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**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

 

----

**FORM 10-Q/A**

 

 

**Amendment No. 1**

 

 

**(Mark One)**

 
| ý     |                                                                                                    |
|------------|---------------------------------------------------------------------------------------------------------|
|       | **For the  Quarterly Period Ended August 28, 2008**                                                |
| ** ** | **or**                                                                                                  |
| o          | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from             to             .**

 

**Commissionfile 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, includingarea code)

 

**Not Applicable** (Former name,former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether theregistrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirements for thepast 90 days.   Yes xNo o

 

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See definition of “largeaccelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

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

 

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  YesoNox

 

The number of shares outstanding of each of the registrant’s classes ofcommon stock as of October 2, 2008:

 

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

 

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**Explanatory Note**

 

This Amendment No. 1 on Form 10-Q/A (this “Amendment”) amendsthe Quarterly Report of Cellu Tissue Holdings, Inc. (the “Company”) on Form 10-Qfor the quarterly period ended August 28, 2008, as filed with theSecurities and Exchange Commission on October 10, 2008 (the “OriginalFiling”).  This Amendment is being filedfor the purpose of restatement to correct errors in (i) accountingfor deferred income taxes in connection with purchase accounting applied infiscal 2007, (ii) classification of borrowings and repayments on the revolvingcredit facility in the statement of cash flows, and certain other adjustmentsthat were initially deemed to be not material by management, including (a)  classification of shipping and handling costsin accordance with EITF 00-10, *Accounting for Shippingand Handling Fees and Costs*(EITF 00-10), (b) accounting forderivative instruments, (c) accounting for foreign exchange gains and losses infiscal 2008 and 2007, and (d) certain other miscellaneous adjustments.These adjustments do not have a negative impact on the Company’s compliancewith the covenants under any of its current debt agreements (see Note 5 —Long-Term Debt to our accompanying consolidated financial statements).

 

All applicable amounts relating to thisrestatement have been reflected in the consolidated financial statements anddisclosed in the notes to the consolidated financial statements in this amendedForm 10-Q/A. For discussion of the individual restatement adjustments, seeNote 2 to the consolidated financial statements. Additionally, see Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations.

 

For the convenience of the reader, this Form 10-Q/Asets forth the second quarter 2008 Form 10-Q in its entirety. However,this Form 10-Q/A only amends and restates certain information in Items 1,2 and 4 of Part I, and Item 6****of Part IIof the Original Filing, and no other items in the Original Filing are amendedhereby. Except for the amended and restated information described above, theforegoing items have not been updated to reflect events subsequent to October 10,2008, the filing date of the Original Filing. Accordingly, this Form 10-Q/Ashould be read in conjunction with our filings made with the Securities andExchange Commission (SEC) on and after the filing of the Original Filing.Pursuant to the rules of the SEC, Item 6 of Part II of the OriginalFiling has been amended to contain currently-dated certifications from ourchief executive officer and chief financial officer, as required by Section 302of the Sarbanes-Oxley Act of 2002.

 

Except as expressly stated or where thecontext requires otherwise, the information in this amended Form 10-Q/Agenerally speaks as of October 10, 2008, the date on which the OriginalFiling was filed with the SEC.

 

**Background**

 

On January 8, 2009, we announced that wewere reviewing (i) accounting for deferred income taxes in connection withpurchase accounting in fiscal year 2007 and other purchase accounting itemsfrom that fiscal year, (ii) classification of shipping and handling feesand costs under EITF 00-10 and (iii) accounting treatment of otherselected accounts.  On January 20,2009, our management and the audit committee of our Board of Directors havedetermined that our consolidated financial statements for fiscal years 2007 and2008 and the first two quarters of fiscal 2009 should no longer be relied upon.  In addition to this Form 10-Q/A, we areamending our Annual Report on Form 10-K for fiscal 2008 and our QuarterlyReport on Form 10-Q for the first quarter of fiscal 2009 to reflect therestatements described above.

 

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CELLU TISSUE HOLDINGS, INC.

FORM 10-Q/A

QUARTER ENDED AUGUST 28, 2008

 

 

INDEX

 

 
| PART I –  FINANCIAL INFORMATION                                                           |
|-----------------------------------------------------------------------------------------------------|
|                                                                                                |
| Item  1. Consolidated Financial Statements                                                          |
|                                                                                                |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                                                                                |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 |
|                                                                                                |
| Item  4. Controls and Procedures                                                                    |
|                                                                                                |
|                                                                                                |
| PART II  – OTHER INFORMATION                                                              |
|                                                                                                |
| Item  1A. Risk Factors                                                                              |
|                                                                                                |
| Item 6.  Exhibits                                                                                   |
|                                                                                                |
|                                                                                                |
| SIGNATURES                                                                                          |

 

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**PART I FINANCIAL INFORMATION**

 

 

**Item 1.  ConsolidatedFinancial Statements**

** **

**CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                       | ** ** | **Three Months**         | ** ** | **Ended**                     | ** ** | **Six Months**           | ** ** | **Ended**                     | ** ** |
|--------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                       | ** ** | **August 28, 2008** | ** ** | **August 30, 2007** | ** ** | **August 28, 2008** | ** ** | **August 30, 2007** | ** ** |
| ** **                                       | ** ** | **(Restated)**                | ** ** | **(Restated)**                | ** ** | **(Restated)**                | ** ** | **(Restated)**                | ** ** |
|                                             |       |                          |       |                          |       |                          |       |                          |       |
| Net sales                                        |       | $133,012,856                  |       | $112,026,009                  |       | $247,540,417                  |       | $218,252,958                  |       |
| Cost of goods sold                               |       | 122,012,927                   |       | 101,161,013                   |       | 224,752,584                   |       | 199,502,197                   |       |
| Gross profit                                     |       | 10,999,929                    |       | 10,864,996                    |       | 22,787,833                    |       | 18,750,761                    |       |
|                                             |       |                          |       |                          |       |                          |       |                          |       |
| Selling, general and administrative expenses     |       | 4,163,350                     |       | 4,519,992                     |       | 9,123,192                     |       | 9,002,729                     |       |
| Terminated acquisition-related transaction costs |       | 65,044                        |       | -                             |       | 140,044                       |       | -                             |       |
| Stock compensation expense                       |       | 226,987                       |       | 186,203                       |       | 445,493                       |       | 419,322                       |       |
| Amortization expense                             |       | 802,435                       |       | -                             |       | 802,435                       |       | -                             |       |
| Income from operations                           |       | 5,742,113                     |       | 6,158,801                     |       | 12,276,669                    |       | 9,328,710                     |       |
|                                             |       |                          |       |                          |       |                          |       |                          |       |
| Interest expense, net                            |       | 6,061,057                     |       | 5,102,666                     |       | 11,040,745                    |       | 10,121,760                    |       |
| Foreign currency loss                            |       | 127,700                       |       | 150,317                       |       | 84,620                        |       | 119,467                       |       |
| Other expense (income)                           |       | 8,910                         |       | (40,261                       | )          | 38,418                        |       | (82,500                       | )          |
| Income before income tax (benefit) expense       |       | (455,554                      | )          | 946,079                       |       | 1,112,886                     |       | (830,017                      | )          |
|                                             |       |                          |       |                          |       |                          |       |                          |       |
| Income tax (benefit) expense                     |       | (208,471                      | )          | 404,930                       |       | 367,499                       |       | (229,325                      | )          |
| Net income (loss)                                |       | $                             | (247,083   | )                             | $541,149   |                          | $          | 745,387                       |       | $ | (600,692 | ) |
|                                                  |            |                               |            |                               |            |                               |            |                               |            |  |  |  |

 

 

See accompanying notes to consolidatedfinancial statements.

 

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**CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 

 
| ** **                                                                                              | ** ** | **August 28** | ** ** | **February 29** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                                              | ** ** | **2008**           | ** ** | **2008**             | ** ** |
| ** **                                                                                              | ** ** | **(Unaudited)**    | ** ** | **(Note 1)**    | ** ** |
| ** **                                                                                              | ** ** | **(Restated)**     | ** ** | **(Restated)**       | ** ** |
| **ASSETS**                                                                                              |       |               |       |                 |       |
| CURRENT ASSETS:                                                                                         |       |               |       |                 |       |
| Cash and cash equivalents                                                                               |       | $2,603,631         |       | $883,388             |       |
| Receivables, net                                                                                        |       | 62,634,374         |       | 44,542,337           |       |
| Inventories                                                                                             |       | 42,264,035         |       | 33,996,439           |       |
| Prepaid expenses and other current assets                                                               |       | 3,700,042          |       | 3,745,989            |       |
| Income tax receivable                                                                                   |       | 142,966            |       | 177,281              |       |
| Deferred income taxes                                                                                   |       | 5,429,241          |       | 7,157,191            |       |
| TOTAL CURRENT ASSETS                                                                                    |       | 116,774,289        |       | 90,502,625           |       |
| PROPERTY, PLANT AND EQUIPMENT, NET                                                                      |       | 306,958,854        |       | 310,488,081          |       |
| GOODWILL                                                                                                |       | 35,100,331         |       | 11,334,755           |       |
| OTHER INTANGIBLES, NET                                                                                  |       | 38,763,565         |       | 9,400,000            |       |
| OTHER ASSETS                                                                                            |       | 2,148,254          |       | 1,491,218            |       |
| TOTAL ASSETS                                                                                            |       | $499,745,293       |       | $423,216,679         |       |
|                                                                                                    |       |               |       |                 |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                           |       |               |       |                 |       |
| CURRENT LIABILITIES:                                                                                    |       |               |       |                 |       |
| Revolving line of credit                                                                                |       | $23,000,000        |       | $9,800,000           |       |
| Accounts payable                                                                                        |       | 26,603,319         |       | 24,055,782           |       |
| Accrued expenses                                                                                        |       | 22,712,503         |       | 19,085,912           |       |
| Accrued interest                                                                                        |       | 8,930,654          |       | 8,253,915            |       |
| Other current liabilities                                                                               |       | 15,592,442         |       | 15,000,000           |       |
| Current portion of long-term debt                                                                       |       | 760,000            |       | 760,000              |       |
| TOTAL CURRENT LIABILITIES                                                                               |       | 97,598,918         |       | 76,955,609           |       |
| LONG-TERM DEBT, LESS CURRENT PORTION                                                                    |       | 241,507,873        |       | 198,086,944          |       |
| DEFERRED INCOME TAXES                                                                                   |       | 80,395,415         |       | 81,940,082           |       |
| OTHER LIABILITIES                                                                                       |       | 20,127,373         |       | 20,148,590           |       |
| 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                                                                          |       | 62,482,173         |       | 47,035,214           |       |
| Accumulated deficit                                                                                     |       | (2,116,730         | )          | (2,862,117           | )          |
| Accumulated other comprehensive (loss) income                                                           |       | (249,730           | )          | 1,912,356            |       |
| TOTAL STOCKHOLDERS’ EQUITY                                                                         |       | 60,115,714         |       | 46,085,454           |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                         |       | $499,745,293       |       | $423,216,679         |       |

 

See accompanying notes to consolidatedfinancial statements.

 

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**CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS     (Unaudited)**

 
| ** **                                                                                | ** ** | **Six Months**           | ** ** | **Ended**                     | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                                                | ** ** | **August 28, 2008** | ** ** | **August 30, 2007** | ** ** |
| ** **                                                                                | ** ** | **(Restated)**                | ** ** | **(Restated)**                | ** ** |
| **Cash flows from operating activities**                                                  |       |                          |       |                          |       |
| Net income (loss)                                                                         |       | $745,387                      |       | ($600,692                     | )          |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |       |                          |       |                          |       |
| Stock-based compensation                                                                  |       | 445,493                       |       | 382,500                       |       |
| Deferred income taxes                                                                     |       | 183,283                       |       | (1,672,467                    | )          |
| Accretion of debt discount                                                                |       | 600,929                       |       | 304,776                       |       |
| Amortization of bond costs                                                                |       | 70,197                        |       | -                             |       |
| Amortization of intangibles                                                               |       | 802,435                       |       | -                             |       |
| Derivatives                                                                               |       | 835,484                       |       | 679,877                       |       |
| Depreciation                                                                              |       | 11,722,167                    |       | 12,714,671                    |       |
| Changes in operating assets and liabilities, net of effects of  acquisitions:             |       |                          |       |                          |       |
| Receivables                                                                               |       | (10,094,518                   | )          | (3,565,303                    | )          |
| Inventories                                                                               |       | (611,272                      | )          | 445,547                       |       |
| Prepaid expenses, other current assets and income tax receivable                          |       | 254,655                       |       | (2,037,399                    | )          |
| Other                                                                                     |       | (665,725                      | )          | 458,540                       |       |
| Accounts payable, accrued expenses and accrued interest                                   |       | 2,436,384                     |       | 6,515,137                     |       |
| Total adjustments                                                                         |       | 5,979,512                     |       | 14,225,879                    |       |
| *Net cash provided by operating activities*                                               |       | 6,724,899                     |       | 13,625,187                    |       |
|                                                                                      |       |                          |       |                          |       |
| **Cash flows from investing activities**                                                  |       |                          |       |                          |       |
| Cash paid for acquisition, net of cash acquired                                           |       | (63,829,401                   | )          | (43,617,819                   | )          |
| Capital expenditures                                                                      |       | (4,820,549                    | )          | (6,940,787                    | )          |
| *Net cash used in investing activities*                                                   |       | (68,649,950                   | )          | (50,558,606                   | )          |

 

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**CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited) (continued)**

 

 
| ** **                                              | ** ** | **Six  Months**      | ** ** | **Ended**           |   |
|---------------------------------------------------------|------------|----------------------|------------|---------------------|--------|
| ** **                                              | ** ** | **August  28, 2008** | ** ** | **August 30, 2007** |   |
| ** **                                              | ** ** | **(Restated)**       | ** ** | **(Restated)**      |   |
| **Cash flows from financing activities**                |       |                 |       |                |   |
| Equity investment by shareholders                       |       | 15,001,466           |       | -                   |   |
| Borrowings on revolving line of credit                  |       | 51,000,000           |       | 19,600,000          |   |
| Payments on revolving line of credit                    |       | (37,800,000          | )          | (17,000,000         | )      |
| Payments of long-term debt                              |       | (380,000             | )          | -                   |   |
| Debt issuance costs                                     |       | (847,813             | )          | -                   |   |
| Net proceeds from bond offering                         |       | 36,900,000           |       | 20,000,000          |   |
| *Net cash provided by financing activities*             |       | 63,873,653           |       | 22,600,000          |   |
|                                                    |       |                 |       |                |   |
| Effect of foreign currency                              |       | (228,359             | )          | 408,124             |   |
| *Net increase (decrease) in cash and cash  equivalents* |       | 1,720,243            |       | (13,925,295         | )      |
| *Cash and cash equivalents at beginning of  period*     |       | 883,388              |       | 16,260,601          |   |
| *Cash and cash equivalents at end of period*            |       | $2,603,631           |       | $2,335,306          |   |

 

*See accompanying notes to consolidatedfinancial statements.*

 

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**CelluTissue Holdings, Inc. and Subsidiaries**

**Notes toConsolidated Financial Statements (Unaudited)**

**August 28,2008**

 

**Note 1 Basis of Presentation and SignificantAccounting Policies**

 

The accompanying unaudited interimconsolidated financial statements include the accounts of Cellu Tissue Holdings, Inc.  (“Cellu Tissue”or the “Company”) and itswholly owned subsidiaries.  The Companyis 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 inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States forcomplete financial statements.  In theopinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included.  Operating results for the quarter and sixmonths ended August 28, 2008 are not necessarily indicative of the resultsthat may be expected for the fiscal year ending February 28, 2009.  For further information, refer to the Company’sconsolidated financial statements and footnotes thereto as of February 29,2008 and for the year then ended contained in the Company’s Annual Report on Form 10-K/A,from which the consolidated balance sheet at February 29, 2008 has beenderived and the Company’s latest Current Reports on Form 8-K, each asfiled with the Securities and Exchange Commission (“SEC”).

 

Stock-Based Compensation

 

The Company accounts for stock basedcompensation in accordance with Statement of Financial Accounting Standards No. 123R(“SFAS 123R”), *Share-Based Payments*, whichrequires the measurement of all share-based payments to employees, includinggrants of employee stock options, using the fair-value-based method and therecording of compensation expense in the Company’s consolidated statements ofoperations.  Cellu Parent has oneshare-based payment arrangement under the 2006 Stock Option and RestrictedStock Plan (the “Plan”).  Under the Plan,the administrator of the Plan (the “Plan Administrator”) may make awards ofoptions to purchase shares of common stock of Cellu Parent and/or awards ofrestricted shares of common stock of Cellu Parent.  A maximum of 8,095 shares of common stock ofCellu Parent may be delivered in satisfaction of awards under the Plan,determined net of shares of common stock withheld by Cellu Parent in payment ofthe exercise price of an award or in satisfaction of tax withholdingrequirements.  Key employees anddirectors of, and consultants and advisors to, Cellu Parent or its affiliateswho, in the opinion of the Plan Administrator, are in a

 

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**CelluTissue Holdings, Inc. and Subsidiaries**

**Notes toConsolidated Financial Statements (Unaudited) (continued)**

 

**Note 1 Basis of Presentation and SignificantAccounting Policies (continued)**

 

position to make a significant contributionto the success of Cellu Parent and its affiliates are eligible to participatein the Plan.   Stock options are grantedwith a strike price at the estimated fair value of the Cellu Parent’s stock onthe date of grant and have a 10-year term. Generally, stock option grants vest ratably over four years from thedate of grant.  The following describeshow certain assumptions affecting the estimated fair value of stock options aredetermined.  The dividend yield is zero;the volatility is based on historical market value of the Cellu Parent’s stock;and the risk-free interest rate is based on U.S. Treasury securities.   The Company uses historical data in order toestimate exercise, termination and holding period behavior for valuationpurposes. The fair value of the stock option grant was estimated on the date ofgrant using the Black-Scholes option pricing model.  The weighted average assumptions used tovalue the grants were no dividend yield; 55% volatility; 1.4% risk freeinterest rate; and 10-year expected life. The weighted average fair value of stock options granted was $498.18 pershare and the unrecognized total compensation cost as of August 28, 2008related to nonvested awards is $543,256.

 

A summary of the outstanding options as of August 28,2008 and the activity during the six months then ended is as follows:

 
|                                 | Options | Weighted  Average  Exercise Price           | Weighted  Average  Remaining  Contractual Life |
|--------------------------------------|---------|---------------------------------------------|------------------------------------------------|
| Outstanding,  February 29, 2008 | 1,125   | $      733.67 | 8.59 Years                                     |
| Forfeited                            | (125)   | 979.25                                      | 8.86 Years                                     |
| Granted                              | 444     | 942.99                                      | 9.85 Years                                     |
| Outstanding,  August 28, 2008   | 1,444   | 776.77                                      | 8.95 Years                                     |
|                                 |    |                                        |                                           |
| Exercisable,  August 28, 2008   | 356     | 620.57                                      | 8.45 Years                                     |

 

On August 6, 2007, Cellu Parent enteredinto a Restricted Stock Agreement with the Company’s newly appointed Chief FinancialOfficer, pursuant to which Cellu Parent granted 700 restricted shares of itscommon stock to the named individual pursuant to the Plan.  The shares will vest and cease to berestricted in four equal annual installments commencing on August 6, 2008,as long as the named individual is continuously employed by the Company untilsuch vesting date with respect to his shares. Any restricted stock outstanding at the time of a Covered Transaction(as defined in the Plan) shall become vested and cease to be restricted stockat the time of a change in control. Additionally, Cellu Parent has agreed to pay an amount to the namedindividual equal to an amount that would be included in such individual’s grossincome and payable as income

 

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**CelluTissue Holdings, Inc. and Subsidiaries**

**Notes toConsolidated Financial Statements (Unaudited) (continued)**

 

**Note 1 Basis of Presentation and SignificantAccounting Policies (continued)**

 

tax as a result of making a Section 83(b) electionunder the Internal Revenue Code of 1986, as amended.  The named individual has made a timely Section 83(b) election.

 

On June 12, 2006, Cellu Parent enteredinto Restricted Stock Agreements with each of the Company’s Chief ExecutiveOfficer, Chief Operating Officer and the then Chief Financial Officer, pursuantto which Cellu Parent granted 3,778 restricted shares of its common stock tothe Chief Executive Officer and 1,349 restricted shares of its common stock toeach of the other two named individuals pursuant to the Plan.  The shares will vest and cease to berestricted in four equal annual installments commencing on June 12, 2007, as long as the named individual,as the case may be, is continuously employed by the Company until each suchvesting date with respect to his or her shares. Any restricted stock outstanding at the time of a Covered Transaction(as defined in the Plan) shall become vested and cease to be restricted stockat the time of a change in control. Additionally, the Parent has agreed to pay an amount to the namedindividuals equal to an amount that would be included in such individuals’gross income and payable as income tax as a result of making a Section 83(b) electionunder the Internal Revenue Code of 1986, as amended.  All named individuals have made a timely Section 83(b) election.

 

Effective July 31, 2007, the then ChiefFinancial Officer resigned and forfeited three-fourths of the individual’srestricted stock grant, and accordingly, the Company only recorded compensationexpense associated with this individual’s grant through June 12, 2007 asall other shares were forfeited and no compensation expense is required to berecognized for forfeited shares.

 

For the three and six months ended August 28,2008, the Company has recorded $179,078 and $356,188, respectively ofcompensation expense related to the above restricted stock grants.   For the three and six months ended August 30,2007 the Company has recorded $152,822 and $326,944, respectively ofcompensation expense related to the vesting of the grants at that time inaccordance with SFAS 123R.

 

 

Derivatives and Hedging

 

The Company uses derivative financial instruments to offset asubstantial portion of its exposure to market risk arising from changes in theprice of natural gas. Hedging of this risk is accomplished by entering intoforward swap contracts, which have not been designated as hedges of specificquantities of natural gas expected to be purchased in future months.    The Company measures fair value of itsderivative financial instruments in accordance with SFAS 157.

 

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 1 Basis of Presentation and Significant Accounting Policies(continued)**

 

SFAS 157 defined fair value as the price that would be received to sellan asset or paid to transfer a liability in an orderly transaction betweenmarket participants. SFAS 157 establishes a fair value hierarchy for valuationinputs that gives the highest priority to quoted prices in active markets foridentical assets or liabilities and the lowest priority to unobservableinputs.  The fair value hierarchy is asfollows:

 
| 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. |

 

Derivatives are reported at fair value utilizing Level 2 inputs.   The fair value of these cash flow hedginginstruments was a liability of $.6 million and an asset of $.2 million as of August 28,2008 and February 29, 2008, respectively. For the three and six months ended August 28, 2008, a $.7 millionloss and $.8 million loss, respectively, and for the three and six months endedAugust 30, 2007, a $.6 million loss in both periods have been recorded toearnings.

 

Recent Accounting Pronouncements

 

In September 2006, the Financial Accounting Standard Board (“FASB”)issued Statement of Financial Accounting Standards No. 157,”*Fair Value Measurements*” (“SFAS 157”).  The Company was required to adopt theprovisions of SFAS 157 effective March 1, 2008.  SFAS 157 provides a common fair valuehierarchy for companies to follow in determining fair value measurements in thepreparation of financial statements and expands disclosure requirementsrelating to how such fair value measurements were developed.  SFAS 157 clarifies the principle that fairvalue should be based on the assumptions that the marketplace would use whenpricing an asset or liability, rather than company specific data.  The adoption of SFAS 157 did not have amaterial impact on the Company’s results of operations and financial position.

 

10

Tableof Contents

** **

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 1 Basis of Presentation and Significant Accounting Policies(continued)**

 

In February 2007, the FASB issued Statement of FinancialAccounting Standards No.159, “*The Fair ValueOption for Financial Assets and Liabilities, Including an amendment of FASBStatement No. 115*” (“SFAS 159”).  This Standard permits entities to choose to measuremany financial instruments and certain other items at fair value that are notcurrently required to be measured at fair value.  SFAS 159 was effective as of the beginning offiscal 2009 and the Company chose not to adopt these fair value provisions.

 

In December 2007, the FASB issued Statement of FinancialAccounting Standards No. 141 (R), “*BusinessCombinations*” (“SFAS 141 (R)”), and Financial Accounting Standards No. 160,*“Accounting and Reporting of NoncontrollingInterests in Consolidated Financial Statements, an amendment of ARB No. 51”*(“SFAS 160”).  These newstandards will significantly change the financial accounting and reporting ofbusiness combination transactions and noncontrolling (or minority) interests inconsolidated financial statements.  SFAS141 (R) is required to be adopted concurrently with FAS 160 and iseffective for business combination transactions for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008.  Earlyadoption is prohibited.  The Company iscurrently assessing the impact that SFAS 141 (R) and SFAS 160 will have onits results of operations and financial position.

 

In March 2008, the FASB issued Statement of Financial AccountingStandards No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133”*(“SFAS 161”).  SFAS 161requires entities to provide enhanced disclosures about derivative instrumentsand hedging activities.  SFAS 161 is effectivefor fiscal years and interim periods beginning on or after November 15,2008.  The Company is currently assessingthe impact that SFAS 161 will have on its results of operations and financialposition.

 

**Note 2  Restatement /Reclassification of Financial Statements**

 

The Company has restated herein its consolidated financial statementsas of August 28, 2008 and February 29, 2008 and for the three and sixmonth periods ended August 28, 2008 and the three and six month periodsended August 30, 2007.  Thisrestatement corrects errors in (i) accounting for deferred income taxes inconnection with purchase accounting applied in fiscal 2007, (ii) classificationof borrowings and repayments on the revolving credit facility in the statementof cash flows, and certain other adjustments that were initially deemed to benot material by management, including (a)  classification of shipping andhandling costs in accordance with EITF 00-10, *Accountingfor Shipping and Handling Fees and Costs*(EITF 00-10), (b) accountingfor derivative instruments, (c) accounting for foreign exchange gains andlosses in fiscal 2008 and 2007, and (d) certain other miscellaneousadjustments.  The tax effect of the aboveitems has also been recorded.  Theseadjustments do not have a negative impact on the Company’s compliance with the

 

11

Table of Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 2  Restatement /Reclassification of Financial Statements (continued)**

 

covenants under any of its current debt agreements (see Note 5 —Long-Term Debt to our accompanying consolidated financial statements).

 

These adjustments are discussed in more detail below. The tables thatfollow the discussion detail the impact on the Company’s consolidated balancesheets, statements of operations, and statements of cash flows.

 

 ***Deferredincome taxes associated with purchase accounting***

 

The Company erroneously recorded a deferred tax asset related to the$35.0 million liability for contingent consideration recorded in connectionwith the Company’s merger (the “Merger”) with Cellu Parent, a corporationcontrolled and owned by Weston Presidio V, L.P. (“Weston Presidio”).  This error has resulted in an understatementof the amounts allocated to long-lived assets in connection with the merger.  The Company has corrected this error by (i) reducingthe deferred tax asset amount recorded in purchase accounting for thecontingent consideration by approximately $14.0 million; (ii) increasingthe amount allocated to acquired property, plant and equipment and trademarksby approximately $15.6 million and $.6 million, respectively; (iii) increasingdeferred tax liabilities associated with the increased allocation of purchaseprice allocated to property, plant and equipment by approximately $6.6 million;and (iv) recognizing goodwill of approximately $4.4 million as a result ofthese adjustments.

 

The increase in property, plant and equipment resulted in increaseddepreciation expense of approximately $.3 million and $.5 million, respectivelyfor the three and six month periods ended August 30, 2007.

 

***Borrowings andrepayments on revolving credit facility***

*** ***

The Company has consistentlyrecorded borrowings and repayments on its revolving credit facility as a netamount in the statement of Cash Flows, which has been determined to beinconsistent with Statement of Financial Accounting Standards No. 95, Statementof Cash Flows. The Company has corrected this error by showing borrowings and repaymentson a gross basis.

*** ***

***Shipping andhandling fees and costs***

 

The Companyhas consistently recorded outbound shipping and handling costs as a reductionof sales, which is inconsistent with the accounting in accordance with EITF00-10.  The Company has corrected thiserror by reclassifying these costs to cost of goods sold from net sales.  The outbound costs were $4.1 million and $7.1million for the three and six month periods ended August 28, 2008,respectively; and $3.0 million and $6.0 million for the three and six monthperiods ended August 30, 2007, respectively.

 

***Foreign exchangegains and losses***

 

The Companyincorrectly recorded the remeasurement of an intercompany loan account with itsforeign subsidiary through other comprehensive income In accordance withStatement of

 

12

Table of Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 2 - Restatement / Reclassification of Financial Statements(continued)**

 

FinancialAccounting Standards No. 52*,**Foreign Currency Translation,*theremeasurement of the portion of the loan functioning as a short-term settlementaccount and not deemed to be of a long term investment nature should have beenrecorded to earnings.  The Company hascorrected this error by increasing (decreasing) foreign currency (loss) gainand decreasing (increasing) accumulated other comprehensive income.  The correction resulted in an increase toforeign currency gain of approximately $.1 million and $.4 million for thethree and six month periods ended August 30, 2007, respectively.

 

***Derivatives***

 

The Company’sdocumentation relating to derivative instruments entered into in fiscal 2007and 2008 did not meet the requirements of Statement of Financial AccountingStandards No.133, *Accounting for DerivativeInstruments and Hedging Activities*for hedge accounting.  The Company has corrected this error byreversing the amounts relating to the mark-to-market adjustment that wereoriginally recorded in accumulated other comprehensive income, with theoffsetting amount recorded to cost of goods sold in each correspondingperiod.  The correction resulted in anincrease to cost of goods sold of approximately $.6 million for the three andsix month periods ended August 30, 2007, respectively.

 

***Other miscellaneousadjustments***

 

The Company has also included in the appropriate periods in itsrestated consolidated financial statements certain other miscellaneousadjustments the effect of which were initially deemed to be not material bymanagement, either individually or in the aggregate.  These adjustments primarily relate to thereversal of certain vacation and freight accruals in the first quarterof fiscal 2008.   The net impactof correcting these items decreased net income by approximately $.1 million forthe three months ended May 31, 2007.

 

***Reclassification***

*** ***

The Company has reclassifiedamortization expense within its Consolidated Statements of Operations for thethree and six months ended August 28, 2008 to be reflected within income fromoperations.

 

13

Tableof Contents

 

**CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS (Unaudited)**
| ** **                                                                                               | ** ** | **              As of August 28, 2008** | ** ** | **                    As of February 29, 2008** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **As Previously  Reported**                                                                                                  | ** ** | **Adjustment**                                                                                                                                                          | ** ** | **Restated** | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                                                                     |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| **ASSETS**                                                                                               |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| CURRENT ASSETS:                                                                                          |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                |       | $2,603,631                                                                                                                        |       |                                                                                                                                                                    |       | $2,603,631 |   | $883,388 |   |   |   | $883,388 |   |
| Receivables, net                                                                                         |       | 62,634,374                                                                                                                        |       |                                                                                                                                                                    |       | 62,634,374 |   | 44,542,337 |   |   |   | 44,542,337 |   |
| Inventories                                                                                              |       | 42,264,035                                                                                                                        |       |                                                                                                                                                                    |       | 42,264,035 |   | 33,996,439 |   |   |   | 33,996,439 |   |
| Prepaid expenses  and other current assets                                                               |       | 3,700,042                                                                                                                         |       |                                                                                                                                                                    |       | 3,700,042 |   | 3,745,989 |   |   |   | 3,745,989 |   |
| Income tax  receivable                                                                                   |       | 142,966                                                                                                                           |       |                                                                                                                                                                    |       | 142,966 |   | 177,281 |   |   |   | 177,281 |   |
| Deferred income  taxes                                                                                   |       | 5,429,241                                                                                                                         |       |                                                                                                                                                                    |       | 5,429,241 |   | 7,157,191 |   |   |   | 7,157,191 |   |
| TOTAL CURRENT  ASSETS                                                                                    |       | 116,774,289                                                                                                                       |       |                                                                                                                                                                    |       | 116,774,289 |   | 90,502,625 |   |   |   | 90,502,625 |   |
|                                                                                                     |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| PROPERTY, PLANT  AND EQUIPMENT, NET                                                                      |       | 293,582,902                                                                                                                       |       | $13,375,952                                                                                                                                                             |       | 306,958,854 |   | 296,597,888 |   | $13,890,193 |   | 310,488,081 |   |
| GOODWILL                                                                                                 |       | 30,735,577                                                                                                                        |       | 4,364,754                                                                                                                                                               |       | 35,100,331 |   | 6,970,001 |   | 4,364,754 |   | 11,334,755 |   |
| OTHER  INTANGIBLES, NET                                                                                  |       | 38,113,879                                                                                                                        |       | 649,686                                                                                                                                                                 |       | 38,763,565 |   | 8,750,314 |   | 649,686 |   | 9,400,000 |   |
| OTHER ASSETS                                                                                             |       | 2,148,254                                                                                                                         |       |                                                                                                                                                                    |       | 2,148,254 |   | 1,491,218 |   |   |   | 1,491,218 |   |
| TOTAL ASSETS                                                                                             |       | $481,354,901                                                                                                                      |       | $18,390,392                                                                                                                                                             |       | $499,745,293 |   | $404,312,046 |   | $18,904,633 |   | $423,216,679 |   |
|                                                                                                     |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                           |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| CURRENT  LIABILITIES:                                                                                    |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| Revolving line of  credit                                                                                |       | $23,000,000                                                                                                                       |       |                                                                                                                                                                    |       | $23,000,000 |   | $9,800,000 |   |   |   | $9,800,000 |   |
| Accounts payable                                                                                         |       | 26,603,319                                                                                                                        |       |                                                                                                                                                                    |       | 26,603,319 |   | 24,055,782 |   |   |   | 24,055,782 |   |
| Accrued expenses                                                                                         |       | 22,791,970                                                                                                                        |       | $(79,467                                                                                                                                                                | )          | 22,712,503 |   | 18,860,526 |   | $225,386 |   | 19,085,912 |   |
| Accrued interest                                                                                         |       | 8,930,654                                                                                                                         |       |                                                                                                                                                                    |       | 8,930,654 |   | 8,253,915 |   |   |   | 8,253,915 |   |
| Other current  liabilities                                                                               |       | 15,592,442                                                                                                                        |       |                                                                                                                                                                    |       | 15,592,442 |   | 15,000,000 |   |   |   | 15,000,000 |   |
| Current portion  of long-term debt                                                                       |       | 760,000                                                                                                                           |       |                                                                                                                                                                    |       | 760,000 |   | 760,000 |   |   |   | 760,000 |   |
| TOTAL CURRENT  LIABILITIES                                                                               |       | 97,678,385                                                                                                                        |       | (79,467                                                                                                                                                                 | )          | 97,598,918 |   | 76,730,223 |   | 225,386 |   | 76,955,609 |   |
| LONG-TERM DEBT,  LESS CURRENT PORTION                                                                    |       | 241,507,873                                                                                                                       |       |                                                                                                                                                                    |       | 241,507,873 |   | 198,086,944 |   |   |   | 198,086,944 |   |
| DEFERRED INCOME  TAXES                                                                                   |       | 60,660,034                                                                                                                        |       | 19,735,381                                                                                                                                                              |       | 80,395,415 |   | 62,008,004 |   | 19,932,078 |   | 81,940,082 |   |
| OTHER LIABILITIES                                                                                        |       | 20,127,373                                                                                                                        |       |                                                                                                                                                                    |       | 20,127,373 |   | 20,148,590 |   |   |   | 20,148,590 |   |
| STOCKHOLDERS’  EQUITY:                                                                              |       |                                                                                                                              |       |                                                                                                                                                                    |       |   |   |   |   |   |   |   |   |
| Common stock,  Class A, $.01 par value, 1,000 shares authorized, 100 shares issued and  outstanding |       | 1                                                                                                                                 |       |                                                                                                                                                                    |       | 1 |   | 1 |   |   |   | 1 |   |
| Capital in excess  of par value                                                                          |       | 62,482,173                                                                                                                        |       |                                                                                                                                                                    |       | 62,482,173 |   | 47,035,214 |   |   |   | 47,035,214 |   |
| Accumulated  deficit                                                                                     |       | (644,537                                                                                                                          | )          | (1,472,193                                                                                                                                                              | )          | (2,116,730 | ) | (2,199,615 | ) | (662,502 | ) | (2,862,117 | ) |
| Accumulated other  comprehensive (loss) income                                                           |       | (456,401                                                                                                                          | )          | 206,671                                                                                                                                                                 |       | (249,730 | ) | 2,502,685 |   | (590,329 | ) | 1,912,356 |   |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                         |       | 61,381,236                                                                                                                        |       | (1,265,522                                                                                                                                                              | )          | 60,115,714 |   | 47,338,285 |   | (1,252,831 | ) | 46,085,454 |   |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                         |       | $481,354,901                                                                                                                      |       | $18,390,392                                                                                                                                                             |       | $499,745,293 |   | $404,312,046 |   | $18,904,633 |   | $423,216,679 |   |

 

14

Table of Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 2  Restatement /Reclassification of Financial Statements (continued)**

 
| ** **                                        | ** ** | ** **                                  | ** ** | **CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES** | ** ** | ** **                            | ** ** |
|---------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                        | ** ** | ** **                                  | ** ** | **CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)** | ** ** | ** **                            | ** ** |
| ** **                                        | ** ** | ** **                                  | ** ** | ** **                                                                | ** ** | ** **                            | ** ** |
| ** **                                        | ** ** | **Three Months  Ended 8/28/2008** | ** ** | ** **                                                                | ** ** | **Six Months  Ended  8/28/2008** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | ** **                                  | ** ** | ** **                                                                | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **As  Previously  Reported**                | ** ** | **Adjustment**                                                            | ** ** | **Restated**                          | ** ** | **As  Previously  Reported** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Net sales                                         |       | $128,956,594                                |       | $4,056,262                                                                |       | $133,012,856                          |       | $240,452,677 |   | $7,087,740 |   | $247,540,417 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Cost of goods  sold                               |       | 117,009,124                                 |       | 5,003,803                                                                 |       | 122,012,927                           |       | 216,353,603 |   | 8,398,981 |   | 224,752,584 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Gross profit                                      |       | 11,947,470                                  |       | (947,541                                                                  | )          | 10,999,929                            |       | 24,099,074 |   | (1,311,241 | ) | 22,787,833 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Selling, general  and administrative expenses     |       | 4,163,350                                   |       |                                                                      |       | 4,163,350                             |       | 9,123,192 |   |   |   | 9,123,192 |   |
| Terminated  acquisition-related transaction costs |       | 65,044                                      |       |                                                                      |       | 65,044                                |       | 140,044 |   |   |   | 140,044 |   |
| Stock  compensation expense                       |       | 226,987                                     |       |                                                                      |       | 226,987                               |       | 445,493 |   |   |   | 445,493 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Amortization  expense                             |       |                                        |       | 802,435                                                                   |       | 802,435                               |       |   |   | 802,435 |   | 802,435 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Income from  operations                           |       | 7,492,089                                   |       | (1,749,976                                                                | )          | 5,742,113                             |       | 14,390,345 |   | (2,113,676 | ) | 12,276,669 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Interest expense,  net                            |       | 6,061,057                                   |       |                                                                      |       | 6,061,057                             |       | 11,040,745 |   |   |   | 11,040,745 |   |
| Amortization  expense                             |       | 802,435                                     |       | (802,435                                                                  | )          |                                  |       | 802,435 |   | (802,435 | ) |   |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Foreign currency  loss                            |       | 127,700                                     |       |                                                                      |       | 127,700                               |       | 84,620 |   |   |   | 84,620 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Other expense                                     |       | 8,910                                       |       |                                                                      |       | 8,910                                 |       | 38,418 |   |   |   | 38,418 |   |
| Income before  income tax (benefit) expense       |       | 491,987                                     |       | (947,541                                                                  | )          | (455,554                              | )          | 2,424,127 |   | (1,311,241 | ) | 1,112,886 |   |
|                                              |       |                                        |       |                                                                      |       |                                  |       |   |   |   |   |   |   |
| Income tax  (benefit) expense                     |       | 153,964                                     |       | (362,435                                                                  | )          | (208,471                              | )          | 869,049 |   | (501,550 | ) | 367,499 |   |
| Net income (loss)                                 |       | $338,023                                    |       | $(585,106                                                                 | )          | $(247,083                             | )          | $1,555,078 |   | $(809,691 | ) | $745,387 |   |

 

15

Tableof Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 2  Restatement /Reclassification of Financial Statements (continued)**

 
| ** **                                    | ** ** | ** **   | ** **                   | **CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**         | ** **                       | ** **   | ** **                     |
|-----------------------------------------------|------------|--------------|------------------------------|-----------------------------------------------------------------------------------|----------------------------------|--------------|--------------------------------|
| ** **                                    | ** ** | ** **   | ** **                   | **CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)**         | ** **                       | ** **   | ** **                     |
| ** **                                    | ** ** | ** **   | ** **                   |    **Three Months**   **Ended 8/30/2007** | ** **                       | ** **   | ** **                     | ** ** | ** ** |    **Six Months**   **Ended**   **8/30/2007** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | ** **   | **As  Previously  Reported** | ** **                                                                        | **   Adjustment** | ** **   | **   Restated** | ** ** | ** ** | **As  Previously  Reported** | ** ** | **   Adjustment** | ** ** | **   Restated** | ** ** |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Net sales                                     |       | $109,000,321 |                         | $3,025,688                                                                        |                             | $112,026,009 |                           | $212,201,107 |   | $6,051,851 |   | $218,252,958 |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Cost of goods  sold                           |       | 97,233,784   |                         | 3,927,229                                                                         |                             | 101,161,013  |                           | 192,142,452 |   | 7,359,745 |   | 199,502,197 |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Gross profit                                  |       | 11,766,537   |                         | (901,541                                                                          | )                                | 10,864,996   |                           | 20,058,655 |   | (1,307,894 | ) | 18,750,761 |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Selling, general and  administrative expenses |       | 4,519,992    |                         |                                                                              |                             | 4,519,992    |                           | 9,002,729 |   |   |   | 9,002,729 |   |
| Stock  compensation expense                   |       | 186,203      |                         |                                                                              |                             | 186,203      |                           | 419,322 |   |   |   | 419,322 |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Income from  operations                       |       | 7,060,342    |                         | (901,541                                                                          | )                                | 6,158,801    |                           | 10,636,604 |   | (1,307,894 | ) | 9,328,710 |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Interest expense,  net                        |       | 5,102,666    |                         |                                                                              |                             | 5,102,666    |                           | 10,121,760 |   |   |   | 10,121,760 |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Foreign currency  loss                        |       | 196,110      |                         | (45,793                                                                           | )                                | 150,317      |                           | 520,408 |   | (400,941 | ) | 119,467 |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Other income                                  |       | (40,261      | )                            |                                                                              |                             | (40,261      | )                              | (82,500 | ) |   |   | (82,500 | ) |
| Income before income tax  (benefit) expense   |       | 1,801,827    |                         | (855,748                                                                          | )                                | 946,079      |                           | 76,936 |   | (906,953 | ) | (830,017 | ) |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Income tax  (benefit) expense                 |       | 731,997      |                         | (327,067                                                                          | )                                | 404,930      |                           | 117,590 |   | (346,915 | ) | (229,325 | ) |
|                                          |       |         |                         |                                                                              |                             |         |                           |   |   |   |   |   |   |
| Net income (loss)                             |       | $1,069,830   |                         | ($528,681                                                                         | )                                | $541,149     |                           | $(40,654 | ) | $(560,038 | ) | $(600,692 | ) |
|                                               |            |              |                              |                                                                                   |                                  |              |                                |  |  |  |  |  |  |  |  |

 

16

Table of Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 2  Restatement /Reclassification of Financial Statements (continued)**

 
| ** **                                                                                | ** ** | ** **                   | **CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**      | ** **                            | ** ** | ** **   |
|-------------------------------------------------------------------------------------------|------------|------------------------------|--------------------------------------------------------------------------------|---------------------------------------|------------|--------------|
| ** **                                                                                | ** ** | ** **                   | **CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)** | ** **                            | ** ** | ** **   |
| ** **                                                                                | ** ** | ** **                   | ** **                                                                     | **Six Months  Ended  8/28/2008** | ** ** | ** **   | ** ** | ** ** | ** ** | **Six Months  Ended  8/30/2007** | ** ** | ** ** | ** ** |
| ** **                                                                                | ** ** | **As  Previously  Reported** | ** **                                                                     | **Adjustment**                        | ** ** | **Restated** | ** ** | **As  Previously  Reported** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| **Cash  flows from operating activities**                                                 |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| ** **                                                                                |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Net income (loss)                                                                         |       | $1,555,078                   |                                                                           | $(809,691                             | )          | $745,387     |   | $(40,654 | ) | $(560,038 | ) | $(600,692 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Stock-based  compensation                                                                 |       | 445,493                      |                                                                           |                                  |       | 445,493      |   | 382,500 |   |   |   | 382,500 |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Deferred income  taxes                                                                    |       | 379,980                      |                                                                           | (196,697                              | )          | 183,283      |   | (1,473,753 | ) | (198,714 | ) | (1,672,467 | ) |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Accretion of debt  discount                                                               |       | 600,929                      |                                                                           |                                  |       | 600,929      |   | 304,776 |   |   |   | 304,776 |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Amortization of  bond costs                                                               |       | 70,197                       |                                                                           |                                  |       | 70,197       |   |   |   |   |   |   |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Amortization of  intangibles                                                              |       | 802,435                      |                                                                           |                                  |       | 802,435      |   |   |   |   |   |   |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Derivatives                                                                               |       |                         |                                                                           | 835,484                               |       | 835,484      |   |   |   | 679,877 |   | 679,877 |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Depreciation                                                                              |       | 11,207,926                   |                                                                           | 514,241                               |       | 11,722,167   |   | 12,194,748 |   | 519,923 |   | 12,714,671 |   |
| Changes in  operating assets and liabilities, net of effects of acquisitions:             |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Receivables                                                                               |       | (10,094,518                  | )                                                                              |                                  |       | (10,094,518  | ) | (3,565,303 | ) |   |   | (3,565,303 | ) |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Inventories                                                                               |       | (611,272                     | )                                                                              |                                  |       | (611,272     | ) | 406,347 |   | 39,200 |   | 445,547 |   |
| Prepaid expenses,  other current assets and income tax receivable                         |       | 254,655                      |                                                                           |                                  |       | 254,655      |   | (2,128,067 | ) | 90,668 |   | (2,037,399 | ) |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Other                                                                                     |       | (665,725                     | )                                                                              |                                  |       | (665,725     | ) | 458,540 |   |   |   | 458,540 |   |
| Accounts payable,  accrued expenses and accrued interest                                  |       | 2,779,721                    |                                                                           | (343,337                              | )          | 2,436,384    |   | 6,685,112 |   | (169,975 | ) | 6,515,137 |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Total adjustments                                                                         |       | 5,169,821                    |                                                                           | 809,691                               |       | 5,979,512    |   | 13,264,900 |   | 960,979 |   | 14,225,879 |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| *Net cash  provided by operating activities*                                              |       | 6,724,899                    |                                                                           |                                  |       | 6,724,899    |   | 13,224,246 |   | 400,941 |   | 13,625,187 |   |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| **Cash  flows from investing activities**                                                 |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| ** **                                                                                |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Cash paid for acquisition,  net of cash acquired                                          |       | (63,829,401                  | )                                                                              |                                  |       | (63,829,401  | ) | (43,617,819 | ) |   |   | (43,617,819 | ) |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Capital  expenditures                                                                     |       | (4,820,549                   | )                                                                              |                                  |       | (4,820,549   | ) | (6,940,787 | ) |   |   | (6,940,787 | ) |
|                                                                                      |       |                         |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| *Net cash  used in investing activities*                                                  |       | (68,649,950                  | )                                                                              |                                  |       | (68,649,950  | ) | (50,558,606 | ) |   |   | (50,558,606 | ) |

 

17

Table of Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 2  Restatement /Reclassification of Financial Statements (continued)**

 
| ** **                                              | ** ** | ** **                       | **CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES**      | ** **                            | ** ** | ** **   |
|---------------------------------------------------------|------------|----------------------------------|--------------------------------------------------------------------------------|---------------------------------------|------------|--------------|
| ** **                                              | ** ** | ** **                       | **CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)** | ** **                            | ** ** | ** **   |
| ** **                                              | ** ** | ** **                       | ** **                                                                     | **Six Months  Ended  8/28/2008** | ** ** | ** **   | ** ** | ** ** | ** ** | **Six Months  Ended  8/30/2007** | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **As Previously  Reported** | ** **                                                                     | **Adjustment**                        | ** ** | **Restated** | ** ** | **As  Previously  Reported** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                    |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| **Cash  flows from financing activities**               |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Equity investment by shareholders                       |       | 15,001,466                       |                                                                           |                                  |       | 15,001,466   |   |   |   |   |   |   |   |
|                                                    |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Borrowings on revolving  line of credit                 |       | 13,200,000                       |                                                                           | 37,800,000                            |       | 51,000,000   |   | 2,600,000 |   | 17,000,000 |   | 19,600,000 |   |
| Payments on  revolving line of credit                   |       |                             |                                                                           | (37,800,000                           | )          | (37,800,000  | ) |   |   | (17,000,000 | ) | (17,000,000 | ) |
|                                                    |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Payments of  long-term debt                             |       | (380,000                         | )                                                                              |                                  |       | (380,000     | ) |   |   |   |   |   |   |
|                                                    |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Debt issuance  costs                                    |       | (847,813                         | )                                                                              |                                  |       | (847,813     | ) |   |   |   |   |   |   |
|                                                    |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Net proceeds form  bond offering                        |       | 36,900,000                       |                                                                           |                                  |       | 36,900,000   |   | 20,000,000 |   |   |   | 20,000,000 |   |
|                                                    |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| *Net cash  provided by financing activities*            |       | 63,873,653                       |                                                                           | —                                |       | 63,873,653   |   | 22,600,000 |   |   |   | 22,600,000 |   |
| * *                                                |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| * *                                                |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| Effect of foreign  currency                             |       | (228,359                         | )                                                                              |                                  |       | (228,359     | ) | 809,065 |   | (400,941 | ) | 408,124 |   |
| *Net  increase (decrease) in cash and cash equivalents* |       | 1,720,243                        |                                                                           | —                                |       | 1,720,243    |   | (13,925,295 | ) |   |   | (13,925,295 | ) |
| *Cash and  cash equivalents at beginning of period*     |       | 883,388                          |                                                                           | —                                |       | 883,388      |   | 16,260,601 |   |   |   | 16,260,601 |   |
| * *                                                |       |                             |                                                                           |                                  |       |         |   |   |   |   |   |   |   |
| *Cash and  cash equivalents at end of period*           |       | $2,603,631                       |                                                                           | —                                |       | $2,603,631   |   | $2,335,306 |   |   |   | $2,335,306 |   |

 

**Note 3 Inventories**

 

Components of inventories are as follows:
| ** **                       | ** ** | August 28, 2008 | ** ** | February 29, 2008 | ** ** |
|----------------------------------|------------|---------------------------|------------|-----------------------------|------------|
|                             |       |                      |       | ** **                  |       |
| Finished goods                   |       | $24,836,058               |       | $17,961,802                 |       |
| Raw materials                    |       | 5,120,073                 |       | 7,073,131                   |       |
| Packaging materials and supplies |       | 12,529,168                |       | 9,082,592                   |       |
|                             |       | 42,485,299                |       | 34,117,525                  |       |
| Inventory reserves               |       | (221,264                  | )          | (121,086                    | )          |
|                             |       | $42,264,035               |       | $33,996,439                 |       |

 

18

Tableof Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 4 Acquisition (continued)**

On July 2, 2008, the Company, through two newlycreated, wholly-owned subsidiaries, Cellu Tissue – Hauppauge, LLC (“CelluHauppauge”) and Cellu Tissue – Thomaston,

 

LLC (“Cellu Thomaston”) consummated the acquisition of certain assets,and assumption of certain liabilities, from Atlantic Paper & FoilCorp. of N.Y., Atlantic Lakeside Properties, LLC, Atlantic Paper &Foil, LLC, Atlantic Paper & Foil of Georgia, LLC and ConsumerLicensing Corporation (collectively, the “Sellers”) pursuant to a definitiveasset purchase agreement (the “Purchase Agreement”) between Cellu Tissue andthe Sellers.  The aggregate purchase price paid was $68,000,000, includinga cash payment at closing of $61,700,000 and the issuance of a promissory noteby Cellu Tissue to Atlantic Paper & Foil Corp. of N.Y. in theprincipal amount of $6,300,000 (the “Seller Note”), plus the assumption ofcertain liabilities.  The Company alsoincurred $2.1 million of transaction related costs.  The purchase price is subject to certainpost-closing working capital adjustments. The acquisition of assets and assumption of liabilities is referred toas the “APF Acquisition” and the acquired business is referred to as “APF”.  The Company financed the cash portion of thepurchase price with cash on-hand, the borrowings described below (Note 5) andan equity contribution from the Parent, which was funded through the issuanceof Cellu Parent stock to Weston Presidio and certain members of management.

 

The APF Acquisition has been accounted for as a purchase in accordancewith the provisions of SFAS 141 and, accordingly, the consolidated statement ofoperations includes the results of APF during the three and six months ended August 28,2008 from the date of acquisition.  Theacquisition has resulted in the recognition of goodwill, which is attributableto our Tissue segment and will be deductible for tax purposes.  Goodwill reflects the future earnings andcash flow potential of the acquired business in excess of fair values that areassigned to all other identifiable assets and liabilities.  Goodwill arises because the purchase pricepaid reflects factors including the strategic fit and expected synergies thisbusiness brings to existing operations. Purchase price allocations are subject to refinement until all pertinentinformation is obtained.    The Companyhas preliminarily allocated the purchase price over the net assets acquired inthe acquisition based on its estimates of the fair value of assets andliabilities as follows:

 
| ** **                                                     | ** ** | Purchase price allocated to: | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------|------------|
| Current assets, primarily accounts  receivable and inventories |       | $15,860,042                                 |       |
| Property, plant and equipment                                  |       | 5,306,225                                   |       |
| Goodwill                                                       |       | 23,765,576                                  |       |
| Noncompete agreements                                          |       | 12,770,000                                  |       |
| Customer lists                                                 |       | 17,340,000                                  |       |
| Trademarks                                                     |       | 56,000                                      |       |
| Current liabilities                                            |       | (4,968,441                                  | )          |
| Total                                                          |       | $70,129,402                                 |       |

 

19

Tableof Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 4 Acquisition (continued)**

 

The Company has estimated the fair value ofthe assets and liabilities of the APF Acquisition, utilizing informationavailable at the time the Company’s unaudited interim financial statements wereprepared and these estimates are subject to refinement until all pertinent informationhas been obtained. The Company is in the process of finalizing outsidethird-party appraisals of the tangible and intangible assets and has recordedthe preliminary fair market values.  Furthermore, depreciation has been calculated on the fair value assignedto the tangible fixed assets based on an average remaining 10-year life.   Intangible assets are being amortized on astraight-line basis, assuming no significant residual value, over the followinglives:  noncompete agreements-5 years,customer lists-7 years and trademarks- 3 years. The fair value assigned and actual lives used in calculatingdepreciation and amortization will be finalized with the aforementionedappraisals.  Accordingly, the purchaseprice allocations are preliminary with respect to these items and also withrespect to finalizing the transferability of tax credits and other minor items.

 

The results of APF’s operations from the July 2,2008 date of acquisition are primarily included in the Company’s tissuesegment.  Part of the acquisitionrelated to the foam business, which the Company will show as a separate segment(see Note 8).  Unaudited pro formaresults of operations for the three and six months ended August 28, 2008and August 30, 2007, as if the Company and APF had been combined as of March 1,2007, are presented below.  The pro formaresults include estimates and assumptions, which the Company’s managementbelieves are reasonable.  However, thepro forma results do not include any cost savings or other effects of theplanned integration of APF and are not necessarily indicative of the resultswhich would have occurred if the business combination had been in effect on thedates indicated, or which may result in the future.

 
|              |       | Three Months Ended August 28, 2008 (1)           |       | Three Months Ended  August 30, 2007 (1)         |       |
|-------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **        | ** ** | Actual**(Restated)**                                  | ** ** | Pro Forma**(Restated)**                              | ** ** | Actual**(Restated)** | ** ** | Pro Forma**(Restated)** |   |
|              |       | (in thousands)                                        |       | (in thousands )                                      |       |
| Net sales         |       | $  133,013                                  |       | $ 145,065                                       |       | $ 112,026 |   | $ 132,158 |   |
| Operating income  |       | $       5,742      |       | $      6,580           |       | $    6,159 |   | $    9,300 |   |
| Net (loss) income |       | $        (247 | )          | $        136 |       | $     541 |   | $    3,198 |   |

 

(1) Proforma operating results include the operating results for APF for the threemonths ended June 30, 2008 and 2007, as APF was previously a calendaryear-end company.  The actual operatingresults include the operating results for APF for the period from theacquisition date (July 2, 2008) to August 28, 2008.

 

20

Tableof Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 4 Acquisition (continued)**

 
|              |       | Six Months Ended  August 28, 2008 (1) |       | Six Months Ended  August 30, 2007 (1) |       |
|-------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **        | ** ** | Actual**(Restated)**                       | ** ** | Pro Forma**(Restated)**                    | ** ** | Actual**(Restated)** |   | Pro Forma**(Restated)** |   |
|              |       | (in thousands )                            |       | (in thousands )                            |       |
| Net sales         |       | $ 247,540                             |       | $ 279,915                             |       | $ 218,253 |   | $ 255,816 |   |
| Operating income  |       | $   12,277                  |       | $ 14,451                              |       | $ 9,329 |   | $  14,046 |   |
| Net income (loss) |       | $    745               |       | $  1,912                         |       | $     (601 | ) | $    3,219 |   |

 

(1) Proforma operating results include the operating results for APF for the sixmonths ended June 30, 2008 and 2007, as APF was previously a calendaryear-end company.      The actualoperating results include the operating results for APF for the period from theacquisition date (July 2, 2008) to August 28, 2008.

 

On March 21, 2007, the Company executed a definitive mergeragreement (the “Acquisition Agreement”) with CityForest Corporation (“CityForest”),Cellu City Acquisition Corporation (“Cellu City Merger Sub”) and Wayne Gullstadas the shareholders’ representative. Pursuant to the Acquisition Agreement, and subject to the terms andconditions therein, Cellu City Merger Sub, a wholly owned subsidiary of theCompany, merged with and into CityForest, with CityForest surviving andbecoming a wholly owned subsidiary of the Company (the “CityForest Acquisition”).  The aggregate merger consideration (includingassumption of $18.4 million in aggregate principal amount of industrial revenuebonds) was approximately $61.0 million subject to certain working capital andnet cash adjustments.  Total cash paidfor the acquisition of $46.8 million (purchase price of $61.0 million lessassumed indebtedness of $18.4 million plus restricted cash and othermiscellaneous adjustments of $1.6 million and acquisition costs of $2.6million) was financed in part by issuance of unregistered 9 3/4% Senior SecuredNotes due 2010 of approximately $20.0 million, borrowings on a revolving lineof credit ($17.4 million) and available cash on hand.

 

The CityForest Acquisition has been accountedfor as a purchase in accordance with the provisions of SFAS 141 and, accordingly,the consolidated statements of operations includes the results of CityForestduring the three months and six months ended August 28, 2008, during thethree months ended August 30, 2007 and during the six months ended August 30,2007 from the date of acquisition.

 

The results of CityForest’s operations fromthe date of acquisition (March 21, 2007) are included in the Company’stissue segment. Unaudited pro forma results of operations for the six monthsended August 30, 2007, as if the Company and CityForest had been combinedas of March 1, 2007, are presented below. The pro forma results include estimates and assumptions, which theCompany’s management believes are reasonable.

 

21

Tableof Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 4 Acquisition (continued)**

 

However, the pro forma results do not includeany cost savings or other effects of the planned integration of CityForest andare not necessarily indicative of the results which would have occurred if thebusiness combination had been in effect on the dates indicated, or which mayresult in the future.

 
|              |       | Six Months Ended  August 30, 2007 (1)                                                      |    |
|-------------------|------------|-------------------------------------------------------------------------------------------------|---------|
| ** **        | ** ** | Actual******(Restated)**                                                                        |    | Pro Forma**(Restated)** |   |
|              |       | (in thousands)                                                                                  |    |
| Net sales         |       | $                                                                                               | 218,253 |   | $         220,963 |   |
| Operating income  |       | $                                                                                               | 9,329   |   | $ | 9,915 |   |
| Net (loss) income |       | $               (601 | )       | $ | (40 | ) |

 

(1) Proforma operating results include the operating results for CityForest for thesix months ended August 30, 2007.      The actual operating results include the operating results forCityForest for the period from the acquisition date (March 21, 2007) to August 30,2007.

 

**Note 5 Long-Term Debt**

 

Long-term debt consists of the following:

 
|                                                                                                           |   | August 28,  2008 |   | February 29, 2008 |   |
|----------------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|------------------------|--------|
|                                                                                                           |   |                  |   |                   |   |
| 9 3/4%  senior secured notes due 2010                                                                          |   | $222,255,572          |   | $182,255,572           |   |
| Less discount                                                                                                  |   | (3,782,699            | )      | (1,283,628             | )      |
|                                                                                                           |   | 218,472,873           |   | 180,971,944            |   |
| Industrial  revenue bond payable, in semi-annual installments, plus variable interest,  due March 1, 2028 |   | 17,495,000            |   | 17,875,000             |   |
| Seller Note  payable, quarterly interest payments only at 12% annum, with principal due  July 2, 2011     |   | 6,300,000             |   | -                      |   |
|                                                                                                           |   | 242,267,873           |   | 198,846,944            |   |
| Less current portion of debt                                                                                   |   | 760,000               |   | 760,000                |   |
|                                                                                                           |   | $241,507,873          |   | $198,086,944           |   |

 

22

Tableof Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 5 Long-Term Debt (continued)**

 

***9******3******/******4% Senior SecuredNotes due 2010***

 

In March 2004, the Company completed a private offering of $162.0million aggregate principal amount of 9 3⁄4% senior secured notes due 2010 (the “OriginalNotes”) pursuant to and are governed by the Indenture, dated as of March 12,2004 (as amended and supplemented, the “Cellu Tissue Indenture”) among theCompany, the subsidiary guarantors party thereto and The Bank of New York TrustCompany, N.A., as successor trustee to the Bank of New York (the “Trustee”).  In connection with the CityForest Acquisition(see Note 3), the Company entered into a Note Purchase Agreement (the “NotePurchase Agreement”) with Wingate Capital Ltd. (“the Purchaser”), dated March 21, 2007, pursuant to which itissued and sold $20.3 million aggregate principal amount of 9 3⁄4% senior securednotes due 2010 (“First Additional Notes”) to the Purchaser for the purchaseprice of $20.0 million, which is equal to 98.7383% of the aggregate principalamount of the Additional Notes.  TheFirst Additional Notes were issued pursuant to and are governed by the CelluTissue Indenture.

 

In connection with the APF Acquisition (see Note 4) the Company enteredinto Note Purchase Agreements (the “Note Purchase Agreements”, or “SecondAdditional Notes”) with each of (i) GMAM Investment Funds Trust II, forthe account of the Promark Alternative High Yield Bond Fund (Account No. 7M2E),GMAM Investment Funds Trust, General Motors Welfare Benefit Trust (VEBA), GMAMInvestment Funds Trust II for the account of the Promark Alternative High YieldBond Fund (Account No. 7MWD), DDJ High Yield Fund, Multi-Style, Multi-ManagerFunds PLC The Global Strategic Yield Fund (f/k/a Multi-Style, Multi-ManagerFunds PLC The Global High Yield Fund), DDJ Capital Management Group Trust,Stichting Pensioenfonds Hoogovens, Caterpillar Inc. Master Retirement Trust,J.C. Penney Corporation, Inc. Pension Plan Trust, Stichting BewaarderInterpolis Pensioenen Global High Yield Pool, DDJ/Ontario OS Investment Sub II,Ltd. and Stichting Pensioenfonds Metaal en Techniek, (ii) Claren RoadCredit Master Fund, Ltd. and (iii) UBS High Yield Relationship Fund, aseries of the UBS Relationship funds (the “Purchasers”), dated July 2,2008, pursuant to which the Company issued and sold $40,000,000 aggregateprincipal amount of unregistered 9 3/4% Senior Secured Notes due 2010 (“SecondAdditional Notes”) to the Purchasers for the purchase price of $36,900,000which is equal to 92.25% of the aggregate principal amount of the SecondAdditional Notes (together with the Original Notes and the First AdditionalNotes, the “Notes”).  The SecondAdditional Notes were issued pursuant to and are governed by the Cellu TissueIndenture.

 

The Notes mature on March 15, 2010 and require semi-annualinterest payments on March 15 and September 15.  The Notes are collateralized by a seniorsecured interest in substantially all of the Company’s assets.  The Cellu Tissue Indenture contains certaincovenants, including limitations on certain restricted payments, the incurrenceof

 

23

Tableof Contents

 

**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 5 Long-Term Debt (continued)**

 

additional indebtedness and the sale of certain assets.    The Cellu Tissue Indenture has been amendedby two subsequent amendments pursuant to which CityForest, Cellu Happauge andCellu Thomaston became parties to the Cellu Tissue Indenture as subsidiaryguarantors (collectively, the “Additional Guarantors”).  As subsidiary guarantors, the AdditionalGuarantors, on a joint and several basis, with all the existing subsidiaryguarantors, fully, unconditionally and irrevocably guarantee the obligations ofCellu Tissue under the Cellu Tissue Indenture and Notes.  The Notes are unconditionally guaranteed byall of the Company’s subsidiaries.

 

***Seller Note Payable***

 

As part of the financing of the APF acquisition, the Company enteredinto the Seller Note in the principal amount of $6,300,000.  Interest only at 12% is payable on the notein quarterly installments with the principal due July 2, 2011.

 

***Credit Agreement***

 

The Company entered into a Credit Agreement, dated as of June 12,2006 (the “Credit Agreement”), among Cellu Tissue, as U.S. Borrower, InterlakeAcquisition Corporation Limited (“Interlake”), a subsidiary of Cellu Tissue, asCanadian Borrower, Parent, the other loan guarantors party thereto, JPMorganChase Bank, N.A., as U.S. Administrative Agent the “U.S. Administrative Agent”),JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent(the “Canadian Administrative Agent”) and the other lenders party thereto.  The Credit Agreement provides for a $35.0million working capital facility, which was subseqeuently increased to $60.0million (see discussion following), including a letter of credit sub-facilityand swing-line loan sub-facility. The Credit Agreement provides that amountsunder the facility may be borrowed, repaid and re-borrowed, subject to aborrowing base test, until the maturity date, which is June 12, 2011. Anamount equal to $32.0 million, which was subsequently increased to $57.0million (see discussion following), is available, in U.S. dollars, to the U.S.Borrower under the facility and an amount equal to $3.0 million is available, inU.S. or Canadian dollars, to the Canadian Borrower under the facility.  Borrowings of $17.4 million were made tofinance a portion of the CityForest Acquisition and borrowings of $12.1 millionwere made to finance a portion of the APF Acquisition.   As of August 28, 2008, there was $23.0million of borrowings outstanding under the working capital facility and excessavailability was $30.2 million.

 

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 5 Long-Term Debt (continued)**

 

Cellu Tissue has entered into a First Amendment, dated March 21,2007 (the “First Amendment”), to the Credit Agreement dated June 12, 2006(as amended by the First Amendment, the “Amended Credit Agreement”) among CelluTissue, Interlake, certain subsidiaries of Cellu Tissue, the Parent, the U.S.Administrative Agent and the Canadian Administrative Agent.

 

The First Amendment (1) increases the working capital facilityfrom $35.0 million to $40.0 million, (2) permits the issuance and sale bythe Company of the First Additional Notes, (3) provides for theconsummation of the CityForest Acquisition and the conversion by CityForestfrom a Minnesota corporation to a Minnesota limited liability company, (4) permitsthe assumption of approximately $18.4 million in aggregate principal amount ofindebtedness of CityForest in connection with the CityForest Acquisition inaccordance with the terms of the CityForest Bond Documents (as defined belowunder “CityForest Bond Documents”), and (5) permits the guarantee by CelluTissue of certain obligations of CityForest under the CityForest Bond Documents.  In connection with the First Amendment,CityForest became a guarantor of the obligations of the borrowers under theAmended Credit Agreement.

 

The Company has entered into a Second Amendment, dated July 2,2008 (the “Second Amendment”), to the Credit Agreement dated June 12, 2006(as amended by the First Amendment, as Amended, and the Second Amendment, “CreditAgreement, as Amended”), among Cellu Tissue, Interlake, certain****subsidiaries of Cellu Tissue, the Parent, the U.S.Administrative Agent and the Canadian Administrative Agent.

 

The Second Amendment (1) increases the working capital facilityfrom $40.0 million to $60.0 million, (2) permits the issuance and sale byCellu Tissue of the Second Additional Notes, (3) provides for theconsummation of the APF Acquisition and (4) permits the issuance of theSeller Note.  In connection with theSecond Amendment, Cellu Hauppauge and Cellu Thomaston became guarantors of theobligations of the borrowers under the Credit Agreement, as Amended.

 

***CityForest Bond Documents***

 

CityForest is party to a LoanAgreement, dated March 1, 1998 (the “Loan Agreement”), with the City ofLadysmith, Wisconsin (the “Issuer”). Pursuant to the Loan Agreement, the Issuer loaned the proceeds of theIssuer’s Variable Rate Demand Solid Waste Disposal Facility Revenue Bonds,Series 1998 (CityForest Corporation Project) (the “Bonds”) to CityForest tofinance the construction by CityForest of a solid waste disposal facility.  Approximately $18.4 million in aggregateprincipal amount of the Bonds was outstanding as of the date of the CityForestAcquisition.  CityForest is required,under the terms of the Indenture of Trust governing the Bonds (the “CityForestIndenture”), to

 

25

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 5 Long-Term Debt (continued)**

 

provide a letter of credit in favor of the trustee under the CityForestIndenture (the “Bonds Trustee”). CityForest has entered into an Amended and Restated ReimbursementAgreement, dated March 21, 2007 (the “Reimbursement Agreement” and,together with the CityForest Indenture and the Loan Agreement, the “CityForestBond Documents”), with Associated Bank, National Association (“Associated Bank”),pursuant to which Associated Bank has extended the required letter of credit(the “Associated Bank Letter of Credit”) and has provided a revolving creditfacility to CityForest in an aggregate principal amount of up to $3.5 million(the “Associated Bank Revolving Credit Facility”).

 

*The BondsTrustee is permitted to draw upon the Associated Bank Letter of Credit to payprincipal and interest due on the Bonds, and to provide liquidity to purchaseBonds put to CityForest by bondholders and not remarketed; and CityForest isobligated under the Reimbursement Agreement to reimburse Associated Bank forany such draws. CityForest is also obligated to pay a fee in respect of theaggregate amount available to be drawn under the Associated Bank Letter ofCredit at a rate per annum initially equal to 1.25%, subject to adjustment on aquarterly basis based on CityForest’s leverage. The expiration date of the Associated Bank Letter of Credit is February 15,2011.*

 

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

* *

The Reimbursement Agreement requires scheduled semi-annual payments ofprincipal of the Bonds equal to approximately 2.00% of the principal amountoutstanding as of the date of the CityForest Acquisition, with the balancepayable at maturity of the Bonds on March 1, 2028. The ReimbursementAgreement also contains a number of other provisions regarding reserve fundsand other mandatory and optional repayments in connection with the Bonds.  In addition, the Reimbursement Agreementprovides that in certain circumstances where the Company incurs indebtedness,as defined, in excess of amounts currently permitted under the CityForestIndenture or refinances the

 

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 5 Long-Term Debt (continued)**

 

*indebtedness issued under the CityForest Indenture, Associated Bank mayrequire CityForest to repay all of its obligations to Associated Bank under theReimbursement Agreement and either to cause the Bonds to be redeemed or toreplace the Associated Bank Letter of Credit with a Substitute Credit Facility,as such term is defined in the CityForest Indenture.*

* *

The Reimbursement Agreement contains various affirmative and negativecovenants customary for working capital and term credit facilities, as well asadditional covenants relating to the Bonds. The negative covenants include limitations on: indebtedness; liens;acquisitions, mergers and consolidations; investments; guarantees; asset sales;sale and leaseback transactions; dividends and distributions; transactions withaffiliates; capital expenditures; and changes to the status of the Bonds.CityForest is also required to comply on a quarterly basis with a maximumleverage covenant and a minimum fixed charge coverage covenant. The ReimbursementAgreement also contains customary events of default, including:  payment defaults; breaches of representationsand warranties; covenant defaults; cross-defaults to certain other debt,including the First Additional Notes and indebtedness under the Amended CreditAgreement; certain events of bankruptcy and insolvency; judgment defaults;certain defaults related to the Employee Retirement Income Security Act of1974, as amended; and a change of control of CityForest or the Company.

 

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

 

**Note 6 Debt and Note Issuance Costs**

 

In connection with the financing related to the APF acquisition, theCompany incurred approximately $225,000 and $623,000 of costs related to theamendment to the credit agreement and note issuance, respectively.  These costs have been capitalized as of thedate of financing and are being amortized over the respective terms of thefinancing.  The debt issuance costs andrelated accumulated amortization balances as of August 28, 2008 are asfollows:

 

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 6 Debt and Note Issuance Costs (continued)**

 
|                                 |   | August 28,  2008 |   |
|--------------------------------------|--------|-----------------------|--------|
|                                 |   |                  |   |
| Debt issuance costs-credit agreement |   | $ 225,171        |   |
| Note issuance costs                  |   | 622,641               |   |
|                                 |   | 847,812               |   |
| Accumulated amortization             |   | (70,197               | )      |
|                                 |   | $ 777,615        |   |

 

These costs, net of accumulated amortization, are included in otherassets on the balance sheet as of August 28, 2008.

 

**Note 7 Comprehensive (Loss) Income**

 

The components of comprehensive (loss) income for the three months andsix months ended August 28, 2008 and August 30, 2007 are as follows:

 
|                                      |       | Three Months Ended                            |       | Six Months Ended                   |       |
|-------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------|------------|
|                                      | ** ** | August 28, 2008**(Restated)**            | ** ** | August 30, 2007**(Restated)** | ** ** | August 28, 2008**(Restated)** | ** ** | August 30, 2007**(Restated)** | ** ** |
| Net (loss) income                         |       | $      (247,083 | )          | $541,149                           |       | $745,387 |   | $(600,692 | ) |
| Foreign currency  translation adjustments |       | (2,013,492                                    | )          | 273,326                            |       | (2,162,086 | ) | 1,227,320 |   |
| Comprehensive  (loss) income              |       | $    (2,260,575           | )          | $814,475                           |       | $(1,416,699 | ) | $626,628 |   |

 

**Note 8 Business Segments**

 

The Company operates in three business segments:  tissue, machine-glazed paper and foam.  The foam business segment was added inconnection with the APF Acquisition (see Note 4).  The Company assesses the performance of itsbusiness segments using income from operations. Income from operations excludes interest income, interest expense, otherincome (expense), income tax expense, amortization expense and the impact offoreign currency gains and losses.   Aportion of corporate and shared expenses is allocated to each segment.  Segment information for the three months andsix months ended August 28, 2008 and August 30, 2007 follows:

 

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 8 Business Segments (continued)**

 
|                                   |       | Three Months Ended                  |       | Six Months  Ended                   |       |
|----------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | August 28,  2008**(Restated)** | ** ** | August 30,  2007**(Restated)** | ** ** | August 28,  2008**(Restated)** |   | August 30,  2007**(Restated)** |   |
| **Net  Sales**                         |       |                                |       |                                |       |   |   |   |   |
| Tissue                                 |       | $103,413,826                        |       | $85,611,186                         |       | $189,210,876 |   | $165,396,041 |   |
| Machine-glazed  paper                  |       | 28,718,124                          |       | 26,414,823                          |       | 57,448,635 |   | 52,856,917 |   |
| Foam                                   |       | 880,906                             |       | -                                   |       | 880,906 |   | - |   |
| Consolidated                           |       | $133,012,856                        |       | $112,026,009                        |       | $247,540,417 |   | $218,252,958 |   |
|                                   |       |                                |       |                                |       |   |   |   |   |
| **Segment  income from operations**    |       |                                |       |                                |       |   |   |   |   |
| Tissue                                 |       | $6,112,624                          |       | $5,550,156                          |       | 12,167,787 |   | $9,290,404 |   |
| Machine-glazed  paper                  |       | 253,267                             |       | 608,645                             |       | 732,660 |   | 38,306 |   |
| Foam                                   |       | 178,657                             |       | -                                   |       | 178,657 |   | - |   |
| Segment  income from operations        |       | 6,544,548                           |       | 6,158,801                           |       | 13,079,104 |   | 9,382,710 |   |
| Amortization  expense                  |       | (802,435                            | )          | -                                   |       | (802,435 | ) | - |   |
| Consolidated  income from operations   |       | 5,742,113                           |       | 6,158,801                           |       | 12,276,669 |   | 9,328,710 |   |
| Interest  expense, net                 |       | (6,061,057                          | )          | (5,102,666                          | )          | (11,040,745 | ) | (10,121,760 | ) |
|                                   |       |                                |       |                                |       |   |   |   |   |
| Net foreign  currency transaction loss |       | (127,700                            | )          | (150,317                            | )          | (84,620 | ) | (119,467 | ) |
| Other  (expense) income                |       | (8,910                              | )          | 40,261                              |       | (38,418 | ) | 82,500 |   |
| Income  before income tax expense      |       | $(455,554                           | )          | $946,079                            |       | $1,112,886 |   | $(830,017 | ) |
|                                   |       |                                |       |                                |       |   |   |   |   |
| **Capital  Expenditures**              |       |                                |       |                                |       |   |   |   |   |
| Tissue                                 |       | $1,779,412                          |       | $3,338,578                          |       | $3,808,941 |   | $5,579,729 |   |
| Machine-glazed  paper                  |       | 421,940                             |       | 718,584                             |       | 676,770 |   | 971,235 |   |
| Foam                                   |       | -                                   |       | -                                   |       | - |   | - |   |
| Corporate                              |       | 144,306                             |       | 237,279                             |       | 334,838 |   | 389,823 |   |
| Consolidated                           |       | $2,345,658                          |       | $4,294,441                          |       | $4,820,549 |   | $6,940,787 |   |
|                                   |       |                                |       |                                |       |   |   |   |   |
| **Depreciation**                       |       |                                |       |                                |       |   |   |   |   |
| Tissue                                 |       | $4,335,471                          |       | $4,344,967                          |       | $8,651,625 |   | $9,544,892 |   |
| Machine-glazed  paper                  |       | 1,519,052                           |       | 1,430,177                           |       | 3,056,936 |   | 3,169,779 |   |
| Foam                                   |       | 13,606                              |       | -                                   |       | 13,606 |   | - |   |
| Consolidated                           |       | $5,868,129                          |       | $5,775,144                          |       | $11,722,167 |   | $12,714,671 |   |

 

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 8 Business Segments (continued)**

 
| ** **           | ** ** | August 28, 2008**(Restated)** |   | February 29, 2008**(Restated)** |
|----------------------|------------|-----------------------------------------|--------|-------------------------------------------|
| **Segment assets**   |       |                                    |   |                                      |
| Tissue               |       | $ 399,412,446                      |   | $                                         |  325,526,456 |
| Machine-glazed paper |       | 93,311,711                              |   | 91,007,538                                |
| Foam                 |       | 1,902,089                               |   | -                                         |
| Corporate assets     |       | 5,119,047                               |   | 6,682,685                                 |
| Consolidated         |       | $ 499,745,293                      |   | $                                         |   423,216,679 |
| Goodwill             |       |                                    |   |                                      |
| Tissue               |       | $   34,015,328           |   | $                                         |     10,249,752 |
| Machine-glazed paper |       | 1,085,003                               |   | 1,085,003                                 |
| Consolidated         |       | $   35,100,331           |   | $                                         |    11,334,755 |

 

**Note 9 Goodwill and Other Intangibles, Net**

 

Goodwill, trademarks and other intangibles and related accumulatedamortization as of August 28, 2008 and February 29, 2008 are asfollows:

 
| ** **               | ** ** | August 28, 2008**(Restated)** | ** ** | February 29, 2008**(Restated)** |
|--------------------------|------------|-----------------------------------------|------------|-------------------------------------------|
|                     |       |                                    |       |                                      |
| Goodwill                 |       | $35,100,331                             |       | $ 11,334,755                         |
|                     |       |                                    |       |                                      |
| Trademarks               |       | $9,456,000                              |       | $ 9,400,000                          |
| Noncompete agreements    |       | 12,770,000                              |       | -                                         |
| Customer lists           |       | 17,340,000                              |       | -                                         |
|                     |       | 39,566,000                              |       | 9,400,000                                 |
| Accumulated amortization |       | (802,435)                               |       | -                                         |
| Other Intangibles, Net   |       | $38,763,565                             |       | $9,400,000                                |

 

Intangible assets are being amortized on a straight-line basis,assuming no significant residual value, over the following lives:  noncompete agreements-5 years, customerlists-7 years and trademarks- 3 years. Annual aggregate amortization expense estimated for each of the 5succeeding years is approximately $5.0 million. Amortization expense for the three months and six months ended August 28,2008 was $802,435.

 

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**Cellu Tissue Holdings, Inc. andSubsidiaries**

**Notes to Consolidated Financial Statements(Unaudited) (continued)**

 

**Note 10 Income Taxes (continued)**

 

The effective income tax rate for the three months and six months endedAugust 28, 2008 was 45.8% (benefit) and 33.0%, respectively compared to42.8% and 27.6% (benefit), respectively for the three months and six monthsended August 30, 2007.   Included inthe income tax expense for the three months and six months ended August 30,2007 is approximately $90,000 related to additional Canadian income taxes paidupon completion of the Company’s fiscal year 2007 tax returns.

 

The Company recognizes interest and penalties related to uncertain taxpositions in income tax expense.  As of August 28,2008, the Company has accrued interest and penalties, if any, related touncertain tax positions.  At August 28,2008, the Company did not have any unrecognized tax benefits.

 

The fiscal tax years 2004 through 2008 remain open to examination bythe major taxing jurisdictions to which the Company is subject.  As of August 28, 2008, the Company doesnot expect any material changes to unrecognized tax positions within the next12 months.

 

**Note 11 Subsequent Events**

 

On August 29, 2008, $15.0 million in contingent consideration inconnection with the Agreement and Plan of Merger that the Parent consummated onJune 12, 2006 with Cellu Parent , a corporation organized and controlledby Weston Presidio, and Cellu Acquisition Corporation (“Merger Sub”), a whollyowned subsidiary of Cellu Parent and a newly formed corporation indirectlycontrolled by Weston Presidio was paid out due to the achievement of certainfinancial targets for fiscal year 2008.  Of the $15 million, $1.3 million was issued in stock of Cellu Parent and$13.7 million was paid out in cash. The $13.7 million was funded by an equityinvestment of $6.7 million by Weston Presidio to Cellu Parent and $7.0 by CelluTissue, which was funded through borrowings on the Company’s revolving line ofcredit.

 

On September 29, 2008 the Company entered into the Third Amendmentto the Credit  Agreement dated as of June 12,2006 (as amended by the First Amendment, as Amended and the Second Amendment,as Amended) and as further amended, supplemented or otherwise modified fromtime to time, by and among the Parent, Cellu Tissue,  Interlake, the Loan Guarantors party thereto,the lenders party thereto,  the USAdministrative Agent and the Canadian Administrative Agent.  This Amendment increases the amount of theCanadian Commitments by $2.0 million and reduces the amount of the USCommitments by the same amount.

 

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**Item2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS**

 

**OVERVIEW**

Certain statements contained in this Quarterly Report on Form 10-Q/Amay contain forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities and Exchange Act of 1934, as amended, and, as such, may involveknown or unknown risks, uncertainties and other factors which may cause ouractual results, performance or achievements to be materially different fromfuture results, performance or achievements expressed or implied by suchforward-looking statements. Forward-looking statements, which are based on certain assumptions anddescribe our future plans, strategies and expectations, are generallyidentifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,”“estimate,” “believe,” “intend,” “project,” or comparable terminology.  Factors which could have a material adverseeffect on our operations and future prospects include, but are not limited to,those set forth in Item 1. Business-Forward-Looking Statements and Item1A.  Risk Factors in our Annual Report onForm 10-K/A for our fiscal year ended February 29, 2008.  These risks and uncertainties should beconsidered in evaluating any forward-looking statements contained herein.

 

The Company has restated its consolidated financial statements as of August 28,2008 and February 29, 2008 and for the three and six month periods ended August 30,2007.  This restatement correctserrors in (i) accounting for deferred income taxes in connection with purchaseaccounting applied in fiscal 2007, (ii) classification of borrowings andrepayments on the revolving credit facility in the statement of cash flows, andcertain other adjustments that were initially deemed to be not material bymanagement, including (a)  classificationof shipping and handling costs in accordance with EITF 00-10, *Accounting for Shipping and Handling Fees and Costs*(EITF00-10), (b) accounting for derivative instruments, (c) accounting for foreignexchange gains and losses in fiscal 2008 and 2007, and (d) certain othermiscellaneous adjustments.  SeeNote 2 — Restatement of Financial Statements in the accompanyingconsolidated financial statements for further information.

 

We manufacture and market a variety of specialty tissue hard rolls andmachine-glazed paper used in the manufacture of various end products, includingdiapers, facial and bath tissue, assorted paper towels and food wraps.  In addition, we produce a variety of convertedtissue products.  Our customers includemajor North American producers of branded and unbranded disposable consumerabsorbent and tissue products for the personal and health care markets;consumer and away-from-home tissue products companies; national and regionaltissue products distributors; and third-party converters who sell theirproducts to food, bakery and confections companies.  We service a diverse group of high-qualitycustomers, with three of our top 10 customers belonging to the Fortune 150 groupof companies.

 

We operate in three business segments: tissue, machine-glazed paper and foam.   The foam business segment was added in connection with the APFAcquisition (see discussion below).  Weassess the performance of our business segments using income

 

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from operations.  Income fromoperations excludes interest income, interest expense, income tax expense,amortization expense, other income (expense) and the impact of foreign currencygains and losses.

 

**Acquisitions**

 

On July 2, 2008, we, through two newly created,wholly-owned subsidiaries, Cellu Hauppauge and Cellu Thomaston consummated theacquisition of certain assets, and assumption of certain liabilities, fromAtlantic Paper & Foil Corp. of N.Y., Atlantic Lakeside Properties,LLC, Atlantic Paper & Foil, LLC, Atlantic Paper & Foil ofGeorgia, LLC and Consumer Licensing Corporation (collectively, the “Sellers”)pursuant to the Purchase Agreement between Cellu Tissue and the Sellers. The aggregate purchase price paid was $68,000,000, including a cash payment atclosing of $61,700,000 and the issuance of a promissory note by Cellu Tissue toAtlantic Paper & Foil Corp. of N.Y. in the principal amount of$6,300,000 (the “Seller Note”), plus the assumption of certainliabilities.  We also incurred $2.1million of transaction related costs. The purchase price is subject to certain post-closing working capitaladjustments.  The acquisition of assetsand assumption of liabilities is referred to as the “APF Acquisition” and theacquired business is referred to as “APF”. We financed the cash portion of the purchase price with cash on-hand,the borrowings described below and an equity contribution from our Parent,which was funded through the issuance of Cellu Parent stock to Weston Presidioand certain members of management.

 

The APF Acquisition has been accounted for as a purchase in accordancewith the provisions of SFAS 141 and, accordingly, the consolidated statement ofoperations includes the results of APF during the three and six months ended August 28,2008 from the date of acquisition.  Theacquisition has resulted in the recognition of goodwill, which is attributableto our Tissue segment and will be deductible for tax purposes.  Goodwill reflects the future earnings andcash flow potential of the acquired business in excess of fair values that areassigned to all other identifiable assets and liabilities.  Goodwill arises because the purchase pricepaid reflects factors including the strategic fit and expected synergies thisbusiness brings to existing operations. Purchase price allocations are subject to refinement until all pertinentinformation is obtained.  We havepreliminarily allocated the purchase price over the net assets acquired in theacquisition based on an estimate of the fair value of assets and liabilities asfollows:

 
| ** **                                                     | ** ** | Purchase price allocated to: | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------|------------|
| Current assets, primarily accounts  receivable and inventories |       | $ 15,860,042                           |       |
| Property, plant and equipment                                  |       | 5,306,225                                   |       |
| Goodwill                                                       |       | 23,765,576                                  |       |
| Noncompete agreements                                          |       | 12,770,000                                  |       |
| Customer lists                                                 |       | 17,340,000                                  |       |
| Trademarks                                                     |       | 56,000                                      |       |
| Current liabilities                                            |       | (4,968,441                                  | )          |
| Total                                                          |       | $ 70,129,402                           |       |

 

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We have estimated the fair value of theassets and liabilities of the APF Acquisition, utilizing information availableat the time our unaudited interim financial statements were prepared and theseestimates are subject to refinement until all pertinent information has beenobtained.  We are in the process offinalizing outside third-party appraisals of our tangible and intangible assetsand have recorded the preliminary fair market values.   Furthermore, depreciation has beencalculated on the fair value assigned to the tangible fixed assets based on anaverage remaining 10-year life.  Intangible assets are being amortized on a straight-line basis, assumingno significant residual value, over the following lives:  noncompete agreements-5 years, customerlists-7 years and trademarks- 3 years. The fair value assigned and actual lives used in calculatingdepreciation and amortization will be finalized with the aforementionedappraisals.  Accordingly, the purchaseprice allocations are preliminary with respect to these items and also withrespect to finalizing the transferability of tax credits and other minor items.

 

The results of APF’s operations from the July 2,2008 date of acquisition are primarily included in our tissue segment.  Part of the acquisition related to thefoam business, which we show as a separate segment as noted above.  Unaudited pro forma results of operations forthe three and six months ended August 28, 2008 and August 30, 2007,as if we and APF had been combined as of March 1, 2007, are presentedbelow.  The pro forma results includeestimates and assumptions, which our management believes are reasonable.  However, the pro forma results do not includeany cost savings or other effects of the planned integration of APF and are notnecessarily indicative of the results which would have occurred if the businesscombination had been in effect on the dates indicated, or which may result in thefuture.

 
|              |       | Three Months Ended August 28, 2008 (1) |                          | Three Months Ended August 30, 2007 (1) |       |
|-------------------|------------|----------------------------------------------------------------------|-------------------------------|----------------------------------------------------------------------|------------|
|              |       | Actual**(Restated)**                                                 |                          | Pro Forma**(Restated)**                                         |       | Actual**(Restated)** |   | Pro Forma**(Restated)** |   |
| ** **        | ** ** | (in thousands)                                                  |                          | (in thousands)                                                  | ** ** |
| Net sales         |       | $                                                                    |  133,013                 |                                                                 | $          |  145,065 |   | $ |  112,026 |   | $ |  132,158 |   |
| Operating income  |       | $                                                                    |     5,742 |                                                                 | $          |      6,580 |   | $ |      6,159 |   | $ |    9,300 |   |
| Net (loss) income |       | $                                                     |    (247        | )                                                                    | $          |        136 |   | $ |      541 |   | $ |     3,198 |   |
|                   |            |                                                                      |                               |                                                                      |            |  |  |  |  |  |  |  |  |  |

 

(1) Proforma operating results include the operating results for APF for the threemonths ended June 30, 2008 and 2007, as APF was previously a calendaryear-end company.  The actual  operating results include the operatingresults for APF for the period from the acquisition date (July 2, 2008) toAugust 28, 2008.

 
| ** **        | ** ** | Six Months Ended August 28, 2008 (1) |                  | Six Months Ended August 30, 2007 (1) | ** ** |
|-------------------|------------|--------------------------------------------------------------------|-----------------------|--------------------------------------------------------------------|------------|
| ** **        | ** ** | Actual**(Restated)**                                               |                  | Pro Forma**(Restated)**                                       |       | Actual **(Restated)** |   | Pro Forma **(Restated)** | ** ** |
| ** **        | ** ** | (in thousands)                                                |                  | (in thousands)                                                | ** ** |
| Net sales         |       | $                                                                  |  247,540         |                                                               | $          |  279,915 |   | $ |  218,253 |   | $ |  255,816 |   |
| Operating income  |       | $                                                                  |   12,277    |                                                               | $          |    14,451 |   | $ |    9,329 |   | $ |    14,046 |   |
| Net income (loss) |       | $                                                                  |    745 |                                                               | $          |      1,912 |   | $   |     (601) |   | $ |     3,219 |   |
|                   |            |                                                                    |                       |                                                                    |            |  |  |  |  |  |  |  |  |  |

 

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(1) Proforma operating results include the operating results for APF for the sixmonths ended June 30, 2008 and 2007, as APF was previously a calendaryear-end company.      The actualoperating results include the operating results for APF for the period from theacquisition date (July 2, 2008) to August 28, 2008.

 

On March 21, 2007, we executed the Acquisition Agreement withCityForest, Cellu City Merger Sub and Wayne Gullstad as the shareholders’representative.  Pursuant to theAcquisition Agreement and subject to the terms and conditions therein, CelluCity Merger Sub, a wholly owned subsidiary of ours, merged with and intoCityForest, with CityForest surviving and becoming our wholly owned subsidiary.  The aggregate merger consideration (includingassumption of $18.4 million in aggregate principal amount of industrial revenuebonds) was approximately $61.0 million subject to certain working capital andnet cash adjustments.  Total cash paidfor the acquisition of $46.8 million (purchase price of $61.0 million lessassumed indebtedness of $18.4 million plus restricted cash and othermiscellaneous adjustments of $1.6 million and acquisition costs of $2.6million), was financed in part by the First Additional Notes of approximately$20.0 million, borrowings on a revolving line of credit ($17.4 million) andavailable cash on hand.

 

The CityForest Acquisition has been accountedfor as a purchase in accordance with the provisions of SFAS 141 and,accordingly, the consolidated statements of operations includes the results ofCityForest during the three months and six months ended August 28, 2008,during the three months ended August 30, 2007 and during the six monthsended August 30, 2007 from the date of acquisition.   The results of CityForest’s operations areincluded in our tissue segment.  Unaudited pro forma results of operations for the six months ended August 30,2007, as if we and CityForest had been combined as of March 1, 2007, arepresented below.  The pro forma results includeestimates and assumptions, which our management believes are reasonable.  However, the pro forma results do not includeany cost savings or other effects of the planned integration of CityForest andare not necessarily indicative of the results which would have occurred if thebusiness combination had been in effect on the date indicated, or which mayresult in the future.

 
| ** **        | ** ** | Six Months Ended August 30, 2007 (1) | ** **                   |
|-------------------|------------|--------------------------------------------------------------------|------------------------------|
| ** **        | ** ** | Actual**(Restated)**                                               |                         | Pro Forma**(Restated)** | ** ** |
| ** **        | ** ** | (in thousands)                                                | ** **                   |
| Net sales         |       | $                                                                  |  218,253                |   | $ |  220,963 |   |
| Operating income  |       | $                                                                  |   9,329            |   | $ |   9,915 |   |
| Net (loss) income |       | $                                                                  |     (601 | ) | $ |    (40) |   |

 

(1) Proforma operating results include the operating results for CityForest for thesix months ended August 30, 2007.      The actual operating results include the operating results forCityForest for the period from the acquisition date (March 21, 2007) to August 30,2007.

 

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**Subsequent Events**

 

On August 29, 2008, $15.0 million in contingent consideration inconnection with the Agreement and Plan of Merger that the Parent consummated onJune 12, 2006 with the Parent, Weston Presidio and Merger Sub, a whollyowned subsidiary of Cellu Parent and a newly formed corporation indirectlycontrolled by Weston Presidio was paid out due to the achievement of certainfinancial targets for fiscal year 2008.  Of the $15 million, $1.3 million was issued in stock of Cellu Parent and$13.7 million was paid out in cash. The $13.7 million was funded by an equityinvestment of $6.7 million by Weston Presidio to Cellu Parent and $7.0 by CelluTissue, which was funded through borrowings on the Company’s revolving line ofcredit.

 

On September 29, 2008, the Company entered into the ThirdAmendment, to the Credit  Agreement datedas of June 12, 2006 (as amended by the First Amendment, as Amended and theSecond Amendment, as Amended, and as further amended, supplemented or otherwisemodified from time to time, by and among the Paper, Cellu Tissue,  Interlake, the Loan Guarantors party thereto,the lenders party thereto,  the USAdministrative Agent and the Canadian Administrative Agent.  ThisAmendment increases the amount of the Canadian Commitments by $2.0 million andreduces the amount of the US Commitments by the same amount.

 

**Results of Operations for the Three Months Ended August 28, 2008(the Fiscal 2009 Three-Month Period) compared to the Three Months Ended August 30,2007 (the Fiscal 2008 Three-Month Period) and the Six Months Ended August 28,2008 (the Fiscal 2009 Six-Month Period) compared to the Six Months ended August 30,2007 (the Fiscal 2008 Six-Month Period)**

 

**Net sales** for the fiscal 2009 three-monthperiod increased $21.0 million, or 18.7%, to****$133.0million from $112.0 million for the comparable period in the prior year. Netsales for the fiscal 2009 six-month period increased $29.2 million, or 13.4%,to $247.5 from $218.3 million for the comparable period in the prior year.  On a company-wide basis, tons sold increasedfor the fiscal 2009 three-month period and the fiscal 2009 six-month periodcompared to the comparable periods of fiscal 2008.  For the fiscal 2009 three-month period, we sold87,036 tons of tissue hard rolls, machine-glazed paper hard rolls and convertedpaper products, an increase of 6,887 tons, or 8.6%, compared to the fiscal 2008three-month period.  For the fiscal 2008six-month period, we sold 164,485 tons of tissue hard rolls, machine-glazedpaper hard rolls and converted paper products, an increase of 6,231 tons, or3.9%, compared to the fiscal 2008 six-month period.   Of these increases, $14.5 million of netsales and 7,941 tons sold related to APF. Net selling price per ton increased from $1,398 and $1,379 for thefiscal 2008 three-month and six-month periods to $1,518 and $1,500 for thefiscal 2009 three-month and six-month periods.

 

Net sales for our tissue segment for the fiscal 2009 three-month periodwere $103.4 million, an increase of $17.8 million, or 20.8%, from thecomparable period in the****prioryear.  Net sales for our tissue segmentfor the fiscal 2009 six-month period were $189.2 

 

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million, an increase of $23.8 million, or 14.4%, from the comparableperiod in the prior year.  Theseincreases are the result of the APF Acquisition, an increase in tonnage sold,primarily in our converting business, and an increase in net selling price perton over the comparable periods in the prior year.

 

Net sales for our machine-glazed segment for the 2009 three-monthperiod were****$28.7 million, an increase of$2.3 million, or 8.7%,****from thecomparable period in the prior year.  Netsales for our machine-glazed segment for the 2009 six-month period were $57.4million, an increase of $4.6 million, or 8.7%, from the comparable period inthe prior year.   These increases aredriven primarily by an increase in net selling price per ton over thecomparable periods in the prior year.

 

Net sales for our foam segment for the 2009 three-month and six-monthperiods were $.9 million.  We startedreporting with respect to the foam segment following the APF Acquisition.

 

**Gross profit** for the fiscal 2009 three-monthperiod increased to $11.0 million from $10.9 million, an increase of $.1million, or 1.2%, from the comparable period in the prior****year.**  **Asa percentage of net sales, gross profit decreased to 8.3% in the fiscal 2009three-month period from 9.7% in the fiscal 2008 three-month period.  Gross profit for the fiscal 2009 six-monthperiod increased to $22.8 million from $18.8 million, an increase of $4.0million, or 21.5%, from the comparable period in the prior year. 

As a percentage of net sales, gross profit increased to 9.2% in thefiscal 2009 six-month period from 8.6% in the fiscal 2008 six-month period. ** **The decrease in grossprofit as a percentage of net sales in the fiscal 2009 three-month period isthe result of increased fiber and energy costs over the comparable period inthe prior year.  Furthermore, included incost of goods sold for the fiscal 2009 three-month and six-month periods isapproximately $.3 million of a charge reflecting purchase price allocated toinventory in connection with the APF acquisition.

 

Gross profit for our tissue segment for the fiscal 2009 three-monthperiod was $9.5 million, an increase of $.6 million, or 7.2%, from thecomparable period in the prior year. Gross profit for our tissue segment for the fiscal 2009 six-month periodwas $19.6 million, an increase of $3.8 million, or 24.0%, from the comparableperiod in the prior year.

 

Gross profit for our machine-glazed segment for the fiscal 2009three-month period was $1.3 million, a decrease of $.7 million, or 35.7%, fromthe comparable period in the prior year. Gross profit for our machine-glazed segment for the fiscal 2009six-month period was $3.0 million consistent with the comparable period in theprior year.

 

Gross profit for our foam segment for the fiscal 2009 three-month andsix-month periods was $.2 million.

 

As a percentage of net sales, gross profit for the tissue segmentdecreased to 9.2% in the fiscal 2009 three-month period and increased to 10.4%in the fiscal 2009 six-month period from****10.4% in thefiscal 2008 three-month period and 9.5% in the fiscal 2008 six-

 

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month period**.**  As a percentage of net sales, gross profitfor the machine-glazed segment decreased to 4.4% in the fiscal 2009 three-monthperiod and 5.3% in the fiscal 2009 six-month period from 7.5% in the fiscal2008 three-month period and 5.6% in the fiscal 2008 six- month period.   As a percentage of net sales, gross profitfor the foam segment for the three-month and six-month periods was 22.3%.

 

**Selling, general and administrative expenses**inthe fiscal 2009 three-month period decreased $.3 million, or 7.9%, to $4.2million from $4.5 million in the fiscal 2008 three-month period.  Selling, general and administrative expensesin the fiscal 2009 six-month period increased $.1 million, or 1.3%, to $9.1million from $9.0 million in the fiscal 2008 six-month period.  As a percentage of net sales, selling,general and administrative expenses decreased to****3.2%in the fiscal 2009 three-month period and decreased to 3.8% in the fiscal 2009six-month period from 4.1% and 4.2%, respectively, for the comparable periodsin the prior year.  Included in thefiscal 2008 three-month and six-month periods are additional costs incurred inconnection with being compliant with Sarbanes Oxley as this was the first yearwe had to meet such requirements.

 

**Terminated acquisition-related transaction costs**forthe fiscal 2009 three-month and six-month periods of less than $.1 million and$.1 million, respectively relate to costs incurred in connection withacquisitions that did not transpire.

 

**Stock compensation expense**in the fiscal 2009three-month and six-month periods of $.2 million and $.4 million, respectively,and fiscal 2008 three-month and six-month periods of $.2 and $.4 million,respectively relates to the accounting for restricted stock and stock optiongrants.

 

**Amortization expense**in the fiscal 2009three-month and six-month periods of $.8 million relates to amortization of theintangible assets recorded in connection with the APF Acquisition.

 

**Interest expense, net**in the fiscal 2009three-month period was $6.1 million compared to $5.1 million in the fiscal 2008three-month period.  Interest expense,net in the fiscal 2009 six-month period was $11.0 million compared to $10.1million in the fiscal 2008 six-month period. These increases are due to the additional debt incurred in connectionwith the APF Acquisition.

 

**Foreign currency loss**in the fiscal 2009three-month period was a loss of $.1 million and in the fiscal 2009 six-monthperiod was a loss of less than $.1 million compared to a loss of $.2 millionand a loss of $.1 million, respectively, for the comparable periods in theprior year.  The fluctuations relate tothe change in the Canadian currency period over period.

 

**Income tax expense**for the fiscal 2009three-month period was an income tax benefit of $.2 million or an effective taxrate of 45.8% compared to income tax expense of $.4 million or an effective taxrate of 42.8% for the fiscal 2008 three-month period.  The income tax expense for the fiscal year2009 six-month period was $.4 million or an effective tax rate of 33.0%compared to income tax benefit of $.2 million or an effective

 

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tax rate of 27.6% for the fiscal year 2008 six-month period.   Included in the income tax expense for thefiscal 2008 three-month and six-month periods is approximately $90,000 relatedto additional Canadian income taxes paid upon completion of our fiscal year2007 tax returns.  The effective taxexpense for the 2008 three-month and six-month periods, without the effect ofthe additional Canadian income tax expense, was 33.3% and 38.5%, respectively.

 

**Net income**for the fiscal 2009 three-monthperiod was a net loss of $.2 million, compared to net income of $.5 million forthe comparable period in the prior year. Net income for the fiscal 2009six-month period was a $.7 million compared to a net loss of $.6 million forthe comparable period in the prior year.

 

**FINANCIAL CONDITION**

 

**Liquidity and Capital Resources**

 

**Net cash provided by operations** was $6.7million for the fiscal 2009 six-month period compared to $13.6 million for thefiscal 2008 six-month period. ** **Non-cash items, consisting ofstock-based compensation, deferred income taxes, derivatives, accretion of debtdiscount, depreciation and amortization for the fiscal 2009 six-month periodtotaled $14.6 million compared to $12.4 million for the 2008 fiscal six-monthperiod.**   **Cashflows used by changes in working capital totaled $8.7 million for the fiscal2009 six-month period compared to cash flows provided by changes in workingcapital of $1.8 million in the fiscal 2008 six-month period. ** **With respect to thechanges in accounts receivable and inventory, cash used by these items was$10.7 million for the fiscal 2009 six-month period compared to $3.1 million forthe comparable period in the prior fiscal year. This increase is reflective of a change in payment terms with a keycustomer, timing of customer payments and an increase in sales.  Cash****used bychanges in prepaid expenses and other current assets was $.4 million for thefiscal 2009 six-month period compared to $1.5 million for the comparable periodin the prior fiscal year.  Cash providedby changes in accounts payable, accrued expenses and accrued interest for thefiscal 2009 six-month period was $2.4 million compared to $6.5 million for thecomparable period in the prior year.

 

**Net cash used in investing activities** for thefiscal 2009 six-month period was $68.6****millioncompared to net cash used in investing activities of $50.6 million for thefiscal 2008 six-month period.  The fiscal2009 six-month period includes $63.8 million of cash paid for the APFAcquisition.  The fiscal 2008 six-monthperiod includes $43.7 million of cash paid for the CityForest Acquisition, netof cash received.  The remaining changerelates to the level of capital spending period over period.

 

**Net cash provided by financing activities**forthe fiscal 2009 six-month period was $63.8 million, primarily related tofinancing obtained in connection with the APF Acquisition.   Net cash provided by financing activitiesfor the fiscal 2008 six-month

 

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period was $22.6 million related to financing obtained in connectionwith the City Forest Acquisition.

 

**9 3⁄4% Senior Secured Notes due 2010**

 

In March 2004, we completed a private offering of the OriginalNotes pursuant to and are governed by the Cellu Tissue Indenture among us, thesubsidiary guarantors party thereto and the Trustee.   In connection with the CityForest Acquisition,we entered into the Note Purchase Agreement with the Purchaser, dated March 21,2007, pursuant to which we issued and sold the First Additional Notes to thePurchaser for the purchase price of $20.0 million, which is equal to 98.7383%of the aggregate principal amount of the Additional Notes.  The First Additional Notes were issuedpursuant to and are governed by the Cellu Tissue Indenture.

 

In connection with the APF Acquisition, we entered into the NotePurchase Agreements with each of the Purchasers, dated July 2, 2008,pursuant to which we issued and sold the Second Additional Notes to thePurchasers for the purchase price of $36,900,000 which is equal to 92.25% ofthe aggregate principal amount of the Second Additional Notes.  The Second Additional Notes were issuedpursuant to and are governed by the Cellu Tissue Indenture.

 

The Notes mature on March 15, 2010 and require semi-annualinterest payments on March 15 and September 15.  The Notes are collateralized by a seniorsecured interest in substantially all of our assets.  The Cellu Tissue Indenture contains certaincovenants, including limitations on certain restricted payments, the incurrenceof additional indebtedness and the sale of certain assets.    The Cellu Tissue Indenture has been amendedby two subsequent amendments pursuant to which CityForest, Cellu Happauge andCellu Thomaston became parties to the Cellu Tissue Indenture as subsidiaryguarantors (collectively, the “Additional Guarantors”).  As subsidiary guarantors, the AdditionalGuarantors, on a joint and several basis, with all the existing subsidiaryguarantors, fully, unconditionally and irrevocably guarantee the obligations ofCellu Tissue under the Cellu Tissue Indenture and Notes.  The Notes are unconditionally guaranteed byall of the Company’s subsidiaries.

 

***Seller Note Payable***

 

As part of the financing of the APF Acquisition, the Company enteredinto the Seller Note in the principal amount of $6,300,000.  Interest only at 12% is payable on the notein quarterly installments with the principal due July 2, 2011.

 

***Credit Agreement***

 

We entered into the Credit Agreement, among Cellu Tissue, Interlake,our Parent, the other loan guarantors party thereto, the U.S. AdministrativeAgent, the Canadian Administrative Agent and the other lenders partythereto.  The Credit Agreement providesfor a $35.0 million working capital facility, which was subseqeuently increasedto $60.0 million (see discussion following), including a letter of creditsub-facility and 

 

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swing-line loan sub-facility. The Credit Agreement provides thatamounts under the facility may be borrowed, repaid and re-borrowed, subject toa borrowing base test, until the maturity date, which is June 12, 2011. Anamount equal to $32.0 million, which was subsequently increased to $57.0million (see discussion following), is available, in U.S. dollars, to the U.S.Borrower under the facility and an amount equal to $3.0 million is available,in U.S. or Canadian dollars, to the Canadian Borrower under the facility.  Borrowings of $17.4 million were made tofinance a portion of the CityForest Acquisition and borrowings of $12.1 millionwere made to finance a portion of the APF Acquisition.   As of August 28, 2008, there was $23.0million of borrowings outstanding under the working capital facility and excessavailability was $30.2 million.

 

Cellu Tissuehas into the First Amendment, to the Credit Agreement dated June 12, 2006(as amended by the First Amendment, the “Amended Credit Agreement”) among CelluTissue, Interlake, certain subsidiaries of Cellu Tissue, the Parent, the U.S.Administrative Agent and the Canadian Administrative Agent.

 

The FirstAmendment (1) increases the working capital facility from $35.0 million to$40.0 million, (2) permits the issuance and sale by us of the FirstAdditional Notes, (3) provides for the consummation of the CityForestAcquisition and the conversion by CityForest from a Minnesota corporation to aMinnesota limited liability company, (4) permits the assumption ofapproximately $18.4 million in aggregate principal amount of indebtedness ofCityForest in connection with the CityForest Acquisition in accordance with theterms of the CityForest Bond Documents (as defined below under “CityForest BondDocuments”), and (5) permits the guarantee by Cellu Tissue of certainobligations of CityForest under the CityForest Bond Documents.  In connection with the First Amendment,CityForest became a guarantor of the obligations of the borrowers under theAmended Credit Agreement.

 

The Company has entered into the Second Amendment, to the CreditAgreement dated June 12, 2006 (as amended by the First Amendment, asAmended, and the Second Amendment, “Credit Agreement, as Amended”), among CelluTissue, Interlake, certain****subsidiariesof Cellu Tissue, the Parent, the U.S. Administrative Agent and the CanadianAdministrative Agent.

 

The Second Amendment (1) increases the working capital facilityfrom $40.0 million to $60.0 million, (2) permits the issuance and sale byCellu Tissue of the Second Additional Notes, (3) provides for theconsummation of the APF Acquisition and (4) permits the issuance of theSeller Note.  In connection with theSecond Amendment, Cellu Hauppauge and Cellu Thomaston became guarantors of theobligations of the borrowers under the Credit Agreement, as Amended.

 

***CityForest Bond Documents***

 

CityForest is party to a Loan Agreement with the City of Ladysmith,Wisconsin, as Issuer.  Pursuant to the LoanAgreement, the Issuer loaned the proceeds of the Issuer’s Bonds to CityForestto finance the construction by CityForest of a solid waste disposalfacility.  Approximately $18.4 million inaggregate principal amount of the Bonds was 

 

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outstanding as of the date of the CityForest Acquisition.  CityForest is required, under the terms ofthe CityForest Indenture, to provide a letter of credit in favor of the BondsTrustee.  CityForest has entered into theReimbursement Agreement with Associated Bank, pursuant to which Associated Bankhas extended the Associated Bank Letter of Credit and has provided theAssociated Bank Revolving Credit Facility to CityForest in an aggregateprincipal amount of up to $3.5 million.

 

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

 

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

* *

*The Reimbursement Agreement requires scheduled semi-annual payments ofprincipal of the Bonds equal to approximately 2.00% of the principal amountoutstanding as of the date of the Acquisition, with the balance payable at maturityof the Bonds on March 1, 2028. The Reimbursement Agreement also contains anumber of other provisions regarding reserve funds and other mandatory andoptional repayments in connection with the Bonds.  In addition, the Reimbursement Agreementprovides that in certain circumstances where we incur indebtedness in excess ofamounts currently permitted under the indenture or refinances the indebtednessissued under the CityForest Indenture, Associated Bank may require CityForestto repay all of its obligations to Associated Bank under the ReimbursementAgreement and either to cause the Bonds to be redeemed or to replace theAssociated Bank Letter of Credit with a Substitute Credit Facility, as suchterm is defined in the CityForest Indenture.*

 

The Reimbursement Agreement contains various affirmative and negativecovenants customary for working capital and term credit facilities, as well asadditional covenants relating to the Bonds. The negative covenants include limitations on: indebtedness; liens; 

 

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acquisitions, mergers and consolidations; investments; guarantees;asset sales; sale and leaseback transactions; dividends and distributions;transactions with affiliates; capital expenditures; and changes to the statusof the Bonds. CityForest is also required to comply on a quarterly basis with amaximum leverage covenant and a minimum fixed charge coverage covenant.  The Reimbursement Agreement also containscustomary events of default, including: payment defaults; breaches of representations and warranties; covenantdefaults; cross-defaults to certain other debt, including the Additional Notesand indebtedness under the Amended Credit Agreement; certain events ofbankruptcy and insolvency; judgment defaults; certain defaults related to theEmployee Retirement Income Security Act of 1974, as amended; and a change ofcontrol of CityForest or us.

 

We have guaranteed all of the obligations of CityForest under theReimbursement Agreement, pursuant to the Cellu Tissue Guaranty executed by usin favor of Associated Bank. In addition, the obligations of CityForest underthe Reimbursement Agreement are secured by first-priority liens in favor ofAssociated Bank in all of CityForest’s assets. The U.S. Administrative Agent, the Canadian Administrative Agent,Associated Bank and CityForest have entered into an Intercreditor Agreement,dated March 21, 2007, which sets forth the respective rights andpriorities of Associated Bank, on the one hand, and the U.S. AdministrativeAgent and the Canadian Administrative Agent, on the other hand, as to thecollateral of CityForest securing the Reimbursement Agreement and the AmendedCredit Agreement.

 

*Inaddition, we have entered into a Third Amendment to the Credit Agreement whichchanges the borrowings under the Credit Agreement so that $55.0 million isavailable, in U.S. dollars, to the U.S. Borrower and $5.0 million is available,in U.S. or Canadian dollars, to the Canadian Borrower.*

* *

**Cash**as of August 28, 2008 increased to$2.6 million from $.9 million as of the end of fiscal year 2008.

 

**Receivables, net**as of August 28, 2008increased to $62.6 million from $44.5 million as of the end of fiscal year2008.  Included in the $62.6 million is$10.0 million of receivables related to APF. Without the effect of the acquisition, receivables increased $8.1million from the end of fiscal year 2008 due primarily to a change in paymentterms for a significant customer, timing of customer payments and an increasein sales.

 

**Inventory**as of August 28, 2008 increasedto $42.3 million from $34.0 million as of the end of fiscal year 2008.   Included in the $42.3 million is $7.8million of inventories related to APF. Without the effect of the acquisition, inventories increased $.5 millionfrom the end of fiscal year 2008.

 

**Property, plant and equipment, net**as of August 28,2008 decreased to $307.0 million from $310.5 million as of the end of fiscalyear 2008.  Included in the $307.0million of property, plant and equipment, net is $5.3 million related toAPF.  Without the effect of theacquisition, property, plant and equipment decreased $8.8 million from the endof 

 

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fiscal year 2008.  This decreaserelates to depreciation expense for the period offset partially by capitalexpenditures for the period.

 

**Goodwill**as of August 28, 2008 increasedto $35.1 million from $11.3 million as of the end of fiscal year 2008 due tothe acquisition of APF.

 

**Other intangibles, net**as of August 28,2008 increased to $38.8 million from $9.4 million as of the end of fiscal year2008.  The additions to other intangiblesrelate to the acquisition of APF.

 

**Other assets**as of August 28, 2008increased to $2.1 million from $1.5 million as of the end of fiscal year 2008due to debt and bond issuance costs capitalized and included in other assetsresulting from the financing in connection with the APF Acquisition.

 

**Revolving line of credit**as of August 28,2008 increased to $23.0 million from $9.8 million as of the end of fiscal year2008 primarily due to additional borrowings in connection with the financing ofthe APF Acquisition.

 

**Accounts payable**as of August 28, 2008increased to $26.6 million from $24.1 million as of the end of fiscal year2008.  Included in the $26.6 million ofaccounts payable is $3.9 million related to APF.  Without the effect of the acquisition,accounts payable decreased $1.4 million from the end of fiscal year 2008 due totiming of payments.

 

**Accrued expenses**as of August 28, 2008increased to $22.7 million from $19.1 million as of the end of fiscal year2008.  Included in the $22.7 million ofaccrued expenses is $2.6 million related to APF.  Without the effect of the acquisition,accrued expenses increased $1.0 million due to timing.

 

**Long-term debt**as of August 28, 2008increased to $242.3 million from $198.8 million as of the end of fiscal year2008 due to debt incurred to finance the APF Acquisition.

 

**Capital in excess of par value**as of August 28,2008 increased to $62.5 million from $47.0 million as of the end of fiscal year2008 due to an equity investment by Parent to fund a portion of the APFAcquisition.

 

Critical Accounting Policies

 

Our critical accounting policies are discussed in Management’sDiscussion and Analysis of Financial Condition and Results of Operations in ourAnnual Report on Form 10-K for fiscal year 2008.  The preparation of our financial statementsrequires us to make estimates that affect the reported amounts of assets,liabilities, revenue and expenses and related disclosures of contingent assetsand liabilities.  We base our accountingestimates on historical experience and other factors that we believe to bereasonable under the circumstances. However, actual results may vary from these estimates under differentassumptions or conditions.

 

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Derivatives and Hedging

 

We use derivative financial instruments to offset a substantial portionof its exposure to market risk arising from changes in the price of naturalgas. Hedging of this risk is accomplished by entering into forward swapcontracts, which are designated as hedges of specific quantities of natural gasexpected to be purchased in future months.   These contracts are held for purposes other than trading and aredesignated as cash flow hedges.  Wemeasure fair value of our derivative financial instruments in accordance withSFAS 157.  SFAS 157 defined fair value asthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants. SFAS 157establishes a fair value hierarchy for valuation inputs that gives the highestpriority to quoted prices in active markets for identical assets or liabilitiesand 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. |

 

Derivatives are reported at fair value utilizing Level 2 inputs.   The fair value of these cash flow hedginginstruments was a liability of $.6 million and an asset of $.2 million as of August 28,2008 and February 29, 2008, respectively. During the next12 months, the entire $.6 million will be reclassified to earningsconsistent with the timing of the underlying hedged transactions.

 

New Accounting Pronouncements

 

In September 2006, the FASB issued SFAS 157.  We were required to adopt the provisions ofSFAS 157 effective March 1, 2008. SFAS 157 provides a common fair value hierarchy for companies to followin determining fair value measurements in the preparation of financialstatements and expands disclosure requirements relating to how such fair valuemeasurements were developed.  SFAS 157clarifies the principle that fair value should be based on the assumptions thatthe marketplace would use when pricing an asset or liability, rather thancompany specific data.  The adoption ofSFAS 157 did not have a material impact on our results of operations andfinancial position.

 

In February 2007, the FASB issued SFAS 159.  This Standard permits entities to choose tomeasure many financial instruments and certain other items at fair value thatare not currently required to be measured at fair value.  SFAS 159 was effective as of the beginning offiscal 2009 and we chose not to adopt these fair value provisions.

 

In December 2007, the FASB issued SFAS 141 (R) and SFAS160.  These new standards willsignificantly change the financial accounting and reporting of businesscombination transactions and noncontrolling (or minority) interests inconsolidated financial statements.  SFAS141 (R) is required to be adopted concurrently with SFAS 160 and iseffective for business combination transactions for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008.  Earlyadoption is prohibited.  We are currentlyassessing the impact that SFAS 141 (R) and SFAS 160 will have on ourresults of operations and financial position.

 

In March 2008, the FASB issued SFAS 161.  SFAS 161 requires entities to provideenhanced disclosures about derivative instruments and hedging activities.  SFAS 161 is effective for fiscal years andinterim periods beginning on or after November 15, 2008. We are currentlyassessing the impact that SFAS 161 will have on our results of operations andfinancial position.

 

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**Item 3. Quantitative and Qualitative Disclosures about Market Risk**

 

In March 2004, we completed a private offering of the Notes.  In connection with the acquisition ofCityForest in March 2007, we issued and sold approximately $20.0 millionof First Additional Notes and assumed $18.4 million of additional debt.  In connection with the APF Acquisition, weissued and sold approximately $40.0 million of Second Additional Notes. OurNotes mature on March 15, 2010.  Wealso have the ability to borrow under our revolving line of credit, up to $60.0million, of which as of August 28, 2008 we have outstanding borrowings of$23.0 million.  Borrowings of $12.1million were made to finance a portion of the APF Acquisition.  As a result, we are highly leveraged.    The interest on our revolving line ofcredit fluctuates based on prime plus .50% or LIBOR plus 1.75% depending on whetherour borrowing is based on prime or LIBOR rates.

 

We have minimal foreign currency translation risk.  All international sales, other than salesoriginating 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 foreigncurrency exchange rates.

 

We are also subject to commodity price risk associated withfluctuations in energy and pulp costs. We currently use derivative financial instruments to offset a portion ofour exposure to market risk arising from changes in the price of naturalgas.  We also continue to take advantageof spot prices on pulps to minimize market risk arising from changes in pulpcosts.

 

**Item 4. Controls and Procedures**

 

**DisclosureControls and Procedures (Restated)**

 

We maintain disclosure controlsand procedures designed to ensure that information required to be disclosed inthe reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures, as defined in Rules13a–15(e) and 15d–15(e) under the Exchange Act, include controls and proceduresdesigned to ensure that information required to be disclosed in the reports wefile or submit under the Exchange Act is accumulated and communicated to ourmanagement, including the Chief Executive Officer and the Chief FinancialOfficer, as appropriate, to allow timely decisions regarding requireddisclosure. Any system of controls, however well designed and operated, can provideonly reasonable, and not absolute, assurance that the objectives of the systemare met. 

 

At the time of our quarterlyfiling of Form 10Q which was filed on October 10, 2008 our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of August 28, 2008. Subsequent to the restatement discussedin Note 2 - Restatement / Reclassification of Financial Statements in theconsolidated financial statements, we have re-evaluated the effectiveness ofthe design and operation of our disclosure controls and procedures covered bythis Quarterly Report on Form 10Q/A. The re-evaluation was carried out underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer. Based on thisre-evaluation, our management including our Chief Executive Officer and ChiefFinancial Officer have concluded that, in light of the material weakness in ourinternal control over financial reporting described below, as of August 28,2008 our disclosure controls and procedures were not effective.

 

As a result of this material weakness,management performed additional procedures to ensure that our consolidatedfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America (US GAAP). Accordingly, webelieve that the financial statements for the periods covered by and includedin this Quarterly Report on Form 10-Q/A fairly present in all material respectsour financial condition, results of operations and cash flows. 

 

**MaterialWeakness**

 

The material weakness has a deficiency,or combination of deficiencies, in internal controls over a financialreporting, such that there is a reasonable possibility that a materialmisstatement of the Company’s annual or interim financial statements will notbe prevented or detected on a timely basis. 

 

In connection with the  restatement of the Company’s financialsstatements as of February 29, 2008, we identified the following materialweakness in our internal control over financial reporting, which continued toexist as of August 28, 2008: 

 

We did not maintain effectiveinternal control over financial reporting with respect to the application of USGAAP as it relates to complex purchase accounting issues and accounting forderivatives.  The Company lackssufficient US GAAP expertise to properly assess and record complex accountingmatters, specifically (i) deferred income taxes associated with purchaseaccounting; (ii) shipping and handling fees and costs; (iii) foreign exchangegains and losses; and (iv) derivatives. See, Note 2 Restatement of Financial Statements in the consolidatedfinancial statements.   

 

**Plan ofRemediation for Identified Material Weakness**

 

The material weakness has notbeen fully remediated. Accordingly, management has determined that thesecontrol deficiencies continue to constitute a material weakness at August 28,2008.

 

Management has prepared anaction plan for all identified deficiencies as of February 29, 2008. The statusof this plan will be monitored by management and reviewed by the AuditCommittee periodically. 

 

With respect to the identifiedmaterial weakness, we will review and assess our internal controls, processesand procedures to timely and properly monitor, evaluate and record complex taxand accounting matters in accordance with US GAAP. We intend to review theresponsibilities within our accounting and finance departments and may hireadditional finance and accounting resources to focus on research and theapplication of US GAAP.  In addition, wemay supplement our internal resources with assistance from outside advisors forthe evaluation of unusual and non-routine transactions. 

 

**Changes inInternal Control Over Financial Reporting**

 

There were no changes to ourinternal control over financial reporting during the quarter ended August 28,2008 that materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

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PART II– OTHER INFORMATION

 

Item1A.  Risk Factors

 

The risk factors included in our Annual Report on Form 10-K/A forthe fiscal year ended February 29, 2008 have not materially changed.

 

Item6.  Exhibits

 

(a)                Exhibits

 
| *10.1*   | *Asset Purchase Agreement, dated  July 2, 2008, between Cellu Tissue Holdings, Inc. and 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, as Sellers (incorporated by  reference to Exhibit 10.1 to the Current Report on Form 8-K filed  on July 8, 2008).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.2*   | *Note Purchase Agreement, dated  July 2, 2008 between Cellu Tissue Holdings, Inc. and GMAM  Investment Funds Trust II, for the account of the Promark Alternative High  Yield Bond Fund (Account No. 7M2E), GMAM Investment Funds Trust, General  Motors Welfare Benefit Trust (VEBA), GMAM Investment Funds Trust II for the  account of the Promark Alternative High Yield Bond Fund (Account  No. 7MWD), DDJ High Yield Fund, Multi-Style, Multi-Manager Funds PLC The  Global Strategic Yield Fund (f/k/a Multi-Style, Multi-Manager Funds PLC The  Global High Yield Fund), DDJ Capital Management Group Trust, Stichting  Pensioenfonds Hoogovens, Caterpillar Inc. Master Retirement Trust, J.C.  Penney Corporation, Inc. Pension Plan Trust, Stichting Bewaarder  Interpolis Pensioenen Global High Yield Pool, DDJ/Ontario OS Investment Sub  II, Ltd. and Stichting Pensioenfonds Metaal en Techniek (incorporated by  reference to Exhibit 10.3 to the Current Report on Form 8-K filed  on July 8, 2008).* |
| * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.3*   | *Note Purchase Agreement, dated  July 2, 2008 between Cellu Tissue Holdings, Inc. and Claren Road  Credit Master Fund, Ltd (incorporated by reference to Exhibit 10.4 to  the Current Report on Form 8-K filed on July 8, 2008).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.4*   | *Note Purchase Agreement, dated  July 2, 2008 between Cellu Tissue Holdings, Inc. and UBS High Yield  Relationship Fund, a series of the UBS Relationship funds (incorporated by  reference to Exhibit 10.5 to the Current Report on Form 8-K filed  on July 8, 2008).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.5*   | *Third Supplemental Indenture,  dated July 2, 2008, by and among Cellu Tissue Holdings, Inc., the  subsidiary guarantors, and The Bank of New York Trust Company, N.A., as  successor trustee to The Bank of New York (incorporated by reference to  Exhibit 10.6 to the Current Report on Form 8-K filed on  July 8, 2008).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

* *

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| *10.6*   | *Second Amendment, dated  July 2, 2008 to the Credit Agreement dated June 12, 2006 among  Cellu Tissue, as U.S. Borrower, Interlake Acquisition Corporation Limited, a  subsidiary of Cellu Tissue, as Canadian Borrower, certain subsidiaries of  Cellu Tissue, Cellu Paper Holdings, Inc., JPMorgan Chase Bank, N.A. and  JPMorgan Chase Bank, N.A., Toronto Branch (incorporated by reference to  Exhibit 10.7 to the Current Report on Form 8-K filed on  July 8, 2008).* |
|----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| *10.7*   | *Third Amendment, dated  September 26, 2008 to the Credit Agreement dated June 12, 2006  among Cellu Tissue, as U.S. Borrower, Interlake Acquisition Corporation  Limited, a subsidiary of Cellu Tissue, as Canadian Borrower, certain  subsidiaries of Cellu Tissue, Cellu Paper Holdings, Inc., JPMorgan Chase  Bank, N.A. and JPMorgan Chase Bank, N.A., Toronto Branch*                                                                                                                  |
| * * | * *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| *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)*                                                                                                                                                                                                                                                                                                                                                                                             |

 

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SIGNATURES

 

 

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

 
|                        | Cellu Tissue Holdings, Inc. |
|-----------------------------|----------------------------------|
|                        |                             |   |
|                        |                             |   |
| Date: February 3, 2009 |                             | /s/ Russell C. Taylor |
|                        |                             | Mr. Russell C. Taylor |
|                        |                             | President and Chief Executive Officer |
|                        |                             |   |
| Date: February 3, 2009 |                             | /s/ David J. Morris |
|                        |                             | Mr. David J. Morris |
|                        |                             | Senior Vice President, Finance and Chief |
|                        |                             | Financial Officer |

 

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