted stock fully vested at the effectivedate

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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 fully gross up heror him, as applicable, for the amount included in gross income for income taxpurposes as a result of making a Section 83(b) election under the Code.  The 2001 Plan was terminated at the effectivedate of the Merger.

**Severance Agreement**

Mr. Vivero terminatedemployment with us on July 21, 2006.   In connection with his termination, we entered into the SeveranceAgreement with Mr. Vivero on July 5, 2006 which provided Mr. Vivero withcertain severance benefits.   For adescription of the Severance Agreement, see “Potential Payments UponTermination or Change of Control–Severance Agreement.”

**Bonus Agreements**

On March 27, 2006, weentered into bonus agreements with each of Russell Taylor, Dianne Scheu andSteven Ziessler,  Pursuant to the bonusagreements, each of the executive officers was entitled to receive a fixedamount one-time stay bonus as an incentive to continue employment with us upthrough and including the effective date of the Merger.  Pursuant to the bonus agreements, each of theexecutive officers was entitled to receive a lump sum cash payment equal to oneyear’s current base salary upon the execution of the applicable agreement.  The bonus payments, as reflected in Column(d) of the Summary Compensation Table, were $425,000 for Mr. Taylor, $230,000for Ms. Scheu and $250,000 for Mr. Ziessler.

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**GRANTS OF PLAN-BASEDAWARDS FOR FISCAL YEAR 2007**
| Name             | ** ** | **Grant   Date** | ** ** | **Threshold  ($)** | ** ** | **Target  ($)** | ** ** | **Max  ($)** | ** ** | **Threshold  ($)** | ** ** | **Target  ($)** | ** ** | **Max  ($)** | ** ** | **All Other  Stock  Awards:  Number of  Shares of  Stock or  Units (#)** | ** ** | **All  Other  Option  Awards:  Number  of  Securities  Underlying  Options (#)** | ** ** | **Exercise  or Base  Price of  Option  Awards ($/SH)** | ** ** | **Grant Date  Fair Value of  Stock and  Option  Awards (1)** | ** ** |
|------------------|------------|-----------------------|------------|--------------------|------------|-----------------|------------|--------------|------------|--------------------|------------|-----------------|------------|--------------|------------|---------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| Russell Taylor   |       | 6/06                  |       | —             |       | —          |       | —       |       | —             |       | —          |       | —       |       | 3,778                                                                                             | (2)        | —                                                                                |       | $                                                                     | 426.69     |                                                                                  | 1,612,035  |   |
| Dianne Scheu     |       | 3/06                  |       | —             |       | —          |       | —       |       | —             |       | —          |       | —       |       | 170.65                                                                                            | (3)        | —                                                                                |       | $                                                                     | 2,805      |                                                                                  | 444,764    |   |
|             |       | 6/06                  |       |               |       |            |       |         |       |               |       |            |       |         |       | 1,349                                                                                             | (2)        | —                                                                                |       | $                                                                     | 426.69     |                                                                                  | 575,605    |   |
| Steven. Ziessler |       | 3/06                  |       | —             |       | —          |       | —       |       | —             |       | —          |       | —       |       | 170.65                                                                                            | (3)        | —                                                                                |       | $                                                                     | 2,805      |                                                                                  | 478,816    |   |
|                  |       | 6/06                  |       |               |       |            |       |         |       |               |       |            |       |         |       | 1,349                                                                                             | (2)        | —                                                                                |       | $                                                                     | 426.69     |                                                                                  | 575,605    |   |
| Eddie Litton     |       | 8/06                  |       | —             |       | —          |       | —       |       | —             |       | —          |       | —       |       | —                                                                                            |       | 25                                                                                    |       | $                                                                     | 426.69     |                                                                                  | 10,667     |   |
|             |       | 12/06                 |       |               |       |            |       |         |       |               |       |            |       |         |       | —                                                                                            |       | 25                                                                                    |       | $                                                                     | 426.69     |                                                                                  | 10,667     |   |
| Hugo E. Vivero   |       | —                |       | —             |       | —          |       | —       |       | —             |       | —          |       | —       |       | —                                                                                            |       | —                                                                                |       | —                                                                |       | —                                                                                |       |

 

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(1)                                  Thiscolumn reflects the full grant date value of stock and option awards under FASNo. 123R granted to named executive officers in fiscal year 2007.  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 the options. The actual value, if any, that a named executive officer may realizeupon exercise of stock options will depend on the excess of the stock priceover the base value on the date of exercise, so there is no assurance that thevalue realized by a named executive officer will be at or near the valueestimated by the Black-Scholes model. The assumptions used in determining the grant date fair values of thesestock and option awards are set forth in the notes to our consolidatedfinancial statements included elsewhere in this Annual Report.

(2)                                  OnJune 12, 2006, in connection with the Merger, Cellu Parent entered intoRestricted Stock Agreements with our chief executive officer, chief operatingofficer and chief financial officer, pursuant to which Cellu Parent granted3,778 restricted shares of its common stock to our chief executive officer and1,349 restricted shares of its common stock to each of the other two namedindividuals under the 2006 Stock Option and Restricted Stock Plan. See furtherdiscussion under “Employment Agreements; Restricted Stock Agreements.”

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(3)           OnMarch 27, 2006 prior to the Merger, our parent entered into Restricted StockAgreements with our chief financial officer and chief operating officer,pursuant to which our parent granted 170.65 restricted shares of its commonstock to each of the named individuals under the 2001 Plan.  In accordance with the terms of the 2001 Plan,the shares of restricted stock fully vested at the effective date of the Mergerand were repurchased by our parent.

**OUTSTANDINGEQUITY 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     |       | —                                                                                                               |       | —                                                                                                                 |       | — |   | — |   | — |   | 3,778 |   | 1,612, 035 |   | — |   | — |   |
| Dianne Scheu       |       | —                                                                                                               |       | —                                                                                                                 |       | — |   | — |   | — |   | 1,349 |   | 575,605 |   | — |   | — |   |
| Steven. Ziessler   |       | —                                                                                                               |       | —                                                                                                                 |       | — |   | — |   | — |   | 1,349 |   | 575,605 |   | — |   | — |   |
|  Eddie Litton |       | —                                                                                                               |       | 50                                                                                                                     |       | — |   | $ | 426.69 |   | 2017 |   | — |   | — |   | — |   | — |   |
| Hugo E. Vivero     |       | —                                                                                                               |       | —                                                                                                                 |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
|                    |            |                                                                                                                      |            |                                                                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**OPTION EXERCISES AND STOCK VESTED**

**Thefollowing table includes certain information with respect to restricted stockawards and options that vested during the fiscal year 2007:**
| ** **         | ** ** | **Option Award**                    | ** ** | **Stock Awards** | ** ** |
|--------------------|------------|------------------------------------------|------------|-----------------------|------------|
| ** **         | ** ** | **Shares  Acquired  on   Exercise** | ** ** | **Value  Realized**   | ** ** | **Number of Shares  Acquired on   Vesting** | ** ** | **Value Realized on  Vesting** | ** ** |
| **Name**           | ** ** | **(#)(1)**                               | ** ** | **($)(2)**            | ** ** | **(#) (3)** | ** ** | **($) (2)** | ** ** |
|               |       |                                     |       |                  |       |   |   |   |   |
| Russell C.  Taylor |       | —                                   |       | —                |       | — |   | — |   |
| Dianne M. Scheu    |       | —                                   |       | —                |       | 170.652 |   | $ | 444,764 |   |
| Steve D.  Ziessler |       | —                                   |       | —                |       | 170.652 |   | 478,816 |   |
| W. Eddie Litton    |       | —                                   |       | —                |       | — |   | — |   |
| Hugo E. Vivo       |       | 109                                      |       | $                     | 99,251     |   |   |   |   |   |
|                    |            |                                          |            |                       |            |  |  |  |  |  |  |

 

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(1)       Representsoptions to purchase shares of our parent’s common stock issued prior to theMerger, which became fully vested at the effective time of the Merger and wererepurchased by our parent.

(2)       Valuerealized represents the number of shares acquired on vesting multiplied by thefair market value of shares of our parent’s common stock on the vesting date, whichwas determined to be $2,915.46.

(3)       Representsrestricted shares of our parent’s common stock issued prior to the Merger,which became fully vested at the effective time of the Merger and wererepurchased by our parent.

**PotentialPayments Upon Termination or Change in Control**

The following tables summarize the value of thetermination payments and benefits that Messrs. Taylor and Ziessler and Ms.Scheu would receive if they had terminated employment on February 28, 2007under the circumstances shown, pursuant to employment agreements and restricted stock agreements we have enteredinto with each of them.  Forfurther description of the employment agreements and restrictive stockagreements governing these payments, see “Employment Agreements; RestrictedStock Award Agreements.”  The tablesexclude (i) amounts accrued through February 28, 2007 that would be paidin the normal course of continued employment, such as accrued but unpaid salaryand earned annual bonus for fiscal year 2007 and reimbursed business expensesand (ii) vested account balances under our 401(k) Plan that is generallyavailable to all of our employees.

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**RussellC. 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)                                                                                                                                  | $          | 1,563,542                                                                                                                                                                          | (3)        | $  | 950,000 | (4) | $ | 1,563,542 | (5) |
| Acceleration of  Restricted Stock | ** ** | **$**                   | **—** |               | $     | 662,480                 | (6)        | $                                                                                                                                 | 662,480    | (6)                                                                                                                                  | **$**      | **—**                                                                                                                                                                         |       | $ | 1,324,960 | (7) | $ | — |   |
| Health & Welfare Benefits     |       | $                  | —     | (8)                | $     | —                  | (8)        | $                                                                                                                                 | —     | (8)                                                                                                                                  | $     | —                                                                                                                                                                             | (8)        | $  | — | (8) | $  | — | (8) |

 

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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 base salaryor (B) base salary for a period equal to the remainder of the term of theemployment 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 months of basesalary or (B) base salary for a period equal to the remainder of the term ofthe employment; and (ii) lump sump equal to the greater of (x) one times theTarget Bonus or (y) payment of the Target Bonus with respect to a period equalto 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 24 months 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 months of basesalary or (B) base salary for a period equal to the remainder of the term ofthe employment agreement; and (ii) lump sump equal to one times the TargetBonus.  Payments in respect of a change incontrol are in lieu of payments for termination by reason of death ordisability or by the Company without cause or the Executive for good reason ornon-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 28, 2007.

(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 

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cause), calculated in accordance with the fair market value of thecommon stock of Cellu Parent as of February 28, 2007.

(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.

**Dianne M.Scheu**
| **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 $(1)** | ** ** |
|-----------------------------------|------------|-------------------------|------------|--------------------|------------|-------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Cash Severance                    | ** ** | **$**                   | **—** |               | $     | 230,000                 | (2)        | $                                                                                                                                 | 230,000    | (2)                                                                                                                                  | $     | 460,000                                                                                                                                                                          | (3)        | $  | 460,000 | (4) | **$ ** | **—** | (5) |
| Acceleration of  Restricted Stock | ** ** | **$**                   | **—** |               | $     | 236,550                 | (6)        | $                                                                                                                                 | 236,500    | (6)                                                                                                                                  | **$**      | **—**                                                                                                                                                                       |       | $  | 473,100 | (7) | $ | — |   |
| Health & Welfare Benefits     |       | $                  | —     | (8)                | $     | —                  | (8)        | $                                                                                                                                 | —     | (8)                                                                                                                                  | $     | —                                                                                                                                                                           | (8)        | $  | — | (8) | $  | — | (8) |

 

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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 base salaryor (B) base salary for a period equal to the remainder of the term of theemployment 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 24 months 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 28, 2007.

(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 

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cause), calculated in accordance with the fair market value of thecommon stock of Cellu Parent as of February 28, 2007.

(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                    |       | $                       | —     |               | $     | 250,000                 | (2)        | $                                                                                                                           | 250,000    | (2)                                                                                                                                  | $     | 500,000                                                                                                                                                                          | (3)        | $  | 500,000 | (4) | $  | — | (5) |
| Acceleration of  Restricted Stock |       | $                       | —     |               | $     | 236,550                 | (6)        | $                                                                                                                           | 236,550    | (6)                                                                                                                                  | $          | —                                                                                                                                                                           |       | $  | 473,100 | (7) | $ | — |   |
| Health & Welfare Benefits     |       | $                  | —     | (8)                | $     | —                  | (8)        | $                                                                                                                           | —     | (8)                                                                                                                                  | $     | —                                                                                                                                                                           | (8)        | $  | — | (8) | $  | — | (8) |

 

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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 base salaryor (B) base salary for a period equal to the remainder of the term of theemployment 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 24 months 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 28, 2007.

(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 

55

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cause), calculated in accordance with the fair market value of thecommon stock of Cellu Parent as of February 28, 2007.

(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.

**W. EddieLitton**

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 a changein control, any unvested stock options held by Mr. Litton to purchase shares ofcommon stock of Cellu Parent would be fully accelerated.  Accordingly, if Mr. Litton’s employment wasterminated on February 28, 2007 due to a change in control, he would not havereceived any value as the fair market value of his 50 shares of common stock ofCellu Parent as of February 28, 2007 equaled the exercise price of his unvestedoptions which would accelerate in connection with a change in control. Notwithstandingthe foregoing, Mr. Litton is entitled to (i) amounts accrued through the dateof termination that would be paid in the normal course of continued employment,such as accrued but unpaid salary and earned annual bonus, (ii) vested accountbalances under our 401(k) Plan that is generally available to all of ouremployees and (iii) any post-employment benefits that are available to all ofour salaried employees and do not discriminate in favor of Mr. Litton.  Furthermore, under the provisions of ERISAplan, he would be entitled to one year’s salary.

**Hugo E. Vivero**

Mr. Vivero terminatedemployment with us on July 21, 2006.  Inconnection with his termination, we entered into the Severance Agreement withMr. Vivero on July 5, 2006.   Pursuant tothe Severance Agreement, Mr. Vivero is entitled to receive:  (i) an aggregate amount of $195,572 equal toMr. Vivero’s current annual base salary at termination, payable on regularlyscheduled salary pay dates for 52 weeks (referred to herein as the severanceperiod); (ii) medical and dental benefits consistent with such coveragereceived by other named executive officers and employees, as well as lifeinsurance and related benefits, in the aggregate amount of $18,017; (iii)monthly automobile lease payments of $683.73 through the term of the lease inDecember 2006, and thereafter $650 (minus applicable taxes and withholdings)included in the payments referred to in clause (i), pro-rated on a monthlybasis, through the term of the severance period; (iv) a lump sum payment in theamount of $1,073.52 for cell phone fee and surcharges; and (v) monthly premiumsfor supplemental life insurance program and the disability program for theseverance period in the aggregate amount of $11,842.  In addition, the Severance Agreement imposescertain non-competition, non-solicitation and non-hire restrictions on Mr.Vivero.  Mr. Vivero is also entitledto vested account balances under our 401(k) plan that is generally available toall of our employees.

**Compensation of Directors**

Members of our board ofdirectors (including Russell C. Taylor, our president and chief executiveofficer) not receive director’s fees or other compensation for serving asdirectors.  All members of our board ofdirectors are reimbursed for actual expenses incurred in connection withattendance at board meetings. Compensation payable to Mr. Taylor as a named executive officer forfiscal year 2007 is reported in the Summary Compensation Tale includedelsewhere in this section.

**ITEM12.  SECURITY OWNERSHIP OF CERTAINBENEFCIAL OWNERS AND MANAGEMENT**

We are a wholly ownedsubsidiary of Cellu Paper Holdings, Inc (referred to herein as our parent) anda wholly owned indirect subsidiary of Cellu Parent Corporation (referred toherein as Cellu Parent).  As of the dateof this report, our parent’s outstanding capital stock consisted of 11,127shares of common stock, par value $0.01 per share, all of which wasbeneficially owned by Cellu Parent.  Asof the date of this 

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report, Cellu Parent’soutstanding capital stock consisted of 45,762 shares of common stock, par value$0.01 per share. The following table sets forth information with respect to thebeneficial ownership of Cellu Parent’s common stock as of May 1, 2007 by:

·      each person who is known by us to beneficially ownmore than 5% of the outstanding shares of common stock;

·      each executive officer named in the summarycompensation table;

·      each member of our board of directors; and

·      all members of our board of directors andexecutive officers as a group.

To our knowledge, each ofthe holders of common stock listed below has sole voting and investment poweras to the shares of common stock beneficially owned by such holder, unlessotherwise noted.  Shares of common stocksubject to options that are currently exercisable or exercisable within 60 daysof May 1, 2007 are deemed outstanding for computing the ownership percentage ofthe stockholder holding such options, but are not deemed outstanding forcomputing the ownership of any other stockholder.  
| **Name and address of   beneficial owner** | ** ** | **Number of shares   of common stock** | ** ** | **Percentage of total   common stock** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Weston Presidio                                                     |       | 42,502                                                          |       | 92.9                                                       | %          |
| Russell C. Taylor (2)  (3)                                          |       | 6,346                                                           |       | 13.9                                                       | %          |
| Dianne M. Scheu (2) (3)                                             |       | 1,445                                                           |       | 3.2                                                        | %          |
| Steven D. Ziessler  (2)(3)                                          |       | 1,445                                                           |       | 3.2                                                        | %          |
| W. Eddie Litton (2)                                                 |       | —                                                          |       | —                                                     |       |
| R. Sean Honey(1)                                                    |       | 42,502                                                          | (5)        | 92.9                                                       | %          |
| David L. Feguson(1)                                                 |       | 42,502                                                          | (5)        | 92.9                                                       | %          |
| Scott M. Bell(1)                                                    |       | —                                                          |       | —                                                     |       |
| All directors and  executive officers as a group (7 persons)        |       | 51,738                                                          |       | 98.0                                                       | %          |

 

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(1)       The address for WestonPresidio and for each of Messrs. Honey, Ferguson and Bell is Pier 1 Bay 2, SanFrancisco, California 94111.

(2)       The address for each officeris c/o Cellu Tissue Holdings, Inc., 1855 Lockeway Drive, Alpharetta, Georgia30004.

(3)       Includes shares of 3,778restricted common stock of Cellu Parent for Mr. Taylor and 1,359 restrictedcommon stock of Cellu Parent for each of Ms. Scheu and Mr. Ziessler, in eachcase that have not vested but for which named executive retains voting rights.

(5)       Each of Messrs. Honey andFerguson is a partner of Weston Presidio and, as such, is deemed to have sharedvoting and investment power (along with other partners of Weston Presidio) asto the shares of common stock beneficially owned directly by Weston Presidio.Each of Messrs. Honey and Ferguson disclaims beneficial ownership with respectto the shares beneficially owned by Weston Presidio.

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The following tablesummarizes shares of common stock of our Cellu Parent, our indirect parent, tobe issued upon exercise of options, the weighted-average exercise price ofoutstanding options and options available for future issuance as of February28, 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     |       | 575                                                                                                                                                                                 |       | $                                                                                                                                    | 426.69     |                                                                                                                                                                                                                                        | 1,044      |   |
| Equity compensation  plans not approved by security holders |       | —                                                                                                                                                                              |       | —                                                                                                                               |       | —                                                                                                                                                                                                                                      |       |
| Total                                                       |       | 575                                                                                                                                                                                 |       | $                                                                                                                                    | 426.69     |                                                                                                                                                                                                                                        | 1,044      |   |

 

The 2006 Stock Option and Restricted Stock Plan authorizes the award ofincentive stock options, which are stock options that qualify for specialfederal income tax treatment.  Theexercise price of any stock option granted under the 2006 Stock Option andRestricted Stock Plan may not be less than the fair market value of the commonstock on the date of grant.  In general,each option granted under the 2006 Stock Option and Restricted Stock Plan vestsannually in four equal installments and expires ten years from the date ofgrant, subject to earlier expiration in case of termination of employment. **  **The vesting period issubject to certain acceleration provisions if a change in control occurs.   The Plan also authorizes awards ofrestricted stock.

**ITEM13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE**

**Management Agreement**

On June 12, 2006, the Company, Cellu Parent, and CelluAcquisition Corporation entered into a Management Agreement with WestonPresidio Service Company, LLC (“Weston Presidio Service Company”), pursuant towhich Weston Presidio Service Company has agreed to provide the Company withcertain management, consulting and financial and other advisory services.  Weston Presidio Service Company is anaffiliate of Weston Presidio, which is the controlling shareholder of CelluParent, which is the sole shareholder of the Company’s parent corporation,Cellu Paper.  In consideration for suchservices, the Company, Cellu Parent and Cellu Acquisition Corporation havejointly and severally agreed to pay Weston Presidio Service Company an annualfee of $450,000, to be paid in equal quarterly installments, and to reimburseexpenses of 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 Agreement expires on June 12,2016 but will be automatically extended on each anniversary of such date for anadditional year unless one of the parties provides written notice of its desirenot to automatically extend the term at least 90 days prior to suchanniversary.  Weston Presidio ServiceCompany may terminate the Management Agreement upon not less than 10 dayswritten notice to the Company, and the Management Agreement will terminate uponthe consummation of an initial public offering or a change of 

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control.  TheManagement Agreement also provides that the Company, Cellu Parent and CelluAcquisition Corporation will jointly and severally indemnify Weston PresidioService Company and its affiliates and their related persons from and againstany and all actions, causes of action, suits, claims, liabilities, losses,damages and costs and expenses incurred as a result of, arising out of, or inany way relating to the Management Agreement, the services provided under theManagement Agreement, the Merger or its equity interest in and ownership of theCompany or Cellu Parent, except for any such indemnified liabilities arising onaccount of gross negligence or willful misconduct of the party seekingindemnification.  If and to the extentthat indemnification may be unavailable or unenforceable for any reason, theCompany, Cellu Parent and Cellu Acquisition Corporation agree to make themaximum contribution to the payment and satisfaction of each of the indemnifiedliabilities that is permissible under applicable law.  The foregoing description is qualified in itsentirety by reference to the actual Management Agreement.

**ITEM14.  PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

Aggregate fees forprofessional services rendered to us by Ernst & Young LLP as of or for thefiscal years ended February 28, 2007 and 2006 are set forth below.  The aggregate fees included in the Auditcategory are fees billed for the fiscal years for the audit of our annualfinancial statements and review of regulatory filings.  The aggregate fees included in each of theother categories are for fees billed in the fiscal years.
| ** **         | ** ** | **February 28, 2007** | ** ** | **February 28, 2006** | ** ** |
|--------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Audit Fees         |       | $                               | 400,000    |                            | $          | 367,000 |   |
| Audit-Related Fees |       | 285,056                         |       | 136,724                         |       |
| Tax Fees           |       | 162,794                         |       | 238,483                         |       |
| Total Fees         |       | $                               | 847,850    |                            | $          | 742,207 |   |

 

*Audit Fees: *Fees for audit servicesinclude fees associated with the annual audits and reviews of our quarterlyreports on Form 10-Q and annual report on Form 10-K.

*Audit- Related Fees: *Fees for audit-relatedservices in fiscal year 2007 relate to the merger transaction and acquisitionrelated audit work.  Fees foraudit-related services in fiscal year 2006 also relate to the mergertransaction.

*Tax Fees: *Fees for tax servicesrelate to the preparation of U.S. and Canadian tax returns, other miscellaneouscompliance matters and foreign tax planning.

**PART IV**

**ITEM15.  EXHIBITS and FINANCIAL STATEMENTSCHEDULES**

(a)    Index to documents filed aspart of this report:

1.     and2.  Financial Statements and FinancialStatement Schedules

The response to this portion of Item 15 is submitted as a separatesection 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:

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**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))                                                                                                                                                                                                                                                       |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1          |       | 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))                                                                                                                       |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.2          |       | 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))                                                                                                                                         |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.4          |       | 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))                                                                                                                                                                |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|  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 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 Form 10-Q for the quarter ended May 25, 2006)                                                                                                                                                                                                                            |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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 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 Form 8-K, dated June 12, 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 Form 8-K, dated June 12, 2006)                                                                                                                                                    |

 

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| 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 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 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 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 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 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., dated as of May 8, 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 Form 8-K, dated June 12, 2006) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.19  |   | 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 Form 8-K, dated  June 12, 2006)                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.20  |   | Merger Agreement Among the Company, Cellu City  Acquisition Corporation, Wayne Gullstad as the Shareholders’ Representative  and CityForest Corporation (incorporated by reference to Exhibit 10.1 of the  Company Form 8-K, dated February 26, 2007                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.21  |   | 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 Form 8-K/A, dated March 21, 2007)                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.22  |   | 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 Form 8-K/A, dated  March 21, 2007)                                                                                                                                                                                               |

 

61

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| 10.23                    |   | 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 Form 8-K/A, dated March 21, 2007) |
|--------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.24                    |   | 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 Form 8-K/A, dated March 21, 2007)                                                                                                                                                                                                                                                                                                                              |
|                     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.25                    |   | 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 Form 8-K/A, dated March 21, 2007)                                                                                                                                                                                                                                                                                                                                                                            |
|                     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.26                    |   | 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 Form 8-K/A, dated March 21, 2007)                                                                                                                                                                                                                                                                                                                                                                           |
|                     |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.27                    |   | 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 Form 8-K/A, dated March 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 FinancialStatements immediately following Index to Consolidated Financial Statements andConsolidated Financial Statement Schedule.

62

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theCompany has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

**CelluTissue Holdings, Inc.**
|   | By:                                                        | /s/ Russell C. Taylor |   |
|--------|------------------------------------------------------------|-----------------------|--------|
|   | Russell C. Taylor, President and Chief Executive   Officer |

 

May 18, 2007

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.
| /s/ Russell C. Taylor          |   |                               | /s/ Dianne M. Scheu |   |
|--------------------------------|--------|------------------------------------|---------------------|--------|
| 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                       |   |                               |
|                                |        |                                    |                     |        |  |  |

 

63

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**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 28, 2007 and 2006

ConsolidatedStatements of Operations-for the periods from June 13, 2006 to February 28,2007 (post-acquisition) and from March 1, 2006 to June 12, 2006(pre-acquisition) and for the fiscal years ended February 28, 2006 and 2005(pre-acquisition)

ConsolidatedStatements of Changes in Stockholders’ Equity (Deficiency)-for the periods fromJune 13, 2006 to February 28, 2007 (post-acquisition) and from March 1, 2006 toJune 12, 2006 (pre-acquisition) and for the fiscal years ended February 28,2006 and 2005 (pre-acquisition)

ConsolidatedStatements of Cash Flows-for the periods from June 13, 2006 to February 28,2007 (post-acquisition) and from March 1, 2006 to June 12, 2006(pre-acquisition) and for the fiscal years ended February 28, 2006 and 2005(pre-acquisition)

Notes to ConsolidatedFinancial Statements

Schedule II –Valuationand Qualifying Accounts of Cellu Tissue Holdings, Inc. is included in Item 15

All otherschedules for which provision is made in the applicable accounting regulationof the Securities and Exchange Commission are not required under the relatedinstructions or are inapplicable, and therefore have been omitted.

F-1

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Report of Independent Registered Public AccountingFirm

To the Board of Directors

Cellu TissueHoldings, Inc. and Subsidiaries

We have auditedthe accompanying consolidated balance sheets of Cellu Tissue Holdings, Inc. andSubsidiaries (the “Company”) as of February 28, 2007 and 2006, and the relatedconsolidated statements of operations, changes in stockholders’ equity(deficiency), and cash flows for the periods from June 13, 2006 to February 28,2007 (post-acquisition), March 1, 2006 to June 12, 2006 (pre-acquisition) andeach of two fiscal years in the period ended February 28, 2006(pre-acquisition). Our audits also include the financial statement schedulelisted in the Index at Item 15(a).  Thesefinancial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedule based on our audits.

We conducted ouraudits in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. We were not engaged to perform anaudit of the Company’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,the financial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Cellu Tissue Holdings, Inc.and Subsidiaries at February 28, 2007 and 2006, and the consolidated results oftheir operations and their cash flows for the periods from June 13, 2006 toFebruary 28, 2007 (post-acquisition), March 1, 2006 to June 12, 2006(pre-acquisition) and each of two fiscal years in the period ended February 28,2006 (pre-acquisition) 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, present fairly in all material respectsthe information set forth therein.

As discussed inNote 2 to the consolidated financial statements effective March 1, 2006, theCompany adopted the provisions of Statement of Financial Accounting StandardsNo. 123R, Share-Based Payment.
| /s/ Ernst & Young  |   |
|------------------------|--------|
|                   |   |
| Hartford,  Connecticut |
| April 27, 2007         |

 

F-2

----

Cellu TissueHoldings, Inc. and Subsidiaries

ConsolidatedBalance Sheets
| ** **                                                                                                                           | ** ** | **February 28** | ** **  | **February 28** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                                                                                                                           | ** ** | **2007**             | ** **  | **2006**             | ** ** |
| **Assets**                                                                                                                           |       |                 |        |                 |       |
| Current assets:                                                                                                                      |       |                 |        |                 |       |
| Cash and cash equivalents                                                                                                            |       | $                    | 16,260,601  |                 | $          | 22,824,062 |   |
| Receivables, net of allowance of $408,314 in 2007  and $300,314 in 2006                                                              |       | 34,140,844           |        | 35,054,372           |       |
| Inventories                                                                                                                          |       | 28,715,495           |        | 27,919,948           |       |
| Prepaid expenses and other current assets                                                                                            |       | 3,697,328            |        | 3,377,952            |       |
| Income tax receivable                                                                                                                |       | 329,861              |        | 362,122              |       |
| Deferred income taxes                                                                                                                |       | 6,498,098            |        | 2,931,599            |       |
| Total current  assets                                                                                                                |       | 89,642,227           |        | 92,470,055           |       |
|                                                                                                                                 |       |                 |        |                 |       |
| Property, plant  and equipment, net                                                                                                  |       | 228,851,765          |        | 98,090,451           |       |
| Debt issuance  costs                                                                                                                 |       | —               |        | 5,745,983            |       |
| Goodwill                                                                                                                             |       | —               |        | 13,723,935           |       |
| Trademarks                                                                                                                           |       | 6,550,314            |        | —               |       |
| Other assets                                                                                                                         |       | 224,438              |        | 201,690              |       |
| Total assets                                                                                                                         |       | $                    | 325,268,744 |                 | $          | 210,232,114 |   |
| **Liabilities  and stockholders’ equity (deficiency)**                                                                          |       |                 |        |                 |       |
| Current  liabilities:                                                                                                                |       |                 |        |                 |       |
| Accounts payable                                                                                                                     |       | $                    | 16,523,755  |                 | $          | 18,648,281 |   |
| Accrued expenses                                                                                                                     |       | 16,315,163           |        | 16,005,155           |       |
| Accrued interest                                                                                                                     |       | 7,226,753            |        | 7,231,888            |       |
| Current portion of long-term debt                                                                                                    |       | —               |        | 290,000              |       |
| Total current  liabilities                                                                                                           |       | 40,065,671           |        | 42,175,324           |       |
|                                                                                                                                 |       |                 |        |                 |       |
| Long-term debt,  less current portion                                                                                                |       | 160,355,507          |        | 160,790,258          |       |
| Deferred income  taxes                                                                                                               |       | 50,677,332           |        | 13,961,743           |       |
| Other  liabilities                                                                                                                   |       | 35,179,252           |        | 210,349              |       |
| Stockholders’  equity (deficiency):                                                                                             |       |                 |        |                 |       |
| Common stock, Class A, $.01 par value, 1,000 shares  authorized, 100 shares issued and outstanding as of February 28, 2007 and  2006 |       | 1                    |        | 1                    |       |
| Capital in excess of par value                                                                                                       |       | 46,259,101           |        | 615,338              |       |
| Accumulated deficit                                                                                                                  |       | (6,192,366           | )           | (11,625,759          | )          |
| Accumulated other comprehensive (loss) income                                                                                        |       | (1,075,754           | )           | 4,104,860            |       |
| Total  stockholders’ equity (deficiency)                                                                                        |       | 38,990,982           |        | (6,905,560           | )          |
| Total liabilities and  stockholders’ equity (deficiency)                                                                        |       | $                    | 325,268,744 |                 | $          | 210,232,114 |   |

 

*See accompanying notes toconsolidated financial statements.*

F-3

----

Cellu TissueHoldings, Inc. and Subsidiaries

ConsolidatedStatements of Operations
| ** **                                                 | ** ** | **For the Periods**                             | ** **  | **Year Ended February 28**             | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------|-------------|-------------------------------------------------------|------------|
| ** **                                                 | ** ** | **June 13, 2006-  February 28, 2007** | ** **  | **March 1,2006-   June 12, 2006** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                 | ** ** | **(Post-Acquisition)**                                    | ** **  | **(Pre-Acquisition)**                                 | ** ** |
|                                                       |       |                                                      |        |                                                  |       |   |   |   |   |
| Net sales                                                  |       | $                                                         | 241,236,592 |                                                  | $          | 94,241,932 |   | $ | 328,832,864 |   | $ | 332,893,044 |   |
| Cost of goods  sold                                        |       | 228,318,155                                               |        | 86,053,812                                            |       | 301,111,146 |   | 292,050,735 |   |
| Gross profit                                               |       | 12,918,437                                                |        | 8,188,120                                             |       | 27,721,718 |   | 40,842,309 |   |
| Selling, general  and administrative expenses              |       | 7,207,057                                                 |        | 4,661,285                                             |       | 12,872,052 |   | 14,550,489 |   |
| Restructuring  costs                                       |       | 240,218                                                   |        | —                                                |       | 1,050,363 |   | — |   |
| Merger-related  transaction costs                          |       | 142,079                                                   |        | 5,933,265                                             |       | 2,284,475 |   | — |   |
| Stock and  related compensation expense                    |       | 3,328,834                                                 |        | —                                                |       | — |   | 3,414,441 |   |
| Vesting of stock  option/restricted stock grants           |       | 497,105                                                   |        | 923,580                                               |       | 81,787 |   | 922,439 |   |
| Impairment of  fixed assets                                |       | 488,274                                                   |        | —                                                |       | — |   | — |   |
| Income (loss)  from operations                             |       | 1,014,870                                                 |        | (3,330,010                                            | )          | 11,433,041 |   | 21,954,940 |   |
| Write-off of  debt issuance costs and prepayment penalties |       | —                                                    |        | —                                                |       | — |   | (3,318,495 | ) |
| Interest  expense, net                                     |       | (11,468,975                                               | )           | (4,896,355                                            | )          | (17,076,757 | ) | (17,427,888 | ) |
| Foreign currency  gain (loss)                              |       | 359,236                                                   |        | (289,010                                              | )          | (503,262 | ) | (633,172 | ) |
| Other income                                               |       | 14,527                                                    |        | 27,049                                                |       | 2,492 |   | 2,446,965 |   |
| (Loss) income  before income tax benefit                   |       | (10,080,342                                               | )           | (8,488,326                                            | )          | (6,144,486 | ) | 3,022,350 |   |
| Income tax  benefit                                        |       | (3,887,976                                                | )           | (1,953,362                                            | )          | (3,575,132 | ) | (73,645 | ) |
| Net (loss) income                                          |       | $                                                         | (6,192,366  | )                                                     | $          | (6,534,964 | ) | $ | (2,569,354 | ) | $ | 3,095,995 |   |

 

*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)** | ** ** | **Unearned   Compensation** | ** ** | **Accumulated Other   Comprehensive   Income (Loss)** | ** ** | **Total Stockholders’   Equity (Deficiency)** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
|                                            |       |                                        |       |                                                            |       |                                             | ** ** |                             |       |                                                                      |       |                                                              |       |
|  Balance, February 28, 2004                |       | $                                           | 204        |                                                            | $          | 65,976,390                                       |       | $                                | 18,659,808 | ** **                                                                | $          | (388,888                                                          | )          | $ | 234,913 |   | $ | 84,482,427 |   |
| Accelerated vesting-stock options               |       |                                        |       | 533,551                                                         |       |                                             |       |                             |       |                                                                      |       | 533,551                                                           |       |
| Cash dividends                                  |       |                                        |       | (65,976,390                                                     | )          | (30,812,411                                      | )          |                             |       |                                                                      |       | (96,788,801                                                       | )          |
| Stock redemption                                |       | (93                                         | )          |                                                            |       | 93                                               |       |                             |       |                                                                      |       | —                                                            |       |
| Net income                                      |       |                                        |       |                                                            |       | 3,095,995                                        |       |                             |       |                                                                      |       | 3,095,995                                                         |       |
| Foreign currency translation                    |       |                                        |       |                                                            |       |                                             |       |                             |       | 702,150                                                                   |       | 702,150                                                           |       |
| Comprehensive income                            |       |                                        |       |                                                            |       |                                             |       |                             |       |                                                                      |       | 3,798,145                                                         |       |
| Reclassification                                |       | (110                                        | )          |                                                            |       | 110                                              |       |                             |       |                                                                      |       | —                                                            |       |
| Restricted stock vested                         |       |                                        |       |                                                            |       |                                             |       | 388,888                          |       |                                                                      |       | 388,888                                                           |       |
| 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 |   |

 

*See accompanying notes toconsolidated financial statements.*

F-5

----

CelluTissue Holdings, Inc. and Subsidiaries

ConsolidatedStatements of Cash Flows
| ** **                                                                                           | ** ** | **For the Periods**                             | ** ** | **Year Ended February 28**             | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **June 13, 2006-  February 28, 2007** | ** ** | **March 1,2006-   June 12, 2006** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                           | ** ** | **(Post-Acquisition)**                                    | ** ** | **(Pre-Acquisition)**                                 | ** ** |
| **Cash  flows from operating activities**                                                            | ** ** | ** **                                                | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (loss)  income                                                                                   |       | $                                                         | (6,192,366 | )                                                     | $          | (6,534,964 | ) | $ | (2,569,354 | ) | $ | 3,095,995 |   |
| Adjustments to  reconcile net (loss) income to net cash provided by (used in) operating  activities: |       |                                                      |       |                                                  |       |   |   |   |   |
| Noncash inventory charge                                                                             |       | 909,264                                                   |       | —                                                |       | — |   | — |   |
| Write-off of debt issuance costs-noncash                                                             |       | —                                                    |       | —                                                |       | — |   | 2,894,868 |   |
| Amortization of debt issuance costs                                                                  |       | —                                                    |       | 405,568                                               |       | 1,423,388 |   | 1,406,118 |   |
| Depreciation                                                                                         |       | 16,133,460                                                |       | 4,226,643                                             |       | 14,854,021 |   | 14,858,114 |   |
| Deferred income taxes                                                                                |       | (6,651,089                                                | )          | (396,024                                              | )          | (2,955,381 | ) | 1,431,369 |   |
| Accretion of debt discount                                                                           |       | 380,560                                                   |       | 85,471                                                |       | 299,970 |   | 290,108 |   |
| Stock-based compensation                                                                             |       | 497,105                                                   |       | 923,580                                               |       | 81,787 |   | 922,439 |   |
| Impairment of fixed assets                                                                           |       | 488,274                                                   |       | —                                                |       | — |   | — |   |
| Gain on disposal of equipment                                                                        |       | —                                                    |       | —                                                |       | (9,005 | ) | (2,364,621 | ) |
| Changes in operating assets and liabilities:                                                         |       |                                                      |       |                                                  |       |   |   |   |   |
| Receivables                                                                                          |       | 2,908,202                                                 |       | (1,994,674                                            | )          | 732,294 |   | 1,382,273 |   |
| Inventories                                                                                          |       | 1,413,120                                                 |       | (2,208,757                                            | )          | (3,318,880 | ) | 202,086 |   |
| Prepaid expenses and other current assets                                                            |       | 1,696,689                                                 |       | (683,329                                              | )          | 427,048 |   | (1,353,542 | ) |
| Other assets                                                                                         |       | (48,517                                                   | )          | (5,328                                                | )          | (11,470 | ) | (12,087 | ) |
| Income tax receivable                                                                                |       | —                                                    |       | —                                                |       | (362,122 | ) | 379,527 |   |
| Accounts payable, accrued expenses, accrued interest  and other liabilities                          |       | (1,395,251                                                | )          | (358,006                                              | )          | 7,470 |   | 9,102,618 |   |
| Total  adjustments                                                                                   |       | 16,331,817                                                |       | (4,856                                                | )          | 11,169,120 |   | 29,139,270 |   |
| Net cash provided by (used  in) operating activities                                                 |       | 10,139,451                                                |       | (6,539,820                                            | )          | 8,599,766 |   | 32,235,265 |   |
|                                                                                                      |            |                                                           |            |                                                       |            |  |  |  |  |  |  |  |  |

 

F-6

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| ** **                                                | ** ** | **For the Periods**                                   | ** ** | **Year Ended February 28**       | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                | ** ** | **June 13, 2006-   February 28, 2007** | ** ** | **March 1, 2006-  June 12,2006** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                | ** ** | **(Post-Acquisition)**                                          | ** ** | **(Pre-Acquisition)**                           | ** ** |
| **Cash flows  from investing activities**                 |       |                                                            |       |                                            |       |   |   |   |   |
| Equity  investment by Weston Presidio                     |       | 45,761,997                                                      |       | —                                          |       | — |   | — |   |
| Proceeds from  sale of property, plant and equipment, net |       | —                                                          |       | —                                          |       | — |   | 4,003,727 |   |
| Capital  expenditures                                     |       | (7,677,141                                                      | )          | (1,937,610                                      | )          | (13,050,166 | ) | (11,419,238 | ) |
| Net cash  provided by (used) in investing activities      |       | 38,084,856                                                      |       | (1,937,610                                      | )          | (13,050,166 | ) | (7,415,511 | ) |
| **Cash  flows from financing activities**                 |       |                                                            |       |                                            |       |   |   |   |   |
| Merger  consideration paid to former shareholders         |       | (45,761,997                                                     | )          | —                                          |       | — |   | — |   |
| Payments of  long-term debt                               |       | —                                                          |       | (290,000                                        | )          | (280,000 | ) | (43,863,541 | ) |
| Payments on  revolving credit facility, net               |       | —                                                          |       | —                                          |       | — |   | (10,953,999 | ) |
| Proceeds from  note offering                              |       | —                                                          |       | —                                          |       | — |   | 160,200,180 |   |
| Cash dividends                                            |       | —                                                          |       | —                                          |       | — |   | (96,788,801 | ) |
| Prepayment  penalties                                     |       | —                                                          |       | —                                          |       | — |   | (423,627 | ) |
| Debt refinancing  costs                                   |       | —                                                          |       | —                                          |       | (1,653 | ) | (6,733,087 | ) |
| Net cash (used  in) provided by financing activities      |       | (45,761,997                                                     | )          | (290,000                                        | )          | (281,653 | ) | 1,437,125 |   |
| Effect of  foreign currency                               |       | (620,553                                                        | )          | 362,212                                         |       | 597,086 |   | 702,150 |   |
| Net increase  (decrease) in cash and cash equivalents     |       | 1,841,757                                                       |       | (8,405,218                                      | )          | (4,134,967 | ) | 26,959,029 |   |
| Cash and cash  equivalents at beginning of period         |       | 14,418,844                                                      |       | 22,824,062                                      |       | 26,959,029 |   | — |   |
| Cash and cash  equivalents at end of period               |       | $                                                               | 16,260,601 |                                            | $          | 14,418,844 |   | $ | 22,824,062 |   | $ | 26,959,029 |   |
| **Supplemental  disclosure of cash flow information**     |       |                                                            |       |                                            |       |   |   |   |   |
| Cash paid during the year for Interest                    |       | $                                                               | 8,000,787  |                                            | $          | 8,000,000 |   | $ | 16,128,129 |   | $ | 8,976,482 |   |
| Cash paid during  the year for Income taxes               |       | $                                                               | 248,476    |                                            | $          | 20,804 |   | $ | 266,366 |   | $ | 834,721 |   |

 

F-7

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Cellu TissueHoldings, Inc. and Subsidiaries

Notes toConsolidated Financial Statements

February 28, 2007

**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-owned subsidiary ofCellu Paper Holdings, Inc. (the “Parent”), operates facilities in the UnitedStates and Canada. The Company manufactures specialty tissue paper for use inpersonal care products such as baby and adult diapers, incontinent products,surgical waddings and sanitary napkins and for use in fast food wrapping, giftwrapping and food service products. The Parent conducts no operatingactivities.

On June 12, 2006, theParent 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 merged withand into Parent, with the Parent surviving (the “Merger”).  Accordingly, the operating results and cashflows are presented in the accompanying financial statements on apre-acquisition (period from March 1, 2006 to June 12, 2006) andpost-acquisition (period from June 13, 2006 to February 28, 2007)) basis.

Beginning on June 13,2006, the Company accounted for the Merger as a purchase in accordance with theprovisions of Statement of Financial Accounting Standards No. 141 (“SFAS 141”),*Business Combinations*, which resulted ina new valuation for the assets and liabilities of the Company based upon fairvalues as of the date of the Merger.  Asallowed under SEC Staff Accounting Bulletin No. 54, *Push DownBasis of Accounting Required in Certain Limited Circumstances*(“PushDown Accounting”), 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, Cellu Parent’sownership basis is reflected in the Company’s consolidated financial statementsbeginning upon completion of the Merger. In order to apply Push Down Accounting, Cellu Parent’s purchase price of$207.8 million, including assumption of $162.0 million in aggregate principalamount of the Company’s outstanding 9.75% senior secured notes (the “Notes”),was allocated to the assets and liabilities based on their relative fairvalues.  The purchase price is subject toadjustment for certain tax benefits the Company may realize.  In addition, total consideration is subjectto adjustment 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 contingentpayments is unable to be made, then Weston Presidio has agreed to provide thenecessary funds to former holders of the Parent’s capital stock,

F-8

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options and warrantsthrough an equity investment in Parent or otherwise.  In accordance with SFAS 141, the $35.0million has been recognized as a liability and is recorded in other liabilitiesas of February 28, 2007.

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 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 |   |

Duringthe period from June 13, 2006 through February 28, 2007, the Company reflected$909,264 of excess purchase price allocated to inventory as a non-cash chargeto cost of goods sold and $5,428,800 of additional depreciation expense in costof goods sold as compared to the Company’s historical basis of accounting priorto the Merger.

The Company has estimatedthe fair value of its assets and liabilities as of the Merger, utilizinginformation available at the time the Company’s unaudited interim financialstatements subsequent to the Merger were prepared and these estimates aresubject to refinement until all pertinent information has been obtained.  At that time, the Company was in the processof obtaining outside third party appraisals of its intangible assets andfinalizing the allocation within property, plant and equipment categories.  In the fourth quarter of the current fiscalyear, the Company obtained a third party appraisal of its intangibleassets.  As a result thereof,identifiable intangible assets of $6.6 million have been recorded with acorresponding reduction in property, plant and equipment.

F-9

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**2. Summary of SignificantAccounting Policies**

**Principlesof Consolidation**

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

**Cash Equivalents**

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

**Revenue Recognition**

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 for estimatedsales returns and other allowances as a reduction of revenue at the time ofrevenue 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.

F-10

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**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.

**Maintenance and Repairs**

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

**Property, Plant and Equipment**

Property, plant andequipment are stated at cost. Depreciation of equipment and amortization ofleasehold improvements are computed using the straight-line method over theestimated useful lives of the related assets or the life of the lease term,whichever is shorter. The estimated useful lives of the principalclassifications of depreciable assets are as follows:
|                             | ** ** | **Life in Years** | ** ** |
|-----------------------------|------------|-----------------------------|------------|
|                        |       |                        |       |
| Buildings and  improvements |       | 20                          |       |
| Machinery and equipment     |       | 10                          |       |
| Furniture and  fixtures     |       | 5                           |       |
| Land  improvements          |       | 5                           |       |
| Computer software           |       | 3-5                         |       |

 

**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 2007, the Company made the decision to shut down itsmachine-glazed paper machine at its Interlake facility permanently (see Note15) and accordingly, has recorded an impairment charge of $488,274, which isreflected as a separate line item in the Company’s statements ofoperations.  The Company believes that asof February 28, 2007 there are no significant impairments of the carryingamounts of such assets and no reduction in their estimated useful life iswarranted.

F-11

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**DebtIssuance Costs**

Debt issuance costs areamortized over the term of the related debt agreement.

**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 exceeded its fair value, an impairment losswould be recognized to the extent the carrying amount of the reporting unit’sgoodwill exceeded its implied fair value. No goodwill impairments were recorded during the periods from March 1,2006 to June 12, 2006 (pre-acquisition) and for fiscal year 2006 or 2005.  The goodwill balance as of June 12, 2006 of$13,723,935 has been eliminated through the Merger purchase price allocation.

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 exceed their implied fair value. No trademark impairments were recorded during the period from June 13,2006 to February 28, 2007 (post-acquisition).

# **Stock-Based Compensation**

In December 2004, theFinancial 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. The Company adopted the provisions of SFAS 123R using the prospectivemethod effective March 1, 2006.  As such,there was no accounting effect on any awards outstanding at the date ofadoption.  At the time of adoption ofSFAS 123R, the Company had only one share-based payment arrangement, the CelluPaper Holdings, Inc. 2001 Stock Incentive Plan (the “Old Plan”), under whichthe Parent granted stock

F-12

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options to certainmembers of the Company’s management.  Inaccordance with the Old Plan, each option outstanding at the time of a changein control immediately vested and became exercisable.  Furthermore, in accordance with the terms ofthe Merger, all outstanding options were cancelled and automatically convertedinto the right to receive the per share merger consideration for anyin-the-money options.

On June 12, 2006, theBoard of Directors of Cellu Parent adopted the 2006 Stock Option and RestrictedStock Plan (the “Plan”).  Under the Plan,the Plan Administrator may make awards of options to purchase shares of commonstock of Cellu Parent and/or awards of restricted shares of common stock ofCellu Parent.  A maximum of 8,095 sharesof common stock of Cellu Parent may be delivered in satisfaction of awardsunder the Plan, determined net of shares of common stock withheld by CelluParent in payment of the exercise price of an award or in satisfaction of taxwithholding requirements.  Key employeesand directors of, and consultants and advisors to, Cellu Parent or its affiliateswho, in the opinion of the Plan Administrator, are in a position to make asignificant contribution to the success of Cellu Parent and its affiliates areeligible to participate in the Plan.  Stock options are granted at the fair market value of the Cellu Parent’sstock on the date of grant and have a 10-year term.  Generally, stock option grants vest ratablyover four years from the date of grant. The following describes how certain assumptions affecting the estimatedfair value of stock options are determined. The dividend yield is zero; the volatility is based on historical marketvalue of the Company’s stock; and the risk-free interest rate is based on U.S.Treasury securities with maturities equal to the expected life of theoption.  The Company uses historicalvalue to estimate exercise, termination and holding period behavior forvaluation purposes.  A summary of theoption activity as of February 28, 2007 and changes during the period from June13, 2006 to February 28, 2007 is as follows:
|                                 | ** ** | **Options** | ** ** | **Weighted   Average   Exercise Price** | ** ** | **Weighted   Average   Remaining   Contractual Life** | ** ** |
|---------------------------------|------------|-------------|------------|--------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| Outstanding,  June 13, 2006     |       | —      |       | $                                                      | —     |                                                                      | —     |   |
| Granted                         |       | 575         |       | $                                                      | 426.69     |                                                                      | 9.5 Years  |   |
| Outstanding,  February 28, 2007 |       | 575         |       | $                                                      | 426.69     |                                                                      | 9.5 Years  |   |
| Exercisable, February  28, 2007 |       | —      |       | $                                                      | —     |                                                                      | —     |   |

 

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; 22.5%volatility; 4.9% risk free interest rate; and 10-year expected life.  The weighted average fair value of stockoptions granted was $196.77 per share and the

F-13

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unrecognized total compensation cost as of February 28, 2007 related tononvested awards is $99,111**.**

On June 12, 2006, CelluParent entered into Restricted Stock Agreements with the Company’s ChiefExecutive Officer, Chief Operating Officer and Chief Financial Officer,pursuant to which Cellu Parent granted 3,778 restricted shares of its commonstock to the Chief Executive Officer and 1,349 restricted shares of its commonstock to each of the other two named individuals pursuant to the Plan.  The shares will vest and cease to berestricted in four equal annual installments commencing on June 12, 2007, aslong as the named individual, as the case may be, is continuously employed bythe Company until each such vesting date with respect to his or hershares.  Any restricted stock outstandingat the time of a Covered Transaction (as defined in the Plan) shall becomevested and cease to be restricted stock at that time.  Additionally, the Parent has agreed to pay anadditional amount to the named individuals, as the case may be, to fully grossup him or her as applicable, for the amount included in gross income for incometax purposes as a result of making a Section 83(b) election under the InternalRevenue Code of 1986, as amended, or the payment of any gross-up amountpayment.  All named individuals have madea timely Section 83(b) election and the Company has made the gross-up amountpayment for two of the named individuals.

For the period from June13, 2006 to February 28, 2007, the Company has recorded $489,661 ofcompensation expense related to the vesting of the above grants in accordancewith SFAS 123R.  Immediately prior toconsummation of the Merger, there were 341.3 restricted shares of Parent’scommon stock.  In accordance with theterms 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 expenserelated to the vesting of the above restricted stock in accordance with SFAS123R.

In connection with theCompany’s debt transaction (Note 6), the Company accelerated vesting of allunvested employee stock options at that time. The Company has estimated and recognized $81,787 and $533,551 ofcompensation expense in the fiscal year ended February 28, 2006 and 2005,respectively, associated with employees that actually benefited from the acceleratedvesting of the stock options.  Noadditional expense needed to be recognized after March 2006 as the originalvesting period associated with the options had expired.

**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

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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 are recorded in the statement of operations in the currentperiod.  As the hedges were highlyeffective for the periods from March 1, 2006 to June 12, 2006 and from June 13,2006 to February 28, 2007, the Company experienced minimal impact to operatingresults.  The effective portion of thehedges is recorded in accumulated comprehensive income.

**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 the fiscal year ended February 28, 2006 isa one-time adjustment of $2.6 million to correct the cumulative effect ofimproperly translating the value of property, plant and equipment.  Historically, the translation of these assetsfrom Canadian dollars to U.S. dollars had been occurring at historical rates,as opposed to actual month-end rates, as required under SFAS 52, “*Foreign Currency Translation.”*

**Concentrations**

For the period from June13, 2006 to February 28, 2007 no customer comprised more than 10% ofsales.  For the period March 1, 2006 toJune 12, 2006, fiscal year 2006 and 2005, one customer comprised 10.3%, 12.3%and 17.6%, respectively of sales. These sales were in the Company’s tissuesegment for the period from March 1, 2006 to June 12, 2006 and for fiscal year2006 and 2005.

### **LaborConcentration**

At February 28, 2007,approximately****72% of the Company’s activefull-time employees were represented by either the United Steel, Paper andForestry, Rubber, Manufacturing, Energy, Allied-Industrial and Service WorkersInternational Union (“USW”) or Independent Paper Workers of Canada throughvarious collective bargaining agreements that expire between August 2008 andFebruary 2010.   In July 2005, the USWwas elected to represent 84 hourly employees at our Mississippi facility, andwas certified by the National Labor Relations Board as

F-15

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the exclusive collectivebargaining representative of such employees. The Company is currently in the process of negotiating a collectivebargaining agreement with USW.

### **Shippingand Handing 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 $6,175,268,$2,501,880, $8,530,418 and $7,254,504 for the period from June 13, 2006 toFebruary 28, 2007, March 1, 2006 to June 12, 2006 and for the years endedFebruary 28, 2006 and 2005, respectively.

**Considerations Paid to Resellers**

TheCompany recognizes consideration paid to a reseller of its products as a reductionof the selling price of its products sold and therefore, reduces net sales inthe 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.

**Reclassifications**

Certain prior yearamounts have been reclassified to conform to the current fiscal year 2007presentation.

F-16

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# **New Accounting Standards**

In June 2006, the FASBissued FASB Interpretation No. 48 (“FIN 48”), *Accountingfor Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)*.The provisions of FIN 48 are effective for fiscal years beginning after December15, 2006. This statement was issued to clarify the accounting for theuncertainty related to income taxes. FIN 48 requires the evaluation of whethera tax position is more likely than not to be sustained upon examination withthe assumption that the position will be examined by the relevant taxauthorities.  FIN 48 also requires suchtax positions to be measured at the largest amount of the respective benefitthat is greater than 50% likely of being realized upon ultimate settlement. TheCompany is currently assessing the impact that the adoption of FIN 48 will haveon its results of operations and financial position.

In September 2006, theFASB issued FAS No. 157,”*Fair Value Measurements*”(“SFAS 157”).  SFAS 157 is effective forfinancial statements issued for fiscal years beginning after November 15, 2007,as well as, interim periods within such fiscal years.  SFAS 157 provides a common fair valuehierarchy for companies to follow in determining fair value measurements in thepreparation of financial statements and expands disclosure requirementsrelating to how such fair value measurements were developed.  SFAS 157 clarifies the principle that fairvalue should be based on the assumptions that the marketplace would use whenpricing an asset or liability, rather than company specific data.  The Company is currently assessing the impactthat SFAS will have on its results of operations and financial position.

**3. Inventories**

Components of inventoriesare as follows:
|                                   | ** ** | **February 28** | ** ** | **February 28** | ** ** |
|-----------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                        | ** ** | **2007**             | ** ** | **2006**             | ** ** |
|                              | ** ** | ** **           |       |                 |       |
| Finished goods                    |       | $                    | 18,896,790 |                 | $          | 18,072,976 |   |
| Raw materials                     |       | 2,742,025            |       | 2,624,006            |       |
| Packaging materials and  supplies |       | 7,210,268            |       | 7,446,184            |       |
|                              |       | 28,849,083           |       | 28,143,166           |       |
|                              |       |                 |       |                 |       |
| Reserve for  obsolescence         |       | (133,588             | )          | (223,218             | )          |
|                              |       | $                    | 28,715,495 |                 | $          | 27,919,948 |   |

 

F-17

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**4. Property, Plant and Equipment**

Property, plant andequipment consist of the following:
|                                 | ** ** | **February 28** | ** **  | **February 28** | ** ** |
|---------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                      | ** ** | **2007**             | ** **  | **2006**             | ** ** |
| Land and improvements           |       | $                    | 4,129,581   |                 | $          | 7,272,169 |   |
| Buildings and  improvements     |       | 22,464,389           |        | 33,028,237           |       |
| Machinery and equipment         |       | 212,598,587          |        | 146,515,139          |       |
| Furniture and fixtures          |       | 37,610               |        | 511,482              |       |
| Computer hardware and  software |       | 2,892,082            |        | 3,989,097            |       |
| Construction-in-progress        |       | 2,862,976            |        | 12,952,381           |       |
|                            |       | 244,985,225          |        | 204,268,505          |       |
| Less accumulated  depreciation  |       | (16,133,460          | )           | (106,178,054         | )          |
|                            |       | $                    | 228,851,765 |                 | $          | 98,090,451 |   |

 

**5. Debt Issuance Costs**

Debt issuance costsconsist of the following:

|                                | ** ** | **February 28** | ** ** |
|--------------------------------|------------|----------------------|------------|
| ** **                     | ** ** | **2006**             | ** ** |
|                           |       |                 |       |
| Debt issuance costs            |       | $                    | 8,541,986  |   |
| Less accumulated  amortization |       | (2,796,003           | )          |
|                           |       | $                    | 5,745,983  |   |

 

Amortization expense for the period from March 1, 2006 to June 12, 2006and for the fiscal years 2006 and 2005 of $405,568, $1,423,388 and $1,406,118,respectively, has been included in interest expense on the respectivestatements of operations.  Theunamortized debt issuance costs as of June 12, 2006 of $5,340,415 have beeneliminated through the Merger purchase price allocation and the fair valueassigned to the Company’s debt.  Accordingly,there are no debt issuance costs as of February 28, 2007.

F-18

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**6. Long-Term Debt**

Long-term debt consistsof the following:
|                                                                                                                  | ** ** | **February 28** | ** **  | **February 28** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                                                                                                       | ** ** | **2007**             | ** **  | **2006**             | ** ** |
| Senior secured 9 3¤4  % notes due 2010                                                                      |       | $                    | 162,000,000 |                 | $          | 162,000,000 |   |
| Less discount                                                                                                    |       | (1,644,493           | )           | (1,209,742           | )          |
|                                                                                                             |       | 160,355,507          |        | 160,790,258          |       |
| Industrial revenue bond  payable, in annual installments, plus interest ranging from 4.8% to 6.65%,  due in 2006 |       | —               |        | 290,000              |       |
|                                                                                                             |       | 160,355,507          |        | 161,080,258          |       |
|                                                                                                             |       |                 |        |                 |       |
| Less current portion of  debt                                                                                    |       | —               |        | (290,000             | )          |
|                                                                                                             |       | $                    | 160,355,507 |                 | $          | 160,790,258 |   |

 

In March 2004, theCompany completed a private offering of $162.0 million aggregate principalamount of 9 3⁄4% senior secured notes due 2010 (the “Notes”).  The Company raised $152.2 million, net ofdebt issuance costs of $8.0 million and original issuance discount of $1.8million.  At the same time, the Companyentered into a new $30.0 million revolving working capital facility with CITGroup/Business Credit Inc.  A portion ofthe proceeds, along with a drawdown from the working capital facility, wereused to pay off existing debt of approximately $56.0 million.  Furthermore, the Company used an aggregate$100.2 million of the proceeds to fund a stockholder dividend to Parent torepurchase a portion of its common stock and warrants ($96.8 million) andcompensation from the redemption of stock options ($3.4 million).  As a result of the extinguishment of debt,approximately $2.9 million of debt issuance costs previously capitalized werewritten off and the Company incurred approximately $.4 million in prepaymentpenalties.  The total amount of $3.3million is reflected in write-off of debt issuance costs and prepaymentpenalties on the fiscal year 2005 income statement.

The Notes mature on March15, 2010 and require semi-annual interest payments on March 15 and September15, which commenced on September 15, 2004. The Notes are collateralized by a senior secured interest insubstantially all of the Company’s assets. Terms of the indenture under which the Notes have been issued containcertain covenants, including limitations on certain restricted payments and theincurrence of additional indebtedness. The Notes are unconditionally guaranteed by all of the Company’ssubsidiaries.

F-19

----

In connection with theMerger, the Company solicited consents with respect to the Notes. Consents werereceived with respect to 100% of the aggregate outstanding principal amount ofthe Notes. The Company accepted all of the consents delivered in the consentsolicitation and paid to the consenting noteholders a consent fee of $40 per$1,000 principal amount of Notes for which they delivered consents.  These payments were made in the Company’ssecond quarter of the fiscal year ended February 28, 2007.  These payments, along with other transactioncosts totaling $5.9 million, are reflected as merger-related transaction costson the statement of operations for the period March 1, 2006 through June 12,2006.  The Company incurred an additional$.1 million in merger-related transaction costs for the period June 13, 2006 toFebruary 28, 2007.   As a result of theacceptance by the Company of the consents delivered by noteholders and thecompletion of the consent solicitation, the amendments to the indenturegoverning the Notes described in the Consent Solicitation Statement dated May9, 2006 and related Supplement dated May 24, 2006 have become operative and theCompany was not required to make a change of control offer to purchase anyNotes in connection with the Merger.

The Company entered intoa Credit Agreement, dated as of June 12, 2006 (the “Credit Agreement”), amongthe Company, as U.S. Borrower, Interlake Acquisition Corporation Limited, asubsidiary of the Company, as Canadian Borrower, Parent, the other loanguarantors party thereto, JPMorgan Chase Bank, N.A., as U.S. AdministrativeAgent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian AdministrativeAgent, and the other lenders party thereto. The Credit Agreement provides for a $35.0 million working capital facility,including a letter of credit sub-facility and swing-line loan sub-facility. TheCredit Agreement provides that amounts under the facility may be borrowed,repaid and re-borrowed, subject to a borrowing base test, until the maturitydate, which is June 12, 2011. An amount equal to $32.0 million is available, inU.S. dollars, to the U.S. Borrower under the facility, and an amount equal to$3.0 million is available, in U.S. or Canadian dollars, to the CanadianBorrower under the facility.  As ofFebruary 28, 2007, there were no outstanding borrowings under the workingcapital facility.

**7. Stockholders’ Equity(Deficiency)**

The equity as of February28, 2007 is reflective of the equity invested in the Company relative to theMerger offset by the net loss generated for the period June 13, 2007 toFebruary 28, 2007 and other equity activity for this period.

The Company usedapproximately $96.8 million of the proceeds from the issuance of the Notes tofund a stockholder dividend to the Parent to purchase shares of the Parent’scommon stock and warrants.  Approximately$66.0 million was charged to capital in excess of par value and the remaining$30.8 million was charged to accumulated earnings, resulting in a deficiency asof February 28, 2006.

F-20

----

**8.  Gain on Sale of Equipment**

In July 2004, the Companysold a previously idled paper machine at its Menominee mill and recorded a gainon the sale of $2.4 million, which is included in other income on the 2005income statement.  The net proceeds fromthe sale were $4.0 million (gross proceeds of $5.2 million less brokerage feesand other direct costs of $1.2 million). All monies were received in fiscal year 2005.

**9. Income Taxes**

The provision for incometaxes (benefit) consisted of the following:
| ** **          | ** ** | **For the Periods**                             | ** ** | **Year Ended February 28**             | ** ** |
|---------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **          | ** ** | **June 13, 2006-  February 28, 2007** | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(Post-Acquisition)**                                    | ** ** | **(Pre-Acquisition)**                                 | ** ** |
| Current:            |       |                                                      |       |                                                  |       |   |   |   |   |
| Federal             |       | $                                                         | 1,398,110  |                                                  | $          | (1,509,493 | ) | $ | (1,029,216 | ) | $ | (1,881,077 | ) |
| State               |       | 27,750                                                    |       | 9,250                                                 |       | 177,000 |   | 423,000 |   |
| Foreign             |       | 1,337,253                                                 |       | (57,095                                               | )          | 232,465 |   | (46,937 | ) |
|                |       | 2,763,113                                                 |       | (1,557,338                                            | )          | (619,751 | ) | (1,505,014 | ) |
|                |       |                                                      |       |                                                  |       |   |   |   |   |
| Deferred:           |       |                                                      |       |                                                  |       |   |   |   |   |
| Federal             |       | (5,645,456                                                | )          | (404,831                                              | )          | (2,569,061 | ) | 1,434,269 |   |
| State               |       | (362,209                                                  | )          | (14,288                                               | )          | (387,963 | ) | 111,890 |   |
| Foreign             |       | (643,424                                                  | )          | 23,095                                                |       | 36,459 |   | 903,351 |   |
|                |       | (6,651,089                                                | )          | (396,024                                              | )          | (2,920,565 | ) | 2,449,510 |   |
|                |       |                                                      |       |                                                  |       |   |   |   |   |
| Valuation allowance |       | —                                                    |       | —                                                |       | (34,816 | ) | (1,018,141 | ) |
|                |       | $                                                         | (3,887,976 | )                                                     | $          | (1,953,362 | ) | $ | (3,575,132 | ) | $ | (73,645 | ) |

 

The foreign portion ofthe provision for income taxes is a result of operations at one of the Company’ssubsidiaries, Interlake Acquisition Corporation Limited, in Canada.  The Company provides tax on foreign earningsthat are remitted or deemed to be remitted.

F-21

----

The reconciliation ofincome tax benefit on (loss) income at the U.S. federal statutory tax rates tothe effective income tax rates is as follows:
| ** **                           | ** ** | **For the Periods**                       | ** ** | **Year Ended February 28**             | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **June 13, 2006-  February 28,2007** | ** ** | **March 1, 2006-  June 12, 2006** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(Post-Acquisition)**                              | ** ** | **(Pre-Acquisition)**                                 | ** ** |
|                                 |       |                                                |       |                                                  |       |   |   |   |   |
| Tax at US statutory  rate            |       | $                                                   | (4,114,274 | )                                                     | $          | (2,852,705 | ) | $ | (2,089,125 | ) | $ | 1,027,599 |   |
| Tax at foreign  statutory rate       |       | 707,163                                             |       | (34,306                                               | )          |   |   |   |   |
| State taxes, net of  federal benefit |       | (377,954                                            | )          | 24,994                                                |       | (210,963 | ) | 279,180 |   |
| Foreign non-deductible  expense      |       | 525                                                 |       | 175                                                   |       | 680 |   | 588,200 |   |
| Non-deductible employee  expense     |       | —                                              |       | —                                                |       | — |   | 181,407 |   |
| U.S. non-deductible  items           |       | 2,060                                               |       | 908,480                                               |       | 38,643 |   | 22,733 |   |
| Change in valuation  allowance       |       | —                                              |       | —                                                |       | (34,816 | ) | (1,018,141 | ) |
| Provision to return  changes         |       | —                                              |       | —                                                |       | (1,215,247 | ) | (214,386 | ) |
| Canadian withholding  tax            |       | —                                              |       | —                                                |       | 136,917 |   | — |   |
| Amended return changes               |       | —                                              |       | —                                                |       | — |   | (323,814 | ) |
| Net operating loss                   |       | —                                              |       | —                                                |       | — |   | (308,473 | ) |
| Alternative minimum tax              |       | —                                              |       | —                                                |       | — |   | (240,000 | ) |
| Other                                |       | (105,496                                            | )          | —                                                |       | (201,221 | ) | (67,950 | ) |
| Income tax benefit                   |       | $                                                   | (3,887,976 | )                                                     | $          | (1,953,362 | ) | $ | (3,575,132 | ) | $ | (73,645 | ) |

 

The reduction inthe valuation allowance during fiscal year 2006 and fiscal year 2005 relates tothe utilization of Canadian NOLs, as the subsidiary was profitable in fiscalyear 2006 and fiscal year 2005.

The components ofpretax (loss) income consist of the following:
| ** **                 | ** ** | **For the Periods**   | ** **  | **Year Ended February 28** | ** ** |
|----------------------------|------------|---------------------------------|-------------|-------------------------------------------|------------|
| ** **                 | ** ** | **June 13, 2006-**    | ** **  | **March 1, 2006-**              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **February 28, 2007** | ** **  | **June 12, 2006**               | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **(Post-Acquisition)**          | ** **  | **(Pre-Acquisition)**                     | ** ** |
| United States              |       | $                               | (12,100,807 | )                                         | $          | (8,390,310 | ) | $ | (6,349,474 | ) | $ | 2,107,142 |   |
| Foreign                    |       | 2,020,465                       |        | (98,016                                   | )          | 204,988 |   | 915,208 |   |
| Total pretax (loss) income |       | $                               | (10,080,342 | )                                         | $          | (8,488,326 | ) | $ | (6,144,486 | ) | $ | 3,022,350 |   |

 

F-22

----

Significant components ofthe Company’s deferred tax assets and liabilities are as follows:
|                                 | ** ** | **February 28** | ** **  | **February 28** | ** ** |
|---------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                      | ** ** | **2007**             | ** **  | **2006**             | ** ** |
|                            |       |                 |        |                 |       |
| Deferred tax assets:            | ** ** | ** **           |        |                 |       |
| Compensation and  benefits      |       | $                    | 565,512     |                 | $          | 580,566 |   |
| NOL carryforward                |       | 5,574,218            |        | 2,024,343            |       |
| Accounts  receivable            |       | 189,630              |        | 119,945              |       |
| Contingent  consideration       |       | 13,979,000           |        | —               |       |
| Refinancing  costs              |       | 2,199,924            |        | —               |       |
| Other                           |       | 253,710              |        | 850,569              |       |
| Total deferred tax  assets      |       | 22,761,994           |        | 3,575,423            |       |
|                            |       |                 |        |                 |       |
| Deferred tax  liabilities:      |       |                 |        |                 |       |
| Goodwill                        |       | —               |        | (812,525             | )          |
| Restricted stock                |       | (908,299             | )           | —               |       |
| Property, plant  and equipment  |       | (65,826,158          | )           | (13,705,430          | )          |
| Other                           |       | (206,771             | )           | (87,612              | )          |
| Total deferred tax  liabilities |       | (66,941,228          | )           | (14,605,567          | )          |
|                            |       |                 |        |                 |       |
| Valuation allowance             |       | —               |        | —               |       |
| Net deferred tax liability      |       | $                    | (44,179,234 | )                    | $          | (11,030,144 | ) |

 

Deferred income taxes areincluded in the balance sheets as follows:
|                                             | ** ** | **February 28** | ** **  | **February 28** | ** ** |
|---------------------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                                  | ** ** | **2007**             | ** **  | **2006**             | ** ** |
| Current deferred  income tax assets         |       | $                    | 6,498,098   |                 | $          | 2,931,599 |   |
| Noncurrent  deferred income tax liabilities |       | (50,677,332          | )           | (13,961,743          | )          |
|                                        |       | $                    | (44,179,234 | )                    | $          | (11,030,144 | ) |

 

F-23

----

The temporary differencesthat give rise to significant portions of the deferred tax assets and deferredtax liabilities are net operating loss carryforwards, differences between financialstatement and tax bases of property, plant and equipment, the allowance fordoubtful accounts and other miscellaneous reserves.

As of February 28, 2007,the Company had federal NOLs of approximately $14,245,000**,**which begin to expire in****2021****and state net NOLs of approximately $12,305,000, whichbegin to expire in 2019.

**10. Retirement Plan**

The Company has a SavingsIncentive and Profit-Sharing Plan (the “Plan”) qualified under Section 401(k)of the Internal Revenue Code. The Plan covers all employees who are 21 years ofage or older with one or more years of service. Employees may contribute up to20% of their annual compensation (subject to certain statutory limitations) tothe Plan through voluntary salary deferred payments. The Company matches 100% ofthe employees’ contribution up to 2% of the employees’ salary and 70% of theremaining employees’ contribution up to 6% of the employees’ salary. TheCompany contributed $1,096,118, $471,808, $1,782,923 and $1,400,740 to the Planfor the period from June 13, 2006 to February 28, 2007, March 1, 2006 to June12, 2006 and for the years ended February 28, 2006 and 2005, respectively.

**11. Commitments and Contingencies**

The Company leasescertain warehouses, vehicles and equipment under noncancelable operating leases,which expire at varying times through February 2011**.**Future minimum lease obligations at February 28, 2007 are as follows:

| Year ending: | ** ** | ** ** | ** ** |
|--------------|------------|------------|------------|
| 2008         |       | $          | 2,357,202  |   |
| 2009         |       | 1,992,889  |       |
| 2010         |       | 1,497,184  |       |
| 2011         |       | 138,582    |       |
|         |       | $          | 5,985,857  |   |

 

F-24

----

Operating lease andrental expenses aggregated $1,918,784, $764,573, $3,160,316 and $3,111,791 forthe period from June 13, 2006 to February 28, 2007, March 1, 2006 to June 12,2006 and for the years ended February 28, 2006 and 2005, respectively.

In the normal course ofbusiness, the Company is involved in various claims. The Company’s policy is to accrue environmental investigatory andremediation costs for identified sites when it is probable that a liability hasbeen incurred and the amount of the loss can be reasonably estimated. Theamount recorded for identified contingent liabilities is based onestimates and is not material.

The Company enters intoagreements with various pulp vendors to purchase various amounts of pulp overthe next two to three years.  Thesecommitments require purchases of pulp up to approximately 114,000 metric tonsper year, at pulp prices below published list prices and allow the Company toshift a portion of its pulp purchases to the spot market to take advantage ofmore favorable spot market prices when such prices fall. The Company believesthat its current commitment under these arrangements or their equivalentapproximates****70% of its annual budgeted pulpneeds.  The future purchase value of thecontracts, valued at the February 28, 2007 price, is $190,611,400.

**12. Related Party Transactions**

On June 12, 2006, theCompany, Cellu Parent, and Merger Sub entered into a Management Agreement withWeston Presidio Service Company, LLC (“Weston Presidio Service Company”), pursuantto which Weston Presidio Service Company has agreed to provide the Company withcertain management, consulting and financial and other advisory services.  Weston Presidio Service Company is anaffiliate of Weston Presidio, which is the controlling shareholder of CelluParent, which is the sole shareholder of 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 equal quarterlyinstallments, and to reimburse out-of-pocket expenses of Weston PresidioService Company and its affiliates.  Inaddition, in connection with the consummation of the Merger and as required bythe Management Agreement, the Company paid Weston Presidio Service Company afee in the amount of $2,000,000.  Thisamount has been capitalized through purchase accounting as part of total mergerconsideration.  The Management Agreementexpires on June 12, 2016, but will be automatically extended on each anniversaryof such date for an additional year, unless one of the parties provides writtennotice of its desire not to automatically extend the term at least 90 daysprior to such anniversary.

F-25

----

Management fees paid toWeston Presidio Service Company of $302,812 for the period June 13, 2006 toFebruary 28, 2007 are reflected in selling, general and administrativeexpenses.

Management fees andout-of-pocket expenses paid to Charterhouse Group International, Inc. (“Charterhouse”)(the former majority stockholder of the Parent) of $153,482, $450,768 and$456,239 for the period March 1, 2006 to June 12, 2006 and in fiscal years 2006and 2005, respectively, are reflected in selling, general and administrativeexpenses.

**13. Business Segments**

TheCompany operates in two reportable business segments: tissue and machine-glazedpaper. The Company assesses the performance of its reportable business segmentsusing income from operations. Income from operations excludes interest income,interest expense, income tax expense (benefit), write-off of debt issuancecosts and prepayment penalties, the impact of foreign currency gains and lossesand gain on sale of equipment. A portion of corporate and shared expenses isallocated to each segment. Included in loss from operations for the period June13, 2006 to February 28, 2007 is $142,079 of merger-related transaction costs,$240,218 of restructuring costs, $909,264 for a non-cash charge to cost ofgoods sold related to excess purchase price allocated to inventory and$5,428,800 of additional depreciation expense related to excess price allocatedto property, plant and equipment.  Ofthese amounts, $92,351, $156,142, $591,022 and $3,528,720, respectively,impacts the tissue segment and $49,728, $84,076, $318,242 and $1,900,080,respectively impacts the machine-glazed paper segment.  Included in loss from operations for theperiod March 1, 2006 to June 12, 2006 is $5,933,265 of merger-relatedtransaction costs.  Of this amount,$3,856,622 impacts the tissue segment and $2,076,643 impacts the machine-glazedpaper segment.  Also, included in lossfrom operations for the periods June 13, 2006 to February 28, 2007 arecompensation charges of $3,825,919 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 these amounts, $1,640,583 and $846,264, respectively, impact thetissue segment and $883,391 and $455,681, respectively, impact themachine-glazed paper segment.  Also,included in loss from operations for the period March 1, 2006 to June 12, 2006are compensation charges of $923,580 related to restricted stock grants priorto the Merger that vested immediately upon the Merger and normal vestingrelated to restricted stock grants made after the Merger.  Of this amount, $323,253 impacts themachine-glazed paper segment and $600,327 impacts the tissue segment.   Included in fiscal year 2006 incomefrom operations is $1,050,363 related to restructuring activities.  Of this amount, $774,187 impacts themachine-glazed paper segment and $276,176 impacts the tissue segment.  Also included in fiscal year 2006 income fromoperations is $2,284,475 million of terminated merger-related transactioncosts.  Of this amount, $799,567 impactsthe machine-glazed paper segment and $1,484,908 impacts the tissue segment.

F-26

----

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 anddebt issuance costs.
| ** **                                                 | ** ** | **For the Periods**   | ** **  | **Year Ended February 28** | ** ** |
|------------------------------------------------------------|------------|---------------------------------|-------------|-------------------------------------------|------------|
| ** **                                                 | ** ** | **June 13, 2006-**    | ** **  | **March 1, 2006-**              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **February 28, 2007** | ** **  | **June 12, 2006**               | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                 | ** ** | **(Post-Acquisition)**          | ** **  | **(Pre-Acquisition)**                     | ** ** |
| **Net Sales**                                              | ** ** | ** **                      |        |                                      |       |   |   |   |   |
| Tissue                                                     |       | $                               | 170,310,446 |                                      | $          | 67,199,611 |   | $ | 232,864,518 |   | $ | 230,369,609 |   |
| Machine-glazed paper                                       |       | 70,926,146                      |        | 27,042,321                                |       | 95,968,346 |   | 102,523,435 |   |
| Consolidated                                               |       | $                               | 241,236,592 |                                      | $          | 94,241,932 |   | $ | 328,832,864 |   | $ | 332,893,044 |   |
| **Income (Loss) from Operations**                          |       |                            |        |                                      |       |   |   |   |   |
| Tissue                                                     |       | $                               | 2,165,197   |                                      | $          | (1,210,487 | ) | $ | 8,372,803 |   | $ | 14,656,409 |   |
| Machine-glazed paper                                       |       | (1,150,327                      | )           | (2,119,523                                | )          | 3,060,238 |   | 7,298,531 |   |
| Consolidated                                               |       | 1,014,870                       |        | (3,330,010                                | )          | 11,433,041 |   | 21,954,940 |   |
| Write-off of debt  issuance costs and prepayment penalties |       | —                          |        | —                                    |       | — |   | (3,318,495 | ) |
| Interest expense, net                                      |       | (11,468,975                     | )           | (4,896,355                                | )          | (17,076,757 | ) | (17,427,888 | ) |
| Net foreign currency  transaction gain (loss)              |       | 359,236                         |        | (289,010                                  | )          | (503,262 | ) | (633,172 | ) |
| Other income                                               |       | 14,527                          |        | 27,049                                    |       | 2,492 |   | 2,446,965 |   |
| Pretax (loss) income                                       |       | $                               | (10,080,342 | )                                         | $          | (8,488,326 | ) | $ | (6,144,486 | ) | $ | 3,022,350 |   |
| ** **                                                 | ** ** | ** **                      |        |                                      |       |   |   |   |   |
| **Capital Expenditures**                                   | ** ** |                            |        |                                      |       |   |   |   |   |
| Tissue                                                     | ** ** | $                               | 6,079,263   |                                      | $          | 1,355,009 |   | $ | 11,770,818 |   | $ | 9,778,871 |   |
| Machine-glazed paper                                       |       | 1,597,878                       |        | 582,601                                   |       | 1,279,348 |   | 1,640,367 |   |
| Consolidated                                               |       | $                               | 7,677,141   |                                      | $          | 1,937,610 |   | $ | 13,050,166 |   | $ | 11,419,238 |   |
|                                                       | ** ** |                            |        |                                      |       |   |   |   |   |
| **Depreciation**                                           | ** ** |                            |        |                                      |       |   |   |   |   |
| Tissue                                                     | ** ** | $                               | 11,186,520  |                                      | $          | 2,981,837 |   | $ | 9,686,799 |   | $ | 8,769,253 |   |
| Machine-glazed paper                                       |       | 4,621,292                       |        | 1,129,705                                 |       | 4,757,120 |   | 5,453,927 |   |
| Corporate                                                  |       | 325,648                         |        | 115,101                                   |       | 410,102 |   | 634,934 |   |
| Consolidated                                               | ** ** | $                               | 16,133,460  |                                      | $          | 4,226,643 |   | $ | 14,854,021 |   | $ | 14,858,114 |   |

 

F-27

----

 
|                       | ** ** | **February 28** | ** **  | **February 28** | ** ** |
|-----------------------|------------|----------------------|-------------|----------------------|------------|
| ** **            | ** ** | **2007**             | ** **  | **2006**             | ** ** |
| **Segment  assets**   | ** ** | ** **           |        |                 |       |
| Tissue                |       | $                    | 214,039,270 |                 | $          | 132,161,765 |   |
| Machine-glazed  paper |       | 79,277,799           |        | 50,420,559           |       |
| Corporate assets      |       | 31,951,675           |        | 27,649,790           |       |
| Consolidated          |       | $                    | 325,268,744 |                 | $          | 210,232,114 |   |
|                  |       |                 |        |                 |       |
| **Goodwill**          |       |                 |        |                 |       |
| Tissue                | ** ** | ** **           |        | $                    | 9,021,495  |   |
| Machine-glazed  paper |       |                 |        | 4,702,440            |       |
| Consolidated          | ** ** | ** **           |        | $                    | 13,723,935 |   |

 

**14. Geographic Data**

Netsales and long-lived assets by geographic area are as follows:
|                  | ** ** | **For the Periods**   | ** **  | **Year Ended February 28** | ** ** |
|------------------|------------|---------------------------------|-------------|-------------------------------------------|------------|
| ** **       | ** ** | **June 13, 2006-**    | ** **  | **March 1, 2006-**              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **       | ** ** | **February 28, 2007** | ** **  | **June 12, 2006**               | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **       | ** ** | **(Post-Acquisition)**          | ** **  | ** **                                | ** ** | **(Pre-Acquisition)** | ** ** | ** ** | ** ** |
|             |       |                            |        |                                      |       |   |   |   |   |
| **Net Sales**    |       |                            |        |                                      |       |   |   |   |   |
| United States    |       | $                               | 208,880,170 |                                      | $          | 80,395,283 |   | $ | 284,737,873 |   | $ | 286,721,458 |   |
| Other            |       | 42,990,743                      |        | 17,787,863                                |       | 58,461,671 |   | 58,079,541 |   |
| Sub-total        |       | 251,870,913                     |        | 98,183,146                                |       | 343,199,544 |   | 344,800,999 |   |
|             |       |                            |        |                                      |       |   |   |   |   |
| Sales deductions |       | 10,634,321                      |        | 3,941,214                                 |       | 14,366,680 |   | 11,907,955 |   |
| Consolidated     |       | $                               | 241,236,592 |                                      | $          | 94,241,932 |   | $ | 328,832,864 |   | $ | 332,893,044 |   |

 
|                                    | ** ** | **February 28** | ** **  | **February 28** | ** ** |
|------------------------------------|------------|----------------------|-------------|----------------------|------------|
| ** **                         | ** ** | **2007**             | ** **  | **2006**             | ** ** |
| **Property,  Plant and Equipment** | ** ** | ** **           |        |                 |       |
| United States                      |       | $                    | 200,839,945 |                 | $          | 87,607,346 |   |
| Other                              |       | 28,011,820           |        | 10,483,105           |       |
| Consolidated                       |       | $                    | 228,851,765 |                 | $          | 98,090,451 |   |

 

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**15.  Restructuring Activities**

On September 26, 2005,the Company announced to its employees its intention to indefinitely idle oneof its paper machines at its Interlake facility in Ontario, Canada effectiveNovember 21, 2005.   This decision wasdue to significant increases in manufacturing costs that the Company was unableto pass on to the machine-glazed segment market.  As a result of this action, 48 employees wereterminated on that date.   In connectiontherewith, the Company estimated severance costs of $741,923 (“Interlakerestructuring”).   The Company alsorecorded $289,670 related to severance costs associated with a change in thecorporate organizational structure of the Company (“Corporate restructuring”).  The total restructuring costs of $1,031,593were recorded in the third quarter 2006 in the Company’s statement ofoperations.  In the fourth quarter 2006,the Company determined that the Interlake restructuring reserve needed to beadjusted downward by $116,447 and additional costs of $135,217 related to thecorporate restructuring were recorded. Accordingly, for the fiscal year ended February 28, 2006 restructuringcosts of $1,050,363 million were recorded as a separate line item in theCompany’s statement of operations.

As of February 28, 2007,the restructuring accrual on the balance sheet is approximately $.1 millionrelated to the corporate restructuring.

In the fourth quarter 2007,the Company made the decision to shut down the Interlake paper machinepermanently and accordingly, has recorded an impairment charge of $488,274,which is reflected as a separate line item in the Company’s statement ofoperations.

**16.  Bonus Agreements**

On March 27, 2006, the Company entered into agreementswith Russell Taylor, its President and Chief Executive Officer; Dianne Scheu,its Senior Vice President, Finance and Chief Financial Officer; and StevenZiessler, its President, Tissue & Machine-Glazed and Chief OperatingOfficer, pursuant to which each received a lump sum cash payment equal to oneyear’s current base salary.  Mr. Taylor’scurrent base salary is $425,000, Ms. Scheu’s current base salary is $230,000and Mr. Ziessler’s current base salary is $250,000.  The payment does not affect any other termsof such executive’s employment arrangements with the Company and will not betaken into account in computing any future compensation.

Pursuant to the terms of his agreement, if Mr. Taylor’semployment with the Company is terminated on or prior to September 27, 2006,for any reason, other than due to his death or disability, he is required torepay the payment to the Company. Pursuant to the terms of her agreement, if Ms. Scheu’s employment withthe Company is terminated on or prior to March 27, 2007, for any reason, otherthan due to her death or disability, she is required to repay the payment tothe Company.  Pursuant to the terms ofhis agreement, if Mr. Ziessler’s employment

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with the Company isterminated on or prior to March 27, 2007, for any reason, other than due to hisdeath or disability, he is required to repay the payment to the Company.

**17.   Subsequent Event**

On March 21, 2007, theCompany consummated a definitive merger agreement (the “Merger Agreement”) withCityForest Corporation (“CityForest”), Cellu City Acquisition Corporation (“CelluCity Merger Sub”) and Wayne Gullstad as the shareholders’ representative.  Pursuant to the Merger Agreement, and subjectto the terms and conditions therein, Cellu City Merger Sub, a wholly-ownedsubsidiary of the Company, merged with and into CityForest, with CityForestsurviving and becoming a wholly-owned subsidiary of the Company.  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. In connection with the MergerAgreement, the following agreements were entered into:

***Note Purchase Agreement***

The Company entered into a Note Purchase Agreement (the “Note PurchaseAgreement”) with Wingate Capital Ltd. (the “Purchaser”), dated March 21, 2007,pursuant to which Cellu Tissue issued and sold $20,255,572 aggregate principalamount of unregistered 9 3/4% Senior Secured Notes due 2010 (the “Notes”) tothe Purchaser for the purchase price of $20,000,007 which is equal to 98.7383%of the aggregate principal amount of the Notes. The Notes were issued pursuant to and will be governed by the Indenture,dated as of March 12, 2004 (as amended and supplemented, the “Cellu TissueIndenture”) among the Company, the subsidiary guarantors party thereto and TheBank of New York Trust Company, N.A., as successor trustee to the Bank of NewYork (the “Trustee”).  The proceeds ofthe sale were used to finance a portion of the acquisition.

***Second Supplemental Indenture***

The Company, certain of its subsidiaries, the Trustee and CityForesthave executed the Second Supplemental Indenture, dated March 21, 2007 (the “SecondSupplemental Indenture”), pursuant to which CityForest became a party to theCellu 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.

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***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 (as amended by theAmendment, the “Amended Credit Agreement”) among Cellu Tissue, as U.S.Borrower, Interlake Acquisition Corporation Limited, a subsidiary of CelluTissue, as Canadian Borrower, certain subsidiaries of Cellu Tissue, Cellu PaperHoldings, Inc., the parent corporation of Cellu Tissue, JPMorgan Chase Bank,N.A. (the “U.S. Administrative Agent”) and JPMorgan Chase Bank, N.A., TorontoBranch (the “Canadian Administrative Agent”).

The Amendment (1) increases the working capital facility from $35.0million to $40.0 million, (2) permits the issuance and sale by Cellu Tissue ofthe Notes, (3) provides for the consummation of the Acquisition and theconversion by CityForest from a Minnesota corporation to a Minnesota limitedliability company, (4) permits the assumption of approximately $18.5million in aggregate principal amount of indebtedness of CityForest inconnection with the Acquisition in accordance with the terms of the CityForestBond Documents (as defined below under “CityForest Bond Documents”), and (5)permits the guarantee by Cellu Tissue of certain obligations of CityForestunder the CityForest Bond Documents.  Inconnection with the Amendment, CityForest became a guarantor of the obligationsof the borrowers under 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, the Issuerloaned the proceeds of the Issuer’s Variable Rate Demand Solid Waste DisposalFacility Revenue Bonds, Series 1998 (CityForest Corporation Project) (the “Bonds”)to CityForest to finance the construction by CityForest of a solid waste disposalfacility.  Approximately $18.5 million inaggregate principal amount of the Bonds was outstanding as of the date of theAcquisition.  CityForest is required,under the terms of the Indenture of Trust governing the Bonds (the “CityForestIndenture”), to provide a letter of credit in favor of the trustee under theCityForest Indenture (the “Bonds Trustee”). CityForest has entered into an Amended and Restated ReimbursementAgreement, dated March 21, 2007 (the “Reimbursement Agreement” and, together withthe CityForest Indenture and the Loan Agreement, the “CityForest Bond Documents”),with Associated Bank, National Association (“Associated Bank”), pursuant towhich Associated Bank has extended the required letter of credit (the “AssociatedBank Letter of Credit”) and has provided a revolving credit facility toCityForest in an aggregate principal amount of up to $3.5 million (the “AssociatedBank Revolving Credit Facility”).

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The Bonds Trustee ispermitted to draw upon the Associated Bank Letter of Credit to pay principaland interest due on the Bonds, and to provide liquidity to purchase Bonds putto CityForest by bondholders and not remarketed; and CityForest is obligatedunder the Reimbursement Agreement to reimburse Associated Bank for any such draws.CityForest is also obligated to pay a fee in respect of the aggregate amountavailable to be drawn under the Associated Bank Letter of Credit at a rate perannum initially equal to 1.25%, subject to adjustment on a quarterly basisbased on CityForest’s leverage.  Theexpiration date of the Associated Bank Letter 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 a 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% of the principal amount outstandingas of the date of the Acquisition, with the balance payable at maturity of theBonds on March 1, 2028. The Reimbursement Agreement also contains a number ofother provisions regarding reserve funds and other mandatory and optionalrepayments in connection with the Bonds. In addition, the Reimbursement Agreement provides that in certaincircumstances where the Company incurs Indebtedness in excess of amountscurrently permitted under its Indenture or refinances the indebtedness issuedunder its Indenture, Associated Bank may require CityForest to repay all of itsobligations to Associated Bank under the Reimbursement Agreement and either tocause the Bonds to be redeemed or to replace the Associated Bank Letter ofCredit with a Substitute Credit Facility, as such term is defined in theCityForest 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.

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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 Notes and indebtedness under the Amended CreditAgreement; certain events of bankruptcy and insolvency; judgment defaults;certain defaults related to the Employee Retirement Income Security Act of1974, as amended; and a change of control of CityForest or Cellu Tissue.

The Company has guaranteed all of the obligations of CityForest underthe Reimbursement Agreement, pursuant to a Guaranty, dated March 21, 2007 (the “CelluTissue Guaranty”), executed by Cellu Tissue in favor of Associated Bank. Inaddition, the obligations of CityForest under the Reimbursement Agreement aresecured by first-priority liens in favor of Associated Bank in all ofCityForest’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, onthe one hand, and the U.S. Administrative Agent and the Canadian AdministrativeAgent, on the other hand, as to the collateral of CityForest securing theReimbursement Agreement and the Amended Credit Agreement.

**18.  Quarterly Results of Operations (Unaudited)**
| **Year Ended  February 28,  2007** | ** ** | **First Quarter** | ** ** | **May 26, 2006-  June 12, 2006** | ** ** | **June 13, 2006-  August23 ,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 | ) |

 

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| **Year Ended  February 28, 2006** | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** | **Year** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|----------|------------|
| Net sales                                        |       | $                      | 77,643,998 |                    | $          | 86,017,502             |       | $                       | 81,512,440 |     | $          | 83,658,924 |   | $ | 328,832,864 |   |
| Gross profit                                     |       | $                      | 6,993,839  |                    | $          | 7,622,737              |       | $                       | 6,728,624  |     | $          | 6,376,518 |   | $ | 27,721,718 |   |
| Income from operations  (3)                      |       | $                      | 3,868,358  |                    | $          | 3,701,395              |       | $                       | 838,065    |     | $          | 3,025,223 |   | $ | 11,433,041 |   |
| Net loss                                         |       | $                      | (110,172   | )                       | $          | (855,779               | )          | $                       | (1,230,465 | )        | $          | (372,938 | ) | $ | (2,569,354 | ) |

 

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(1)                                  Grossprofit for the period from June 13, 2006 to August 23, 2006, for the thirdquarter of fiscal year 2007 and for the fourth quarter of fiscal year 2007includes $1.5 million, $1.9 million and $2.0 million, respectively, foradditional depreciation expense related to excess purchase price allocated toproperty, plant and equipment.  Also,included in gross profit for the period from June 13, 2006 to August 23, 2006 isa $.9 million non-cash charge to cost of goods sold related to excess purchaseprice allocated to inventory.

(2)                                  Incomefrom operations for the period March 1, 2006 to June 12, 2006, for the periodJune 13, 2006, for the third quarter of fiscal year 2007 and for the fourthquarter 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 with suchawards and other compensation expense related to the Merger.

(3)                                  Income from operations for the third quarterof fiscal year 2006 includes $1.0 million related to restructuring activitiesand $2.3 million of terminated merger-related transaction costs.

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##### **ScheduleII—Valuation and Qualifying Accounts**

**CelluTissue Holdings, Inc.**

**Fiscalyears ended February 28, 2007, 2006 and 2005**
| **Description**                       | ** ** | **Balance at  Beginning  of Year** | ** ** | **Charged  to Costs  and  Expenses** | ** ** | **Deductions** | ** ** | **Balance at  End of  Year** | ** ** |
|---------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------|------------|----------------|------------|----------------------------------------|------------|
| **Allowance  for Doubtful Accounts:** |       |                                         |       |                                      |       |           |       |                                   |       |
| **February 28, 2007**                 |       | $                                            | 300,314    |                                      | $          | 328,405        |       | $                                      | 220,405    |   | $ | 408,314 |   |
| **February 28, 2006**                 |       | 398,749                                      |       | 115,269                                   |       | 213,704        |       | 300,314                                |       |
| **February 28, 2005**                 |       | 373,433                                      |       | 117,675                                   |       | 92,359         |       | 398,749                                |       |
| **Income  Tax Valuation Allowance:**  |       |                                         |       |                                      |       |           |       |                                   |       |
| **February 28, 2007**                 |       | $                                            | —     |                                      | $          | —         |       | $                                      | —     |   | $ | — |   |
| **February 28, 2006**                 |       | 34,816                                       |       | —                                    |       | 34,816         |       | —                                 |       |
| **February 28, 2005**                 |       | 1,052,957                                    |       | —                                    |       | 1,018,141      |       | 34,816                                 |       |
| ** **                            | ** ** | ** **                                   | ** ** | ** **                                | ** ** | ** **     | ** ** | ** **                             | ** ** |
| **Inventory  Obsolescence Reserve:**  |       |                                         |       |                                      |       |           |       |                                   |       |
| **February 28, 2007**                 |       | $                                            | 223,218    |                                      | $          | 50,841         |       | $                                      | 140,471    |   | $ | 133,588 |   |
| **February 28, 2006**                 |       | 114,015                                      |       | 144,427                                   |       | 35,224         |       | 223,218                                |       |
| **February  29, 2005**                |       | 156,909                                      |       | 34,892                                    |       | 77,786         |       | 114,015                                |       |

 

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