UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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




For
the quarterly period ended: July 5, 2009





OR




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


For
The Transition Period
From            To            
..




Commission
file numbers: 333-82084-01


333-82084


PAPERWEIGHT
      DEVELOPMENT CORP.
            APPLETON
      PAPERS INC.(Exact
      Name of Registrant as Specified in Its Charter)
            (Exact
      Name of Registrant as Specified in Its Charter)Wisconsin
            Delaware(State
      or Other Jurisdiction of
              Incorporation
      or Organization)
            (State
      or Other Jurisdiction of
              Incorporation
      or Organization)39-2014992
            36-2556469(I.R.S.
      Employer
              Identification
      No.)
            (I.R.S.
      Employer
              Identification
      No.)825
      East Wisconsin Avenue, P.O. Box 359,
              Appleton,
      Wisconsin
            54912-0359(Address
      of Principal Executive Offices)
            (Zip
      Code)





Registrant’s
telephone number, including area code: (920) 734-9841




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




Indicate
by check mark whether each registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes  ̈    No   ̈




Indicate
by check mark whether either of the registrants is a large accelerated filer, an
accelerated filer, or a non-accelerated filer or a smaller reporting company.
See definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act (Check one).


Large
Accelerated filer   ̈    Accelerated
filer   ̈    Non-accelerated
filer  x    Smaller
reporting company   ̈


(Do not
check if a smaller reporting company)




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





As of
August 2, 2009, 10,244,292 shares of Paperweight Development Corp. common stock,
$.01 par value, were outstanding. There is no trading market for the common
stock of Paperweight Development Corp. As of May 1, 2009, 100 shares of
Appleton Papers Inc.’s common stock, $100.00 par value, were outstanding. There
is no trading market for the common stock of Appleton Papers Inc. No shares of
Paperweight Development Corp. or Appleton Papers Inc. were held by
non-affiliates.




Documents
incorporated by reference: None.




Appleton
Papers Inc. meets the conditions set forth in General Instruction -H(1)(a) and
(b) of Form 10-Q and is therefore filing this form with the reduced
disclosure format.





INDEX





Page
              NumberPART I
            FINANCIAL
      INFORMATIONItem 1
            Financial
      Statements (unaudited)a)
      Condensed Consolidated Balance Sheets
            3b)
      Condensed Consolidated Statements of Operations
            4c)
      Condensed Consolidated Statements of Cash Flows
            5d)
      Consolidated Statements of Redeemable Common Stock, Accumulated Deficit,
      Accumulated
              Other
      Comprehensive (Loss) Income and Comprehensive Income
(Loss)
            6e)
      Notes to Condensed Consolidated Financial Statements
            7Item 2
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            33Item 3
            Quantitative
      and Qualitative Disclosures About Market Risk
            41Item 4T
            Controls
      and Procedures
            41PART II
            OTHER
      INFORMATIONItem
      1
            Legal
      Proceedings
            42Item 1A
            Risk
      Factors
            42Item
      3
            Defaults
      Upon Senior Securities
            43Item 6
            Exhibits
            44Signatures





PART 1 – FINANCIAL
INFORMATION


Item 1 – Financial
Statements (unaudited)





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESCONDENSED
      CONSOLIDATED BALANCE SHEETS(unaudited)(dollars
      in thousands, except share data)July 5, 2009
                                
                                
                                January 3, 2009ASSETSCurrent
      assetsCash
      and cash equivalents
                                
                                $
                                3,089
                                
                                
                                $
                                4,180Accounts
      receivable, less allowance for doubtful accounts of $1,697 and $1,715,
      respectively
                                
                                
                                105,238
                                
                                
                                
                                88,218Inventories
                                
                                
                                116,417
                                
                                
                                
                                124,856Other
      current assets
                                
                                
                                60,296
                                
                                
                                
                                45,920Assets
      held for sale
                                
                                
                                9,049
                                
                                
                                
                                9,327Total
      current assets
                                
                                
                                294,089
                                
                                
                                
                                272,501Property,
      plant and equipment, net of accumulated depreciation of
                                  $421,786
      and $394,075, respectively
                                
                                
                                422,180
                                
                                
                                
                                439,301Goodwill
                                
                                
                                9,251
                                
                                
                                
                                9,251Intangible
      assets, net
                                
                                
                                69,567
                                
                                
                                
                                71,404Environmental
      indemnification receivable
                                
                                
                                50,032
                                
                                
                                
                                114,300Other
      assets
                                
                                
                                15,859
                                
                                
                                
                                13,909Assets
      held for sale
                                
                                
                                8,762
                                
                                
                                
                                9,255Total
      assets
                                
                                $
                                869,740
                                
                                
                                $
                                929,921LIABILITIES,
      REDEEMABLE COMMON STOCK,
                                  ACCUMULATED
      DEFICIT AND
                                  ACCUMULATED
      OTHER COMPREHENSIVE LOSSCurrent
      liabilitiesCurrent
      portion of long-term debt
                                
                                $
                                5,866
                                
                                
                                $
                                5,455Accounts
      payable
                                
                                
                                51,329
                                
                                
                                
                                61,093Accrued
      interest
                                
                                
                                4,958
                                
                                
                                
                                3,628Other
      accrued liabilities
                                
                                
                                77,419
                                
                                
                                
                                83,502Liabilities
      held for sale
                                
                                
                                1,862
                                
                                
                                
                                2,085Total
      current liabilities
                                
                                
                                141,434
                                
                                
                                
                                155,763Long-term
      debt
                                
                                
                                619,037
                                
                                
                                
                                598,598Postretirement
      benefits other than pension
                                
                                
                                45,644
                                
                                
                                
                                45,364Accrued
      pension
                                
                                
                                111,688
                                
                                
                                
                                109,532Environmental
      liability
                                
                                
                                50,032
                                
                                
                                
                                114,300Other
      long-term liabilities
                                
                                
                                9,284
                                
                                
                                
                                13,309Commitments
      and contingencies (Note 13)
                                
                                
                                -
                                
                                
                                
                                -Redeemable
      common stock, $0.01 par value,shares
      authorized: 30,000,000,shares
      issued and outstanding:
                                    10,245,419
      and10,643,894,
      respectively
                                
                                
                                135,579
                                
                                
                                
                                147,874Accumulated
      deficit
                                
                                
                                (147,465
                                )
                                
                                
                                (159,650
                                )Accumulated
      other comprehensive loss
                                
                                
                                (95,493
                                )
                                
                                
                                (95,169
                                )Total
      liabilities, redeemable common stock, accumulated
                                  deficit
      and accumulated other comprehensive loss
                                
                                $
                                869,740
                                
                                
                                $
                                929,921








The accompanying notes are an integral
part of these condensed consolidated financial
statements.


3





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)(dollars
      in thousands)Three
      Months Ended
                            July 5,
      2009
                          
                          
                          Three
      Months
                            Ended
                            June 29,
      2008
                          
                          Six
      Months
                            Ended
                            July 5,
      2009
                          
                          Six
      Months
                            Ended
                            June 29, 2008Net
      sales
                          
                          $
                          213,411
                          
                          
                          $
                          250,113
                          
                          $
                          425,961
                          
                          $
                          486,725Cost
      of sales
                          
                          
                          163,191
                          
                          
                          
                          199,159
                          
                          
                          334,000
                          
                          
                          380,849Gross
      profit
                          
                          
                          50,220
                          
                          
                          
                          50,954
                          
                          
                          91,961
                          
                          
                          105,876Selling,
      general and administrative expenses
                          
                          
                          31,930
                          
                          
                          
                          40,516
                          
                          
                          66,248
                          
                          
                          85,134Operating
      income
                          
                          
                          18,290
                          
                          
                          
                          10,438
                          
                          
                          25,713
                          
                          
                          20,742Other
      expense (income)Interest
      expense
                          
                          
                          12,830
                          
                          
                          
                          10,212
                          
                          
                          24,222
                          
                          
                          21,286Debt
      extinguishment income, net
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          (5,380
                          )
                          
                          -Interest
      income
                          
                          
                          (21
                          )
                          
                          
                          (56)
                          
                          
                          (37
                          )
                          
                          (237)Litigation
      settlement, net (Note 13)
                          
                          
                          -
                          
                          
                          
                          (41)
                          
                          
                          -
                          
                          
                          (22,274)Foreign
      exchange (gain) loss
                          
                          
                          (881
                          )
                          
                          
                          (6)
                          
                          
                          (602
                          )
                          
                          226Other
      income
                          
                          
                          (820
                          )
                          
                          
                          -
                          
                          
                          (820
                          )
                          
                          -Income
      from continuing operations before income taxes
                          
                          
                          7,182
                          
                          
                          
                          329
                          
                          
                          8,330
                          
                          
                          21,741(Benefit)
      provision for income taxes
                          
                          
                          (62
                          )
                          
                          
                          55
                          
                          
                          (77
                          )
                          
                          92Income
      from continuing operations
                          
                          
                          7,244
                          
                          
                          
                          274
                          
                          
                          8,407
                          
                          
                          21,649Discontinued
      operationsLoss
      from discontinued operations, net of income
                            taxes
                          
                          
                          -
                          
                          
                          
                          (42,950)
                          
                          
                          -
                          
                          
                          (42,925)Net
      income (loss)
                          
                          $
                          7,244
                          
                          
                          $
                          (42,676)
                          
                          $
                          8,407
                          
                          $
                          (21,276)The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.


4





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESCONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWSFOR
      THE SIX MONTHS ENDED(unaudited)(dollars
      in thousands)July 5, 2009
                                                                              
                                                                              June 29, 2008Cash
      flows from operating activities:Net
      income (loss)
                                                                              
                                                                              $
                                                                              8,407
                                                                              
                                                                              
                                                                              $
                                                                              (21,276)Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
                                                                              
                                                                              
                                                                              28,987
                                                                              
                                                                              
                                                                              
                                                                              27,100Amortization
      of intangible assets
                                                                              
                                                                              
                                                                              1,921
                                                                              
                                                                              
                                                                              
                                                                              2,466Impairment
      of discontinued operations goodwill and long-lived
      assets
                                                                              
                                                                              
                                                                              -
                                                                              
                                                                              
                                                                              
                                                                              40,134Amortization
      of financing fees
                                                                              
                                                                              
                                                                              1,315
                                                                              
                                                                              
                                                                              
                                                                              1,160Employer
      401(k) noncash matching contributions
                                                                              
                                                                              
                                                                              2,111
                                                                              
                                                                              
                                                                              
                                                                              3,082Foreign
      exchange (gain) loss
                                                                              
                                                                              
                                                                              (602)
                                                                              
                                                                              
                                                                              
                                                                              426Loss
      on disposals of equipment
                                                                              
                                                                              
                                                                              123
                                                                              
                                                                              
                                                                              
                                                                              844Accretion
      of capital lease obligation
                                                                              
                                                                              
                                                                              40
                                                                              
                                                                              
                                                                              
                                                                              61Gain
      on debt extinguishment
                                                                              
                                                                              
                                                                              (5,380)
                                                                              
                                                                              
                                                                              
                                                                              -(Increase)/decrease
      in assets and increase/(decrease) in liabilities:Accounts
      receivable
                                                                              
                                                                              
                                                                              (15,708)
                                                                              
                                                                              
                                                                              
                                                                              2,875Inventories
                                                                              
                                                                              
                                                                              7,982
                                                                              
                                                                              
                                                                              
                                                                              (21,676)Other
      current assets
                                                                              
                                                                              
                                                                              (14,404)
                                                                              
                                                                              
                                                                              
                                                                              216Accounts
      payable and other accrued liabilities
                                                                              
                                                                              
                                                                              2,175
                                                                              
                                                                              
                                                                              
                                                                              (18,000)Restructuring
      reserve
                                                                              
                                                                              
                                                                              (1,924)
                                                                              
                                                                              
                                                                              
                                                                              (239)Accrued
      pension
                                                                              
                                                                              
                                                                              2,670
                                                                              
                                                                              
                                                                              
                                                                              (2,654)Other,
      net
                                                                              
                                                                              
                                                                              (5,077)
                                                                              
                                                                              
                                                                              
                                                                              (11,337)Net
      cash provided by operating activities
                                                                              
                                                                              
                                                                              12,636
                                                                              
                                                                              
                                                                              
                                                                              3,182Cash
      flows from investing activities:Proceeds
      from sale of equipment
                                                                              
                                                                              
                                                                              27
                                                                              
                                                                              
                                                                              
                                                                              4Additions
      to property, plant and equipment
                                                                              
                                                                              
                                                                              (11,524)
                                                                              
                                                                              
                                                                              
                                                                              (50,728)Net
      cash used by investing activities
                                                                              
                                                                              
                                                                              (11,497)
                                                                              
                                                                              
                                                                              
                                                                              (50,724)Cash
      flows from financing activities:Payments
      of senior secured notes payable
                                                                              
                                                                              
                                                                              (1,125)
                                                                              
                                                                              
                                                                              
                                                                              (1,125)Payments
      of senior subordinated notes payable
                                                                              
                                                                              
                                                                              (1,687)
                                                                              
                                                                              
                                                                              
                                                                              -Debt
      acquisition costs
                                                                              
                                                                              
                                                                              (3,124)
                                                                              
                                                                              
                                                                              
                                                                              -Payments
      relating to capital lease obligation
                                                                              
                                                                              
                                                                              (366)
                                                                              
                                                                              
                                                                              
                                                                              (366)Proceeds
      from revolving credit facility
                                                                              
                                                                              
                                                                              119,450
                                                                              
                                                                              
                                                                              
                                                                              178,958Payments
      of revolving credit facility
                                                                              
                                                                              
                                                                              (91,450)
                                                                              
                                                                              
                                                                              
                                                                              (137,771)Proceeds
      from State of Ohio loan
                                                                              
                                                                              
                                                                              3,000
                                                                              
                                                                              
                                                                              
                                                                              -Payments
      of State of Ohio loan
                                                                              
                                                                              
                                                                              (400)
                                                                              
                                                                              
                                                                              
                                                                              -Payments
      of secured financing
                                                                              
                                                                              
                                                                              (1,125)
                                                                              
                                                                              
                                                                              
                                                                              -Proceeds
      from issuance of redeemable common stock
                                                                              
                                                                              
                                                                              2,075
                                                                              
                                                                              
                                                                              
                                                                              3,721Payments
      to redeem common stock
                                                                              
                                                                              
                                                                              (12,550)
                                                                              
                                                                              
                                                                              
                                                                              (17,429)Decrease
      in cash overdraft
                                                                              
                                                                              
                                                                              (14,928)
                                                                              
                                                                              
                                                                              
                                                                              (6,819)Net
      cash (used) provided by financing activities
                                                                              
                                                                              
                                                                              (2,230)
                                                                              
                                                                              
                                                                              
                                                                              19,169Effect
      of foreign exchange rate changes on cash and cash
      equivalents
                                                                              
                                                                              
                                                                              -
                                                                              
                                                                              
                                                                              
                                                                              159Change
      in cash and cash equivalents
                                                                              
                                                                              
                                                                              (1,091)
                                                                              
                                                                              
                                                                              
                                                                              (28,214)Cash
      and cash equivalents at beginning of period
                                                                              
                                                                              
                                                                              4,180
                                                                              
                                                                              
                                                                              
                                                                              44,838Cash
      and cash equivalents at end of period
                                                                              
                                                                              $
                                                                              3,089
                                                                              
                                                                              
                                                                              $
                                                                              16,624







The
accompanying notes are an integral part of these condensed consolidated
financial statements.


5


PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF REDEEMABLE COMMON STOCK,ACCUMULATED
      DEFICIT, ACCUMULATED OTHER COMPREHENSIVE (LOSS)INCOME
      AND COMPREHENSIVE INCOME (LOSS)FOR
      THE SIX MONTHS ENDED(unaudited)(dollars
      in thousands, except share data)Redeemable
      Common StockShares
                  Outstanding
                
                
                Amount
                
                
                Accumulated
                  Deficit
                
                
                Accumulated
                  Other
                  Comprehensive
                  (Loss)
      Income
                
                
                Comprehensive
                  Income
      (Loss)Balance,
      January 3, 2009
                
                
                10,643,894
                
                
                $
                147,874
                
                
                $
                (159,650
                )
                
                $
                (95,169
                )Comprehensive
      incomeNet
      income
                
                
                -
                
                
                
                -
                
                
                
                8,407
                
                
                
                -
                
                
                $
                8,407Changes
      in retiree plans, net
                -
                -
                -
                (575
                )
                
                (575
                )Realized
      and unrealized gain onderivatives
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                251
                
                
                
                251Total
      comprehensive income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                8,083Issuance
      of redeemable commonstock
                
                
                213,730
                
                
                
                4,033
                
                
                
                -
                
                
                
                -Redemption
      of redeemablecommon
      stock
                
                
                (612,205
                )
                
                
                (12,550
                )
                
                
                -
                
                
                
                -Accretion
      of redeemable commonstock
                
                
                -
                
                
                
                (3,778
                )
                
                
                3,778
                
                
                
                -Balance,
      July 5, 2009
                
                
                10,245,419
                
                
                $
                135,579
                
                
                $
                (147,465
                )
                
                $
                (95,493
                )Balance,
      December 29, 2007
                
                
                11,116,751
                
                
                $
                182,040
                
                
                $
                (80,086
                )
                
                $
                3,679Comprehensive
      lossNet
      loss
                
                
                -
                
                
                
                
                
                
                
                (21,276
                )
                
                
                -
                
                
                $
                (21,276
                )Change
      in retiree plans, net
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                27
                
                
                
                27Foreign
      currency translationadjustment
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (41
                )
                
                
                (41
                )Realized
      and unrealized gain onderivatives
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,731
                
                
                
                2,731Total
      comprehensive loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (18,559
                )Issuance
      of redeemable commonstock
                
                
                253,936
                
                
                
                6,813
                
                
                
                -
                
                
                
                -Redemption
      of redeemable common stock
                
                
                (575,239
                )
                
                
                (17,429
                )
                
                
                -
                
                
                
                -Accretion
      of redeemable common stock
                
                
                -
                
                
                
                (1,345
                )
                
                
                1,345
                
                
                
                -Balance,
      June 29, 2008
                
                
                10,795,448
                
                
                $
                170,079
                
                
                $
                (100,017
                )
                
                $
                6,396




















The
accompanying notes are an integral part of these condensed consolidated
financial statements.


6


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





(unaudited)





1.         BASIS
OF PRESENTATION




In the
opinion of management, all adjustments necessary for the fair presentation of
the results of operations for the three and six months ended July 5, 2009
and June 29, 2008, the cash flows for the six months ended July 5,
2009 and June 29, 2008 and financial position at July 5, 2009 have
been made. All adjustments made were of a normal recurring nature.





These
condensed financial statements should be read in conjunction with the audited
consolidated financial statements and notes of Paperweight Development Corp.
(“PDC”) and its wholly-owned subsidiaries (collectively the “Company”) for each
of the three years in the period ended January 3, 2009, which are included
in the annual report on Form 10-K for the year ended January 3, 2009. The
consolidated balance sheet data as of January 3, 2009, contained within
these condensed financial statements, was derived from the audited financial
statements but does not include all disclosures required by accounting
principles generally accepted in the United States of America. Appleton Papers
Inc. (“Appleton”) is a wholly-owned subsidiary of PDC.





The
results of operations for any interim period are not necessarily indicative of
the results to be expected for the full year. The Company has performed an
evaluation of subsequent events through August 7, 2009, the date the
financial statements were issued. Certain immaterial prior year financial
statement amounts have been reclassified to conform to their current year
presentation.


2.         DISPOSITIONS





During
second quarter 2009, Appleton committed to a formal plan to sell C&H
Packaging Company, Inc. (“C&H”). C&H, located in Merrill, Wisconsin, was
acquired in 2003 and prints and converts flexible plastic packaging materials
for companies in the food processing, household and industrial products
industries. The assets and liabilities of C&H are reported as held for
sale for the periods ended July 5, 2009 and January 3, 2009.
Prospectively, as of the end of second quarter 2009, depreciation and
amortization expense will be suspended. The sale is expected to be completed
prior to the end of 2009. C&H is included within the performance packaging
business segment.





Net
assets held for sale consist of the following (dollars in
thousands):





July 5,
      2009
                
                
                January 3,
      2009Accounts
      receivable
                
                $
                2,869
                
                
                $
                3,811Inventories
                
                
                5,824
                
                
                
                5,197Other
      current assets
                
                
                356
                
                
                
                319Property,
      plant and equipment, net
                
                
                5,961
                
                
                
                6,370Goodwill
                
                
                1,350
                
                
                
                1,350Intangible
      assets, net
                
                
                1,451
                
                
                
                1,535Accounts
      payable
                
                
                (1,449
                )
                
                
                (1,445
                )Other
      accrued liabilities
                
                
                (413
                )
                
                
                (640
                )Net
      assets held for sale
                
                $
                15,949
                
                
                $
                16,497





Late in
2007, Appleton committed to a formal plan to sell Bemrose Group Limited
(“Bemrose”), its secure and specialized print services business based in Derby,
England. After conducting a strategic review in the fourth quarter of 2007,
Appleton decided to focus its attention and expand its leadership positions in
its core businesses. The operating results of Bemrose for the three and six
months ended June 29, 2008 are reported separately as discontinued
operations. For the three and six months ended June 29, 2008, Bemrose
recorded net sales of $24.4 million and $47.2 million, respectively, and a loss
before income taxes of $42.9 million for each period.





7


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





On
August 1, 2008, Appleton completed the sale of Bemrose receiving £2.0
million ($3.9 million) of cash and £3.2 million ($6.4 million) of notes
receivable to be settled within 75 and 180 days after closing. The first tranche
of notes receivable was paid in November 2008, however, due to continuing
difficult business conditions in Bemrose markets, Appleton established a £1.0
million ($1.5 million) reserve against the £2.0 million ($3.0 million) remaining
principal and interest due at year-end 2008. During second quarter 2009,
Appleton and Bemrose negotiated an amendment to the original sales agreement
related to the second tranche of the note receivable. Bemrose agreed to pay
Appleton £1.5 million (or approximately $2.5 million). In return, Appleton
agreed to release Bemrose from the remaining £0.5 million ($0.8 million). During
July 2009, £1.0 million ($1.6 million) was received from Bemrose. Interest will
accrue on the unpaid balance and will be paid in addition to the remaining
principal in January 2012. These renegotiated terms resulted in a partial
recovery of the reserve established at year-end 2008 and the recording of a £0.5
million ($0.8 million) gain in other income from continuing operations in the
Condensed Consolidated Statement of Operations for the three and six months
ended July 5, 2009. The note receivable has been recorded within other long-term
assets.
  3.        GOODWILL
AND OTHER INTANGIBLE ASSETS
  The Company
reviews the carrying value of goodwill and intangible assets with indefinite
lives for impairment annually or more frequently if events or changes in
circumstances indicate that an asset might be impaired. The carrying amount of
goodwill as of July 5, 2009 and January 3, 2009 was $9.3 million and
was assigned entirely to the performance packaging segment.





The
Company’s other intangible assets consist of the following (dollars in
thousands):





As
      of July 5, 2009
                
                
                As
      of January 3, 2009Gross
      Carrying Amount
                
                
                Accumulated
      Amortization
                
                
                Gross
      Carrying Amount
                
                
                Accumulated
      AmortizationAmortizable
      intangible assets:Trademarks
                
                $
                47,835
                
                
                $
                19,718
                
                
                $
                47,835
                
                
                $
                18,590Patents
                
                
                30,778
                
                
                
                30,670
                
                
                
                30,778
                
                
                
                30,570Customer
      relationships
                
                
                25,064
                
                
                
                6,592
                
                
                
                25,064
                
                
                
                5,983Non-compete
      agreements
                
                
                691
                
                
                
                686
                
                
                
                691
                
                
                
                686Subtotal
                
                
                104,368
                
                
                $
                57,666
                
                
                
                104,368
                
                
                $
                55,829Unamortizable
      intangible assets:Trademarks
                
                
                22,865
                
                
                
                
                
                
                
                22,865Total
                
                $
                127,233
                
                
                
                
                
                
                $
                127,233





Of the
$127.2 million of acquired intangible assets, $70.7 million was assigned to
registered trademarks. Trademarks of $44.6 million related to carbonless paper
and $3.2 million related to the Company’s 2003 and 2005 acquisitions are being
amortized over their estimated useful life of 20 years, while the remaining
$22.9 million are considered to have an indefinite life and, as such, are not
subject to amortization. The remaining acquired intangible assets are being
amortized over their estimated useful lives ranging from 3 to 25 years for
patents and customer relationships and 1 to 5 years for non-compete
agreements.





Total
amortization expense for the three and six months ended July 5, 2009
was $0.9 million and $1.9 million, respectively. Of these amounts, C&H
reported amortization expense of $0.1 million for the six months ended July 5,
2009. Amortization expense for the three and six months ended June 29,
2008 was $1.1 million and $2.5 million, respectively. Of these
amounts, C&H recorded amortization expense of $0.1 million for the
six months ended June 29, 2008.





4.         RESTRUCTURING
AND OTHER CHARGES





Due to
the impact of the economic downturn on the business, salaried headcount was
reduced by 72 during December 2008. In addition, due to a shift of production
from the Appleton, Wisconsin plant to the West Carrollton, Ohio paper mill and
the impact of the economic downturn on the business, production headcount was
reduced by 127. As a result, the Company recorded $2.6 million of restructuring
and other charges, for employee termination benefits, during 2008.








8


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





The table
below summarizes the restructuring reserve included in the consolidated balance
sheets at July 5, 2009 and January 3, 2009 (dollars in
thousands):






January 3, 2009
                  
                  
                  
                  2009
      Additions
                  
                  
                  2009
                  
                  
                  July
      5, 2009Reserve
                  
                  
                  
                  to
      Reserve
                  
                  
                  Utilization
                  
                  
                  Reserve$
                  
                  
                  
                  
                  $
                  
                  
                  
                  
                  $
                  
                  
                  
                  $U.S.
      employee termination benefits
                  2,138
                  
                  -
                  (1,924
                  )
                  214


5.         INVENTORIES





Inventories
consist of the following (dollars in thousands):





July 5,
      2009
                
                
                January 3,
      2009Finished
      goods
                
                $
                67,196
                
                
                $
                70,448Raw
      materials, work in process and supplies
                
                
                63,548
                
                
                
                69,255130,744
                
                
                
                139,703Inventory
      reserve
                
                
                (3,619
                )
                
                
                (4,330
                )127,125
                
                
                
                135,373LIFO
      reserve
                
                
                (10,708
                )
                
                
                (10,517
                )$
                116,417
                
                
                $
                124,856





Stores
and spare parts inventory balances of $23.3 million and $23.1 million at
July 5, 2009 and January 3, 2009, respectively, are valued at average
cost and are included in raw materials, work in process and supplies.
Inventories valued using the FIFO method approximate 9% of the Company’s total
inventory balance at both July 5, 2009, and January 3,
2009.





6.         PROPERTY,
PLANT AND EQUIPMENT





Property,
plant and equipment balances consist of the following (dollars in
thousands):





July 5,
      2009
                
                
                January 3,
      2009Land
      and improvements
                
                $
                9,909
                
                
                $
                9,880Buildings
      and improvements
                
                
                132,441
                
                
                
                132,110Machinery
      and equipment
                
                
                648,692
                
                
                
                646,294Software
                
                
                32,654
                
                
                
                32,112Capital
      lease
                
                
                4,764
                
                
                
                4,764Construction
      in progress
                
                
                15,506
                
                
                
                8,216843,966
                
                
                
                833,376Accumulated
      depreciation/amortization
                
                
                (421,786
                )
                
                
                (394,075
                )$
                422,180
                
                
                $
                439,301





9


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





Depreciation  expense for
the three and six months ended July 5, 2009 and June 29, 2008,
consists of the following (dollars in thousands):





For
      the Three
                    
                    
                    For
      the Three
                    
                    
                    For
      the Six
                    
                    
                    For
      the SixMonths
      Ended
                    
                    
                    Months
      Ended
                    
                    
                    Months
      Ended
                    
                    
                    Months
      EndedDepreciation
      Expense
                    
                    July5,
      2009
                    
                    
                    June29,
      2008
                    
                    
                    July5,
      2009
                    
                    
                    June29,
      2008Cost
      of sales
                    
                    $
                    12,890
                    
                    
                    $
                    11,752
                    
                    
                    $
                    25,651
                    
                    
                    $
                    23,304Selling,
      general and administrative expenses
                    
                    
                    1,668
                    
                    
                    
                    1,920
                    
                    
                    
                    3,336
                    
                    
                    
                    3,796$
                    14,558
                    
                    
                    $
                    13,672
                    
                    
                    $
                    28,987
                    
                    
                    $
                    27,100




Included in
the amounts above, C&H recorded depreciation of $0.2 million and $0.4
million for the three and six months ended July 5, 2009, respectively. Also
included in the above table, C&H recorded depreciation of $0.2 million and
$0.4 million for the three and six months ended June 29, 2008,
respectively.





7.        OTHER
CURRENT AND NONCURRENT ASSETS


Other
current assets consist of the following (dollars in thousands):
 
 July 5,
      2009
                                            
                                            January 3,
      2009Environmental
      indemnification receivable
                                            $
                                            37,700
                                            
                                            $
                                            37,700Alternative
      fuels tax credit receivable
                                            
                                            7,962
                                            
                                            
                                            -Note
      receivable from Bemrose
                                            
                                            1,639
                                            
                                            
                                            1,449Other
                                            
                                            12,995
                                            
                                            
                                            6,771$
                                            60,296
                                            
                                            $
                                            45,920


Other
noncurrent assets consist of the following (dollars in thousands):





July 5,
      2009
                            
                            January 3,
      2009Deferred
      debt issuance costs
                            $
                            12,344
                            
                            $
                            10,968Other
                            
                            3,515
                            
                            
                            2,941$
                            15,859
                            
                            $
                            13,909





8.        OTHER
ACCRUED LIABILITIES





Other
accrued liabilities, as presented in the current liabilities section of the
balance sheet, consist of the following (dollars in thousands):





July 5,
      2009
              
              
              January 3,
      2009Payroll
      and bonus
              
              $
              5,377
              
              
              $
              4,776Trade
      discounts
              
              
              15,891
              
              
              
              18,537Workers’
      compensation
              
              
              3,989
              
              
              
              4,489Accrued
      insurance
              
              
              1,673
              
              
              
              1,744Other
      accrued taxes
              
              
              974
              
              
              
              1,787Postretirement
      benefits other than pension
              
              
              3,329
              
              
              
              3,329Fox
      River Liabilities
              
              
              37,700
              
              
              
              37,700Restructuring
      reserve
              
              
              214
              
              
              
              2,138Other
              
              
              8,272
              
              
              
              9,002$
              77,419
              
              
              $
              83,502





10


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





9.         NEW
ACCOUNTING PRONOUNCEMENTS




In June 2009, the
Financial Accounting Standards Board (“FASB”) issued the FASB Accounting
Standards Codification (“Codification”). The Codification will become the single
source for all authoritative generally accepted accounting principles (“GAAP”)
recognized by the FASB to be applied for financial statements issued for periods
ending after September 15, 2009. The Codification does not change GAAP and
the Company has determined that it will not have an impact on its consolidated
results of operations, financial position and cash flows.


In May 2009,
the FASB issued SFAS 165, “Subsequent
Events.”  This statement is applicable to the accounting for and
disclosure of subsequent events not addressed in other GAAP. It provides a
definition of subsequent events and guidance as to when subsequent events are
recognized or not recognized. SFAS 165 requires the disclosure of the date
through which subsequent events have been evaluated, as well as whether the date
is the date the financial statements were issued or the date the financial
statements were available to be issued. These provisions are effective for
interim or annual financial periods ending after June 15, 2009, and should
be applied prospectively. The provisions of SFAS 165 were adopted by the Company
during its second quarter ended July 5, 2009 and had no material impact on
its financial statements.





In April
2009, the FASB issued FASB Staff Position (“FSP”) FAS 157-4 “Determining Fair
Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly.”
Based on the guidance, if an entity determines that the level of activity for an
asset or liability has significantly decreased and that a transaction is not
orderly, further analysis of transactions or quoted prices is needed, and a
significant adjustment to the transaction or quoted prices may be necessary to
estimate fair value in accordance with SFAS 157 “Fair Value Measurements.” The
provisions of FSP FAS 157-4 were adopted by the Company during its second
quarter ended July 5, 2009. There was no current period impact on its
financial statements.





In April
2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”) 28-1
“Interim Disclosures about Fair Value of Financial Instruments.” The FSP amends
SFAS 107 “Disclosures about Fair Value of Financial Instruments” to require an
entity to provide disclosures about fair value of financial instruments in
interim financial information. The provisions of FSP FAS 107-1 were adopted by
the Company during its second quarter ended July 5, 2009. The current
period impact is addressed in Note 17, Fair Value of Financial
Instruments.





In
December 2008, the FASB issued FASB Staff Position FAS 132(R)-1,
“Employer’s Disclosures about Postretirement Benefit Plan Assets,” which amends
SFAS 132 (Revised 2003), “Employers’ Disclosures about Pension and Other
Postretirement Benefits,” to provide guidance on an employers’ disclosures about
plan assets of a defined benefit pension or other postretirement plan. This
pronouncement is effective for fiscal years ending after December 15, 2009.
Upon initial application, the provisions are not required to be adopted for
earlier periods as presented for comparative purposes. Earlier application of
the provisions is permitted. The Company does not believe adoption will have a
material impact on its consolidated financial statements.





In
March 2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133.” This statement changes the disclosure requirements for
derivative instruments and hedging activities. SFAS 161 requires enhanced
disclosures about (a) how and why an entity uses derivative instruments,
(b) how derivative instruments and related hedged items are accounted for
under SFAS 133 and its related interpretations and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance and cash flows. These provisions are effective for
financial statements issued for fiscal years beginning after November 15,
2008. The Company adopted SFAS 161 during its first quarter 2009. The
principal impact to the Company was to require the expansion of its disclosures
regarding derivative instruments.





In
December 2007, the FASB issued SFAS 141 (Revised 2007), “Business Combinations.”
SFAS 141R requires that an acquiring entity recognize all the assets acquired
and liabilities assumed in a transaction at the acquisition date fair value with
limited exceptions. SFAS 141R will change the accounting treatment for
acquisition costs, non-controlling interests, contingent liabilities, in-process
research and development, restructuring costs and income taxes. In addition, it
also requires a substantial number of new disclosure requirements. This
statement applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Earlier adoption is
prohibited. The Company adopted SFAS 141R during the first quarter of 2009. The
adoption did not have a material impact on its consolidated financial
statements.


11


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





10.      EMPLOYEE
BENEFITS





The
Company has various defined benefit pension plans and defined contribution
pension plans. This includes a Supplemental Executive Retirement Plan (“SERP”)
to provide retirement benefits for management and other highly compensated
employees whose benefits are reduced by the tax-qualified plan limitations of
the pension plan for eligible salaried employees. The components of net periodic
pension cost include the following (dollars in thousands):





For
      the
                    
                    
                    For
      the
                    
                    
                    For
      the
                    
                    
                    For
      theThree
      Months
                    
                    
                    Three
      Months
                    
                    
                    Six
      Months
                    
                    
                    Six
      MonthsEnded
                    
                    
                    Ended
                    
                    
                    Ended
                    
                    
                    EndedPension
      Benefits
                    
                    July 5,
      2009
                    
                    
                    June 29,
      2008
                    
                    
                    July 5,
      2009
                    
                    
                    June 29,
      2008Net
      periodic benefit costService
      cost
                    
                    $
                    1,458
                    
                    
                    $
                    1,539
                    
                    
                    $
                    2,916
                    
                    
                    $
                    3,077Interest
      cost
                    
                    
                    4,908
                    
                    
                    
                    4,488
                    
                    
                    
                    9,817
                    
                    
                    
                    8,976Expected
      return on plan assets
                    
                    
                    (5,199
                    )
                    
                    
                    (5,186
                    )
                    
                    
                    (10,399
                    )
                    
                    
                    (10,372
                    )Amortization
      ofPrior
      service cost
                    
                    
                    135
                    
                    
                    
                    48
                    
                    
                    
                    270
                    
                    
                    
                    96Actuarial
      loss
                    
                    
                    123
                    
                    
                    
                    -
                    
                    
                    
                    245
                    
                    
                    
                    -Net
      periodic benefit cost
                    
                    $
                    1,425
                    
                    
                    $
                    889
                    
                    
                    $
                    2,849
                    
                    
                    $
                    1,777





Effective
January 1, 2008, the Company amended the Appleton Papers Inc. Retirement
Plan (the “Plan”) to provide that no individuals hired or re-hired on or after
January 1, 2008, shall be eligible to participate in the Plan. Also, plan
benefits accrued under the Plan were frozen as of April 1, 2008, with
respect to Plan participants who elected to participate effective April 1,
2008, in a “Mandatory Profit Sharing Contribution” under the Appleton Papers
Inc. Retirement Savings and Employee Stock Ownership Plan (the “KSOP”) or will
be frozen as of January 1, 2015, in the case of any other Plan
participants.




The
Company expects to contribute approximately $10 million to its pension plan
in fiscal 2009 for plan year 2008. No contributions were made to the pension
plan during the first half of 2009.





11.      POSTRETIREMENT
BENEFIT PLANS OTHER THAN PENSIONS





The
Company has defined postretirement benefit plans that provide medical, dental
and life insurance for certain retirees and eligible dependents. The components
of other postretirement benefit cost include the following (dollars in
thousands):





For
      the
                        
                        
                        For
      the
                        
                        
                        For
      the
                        
                        
                        For
      theThree
      Months
                        
                        
                        Three
      Months
                        
                        
                        Six
      Months
                        
                        
                        Six
      MonthsEnded
                        
                        
                        Ended
                        
                        
                        Ended
                        
                        
                        EndedOther
      Postretirement Benefits
                        
                        July 5,
      2009
                        
                        
                        June 29,
      2008
                        
                        
                        July 5,
      2009
                        
                        
                        June 29,
      2008Net
      periodic benefit costService
      cost
                        
                        $
                        185
                        
                        
                        $
                        233
                        
                        
                        $
                        370
                        
                        
                        $
                        465Interest
      cost
                        
                        
                        767
                        
                        
                        
                        770
                        
                        
                        
                        1,534
                        
                        
                        
                        1,540Amortization
      ofPrior
      service cost
                        
                        
                        (545
                        )
                        
                        
                        (539
                        )
                        
                        
                        (1,090
                        )
                        
                        
                        (1,078
                        )Actuarial
      loss
                        
                        
                        -
                        
                        
                        
                        1
                        
                        
                        
                        -
                        
                        
                        
                        2Net
      periodic benefit cost
                        
                        $
                        407
                        
                        
                        $
                        465
                        
                        
                        $
                        814
                        
                        
                        $
                        929





12


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





12.      LONG-TERM
INCENTIVE COMPENSATION





In
December 2001, the Company adopted the Appleton Papers Inc. Long-Term Incentive
Plan. In July 2002, the Company adopted the Appleton Papers Canada Ltd. Share
Appreciation Rights Plan. These plans provide officers and key employees the
opportunity to be awarded phantom units, the value of which is based on the
change in the fair market value of PDC’s common stock under the terms of the
employee stock ownership plan (the “ESOP”) prior to the grant date or the
exercise date, as applicable. During the first quarter of 2009, 463,000 new
phantom units were issued under the Appleton Papers Inc. Long-Term Incentive
Plan at a share price of $21.43 which was the fair market value of one share of
PDC common stock as of January 3, 2009. There was no expense recorded for
this plan during the three and six months ended July 5, 2009. As a result
of a June 29, 2008 decline in share price, the Company recorded reductions
to compensation expense of $2.8 million and $2.7 million within selling, general
and administrative expenses for the three and six months ended June 29,
2008, respectively.





Beginning
in 2006, the Company established a nonqualified deferred compensation agreement
with each of its non-employee directors. Deferred compensation is in the form of
phantom units and is earned over the course of six-month calendar periods of
service beginning January 1 and July 1. The number of units to be
earned is calculated using the established dollar value of the compensation
divided by the fair market value of one share of PDC common stock as established
under the terms of the ESOP as of the prior December 31 and June 30,
respectively. This deferred compensation vests coincidental with the board
member’s continued service on the board. Upon cessation of service as a
director, the deferred compensation will be paid in five equal annual cash
installments. There was no expense recorded for this plan during the three
months ended July 5, 2009. Approximately $0.1 million was recorded as
expense, related to this plan, for the first half of 2009. There was no expense
recorded for this plan during the three and six months ended June 29,
2008.





13.      COMMITMENTS
AND CONTINGENCIES





Lower
Fox River





Introduction.Various federal and state government agencies and Native American tribes
have asserted claims against Appleton and others with respect to historic
discharges of polychlorinated biphenyls (“PCBs”) into the Lower Fox River in
Wisconsin. Carbonless paper containing PCBs was manufactured at what is
currently the Appleton plant from 1954 until 1971. During this period,
wastewater containing PCBs was discharged into the Lower Fox River from a
publicly-owned treatment works, from the Appleton Coated paper mill and from
other local industrial facilities. Wastewater from the Appleton plant was
processed through the publicly-owned treatment works. As a result, there are
allegedly eleven million cubic yards of PCB contaminated sediment spread over 39
miles of the Lower Fox River and Green Bay, which is part of Lake
Michigan.





The
United States Environmental Protection Agency (“EPA”) published a notice in 1997
that it intended to list the Lower Fox River on the National Priorities List of
Contaminated Sites pursuant to the federal Comprehensive Environmental Response,
Compensation, and Liability Act, (“CERCLA” or “Superfund”). The EPA identified
seven potentially responsible parties (“PRPs”) for PCB contamination in the
Lower Fox River, including NCR, Appleton, Georgia-Pacific, P.H. Glatfelter
Company, WTMI Co., owned by Chesapeake Corporation, Riverside Paper Corporation
and U.S. Paper Mills Corp., which is now owned by Sonoco Products
Company.





Remedial Action.The EPA and the Wisconsin Department of Natural Resources (“DNR”) issued
two Records of Decision (“ROD”) in 2003, estimating the total costs for the
Lower Fox River remedial action at approximately $400 million. Other estimates
obtained by the PRPs range from a low of $450 million to as much as $1.6
billion. More recent estimates place the cost between $594 million and $900
million. In June 2007, the EPA and DNR issued an amended ROD which modified the
remedial action plan for the Lower Fox River.




The EPA
issued an administrative order in November 2007, directing the PRPs to implement
the remedial action of the Fox River. The PRPs have initiated remediation work
under a work plan and are negotiating to reach a funding arrangement to complete
the work plan.




13


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





Appleton
and NCR filed a lawsuit in January 2008 in federal court against various
defendants, including other PRPs and certain municipalities in an effort to
require contribution to the cost of cleaning up PCB-contaminated sediment in the
Fox River.





Natural Resource
Damages.In 2000, the U.S. Fish & Wildlife Service (“FWS”)
released a proposed plan for restoring natural resources injured by PCBs. The
plan estimates that natural resource damages (“NRDs”) will fall in the range of
$176 million to $333 million for all PRPs. However, based on settlements of NRD
claims to date, which have been substantially less than original estimates, the
Company anticipates the actual costs of NRD claims will be less than the
original estimates provided by FWS.




Interim
Restoration and Remediation Consent Decree.Appleton and NCR collectively
paid $41.5 million for interim restoration and remediation efforts pursuant to a
2001 consent decree with various governmental agencies (the “Intergovernmental
Parties” or “IGP”). In addition, Appleton and NCR collectively paid
approximately $750,000 toward interim restoration efforts and the preparation of
a progress report pursuant to a 2006 consent decree with the IGP. Appleton and
NCR also paid $2.8 million in 2007 to fund a land acquisition in partial
settlement of NRD claims. Neither of the consent decrees nor the land
acquisition constitutes a final settlement or provides protection against future
claims; however, Appleton and NCR will receive full credit against remediation
costs and NRD claims for all monies expended.





Appleton’s
Liability. CERCLA imposes liability on parties responsible for, in
whole or in part, the presence of hazardous substances at a site.
Superfund-liable parties can include both current and prior owners and operators
of a facility. While any PRP may be held liable for the entire cleanup of a
site, the final allocation of liability among PRPs generally is determined by
negotiation, litigation or other dispute resolution processes.




Appleton
purchased the Appleton plant and the Combined Locks paper mill from NCR in 1978,
after the use of PCBs in the manufacturing process was discontinued.
Nonetheless, the EPA named both Appleton and NCR as PRPs in connection with
remediation of the Lower Fox River. Appleton’s and NCR’s obligations to share
defense and liability costs are defined by a 2006 arbitration
determination.




The 2000
FWS study offered a preliminary conclusion that the discharges from the Appleton
plant and the Combined Locks paper mill were responsible for 36% to 52% of the
total PCBs discharged. These estimates have not been finalized and are not
binding on the PRPs. Appleton has obtained its own historical and technical
analyses which suggest that the percentage of PCBs discharged from the Appleton
and Combined Locks facilities is less than 20% of the total PCBs
discharged.




A portion of
Appleton’s potential liability for the Lower Fox River may be joint and several.
If, in the future, one or more of the other PRPs were to become insolvent or
unable to pay its respective share(s) of the potential liability, Appleton could
be responsible for a portion of its share(s). Based on a review of publicly
available financial information, Appleton believes that other PRPs will be
required, and have adequate financial resources, to pay their shares of the
remediation and natural resource damage claims for the Lower Fox
River.





Estimates of
Liability.
Appleton cannot precisely estimate its ultimate share of liability due to
uncertainties regarding the scope and cost of implementing the final remediation
plan, the scope of restoration and final valuation of NRD assessments, the
evolving nature of remediation and restoration technologies and governmental
policies, and Appleton’s share of liability relative to other PRPs. However, the
issuance of the RODs, the receipt of bid proposals and the beginning of
remediation activities provide evidence to reasonably estimate a range of
Appleton’s potential liability.





Accordingly,
Appleton has recorded a reserve for its potential liability for the Lower Fox
River. At January 3, 2009, this reserve was $152.0 million. During the
first six months of 2009, $64.3 million of payments were made from the reserve.
This resulted in a remaining reserve of $87.7 million as of July 5, 2009,
of which $37.7 million is recorded in other accrued liabilities and $50.0
million is recorded as a long-term environmental liability.





The
following assumptions were used in evaluating Appleton’s potential Lower Fox
River liability and establishing a remediation reserve:




•
            total
      remediation costs of $654 million, based on the most recent bids received
      with a range from $594 million to $900
million;


14


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)




•
            the
      FWS preliminary estimate that discharges from the Appleton plant and the
      Combined Locks mill represent 36% to 52%  of the total PCBs
      discharged by the PRPs, which is substantially greater than Appleton’s
      estimate;




•
            costs
      to settle NRD claims against Appleton and NCR, estimated at $20 million or
      less, based on the IGP’s settlement of other NRD
  claims;




•
            Appleton’s
      responsibility for over half of the claims asserted against Appleton and
      NCR, based on the Company’s interim settlement agreement with NCR and the
      arbitration determination; and




•
            $25
      million in fees and expenses.




Although
Appleton believes its recorded environmental liability reflects a reasonable
estimate of its liabilities associated with the Lower Fox River, the actual
amount of liabilities associated with the Lower Fox River could prove to be
significantly larger than the recorded environmental liability.




AWA
Indemnification. Pursuant to two indemnification agreements entered in
2001, AWA agreed to indemnify PDC and PDC agreed to indemnify Appleton for
costs, expenses and liabilities related to certain governmental and third-party
environmental claims, which are defined in the agreements as the Fox River
Liabilities.




Under the
indemnification agreements, Appleton is indemnified for the first $75 million of
Fox River Liabilities and for amounts in excess of $100 million. During 2008,
Appleton paid $25 million in satisfaction of its unindemnified portion of the
Fox River Liabilities. AWA has paid $151.9 million in connection with Fox River
Liabilities through first half 2009. At July 5, 2009, the total
indemnification receivable from AWA was $87.7 million, of which $37.7 million is
recorded in other current assets and $50.0 million is recorded as an
environmental indemnification receivable.




In connection
with the indemnification agreements, AWA purchased and fully paid for indemnity
claim insurance from Commerce & Industry Insurance Company, an affiliate of
American International Group, Inc. The insurance policy provides up to $250
million of coverage for Fox River Liabilities, subject to certain limitations
defined in the policy. At July 5, 2009, the policy had $98.1 million of
remaining coverage which is sufficient to cover Appleton’s currently estimated
share of the Fox River Liabilities. AWA’s obligations to maintain indemnity
claim insurance covering the Fox River Liabilities are defined in and limited by
the terms of the Fox River AWA Environmental Indemnity Agreement, as
amended.





The
indemnification agreements negotiated with AWA and the Commerce & Industry
Insurance policy are designed to ensure that Appleton will not be required to
fund any of the indemnified costs and expenses in relation to the Fox River
Liabilities and to assure the ESOP Trustee and Appleton’s lenders and investors
that Appleton will not have to rely solely on AWA itself to make these payments.
This arrangement is working as designed and is expected to continue to protect
Appleton with respect to the indemnified costs and expenses, based on Appleton’s
review of the insurance policy and the financial condition of AWA and Commerce
& Industry Insurance Company. AWA, PDC, the special purpose subsidiaries and
the policyholder entered into a Relationship Agreement, which, among other
things and subject to certain limited exceptions, prohibits AWA and PDC from
taking any actions that would result in any change to this design
structure.





In
March 2008, Appleton received favorable jury verdicts in a state court
declaratory judgment relating to insurance coverage of its environmental claims
involving the Fox River. A final judgment and order was entered in January 2009.
The insurers have appealed the final judgment. Under the terms of the
indemnification agreement, recoveries from insurance are reimbursed to AWA to
the extent of its indemnification obligation.


15


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





West
Carrollton Mill




The West
Carrollton, Ohio mill operates pursuant to various state and federal permits for
discharges and emissions to air and water. As a result of the de-inking of
carbonless paper containing PCBs through the early 1970s, there have been
releases of PCBs and volatile organic compounds into the soil in the area of
thewastewater
impoundments at the West Carrollton facility and low levels of PCBs have been
detected in groundwater immediately under this area. In addition, PCB
contamination is present in sediment in the adjacent Great Miami River, but it
is believed that this contamination is from a source other than the West
Carrollton mill.





Based on
investigation and delineation of PCB contamination in soil and groundwater in
the area of the wastewater impoundments, Appleton believes that it could be
necessary to undertake remedial action in the future, although Appleton is
currently under no obligation to do so. Appleton has not had any discussions or
communications with any federal, state or local agencies or authorities
regarding remedial action to address PCB contamination at the West Carrollton
mill. The cost for remedial action, which could include installation of a cap,
long-term pumping, treating and/or monitoring of groundwater and removal of
sediment in the Great Miami River, was estimated in 2001 to range up to
approximately $10.5 million, with approximately $3 million in short-term capital
costs and the remainder to be incurred over a period of 30 years. However, costs
could exceed this amount if additional contamination is discovered, if
additional remedial action is necessary or if the remedial action costs are more
than expected.





Because
of the uncertainty surrounding the ultimate course of action for the West
Carrollton mill property, the Great Miami River remediation and Appleton’s share
of these remediation costs, if any, and since Appleton is currently under no
obligation to undertake remedial action in the future, no provision has been
recorded in its financial statements for estimated remediation costs. In
conjunction with the acquisition of PDC by the ESOP in 2001, and as limited by
the terms of the purchase agreement, AWA agreed to indemnify the Company for 50%
of all environmental liabilities at the West Carrollton mill up to $5.0 million
and 100% of all such environmental costs exceeding $5.0 million. In addition,
the former owners and operators of the West Carrollton mill may be liable for
all or part of the cost of remediation of historic PCB
contamination.





Litigation
Settlement





In 1996,
after being named as a defendant in a lawsuit, Appleton notified its insurance
carriers of a coverage claim under policies in effect at the time. The lawsuit
ultimately was resolved and Appleton recovered expenses from three of four
insurers. The fourth insurer disputed coverage for its share of previously
incurred costs. As a result, Appleton filed a lawsuit against the
insurer. In 2007, a Wisconsin state appellate court issued an
order estopping the insurer from denying its obligation to cover
Appleton. Pursuant to a judgment in favor of Appleton which was entered in
March 2008, and subsequent settlement negotiations with the insurer,
Appleton recorded $22.2 million of income, net of fees. These proceeds were
received in April 2008.




Other
Litigation
 
 In
September, 2007, Appleton commenced litigation against a former contractor. The
claims asserted included breach of obligations under a February 2007 agreement
to perform certain engineering services. This matter proceeded to trial and, on
May 14, 2009, Appleton received a favorable jury verdict. The defendant
filed post-trial motions in response to the verdict. A hearing on the motions is
scheduled for August 11, 2009, and a final judgment will be entered thereafter.
The Company anticipates that the defendants will appeal any final judgment
decided in Appleton’s favor. Ultimate resolution of the litigation could have a
material effect on Appleton's financial results.
  Other





From time
to time, Appleton may be subject to various demands, claims, suits or other
legal proceedings arising in the ordinary course of business. A comprehensive
insurance program is maintained to provide a measure of financial protection
against such matters, though not all such exposures are, or can be, addressed by
insurance. Estimated costs are recorded for such demands, claims, suits or
proceedings of this nature when reasonably determinable. The Company has
successfully defended such claims, settling some for amounts which are not
material to the business and obtaining dismissals in others. While the Company
vigorously defends itself and expects to prevail in any similar cases that may
be brought against Appleton in the future, there can be no assurance that the
Company will be successful in its defense.


16


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)




Except as
described above, and assuming the Company’s expectations regarding defending
such demands, claims, suits or other legal or regulatory proceedings prove
accurate, Appleton does not believe that any pending or threatened demands,
claims, suits or other legal proceedings will have, individually or in the
aggregate, a materially adverse effect on its financial position, results of
operations or cash flows.





14.      EMPLOYEE
STOCK OWNERSHIP PLAN





Appleton’s
matching contributions charged to expense were $1.0 million and $1.2 million for
the three months ended July 5, 2009 and June 29, 2008, respectively.
Appleton’s matching contributions charged to expense were $2.1 million and $3.1
million for the six months ended July 5, 2009 and June 29, 2008,
respectively. As a result of hardship withdrawals, required diversifications and
employee terminations, 612,205 shares of PDC redeemable common stock were
repurchased during the first six months of 2009 at an aggregate price of
approximately $12.6 million. During the same period, the ESOP trustee purchased
109,964 shares of PDC redeemable common stock for an aggregate price of $2.1
million from pre-tax deferrals, rollovers and loan payments made by employees,
while Appleton’s matching contribution for this same period resulted in an
additional 103,766 shares of PDC redeemable common stock being issued. During
the first six months of 2008, the ESOP trustee purchased PDC redeemable common
stock for an aggregate price of $3.7 million, also from pre-tax deferrals,
rollovers and loan payments made by employees.





Redeemable
common stock is being accreted up to the earliest redemption date based upon the
estimated fair market value of the redeemable common stock as of July 5,
2009. Due to a reduction in the July 5, 2009 share price, redeemable common
stock accretion was reduced by $3.8 million for the six months ended
July 5, 2009. Based upon the estimated fair value of the redeemable common
stock, an ultimate redemption liability of approximately $193 million was
determined. The redeemable common stock recorded book value as of July 5,
2009 was $136 million, which leaves a remaining unrecognized liability to be
accreted of approximately $57 million.




15.      DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES




In
March 2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133.” This statement changes the disclosure requirements for
derivative instruments and hedging activities. SFAS 161 requires enhanced
disclosures about (a) how and why an entity uses derivative instruments,
(b) how derivative instruments and related hedged items are accounted for
under SFAS 133 and its related interpretations and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance and cash flows.





The
Company selectively uses financial instruments to manage some market risk from
changes in interest rates or foreign currency exchange rates. The fair values of
all derivatives are recorded in the consolidated balance sheet. The change in a
derivative’s fair value is recorded each period in current earnings or
accumulated other comprehensive loss (“AOCI”), depending on whether the
derivative is designated and qualifies as part of a hedge transaction and, if
so, the type of hedge transaction.





The
Company selectively hedges forecasted transactions that are subject to foreign
currency exchange exposure by using forward exchange contracts to reduce its
cash flow exposure to foreign currency fluctuations associated with its
anticipated cash flows. These instruments are designated as cash flow hedges in
accordance with SFAS 133 and are recorded in the consolidated balance sheet at
fair value. The effective portion of the contracts’ gains or losses, due to
changes in fair value, are initially recorded as a component of accumulated
other comprehensive loss and are subsequently reclassified into earnings when
the underlying transactions occur and affect earnings. These contracts are
highly effective in hedging the variability in future cash flows attributable to
changes in currency exchange rates. The notional amount of foreign exchange
contracts used to hedge foreign currency transactions was $7.0 million as of
July 5, 2009.


In February
2008, Appleton fixed the interest rate, at 5.45%, on $75.0 million of its
variable rate notes with a five-year interest rate swap contract. This interest
rate swap was being accounted for as a cash flow hedge. As discussed in Note 16,
Long-Term Obligations, the covenant violation at January 3, 2009 and
subsequent waiver and amendment in March 2009, to the senior secured credit
facilities, changed the basis of the forecasted transactions for the interest
rate swap contract. As amended, the senior secured credit facilities contain
interest payments based on LIBOR with a 2% floor, whereas the forecasted
transactions assumed interest payments based on LIBOR. As a result, this
derivative is no longer designated as a hedging instrument under
SFAS 133.


17


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)




The following table
presents the location and fair values of derivative instruments included in the
Company’s condensed consolidated balance sheet at July 5, 2009 (dollars in
thousands):





As
      of July 5, 2009Derivatives
                      
                      
                      Derivatives
      NotDesignated
      as Hedging Instruments
                      
                      
                      Designated
      as Hedging Instrumentsunder
      SFAS 133
                      
                      
                      under
      SFAS 133Other
      current liabilitiesForeign
      currency exchange derivatives
                      
                      $
                      112
                      
                      
                      $
                      -Other
      long-term liabilitiesInterest
      rate swap contract
                      
                      
                      -
                      
                      
                      
                      3,835Total
      liabilities
                      
                      $
                      112
                      
                      
                      $
                      3,835





The
following table presents the location and amount of losses and/or gains on
derivative instruments and related hedge items included in the Company’s
Condensed Consolidated Statement of Operations for the three and six months
ended July 5, 2009 and losses initially recognized in accumulated other
comprehensive loss in the Condensed Consolidated Balance Sheet at July 5,
2009 (dollars in thousands):





Effective
      PortionAmount
      of Loss Reclassified fromAOCI
      into IncomeDerivatives
      in SFAS 133
                  Cash
      Flow Hedging
                  Relationships
                
                Amount
      of Loss
                  Recognized
      in
                  AOCI
      on Derivatives
                  As
      of July 5, 2009
                
                Location
      of Loss
                  Reclassified
      from
                  AOCI
      into Income
                
                For
      the three months
                  ended
      July 5, 2009
                
                
                For
      the six months
                  ended
      July 5, 2009Foreign
      currency exchange derivatives
                
                $
                54
                
                Net
      sales
                
                $
                (172
                )
                
                $
                (140
                )Amount
      of Gain Recognizedin
      Income on DerivativeDerivatives
      Not Designated
                  as
      Hedging Instruments under
                
                
                
                
                Location
      of Gain
                  Recognized
      inIncome
      on
                
                For
      the three months
                
                
                For
      the six monthsSFAS
      133
                
                
                
                
                Derivative
                
                ended
      July 5, 2009
                
                
                ended
      July 5, 2009Interest
      rate swap contract
                
                
                
                
                Interest
      expense
                
                $
                712
                
                
                $
                916





For a
discussion of the fair value of financial instruments, see Note 17, Fair Value
of Financial Instruments.


18


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





16.      LONG-TERM
OBLIGATIONS





Long-term
obligations, excluding the capital lease obligation, consist of the following
(dollars in thousands):





July 5,
      2009
                  
                  January 3,
      2009At
      July 5, 2009 the senior secured variable rate notes payable were at 6.5%,
      $563 due quarterly with $212,062 due June 2013. At January 3, 2009
      the notes were at approximately 4.5%, $563 due quarterly with $209,812 due
      June 2014.
                  $
                  220,500
                  
                  
                  $
                  221,625Secured
      term note payable at 14.25%, approximately $300 due monthly with $6,831
      due December 2013. At January 3, 2009 the note was at 12.5%,
      approximately $200 due monthly with $6,943 due December
      2013.
                  20,689
                  
                  21,814At
      July 5, 2009 the revolving credit facility was at approximately 6.6%. At
      January 3, 2009 the revolving credit facility was at approximately
      4.0%.
                  
                  111,734
                  
                  
                  
                  83,734352,923
                  
                  327,173Less
      obligations due within one year
                  (4,738
                  )
                  (4,640
                  )348,185
                  
                  322,533Secured
      variable rate industrial development bonds, 0.7% average
      interest rate at July 5, 2009, $2,650 due in 2013 and $6,000 due in
      2027
                  8,650
                  
                  8,650State
      of Ohio assistance loan at 6%, approximately $100 due monthly
      and final payment due May 2017
                  8,380
                  
                  8,780State
      of Ohio loan at 1% until July 2011, then 3% until May 2019,
      approximately $30 due monthly and final paymentdueMay
      2019
                  3,000
                  
                  -Less
      obligations due within one year
                  (1,128
                  )
                  (815
                  )10,252
                  
                  7,965Senior
      notes payable at 8.125%, due June 2011
                  109,450
                  
                  109,450Senior
      subordinated notes payable at 9.75%, due
    June 2014
                  142,500
                  
                  150,000





During
first quarter 2009, Appleton purchased $7.5 million, plus interest, of the 9.75%
senior subordinated notes payable due June 2014. As these senior
subordinated notes were purchased at a price less than face value, the Company
recorded a $5.8 million gain on this purchase. Also as a result of this
purchase, $0.3 million of deferred debt issuance costs were written off,
resulting in a net gain of $5.5 million.





In the
first half of 2009, Appleton made mandatory debt repayments of $2.7 million,
plus interest, on its senior secured variable rate notes payable, secured term
note payable and State of Ohio assistance loan. Also during the first half of
2009, Appleton borrowed $119.5 million and repaid $91.5 million against its
revolving credit facility, leaving an outstanding balance of $111.7 million that
the Company has the ability and intent to finance on a long-term
basis. Approximately $15.4 million of the revolving credit facility was
used to support outstanding letters of credit. At July 5, 2009, there
was approximately $22.9 million of unused borrowing capacity under the $150
million revolving credit facility for working capital and other corporate
purposes. A commitment fee of 0.5% per annum is assessed on the unused borrowing
capacity.





During
July 2007, Appleton entered into a new $12.1 million Loan and Security Agreement
with the Director of Development of the State of Ohio, consisting of a $9.1
million State Assistance Loan and a $3.0 million State Loan (together “the Ohio
Loans”). The Company received the proceeds of the $3.0 million State Loan during
second quarter 2009. The proceeds of the $9.1 million State Assistance Loan were
received in 2007. All proceeds of these Ohio Loans were used to fund a portion
of the costs of acquiring and installing paper coating and production equipment
at the Company’s paper mill in West Carrollton, Ohio.








19


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)




Appleton’s senior
secured credit facilities and senior secured term note payable contain
provisions that require Appleton to maintain specified financial ratios. Prior
to the waivers and amendments discussed below, the most restrictive limitations
were quarter-end debt to earnings before interest, taxes, depreciation and
amortization (EBITDA) of not more than a 4.50 to 1.00 ratio as such terms are
defined in the debt agreements. As a result of the significant downturn in
Appleton’s business markets and the resulting loss reported for the three months
ended January 3, 2009, Appleton was not in compliance with the leverage
ratio covenant at January 3, 2009, which constituted events of default
under the debt agreements. In order to waive the events of default existing at
January 3, 2009, under the senior secured credit facilities and the senior
secured term note payable, and to amend other provisions of the agreements,
Appleton and its lenders entered into the following agreements in
March 2009.





•      First
Amendment to the senior secured credit facilities


•      First
Amendment to the senior secured term note payable




Under the
First Amendment to the senior secured credit facilities, Appleton will pay
interest rates equal to LIBOR, but not less than 2 percent, plus 450 basis
points for any amounts outstanding on the senior secured variable rate notes
payable and, interest rates initially equal to LIBOR, but not less than 2
percent, plus 450 basis points for any amounts outstanding on the revolving
credit facility. The First Amendment to the senior secured credit
facilities provides a grid under which the interest rates payable, for amounts
outstanding on the revolving credit facility, may be reduced, based on measures
of Appleton’s total leverage as defined in the senior secured credit facilities.
Under the First Amendment to the senior secured term note payable, Appleton will
pay an interest rate of 14.25 percent on the senior secured term note
payable. For accounting purposes, the amendments to the senior secured
credit facilities and the senior secured term note payable were treated as debt
modifications. The Company paid $2.8 million of fees to the creditors in
conjunction with the amendment to the senior secured credit facilities. These
debt issuance costs will be amortized over the term of the modified agreement
along with pre-existing unamortized debt issuance costs as an adjustment to
interest expense over the remaining term of the modified
agreement. Unamortized debt issuance costs of $0.1 million, relating to the
revolving credit facility, were written off. The unamortized debt issuance costs
remaining after the writeoff will be deferred and amortized over the term of the
modified revolving credit facility.




Pursuant to
the terms of the First Amendment to the senior secured credit
facilities:





•
            The
      maturity date for the revolving credit facility will be June 5, 2012,
      and the maturity date for the senior secured variable rate notes payable
      will be June 5, 2013;


•
            Appleton
      will be permitted up to $35 million of capital expenditures in 2009 and up
      to $40 million of capital expenditures in 2010, with no limit in 2011or
      thereafter;


•
            Appleton
      may not make acquisitions until December 31,
  2010;


•
            Other
      restrictions are imposed on liens, indebtedness, investments, restricted
      payments and note repurchases;


•
            Mandatory
      prepayments are increased from 50% to 75% of excess cash flow as defined
      in the senior secured credit
facilities;


•
            Financial
      covenants are modified to increase the total leverage ratio, to eliminate
      the interest coverage ratio, to add a senior secured leverage ratio, and
      to add a fixed charge coverage ratio, all as defined in the senior secured
      credit facilities and the First Amendment to the senior secured credit
      facilities.


20


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





In
February 2008, Appleton fixed the interest rate, at 5.45%, on $75.0 million of
its variable rate notes with a five-year interest rate swap contract. Also
during first quarter 2008, Appleton fixed the interest rate, at 5.4%, on an
additional $75.0 million of its variable rate notes with a five-year interest
rate swap contract. As discussed below, one of the swap contracts was terminated
in February 2009. The covenant violation at January 3, 2009 and subsequent
waiver and amendment, in March 2009, to the senior secured credit
facilities, changed the basis of the forecasted transactions for the two
interest rate swap contracts that were placed in 2008. As amended, the senior
secured credit facilities contain interest payments based on LIBOR with a 2%
floor, whereas the forecasted transactions assumed interest payments based on
LIBOR. As a result, Appleton concluded it was remote that the original
forecasted transactions would occur as originally documented and reclassified as
a charge against 2008 earnings, within interest expense, $9.4 million of swap
losses originally classified in other comprehensive loss. The events of default
also triggered an event of default pursuant to a cross-default provision under
one of the interest rate swap contracts. As a result of the cross-default, the
counterparty elected to terminate the swap contract. In February 2009, Appleton
and the counterparty resolved Appleton’s obligation under the swap contract with
an agreement to pay $4.7 million over the nine-month period ending October 2009.
During the first half of 2009, Appleton paid $2.9 million in accordance with the
termination agreement thereby reducing its liability to $1.8 million as of
July 5, 2009. The remaining swap contract is expected to remain in place
and future fluctuations in market value will be reflected as adjustments to
interest expense. As of July 5, 2009, the remaining swap contract was
recorded as a long-term liability of $3.8 million based on a fair value
measurement using Level 2 inputs as described in SFAS 157, "Fair Value
Measurements." The fair value of the interest rate swap derivative is primarily
based on models that utilize the appropriate market-based forward swap curves
and zero-coupon interest rates to determine the discounted cash flows. In
comparison to the fair value reported at fiscal year-end 2008, the current fair
value of this long-term liability is $0.9 million lower, with this change
recorded in interest expense on the Condensed Consolidated Statement of
Operations for the six months ended July 5, 2009.





The
senior secured credit facilities, as amended, senior secured term note payable,
as amended, senior notes and senior subordinated notes contain affirmative and
negative covenants. In general, the covenants contained in the senior credit
facilities, as amended, are more restrictive than those of the senior notes and
senior subordinated notes. Among other restrictions, the covenants contained in
the senior credit facilities, as amended, and senior secured term note payable,
as amended, require Appleton to meet specified financial tests, including
leverage and fixed charge coverage ratios, which become more restrictive over
the term of the debt.




The
senior secured credit facilities, as amended, senior secured term note payable,
as amended, senior notes and senior subordinated notes also contain covenants
which, among other things, restrict Appleton’s ability and the ability of
Appleton’s other guarantors of the senior secured credit facilities, as amended,
senior secured term note payable, as amended, senior notes and senior
subordinated notes to incur liens; engage in transactions with affiliates; incur
or guarantee additional indebtedness; declare dividends or redeem or repurchase
capital stock; make loans and investments; engage in mergers, acquisitions,
consolidations and asset sales; acquire assets, stock or debt securities of any
person; terminate the subchapter S corporation status of PDC or the qualified
subchapter S subsidiary status of its subsidiaries eligible to elect such
status; amend its debt instruments; amend or terminate the ESOP; amend other
agreements related to the transaction with AWA; repay other indebtedness; use
assets as security in other transactions; enter into sale and leaseback
transactions; sell equity interests in the Company’s subsidiaries; and engage in
new lines of business.





The
senior secured credit facilities, as amended, contain a provision that defines
an event of default to include defaults or events of default under other
indebtedness as defined in the senior secured credit facilities. The senior
secured term note payable, as amended, contains a provision which defines an
event of default to include defaults or events of default under the senior
secured credit facilities, as amended, the senior notes and the senior
subordinated notes.





The
senior secured credit facilities, as amended, are unconditionally guaranteed by
PDC and by substantially all of Appleton’s subsidiaries, other than two small
foreign subsidiaries. In addition, they are secured by liens on substantially
all of Appleton’s, the subsidiary guarantors’ and certain of Appleton’s other
subsidiaries’ assets and by a pledge of Appleton’s and its subsidiaries’ capital
stock. The senior secured term note payable, as amended, is unconditionally
guaranteed by PDC and by substantially all of Appleton’s subsidiaries, other
than certain immaterial subsidiaries. In addition, it is secured by a lien on
specified manufacturing equipment located in Appleton’s paper mill in West
Carrollton, Ohio. The senior notes and senior subordinated notes are
unconditionally guaranteed by PDC, C&H Packaging Company, Inc., American
Plastics Company, Inc., Rose Holdings Limited, HBGI Holdings Limited and New
England Extrusion Inc.


21


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





As of
July 5, 2009, Appleton was in compliance with its various amended covenants
as disclosed in the 2008 Form 10-K. Based on Appleton’s forecasted operating
results and related debt reductions, Appleton has projected compliance with all
covenants for the next twelve-month period. Appleton’s ability to comply with
the financial covenants in the future depends on further debt reduction and
achieving forecasted operating results, which have become more difficult to
project in the current economic environment. Given the uncertain global economic
conditions,  continued constraints in the credit markets and other market
uncertainties, there are various scenarios, including a reduction from
forecasted operating results, under which Appleton could violate its financial
covenants during 2009 and 2010. Appleton’s failure to comply with such
covenants or an assessment that it is likely to fail to comply with such
covenants, could also lead Appleton to seek amendments to or waivers of the
financial covenants contained in the senior secured credit facilities and senior
secured term note payable. Appleton cannot provide assurance that it would
be able to obtain any amendments to or waivers of the covenants contained in the
senior secured credit facilities and senior secured term note payable. Any
such amendment to or waiver of the covenants would likely involve upfront fees,
higher annual interest costs and other terms less favorable to the Company than
those currently in the senior secured credit facilities and senior secured term
note payable. In the event the lenders will not amend or waive the
covenants, the debt would be due and Appleton would need to seek alternative
financing. Appleton cannot provide assurance that it would be able to
obtain alternative financing. If Appleton were not able to secure
alternative financing, this would have a material adverse impact on the
Company.





17.      FAIR
VALUE OF FINANCIAL INSTRUMENTS





The
carrying amount (including current portions) and estimated fair value of certain
of the Company’s recorded financial instruments are as follows (dollars in
thousands):





July 5, 2009
                
                
                January 3, 2009Carrying
                
                
                Fair
                
                
                Carrying
                
                
                FairFinancial
      Instruments
                
                Amount
                
                
                Value
                
                
                Amount
                
                
                ValueSenior
      subordinated notes payable
                
                $
                142,500
                
                
                $
                48,450
                
                
                $
                150,000
                
                
                $
                80,250Senior
      notes payable
                
                
                109,450
                
                
                
                74,289
                
                
                
                109,450
                
                
                
                75,521Senior
      credit facility
                
                
                220,500
                
                
                
                155,453
                
                
                
                221,625
                
                
                
                162,894Senior
      secured debt
                
                
                20,689
                
                
                
                20,689
                
                
                
                21,814
                
                
                
                21,814Revolving
      credit facility
                111,734
                111,734
                83,734
                83,734State
      of Ohio loans
                11,380
                10,349
                8,780
                7,978Industrial
      development bonds
                
                
                8,650
                
                
                
                8,650
                
                
                
                8,650
                
                
                
                8,650$
                624,903
                
                
                $
                429,614
                
                
                $
                604,053
                
                
                $
                440,841Interest
      rate swap derivatives
                
                $
                3,835
                
                
                $
                3,835
                
                
                $
                9,446
                
                
                $
                9,446





The
senior subordinated notes payable and the senior notes payable are traded in
public markets and, therefore, the fair value was determined based on quoted
market prices. The senior credit facility is traded in interbank markets and,
therefore, the fair value was determined based on quoted market prices. The
senior secured debt is not traded in public markets, but was recently repriced
during an amendment negotiated during March 2009. At July 5, 2009, it was
determiend that the proceeds represented current market conditions due to the
currency of the recent amendment and based on discussions with market makers for
similar debt instruments. The fair value of the State of Ohio assistance loan
was determined based on current rates for similar financial instruments of the
same remaining maturity and similar terms. The industrial development bonds have
a variable interest rate that reflects current market terms and conditions. The
fair value of interest rate swap derivatives is primarily based on models that
utilize the appropriate market-based forward swap curves and zero-coupon
interest rates to determine the discounted cash flows that result in a
measurement that is classified as Level 2 under SFAS 157.





18.      SEGMENT
INFORMATION





The
Company’s four reportable segments are as follows: coated solutions, thermal
papers, security papers and performance packaging. Management evaluates the
performance of the segments based primarily on operating income. Items excluded
from the determination of segment operating income are unallocated corporate
charges, business development costs not associated with specific segments,
interest income, interest expense, debt extinguishment income and expense,
foreign currency gains and losses, the nonrecurring litigation settlement
and other income.








22


PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





The
Company does not allocate total assets internally in assessing operating
performance and does not track capital expenditures by segment. Net sales,
operating income and depreciation and amortization, as determined by the Company
for its reportable segments, are as follows (dollars in thousands):


For
      the Three
                
                
                For
      the Three
                
                
                For
      the Six
                
                
                For
      the SixMonths
      Ended
                
                
                Months
      Ended
                
                
                Months
      Ended
                
                
                Months
      EndedJuly 5,
      2009
                
                
                June 29,
      2008
                
                
                July 5,
      2009
                
                
                June 29,
      2008Net
      salesTechnical
      PapersCoated
      solutions
                
                $
                110,339
                
                
                $
                143,072
                
                
                $
                223,642
                
                
                $
                280,992Thermal
      papers
                
                
                70,455
                
                
                
                70,756
                
                
                
                135,485
                
                
                
                133,784Security
      papers
                
                
                8,682
                
                
                
                9,004
                
                
                
                18,955
                
                
                
                17,668189,476
                
                
                
                222,832
                
                
                
                378,082
                
                
                
                432,444Performance
      packaging
                
                
                23,935
                
                
                
                27,281
                
                
                
                47,879
                
                
                
                54,281Total
                
                $
                213,411
                
                
                $
                250,113
                
                
                $
                425,961
                
                
                $
                486,725Operating
      income (loss)Technical
      PapersCoated
      solutions
                
                $
                18,774
                
                
                $
                9,642
                
                
                $
                29,633
                
                
                $
                19,018Thermal
      papers
                
                
                (2,227
                )
                
                
                1,403
                
                
                
                (5,743
                )
                
                
                3,732Security
      papers
                
                
                2,785
                
                
                
                1,004
                
                
                
                4,402
                
                
                
                1,77219,332
                
                
                
                12,049
                
                
                
                28,292
                
                
                
                24,522Performance
      packaging
                
                
                840
                
                
                
                1,758
                
                
                
                1,184
                
                
                
                3,221Unallocated
      corporate charges and business development costs
                
                
                (1,882
                )
                
                
                (3,369
                )
                
                
                (3,763
                )
                
                
                (7,001
                )Total
                
                $
                18,290
                
                
                $
                10,438
                
                
                $
                25,713
                
                
                $
                20,742Depreciation
      and amortizationTechnical
      PapersCoated
      solutions
                
                $
                8,027
                
                
                $
                9,227
                
                
                $
                16,126
                
                
                $
                18,342Thermal
      papers
                
                
                5,117
                
                
                
                3,079
                
                
                
                10,004
                
                
                
                6,295Security
      papers
                
                
                695
                
                
                
                761
                
                
                
                1,390
                
                
                
                1,52213,839
                
                
                
                13,067
                
                
                
                27,520
                
                
                
                26,159Performance
      packaging
                
                
                1,574
                
                
                
                1,687
                
                
                
                3,176
                
                
                
                3,374Unallocated
      corporate charges
                
                
                106
                
                
                
                17
                
                
                
                212
                
                
                
                33Total
                
                $
                15,519
                
                
                $
                14,771
                
                
                $
                30,908
                
                
                $
                29,566




No
restructuring expense was recorded during the three- and six-month periods ended
July 5, 2009 and June 29, 2008.











23





PAPERWEIGHT
DEVELOPMENT CORP. AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





(unaudited)





19.      ALTERNATIVE
FUELS TAX CREDIT





The U.S.
Internal Revenue Code provides a tax credit for companies that use alternative
fuel mixtures to produce energy to operate their businesses. The credit, equal
to $0.50 per gallon of alternative fuel contained in the mixture, is refundable
to the taxpayer. In February 2009, Appleton began mixing black liquor with
diesel fuel and using the mixture at its mill in Roaring Spring, Pennsylvania.
The Company applied to the Internal Revenue Service to be registered as an
alternative fuel mixer and received its registration in May 2009. As of
July 5, 2009, Appleton filed for excise tax refunds totaling $7.6 million
and accrued $0.4 million for eligible alternative fuel usage through
July 5, 2009 to be included in subsequent filings. This $8.0 million is
recorded in other current assets in the accompanying Condensed Consolidated
Balance Sheet. Accordingly, the Condensed Consolidated Statement of Operations
for the three and six months ended July 5, 2009 includes the $8.0
million tax credit as a reduction to cost of sales. Expenses related to
this excise tax refund total $0.1 million for the first six months of 2009. As
of August 7, 2009, $7.1 million has been received in cash from the Internal
Revenue Service.





20.      GUARANTOR
FINANCIAL INFORMATION





Appleton
(the “Issuer”) has issued senior notes and senior subordinated notes (the
“Notes”) which have been guaranteed by PDC (the “Parent Guarantor”), C&H
Packaging Company, Inc., American Plastics Company, Inc., Rose Holdings Limited,
HBGI Holdings Limited and New England Extrusion Inc., each of which is a
wholly-owned subsidiary of Appleton (the “Subsidiary Guarantors”). These
guarantees are full, unconditional and joint and several. Bemrose Group Limited,
The Henry Booth Group Limited, BemroseBooth Limited and Bemrose Security &
Promotional Printing Limited were Subsidiary Guarantors that were classified as
discontinued operations during 2008 and disposed of in third quarter 2008 as
discussed in Note 2 to the Condensed Consolidated Financial Statements. As of
July 5, 2009, C&H is classified as held for sale.





Presented
below is condensed consolidating financial information for the Parent Guarantor,
the Issuer, the Subsidiary Guarantors and a wholly-owned non-guarantor
subsidiary (the “Non-Guarantor Subsidiary”) as of July 5, 2009 and
January 3, 2009, and for the three and six months ended July 5,
2009 and June 29, 2008. This financial information should be read in conjunction
with the condensed consolidated financial statements and other notes related
thereto.





Separate
financial statements for the Parent and Subsidiary Guarantors are not presented
based on management’s determination that they would not provide additional
information that is material to readers of these financial
statements.





The
senior secured credit facilities, as amended, the senior secured term note
payable, as amended, the senior notes and the senior subordinated notes place
restrictions on the subsidiaries of the Issuer that would limit dividend
distributions by these subsidiaries.


24





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL
      STATEMENTS - (Continued)CONDENSED
      CONSOLIDATING BALANCE SHEETJULY
      5, 2009(unaudited)(dollars
      in thousands)Parent
                                  Guarantor
                                
                                
                                Issuer
                                
                                
                                Subsidiary
                                  Guarantors
                                
                                
                                Non-Guarantor
                                  Subsidiary
                                
                                
                                Eliminations
                                
                                
                                ConsolidatedASSETSCurrent
      assetsCash and cash equivalents
                                
                                $
                                -
                                
                                
                                $
                                1,571
                                
                                
                                $
                                1
                                
                                
                                $
                                1,517
                                
                                
                                $
                                -
                                
                                
                                $
                                3,089Accounts receivable, net
                                
                                
                                -
                                
                                
                                
                                91,023
                                
                                
                                
                                9,053
                                
                                
                                
                                5,162
                                
                                
                                
                                -
                                
                                
                                
                                105,238Inventories
                                
                                
                                -
                                
                                
                                
                                106,312
                                
                                
                                
                                7.980
                                
                                
                                
                                2,125
                                
                                
                                
                                -
                                
                                
                                
                                116,417Other current assets
                                
                                
                                37,700
                                
                                
                                
                                20,474
                                
                                
                                
                                1,883
                                
                                
                                
                                239
                                
                                
                                
                                -
                                
                                
                                
                                60,296Assets held for sale
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                9,049
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                9,049Total
      current assets
                                
                                
                                37,700
                                
                                
                                
                                219,380
                                
                                
                                
                                27,966
                                
                                
                                
                                9,043
                                
                                
                                
                                -
                                
                                
                                
                                294,089Property, plant and equipment, net
                                
                                
                                -
                                
                                
                                
                                401,187
                                
                                
                                
                                20,982
                                
                                
                                
                                11
                                
                                
                                
                                -
                                
                                
                                
                                422,180Investment in subsidiaries
                                
                                
                                160,841
                                
                                
                                
                                126,123
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                (286,964
                                )
                                
                                
                                -Other assets
                                
                                
                                50,044
                                
                                
                                
                                66,909
                                
                                
                                
                                27,713
                                
                                
                                
                                43
                                
                                
                                
                                -
                                
                                
                                
                                144,709Assets held for sale
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                8,762
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                8,762Total assets
                                
                                $
                                248,585
                                
                                
                                $
                                813,599
                                
                                
                                $
                                85,423
                                
                                
                                $
                                9,097
                                
                                
                                $
                                (286,964
                                )
                                
                                $
                                869,740LIABILITIES,
      REDEEMABLE COMMON STOCK, ACCUMULATED DEFICIT AND ACCUMULATED OTHER
      COMPREHENSIVE LOSSCurrent
      liabilitiesCurrent portion of long-term debt
                                
                                $
                                -
                                
                                
                                $
                                5,866
                                
                                
                                $
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                5,866Accounts payable
                                
                                
                                -
                                
                                
                                
                                50,152
                                
                                
                                
                                1,055
                                
                                
                                
                                122
                                
                                
                                
                                -
                                
                                
                                
                                51,329Due to (from) parent and affiliated companies
                                
                                
                                355,964
                                
                                
                                
                                (319,097
                                )
                                
                                
                                (33,802
                                )
                                
                                
                                (3,065
                                )
                                
                                
                                -
                                
                                
                                
                                -Other accrued liabilities
                                
                                
                                -
                                
                                
                                
                                80,152
                                
                                
                                
                                995
                                
                                
                                
                                1,230
                                
                                
                                
                                -
                                
                                
                                
                                82,377Liabilities held for sale
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1,862
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1,862Total current liabilities
                                
                                
                                355,964
                                
                                
                                
                                (182,927
                                )
                                
                                
                                (29,890
                                )
                                
                                
                                (1,713
                                )
                                
                                
                                -
                                
                                
                                
                                141,434Long-term
      debt
                                
                                
                                -
                                
                                
                                
                                619,037
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                619,037Other
      long-term liabilities
                                
                                
                                -
                                
                                
                                
                                216,648
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                216,648Redeemable
      common stock, accumulated deficit and accumulated other comprehensive
      loss
                                
                                
                                (107,379
                                )
                                
                                
                                160,841
                                
                                
                                
                                115,313
                                
                                
                                
                                10,810
                                
                                
                                
                                (286,964
                                )
                                
                                
                                (107,379
                                )Total
      liabilities, redeemable common stock, accumulated deficit and accumulated
      other comprehensive loss
                                
                                $
                                248,585
                                
                                
                                $
                                813,599
                                
                                
                                $
                                85,423
                                
                                
                                $
                                9,097
                                
                                
                                $
                                (286,964
                                )
                                
                                $
                                869,740








25





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
    (Continued)CONDENSED CONSOLIDATING BALANCE
      SHEETJANUARY 3, 2009(dollars
      in thousands)Parent
                                Guarantor
                              
                              
                              Issuer
                              
                              
                              Subsidiary
                                Guarantors
                              
                              
                              Non-Guarantor
                                Subsidiary
                              
                              
                              Eliminations
                              
                              
                              ConsolidatedASSETSCurrent
      assetsCash and cash equivalents
                              
                              $
                              -
                              
                              
                              $
                              2,111
                              
                              
                              $
                              65
                              
                              
                              $
                              2,004
                              
                              
                              $
                              -
                              
                              
                              $
                              4,180Accounts receivable, net
                              
                              
                              -
                              
                              
                              
                              73,738
                              
                              
                              
                              9,057
                              
                              
                              
                              5,423
                              
                              
                              
                              -
                              
                              
                              
                              88,218Inventories
                              
                              
                              -
                              
                              
                              
                              113,406
                              
                              
                              
                              9,461
                              
                              
                              
                              1,989
                              
                              
                              
                              -
                              
                              
                              
                              124,856Other current assets
                              
                              
                              37,700
                              
                              
                              
                              6,343
                              
                              
                              
                              1,674
                              
                              
                              
                              203
                              
                              
                              
                              -
                              
                              
                              
                              45,920Assets held for sale
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              9,327
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              9,327Total
      current assets
                              
                              
                              37,700
                              
                              
                              
                              195,598
                              
                              
                              
                              29,584
                              
                              
                              
                              9,619
                              
                              
                              
                              -
                              
                              
                              
                              272,501Property, plant and equipment, net
                              
                              
                              -
                              
                              
                              
                              416,630
                              
                              
                              
                              22,658
                              
                              
                              
                              13
                              
                              
                              
                              -
                              
                              
                              
                              439,301Investment in subsidiaries
                              
                              
                              146,562
                              
                              
                              
                              124,971
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (271,533
                              )
                              
                              
                              -Other assets
                              
                              
                              114,312
                              
                              
                              
                              66,964
                              
                              
                              
                              27,547
                              
                              
                              
                              41
                              
                              
                              
                              -
                              
                              
                              
                              208,864Assets held for sale
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              9,255
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              9,255Total assets
                              
                              $
                              298,574
                              
                              
                              $
                              804,163
                              
                              
                              $
                              89,044
                              
                              
                              $
                              9,673
                              
                              
                              $
                              (271,533
                              )
                              
                              $
                              929,921LIABILITIES,
      REDEEMABLE COMMON STOCK, ACCUMULATED DEFICIT AND ACCUMULATED OTHER
      COMPREHENSIVE LOSSCurrent
      liabilitiesCurrent portion of long-term debt
                              
                              $
                              -
                              
                              
                              $
                              5,455
                              
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              5,455Accounts payable
                              
                              
                              -
                              
                              
                              
                              60,573
                              
                              
                              
                              395
                              
                              
                              
                              125
                              
                              
                              
                              -
                              
                              
                              
                              61,093Due to (from) parent and affiliated companies
                              
                              
                              405,519
                              
                              
                              
                              (373,446
                              )
                              
                              
                              (28,861
                              )
                              
                              
                              (3,212
                              )
                              
                              
                              -
                              
                              
                              
                              -Other accrued liabilities
                              
                              
                              -
                              
                              
                              
                              83,916
                              
                              
                              
                              1,221
                              
                              
                              
                              1,993
                              
                              
                              
                              -
                              
                              
                              
                              87,130Liabilities held for sale
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2,085
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2,085Total current liabilities
                              
                              
                              405,519
                              
                              
                              
                              (223,502
                              )
                              
                              
                              (25,160
                              )
                              
                              
                              (1,094
                              )
                              
                              
                              -
                              
                              
                              
                              155,763Long-term
      debt
                              
                              
                              -
                              
                              
                              
                              598,598
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              598,598Other
      long-term liabilities
                              
                              
                              -
                              
                              
                              
                              282,505
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              282,505Redeemable
      common stock, accumulated deficit and accumulated other comprehensive
      loss
                              
                              
                              (106,945
                              )
                              
                              
                              146,562
                              
                              
                              
                              114,204
                              
                              
                              
                              10,767
                              
                              
                              
                              (271,533
                              )
                              
                              
                              (106,945
                              )Total
      liabilities, redeemable common stock, accumulated deficit and accumulated
      other comprehensive loss
                              
                              $
                              298,574
                              
                              
                              $
                              804,163
                              
                              
                              $
                              89,044
                              
                              
                              $
                              9,673
                              
                              
                              $
                              (271,533
                              )
                              
                              $
                              929,921








26





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
    (Continued)CONDENSED
      CONSOLIDATING STATEMENT OF OPERATIONSFOR
      THE SIX MONTHS ENDED JULY 5, 2009(unaudited)(dollars
      in thousands)Parent
              
              
              
              
              
              Subsidiary
              
              
              Non-GuarantorGuarantor
              
              
              Issuer
              
              
              Guarantors
              
              
              Subsidiary
              
              
              Eliminations
              
              
              ConsolidatedNet
      sales
              
              $
              -
              
              
              $
              378,041
              
              
              $
              47,879
              
              
              $
              22,000
              
              
              $
              (21,959
              )
              
              $
              425,961Cost
      of sales
              
              
              -
              
              
              
              293,817
              
              
              
              40,273
              
              
              
              21,962
              
              
              
              (22,052
              )
              
              
              334,000Gross
      profit
              
              
              -
              
              
              
              84,224
              
              
              
              7,606
              
              
              
              38
              
              
              
              93
              
              
              
              91,961Selling,
      general and administrative expenses
              
              
              -
              
              
              
              59,032
              
              
              
              6,477
              
              
              
              739
              
              
              
              -
              
              
              
              66,248Operating
      income (loss)
              
              
              -
              
              
              
              25,192
              
              
              
              1,129
              
              
              
              (701
              )
              
              
              93
              
              
              
              25,713Interest
      expense
              
              
              6,184
              
              
              
              24,222
              
              
              
              17
              
              
              
              -
              
              
              
              (6,201
              )
              
              
              24,222Debt
      extinguishment income, net
              
              
              -
              
              
              
              (5,380
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (5,380
              )Interest
      income
              
              
              -
              
              
              
              (6,220
              )
              
              
              (17
              )
              
              
              (1
              )
              
              
              6,201
              
              
              
              (37
              )Income
      in equity investments
              
              
              (14,591
              )
              
              
              (1,322
              )
              
              
              -
              
              
              
              -
              
              
              
              15,913
              
              
              
              -Other
      income
              
              
              -
              
              
              
              (859
              )
              
              
              -
              
              
              
              (485
              )
              
              
              (78
              )
              
              
              (1,422
              )Income
      (loss) before income taxes
              
              
              8,407
              
              
              
              14,751
              
              
              
              1,129
              
              
              
              (215
              )
              
              
              (15,742
              )
              
              
              8,330Provision
      (benefit) for income taxes
              
              
              -
              
              
              
              160
              
              
              
              21
              
              
              
              (258
              )
              
              
              -
              
              
              
              (77
              )Net
      income
              
              $
              8,407
              
              
              $
              14,591
              
              
              $
              1,108
              
              
              $
              43
              
              
              $
              (15,742
              )
              
              $
              8,407








27





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
    (Continued)CONDENSED
      CONSOLIDATING STATEMENT OF OPERATIONSFOR
      THE SIX MONTHS ENDED JUNE 29, 2008(unaudited)(dollars
      in thousands)Parent
                
                
                
                
                
                Subsidiary
                
                
                Non-GuarantorGuarantor
                
                
                Issuer
                
                
                Guarantors
                
                
                Subsidiary
                
                
                Eliminations
                
                
                ConsolidatedNet
      sales
                
                $
                -
                
                
                $
                434,070
                
                
                $
                54,229
                
                
                $
                29,850
                
                
                $
                (31,424
                )
                
                $
                486,725Cost
      of sales
                
                
                -
                
                
                
                339,473
                
                
                
                43,748
                
                
                
                29,437
                
                
                
                (31,809
                )
                
                
                380,849Gross
      profit
                
                
                -
                
                
                
                94,597
                
                
                
                10,481
                
                
                
                413
                
                
                
                385
                
                
                
                105,876Selling,
      general and administrative expenses
                
                
                -
                
                
                
                76,636
                
                
                
                7,477
                
                
                
                1,021
                
                
                
                -
                
                
                
                85,134Operating
      income (loss)
                
                
                -
                
                
                
                17,961
                
                
                
                3,004
                
                
                
                (608
                )
                
                
                385
                
                
                
                20,742Interest
      expense
                
                
                5,829
                
                
                
                21,286
                
                
                
                -
                
                
                
                -
                
                
                
                (5,829
                )
                
                
                21,286Interest
      income
                
                
                -
                
                
                
                (8,287
                )
                
                
                -
                
                
                
                (33
                )
                
                
                8,083
                
                
                
                (237
                )Loss
      in equity investments
                
                
                15,447
                
                
                
                41,660
                
                
                
                -
                
                
                
                -
                
                
                
                (57,107
                )
                
                
                -Litigation
      settlement, net
                
                
                -
                
                
                
                (22,274
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (22,274
                )Other
      (income) expense
                
                
                -
                
                
                
                (133
                )
                
                
                -
                
                
                
                289
                
                
                
                70
                
                
                
                226(Loss)
      income from continuing operations before income
taxes
                
                
                (21,276
                )
                
                
                (14,291
                )
                
                
                3,004
                
                
                
                (864
                )
                
                
                55,168
                
                
                
                21,741Provision
      for income taxes
                
                
                -
                
                
                
                63
                
                
                
                29
                
                
                
                -
                
                
                
                -
                
                
                
                92(Loss)
      income from continuing operations
                
                
                (21,276
                )
                
                
                (14,354
                )
                
                
                2,975
                
                
                
                (864
                )
                
                
                55,168
                
                
                
                21,649Loss
      from discontinued operations, net of income taxes
                
                
                -
                
                
                
                (1,093
                )
                
                
                (44,086
                )
                
                
                -
                
                
                
                2,254
                
                
                
                (42,925
                )Net
      loss
                
                $
                (21,276
                )
                
                $
                (15,447
                )
                
                $
                (41,111
                )
                
                $
                (864
                )
                
                $
                57,422
                
                
                $
                (21,276
                )








28





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
    (Continued)CONDENSED
      CONSOLIDATING STATEMENT OF OPERATIONSFOR
      THE THREE MONTHS ENDED JULY 5, 2009(unaudited)(dollars
      in thousands)Parent
                        
                        
                        
                        
                        
                        Subsidiary
                        
                        
                        Non-GuarantorGuarantor
                        
                        
                        Issuer
                        
                        
                        Guarantors
                        
                        
                        Subsidiary
                        
                        
                        Eliminations
                        
                        
                        ConsolidatedNet
      sales
                        
                        $
                        -
                        
                        
                        $
                        189,060
                        
                        
                        $
                        23,935
                        
                        
                        $
                        10,368
                        
                        
                        $
                        (9,952
                        )
                        
                        $
                        213,411Cost
      of sales
                        
                        
                        -
                        
                        
                        
                        143,168
                        
                        
                        
                        20,004
                        
                        
                        
                        10,436
                        
                        
                        
                        (10,417
                        )
                        
                        
                        163,191Gross
      profit (loss)
                        
                        
                        -
                        
                        
                        
                        45,892
                        
                        
                        
                        3,931
                        
                        
                        
                        (68
                        )
                        
                        
                        465
                        
                        
                        
                        50,220Selling,
      general and administrative expenses
                        
                        
                        -
                        
                        
                        
                        28,405
                        
                        
                        
                        3,150
                        
                        
                        
                        375
                        
                        
                        
                        -
                        
                        
                        
                        31,930Operating
      income (loss)
                        
                        
                        -
                        
                        
                        
                        17,487
                        
                        
                        
                        781
                        
                        
                        
                        (443
                        )
                        
                        
                        465
                        
                        
                        
                        18,290Interest
      expense
                        
                        
                        3,085
                        
                        
                        
                        12,830
                        
                        
                        
                        17
                        
                        
                        
                        -
                        
                        
                        
                        (3,102
                        )
                        
                        
                        12,830Interest
      income
                        
                        
                        -
                        
                        
                        
                        (3,106
                        )
                        
                        
                        (17
                        )
                        
                        
                        -
                        
                        
                        
                        3,102
                        
                        
                        
                        (21
                        )Income
      in equity investments
                        
                        
                        (10,329
                        )
                        
                        
                        (1,572
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        11,901
                        
                        
                        
                        -Other
      income
                        
                        
                        -
                        
                        
                        
                        (1,087
                        )
                        
                        
                        -
                        
                        
                        
                        (696
                        )
                        
                        
                        82
                        
                        
                        
                        (1,701
                        )Income
      before income taxes
                        
                        
                        7,244
                        
                        
                        
                        10,422
                        
                        
                        
                        781
                        
                        
                        
                        253
                        
                        
                        
                        (11,518
                        )
                        
                        
                        7,182Provision
      (benefit) for income taxes
                        
                        
                        -
                        
                        
                        
                        93
                        
                        
                        
                        10
                        
                        
                        
                        (165
                        )
                        
                        
                        -
                        
                        
                        
                        (62
                        )Net
      income
                        
                        $
                        7,244
                        
                        
                        $
                        10,329
                        
                        
                        $
                        771
                        
                        
                        $
                        418
                        
                        
                        $
                        (11,518
                        )
                        
                        $
                        7,244








29





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
    (Continued)CONDENSED
      CONSOLIDATING STATEMENT OF OPERATIONSFOR
      THE THREE MONTHS ENDED JUNE 29, 2008(unaudited)(dollars
      in thousands)Parent
                
                
                
                
                
                Subsidiary
                
                
                Non-GuarantorGuarantor
                
                
                Issuer
                
                
                Guarantors
                
                
                Subsidiary
                
                
                Eliminations
                
                
                ConsolidatedNet
      sales
                
                $
                -
                
                
                $
                223,432
                
                
                $
                27,224
                
                
                $
                14,819
                
                
                $
                (15,362
                )
                
                $
                250,113Cost
      of sales
                
                
                -
                
                
                
                178,670
                
                
                
                21,868
                
                
                
                13,912
                
                
                
                (15,291
                )
                
                
                199,159Gross
      profit
                
                
                -
                
                
                
                44,762
                
                
                
                5,356
                
                
                
                907
                
                
                
                (71
                )
                
                
                50,954Selling,
      general and administrative expenses
                
                
                -
                
                
                
                36,239
                
                
                
                3,829
                
                
                
                448
                
                
                
                -
                
                
                
                40,516Operating
      income
                
                
                -
                
                
                
                8,523
                
                
                
                1,527
                
                
                
                459
                
                
                
                (71
                )
                
                
                10,438Interest
      expense
                
                
                2,976
                
                
                
                10,212
                
                
                
                -
                
                
                
                -
                
                
                
                (2,976
                )
                
                
                10,212Interest
      income
                
                
                -
                
                
                
                (4,142
                )
                
                
                -
                
                
                
                (13
                )
                
                
                4,099
                
                
                
                (56
                )Loss
      in equity investments
                
                
                39,700
                
                
                
                41,654
                
                
                
                -
                
                
                
                -
                
                
                
                (81,354
                )
                
                
                -Litigation
      settlement, net
                
                
                -
                
                
                
                (41
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (41
                )Other
      expense (income)
                
                
                -
                
                
                
                120
                
                
                
                -
                
                
                
                (23
                )
                
                
                (103
                )
                
                
                (6
                )(Loss)
      income from continuing operations before income
taxes
                
                
                (42,676
                )
                
                
                (39,280
                )
                
                
                1,527
                
                
                
                495
                
                
                
                80,263
                
                
                
                329Provision
      for income taxes
                
                
                -
                
                
                
                43
                
                
                
                12
                
                
                
                -
                
                
                
                -
                
                
                
                55(Loss)
      income from continuing operations
                
                
                (42,676
                )
                
                
                (39,323
                )
                
                
                1,515
                
                
                
                495
                
                
                
                80,263
                
                
                
                274Loss
      from discontinued operations, net of income taxes
                
                
                -
                
                
                
                (377
                )
                
                
                (43,696
                )
                
                
                -
                
                
                
                1,123
                
                
                
                (42,950
                )Net
      (loss) income
                
                $
                (42,676
                )
                
                $
                (39,700
                )
                
                $
                (42,181
                )
                
                $
                495
                
                
                $
                81,386
                
                
                $
                (42,676
                )











30





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
    (Continued)CONDENSED
      CONSOLIDATING STATEMENT OF CASH FLOWSFOR
      THE SIX MONTHS ENDED JULY 5, 2009(unaudited)(dollars
      in thousands)Parent
                
                
                
                
                
                Subsidiary
                
                
                Non-GuarantorGuarantor
                
                
                Issuer
                
                
                Guarantors
                
                
                Subsidiary
                
                
                Eliminations
                
                
                ConsolidatedCash
      flows from operating activities:Net
      income
                
                $
                8,407
                
                
                $
                14,591
                
                
                $
                1,108
                
                
                $
                43
                
                
                $
                (15,742
                )
                
                $
                8,407Adjustments
      to reconcile net income to net cash provided (used) by operating
      activities:Depreciation
      and amortization
                
                
                -
                
                
                
                27,806
                
                
                
                3,099
                
                
                
                3
                
                
                
                -
                
                
                
                30,908Other
                
                
                -
                
                
                
                (1,908
                )
                
                
                -
                
                
                
                (485
                )
                
                
                -
                
                
                
                (2,393
                )Change
      in assets and liabilities, net
                
                
                51,623
                
                
                
                (92,384
                )
                
                
                928
                
                
                
                (195
                )
                
                
                15,742
                
                
                
                (24,286
                )Net
      cash provided (used) by operating activities
                
                
                60,030
                
                
                
                (51,895
                )
                
                
                5,135
                
                
                
                (634
                )
                
                
                -
                
                
                
                12,636Cash
      flows from investing activities:Proceeds
      from sale of equipment
                
                
                -
                
                
                
                27
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                27Additions
      to property, plant and equipment
                
                
                -
                
                
                
                (11,266
                )
                
                
                (258
                )
                
                
                -
                
                
                
                -
                
                
                
                (11,524
                )Net
      cash used by investing activities
                
                
                -
                
                
                
                (11,239
                )
                
                
                (258
                )
                
                
                -
                
                
                
                -
                
                
                
                (11,497
                )Cash
      flows from financing activities:Payments
      of senior secured notes payable
                
                
                -
                
                
                
                (1,125
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,125
                )Payments
      of senior notes payable
                
                
                -
                
                
                
                (1,687
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,687
                )Debt
      acquisition costs
                
                
                -
                
                
                
                (3,124
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (3,124
                )Payments
      relating to capital lease obligation
                
                
                -
                
                
                
                (366
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (366
                )Proceeds
      from revolving line of credit
                
                
                -
                
                
                
                119,450
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                119,450Payments
      of revolving line of credit
                
                
                -
                
                
                
                (91,450
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (91,450
                )Proceeds
      from State of Ohio loan
                
                
                -
                
                
                
                3,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,000Payments
      of State of Ohio loan
                
                
                -
                
                
                
                (400
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (400
                )Payments
      of secured financing
                
                
                -
                
                
                
                (1,125
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,125
                )Due
      to parent and affiliated companies, net
                
                
                (49,555
                )
                
                
                54,349
                
                
                
                (4,941
                )
                
                
                147
                
                
                
                -
                
                
                
                -Proceeds
      from issuance of redeemable common stock
                
                
                2,075
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                
                
                
                
                2,075Payments
      to redeem common stock
                
                
                (12,550
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (12,550
                )Decrease
      in cash overdraft
                
                
                -
                
                
                
                (14,928
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (14,928
                )-Net
      cash (used) provided by financing activities
                
                
                (60,030
                )
                
                
                62,594
                
                
                
                (4,941
                )
                
                
                147
                
                
                
                -
                
                
                
                (2,230
                )-Change
      in cash and cash equivalents
                
                
                -
                
                
                
                (540
                )
                
                
                (64
                )
                
                
                (487
                )
                
                
                -
                
                
                
                (1,091
                )Cash
      and cash equivalents at beginning of period
                
                
                -
                
                
                
                2,111
                
                
                
                65
                
                
                
                2,004
                
                
                
                -
                
                
                
                4,180Cash
      and cash equivalents at end of period
                
                $
                -
                
                
                $
                1,571
                
                
                $
                1
                
                
                $
                1,517
                
                
                $
                -
                
                
                $
                3,089








31





PAPERWEIGHT
      DEVELOPMENT CORP. AND SUBSIDIARIESNOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
    (Continued)CONDENSED
      CONSOLIDATING STATEMENT OF CASH FLOWSFOR
      THE SIX MONTHS ENDED JUNE 29, 2008(unaudited)(dollars
      in thousands)Parent
                
                
                
                
                
                Subsidiary
                
                
                Non-GuarantorGuarantor
                
                
                Issuer
                
                
                Guarantors
                
                
                Subsidiary
                
                
                Eliminations
                
                
                ConsolidatedCash
      flows from operating activities:Net
      loss
                
                $
                (21,276
                )
                
                $
                (15,447
                )
                
                $
                (41,111
                )
                
                $
                (864
                )
                
                $
                57,422
                
                
                $
                (21,276
                )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                -
                
                
                
                26,533
                
                
                
                3,027
                
                
                
                6
                
                
                
                -
                
                
                
                29,566Impairment
                
                
                -
                
                
                
                -
                
                
                
                40,134
                
                
                
                -
                
                
                
                -
                
                
                
                40,134Other
                
                
                -
                
                
                
                5,020
                
                
                
                264
                
                
                
                289
                
                
                
                -
                
                
                
                5,573Change
      in assets and liabilities, net
                
                
                23,029
                
                
                
                (15,584
                )
                
                
                (2,103
                )
                
                
                1,265
                
                
                
                (57,422
                )
                
                
                (50,815
                )Net
      cash provided by operating activities
                
                
                1,753
                
                
                
                522
                
                
                
                211
                
                
                
                696
                
                
                
                -
                
                
                
                3,182Cash
      flows from investing activities:Proceeds
      from sale of equipment
                
                
                -
                
                
                
                4
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                4Additions
      to property, plant and equipment
                
                
                -
                
                
                
                (49,720
                )
                
                
                (1,008
                )
                
                
                -
                
                
                
                -
                
                
                
                (50,728
                )Net
      cash used by investing activities
                
                
                -
                
                
                
                (49,716
                )
                
                
                (1,008
                )
                
                
                -
                
                
                
                -
                
                
                
                (50,724
                )Cash
      flows from financing activities:Payments
      of senior secured notes payable
                
                
                -
                
                
                
                (1,125
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,125
                )Payments
      relating to capital lease obligation
                
                
                -
                
                
                
                (366
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (366
                )Proceeds
      from revolving line of credit
                
                
                -
                
                
                
                178,958
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                178,958Payments
      of revolving line of credit
                
                
                -
                
                
                
                (137,771
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (137,771
                )Due
      to parent and affiliated companies, net
                
                
                11,955
                
                
                
                (7,383
                )
                
                
                (3,568
                )
                
                
                (1,004
                )
                
                
                -
                
                
                
                -Proceeds
      from issuance of redeemable common stock
                
                
                3,721
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,721Payments
      to redeem common stock
                
                
                (17,429
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (17,429
                )Decrease
      in cash overdraft
                
                
                -
                
                
                
                (6,819
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (6,819
                )Net
      cash (used) provided by financing activities
                
                
                (1,753
                )
                
                
                25,494
                
                
                
                (3,568
                )
                
                
                (1,004
                )
                
                
                -
                
                
                
                19,169Effect
      of foreign exchange rate changes on cash and cash
      equivalents
                
                
                -
                
                
                
                159
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                159Change
      in cash and cash equivalents
                
                
                -
                
                
                
                (23,541
                )
                
                
                (4,365
                )
                
                
                (308
                )
                
                
                -
                
                
                
                (28,214
                )Cash
      and cash equivalents at beginning of period
                
                
                -
                
                
                
                33,567
                
                
                
                9,247
                
                
                
                2,024
                
                
                
                -
                
                
                
                44,838Cash
      and cash equivalents at end of period
                
                $
                -
                
                
                $
                10,026
                
                
                $
                4,882
                
                
                $
                1,716
                
                
                $
                -
                
                
                $
                16,624


32


Item 2—Management’s
Discussion and Analysis of Financial Condition and Results of
Operations




Unless
stated to the contrary or the context requires otherwise, all references to
“Paperweight Development,” “PDC” or “Company” refer to Paperweight Development
Corp. and its subsidiaries and predecessors. Appleton Papers Inc. is a
wholly-owned subsidiary of Paperweight Development, which is referred to as
“Appleton” in this report.





Overview




This
discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity of PDC and Appleton for the
quarter ended July 5, 2009. This discussion should be read in conjunction
with the accompanying Condensed Consolidated Financial Statements and related
Notes.




Reference
should also be made to the Annual Report on Form 10-K for the year ended
January 3, 2009, the consolidated financial statements and related notes
included therein.




Financial
Highlights




Net sales
for second quarter 2009 totaled $213.4 million, compared to $250.1 million for
second quarter 2008. This 14.7% decrease in net sales was largely due to the
continued economic slowdown which negatively impacted shipment volumes
world-wide. Technical Papers second quarter 2009 net sales decreased by $33.4
million, or 15.0%, when compared to net sales during second quarter 2008. Second
quarter 2009 net sales within the Packaging business were $3.3 million, or
12.3%, lower than net sales for the same quarter last year. This decrease in
revenue was largely due to lower selling prices to the customer in response to
lower resin prices. Net sales for the six months ended July 5, 2009 totaled
$426.0 million, compared to $486.7 million for the six months ended
June 29, 2008.




Income
from continuing operations was $7.2 million for second quarter 2009 compared to
income from continuing operations of $0.3 million in second quarter 2008.
Despite lower shipment volumes and reduced mill operations to match customer
demand, operating income in the current period was positively impacted by cost
reductions related to manufacturing and distribution costs and reductions in
selling, general and administrative expenses. Also during second quarter 2009,
the Company recorded an $8.0 million alternative fuels tax credit as a reduction
to cost of sales. During second quarter 2009 there was no discontinued
operations loss compared to a second quarter 2008 loss from discontinued
operations of $43.0 million. This $43.0 million loss was entirely related to
Bemrose Group Limited, which was sold on August 1, 2008, and included an
impairment charge of $41.2 million. For the six months ended July 5, 2009,
the Company reported net income of $8.4 million compared to a net loss of $21.3
million for the six months ended June 29, 2008. First half 2008 results
included an impairment charge within discontinued operations of $40.1 million
and a $22.3 million net gain from a litigation settlement.





During
these challenging economic times, the Company continues its efforts to reduce
spending and waste. The Company continually evaluates production output and
takes steps to reduce staffing at all levels and to reduce operations by
temporary slowdowns and shutdowns of production equipment. Beginning in second
quarter 2009, all non-union employees in the Company are required to take two
weeks of unpaid leave, or furlough, before the end of third quarter 2009. In
addition, beginning in second quarter 2009, Appleton suspended its company match
of employee deferrals made into the 401(k) plan by non-union employees. This
company match will be reinstated in October 2009 as will other
previously-suspended employee benefits. The company match for deferrals into the
company stock fund remained intact.





During
second quarter 2009, Appleton committed to a formal plan to sell C&H
Packaging Company, Inc. (“C&H”). C&H, located in Merrill, Wisconsin, was
acquired in 2003 and prints and converts flexible plastic packaging materials
for companies in the food processing, household and industrial products
industries. The assets and liabilities of C&H are reported as held for sale
for the periods ended July 5, 2009 and January 3, 2009. Prospectively,
as of the end of second quarter 2009, depreciation and amortization expense
will be suspended. The sale is expected to be completed prior to the end of
2009. C&H is included within the performance packaging business
segment.





33


Comparison
of Results of Operations for the Quarters Ended July 5, 2009 and June 29,
2008





For
      the Quarter EndedJuly 5,
                
                
                June 29,
                
                
                %2009
                
                
                2008
                
                
                Chg(dollars
      in millions)Net
      sales
                
                $
                213.4
                
                
                $
                250.1
                
                
                
                -14.7
                %Cost
      of sales
                
                
                163.2
                
                
                
                199.2
                
                
                
                -18.1
                %Gross
      profit
                
                
                50.2
                
                
                
                50.9
                
                
                
                -1.4
                %Selling,
      general and administrative expenses
                
                
                31.9
                
                
                
                40.5
                
                
                
                -21.2
                %Operating
      income
                
                
                18.3
                
                
                
                10.4
                
                
                
                76.0
                %Interest
      expense, net
                
                
                12.8
                
                
                
                10.2
                
                
                
                25.5
                %Other
      non-operating income, net
                
                
                (1.7)
                
                
                
                (0.1)
                
                
                nmIncome
      from continuing operations before income taxes
                
                
                7.2
                
                
                
                0.3
                
                
                nmProvision
      for income taxes
                
                
                -
                
                
                
                -
                
                
                
                -Income
      from continuing operations
                
                
                7.2
                
                
                
                0.3
                
                
                nmLoss
      from discontinued operations, net of income taxes
                
                
                -
                
                
                
                (43.0)
                
                
                
                -100.0
                %Net
      income (loss)
                
                $
                7.2
                
                
                $
                (42.7)
                
                
                nmComparison
      as a percentage of net salesCost
      of sales
                
                
                76.5
                %
                
                
                79.6
                %
                
                
                -3.1
                %Gross
      margin
                
                
                23.5
                %
                
                
                20.4
                %
                
                
                3.1
                %Selling,
      general and administrative expenses
                
                
                14.9
                %
                
                
                16.2
                %
                
                
                -1.3
                %Operating
      margin
                
                
                8.6
                %
                
                
                4.2
                %
                
                
                4.4
                %Income
      from continuing operations before income taxes
                
                
                3.4
                %
                
                
                0.1
                %
                
                
                3.3
                %Income
      from continuing operations
                
                
                3.4
                %
                
                
                0.1
                %
                
                
                3.3
                %Loss
      from discontinued operations, net of income taxes
                
                
                -
                
                
                
                -17.2
                %
                
                
                17.2
                %Net
      income (loss)
                
                
                3.4
                %
                
                
                -17.1
                %
                
                
                20.5
                %




Net sales
for second quarter 2009 were $213.4 million, a decrease of $36.7 million, or
14.7%, compared to the prior year period. This reduction was largely due to
volume shortfalls.




Operating
income in second quarter 2009 increased 76.0% to $18.3 million. During second
quarter 2009, the Company recorded an $8.0 million alternative fuels tax credit
as a reduction to cost of sales. Though operating income was negatively impacted
by volume shortfalls, this was partially offset by a 21.2% reduction in selling,
general and administrative expenses. Within selling, general and administrative
costs, distribution costs were 27.8% lower than the year earlier period.
Salaries, and related expenses, were approximately $3.1 million lower than such
expenses for the second quarter of 2008 as a result of the headcount reductions
made during 2008, furloughs taken during the current quarter, reduced severance
expense and curtailment of the company match on the 401(k). In comparison to
second quarter 2008, other areas of significantly reduced spending included
legal fees, consulting fees and travel and entertainment. The positive impact of
this reduced spending was partially offset by higher group health and pension
expenses. Second quarter 2008 also included a recovery of $2.3 million of
incentive compensation expense largely the result of a reduction in the June
2008 share price. As a percent of net sales, selling, general and administrative
expenses were 14.9% during second quarter 2009 compared to 16.2% during second
quarter 2008.





Income
from continuing operations of $7.2 million was recorded in second quarter 2009
compared to income from continuing operations of $0.3 million recorded in second
quarter 2008.




The
second quarter 2008 loss from discontinued operations of $43.0 million was
entirely related to Bemrose Group Limited, which was sold on August 1,
2008, and included an impairment charge of $41.2 million.








34


Comparison of Results of Operations
for the Six Months Ended July 5, 2009 and June 29, 2008





For
      the Six Months EndedJuly 5,
                
                
                June 29,
                
                
                %2009
                
                
                2008
                
                
                Chg(dollars
      in millions)Net
      sales
                
                $
                426.0
                
                
                $
                486.7
                
                
                
                -12.5
                %Cost
      of sales
                
                
                334.1
                
                
                
                380.8
                
                
                
                -12.3
                %Gross
      profit
                
                
                91.9
                
                
                
                105.9
                
                
                
                -13.2
                %Selling,
      general and administrative expenses
                
                
                66.2
                
                
                
                85.2
                
                
                
                -22.3
                %Operating
      income
                
                
                25.7
                
                
                
                20.7
                
                
                
                24.2
                %Interest
      expense, net
                
                
                24.2
                
                
                
                21.0
                
                
                
                15.2
                %Debt
      extinguishment income, net
                
                
                (5.4)
                
                
                
                -
                
                
                
                100.0
                %Other
      non-operating income, net
                
                
                (1.4)
                
                
                
                (22.0)
                
                
                nmIncome
      from continuing operations before income taxes
                
                
                8.3
                
                
                
                21.7
                
                
                -61.8
                %(Benefit)
      provision for income taxes
                
                
                (0.1)
                
                
                
                0.1
                
                
                
                -200.0
                %Income
      from continuing operations
                
                
                8.4
                
                
                
                21.6
                
                
                -61.1
                %Loss
      from discontinued operations, net of income taxes
                
                
                -
                
                
                
                (42.9)
                
                
                
                -100.0
                %Net
      income (loss)
                
                $
                8.4
                
                
                $
                (21.3)
                
                
                139.4
                %Comparison
      as a percentage of net salesCost
      of sales
                
                
                78.4
                %
                
                
                78.2
                %
                
                
                0.2
                %Gross
      margin
                
                
                21.6
                %
                
                
                21.8
                %
                
                
                -0.2
                %Selling,
      general and administrative expenses
                
                
                15.5
                %
                
                
                17.5
                %
                
                
                -2.0
                %Operating
      margin
                
                
                6.1
                %
                
                
                4.3
                %
                
                
                1.8
                %Income
      from continuing operations before income taxes
                
                
                1.9
                %
                
                
                4.5
                %
                
                
                -2.6
                %Income
      from continuing operations
                
                
                2.0
                %
                
                
                4.4
                %
                
                
                -2.4
                %Loss
      from discontinued operations, net of income taxes
                
                
                -
                
                
                
                -8.8
                %
                
                
                8.8
                %Net
      income (loss)
                
                
                2.0
                %
                
                
                -4.4
                %
                
                
                6.4
                %





Net sales
for the first six months of 2009 were $426.0 million, a decrease of $60.7
million, or 12.5%, compared to the prior year period. The decrease in net sales
for the first six months of 2009 was largely due to the continued economic
slowdown which negatively impacted shipment volumes world-wide.





Operating
income in the first six months of 2009 increased $5.0 million, or 24.2%, to
$25.7 million. During the first half of 2009, the Company recorded an $8.0
million alternative fuels tax credit as a reduction to cost of sales. Though
operating income was negatively impacted by volume shortfalls, this was
partially offset by a 22.3% reduction in selling, general and administrative
expenses. Within selling, general and administrative costs, distribution costs
were 24.6% lower than the year earlier period. Salaries and related expenses
were approximately $5.8 million lower than such expenses for the first half of
2008 as a result of the headcount reductions made during 2008, furloughs taken
during the current quarter, reduced severance expense and curtailment of the
company match on the 401(k). Other areas of significantly reduced spending
included legal fees, consulting fees and travel and entertainment. The positive
impact of this reduced spending was partially offset by higher group health and
pension expenses. First half 2008 also included a recovery of $0.5 million of
incentive compensation expense largely the result of a reduction in the June
2008 share price. As a percent of net sales, selling, general and administrative
expenses were 15.5% during the first six months of  2009 compared to
17.5% during the same period of 2008.





Continuing
operations reported $8.4 million of income for the first six months of 2009
compared to income from continuing operations of $21.6 million recorded during
first half 2008. First half 2008 income from continuing operations included a
$22.3 million net litigation settlement gain as the result of prevailing in a
lawsuit to recover previously incurred costs from an insurance
carrier.





35


The $42.9
million loss from discontinued operations, recorded during the first six months
of 2008, was entirely related to Bemrose Group Limited and included an
impairment charge of $40.1 million.





Business
Segment Discussion




Technical
Papers





Second
quarter Technical Papers net sales of $189.5 million were $33.4 million lower
than second quarter 2008 net sales. First half 2009 Technical Papers net sales
of $378.1 million were $54.4 million lower compared to the first half of 2008.
Second quarter operating income of $19.3 million was $7.3 million higher than
second quarter 2008 operating income. First half 2009 operating income of $28.3
million was $3.8 million higher than the first six months of 2008. The
year-on-year operating income variances were the result of the
following:





For
      the Three Months Ended July 5, 2009 v. the Three Months
    Ended
                              
                              
                              For
      the Six Months Ended July 5, 2009 v. the Six Months EndedJune 29,
      2008
                              
                              
                              June 29,
      2008(dollars
      in millions)Lower
      shipment volumes
                              
                              $
                              (9.3
                              )
                              
                              $
                              (16.0
                              )Mill
      curtailments to match customer demand
                              
                              
                              (3.2
                              )
                              
                              
                              (8.8
                              )Planned
      start-up costs of the thermal coater at the West Carrollton, Ohio paper
      mill
                              
                              
                              (2.5
                              )
                              
                              
                              (5.4
                              )Reduced
      manufacturing spending
                              
                              
                              6.6
                              
                              
                              
                              9.4Lower
      distribution costs
                              
                              
                              5.3
                              
                              
                              
                              9.1Favorable
      selling, general and administrative spending
                              
                              
                              2.4
                              
                              
                              
                              7.5Alternative
      fuels tax credit
                              
                              
                              8.0
                              
                              
                              
                              8.0$
                              7.3
                              
                              
                              $
                              3.8





A segment
analysis follows.





•
            Second
      quarter 2009 coated solutions net sales totaled $110.4 million, a decrease
      of $32.7 million, or 22.9%, from prior year levels. Second quarter 2009
      carbonless shipment volumes were 24.9% lower than second quarter 2008.
      Volume shortfalls were recorded in all market channels with international
      declining more than domestic. During the first six months of 2009, coated
      solutions net sales totaled $223.6 million, a decrease of $57.4 million,
      or 20.4%, from prior year levels.





Second
quarter 2009 coated solutions operating income of $18.8 million increased
$9.1 million compared to second quarter 2008. During the first six months
of 2009, operating income of $29.6 million increased $10.6 million compared to
the same 2008 period. The adverse impact of lower shipment volumes on 2009
operating margins was more than offset by lower distribution costs and favorable
selling, general and administrative spending as well as the alternative fuels
tax credit recorded as a reduction to cost of sales. The alternative fuels tax
credit of $8.0 million was allocated between the coated solutions and security
papers segments with $6.5 million allocated to coated solutions.




•
            Second
      quarter 2009 thermal papers net sales of $70.4 million were flat when
      compared to second quarter 2008 thermal papers net sales though shipment
      volumes were 3.2% higher. During the first six months of 2009, thermal
      papers net sales totaled $135.5 million, an increase of $1.7 million, or
      1.3%, when compared to the same prior year period. First half 2009
      shipment volumes were 5.9% higher than first half 2008 shipment volumes.
      Throughout 2009, revenue has been negatively impacted by continued
      pressure within the market to lower
prices.





36


During
second quarter 2009, the thermal papers business reported an operating loss of
$2.3 million which was a $3.6 million decrease in operating income as compared
to second quarter 2008. A $5.7 million operating loss was recorded for this
business during the first half of 2009 which was a decrease in operating income
of $9.5 million as compared to the same 2008 period. Despite higher shipment
volumes and lower manufacturing costs and selling, general and administrative
expenses, unfavorable product mix, higher input costs and $5.4 million of
planned start-up costs drove gross margins down when compared to
2008.




•
            Second
      quarter 2009 security papers segment net sales were $8.7 million, a slight
      decrease from second quarter 2008 net sales of $9.0 million. First half
      2009 security papers net sales were $19.0 million, an increase of $1.3
      million, or 7.3%, from first half 2008. The increase was due to increased
      shipment volumes of 6.7%.





Second
quarter 2009 operating income of $2.8 million was $1.8 million higher than
second quarter 2008 largely the result of reduced cost of sales due to the $1.5
million alternative fuels tax credit allocated to this business segment.
Security papers operating income of $4.4 million for the first half of the year
was an increase of $2.7 million when compared to first half 2008 due to
increased shipment volumes, manufacturing gains, the alternative fuels tax
credit and reduced selling, general and administrative spending.




Performance
Packaging




•
            Performance
      packaging segment net sales totaled $23.9 million in second quarter 2009,
      a decrease of $3.3 million, or 12.3%, from second quarter 2008. During the
      first six months of 2009, this segment recorded net sales of $47.9 million
      which was a decrease of $6.4 million, or 11.8%, from the first six months
      of 2008. The decrease in revenue was largely due to lower selling prices
      to the customer in response to lower resin
  prices.





Operating
      income recorded during second quarter 2009 of $0.8 million was $0.9
      million lower than second quarter 2008. Operating income recorded during
      the first six months of 2009, of $1.2 million, was $2.0 million, or 63.2%,
      lower than the first six months of 2008. This was the result of margin
      compression arising from resin pricing
  fluctuations.





During
second quarter 2009, Appleton committed to a formal plan to sell C&H
Packaging Company, Inc. (“C&H”). C&H, located in Merrill, Wisconsin, was
acquired in 2003 and prints and converts flexible plastic packaging materials
for companies in the food processing, household and industrial products
industries. The assets and liabilities of C&H are reported as held for sale
for the periods ended July 5, 2009 and January 3, 2009. Prospectively,
as of the end of second quarter 2009, depreciation and amortization expense
will be suspended. The sale is expected to be completed prior to the end of
2009. C&H is included within the performance packaging business
segment.





Unallocated Corporate
Charges and Business Development Costs




•
            Unallocated
      corporate charges and business development costs decreased $1.5 million
      and $3.2 million during the three and six months ended July 5, 2009,
      respectively, when compared to the same periods of 2008 due to reduced
      selling, general and administrative
expenses.





Liquidity
and Capital Resources




Overview. Appleton’s primary
sources of liquidity and capital resources are cash provided by operations and
available borrowings under its revolving credit facility. Appleton generally
expects that cash on hand, internally generated cash flow and available credit
from its revolving credit facility will provide the necessary funds for the
reasonably foreseeable operating and recurring cash needs (e.g., working
capital, debt service, other contractual obligations and capital expenditures).
At July 5, 2009, Appleton had $3.1 million of cash and approximately $22.9
million of unused borrowing capacity under its revolving credit facility and was
in compliance with all of its debt covenants.




Cash Flows from Operating
Activities. Net cash provided by operating activities for the first six
months of 2009, of $12.6 million, was a $9.5 million improvement when compared
to net cash provided by operating activities for the first six months of 2008.
Net income, adjusted for non-cash charges, provided $36.9 million in operating
cash for the period. Non-cash charges included $30.9 million in depreciation and
amortization, $2.1 million of non-cash employer matching contributions to the
KSOP and $0.9 million of other non-cash charges. A $5.4 million net gain on debt
extinguishment, which is discussed below in cash flows from financing activities,
was also recorded during the first half of this year. Uses of cash included a
$21.9 million change in working capital and a net $2.4 million of other
uses.


37


Major
components of the $21.9 million increase in working capital were a $15.7 million
increase in accounts receivable and a $14.4 million increase in other current
assets. Quarter-end receivables were at a more normal level compared to year-end
2008 which was impacted by increased collections due to the January 3, 2009
year-end date. As of July 5, 2009, other current assets included an $8.0 million
receivable for the alternative fuels tax credit. Payments of $1.9 million
were also made out of the restructuring reserve. As a result of aggressive
inventory management, inventories decreased by $8.0 million. Accounts payable
and accrued liabilities increased $2.1 million.





Cash Flows from Investing
Activities.Net cash used by investing activities during the first half
of 2009 totaled $11.5 million versus $50.7 million during the first six months
of 2008. During 2008, Appleton was investing in the expansion project at the
West Carrollton, Ohio paper mill. This expansion project, which was funded
through cash flows from operations, special financing provided by the State of
Ohio and borrowings under Appleton’s revolving credit facility, accounted for
$44.6 million of the capital spending during first half 2008. This expansion was
put into operation during the second half of 2008.





Cash Flows from Financing
Activities. Net cash used by financing activities was $2.2 million for
the first six months of 2009, while $19.2 million of cash was provided in the
comparable 2008 period. During the first half of 2009, Appleton borrowed a net
$28.0 million on its revolving credit facility. First half 2009 proceeds from
the issuance of PDC redeemable common stock totaled $2.1 million. The ESOP
trustee purchased this stock with pre-tax deferrals, rollovers and loan payments
made by employees during the first six months of 2009. Payments to redeem PDC
common stock were $12.6 million during this same period of 2009. The net cash
decrease realized from these proceeds and redemptions was $3.2 million less than
in the comparable period of 2008. Also, during first quarter 2009, the Company
made market purchases of $7.5 million face value of its senior subordinated
notes for a cash outlay of $1.7 million. As these notes were purchased at a
price significantly less than face value, the Company recorded a $5.5 million
net gain on these purchases. Appleton also made $3.0 million of mandatory debt
and capital lease payments.





During
July 2007, Appleton entered into a new $12.1 million Loan and Security Agreement
with the Director of Development of the State of Ohio, consisting of a $9.1
million State Assistance Loan and a $3.0 million State Loan (together “the Ohio
Loans”). The Company received the proceeds of the $3.0 million State Loan during
second quarter 2009. The proceeds of the $9.1 million State Assistance Loan were
received in 2007. All proceeds of these Ohio Loans were used to fund a portion
of the costs of acquiring and installing paper coating and production equipment
at the Company’s paper mill in West Carrollton, Ohio.




Cash
overdrafts decreased $14.9 million during the first half of 2009. Cash
overdrafts represent checks issued (thereby eliminating the corresponding
accounts payable) but not yet cleared through the banking system. Fluctuations
in the balance are a function of quarter-end payment patterns and the speed with
which the payees deposit the checks.


Appleton’s
senior secured credit facilities and senior secured term note payable contain
provisions that require Appleton to maintain specified financial ratios. Prior
to the waivers and amendments discussed below, the most restrictive limitations
were quarter-end debt to earnings before interest, taxes, depreciation and
amortization (EBITDA) of not more than a 4.50 to 1.00 ratio as such terms are
defined in the debt agreements. As a result of the significant downturn in
Appleton’s business markets and the resulting loss reported for the three months
ended January 3, 2009, Appleton was not in compliance with the leverage
ratio covenant at January 3, 2009, which constituted events of default
under the debt agreements. In order to waive the events of default existing at
January 3, 2009, under the senior secured credit facilities and the senior
secured term note payable, and to amend other provisions of the agreements,
Appleton and its lenders entered into the following agreements in
March 2009:





•      First
Amendment to the senior secured credit facilities


•      First
Amendment to the senior secured term note payable




Under the
First Amendment to the senior secured credit facilities, Appleton will pay
interest rates equal to LIBOR, but not less than 2 percent, plus 450 basis
points for any amounts outstanding on the senior secured variable rate notes
payable and, interest rates initially equal to LIBOR, but not less than 2
percent, plus 450 basis points for any amounts outstanding on the revolving
credit facility. The First Amendment to the senior secured credit
facilities provides a grid under which the interest rates payable, for amounts
outstanding on the revolving credit facility, may be reduced, based on measures
of Appleton’s total leverage as defined in the senior secured credit facilities.
Under the First Amendment to the senior secured term note payable, Appleton will
pay an interest rate of 14.25 percent on the senior secured term note
payable. For accounting purposes, the amendments to the senior secured
credit facilities and the senior secured term note payable were treated as debt
modifications. The Company paid $2.8 million of fees to the creditors in
conjunction with the amendment to the senior secured credit facilities. These
debt issuance costs will be amortized over the term of the modified agreement
along with pre-existing unamortized debt issuance costs as an adjustment to
interest expense over the remaining term of the modified
agreement. Unamortized debt issuance costs of $0.1 million, relating to the
revolving credit facility, were written off. The unamortized debt issuance costs
remaining after the writeoff will be deferred and amortized over the term of the
modified revolving credit facility.





38









•
            The
      maturity date for the revolving credit facility will be June 5, 2012,
      and the maturity date for the senior secured variable rate notes payable
      will be June 5, 2013;


•
            Appleton
      will be permitted up to $35 million of capital expenditures in 2009 and up
      to $40 million of capital expenditures in 2010, with no limit in 2011or
      thereafter;


•
            Appleton
      may not make acquisitions until December 31,
  2010;


•
            Other
      restrictions are imposed on liens, indebtedness, investments, restricted
      payments and note repurchases;


•
            Mandatory
      prepayments are increased from 50% to 75% of excess cash flow as defined
      in the senior secured credit
facilities;


•
            Financial
      covenants are modified to increase the total leverage ratio, to eliminate
      the interest coverage ratio, to add a senior secured leverage ratio, and
      to add a fixed charge coverage ratio, all as defined in the senior secured
      credit facilities and the First Amendment to the senior secured credit
      facilities.




In February
2008, Appleton fixed the interest rate, at 5.45%, on $75.0 million of its
variable rate notes with a five-year interest rate swap contract. Also during
first quarter 2008, Appleton fixed the interest rate, at 5.4%, on an additional
$75.0 million of its variable rate notes with a five-year interest rate swap
contract. As discussed below, one of the swap contracts was terminated in
February 2009. The covenant violation at January 3, 2009 and subsequent
waiver and amendment, in March 2009, to the senior secured credit
facilities, changed the basis of the forecasted transactions for the two
interest rate swap contracts that were placed in 2008. As amended, the senior
secured credit facilities contain interest payments based on LIBOR with a 2%
floor, whereas the forecasted transactions assumed interest payments based on
LIBOR. As a result, Appleton concluded it was remote that the original
forecasted transactions would occur as originally documented and reclassified as
a charge against 2008 earnings, within interest expense, $9.4 million of swap
losses originally classified in other comprehensive loss. The events of default
also triggered an event of default pursuant to a cross-default provision under
one of the interest rate swap contracts. As a result of the cross-default, the
counterparty elected to terminate the swap contract. In February 2009, Appleton
and the counterparty resolved Appleton’s obligation under the swap contract with
an agreement to pay $4.7 million over the nine-month period ending October 2009.
During the first half of 2009, Appleton paid $2.9 million in accordance with the
termination agreement thereby reducing its liability to $1.8 million as of
July 5, 2009. The remaining swap contract is expected to remain in place
and future fluctuations in market value will be reflected as adjustments to
interest expense. As of July 5, 2009, the remaining swap contract was
recorded as a long-term liability of $3.8 million based on a fair value
measurement using Level 2 inputs as described in SFAS 157, "Fair Value
Measurements." The fair value of the interest rate swap derivative is primarily
based on models that utilize the appropriate market-based forward swap curves
and zero-coupon interest rates to determine the discounted cash flows. In
comparison to the fair value reported at fiscal year-end 2008, the current fair
value of this long-term liability is $0.9 million lower, with this change
recorded in interest expense on the Condensed Consolidated Statement of
Operations for the six months ended July 5, 2009.





The
Company is subject to credit risk relative to the ability of counterparties to
meet their contractual payment obligations or the potential non-performance of
counterparties to deliver contracted commodities or services at the contracted
price. The recent unprecedented volatility in capital and credit markets may
create additional risks to the Company, directly or indirectly, because of its
potential to also impact major customers and suppliers in the upcoming months
and possibly years. The adverse effect of a sustained U.S. or international
economic downturn, including sustained periods of decreased consumer and
business spending, high unemployment levels or declining consumer or business
confidence, along with continued volatility and disruption in the credit and
capital markets, has and may continue to result in reduced demand for Appleton’s
products and, therefore, reduced sales and profitability.





The
senior secured credit facilities, as amended, senior secured term note payable,
as amended, senior notes and senior subordinated notes contain affirmative and
negative covenants. In general, the covenants contained in the senior credit
facilities, as amended, are more restrictive than those of the senior notes and
senior subordinated notes. Among other restrictions, the covenants contained in
the senior credit facilities, as amended, and senior secured term note payable,
as amended, require Appleton to meet specified financial tests, including
leverage and fixed charge coverage ratios, which become more restrictive over
the term of the debt.




The
senior secured credit facilities, as amended, senior secured term note payable,
as amended, senior notes and senior subordinated notes also contain covenants
which, among other things, restrict Appleton’s ability and the ability of
Appleton’s other guarantors of the senior secured credit facilities, as amended,
senior secured term note payable, as amended, senior notes and senior
subordinated notes to incur liens; engage in transactions with affiliates; incur
or guarantee additional indebtedness; declare dividends or redeem or repurchase
capital stock; make loans and investments; engage in mergers, acquisitions,
consolidations and asset sales; acquire assets, stock or debt securities of any
person; terminate the subchapter S corporation status of PDC or the qualified
subchapter S subsidiary status of its subsidiaries eligible to elect such
status; amend its debt instruments; amend or terminate the ESOP; amend other
agreements related to the transaction with AWA; repay other indebtedness; use
assets as security in other transactions; enter into sale and leaseback
transactions; sell equity interests in the Company’s subsidiaries; and engage in
new lines of business.


39





The
senior secured credit facilities, as amended, contain a provision that defines
an event of default to include defaults or events of default under other
indebtedness as defined in the senior secured credit facilities. The senior
secured term note payable, as amended, contains a provision which defines an
event of default to include defaults or events of default under the senior
secured credit facilities, as amended, the senior notes and the senior
subordinated notes.





The
senior secured credit facilities, as amended, are unconditionally guaranteed by
PDC and by substantially all of Appleton’s subsidiaries, other than two small
foreign subsidiaries. In addition, they are secured by liens on substantially
all of Appleton’s, the subsidiary guarantors’ and certain of Appleton’s other
subsidiaries’ assets and by a pledge of Appleton’s and its subsidiaries’ capital
stock. The senior secured term note payable, as amended, is unconditionally
guaranteed by PDC and by substantially all of Appleton’s subsidiaries, other
than certain immaterial subsidiaries. In addition, it is secured by a lien on
specified manufacturing equipment located in Appleton’s paper mill in West
Carrollton, Ohio. The senior notes and senior subordinated notes are
unconditionally guaranteed by PDC, C&H Packaging Company, Inc., American
Plastics Company, Inc., Rose Holdings Limited, HBGI Holdings Limited and New
England Extrusion Inc.





As of
July 5, 2009, Appleton was in compliance with its various amended covenants
as disclosed in the 2008 Form 10-K. Based on Appleton’s forecasted operating
results and related debt reductions, Appleton has projected compliance with all
covenants for the next twelve-month period. Appleton’s ability to comply with
the financial covenants in the future depends on further debt reduction and
achieving forecasted operating results, which have become more difficult to
project in the current economic environment. Given the uncertain global economic
conditions, continued constraints in the credit markets and other market
uncertainties, there are various scenarios, including a reduction from
forecasted operating results, under which Appleton could violate its financial
covenants during 2009 and 2010. Appleton’s failure to comply with such
covenants or an assessment that it is likely to fail to comply with such
covenants, could also lead Appleton to seek amendments to or waivers of the
financial covenants contained in the senior secured credit facilities and senior
secured term note payable. Appleton cannot provide assurance that it would
be able to obtain any amendments to or waivers of the covenants contained in the
senior secured credit facilities and senior secured term note payable. Any
such amendment to or waiver of the covenants would likely involve upfront fees,
higher annual interest costs and other terms less favorable to the Company than
those currently in the senior secured credit facilities and senior secured term
note payable. In the event the lenders will not amend or waive the
covenants, the debt would be due and Appleton would need to seek alternative
financing. Appleton cannot provide assurance that it would be able to
obtain alternative financing. If Appleton were not able to secure
alternative financing, this would have a material adverse impact on the
Company.





Prior
Period Error Corrections




During
the preparation of the first quarter 2009 Form 10-Q, the Company identified an
error in classification of gain on debt extinguishment in its 2008 Consolidated
Statement of Cash Flows which affected cash flows from operating activities and
cash flows from financing activities. During fourth quarter 2008, Appleton
purchased $40.6 million, plus interest, of its 8.125% senior notes payable due
June 15, 2011. The actual cash outlay for these purchases totaled $28.0
million. As these senior notes were purchased at prices less than face value,
the Company appropriately recorded a $12.6 million gain. In accordance with
Statement of Financial Accounting Standards (“SFAS”) 95, “Statement of Cash
Flows,” gains or losses on extinguishment of debt is a financing activity and
should be adjusted from the net income of the business to arrive at cash flows
from operations. Appleton did not remove the non-cash gain on the extinguishment
of debt from cash flows from operating activities resulting in an overstatement
of cash flows from operations and cash outflows from financing activities on the
Company’s Consolidated Statement of Cash Flows for the Twelve Months Ended
January 3, 2009. This error had no impact on the Consolidated Statement of
Operations and Consolidated Balance Sheet for 2008. After considering both
quantitative and qualitative factors in accordance with Staff Accounting
Bulletin 99, "Materiality," the Company determined that the errors were not
material and the cash flow presentations will be revised for these errors in the
2009 Form 10-K.
  As a
result of researching the appropriate classification of the gain associated with
the Bemrose note receivable, as discussed in Note 2 to the Condensed
Consolidated Financial Statements contained in this report, it was determined
that the initial reserve of $1.5 million should have also been recorded within
continuing operations at year-end 2008, at which time the reserve was initially
recorded in (loss) income from discontinued operations in the 2008 Form 10-K.
Management assessed the error in accordance with Staff Accounting Bulletin 99,
“Materiality,” and concluded the error is immaterial to the consolidated
financial statements as of January 3, 2009, taken as a whole. The
Consolidated Statement of Operations will be revised for this error in the 2009
Form 10-K.


Collective
Bargaining Unit
  Appleton’s
collective bargaining agreement with the United Steel, Paper and Forestry,
Rubber, Manufacturing, Energy, Allied Industrial and Service Workers
International Union (“USW”) for employees at the West Carrollton, Ohio paper
mill was due to expire on April 1, 2009. On March 30, 2009, the mill’s
union employees voted to ratify a new three-year labor agreement. The new
agreement includes improvements to wages and pension contributions as well as a
schedule of health care cost sharing provisions.
 Alternative
Fuels Tax Credit





The U.S.
Internal Revenue Code provides a tax credit for companies that use alternative
fuel mixtures to produce energy to operate their businesses. The credit, equal
to $0.50 per gallon of alternative fuel contained in the mixture, is refundable
to the taxpayer. In February 2009, Appleton began mixing black liquor with
diesel fuel and using the mixture at its mill in Roaring Spring, Pennsylvania.
The Company applied to the Internal Revenue Service to be registered as an
alternative fuel mixer and received its registration in May 2009. As of
July 5, 2009, Appleton filed for excise tax refunds totaling $7.6 million
and accrued $0.4 million for eligible alternative fuel usage through
July 5, 2009 to be included in subsequent filings. This $8.0 million is
recorded in other current assets in the accompanying Condensed Consolidated
Balance Sheet. Accordingly, the Condensed Consolidated Statement of Operations
for the three and six months ended July 5, 2009 includes the $8.0
million tax credit as a reduction to cost of sales. Expenses related to
this excise tax refund total $0.1 million for the first six months of 2009. As
of August 7, 2009, $7.1 million has been received in cash from the Internal
Revenue Service.





40
  New
Accounting Pronouncements
  In June 2009, the
Financial Accounting Standards Board ("FASB") issued the FASB Accounting
Standards Codification ("Codification"). The Codification will become the single
source for all authoritative generally accepted accounting principles ("GAAP")
recognized by the FASB to be applied for financial statements issued for periods
ending after September 15, 2009. The Codification does not change GAAP and
the Company has determined that it will not have an impact on its consolidated
results of operations, financial position and cash flows.
  In May
2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”)
165, “Subsequent Events.”  This statement is applicable to the
accounting for and disclosure of subsequent events not addressed in other GAAP.
It provides a definition of subsequent events and guidance as to when subsequent
events are recognized or not recognized. SFAS 165 requires the disclosure of the
date through which subsequent events have been evaluated, as well as whether the
date is the date the financial statements were issued or the date the financial
statements were available to be issued. These provisions are effective for
interim or annual financial periods ending after June 15, 2009, and should
be applied prospectively. The provisions of SFAS 165 were adopted by the Company
during its second quarter ended July 5, 2009 and had no material impact on
its financial statements.





In April
2009, the FASB issued FASB Staff Position (“FSP”) FAS 157-4 “Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly.”
Based on the guidance, if an entity determines that the level of activity for an
asset or liability has significantly decreased and that a transaction is not
orderly, further analysis of transactions or quoted prices is needed, and a
significant adjustment to the transaction or quoted prices may be necessary to
estimate fair value in accordance with SFAS 157 “Fair Value Measurements.”
The provisions of FSP FAS 157-4 were adopted by the Company during its second
quarter ended July 5, 2009. There was no current period impact on its
financial statements.





In April
2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”) 28-1
“Interim Disclosures about Fair Value of Financial Instruments.” The FSP amends
SFAS 107 “Disclosures about Fair Value of Financial Instruments” to require an
entity to provide disclosures about fair value of financial instruments in
interim financial information. The provisions of FSP FAS 107-1 were adopted by
the Company during its second quarter ended July 5, 2009. The current
period impact is addressed in Note 17 to the Condensed Consolidated Financial
Statements contained in this report.





In
December 2008, the FASB issued FASB Staff Position FAS 132(R)-1, “Employer’s
Disclosures about Postretirement Benefit Plan Assets,” which amends SFAS 132
(Revised 2003), “Employers’ Disclosures about Pension and Other Postretirement
Benefits,” to provide guidance on an employers’ disclosures about plan assets of
a defined benefit pension or other postretirement plan. This pronouncement is
effective for fiscal years ending after December 15, 2009. Upon initial
application, the provisions are not required to be adopted for earlier periods
as presented for comparative purposes. Earlier application of the provisions is
permitted. The Company does not believe adoption will have a material impact on
its consolidated financial statements.





In
March 2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133.” This statement changes the disclosure requirements for
derivative instruments and hedging activities. SFAS 161 requires enhanced
disclosures about (a) how and why an entity uses derivative instruments,
(b) how derivative instruments and related hedged items are accounted for
under SFAS 133 and its related interpretations and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance and cash flows. These provisions are effective for
financial statements issued for fiscal years beginning after November 15,
2008. The Company adopted SFAS 161 during its first quarter 2009. The
principal impact to the Company was to require the expansion of its disclosures
regarding derivative instruments.





In
December 2007, the FASB issued SFAS 141 (Revised 2007), “Business Combinations.”
SFAS 141R requires that an acquiring entity recognize all the assets acquired
and liabilities assumed in a transaction at the acquisition date fair value with
limited exceptions. SFAS 141R will change the accounting treatment for
acquisition costs, non-controlling interests, contingent liabilities, in-process
research and development, restructuring costs and income taxes. In addition, it
also requires a substantial number of new disclosure requirements. This
statement applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Earlier adoption is
prohibited. The Company adopted SFAS 141R during the first quarter of 2009. The
adoption did not have a material impact on its consolidated financial
statements.




Item 3—Quantitative and
Qualitative Disclosures About Market Risk




For
information regarding quantitative and qualitative disclosures about market
risk, see the Annual Report on Form 10-K for the year ended January 3,
2009. There have been no other material changes in the quantitative or
qualitative exposure to market risk from that described in the Form
10-K.





Item 4T—Controls and
Procedures




Internal Controls Over
Financial Reporting




There
were no changes in the internal control over financial reporting of Appleton or
PDC, as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange
Act, during the fiscal quarter covered by this report that have materially
affected, or are reasonably likely to materially affect, the Registrants’
internal control over financial reporting.




41


Disclosure Controls
and Procedures




Appleton
and PDC carried out an evaluation, under the supervision and with the
participation of their management, including their respective principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of their disclosure controls and procedures as such terms
are defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of
1934, as amended (the “Exchange Act”). Appleton and PDC maintain disclosure
controls and procedures that are designed to ensure that information required to
be disclosed by Appleton and PDC in the reports filed or submitted by them under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms. The disclosure controls and
procedures are also designed to ensure that the information is accumulated and
communicated to management, including their respective principal executive and
principal financial officers, to allow timely decisions regarding required
disclosures. Based on their evaluation, the Chief Executive Officer and Chief
Financial Officer of Appleton and PDC have concluded that their disclosure
controls and procedures are effective as of the end of the period covered by
this Form 10-Q.





PART
II – OTHER INFORMATION





Item
1 – Legal Proceedings





Information
regarding legal proceedings is contained in Note 13 to the Condensed
Consolidated Financial Statements contained in this report and is incorporated
herein by reference.





Item 1A
– Risk Factors




Other
than with respect to the risk factors set forth below, there have been no
material changes in the risk factors disclosed in the Annual Report on Form 10-K
for the year ended January 3, 2009.





Changes
in tax laws may have a material effect on Appleton’s future cash flows and
results of operations.





Earnings
in the three and six months ended July 5, 2009, included an alternative
fuels tax credit of $8.0 million for alternative fuel mixtures produced for use
as a fuel in the business. The credit is scheduled to expire December 31,
2009. Legislation has been proposed that would terminate the credit for fuel
used in the production of paper or pulp prior to December 31, 2009. We cannot
predict whether such legislation will be enacted, or what its effective date
would be. If the excise tax credit were to be terminated or materially changed
prior to December 31, 2009, this may have a material effect on Appleton’s
future cash flows and results of operations.





Appleton
has competitors in its various markets and it may not be able to maintain prices
and margins for its products.




Appleton
faces strong competition in all of its business segments. Its competitors vary
in size and the breadth of their product offerings and some of its competitors
have significantly greater financial, technical and marketing resources than
Appleton does. Regardless of the continuing quality of our primary products,
Appleton may be unable to maintain its prices or margins due to:




•
            declining
      overall carbonless market size;




•
            accelerating
      decline in carbonless sheet sales;





•
            variations
      in demand for, or pricing of, carbonless
  products;





•
            increasing
      manufacturing costs;





•
            increasing
      competition in international markets or from domestic or foreign
      producers; or





•
            declining
      general economic conditions.




Appleton’s
inability to compete effectively or to maintain its prices and margins could
have a material adverse effect on its earnings and cash flow.





The
carbonless paper market is highly competitive. Appleton competes based on a
number of factors, including price, product availability, quality and customer
service. Additionally, Appleton competes with domestic production and imports
from Europe and Asia. In March 2009, the Mexican government began imposing
tariffs on 90 U.S. products sold into Mexico, including carbonless paper. All
U.S. sales of carbonless paper into Mexico are assessed a 10% tariff. Though the
tariff is paid by the customer, this automatically increases the price of
carbonless paper by 10% which could open the door for non-U.S. competitors to
enter the Mexican market with their carbonless products and take advantage of
the ability to offer customers more favorable pricing. Appleton may need to
adjust its carbonless pricing accordingly in reaction to competitive pressures
from both customers seeking more favorable pricing and foreign producers of
carbonless paper seeking market entry.





42


Future
greenhouse gas/carbon regulations or legislation could adversely affect
Appleton’s costs of compliance with environmental laws.
  In 2009, the U.S. Environmental Protection Agency (“EPA”) released a finding
that greenhouse gas (“GHG”) emissions endanger the public health and
welfare.  Should the EPA finalize the findings, it may then begin
developing rules to regulate GHG emissions under the federal Clean Air
Act.  It is uncertain whether such GHG emissions regulations will be
issued, when they might be issued or what form they may take.  Also in
2009, several bills were introduced in the U.S. Congress concerning climate
change and the emission into the environment of carbon dioxide and other
GHGs.  It is expected that eventual legislation will take the form of a
cap-and-trade program where generators will be required to purchase allowances
to emit carbon dioxide andother
GHGs, although it is possible that legislation may take other forms, such as a
carbon tax on each unit of carbon dioxide and other GHGs emitted in excess of
mandated limits.  As a result, Appleton could be required, among other
things, to purchase allowances or offsets to emit GHGs or other regulated
pollutants or to pay taxes on such emissions.  At this time there is no
basis for estimating the effect of such legislation on the costs Appleton will
incur to comply with environmental laws, although the Company is investigating
ways to reduce carbon emissions.




Item 3
– Defaults Upon Senior Securities





At
January 3, 2009, Appleton was not in compliance with the leverage ratio
covenant under the senior secured credit facilities and the senior secured term
note payable, which constituted events of default under the debt agreements.
Subsequent waiver of such events of default and amendments to the senior secured
credit facilities and the senior secured term note payable, were entered into in
March 2009. Information regarding such events is contained in Note 16 to the
Condensed Consolidated Financial Statements contained in this report and is
incorporated herein by reference, as well under Item 7 in the Annual Report on
Form 10-K for the year ended January 3, 2009 and Note 10 to the
Consolidated Financial Statements contained in such Annual Report.





SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS





This
report contains forward-looking statements. The words “will,” “may,” “should,”
“believes,” “anticipates,” “intends,” “estimates,” “expects,” “projects,”
“plans,” “seek” or similar expressions are intended to identify forward-looking
statements. All statements in this report other than statements of historical
fact, including statements which address Appleton’s strategy, future operations,
future financial position, estimated revenues, projected costs, prospects, plans
and objectives of management and events or developments that Appleton expects or
anticipates will occur, are forward-looking statements. All forward-looking
statements speak only as of the date on which they are made. They rely on a
number of assumptions concerning future events and are subject to a number of
risks and uncertainties, many of which are outside the Company’s control that
could cause actual results to differ materially from such statements. These
risks and uncertainties include, but are not limited to, the factors listed
under “Item 1A – Risk Factors” in the Annual Report on Form 10-K for the year
ended January 3, 2009, as well as in the Quarterly Report on Form 10-Q for
the current quarter ended July 5, 2009, which factors are incorporated
herein by reference and as updated above. Many of these factors are beyond
Appleton’s ability to control or predict. Given these uncertainties, do not
place undue reliance on the forward-looking statements. Appleton disclaims any
obligation to update or revise publicly any forward-looking statements, whether
as a result of new information, future events or otherwise.





43





Item 6—Exhibits


31.1
            Certification
      of Mark R. Richards, Chairman, President and Chief Executive Officer of
      Appleton Papers Inc., pursuant to Rule 15d-14(a) of the Securities
      Exchange Act of 1934 as amended.31.2
            Certification
      of Thomas J. Ferree, Vice President Finance, Chief Financial Officer and
      Treasurer of Appleton Papers Inc., pursuant to Rule 15d-14(a) of the
      Securities Exchange Act of 1934 as amended.31.3
            Certification
      of Mark R. Richards, Chairman, President and Chief Executive Officer of
      Paperweight Development Corp., pursuant to Rule 15d-14(a) of the
      Securities Exchange Act of 1934 as amended.31.4
            Certification
      of Thomas J. Ferree, Chief Financial Officer and Treasurer of Paperweight
      Development Corp., pursuant to Rule 15d-14(a) of the Securities Exchange
      Act of 1934 as amended.32.1
            Certification
      of Mark R. Richards, Chairman, President and Chief Executive Officer of
      Appleton Papers Inc., pursuant to 18 U.S.C. Section
  1350.32.2
            Certification
      of Thomas J. Ferree, Vice President Finance, Chief Financial Officer and
      Treasurer of Appleton Papers Inc., pursuant to 18 U.S.C. Section
      1350.32.3
            Certification
      of Mark R. Richards, Chairman, President and Chief Executive Officer of
      Paperweight Development Corp., pursuant to 18 U.S.C. Section
      1350.32.4
            Certification
      of Thomas J. Ferree, Chief Financial Officer and Treasurer of Paperweight
      Development Corp., pursuant to 18 U.S.C. Section
  1350.








44





SIGNATURES




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




APPLETON
      PAPERS INC.
              (Registrant)Date:
      August 7, 2009
            /s/
      Thomas J. FerreeThomas
      J. FerreeVice
      President Finance, Chief Financial Officer and Treasurer (Signing on
      behalf of the Registrant and as the Principal Financial
      Officer)










45





SIGNATURES




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




PAPERWEIGHT
      DEVELOPMENT CORP.
              (Registrant)Date:
      August 7, 2009
            /s/
      Thomas J. FerreeThomas
      J. FerreeChief
      Financial Officer and Treasurer (Signing on behalf of the Registrant and
      as the Principal Financial Officer)




46