10-Q

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

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended August 30, 2007
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 ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer”in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o      Accelerated filer  o     Non-accelerated filer   x

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 5, 2007:

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

CELLU TISSUE HOLDINGS, INC.

FORM 10-Q

QUARTER ENDED AUGUST 30, 2007

INDEX

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PART I – FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements

CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	For the Periods
	Post - Merger						Pre-Merger
	June 1, 2007-			June 13, 2006-			May 26, 2006-
	August 30,2007			August 24, 2006			June 12, 2006
Net sales	$	109,000,321		$	68,562,386		$	15,599,955
Cost of goods sold	97,233,784			65,217,759			14,262,654
Gross profit	11,766,537			3,344,627			1,337,301
Selling, general and administrative expenses	4,519,992			3,778,374			2,437,561
Stock and related compensation expense	186,203			136,290			—
Restructuring costs	—			240,218			—
Merger-related transaction costs	—			102,375			5,806,058
Income (loss) from operations	7,060,342			(912,630		)	(6,906,318		)
Interest expense, net	5,102,666			3,152,536			843,630
Foreign currency loss (gain)	196,110			(66,676		)	83,510
Other income	(40,261		)	(17,453		)	(1,657		)
Income (loss) before income tax expense (benefit)	1,801,827			(3,981,037		)	(7,831,801		)
Income tax expense (benefit)	731,997			(1,361,649		)	(1,772,489		)
Net income (loss)	$	1,069,830		$	(2,619,388	)	$	(6,059,312	)

See accompanying notes to consolidated financial statements.

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	For the Periods
	Post - Merger						Pre-Merger
	March 1, 2007-			June 13, 2006-			March 1, 2006-
	August 30, 2007			August 24, 2006			June 12, 2006
Net sales	$	212,201,107		$	68,562,386		$	94,241,932
Cost of goods sold	192,142,452			65,217,759			86,053,812
Gross profit	20,058,655			3,344,627			8,188,120
Selling, general and administrative expenses	9,002,729			3,778,374			5,584,865
Stock and related compensation expense	419,322			136,290
Restructuring costs	—			240,218			—
Merger-related transaction costs	—			102,375			5,933,265
Income (loss) from operations	10,636,604			(912,630		)	(3,330,010		)
Interest expense, net	10,121,760			3,152,536			4,896,355
Foreign currency loss (gain)	520,408			(66,676		)	289,010
Other income	(82,500		)	(17,453		)	(27,049		)
Income (loss) before income tax expense (benefit)	76,936			(3,981,037		)	(8,488,326		)
Income tax expense (benefit)	117,590			(1,361,649		)	(1,953,362		)
Net loss	$	(40,654	)	$	(2,619,388	)	$	(6,534,964	)

See accompanying notes to consolidated financial statements.

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CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	August 30			February 28
	2007			2007
	(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	2,335,306		$	16,260,601
Receivables, net	43,277,645			34,140,844
Inventories	30,742,895			29,603,809
Prepaid expenses and other current assets	6,097,851			2,809,014
Income tax receivable	327,183			329,861
Deferred income taxes	5,652,643			6,498,098
TOTAL CURRENT ASSETS	88,433,523			89,642,227
PROPERTY, PLANT AND EQUIPMENT, NET	291,711,662			228,851,765
GOODWILL	6,924,559			—
TRADEMARKS	8,750,314			6,550,314
OTHER ASSETS	1,436,426			224,438
TOTAL ASSETS	$	397,256,484		$	325,268,744
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Revolving line of credit	$	2,600,000		$	—
Accounts payable	26,978,335			16,523,755
Accrued expenses	19,188,428			16,315,163
Accrued interest	8,294,935			7,226,753
Current portion of long-term debt	760,000			—
TOTAL CURRENT LIABILITIES	57,821,698			40,065,671
LONG-TERM DEBT, LESS CURRENT PORTION	198,350,283			160,355,507
DEFERRED INCOME TAXES	65,596,632			50,677,332
OTHER LIABILITIES	35,159,782			35,179,252
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	46,641,601			46,259,101
Accumulated deficit	(6,233,020		)	(6,192,366		)
Accumulated other comprehensive loss	(80,493		)	(1,075,754		)
TOTAL STOCKHOLDERS’ EQUITY	40,328,089			38,990,982
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	397,256,484		$	325,268,744

See accompanying notes to consolidated financial statements.

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CELLU TISSUE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)

	For the Periods
	Post - Merger						Pre-Merger
	March 1, 2007-			June 13, 2006-			March 1, 2006-
	August 30, 2007			August 24, 2006			June 12, 2006
Cash flows from operating activities
Net loss	$	(40,654	)	$	(2,619,388	)	$	(6,534,964	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Noncash inventory charge	—			909,264			—
Stock-based compensation	382,500			136,290			923,580
Deferred income taxes	(1,473,753		)	(558,206		)	(396,024		)
Accretion of debt discount	304,776			59,994			85,471
Amortization of intangibles	—			—			405,568
Depreciation	12,194,748			4,515,763			4,226,643
Changes in operating assets and liabilities:
Receivables	(3,565,303		)	2,998,825			(1,994,674		)
Inventories	406,347			2,185,566			(2,208,757		)
Prepaid expenses, other current assets and income tax receivable	(2,128,067		)	177,486			(683,329		)
Other	458,540			(15,410		)	(5,328		)
Accounts payable, accrued expenses and accrued interest	6,685,112			(2,139,598		)	(358,006		)
Total adjustments	13,264,900			8,269,974			(4,856		)
Net cash provided by (used in) operating activities	13,224,246			5,650,586			(6,539,820		)
Cash flows from investing activities
Cash paid for acquisition, net of cash received	(43,617,819		)
Equity investment by Weston Presidio	—			45,761,997			—
Capital expenditures, net	(6,940,787		)	(1,884,457		)	(1,937,610		)
Net cash (used in) provided by investing activities	(50,558,606		)	43,877,540			(1,937,610		)

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	For the Periods
	Post - Merger						Pre-Merger
	March 1, 2007-			June 13, 2006-			March 1, 2006-
	August 30, 2007			August 24, 2006			June 12, 2006
Cash flows from financing activities
Merger consideration paid to former shareholders	—			(45,761,997		)	—
Payments of long-term debt	—			—			(290,000		)
Borrowings on revolving line of credit,net	2,600,000			—			—
Proceeds from bond offering	20,000,000			—			—
Net cash provided by (used in) financing activities	22,600,000			(45,761,997		)	(290,000		)
Effect of foreign currency	809,065			(48,535		)	362,212
Net (decrease) increase in cash and cash equivalents	(13,925,295		)	3,717,594			(8,405,218		)
Cash and cash equivalents at beginning of period	16,260,601			14,418,844			22,824,062
Cash and cash equivalents at end of period	$	2,335,306		$	18,136,438		$	14,418,844

See accompanying notes to consolidated financial statements.

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Cellu Tissue Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

August 30, 2007

Note 1 Basis of Presentation and Significant Accounting Policies

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

On June 12, 2006 the Parent consummated an Agreement and Plan of Merger with Cellu Parent Corporation (“Cellu Parent”), a corporation organized and controlled by Weston Presidio V, L.P. (“Weston Presidio”), and Cellu Acquisition Corporation, a wholly owned subsidiary of Cellu Parent and a newly formed corporation indirectly controlled by Weston Presidio (“Merger Sub”).  Pursuant to the agreement, on June 12, 2006, Merger Sub was merged with and into Parent, with Parent surviving (the “Merger”).  Accordingly, the operating results and cash flows for the prior year are presented in the accompanying financial statements on a pre-merger (period from May 26, 2006 to June 12, 2006 and period from March 1, 2006 to June 12, 2006) and post-merger (period from June 13, 2006 to August 24, 2006) basis.  The current year operating results and cash flows are post-merger.

 These statements have been prepared in accordance with U.S. generally accepted accounting principles 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 U.S. generally accepted accounting principles 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 30, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending February 29, 2008.  For further information, refer to the Company’s consolidated financial statements and footnotes thereto as of February 28, 2007 and for the year then ended contained in the Company’s Annual Report on Form 10-K, from which the consolidated balance sheet at February 28, 2007 has been derived and the Company’s latest Current Reports on Form 8-K as filed with the Securities and Exchange Commission (“SEC”).

The Company accounted for the Merger as a purchase in accordance with the provisions of Statement of Financial Accounting Standards No. 141 (“SFAS 141”), Business Combinations, which resulted in a new valuation for the assets and liabilities of the Company based upon fair values as of the date of the Merger.  As allowed under SEC Staff Accounting Bulletin No. 54, Push Down Basis of Accounting Required in Certain Limited Circumstances, the Company has reflected all applicable purchase accounting

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adjustments in the Company’s consolidated financial statements for all periods subsequent to the Merger date (“Push Down Accounting”).  Push Down Accounting requires the Company to establish a new basis for its assets and liabilities based on the amount paid for its equity at close of business on June 12, 2006.  Accordingly, Cellu Parent’s ownership basis is reflected in the Company’s consolidated financial statements beginning upon completion of the Merger.  In order to apply Push Down Accounting, Cellu Parent’s purchase price of $207.8 million, including assumption of $162.0 million in aggregate principal amount of the Company’s outstanding 9.75% senior secured notes (the “Notes”), was allocated to the assets and liabilities based on their relative fair values.  The purchase price is subject to adjustment for certain tax benefits that the Company may realize.  In addition, total consideration is subject to adjustment for up to an additional $35.0 million in contingent earnout consideration based upon the achievement of certain financial targets.  If any portion of the earned contingent payments is unable to be made, then Weston Presidio has agreed to provide the necessary funds to former holders of the Parent’s capital stock, options and warrants through an equity investment in Parent or otherwise.  In accordance with SFAS 141, the $35.0 million has been recognized as a liability in the Company’s balance sheet and is recorded in other liabilities as of August 30, 2007.

The Company has allocated the excess purchase price over the net assets acquired in the Merger based on its estimates of the fair value of assets and liabilities as follows:

	Excess purchase price allocated to:
Inventories	$	909,264
Property, plant and equipment	142,292,525
Trademarks	6,550,314
Long-term debt	(900,729		)
Contingent consideration	(35,000,000		)
Deferred income taxes	(50,830,323		)
Total	$	63,021,051

In conjunction with the valuation of the Company’s fixed assets, the lives over which the assets are depreciated were re-evaluated and the resulting estimated useful lives of the principal classifications of depreciable assets are as follows:

	Life in Years
Buildings and improvements	20-30
Machinery and equipment	15-30
Furniture and fixtures	10
Land improvements	5
Computer software	5

9

Reclassification

Certain prior year amounts have been reclassified to conform to the current fiscal year 2008 presentation.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS 123R”), Share-Based Payment, which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using fair-value-based method and the recording of such expense in the Company’s consolidated statement of operations.  The Company adopted the provisions of SFAS 123R using the prospective method effective March 1, 2006.  As such, there was no accounting effect on any outstanding awards.  Upon adoption of SFAS 123R, the Company had only one share-based payment arrangement under which the Parent granted stock options to certain members of the Company’s management under the Cellu Paper Holdings, Inc. 2001 Stock Incentive Plan (the “old Plan”).  In accordance with the old Plan, each option outstanding at the time of a change in control immediately vested and became exercisable.  Furthermore, in accordance with the terms of the Merger, all outstanding options were cancelled and automatically converted into the right to receive the per share merger consideration for in-the-money options.

On June 12, 2006, the Board of Directors of Cellu Parent adopted the 2006 Stock Option and Restricted Stock Plan (the “Plan”).  Under 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 position to make a significant contribution to the success of Cellu Parent and its affiliates are eligible to participate in the Plan.   Stock options are granted at the market price of the Company’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 Company’s stock; and the risk-free interest rate is based on U.S. Treasury securities with

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maturities equal to the expected life of the option.  The Company uses historical data in order to estimate exercise, termination and holding period behavior for valuation purposes.  A summary of the outstanding options as of August 30, 2007 is as follows:  There was no activity during the three months then ended.

	Options	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
Outstanding, June 1, 2007 and August 30, 2007	1,150	$	726.99	9.53 and 9.28 years, respectively
Exercisable, August 30, 2007	—	—		—

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; 57% volatility; 4.9% risk free interest rate; and 10-year expected life.  The weighted average fair value of stock options granted was $472.69 per share and the unrecognized total compensation cost as of August 30, 2007 related to nonvested awards is $473,352.

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, 2007, as long as the named individual is continuously employed by the Company until such vesting date with respect to his shares.  Any restricted stock outstanding at the time of a Covered Transaction (as defined in the Plan) shall become vested and cease to be restricted stock at the time of a change in control.  Additionally, the Parent has agreed to pay an amount to the named individual equal to an amount that would be included in such individual’s gross income and payable as income 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 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,

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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 2/3 of the restricted stock grant, and accordingly, the Company only recorded compensation expense associated with this individual’s grant through June 12, 2007 as all other shares were forfeited and no compensation expense is required to be recognized for forfeited shares.

For the three months ended August 30, 2007, the Company has recorded $152,822 of compensation expense related to the above restricted stock grants.  For the period from June 13, 2006 to August 24, 2006, the Company has recorded $136,290 of compensation expense related to the vesting of the grants at that time in accordance with SFAS 123R.

Immediately prior to consummation of the Merger, there were 341.3 restricted shares of the Parent’s common stock.  In accordance with the terms of the old Plan, the restricted stock immediately vested.  Accordingly, for the period from May 26, 2006 to June 12, 2006, the Company has recorded $870,922 of compensation expense related to the vesting of the above restricted stock in accordance with SFAS 123R.  The Company had previously recorded $52,658 related to the normal vesting in the three-month period ended May 25, 2006.

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 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.  The Company measures hedge effectiveness by formally assessing, at least quarterly, the correlation of the expected future cash flows of the hedged item and the derivative hedging instrument.  The ineffective portions of the hedges, which are not material for any period presented, are immediately recognized in earnings.  The fair value of these cash flow hedging instruments was a liability of $.6 million and an asset of less than $.1 million as of August 30, 2007 and February 28, 2007, respectively.  During the next 12 months, the entire $.6 million will be reclassified to earnings consistent with the timing of the underlying hedged transactions.

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Note 2 Inventories

Components of inventories are as follows:

	August 30, 2007			February 28, 2007
Finished goods	$	17,017,370		$	18,896,790
Raw materials	4,858,104			2,742,025
Packaging materials and supplies	9,082,168			8,098,582
	30,957,642			29,737,397
Inventory reserves	(214,747		)	(133,588		)
	$	30,742,895		$	29,603,809

Note 3 Acquisitions

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

The Acquisition has been accounted for as a purchase in accordance with the provisions of SFAS 141 and, accordingly, the consolidated statements of operations includes the results of CityForest during the three months and six months ended August 30, 2007 from the date of acquisition.  Purchase price allocations are subject to refinement until all pertinent information is obtained.  The Company has allocated the excess of purchase price over the net assets acquired in the acquisition based on its estimates of the fair value of assets and liabilities as follows:

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	Excess purchase price allocated to:
Property, plant and equipment	$	32,874,272
Trademarks	2,200,000
Goodwill	6,924,559
Long-term debt	(1,724,684		)
Deferred income taxes	(17,238,509		)
Total	$	23,035,638

The Company has estimated the fair value of the assets and liabilities of the Acquisition, utilizing information available at the time the Company’s unaudited interim financial statements subsequent to the Acquisition were prepared, and these estimates are subject to refinement until all pertinent information has been obtained. At that time, the Company was in the process of obtaining outside third-party appraisals of its tangible and intangible assets and had assumed no intangible assets or goodwill arising from the acquisition.  In the second quarter of the fiscal year ending February 29, 2008 (“fiscal year 2008”), the Company obtained a third-party appraisal of CityForest’s tangible and intangible assets and has finalized its calculation of deferred income taxes resulting from the book to tax differences arising from the application of purchase accounting.  As a result thereof, trademarks of $2.2 million and goodwill of $6.9 million have been recorded.  Furthermore, the net deferred income tax liability has increased $4.2 million from the Company’s original estimate.

The results of CityForest’s operations from the date of acquisition (March 21, 2007) are included in the Company’s tissue segment and accordingly, are included for the three months ended August 30, 2007.  Unaudited pro forma results of operations for the periods June 13, 2006-August 24, 2006 and May 26, 2006-June 12, 2006, for the six months ended August 30, 2007, for the period June 13, 2006-August 24, 2006 and for the period March 1, 2006-June 12, 2006, as if the Company and CityForest had been combined as of March 1, 2006, 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 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.

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	June 13, 2006-August 24, 2006 (1)						May 26, 2006 – June 12, 2006 (1)
	As Filed			Pro Forma			As Filed			Pro Forma
	(in thousands)						(in thousands)
Net sales	$	68,562		$	78,146		$	15,600		$	17,802
Operating (loss) income	$	(913	)	$	1,715		$	(6,906	)	$	(6,302	)
Net loss	$	(2,619	)	$	(661	)	$	(6,059	)	$	(5,609	)

(1) Pro forma operating results include the operating results for CityForest for the three months ended June 30, 2006, prorated between the two reporting periods presented for the Company,  as CityForest was previously a calendar year-end company.

	Six Months Ended August 30,2007(1)					June 13, 2006-August 24, 2006 (2)						March 1, 2006-June 12, 2006 (2)
	As Filed			Pro Forma		As Filed			Pro Forma			As Filed			Pro Forma
	(in thousands)					(in thousands)						(in thousands)
Net sales	$	212,201		$	214,911	$	68,562		$	78,146		$	94,242		$	107,644
Operating income	$	10,637		$	11,223	$	(913	)	$	1,715		$	(3,330	)	$	(266	)
Net (loss) income	$	(41	)	$	520	$	(2,619	)	$	(661	)	$	(6,535	)	$	(4,344	)

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

(2)  Pro forma operating results include the operating results for CityForest for the six months ended June 30, 2006, prorated between the two reporting periods presented for the Company, as CityForest was previously a calendar year-end company.

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Note 4 Long-Term Debt

Long-term debt consists of the following:

	August 30, 2007			February 28, 2007
9 ¾% senior secured notes due 2010	$	182,255,572		$	162,000,000
Less discount	(1,595,289		)	(1,644,493		)
	180,660,283			160,355,507
Industrial revenue bond payable, in semi-annual installments, plus variable interest, due March 1, 2008	18,450,000			—
	199,110,283			160,355,507
Less current portion of debt	760,000			—
	$	198,350,283		$	160,355,507

In connection with the Acquisition (see Note 3), the Company entered into a Note Purchase Agreement (the “Note Purchase Agreement”) with Wingate Capital Ltd. (“Wingate”), dated March 21, 2007, pursuant to which it issued and sold $20.3 million aggregate principal amount of Additional Notes to Wingate for the purchase price of $20.0 million, which is equal to 98.7383% of the aggregate principal amount of the Additional Notes. The Additional Notes were issued pursuant to and will be governed by the Indenture, dated as of March 12, 2004 (as amended and supplemented, the “Cellu Tissue Indenture”) among the Company, the subsidiary guarantors party thereto and The Bank of New York Trust Company, N.A., as successor trustee to the Bank of New York (the “Trustee”).

The Notes and Additional Notes mature on March 15, 2010 and require semi-annual interest payments on March 15 and September 15, which commenced on September 15, 2004.  The Notes and Additional Notes are collateralized by a senior secured interest in substantially all of the Company’s assets.  Terms of the indenture under which the Notes and Additional Notes have been issued contain certain covenants, including limitations on certain restricted payments and the incurrence of additional indebtedness.  The Notes and Additional Notes are unconditionally guaranteed by all of the Company’s subsidiaries.

In connection with the Merger (see Note 1), the Company solicited consents with respect to the Notes.  Consents were received with respect to 100% of the aggregate outstanding principal amount of the Notes. The Company accepted all of the consents delivered in the consent solicitation and paid to the consenting noteholders a consent fee of $40 per $1,000 principal amount of Notes for which they delivered consents.  These payments were made in the Company’s second quarter of the fiscal year ended February 28, 2007

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(“fiscal year 2007”).  These payments along with other transaction costs totaling $5.9 million are reflected as merger-related transaction costs on the statement of operations for the prior year.  The Company had previously incurred $.1 million in the first quarter of fiscal year 2007.  As a result of the acceptance by the Company of the consents delivered by noteholders and the completion of the consent solicitation, the amendments to the Cellu Tissue Indenture described in the Consent Solicitation Statement dated May 9, 2006 and related Supplement dated May 24, 2006 became operative and the Company was not required to make a change of control offer to purchase any Notes in connection with the Merger.

The Company entered into a Credit Agreement, dated as of June 12, 2006 (the “Credit Agreement”), among the Company, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of the Company, as Canadian Borrower, Parent, the other loan guarantors party thereto, JPMorgan Chase Bank, N.A., as U.S. Administrative Agent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent, and the other lenders party thereto.  The Credit Agreement provides for a $35.0 million working capital facility, 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 is available, in U.S. dollars, to the U.S. Borrower under the facility, and an amount equal to $3.0 million is available, in U.S. or Canadian dollars, to the Canadian Borrower under the facility.  Borrowings of $17.4 million were made to finance a portion of the Acquisition.  As of August 30, 2007, $2.6 million of borrowings remained outstanding under the working capital facility.

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

Second Supplemental Indenture

The Company, certain of its subsidiaries, the Trustee and CityForest have executed the Second Supplemental Indenture, dated March 21, 2007 (the “Second Supplemental Indenture”), pursuant to which CityForest became a party to the Cellu Tissue Indenture as a subsidiary guarantor.  As a subsidiary guarantor, CityForest, on a joint and several basis with all the existing subsidiary guarantors, fully, unconditionally and irrevocably guarantees to each holder of the Notes and the Trustee the obligations of Company under its Indenture and the Notes.

Amendment to Credit Agreement

The Company has entered into a First Amendment, dated March 21, 2007 (the “Amendment”), to the Credit Agreement dated June 12, 2006 (as amended by the

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Amendment, the “Amended Credit Agreement”) among Cellu Tissue, as U.S. Borrower, Interlake Acquisition Corporation Limited, a subsidiary of Cellu Tissue, as Canadian Borrower, certain subsidiaries of Cellu Tissue, Cellu Paper Holdings, Inc., the parent corporation of Cellu Tissue, JPMorgan Chase Bank, N.A. (the “U.S. Administrative Agent”) and JPMorgan Chase Bank, N.A., Toronto Branch (the “Canadian Administrative Agent”).

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

CityForest Bond Documents

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

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is also obligated to pay a fee in respect of the aggregate amount available to be drawn under the Associated Bank Letter of Credit at a rate per annum initially equal to 1.25%, subject to adjustment on a quarterly basis based on CityForest’s leverage.  The expiration date of the Associated Bank Letter of Credit is February 15, 2011.

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

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

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

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comply on a quarterly basis with a maximum leverage covenant and a minimum fixed charge coverage covenant.

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

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

Note 5 Comprehensive Income (Loss)

The components of comprehensive income (loss) for the three months ended August 30, 2007 and for the periods from June 13, 2006 to August 24, 2006 and May 26, 2006 to June 12, 2006 are as follows:

				For the Periods
	Three Months Ended August 30, 2007			June 13, 2006- August 24, 2006			May 26, 2006- June 12, 2006
	(Post-Merger)						(Pre-Merger)
Net income (loss)	$	1,069,830		$	(2,619,388	)	$	(6,059,312	)
Foreign currency translation adjustments	370,020			(48,535		)	41,139
Derivative loss	(643,300		)	(154,672		)	—
Comprehensive income (loss)	$	796,550		$	(2,822,595	)	$	(6,018,173	)

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The components of comprehensive income (loss) for the six months ended August 30, 2007 and for the periods from June 13, 2006 to August 24, 2006 and March 1, 2006 to June 12, 2006 are as follows:

	Six Months Ended August 30, 2007			June 13, 2006- August 24, 2006			March 1, 2006- June 12, 2006
	(Post-Merger)						(Pre-Merger)
Net loss	$	(40,654	)	$	(2,619,388	)	$	(6,534,964	)
Foreign currency translation adjustments	809,065			(48,535		)	362,212
Derivative loss	(633,170		)	(154,672		)	—
Comprehensive income (loss)	$	135,241		$	(2,822,595	)	$	(6,172,752	)

Note 6 Business Segments

The Company operates in two reportable business segments:  tissue and machine-glazed paper.  The Company assesses the performance of its reportable business segments using income from operations.  Income from operations excludes interest income, interest expense, other income (expense), income tax expense (benefit) and the impact of foreign currency gains and losses.   A portion of corporate and shared expenses is allocated to each segment.  Included in loss from operations for the period May 26, 2006 to June 12, 2006 is $5,806,058 of merger-related transaction costs.  Of this amount, $3,773,938 impacts the tissue segment and $2,032,120 impacts the machine-glazed paper segment.  Included in loss from operations for the period June 13, 2006 to August 24, 2006 is $102,375 of merger-related transaction costs, $240,218 of restructuring costs, $909,264 for a non-cash charge to cost of goods sold related to excess purchase price allocated to inventory and $1,518,430 of additional depreciation expense related to excess purchase price allocated to property, plant and equipment.  Of these amounts, $66,544, $156,142, $591,022 and $986,980, respectively, impacts the tissue segment and $35,831, $84,076, $318,242 and $531,450, respectively, impacts the machine-glazed paper segment. Also, included in loss from operations for the periods June 13, 2006 to August 24, 2006 and May 26, 2006 to June 12, 2006 is compensation charges of $2,687,092 and $397,279, respectively, related to non-cash compensation expense related to the vesting of restricted stock awards, payments of taxes associated with such awards and other compensation expense related to the Merger.  Of theses amounts, $1,746,610 and $258,231, respectively, impacts the tissue segment and $940,482 and $139,048, respectively, impacts the machine-glazed segment.  Segment information for the three months ended August 30, 2007 and for the periods June 13, 2006 to August 24, 2006 and May 26, 2006 to June 12, 2006 follows:

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	(Post-Merger)						(Pre-Merger)
	Three Months Ended August 30, 2007			June 13, 2006- August 24, 2006			May 26, 2006- June 12, 2006
Net Sales
Tissue	$	83,494,959		$	49,024,665		$	11,870,989
Machine-glazed paper	25,505,362			19,537,721			3,728,966
Consolidated	$	109,000,321		$	68,562,386		$	15,599,955
Income (loss) from operations
Tissue	$	6,383,420		$	(119,515	)	$	(4,149,980	)
Machine-glazed paper	676,922			(793,115		)	(2,756,338		)
Consolidated	7,060,342			(912,630		)	(6,906,318		)
Interest expense	(5,146,223		)	(3,224,321		)	(865,095		)
Net foreign currency transaction (loss) gain	(196,110		)	66,676			(83,510		)
Interest income	43,557			71,785			21,465
Other income	40,261			17,453			1,657
Pretax income (loss)	$	1,801,827		$	(3,981,037	)	$	(7,831,801	)
Capital Expenditures
Tissue	$	3,338,578		$	1,198,562		$	42,068
Machine-glazed paper	718,584			304,582			94,618
Corporate	237,279			381,313			118,359
Consolidated	$	4,294,441		$	1,884,457		$	255,045
Depreciation
Tissue	$	4,154,703		$	3,190,553		$	492,758
Machine-glazed paper	1,361,900			1,325,210			199,410
	$	5,516,603		$	4,515,763		$	692,168

Segment information for the six months ended August 30, 2007 and for the periods June 13, 2006 to August 24, 2006 and March 1, 2006 to June 12, 2006 follows:

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	(Post-Merger)						(Pre-Merger)
	Six Months Ended August 30, 2007			June 13, 2006- August 24, 2006			March 1, 2006- June 12, 2006
Net Sales
Tissue	$	161,130,856		$	49,024,665		$	67,199,611
Machine-glazed paper	51,070,251			19,537,721			27,042,321
Consolidated	$	212,201,107		$	68,562,386		$	94,241,932
Income (loss) from operations
Tissue	$	10,466,397		$	(119,515	)	$	(1,210,487	)
Machine-glazed paper	170,207			(793,115		)	(2,119,523		)
Consolidated	10, 636,604			(912,630		)	(3,330,010		)
Interest expense	(10,184,898		)	(3,224,321		)	(5,000,732		)
Net foreign currency transaction gain (loss)	(520,408		)	66,676			(289,010		)
Interest income	63,138			71,785			104,377
Other income	82,500			17,453			27,049
Pretax income (loss)	$	76,936		$	(3,981,037	)	$	(8,488,326	)
Capital Expenditures
Tissue	$	5,579,729		$	1,198,562		$	711,857
Machine-glazed paper	971,235			304,582			236,288
Corporate	389,823			381,313			989,465
Consolidated	$	6,940,787		$	1,884,457		$	1,937,610
Depreciation
Tissue	$	9,156,870		$	3,190,553		$	3,056,653
Machine-glazed paper	3,037,878			1,325,210			1,169,990
	$	12,194,748		$	4,515,763		$	4,226,643

	August 30, 2007		February 28, 2007
Segment assets
Tissue	$	307,801,310	$	214,039,270
Machine-glazed paper	82,734,671		79,277,799
Corporate assets	6,720,503		31,951,675
Consolidated	$	397,256,484	$	325,268,744

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Note 7 Income taxes

The effective income tax expense for the three months ended August 30, 2007 was 40.6% compared to effective income tax benefit of 34.20% and 22.6%, respectively, for the periods June 13, 2006 to August 24, 2006 and May 26, 2006 to June 12, 2006.  The effective income tax expense for the six months ended August 30, 2007 was 152.8% compared to an effective income tax benefit of 34.20% and 23.0%, respectively, for the periods June 13, 2006 to August 24, 2006 and March 1, 2006 to June 12, 2006.  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 effective tax expense for the three months and six months ended August 30, 2007, without the effect of the additional Canadian income tax expense, was 35.6% and 35.1%, respectively.   The effective tax rate for the periods May 26, 2006 to June 12, 2006 and March 1, 2006 to June 12, 2006 differs from the federal statutory rate primarily due to non-deductible transaction costs expensed for book purposes.

The Company adopted Financial Accounting Standards Board (“FASB”) Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), at the beginning of fiscal year 2008.  The implementation of FIN 48 did not have a material impact on the Company’s results of operations and financial position.  At August 30, 2007, the Company did not have any unrecognized tax benefits.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.  As of August 30, 2007, the Company has accrued interest and penalties, if any, related to uncertain tax positions.

The fiscal tax years 2003 through 2007 remain open to examination by the major taxing jurisdictions to which the Company is subject.  As of August 30, 2007, the Company does not expect any material changes to unrecognized tax positions within the next 12 months.

Note 8 Union Contract

In July 2005, the United Steelworkers of America, referred to as USW, (formerly the Paper, Allied – Industrial, Chemical & Energy Workers International Union, referred to as PACE prior to PACE’s merger with and into USW) was elected to represent 84 hourly employees at our Mississippi facility, and was certified by the National Labor Relations Board as the exclusive collective bargaining representative of such employees.  On June 29, 2007, a collective bargaining agreement with USW was ratified.

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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 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 for our fiscal year ended February 28, 2007.  These risks and uncertainties should be considered in evaluating any forward-looking statements contained herein.

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

We operate in two reportable business segments:  tissue and machine-glazed paper.  We assess the performance of our reportable business segments using income from operations.  Income from operations excludes interest income, interest expense, income tax expense (benefit), other income and expense and the impact of foreign currency gains and losses.

Merger

On June 12, 2006 Cellu Paper Holdings, Inc., our parent, consummated an Agreement and Plan of Merger with Cellu Parent, a corporation organized and controlled by Weston Presidio, and Cellu Acquisition Corporation, a wholly owned subsidiary of Cellu Parent and a newly formed corporation indirectly controlled by Weston Presidio, or Merger Sub.  Pursuant to the agreement, on June 12, 2006, Merger Sub was merged with and into our parent, with our parent surviving (referred to herein as the Merger).  Accordingly, the operating results and cash flows for the prior year are presented in the accompanying

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financial statements on a pre-merger (period from March 1, 2006 to June 12, 2006) and post-merger (period from June 13, 2006-August 24, 2006) basis.  The current year operating results and cash flows are post-merger.

We accounted for the Merger as a purchase in accordance with the provisions of Statement of Financial Accounting Standards No. 141, or SFAS 141, Business Combinations, which resulted in a new valuation for our assets and liabilities based upon fair values as of the date of the Merger.  As allowed under SEC Staff Accounting Bulletin No. 54, Push Down Basis of Accounting Required in Certain Limited Circumstances, we have reflected all applicable purchase accounting adjustments in our consolidated financial statements for all periods subsequent to the Merger date (referred to herein as push down accounting).  Push down accounting requires us to establish a new basis for our assets and liabilities based on the amount paid for our equity at close of business on June 12, 2006.  Accordingly, Cellu Parent’s equity basis is reflected in our consolidated financial statements beginning upon completion of the Merger.

In order to apply push down accounting, Cellu Parent’s purchase price of $207.8 million (including assumption of $162.0 million in aggregate principal amount of our outstanding 9.75% senior secured notes), or the Notes, was allocated to the assets and liabilities based on their relative fair values.  The purchase price is subject to adjustment for certain tax benefits that we may realize.  In addition, total consideration is subject to adjustment for up to an additional $35.0 million in contingent earnout consideration based upon the achievement of certain financial targets.  If any portion of the contingent payments are unable to be made, then Weston Presidio has agreed to provide the necessary funds to former holders of our parent’s capital stock, options and warrants through an equity investment in our parent or otherwise.  In accordance with SFAS 141, the $35.0 million has been recognized as a liability and is recorded in other liabilities as of August 30, 2007.

We have allocated the excess purchase price over the net assets acquired in the Merger based on our estimates of the fair value of assets and liabilities as follows:

	Excess purchase price allocated to:
Inventories	$	909,264
Property, plant and equipment	142,292,525
Trademarks	6,550,314
Long-term debt	(900,729		)
Contingent consideration	(35,000,000		)
Deferred income taxes	(50,830,323		)
Total	$	63,021,051

Acquisition

On March 21, 2007, we executed the Acquisition Agreement with CityForest, Cellu City Merger Sub and Wayne Gullstad as the shareholders’ representative.  Pursuant to the

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

The Acquisition has been accounted for as a purchase in accordance with the provisions of SFAS 141 and, accordingly, the consolidated statements of operations includes the results of CityForest during the three months and six months ended August 30, 2007 from the date of Acquisition.  Purchase price allocations are subject to refinement until all pertinent information is obtained.  We have allocated the excess of purchase price over the net assets acquired in the acquisition based on our estimates of the fair value of assets and liabilities as follows:

	Excess purchase price allocated to:
Property, plant and equipment	$	32,874,272
Trademarks	2,200,000
Goodwill	6,924,559
Long-term debt	(1,724,684		)
Deferred income taxes	(17,238,509		)
Total	$	23,035,638

We have estimated the fair value of the assets and liabilities of the Acquisition, utilizing information available at the time our unaudited interim financial statements subsequent to the Acquisition were prepared, and these estimates are subject to refinement until all pertinent information has been obtained. At that time, we were in the process of obtaining outside third-party appraisals of our tangible and intangible assets and had assumed no intangible assets or goodwill arising from the acquisition.  In the second quarter of fiscal year 2008, we obtained a third-party appraisal of CityForest’s tangible and intangible assets and have finalized the calculation of deferred income taxes resulting from the book to tax differences arising from the application of purchase accounting.  As a result thereof, trademarks of $2.2 million and goodwill of $6.9 million have been recorded.  Furthermore, the net deferred income tax liability has increased $4.2 million from our original estimate.

The results of CityForest’s operations from the date of acquisition (March 21, 2007) are included in our  tissue segment and accordingly, are included for the three months ended August 30, 2007.  Unaudited pro forma results of operations for the periods June 13, 2006-August 24, 2006 and May 26, 2006-June 12, 2006, for the six months ended August 30, 2007, for the periods June 13, 2006-August 24, 2006 and March 1, 2006-June 12, 2006,

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as if we and CityForest had been combined as of March 1, 2006, are presented below.  The pro forma results include estimates and assumptions, which our management believes are reasonable.  However, the pro forma results do not include any cost savings or other effects of the planned integration of CityForest and are not necessarily indicative of the results which would have occurred if the business combination had been in effect on the dates indicated, or which may result in the future.

	June 13, 2006-August 24, 2006 (1)						May 26, 2006 – June 12, 2006 (1)
	As Filed			Pro Forma			As Filed			Pro Forma
	(in thousands)						(in thousands)
Net sales	$	68,562		$	78,146		$	15,600		$	17,802
Operating (loss) income	$	(913	)	$	1,715		$	(6,906	)	$	(6,302	)
Net loss	$	(2,619	)	$	(661	)	$	(6,059	)	$	(5,609	)

(1) Pro forma operating results include the operating results for CityForest for the three months ended June 30, 2006, prorated between the two reporting periods presented for the Company,  as CityForest was previously a calendar year-end company.

	Six Months Ended August 30,2007(1)					June 13, 2006-August 24, 2006 (2)						March 1, 2006-June 12, 2006 (2)
	As Filed			Pro Forma		As Filed			Pro Forma			As Filed			Pro Forma
	(in thousands)					(in thousands)						(in thousands)
Net sales	$	212,201		$	214,911	$	68,562		$	78,146		$	94,242		$	107,644
Operating income	$	10,637		$	11,223	$	(913	)	$	1,715		$	(3,330	)	$	(266	)
Net (loss) income	$	(41	)	$	520	$	(2,619	)	$	(661	)	$	(6,535	)	$	(4,344	)

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

(2)  Pro forma operating results include the operating results for CityForest for the six months ended June 30, 2006, prorated between the two reporting periods presented for us,  as CityForest was previously a calendar year-end company.

Union Contract

In July 2005, the United Steelworkers of America, referred to as USW, (formerly represented by the Paper, Allied –Industrial, Chemical & Energy Workers International Union, referred to as PACE prior to PACE’s merger with and into USW) was elected to represent 84 hourly employees at our Mississippi facility, and was certified by the National Labor Relations Board as the exclusive collective bargaining representative of such employees.  On June 29, 2007, a collective bargaining agreement with USW was ratified.

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RESULTS OF OPERATIONS

The three months and six months ended August 30, 2007 have been compared to the combined three months and six months ended August 24, 2006 pre- and post-Merger for purposes of management’s discussion and analysis of the results of operations.  Any references below to the three months and six months ended August 24, 2006 shall refer to the combined periods. 

	Pre-Merger			Post-Merger			Combined
	May 26, 2006-			June 13, 2006-			Three Months Ended
	June 12, 2006			August 24, 2006			August 24, 2006
Net sales	$	15,599,955		$	68,562,386		$	84,162,341
Cost of goods sold	14,262,654			65,217,759			79,480,413
Gross profit	1,337,301			3,344,627			4,681,928
Selling, general and administrative expenses	2,437,561			3,778,374			6,215,935
Stock and related compensation expense	—			136,290			136,290
Restructuring costs	—			240,218			240,218
Merger-related transaction costs	5,806,058			102,375			5,908,433
Loss from operations	(6,906,318		)	(912,630		)	(7,818,948		)
Interest expense, net	843,630			3,152,536			3,996,166
Foreign currency (gain) loss	83,510			(66,676		)	16,834
Other income	(1,657		)	(17,453		)	(19,110		)
Loss before income tax benefit	(7,831,801		)	(3,981,037		)	(11,812,838		)
Income tax benefit	(1,772,489		)	(1,361,649		)	(3,134,138		)
Net loss	$	(6,059,312	)	$	(2,619,388	)	$	(8,678,700	)

	Pre-Merger			Post-Merger			Combined
	March 1, 2006-			June 13, 2006-			Six Months Ended
	June 12, 2006			August 24, 2006			August 24, 2006
Net sales	$	94,241,932		$	68,562,386		$	162,804,318
Cost of goods sold	86,053,812			65,217,759			151,271,571
Gross profit	8,188,120			3,344,627			11,532,747
Selling, general and administrative expenses	5,584,865			3,778,374			9,363,239
Stock and related compensation expense	—			136,290			136,290
Restructuring costs	—			240,218			240,218
Merger-related transaction costs	5,933,265			102,375			6,035,640
Loss from operations	(3,330,010		)	(912,630		)	(4,242,640		)
Interest expense, net	4,896,355			3,152,536			8,048,891
Foreign currency (gain) loss	289,010			(66,676		)	222,334
Other income	(27,049		)	(17,453		)	(44,502		)
Loss before income tax benefit	(8,488,326		)	(3,981,037		)	(12,469,363		)
Income tax benefit	(1,953,362		)	(1,361,649		)	(3,315,011		)
Net loss	$	(6,534,964	)	$	(2,619,388	)	$	(9,154,352	)

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The tables that follow present unaudited net sales and gross profit for our principal segments for the combined three months and six months ended August 24, 2006.

	Pre-Merger		Post-Merger		Combined
	May 26, 2006-		June 13, 2006-		Three Months Ended
	June 12, 2006		August 24, 2006		August 24, 2006
Net Sales
Tissue	$	11,870,989	$	49,024,665	$	60,895,654
Machine-glazed paper	3,728,966		19,537,721		23,266,687
Consolidated	$	15,599,955	$	68,562,386	$	84,162,341
Gross Profit
Tissue	$	1,234,589	$	2,753,737	$	3,988,326
Machine-glazed paper	102,712		590,890		693,602
Consolidated	$	1,337,301	$	3,344,627	$	4,681,928

	Pre-Merger		Post-Merger		Combined
	March 1, 2006-		June 13, 2006-		Six Months Ended
	June 12, 2006		August 24, 2006		August 24, 2006
Net Sales
Tissue	$	67,199,611	$	49,024,665	$	116,224,276
Machine-glazed paper	27,042,321		19,537,721		46,580,042
Consolidated	$	94,241,932	$	68,562,386	$	162,804,318
Gross Profit
Tissue	$	6,423,465	$	2,753,737	$	9,177,202
Machine-glazed paper	1,764,655		590,890		2,355,545
Consolidated	$	8,188,120	$	3,344,627	$	11,532,747

Results of Operations for the Three Months Ended August 30, 2007 (the Fiscal 2008 Three-Month Period) compared to the Three Months Ended August 24, 2006 (the Fiscal 2007 Three-Month Period) and the Six Months Ended August 30, 2007 (the Fiscal 2008 Six-Month Period) compared to the Six Months ended August 24, 2006 (the Fiscal 2007 Six-Month Period)

Net sales for the fiscal 2008 three-month period increased $24.8 million, or 29.5%, to $109.0 million from $84.2 million for the comparable period in the prior year. Net sales for the fiscal 2008 six-month period increased $49.4 million, or 30.3%, to $212.2 from $162.8 million for the comparable period in the prior year.  On a company-wide basis, tons sold increased for the fiscal 2008 three-month period and the fiscal 2008 six-month period compared to the comparable periods of fiscal 2007.  For the fiscal 2008 three-month period, we sold 80,151 tons of tissue hard rolls, machine-glazed paper hard rolls and converted paper products, an increase of 15,311 tons, or 23.6%, compared to the fiscal 2007 three-month period.  For the fiscal 2008 six-month period, we sold 158,403 tons of tissue hard rolls, machine-glazed paper hard rolls and converted paper products,

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an increase of 32,204 tons, or 25.5%, compared to the fiscal 2007 six-month period.  Of the increase for the fiscal 2008 three-month period, $11.2 million and 11,393 tons resulted from the acquisition of CityForest.  Of the increase for the fiscal 2008 six-month period, $20.1 million and 20,534 tons resulted from the acquisition of CityForest.  Net selling price per ton increased from $1,298 and $1,290 for the fiscal 2007 three-month and six-month periods to $1,360 and $1,340 for the fiscal 2008 three-month and six-month periods.

Net sales for our tissue segment for the fiscal 2008 three-month period were $83.5 million, an increase of $22.6 million, or 37.1%, from the comparable period in the prior year.  Net sales for our tissue segment for the fiscal 2008 six-month period were $161.1 million, an increase of $44.9 million, or 38.6%, from the comparable period in the prior year.  These increases are attributable to the acquisition of CityForest, 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 2008 three-month period were $25.5 million, an increase of $2.2 million, or 9.6%, from the comparable period in the prior year.  Net sales for our machine-glazed segment for the 2008 six-month period were $51.1 million, an increase of $4.5 million, or 9.6%, 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.

Gross profit for the fiscal 2008 three-month period increased to $11.8 million from $4.7 million, an increase of $7.1 million, or 151.3%, from the comparable period in the prior year.   As a percentage of net sales, gross profit increased to 10.8% in the fiscal 2008 three-month period from 5.6% in the fiscal 2007 three-month period.  Gross profit for the fiscal 2008 six-month period increased to $20.1 million from $11.5 million, an increase of $8.6 million, or 73.9%, from the comparable period in the prior year. As a percentage of net sales, gross profit increased to 9.5% in the fiscal 2008 six-month period from 7.1% in the fiscal 2007 six-month period.  The increases in gross profit is attributable to continued improvement in product mix, lower manufacturing cost and the strong market for tissue hard rolls, compared to the comparable period in the prior year.

Gross profit for our tissue segment for the fiscal 2008 three-month period was $9.7 million, an increase of $5.7 million, or 143.8%, from the comparable period in the prior year.  Gross profit for our tissue segment for the fiscal 2008 six-month period was $17.0 million, an increase of $7.8 million, or 84.7%, from the comparable period in the prior year.

Gross profit for our machine-glazed segment for the fiscal 2008 three-month period was $2.1 million, an increase of $1.4 million, or 194.8%, from the comparable period in the prior year.  Gross profit for our machine-glazed segment for the fiscal 2008 six-month period was $3.1 million, an increase of $.7 million, or 31.8%, from the comparable period in the prior year.

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As a percentage of net sales, gross profit for the tissue segment increased to 11.6% in the fiscal 2008 three-month period and 10.5% in the fiscal 2008 six-month period from 6.5% in the fiscal 2007 three-month period and 7.9% in the fiscal 2007 six-month period.  As a percentage of net sales, gross profit for the machine-glazed segment increased to 8.0% in the fiscal 2008 three-month period and 6.1% in the fiscal 2008 six-month period from 3.0% in the fiscal 2007 three-month period and 5.1% in the fiscal 2007 six-month period.

Selling, general and administrative expenses in the fiscal 2008 three-month period decreased $1.7 million, or 27.3%, to $4.5 million from $6.2 million in the fiscal 2007 three-month period.  Selling, general and administrative expenses in the fiscal 2008 six-month period decreased $.4 million, or 3.9%, to $9.0 million from $9.4 million in the fiscal 2007 six-month period.  As a percentage of net sales, selling, general and administrative expenses decreased to 4.1% in the fiscal 2008 three-month period and decreased to 4.2% in the fiscal 2008 six-month period from 7.3% and 5.8%, respectively, for the comparable periods in the prior year.  Included in the fiscal 2008 three-month and six-month periods are $.4 million and $.8 million, respectively, of ongoing CityForest administrative expenses.  Also, included in the fiscal 2008 three-month and six-month periods are additional costs incurred in connection with being compliant with Sarbanes Oxley and increases in incentive compensation expense associated with strong business performance.  Included in the fiscal 2007 three-month and six-month periods is $1.0 million of non-cash compensation expense related to the vesting of restricted stock awards, $1.5 million of other compensation expense related to tax payments associated with such awards and $.6 million of other compensation expense related to the Merger.

Stock and related compensation expense in the fiscal 2008 three-month and six-month periods of $.2 million and $.4 million, respectively, and in each of the fiscal 2007 three-month and six-month periods of $.1 million relates to the accounting for restricted stock and stock option grants.

Restructuring costs in the fiscal 2007 three-month and six-month periods were $.2 million related to severance costs associated with the elimination of a corporate position.

Merger-related transaction costs in the fiscal 2007 three-month period were $5.9 million and in the fiscal 2007 six-month period were $6.0 million associated with the Merger.

Interest expense, net in the fiscal 2008 three-month period was $5.1 million compared to $4.0 million in the fiscal 2007 three-month period.  Interest expense, net in the fiscal 2008 six-month period was $10.1 million compared to $8.0 million in the fiscal 2007 six-month period.  These increases are due to the assumption of CityForest debt and additional debt incurred in connection with the acquisition thereof.

Foreign currency loss (gain) in the fiscal 2008 three-month period was a loss of $.2 million and in the fiscal 2008 six-month period was a loss of $.5 million compared to a loss of less than $.1 million and a loss of $.2 million, respectively, for the comparable periods in the prior year.  The fluctuations relate to the change in the Canadian currency period over period.

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Income tax expense for the fiscal 2008 three-month period was $.7 million or an effective tax rate of 40.6% compared to income tax benefit of $3.1 million or an effective tax rate of 26.5% for the fiscal 2007 three-month period.  The income tax expense for the fiscal year 2008 six-month period was $.1 million or an effective tax rate of 152.8% compared to income tax benefit of $3.3 million or an effective tax rate of 26.6% for the fiscal year 2007 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 2007 three-month and six-month periods, without the effect of the additional Canadian income tax expense, was 35.6% and 35.1%, respectively.   The effective tax rate for the fiscal year 2007 three-month and six-month periods differ from the federal statutory rate primarily due to non-deductible transaction costs expensed for book purposes.

Net income for the fiscal 2008 three-month period was $1.1 million, compared to a net loss of $8.6 million for the comparable period in the prior year. Net loss for the fiscal 2008 six-month period was a net loss of $.1 million compared to a net loss of $9.2 million for the comparable period in the prior year.

FINANCIAL CONDITION

Liquidity and Capital Resources

The table that follows presents cash flows information for the combined six months ended August 24, 2006.

	Pre-Acquisition			Post-Acquisition			Combined
	March 1, 2006-			June 13, 2006-			Six Months Ended
	June 12, 2006			August 24, 2006			August 24, 2006
Net Provided by (Used in) Operating Activities
Net loss	$	(6,534,964	)	$	(2,619,388	)	$	(9,154,352	)
Non-cash items	5,245,238			5,063,105			10,308,343
Changes in working capital	(5,250,094		)	3,206,869			(2,043,225		)
Net cash provided by (used in) operating activities	$	(6,539,820	)	$	5,650,586		$	(889,234	)
Net Cash Provided by (Used in) Investing Activities	$	(1,937,610	)	$	43,877,540		$	41,939,930
Net Cash Used in Financing Activities	$	(290,000	)	$	(45,761,997	)	$	(46,051,997	)

Net cash provided by operations was $13.2 million for the fiscal 2008 six-month period, compared to net cash used in operations of $.9 million for the fiscal 2007 six-month period.  Non-cash items, consisting of inventory charge, stock-based compensation, deferred income taxes, depreciation and amortization for the fiscal 2008

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six-month period totaled $11.4 million compared to $10.3 million for the 2007 fiscal six-month period.  Cash flows provided by changes in working capital totaled $1.9 million for the fiscal 2008 six-month period, compared to cash flows used by changes in working capital of $2.0 million in the fiscal 2007 six-month period.  With respect to the changes in accounts receivable and inventory, cash used by these items was $3.1 million for the fiscal 2008 six-month period compared to cash provided by these items of $.9 million for the comparable period in the prior fiscal year.  Cash used by changes in prepaid expenses and other current assets was $1.7 million for the fiscal 2008 six-month period compared to cash used of $.4 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 2008 six-month period was $6.7 million compared to cash used of $2.5 million for the comparable period in the prior year.

Net cash used in investing activities for the fiscal 2008 six-month period was $50.6 million compared to net cash used in investing activities of $41.9 million for the fiscal 2007 six-month period.  The fiscal 2008 six-month period includes $43.7 million of cash paid for the Acquisition, net of cash received.  The fiscal 2007 six-month period includes $45.8 million related to the equity investment by Weston Presidio.  The remaining change relates to the level of capital spending period over period.

Net cash provided by financing activities for the fiscal 2008 six-month period was $22.6 million related to financing obtained in connection with the Acquisition.  The net cash used by financing activities for the fiscal 2007 six-month period includes $45.8 million related to merger consideration paid to former shareholders.  The remaining $.3 million for the fiscal 2007 six-month period relates to payments on our industrial revenue bond. Our last payment on our industrial revenue bond was made in the first quarter of fiscal year 2007.

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

Our Notes and Additional Notes mature on March 15, 2010 and require semi-annual interest payments on March 15 and September 15, which commenced on September 15, 2004.

In connection with the Merger, we solicited consents with respect to the Notes.   Consents were received with respect to 100% of the aggregate outstanding principal amount of the Notes.  We accepted all of the consents delivered in the consent solicitation and paid to the consenting noteholders a consent fee of $40 per $1,000 principal amount of Notes for which they delivered consents.  As a result of the acceptance by us of the consents delivered by noteholders and the completion of the consent solicitation, the amendments to the Cellu Tissue Indenture described in the Consent Solicitation

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Statement dated May 9, 2006 and related Supplement dated May 24, 2006 became operative and we were not required to make a change of control offer to purchase any Notes in connection with the Merger.

Furthermore, in connection with the Merger, we entered into the Credit Agreement, among us, as U.S. Borrower, Interlake Acquisition Corporation Limited, one of our subsidiaries, as Canadian Borrower, our Parent, the other loan guarantors party thereto, JPMorgan Chase Bank, N.A., as U.S. Administrative Agent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent, and the other lenders party thereto.

The Credit Agreement provides for a $35.0 million working capital facility, which has subsequently been increased to $40.0 million (see below), 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 is available, in U.S. dollars, to the U.S. Borrower under the facility, and an amount equal to $3.0 million is available, in U.S. or Canadian dollars, to the Canadian Borrower under the facility.  Borrowings of $17.4 million were made to finance a portion of the acquisition of CityForest.    As of August 30, 2007, there was $2.6 million of borrowings outstanding under the working capital facility.

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

Second Supplemental Indenture

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

Amendment to Credit Agreement

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

The Amendment (1) increases the working capital facility from $35.0 million to $40.0 million, (2) permits the issuance and sale by us of the Additional Notes, (3) provides for the consummation of the acquisition of CityForest and the conversion by CityForest from a Minnesota corporation to a Minnesota limited liability company, (4) permits the

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assumption of approximately $18.4 million in aggregate principal amount of indebtedness of CityForest in connection with the acquisition of CityForest in accordance with the terms of the CityForest Bond Documents and (5) permits the guarantee by us of certain obligations of CityForest under the CityForest Bond Documents.  In connection with the Amendment, CityForest became a guarantor of the obligations of the borrowers under the Amended Credit Agreement.

CityForest Bond Documents

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

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

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

The Reimbursement Agreement requires scheduled semi-annual payments of principal of the Bonds equal to approximately 2.00% of the principal amount outstanding as of the date of the Acquisition, with the balance payable at maturity of the Bonds on March 1, 2028.

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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; acquisitions, mergers and consolidations; investments; guarantees; asset sales; sale and leaseback transactions; dividends and distributions; transactions with affiliates; capital expenditures; and changes to the status of the Bonds. CityForest is also required to comply on a quarterly basis with a maximum leverage covenant and a minimum fixed charge coverage covenant.

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

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

Cash as of August 30, 2007 decreased to $2.3 million from $16.3 million as of the end of fiscal year 2007.  The decrease in our cash position was primarily due to cash on hand to finance a portion of the acquisition of CityForest, payment of our semi-annual interest in March 2007 and paydown on the revolving line of credit.

Receivables, net as of August 30, 2007 increased to $43.3 million from $34.1 million as of the end of fiscal year 2007.  Included in the $43.3 million is $4.0 million of receivables related to CityForest.  Without the effect of the acquisition, receivables increased $5.2 million

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from the end of fiscal year 2007, primarily due to the increase in net sales for the period.

Inventory as of August 30, 2007 increased to $30.7 million from $29.6 million as of the end of fiscal year 2007.   Included in the $30.7 million is $1.3 million of inventories related to CityForest.  Without the effect of the acquisition, inventories decreased $.2 million from the end of fiscal year 2007.

Prepaid expenses and other current assets as of August 30, 2007 increased to $6.1 million from $2.8 million as of the end of fiscal year 2007.  Included in the $6.1 million is $1.2 of prepaid expenses and other current assets related to CityForest.  Without the effect of the acquisition, prepaid expense and other current assets increased $2.1 million from the end of fiscal year 2007.  The increase is due to the timing of prepayments.

Property, plant and equipment, net as of August 30, 2007 increased to $291.7 million from $228.9 million as of the end of fiscal year 2007.  Included in the $291.7 million of property, plant and equipment, net is $67.0 million related to CityForest.  Without the effect of the acquisition, property, plant and equipment decreased $4.2 million from the end of fiscal year 2007.  This decrease relates to depreciation expense for the period offset partially by capital expenditures for the period.

Goodwill as of August 30, 2007 of $6.9 million arose due to the acquisition of CityForest.

Trademarks as of August 30, 2007 increased to $8.8 million from $6.6 million as of the end of fiscal year 2007.  The additions to trademarks relate to the acquisition of CityForest.

Other assets as of August 30, 2007 increased to $1.4 million from $.2 million as of the end of fiscal year 2007.  Included in the $1.4 million of other assets is $1.2 million related to CityForest.  Without the effect of the acquisition, other assets are consistent with the end of fiscal year 2007.

Revolving line of credit as of August 30, 2007 represents $17.4 million of borrowings to finance a portion of the acquisition of CityForest, offset by payments of $14.8 million since the date of the acquisition.

Accounts payable as of August 30, 2007 increased to $27.0 million from $16.5 million as of the end of fiscal year 2007.  Included in the $27.0 million of accounts payable is $3.4 million related to CityForest.  Without the effect of the acquisition, accounts payable increased $7.1 million from the end of fiscal year 2007 due to increased pulp purchases and the timing of payments.

Accrued expenses as of August 30, 2007 increased to $19.2 million from $16.3 million as of the end of fiscal year 2007.  Included in the $19.2 million of accrued expenses is $.8 million related to CityForest.  Without the effect of the acquisition, accrued expenses

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increased $2.1 million due to accrued legal expense and accrual of bonuses during the second quarter fiscal year 2007.

Long-term debt as of August 30, 2007 increased to $199.1 million from $160.4 million as of the end of fiscal year 2007 due to the assumption of CityForest debt and debt incurred to finance the acquisition.

Deferred income taxes as of August 30, 2007 increased to $65.6 million from $50.7 million as of the end of fiscal year 2007 primarily due to the deferred taxes recorded in purchase accounting for CityForest.

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 2007.  The preparation of our financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent assets and liabilities.  We base our accounting estimates on historical experience and other factors that we believe to be reasonable under the circumstances.  However, actual results may vary from these estimates under different assumptions or conditions.

New Accounting Pronouncements

We adopted FIN 48 at the beginning of fiscal year 2008.  The implementation did not have a material impact on our results of operations and financial position. At August 30, 2007, we did not have any unrecognized tax benefits.

We recognize interest and penalties related to uncertain tax positions in income tax expense.  As of August 30, 2007, we have accrued interest and penalties, if any, related to uncertain tax positions.

The fiscal tax years 2003 through 2007 remain open to examination by the major taxing jurisdictions to which we are subject.  As of August 30, 2007, we do not expect any material changes to unrecognized tax positions within the next 12 months.

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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 million of Additional Notes and assumed $18.4 million of additional debt.  We also have the ability to borrow under a revolving line of credit, up to $40.0 million, of which as of August 30, 2007 we have outstanding borrowings of $2.6 million.  As a result, we are highly leveraged.

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.

Item 4.  Controls and Procedures

(a)Disclosure Controls and Procedures.  The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report.  The Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in ensuring them that all material information required to be disclosed by the Company in this Quarterly Report on Form 10-Q was  recorded, processed, summarized, reported and properly disclosed in the time period specified in the rules and regulations of the Securities and Exchange Commission, and that such information was accumulated and communicated to the Company’s management (including its Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure.  Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company is in compliance with Rule 13a-15(e) of the Exchange Act.

(b)Changes in Internal Control Over Financial Reporting.  There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s 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 for fiscal year 2007 have not materially changed.

Item 6.  Exhibits

(a)  Exhibits

10.1	Employment Agreement by and between the Company and David J. Morris, effective August 6, 2007
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:	October 12, 2007	/s/ Russell C. Taylor
		Mr. Russell C. Taylor
		President and Chief Executive Officer
Date:	October 12, 2007	/s/ David J. Morris
		Mr. David J. Morris
		Senior Vice President, Finance and Chief
		Financial Officer

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EX-10.1

Exhibit 10.1

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (the “Agreement”) made and entered into by and between Cellu Tissue Holdings, Inc., a Delaware corporation (the “Company”), and Mr. David J. Morris (the “Executive”), effective as of August 6, 2007, and which is hereafter referred to as the “Effective Date.

WHEREAS, the operations of the Company and its Affiliates are a complex matter requiring direction and leadership in a variety of areas, including financial, strategic planning, regulatory, community relations and others;

WHEREAS, the Executive is possessed of certain experience and expertise that qualify the Executive to provide the direction and leadership required by the Company and its Affiliates;

WHEREAS, subject to the terms and conditions hereinafter set forth, the Company wishes to employ the Executive as its Chief Financial Officer and the Executive wishes to accept such continued employment;

NOW, THEREFORE, in consideration of the foregoing premises and the mutual promises, terms, provisions and conditions set forth in this Agreement, the parties hereby agree:

1.Employment.  Subject to the terms and conditions set forth in this Agreement, the Company hereby offers and the Executive hereby accepts employment.

2.Term.Subject to earlier termination as hereinafter provided, the Executive’s employment hereunder shall be for a term of four (4) years, commencing on the Effective Date, and shall be automatically extended thereafter for successive terms of one year each, unless either party provides notice to the other at least sixty (60) days prior to the expiration of the original or any extension term that the Agreement is not to be extended.  The term of this Agreement, as from time to time extended or renewed, is hereafter referred to as “the term of this Agreement” or “the term hereof.”

3.Capacity and Performance.

(a)Subject to earlier termination as hereinafter provided, during the term of this Agreement, the Executive shall serve the Company as its Chief Financial Officer, reporting to the Company’s Chief Executive Officer.  In addition, and without further compensation, the Executive shall serve as a director and/or officer of one or more of the Company’s Affiliates (as defined below) if so elected or appointed from time to time.

(b)During the term hereof, the Executive shall be employed by the Company on a full-time basis and shall perform such duties and responsibilities on behalf of the Company and its Affiliates consistent with the Executive’s position with the Company as may be designated from time to time by the Chief Executive Officer.

(c)During the term of the Executive’s employment, the Executive shall devote the Executive’s full business time and the Executive’s best efforts, business judgment, skill and knowledge exclusively to the advancement of the business and interests of the Company and its Affiliates and to the discharge of the Executive’s duties and responsibilities hereunder.  The Executive shall not engage in any other business activity or serve in any industry, trade, professional, governmental or academic position during the term of this Agreement, except as may be expressly approved in advance by the Chief Executive Officer in writing.

4.Compensation and Benefits.  As compensation for all services performed by the Executive under and during the term hereof and subject to performance of the Executive’s duties and of the obligations of the Executive to the Company and its Affiliates, pursuant to this Agreement or otherwise:

(a)Base Salary.  During the term hereof, the Company shall pay the Executive a base salary at the rate of Two Hundred Fifty Thousand Dollars ($250,000) per annum, payable in accordance with the normal payroll practices of the Company for its executives and subject to increase (but not decrease).  The Company’s Board of Directors (the “Board”) at the request of the Chief Executive Officer will review the Executive’s base salary each year.  Such base salary, as from time to time increased, is hereafter referred to as the “Base Salary”.

(b)Annual Bonus Compensation.

(i)During the term hereof and beginning with the first fiscal year after the Effective Date, Executive shall be eligible to receive an annual bonus of 50% of Base Salary (the “Target Bonus”), subject to the achievement of an EBITDA target set by the Company, approved by the Board and subject to the terms and conditions of any applicable annual incentive program in effect from time to time (the “Incentive Plan”).  The amount of any bonus awarded (whether more than or less than the Target Bonus) shall be determined by the Company, and subject to Board approval, based upon the achievement of the EBITDA target, after the completion of the Company’s annual audit and the Board’s review thereof, and shall further be subject to the terms of the Incentive Plan as in effect from time to time.  Except as otherwise expressly provided under this Agreement or under the terms of the Incentive Plan as in effect from time to time, the Executive shall not be entitled to earn bonus compensation for any period of service less than a full year, except; (1) the Executive shall be entitled to earn a pro rated share of bonus compensation for the time period of employment from the Effective Date until the end of that first fiscal year; and (2) as set forth in Sections 5(a), 5(b), 5(d), 5(e), 5 (g) and 5 (h).

(ii)Any bonus due hereunder shall be payable not later than two and one half months following the fiscal year for which the bonus was earned or as soon as is

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practicable within the meaning of Section 409A of the Internal Revenue Code of 1986, as amended, (“Section 409A”).

(c)Equity Arrangements.  On the Effective Date, the Company will make a grant of restricted stock to the Executive under the Company’s Stock Option and Restricted Stock Plan (the “Plan”).  The terms and conditions of such restricted stock grant shall be subject to the terms of the Plan and the Restricted Stock Award Agreement in the form attached hereto as Exhibit A.

(d)Vacations.  During the term hereof, the Executive shall be entitled to four (4) weeks of vacation per annum, to be taken at such times and intervals as shall be determined by the Executive, subject to the reasonable business needs of the Company.

(e)Other Benefits.  During the term hereof and subject to any contribution generally required of employees of the Company, the Executive shall be entitled to participate in any and all employee benefit plans from time to time in effect for employees of the Company generally, except to the extent such plans are in a category of benefit otherwise provided to the Executive.  Such participation shall be subject to (i) the terms of the applicable plan documents, (ii) generally applicable Company policies and (iii) the discretion of the Board or any administrative or other committee provided for in or contemplated by such plan.  The Company may alter, modify, add to or delete its employee benefit plans at any time as it, in its sole judgment, determines to be appropriate, without recourse by the Executive.

(f)Perquisites.  During the term hereof, the Executive shall be entitled to receive any and all perquisites in effect from time to time for senior executives of the Company generally, except to the extent such perquisite is otherwise provided to the Executive.  Such receipt shall be subject to (i) generally applicable Company policies and (ii) the discretion of the Board.  The Company may alter, modify, add to or delete any such perquisite at any time as it, in its sole judgment, determines to be appropriate without recourse by the Executive.

(g)Business Expenses.  The Company shall pay or reimburse the Executive for reasonable, customary and necessary business expenses incurred or paid by the Executive in the performance of the Executive’s duties and responsibilities hereunder, subject to such reasonable substantiation and documentation as may be specified by the Board or Company policy from time to time.

5.Termination of Employment and Severance Benefits.  The Executive’s employment hereunder shall terminate under the following circumstances:

(a)Death.  In the event of the Executive’s death during the term hereof, the Executive’s employment hereunder shall terminate and the Company shall pay or provide to the Executive’s designated beneficiary or, if no beneficiary has been designated by the Executive, to the Executive’s estate:  (i) any earned, but unpaid, Base Salary through the date of termination; (ii) any earned, but unpaid annual bonus for any fiscal year prior to the fiscal year

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of the Executive’s termination; (iii) a pro rata portion (based on the number of days preceding the Executive’s termination in the fiscal year of termination) of the Target Bonus; (iv) a lump sum equal to the lesser of (A) twelve (12) months of Base Salary or (B) Base Salary for the remainder of the term hereof; and (v) any unreimbursed business expenses.  In addition, subject to any employee contribution applicable to employees and their dependents generally, for the twelve (12) month period following termination, the Company shall continue to contribute to the premium cost of coverage for the Executive’s dependents under the Company’s medical and dental plans provided that a timely COBRA election is made.  The payments referred to in clauses (i), (ii) and (v) above shall be payable in a lump-sum within thirty (30) days after the date of termination.  The Company’s payments under clauses (iii) and (iv) above, as well as the continued contribution toward medical and dental premiums, are expressly conditioned upon the Executive’s designated beneficiary, or if no beneficiary has been designated, a representative of the Executive’s estate executing and delivering to the Company a timely and effective general release of claims, in form and substance satisfactory to the Company (“Separation Agreement”).  Payment under clauses (iii) and (iv) will be made within thirty (30) days after the Company’s receipt of such release of claims in form and substance satisfactory to the Company.  Other than as set forth in this clause (a), the Company shall have no further obligation to the Executive’s beneficiary or the Executive’s estate.

(b)Disability.

(i)The Company may terminate the Executive’s employment hereunder, upon notice to the Executive, in the event that the Executive becomes disabled during the Executive’s employment hereunder through any illness, injury, accident or condition of either a physical or psychological nature and, as a result, is unable to perform substantially all of the Executive’s material duties and responsibilities hereunder for (x) ninety (90) consecutive calendar days or (y) one hundred and twenty (120) total days during any period of three hundred and sixty-five (365) consecutive calendar days.  The Board may designate another employee to act in the Executive’s place during any period of the Executive’s disability.

(ii)If any question shall arise as to whether during any period the Executive is disabled through any illness, injury, accident or condition of either a physical or psycholog­ical nature so as to be unable to perform substantially all of the Executive’s duties and responsibilities hereunder, the Executive may, and at the request of the Company shall, submit to a medical examination by a physician selected by the Company to whom the Executive or the Executive’s duly appointed guardian, if any, has no reasonable objection to determine whether the Executive is so disabled and such determination shall for the purposes of this Agreement be conclusive of the issue.  If such question shall arise and the Executive shall fail to submit to such medical examination, the Company’s determination of the issue shall be binding on the Executive.

(iii)Upon the giving of notice of termination of the Executive’s employment due to disability hereunder, the Company shall have no further obligation or

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liability to the Executive, other than for (i) any earned, but unpaid, Base Salary through the date of termination; (ii) any earned, but unpaid annual bonus for any fiscal year prior to the fiscal year of the Executive’s termination; (iii) a pro rata portion (based on the number of days preceding the Executive’s termination in the fiscal year of termination) of the Target Bonus; (iv) a lump sum payment equal to the lesser of (A) twelve (12) months of Base Salary or (B) Base Salary for the remainder of the term hereof; and (v) any unreimbursed business expenses.  In addition, (x) the Company shall continue the benefits contemplated by Section 4(h) for the period contemplated therein, and (y) subject to any employee contribution applicable to active employees and their dependents generally, for the twelve (12) month period following termination, the Company shall continue to contribute to the premium cost of coverage for the Executive and the Executive’s dependents under the Company’s medical and dental plans provided that a timely COBRA election is made.  The payments referred to in clauses (i), (ii) and (v) above shall be payable in a lump-sum within thirty (30) days after the date of termination.  The Company’s payments under clauses (iii) and (iv) above, as well as the continued contribution toward medical and dental premiums, are expressly conditioned upon the Executive (or the Executive’s duly appointed guardian, if any) executing and delivering to the Company a timely and effective Separation Agreement.  Payment under clauses (iii) and (iv) will be made within thirty (30) days after the Company’s receipt of the Separation Agreement.  Other than as set forth in this clause (b), the Company shall have no further obligation to the Executive.

(c)By the Company for Cause.  The Company may terminate the Executive’s employment hereunder for Cause at any time upon notice to the Executive setting forth in reasonable detail the nature of such Cause.  The following, as determined by the Board in its reasonable judgment, shall constitute Cause for termination:

(i)the Executive’s repeated and willful refusal or failure (other than during periods of illness, disability or vacation) to perform the Executive’s duties hereunder or under any lawful directive of the Board (consistent with the terms of this Agreement;

(ii)the Executive’s willful misconduct or gross neglect in the performance of the Executive’s duties hereunder which in either case is materially injurious to the Company or any of its Subsidiaries, monetarily or otherwise;

(iii)the willful material breach of this Agreement by the Executive;

(iv)except as provided in clause (v) below, the conviction of the Executive of any felony or any other crime involving dishonesty or moral turpitude or the Executive’s pleading guilty to any felony, other than motor vehicle offenses, or any other crime involving dishonesty or moral turpitude;

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(v)the commission of fraud, embezzlement, theft or other dishonesty by the Executive with respect to the Company or any of its Affiliates;

(vi)any other conduct that involves a breach of fiduciary obligation on the part of the Executive or otherwise could reasonably be expected to have a material adverse effect upon the business, interests or reputation of the Company or any of its Affiliates; or

(vii)a previous employer of Executive shall commence against Executive and/or Cellu Tissue an action, suit, proceeding or demand arising from an alleged violation of a non-competition or other similar agreement between Executive and such previous employer.

For purposes of this Section 5(c), no act, or failure to act, on the Executive’s part, will be considered “willful” unless done or omitted to be done by him not in good faith and without a reasonable belief that the Executive’s action or omission was in furtherance of the Company’s business. If the Company desires to terminate the Executive’s employment pursuant to clause (i), (ii), (iii) or (v) above, it shall first give the Executive written notice of the facts and circumstances providing Cause and shall allow the Executive no less than twenty (20) days (x) in the case of a proposed termination pursuant to clause (i), (ii) or (iii) above to remedy, cure or rectify the situation giving rise to Cause and (y) in the case of a proposed termination pursuant to clause (v) above to explain the circumstances of the Executive’s actions or to show that the circumstances underlying the indictment do not constitute the type of felony described in clause (v). Termination by the Company for Cause pursuant to clause (iv) above may be effected by written notice of the Company to the Executive.  Upon the giving of notice of termination of the Executive’s employment hereunder for Cause, the Company shall have no further obligation to the Executive, other than for (i) Base Salary earned, but unpaid at the date of termination; (ii) any earned, but unpaid annual bonus for any fiscal year prior to the fiscal year of the termination of the Executive’s employment; and (iii) any unreimbursed business expenses.

(d)By the Company without Cause.  The Company may terminate the Executive’s employment hereunder without Cause at any time upon notice to the Executive.  In the event of such termination, the Company shall have no further obligation or liability to the Executive, other than for (i) any earned, but unpaid, Base Salary through the date of termination; (ii) any earned, but unpaid annual bonus for any fiscal year prior to the fiscal year of the Executive’s termination; (iii) a pro rata portion (based on the number of days preceding the Executive’s termination in the fiscal year of termination) of the Target Bonus; (iv) a lump sum equal to the greater of (x) twenty-four (24) months of Base Salary or (y) Base Salary for a period equal to the remainder of the term of this Agreement; (v) a lump sum equal to the greater of (x) one times the Target Bonus or (y) payment of the Target Bonus with respect to a period equal to the remainder of the term of this Agreement; and (vi) any unreimbursed business expenses.  In addition, (x) the Company shall continue the benefits contemplated by Section 4(h) for the period contemplated therein, and (y) subject to any employee contribution applicable to employees and their dependents generally, for the period following termination

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specified in clause (iv) above, or if earlier, until the date that the Executive becomes eligible for coverage with a subsequent employer, the Company shall continue to contribute to the premium cost of coverage for the Executive and the Executive’s dependents under the Company’s medical and dental plans provided that a timely COBRA election is made.  The payments referred to in clauses (i), (ii) and (vi) above shall be payable in a lump-sum within thirty (30) days after the date of termination.  The Company’s payments under clauses (iii), (iv) and (v) above, as well as the continued contribution toward medical and dental premiums, are expressly conditioned upon the Executive executing and delivering to the Company a timely and effective Separation Agreement.  Payment under clauses (iii), (iv) and (v) will be made within thirty (30) days after the Company’s receipt of the Separation Agreement.  Other than as set forth in this clause (d), the Company shall have no further obligation to the Executive.

(e) By the Executive for Good Reason.  The Executive may terminate the Executive’s employment hereunder for Good Reason, provided that the Executive shall have given written notice setting forth in reasonable detail the nature of such Good Reason to the Company upon the Executive’s becoming aware or at such time as Executive should have been aware of the occurrence of any such event or condition, and the Company shall not have fully corrected the situation within ten (10) days after such notice of Good Reason.  The following shall constitute “Good Reason” for termination by the Executive:

(i)failure by the Company to pay any compensation when due hereunder;

(ii)any significant reduction by the Company’s of the Executive’s title, duties or responsibilities (except in connection with termination of the Executive’s employment for Cause, as a result of Disability, as a result of the Executive’s death or by the Executive other than for Good Reason);

(iii)a reduction by the Company in the Executive’s Base Salary or any other compensation due hereunder; or

(iv)any material breach by the Company of any other provision of this Agreement.

If the Executive desires to terminate the Executive’s employment with the Company pursuant to this Section 5(e), the Executive shall first give written notice of the facts and circumstances providing Good Reason to the Company, and shall allow the company no less than twenty (20) days to remedy, cure or rectify the situation giving rise to Good Reason.  The Company’s failure to continue the Executive’s appointment or election as a director or officer of any of its Affiliates shall not constitute Good Reason.  In the event of termination in accordance with this Section 5(e), then the Executive will be entitled to receive the payments and benefits in accordance with Section 5(d) hereof provided the Executive complies with the requirement of executing and delivering the Separation Agreement.  Other than as set forth in this clause (e), the Company shall have no further obligation to the Executive.

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(f)By the Executive Without Good Reason.  The Executive may terminate the Executive’s employment hereunder at any time upon sixty (60) days’ written notice to the Company.  In the event of termination of the Executive pursuant to this Section 5(f), the Board may elect to waive the period of notice, or any portion thereof, and, if the Board so elects, the Company will pay the Executive the Executive’s Base Salary for the notice period (or for any remaining portion of the period).  The Company shall also pay the Executive (i) any earned, but unpaid annual bonus for any fiscal year prior to the fiscal year of the termination of the Executive’s employment, and (ii) any unreimbursed business expenses.

(g)Non-Renewal by Company.  The Company may elect not to renew this Agreement in accordance with Section 2 above.  In the event of such non-renewal for a reason other than Cause (as defined in Section 5(c) above), the Company shall have no further obligation or liability to the Executive other than for (i) any earned, but unpaid, Base Salary through the date of termination; (ii) any earned, but unpaid annual bonus for any fiscal year prior to the fiscal year of the Executive’s termination; (iii) a pro rata portion (based on the number of days preceding the Executive’s termination in the fiscal year of termination) of the Target Bonus; (iv) a lump sum equal to twenty-four (24) months of Base Salary and (v) any unreimbursed business expenses.  In addition, subject to any employee contribution applicable to employees and their dependents generally, for the twenty-four (24) month period following termination, or if earlier until the date that the Executive becomes eligible for coverage with a subsequent employer, the Company shall continue to contribute to the premium cost of coverage for the Executive and the Executive’s dependents under the Company’s medical and dental plans provided that a timely COBRA election is made.  The payments referred to in clauses (i), (ii) and (v) above shall be payable in a lump-sum within thirty (30) days after the date of termination.  The Company’s payments under clauses (iii) and (iv) above, as well as the continued contribution toward medical and dental premiums, are expressly conditioned upon the Executive executing and delivering to the Company a timely and effective Separation Agreement.  Payment under clauses (iii) and (iv) will be made within thirty (30) days after the Company’s receipt of such Separation Agreement.  Other than as set forth in this clause (g), the Company shall have no further obligation to the Executive or the Executive’s estate hereunder.

(h)Change of Control/Gross Up Payment.  The Company and the Executive agree that in the event that any of the severance payments or severance benefits under Sections 5(d), 5(e), 5(g) or 5(h) of this Agreement might be characterized as parachute payments under Section 280G of the Internal Revenue Code of 1986, as amended (“Section 280G”), the parties shall timely take reasonable steps to avoid the tax liability under Section 280G and Section 4999 of the Internal Revenue Code of 1986, as amended (the “Code”) to the extent permitted by law.  Accordingly, the Executive agrees to cooperate fully in procuring a shareholder vote (including, but not limited to, providing any required consents or waivers) to approve the severance payments or severance benefits under this Agreement received, to be received by, or payable on behalf of, the Executive in satisfaction of the shareholder approval requirements described in Treas. Reg. Section 1.280G-1, Q&A-7, to the extent applicable.  If the shareholder approval requirements described in Treas. Reg. Section 1.280G-1, Q&A-7 cannot be satisfied and if the Company determines that any of the severance payments or severance benefits under

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this Agreement received, to be received by, or payable on behalf of, the Executive would be subject to the excise tax imposed by Section 4999 of the Code, (the “Excise Tax”), then the Company will, on or prior to the date on which the Excise Tax must be paid or withheld, make an additional lump sum payment (the “gross up payment”) to the Executive.  The gross up payment will be sufficient, after giving effect to federal, state, and local income taxes (excluding any taxes imposed under or as a result of Section 409A, but otherwise including interest and penalties, if any) with respect to the gross up payment, to make the Executive whole for such taxes and associated interest and penalties imposed under or as a result of Section 4999.  Determinations under this Section 5(h) will be made by the Company’ s independent auditors unless the Executive has reasonable objections to the use of that firm, in which case the determinations will be made by a comparable firm chosen by the Executive after consultation with the Company (the firm making the determinations to be referred to as the “Firm”).  The determinations of the Firm will be binding upon the Company and the Executive except as the determinations are established in resolution (including by settlement) of a controversy with the Internal Revenue Service to have been incorrect.  All fees and expenses of the Firm will be paid by the Company.  If the Internal Revenue Service asserts a claim that, if successful, would require the Company to make a gross up payment or an additional gross up payment, the Company and the Executive will cooperate fully in resolving the controversy with the Internal Revenue Service.  The Company will make or advance such gross up payments as are necessary to prevent the Executive from having to bear the cost of the payments to the Internal Revenue Service in the course of, or as a result of, the controversy.  The Firm will determine the amount of such gross up payments or advances and will determine after resolution of the controversy whether any advances must be returned by the Executive to the Company.  The Company will bear all expenses of the controversy.

(i)Timing of Payments.  If at the time of the Executive’s separation from service, the Executive is a “specified employee,” as hereinafter defined, any and all amounts payable under this Section 5 in connection with such separation from service that constitute deferred compensation subject to Section 409A, as determined by the Company in its sole discretion, and that would (but for this sentence) be payable within six months following such separation from service, shall instead be paid on the date that follows the date of such separation from service by six (6) months.  For purposes of the preceding sentence, “separation from service” shall be determined in a manner consistent with subsection (a)(2)(A)(i) of Section 409A and the term “specified employee” shall mean an individual determined by the Company to be a specified employee as defined in subsection (a)(2)(B)(i) of Section 409A.

6.Effect of Termination.  The provisions of this Section 6 shall apply to a termination pursuant to Section 5 or otherwise.

(a)A condition precedent to the Company’s obligations to provide any severance payments or severance benefits hereunder, including lump-sum payments, vesting of restricted stock and contributions toward health insurance premiums, shall be the Executive’s executing and delivering (and not revoking) a timely and effective Separation Agreement, or in the case of a termination due to the death of the Executive, the Executive’s beneficiary or

9

representative of the Executive’s estate executing and delivering a general release of claims in form and substance satisfactory to the Company.

(b)Upon termination of the Executive’s employment with the Company, unless otherwise specifically provided herein, the Executive’s rights to benefits and payments under any benefits or welfare plan or under any stock option, restricted stock, stock appreciation right, bonus unit, management or bonus incentive or other plan of the Company shall be determined in accordance with the terms and provisions of such plans and any agreements under which such stock options, restricted stock or other awards were granted.

(c)Provisions of this Agreement shall survive any termination if so provided herein or if necessary or desirable fully to accomplish the purposes of such provision, including without limitation the obligations of the Executive under Sections 7, 8 and 9 hereof.  The obligation of the Company to provide any severance payment or benefit is expressly conditioned upon the Executive’s continued full performance of obligations under Sections 7, 8 and 9 hereof.  The Executive recognizes that, except as expressly provided in Sections 5(d), 5(e), 5(g) or 5(h), no compen­sation is earned after termination of employment.

(d)Except as expressly provided herein, Executive is entitled to no payments or benefits in connection with a termination of the Executive’s employment.

7.Confidential Information.

(a)The Executive acknowledges that the Company and its Affiliates continually develop “Trade Secrets” and “Confidential Information” that the Executive may develop Trade Secrets and Confidential Information for the Company or its Affiliates and that the Executive may learn of Trade Secrets and Confidential Information during the course of employment.  The Executive will comply with the policies and procedures of the Company and its Affiliates for protecting Trade Secrets and Confidential Information and shall never disclose to any Person (except as required by applicable law or for the proper performance of the Executive’s duties and responsibilities to the Company and its Affiliates), or use for the Executive’s own benefit or gain, any Trade Secrets or Confidential Information obtained by the Executive incident to the Executive’s employment or other association with the Company or any of its Affiliates.

(b) For purposes of this Agreement, “Trade Secrets mean all information that constitutes a trade secret within the meaning of the Georgia Trade Secrets Act, as amended (the “Georgia Act”).  Under the Georgia Act, a trade secret is defined as:  “Information without regard to form, including, but not limited to, technical or non-technical data, a formula, a pattern, a compilation, a program, a device, a method, a technique, a drawing, a process, financial data, financial plans, product plans, or a list of actual or potential customers or suppliers which is not commonly known by or available to the public and which information:  (i) derives economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value

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from its disclosure or use; and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

(c)For purposes of this Agreement, “Confidential Information” means any and all information of the Company and its Affiliates other than Trade Secrets that is not generally known by others with whom they compete or do business, or with whom they plan to compete or do business and any and all information, not publicly known, which, if disclosed by the Company or its Affiliates would assist in competition against them.  Confidential Information includes without limitation such information relating to (i) the development, research, testing, manufacturing, marketing and financial activities of the Company and its Affiliates, (ii) the Products, (iii) the costs, sources of supply, financial performance and strategic plans of the Company and its Affiliates, (iv) the identity and special needs of the customers of the Company and its Affiliates and (v) the people and organizations with whom the Company and its Affiliates have business relationships and those relationships.  Confidential Information also includes comparable information that the Company or any of its Affiliates have received belonging to others or which was received by the Company or any of its Affiliates with any understanding that it would not be disclosed.

(d) The foregoing obligations do not apply to the extent that the Confidential Information is or becomes generally available to the public through no fault of the Executive.  The Executive understands and agrees that the Executive’s obligations under this Agreement with regard to Trade Secrets shall remain in effect for as long as such information shall remain a trade secret under applicable law.  The Executive acknowledge that the Executive’s obligations with regard to the Confidential Information shall remain in effect while employed or retained by the Company and for three (3) years after the termination of employment, regardless of the reason for such termination.

(e)All documents, records, tapes and other media of every kind and description relating to the business, present or otherwise, of the Company or its Affiliates and any copies, in whole or in part, thereof (the “Documents”), whether or not prepared by the Executive, shall be the sole and exclusive property of the Company and its Affiliates.  The Executive shall safeguard all Documents and shall surrender to the Company at the time the Executive’s employment terminates, or at such earlier time or times as the Board or its designee may specify, all Documents then in the Executive’s possession or control.

8.Assignment of Rights to Intellectual Property.  The Executive shall promptly and fully disclose all Intellectual Property to the Company.  The Executive hereby assigns and agrees to assign to the Company (or as otherwise directed by the Company) the Executive’s full right, title and interest in and to all Intellectual Property.  The Executive agrees to execute any and all applications for domestic and foreign patents, copyrights or other proprietary rights and to do such other acts (including without limitation the execution and delivery of instruments of further assurance or confirmation) requested by the Company to assign the Intellectual Property to the Company and to permit the Company to enforce any patents, copyrights or other proprietary rights to the Intellectual Property.  The Executive will not charge the Company for time spent in

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complying with these obligations.  All copyrightable works that the Executive creates shall be considered “work made for hire.”

9.Restricted Activities.  In exchange for good and valuable consideration including, without limitation, the grant of restricted stock hereunder, the Executive agrees that some restrictions on the Executive’s activities during and after the Executive’s employment are necessary to protect the goodwill, Confidential Information and other legitimate interests of the Company and its Affiliates:

(a)While the Executive is employed by the Company and for a period of twenty-four (24) months after the Executive’s employment terminates (the “Non-Competition Period”), the Executive shall not, directly or indirectly, provide services in a Restricted Capacity to any Person with respect to any product or service of that Person which directly competes with, or may be used in substitution for, one or more of the products of the Company and/or its Subsidiaries with respect to which the Executive has had access to Confidential Information or customer goodwill as a result of the Executive’s employment or other association with the Company and/or its Subsidiaries, but this restriction shall apply only with respect to the following states:  Alabama, Alaska, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Utah, Virginia, Washington and Wisconsin.  For the purposes of this Section 9, the business of the Company and its Subsidiaries shall include, without limitation, all Products and the Executive’s undertaking shall encompass all items, products and services that may be used in substitution for Products.

(b)The Executive further agrees that while the Executive is employed by the Company and during the Non-Competition Period, the Executive will not, and will not assist anyone else to solicit for hiring any employee of the Company or any of its Affiliates, or seek to persuade any employee of the Company or any of its Affiliates to discontinue employment.  For purposes of this Agreement, an “employee” of the Company or any of its Affiliates is any person who was such at any time within the preceding one year.

(c)The Executive further agrees that while the Executive is employed by the Company and during the Non-Competition Period, the Executive will not directly or indirectly (1) solicit or encourage any customer of the Company or any of its Affiliates to terminate or diminish its relationship with them, or, (2) seek to persuade any customer or prospective customer of the Company or any of its Affiliates to conduct with any Person any business or activity which such customer or prospective customer conducts or could conduct with the Company; provided that these restrictions shall apply (a) only with respect to those Persons who are or have been a customer of the Company of any of its Affiliates at any time within the immediately preceding one year period or whose

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business has been solicited on behalf of the Company or any of its Affiliates by any of their officers, employees or agents within said one year period, other than by form letter, blanket mailing or published advertisement, and (b) only if the Executive had a business relationship with such Person as a result of the Executive’s employment or other associations with the Company or one of its Affiliates.  Notwithstanding anything to the contrary contained in this Section 9, after termination of Executive’s employment, this restriction shall apply only to customers or prospective customers located in those states within the United States in which the Company was doing business during the year preceding Executive’s termination.

(d) The Executive further agrees that while the Executive is employed by the Company and during the Non-Competition Period the Executive shall not willfully make false, misleading or disparaging statements about the Company including, without limitation, its products, services, management, direct or indirect equity holders, employees and customers.

10.Enforcement of Covenants.  The Executive acknowledges that the Executive has carefully read and considered all the terms and conditions of this Agreement, including the restraints imposed upon the Executive’s pursuant to Sections 7, 8 and 9 hereof.  The Executive agrees without reservation that each of the restraints contained herein is necessary for the reasonable and proper protection of the goodwill, Confidential Information and other legitimate interests of the Company and its Affiliates; that each and every one of those restraints is reasonable in respect to subject matter, length of time and geographic area; and that these restraints, individually or in the aggregate, will not prevent the Executive from obtaining other suitable employment during the period in which the Executive is bound by these restraints.  The Executive further agrees that the Executive will never assert, or permit to be asserted on the Executive’s behalf, in any forum, any position contrary to the foregoing.   The Executive further acknowledges that, were the Executive to breach any of the covenants contained in Sections 7, 8 or 9 hereof, the damage to the Company would be irreparable.  The Executive therefore agrees that the Company, in addition to any other remedies available to it, shall be entitled to preliminary and permanent injunctive relief against any breach or threatened breach by the Executive of any of said covenants, without having to post bond.  The parties further agree that, in the event that any provision of Section 7, 8 or 9 hereof shall be determined by any court of competent jurisdiction to be unenforceable by reason of its being extended over too great a time, too large a geographic area or too great a range of activities, such provision shall be deemed to be modified to permit its enforcement to the maximum extent permitted by law.

11.Conflicting Agreements.  The Executive hereby represents and warrants that the execution of this Agreement and the performance of the Executive’s obligations hereunder will not breach or be in conflict with any other agreement to which the Executive is a party or is bound and that the Executive is not now subject to any covenants against competition or similar covenants that would affect the performance of the Executive’s obligations hereunder.  The Executive will not disclose to or use on behalf of the Company any proprietary information of a third party without such party’s consent.

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12.Indemnification.  The Executive shall be entitled, at all times (including after the termination of this Agreement for any reason), to the benefit of the maximum indemnification and advancement of expenses available from time to time under the Company’s certificate of incorporation and Bylaws, and if not set forth therein, to the maximum extent available under the laws of the State of Delaware. In addition, the Company shall maintain in full force and effect the directors’ and officers’ liability insurance policy currently in effect or such other insurance with reputable insurance carriers which may provide for a reduced level of coverage for the Executive, provided that such coverage is identical to that provided by the Company for the benefit of the other directors of the Company and its other executive officers.  The Executive agrees to promptly notify the Company of any actual or threatened claim arising out of or as a result of the Executive’s employment with the Company.  The Executive hereby represents and warrants to the Company that, as of the date hereof, the Executive has no and is aware of no such claim.

13.Definitions.  Words or phrases which are initially capitalized or are within quotation marks shall have the meanings provided in this Section 13 and as provided elsewhere herein.  For purposes of this Agreement, the following definitions apply:

(a)“Affiliates” means all persons and entities directly or indirectly controlling, controlled by or under common control with the Company, where control may be by either management authority or equity interest.

(b)“Change of Control” means (i) a sale of all or substantially all of the assets of the Company, Cellu Paper or Cellu Parent to a Person in which the shareholders of Cellu Parent immediately prior to such transaction do not, directly or indirectly, own securities representing more than 50% of the voting power of the Person acquiring such assets immediately following the transaction, (ii) a sale of shares of capital stock of Cellu Parent by Cellu Parent or its shareholders resulting in more than 50% of the voting power of Cellu Parent being held, directly or indirectly, by a Person other than the shareholders of Cellu Parent immediately prior to such sale, (iii) a sale by Cellu Parent of the equity securities of Cellu Paper or the Company resulting in more than 50% of the voting power of Cellu Paper or Cellu Tissue (as the case may be) being held directly or indirectly by a Person other than Cellu Parent or the shareholders of Cellu Parent immediately prior to such sale, or (iv) a merger or consolidation of the Company, Cellu Paper or Cellu Parent with or into another Person, if and only if, after such merger or consolidation, more than 50% of the voting power of the Company, Cellu Paper or Cellu Parent (as the case may be) is directly or indirectly owned by a Person other than Cellu Parent or the shareholders of Cellu Parent immediately prior to such merger or consolidation.  For the avoidance of doubt, the transaction contemplated by the Merger Agreement shall not constitute a Change of Control.

(c) “Intellectual Property” means inventions, discoveries, developments, methods, processes, compositions, works, concepts and ideas (whether or not patentable or copyrightable or constituting trade secrets) conceived, made, created, developed or reduced to practice by the Executive (whether alone or with others, whether or not during normal business

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hours or on or off Company premises) during the Executive’s employment and during the period of six (6) months immediately following termination of the Executive’s employment that relate to either the Products or any prospective activity of the Company or any of its Affiliates.

(d) “Person” means an individual, a corporation, an association, a partnership, an estate, a trust and any other entity or organization, other than the Company or any of its Affiliates.

(e)“Products” mean all products planned, researched, developed, tested, manufactured, sold, licensed, leased or otherwise distributed or put into use by the Company or any of its Affiliates, together with all services provided or planned by the Company or any of its Affiliates, during the Executive’s employment.

(f)“Restricted Capacity” means a position with a competitor of the Company or its Subsidiaries which is the same or comparable to the position the Executive held with the Company or in which the Confidential Information or customer goodwill which the Executive created or to which the Executive had access during the Executive’s employment with the Company would give that competitor an unfair competitive advantage.  For the avoidance of doubt, this definition as used herein shall in no way diminish the Executive’s obligations under Section 7.

14.Withholding.  All payments made by the Company under this Agreement shall be reduced by any tax or other amounts required to be withheld by the Company under applicable law.

15.Assignment.  Neither the Company nor the Executive may make any assignment of this Agreement or any interest herein, by operation of law or otherwise, without the prior written consent of the other; provided, however, that the Company may assign its rights and obligations under this Agreement without the consent of the Executive in the event that the Company shall hereafter affect a reorganization, consolidate with, or merge into, any other Person or transfer all or substantially all of its properties or assets to any other Person.  This Agreement shall inure to the benefit of and be binding upon the Company and the Executive, their respective successors, executors, administrators, heirs and permitted assigns.

16.Severability.  If any portion or provision of this Agreement shall to any extent be declared illegal or unenforceable by a court of competent jurisdiction, then the remainder of this Agreement, or the application of such portion or provision in circumstances other than those as to which it is so declared illegal or unenforceable, shall not be affected thereby, and each portion and provision of this Agreement shall be valid and enforceable to the fullest extent permitted by law.

17.Waiver.  No waiver of any provision hereof shall be effective unless made in writing and signed by the waiving party.  The failure of either party to require the performance of any term or obligation of this Agreement, or the waiver by either party of any breach of this

15

Agreement, shall not prevent any subsequent enforcement of such term or obligation or be deemed a waiver of any subsequent breach.

18.Notices.  Any and all notices, requests, demands and other communications provided for by this Agreement shall be in writing and shall be effective when delivered in person or deposited in the United States mail, postage prepaid, registered or certified, and addressed to the Executive at the Executive’s last known address on the books of the Company or, in the case of the Company, at its principal place of business, attention of the Chairman of the Board, or to such other address as either party may specify by notice to the other actually received.

19.Entire Agreement.  This Agreement constitutes the entire agreement between the parties and supersedes and terminates all prior communications, agreements and understandings, written or oral, with respect to the terms and conditions of the Executive’s employment with the Company.

20.Amendment; Section 409A.  This Agreement may be amended or modified only by a written instrument signed by the Executive and by an expressly authorized representative of the Company.  The parties acknowledge that certain provisions of this Agreement may be required to be amended, following the issuance of additional guidance by the Internal Revenue Service with respect to Section 409A, to avoid the possible imposition of additional tax under Section 409A with respect to certain payments and benefits under this Agreement.  The Company agrees that it will not unreasonably withhold its consent to any such amendments which in its determination are (i) feasible and necessary to avoid adverse tax treatment under Section 409A for the Executive, and (ii) not adverse to the interests of the Company.

21.Dispute Resolution.  In the event of any dispute relating to Executive’s employment, the termination thereof, or this Agreement, other than a dispute in which the primary relief sought is an equitable remedy such as an injunction, the parties shall be required to have the dispute, controversy or claim settled by alternative dispute resolution conducted by JAMS (or, if JAMS is not available, another mutually agreeable alternative dispute resolution organization), in the city of Executive’s principal place of employment.  Any award entered by JAMS (or such other organization) shall be final, binding and nonappealable, and judgment may be entered thereon by either party in accordance with applicable law in any court of competent jurisdiction.  This Section 21 shall be specifically enforceable.  JAMS (or such other organization) shall have no authority to modify any provision of this Agreement.  The Company shall reimburse the Executive the Executive’s reasonable attorney’s fees and costs in the event that the Executive prevails in an action brought by the Executive’s against the Company to enforce the terms of this Agreement.  THE PARTIES IRREVOCABLY WAIVE ANY RIGHT TO TRIAL BY JURY AS TO ALL CLAIMS HEREUNDER.

22.Headings.  The headings and captions in this Agreement are for convenience only and in no way define or describe the scope or content of any provision of this Agreement.

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23.Counterparts.  This Agreement may be executed in two or more counterparts, each of which shall be an original and all of which together shall constitute one and the same instrument.

24.Governing Law, Choice of Forum.  This is a New York contract and shall be construed and enforced under and be governed in all respects by the laws of the State of New York, without regard to the conflict of laws principles thereto.  The parties consent to the jurisdiction of any state or federal court sitting in the State of New York and waive any objection either party may have to the laying of venue of any such suit, action or proceeding in any such court.  The Company and the Executive each also irrevocably and unconditionally consent to service of any process, pleadings, notices or other papers in a manner permitted by the notice provisions of Section 18 of this Agreement.

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IN WITNESS WHEREOF, this Agreement has been executed as a sealed instrument by the Company, by its duly authorized representative, and by the Executive, as of the date first above written.

THE EXECUTIVE:	THE COMPANY:
	CELLU TISSUE HOLDINGS, INC.
/s/ David J. Morris	By:	/s/ Russell C. Taylor
David J. Morris
	Title:		President & CEO

EXHIBIT A

THE SHARES RECEIVED PURSUANT TO THIS STOCK OPTION SHALL BE SUBJECT TO THE RIGHTS, RESTRICTIONS, AND OBLIGATIONS APPLICABLE TO SUCH SECURITIES, ALL AS PROVIDED IN THE SHAREHOLDERS AGREEMENT DATED AS OF JUNE 12, 2006 BETWEEN THE COMPANY AND IT SHAREHOLDERS, AS AMENDED AND IN EFFECT FROM TIME TO TIME (THE “SHAREHOLDERS AGREEMENT”).

Mr. David J. Morris

CELLU PARENT CORPORATION
2006 STOCK OPTION AND RESTRICTED STOCK PLAN

Restricted Stock Award Agreement

Cellu Parent Corporation
c/o Weston Presidio
Pier 1, Bay 2
San Francisco, CA 94111

Attn:       Chief Executive Officer

Ladies and Gentlemen:

The undersigned (i) acknowledges that he has received and award (the “Award”) of restricted stock From Cellu Parent Corporation (the “Company”) under the Cellu parent Corporation 2006 Stock Option and Restricted Stock Plan (the “Plan”), subject to the terms set forth below and in the Plan; (ii) further acknowledges receipt of a copy o0f the Plan as in effect on the date hereof; and (iii) agrees with the Company as follows:

1.Effective Date.  This Agreement shall take effect as of August 6, 2007, which is the date of the grant of the Award.

2.Shares Subject to Award.  The Award consists of 700 shares (the “Shares”) of common stock of the Company (“Stock”).  The undersigned’s rights to the Shares are subject to the restrictions described in this Agreement and the Plan (which is incorporated herein by reference with the same effect as if set forth herein in full) in addition to such other restrictions, if any, as may be imposed by law.

3.Meaning of Certain Terms.  Except as otherwise expressly provided, all terms used herein shall have the same meaning as in the Plan.  The term “vest” as used herein with respect to any Shares means the lapsing of the restrictions described herein with respect to such Share.

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4.Nontransferability of Shares.  The Shares acquired by the undersigned pursuant to this Agreement shall not be sold, transferred, pledged, assigned or otherwise encumbered or disposed of except as provided below and in the Plan.

5.Forfeiture Risk.  If the undersigned ceases to be employed by the Company and its subsidiaries any then outstanding and unvested Shares acquired by the undersigned hereunder shall be automatically and immediately forfeited; provided, however, that if the undersigned ceases to be employed by the Company due to the undersigned’s death or disability, fifty percent (50%) of the Shares granted under this Agreement that are not already vested shall vest; and further provided that if the undersigned ceases to be employed by the Company by reason of the Company’s election not to renew the undersigned’s employment agreement with the Company dated August 6, 2007 (the “Employment Agreement”) and at the time the Company elects not to renew such Employment Agreement there exists no Cause for the termination of the undersigned, one hundred percent (100%) of the Shares granted under this Award that are not then already vested shall vest.  For purposes of the preceding sentence, Cause shall be defined in the Employment Agreement.  The undersigned hereby (i) appoints the Company as the attorney-in-fact of the undersigned to take such actions as may be necessary or appropriate to effectuate a transfer of the record ownership of any such shares that are unvested and forfeited hereunder, (ii) agrees to deliver to the Company, as a precondition to the issuance of any certificate or certificates with respect to unvested Shares, and (iii) agrees to sign such other powers and take such other actions as the Company may reasonably request to accomplish the transfer or forfeiture of any unvested Shares that are forfeited hereunder.

6. Retention of Certificate.  Any certificates representing unvested Shares shall be held by the Company.  If unvested Shares are held in book entry form, the undersigned agrees that the Company may give stop transfer instructions to the depository to ensure compliance with the provisions hereof.

7.Vesting of Shares.  The Shares acquired hereunder shall vest in accordance with the provisions of this Paragraph 7 and applicable provisions of the Plan, as follows:

25% of the Shares on and after one (1) year from the Effective Date;

an additional 25% of the Shares on and after two (2) years from the Effective Date;

an additional 25% of the Shares on and after three (3) years from the Effective Date; and

an additional 25% of the Shares on and after four (4) years from the Effective Date.

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Notwithstanding the foregoing, no Shares shall vest on any vesting date specified above unless the undersigned is then, and since the date of grant has continuously been, employed by the Company or its subsidiaries.

8.Shareholders Agreement.  The granting of this Award and the issuance of Shares received under this Award shall be subject to the Plan and the Shareholders Agreement, and the issuance of this Award shall be conditional upon the exe3cution and delivery by the undersigned of the Shareholders Agreement.  Any Shares received under this Award shall be subject to the rights, restrictions and obligations applicable to options and shares of Stock of the Company as provided from time to time in such Shareholders Agreement.

9.Legend.  Any certificates representing unvested Shares shall be held by the Company, and such certificate shall contain a legend substantially in the following form:

THE TRANSFERABILITY OF THIS CERTIFICATE AND THE SHARES OF STOCK REPRESENTED HEREBY ARE SUBJECT TO THE TERMS AND CONDITIONS (INCLUDING FORFEITURE) OF THE CELLU PARENT CORPORATION 2006 STOCK OPTION AND RESTRICTED STOCK PLAN AND A RESTRICTED STOCK AWARD AGREEMENT ENTERED INTO BETWEEN THE REGISTERED OWNERAND CELLU PARENT CORPORATION.  COPIES OF SUCH PLAN AND AGREEMENT ARE ON FILE IN THE OFFICES OF CELLU PARNET CORPORATION.

THE SECURITITES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO THE TERMS AND CONDITIONS, INCLUDING CERTAIN RESTRICTIONS ON TRANSFER, OR A SHAREHOLDERS AGREEMENT DATED AS OF JUNE 12, 2006 BETWEEN CELLU TISSUE CORPORATION AND ITS SHAREHOLDERS, AS AMENDED FROM TIME TO TIME, AND NONE OF SUCH SECURITIES, OR ANY INTEREST THEREIN, SHALL BE TRANSFERRED, PLEDGED, ENCUMBERED OR OTHERWISE DISPOSED OF EXCEPT AS PROVIDED IN THAT AGREEMENT.  A COPY OF THE SHAREHOLDERS AGREEMENT IS ON FILE IN THE OFFICES OF CELLU PARENT CORPORATION.

As soon as practicable following the vesting of any such Shares the Company shall cause a certificate or certificates covering such Shares, without the aforesaid legend, to be issued and delivered to the undersigned.  If any Shares are held in book-entry form, the Company may take such steps as it deems necessary or appropriate to record and manifest the restrictions applicable to such Shares.

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10.Dividends, etc..  The undersigned shall be entitled to (i) receive any and all dividends or other distributions paid with respect to those Shares of which he is the record owner on the record date for such dividend or other distribution, and (ii) vote any Shares of which he is the record owner on the record date for such vote; provided, however, that any property (other than cash) distributed with respect to a share of Stock (the “associated share”) acquired hereunder, including without limitation a distribution of Stock by reason of a stock dividend, stock split or otherwise, or a distribution of other securities with respect to an associated share, shall be subject to the restrictions of this Agreement in the same manner and for so long as the associated share remains subject to such restrictions, and shall be promptly forfeited if and when the associated share is so forfeited; and further provided, that the Administrator may require that any cash distribution with respect to the Shares other than a normal cash dividend be placed in escrow or otherwise made subject to such restrictions as the Administrator deems appropriate to carry out the intent of the Plan, consistent with Section 409A of the Code to the extent applicable.  References in this Agreement to the Shares shall refer, mutatis mutandis, to any such restricted amounts.

11.Sale of Vested Shares.  The undersigned understands that he will be free to sell any Share once it has vested, subject to (i) satisfaction of any applicable tax withholding requirements with respect to the vesting or transfer of such Share; (ii) the completion of any administrative steps (for example, but without limitation, the transfer of certificates) that the Company may reasonably impose; (iii) applicable requirements of federal and state securities laws; and (iv) the terms and conditions of the Shareholders Agreement.

12.Certain Tax Matters.  The undersigned expressly acknowledges the following:

a.The undersigned has been advised to confer promptly with a professional tax advisor to consider whether the undersigned should make a so-called “83(b) election” with respect to the Shares.  Any such election, to be effective, must be made in accordance with applicable regulations and within thirty (30) days following the date of this Award.  The Company has made no recommendation to the undersigned with respect to the advisability of making such an election.  In the event that the undersigned makes an 83(b) election and incurs a tax liability as a result, the Company will, on a date prior to the date on which the taxes must be paid or withheld, make a lump sum payment (a “Gross Up Payment”) to the undersigned that will be sufficient, after giving effect to federal, state, and local income taxes with respect to the Gross Up Payment, to pay any marginal increase in tax liability of the undersigned as a result of such 83(b) election.  For this purpose, a tax liability will be treated as incurred only to the extent that the inclusion of the income by reason of the grant will increase the undersigned’s tax liability for the year of inclusion, after giving effect

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to all losses, credits, carry-forwards, carry-backs, etc. that the undersigned may be able to utilize in such year and without regard to any decrease in losses, credits, carry-forwards, carry-backs, etc. and the effect of any such decrease on other tax years.

b.The award or vesting of the Shares acquired hereunder, and the payments of dividends with respect to such Shares, may give rise to “wages” subject to withholding.  The undersigned expressly acknowledges and agrees that his rights hereunder are subject to his promptly paying to the Company in cash (or by such other means as may be acceptable to the Company in its discretion, including, if the Administrator so determines, by the delivery of previously acquired Stock or shares of Stock acquired hereunder or by the withholding of amounts from any payment hereunder) all taxes required to be withheld in connection with such award, vesting or payment.

	Very truly yours,
	David J. Morris
Dated:
The foregoing Restricted Stock
Award Agreement is hereby accepted:
CELLU PARENT CORPORATION
By:
Name: R. Sean Honey
Title: President

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EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Russell C. Taylor, President and Chief Executive Officer of Cellu Tissue Holdings, Inc., certify that:

1.I have reviewed this quarterly report on Form 10-Q of Cellu Tissue Holdings, Inc.  for the period ended August 30, 2007;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has material affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	October 12, 2007
		/s/ Russell C. Taylor
		Russell C. Taylor
		President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, David J. Morris, Senior Vice President, Finance and Chief Financial Officer of Cellu Tissue Holdings, Inc., certify that:

1.I have reviewed this quarterly report on Form 10-Q of Cellu Tissue Holdings, Inc.  for the period ended August 30, 2007;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has material affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	October 12, 2007
		/s/ David J. Morris
		David J.Morris
		Senior Vice President, Finance and Chief Financial Officer