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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

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

For the Quarterly Period Ended November 26, 2009

or



| ̈ | 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





Cellu Tissue Holdings, Inc.

(Exact name of registrant as specified in its charter)







|                         |  |                                  
|------------------------ |  | ---------------------------------
|Delaware                 |  | 06-1346495                       
|(State of incorporation) |  | (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)





Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past
90 days.    Yes  x    No   ̈

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post
such files).     ̈  Yes     ̈  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definition of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.



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

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

The number of shares outstanding of each of the registrants classes of common stock as of December 31, 2009:



|                             |  |                   
|---------------------------- |  | ------------------
|Title of Class               |  | Shares Outstanding
|Common Stock, $.01 par value |  | 100               









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CELLU TISSUE HOLDINGS, INC.

FORM 10-Q

QUARTER ENDED NOVEMBER 26, 2009

INDEX



|                             |  |                                                                                       |  |   
|---------------------------- |  | ------------------------------------------------------------------------------------- |  | --
|PART IFINANCIAL INFORMATION |  | 3                                                                                    
|                             |  |                                                                                      
|Item 1.                      |  | Consolidated Financial Statements                                                     |  | 3 
|                             |  |                                                                                      
|Item 2.                      |  | Managements Discussion and Analysis of Financial Condition and Results of
Operations |  | 14
|                             |  |                                                                                      
|Item 3.                      |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 22
|                             |  |                                                                                      
|Item 4.                      |  | Controls and Procedures                                                               |  | 22
|                             | 
|PART IIOTHER INFORMATION    |  | 23                                                                                   
|                             |  |                                                                                      
|Item 1.                      |  | Legal Proceedings                                                                     |  | 23
|                             |  |                                                                                      
|Item 1A.                     |  | Risk Factors                                                                          |  | 23
|                             |  |                                                                                      
|Item 6.                      |  | Exhibits                                                                              |  | 28
|                             | 
|SIGNATURES                   |  | 30                                                                                   



2



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##### Table of Contents

Part 1 FINANCIAL INFORMATION



|Item 1. | Consolidated Financial Statements
|------- | ---------------------------------

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)



|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  
|------------------------------------------------ |  | -------------------------- | ----------- | - | ------------------------- | - | ----------- | ---------------- |  | - | ---------------- | - |  | - | ----------- | -
|                                                 |  | For the three months ended |             |   | For the nine months ended |  
|                                                 |  | November 26,2009           |             |   | November 27,2008          |   |             | November 26,2009 |  |   | November 27,2008 |  
|Net sales                                        |  | $                          | 130,147,065 |   |                           | $ | 143,042,017 |                  |  | $ | 386,871,937      |   |  | $ | 390,582,434 |  
|Cost of goods sold                               |  |                            | 109,873,809 |   |                           |   | 126,941,122 |                  |  |   | 324,143,190      |   |  |   | 351,693,706 |  
|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  
|Gross profit                                     |  |                            | 20,273,256  |   |                           |   | 16,100,895  |                  |  |   | 62,728,747       |   |  |   | 38,888,728  |  
|                                                 |  |                            |             |  
|Selling, general and administrative expenses     |  |                            | 5,014,478   |   |                           |   | 5,469,559   |                  |  |   | 15,871,380       |   |  |   | 15,038,246  |  
|Terminated acquisition-related transaction costs |  |                            |            |   |                           |   |            |                  |  |   |                 |   |  |   | 140,044     |  
|Amortization expense                             |  |                            | 1,080,163   |   |                           |   | 1,258,994   |                  |  |   | 3,215,855        |   |  |   | 2,061,429   |  
|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  
|Income from operations                           |  |                            | 14,178,615  |   |                           |   | 9,372,342   |                  |  |   | 43,641,512       |   |  |   | 21,649,009  |  
|Interest expense, net                            |  |                            | 8,512,921   |   |                           |   | 6,910,402   |                  |  |   | 27,350,917       |   |  |   | 17,951,147  |  
|Foreign currency (gain) loss                     |  |                            | 397,491     |   |                           |   | (241,333    | )                |  |   | 1,110,719        |   |  |   | (156,713    | )
|Other expense (income)                           |  |                            | (85,566     | ) |                           |   | (36,975     | )                |  |   | (458,015         | ) |  |   | 1,443       |  
|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  
|Income before income tax expense                 |  |                            | 5,353,769   |   |                           |   | 2,740,248   |                  |  |   | 15,637,891       |   |  |   | 3,853,132   |  
|Income tax expense                               |  |                            | 3,353,758   |   |                           |   | 901,500     |                  |  |   | 8,609,541        |   |  |   | 1,268,999   |  
|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  
|Net income                                       |  | $                          | 2,000,011   |   |                           | $ | 1,838,748   |                  |  | $ | 7,028,350        |   |  | $ | 2,584,133   |  
|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  
|Basic and diluted income per share               |  | $                          | 20,000.11   |   |                           | $ | 18,387.48   |                  |  | $ | 70,283.50        |   |  | $ | 25,841.33   |  
|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  
|Basic and diluted shares outstanding             |  |                            | 100         |   |                           |   | 100         |                  |  |   | 100              |   |  |   | 100         |  
|                                                 |  |                            |             |   |                           |   |             |                  |  |   |                  |   |  |   |             |  

See accompanying notes to consolidated financial statements



3



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CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)



|                                                                                                  |  |                  |             |                  |   |             |  
|------------------------------------------------------------------------------------------------- |  | ---------------- | ----------- | ---------------- | - | ----------- | -
|                                                                                                  |  | November 26,2009 |             | February 28,2009 |  
|ASSETS                                                                                            |  |                  |             |                  |   |             |  
|Current Assets:                                                                                   |  |                  |             |                  |   |             |  
|Cash and cash equivalents                                                                         |  | $                | 7,149,239   |                  | $ | 361,035     |  
|Receivables, net                                                                                  |  |                  | 50,590,365  |                  |   | 54,065,899  |  
|Inventories                                                                                       |  |                  | 46,293,794  |                  |   | 47,216,049  |  
|Prepaid expenses and other current assets                                                         |  |                  | 3,793,227   |                  |   | 2,085,774   |  
|Income tax receivable                                                                             |  |                  | 114,077     |                  |   | 174,084     |  
|Deferred income taxes                                                                             |  |                  | 6,858,622   |                  |   | 3,515,295   |  
|                                                                                                  |  |                  |             |                  |   |             |  
|Total Current Assets                                                                              |  |                  | 114,799,324 |                  |   | 107,418,136 |  
|Property, plant and equipment, net                                                                |  |                  | 307,389,840 |                  |   | 301,987,941 |  
|Goodwill                                                                                          |  |                  | 41,020,138  |                  |   | 41,020,138  |  
|Other intangibles                                                                                 |  |                  | 28,456,622  |                  |   | 31,672,477  |  
|Other assets                                                                                      |  |                  | 10,435,170  |                  |   | 1,948,108   |  
|                                                                                                  |  |                  |             |                  |   |             |  
|Total Assets                                                                                      |  | $                | 502,101,094 |                  | $ | 484,046,800 |  
|                                                                                                  |  |                  |             |                  |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                              |  |                  |             |                  |   |             |  
|Current Liabilities:                                                                              |  |                  |             |                  |   |             |  
|Bank overdrafts                                                                                   |  | $                |            |                  | $ | 3,285,420   |  
|Revolving line of credit                                                                          |  |                  |            |                  |   | 18,530,824  |  
|Accounts payable                                                                                  |  |                  | 21,251,246  |                  |   | 16,726,143  |  
|Accrued expenses                                                                                  |  |                  | 29,043,137  |                  |   | 26,548,639  |  
|Accrued interest                                                                                  |  |                  | 14,376,826  |                  |   | 10,160,124  |  
|Other current liabilities                                                                         |  |                  | 955,155     |                  |   | 17,448,707  |  
|Current portion of long-term debt                                                                 |  |                  | 760,000     |                  |   | 760,000     |  
|                                                                                                  |  |                  |             |                  |   |             |  
|Total Current Liabilities                                                                         |  |                  | 66,386,364  |                  |   | 93,459,857  |  
|Long-term debt, less current portion                                                              |  |                  | 268,322,681 |                  |   | 242,361,944 |  
|Deferred income taxes                                                                             |  |                  | 82,004,394  |                  |   | 75,110,277  |  
|Other liabilities                                                                                 |  |                  | 1,025,426   |                  |   | 5,378,059   |  
|Stockholders Equity:                                                                             |  |                  |             |                  |   |             |  
|Common stock, Class A, $.01 par value, 1,000 shares authorized, 100 shares issued
and outstanding |  |                  | 1           |                  |   | 1           |  
|Capital in excess of par value                                                                    |  |                  | 73,284,301  |                  |   | 70,948,860  |  
|Accumulated earnings                                                                              |  |                  | 10,726,421  |                  |   | 3,698,071   |  
|Accumulated other comprehensive income                                                            |  |                  | 351,506     |                  |   | (6,910,269  | )
|                                                                                                  |  |                  |             |                  |   |             |  
|Total Stockholders Equity                                                                        |  |                  | 84,362,229  |                  |   | 67,736,663  |  
|                                                                                                  |  |                  |             |                  |   |             |  
|Total Liabilities and Stockholders Equity                                                        |  | $                | 502,101,094 |                  | $ | 484,046,800 |  
|                                                                                                  |  |                  |             |                  |   |             |  

See accompanying notes to consolidated financial statements.



4



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CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                  |  |                   |              |   |                  |   |             |  
|--------------------------------------------------------------------------------- |  | ----------------- | ------------ | - | ---------------- | - | ----------- | -
|                                                                                  |  | Nine Months Ended |             
|                                                                                  |  | November 26,2009  |              |   | November 27,2008 |  
|                                                                                  |  | (Unaudited)       |             
|Cash flows from operating activities                                              |  |                   |              |   |                  |   |             |  
|Net income                                                                        |  | $                 | 7,028,350    |   |                  | $ | 2,584,133   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                   |              |   |                  |   |             |  
|Depreciation                                                                      |  |                   | 18,231,462   |   |                  |   | 17,614,651  |  
|Amortization of intangibles                                                       |  |                   | 3,215,855    |   |                  |   | 2,061,429   |  
|Amortization of deferred financing fees                                           |  |                   | 883,013      |   |                  |   | 188,816     |  
|Accretion of debt discount                                                        |  |                   | 1,326,436    |   |                  |   | 1,211,258   |  
|Loss from write-off of discount on notes                                          |  |                   | 1,911,471    |   |                  |   |            |  
|Write-off of deferred financing fees                                              |  |                   | 299,803      |   |                  |   |            |  
|Stock-based compensation                                                          |  |                   | 636,686      |   |                  |   | 689,534     |  
|Deferred income taxes                                                             |  |                   | 3,550,790    |   |                  |   | 177,625     |  
|Loss on disposal of fixed asset                                                   |  |                   | 316,623      |   |                  |   |            |  
|Loss from natural gas swaps                                                       |  |                   |             |   |                  |   | 953,523     |  
|Changes in operating assets and liabilities, net of effects of acquisitions:      |  |                   |              |   |                  |   |             |  
|Receivables                                                                       |  |                   | 4,424,208    |   |                  |   | (11,531,614 | )
|Inventories                                                                       |  |                   | 1,745,955    |   |                  |   | (3,417,251  | )
|Prepaid expenses, other current assets and income tax receivable                  |  |                   | (1,717,083   | ) |                  |   | 645,075     |  
|Other assets and liabilities                                                      |  |                   | 465,471      |   |                  |   | (45,630     | )
|Accounts payable, accrued expenses and accrued interest                           |  |                   | 11,364,625   |   |                  |   | (1,530,539  | )
|                                                                                  |  |                   |              |   |                  |   |             |  
|Total adjustments                                                                 |  |                   | 46,655,315   |   |                  |   | 7,016,877   |  
|                                                                                  |  |                   |              |   |                  |   |             |  
|Net cash provided by operating activities                                         |  |                   | 53,683,665   |   |                  |   | 9,601,010   |  
|Cash flows from investing activities                                              |  |                   |              |   |                  |   |             |  
|Cash paid for acquisition, net of cash acquired                                   |  |                   |             |   |                  |   | (64,148,096 | )
|Capital expenditures                                                              |  |                   | (19,772,877  | ) |                  |   | (9,734,100  | )
|                                                                                  |  |                   |              |   |                  |   |             |  
|Net cash used in investing activities                                             |  |                   | (19,772,877  | ) |                  |   | (73,882,196 | )
|Cash flows from financing activities                                              |  |                   |              |   |                  |   |             |  
|Equity investment by shareholders                                                 |  |                   |             |   |                  |   | 21,701,817  |  
|Cash portion of earnout payment                                                   |  |                   | (18,301,245  | ) |                  |   | (13,727,700 | )
|Bank overdrafts                                                                   |  |                   | (3,285,420   | ) |                  |   | 1,348,876   |  
|Borrowings on revolving line of credit, net                                       |  |                   | 22,411,826   |   |                  |   | 76,600,000  |  
|Payments on revolving line of credit, net                                         |  |                   | (40,942,650  | ) |                  |   | (57,900,000 | )
|Payments on long-term debt                                                        |  |                   | (760,000     | ) |                  |   | (760,000    | )
|Retirement of long-term debt                                                      |  |                   | (222,255,572 | ) |                  |   |            |  
|Payment of deferred financing fees                                                |  |                   | (9,736,006   | ) |                  |   | (885,959    | )
|Net proceeds from bond offering                                                   |  |                   | 245,738,400  |   |                  |   | 36,900,000  |  
|                                                                                  |  |                   |              |   |                  |   |             |  
|Net cash (used in) provided by financing activities                               |  |                   | (27,130,667  | ) |                  |   | 63,277,034  |  
|Effect of foreign currency                                                        |  |                   | 8,083        |   |                  |   | 634,126     |  
|                                                                                  |  |                   |              |   |                  |   |             |  
|Net increase (decrease) in cash and cash equivalents                              |  |                   | 6,788,204    |   |                  |   | (370,026    | )
|Cash and cash equivalents at beginning of period                                  |  |                   | 361,035      |   |                  |   | 883,388     |  
|                                                                                  |  |                   |              |   |                  |   |             |  
|Cash and cash equivalents at end of period                                        |  | $                 | 7,149,239    |   |                  | $ | 513,362     |  
|                                                                                  |  |                   |              |   |                  |   |             |  

See accompanying notes to consolidated financial statements.



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Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

November 26, 2009

Note 1. Basis of Presentation

Cellu Tissue Holdings, Inc., a Delaware corporation, together with its consolidated subsidiaries, primarily produces converted tissue
products, tissue hard rolls and machine-glazed tissue that are sold to leading consumer retailers and away-from-home distributors of tissue products, vertically integrated manufacturers and third-party converters serving the tissue and
machine-glazed tissue segments.

The accompanying unaudited interim consolidated financial statements include the accounts of
Cellu Tissue Holdings, Inc. (Cellu Tissue or the Company) and its wholly-owned subsidiaries. The Company is a wholly-owned subsidiary of Cellu Paper Holdings, Inc. (the Parent), which is a wholly-owned
subsidiary of Cellu Parent Corporation (Cellu Parent).

These statements have been prepared in accordance with
accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement have been included. Operating results for
the three and nine months ended November 26, 2009 are not necessarily indicative of the results that may be expected for the fiscal year ending February 28, 2010. The year-end condensed consolidated balance sheet data was derived from
audited financial statements, but does not include all disclosures required by GAAP.

Certain amounts have been reclassified
from prior year to conform to the current year presentation.

The Financial Accounting Standards Board (FASB) is
the authoritative body for financial accounting and reporting in the United States. On July 31, 2009, the FASB Accounting Standards Codification (the Codification) became the authoritative source of accounting principles to be
applied to the financial statements of nongovernmental entities prepared in accordance with GAAP. The following is a list of recent pronouncements recently issued by the FASB and which were adopted by the Company during the second quarter of fiscal
2010:



| |  |  | Fair Value Measurements and Disclosures: The pronouncements define fair value, establish guidelines for measuring fair value and expand
disclosures regarding fair value measurements. The adoption of fair value measurements and disclosures did not have a material impact on the Companys results of operations and financial position.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Subsequent Events: The pronouncement codifies existing standards of accounting for and disclosures of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued. The Company adopted the pronouncement in the second quarter of fiscal 2010. The adoption did not have any impact on the Companys Consolidated Financial Statements.
See Note 16 for additional information.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Note 2. APF Acquisition

On July 2, 2008, the Company, through two newly created, wholly-owned subsidiaries, Cellu TissueHauppauge, LLC (Cellu
Hauppauge) and Cellu TissueThomaston, LLC (Cellu Thomaston), consummated the acquisition of certain assets and assumption of certain liabilities, from Atlantic Paper & Foil Corp. of N.Y., Atlantic Lakeside
Properties, LLC, Atlantic Paper & Foil, LLC, Atlantic Paper & Foil of Georgia, LLC and Consumer Licensing Corporation (collectively, the Sellers) pursuant to a definitive asset purchase agreement (the
Purchase Agreement) between the Company and the Sellers. The aggregate purchase price paid was $68.0 million, including a cash payment at closing of $61.7 million and the issuance of a promissory note by the Company to Atlantic
Paper & Foil Corp. of N.Y. in the principal amount of $6.3 million (the Seller Note), plus the assumption of certain liabilities. The Company also incurred $2.5 million of transaction related costs. The purchase price,
which was subject to certain post-closing working capital adjustments, was adjusted downward by approximately $63,000 for the working capital adjustment settlement that was finalized in the third fiscal quarter 2009. The acquisition of assets and
assumption of liabilities is referred to as the APF Acquisition and the acquired business is referred to as APF. The Company financed the cash portion of the purchase price with cash on hand, the borrowings described at
Note 4 and a $15 million equity contribution from the Parent.



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



The APF Acquisition has been accounted for as a purchase and, accordingly, the
consolidated statement of operations includes the results of APF from the date of acquisition. The acquisition has resulted in the recognition of goodwill, which is attributable to our tissue segment and will be deductible for tax purposes. Goodwill
reflects the future earnings and cash flow potential of the acquired business in excess of fair values that are assigned to all other identifiable assets and liabilities. Goodwill arises because the purchase price paid reflects factors including the
strategic fit and expected synergies this business brings to existing operations. The Company has allocated the purchase price to the net assets acquired in the acquisition based on its estimates of the fair value of assets and liabilities as
follows:



|                                                              |  |                             |            |  
|------------------------------------------------------------- |  | --------------------------- | ---------- | -
|                                                              |  | Purchase priceallocated to: |           
|Current assets, primarily accounts receivable and inventories |  | $                           | 15,241,036 |  
|Property, plant and equipment                                 |  |                             | 5,306,225  |  
|Goodwill                                                      |  |                             | 29,685,383 |  
|Noncompete agreements                                         |  |                             | 12,770,000 |  
|Customer lists                                                |  |                             | 12,319,000 |  
|Trademarks                                                    |  |                             | 56,000     |  
|Current liabilities                                           |  |                             | (4,922,736 | )
|                                                              |  |                             |            |  
|Total                                                         |  | $                           | 70,454,908 |  
|                                                              |  |                             |            |  

The Company has estimated the fair value of the assets and liabilities of the APF
Acquisition, utilizing information available at the time of acquisition. The Company considered outside third-party appraisals of the tangible and intangible assets to determine the applicable fair market values. Depreciation has been calculated on
the fair value assigned to the tangible fixed assets based on an average remaining useful life. Intangible assets are being amortized on a straight-line basis, assuming no significant residual value, over the following lives: noncompete
agreements5 years, customer lists7 years and trademarks3 years.

The results of APFs
operations from the July 2, 2008 date of acquisition are primarily included in the Companys tissue segment. Part of the acquisition related to the foam business, which the Company reports as a separate segment. Unaudited pro forma results
of operations for the nine-months ended November 27, 2008, are treated as if the Company and APF had been combined at the beginning of the period presented and are presented below. The pro forma results include estimates and assumptions, which
the Companys management believes are reasonable. However, the pro forma results do not include any cost savings or other effects of the planned integration of APF and are not necessarily indicative of the results which would have occurred if
the business combination had been in effect on the dates indicated, or which may result in the future.



|                  |  |                                       |         |           |   |        
|----------------- |  | ------------------------------------- | ------- | --------- | - | -------
|                  |  | Nine Months EndedNovember 27, 2008(1)
|                  |  | Actual                                |         | Pro Forma
|                  |  | (in thousands)                       
|Net sales         |  | $                                     | 390,582 |           | $ | 422,669
|Operating income  |  |                                       | 21,649  |           |   | 25,258 
|Net income (loss) |  |                                       | 2,584   |           |   | 3,368  



|(1) | Pro forma operating results include the operating results for APF for the period March 1, 2008 to June 30, 2008, prior to its acquisition on July 2,
2008. The actual operating results include the operating results for APF for the period from the acquisition date (July 2, 2008) to November 27, 2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Note 3. Stock Based Compensation

The Company accounts for stock based
compensation using the fair value-based method and the recording of such expense in the Companys consolidated statements of operations. The Company has one share-based payment arrangement under the 2006 Stock Option and Restricted Stock Plan
(the Plan). Under the Plan, the administrator of the Plan (the Plan Administrator) may make awards of options to purchase shares of common stock of Cellu Parent and/or awards of restricted shares of common stock of Cellu
Parent. A maximum of 12,095 shares of common stock of Cellu Parent may be delivered in satisfaction of awards under the Plan, determined net of shares of common stock withheld by Cellu Parent in payment of the exercise price of an award or in
satisfaction of tax withholding requirements. The maximum number was increased from 8,095 to accommodate the grant made during the first quarter of fiscal 2010. Key employees and directors of, and consultants and advisors to, Cellu Parent or its
affiliates who, in the opinion of the Plan Administrator, are in a position to make a significant contribution to the success of Cellu Parent and its affiliates are eligible to participate in the Plan. Stock options are granted at a strike price at
the estimated fair value of Cellu Parents stock on the date of grant.



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



On April 13, 2009, Cellu Parent granted 1,600 stock options to non-executive
employees whereby 35% of each individuals stock options vest ratably over 4 years and 65% are earned only upon attainment of certain market conditions relative to a change in ownership of the Company. Furthermore, Cellu Parent granted
2,126 stock options which are earned only upon attainment of certain market conditions relative to a change in ownership of the Company. The fair value of the stock option grants related to service (35% of 1,600, or 562) was estimated on the date of
grant using the Black-Scholes option pricing model. The assumptions used to value the grants were: no dividend yield; 40% volatility; 1.4% risk free interest rate; and 10-year expected life. With respect to the remaining stock options granted
associated with the attainment of certain market conditions, the Company has determined the fair value of these stock options at the date of grant using the Monte-Carlo model and the followings assumptions: no dividend yield; 40% volatility; 1.4%
risk-free interest rate; and 3.5 year expected term. The total fair value estimated for these options was $0.7 million and is not recognized as expense until the change in ownership occurs.

Total stock compensation expense for the three months ended November 26, 2009 and November 27, 2008 was $0.2 million and for
the nine months ended November 26, 2009 and November 27, 2008, was $0.6 million and $0.7 million respectively.

Note 4. Long-Term
Debt

During June 2009, through a series of transactions, the Company refinanced its debt, which
resulted in higher overall interest rates and extended the overall maturity of its long-term debt. The new 111/2% Senior Secured Notes due in 2014 (2014 Notes) generated cash proceeds of $245,738,400. These proceeds were used to retire all of the 93/4% Senior Secured Notes due in 2010 (2010 Notes). In
connection with the refinancing, the Company recorded a loss of $2,211,274 for the early extinguishment of debt. Long-term debt consists of the following:



|                             |  |                  |             |                  |   |            
|---------------------------- |  | ---------------- | ----------- | ---------------- | - | -----------
|                             |  | November 26,2009 |             | February 28,2009
|2014 Notes                   |  | $                | 246,427,681 |                  | $ |           
|2010 Notes                   |  |                  |            |                  |   | 219,706,944
|City Forest Industrial Bonds |  |                  | 16,355,000  |                  |   | 17,115,000 
|Seller Note Payable          |  |                  | 6,300,000   |                  |   | 6,300,000  
|                             |  |                  |             |                  |   |            
|                             |  |                  | 269,082,681 |                  |   | 243,121,944
|Less current portion of debt |  |                  | 760,000     |                  |   | 760,000    
|                             |  |                  |             |                  |   |            
|                             |  | $                | 268,322,681 |                  | $ | 242,361,944
|                             |  |                  |             |                  |   |            

2014 Notes: In June 2009, the Company completed a private
placement of $255 million principal face amount of 111/2% senior secured notes maturing on June 1, 2014 (the 2014 Notes), which have an effective interest rate of 12.48%. The 2014 Notes pay interest in arrears on June 1 and December 1 of each year, commencing on
December 1, 2009. The 2014 Notes are secured by liens on substantially all of the Companys assets. The Indenture in connection with the 2014 Notes contains customary covenants and events of default, including limitations on certain
restricted payments, the incurrence of additional indebtedness and the sale of certain assets. The Company is compliant with these covenants as of November 26, 2009. All of the Companys subsidiaries guarantee the 2014 Notes. During the
third quarter of fiscal year 2010, the Company exchanged all of the original 2014 Notes for new 2014 Notes substantially identical to the old notes, except that the new 2014 Notes are registered with the Securities and Exchange Commission. Cellu
Tissue has no independent assets or operations and the 2014 Notes are unconditionally guaranteed by all of the Companys subsidiaries.

2010 Notes: In March 2004, the Company completed a private offering of $162.0 million aggregate principal amount of 93/4% senior secured notes due 2010 pursuant to and governed by an
Indenture, dated as of March 12, 2004. Subsequently, in fiscal year 2008 and fiscal 2009, in connection with the acquisition of CityForest Corporation and APF, the Company issued and sold $60.3 million aggregate principal amount of the
2010 Notes for $56.9 million, which is equal to 94.3615% of the aggregate principal amount. The Company redeemed the entire $222.3 million principal amount outstanding of these notes in July 2009. In connection with this redemption, the
company recorded a loss on early extinguishment totaling $2.2 million, which includes $1.9 million for the unaccreted effective discount and $0.3 million related to the unamortized deferred financing fees.

2006 Credit Agreement: In June 2006, the Company entered into a Credit Agreement (the Credit Agreement), that currently
provides for a $60.0 million working capital facility, including a letter of credit sub-facility and swing-line loan



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



sub-facility. The Credit Agreement provides that 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 $55.0 million is available, in U.S. dollars, to the U.S. Borrower under the facility and an amount equal to $5.0 million is available, in U.S. or Canadian dollars, to the Canadian Borrower under the
facility. Borrowings under the working capital facility are secured by substantially all of the Companys assets and guaranteed by the Companys subsidiaries. As of November 26, 2009, there were no borrowings outstanding under the
working capital facility. As of February 28, 2009, $18.5 million of borrowings were outstanding under this working capital facility.

In connection with a potential initial public equity offering, the Company obtained an amendment to the Credit Agreement, effective upon closing of the initial public offering, to:



| |  |  | remove Parent from relevant provisions of the Credit Agreement;
| | - |  | ---------------------------------------------------------------



| |  |  | revise the definition of the term change in control to include, among other items, any person becoming the beneficial owner of more than
50% of the total voting power of Cellu Tissue (other than Weston Presidio V, L.P. and its co-investors) or a change in the majority of our board of directors;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | revise the definition of the term prepayment event to exclude from this definition the issuance of common stock in the offering;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | revise the definition of the term swap agreement to include energy hedging contracts, which we may enter into from time to time to hedge or
mitigate risks to which we have actual exposure;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | permit the reorganization transactions and this offering under the Credit Agreements covenants prohibiting certain structural changes and changes
to our organizational documents; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | permit the payment, redemption or repurchase of any portion of our 2014 Notes, our indebtedness related to our CityForest industrial revenue bonds and
our $6.3 million promissory note issued in the APF Acquisition with the proceeds from this offering.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

CityForest Industrial Bonds: Cellu Tissue CityForest LLC (CityForest) is party to a loan agreement, dated March 1, 1998, with the City of Ladysmith, Wisconsin, pursuant to which the City of Ladysmith loaned the proceeds
of its Variable Rate Demand Solid Waste Disposal Facility Revenue Bonds, Series 1998, to CityForest to finance the construction by CityForest of a solid waste disposal facility. Approximately $18.4 million in aggregate principal face amount was
outstanding as of the date of the Companys acquisition of CityForest. The municipal bonds have scheduled semi-annual payments of principal equal to approximately 2.00% of the principal amount outstanding as of the date of the acquisition of
CityForest (CityForest Acquisition). The balance is payable at maturity of the municipal bonds on March 1, 2028. The bonds are guaranteed by the Company and contain various customary covenants and events of default.

In connection with this borrowing, CityForest entered into an Amended and Restated Reimbursement Agreement (the Reimbursement
Agreement) pursuant to which Associated Bank has provided a letter of credit and a revolving credit facility in an aggregate principal amount of up to $3.5 million. The letter of credit and revolving credit facility can be used by the
bond trustee to pay principal and interest due on the Bonds, and to provide liquidity to purchase bonds put to CityForest by bondholders and not remarketed; and CityForest is obligated to repay any such draws. CityForest is also obligated to pay a
fee in respect of the aggregate amount available to be drawn at a rate per annum initially equal to 1.25%, subject to adjustment on a quarterly basis based on CityForests leverage. The expiration date of the letter of credit is
February 15, 2011.

In connection with a potential initial public equity offering, the Company obtained an amendment to
the Reimbursement Agreement, effective upon closing of the initial public offering, which:



| |  |  | increases the annual letter of credit fee to 2.5%;
| | - |  | --------------------------------------------------



| |  |  | revises the definition of the term change of control to include, among other items, any person becoming the beneficial owner of more than
50% of the total voting power of Cellu Tissue (other than Weston Presidio V, L.P. and its co-investors) or a change in the majority of our board of directors;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | decreases the maximum leverage ratio from a ratio of 3.5 to 1.0 to a ratio of 2.5 to 1.0; and
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | increases the minimum fixed charge coverage ratio from a ratio of 1.0 to 1.0 to a ratio of 1.2 to 1.0.
| | - |  | ------------------------------------------------------------------------------------------------------



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



Amounts borrowed by CityForest under the revolving credit facility bear interest at a
rate per annum equal to the LIBOR Rate (as defined in the Reimbursement Agreement), plus an applicable margin. The applicable margin percentage initially is 1.75%, subject to adjustment on a quarterly basis based upon CityForests leverage. The
interest rate was 1.99% and 2.25% at November 26, 2009 and February 28, 2009, respectively. CityForest is also obligated to pay a commitment fee with respect to any unused commitment under the revolving credit facility in an amount equal
to 0.50% per annum. The maturity date of the revolving credit facility is February 15, 2011. The revolving credit facility is secured by the assets of CityForest.

In connection with these CityForest credit facilities, the Company has $1.2 million of restricted cash as of November 26, 2009 and
February 28, 2008, which is included in other assets on the balance sheet. In addition, the Reimbursement Agreement provides that in certain circumstances where the Company incurs indebtedness, as defined, in excess of amounts currently
permitted under the CityForest Indenture or refinances the indebtedness issued under the CityForest Indenture, CityForest may be required to repay all of its obligations under the revolving line of credit and either cause the bonds to be redeemed or
to replace the revolving credit facility and provide a new letter of credit from another lender.

Seller Note Payable:
As part of the financing of the APF Acquisition, the Company entered into a Seller Note in the principal amount of $6,300,000. Interest at 12% is payable on the note in quarterly installments with the principal due July 2, 2011.

Note 5. Deferred Financing Fees

In connection with the debt refinancing discussed in Note 4, the Company capitalized deferred financing fees of $9.7 million related to the 2014 Notes which are being amortized using the effective interest method over their five
year life. In addition, in connection with the APF Acquisition, the Company incurred approximately $0.2 million of costs related to the amendment to the Credit Agreement and $0.7 million of costs related to an additional issuance of 2010
Notes.

As a result of the debt refinancing, the Company wrote off the remaining unamortized 2010 Notes deferred financing
fees of $0.3 million during the three months ended August 27, 2009.

The deferred financing fees and related
accumulated amortization balances as of November 26, 2009 and February 28, 2009 are as follows:



|                         |  |                  |           |   |                  |   |          |  
|------------------------ |  | ---------------- | --------- | - | ---------------- | - | -------- | -
|                         |  | November 26,2009 |           |   | February 28,2009 |  
|2014 Notes               |  | $                | 9,736,006 |   |                  | $ |         |  
|Credit agreement         |  |                  | 231,651   |   |                  |   | 231,651  |  
|2010 Notes               |  |                  |          |   |                  |   | 654,307  |  
|                         |  |                  |           |   |                  |   |          |  
|                         |  |                  | 9,967,657 |   |                  |   | 885,958  |  
|Accumulated amortization |  |                  | (835,179  | ) |                  |   | (306,668 | )
|                         |  |                  |           |   |                  |   |          |  
|                         |  | $                | 9,132,478 |   |                  | $ | 579,290  |  
|                         |  |                  |           |   |                  |   |          |  

These fees, net of accumulated amortization, are included in other assets on the
balance sheet as of November 26, 2009 and February 28, 2009.

Note 6. Comprehensive Income

The components of comprehensive income (loss) are as follows:



|                                           |  |                    |           |                  |                   |            |                  |  |                  |            |  |   |            |  
|------------------------------------------ |  | ------------------ | --------- | ---------------- | ----------------- | ---------- | ---------------- |  | ---------------- | ---------- |  | - | ---------- | -
|                                           |  | Three Months Ended |           |                  | Nine Months Ended |           
|                                           |  | November 26,2009   |           | November 27,2008 |                   |            | November 26,2009 |  | November 27,2008 |           
|Net income (loss)                          |  | $                  | 2,000,011 |                  | $                 | 1,838,748  |                  |  | $                | 7,028,350  |  | $ | 2,584,133  |  
|Change in unrealized gain (loss) on hedges |  |                    | 774,901   |                  |                   | (570,701   | )                |  |                  | 1,762,309  |  |   | (570,701   | )
|Foreign currency translation adjustments   |  |                    | 803,403   |                  |                   | (4,808,189 | )                |  |                  | 5,499,467  |  |   | (6,970,275 | )
|                                           |  |                    |           |                  |                   |            |                  |  |                  |            |  |   |            |  
|Comprehensive income (loss)                |  | $                  | 3,578,315 |                  | $                 | (3,540,142 | )                |  | $                | 14,290,126 |  | $ | (4,956,843 | )
|                                           |  |                    |           |                  |                   |            |                  |  |                  |            |  |   |            |  



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



Note 7. Business Segments

The Company operates in three business segments: tissue, machine-glazed tissue and foam. The foam business segment was added in connection
with the APF Acquisition (see Note 2). The Company assesses the performance of its business segments using income from operations. Income from operations excludes interest income, interest expense, other income (expense), income tax expense
(benefit) and the impact of foreign currency gains and losses. Corporate and shared expenses are allocated to each segment. Segment information is as follows:



|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|---------------------------------------- |  | ------------------ | ----------- | - | ----------------- | - | ----------- | ---------------- |  | - | ---------------- | - |  | - | ----------- | -
|                                         |  | Three Months Ended |             |   | Nine Months Ended |  
|                                         |  | November 26,2009   |             |   | November 27,2008  |   |             | November 26,2009 |  |   | November 27,2008 |  
|Net Sales                                |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Tissue                                   |  | $                  | 98,631,644  |   |                   | $ | 111,144,412 |                  |  | $ | 299,880,029      |   |  | $ | 300,355,288 |  
|Machine-glazed tissue                    |  |                    | 29,674,620  |   |                   |   | 30,455,456  |                  |  |   | 81,194,563       |   |  |   | 87,904,091  |  
|Foam                                     |  |                    | 1,840,801   |   |                   |   | 1,442,149   |                  |  |   | 5,797,345        |   |  |   | 2,323,055   |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Consolidated                             |  | $                  | 130,147,065 |   |                   | $ | 143,042,017 |                  |  | $ | 386,871,937      |   |  | $ | 390,582,434 |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Segment Income From Operations           |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Tissue                                   |  | $                  | 12,775,812  |   |                   | $ | 8,590,369   |                  |  | $ | 40,487,145       |   |  | $ | 20,759,448  |  
|Machine-glazed tissue                    |  |                    | 1,698,158   |   |                   |   | 1,969,014   |                  |  |   | 4,365,119        |   |  |   | 2,700,380   |  
|Foam                                     |  |                    | 784,808     |   |                   |   | 71,953      |                  |  |   | 2,005,103        |   |  |   | 250,610     |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Total segment income from operations     |  |                    | 15,258,778  |   |                   |   | 10,631,336  |                  |  |   | 46,857,367       |   |  |   | 23,710,438  |  
|Amortization expense                     |  |                    | (1,080,163  | ) |                   |   | (1,258,994  | )                |  |   | (3,215,855       | ) |  |   | (2,061,429  | )
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Consolidated income from operations      |  |                    | 14,178,615  |   |                   |   | 9,372,342   |                  |  |   | 43,641,512       |   |  |   | 21,649,009  |  
|Interest expense, net                    |  |                    | (8,512,921  | ) |                   |   | (6,910,402  | )                |  |   | (27,350,917      | ) |  |   | (17,951,147 | )
|Foreign currency transaction gain (loss) |  |                    | (397,491    | ) |                   |   | 241,333     |                  |  |   | (1,110,719       | ) |  |   | 156,713     |  
|Other income (expense)                   |  |                    | 85,566      |   |                   |   | 36,975      |                  |  |   | 458,015          |   |  |   | (1,443      | )
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Income (loss) before income tax expense  |  | $                  | 5,353,769   |   |                   | $ | 2,740,248   |                  |  | $ | 15,637,891       |   |  | $ | 3,853,132   |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Capital Expenditures                     |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Tissue                                   |  | $                  | 7,903,501   |   |                   | $ | 4,359,725   |                  |  | $ | 17,856,267       |   |  | $ | 8,168,666   |  
|Machine-glazed tissue                    |  |                    | 420,074     |   |                   |   | 300,714     |                  |  |   | 1,181,365        |   |  |   | 977,484     |  
|Foam                                     |  |                    |            |   |                   |   |            |                  |  |   |                 |   |  |   |            |  
|Corporate                                |  |                    | 287,288     |   |                   |   | 253,112     |                  |  |   | 735,245          |   |  |   | 587,950     |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Consolidated                             |  | $                  | 8,610,863   |   |                   | $ | 4,913,551   |                  |  | $ | 19,772,877       |   |  | $ | 9,734,100   |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Depreciation                             |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Tissue                                   |  | $                  | 4,666,446   |   |                   | $ | 4,381,706   |                  |  | $ | 13,708,777       |   |  | $ | 13,032,038  |  
|Machine-glazed tissue                    |  |                    | 1,493,603   |   |                   |   | 1,489,430   |                  |  |   | 4,459,115        |   |  |   | 4,547,660   |  
|Foam                                     |  |                    | 21,346      |   |                   |   | 21,347      |                  |  |   | 63,570           |   |  |   | 34,953      |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  
|Consolidated                             |  | $                  | 6,181,395   |   |                   | $ | 5,892,483   |                  |  | $ | 18,231,462       |   |  | $ | 17,614,651  |  
|                                         |  |                    |             |   |                   |   |             |                  |  |   |                  |   |  |   |             |  

Note 8. Income Taxes

The Companys tax provision consists primarily of federal, state and foreign taxes. The fiscal 2010 annual effective tax rate is greater
than the United States statutory rate due to changes in foreign tax credits and discrete items. During the three months ended November 26, 2009, the Company reduced its estimate of foreign tax credits that will be generated in the current year,
which increased the Companys underlying estimated annual effective tax rate from 34.7% to 36.3%, excluding discrete items. The Company recorded discrete tax expense of $1.2 million associated with the filing of the Companys 2009
federal income tax return in the current quarter. The differences primarily related to estimates used to calculate foreign subsidiary deemed dividends and estimates affecting the generation and utilization of alternative minimum tax credits.
The resulting effective income tax rate for the nine months ended November 26, 2009 is 55.1% compared to 32.9% for the nine months ended November 27, 2008.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. The fiscal tax years 2005 through 2009 remain open to examination by the major taxing jurisdictions
to which the Company is subject. As of November 26, 2009, the Company does not expect any material changes to unrecognized tax positions within the next 12 months.



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



Note 9. Goodwill and Other Intangibles, Net



|                              |  |                  |            |   |                  |   |            |  
|----------------------------- |  | ---------------- | ---------- | - | ---------------- | - | ---------- | -
|                              |  | November 26,2009 |            |   | February 28,2009 |  
|Goodwill                      |  | $                | 41,020,138 |   |                  | $ | 41,020,138 |  
|Other Intangible Assets       |  |                  |            |   |                  |   |            |  
|Trademarks                    |  | $                | 9,456,000  |   |                  | $ | 9,456,000  |  
|Non-compete agreements        |  |                  | 12,770,000 |   |                  |   | 12,770,000 |  
|Customer lists                |  |                  | 12,319,000 |   |                  |   | 12,319,000 |  
|                              |  |                  |            |   |                  |   |            |  
|                              |  |                  | 34,545,000 |   |                  |   | 34,545,000 |  
|Accumulated amortization      |  |                  | (6,088,378 | ) |                  |   | (2,872,523 | )
|                              |  |                  |            |   |                  |   |            |  
|Other Intangibles Assets, Net |  | $                | 28,456,622 |   |                  | $ | 31,672,477 |  
|                              |  |                  |            |   |                  |   |            |  

Intangible assets, except for certain trademarks which have an indefinite life, are
being amortized on a straight-line basis, assuming no significant residual value, over the following lives: non-compete agreements-5 years, customer lists-7 years and trademarks with a definite life-3 years.

Note 10. Earnout Payment

In connection with the acquisition of the Company by the current owners in 2006, the Company was required to pay contingent consideration totaling $35.0 million, consisting of cash and shares of Cellu Parents Series A
preferred stock, to the former owners and advisors of Cellu Parent in the event certain financial targets were met. Those financial targets were met and the Company recorded a liability for $35.0 million. All amounts associated with the earnout
were paid as of November 24, 2009 and are listed below:



| |  |  | On August 29, 2008, a $15.0 million contingent consideration payment was made to the former owners and advisors of Cellu Parent, consisting
of $13.7 million in cash and 1,274 shares of Cellu Parents Series A preferred stock valued at approximately $1.3 million.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On August 28, 2009, a $15.0 million contingent consideration payment was made to the former owners and advisors of Cellu Parent, consisting
of $13.7 million in cash and 1,274 shares of Cellu Parents Series A preferred stock valued at approximately $1.3 million.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On November 24, 2009, the remaining payment of $5.0 million was paid to the former owners and advisors of Cellu Parent, consisting of $4.6 million
in cash and 425 shares of Cellu Parents Series A preferred stock valued at approximately $0.4 million.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The contingent consideration was paid out due to the achievement of certain financial targets.

Note 11. Derivatives and Hedging

The Company uses derivative financial instruments to offset a substantial portion of its exposure to market risk arising
from changes in the price of natural gas. Hedging of this risk is accomplished by entering into forward swap contracts, which are designated as hedges of specific quantities of natural gas expected to be purchased in future months. These contracts
are held for purposes other than trading and are designated as cash flow hedges. The Company measures fair value of its derivative financial instruments using fair value as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants. The Company uses a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest
priority to unobservable inputs. The fair value hierarchy is as follows: level 1inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access;
level 2inputs utilize data points that are observable such as quoted prices, interest rate and yield curves; level 3inputs are unobservable data points for the asset or liability, and include situations where there is little,
if any, market activity for the asset or liability.

The Companys natural gas forward contracts are valued using
industry-standard models that use observable market inputs (forward market prices for natural gas) as their basis. The Company classifies these instruments within level 2 of the valuation hierarchy. For level 2 and 3 of the fair value
hierarchy, where appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations (non performance risk). As of November 26, 2009, the fair value of these cash flow hedging instruments was
$1.0 million and is included in other current liabilities. The fair value of cash flow hedges at February 28, 2009 was a liability of $2.7 million, of which $2.4 million is included in other current liabilities and
$0.3 million is included in other liabilities. The notional value of the natural gas forward contracts outstanding is $3.7 million as of November 26, 2009.



12



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



The effects of the Companys natural gas swap contracts on the consolidated
statements of operations are presented below.



|                                                                        |  |                    |           |                  |                   |          |                  |  |                  |           |  |   |        
|----------------------------------------------------------------------- |  | ------------------ | --------- | ---------------- | ----------------- | -------- | ---------------- |  | ---------------- | --------- |  | - | -------
|                                                                        |  | Three Months Ended |           |                  | Nine Months Ended
|                                                                        |  | November 26,2009   |           | November 27,2008 |                   |          | November 26,2009 |  | November 27,2008
|Gain (loss) recognized in comprehensive income/loss                     |  | $                  | 774,901   |                  | $                 | (570,701 | )                |  | $                | 1,762,309 |  | $ | 570,701
|Loss reclassified from accumulated other comprehensive loss into income |  | $                  | 1,389,478 |                  | $                 |         |                  |  | $                | 4,480,221 |  | $ |       

The Companys natural gas swaps for the three and nine months ended
November 27, 2008 did not qualify for hedge accounting treatment, and accordingly, no amounts were recognized in other comprehensive income.

Note 12. Fair Value of Financial Instruments

The following methods and assumptions, including those discussed
in Note 11, were used to estimate fair value for purposes of disclosure:

The Companys 2014 Notes are treated as
level 1 instruments and are recorded at cost which was $246.4 million at November 26, 2009. The estimated fair value of these notes was $279.9 million at November 26, 2009 based on the quoted market price of this debt.

The Companys City Forest Industrial Revenue Bonds in the amount of $16.4 million at November 26, 2009 and
$17.1 million at February 28, 2009 are carried at cost. These bonds are determined to be level 1 instruments. These bonds always trade at par value, with adjustments to the variable interest rate by our independent third party market
maker. The estimated fair value of these bonds was $16.4 million at November 26, 2009 and $17.1 million at February 28, 2009.

The Companys Seller Note Payable in the amount of $6.3 million at November 26, 2009 and February 28, 2009 is carried at cost. The estimated fair value of this note was
$6.3 million at November 26, 2009 and February 28, 2009 based on the discounted cash flows of this instrument. This note has been determined to be a level 3 instrument. The note payable is between the Company and a private party
and has no observable data points to determine fair value.

Note 13. Supplemental Balance Sheet Information

Selected supplemental balance sheet information is presented below.



|                                    |  |                  |             |   |                  |   |             |  
|----------------------------------- |  | ---------------- | ----------- | - | ---------------- | - | ----------- | -
|                                    |  | November 26,2009 |             |   | February 28,2009 |  
|Finished goods                      |  | $                | 31,453,323  |   |                  | $ | 30,608,649  |  
|Raw materials                       |  |                  | 4,756,769   |   |                  |   | 5,133,206   |  
|Packaging materials and supplies    |  |                  | 13,151,815  |   |                  |   | 12,326,731  |  
|Inventory reserves                  |  |                  | (3,068,113  | ) |                  |   | (852,537    | )
|                                    |  |                  |             |   |                  |   |             |  
|                                    |  | $                | 46,293,794  |   |                  | $ | 47,216,049  |  
|                                    |  |                  |             |   |                  |   |             |  
|Property, plant and equipment, net: |  |                  |             |   |                  |   |             |  
|Land                                |  | $                | 4,548,085   |   |                  | $ | 4,307,317   |  
|Buildings                           |  |                  | 37,066,037  |   |                  |   | 35,907,105  |  
|Machinery and equipment             |  |                  | 329,708,554 |   |                  |   | 312,775,269 |  
|Other                               |  |                  | 5,802,862   |   |                  |   | 4,970,279   |  
|Construction in progress            |  |                  | 13,441,511  |   |                  |   | 7,867,380   |  
|                                    |  |                  |             |   |                  |   |             |  
|                                    |  |                  | 390,567,049 |   |                  |   | 365,827,350 |  
|Accumulated depreciation            |  |                  | (83,177,209 | ) |                  |   | (63,839,409 | )
|                                    |  |                  |             |   |                  |   |             |  
|                                    |  | $                | 307,389,840 |   |                  | $ | 301,987,941 |  
|                                    |  |                  |             |   |                  |   |             |  



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##### Table of Contents

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)(Continued)

November 26, 2009



Note 14. Commitments and Contingencies

Investment in Converting Capacity

To satisfy increased customer demand for converted tissue products and to further expand the Companys geographic reach, the Company has accelerated its growth strategy and expects to invest
approximately $30 million over the next 18-24 months to increase retail converting capacity by 50,000 tons. It is anticipated that a portion of this investment will be used to add converting capacity to a new 323,000 square foot facility in Oklahoma
City, Oklahoma. The balance of this investment is expected to be used to add converting capacity to our three established facilities in Neenah, Wisconsin, Thomaston, Georgia and Long Island, New York.

Gabayzadeh Litigation

The Company was a defendant in a suit filed August 11, 2008 in the United States District Court for the Eastern District of New York by Mahin Gabayzadeh, as trustee for and on behalf of The Diane
Gabayzadeh Trust, The Deborah Gabayzadeh Trust and The John Gabayzadeh U.T.M.A. Trust (the Gabayzadeh Litigation). The other defendants in the lawsuit were one of the Companys officers; Steven C. Catalfamo; Kimberly-Clark
Corporation; and Charterhouse Group, Inc. The complaint alleged that the Company fraudulently acquired American Tissue Co.s Neenah, Wisconsin plant for $5.85 million, which the plaintiffs alleged was approximately
$125 million below the then-current appraised liquidation value. The other defendants were alleged to have participated in the fraud. Plaintiffs sought $250 million in damages and alleged joint and several liability. On September 15,
2009, the United States District Court for the Eastern District of New York entered a judgment dismissing the complaint without prejudice.

Note 15. Income Per Share

Basic earnings per share is based on the weighted-average effect of all common
shares issued and outstanding and is calculated by dividing net income by the weighted-average shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common share used
in the basic earnings per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive shares outstanding. Basic and diluted shares outstanding are equal for all periods
presented as there are no potentially dilutive shares outstanding. The following presents basic net income per share and diluted net income per share:



|                                          |  |                    |           |                   |   |                  |  |                  |           |  |   |          
|----------------------------------------- |  | ------------------ | --------- | ----------------- | - | ---------------- |  | ---------------- | --------- |  | - | ---------
|                                          |  | Three Months Ended |           | Nine Months Ended
|                                          |  | November 26,2009   |           | November 27,2008  |   | November 26,2009 |  | November 27,2008
|Basic net income                          |  | $                  | 2,000,011 |                   | $ | 1,838,748        |  | $                | 7,028,350 |  | $ | 2,584,133
|Basic and diluted net income per share:   |  |                    |           |                   |   |                  |  |                  |           |  |   |          
|Weighted average basic and diluted shares |  |                    | 100       |                   |   | 100              |  |                  | 100       |  |   | 100      
|Basic and diluted net income per share    |  | $                  | 20,000.11 |                   | $ | 18,387.48        |  | $                | 70,283.50 |  | $ | 25,841.33

Note 16. Subsequent Events

These financial statements have been evaluated for subsequent events through the filing of these financial statements with the Securities and
Exchange Commission on December 31, 2009.



|Item 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

OVERVIEW

Certain statements contained in this Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended (the Exchange Act), and, as such, may involve known or unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future
results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable
by use



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of the words may, will, should, expect, anticipate, estimate, believe, intend, project,
or comparable terminology. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, those set forth in Item 1. Business-Forward-Looking Statements and Item 1A. Risk Factors
in our Annual Report on Form 10-K for our fiscal year ended February 28, 2009 and Part II Item IA. Risk Factors in this Form 10-Q for the three months ended November 26, 2009. These risks and uncertainties should be considered in
evaluating any forward-looking statements contained herein.

We produce converted tissue products, tissue hard rolls and
machine-glazed tissue, and we believe we are one of the leaders in the value retail converted tissue market. Our customers include leading consumer retailers and away-from-home distributors of tissue products, vertically integrated manufacturers and
third-party converters serving the tissue and machine-glazed tissue segments. Most of the tissue products we convert are internally sourced from the tissue hard rolls that we manufacture to the specifications requested by our customers. The tissue
hard rolls that we manufacture, but do not convert, are marketed to customers for use in various end products, including diapers, bath and facial tissue, assorted paper towels and napkins. In addition to converted tissue products and tissue hard
rolls, we also manufacture machine-glazed tissue and polystyrene foam used in various end products, including food wraps and foam plates. However, foam products are not a significant portion of our business.

We operate in three business segments: tissue, machine-glazed tissue and foam, although we generally operate our business as an integrated
tissue paper company. In our tissue segment, we derive our revenues from the sale of:



| |  |  | converted tissue products, including a variety of private label consumer and away-from-home bath and facial tissue, napkins and folded and rolled
towels; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | tissue hard rolls sold as facial and bath tissue, special medical tissue, industrial wipers, napkin and paper towel stock and absorbent cover stock.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------

We derive our revenues in our machine-glazed tissue segment from the sale of:



| |  |  | machine-glazed tissue paper hard rolls to third-party converters that manufacture fast food and commercial food wrap, as well as niche market products
such as gum wrappers, coffee filters, paper used to line packs of cigarettes, wax paper and butter wraps; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | converted wax products, including wet and dry wax paper, sandwich bags and wax paper.
| | - |  | -------------------------------------------------------------------------------------

We derive our revenues in our foam segment, which was added in fiscal year 2009 in connection with the APF Acquisition, primarily from the
sale of foam plates as a private branded product to a single customer.

APF Acquisition

On July 2, 2008, we consummated the APF Acquisition. The aggregate purchase price paid was $68.0 million, including a cash payment
at closing of $61.7 million and the issuance of a promissory note by us to Atlantic Paper & Foil Corp. of N.Y. in the principal amount of $6.3 million (the Seller Note), plus the assumption of certain liabilities. We
also incurred $2.5 million of transaction related costs. The purchase price, which was subject to post-closing working capital adjustments, was adjusted downward by approximately $63,000 by the working capital adjustment settlement that was
finalized in the third quarter of fiscal year 2009.

The results of operations of the APF entities from the July 2, 2008
date of acquisition are primarily included in our tissue segment. Part of the acquisition related to the foam business, which we report as a separate segment. Unaudited pro forma results of operations for the nine months ended November 27,
2008, as if we and APF had been combined at the beginning of the periods presented, are presented in the notes to the consolidated financial statements.

Business Developments and Trends

The Company has recently filed a Form S-1
with the Securities and Exchange Commission in anticipation of an initial public offering of equity securities (IPO) in 2010. In the event we complete the IPO, we would raise capital that would be used to repay certain debt obligations,
including a portion of our 2014 Notes. In that event, in the reporting period we repay a portion of our 2014 Notes, we will incur one-time non-cash expenses associated with this repayment, including the write-off of a portion of deferred financing
fees and a portion of the unaccreted effective debt discount. In the event we do not complete our IPO, we will be required to expense certain IPO costs that have been incurred and capitalized, such as legal and accounting fees.



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During the second quarter of fiscal 2010, the Company filled its converting capacity for a
number of converted tissue product grades, as strong customer demand reduced inventory below targeted levels. Therefore, to maintain effective customer service levels, improve product mix and support the growth of converted tissue products, the
Company rebuilt inventory levels during the third quarter of fiscal 2010 and completed the installation of a new tissue converting line that became fully operational subsequent to November 26, 2009.

Additionally, to satisfy increased customer demand for converted tissue products and to further expand our geographic reach, the Company has
accelerated its growth strategy and expects to invest approximately $30 million over the next 18-24 months to increase retail converting capacity by 50,000 tons. It is anticipated that a portion of this investment will be used to add converting
capacity to the Companys new 323,000 square foot facility in Oklahoma City, Oklahoma. We expect that the balance of this investment will be used to add converting capacity to our three established facilities in Neenah, Wisconsin, Thomaston,
Georgia and Long Island, New York.

Results of Operations for the Three Months Ended November 26, 2009 (the Fiscal 2010
Three-Month Period)

compared to the Three Months Ended November 27, 2008 (the Fiscal 2009 Three-Month Period)

Consolidated net sales for the fiscal 2010 three month-period decreased $12.9 million, or 9.0%, to
$130.1 million from $143.0 million for the comparable prior year period. On an overall basis, volume contributed $10.0 million to the decrease and lower pricing contributed $2.9 million. During the fiscal 2010 three-month period, we sold
82,012 tons of tissue hardrolls, machine-glazed tissue hardrolls and converted tissue products, a decrease of 6,010 tons, or a decrease of 6.8% over the comparable prior year period. During the fiscal 2010 three-month period, we in-sourced an
additional 5,484 tons of hardrolls for our converting operations that were previously purchased on the hardroll market in the prior year period. This served to reduce external hardroll shipments by a similar amount and improved our overall sales mix
due to higher selling prices for converted tissue products. This is consistent with our strategy to increase the vertical integration of our acquired operations, supporting improved quality control and profitability. Net selling price per ton
decreased to $1,564 during the current period from $1,609 during the comparable prior year period. This decrease in price primarily reflects the downward pricing pressure brought on by lower pulp prices, which was partially offset by the impact of
mix improvements.

Net sales for our tissue segment were $98.6 million during the fiscal 2010 three-month period, a
decrease of $12.5 million, or 11.3% from $111.1 million in the comparable prior year period. The decrease was due primarily to in-sourcing an additional 5,484 tons of hardrolls into our converting operations, partially offset by our October
2009 hardroll price increase and an improved mix with respect to converted tissue products sold. Net selling price per ton increased to $1,675 for the fiscal 2010 three-month period from $1,661 for the fiscal 2009 three-month period. This increase
in net selling price per ton was primarily the result of improvements in product mix and an increase in converted product selling prices, partially offset by downward pricing pressure brought on by lower pulp prices. For the fiscal 2010 three-month
period, we sold 58,884 tons of tissue, of which 30,920 tons were sold as hardrolls and 27,964 tons were sold as converted tissue products, compared to the fiscal 2009 three-month period when we sold 66,903 tons of tissue, of which 39,188 tons were
sold as hardrolls and 27,715 tons were sold as converted tissue products.

Net sales for our machine-glazed tissue segment for
the fiscal 2010 three-month period were $29.7 million, a decrease of $0.8 million or 2.6%, compared to $30.4 million in the comparable prior year period. Tons sold during the fiscal 2010 period increased 9.5%, but this increase was
offset by a decline in selling prices associated with lower pulp prices. Net selling price per ton was $1,283 for the fiscal 2010 three-month period compared to $1,442 per ton for the fiscal 2009 three-month period. For the fiscal 2010 three-month
period, we sold 23,128 tons of machine-glazed tissue, of which 21,057 tons were sold as hardrolls and 2,071 tons were sold as converted machine-glazed tissue products, compared to the fiscal 2009 three-month period when we sold 21,119 tons of
machine-glazed tissue, of which 19,452 tons were sold as hardrolls and 1,667 tons were sold as converted machine-glazed tissue products.

Net sales for our foam segment for the fiscal 2010 three-month period were $1.8 million compared to $1.4 million in the comparable prior year period, due to higher prices and volumes.

Consolidated gross profit was $20.3 million for the fiscal 2010 three-month period or an increase of
$4.2 million from $16.1 million in the comparable prior year period. As a percentage of net sales, gross profit increased to 15.6% in the fiscal 2010 three-month period from 11.3% in the fiscal 2009 three-month period. The improvement was
primarily driven by an increase in converted product selling prices, sales mix, as well as lower pulp and energy costs.



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##### Table of Contents

Gross profit by segment is as follows (in thousands):



|                      |  |                            |        |                  |   |                    |  |   |       |  
|--------------------- |  | -------------------------- | ------ | ---------------- | - | ------------------ |  | - | ----- | -
|                      |  | For the three months ended |        |                  |  
|                      |  | November 26,2009           |        | November 27,2008 |   | Increase(Decrease) | 
|Tissue                |  | $                          | 16,645 |                  | $ | 12,736             |  | $ | 3,909 |  
|Machine-glazed tissue |  |                            | 2,833  |                  |   | 3,287              |  |   | (454  | )
|Foam                  |  |                            | 795    |                  |   | 78                 |  |   | 717   |  
|                      |  |                            |        |                  |   |                    |  |   |       |  
|Total                 |  | $                          | 20,273 |                  | $ | 16,101             |  | $ | 4,172 |  
|                      |  |                            |        |                  |   |                    |  |   |       |  

Tissue gross margins increased to 16.9% for the three months ended November 26,
2009 compared to 11.5% in the comparable prior year period. In addition to the factors also noted above for net sales, these favorable results were also due to reduced fiber and energy prices and increased sales of our converted tissue products,
which leveraged our ability to incrementally use more internally manufactured hardrolls.

Machine-glazed tissue gross margins
decreased to 9.5% for the three months ended November 26, 2009 compared to 10.8% in the comparable prior year period. The decrease in gross margin was primarily attributable to lower selling prices, partially offset by lower fiber costs.

Foam gross margins were 43.2% for the three months ended November 26, 2009 compared to 5.4% in the comparable prior year
period as a result of lower resin prices, the primary raw material used to manufacture our foam products, and an improvement in selling prices.

Selling, general and administrative expenses were $5.0 million for the three months ended November 26, 2009 compared to $5.5 million for the comparable three month period in fiscal 2009.
As a percentage of net sales, expenses were 3.9% for the current period, compared to 3.8% for the prior period. Additionally, stock-based compensation was $0.2 million in both the 2010 and 2009 three-month period.

Amortization expense in the fiscal 2010 three-month period of $1.1 million relates to the amortization of the intangible assets
recorded in connection with the APF Acquisition.

Interest expense, net in the fiscal 2010 three-month period was
$8.5 million compared to $6.9 million in the fiscal 2009 three-month period. The increase in the fiscal 2010 three-month period is primarily attributable to the higher interest rate and debt issuance costs related to the 2014 Notes that
were issued in the three-month period ended August 27, 2009.

Foreign currency gain (loss)in the fiscal 2010
three-month period was a loss of $0.4 million compared to a gain of $0.2 million in the fiscal 2009 three-month period. The fluctuation relates to the change in the Canadian currency exchange rate period over period.

Income tax expensefor the fiscal 2010 third quarter was $3.4 million compared to income tax expense of $0.9 million for
the fiscal 2009 third quarter. During the fiscal 2010 third quarter, the Company reduced its estimate of foreign tax credits that will be generated in the current year, which increased the Companys underlying estimated annual effective tax
rate from 34.7% to 36.3%. In addition, included in income tax expense for the fiscal 2010 third quarter are $1.2 million of discrete tax adjustments that increased income tax expense. These discrete adjustments primarily arose from changes in
management estimates relating to the calculation of foreign subsidiary deemed dividends and the generation and utilization of alternative minimum tax credits, which were recorded as tax expense in the current quarter.

Results of Operations for the Nine Months Ended November 26, 2009 (the Fiscal 2010 Nine Month Period)

compared to the Nine Months ended November 27, 2008 (the Fiscal 2009 Nine Month Period)

Consolidated net sales for the fiscal 2010 nine-month period decreased $3.7 million, or 0.9%, to $386.9 million from
$390.6 million for the comparable prior year period. On an overall basis, pricing contributed $4.8 million of the decrease and was partially offset by higher volume of $1.1 million. During the fiscal 2010 nine-month period, we sold 249,348 tons
of tissue hard rolls, machine-glazed tissue hard rolls and converted paper products. This decrease of 1,130 tons, or 0.5% over the comparable prior year period, which was due to fewer tons of tissue hardrolls sold, partially offset by an increase in
tons sold of converted tissue products, a portion of which was due to the July 2008 acquisition of APF, and machine-glazed tissue. During the fiscal 2010 nine-month period, we in-sourced an additional 9,025 tons of hardrolls for our converting
operations that were previously purchased on the hardroll market. This served to reduce external hardroll shipments by a similar amount. Net selling price per ton decreased to $1,528 during the current period from $1,550 during the prior year
period. This decrease in price primarily reflects the downward pricing pressure associated with declines in pulp prices, partially offset by improvements in product mix.



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##### Table of Contents

Net sales for our tissue segment were $299.9 million during the fiscal 2010 nine-month
period, a decrease of $0.5 million over the comparable prior year period. Decreased hardroll sales volumes were partially offset by an improvement in mix with respect to increased converting tons sold and moderate overall price improvements in
revenue per ton of approximately 2.1%. Price and mix improvements were driven by the APF Acquisition in fiscal 2009 and the achievement of related synergies. Net selling price per ton increased to $1,631 for the fiscal 2010 nine-month period from
$1,598 for the fiscal 2009 nine-month period. This increase in net selling price per ton was primarily the result of improvements in product mix derived both from the APF Acquisition and organic growth in converted sales and, to a lesser extent,
increase in prices. During the fiscal 2010 nine-month period we in-sourced an additional 9,025 tons of hardrolls into our converting operations that were previously purchased on the hardroll market in the prior year period. This served to reduce
external hardroll shipments by a similar amount. For the fiscal 2010 nine-month period, we sold 183,850 tons of tissue, of which 102,010 tons were sold as hardrolls and 81,840 tons were sold as converted tissue products, compared to the fiscal 2009
nine-month period when we sold 188,004 tons of tissue, of which 121,953 tons were sold as hardrolls and 66,051 tons were sold as converted tissue products. Compared to the fiscal 2009 nine-month period, the increase in converted tons sold primarily
reflects the APF Acquisition and organic growth in our converted tissue shipments. The reduction in hardroll shipments reflects a mix shift from hardrolls to converted tons within the tissue segment.

Net sales for our machine-glazed tissue segment for the fiscal 2010 nine-month period were $81.2 million, a decrease of $6.7 million or
7.6%, compared to $87.9 million in the comparable prior year period. Tons sold during the fiscal 2010 nine-month period increased 4.8%, but were more than offset by an 11.9% decline in selling prices that resulted from lower pulp prices. Net
selling price per ton was $1,240 for the fiscal 2010 nine-month period compared to $1,407 per ton for the fiscal 2009 nine-month period. For the fiscal 2010 nine-month period, we sold 65,498 tons of machine-glazed tissue, of which 61,003 tons were
sold as hardrolls and 4,495 tons were sold as converted machine-glazed tissue products, compared to the fiscal 2009 nine-month period where we sold 62,474 tons of machine-glazed tissue, of which 57,960 tons were sold as hardrolls and 4,514 tons were
sold as converted machine-glazed tissue products.

Net sales for our foam segment for the fiscal 2010 nine-month period were
$5.8 million compared to $2.3 million in the prior year period. The comparable prior year nine-month period consisted of approximately five months of results from APF, which was acquired in July 2008.

Consolidated gross profit was $62.7 million for the fiscal 2010 nine-month period or an increase of $23.8 million from
$38.9 million in the comparable prior year period. As a percentage of net sales, gross profit increased to 16.2% in the fiscal 2010 nine-month period from 10.0% in the fiscal 2009 nine-month period. The improvement was driven by the overall
volume, mix and selling price changes as discussed above, as well as favorable improvements in pulp pricing and lower energy costs, which were partially offset by a $2.1 million increase in expense to record inventory at the lower of cost or
market value.

Gross profit by segment is as follows, (in thousands):



|                      |  |                           |        |                  |   |          |  |   |       
|--------------------- |  | ------------------------- | ------ | ---------------- | - | -------- |  | - | ------
|                      |  | For the nine months ended |        |                 
|                      |  | November 26,2009          |        | November 27,2008 |   | Increase
|Tissue                |  | $                         | 52,700 |                  | $ | 32,328   |  | $ | 20,372
|Machine-glazed tissue |  |                           | 7,994  |                  |   | 6,300    |  |   | 1,694 
|Foam                  |  |                           | 2,035  |                  |   | 261      |  |   | 1,774 
|                      |  |                           |        |                  |   |          |  |   |       
|Total                 |  | $                         | 62,729 |                  | $ | 38,889   |  | $ | 23,840
|                      |  |                           |        |                  |   |          |  |   |       

Tissue gross margins increased to 17.6% for the nine months ended November 26,
2009 compared to 10.8% in the comparable prior year period. In addition to the factors noted above for net sales, these favorable results were also due to lower fiber and energy costs and increased sales of our converted tissue products, which
leveraged our ability to incrementally use more internally manufactured hardrolls, which were partially offset by a $2.1 million increase in expense to record inventory at the lower of cost or market value.

Machine-glazed tissue gross margins increased to 9.8% for the nine months ended November 26, 2009 compared to 7.2% in the comparable
prior year period. In addition to the factors noted above for net sales, the increase in gross margin was primarily attributable to lower pulp, energy and other raw material prices, along with favorable machine productivity.

Foam gross margins were 35.1% for the nine months ended November 26, 2009 compared to 11.2% in the comparable prior year period as a
result of reduced resin prices, which is the primary raw material used to manufacture our foam products, and improvement in selling price.



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##### Table of Contents

Selling, general and administrative expenses were $15.9 million for the nine
months ended November 26, 2009 compared to $15.0 million for the comparable nine month period. As a percentage of net sales, expenses were 4.1% for the current period, compared to 3.9% for the prior period. The increase is primarily
attributable to cash-based incentive compensation expense as a result of the achievement of previously established performance goals. Additionally, stock-based compensation was $0.6 million and $0.7 million in the 2010 and 2009 nine-month
periods, respectively.

Amortization expense in the fiscal 2010 nine-month period of $3.2 million relates to the
amortization of the intangible assets recorded in connection with the APF Acquisition.

Interest expense, net in the
fiscal 2010 nine-month period was $27.4 million compared to $18.0 million in the fiscal 2009 nine month period. The fiscal 2010 nine-month period includes the effects of extinguishing our 2010 Notes and the issuance of our 2014 Notes.
Non-recurring costs of extinguishing our 2010 Notes include both the write-off of deferred financing fees of $2.2 million and incremental interest expense of $1.7 million due to the period of time that elapsed between the issuance of the
2014 Notes and the extinguishment of the 2010 Notes. The remaining increase is primarily attributable to the higher interest rates and debt issuance costs related to the 2014 Notes.

Foreign currency (gain) lossin the fiscal 2010 nine-month period was a loss of $1.1 million compared to a gain of
$0.2 million in the fiscal 2009 nine-month period. The fluctuation relates to the change in the Canadian currency exchange rate period over period.

Income tax expensefor the fiscal 2010 nine-month period was $8.6 million compared to income tax expense of $1.3 million for the fiscal 2009 comparable period. During the fiscal 2010
nine-month period, the Company reduced its estimate of foreign tax credits that will be generated in the current year, which increased the Companys underlying estimated annual effective tax rate from 34.7% to 36.3%. In addition, included in
income tax expense for the fiscal 2010 nine-month period are $1.2 million of discrete tax adjustments that increased income tax expense. These discrete adjustments primarily arose from changes in management estimates relating to the calculation of
foreign subsidiary deemed dividends and the generation and utilization of alternative minimum tax credits, which were recorded as tax expense in the current quarter. Additionally, the fiscal 2010 nine-month period also includes discrete tax expense
of $1.8 million associated with an increase in the Companys federal tax rate from 34% to 35% for fiscal 2010 based on projected taxable income and the benefit of a change in state tax laws.

FINANCIAL CONDITION

Liquidity and Capital Resources

Our principal liquidity requirements are
to service debt and meet working capital, tax and capital expenditure needs. Our total debt at November 26, 2009 was $269.1 million. We fund our working capital requirements, capital expenditure needs and tax liabilities from net cash
provided by operating activities and borrowings under our working capital facility. Additionally, in the past, we have issued debt securities to fund acquisitions.

Based on current forecasts and anticipated market conditions, we believe that funding generated from operating cash flows and available sources of liquidity will be sufficient to meet all of our operating
needs, to make planned capital expenditures and to make all required interest and principal payments on indebtedness for the next twelve to eighteen months. However, our operating cash flows and liquidity are significantly influenced by numerous
factors, including prices of pulp fiber, interest rates and the general economy.

As a result of the debt financing completed
during June 2009, our principal debt payments are expected to be $0.8 million in fiscal 2010, $0.8 million in fiscal 2011, $7.1 million in fiscal 2012, $0.8 million in fiscal 2013, $0.8 million in fiscal 2014 and
$268.3 million in fiscal 2015 and thereafter. Additionally, cash interest payments are expected to be $22.4 million fiscal 2010, $30.6 million in fiscal 2011, $30.2 million in fiscal 2012, $29.8 million in fiscal 2013,
$29.7 million in fiscal 2014 and $18.0 million in fiscal 2015 and thereafter.

The following is a summary of our
indebtedness. For additional information regarding our indebtedness, see the notes to the consolidated financial statements.



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Working capital facility

We have a $60.0 million working capital facility that matures on June 12, 2011. Borrowings under the working capital facility are
secured by liens on substantially all of the Companys assets and guaranteed by the Companys subsidiaries. As of November 26, 2009, there were no borrowings outstanding under the working capital facility and excess availability, less
letters of credit of $4.6 million in the aggregate principal amount was $52.2 million.

2014 Notes

In June 2009, we issued $255 million principal face amount of 111/2% senior secured notes maturing on June 1, 2014 (the 2014
Notes), with an effective interest rate of 12.48%. The 2014 Notes pay interest in arrears on June 1 and December 1 of each year, commencing on December 1, 2009. The 2014 Notes are secured by liens on substantially all of the
Companys assets and guaranteed by the Companys subsidiaries. The net proceeds of $245.7 million from the issuance of the 2014 Notes were primarily used to redeem the 2010 Notes and fund the contingent earnout payment made on
August 28, 2009 in conjunction with the 2006 acquisition of Parent by Weston Presidio V, L.P.

APF Note

As part of the financing of the APF Acquisition, we entered into a subordinated, unsecured promissory note in the
amount of $6.3 million that bears interest at 12% per year payable in quarterly installments with the principal due July 2, 2011.

CityForest Industrial Revenue Bonds

Our subsidiary, CityForest, had
approximately $16.4 million in aggregate principal amount of industrial revenue bonds outstanding as of November 26, 2009. We have guaranteed all of the obligations of CityForest. We are required to annually pay $760,000 of principal of
the bonds in two semi-annual payments of $380,000.

Contingent Payment

In connection with the acquisition of the Company by the current owners, the Company was required to pay up to $35.0 million of
contingent consideration in cash and shares of Cellu Parents Series A preferred stock to the former owners and advisors of Cellu Parent in the event certain financial targets were met. All financial targets were met and
$15.0 million, consisting of cash and shares of Series A preferred stock, was paid in fiscal 2009. A second payment of $15.0 million, consisting of cash and shares of Series A preferred stock, was paid on August 28, 2009.
The final payment of $5.0 million, consisting of cash and shares of Series A preferred stock, was paid on November 24, 2009.

Cash Flows

Net cash provided by operations was $53.7 million
for the fiscal 2010 nine month period compared to $9.6 million for the fiscal 2009 nine month period. Net income for the fiscal 2010 nine-month period was $7.0 million, an increase of $4.4 million over the fiscal 2009 nine-month period.
Net cash flow provided from working capital was $16.3 million for the fiscal 2010 nine month period compared to net cash used by working capital of $15.9 million in the fiscal 2009 period. This favorable increase is primarily reflective of
the timing of long-term debt interest payments, the timing of payments related to purchases of pulp fiber, an improvement in customer cash collections and a focus on managing inventory production to more closely match the timing of our
customers orders. We also incurred $2.2 million of non-cash expenditures as a result of extinguishing a portion of our debt during the fiscal 2010 period. Additionally, net deferred income tax assets increased $3.4 million during the
fiscal 2010 period as a result of an increase in the Companys federal tax rate, and amortization expense increased by $1.2 million in the fiscal 2010 period as a result of the APF Acquisition.

Net cash used in investing activities for the fiscal 2010 nine month period was $19.8 million compared to $73.9 million in
the fiscal 2009 nine month period. The fiscal 2009 nine month period includes $64.2 million of cash paid for the APF Acquisition. The remaining change relates to the level of capital spending period over period. The increased level of spending
is primarily due to expanding our converting capacity and the completion of our East Hartford, Connecticut energy cogeneration facility.

Net cash used by financing activities for the fiscal 2010 nine month period was $27.1 million compared to cash provided by financing activities of $63.3 million in fiscal 2009 nine month
period. The activity in the fiscal 2010 period is



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primarily driven by the refinancing of our debt that was to mature during fiscal 2010 and the excess cash generated by operations. Both were used to reduce borrowings on our revolving line of
credit to zero. The financing activity for the fiscal 2009 period was primarily related to financing obtained in connection with the APF Acquisition.

Balance Sheet

Receivables, net as of November 26, 2009
decreased to $50.6 million from $54.1 million as of the end of fiscal year 2009. Receivables decreased as a result of increased cash collections that resulted primarily from a focus on accelerating certain customer payments.

Property, plant and equipment, net as of November 26, 2009 increased $5.4 million to $307.4 million from
$302.0 million as of the end of fiscal year 2009. Routine capital expenditures, including deposits made in conjunction with our efforts to expand our converting capacity, were partially offset by depreciation expense.

Other intangibles, net as of November 26, 2009 decreased to $28.5 million from $31.7 million as of the end of fiscal
year 2009 as a result of amortization expense during the current period.

Other assets as of November 26, 2009
increased to $10.4 million from $1.9 million as of the end of fiscal year 2009 due to payment of deferred financing fees that were capitalized in conjunction with the issuance of the 2014 Notes.

Bank overdrafts were $0 as of November 26, 2009 compared to $3.3 million at February 28, 2009 due to increased cash
balances as of November 26, 2009.

Revolving line of credit was $0 as of November 26, 2009 compared to a
balance of $18.5 million as a result of cash generated from operations and the issuance of the 2014 Notes during fiscal 2010. Available cash generated during the current period was applied to the revolving line of credit.

Accounts payable as of November 26, 2009 increased to $21.3 million from $16.7 million as of the end of fiscal year 2009
primarily as a result of the timing of various payments, including for spot pulp purchases.

Accrued interest as of
November 26, 2009 increased to $14.4 million from $10.2 million at the end of fiscal year 2009 as a result of the issuance of the 2014 Notes which have interest payments due in June and December. The 2010 Notes, which were retired
during the quarter ended August 27, 2009, had interest payments due in March and September.

Other current
liabilities as of November 26, 2009, decreased to $1.0 million from $17.4 million as of the end of fiscal year 2009 as a result of the $15.0 million earnout payment paid on August 28, 2009.

Deferred income tax assets and liabilities increased as a result of the Companys increase in the statutory federal income rate
from 34% to 35% and the current year income tax provision.

Long-term debt as of November 26, 2009 increased to
$268.3 million from $242.4 million as of the end of fiscal year 2009 as a result of the issuance of the 2014 Notes and the redemption of the 2010 Notes during the quarter ended August 27, 2009.

Other liabilities as of November 26, 2009 decreased to $1.0 million from $5.4 million as of the end of fiscal year 2009 as a
result of the $5.0 million earnout payment paid on November 24, 2009.

Commitments

To satisfy increased customer demand for converted tissue products and to further expand our geographic reach, we have accelerated our growth
strategy and expect to invest approximately $30 million over the next 18-24 months to increase retail converting capacity by 50,000 tons. It is anticipated that a portion of this investment will be used to add converting capacity to our new 323,000
square foot facility in Oklahoma City, Oklahoma. We expect that the balance of this investment will be used to add converting capacity to our three established facilities in Neenah, Wisconsin, Thomaston, Georgia and Long Island, New York.



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Critical Accounting Policies

Our critical accounting policies are discussed in Managements Discussion and Analysis of Financial Condition and Results of Operations
in our Annual Report on Form 10-K for fiscal year 2009. The preparation of our financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of
contingent assets and liabilities. We base our accounting estimates on historical experience and other factors that we believe to be reasonable under the circumstances. However, actual results may vary from these estimates under different
assumptions or conditions.

New Accounting Pronouncements

See Note 1 of Notes to Consolidated Financial Statements included in Part I  Item 1  Financial
Statements for a description of recently issued and adopted accounting pronouncements, including the expected dates of adoption and estimated effects on our results of operations, financial position and cash flows.



|Item 3. | Quantitative and Qualitative Disclosures about Market Risk
|------- | ----------------------------------------------------------

We use natural gas swap contracts with a cumulative total notional amount of approximately $3.7 million for 525,767 MMbtu at November 26, 2009 to hedge against cash flow variability arising from
changes in natural gas prices in conjunction with our anticipated purchases of natural gas through August 2010. These swap contracts fix the rates on portions of our natural gas purchases to rates ranging from $4.62 per MMbtu to $7.52 per MMbtu for
various periods through August 2010. These swap contracts were accounted for as effective hedges during fiscal year 2010. These natural gas swap contracts had a liability fair value of $1.0 million at November 26, 2009, which was included
in other current liabilities. Approximately 52% of our natural gas requirements are hedged through August 2010.

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

Although as of November 26, 2009 we did not have any outstanding
borrowings under our working capital facility, to the extent that we borrow under the working capital facility in the future our interest expense for such borrowings would be affected by changes in interest rates. In addition, amounts borrowed by
CityForest under the CityForest revolving credit facility bear interest at a rate per annum equal to the LIBOR Rate (as defined in the Reimbursement Agreement), plus an applicable margin. Accordingly, the interest expense for borrowings under the
CityForest revolving credit facility would also be affected by changes in interest rates.

We are also subject to commodity
price risk associated with pulp costs and take advantage of spot prices on pulps to minimize market risk arising from changes in pulp costs.



|Item 4. | Controls and Procedures
|------- | -----------------------

(a) Disclosure Controls and Procedures. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and Exchange Commission (SEC) rules and forms. Disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act,
include controls and procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including the Chief Executive Officer and the
Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system
are met.

As required by SEC rules, we have evaluated the effectiveness of the design and operation of our disclosure controls
and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. This evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief
Financial Officer. Based on this evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, has concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of
November 26, 2009.



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(b) Changes in Internal Control Over Financial Reporting. There have not been any changes in
the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended November 26, 2009 to which this report relates that have materially
affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.

PART IIOTHER INFORMATION



|Item 1. | Legal Proceedings:
|------- | ------------------

Gabayzadeh Litigation

We were a defendant in a suit filed August 11, 2008 in the United States
District Court for the Eastern District of New York by Mahin Gabayzadeh, as trustee for and on behalf of The Diane Gabayzadeh Trust, The Deborah Gabayzadeh Trust and The John Gabayzadeh U.T.M.A. Trust (the Gabayzadeh Litigation). The
other defendants in the lawsuit were Russell C. Taylor, our chief executive officer; Steven C. Catalfamo; Kimberly-Clark Corporation; and Charterhouse Group, Inc. The complaint alleged that we fraudulently acquired American
Tissue Co.s Neenah, Wisconsin plant for $5.85 million, which the plaintiffs alleged was approximately $125 million below the then-current appraised liquidation value. The other defendants were alleged to have participated in the
fraud. Plaintiffs sought $250 million in damages and alleged joint and several liability. On September 15, 2009, the United States District Court for the Eastern District of New York entered a judgment dismissing the complaint without
prejudice.



|Item 1A. | Risk Factors
|-------- | ------------

Except as
set forth below, the risk factors included in our Annual Report on Form 10-K for the fiscal year ended February 28, 2009 have not materially changed.

Our operating results depend upon our wood pulp costs. An increase in wood pulp costs could have a material adverse effect on our business, financial condition and operating results.

Pulp is the principal raw material used in the manufacture of our specialty paper and tissue products. It is
purchased in highly competitive, price sensitive markets. We buy a significant amount of pulp and other raw materials either through supply agreements or on the spot market. For fiscal year 2009, we purchased approximately 331,000 metric tons of
pulp and recycled fiber at a cost of $185.7 million compared to 322,000 metric tons in fiscal year 2008 at a cost of $178.5 million. For the nine months ended November 26, 2009, we purchased approximately 239,126 metric tons of pulp
and recycled fiber at a cost of $100.5 million compared to 244,544 metric tons in the nine months ended November 27, 2008 at a cost of $144.5 million. Pulp prices continued to increase in the third quarter of fiscal 2010 from their low point in
April 2009 and are expected to increase in the fourth quarter of fiscal 2010, though they have remained below the peak price levels of fiscal 2009. When pulp prices increase, we can generally pass most increases in the cost of pulp through to our
customers, but price increases may not be passed to customers for three months or more after such increases in pulp prices occur. In some cases, the lag may be longer or we may not be able to pass through such cost increases at all. When pulp prices
decline, we generally pass most decreases in the cost of pulp through to our tissue and machine-glazed tissue hardroll customers. For example, net sales in our machine-glazed tissue segment decreased 8.0% in the fourth quarter of fiscal year 2009 in
part because of a decrease in net selling price per ton following a decrease in pulp prices. In addition, many of our arrangements with away-from-home hardroll customers do not have price escalators relating to wood pulp prices, and consequently, in
some instances, we are unable to pass along an increase in pulp costs to these customers.

We have agreements with various
pulp vendors to purchase various amounts of pulp over the next two years. These commitments require purchases of pulp up to approximately 153,000 metric tons per year at pulp prices below published list prices and allow us to shift a portion of our
pulp purchases to the spot market to take advantage of spot market prices when such prices fall. We believe that our current commitment under these arrangements or their equivalent approximates 50% to 65% of our current budgeted pulp needs through
fiscal year 2012. If upon expiration of these agreements, or upon failure of our suppliers to fulfill their obligations under these agreements, we are unable to obtain wood pulp on terms as favorable as those contained therein, our cost of goods
sold may increase and results of operations will be impaired. As a result, our ability to satisfy customer demands and to manufacture products in a cost-effective manner may be materially adversely affected.

In addition, the costs and availability of wood pulp have at times fluctuated greatly because of weather, economic global buying behaviors
or general industry conditions. From time to time, timber harvesting may be limited by natural events, such as fire, insect infestation, disease, ice storms, excessive rainfall and wind storms or by harvesting restrictions. Production levels within
the forest products industry are also affected by such factors as currency fluctuations, duties and finished lumber prices. These factors may increase the price we have to pay to our existing or any new suppliers. In the presence of oversupply in
the markets we serve, selling prices of our finished products may not increase in response to raw material price increases. If we are unable to pass any raw material price increases through to our customers, our business financial condition and
operating results may be materially adversely affected.



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Our significant debt obligations, or our incurrence of additional debt, could limit our flexibility in
managing our business and could materially and adversely effect our financial performance.

We are highly leveraged.
As of November 26, 2009, we had approximately $268.3 million of long-term indebtedness outstanding. In addition, we are permitted under our revolving line of credit, which we refer to in this prospectus as our working capital facility, and the
indenture governing our senior secured notes to incur additional debt, subject to certain limitations. Our high degree of leverage may have important consequences to you, including the following:



| |  |  | we may have difficulty satisfying our obligations under our indebtedness and, if we fail to comply with these requirements, an event of default could
result;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may be required to dedicate a substantial portion of our cash flow from operations to required payments on indebtedness, thereby reducing the
availability of cash flow for working capital, capital expenditures and other general corporate activities (please refer to the table below under the heading Managements Discussion and Analysis of Financial Condition and Results of
OperationsContractual Obligations, which sets forth our payment obligations with respect to our existing long-term debt);
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | covenants relating to our debt may limit our ability to obtain additional financing for working capital, capital expenditures and other general
corporate activities;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | covenants relating 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 more vulnerable than our competitors to the impact of economic downturns and adverse developments in our business; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may be placed at a competitive disadvantage against any less leveraged competitors.
| | - |  | --------------------------------------------------------------------------------------

The occurrence of any one of these events could have a material adverse effect on our business, financial condition, operating results, and
ability to satisfy our obligations under our indebtedness.

In addition, subject to restrictions in the indenture governing
our senior secured notes and restrictions in our working capital facility, we may incur additional indebtedness. As of November 26, 2009, we had approximately $52.2 million of availability under our working capital facility, after giving effect
to outstanding letters of credit having a face amount of approximately $4.6 million. The terms of the indenture governing our senior secured notes permit us to incur additional debt, including a limited amount of additional secured debt. Any
additional indebtedness we incur could increase the risks associated with our already substantial indebtedness and could have a material adverse effect on our business, financial condition and operating results.

Our energy costs may be higher than we anticipate, which could have a material adverse effect on our business, financial condition and operating
results.

We use energymainly natural gas and electricityto operate machinery and to generate steam, which
we use in our production process. In the past, energy prices, particularly for natural gas and fuel oil, have increased, with a corresponding effect on our production costs. Although energy prices have been decreasing recently, such costs may
increase again in the future. During fiscal year 2009 and 2008, and the nine months ended November 26, 2009 and November 27, 2008, we spent approximately $56.3 million, $50.7 million, $33.7 million and $42.6 million,
respectively, on electricity, natural gas, oil and coal. If our energy costs are greater than anticipated, our business, financial condition and operating results may be materially adversely affected.

Labor disputes or increased labor costs could disrupt our business and have a material adverse effect on our financial condition and operating
results.

As of February 28, 2009, approximately 54% of our active full-time employees were represented by either
the United Steelworkers of America or the Independent Paper Workers of Canada through various collective bargaining agreements. The collective bargaining agreements for our facilities expire between October 2009 and June 2013. We commenced
collective bargaining negotiations at our Menominee, Michigan facility in late November 2009 and we are currently preparing for collective bargaining negotiations at our Gouverneur, New York facility, which we expect to begin in early January 2010.
It is likely that our workers will seek an increase in wages and benefits at the expiration of each of those contracts. Any significant work stoppage in the future or any significant increase in labor costs could have a material adverse effect on
our business, financial condition and operating results.



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We are dependent upon continued demand from our large customers. If we lose order volumes from any of
our largest customers, our business, financial condition and operating results could be materially and adversely affected.

Our largest customers account for a significant portion of our sales. Our ten largest customers represented 54.9% of our sales for fiscal year 2007, 51.3% of our sales for fiscal year 2008 and 46.3% of our sales for the fiscal year 2009.
Our largest single customer represented 13.4% of our sales in fiscal year 2008 and less than 10% of our sales in fiscal year 2009. Our ten largest customers represented 46.5% and 46.7% of our sales for the nine months ended November 26, 2009
and November 27, 2008, respectively. Our single largest customer represented 10.5% and 8.1% of our sales in the nine months ended November 26, 2009 and November 27, 2008, respectively. Some of our large customers (including four of
our ten largest customers) have the capability of producing the products that they currently buy from us. The loss or significant reduction of orders from any of our largest customers could have a material adverse effect on our business, financial
condition and operating results.

Restrictive covenants in our working capital facility and the indenture governing our senior secured
notes may restrict our ability to pursue our business strategies.

Our working capital facility and the indenture
governing our senior secured notes limit our ability, among other things, to:



| |  |  | incur additional debt and guarantees;
| | - |  | -------------------------------------



| |  |  | pay dividends and repurchase our stock;
| | - |  | ---------------------------------------



| |  |  | make other restricted payments, including without limitation, investments;
| | - |  | --------------------------------------------------------------------------



| |  |  | create liens;
| | - |  | -------------



| |  |  | sell or otherwise dispose of assets, including capital stock of restricted subsidiaries;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | enter into sale and leaseback transactions;
| | - |  | -------------------------------------------



| |  |  | enter into agreements that restrict dividends from subsidiaries;
| | - |  | ----------------------------------------------------------------



| |  |  | enter into transactions with our affiliates;
| | - |  | --------------------------------------------



| |  |  | consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | enter into new lines of business.
| | - |  | ---------------------------------

The agreement governing our working capital facility also requires us to maintain compliance with a 1:1 fixed charge coverage ratio if the average monthly availability under the facility is less than 15%
of the facility commitment. Although the average monthly availability as of November 26, 2009 $52.2 million, which was significantly higher than the covenant trigger level of $9.0 million, our ability to comply with this ratio may be
affected by events beyond our control.

The restrictions contained in the indenture governing our senior secured notes and the
agreement governing our working capital facility could:



| |  |  | limit our ability to plan for or react to market conditions or meet capital needs or otherwise restrict our activities or business plans; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adversely affect our ability to finance our operations, strategic acquisitions, investments or alliances or other capital needs or to engage in other
business activities that would be in our interest.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Any failure on our part to comply with these restrictive
covenants may result in an event of default. Such event of default may trigger an acceleration right for our lenders under our working capital facility or the holders of our senior secured notes. If our obligations to repay the indebtedness under
our working capital facility or our senior secured notes were accelerated, we cannot assure you that we would have sufficient assets to repay in full such indebtedness.

We may not be able to generate sufficient cash flows to meet our debt service obligations.

Our ability to make scheduled payments on, or to refinance, our obligations with respect to our indebtedness will depend on our financial and operating performance, which in turn will be affected by
general economic conditions and by



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financial, competitive, regulatory and other factors beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future sources of
capital will be available to us in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. If we are unable to generate sufficient cash flow to satisfy our debt obligations, we may have to undertake
alternative financing plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital investments or seeking to raise additional capital. We cannot assure you that any refinancing would be possible, that any assets
could be sold, or, if sold, of the timing of the sales and the amount of proceeds that may be realized from those sales, or that additional financing could be obtained on acceptable terms, if at all. Our working capital facility and the indenture
governing our senior secured notes restrict our ability to dispose of assets and use the proceeds from the disposition. Our inability to generate sufficient cash flows to satisfy our debt obligations, or to refinance our indebtedness on commercially
reasonable terms, would materially and adversely affect our financial condition and operating results.

We are subject to significant
environmental, health and safety laws and regulations and compliance expenditures. The cost of compliance with, and liabilities under, such laws and regulations could materially and adversely affect our business, financial condition and operating
results.

Our business is subject to a wide range of federal, state, local and foreign general and industry specific
environmental, health and safety laws and regulations, including those relating to air emissions, wastewater discharges, solid and hazardous waste management and disposal and site remediation. We are also subject to frequent inspections and
monitoring by government enforcement authorities. Compliance with these laws and regulations is a significant factor in our business. From time to time, we incur significant capital and operating expenditures to achieve and maintain compliance with
applicable environmental laws and regulations. Our failure to comply with applicable environmental laws and regulations or permit requirements could result in substantial civil or criminal fines or penalties or enforcement actions, including
regulatory or judicial orders enjoining or curtailing operations or requiring remedial or corrective measures, installation of pollution control equipment or other actions, which could have a material adverse effect on our business, financial
condition and operating results.

Certain of our operations also require environmental permits or other approvals from
governmental authorities, and certain of these permits and approvals are subject to expiration, denial, revocation or modification under various circumstances. Failure to obtain or comply with these permits and approvals, or with other environmental
requirements, may subject us to civil or criminal enforcement proceedings that could lead to substantial fines and penalties being imposed against us, orders requiring us to take certain actions or temporary or permanent shutdown of our affected
operations. Such enforcement proceedings could also have a material adverse effect on our business, financial condition and operating results.

In addition, as an owner and operator of real estate, we may be responsible under environmental laws and regulations for the investigation, remediation and monitoring, as well as associated costs,
expenses and third-party damages, including tort liability and natural resource damages, relating to past or present releases of hazardous substances on or from our properties. Liability under these laws may be imposed without regard to whether we
knew of, or were responsible for, the presence of those substances on our property, may be joint and several, meaning that the entire liability may be imposed on each party without regard to contribution, and retroactive and may not be limited to
the value of the property. In addition, we or others may discover new material environmental liabilities, including liabilities related to third-party owned properties that we or our predecessors formerly owned or operated, or at which we or our
predecessors have disposed of, or arranged for the disposal of, certain materials. We may be involved in administrative or judicial proceedings and inquiries in the future relating to such environmental matters which could have a material adverse
effect on our business, financial condition and operating results.

New environmental laws or regulations (or changes in
existing laws or regulations or their enforcement) may be enacted that require significant expenditures by us. If the resulting expenses significantly exceed our expectations, our business, financial condition and operating results could be
materially and adversely affected. For example, there has been a recent legislative focus on greenhouse gas emissions, which could lead to laws or regulations requiring expenditures at our coal-based Menominee, Michigan facility or at other of our
facilities.

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



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We may expand through acquisitions of other companies, which may divert our managements
attention and result in unexpected operating difficulties, increased costs and dilution to our stockholders.

We may
make strategic acquisitions of other businesses. An acquisition may result in unforeseen operating difficulties and expenditures in assimilating or integrating the businesses, technologies, products, personnel or operations of the acquired
companies. Furthermore, future acquisitions may:



| |  |  | involve our entry into geographic or business markets in which we have little or no prior experience;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | create difficulties in retaining the customers of any acquired business;
| | - |  | ------------------------------------------------------------------------



| |  |  | result in a delay or reduction of sales for both us and the company we acquire; and
| | - |  | -----------------------------------------------------------------------------------



| |  |  | disrupt our ongoing business, divert our resources and require significant management attention that would otherwise be available for ongoing
development of our current business.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

To complete an acquisition, we may be required to use a substantial
amount of our cash or engage in equity or debt financing. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we
issue could have rights, preferences and privileges senior to those of holders of our common stock. Any debt financing obtained by us in the future could involve restrictive covenants relating to our capital-raising activities and other financial
and operational matters that make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us,
if at all, which could limit our ability to engage in acquisitions. Moreover, we can make no assurances that the anticipated benefits of any acquisition, such as operating improvements or anticipated cost savings, would be realized or that we would
not be exposed to unexpected liabilities.

Further, an acquisition may negatively impact our results of operations because it
may require us to incur charges and substantial debt or liabilities, may cause adverse tax consequences, substantial depreciation and amortization or deferred compensation charges, or may require the amortization, write-down or impairment of amounts
related to deferred compensation, goodwill and other intangible assets, or may not generate sufficient financial return to offset acquisition costs.

We may develop unexpected legal contingencies, which may have a material adverse effect on our business, financial condition and operating results.

We are, from time to time, party to various routine legal proceedings arising out of our business. These proceedings primarily involve commercial claims, personal injury claims and workers
compensation claims. We cannot predict the outcome of these lawsuits, legal proceedings and claims with certainty. In the event of unexpected future developments, it is possible that the ultimate resolutions of such matters, if unfavorable, could
have a material adverse effect on our business, financial condition and operating results. In addition, there may also be adverse publicity associated with legal proceedings that could negatively affect the perception of our business, regardless of
whether the allegations are valid or whether we are ultimately found liable. As a result, legal proceedings may have a material adverse effect on our business, financial condition and operating results.

If we fail to establish and maintain effective internal control over financial reporting, we may have material misstatements in our financial
statements, and we may not be able to report our financial results in a timely and reliable manner.

Pursuant to the
Sarbanes-Oxley Act of 2002, we are required to provide a report by management in our Form 10-K on internal control over financial reporting, including managements assessment of the effectiveness of such control. Internal control over
financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls or fraud. Therefore, even effective internal controls can provide
only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal controls, we may be unable to provide financial information in a timely and reliable manner.
Any such difficulties or failure may have a material adverse effect on our business, financial condition and operating results.

During fiscal year 2009, we identified a material weakness in our internal control related to the application of GAAP as it relates to complex purchase accounting issues and accounting for derivatives, specifically:



| |  |  | deferred income taxes associated with purchase accounting;
| | - |  | ----------------------------------------------------------



| |  |  | shipping and handling fees and costs;
| | - |  | -------------------------------------



| |  |  | foreign exchange gains and losses; and
| | - |  | --------------------------------------



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| |  |  | derivatives.
| | - |  | ------------

These deficiencies resulted in our restatement in February 2009 of our consolidated financial statements as of and for the fiscal years ended February 29, 2008 and February 28, 2007 and for the first two quarters of fiscal year
2009. In connection with the restatement, we also corrected errors in our treatment of classification of borrowings and repayments on the working capital facility in the statement of cash flows and classification of the equity investment by Weston
Presidio V, L.P. and other stockholders.

In order to remediate the material weakness, we have:



| |  |  | implemented formal policies and procedures to identify, review, research and document accounting and disclosure of any unusual, nonrecurring and/or
complex accounting transactions on a quarterly basis, including consultation with third-party consultants, when appropriate;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | corrected shipping and handling fees and costs presentation by restating prior periods and applied consistent presentation prospectively;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | implemented monthly reconciliation processes with respect to the translation of our foreign subsidiarys accounts from the functional currency to
the U.S. dollar;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | enhanced documentation with respect to our hedging transactions; and
| | - |  | --------------------------------------------------------------------



| |  |  | reviewed the responsibilities within our accounting and finance department.
| | - |  | ---------------------------------------------------------------------------

Management believes that the additional control procedures that have been implemented have fully remediated the material weakness; however,
we cannot guarantee that we will not have additional material weaknesses in the future.



|Item 6. | Exhibits
|------- | --------

(a)
Exhibits



|     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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))                                                                                                                                                                                                                                                                                                                
|     | 
|3.3  |  | Fifth Amendment dated December 4, 2009 to the Credit Agreement dated June 12, 2006 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., JPMorgan Chase Bank, N.A. and JPMorgan Chase Bank, N.A., Toronto Branch (incorporated by reference to Exhibit 10.1 of the Companys
Current Report on Form 8-K dated December 4, 2009).
|     | 
|3.4  |  | First Amendment dated December 4, 2009 to the Amended and Restated Reimbursement Agreement dated March 21, 2007 among Cellu Tissue-CityForest LLC and Associated Bank, National
Association (incorporated by reference to Exhibit 10.2 of the Companys Current Report on Form 8-K dated December 4, 2009).                                                                                                                                                                   
|     | 
|31.1 |  | Certification by President and Chief Executive Officer pursuant to Rule 13a-14(a)                                                                                                                                                                                                                                                                                                                                                                                             
|     | 
|31.2 |  | Certification by Senior Vice President, Finance and Chief Financial Officer pursuant to Rule 13a-14(a)                                                                                                                                                                                                                                                                                                                                                                        
|     | 
|32.1 |  | Certification by President and Chief Executive Officer furnished pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.                                                                                                                                                                                                                                                                                                            



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|     |  |                                                                                                                                                                                     
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|32.2 |  | Certification by Senior Vice President, Finance and Chief Financial Officer furnished pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 the Sarbanes-Oxley Act of
2002.



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.



|                        |  |  |  |  |  |                                                           
|----------------------- |  |  |  |  |  | ----------------------------------------------------------
|                        |  |  |  |  |  | Cellu Tissue Holdings, Inc.                               
|                        |  |  | 
|Date: December 31, 2009 |  |  |  |  |  | /S/    RUSSELL C.
TAYLOR                                  
|                        |  |  |  |  |  | Mr. Russell C. Taylor                                     
|                        |  |  |  |  |  | President and Chief Executive Officer                     
|                        |  |  | 
|Date: December 31, 2009 |  |  |  |  |  | /S/    DAVID J.
MORRIS                                    
|                        |  |  |  |  |  | Mr. David J. Morris                                       
|                        |  |  |  |  |  | Senior Vice President, Finance and Chief Financial Officer



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