**FORM 10-Q**

**SECURITIESAND EXCHANGE COMMISSIONWashington, D.C.  20549**
| **(Mark One)**                                         |
|--------------------------------------------------------|
|                                                   |   | ** ** |
| x                                                      |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                             |   | ** ** |
| **For the  quarterly period ended September 30, 2006** |
| ** **                                             |
| **OR**                                                 |
|                                                   |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

### ** **

### **For thetransition period from                     to**                            

**Registration Number:  333-114032**

**BLUERIDGE PAPER PRODUCTS INC.**(Exact name of registrant as specified in charter)

| **Delaware**              |   | **56-2136509**                           |
|---------------------------|--------|------------------------------------------|
| (State of  incorporation) |   | (I.R.S. Employer  Identification Number) |
|                      |   |                                     |

##  

## **41 MAIN STREETCANTON, NORTH CAROLINA  28716**(Address of principal executive office)

Registrant’stelephone number, including area code:  **828-454-0676**

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.
|  | Yes | x |   | No | o |   |
|--|-----|---|--------|----|---|--------|

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act.  (Checkone):

# Large Accelerated Filer   o         AcceleratedFiler    o         Non-AcceleratedFiler   x

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

 

The number of commonshares outstanding at September 30, 2006 was 1,000.

 

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**BLUERIDGE PAPER PRODUCTS INC.**

**ANDSUBSIDIARIES**

** **

 
|                                    |       |                     | INDEX                                                                                                                                                                    |   |   |   |
|------------------------------------|------------|--------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|                               |       |                     |                                                                                                                                                                     |   |   |   |
| PART I.                            |       |                     | FINANCIAL  INFORMATION                                                                                                                                                   |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       | Item 1.                  | Financial Statements                                                                                                                                                     |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       |                     | Condensed Consolidated Balance Sheets, September 30,  2006 (unaudited) and December 31, 2005 (derived from audited financial  statements)                                |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       |                     | Condensed Consolidated Statements of Operations,  Three Months Ended September 30, 2006 and 2005 (unaudited), Nine Months Ended  September 30, 2006 and 2005 (unaudited) |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       |                     | Condensed Consolidated Statements of Cash Flows,  Nine Months Ended September 30, 2006 and 2005 (unaudited)                                                              |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       |                     | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                                                        |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       | Item 2.                  | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                                              |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       | Item 3.                  | Quantitative and Qualitative Disclosures About  Market Risk                                                                                                              |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       | Item 4.                  | Controls and Procedures                                                                                                                                                  |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
| PART II.                           |       |                     | OTHER  INFORMATION                                                                                                                                                       |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       | Item 1A.                 | Risk Factors                                                                                                                                                             |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       | Item 5.                  | Other Information                                                                                                                                                        |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       | Item 6.                  | Exhibits                                                                                                                                                                 |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
| **PART I.  FINANCIAL INFORMATION** |
|                               |       |                     |                                                                                                                                                                     |   |   |   |
| **ITEM 1.**                        | ** ** | **FINANCIAL STATEMENTS** |                                                                                                                                                                     |   |   |

 

2

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**BLUE RIDGE PAPERPRODUCTS INC.**

**Condensed Consolidated Balance SheetsSeptember 30, 2006 and December 31, 2005(Dollars in thousands)(unaudited)**

** **
| ** **                                                                                                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                      | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **Assets**                                                                                                                      | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                 |       |                   |       |                  |       |
| Cash                                                                                                                            |       | $                      | 3,752      |                  | $          | 2,110 |   |
| Accounts  receivable, net of allowance for doubtful accounts and discounts of $1,276  and $2,298 in 2006 and 2005, respectively |       | 56,854                 |       | 56,002                |       |
| Inventories                                                                                                                     |       | 51,431                 |       | 53,988                |       |
| Prepaid expenses                                                                                                                |       | 2,132                  |       | 1,029                 |       |
| Insurance  proceeds receivable                                                                                                  |       | —                 |       | 291                   |       |
| Income tax  receivable                                                                                                          |       | —                 |       | 50                    |       |
| Deferred tax  asset                                                                                                             |       | 4,373                  |       | 4,448                 |       |
| Total current  assets                                                                                                           |       | 118,542                |       | 117,918               |       |
| Property, plant  and equipment, net of accumulated depreciation of $116,340 and $105,253 in  2006 and 2005, respectively        |       | 188,406                |       | 190,463               |       |
| Deferred financing  costs, net                                                                                                  |       | 3,966                  |       | 5,108                 |       |
| Other assets                                                                                                                    |       | 57                     |       | 193                   |       |
| Total assets                                                                                                                    |       | $                      | 310,971    |                  | $          | 313,682 |   |
| **Liabilities  and Stockholder’s Deficit**                                                                                 | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                            |       |                   |       |                  |       |
| Current portion  of senior debt                                                                                                 |       | $                      | 43         |                  | $          | 41 |   |
| Current portion  of capital lease obligation                                                                                    |       | 402                    |       | 595                   |       |
| Accounts payable                                                                                                                |       | 43,286                 |       | 48,917                |       |
| Accrued expenses  and other current liabilities                                                                                 |       | 31,086                 |       | 33,987                |       |
| Interest payable                                                                                                                |       | 5,698                  |       | 1,875                 |       |
| Total current  liabilities                                                                                                      |       | 80,515                 |       | 85,415                |       |
| Senior debt, net of  current portion                                                                                            |       | 161,555                |       | 159,749               |       |
| Parent Pay-In-Kind  (PIK) Senior Subordinated Note                                                                              |       | 46,424                 |       | 44,425                |       |
| Capital lease  obligations                                                                                                      |       | 707                    |       | 979                   |       |
| Pension and  postretirement benefits                                                                                            |       | 24,341                 |       | 22,678                |       |
| Deferred tax liability                                                                                                          |       | 4,373                  |       | 4,448                 |       |
| Other liabilities                                                                                                               |       | 1,168                  |       | 730                   |       |
| Total  liabilities                                                                                                              |       | 319,083                |       | 318,424               |       |
| Obligation to redeem  ESOP shares                                                                                               |       | 28,455                 |       | 27,716                |       |
| Obligation to redeem  restricted stock units of Parent                                                                          |       | 1,180                  |       | 1,631                 |       |
| Commitments and  contingencies (See notes)                                                                                      |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                      |       |                   |       |                  |       |
| Common stock  (par value $0.01, 1000 shares authorized and outstanding in 2006 and 2005,  respectively)                         |       | —                 |       | —                |       |
| Additional  paid-in capital                                                                                                     |       | 65,459                 |       | 64,121                |       |
| Accumulated  deficit                                                                                                            |       | (89,713                | )          | (86,054               | )          |
| Unearned  compensation                                                                                                          |       | —                 |       | (25                   | )          |
| Accumulated  other comprehensive loss                                                                                           |       | (4,183                 | )          | (4,183                | )          |
|                                                                                                                            |       | (28,437                | )          | (26,141               | )          |
| Receivable from  Parent                                                                                                         |       | (9,310                 | )          | (7,948                | )          |
| Total  stockholders’ deficit                                                                                               |       | (37,747                | )          | (34,089               | )          |
| Total liabilities and  stockholders’ deficit                                                                               |       | $                      | 310,971    |                  | $          | 313,682 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

3

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**BLUE RIDGE PAPERPRODUCTS INC.**

**CondensedConsolidated Statements of OperationsThree- and Nine-Month Periods Ended September 30, 2006 and 2005(Dollars in thousands)(unaudited)**
| ** **                                                                                                             | ** ** | **Three-Month Period Ended  September 30,** | ** ** | **Nine-Month Period Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2006**                                                   | ** ** | **2005**                                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                                             | ** ** | ** **                                                 | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                                                              |       | $                                                          | 145,242    |                                                      | $          | 129,781 |   | $ | 430,205 |   | $ | 383,534 |   |
| Cost of goods sold:                                                                                                    |       |                                                       |       |                                                      |       |   |   |   |   |
| Cost of goods  sold, excluding depreciation and amortization, flood-related loss and repairs  and insurance recoveries |       | 130,815                                                    |       | 117,632                                                   |       | 387,316 |   | 344,722 |   |
| Depreciation and  amortization                                                                                         |       | 3,760                                                      |       | 3,749                                                     |       | 10,998 |   | 11,486 |   |
| Flood-related loss and  repairs                                                                                        |       | —                                                     |       | 634                                                       |       | — |   | 1,960 |   |
| Insurance recoveries                                                                                                   |       | —                                                     |       | (257                                                      | )          | — |   | (357 | ) |
| Gross profit                                                                                                           |       | 10,667                                                     |       | 8,023                                                     |       | 31,891 |   | 25,723 |   |
| Selling, general and  administrative expenses.                                                                         |       | 8,777                                                      |       | 6,110                                                     |       | 20,673 |   | 16,356 |   |
| Loss on litigation                                                                                                     |       | —                                                     |       | 2,000                                                     |       | — |   | 2,000 |   |
| Depreciation and  amortization                                                                                         |       | 28                                                         |       | 427                                                       |       | 114 |   | 1,289 |   |
| ESOP expense                                                                                                           |       | —                                                     |       | 1,630                                                     |       | 1,627 |   | 4,892 |   |
| Operating profit  (loss)                                                                                               |       | 1,862                                                      |       | (2,144                                                    | )          | 9,477 |   | 1,186 |   |
| Other income (expense):                                                                                                |       |                                                       |       |                                                      |       |   |   |   |   |
| Interest  expense, excluding amortization of deferred financing costs                                                  |       | (4,598                                                     | )          | (4,333                                                    | )          | (13,554 | ) | (12,988 | ) |
| Amortization of  deferred financing costs                                                                              |       | (391                                                       | )          | (350                                                      | )          | (1,142 | ) | (1,023 | ) |
| Government grant  income                                                                                               |       | 369                                                        |       | 1,436                                                     |       | 1,554 |   | 3,742 |   |
| Gain (loss) on  equity method investment                                                                               |       | 2                                                          |       | (1                                                        | )          | 6 |   | (1 | ) |
|                                                                                                                   |       | (4,618                                                     | )          | (3,248                                                    | )          | (13,136 | ) | (10,270 | ) |
| Loss before  income taxes                                                                                              |       | (2,756                                                     | )          | (5,392                                                    | )          | (3,659 | ) | (9,084 | ) |
|                                                                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| Income taxes                                                                                                           |       | —                                                     |       | —                                                    |       | — |   | — |   |
|                                                                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| Net loss                                                                                                               |       | $                                                          | (2,756     | )                                                         | $          | (5,392 | ) | $ | (3,659 | ) | $ | (9,084 | ) |

 

Seeaccompanying notes to condensed consolidated financial statements.

4

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**BLUE RIDGE PAPER PRODUCTS INC.**

**Condensed Consolidated Statements of Cash FlowsNine Months Ended September 30, 2006 and 2005(Dollars in thousands)(unaudited)**
| ** **                                                                                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                                                   |       | $        | (3,659     | )        | $          | (9,084 | ) |
| Net loss                                                                                                 |       |     |       |     |       |
| Adjustment to  reconcile net loss to net cash provided by operating activities:                          |       |     |       |     |       |
| Depreciation and  amortization                                                                           |       | 11,112   |       | 12,775   |       |
| Compensation  expense for Parent restricted stock                                                        |       | 25       |       | 222      |       |
| Amortization of  deferred financing costs                                                                |       | 1,142    |       | 1,023    |       |
| ESOP expense                                                                                             |       | 1,627    |       | 4,892    |       |
| Gain on sale of  assets                                                                                  |       | (6       | )          | (44      | )          |
| Parent PIK  Senior Subordinated Note for interest                                                        |       | 3,089    |       | 2,828    |       |
| Changes in  operating assets and liabilities:                                                            |       |     |       |     |       |
| Accounts  receivable, net                                                                                |       | (852     | )          | (16,106  | )          |
| Inventories                                                                                              |       | 2,557    |       | (3,283   | )          |
| Prepaid expenses                                                                                         |       | (1,103   | )          | 744      |       |
| Insurance  proceeds receivable                                                                           |       | 291      |       | 10,282   |       |
| Income tax  receivable                                                                                   |       | 50       |       | 21       |       |
| Other current  assets                                                                                    |       | —   |       | (36      | )          |
| Accounts payable                                                                                         |       | (3,916   | )          | 1,889    |       |
| Accrued expenses  and other current liabilities                                                          |       | (2,901   | )          | (857     | )          |
| Interest payable                                                                                         |       | 2,733    |       | 2,822    |       |
| Pension and  postretirement benefits                                                                     |       | 1,663    |       | 1,033    |       |
| Other assets and  liabilities                                                                            |       | 573      |       | (628     | )          |
| Net cash  provided by operating activities                                                               |       | 12,425   |       | 8,493    |       |
| Cash flows used in  investing activities:                                                                |       |     |       |     |       |
| Additions to  property, plant and equipment                                                              |       | (9,066   | )          | (12,739  | )          |
| Proceeds from  sale of property, plant and equipment                                                     |       | 17       |       | 45       |       |
| Net cash used in  investing activities                                                                   |       | (9,049   | )          | (12,694  | )          |
| Cash flows from  financing activities:                                                                   |       |     |       |     |       |
| Repurchase of  Parent common and preferred stock                                                         |       | (1,362   | )          | (1,254   | )          |
| Proceeds from  borrowings under line of credit                                                           |       | 115,515  |       | 124,800  |       |
| Repayment of  borrowings under line of credit                                                            |       | (113,677 | )          | (119,530 | )          |
| Repayments of  long-term debt and capital lease obligations                                              |       | (495     | )          | (477     | )          |
| Other financing  activities                                                                              |       | (1,715   | )          | —   |       |
| Net cash provided  by (used in) financing activities                                                     |       | (1,734   | )          | 3,539    |       |
| Net increase  (decrease) in cash                                                                         |       | 1,642    |       | (662     | )          |
| Cash, beginning of  period                                                                               |       | 2,110    |       | 2,466    |       |
| Cash, end of period                                                                                      |       | $        | 3,752      |     | $          | 1,804 |   |
| Supplemental  disclosures of cash flow information:                                                      |       |     |       |     |       |
| Cash paid for  interest, including capitalized interest of $730 and $305 in 2006 and 2005,  respectively |       | $        | 7,766      |     | $          | 7,375 |   |
| Noncash investing and  financing activities:                                                             |       |     |       |     |       |
| Conversion of  accrued interest to note payable                                                          |       | 1,999    |       | 1,831    |       |
| Issuance of restricted  stock units                                                                      |       | —   |       | 333      |       |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

 

5

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**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Dollars in thousands) (unaudited)**

**(1)  Basis of Presentation**

The accompanying unaudited condensed consolidated interim financialstatements have been prepared in accordance with Regulation S-X related tointerim period financial statements and, in the opinion of management, includeall adjustments (consisting only of normal recurring accruals) that arenecessary for the fair presentation of results for the interim periods.  Results for the nine months ended September30, 2006 may not necessarily be indicative of full-year results.  It is suggested that these condensedconsolidated interim financial statements be read in conjunction with theaudited consolidated financial statements of Blue Ridge Paper Products Inc.(the “Company”) included in the Company’s annual report on Form 10-K for theyear ended December 31, 2005.

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make a number of estimates and assumptions relating to thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements.  These estimates and assumptions also affectthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

**(2)  Liquidity**

The Company’s working capital needs are satisfiedthrough its $50,000 revolving credit facility, which expires December 15,2008.  The credit agreement requires thatthe Company meet certain financial covenants, including a minimum borrowingavailability threshold and a fixed charge coverage ratio.  At various times during 2004 and 2005, thecredit agreement was amended to reduce the minimum borrowing availabilitythreshold from $15,000 to $5,000 for specified periods of time.  On March 15, 2006, the revolving creditagreement was amended on a permanent basis to change the minimum borrowingavailability threshold from $7,500 to $5,000. For further discussion, see the Company’s annual report on Form 10-K forthe year ended December 31, 2005.  Inaddition, the Company must meet certain affirmative and negative operatingcovenants.  In the event of default or ifthe outstanding balance of the revolving credit facility is greater than$25,000, the borrowing availability falls below $5,000 and the fixed chargecoverage ratio is less than 1.1 to 1.0, the credit agreement provides foractivation of controlled bank accounts to apply daily cash collections towardthe outstanding revolving loan balance. On June 9, 2006, the revolving credit facility was amended to reduce theinterest and applicable margins by 50 to 75 basis points depending on the levelof borrowing.  Management believes theexisting credit facility is adequate for the Company’s current cash flowneeds.  Continued compliance with debtcovenants and sufficient liquidity is dependent upon business operationsconsistent with management’s plan for 2006. However, uncertainties exist within the Company’s markets that include,but are not limited to, availability and pricing of raw materials and energy,unforeseen disruption in plant operations, labor disputes, significantcompetition, relationships with large customers, product demand, environmentalcompliance, litigation, loss of key managers and exposures to interest ratechanges.

6

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The borrowingavailability at September 30, 2006 and December 31, 2005 is as follows:

|                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2006**               | ** ** | **2005**              | ** ** |
|                            |       |                   |       |                  |       |
| Borrowing base                  |       | $                      | 56,375     |                  | $          | 53,629 |   |
| Credit agreement  restriction   |       | (5,000                 | )          | (7,500                | )          |
| Suppressed  availability (1)    |       | (1,375                 | )          | —                |       |
| Credit line  availability       |       | 50,000                 |       | 46,129                |       |
| Revolver balance                |       | (35,903                | )          | (34,065               | )          |
| Letters of  credit              |       | (5,691                 | )          | (6,519                | )          |
| Maximum borrowing  availability |       | $                      | 8,406      |                  | $          | 5,545 |   |

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(1)             Theexcess of the value of the assets collateralized over the maximum line ofcredit after subtracting the credit agreement restriction.

**(3)  Inventories**

Components of inventory atSeptember 30, 2006 and December 31, 2005 are as follows:

|                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------|------------|------------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2006**               | ** ** | **2005**              | ** ** |
|                 |       |                   |       |                  |       |
| Raw materials        |       | $                      | 17,029     |                  | $          | 17,411 |   |
| Work in progress     |       | 14,837                 |       | 20,113                |       |
| Finished goods:      |       |                   |       |                  |       |
| Paper and paperboard |       | 13,388                 |       | 12,407                |       |
| Cartons              |       | 6,177                  |       | 4,057                 |       |
| Total                |       | $                      | 51,431     |                  | $          | 53,988 |   |

 

**(4)  Debt**

*9.5% Senior Secured Notes*

On December 17, 2003, the Company sold $125,000 of the 9.5% seniorsecured notes (the “Notes”) through a private placement offering underRule 144A.  The Notes have a term offive years, are due on December 15, 2008 and bear interest at a statedrate of 9.5%, which is payable semiannually in arrears on June 15 andDecember 15.  The Notes arecollateralized by a senior secured interest in substantially all of the Company’stangible and intangible assets and have a subordinated secured interest in theoutstanding trade accounts receivable and inventories.  The Company has the right to redeem the Notesat 104.75% and 100.00%, plus accrued interest on or after December 15,2006 and December 15, 2007, respectively. Terms of the indenture under which the Notes have been issued containcertain covenants, including limitations on certain restricted payments and theincurrence of additional indebtedness.

7

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*Revolving Credit Facility*

On December 17,2003, the Company entered into a revolving credit facility with a financialinstitution, which provided for maximum borrowings of $45,000, subject to aborrowing base calculated using eligible accounts receivable and inventories.  On September 15, 2004, the credit agreementwas amended to increase the maximum borrowings to $50,000 on a permanentbasis.  On August 5, 2005, the creditagreement was amended to include specified foreign account debtors as eligibleaccounts in determining borrowing base availability.  On June 9, 2006, the credit agreement wasfurther amended to reduce the interest and applicable margins by 50 to 75 basispoints depending on the level of borrowing. The revolving credit facility is collateralized by a senior securedinterest in the Company’s outstanding trade accounts receivable and inventoriesand by a subordinated secured interest in substantially all of the Company’stangible and intangible assets.  Therevolving credit facility matures on December 15, 2008, and requires theCompany to pay an annual fee of 0.375% on the unused facility amount.  The Company had an outstanding balance of$35,903 and $34,065 at September 30, 2006 and December 31, 2005, respectively,and letters of credit outstanding as of September 30, 2006 and December 31,2005 were $5,691 and $6,519, respectively. The maximum borrowing availability at September 30, 2006 was $8,406,adjusting for the availability restriction described in Note 2 above.  The interest rate on the revolving creditfacility at September 30, 2006 and December 31, 2005 was 7.69% and 7.71%,respectively.  This is a blended rate ofLIBOR contracts plus margin.

*ParentPIK Senior Subordinated Note*

BlueRidge Holding Corp. (the “Parent”) partially financed the acquisition of theCanton System from International Paper Company (formerly Champion InternationalCorporation) with a PIK Senior Subordinated Note payable to International Paperin the principal amount of $30,000, wherein interest would accrue on the unpaidprincipal balance at a rate of 9% per annum until May 14, 2007.  On November 14, 2003, the Company enteredinto an agreement with International Paper to extend the maturation date of theParent PIK Senior Subordinated Note to May 14, 2009 in return for a principalpayment of $7,000.  This payment was madeon December 17, 2003 with proceeds from the sale of the Notes.  On each semi-annual interest payment date(March 31 and September 30), the Parent records interest on this note byissuing “Secondary Notes,” which bear substantially the same terms as theoriginal Parent PIK Senior Subordinated Note. Payments of principal and interest under the Parent PIK SeniorSubordinated Note are legal obligations of the Parent and have not beenguaranteed in any way by the Company. However, the Parent will be dependent upon the Company to settle theseobligations in their entirety.  Inaddition, under certain circumstances, primarily future Parent equitytransactions transferring at least 50% of the common stock to a third party,payment by the Parent of the Parent PIK Senior Subordinated Note would betriggered prior to its maturity.  Theentire amount is due on May 14, 2009.

8

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**(5)  Retirement Plans**

*PensionPlan*

The components of netperiodic benefit costs relating to the Company’s pension plan are as followsfor the three-month periods and nine-month periods ended September 30,2006 and 2005:
| ** **                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                          | ** ** | **2006**                                        | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                        |       | $                                               | 414        |                                           | $          | 370 |   | $ | 1,231 |   | $ | 1,110 |   |
| Interest cost                       |       | 283                                             |       | 224                                            |       | 785 |   | 672 |   |
| Expected return  on assets          |       | (264                                            | )          | (225                                           | )          | (792 | ) | (675 | ) |
| Amortization of  prior service cost |       | (16                                             | )          | (13                                            | )          | (48 | ) | (39 | ) |
| Amortization of  actuarial loss     |       | 172                                             |       | 132                                            |       | 408 |   | 396 |   |
| Total net periodic  benefits costs  |       | $                                               | 589        |                                           | $          | 488 |   | $ | 1,584 |   | $ | 1,464 |   |

 

Management is primarilyresponsible for determining the cost of pension benefits for this plan. Management considered a number of factors, including consulting with anactuarial firm, when determining this cost. The Company estimates its benefits payments in fiscal year 2006 will beapproximately $326.  Benefits payments infiscal year 2005 were $355.

*PostretirementMedical Plan*

The components of netperiodic benefit costs relating to the Company’s postretirement medical planare as follows for the three-month periods and nine-month periods endedSeptember 30, 2006 and 2005:
| ** **                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **2006**                              | ** ** | **2005**                             | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                        |       | $                                     | 118        |                                 | $          | 163 |   | $ | 354 |   | $ | 489 |   |
| Interest cost                       |       | 227                                   |       | 277                                  |       | 681 |   | 831 |   |
| Amortization of  prior service cost |       | (100                                  | )          | 45                                   |       | (300 | ) | 135 |   |
| Total net periodic  benefits costs  |       | $                                     | 245        |                                 | $          | 485 |   | $ | 735 |   | $ | 1,455 |   |

 

Managementis primarily responsible for determining the cost of postretirement medicalbenefits for this plan.  Management considered a number of factors,including consulting with an actuarial firm, when determining this cost.  The Company estimates its benefits paymentsfor the fiscal year ending December 31, 2006 will be approximately $388.  Benefits payments for the fiscal year endedDecember 31, 2005 were $154.

**(6)  Recent Accounting Developments**

In December 2004, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards (“SFAS”) 123R, “Share-BasedPayment,” which requires the measurement of all employee share-based paymentsto employees, including grants of employee stock options, using afair-value-based method and the recording of such expense 

9

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in the Company’s consolidated statements of income.  The Company adopted the provisions of SFAS123R using the prospective method effective January 1, 2006.  As such, there was no accounting effect onany outstanding awards.  Upon adoption ofSFAS 123R, the Company has only one share-based payment arrangement asdescribed in the following paragraph.

Certain management employees have received restricted stock awardsentitling them to receive the Parent’s restricted common stock units.  These units vest over varying periods fromone to five years unless the Parent’s majority stockholder sells or otherwisedisposes of 80% of its shares or there is a change in control, at which timethe restricted stock units vest immediately. Restricted stock units issued under these arrangements typically containprovisions granting the holder the right, upon the occurrence of certain eventsor conditions or for the 90-day period commencing at least six months afterbecoming fully vested and share certificates being issued and not repurchased,to require the Parent to repurchase such fully vested shares of the Parent’sstock underlying the respective restricted stock awards at the then-determinedfair value, which is based on an appraisal of the Parent’s common stockperformed by an independent valuation specialist.  On June 30, 2006, restricted stock unitstotaling 230,300 became due to the employees. These units have a put option during a 90-day period beginning January1, 2007 if the employee has held their respective share certificate for atleast six months.  The Company repurchased76,483 of the fully vested shares in July 2006 to cover the tax withholding ofthe employees as allowed by the agreements. As of September 30, 2006, the Parent had issued and not repurchaseda total of 190,355 restricted stock units, net of units canceled, of which allwere fully vested.  The obligation toredeem restricted stock units of the Parent was $1,180 at September 30,2006, which is recorded in temporary equity on the condensed consolidatedbalance sheet.  The Company records thefair value of the units issued as unearned compensation as a separate componentof stockholder’s equity and amortizes them to expense over the vesting periodsof the respective units.

In November 2004, the FASB issued SFAS 151, “InventoryCosts, an Amendment of ARB No. 43, Chapter 4,” which clarifies the types ofcosts that should be expensed rather than capitalized as inventory.  This statement also clarifies thecircumstances under which fixed overhead costs associated with operatingfacilities involved in inventory production should be capitalized.  The Company adopted this standard effectiveJanuary 1, 2006.  The adoption of SFAS151 did not have a material effect on the Company’s financial position orresults of operations.

In June 2006, the FASB issued FAS Interpretation No. 48(FIN 48) “Accounting for Uncertainty in Income Taxes,” which clarifies theaccounting for uncertainty in income taxes recognized in an entity’s financialstatements in accordance with SFAS 109, “Accounting for Income Taxes.”  The accounting provisions of FIN 48 prescribea recognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  This interpretationestablishes a consistent threshold for recognizing current and deferredtaxes.  The Company will adopt theprovisions of FIN 48 effective January 1, 2007. The adoption of FIN 48 will not have a material effect on the Company’sfinancial statements or results of operations.

OnSeptember 29, 2006, the FASB issued FASB Statement No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans — AnAmendment of FASB Statements No. 87, 88, 106 and 132R.”  This new standard requires an employer to:(a) recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s under funded status: (b) measure aplan’s assets and its obligations that determine its funded status as of theend of the employer’s fiscal year (with limited exceptions); and (c) recognizechanges in the funded status of a defined benefit postretirement plan in theyear in which the changes occur.  Thosechanges will be reported in comprehensive income.  The requirement to recognize the fundedstatus of a benefit plan and the disclosure requirements are effective as ofthe end of the fiscal year ending after June 15, 2007, for entities withnon-publicly traded equity securities as defined by Statement No. 158.  The Company will adopt the provisions of StatementNo. 158 in December 2007.

10

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InSeptember 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements*.*” SAB 108provides guidance on how uncorrected errors in previous years should beconsidered when quantifying errors in current-year financial statements. SAB108 requires registrants to consider the effect of all carry over and reversingeffects of prior-year misstatements when quantifying errors in current-yearfinancial statements. SAB 108 allows registrants to record the effects ofadapting the guidance as a cumulative-effect adjustment to retained earnings. Theguidance in SAB 108 is effective for the Company in the fourth quarter of 2006.The Company does not anticipate that the adoption of SAB 108 will have amaterial effect on its consolidated financial statements.

OnSeptember 8, 2006, the FASB released FASB Staff Position (FSP AUG AIR-1), “Accounting for Planned Major MaintenanceActivities,” which prohibits the use of the “accrue in advance” methodof accounting for planned major maintenance activities in annual and interimfinancial reporting periods. The guidance in FSP AUG AIR-1 is effective for thefirst fiscal year beginning after December 15, 2006. The Company does not usethe “accrue in advance” method of accounting for planned major maintenance,therefore, the provisions of FSP AUG AIR-1 will have no effect on the Company’sinterim financial statements.

InSeptember 2006, the FASB issued Statement of Financial Accounting Standards No.157 (“Statement 157”), “FairValue Measurements.” Statement 157 establishes a framework for measuringfair value in generally accepted accounting principles and enhances disclosuresabout fair value measurements. Statement 157 applies when other accountingpronouncements require fair value measurements; it does not require new fairvalue measurements. Statement 157 applies to interim reporting and will be effectivefor the Company in the first quarter of fiscal year 2008. The Company iscurrently evaluating the effects of Statement 157 but does not anticipate thatit will have a material effect on its consolidated financial statements.

**(7) Commitmentsand Contingencies**

(a)*Purchase Commitments*

TheCompany has an agreement with International Paper for supply of wood chipsthrough May 2009. The agreement requires minimum volume purchases anddeliveries of 815,000 tons of wood chips during each contract year. These chipsare supplied by two International Paper facilities in South Carolina andTennessee and account for approximately 44% of the total Canton millrequirements. As of September 30, 2006, the Company had commitments to purchasewood chips of approximately $72,419 over the remaining term of the agreement. InMay 2006, the agreement was amended to discontinue the invoicing of in-transitchips. The agreement states that title will transfer upon delivery at theCanton mill but risk of loss in the event of casualty while in-transit will bethe responsibility of the Company.

(b)*Labor Agreements*

On July 7, 2006, a newlabor agreement was ratified between the United Steelworkers InternationalUnion (USW) and the Company. The new contract provides for annual increases of4%, 3% and 3% over the next three years, retroactive to May 14, 2006. Inaddition, the Company will increase its contribution to the bargaining unitpension plan to maintain benefits at current levels. Modifications to theemployees’ healthcare plan were also made, which included eliminating thehighest cost and least utilized healthcare plan, and increasing employeecontributions toward healthcare.

11

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(c)*Litigation, Claims and Assessments*

OnApril 15, 2003, a class action lawsuit was filed against the Company for thetime period June 1, 1999 until the date of the verdict on behalf of certainowners of property along the Pigeon River in Cocke County, Tennessee. Thedemand for damages by the class participants totaled approximately $22,500. OnAugust 17, 2005, a jury in the Circuit Court of Cocke County, Tennessee ruledin favor of the Plaintiffs awarding $2,000 for nuisance damages with nopunitive damages being awarded. A liability of $2,000 was recorded in 2005. TheCompany has appealed the decision to the Tennessee Court of Appeals EasternSection in Knoxville, Tennessee.

OnOctober 11, 2005, the Company was sued by the same plaintiff group for the samecause of action for the time period August 17, 2005 until the trial date in alawsuit filed in the Circuit Court for Cocke County, Tennessee. The plaintiffshave limited the claim for damages to $4,900. Although the complaint wasdesigned to maintain state jurisdiction, on January 12, 2006, the Companyremoved the case to Federal court. On September 19, 2006, the case was remandedback to Tennessee State Court.

On June 6, 2006, the Parent received notices of taxassessment for corporate and franchise tax for tax years 1999 through 2004. Theaggregate amount assessed is $806, consisting of $443 in taxes, $97 in interestand $266 in penalties for the full six-year period. The Parent formallyprotested the tax assessment on July 5, 2006. The Company had not recorded aliability for any amount related to this assessment as of September 30, 2006because the ultimate loss, if any, associated with the assessment is notprobable or estimable.

The Company is subject to litigation that mayarise in the normal course of business. In the opinion of management, theCompany’s liability, if any, under any pending litigation will not materiallyimpact its financial condition or operations.

(d)*EnvironmentalLiabilities*

As part of its environmental management program, the Company recognizesobligations for closure of landfills in accordance with SFAS No. 143, “Accountingfor Asset Retirement Obligations.” The Company had accrued $1,168 and $730 forthe closure of landfills at September 30, 2006 and December 31, 2005,respectively. An engineering study received in March 2006 revealed that theestimated cost to close the landfill had increased by $317. Additionally, theestimated remaining months to fill decreased by 27 months because of increasedusage in the landfill due to increased production rates at the Canton mill. TheCompany has recorded expenses of $92 and $191 in the three-month period andnine-month period ended September 30, 2006, and $26 and $77 in the three-monthperiod and nine-month period ended September 30, 2005 respectively, related tothe closure of this landfill.

**(8) Other Matters**

*Flood Losses and Government Grants*

In 2004, the Company experiencedsignificant losses related to floods caused by Hurricanes Frances and Ivan. Propertydamage losses and related repairs and maintenance from these two floods throughDecember 31, 2005 were $25,124. No additional expenses were recorded during thenine-month period ended September 30, 2006 and all recorded insurancerecoveries had been collected.

In the wake of these events, the Company was awardedthree grants for repairs and maintenance of the wastewater treatment facilitylocated within the Canton mill that is also used by the Town of Canton. Thefirst grant was awarded by FEMA for repairs incurred from the two floods. Thisgrant was in the amount of $1,479, all of which

12

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was received in the first two quarters of 2005. Thesecond grant was awarded by the State of North Carolina in the amount of $4,500to be paid on a reimbursement basis. This grant provides for flood controlrepairs and improvements to the wastewater treatment facilities. The thirdgrant for $485 was awarded under the U.S. Environmental Protection Agency thatalso provided for flood control repairs and improvements to the wastewatertreatment facilities to be paid on a reimbursement basis. The Company hasrecognized these grants to the extent they have incurred costs from repairs andimprovements resulting in the recognition of government grant income of $369and $1,554 in the three-month period and nine-month period ended September 30,2006, respectively. The Company recorded $4,910 as government grant income inthe year ended December 31, 2005. Through September 30, 2006, the Company hasrecognized as income all of the government grants awarded.

*Due Diligence Costs*

The Company incurred certain due diligence costsincluding external legal and accounting fees associated with a potentialtransaction. During the three-month period ended September 30, 2006, theCompany changed its estimate regarding the potential outcome of thistransaction; therefore, costs and fees in the amount of $2,096 were recorded inselling, general and administrative expenses.

**(9) SegmentInformation**

The Company’s management makes financial decisions and allocatesresources based on sales and operating income of the paper and packagingsegments. Although raw materials, the production processes, distributionmethods and the regulatory environment are similar, management believes it isappropriate to separately disclose these segments. The Company does notallocate selling, research and administration expenses to each segment, but managementuses operating income to measure the performance of the segments. The financialinformation attributed to these segments is included in the following tables:

**Blue Ridge PaperProducts Inc.**

**Three MonthsEnded September 30, 2006 and 2005**

**(Dollars inThousands)**
| ** **                     | ** ** | ** ** | ** ** | **Paper** | ** ** | **Packaging** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|---------------|------------|---------------|------------|-----------|------------|
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Net sales                      |       | 2006       |       | $         | 60,299     |          | $          | 84,943        |       | —    |       | $ | 145,242 |   |
|                           |       | 2005       |       | 54,299    |       | 75,482        |       | —        |       | 129,781   |       |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Operating profit  (loss)       |       | 2006       |       | 5,483     |       | 5,185         |       | (8,806        | )          | 1,862     |       |
|                           |       | 2005       |       | 5,347     |       | 2,676         |       | (10,167       | )          | (2,144    | )          |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Depreciation and  amortization |       | 2006       |       | 2,900     |       | 860           |       | 28            |       | 3,788     |       |
|                           |       | 2005       |       | 2,906     |       | 843           |       | 427           |       | 4,176     |       |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Total assets                   |       | 2006       |       | 202,833   |       | 91,044        |       | 17,094        |       | 310,971   |       |
|                           |       | 2005       |       | 201,984   |       | 95,653        |       | 15,006        |       | 312,643   |       |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Capital  expenditures          |       | 2006       |       | 2,925     |       | 888           |       | —        |       | 3,813     |       |
|                           |       | 2005       |       | 6,917     |       | 1,088         |       | 126           |       | 8,131     |       |
|                                |            |            |            |           |            |               |            |               |            |           |            |  |  |  |

 

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**Blue Ridge PaperProducts Inc.**

**Nine MonthsEnded September 30, 2006 and 2005**

**(Dollars inThousands)**
| ** **                     | ** ** | ** ** | ** ** | **Paper** | ** ** | **Packaging** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|---------------|------------|---------------|------------|-----------|------------|
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Net sales                      |       | 2006       |       | $         | 177,033    |          | $          | 253,172       |       | —    |       | $ | 430,205 |   |
|                           |       | 2005       |       | 158,091   |       | 225,443       |       | —        |       | 383,534   |       |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Operating profit  (loss)       |       | 2006       |       | 16,342    |       | 15,549        |       | (22,414       | )          | 9,477     |       |
|                           |       | 2005       |       | 14,793    |       | 10,930        |       | (24,537       | )          | 1,186     |       |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Depreciation and  amortization |       | 2006       |       | 8,429     |       | 2,569         |       | 114           |       | 11,112    |       |
|                           |       | 2005       |       | 8,997     |       | 2,489         |       | 1,289         |       | 12,775    |       |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Total assets                   |       | 2006       |       | 202,833   |       | 91,044        |       | 17,094        |       | 310,971   |       |
|                           |       | 2005       |       | 201,984   |       | 95,653        |       | 15,006        |       | 312,643   |       |
|                           |       |       |       |      |       |          |       |          |       |      |       |
| Capital  expenditures          |       | 2006       |       | 6,973     |       | 2,053         |       | 40            |       | 9,066     |       |
|                           |       | 2005       |       | 10,200    |       | 2,413         |       | 126           |       | 12,739    |       |
|                                |            |            |            |           |            |               |            |               |            |           |            |  |  |  |

####  

**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

**FORWARD-LOOKINGSTATEMENTS**

This filing includes “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. Forward-looking statements are those that do not relate solely tohistorical fact. They include, but are not limited to, any statement that maypredict, forecast, indicate or imply future results, performance, achievementsor events. They may contain words such as “believe,” “anticipate,” “expect,” “estimate,”“intend,” “project,” “plan,” “will” or words or phrases of similar meaning.

These forward-lookingstatements are not guarantees of future performance. Forward-looking statementsare based on management’s expectations that involve risks and uncertainties,including, but not limited to, economic, competitive, governmental andtechnological factors outside of our control, that may cause actual results todiffer materially from trends, plans or expectations set forth in theforward-looking statements. Given these risks and uncertainties, actual futureresults may be materially different from what we plan or expect. We will notupdate these forward-looking statements even if our situation changes in the future.

#### **QUARTERLYOVERVIEW; COMPARISON TO IMMEDIATELY PRECEDING QUARTER**

We reported a net loss of$2.8 million for the third quarter ended September 30, 2006. This compared to anet income of $2.0 million for the second quarter ended June 30, 2006 and a netloss of $5.4 million for the third quarter ended September 30, 2005. Total netsales for the third quarter ended September 30, 2006 were $145.2 millioncompared to $144.9 million and $129.8 million in the second quarter ended June30, 2006 and third quarter ended September 30, 2005, respectively.

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Our net loss wasattributable to an extended scheduled mill maintenance outage and $2.1 millionin charges related to an acquisition opportunity that did not materialize. We continuedto see significantly improved year-over-year financial performance resultingfrom strong productivity and improving market conditions.

Uncoated paper shipmentstotaled 70,829 tons in the third quarter ended September 30, 2006 compared to70,220 tons in the second quarter ended June 30, 2006. Average pricing in thethird quarter ended September 30, 2006 increased 2.2% compared to the secondquarter ended June 30, 2006 and 16.0% when compared to the third quarter endedSeptember 30, 2005. Price increases announced in the first quarter ended March31, 2006 have been substantially implemented.

Packaging segmentshipments for the quarter ended September 30, 2006 decreased 3.4% when comparedto the second quarter ended June 30, 2006. Shipments decreased compared to thesecond quarter ended June 30, 2006 due primarily to the seasonality impact fromschool milk demand. Pricing for the packaging segment for the third quarterended September 30, 2006 increased 3.0% over the second quarter ended June 30,2006. During the third quarter ended September 30, 2006, the Company signed amulti-year contract to supply gable-top cartons to a new major premium juicecustomer.

Raw material costsincreased in the third quarter ended September 30, 2006 compared to the secondquarter ended June 30, 2006 by approximately $0.7 million. This increase wasprimarily due to increases in the costs of purchased pulp, wood chips andpolyethylene. Recent decreases in energy prices have resulted in lower rawmaterial and transportation costs going into the fourth quarter.

The Canton mill conductedits annual planned hardwood pulp mill maintenance outage in the third quarterended September 30, 2006. A corresponding planned annual outage was conductedin the pine pulp mill in the second quarter ended June 30, 2006. The cost ofthe third quarter outage was approximately $3.7 million greater than the secondquarter outage due primarily to additional planned work in the recovery boilerarea and a planned maintenance outage of 3.5 days on the paperboard machine,both of which did not occur during the second quarter outage.

Through September 30,2006, we incurred due diligence and legal fees associated with a potentialgrowth opportunity totaling $2.1 million. The transaction was not consummated;therefore, these costs were expensed in the third quarter ended September 30,2006.

#### **Resultsof Operations**

The following table setsforth certain sales and operating data for our business segments for theperiods indicated:

 

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**(Dollars in millions, except per ton amounts)**
| ** **                                                           | ** ** | **Three-Month Period**       | ** ** | **Nine-Month Period  **  | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------|------------|
| ** **                                                           | ** ** | **Ended September 30,** | ** ** | **Ended September 30, ** | ** ** |
| ** **                                                           | ** ** | **2006**                          | ** ** | **2005**                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales:                                                           |       |                              |       |                                    |       |   |   |   |   |
| Packaging                                                            |       | $                                 | 84.9       |                                    | $          | 75.5 |   | $ | 253.2 |   | $ | 225.4 |   |
| Paper                                                                |       | 60.3                              |       | 54.3                                    |       | 177.0 |   | 158.1 |   |
| Total                                                                |       | $                                 | 145.2      |                                    | $          | 129.8 |   | $ | 430.2 |   | $ | 383.5 |   |
|                                                                 |       |                              |       |                                    |       |   |   |   |   |
| Segments’ operating  profit:                                    |       |                              |       |                                    |       |   |   |   |   |
| Packaging                                                            |       | $                                 | 5.2        |                                    | $          | 2.7 |   | $ | 15.6 |   | $ | 10.9 |   |
| Paper                                                                |       | 5.5                               |       | 5.3                                     |       | 16.3 |   | 14.8 |   |
| Total segments’  operating profit, excluding corporate expenses |       | $                                 | 10.7       |                                    | $          | 8.0 |   | $ | 31.9 |   | $ | 25.7 |   |
|                                                                 |       |                              |       |                                    |       |   |   |   |   |
| Corporate expenses:                                                  |       | 8.8                               |       | 10.1                                    |       | 22.4 |   | 24.5 |   |
| Total operating  profit (loss)                                       |       | $                                 | 1.9        |                                    | $          | (2.1 | ) | $ | 9.5 |   | $ | 1.2 |   |
|                                                                 |       |                              |       |                                    |       |   |   |   |   |
| Percentage of net  sales:                                            |       |                              |       |                                    |       |   |   |   |   |
| Packaging                                                            |       | 58.5                              | %          | 58.2                                    | %          | 58.9 | % | 58.8% |   |
| Paper                                                                |       | 41.5                              | %          | 41.8                                    | %          | 41.1 | % | 41.2 | % |
| Total                                                                |       | 100.0                             | %          | 100.0                                   | %          | 100.0 | % | 100.0 | % |
|                                                                 |       |                              |       |                                    |       |   |   |   |   |
| Segments’ operating  margin:                                    |       |                              |       |                                    |       |   |   |   |   |
| Packaging  segment                                                   |       | 6.1                               | %          | 3.6                                     | %          | 6.2 | % | 4.8 | % |
| Paper segment                                                        |       | 9.1                               | %          | 9.8                                     | %          | 9.2 | % | 9.4 | % |
| Average margin                                                       |       | 7.4                               | %          | 6.2                                     | %          | 7.4 | % | 6.7 | % |
|                                                                 |       |                              |       |                                    |       |   |   |   |   |
| Shipments (tons):                                                    |       |                              |       |                                    |       |   |   |   |   |
| Packaging  segment                                                   |       | 69,681                            |       | 64,404                                  |       | 210,414 |   | 194,538 |   |
| Paper segment                                                        |       | 73,737                            |       | 77,455                                  |       | 226,471 |   | 223,636 |   |
| Total                                                                |       | 143,418                           |       | 141,859                                 |       | 436,885 |   | 418,174 |   |
|                                                                 |       |                              |       |                                    |       |   |   |   |   |
| Average price ($ per  ton):                                     |       |                              |       |                                    |       |   |   |   |   |
| Packaging  segment                                                   |       | $                                 | 1,218      |                                    | $          | 1,172 |   | $ | 1,203 |   | $ | 1,159 |   |
| Paper segment                                                        |       | 818                               |       | 701                                     |       | 782 |   | 707 |   |
| Average price                                                        |       | $                                 | 1,012      |                                    | $          | 915 |   | $ | 985 |   | $ | 917 |   |

 

**THREEMONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30,2005**

*NetSales.*   Net sales forthe three-month period ended September 30, 2006, or the 2006 three-monthperiod, increased $15.4 million or 11.9% to $145.2 million compared to $129.8million for the three-month period ended September 30, 2005, or the 2005three-month period.

Net sales for ourpackaging segment for the 2006 three-month period increased $9.4 million or12.5% to $84.9 million compared to $75.5 million for the 2005 three-monthperiod.  For the 2006 three-month period,our packaging segment sold 69,681 tons of coated and converted paperboardproducts at an average price of $1,218 per ton, compared to 64,404 tons soldfor the 2005 three-month period at an average price of $1,172 per ton.  The increase in packaging segment sales isattributable to an 8.2% increase in volume shipped and a 3.9% increase in averagerevenue per ton shipped.

Net sales for our papersegment for the 2006 three-month period increased $6.0 million or 11.0% to$60.3 million compared to $54.3 million in the 2005 three-month period.  Net sales volume in our paper segmentdeclined 3,718 tons to 73,737 tons shipped in the 2006 three-month period ascompared to 77,455 tons shipped 

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in the 2005 three-monthperiod.  Most of the net sales volumedecline was related to reduced sales of non-converted bleached board, whichresulted from increased transfers to our packaging division for furtherconverting into value-added products. All of the increase in revenue for our paper segment in the 2006three-month period reflects improved pricing for our products.  Average pricing in our paper segment improvedto $818 per ton shipped in the 2006 three-month period as compared to $701 perton shipped in the 2005 three-month period.

*Operating Profit*.  Total segments’ operating profit increased$2.7 million to $10.7 million in the 2006 three-month period compared to anoperating profit of $8.0 million for the 2005 three-month period. As apercentage of sales, total segments’ operating profit increased to 7.4% in the2006 three-month period from 6.2% in the 2005 three-month period.

Thefollowing table sets forth significant items that increased (decreased) totalsegments’ operating profit:
| ** **                       | ** ** | **Three-Month Period Ended  September 30, 2006** | ** ** | **Three-Month Period Ended  September 30, 2005** | ** ** | **Change** | ** ** |
|----------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|------------|
| Segments’  Operating Profit |       | $10.7                                                                |       | $8.0                                                                 |       | $2.7       |       |

 
| Product pricing  improvement                                          |   | $      | 14.9   |   |
|-----------------------------------------------------------------------|--------|--------|--------|--------|
|                                                                  |   |   |   |
| Productivity  improvements                                            |   | 1.9    |   |
|                                                                  |   |   |   |
| Outbound  transportation costs                                        |   | (0.5   | )      |
|                                                                  |   |   |   |
| Sales of excess  NOx credits in 2005                                  |   | (1.3   | )      |
|                                                                  |   |   |   |
| Increased energy  costs                                               |   | (1.3   | )      |
|                                                                  |   |   |   |
| Plastic resin  costs used at Waynesville coating facility             |   | (2.2   | )      |
|                                                                  |   |   |   |
| Increased  chemical and other raw material costs                      |   | (2.8   | )      |
|                                                                  |   |   |   |
| Increased wage  and benefit costs                                     |   | (3.0   | )      |
|                                                                  |   |   |   |
| Additional costs  to execute semi-annual pulp mill maintenance outage |   | (2.7   | )      |
|                                                                  |   |   |   |
| Other  miscellaneous and offsetting items                             |   | (0.3   | )      |
|                                                                  |   |   |   |
| Total                                                                 |   | $      | 2.7    |   |

 

Operating profitfor our packaging segment increased $2.5 million or 92.6% in the 2006three-month period to $5.2 million or 6.1% of packaging segment sales, comparedto $2.7 million or 3.6% of packaging segment sales for the 2005 three-monthperiod.  The increase in operating profitfor our packaging segment was due primarily to: (i) increased pricing on coatedboard sales of $1.7 million and on converted carton sales of $5.0 million; (ii)improved productivity of approximately $0.7 million; and (iii) othermiscellaneous and offsetting variances totaling $0.3 million.  The increase in packaging segment operatingprofit in the 2006 three-month period was partially offset by: (i) a $2.2million increase in purchase costs of plastic/resin, our primary raw materialused at our Waynesville converting facility; (ii) a $1.5 million increase incosts of internally produced board received 

17

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from the Cantonmill and passed on to the packaging division through interdivisional transfercosts; (iii) an increase of $0.2 million in energy costs; (iv) an increase of$0.8 million in costs incurred for wages and benefits; and (v) increased costsfor packing materials and outbound transportation costs of $0.5 million.

Operating profitfor our paper segment increased $0.2 million in the 2006 three-month period to$5.5 million or 9.1% of paper segment sales, compared to an operating profit of$5.3 million or 9.8% of paper segment sales for the 2005 three-monthperiod.  The increase in operating profitfor our paper segment was due primarily to: (i) increased pricing on uncoatedpaper sales of $8.0 million and on uncoated board sales of $0.2 million; (ii)improved productivity of approximately $1.2 million; and (iii) increasedtransfer revenue for the rawstock sent to our Waynesville facility of $1.5 million.  The increase in paper segment operatingprofit in the 2006 three-month period was partially offset by: (i) a $1.1million increase in purchase costs of fuels and electricity consumed at ourCanton, North Carolina mill; (ii) a $2.5 million increase in the cost of woodchips, chemicals and other primary raw material used at our Canton, NorthCarolina mill; (iii) the sale of excess NOx credits of approximately $1.3million in the 2005 three-month period; (iv) a $2.2 million increase in costsincurred for wages and benefits; (v) a $0.3 million increase in outboundtransportation costs due primarily to higher fuel costs; (vi) increased costsof $2.7 million to execute our fall pulp mill maintenance outage due toadditional scope of work as compared to the semi-annual outage we completed inthe 2005 three-month period; and (vii) other miscellaneous and offsettingvariances totaling $0.6 million.

*Selling,General and Administrative Expenses. *Totalselling, general and administrative expenses increased $2.7 million or 44.3% to$8.8 million in the 2006 three-month period compared to $6.1 million for the2005 three-month period.  The increase inselling, general and administrative expenses for the 2006 three-month periodwas attributable to increased salary payroll costs of approximately $0.6million and the incurrence of $2.1 million in due diligence expense in the 2006three-month period.  Through September30, 2006, the Company incurred due diligence and legal fees associated with apotential growth opportunity totaling $2.1 million.  The transaction was not consummated;therefore, these costs were expensed in the quarter ended September 30, 2006.

*Loss onLitigation.*  There wasno expense recognized for loss on litigation in the 2006 three-month period;however, we did establish a $2.0 million liability in the 2005 three-monthperiod to recognize the potential liability from a class action lawsuit thatwas filed against us on behalf of certain owners of property along the PigeonRiver in Cocke County, Tennessee.  Thedemand for damages by the class participants totaled approximately $22.5million.  On August 17, 2005, a jury inthe Circuit Court of Cocke County, Tennessee ruled in favor of the Plaintiffsawarding $2.0 million for nuisance damages with no punitive damages beingawarded.  We have appealed this verdictto the Tennessee appellate court.

*Depreciation and Amortization Expense (non-operations).*  Depreciation and amortization expensesunrelated to manufacturing decreased $0.4 million or 100% to $0.0 million inthe 2006 three-month compared to $0.4 million in the 2005 three-monthperiod.  The drop in depreciation expenserelates primarily to the completion of depreciation on system-related assetspurchased in prior years.

*ESOP Expense. *ESOP expensedecreased $1.6 million or 100.0% to $0.0 million in 2006 three-month periodcompared to $1.6 million in the 2005 three-month period.  The ESOP expense is a non-cash expense, whichresults from the annual transfer of shares into the ESOP.  The amount of the ESOP expense varies withthe value of the shares of our parent’s common stock, which is determined by anindependent valuation specialist at the end of each year.  The decrease in the 2006 three-month periodreflects the decline in annual valuation of the shares of our Parent’s commonstock to $6.20 per share in fiscal year 2006 compared to $9.06 in fiscal year2005 as well as the completion of the seven-year share distribution into theESOP, which began in May 1999 

18

----

 

andended in May 2006.  Going forward, onemore valuation adjustment will be recorded in the fourth quarter of 2006.  Following that adjustment, we should nolonger incur ESOP expense.

*Interestand Amortization Expenses.  *Interestand amortization expenses increased $0.3 million to $5.0 million for the 2006three-month period compared to $4.7 million for 2005 three-month period.  This increase is due primarily to anincreased borrowing level and increased interest rate on our revolving line ofcredit as well as increased amounts outstanding on our Parent PIK SeniorSubordinated Note.

*GovernmentGrant Income.*  Floodprevention activities continue at our Canton, North Carolina mill following theflood damage incurred at the mill in 2004. In the 2006 three-month period, we recognized government grant income of$0.4 million as compared to $1.4 million in the 2005 period.  The grant is being used to repair and morepermanently protect our wastewater facility, which also serves the Town ofCanton, North Carolina.  As of the end ofthe 2006 three-month period, we have recorded income for all grants awarded todate.

*IncomeTax Expense.*  There wasno income tax expense recorded in either the 2006 three-month period or 2005three-month period.  This was due to ouryear-to-date net losses as of September 30, 2006 and 2005.

**NINEMONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,2005**

*NetSales. *Net sales forthe nine months ended September 30, 2006, or the 2006 nine-month period,increased to $430.2 million or 12.2*%*comparedto**$383.5 million for the ninemonths ended September 30, 2005, or the 2005 nine-month period.  This increase in total revenue isattributable to an increase in the average weighted revenue per ton shipped to$985 per ton in the 2006 nine-month period from $917 per ton in the 2005nine-month period as well as an increase in the total volume of productsshipped.  The increase in average revenueper ton sold resulted primarily from continued improvement pricing in all fourof our major grade lines: paper, uncoated board, coated board and cartons.  The increase in average weighted revenue perunit sold resulted in an approximate $29.7 million increase in total revenue inthe 2006 nine-month period as compared to the 2005 nine-month period.  Total sales volume increased by 18,711 tonsor 4.5% to 436,885 tons in the 2006 nine-month period compared to 418,174 tonsfor the 2005 nine-month period.

Net sales for ourpackaging segment for the 2006 nine-month period increased $27.8 million or12.3% to $253.2 million compared to $225.4 million for the 2005 nine-monthperiod.  The increase in net sales isattributable to: (i) an average net sales price per ton increase of 9.4% forcartons and 5.9% for non-converted coated paperboard in the 2006 nine-monthperiod compared to the 2005 nine-month period; and (ii) a 24.9% increase involume of our non-converted coated paperboard shipments in the 2006 nine-monthperiod as compared to the 2005 nine-month period.  The increase in net sales was partially offsetby a decrease in shipment volume for our converted cartons of 7.0% in the 2006nine-month period as compared to the 2005 nine-month period.

Sales for our papersegment for the 2006 nine-month period have increased by $18.9 million or 12.0%to $177.0 million compared to $158.1 million for the 2005 nine-monthperiod.  This increase was attributableto an improvement in our average net sales price per ton for our products soldas well as increased shipment volume. Our average net sales price per ton increased 10.7% for our paper gradesand 6.6% for uncoated paperboard in the 2006 nine-month period as compared tothe 2005 nine-month period.  Totalsegment outside shipment volume increased 2,835 tons or 1.3% to 226,471 tons inthe 2006 nine-month period as compared to 223,636 tons in the 2005 nine-monthperiod.  The increase in the papersegment shipment volume reflects improved productivity at our Canton, NorthCarolina manufacturing facility.  Thisimproved productivity also enabled us to increase transfers of uncoated boardto our packaging division for further value-added converting.

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*Operating Profit*.  Total segments’ operating profit increased$6.2 million to $31.9 million in the 2006 nine-month period compared to anoperating profit of $25.7 million for the 2005 nine-month period. As a percentageof sales, total segments’ operating profit increased to 7.4% in the 2006nine-month period from 6.7% in the 2005 nine-month period.

Thefollowing table sets forth significant items that increased (decreased) totalsegments’ operating profit:
| ** **                       | ** ** | **Nine-Month Period Ended  September 30, 2006** | ** ** | **Nine-Month Period Ended  September 30, 2005** | ** ** | **Change** | ** ** |
|----------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|
| Segments’  Operating Profit |       | $31.9                                                               |       | $25.7                                                               |       | $6.2       |       |

 
| Product pricing  improvement                                               |   | $      | 35.4   |   |
|----------------------------------------------------------------------------|--------|--------|--------|--------|
|                                                                       |   |   |   |
| Net flood impact  in 2005                                                  |   | 2.0    |   |
|                                                                       |   |   |   |
| Productivity  improvements                                                 |   | 4.5    |   |
|                                                                       |   |   |   |
| Increased wage  and benefit costs                                          |   | (6.9   | )      |
|                                                                       |   |   |   |
| Outbound  transportation costs                                             |   | (1.5   | )      |
|                                                                       |   |   |   |
| Increased wood  and purchased fiber costs                                  |   | (5.1   | )      |
|                                                                       |   |   |   |
| Major raw  material costs (plastic resin, chemicals and packing materials) |   | (10.2  | )      |
|                                                                       |   |   |   |
| Additional costs  to execute semi-annual pulp mill outages                 |   | (2.3   | )      |
|                                                                       |   |   |   |
| Change in  inventory valuation                                             |   | (1.3   | )      |
|                                                                       |   |   |   |
| Increased energy  costs                                                    |   | (4.6   | )      |
|                                                                       |   |   |   |
| Sales of excess  NOx credits in 2005                                       |   | (2.2   | )      |
|                                                                       |   |   |   |
| Other  miscellaneous and offsetting items                                  |   | (1.6   | )      |
|                                                                       |   |   |   |
| Total                                                                      |   | $      | 6.2    |   |

####  

Operating profitfor our packaging segment in the 2006 nine-month period increased $4.7 millionto $15.6 million compared to $10.9 million for the 2005 nine-month period.  The increase was primarily due to increases inthe average net selling prices for coated paperboard and carton products of9.4% and 5.9%, respectively, compared to the 2005 nine-month period, adding$18.7 million to revenues and operating profit for the 2006 nine-month periodas compared to the 2005 nine-month period. In addition, other miscellaneous and offsetting items totaling $0.3million added to operating profit for the 2006 nine-month period.  The increase in packaging segment operatingprofit in the 2006 nine-month period was partially offset by: (i) a $3.7million increase in purchase costs of plastic/resin, our primary raw materialused at our Waynesville converting facility; (ii) reduced productivity for thesegment of approximately $0.2 million and centered in our carton manufacturingvolume, reflecting lower converted carton demand; (iii) a $3.7 million increasein our wage and benefits costs; (iv) increased transfer cost of rawstockpaperboard of $4.3 million; (v) increased energy costs of $0.6 million; 

20

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(vi) impact ofchange in inventory valuation in the 2005 nine-month period of $0.9 million;(vii) a $0.1 million increase in outbound transportation costs due primarily tohigher fuel costs; and (viii) increased costs for miscellaneous raw materialsof $0.8 million.

Operating profit for our paper segment increased $1.5 million in the2006 nine-month period to $16.3 million as compared to $14.8 million for the2005 nine-month period.  The increase inoperating profit for our paper segment was due primarily to: (i) increasedpricing on paper sales of $16.2 million and on uncoated board sales of $0.5million; (ii) an approximate $4.7 million from improved productivity; (iii)increased transfer cost for the rawstock sent to our Waynesville facility of$4.3 million; and (iv) flood losses, net of insurance proceeds, of $2.0 millionincurred in the 2005 nine-month period. The increase in paper segment operating profit in the 2006 nine-monthperiod was partially offset by: (i) a $4.0 million increase in purchase costsof fuels and electricity consumed at our Canton, North Carolina mill; (ii) a$1.4 million increase in outbound transportation costs due primarily to higherfuel costs; (iii) a $4.3 million increase in the cost of wood chips, ourprimary raw material at our Canton, North Carolina mill; (iv) an approximate$6.5 million increase in cost of chemicals and packing materials utilized inour manufacturing process; (v) increased wage and benefits costs of $3.2million; (vi) the sale of excess NOx credits of approximately $2.2 million inthe 2005 nine-month period; (vii) impact of change in inventory valuation inthe 2005 nine-month period of $0.4 million; (viii) increased costs of $2.3million to execute our two semi-annual pulp mill maintenance outages in the2006 nine-month period due to additional scope of work as compared to the outagesconducted in the 2005 nine-month period; and (ix) other miscellaneous and offsetting variances totaling $1.9million.

*Selling,General and Administrative Expenses.  *Totalselling, general and administrative expenses increased $4.3 million or 26.2% to$20.7 million in the 2006 nine-month period compared to $16.4 million for the2005 nine-month period.  The increase inselling, general and administrative expenses for the 2006 nine-month period wasprimarily attributable to: (i) reduction of a $0.5 million environmentalreserve in the 2005 nine-month period; (ii) increased salary payroll costs ofapproximately $0.8 million primarily related to merit adjustments andmanagement incentive payments;  (iii) a$0.7 million reversal in the 2005 nine-month period of severance reservesrelated to the completed closure of our Fort Worth, Texas DairyPak facility andother miscellaneous severance transactions; (iv) the incurrence of $2.1 millionin due diligence expenses in 2006; and (v) other miscellaneous and offsettingvariance totaling $0.2 million.

*Loss onLitigation.*  There wasno expense recognized for loss on litigation in the 2006 nine-month period;however, we did establish a $2.0 million liability in the 2005 nine-monthperiod to recognize the potential liability from a class action lawsuit thatwas filed against us on behalf of certain owners of property along the PigeonRiver in Cocke County, Tennessee.  Thedemand for damages by the class participants totaled approximately $22.5million.  On August 17, 2005, a jury inthe Circuit Court of Cocke County, Tennessee ruled in favor of the Plaintiffsawarding $2.0 million for nuisance damages with no punitive damages beingawarded.  We have appealed this verdictto the Tennessee appellate court.

*Depreciation and Amortization Expense (non-operations).*  Depreciation and amortization expensesunrelated to manufacturing decreased $1.2 million to $0.1 million in the 2006nine-month compared to $1.3 million in the 2005 nine-month period.  The drop in depreciation expense relatesprimarily to the completion of depreciation on system-related assets purchasedin prior years.

*ESOP Expense. *ESOP expensedecreased $3.3 million or 67.3% to $1.6 million in 2006 nine-month periodcompared to $4.9 million in the 2005 nine-month period.  The ESOP expense is a non-cash expense, whichresults from the annual transfer of shares into the ESOP.  The amount of the ESOP expense varies withthe value of the shares of our Parent’s common stock, which is determined by anindependent valuation specialist at the end of each year.  The decrease in the 2006 nine-month periodreflects the decline in annual valuation of the 

21

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sharesof our Parent’s common stock to $6.20 per share in fiscal year 2006 compared to$9.06 in fiscal year 2005 as well as the completion of the seven-year sharedistribution into the ESOP, which began in May 1999 and ended in May 2006.  Going forward, one more valuation adjustmentwill be recorded in the fourth quarter of 2006. Following that adjustment, we should no longer incur ESOP expense.

*Interest and Amortization Expenses.  *Interest and amortizationexpenses increased $0.7 million to $14.7 million for the 2006 nine-month periodcompared to $14.0 million for the 2005 nine-month period.  This increase is due primarily to anincreased borrowing level and increased interest rate on our revolving line ofcredit as well as increased amounts outstanding on our Parent PIK SeniorSubordinated Note.

*GovernmentGrant Income.*  Floodprevention activities continue at our Canton, North Carolina mill following theflood damage incurred at the mill in the 2004. In the 2006 nine-month period, we recognized government grant incometotaling approximately $1.6 million compared to $3.7 million in the 2005nine-month period.  The grants are beingused to repair and more permanently protect our wastewater treatment facility,which also serves the Town of Canton, North Carolina.  As of the end of the 2006 nine-month period,we have recorded income for all grants awarded to date.

*IncomeTax Expense.*  There wasno income tax expense recorded in either the 2006 nine-month period or 2005nine-month period since we had a year-to-date net loss in both of the periods.

#### **LIQUIDITYAND CAPITAL RESOURCES**

Our principal liquidityrequirements are to service our debt and fund our operations and capitalexpenditure needs.  Our total seniordebt, defined as total debt less the Parent PIK Senior Subordinated Note, atSeptember 30, 2006 was $162.7 million. Subject to our performance, which if adversely affected could affect theavailability of funds, we expect to be able to meet our liquidity requirementsfor the remainder of fiscal year 2006 through cash provided by operations andthrough borrowings available under our working capital facility.  We cannot assure you, however, that this willbe the case.  In December 2003, we issued$125.0 million of the Notes in a private offering.  Proceeds from issuance of the Notes were usedto repay our Term Loans A and B and our then existing revolving credit facilityunder the 1999 credit agreement.  Inaddition, we paid $7.0 million on the Parent PIK Subordinated Note.  We entered into a $45.0 million revolvingcredit facility in December 2003.  OnSeptember 15, 2004, the credit agreement was amended to increase the facilityfrom $45.0 million to $50.0 million on a permanent basis.  On August 5, 2005, the credit agreement wasamended to include specified foreign account debtors as eligible accounts indetermining borrowing base availability. On March 15, 2006, the revolving credit agreement was amended on apermanent basis to change the minimum borrowing availability threshold from$7.5 million to $5.0 million.  On June 9,2006, the credit agreement was further amended to reduce the interest andapplicable margins by 50 to 75 basis points depending on level ofborrowing.  The maximum borrowingavailability at September 30, 2006 and December 31, 2005 was $8.4 million and$5.5 million, respectively.  Adding themaximum borrowing availability to the cash on hand increases our totalliquidity to $12.2 million and $7.7 million at September 30, 2006 and December31, 2005, respectively.  The revolvingcredit facility contains covenant restrictions, which require covenantavailability to exceed $5.0 million (as amended March 15, 2006).  If the covenant availability does not meetthe required minimum availability, a fixed charge coverage ratio covenant of1.1 to 1.0 will be triggered.  As ofSeptember 30, 2006, we had a covenant availability of $14.8 million, which is$9.8 million in excess of the required minimum of $5.0 million.  This availability includes $1.4 million ofsuppressed availability.  Covenantavailability is defined as borrowing base less outstanding revolver and lettersof credit.

22

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Summary of Cash Flow ($in millions):
| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| Net cash  provided by operating activities           |       | $                                                       | 12.4       |   | $ | 8.5 |   |
| Net cash used in  investing activities               |       | (9.1                                                    | )          | (12.7 | ) |
| Net cash  provided by (used in) financing activities |       | (1.7                                                    | )          | 3.5 |   |
| Net increase  (decrease) in cash                     |       | $                                                       | 1.6        |   | $ | (0.7 | ) |
| Cash balance                                         |       | $                                                       | 3.8        |   | $ | 1.8 |   |

 

The cash provided byoperations was $12.4 million for the 2006 nine-month period.  The improvement in cash provided byoperations when compared to the 2005 nine-month period was attributable to the decreasedloss discussed in the Management’s Discussion and Analysis of FinancialCondition and Results of Operations as well as changes in working capital asreflected in the condensed consolidated statements of cash flows includedelsewhere in this quarterly report on Form 10-Q.

The cash used ininvesting activities for the 2006 nine-month period was $9.1 million.  Capital spending for the 2006 nine-monthperiod was $9.1 million of which $1.6 million was reimbursed by governmentgrants.  For the fiscal year endingDecember 31, 2006, we currently estimate that our capital spending will beapproximately $12.2 million of which $1.6 million will be offset bygovernment grants.

Net cash used infinancing activities was $1.7 million for the 2006 nine-month period, which isprimarily attributable to net borrowings on our revolving line of credit.

**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

Weare exposed to certain market risks, including interest rate risk.  Risk exposure relating to this market risk issummarized below.  This informationshould be read in connection with the condensed consolidated financialstatements and the related notes thereto included elsewhere in this quarterlyreport on Form 10-Q.

We manage interest costusing a combination of fixed and variable rate debt.  As of September 30, 2006, we have $125.0million of Notes outstanding at a 9.5% fixed rate of interest and a $50.0million working capital credit facility at variable rates of interest.  As of September 30, 2006, approximately $35.9million was outstanding under our working capital credit facility consisting ofshort-term interest rates of 0.25% over Applicable Revolver Index Margin and2.00% over Applicable Revolver Libor Margin, as defined in the Credit Agreementdated as of December 17, 2003.  Ourworking capital facility offers two options for interest rates:  Applicable Revolver Libor Margin ranging from2.25% - 2.75% or Applicable Revolver Index Margin ranging from 0.50% -1.00%.  These rates were amended June 9,2006 to reduce interest of Applicable Revolver Libor Margin to 1.50% - 2.00%and Applicable Revolver Index Margin to 0.00% - 0.25%.  The rate is based on revolver availability.  At the end of September 2006, we were at thehigh point of the interest rate grid for Libor and Index Margins.  In addition, as of September 30, 2006, wehave a $0.7 million mortgage note with a maximum interest rate of 5.5% and aremaining duration of four years.

#### **ITEM4. CONTROLS AND PROCEDURES**

(A) Evaluation ofDisclosure Controls and Procedures

 

23

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Our management, with theparticipation of our Chief Executive Officer and Chief Financial Officer, hascarried out an evaluation of the effectiveness of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)), as of the end of theperiod covered by this report.  Our ChiefExecutive Officer and Chief Financial Officer have concluded that, as of theend of such period, our disclosure controls and procedures were effective inensuring that all material information required to be disclosed by the Companyin this quarterly report on Form 10-Q was recorded, processed, summarized,reported and properly disclosed in the time periods specified in the rules andforms of the Securities and Exchange Commission, and that such information wasaccumulated and communicated to our management (including our Chief ExecutiveOfficer and Chief Financial Officer) to allow timely decisions regardingrequired disclosure.  Based on suchevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that the Company is in compliance with Rule 13a-15(e) of the ExchangeAct.

(B) Changes inInternal Controls Over Financial Reporting

There have been nosignificant changes in our internal controls over financial reporting duringthe three months ended September 30, 2006 that have materially affected or arereasonably likely to materially affect our internal control over financialreporting.

**PART II.  OTHER INFORMATION**

#### **ITEM1A.  RISK FACTORS**

The risk factors includedin our Annual Report on Form 10-K for the fiscal year ended December 31, 2005have not materially changed other than as disclosed in our quarterly report onForm 10-Q ended June 30, 2006.

#### **ITEM5. OTHER INFORMATION**

None

#### **ITEM6. EXHIBITS**

(a) Exhibits required by Item 601 of Regulation S-K

10.1 United Steelworkers International Union LaborAgreement with Blue Ridge Paper Products Inc.

31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Actof 2002

31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Actof 2002

24

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## **SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

**BLUERIDGE PAPER PRODUCTS INC.**

Date:  November 9, 2006
| ** ** | **/S/ JOHN B. WADSWORTH**            |
|------------|--------------------------------------|
|       | John B.  Wadsworth                   |
|       | Chief Financial  Officer             |
|       |                                 |
|       | (On behalf of  the Registrant and as |
|       | Principal  Financial Officer)        |

###  

25

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### EXHIBIT INDEXTOFORM 10-QOFBLUE RIDGE PAPER PRODUCTS INC.FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006Pursuant to Section 102(d) of Regulation S-T(17 C.F.R. Section 232.102(d))

The following exhibitsare filed as part of this report:

10.1                           UnitedSteelworkers International Union Labor Agreement with Blue Ridge Paper ProductsInc.

31.1                           Certificationof CEO pursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2                           Certificationof CFO pursuant to Section 302 of Sarbanes-Oxley Act of 2002

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