Cellu Tissue (CLU) 10-Q/A 2009 Q2 Quarterly report (amended)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q/A

Amendment No. 1

(Mark One)

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

For the transition period from             to              .

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.  See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

The number of shares outstanding of each of the registrant’s classes of common stock as of October 2, 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 August 28, 2008, as filed with the Securities and Exchange Commission on October 10, 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. These adjustments 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).

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 second quarter 2008 Form 10-Q in its entirety. However, this Form 10-Q/A only amends and restates certain information in Items 1, 2 and 4 of Part I, and Item 6 of Part 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 October 10, 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 October 10, 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 first quarter of fiscal 2009 to reflect the restatements described above.

CELLU TISSUE HOLDINGS, INC.

FORM 10-Q/A

QUARTER ENDED AUGUST 28, 2008

INDEX

2

PART I FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

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

See accompanying notes to consolidated financial statements.

3

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	August 28		February 29
	2008		2008
	(Unaudited)		(Note 1)
	(Restated)		(Restated)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$2,603,631		$883,388
Receivables, net	62,634,374		44,542,337
Inventories	42,264,035		33,996,439
Prepaid expenses and other current assets	3,700,042		3,745,989
Income tax receivable	142,966		177,281
Deferred income taxes	5,429,241		7,157,191
TOTAL CURRENT ASSETS	116,774,289		90,502,625
PROPERTY, PLANT AND EQUIPMENT, NET	306,958,854		310,488,081
GOODWILL	35,100,331		11,334,755
OTHER INTANGIBLES, NET	38,763,565		9,400,000
OTHER ASSETS	2,148,254		1,491,218
TOTAL ASSETS	$499,745,293		$423,216,679
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Revolving line of credit	$23,000,000		$9,800,000
Accounts payable	26,603,319		24,055,782
Accrued expenses	22,712,503		19,085,912
Accrued interest	8,930,654		8,253,915
Other current liabilities	15,592,442		15,000,000
Current portion of long-term debt	760,000		760,000
TOTAL CURRENT LIABILITIES	97,598,918		76,955,609
LONG-TERM DEBT, LESS CURRENT PORTION	241,507,873		198,086,944
DEFERRED INCOME TAXES	80,395,415		81,940,082
OTHER LIABILITIES	20,127,373		20,148,590
STOCKHOLDERS’ EQUITY:
Common stock, Class A, $.01 par value, 1,000 shares authorized, 100 shares issued and outstanding	1		1
Capital in excess of par value	62,482,173		47,035,214
Accumulated deficit	(2,116,730	)	(2,862,117	)
Accumulated other comprehensive (loss) income	(249,730	)	1,912,356
TOTAL STOCKHOLDERS’ EQUITY	60,115,714		46,085,454
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$499,745,293		$423,216,679

See accompanying notes to consolidated financial statements.

4

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS     (Unaudited)

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

5

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (continued)

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

See accompanying notes to consolidated financial statements.

6

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

August 28, 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.  (“Cellu Tissue”or the “Company”) and its wholly owned subsidiaries.  The Company is a wholly owned subsidiary of Cellu Paper Holdings, Inc. (the “Parent”), which is a wholly owned subsidiary of Cellu Parent Corporation (“Cellu Parent”).

These statements have been prepared in accordance with accounting principles generally accepted in the United States 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 and six months ended August 28, 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 contained 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 Payments, which requires the measurement of all share-based payments to employees, including grants of employee stock options, using the fair-value-based method and the recording of compensation expense in the Company’s consolidated statements of operations.  Cellu Parent 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 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

7

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

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

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 with a strike price at the estimated fair value of the 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 the Cellu Parent’s stock; and the risk-free interest rate is based on U.S. Treasury securities.   The Company uses historical data in order to estimate exercise, termination and holding period behavior for valuation purposes. The fair value of the stock option grant was estimated on the date of grant using the Black-Scholes option pricing model.  The weighted average 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 August 28, 2008 related to nonvested awards is $543,256.

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

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

On August 6, 2007, Cellu Parent 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, Cellu 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

8

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.

On June 12, 2006, Cellu Parent entered into Restricted Stock Agreements with each of the Company’s Chief Executive Officer, Chief Operating Officer and the then 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 the time of a change in control.  Additionally, the Parent has agreed to pay an amount to the named individuals equal to an amount that would be included in such individuals’ gross income and payable as income tax as a result of making a Section 83(b) 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 three-fourths 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 and six months ended August 28, 2008, the Company has recorded $179,078 and $356,188, respectively of compensation expense related to the above restricted stock grants.   For the three and six months ended August 30, 2007 the Company has recorded $152,822 and $326,944, respectively of compensation expense related to the vesting of the grants at that time 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 Company measures fair value of its derivative financial instruments in accordance with SFAS 157.

9

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

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

SFAS 157 defined fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The fair value hierarchy is as follows:

Level 1	-	Inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2	-	Inputs utilize data points that are observable such as quoted prices, interest rate and yield curves.
Level 3	-	Inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.

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

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.

10

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

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

In February 2007, the FASB issued Statement of 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 its results of operations and financial position.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (“SFAS 161”).  SFAS 161 requires entities to provide enhanced disclosures about derivative instruments and hedging activities.  SFAS 161 is effective for fiscal years and interim periods beginning on or after November 15, 2008.  The Company is currently assessing the impact that SFAS 161 will have on its results of operations and financial position.

Note 2  Restatement / Reclassification of Financial Statements

The Company has restated herein its consolidated financial statements as of August 28, 2008 and February 29, 2008 and for the three and six month periods ended August 28, 2008 and the three and six month periods ended August 30, 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.  These adjustments do not have a negative impact on the Company’s compliance with the

11

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement / Reclassification of Financial Statements (continued)

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

These adjustments are discussed in more detail below. The tables 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 controlled and owned 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 and $.5 million, respectively for the three and six month periods ended August 30, 2007.

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 $4.1 million and $7.1 million for the three and six month periods ended August 28, 2008, respectively; and $3.0 million and $6.0 million for the three and six month periods ended August 30, 2007, respectively.

Foreign exchange gains and losses

The Company incorrectly recorded the remeasurement of an intercompany loan account with its foreign subsidiary through other comprehensive income In accordance with Statement of

12

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

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

Financial Accounting Standards 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 $.1 million and $.4 million for the three and six month periods ended August 30, 2007, respectively.

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 Standards 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 $.6 million for the three and six month periods ended August 30, 2007, respectively.

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.

Reclassification

The Company has reclassified amortization expense within its Consolidated Statements of Operations for the three and six months ended August 28, 2008 to be reflected within income from operations.

13

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Unaudited)

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

14

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement / Reclassification of Financial Statements (continued)

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

15

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement / Reclassification of Financial Statements (continued)

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

16

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement / Reclassification of Financial Statements (continued)

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

17

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 2  Restatement / Reclassification of Financial Statements (continued)

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

Note 3 Inventories

Components of inventories are as follows:

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

18

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 4 Acquisition (continued)

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

LLC (“Cellu Thomaston”) consummated the acquisition of certain assets, and assumption of certain liabilities, from Atlantic Paper & Foil Corp. of N.Y., Atlantic Lakeside Properties, LLC, Atlantic Paper & Foil, LLC, Atlantic Paper & Foil of Georgia, LLC and Consumer Licensing Corporation (collectively, the “Sellers”) pursuant to a definitive asset purchase agreement (the “Purchase Agreement”) between Cellu Tissue 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 Cellu Tissue to Atlantic Paper & Foil Corp. of N.Y. in the principal amount of $6,300,000 (the “Seller Note”), plus the assumption of certain liabilities.  The Company also incurred $2.1 million of transaction related costs.  The purchase price is subject to certain post-closing working capital adjustments.  The acquisition of assets and assumption of liabilities is referred to as the “APF Acquisition” and the acquired business is referred to as “APF”.  The Company financed the cash portion of the purchase price with cash on-hand, the borrowings described below (Note 5) and an equity contribution from the Parent, which was funded through the issuance of Cellu Parent stock to Weston Presidio and certain members of management.

The APF 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 APF during the three and six months ended August 28, 2008 from the date of acquisition.  The acquisition has resulted in the recognition of goodwill, which is attributable to our Tissue segment and will be deductible for tax purposes.  Goodwill reflects the future earnings and cash flow potential of the acquired business in excess of fair values that are assigned to all other identifiable assets and liabilities.  Goodwill arises because the purchase price paid reflects factors including the strategic fit and expected synergies this business brings to existing operations.  Purchase price allocations are subject to refinement until all pertinent information is obtained.    The Company has preliminarily allocated the purchase price over the net assets acquired in the acquisition based on its estimates of the fair value of assets and liabilities as follows:

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

19

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 4 Acquisition (continued)

The Company has estimated the fair value of the assets and liabilities of the APF Acquisition, utilizing information available at the time the Company’s unaudited interim financial statements were prepared and these estimates are subject to refinement until all pertinent information has been obtained. The Company is in the process of finalizing outside third-party appraisals of the tangible and intangible assets and has recorded the preliminary fair market values.   Furthermore, depreciation has been calculated on the fair value assigned to the tangible fixed assets based on an average remaining 10-year life.   Intangible assets are being amortized on a straight-line basis, assuming no significant residual value, over the following lives:  noncompete agreements-5 years, customer lists-7 years and trademarks- 3 years.  The fair value assigned and actual lives used in calculating depreciation and amortization will be finalized with the aforementioned appraisals.  Accordingly, the purchase price allocations are preliminary with respect to these items and also with respect to finalizing the transferability of tax credits and other minor items.

The results of APF’s operations from the July 2, 2008 date of acquisition are primarily included in the Company’s tissue segment.  Part of the acquisition related to the foam business, which the Company will show as a separate segment (see Note 8).  Unaudited pro forma results of operations for the three and six months ended August 28, 2008 and August 30, 2007, as if the Company and APF 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.  However, the pro forma results do not include any cost savings or other effects of the planned integration of APF and are not necessarily indicative of the results which would have occurred if the business combination had been in effect on the dates indicated, or which may result in the future.

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

(1) Pro forma operating results include the operating results for APF for the three months ended June 30, 2008 and 2007, as APF was previously a calendar year-end company.  The actual operating results include the operating results for APF for the period from the acquisition date (July 2, 2008) to August 28, 2008.

20

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 4 Acquisition (continued)

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

(1) Pro forma operating results include the operating results for APF for the six months ended June 30, 2008 and 2007, as APF was previously a calendar year-end company.      The actual operating results include the operating results for APF for the period from the acquisition date (July 2, 2008) to August 28, 2008.

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 “CityForest 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 of approximately $20.0 million, borrowings on a revolving line of credit ($17.4 million) and available cash on hand.

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

The results of CityForest’s operations from the date of acquisition (March 21, 2007) are included in the Company’s tissue segment. Unaudited pro forma results of operations for the six months ended August 30, 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.

21

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.

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

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

Note 5 Long-Term Debt

Long-term debt consists of the following:

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

22

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

9 3/4% Senior Secured Notes due 2010

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”) pursuant to and are 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”).  In connection with the CityForest Acquisition (see Note 3), 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 aggregate principal amount of 9 ¾% senior secured notes due 2010 (“First 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 First Additional Notes were issued pursuant to and are governed by the Cellu Tissue Indenture.

In connection with the APF Acquisition (see Note 4) the Company entered into Note Purchase Agreements (the “Note Purchase Agreements”, or “Second Additional Notes”) 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 “Purchasers”), 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 (“Second Additional 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 Second Additional Notes (together with the Original Notes and the First Additional Notes, the “Notes”).  The Second Additional Notes were issued pursuant to and are governed by the Cellu Tissue Indenture.

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.  The Cellu Tissue Indenture contains certain covenants, including limitations on certain restricted payments, the incurrence of

23

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

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

Seller Note Payable

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

Credit Agreement

The Company entered into a Credit Agreement, dated as of June 12, 2006 (the “Credit Agreement”), among Cellu Tissue, as U.S. Borrower, Interlake Acquisition Corporation Limited (“Interlake”), a subsidiary of Cellu Tissue, as Canadian Borrower, Parent, the other loan guarantors party thereto, JPMorgan Chase Bank, N.A., as U.S. Administrative Agent the “U.S. Administrative Agent”), JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent (the “Canadian Administrative Agent”) and the other lenders party thereto.  The Credit Agreement provides for a $35.0 million working capital facility, which was subseqeuently increased to $60.0 million (see discussion following), 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), 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 CityForest Acquisition and borrowings of $12.1 million were made to finance a portion of the APF Acquisition.   As of August 28, 2008, there was $23.0 million of borrowings outstanding under the working capital facility and excess availability was $30.2 million.

24

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

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

The First Amendment (1) increases the working capital facility from $35.0 million to $40.0 million, (2) permits the issuance and sale by the Company of the First Additional Notes, (3) provides for the consummation of the CityForest 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 CityForest Acquisition in accordance with the terms of the CityForest Bond Documents (as defined below under “CityForest Bond Documents”), and (5) permits the guarantee by Cellu Tissue of certain obligations of CityForest under the CityForest Bond Documents.  In connection with the First Amendment, CityForest became a guarantor of the obligations of the borrowers under the Amended Credit Agreement.

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

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

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 CityForest Acquisition.  CityForest is required, under the terms of the Indenture of Trust governing the Bonds (the “CityForest Indenture”), to

25

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

provide a letter of credit in favor of the trustee under the 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 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 CityForest 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 the CityForest Indenture or refinances the

26

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 5 Long-Term Debt (continued)

indebtedness issued under the CityForest 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.

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 First 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 Debt and Note Issuance Costs

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

27

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 6 Debt and Note Issuance Costs (continued)

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

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

Note 7 Comprehensive (Loss) Income

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

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

Note 8 Business Segments

The Company operates in three business segments:  tissue, machine-glazed paper and foam.  The foam business segment was added in connection with the APF Acquisition (see Note 4).  The Company assesses the performance of its business segments using income from operations.  Income from operations excludes interest income, interest expense, other income (expense), income tax expense, amortization expense 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 and six months ended August 28, 2008 and August 30, 2007 follows:

28

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 8 Business Segments (continued)

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

29

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 8 Business Segments (continued)

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

Note 9 Goodwill and Other Intangibles, Net

Goodwill, trademarks and other intangibles and related accumulated amortization as of August 28, 2008 and February 29, 2008 are as follows:

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

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

30

Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited) (continued)

Note 10 Income Taxes (continued)

The effective income tax rate for the three months and six months ended August 28, 2008 was 45.8% (benefit) and 33.0%, respectively compared to 42.8% and 27.6% (benefit), respectively for the three months and six months ended August 30, 2007.   Included in the income tax expense for the three months and six months ended August 30, 2007 is approximately $90,000 related to additional Canadian income taxes paid upon completion of the Company’s fiscal year 2007 tax returns.

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

The fiscal tax years 2004 through 2008 remain open to examination by the major taxing jurisdictions to which the Company is subject.  As of August 28, 2008, the Company does not expect any material changes to unrecognized tax positions within the next 12 months.

Note 11 Subsequent Events

On August 29, 2008, $15.0 million in contingent consideration in connection with the Agreement and Plan of Merger that the Parent consummated on June 12, 2006 with Cellu Parent , a corporation organized and controlled by Weston Presidio, and Cellu Acquisition Corporation (“Merger Sub”), a wholly owned subsidiary of Cellu Parent and a newly formed corporation indirectly controlled by Weston Presidio was paid out due to the achievement of certain financial targets for fiscal year 2008.   Of the $15 million, $1.3 million was issued in stock of Cellu Parent and $13.7 million was paid out in cash. The $13.7 million was funded by an equity investment of $6.7 million by Weston Presidio to Cellu Parent and $7.0 by Cellu Tissue, which was funded through borrowings on the Company’s revolving line of credit.

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

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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 and 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 Item 1. Business-Forward-Looking Statements and Item 1A.  Risk Factors 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 August 28, 2008 and February 29, 2008 and for the three and six month periods ended August 30, 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 three business segments:  tissue, machine-glazed paper and foam.    The foam business segment was added in connection with the APF Acquisition (see discussion below).  We assess the performance of our business segments using income

32

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

Acquisitions

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

The APF 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 APF during the three and six months ended August 28, 2008 from the date of acquisition.  The acquisition has resulted in the recognition of goodwill, which is attributable to our Tissue segment and will be deductible for tax purposes.  Goodwill reflects the future earnings and cash flow potential of the acquired business in excess of fair values that are assigned to all other identifiable assets and liabilities.  Goodwill arises because the purchase price paid reflects factors including the strategic fit and expected synergies this business brings to existing operations.  Purchase price allocations are subject to refinement until all pertinent information is obtained.  We have preliminarily allocated the purchase price over the net assets acquired in the acquisition based on an estimate of the fair value of assets and liabilities as follows:

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

33

We have estimated the fair value of the assets and liabilities of the APF Acquisition, utilizing information available at the time our unaudited interim financial statements were prepared and these estimates are subject to refinement until all pertinent information has been obtained.  We are in the process of finalizing outside third-party appraisals of our tangible and intangible assets and have recorded the preliminary fair market values.   Furthermore, depreciation has been calculated on the fair value assigned to the tangible fixed assets based on an average remaining 10-year life.   Intangible assets are being amortized on a straight-line basis, assuming no significant residual value, over the following lives:  noncompete agreements-5 years, customer lists-7 years and trademarks- 3 years.  The fair value assigned and actual lives used in calculating depreciation and amortization will be finalized with the aforementioned appraisals.  Accordingly, the purchase price allocations are preliminary with respect to these items and also with respect to finalizing the transferability of tax credits and other minor items.

The results of APF’s operations from the July 2, 2008 date of acquisition are primarily included in our tissue segment.  Part of the acquisition related to the foam business, which we show as a separate segment as noted above.  Unaudited pro forma results of operations for the three and six months ended August 28, 2008 and August 30, 2007, as if we and APF had been combined as of March 1, 2007, are 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 APF and are not necessarily indicative of the results which would have occurred if the business combination had been in effect on the dates indicated, or which may result in the future.

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

(1) Pro forma operating results include the operating results for APF for the three months ended June 30, 2008 and 2007, as APF was previously a calendar year-end company.  The actual  operating results include the operating results for APF for the period from the acquisition date (July 2, 2008) to August 28, 2008.

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

34

(1) Pro forma operating results include the operating results for APF for the six months ended June 30, 2008 and 2007, as APF was previously a calendar year-end company.      The actual operating results include the operating results for APF for the period from the acquisition date (July 2, 2008) to August 28, 2008.

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 the First Additional Notes of approximately $20.0 million, borrowings on a revolving line of credit ($17.4 million) and available cash on hand.

The CityForest Acquisition has been accounted for as a purchase in accordance with the provisions of SFAS 141 and, accordingly, the consolidated statements of operations includes the results of CityForest during the three months and six months ended August 28, 2008, during the three months ended August 30, 2007 and during the six months ended August 30, 2007 from the date of acquisition.   The results of CityForest’s operations are included in our tissue segment.   Unaudited pro forma results of operations for the six months ended August 30, 2007, as if we and CityForest had been combined as of March 1, 2007, 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 date indicated, or which may result in the future.

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

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

35

Subsequent Events

On August 29, 2008, $15.0 million in contingent consideration in connection with the Agreement and Plan of Merger that the Parent consummated on June 12, 2006 with the Parent, Weston Presidio and Merger Sub, a wholly owned subsidiary of Cellu Parent and a newly formed corporation indirectly controlled by Weston Presidio was paid out due to the achievement of certain financial targets for fiscal year 2008.   Of the $15 million, $1.3 million was issued in stock of Cellu Parent and $13.7 million was paid out in cash. The $13.7 million was funded by an equity investment of $6.7 million by Weston Presidio to Cellu Parent and $7.0 by Cellu Tissue, which was funded through borrowings on the Company’s revolving line of credit.

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

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

Net sales for the fiscal 2009 three-month period increased $21.0 million, or 18.7%, to $133.0 million from $112.0 million for the comparable period in the prior year. Net sales for the fiscal 2009 six-month period increased $29.2 million, or 13.4%, to $247.5 from $218.3 million for the comparable period in the prior year.  On a company-wide basis, tons sold increased for the fiscal 2009 three-month period and the fiscal 2009 six-month period compared to the comparable periods of fiscal 2008.  For the fiscal 2009 three-month period, we sold 87,036 tons of tissue hard rolls, machine-glazed paper hard rolls and converted paper products, an increase of 6,887 tons, or 8.6%, compared to the fiscal 2008 three-month period.  For the fiscal 2008 six-month period, we sold 164,485 tons of tissue hard rolls, machine-glazed paper hard rolls and converted paper products, an increase of 6,231 tons, or 3.9%, compared to the fiscal 2008 six-month period.   Of these increases, $14.5 million of net sales and 7,941 tons sold related to APF.  Net selling price per ton increased from $1,398 and $1,379 for the fiscal 2008 three-month and six-month periods to $1,518 and $1,500 for the fiscal 2009 three-month and six-month periods.

Net sales for our tissue segment for the fiscal 2009 three-month period were $103.4 million, an increase of $17.8 million, or 20.8%, from the comparable period in the prior year.  Net sales for our tissue segment for the fiscal 2009 six-month period were $189.2

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million, an increase of $23.8 million, or 14.4%, from the comparable period in the prior year.  These increases are the result of the APF Acquisition, an increase in tonnage sold, primarily in our converting business, and an increase in net selling price per ton over the comparable periods 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.  Net sales for our machine-glazed segment for the 2009 six-month period were $57.4 million, an increase of $4.6 million, or 8.7%, from the comparable period in the prior year.   These increases are driven primarily by an increase in net selling price per ton over the comparable periods in the prior year.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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tax rate of 27.6% for the fiscal year 2008 six-month period.   Included in the income tax expense for the fiscal 2008 three-month and six-month periods is approximately $90,000 related to additional Canadian income taxes paid upon completion of our fiscal year 2007 tax returns.  The effective tax expense for the 2008 three-month and six-month periods, without the effect of the additional Canadian income tax expense, was 33.3% and 38.5%, respectively.

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

FINANCIAL CONDITION

Liquidity and Capital Resources

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

Net cash used in investing activities for the fiscal 2009 six-month period was $68.6 million compared to net cash used in investing activities of $50.6 million for the fiscal 2008 six-month period.  The fiscal 2009 six-month period includes $63.8 million of cash paid for the APF Acquisition.  The fiscal 2008 six-month period includes $43.7 million of cash paid for the CityForest Acquisition, net of cash received.  The remaining change relates to the level of capital spending period over period.

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

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

9 ¾% Senior Secured Notes due 2010

In March 2004, we completed a private offering of the Original Notes pursuant to and are governed by the Cellu Tissue Indenture among us, the subsidiary guarantors party thereto and the Trustee.   In connection with the CityForest Acquisition, we entered into the Note Purchase Agreement with the Purchaser, dated March 21, 2007, pursuant to which we issued and sold the First Additional Notes to 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 First Additional Notes were issued pursuant to and are governed by the Cellu Tissue Indenture.

In connection with the APF Acquisition, we entered into the Note Purchase Agreements with each of the Purchasers, dated July 2, 2008, pursuant to which we issued and sold the Second Additional 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 Second Additional Notes.  The Second Additional Notes were issued pursuant to and are governed by the Cellu Tissue Indenture.

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 our assets.  The Cellu Tissue Indenture contains certain covenants, including limitations on certain restricted payments, the incurrence of additional indebtedness and the sale of certain assets.    The Cellu Tissue Indenture has been amended by two subsequent amendments pursuant to which CityForest, Cellu Happauge and Cellu Thomaston became parties to the Cellu Tissue Indenture as subsidiary guarantors (collectively, the “Additional Guarantors”).  As subsidiary guarantors, the Additional Guarantors, on a joint and several basis, with all the existing subsidiary guarantors, fully, unconditionally and irrevocably guarantee the obligations of Cellu Tissue under the Cellu Tissue Indenture and Notes.  The Notes are unconditionally guaranteed by all of the Company’s subsidiaries.

Seller Note Payable

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

Credit Agreement

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

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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), 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 CityForest Acquisition and borrowings of $12.1 million were made to finance a portion of the APF Acquisition.   As of August 28, 2008, there was $23.0 million of borrowings outstanding under the working capital facility and excess availability was $30.2 million.

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

The First Amendment (1) increases the working capital facility from $35.0 million to $40.0 million, (2) permits the issuance and sale by us of the First Additional Notes, (3) provides for the consummation of the CityForest 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 CityForest Acquisition in accordance with the terms of the CityForest Bond Documents (as defined below under “CityForest Bond Documents”), and (5) permits the guarantee by Cellu Tissue of certain obligations of CityForest under the CityForest Bond Documents.  In connection with the First Amendment, CityForest became a guarantor of the obligations of the borrowers under the Amended Credit Agreement.

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

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

CityForest Bond Documents

CityForest is party to a Loan Agreement with the City of Ladysmith, Wisconsin, as Issuer.  Pursuant to the 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

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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 CityForest 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.

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;

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acquisitions, mergers and consolidations; investments; guarantees; asset sales; sale and leaseback transactions; dividends and distributions; transactions with affiliates; capital expenditures; and changes to the 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.

In addition, we have entered into a Third Amendment to the Credit Agreement which changes the borrowings under the Credit Agreement so that $55.0 million is available, in U.S. dollars, to the U.S. Borrower and $5.0 million is available, in U.S. or Canadian dollars, to the Canadian Borrower.

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

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

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

Property, plant and equipment, net as of August 28, 2008 decreased to $307.0 million from $310.5 million as of the end of fiscal year 2008.  Included in the $307.0 million of property, plant and equipment, net is $5.3 million related to APF.  Without the effect of the acquisition, property, plant and equipment decreased $8.8 million from the end of

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fiscal year 2008.  This decrease relates to depreciation expense for the period offset partially by capital expenditures for the period.

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

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

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

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

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

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

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

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

Critical Accounting Policies

Our critical accounting policies are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for fiscal year 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.

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Derivatives and Hedging

We use derivative financial instruments to offset a substantial portion of its exposure to market risk arising from changes in the price of natural gas. Hedging of this risk is accomplished by entering into forward swap contracts, which are designated as hedges of specific quantities of natural gas expected to be purchased in future months.    These contracts are held for purposes other than trading and are designated as cash flow hedges.  We measure fair value of our derivative financial instruments in accordance with SFAS 157.  SFAS 157 defined fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The fair value hierarchy is as follows:

Level 1-	Inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2-	Inputs utilize data points that are observable such as quoted prices, interest rate and yield curves.
Level 3-	Inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.

Derivatives are reported at fair value utilizing Level 2 inputs.   The fair value of these cash flow hedging instruments was a liability of $.6 million and an asset of $.2 million as of August 28, 2008 and February 29, 2008, respectively.  During the next 12 months, the entire $.6 million will be reclassified to earnings consistent with the timing of the underlying hedged transactions.

New Accounting Pronouncements

In September 2006, the FASB issued SFAS 157.  We were required to adopt the provisions 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 our results of operations and financial position.

In February 2007, the FASB issued 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 we 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.

In March 2008, the FASB issued SFAS 161.  SFAS 161 requires entities to provide enhanced disclosures about derivative instruments and hedging activities.  SFAS 161 is effective for fiscal years and interim periods beginning on or after November 15, 2008. We are currently assessing the impact that SFAS 161 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 First Additional Notes and assumed $18.4 million of additional debt.  In connection with the APF Acquisition, we issued and sold approximately $40.0 million of Second Additional Notes. Our Notes mature on March 15, 2010.  We also have the ability to borrow under our revolving line of credit, up to $60.0 million, of which as of August 28, 2008 we have outstanding borrowings of $23.0 million.  Borrowings of $12.1 million were made to finance a portion of the APF 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 October 10, 2008 our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of August 28, 2008. Subsequent to the restatement discussed in Note 2 - Restatement / Reclassification 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 August 28, 2008 our disclosure controls and procedures were not effective.

As a result of this material weakness, management performed additional procedures to ensure that our 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

The material weakness has a deficiency, or combination of deficiencies, in internal controls over a 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 August 28, 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

The material weakness has not been fully remediated. Accordingly, management has determined that these control deficiencies continue to constitute a material weakness at August 28, 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 August 28, 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

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

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

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10.6	Second Amendment, dated July 2, 2008 to the Credit Agreement dated June 12, 2006 among Cellu Tissue, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of Cellu Tissue, as Canadian Borrower, certain subsidiaries of Cellu Tissue, Cellu Paper Holdings, Inc., JPMorgan Chase Bank, N.A. and JPMorgan Chase Bank, N.A., Toronto Branch (incorporated by reference to Exhibit 10.7 to the Current Report on Form 8-K filed on July 8, 2008).
10.7	Third Amendment, dated September 26, 2008 to the Credit Agreement dated June 12, 2006 among Cellu Tissue, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of Cellu Tissue, as Canadian Borrower, certain subsidiaries of Cellu Tissue, Cellu Paper Holdings, Inc., JPMorgan Chase Bank, N.A. and JPMorgan Chase Bank, N.A., Toronto Branch
31.1	Certification by President and Chief Executive Officer pursuant to Rule 13a-14(a)
31.2	Certification by Senior Vice President, Finance and Chief Financial Officer pursuant to Rule 13a-14(a)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, 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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