Cellu Tissue (CLU) 10-Q/A 2009 Q1 Quarterly report (amended)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

Amendment No. 1

(Mark One)

	x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended May 29, 2008
or
	o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from          to         .

Commission file number 333-118829

Cellu Tissue Holdings, Inc.

(Exact name of registrant as specified in its charter)

Delaware	06-1346495
(State of incorporation)	(IRS Employer Identification No.)
1855 Lockeway Drive, Suite 501, Alpharetta , Georgia	30004
(Address of principal executive offices)	(zip code)

(678) 393-2651

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company in Rule 12b-2 of the Exchange Act (Check One):.

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes oNo x

The number of shares outstanding of each of the registrant’s classes of common stock as of July 3, 2008:

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

Explanatory Note

This Amendment No. 1 on Form 10-Q/A (this “Amendment”) amends the Quarterly Report of Cellu Tissue Holdings, Inc. (the “Company”) on Form 10-Q for the quarterly period ended May 29, 2008, as filed with the Securities and Exchange Commission on July 11, 2008 (the “Original Filing”).  This Amendment is being filed for the purpose of restatement to correct errors in (i) accounting for deferred income taxes in connection with purchase accounting applied in fiscal 2007, (ii) classification of borrowings and repayments on the revolving credit facility in the statement of cash flows, and certain other adjustments that were initially deemed to be not material by management, including (a) classification of shipping and handling costs in accordance with EITF 00-10, Accounting for Shipping and Handling Fees and Costs (EITF 00-10), (b) accounting for derivative instruments, (c) accounting for foreign exchange gains and losses in fiscal 2008 and 2007, and (d) certain other miscellaneous adjustments as described in Note 2 to the consolidated financial statements.All applicable amounts relating to this restatement have been reflected in the consolidated financial statements and disclosed in the notes to the consolidated financial statements in this amended Form 10-Q/A. For discussion of the individual restatement adjustments, see Note 2 to the consolidated financial statements. Additionally, see Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 For the convenience of the reader, this Form 10-Q/A sets forth the first quarter 2008 Form 10-Q in its entirety. However, this Form 10-Q/A only amends and restates certain information in Items 1, 2 and 4 of Part I, and Item 6 of Part II of the Original Filing, and no other items in the Original Filing are amended hereby. Except for the amended and restated information described above, the foregoing items have not been updated to reflect events subsequent to July 11, 2008, the filing date of the Original Filing. Accordingly, this Form 10-Q/A should be read in conjunction with our filings made with the Securities and Exchange Commission (SEC) on and after the filing of the Original Filing. Pursuant to the rules of the SEC, Item 6 of Part II of the Original Filing has been amended to contain currently-dated certifications from our chief executive officer and chief financial officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.

Except as expressly stated or where the context requires otherwise, the information in this amended Form 10-Q/A generally speaks as of July 11, 2008, the date on which the Original Filing was filed with the SEC.

Background

On January 8, 2009, we announced that we were reviewing (i) accounting for deferred income taxes in connection with purchase accounting in fiscal year 2007 and other purchase accounting items from that fiscal year, (ii) classification of shipping and handling fees and costs under EITF 00-10 and (iii) accounting treatment of other selected accounts.  On January 20, 2009, our management and the audit committee of our Board of Directors have determined that our consolidated financial statements for fiscal years 2007 and 2008 and the first two quarters of fiscal 2009 should no longer be relied upon.  In addition to this Form 10-Q/A, we are amending our Annual Report on Form 10-K for fiscal 2008 and our Quarterly Report on Form 10-Q for the second quarter of fiscal 2009 to reflect the restatements described above.

CELLU TISSUE HOLDINGS, INC.

FORM 10-Q/A

QUARTER ENDED MAY 29, 2008

INDEX

PART I – FINANCIAL INFORMATION
Item 1.	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 6.	Exhibits
SIGNATURES

2

PART I FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements

CELLU TISSUE HOLDINGS, INC.  AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	Three Months Ended
	May 29		May 31
	2008		2007
	(Restated)		(Restated)
Net sales	$114,527,561		$106,226,949
Cost of goods sold	102,739,657		98,341,184
Gross profit	11,787,904		7,885,765
Selling, general and administrative expenses	4,959,842		4,482,737
Terminated acquisition-related transaction costs	75,000		-
Stock and related compensation expense	218,506		233,119
Income from operations	6,534,556		3,169,909
Interest expense, net	4,979,688		5,019,094
Foreign currency gain	(43,080	)	(30,850	)
Other expense (income)	29,508		(42,239	)
Income (loss) before income tax	1,568,440		(1,776,096	)
Income tax expense (benefit)	575,970		(634,255	)
Net income (loss)	$992,470		($1,141,841	)

See accompanying notes to consolidated financial statements.

3

CELLU TISSUE HOLDINGS, INC.  AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	May 29		February 29
	2008		2008
	(Unaudited)
	(Restated)		(Restated)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$1,625,424		$883,388
Receivables, net	52,197,208		44,542,337
Inventories	34,900,313		33,996,439
Prepaid expenses and other current assets	3,006,025		3,745,989
Income tax receivable	142,966		177,281
Deferred income taxes	6,216,017		7,157,191
TOTAL CURRENT ASSETS	98,087,953		90,502,625
PROPERTY, PLANT AND EQUIPMENT, NET	306,936,967		310,488,081
GOODWILL	11,334,755		11,334,755
TRADEMARKS	9,400,000		9,400,000
OTHER ASSETS	1,515,762		1,491,218
TOTAL ASSETS	$427,275,437		$423,216,679
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Revolving line of credit	$18,000,000		$9,800,000
Accounts payable	22,002,057		24,055,782
Accrued expenses	21,536,099		19,085,912
Accrued interest	3,765,379		8,253,915
Other current liabilities	15,000,000		15,000,000
Current portion of long-term debt	760,000		760,000
TOTAL CURRENT LIABILITIES	81,063,535		76,955,609
LONG-TERM DEBT, LESS CURRENT PORTION	197,862,013		198,086,944
DEFERRED INCOME TAXES	81,065,985		81,940,082
OTHER LIABILITIES	20,136,068		20,148,590
STOCKHOLDERS’ EQUITY:
Common stock, $.01 par value, 1,000 shares authorized, 100 shares issued and outstanding	1		1
Capital in excess of par value	47,253,720		47,035,214
Accumulated deficit	(1,869,647	)	(2,862,117	)
Accumulated other comprehensive income	1,763,762		1,912,356
TOTAL STOCKHOLDERS’ EQUITY	47,147,836		46,085,454
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$427,275,437		$423,216,679

See accompanying notes to consolidated financial statements.

4

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three Months Ended
	May 29		May 31
	2008		2007
	(Restated)		(Restated)
Cash flows from operating activities
Net income (loss)	$992,470		($1,141,841	)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Stock-based compensation	218,506		196,297
Deferred income taxes	67,077		(1,317,791	)
Accretion of debt discount	155,069		150,772
Derivatve loss (gain)	119,802		(13,359	)
Depreciation	5,854,038		6,939,527
Changes in operating assets and liabilities, net of the effects of acquisition:
Receivables	(7,654,871	)	194,152
Inventories	(903,874	)	906,690
Prepaid expenses and other current assets and income tax receivable	774,279		555,019
Other			(1,521	)
Accounts payable, accrued expenses and accrued interest	(4,103,876	)	(3,619,187	)
Total adjustments	(5,473,850	)	3,990,599
Net cash (used in) provided by operating activities	(4,481,380	)	2,848,758
Cash flows from investing activities
Cash paid for acquisition, net of cash received	-		(43,343,798	)
Capital expenditures	(2,474,891	)	(2,646,346	)
Other	(145,252	)	383,835
Net cash used in investing activities	(2,620,143	)	(45,606,309	)
Cash flows from financing activities
Payments of long-term debt	(380,000	)	-
Payment on revolving line of credit	(18,300,000	)	(3,000,000	)
Borrowings on revolving line of credit	26,500,000		17,400,000
Proceeds from bond offering	-		20,000,000
Net cash provided by financing activities	7,820,000		34,400,000
Effect of foreign currency	23,559		83,897
Net increase (decrease) in cash and cash equivalents	742,036		(8,273,654	)
Cash and cash equivalents at beginning of period	883,388		16,260,601
Cash and cash equivalents at end of period	$1,625,424		$7,986,947

See accompanying notes to consolidated financial statements.

5

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

May 29, 2008

Note 1 Basis of Presentation and Significant Accounting Policies

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

These statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the quarter ended May 29, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending February 28, 2009.  For further information, refer to the Company’s consolidated financial statements and footnotes thereto as of February 29, 2008 and for the year then ended included in the Company’s Annual Report on Form 10-K/A, from which the consolidated balance sheet at February 29, 2008 has been derived, and the Company’s latest current reports on Form 8-K, each as filed with the Securities and Exchange Commission (“SEC”).

Stock-Based Compensation

The Company accounts for stock based compensation in accordance with Statement of Financial Accounting Standards No. 123R (“SFAS 123R”), Share-Based Payment, which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using the fair-value-based method and the recording of such expense in the Company’s consolidated statement of operations.  The Company has one share-based payment arrangement under the 2006 Stock Option and Restricted Stock Plan (the “Plan”).  Under the Plan, the administrator of the Plan (the “Plan Administrator”) may make awards of options to purchase shares of common stock of Cellu Parent and/or awards of restricted shares of common stock of Cellu Parent.  A maximum of 8,095 shares of common stock of Cellu Parent may be delivered in satisfaction of awards under the Plan, determined net of shares of common stock withheld by Cellu Parent in payment of the exercise price of an

6

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

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

award or in satisfaction of tax withholding requirements.  Key employees and directors of, and consultants and advisors to, Cellu Parent or its affiliates who, in the opinion of the Plan Administrator, are in a position to make a significant contribution to the success of Cellu Parent and its affiliates are eligible to participate in the Plan.   Stock options are granted at the market price of Cellu Parent’s stock on the date of grant and have a 10-year term.  Generally, stock option grants vest ratably over four years from the date of grant.  The following describes how certain assumptions affecting the estimated fair value of stock options are determined.  The dividend yield is zero; the volatility is based on historical market value of Cellu Parent’s stock; and the risk-free interest rate is based on U.S. Treasury securities.  The Company includes historical data to estimate exercise, termination and holding period behavior for valuation purposes.  A summary of the outstanding options as of May 29, 2008 and the activity during the three months then ended is as follows:

	Options		Weighted Average Exercise Price	Weighted Average Remaining Contractual Life
Outstanding, February 29, 2008	1,125		$ 733.67	8.59 Years
Forfeited	(125	)	$ 979.25	8.86 Years
Granted	444		$ 942.99	9.85 Years
Outstanding, May 29, 2008	1,444		$ 776.77	8.95 Years
Exercisable, May 29, 2008	250		$ 702.97	8.56 Years

The fair value of the stock option grants was estimated on the date of grant using the Black-Scholes option pricing model.  The assumptions used to value the grants were: no dividend yield; 55% volatility; 1.4% risk free interest rate; and 10-year expected life.  The weighted average fair value of stock options granted was $498.18 per share and the unrecognized total compensation cost as of May 29, 2008 related to nonvested awards is $591,166.

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

7

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

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

tax as a result of making a Section 83(b) election under the Internal Revenue Code of 1986, as amended.  The named individual has made a timely Section 83(b) election.  In connection with this election, the Company has recorded compensation expense of $42,255 for the three months ended May 29, 2008.

On June 12, 2006, Cellu Parent entered into Restricted Stock Agreements with the Company’s Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, pursuant to which Cellu Parent granted 3,778 restricted shares of its common stock to the Chief Executive Officer and 1,349 restricted shares of its common stock to each of the other two named individuals pursuant to the Plan.  The shares will vest and cease to be restricted in four equal annual installments commencing on June 12, 2007, as long as the named individual, as the case may be, is continuously employed by the Company until each such vesting date with respect to his or her shares.  Any restricted stock outstanding at the time of a Covered Transaction (as defined in the Plan) shall become vested and cease to be restricted stock at that time.  Additionally, the Parent has agreed to pay an amount to the named individual equal to an amount that would be included in gross income and payable as income tax as a result of making a Section 83(b) election under the Internal Revenue Code of 1986, as amended.  All named individuals have made a timely Section 83(b) election.  Effective July 31, 2007, the then Chief Financial Officer resigned and forfeited two-thirds of the individual’s restricted stock grant and, accordingly, the Company only recorded compensation expense associated with this individual’s grant through June 12, 2007 as all other shares were forfeited and no compensation expense is required to be recognized for forfeited shares.

For the three months ended May 29, 2008 and May 31, 2007, the Company has recorded $134,853 and $196,297 of compensation expense related to the vesting of the above grants in accordance with SFAS 123R.

Derivatives and Hedging

The Company uses derivative financial instruments to offset a substantial portion of its exposure to market risk arising from changes in the price of natural gas.  Hedging of this risk is accomplished by entering into forward swap contracts, which have not been designated as hedges of specific quantities of natural gas expected to be purchased in future months.   The fair value of these cash flow hedging instruments was an asset of $.1 million and $.2 million as of May 29, 2008 and February 29, 2008, respectively.   For the three months ended May 29, 2008 and May 31, 2007, $.1 million loss and less than $.1 gain, respectively, has been recorded to earnings.

8

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

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

Recent Accounting Pronouncements

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

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

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (R), “Business Combinations” (“SFAS 141 (R)”), and Financial Accounting Standards No. 160, “Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”).  These new standards will significantly change the financial accounting and reporting of business combination transactions and noncontrolling (or minority) interests in consolidated financial statements.  SFAS 141 (R ) is required to be adopted concurrently with FAS 160 and is effective for business combination transactions for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  Early adoption is prohibited.  The Company is currently assessing the impact that SFAS 141 (R) and SFAS 160 will have on our results of operations and financial position.

Note 2  Restatement of Financial Statements

The Company has restated herein its consolidated financial statements as of May 29, 2008 and February 29, 2008 and for the three month periods ended May 29, 2008 and

9

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2 Restatement of Financial Statements (continued)

May 31, 2007.  This restatement corrects errors in (i) accounting for deferred income taxes in connection with purchase accounting applied in fiscal 2007, (ii) classification of borrowings and repayments on the revolving credit facility in the statement of cash flows, and certain other adjustments that were initially deemed to be not material by management, including (a) classification of shipping and handling costs in accordance with EITF 00-10, Accounting for Shipping and Handling Fees and Costs (EITF 00-10), (b) accounting for derivative instruments, (c) accounting for foreign exchange gains and losses in fiscal 2008 and 2007, and (d) certain other miscellaneous adjustments. The tax effect of the above items has also been recorded. The restatements do not have a negative impact on the Company’s compliance with the covenants under any of its current debt agreements (see Note 5 — Long-Term Debt to our accompanying consolidated financial statements).

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

Deferred income taxes associated with purchase accounting

The Company erroneously recorded a deferred tax asset related to the $35.0 million liability for contingent consideration recorded in connection with the Company’s merger (the “Merger”) with Cellu Parent, a corporation organized and controlled by Weston Presidio V, L.P. (‘Weston Presidio”).  This error has resulted in an understatement of the amounts allocated to long-lived assets in connection with the merger.  The Company has corrected this error by (i) reducing the deferred tax asset amount recorded in purchase accounting for the contingent consideration by approximately $14.0 million; (ii) increasing the amount allocated to acquired property, plant and equipment and trademarks by approximately $15.6 million and $.6 million, respectively; (iii) increasing deferred tax liabilities associated with the increased allocation of purchase price allocated to property, plant and equipment by approximately $6.6 million; and (iv) recognizing goodwill of approximately $4.4 million as a result of these adjustments.

The increase in property, plant and equipment resulted in increased depreciation expense of approximately $.3 million for each of the three months ended May 29, 2008 and May 31, 2007, respectively.

Borrowings and repayments on revolving credit facility

The Company has consistently recorded borrowings and repayments on its revolving credit facility as a net amount in the statement of cash flows, which has been determined to be inconsistent with Statement of Financial Accounting Standards No. 95 Statement of Cash Flows.  The Company has corrected this error by showing borrowings and repayments on a gross basis.

Shipping and handling fees and costs

The Company has consistently recorded outbound shipping and handling costs as a reduction of sales, which is inconsistent with the accounting in accordance with EITF 00-10.  The Company has corrected this error by reclassifying these costs to cost of goods sold from net sales.  The outbound costs were approximately $3.0 million for each of the three months ended May 29, 2008 and May 31, 2007, respectively.

10

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement of Financial Statements (continued)

Foreign exchange gains and losses

The Company incorrectly recorded the remeasurement of an intercompany loan account with its foreign subsidiary through accumulated other comprehensive income. In accordance with FASB Statement No. 52, Foreign Currency Translation, the remeasurement of the portion of the loan functioning as a short-term settlement account and not deemed to be of a long term investment nature should have been recorded to earnings.  The Company has corrected this error by increasing (decreasing) foreign currency (loss) gain and decreasing (increasing) accumulated other comprehensive income.  The correction resulted in an increase to foreign currency gain of approximately $.4 million for the three months ended May 31, 2007.

Derivatives

The Company’s documentation relating to derivative instruments entered into in fiscal 2007 and 2008 did not meet the requirements of Statement of Financial Accounting No. 133, Accounting for Derivative Instruments and Hedging Activities for hedge accounting. The Company has corrected this error by reversing the amounts relating to the mark-to-market adjustment that were originally recorded in accumulated other comprehensive income, with the offsetting amount recorded to cost of goods sold in each corresponding period.  The correction resulted in an increase to cost of goods sold of approximately $.1 million for the three months ended May 29, 2008 and a decrease to cost of goods sold of less than $.1 million for the three months ended May 31, 2007.

Other miscellaneous adjustments

The Company has also included in the appropriate periods in its restated consolidated financial statements certain other miscellaneous adjustments the effect of which were initially deemed to be not material by management, either individually or in the aggregate.  These adjustments primarily relate to the reversal of certain vacation and freight accruals in the first quarter of fiscal 2008.   The net impact of correcting these items decreased net income by approximately $.1 million for the three months ended May 31, 2007.

11

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement of Financial Statements (continued)

CELLU TISSUE HOLDINGS, INC.  AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

			As of May 29, 2008 (unaudited)						As of February 29, 2008
	As Previously						As Previously
	Reported		Adjustment		Restated		Reported		Adjustment		Restated
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$1,625,424				$1,625,424		$883,388				$883,388
Receivables, net	52,197,208				52,197,208		44,542,337				44,542,337
Inventories	34,900,313				34,900,313		33,996,439				33,996,439
Prepaid expenses and other current assets	3,006,025				3,006,025		3,745,989				3,745,989
Income tax receivable	142,966				142,966		177,281				177,281
Deferred income taxes	6,216,017				6,216,017		7,157,191				7,157,191
TOTAL CURRENT ASSETS	98,087,953				98,087,953		90,502,625				90,502,625
PROPERTY, PLANT AND EQUIPMENT, NET	293,302,474		$13,634,493		306,936,967		296,597,888		$13,890,193		310,488,081
GOODWILL	6,970,001		4,364,754		11,334,755		6,970,001		4,364,754		11,334,755
TRADEMARKS	8,750,314		649,686		9,400,000		8,750,314		649,686		9,400,000
OTHER ASSETS	1,515,762				1,515,762		1,491,218				1,491,218
TOTAL ASSETS	$408,626,504		$18,648,933		$427,275,437		$404,312,046		$18,904,633		$423,216,679
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Revolving line of credit	$18,000,000				$18,000,000		$9,800,000				$9,800,000
Accounts payable	22,002,057				22,002,057		24,055,782				24,055,782
Accrued expenses	21,352,023		$184,076		21,536,099		18,860,526		$225,386		19,085,912
Accrued interest	3,765,379				3,765,379		8,253,915				8,253,915
Other current liabilities	15,000,000				15,000,000		15,000,000				15,000,000
Current portion of long-term debt	760,000				760,000		760,000				760,000
TOTAL CURRENT LIABILITIES	80,879,459		184,076		81,063,535		76,730,223		225,386		76,955,609
LONG-TERM DEBT, LESS CURRENT PORTION	197,862,013				197,862,013		198,086,944				198,086,944
DEFERRED INCOME TAXES	61,231,712		19,834,273		81,065,985		62,008,004		19,932,078		81,940,082
OTHER LIABILITIES	20,136,068				20,136,068		20,148,590				20,148,590
STOCKHOLDERS’ EQUITY:
Common stock, $.01 par value, 1,000 shares authorized, 100 shares issued and outstanding	1				1		1				1
Capital in excess of par value	47,253,720				47,253,720		47,035,214				47,035,214
Accumulated deficit	(982,560	)	(887,087	)	(1,869,647	)	(2,199,615	)	(662,502	)	(2,862,117	)
Accumulated other comprehensive income	2,246,091		(482,329	)	1,763,762		2,502,685		(590,329	)	1,912,356
TOTAL STOCKHOLDERS’ EQUITY	48,517,252		(1,369,416	)	47,147,836		47,338,285		(1,252,831	)	46,085,454
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$408,626,504		$18,648,933		$427,275,437		$404,312,046		$18,904,633		$423,216,679

12

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement of Financial Statements (continued)

CELLU TISSUE HOLDINGS, INC.  AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

					Three Months Ended						Three Months Ended
					May 29, 2008						May 31, 2007
	As Previously								As Previously
	Reported				Adjustment		Restated		Reported		Adjustment		Restated
Net sales	$	111,496,083			$3,031,478		$114,527,561		$103,200,786		$3,026,163		$106,226,949
Cost of goods sold	99,344,479				3,395,178		102,739,657		94,908,668		3,432,516		98,341,184
Gross profit	12,151,604				(363,700	)	11,787,904		8,292,118		(406,353	)	7,885,765
Selling, general and administrative expenses	4,959,842						4,959,842		4,482,737				4,482,737
Terminated acquisition-related transaction costs	75,000						75,000
Stock and related compensation expense	218,506						218,506		233,119				233,119
Income from operations	6,898,256				(363,700	)	6,534,556		3,576,262		(406,353	)	3,169,909
Interest expense, net	4,979,688						4,979,688		5,019,094				5,019,094
Foreign currency (gain) loss	(43,080			)			(43,080	)	324,298		(355,148	)	(30,850	)
Other expense (income)	29,508						29,508		(42,239	)			(42,239	)
Income (loss) before income tax	1,932,140				(363,700	)	1,568,440		(1,724,891	)	(51,205	)	(1,776,096	)
Income tax expense (benefit)	715,085				(139,115	)	575,970		(614,407	)	(19,848	)	(634,255	)
Net income (loss)	$		1,217,055		$(224,585	)	$992,470		($1,110,484	)	($31,357	)	($1,141,841	)

13

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement of Financial Statements (continued)

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

			Three Months Ended May 29, 2008						Three Months  Ended May 31, 2007
	As Previously						As Previously
	Reported		Adjustment		Restated		Reported		Adjustment		Restated
Cash flows from operating activities
Net income (loss)	$1,217,055		$(224,585	)	$992,470		($1,110,484	)	($31,357	)	($1,141,841	)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Stock-based compensation	218,506				218,506		196,297				196,297
Deferred income taxes	164,882		(97,805	)	67,077		(1,217,891	)	(99,900	)	(1,317,791	)
Accretion of debt discount	155,069				155,069		150,772				150,772
Derivative (gain) loss			119,802		119,802				(13,359	)	(13,359	)
Depreciation	5,598,338		255,700		5,854,038		6,678,145		261,382		6,939,527
Changes in operating assets and liabilities, net of the effects of acquisition:
Receivables	(7,654,871	)			(7,654,871	)	194,152				194,152
Inventories	(903,874	)			(903,874	)	867,490		39,200		906,690
Prepaid expenses and other current assets and  income tax receivable	774,279				774,279		464,351		90,668		555,019
Other	-						(1,521	)			(1,521	)
Accounts payable, accrued expenses and accrued interest	(4,050,764	)	(53,112	)	(4,103,876	)	(3,727,701	)	108,514		(3,619,187	)
Total adjustments	(5,698,435	)	224,585		(5,473,850	)	3,604,094		386,505		3,990,599
Net cash (used in) provided by operating activities	(4,481,380	)	-		(4,481,380	)	2,493,610		355,148		2,848,758
Cash flows from investing activities
Cash paid for acquisition, net of cash received							(43,343,798	)			(43,343,798	)
Capital expenditures	(2,474,891	)			(2,474,891	)	(2,646,346	)			2,848,758	)
Other	(145,252	)			(145,252	)	383,835		-		383,835
Net cash used in investing activities	(2,620,143	)			(2,620,143	)	(45,606,309	)			(45,606,309	)
Cash flows from financing activities
Payments of long-term debt	(380,000	)			(380,000	)
Payments on revolving line of credit			(18,300,000	)	(18,300,000	)			(3,000,000	)	(3,000,000	)
Borrowings on revolving line of credit	8,200,000		18,300,000		26,500,000		14,400,000		3,000,000		17,400,000
Proceeds from bond offering							20,000,000				20,000,000
Net cash provided by financing activities	7,820,000		-		7,820,000		34,400,000		-		34,400,000
Effect of foreign currency	23,559		-		23,559		439,045		(355,148	)	83,897
Net increase (decrease) in cash and cash equivalents	742,036		-		742,036		(8,273,654	)	-		(8,273,654	)
Cash and cash equivalents at beginning of period	883,388		-		883,388		16,260,601		-		16,260,601
Cash and cash equivalents at end of period	$1,625,424		-		$1,625,424		$7,986,947		-		$7,986,947

14

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 3 Inventories

Components of inventories are as follows:

	May 29, 2008		February 29, 2008
Finished goods	$ 19,048,274		$ 17,961,802
Raw materials	5,852,935		7,073,131
Packaging materials and supplies	10,088,420		9,082,592
	34,989,629		34,117,525
Inventory reserves	(89,316	)	(121,086	)
	$ 34,900,313		$ 33,996,439

Note 4 Acquisition

On March 21, 2007, the Company executed a definitive merger agreement (the “Acquisition Agreement”) with CityForest Corporation (“CityForest”), Cellu City Acquisition Corporation (“Cellu City Merger Sub”) and Wayne Gullstad as the shareholders’ representative.  Pursuant to the Acquisition Agreement and, subject to the terms and conditions therein, Cellu City Merger Sub, a wholly-owned subsidiary of the Company, merged with and into CityForest, with CityForest surviving and becoming a wholly-owned subsidiary of the Company (the “Acquisition”).  The aggregate merger consideration (including assumption of $18.4 million in aggregate principal amount of industrial revenue bonds) was approximately $61.0 million subject to certain working capital and net cash adjustments.  Total cash paid for the acquisition of $46.8 million (purchase price of $61.0 million less assumed indebtedness of $18.4 million plus restricted cash and other miscellaneous adjustments of $1.6 million and acquisition costs of $2.6 million), was financed in part by issuance of unregistered 9 3/4% Senior Secured Notes due 2010 (the “Additional Notes”) of approximately $20.0 million, borrowings on a revolving line of credit ($17.4 million) and available cash on hand.

The Acquisition has been accounted for as a purchase in accordance with the provisions of SFAS 141 and, accordingly, the consolidated statement of operations includes the results of CityForest during the three-months ended May 29, 2008 and during the three-months ended May 31, 2007 from the date of acquisition.

The results of CityForest’s operations from the March 21, 2007 date of acquisition are included in the Company’s tissue segment.  Unaudited pro forma results of operations for the three months ended May 31, 2007, as if the Company and CityForest had been combined as of March 1, 2007, are presented below.  The pro forma results include estimates and assumptions, which the Company’s management believes are reasonable.

15

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 4 Acquisition (continued)

However, the pro forma results do not include any cost savings or other effects of the planned integration of CityForest, and are not necessarily indicative of the results which would have occurred if the business combination had been in effect on the dates indicated, or which may result in the future.

	Three Months Ended May 31, 2007 (1)
	Actual	Pro Forma
	(Restated)	(Restated)
	(in thousands)
Net sales	$106,227	$108,937
Operating income	$    3,170	$    3,756
Net loss	$   (1,142)	$     (581)

(1)Pro forma operating results include the operating results for CityForest for the three months ended May 31, 2007.   The actual operating results include the operating results for CityForest for the period from the acquisition date (March 21, 2007) to May 31, 2007.

Note 5 Long-Term Debt

Long-term debt consists of the following:

	May 29, 2008		February 29, 2008
93/4% senior secured notes due 2010	$182,255,572		$182,255,572
Less discount	(1,128,559	)	(1,283,628	)
	181,127,013		180,971,944
Industrial revenue bond payable in semi-annual installments, plus variable interest, due March 1, 2028	17,495,000		17,875,000
	198,622,013		198,846,944
Less current portion of debt	760,000		760,000
	$197,862,013		$198,086,944

In March 2004, the Company completed a private offering of $162.0 million aggregate principal amount of 9 ¾% senior secured notes due 2010 (the “Original Notes”).  In connection with the Acquisition (see Note 4), the Company entered into a Note Purchase Agreement (the “Note Purchase Agreement”) with Wingate Capital Ltd. (the “Purchaser”), dated March 21, 2007, pursuant to which it issued and sold $20.3 million

16

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

aggregate principal amount of Additional Notes (together with the Original Notes, the “Notes”) to the Purchaser for the purchase price of $20.0 million which is equal to 98.7383% of the aggregate principal amount of the Additional Notes.  The Additional Notes were issued pursuant to and will be governed by the Indenture, dated as of March 12, 2004 (as amended and supplemented, the “Cellu Tissue Indenture”) among the Company, the subsidiary guarantors party thereto and The Bank of New York Trust Company, N.A., as successor trustee to the Bank of New York (the “Trustee”).

The Notes mature on March 15, 2010 and require semi-annual interest payments on March 15 and September 15.  The Notes are collateralized by a senior secured interest in substantially all of the Company’s assets.  Terms of the indenture under which the Notes have been issued contain certain covenants, including limitations on certain restricted payments and the incurrence of additional indebtedness.  The Notes are unconditionally guaranteed by all of the Company’s subsidiaries.

The Company entered into a Credit Agreement, dated as of June 12, 2006 (the “Credit Agreement”), among the Company, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of the Company, as Canadian Borrower, Parent, the other loan guarantors party thereto, JPMorgan Chase Bank, N.A., as U.S. Administrative Agent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent, and the other lenders party thereto.  The Credit Agreement provides for a $35.0 million working capital facility, which was subsequently increased to $60.0 million (see discussion following and footnote 9), including a letter of credit sub-facility and swing-line loan sub-facility. The Credit Agreement provides that amounts under the facility may be borrowed, repaid and re-borrowed, subject to a borrowing base test, until the maturity date, which is June 12, 2011. An amount equal to $32.0 million, which was subsequently increased to $57.0 million (see discussion following and footnote 9) is available, in U.S. dollars, to the U.S.  Borrower under the facility, and an amount equal to $3.0 million is available, in U.S. or Canadian dollars, to the Canadian Borrower under the facility.  Borrowings of $17.4 million were made to finance a portion of the Acquisition.  As of May 29, 2008, there was $18.0 million of borrowings outstanding under the working capital facility and excess availability was $18.1 million.

In addition to the Note Purchase Agreement, the following agreements were entered into in connection with the Acquisition:

Second Supplemental Indenture

The Company, certain of its subsidiaries, the Trustee and CityForest have executed the Second Supplemental Indenture, dated March 21, 2007 (the “Second Supplemental Indenture”), pursuant to which CityForest became a party to the Cellu Tissue Indenture as

17

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

a subsidiary guarantor.  As a subsidiary guarantor, CityForest, on a joint and several basis with all the existing subsidiary guarantors, fully, unconditionally and irrevocably guarantees to each holder of the Notes and the Trustee the obligations of Company under its Indenture and the Notes.

Amendment to Credit Agreement

The Company has entered into a First Amendment, dated March 21, 2007 (the “Amendment”), to the Credit Agreement dated June 12, 2006 (as amended by the Amendment, the “Amended Credit Agreement”) among Cellu Tissue, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of Cellu Tissue, as Canadian Borrower, certain subsidiaries of Cellu Tissue, Cellu Paper Holdings, Inc., the parent corporation of Cellu Tissue, JPMorgan Chase Bank, N.A. (the “U.S. Administrative Agent”) and JPMorgan Chase Bank, N.A., Toronto Branch (the “Canadian Administrative Agent”).

The Amendment (1) increases the working capital facility from $35.0 million to $40.0 million, (2) permits the issuance and sale by the Company of the Additional Notes, (3) provides for the consummation of the Acquisition and the conversion by CityForest from a Minnesota corporation to a Minnesota limited liability company, (4) permits the assumption of approximately $18.4 million in aggregate principal amount of indebtedness of CityForest in connection with the Acquisition in accordance with the terms of the CityForest Bond Documents (as defined below under “CityForest Bond Documents”), and (5) permits the guarantee by the Company of certain obligations of CityForest under the CityForest Bond Documents.  In connection with the Amendment, CityForest became a guarantor of the obligations of the borrowers under the Amended Credit Agreement.

CityForest Bond Documents

CityForest is party to a Loan Agreement, dated March 1, 1998 (the “Loan Agreement”), with the City of Ladysmith, Wisconsin (the “Issuer”).  Pursuant to the Loan Agreement, the Issuer loaned the proceeds of the Issuer’s Variable Rate Demand Solid Waste Disposal Facility Revenue Bonds, Series 1998 (CityForest Corporation Project) (the “Bonds”) to CityForest to finance the construction by CityForest of a solid waste disposal facility.  Approximately $18.4 million in aggregate principal amount of the Bonds was outstanding as of the date of the Acquisition.  CityForest is required, under the terms of the Indenture of Trust governing the Bonds (the “CityForest Indenture”), to provide a letter of credit in favor of the trustee under the CityForest Indenture (the “Bonds Trustee”).  CityForest has entered into an Amended and Restated Reimbursement Agreement, dated March 21, 2007 (the “Reimbursement Agreement” and, together with

18

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

the CityForest Indenture and the Loan Agreement, the “CityForest Bond Documents”), with Associated Bank, National Association (“Associated Bank”), pursuant to which Associated Bank has extended the required letter of credit (the “Associated Bank Letter of Credit”) and has provided a revolving credit facility to CityForest in an aggregate principal amount of up to $3.5 million (the “Associated Bank Revolving Credit Facility”).

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

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

The Reimbursement Agreement requires scheduled semi-annual payments of principal of the Bonds equal to approximately 2.00% of the principal amount outstanding as of the date of the Acquisition, with the balance payable at maturity of the Bonds on March 1, 2028. The Reimbursement Agreement also contains a number of other provisions regarding reserve funds and other mandatory and optional repayments in connection with the Bonds.  In addition, the Reimbursement Agreement provides that in certain circumstances where the Company incurs indebtedness, as defined, in excess of amounts currently permitted under its Indenture or refinances the indebtedness issued under its Indenture, Associated Bank may require CityForest to repay all of its obligations to Associated Bank under the Reimbursement Agreement and either to cause the Bonds to be redeemed or to replace the Associated Bank Letter of Credit with a Substitute Credit Facility, as such term is defined in the CityForest Indenture.

19

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

The Reimbursement Agreement contains various affirmative and negative covenants customary for working capital and term credit facilities, as well as additional covenants relating to the Bonds.  The negative covenants include limitations on: indebtedness; liens; acquisitions, mergers and consolidations; investments; guarantees; asset sales; sale and leaseback transactions; dividends and distributions; transactions with affiliates; capital expenditures; and changes to the status of the Bonds. CityForest is also required to comply on a quarterly basis with a maximum leverage covenant and a minimum fixed charge coverage covenant.

The Reimbursement Agreement also contains customary events of default, including:  payment defaults; breaches of representations and warranties; covenant defaults; cross-defaults to certain other debt, including the Additional Notes and indebtedness under the Amended Credit Agreement; certain events of bankruptcy and insolvency; judgment defaults; certain defaults related to the Employee Retirement Income Security Act of 1974, as amended; and a change of control of CityForest or the Company.

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

Note 6 Comprehensive Income

The components of comprehensive income for the three months ended May 29, 2008 and May 31, 2007 are as follows:

	Three Months Ended
	May 29, 2008		May 31, 2007
	(Restated)		(Restated)
Net income (loss)	$992,470		$(1,141,841	)
Foreign currency translation adjustments	(148,594	)	953,994
Comprehensive (loss) income	$843,876		$(187,847	)

20

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 7 Business Segments

The Company operates in two business segments:  tissue and machine-glazed paper.  The Company assesses the performance of its business segments using income from operations. Income from operations for the three months ended May 29, 2008 includes $.3 million of bad debt expense associated with a customer bankruptcy and $.3 million related to additional sales tax incurred at one of our facilities.  Of this $.6 million, $.2 million impacts the machine-glazed paper segment and $.4 million impacts the tissue segment.   Income from operations excludes interest income, interest expense, other income (expense), income tax expense (benefit) and the impact of foreign currency gains and losses.   A portion of corporate and shared expenses is allocated to each segment.  Segment information for the three months ended May 29, 2008 and May 31, 2007 follows:

	Three Months Ended
	May 29, 2008		May 31, 2007
	(Restated)		(Restated)
Net Sales
Tissue	$85,797,050		$79,784,855
Machine-glazed paper	28,730,511		26,442,094
Consolidated	$114,527,561		$106,226,949
Income (loss) from operations
Tissue	$6,052,591		$3,745,653
Machine-glazed paper	481,965		(575,744	)
Consolidated	6,534,556		3,169,909
Interest expense, net	(4,979,688	)	(5,019,094	)
Net foreign currency transaction gain	43,080		30,850
Other (expense) income	(29,508	)	42,239
Pretax income (loss)	$1,568,440		$(1,776,096	)
Capital Expenditures
Tissue	$2,029,529		$2,241,151
Machine-glazed paper	254,830		252,651
Corporate	190,532		152,544
Consolidated	$2,474,891		$2,646,346
Depreciation
Tissue	$4,318,726		$5,194,521
Machine-glazed paper	1,535,312		1,745,006
Consolidated	$5,854,038		$6,939,527

21

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued

Note 8 Income taxes

The effective income tax rate for the three months ended May 29, 2008 was 36.7% compared to a 35.7% benefit for the three months ended May 31, 2007.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.  As of May 29, 2008, the Company had accrued $1.6 million related to uncertain tax positions.

The tax years 2004 through 2008 remain open to examination by the major taxing jurisdictions to which the Company is subject.  As of May 29, 2008, the Company does not expect any material changes to unrecognized tax positions within the next twelve months.

Note 9 Subsequent Event

On July 2, 2008, the Company, through two newly created, wholly-owned subsidiaries, Cellu Tissue-Hauppauge, LLC (“Cellu Tissue-Hauppauge”) and Cellu Tissue-Thomaston, LLC (“Cellu Tissue-Thomaston”) consummated the acquisition of certain assets, and assumption of certain liabilities, from Atlantic Paper & Foil Corp. of N.Y., Atlantic Lakeside Properties, LLC, Atlantic Paper & Foil, LLC, Atlantic Paper & Foil of Georgia, LLC and Consumer Licensing Corporation (collectively, the “Sellers”) pursuant to a definitive asset purchase agreement between the Company and the Sellers.  The aggregate purchase price paid was $68,000,000, including a cash payment at closing of $61,700,000 and the issuance of a promissory note by the Company to Atlantic Paper & Foil Corp. of N.Y. in the aggregate principal amount equal of $6,300,000 plus the assumption of certain liabilities.  The Company financed the cash portion of the purchase price with cash on-hand, the borrowings described below and an equity contribution from Parent.  The purchase price is subject to certain post-closing working capital adjustments.

In connection with the Acquisition, the following agreements were entered into:

Note Purchase Agreement

The Company has entered into Note Purchase Agreements (the “Note Purchase Agreements”) with each of (i) GMAM Investment Funds Trust II, for the account of the Promark Alternative High Yield Bond Fund (Account No. 7M2E), GMAM Investment Funds Trust, General Motors Welfare Benefit Trust (VEBA), GMAM Investment Funds Trust II for the account of the Promark Alternative High Yield Bond Fund (Account No. 7MWD), DDJ High Yield Fund, Multi-Style, Multi-Manager Funds PLC The Global Strategic Yield Fund (f/k/a Multi-Style, Multi-Manager Funds PLC The Global High

22

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued

Note 9 Subsequent Event (continued)

Yield Fund), DDJ Capital Management Group Trust, Stichting Pensioenfonds Hoogovens, Caterpillar Inc. Master Retirement Trust, J.C. Penney Corporation, Inc. Pension Plan Trust, Stichting Bewaarder Interpolis Pensioenen Global High Yield Pool,  DDJ/Ontario OS Investment Sub II, Ltd. and Stichting Pensioenfonds Metaal en Techniek, (ii) Claren Road Credit Master Fund, Ltd. and (iii) UBS High Yield Relationship Fund, a series of the UBS Relationship funds (the “Purchaser”), dated July 2, 2008, pursuant to which the Company issued and sold $40,000,000 aggregate principal amount of unregistered 9 3/4% Senior Secured Notes due 2010 (the “New Notes”) to the Purchasers for the purchase price of $36,900,000 which is equal to 92.25% of the aggregate principal amount of the New Notes. The New Notes were issued pursuant to and will be governed by the Indenture, dated as of March 12, 2004 (as amended and supplemented, the “Cellu Tissue Indenture”) among the Company, the subsidiary guarantors party thereto and The Bank of New York Mellon Trust Company, N.A., as successor trustee to the Bank of New York (the “Trustee”). The proceeds of the sale were used to finance a portion of the Acquisition.

Third Supplemental Indenture

The Company, certain subsidiaries of the Company and the Trustee have executed the Third Supplemental Indenture, dated July 2, 2008 (the “Third Supplemental Indenture”), pursuant to which Cellu Hauppauge and Cellu Thomaston became parties to the Cellu Tissue Indenture as subsidiary guarantors.  As subsidiary guarantors, Cellu Hauppauge and Cellu Thomaston, on a joint and several basis, with all the existing subsidiary guarantors, fully, unconditionally and irrevocably guarantees to each holder of the New Notes and the Trustee the obligations of the Company under the Company Indenture and the New Notes.

Amendment to Credit Agreement

The Company has entered into a Second Amendment, dated July 2, 2008 (the “Amendment”), to the Credit Agreement dated June 12, 2006 (as amended by the First Amendment, dated as of March 21, 2007, and the Amendment, the “Amended Credit Agreement”) among the Company, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of  the Company, as Canadian Borrower, certain subsidiaries of the Company,  Parent, JPMorgan Chase Bank, N.A. (the “U.S. Administrative Agent”) and JPMorgan Chase Bank, N.A., Toronto Branch (the “Canadian Administrative Agent”).

The Amendment (1) increases the working capital facility from $40.0 million to $60.0 million, (2) permits the issuance by the Company of the Notes, (3) provides for the consummation of the Acquisition and (4) permits the issuance of the Seller Note.  In connection with Amendment, Cellu Hauppauge and Cellu Thomaston became guarantors of the obligations of the borrowers under the Amended Credit Agreement.

23

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

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

The Company has restated its consolidated financial statements as of May 29, 2008 and February 29, 2008 and for the three month periods ended May 29, 2008 and May 31, 2007.  This restatement corrects errors in (i) accounting for deferred income taxes in connection with purchase accounting applied in fiscal 2007, (ii) classification of borrowings and repayments on the revolving credit facility in the statement of cash flows, and certain other adjustments that were initially deemed to be not material by management, including (a) classification of shipping and handling costs in accordance with EITF 00-10, Accounting for Shipping and Handling Fees and Costs (EITF 00-10), (b) accounting for derivative instruments, (c) accounting for foreign exchange gains and losses in fiscal 2008 and 2007, and (d) certain other miscellaneous adjustments.  See Note 2 — Restatement of Financial Statements in the accompanying consolidated financial statements for further information.

We manufacture and market a variety of specialty tissue hard rolls and machine-glazed paper used in the manufacture of various end products, including diapers, facial and bath tissue, assorted paper towels and food wraps.  In addition, we produce a variety of converted tissue products.  Our customers include major North American producers of branded and unbranded disposable consumer absorbent and tissue products for the personal and health care markets; consumer and away-from-home tissue products companies; national and regional tissue products distributors; and third-party converters who sell their products to food, bakery and confections companies. We service a diverse group of high-quality customers, with three of our top 10 customers belonging to the Fortune 150 group of companies

We operate in two business segments:  tissue and machine-glazed paper.  We assess the performance of our business segments using income from operations.  Income from

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operations excludes interest income, interest expense, income tax expense (benefit), other income and expense and the impact of foreign currency gains and losses.

Acquisition

On March 21, 2007, we executed the Acquisition Agreement with CityForest, Cellu City Merger Sub and Wayne Gullstad as the shareholders’ representative.  Pursuant to the Acquisition Agreement, and subject to the terms and conditions therein, Cellu City Merger Sub, a wholly-owned subsidiary of ours, merged with and into CityForest, with CityForest surviving and becoming our wholly-owned subsidiary.  The aggregate merger consideration (including assumption of $18.4 million in aggregate principal amount of industrial revenue bonds) was approximately $61.0 million subject to certain working capital and net cash adjustments.  Total cash paid for the acquisition of $46.8 million (purchase price of $61.0 million less assumed indebtedness of $18.4 million plus restricted cash and other miscellaneous adjustments of $1.6 million and acquisition costs of $2.6 million), was financed in part by issuance of the Additional Notes of approximately $20.0 million, borrowings on a revolving line of credit ($17.4 million) and available cash on hand.

The Acquisition has been accounted for as a purchase in accordance with the provisions of SFAS 141 and, accordingly, the consolidated statement of operations includes the results of CityForest during the three-months ended May 29, 2008 and during the three-months ended May 31., 2007 from the date of acquisition.  The results of CityForest’s operations from the March 21, 2007 date of acquisition are included in our tissue segment.  Unaudited pro forma results of operations for the three months ended May 31, 2007 as if we and CityForest had been combined as of March 1, 2007, are presented below.  The pro forma results include estimates and assumptions, which our management believes are reasonable.  However, the pro forma results do not include any cost savings or other effects of the planned integration of CityForest, and are not necessarily indicative of the results which would have occurred if the business combination had been in effect on the dates indicated, or which may result in the future.

	Three Months Ended May 31, 2007 (1)
	Actual (Restated)		Pro Forma (Restated)
	(in thousands)
Net sales	$106,227		$108,937
Operating income	$    3,170		$    3,756
Net loss	$ (1,142	)	$    (581	)

(1)Pro forma operating results include the operating results for CityForest for the three months ended May 31, 2007.  The actual operating results include the operating results for CityForest for the period from the acquisition date (March 21, 2007) to May 31, 2007.

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Subsequent Event

On July 2, 2008, we, through two newly created, wholly-owned subsidiaries, Cellu Tissue-Hauppauge, LLC (“Cellu Tissue-Hauppauge”) and Cellu Tissue-Thomaston, LLC (“Cellu Tissue-Thomaston”) consummated the acquisition of certain assets, and assumption of certain liabilities, from Atlantic Paper & Foil Corp. of N.Y., Atlantic Lakeside Properties, LLC, Atlantic Paper & Foil, LLC, Atlantic Paper & Foil of Georgia, LLC and Consumer Licensing Corporation (collectively, the “Sellers”) pursuant to a definitive asset purchase agreement between us and the Sellers.  The aggregate purchase price paid was $68,000,000, including a cash payment at closing of $61,700,000 and the issuance of a promissory notes by us to the Atlantic Paper & Foil Corp. of N.Y. in the aggregate principal amount equal of $6,300,000 plus assumption of certain liabilities.  The Company financed the cash portion of the purchase price with cash on-hand, the borrowings described below and an equity contribution from Parent.  The purchase price is subject to certain post-closing working capital adjustments.

In connection with the Acquisition, the following agreements were entered into:

Note Purchase Agreement

We have entered into Note Purchase Agreements (the “Note Purchase Agreements”) with each of (i) GMAM Investment Funds Trust II, for the account of the Promark Alternative High Yield Bond Fund (Account No. 7M2E), GMAM Investment Funds Trust, General Motors Welfare Benefit Trust (VEBA), GMAM Investment Funds Trust II for the account of the Promark Alternative High Yield Bond Fund (Account No. 7MWD), DDJ High Yield Fund, Multi-Style, Multi-Manager Funds PLC The Global Strategic Yield Fund (f/k/a Multi-Style, Multi-Manager Funds PLC The Global High Yield Fund), DDJ Capital Management Group Trust, Stichting Pensioenfonds Hoogovens, Caterpillar Inc. Master Retirement Trust, J.C. Penney Corporation, Inc. Pension Plan Trust, Stichting Bewaarder Interpolis Pensioenen Global High Yield Pool, DDJ/Ontario OS Investment Sub II, Ltd. and Stichting Pensioenfonds Metaal en Techniek, (ii) Claren Road Credit Master Fund, Ltd. and (iii) UBS High Yield Relationship Fund, a series of the UBS Relationship funds (the “Purchaser”), dated July 2, 2008, pursuant to which we issued and sold $40,000,000 aggregate principal amount of unregistered 9 3/4% Senior Secured Notes due 2010 (the “New Notes”) to the Purchasers for the purchase price of $36,900,000 which is equal to 92.25% of the aggregate principal amount of the New Notes. The New Notes were issued pursuant to and will be governed by the Indenture, dated as of March 12, 2004 (as amended and supplemented, the “Cellu Tissue Indenture”) among us, the subsidiary guarantors party thereto and The Bank of New York Mellon Trust Company, N.A., as successor trustee to the Bank of New York (the “Trustee”). The proceeds of the sale were used to finance a portion of the Acquisition.

Third Supplemental Indenture

We, certain subsidiaries of us and the Trustee have executed the Third Supplemental Indenture, dated July 2, 2008 (the “Third Supplemental Indenture”), pursuant to which Cellu Hauppauge and Cellu Thomaston became parties to the Cellu Tissue Indenture as subsidiary guarantors.  As subsidiary guarantors, Cellu Hauppauge and Cellu Thomaston, on a joint and several basis, with all the existing subsidiary guarantors, fully,

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unconditionally and irrevocably guarantees to each holder of the New Notes and the Trustee the obligations of us under the Company Indenture and the New Notes.

Amendment to Credit Agreement

We have entered into a Second Amendment, dated July 2, 2008 (the “Amendment”), to the Credit Agreement dated June 12, 2006 (as amended by the First Amendment, dated as of March 21, 2007, and the Amendment, the “Amended Credit Agreement”) among us, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of  us, as Canadian Borrower, certain subsidiaries of the Company,  Parent, JPMorgan Chase Bank, N.A. (the “U.S. Administrative Agent”) and JPMorgan Chase Bank, N.A., Toronto Branch (the “Canadian Administrative Agent”).

The Amendment (1) increases the working capital facility from $40.0 million to $60.0 million, (2) permits the issuance by us of the Notes, (3) provides for the consummation of the Acquisition and (4) permits the issuance of the Seller Note.  In connection with Amendment, Cellu Hauppauge and Cellu Thomaston became guarantors of the obligations of the borrowers under the Amended Credit Agreement.

RESULTS OF OPERATIONS

Results of Operations for the Three Months Ended May 29, 2008 (the fiscal 2009 three-month period) compared to the Three Months Ended May 31, 2007 (the fiscal 2008 three-month period)

Net sales for the fiscal 2009 three-month period increased $8.3 million, or 7.8%, to $114.5 million from $106.2 million for the comparable period in the prior year.   For the fiscal 2009 three-month period, we sold 77,449 tons of tissue hard rolls, machine-glazed paper hard rolls and converted paper products.  This is a decrease of 656 tons, or less than 1%, from the comparable period in the prior year.  Net selling price per ton increased from $1,360 for the fiscal 2008 three-month period to $1,479 for the fiscal 2009 three-month period.

Net sales for our tissue segment for the fiscal 2009 three-month period were $85.8 million, an increase of $6.0 million, or 7.5%, from the comparable period in the prior year.  Net sales for our machine-glazed segment for the 2009 three-month period were $28.7 million, an increase of $2.3 million, or 8.7%, from the comparable period in the prior year.  These increases are primarily attributable to increases in net selling price per ton.

Gross profit for the fiscal 2009 three-month period increased to $11.8 million from $7.9 million, an increase of $3.9 million, or 49.5%, from the comparable period in the prior year.   As a percentage of net sales, gross profit increased to 10.3% in the fiscal 2009 three-month period from 7.4% in the fiscal 2008 three-month period.  The increase in gross profit in the fiscal 2008 three-month period is primarily attributable to the increase

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in net selling price per ton, despite an increase in net pulp cost and net energy cost per ton.

Gross profit for our tissue segment for the fiscal 2009 three-month period increased to $10.1 million from $6.9 million, an increase of $3.1 million, or 45.7%, from the comparable period in the prior year.  Gross profit for our machine-glazed segment for the fiscal 2009 three-month period increased to $1.7 million, an increase of $.8 million, or 76.1%, from the comparable period in the prior year.  As a percentage of net sales, gross profit for the tissue segment increased to 11.7% in the fiscal 2009 three-month period from 8.6% in the fiscal 2008 three-month period.  As a percentage of net sales, gross profit for the machine-glazed segment increased to 6.1% in the fiscal 2009 three-month period from 3.8% in the fiscal 2008 three-month period.  These increases are reflective of increases in net selling price per ton, which more than offset increases in net pulp and energy cost per ton, over the comparable period in the prior year.

Selling, general and administrative expenses in the fiscal 2009 three-month period increased $.5 million, or 10.6%, to $5.0 million from $4.5 million in the fiscal 2008 three-month period.  This increase reflects $.3 million of bad debt expense associated with a customer bankruptcy and $.3 million related to additional sales tax incurred at one of our facilities.

Terminated acquisition-related transaction costs in the fiscal 2009 three-month period of less than $.1 million related to costs incurred related to an acquisition that did not transpire.

Stock and related compensation expense in the fiscal 2009 and 2008 three-month periods of $.2 million relates primarily to the accounting for restricted stock and stock option grants.

Foreign currency gain in the fiscal 2009 three-month period and in the fiscal 2008 three-month period was less than $.1 million.

Income tax expense for the fiscal 2009 three-month period was $.6 million or an effective tax rate of 36.7% compared to income tax benefit of $.6 million or an effective tax rate 35.7% benefit for the fiscal 2008 three-month period.

Net income for the fiscal 2009 three-month period was $1.0 million compared to net loss of $1.1 million for the comparable period in the prior year.

FINANCIAL CONDITION

Liquidity and Capital Resources

Net cash used in operations was $4.5 million for the fiscal 2009 three-month period, compared to cash provided by operations of $2.8 million for the fiscal 2008 three-month

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period.  Non-cash items, consisting primarily of depreciation, stock-based compensation, derivatives and deferred income taxes, for the fiscal 2009 three-month period totaled $6.4 million compared to $6.0 million for the 2008 fiscal three-month period.    Cash flows used by changes in working capital totaled $12.0 million for the fiscal 2009 three-month period compared to $1.6 million in the fiscal 2008 three-month period.  With respect to the changes in accounts receivable and inventory, cash used by these items was $8.6 million for the fiscal 2009 three-month period, compared to cash provided of $1.1 million for the comparable period in the prior fiscal year.    This increase is reflective of changes in sales terms with a key customer and timing of customer payments. Cash provided by changes in prepaid expenses and other current assets was $.8 million for the 2009 fiscal three-month period compared to cash provided by changes in prepaid expenses and other current assets of $.6 million for the comparable period in the prior fiscal year.   Cash used in changes in accounts payable, accrued expenses and accrued interest for the fiscal 2009 three-month period was $4.1 million, compared to cash used of $3.6 million for the comparable period in the prior year.

Net cash used in investing activities for the fiscal 2009 three-month period was $2.6 million compared to $45.6 million used in the fiscal 2008 three-month period.  Included in the prior year is $43.3 attributable to the cash paid for the acquisition of CityForest.  The remaining change relates to the level of capital spending period over period.

Net cash provided by financing activities for the fiscal 2009 three-month period was $7.8 million compared to $34.4 million for the fiscal 2008 three-month period.  Net cash provided for the fiscal 2009 three-month period relates to net borrowings on our revolving line of credit offset by payment on CityForest’s industrial revenue bond.   Net cash provided for the fiscal 2008 three-month period relates to financing obtained in connection with the acquisition of CityForest.

In connection with the acquisition of CityForest, we entered into the Note Purchase Agreement, pursuant to which we issued and sold $20.3 million aggregate principal amount of Additional Notes to the Purchaser for the purchase price of $20.0 million, which is equal to 98.7383% of the aggregate principal amount of the Additional Notes.  The Additional Notes were issued pursuant to and will be governed by Cellu Tissue Indenture among us, our subsidiary guarantors party thereto and the Trustee.

Our Notes mature on March 15, 2010 and require semi-annual interest payments on March 15 and September 15.

We entered into the Credit Agreement, dated as of June 12, 2006, among us, as U.S. Borrower, Interlake Acquisition Corporation Limited, one of our subsidiaries, as Canadian Borrower, our Parent, the other loan guarantors party thereto, JPMorgan Chase Bank, N.A., as U.S. Administrative Agent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent, and the other lenders party thereto.

The Credit Agreement provides for a $35.0 million working capital facility, which has subsequently been increased to $60.0 million (see below and preceding discussion),

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including a letter of credit sub-facility and swing-line loan sub-facility. The Credit Agreement provides that amounts under the facility may be borrowed, repaid and re-borrowed, subject to a borrowing base test, until the maturity date, which is June 12, 2011. An amount equal to $32.0 million, which was subsequently increased to $57.0 million, is available, in U.S. dollars, to the U.S. Borrower under the facility, and an amount equal to $3.0 million is available, in U.S. or Canadian dollars, to the Canadian Borrower under the facility.  Borrowings of $17.4 million were made to finance a portion of the acquisition of CityForest.    As of May 29, 2008, there was $18.0 million of borrowings outstanding under the working capital facility and excess availability was $18.1 million.

In addition to the Note Purchase Agreement, the following agreements were entered into in connection with the acquisition of CityForest:

Second Supplemental Indenture

We, certain of our subsidiaries, the Trustee and CityForest have executed the Second Supplemental Indenture, pursuant to which CityForest became a party to the Cellu Tissue Indenture as a subsidiary guarantor.  As a subsidiary guarantor, CityForest, on a joint and several basis with all the existing subsidiary guarantors, fully, unconditionally and irrevocably guarantees to each holder of the Notes and the Trustee our obligations under its Indenture and the Notes.

Amendment to Credit Agreement

We have entered into the Amendment to the Credit Agreement dated June 12, 2006 among us, as U.S. Borrower, Interlake Acquisition Corporation Limited, one of our subsidiaries, as Canadian Borrower, certain other of our subsidiaries and our Parent, JPMorgan Chase Bank, N.A. (the “U.S. Administrative Agent”) and JPMorgan Chase Bank, N.A., Toronto Branch (the “Canadian Administrative Agent”).

The Amendment (1) increases the working capital facility from $35.0 million to $40.0 million, (2) permits the issuance and sale by us of the Additional Notes, (3) provides for the consummation of the acquisition of CityForest and the conversion by CityForest from a Minnesota corporation to a Minnesota limited liability company, (4) permits the assumption of approximately $18.4 million in aggregate principal amount of indebtedness of CityForest in connection with the acquisition of CityForest in accordance with the terms of the CityForest Bond Documents and (5) permits the guarantee by us of certain obligations of CityForest under the CityForest Bond Documents.  In connection with the Amendment, CityForest became a guarantor of the obligations of the borrowers under the Amended Credit Agreement.

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CityForest Bond Documents

CityForest is party to a Loan Agreement with the City of Ladysmith, Wisconsin, as Issuer.  Pursuant to the Loan Agreement, the Issuer loaned the proceeds of the Issuer’s Bonds to CityForest to finance the construction by CityForest of a solid waste disposal facility.  Approximately $18.4 million in aggregate principal amount of the Bonds was outstanding as of the date of the CityForest acquisition.  CityForest is required, under the terms of the CityForest Indenture to provide a letter of credit in favor of the Bonds Trustee.  CityForest has entered into the Reimbursement Agreement with Associated Bank, pursuant to which Associated Bank has extended the Associated Bank Letter of Credit and has provided the Associated Bank Revolving Credit Facility to CityForest in an aggregate principal amount of up to $3.5 million.

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

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

The Reimbursement Agreement requires scheduled semi-annual payments of principal of the Bonds equal to approximately 2.00% of the principal amount outstanding as of the date of the Acquisition, with the balance payable at maturity of the Bonds on March 1, 2028. The Reimbursement Agreement also contains a number of other provisions regarding reserve funds and other mandatory and optional repayments in connection with the Bonds.  In addition, the Reimbursement Agreement provides that in certain circumstances where we incur indebtedness in excess of amounts currently permitted under the indenture or refinances the indebtedness issued under the indenture, Associated Bank may require CityForest to repay all of its obligations to Associated Bank under the Reimbursement Agreement and either to cause the Bonds to be redeemed or to replace the Associated Bank Letter of Credit with a Substitute Credit Facility, as such term is defined in the CityForest Indenture.

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The Reimbursement Agreement contains various affirmative and negative covenants customary for working capital and term credit facilities, as well as additional covenants relating to the Bonds.  The negative covenants include limitations on: indebtedness; liens; acquisitions, mergers and consolidations; investments; guarantees; asset sales; sale and leaseback transactions; dividends and distributions; transactions with affiliates; capital expenditures; and changes to the status of the Bonds. CityForest is also required to comply on a quarterly basis with a maximum leverage covenant and a minimum fixed charge coverage covenant.

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

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

Cash as of May 29, 2008 increased to $1.6 million from $.9 million as of the end of fiscal year 2008.

Receivables, net as of May 29, 2008 increased to $52.2 million from $44.5 million as of the end of fiscal year 2008.  The increase is attributable to a change in payments terms for a significant customer and timing of customer payments.

Property, plant and equipment, net as of May 29, 2008 decreased to $306.9 million from $310.5 million as of the end of fiscal year 2008.  This decrease relates to depreciation expense for the period offset partially by capital expenditures for the period.

Revolving line of credit amount outstanding as of May 29, 2008 increased to $18.0 million from $9.8 million as of the end of fiscal year 2008 primarily due to increased borrowing to pay the semi-annual interest payments due on the Notes and funding of increases in accounts receivable.

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Accrued interest as of May 29, 2008 decreased to $3.8 million from $8.3 million as of the end of fiscal year 2008 due primarily to the timing of semi-annual interest payments on the Notes.

Stockholders’ equity as of May 29, 2008 was $47.1 million compared to $46.1 as of the end of fiscal year 2008.   The increase is primarily attributable to the net income generated for the three-month period.

Critical Accounting Policies

Our critical accounting policies are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended February 29, 2008.  The preparation of our financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent assets and liabilities.  We base our accounting estimates on historical experience and other factors that we believe to be reasonable under the circumstances.  However, actual results may vary from these estimates under different assumptions or conditions.

New Accounting Pronouncements

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

In February 2007, the FASB issue SFAS 159.  This Standard permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value.  SFAS 159 was effective as of the beginning of fiscal 2009 and the Company chose not to adopt these fair value provisions.

In December 2007, the FASB issued SFAS 141 (R) and SFAS 160.  These new standards will significantly change the financial accounting and reporting of business combination transactions and noncontrolling (or minority) interests in consolidated financial statements.  SFAS 141 (R) is required to be adopted concurrently with SFAS 160 and is effective for business combination transactions for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  Early adoption is prohibited.  We are currently assessing the impact that SFAS 141 (R) and SFAS 160 will have on our results of operations and financial position.

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Item 3.  Quantitative and Qualitative Disclosures about Market Risk

In March 2004, we completed a private offering of the Notes.  In connection with the acquisition of CityForest in March 2007, we issued and sold approximately $20.0 million of Additional Notes and assumed $18.4 million of additional debt.  In connection with our recent acquisition by Cellu Tissue-Hauppauge and Cellu Tissue-Thomaston, we issued and sold approximately $40.0 million of New Notes. We also have the ability to borrow under our revolving line of credit, up to $60.0 million, of which as of May 29, 2008 we have outstanding borrowings of $18.0 million.  Furthermore, we borrowed an additional $12.1 million under the revolving line of credit to finance a portion of our recent acquisition.  As a result, we are highly leveraged.    The interest on our revolving line of credit fluctuates based on prime plus .50% or LIBOR plus 1.75% depending on whether our borrowing is based on prime or LIBOR rates.

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

We are also subject to commodity price risk associated with fluctuations in energy and pulp costs.  We currently use derivative financial instruments to offset a portion of our exposure to market risk arising from changes in the price of natural gas.  We also continue to take advantage of spot prices on pulps to minimize market risk arising from changes in pulp costs.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures (Restated)

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

At the time of our quarterly filing of Form 10Q which was filed on July 11, 2008, Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of May 29, 2008. Subsequent to the restatement described in Note 2 — Restatement of Financial Statements in the consolidated financial statements, we have re-evaluated the effectiveness of the design and operation of our disclosure controls and procedures covered by this Quarterly Report on Form 10Q/A. The re-evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based on this re-evaluation, our management including our Chief Executive Officer and Chief Financial Officer have concluded that, in light of the material weakness in our internal control over financial reporting described below, as of May 29, 2008 our disclosure controls and procedures were not effective.

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

Material Weakness

A material weakness is a deficiency, or combination of deficiencies, in internal controls over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

In connection with the restatement of the Company’s financials statements as of February 29, 2008, we identified the following material weakness in our internal control over financial reporting, which continued to exist as of May 29, 2008:

We did not maintain effective internal control over financial reporting with respect to the application of US GAAP as it relates to complex purchase accounting issues and accounting for derivatives.  The Company lacks sufficient US GAAP expertise to properly assess and record complex accounting matters, specifically (i) deferred income taxes associated with purchase accounting; (ii) shipping and handling fees and costs; (iii) foreign exchange gains and losses; and (iv) derivatives.  See, Note 2 Restatement of Financial Statements in the consolidated financial statements.

Plan of Remediation for Identified Material Weakness

These deficiencies have not been fully remediated. Accordingly, management has determined that these control deficiencies continue to constitute a material weakness at May 29, 2008.

Management has prepared an action plan for all identified deficiencies as of February 29, 2008. The status of this plan will be monitored by management and reviewed by the Audit Committee periodically.

With respect to the identified material weakness, we will review and assess our internal controls, processes and procedures to timely and properly monitor, evaluate and record complex tax and accounting matters in accordance with US GAAP. We intend to review the responsibilities within our accounting and finance departments and may hire additional finance and accounting resources to focus on research and the application of US GAAP.  In addition, we may supplement our internal resources with assistance from outside advisors for the evaluation of unusual and non-routine transactions.

Changes in Internal Control Over Financial Reporting

There were no changes to our internal control over financial reporting during the quarter ended May 29, 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1A.  Risk Factors

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

Item 6.  Exhibits

(a)	Exhibits
	31.1      Certification by President and Chief Executive Officer pursuant to Rule 13a-14(a)
	31.2      Certification by Senior Vice President, Finance and Chief Financial Officer pursuant to Rule 13a-14(a)

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SIGNATURES

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

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

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