Clearwater Paper Corp - Annual Report: 2008 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-K

Commission File Number 001-34146

CLEARWATER PAPER CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (509) 344-5900

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ¨ Yes    x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨ Yes    x No

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.    x Yes    ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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

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

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

On June 30, 2008, the registrant’s common stock was not publicly traded.

The number of shares of common stock outstanding as of March 5, 2009: 11,354,542 shares of Common Stock, par value of $0.0001 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement to be filed on or about April 7, 2009, with the Commission in connection with the 2009 annual meeting of stockholders are incorporated by reference in Part III hereof.

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Index to 2008 Form 10-K

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PART I

GENERAL

Clearwater Paper Corporation is principally engaged in the manufacturing and selling of pulp-based products. We are a leading producer of private label tissue products sold in grocery stores in the United States, and we manufacture and market bleached paperboard for the high-end segment of the packaging industry. We also manufacture and market bleached pulp and wood products, including appearance grade cedar and dimensional framing lumber products.

Our lumber facility was established in Lewiston, Idaho, in 1927. Our businesses were owned directly by Potlatch Corporation, which we refer to in this report as Potlatch, until December 2005, and we were a subsidiary of Potlatch until our spin-off on December 16, 2008. On December 1, 2008, Potlatch’s board of directors approved the distribution of our common stock to Potlatch’s stockholders in a tax-free spin-off, which we refer to in this report as the “spin-off.” On December 16, 2008, Potlatch distributed 100% of the issued and outstanding shares of our common stock to the holders of record of Potlatch common stock as of the close of business on December 9, 2008. Each Potlatch stockholder received one share of our common stock for every 3.5 shares of Potlatch common stock held on the record date.

Unless the context otherwise requires or unless otherwise indicated, references in this report to “Clearwater Paper Corporation,” “we,” “our,” “our company” and “us” refer:

We are focused on our Consumer Products business that manufactures at-home tissue products, such as facial and bath tissue, paper towels and napkins, which are sold on a private label basis. We are also focused on manufacturing and selling premium bleached paperboard for the high-end segment of the packaging industry, softwood market pulp and slush pulp, which is used as a basis for our paper and tissue products.

We believe that the spin-off of our business from Potlatch provides us with certain opportunities and benefits, including the following:

Our businesses are organized into three reportable operating segments, as defined by Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 131, Disclosures

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About Segments of an Enterprise and Related Information: Consumer Products; Pulp and Paperboard; and Wood Products. Discussion of each of our segments is included on pages 2-6. Information relating to the amounts of net sales, operating income (loss), depreciation and amortization, identifiable assets and capital expenditures attributable to each of our operating segments for 2006-2008, as well as geographic information regarding our net sales, is included in Note 13 to the financial statements on pages 69-70 of this report.

Interested parties may access our periodic and current reports filed with the Securities and Exchange Commission, or SEC, at no charge, by visiting our website, www.clearwaterpaper.com. In the menu select “Investor Relations,” then select “Financial Information & SEC Filings.” Information on our website is not part of this report.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This report contains, in addition to historical information, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended, including without limitation, statements regarding future revenues, cash flows, energy costs, wood fiber costs, future dividends, manufacturing output, additional corporate overhead and administrative expenses associated with being a stand-alone company, benefit plan funding levels, expected opportunities and benefits associated with our separation from Potlatch, the terms of our agreements with Potlatch and capital expenditures. Words such as “anticipate,” “expect,” “will,” “intend,” “plan,” “target,” “project,” “believe,” “seek,” “schedule,” “estimate,” “could,” “can,” “may,” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are based on management’s current expectations, estimates, assumptions and projections that are subject to change. Our actual results of operations may differ materially from those expressed or implied by the forward-looking statements contained in this report. Important factors that could cause or contribute to such differences include those risks discussed in Item 1A of this report, as well as the following:

Forward-looking statements contained in this report present management’s views only as of the date of this report. Except as required under applicable law, we do not intend to issue updates concerning any future revisions of management’s views to reflect events or circumstances occurring after the date of this report.

CONSUMER PRODUCTS SEGMENT

Our Consumer Products segment manufactures and markets household private label consumer tissue products—household paper towels, napkins, and facial and bathroom tissue—that we believe match the

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quality of branded products in each category. A description of the facilities used to produce these products is included under Item 2 of this report. In 2008, our Consumer Products segment had net sales of $504.6 million.

Tissue Industry Overview

Our Consumer Products business competes in the consumer segment of the U.S. tissue market. The U.S. tissue market is generally divided into two segments: the at-home or consumer segment, which represents the majority of the U.S. tissue market; and the away-from-home segment, which represents a smaller portion of the U.S. tissue market.

The United States at-home tissue segment consists of bath, towel, facial and napkin products. Each category of products is further distinguished according to quality classifications: ultra, premium, value and economy. As a result of process improvements and consumer demand, the majority of at-home tissue sold in the United States has shifted from value and economy quality to premium or ultra quality.

At-home tissue producers are comprised of companies that manufacture branded and private label tissue products. Branded tissue suppliers manufacture, market and sell tissue products under their own nationally branded labels. Private label tissue producers sell tissue products to retailers who in turn sell the tissue to consumers as the retailers’ private label brand. Some manufacturers sell both branded and private label tissue products.

In the United States, at-home tissue is primarily sold through grocery stores, mass merchants, warehouse clubs, drug stores and dollar stores. Tissue has historically been one of the strongest segments of the paper and forest products industry due to its steady demand growth and the absence of severe supply imbalances that occur in a number of other paper segments. In addition to economic and demographic drivers, tissue demand is affected by product innovations and shifts in distribution channels.

Our Consumer Products Business

We manufacture and sell a complete line of products in each tissue category discussed above, focusing primarily on the ultra and premium quality products in each category. In household paper towels, we produce and sell high-end through-air-dried, or TAD, towels as well as premium and value towels. In napkins, we manufacture ultra two- and three-ply dinner napkins, as well as premium and value one-ply luncheon napkins. In bathroom tissue, the majority of our sales are high quality two-ply ultra and premium products. In the facial category, we sell an ultra lotion facial tissue as well as a complete line of premium products.

Our tissue products are manufactured on three machines at our facility in Lewiston, Idaho, as well as one machine at our facility in Las Vegas, Nevada. The tissue is then converted into packaged tissue products at three converting facilities in Lewiston, Las Vegas, and Elwood, Illinois. In 2008, approximately 54% of the pulp we used to make our tissue products was obtained from our Lewiston pulp mill. The remaining portion was purchased on the open market and consisted primarily of hardwood pulp, which enhances the quality of certain grades of tissue.

Our conventional paper machines located at our facility in Lewiston produce ultra and premium products. However, these paper machines cannot produce a high-end ultra household towel. In 2004, to meet this demand we invested in a new TAD paper machine at our Las Vegas facility. Since TAD machine production commenced, our ultra household towel sales have steadily grown.

The process of making tissue starts with pulp made from wood chips. The pulp is mixed in a giant blending chest until it reaches a consistency of 96% water and 4% pulp. This mixture is sprayed onto a large rotating porous screen on the paper machine, where the sheet is formed. From this point the sheet travels through numerous pressure rolls to remove excess water and finally over a large heated drum to dry. The dry sheet is wound into parent rolls weighing several tons, which are placed into storage until the paper is converted. During the converting process, the parent rolls are placed on a converting line where the paper is rewound onto a smaller core for bathroom tissue or household towels, or folded for facial tissue or napkins. Once the product is rewound or folded, it goes through a packaging or wrapping process and is placed in a shipping case. This case is placed in storage until it is shipped to the customer.

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We are a significant producer of private label household tissue products in the United States. In 2008, we produced approximately 56% of the total private label tissue products sold in grocery stores in the United States. We compete with at least three companies that are much larger than us who sell national brand tissue products, as well as commercial, industrial and private label products. We also compete with other companies that sell regional brand products and commercial, industrial and private label products. Our household tissue products are packaged to order for retail chains, wholesalers and cooperative buying organizations throughout the United States and, to a lesser extent, Canada. These products are sold to consumers under our customers’ own brand names. We sell a majority of our tissue products to three national grocery store chains. Although we believe we have strong long-term relationships with our grocery chain customers and have successfully integrated ourselves within their strategic decision making processes, we do not have long-term supply contracts with any of these national chains. The loss of one or more of these customers could have a material adverse effect upon the operating results of the Consumer Products segment. The average tenure of our top 10 Consumer Products customers in 2008 is over 20 years.

We believe that we are the only U.S. consumer tissue manufacturer that produces solely private label tissue products. Most U.S. tissue producers manufacture both private label and branded products. Branded producers generally manufacture their private label products a quality grade or two below their branded products so as not to impair sales of the branded products. Because we do not produce branded tissue products, we are able to offer products that match the quality of the branded products at lower prices.

We sell private label tissue products through our own sales force primarily to grocery stores. Our principal methods of competing are product quality, customer service and price. We deliver customer-focused business solutions by assisting in managing product assortment, category management, and pricing and promotion optimization.

We are committed to maintaining a high level of quality for our products that matches the quality of the leading national brands. We utilize independent companies to routinely test our product quality.

PULP AND PAPERBOARD SEGMENT

Our Pulp and Paperboard segment manufactures and markets bleached paperboard for the high-end segment of the packaging industry and is a leading producer of solid bleach sulfate, or SBS paperboard. This segment also produces softwood market pulp, which is used as the basis for many paper products, and slush pulp, which it supplies to our Consumer Products segment. A description of the facilities used to produce these products is included under Item 2 of this report. In 2008, our Pulp and Paperboard segment had net sales of $737.6 million, which included $65.3 million of intersegment sales to our Consumer Products segment.

Pulp and Paperboard Industry Overview

SBS is a premium paperboard grade that is most frequently used to produce folding cartons, liquid packaging, cups and plates, and commercial printing items. SBS is used to make these products because it is manufactured using virgin fiber produced in a kraft bleaching process, which results in superior stiffness and cleanliness. SBS is often coated with a clay surface, which in many cases provides superior surface printing qualities. SBS can also be coated with a plastic film to provide a moisture barrier for some uses.

Folding Cartons Segment. Folding carton is the largest portion of the SBS segment of the paperboard industry. Within the folding carton segment there are varying qualities of SBS. The high end of the folding carton category in general requires a premium print surface and includes uses such as packaging for pharmaceuticals, cosmetics, DVDs and CDs, and other premium retail goods. On the lower end of the quality spectrum, SBS is used in the packaging of commodity frozen foods, beverages, and baked goods.

Liquid Packaging and Cup Segment. SBS liquid packaging is primarily used in the United States for the packaging of juices. In Japan and other Asian countries, SBS liquid packaging is primarily used for the packaging of milk, juice and other liquid items.

The cup segment of the market consists primarily of cold and hot drink cups and is largely characterized by highly commoditized, lower margin uses that place less emphasis on printability or brightness. Since this

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segment is mostly commoditized, it tends to attract producers employing a high-volume, low-margin strategy. While we serve demand in this commodity cup segment, we are particularly focused on the high-end portion of the segment that demands good printability.

Commercial Printing Segment. Commercial printing applications use light-weight bleached bristols, which are used to produce postcards, signage, sales literature, and cover stock for publications such as annual reports, among other things. The customers in this segment are accustomed to high-quality paper grades, which possess superior printability and brightness compared to most paperboard grades.

Market Pulp. The majority of the pulp manufactured worldwide is integrated with paper and paperboard production, usually at the same mill. In those cases where a paper mill does not produce its own pulp, it must purchase it on the open market. Market pulp is defined as pulp produced for sale to these customers and it excludes tonnage consumed by the producing mill or shipped to any of its affiliated mills within the same country.

Our Pulp and Paperboard Business

Our Pulp and Paperboard segment operates two facilities, one in Idaho and one in Arkansas. We are a significant producer of bleached paperboard in the United States, where we compete with at least five other domestic pulp and paperboard producers. As of December 31, 2008, we had approximately 12% of the available domestic bleached paperboard capacity.

In general, the process of making paperboard begins by chemically cooking wood chips and sawdust to make pulp. The pulp is bleached to provide a white, bright pulp used to produce paperboard grades, which are formed using our three paperboard machines. Bleached pulp that we sell as market pulp is dried and baled on a pulp drying machine, bypassing the paperboard machines. The various grades of paperboard may be coated with starch and clay, and are wound into rolls for shipment to customers for converting to final end uses. For liquid paperboard packaging, a polyethylene or plastic coating is applied by a separate operation to create a barrier that is water resistant and durable.

Our bleached paperboard is converted by our customers into a variety of end products, including packaging for liquids, food products, pharmaceuticals, toiletries, paper cups and plates, blister packaging and other consumable goods. We also manufacture lightweight bleached bristols. Our overall pulp and paperboard production consists primarily of folding carton and plate, liquid packaging and cup, pulp, and commercial printing applications.

Folding cartons used in pharmaceuticals, cosmetics and blister and skin packaging, as well as those that incorporate foil and holographic lamination, account for the largest portion of our total paperboard sales. We focus on high-end folding carton applications where the heightened focus on product quality provides for differentiation among suppliers, resulting in margins that are more attractive than in lower grade packaging.

Our liquid carton paperboard is known for its cleanliness and printability, and is engineered for long-lived performance due to its three-ply, 100% softwood construction, and optional polyethylene coating. Our reputation for producing liquid packaging meeting the most demanding standards for paperboard quality and cleanliness has resulted in meaningful sales in Japan, where consumers have a particular tendency to associate blemish-free, vibrant packaging with the cleanliness, quality, and freshness of the liquids contained inside.

We also sell paperboard for use in cup and plate products. A majority of our sales in this area are to the standard cup and plate segment of the market, but we also provide paperboard to high-end food manufacturers, such as those who make premium ice cream. We also sell limited quantities of plate quality SBS.

Our Pulp and Paperboard segment also sells products for commercial printing applications. The commercial print market requires a premium print surface consistent with the demands of high-end folding carton converters. Further, a supplier must be able to deliver small volumes, often within 24 hours. We have achieved growth in this market through investing in improvements in print surface quality at both our paperboard mills and by focusing sales and marketing efforts on printers and regional paper merchants. In addition, in 2006 we also expanded our product lines to the lighter weights desired by the commercial print segments and added a coated two-side offering, branded as Ancora.

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We have long-standing customer relationships with our paperboard customers. Our top 10 customers accounted for approximately 45% of our total paperboard revenues from each mill in each of the last four years, and although most of our contracts are annual agreements that can be terminated without penalty, our relationships extend over many years with our top 10 customers.

We do not produce paperboard end products, so we are not simultaneously a supplier of, and a competitor to, our customers. For example, of the five largest SBS producers in the United States, we are the only producer that does not also convert SBS into end products. We believe our position as a non-integrated supplier has resulted in a diverse group of loyal customers, as they do not have to worry that, in the event of decreased market availability of SBS, we will re-direct production to meet internal conversion requirements.

At our Lewiston, Idaho facility we produce and sell bleached softwood market pulp, both for internal use as well to external customers. In 2008, approximately 71% of our pulp sales were comprised of internal sales to our Consumer Products segment and the remaining approximately 29% represented pulp sales to external customers, with the majority of these external sales shipped to customers in Asia.

Of the segment’s $737.6 million of net sales in 2008, $644.4 million, or 87%, was derived from sales of our paperboard products, $27.0 million, or 4%, was derived from the sale to third parties of pulp produced at our facilities, $65.3 million, or 9%, was derived from internal pulp sales to our Consumer Products segment, and $0.9 million was derived from the sale of other paperboard related products. In 2008, approximately 21% of the Pulp and Paperboard segment’s net sales were generated from sales to international customers, mainly located in Japan, China, Taiwan and The Netherlands.

We utilize various methods for the sale and distribution of our paperboard and softwood pulp. The majority of our paperboard is sold to packaging converters domestically through sales offices located throughout the United States, while a growing percentage is channeled through distribution to commercial printers. The majority of our international paperboard sales, as well as our softwood market pulp, are conducted through sales agents. Our principal methods of competing are product quality, customer service and price.

WOOD PRODUCTS SEGMENT

Our Wood Products segment consists of a single lumber facility located on the same site in Lewiston, Idaho, as our tissue and pulp and paperboard manufacturing facilities. A description of this manufacturing facility is included under Item 2 of this report. This segment produces and markets appearance grade cedar and dimensional framing lumber products, including glued and profile lumber for building products end-users. Our cedar products include appearance grade boards, siding and trim. Our glued cedar process utilizes low grade cedar to produce finger jointed and edge glued board and siding. Our dimensional lumber business includes two-inch dimensional framing lumber, industrial timbers and railroad ties. These products are sold through Potlatch sales offices, under the terms of a lumber sales and marketing agreement under which Potlatch acts as our exclusive representative for the marketing and sale of our dimensional lumber and cedar lumber products. These products are sold under the “Potlatch” name primarily to distributors, professional dealers and wholesalers for nationwide distribution. In 2008, our Wood Products segment had net sales of $89.0 million, which included $10.5 million of intersegment sales of residual wood fiber to our Pulp and Paperboard facility in Lewiston.

Our share of the market for our lumber products is not significant compared to the total United States market for these products. We believe that competitiveness in this industry is largely based on individual mill efficiency and on the availability of competitively priced resources on a facility-by-facility basis, rather than the number of mills operated. This is due to the fact that it is generally not economical to transfer wood between or among facilities, which would permit a greater degree of specialization and operating efficiencies. Instead, each facility must utilize the raw materials that are available to it in a relatively limited geographic area. For these reasons, we believe we are able to compete effectively with companies that have a larger number of mills. We compete based on product quality, customer service and price.

RAW MATERIALS

For our manufacturing operations, the principal raw material used is wood fiber, which is purchased under supply agreements we entered into with Potlatch in connection with the spin-off or on the open market. Our Pulp and Paperboard segment purchases a substantial amount of wood chips and sawdust from third

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parties for use in the production of pulp. Our Consumer Products segment purchases several varieties of pulp from third parties, in addition to pulp provided by our Pulp and Paperboard segment, for use in manufacturing tissue products. Our Wood Products segment purchases its log needs from Potlatch pursuant to a supply agreement, as well as purchasing a lesser portion of its needs from other sources. Specific information regarding supply agreements entered into with Potlatch are set forth under the heading “Transactions with Related Persons” in the 2009 Proxy Statement and is incorporated herein by reference.

SEASONALITY

Our Consumer Products and Pulp and Paperboard segments are generally not affected by seasonal changes, although a number of our paperboard contracts are renewed at the beginning of each year. Demand for our wood products typically decreases in the winter months when construction activity is slower, and increases in the spring, summer and fall when construction activity is generally higher.

ENVIRONMENTAL

Information regarding environmental matters is included under Part II, Item 7—“Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 43 of this report, and is incorporated herein by reference.

EMPLOYEES

As of December 31, 2008, we had approximately 2,460 employees, of which approximately 1,040 were employed by our Consumer Products segment, approximately 1,050 were employed by our Pulp and Paperboard segment, approximately 300 were employed by our Wood Products segment and approximately 70 were corporate administration employees. This workforce consisted of approximately 670 salaried and fixed rate employees, approximately 1,760 hourly employees and 30 temporary or part-time employees. As of December 31, 2008, approximately 65% of the workforce was covered under collective bargaining agreements.

Unions represent hourly employees at our Idaho and Arkansas facilities. Hourly union labor contracts expiring in 2009 are set forth below:

Investing in our common stock involves a significant degree of risk. You should carefully consider each of the following risks and all of the other information contained in this report. Some of the risks described below relate principally to our business and the industry in which we operate, while others relate principally to our spin-off from Potlatch. The remaining risks relate principally to the securities markets generally and ownership of our common stock.

Our business, financial condition, results of operations or liquidity could be materially adversely affected by any of these risks, and, as a result, the trading price of our common stock could decline.

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Risks Related to Our Business

The current downturn in the United States and global economy and conditions in financial markets could have adverse affects on our business and financial results.

The current U.S. and global economic recession, coupled with the disruption in the global financial and credit markets, have negatively affected, and may continue to negatively affect, our business and financial results. Potential negative effects on our business include:

In addition, current conditions in financial markets, which include the bankruptcy and restructuring of certain financial institutions, could limit access to our credit facility and thus adversely affect our ability to fund our operations. Also, continuing turmoil in the financial markets could make it more difficult for us to refinance our existing indebtedness, sell assets, enter into agreements for new indebtedness or obtain funding from the issuance of our securities.

Significant declines in the value of our pension asset portfolio have resulted in an underfunded status of our pension plans, which may require us to make significant cash contributions to our plans over time.

We have company-sponsored pension plans covering our salaried and hourly employees. The significant decline of the stock market in 2008 and resulting substantial decline in the value of equity and fixed income investments held by the plans in 2008 has caused these pension plans to be underfunded because our projected benefit obligation exceeds the aggregate fair value of plan assets. Under applicable law, we are required to make cash contributions to the extent necessary to comply with minimum funding levels imposed by regulatory requirements. Despite passage in December 2008 of federal legislation providing short-term funding relief, we are required to make contributions to our qualified pension plans for 2009 ($8.7 million plus interest payable by September 2010), and we may be required to make increased annual contributions to our pension plans in future years, which would reduce the cash available for business and other needs. There can be no assurance that the value of pension plans will be sufficient to cover future liabilities.

Changes in the cost and availability of wood fiber used in production of our products may adversely affect our results of operations and cash flow.

Wood fiber, primarily wood chips and sawdust, is the principal raw material for our pulp and paperboard products and, in 2008, accounted for approximately 34% of our Pulp and Paperboard segment’s total costs of production. Wood chip and sawdust prices were at historically high levels in 2008. Our average cost per ton of wood chips and sawdust was approximately $203 per ton in 2008, an increase of 25% over the approximately $163 per ton in 2007, which was an increase of 20% over the approximately $136 per ton in 2006. In the event we are not able to pass increases in wood fiber costs along to our customers, our operating results may be significantly harmed.

Much of the wood fiber we use in our pulp manufacturing process is the by-product of lumber mill operations, particularly in Idaho. As a result, the price of these residual wood fibers is affected by operating levels in the lumber industry. Prices for these residual fibers are currently very high, largely because of limited supplies due to the slowdown or shutdown of lumber mill operations in the United States as a result of the home construction market downturn. In addition, we have had to locate new suppliers as some of the suppliers located near our Idaho facility have ceased operations, which has resulted in increased costs to us for transporting wood fiber to our Idaho facility. The price of wood fiber is expected to remain high until the housing market recovers and lumber mill operations increase. If we are not able to obtain wood fiber at favorable prices or at all, our financial results and operations may be materially adversely affected.

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The cost of energy and chemicals needed for our manufacturing processes significantly affects our business.

Energy costs, including costs for natural gas and purchased electricity, accounted for approximately 10% and 9% of our total production costs in 2008 and 2007, respectively. While we produce internally a significant portion of the steam and electricity we consume at our Idaho facility, our energy costs have been rising. Our expenses for energy used in our manufacturing processes were $113.7 million in 2008, an increase of 27% over the $89.8 million in 2007, which in turn was 5% higher than the $85.8 million we spent in 2006. In periods of high energy prices, market conditions may prevent us from passing higher energy costs on to our customers through price increases, and therefore increased costs could adversely affect our operating results. We purchase on the open market a substantial portion of the natural gas necessary to produce our products, and, as a result, the price and other terms of those purchases are subject to change based on factors such as worldwide supply and demand and government regulation. To help mitigate the exposure to market risk for changes in natural gas commodity pricing, we use firm-price contracts to supply a portion of our natural gas requirements. As of December 31, 2008, these contracts covered approximately 39% of the expected average monthly natural gas requirements for our Pulp and Paperboard and Consumer Products segments for 2009, plus lesser amounts for 2010. Our energy costs in future periods will depend principally on our ability to produce a substantial portion of our electricity needs internally, on changes in market prices for natural gas and on reducing energy usage.

The supply of energy may be adversely affected by, among other things, hurricanes and other natural disasters or an outbreak or escalation of hostilities between the United States and any foreign power and, in particular, events in the Middle East. Any significant shortage or significant increase in our energy costs in circumstances where we cannot raise the price of our products could have a material adverse effect on our business, financial condition and results of operations. Any disruption in the supply of energy could also affect our ability to meet customer demand in a timely manner and could harm our reputation. Furthermore, we may be required to post letters of credit or other financial assurance obligations with our natural gas suppliers, which could limit our financial flexibility.

We also use a variety of chemicals in our manufacturing processes, including latex and polyethylene, many of which are petroleum-based chemicals. Prices for these chemicals have been and are expected to remain volatile. In 2008, a supplier announced two separate price increases of the chemicals that we purchase from it, for an aggregate price increase of 50%. In addition, chemical suppliers that use petroleum-based products in the manufacture of their chemicals may, due to supply shortages and cost increases, ration the amount of chemicals available to us, and therefore we may not be able to obtain at favorable prices the chemicals we need to operate our business, if we are able to obtain them at all. Finally, certain specialty chemicals that we purchase are available only from a small number of suppliers. If any of these suppliers were to cease operations or cease doing business with us, we may be unable to obtain such chemicals at favorable prices, if at all.

Cyclical industry conditions have in the past affected and may continue to adversely affect the operating results and cash flow of our Pulp and Paperboard business.

The pulp and paperboard industries are highly cyclical. Historically, economic and market shifts, fluctuations in manufacturing capacity and changes in foreign currency exchange rates have created cyclical changes in prices, sales volumes and margins for our pulp and paperboard products. The length and magnitude of industry cycles have varied over time, but generally reflect changes in macroeconomic conditions and levels of industry manufacturing capacity. Pulp and most of our paperboard products are commodities that are widely available from other producers. Because commodity products have few distinguishing qualities from producer to producer, competition for these products is based primarily on price, which is determined by supply relative to demand.

Industry supply of pulp and paperboard products is primarily influenced by fluctuations in available manufacturing capacity. When manufacturing capacity is increased, there may be an oversupply of products in our industry which results in a weak pricing environment. During periods of oversupply, some producers may choose to idle or permanently close individual machines or entire mills. Alternatively, some producers may choose to continue to operate at a loss, sometimes even a cash loss, which could prolong weak pricing

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environments. Oversupply can also result from producers introducing new capacity in response to favorable short-term pricing trends.

Industry supply of pulp and paperboard products is also influenced by overseas production capacity, which has grown in recent years and is expected to continue to grow. While the weakness of the U.S. dollar has mitigated the levels of imports in recent years, strengthening of the U.S. dollar in the future could result in an increase in imports of pulp and paperboard products, putting downward pressure on prices. Variations in the exchange rates between the U.S. dollar and other currencies may significantly affect our competitive position by making it more attractive for foreign producers to restart closed mills or increase production capacity.

The overall levels of demand for pulp and paperboard products reflect fluctuations in levels of end-user demand, which depend in part on general macroeconomic conditions in North America and worldwide. Market prices for pulp have decreased significantly since the third quarter of 2008, driven, in part, by decreased demand for pulp from China.

Prices for our pulp and paperboard products are driven by many factors outside of our control, and we have little influence over the timing and extent of price changes. As a result, the price for any one or more of these products may fall below our production costs, requiring us to either incur losses on product sales or cease production at one or more of our manufacturing facilities. Our profitability with respect to these products depends on our ability to manage our cost structure, particularly wood fiber, chemical and energy costs, which represent the largest components of our operating costs and can fluctuate based upon factors beyond our control. If the prices of, or demand for, our pulp and paperboard products decline, or if our wood fiber, chemical, energy or other key production costs increase, or both, our sales and operating results could be materially and adversely affected.

Our Consumer Products business receives a substantial portion of its net sales from three customers, and the loss of, or a significant reduction in, orders from any of these customers could adversely affect our operating results and financial condition.

Our Consumer Products segment derived 58% of its net sales in 2008, and we derived 23% of our total net sales in 2008, from three customers. Sales to these three customers have represented approximately 58% of segment net sales in each of the last three fiscal years. We do not have long-term contracts with any of these customers that ensure a continuing level of business from them. Our agreements with these customers are not exclusive and do not contain minimum volume commitments.

Our relationships with these three customers depend on our ability to continue to meet their needs for quality products at competitive prices. If we lose one of these customers or if we experience a significant decline in the level of purchases by any of them, we may not be able to quickly replace the lost business volume and our operating results and business could be harmed. In addition, our focus on these large accounts could affect our ability to serve our smaller accounts, particularly when product supply is tight and we are not able to fully satisfy orders for these smaller accounts.

Significant competition could prevent us from increasing or sustaining our net sales and profitability.

The markets for our products are highly competitive, and companies that have substantially greater financial resources than we do compete with us in each market. Some of our competitors have advantages over us, including lower raw material and labor costs.

Our Consumer Products business faces competition from companies that produce the same type of products that we produce or that produce alternative products that customers may use instead of our products. Our Consumer Products business competes with the branded tissue products producers, such as Procter & Gamble, and branded label producers who manufacture branded and private label products, such as Georgia-Pacific and Kimberly-Clark. These companies are far larger than us, have much greater sales, marketing and research and development resources than we do, and enjoy significant cost advantages due to economies of scale. Because of their size and resources, these companies may foresee market trends more accurately than we do and develop new technologies that render our products less attractive or obsolete.

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Our ability to successfully compete in the pulp and paperboard industry is influenced by a number of factors, including manufacturing capacity, general economic conditions and the availability and demand for paperboard substitutes. Our Pulp and Paperboard business competes with International Paper, MeadWestvaco, Georgia-Pacific, Rock-Tenn and international producers, most of whom are much larger than us. Any increase in manufacturing capacity by any of these producers could result in overcapacity in the pulp and paperboard industry, which could cause downward pressure on pricing. In addition, customers could choose to use types of paperboard that we do not produce or could rely on alternative materials, such as plastic, for their products. An increased supply of any of these products could cause us to lower our prices or lose sales to competitors, either of which could have a material adverse effect on our business, financial condition and results of operations.

Increases in our freight costs could have a material adverse effect on the gross margins of our business.

Our business, primarily our Consumer Products business, is substantially dependent on freight services to transport our products to our customers and deliver raw materials to us. In 2008, freight costs for our business were 12% of our total production costs. The costs of these freight services were affected by increasing fuel prices. During 2008, we incurred increased fuel surcharges, which were over and above the standard price quoted for these services. We have not been in the past and may not in the future be able to pass along part or all of these fuel surcharges to our customers. If we are unable to increase our prices to respond to increased fuel costs charged to us by our transportation providers, our gross margins may be materially adversely affected.

We depend on third parties for certain transportation services and any disruption in these services may have a material adverse effect on our business.

We rely primarily on third parties for transportation of our raw materials to us and transportation of our products to our customers. If any of our transportation providers fail to deliver raw materials to us in a timely manner, we may be unable to manufacture our products on a timely basis. Shipments of products and raw materials may be delayed due to weather conditions, strikes or other events. Any failure of a third-party transportation provider to deliver raw materials or products in a timely manner could harm our reputation, negatively impact our customer relationships and have a material adverse effect on our business, financial condition and results of operations.

We are subject to significant environmental regulation and environmental compliance expenditures, which could increase our costs and subject us to liabilities.

We are subject to a wide range of general and industry-specific environmental laws and regulations, particularly with respect to air emissions, wastewater discharges, solid and hazardous waste management and chemicals contained in our products. Compliance with these laws and regulations is a significant factor in our business. We expect to continue to incur capital and operating expenditures to maintain compliance with applicable environmental laws and regulations. Capital expenditures specifically designated for environmental compliance totaled approximately $0.6 million and $2.0 million in 2008 and 2007, respectively.

Our failure to comply with applicable environmental laws and regulations and permit requirements could result in civil or criminal fines or penalties or enforcement actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of pollution control equipment, remedial actions or product recalls or labeling. We may be liable under environmental laws for cleanup and other costs and damages, including tort liability, resulting from past or present spills or releases of hazardous or toxic substances on or from our mills. Liability under these laws may be imposed without regard to whether we knew of, or were responsible for, the presence of such substances on our property, and, in some cases, may not be limited to the value of the property.

We believe that our facilities and operations are currently in substantial compliance with applicable environmental laws and regulations. We cannot be certain, however, that situations that may give rise to material environmental liabilities will not be discovered or that the enactment of new environmental laws or regulations or changes in existing laws or regulations will not require significant expenditures by us. There

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can be no assurance that internally generated funds or other sources of liquidity and capital will be sufficient to fund unforeseen environmental liabilities or expenditures.

Our business and financial performance may be harmed by future labor disruptions.

As of December 31, 2008, approximately 65% of our workforce was unionized. As a result, there is a risk of work stoppage due to strikes or walkouts. Any significant work stoppage as a result of failure to successfully negotiate new collective bargaining agreements could have a material adverse effect on our business, financial condition and results of operations. During 2009, one collective bargaining agreement covering approximately 225 employees will expire.

We regularly incur significant expenses to maintain our manufacturing equipment and any interruption in the operations of our facilities may affect our operating performance.

We regularly incur significant expenses to maintain our manufacturing equipment. The machines and equipment that we use to produce our products are complex, have many parts and some are run on a continuous basis. We must perform routine maintenance on our equipment and have to periodically replace a variety of parts such as motors, pumps, pipes and electrical parts. In 2008, equipment maintenance and repair expenses, including labor, were $62.0 million in our Pulp and Paperboard segment, $21.3 million in our Consumer Products segment and $4.8 million in our Wood Products segment. If our business does not generate sufficient cash flows from operations to fund our ongoing maintenance requirements, our business, financial condition and results of operations could be materially harmed.

In addition, our pulp and paperboard mills require periodic shutdowns to perform major maintenance. We generally schedule shutdowns of our Idaho pulp and paperboard mill for up to a week each year. Scheduled shutdowns of our Arkansas pulp and paperboard mill occur approximately every 18 months and typically last up to a week. These scheduled shutdowns of our pulp and paperboard mills result in decreased sales and increased costs in the periods in which the shutdown occurs.

Unexpected production disruptions could also cause us to shut down any of our mills. Those disruptions could occur due to any number of circumstances, including shortages of raw materials, disruptions in the availability of transportation, labor disputes and mechanical or process failures. In addition, the geographic areas where our production is located and where we conduct our business may be affected by natural disasters, including snow and ice storms, forest fires and flooding. Any mill shutdowns may be followed by prolonged startup periods, regardless of the reason for the shutdown. Those startup periods could range from several days to several weeks, depending on the reason for the shutdown and other factors. Furthermore, during periods of weak demand for our products, we have in the past and may in the future experience market-related downtime. The shutdown of any of our mills for a substantial period of time for any reason could harm our results of operations.

Our obligations under the retained obligation agreement could have a negative impact on our financing options and liquidity position.

In connection with the spin-off, we retained the obligation to pay the interest and principal associated with $100 million principal amount of debentures previously issued by an affiliate of Potlatch that becomes due and payable in full in December 2009. In addition, we immediately drew $50 million from our $125 million revolving credit facility and transferred such amount to a subsidiary of Potlatch. As a result, we had $150 million principal amount of debt outstanding at December 31, 2008.

The interest rate that we are required to pay on the debentures, currently 12.5%, is based on Potlatch’s credit ratings applicable to the debentures. If Potlatch’s credit ratings decline, we will be required to pay interest on the debentures at an interest rate as high as 14.0%. We have no control over whether the interest rate on the debentures will increase.

We are required to use commercially reasonable efforts to issue, as soon as reasonably practical, debt or equity securities, or to borrow money from one or more financial institutions or other lenders, on terms reasonably acceptable to us, in an aggregate amount sufficient to pay all amounts owing under the debentures. We may not be able to obtain such financing on commercially reasonable terms or at all, in which case we will be required to use cash from our operations to pay the obligations or incur indebtedness

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to Potlatch that will bear an increased interest rate and be secured by certain of our assets. In addition, we will have to apply the proceeds from future debt or equity issuance, or asset sales in excess of $50 million to satisfy our obligations under the retained obligation agreement. Our obligation to pay the amounts due on the debentures or any indebtedness to Potlatch arising by virtue of our inability to make payments due on the debentures may:

In the event we are unable to timely pay the debenture obligations in full, and Potlatch thereafter makes payment of principal or interest due under the debentures, we will be deemed to have a loan payable to Potlatch in the amount paid by Potlatch, and we will be obligated to issue a promissory note to Potlatch equal to such amount. All amounts owing under any promissory note issued by us to Potlatch will be due and payable on December 1, 2011. Any such promissory note will initially accrue interest at a rate per annum equal to the rate of interest applicable to the debentures at the time the note is issued, plus one percent, and after December 1, 2010 until paid in full, the rate of interest applicable to the debentures at the time the note is issued, plus two percent. As discussed above, the rate currently applicable to the debentures is 12.5% per annum. In the event we issue a promissory note to Potlatch, we will be obligated to use commercially reasonable efforts prior to the maturity date to issue, as soon as reasonably practical, debt or equity securities or to borrow money (other than under our revolving credit facility), on terms reasonably acceptable to us, in an aggregate amount sufficient to prepay all amounts owing under the promissory note. As security for any such promissory note issued by us to Potlatch, we will grant Potlatch a security interest in our real property, fixtures and equipment at our Arkansas pulp and paperboard facility.

Our business may suffer if we are unable to effectively respond to changes in demand for some of our products or implement our strategies.

We have in the past and may in the future experience changes in demand for our products. Our ability to compete successfully depends on our ability to adjust to increases and decreases in demand. For example, our Consumer Products business is experiencing a high demand for napkins and we are outsourcing part of our napkin production to a third party, which increases our costs. If we are unable to implement our business strategies to respond to changes in demand, we may need to limit deliveries of some orders for existing customers, which could harm our reputation and our long-term relationships with these customers. Alternatively, if we experience a decrease in demand for certain products, we may incur significant costs in revising our manufacturing plan and restructuring our manufacturing equipment. If we are not able to respond to changes in demand for our products in a timely manner, our financial position and results of operations may be adversely affected.

In addition, our success depends in part upon our ability to implement our strategies, including the possibility of opening a tissue facility or facilities on the East Coast. The costs associated with establishing a facility or facilities on the East Coast would be significant. Should we choose to pursue this option, there is no assurance that the new facilities would successfully achieve our goal of expanding our customer base to include East Coast retailers or that the new facilities would generate a positive internal rate of return. Furthermore, the costs associated with establishing the facilities could negatively impact our cash flows and

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earnings in the short-term. Finally, adding new facilities on the East Coast could increase our exposure to other risks, including labor disputes, environmental risks and interruptions in the operations of our facilities to the extent that the new facilities would be subject to such risks.

We have significant indebtedness and federal and state deferred tax liabilities, which will require a significant amount of cash to service and pay. If we are unable to generate sufficient cash to pay our obligations or fund our liquidity needs, our business may be materially adversely affected.

Our indebtedness was approximately $150 million at December 31, 2008. Our ability to make payments on, to refinance our indebtedness and to fund capital expenditures, acquisitions and development efforts, will depend on our ability to generate cash. A number of factors that affect our ability to generate cash are beyond our control, including economic, financial, competitive and other factors.

As of December 31, 2008, we had a deferred tax liability of approximately $101.8 million with respect to the difference between the book and tax basis of our fixed assets. It is anticipated that this liability will become a current tax liability beginning in 2009 at the rate of approximately $8 million per year. In addition, we have other less significant deferred tax balances relating to temporary differences that will impact current taxes payable in future periods.

We cannot be certain that our business will generate sufficient cash flows from operations or that future borrowings will be available to us under our revolving credit facility in amounts sufficient to enable us to service our indebtedness, including our obligations to pay certain Potlatch affiliate indebtedness, our additional tax liabilities or other liquidity needs. If our future cash flows from operating activities and other capital resources are insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to reduce or delay business activities, sell assets, obtain additional debt or equity capital, restructure or refinance all or a portion of our debt. We cannot be certain that we will be able to implement any of these alternatives on a timely basis or on satisfactory terms, if at all. In addition, the terms of future debt financings could involve restrictive covenants that limit our ability to pursue these alternatives.

Risks Relating to the Spin-off

Our financial information may not be fully representative of our results as a stand-alone public company.

We were not operated, and Potlatch did not account for us, as a stand-alone public company for the periods presented in our financial statements included in this report prior to December 16, 2008. Our financial statements have been carved out from Potlatch’s consolidated financial statements and reflect assumptions and allocations made by Potlatch and prescribed by generally accepted accounting principles. Our financial statements do not fully represent what our financial position, results of operations and cash flow would have been had we operated as a stand-alone public company during the periods presented. We have not made adjustments to reflect the many significant changes that will occur in our capital structure, cost structure, funding and operations as a result of our separation from Potlatch, including the debt and interest expense we will have associated with our revolving credit facility, increased costs associated with reduced economies of scale and other costs associated with being a stand-alone public company. Further, we expect to incur approximately $10 million of costs and expenses associated with being an independent public company in 2009 in addition to those costs reflected in our financial statements for 2008. As a result, the historical information included in this report is not necessarily indicative of what our financial position, results of operations and cash flow may be subsequent to the spin-off. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto included elsewhere in this report.

We have only a limited operating history as an independent, public company.

We have only a limited experience operating as an independent, public company and our management has little experience, as a group, in operating our business as a stand-alone entity. We are now fully responsible for arranging our own funding, managing all of our own administrative and employee arrangements and supervising all of our legal and financial affairs, including publicly reported financial statements. We adopted separate stock-based and performance-based incentive plans for our employees and are developing our

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own compliance and administrative procedures necessary for a publicly held company. Our success in these endeavors will depend substantially upon the ability of our senior management and other key employees to work together. In addition, our Chief Executive Officer and Chief Financial Officer are relatively new to our businesses and therefore do not have a history of operating our businesses. Accordingly, we cannot be certain that as an independent company our aggregate results of operations will continue at the same level. The loss of services of members of our senior management team could adversely affect our business until suitable replacements can be found. There may be a limited number of persons with the requisite skills to serve in these positions and we may be unable to locate or employ qualified personnel on acceptable terms. In addition, our future success requires us to continue to attract and retain competent personnel.

The requirements of being a stand-alone public company will increase certain of our costs and require significant management focus.

As a stand-alone public company, we will incur significant legal, accounting and other expenses associated with compliance-related and other activities. The Sarbanes-Oxley Act of 2002, related SEC rules and the New York Stock Exchange, or NYSE, regulate corporate governance practices of public companies. We have had no experience as, and our senior management has limited experience managing, a public company, and our separation from Potlatch resulted in loss of access to Potlatch’s resources and experience in this area. Compliance with these requirements will also result in other costs and obligations and make some activities more time-consuming. In addition, we will incur additional expenses associated with our SEC reporting requirements and other securities law compliance measures. Under Section 404 of the Sarbanes-Oxley Act, for purposes of subsequent reports, we will have to document and test our internal control procedures and our management will have to assess and report on our internal control over financial reporting. Going forward, if we identify any issues in complying with those requirements, we could incur additional costs rectifying those issues, and the existence of those issues could adversely affect us, our reputation or investor perceptions. Our prospects must be considered in light of the risks, difficulties and expenses encountered by newly public companies. Costs of director and officer liability insurance will contribute to our increased costs. As a result of the associated liability, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. Advocacy efforts by stockholders and third parties may also prompt even more changes in governance and reporting requirements.

The terms of agreements that we entered into with Potlatch in connection with the spin-off were established at a time when we were a wholly owned subsidiary of Potlatch and, accordingly, the terms of these agreements may not be as favorable to us as they might have been had they been negotiated by persons fully independent of Potlatch.

In connection with the spin-off, we entered into various agreements with Potlatch regarding our relationship with Potlatch following the spin-off, including a separation and distribution agreement, retained obligation agreement, transition services agreement, employee matters agreement, tax sharing agreement, lease and option agreement and supply agreements. These agreements address important matters, such as allocation of assets, liabilities, rights, indemnifications and other obligations between Potlatch and us. The terms of these agreements were negotiated while we were a wholly owned subsidiary of Potlatch, although these agreements are intended to reflect arms-length terms and the pricing provisions of our supply agreements are based on market pricing. These agreements may not be as favorable to us as they might have been had they been negotiated by persons with no relationship to Potlatch.

The transition services Potlatch is providing to us may not be sufficient to meet our needs, and we may have difficulty finding replacement services or be required to pay increased costs to replace these services after our agreements with Potlatch expire.

For a limited period of time following the spin-off, Potlatch has agreed to provide certain transition services to us, including employee benefits administration, information systems, accounting and other services.

After the expiration of the transition services agreement, we may not be able to replace the transition services or enter into appropriate third-party agreements on terms and conditions, including cost,

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comparable to those we are receiving from Potlatch under this agreement. While transition services are being provided by Potlatch to us, our operational flexibility to modify or implement changes with respect to the services covered may be limited.

Potlatch historically provided us, directly or through its own vendor relationships, with insurance coverage, banking services, health and other insurance benefits for our employees and employee benefit plans, as well as with its expertise in certain areas of our operations. We are now responsible for securing all of our own management, financing, legal and other similar resources.

Although we are in the process of replacing portions of the transition services currently provided by Potlatch, we may encounter difficulties replacing such services quickly or be unable to negotiate pricing or other terms as favorable as those we currently have in effect.

If the spin-off is determined to be taxable for U.S. federal income tax purposes, we, our stockholders, and Potlatch could incur significant U.S. federal income tax liabilities.

Potlatch has received a private letter ruling from the Internal Revenue Service, or IRS, that the spin-off qualifies for tax-free treatment under applicable sections of the Internal Revenue Code. In addition, Potlatch has received an opinion from tax counsel that the spin-off so qualifies. The IRS ruling and the opinion rely on certain representations, assumptions and undertakings, including those relating to the past and future conduct of our business, and neither the IRS ruling nor the opinion would be valid if such representations, assumptions and undertakings were incorrect. Moreover, the IRS private letter ruling does not address all the issues that are relevant to determining whether the spin-off qualifies for tax-free treatment. Notwithstanding the IRS private letter ruling and opinion, the IRS could determine that the spin-off should be treated as a taxable transaction if it determines that any of the representations, assumptions or undertakings that were included in the request for the private letter ruling are false or have been violated or if it disagrees with the conclusions in the opinion that are not covered by the IRS ruling.

If the spin-off fails to qualify for tax-free treatment, Potlatch would be subject to tax as if it had sold our common stock in a taxable sale for its fair market value, and our initial public stockholders would be subject to tax as if they had received a taxable distribution equal to the fair market value of our common stock that was distributed to them. Under the tax sharing agreement between Potlatch and us, we would generally be required to indemnify Potlatch against any tax resulting from the spin-off (including any tax that would result if Potlatch were to fail to qualify as a real estate investment trust, as a result of income recognized by Potlatch if the spin-off were determined to be taxable) to the extent that such tax resulted from (1) an issuance of our equity securities, a redemption of our equity securities or our involvement in other acquisitions of our equity securities, (2) other actions or failures to act by us, or (3) any of our representations or undertakings being incorrect or violated. Our indemnification obligations to Potlatch and its subsidiaries, officers and directors are not limited by any maximum amount. If we are required to indemnify Potlatch or such other persons under the circumstances set forth in the tax sharing agreement, we may be subject to substantial liabilities.

We must abide by certain restrictions to preserve the tax-free treatment of the spin-off and may not be able to engage in desirable acquisitions and other strategic transactions following the spin-off.

To preserve the tax-free treatment of the spin-off to Potlatch and our stockholders, under the tax sharing agreement that we entered into with Potlatch, for the two-year period following the distribution, we may be prohibited, except with the consent of Potlatch, from:

These restrictions may limit our ability to pursue strategic transactions or engage in new business or other transactions that may maximize the value of our business.

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Risks Related to Ownership of Our Common Stock

The market price of our shares may fluctuate significantly.

The market price at which our common stock trades may fluctuate significantly, depending on many factors, some of which may be beyond our control, including:

In addition, the stock market regularly experiences significant price and volume fluctuations. This volatility has had a significant impact on the market price of securities issued by many companies, including us and other companies in our industry. The changes frequently appear to occur without regard to the operating performance of the affected companies. Hence, the price of our common stock may fluctuate based upon factors that have little or nothing to do with us, and these fluctuations could materially reduce our share price.

Certain provisions of our certificate of incorporation and bylaws, Delaware law and our stockholder rights plan may make it difficult for stockholders to change the composition of our board of directors and may discourage hostile takeover attempts that some of our stockholders may consider to be beneficial.

Certain provisions of our certificate of incorporation and bylaws, Delaware law and our stockholder rights plan may have the effect of delaying or preventing changes in control if our board of directors determines that such changes in control are not in the best interests of us and our stockholders. The provisions in our certificate of incorporation and bylaws include, among other things, the following:

In addition, our stockholder rights plan would cause substantial dilution to any person or group who attempts to acquire a significant interest in us without advance approval from our board of directors.

While these provisions and our stockholder rights plan have the effect of encouraging persons seeking to acquire control of our company to negotiate with our board of directors, they could enable the board of directors to hinder or frustrate a transaction that some, or a majority, of the stockholders might believe to be

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in their best interests and, in that case, may prevent or discourage attempts to remove and replace incumbent directors. We are also subject to Delaware laws that could have similar effects. One of these laws prohibits us from engaging in a business combination with a significant stockholder unless specific conditions are met.

Not applicable.

FACILITIES

Idaho. Our Consumer Products, Pulp and Paperboard and Wood Products segments share an 880 acre site in Lewiston, Idaho owned by us.

Our Consumer Products segment operates three dedicated conventional tissue machines at the site. These machines operate 24 hours a day, 7 days a week. The facility has 475,000 square feet of warehouse space for finished goods, raw materials and parent rolls.

Our Pulp and Paperboard segment built a mill at the Idaho site in 1950, which underwent pulp and utilities rebuilds throughout the 1980s and early 1990s. Excess pulp produced at this mill is either transferred to our Consumer Products facility in the form of slush pulp for use in the production of tissue products or is dried and sold as baled pulp on the open market.

Our Wood Products segment built its Lewiston, Idaho lumber mill in 1927, which has undergone a series of rebuilds and other capital investment improvements in recent years.

Arkansas. Our Pulp and Paperboard segment constructed its mill in Arkansas in 1977, making it the newest SBS mill in North America.

Nevada. Our Consumer Products segment established its Las Vegas, Nevada, facility to service the Southwestern United States. The first phase of the Nevada facility was completed in 1994. The initial construction included the current converting facility and 100,000 square feet of finished goods storage. In 2004, the TAD paper machine began operation in Nevada. The Nevada facility is a 24 hours a day, 7 days a week operation. The Nevada operation also has two warehouses with over 500,000 square feet of space for finished goods, raw materials and parent rolls. One of the warehouses is leased and provides rail access to the operation.

Illinois. Our Consumer Products’ facility in Elwood, Illinois is leased. From this site we manufacture and distribute tissue products primarily for customers in the Midwestern and Eastern United States. The Illinois facility is a 24 hours a day, 7 days a week operation. This facility also has a leased warehouse with 400,000 square feet of space for finished goods, raw materials and parent rolls.

Texas and California. Our Consumer Products segment operates two other distribution centers, one in Fort Worth, Texas and one in Tracy, California.

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Our principal manufacturing facilities at December 31, 2008, together with their respective 2008 annual capacities and production, are as follows:

We believe there is no pending or threatened litigation that would have a material adverse effect on our financial position, operations or liquidity.

Prior to and in connection with our spin-off, our sole stockholder, Potlatch Corporation, took the following actions by written consent dated December 1, 2008:

Copies of the restated certificate of incorporation, the Clearwater Paper Corporation 2008 Stock Incentive Plan, the Clearwater Paper Corporation Annual Incentive Plan and the form of indemnification agreement are filed as exhibits to this report.

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EXECUTIVE OFFICERS OF THE REGISTRANT

Information as of March 1, 2009, and for at least the past five years concerning the executive officers of the company is as follows:

Gordon L. Jones (age 59) has served as President and Chief Executive Officer, and a director of the company since December 2008. From July 2008 to December 2008, Mr. Jones served as a Vice President of Potlatch Corporation, pending completion of the spin-off of Clearwater Paper Corporation. From January 2001 to June 2008, Mr. Jones served as the President and Managing Member of Jones Investment Group LLC, an investment company. Prior to that, Mr. Jones served from May 1999 to November 2000 as President, Chief Executive Officer, and Director for Blue Ridge Paper Products, Inc.

Linda K. Massman (age 42) has served as Vice President, Finance and Chief Financial Officer since December 2008. From September 2008 to December 2008, Ms. Massman served as a Vice President of Potlatch Corporation, pending completion of the spin-off of Clearwater Paper Corporation. From May 2002 to August 2008, Ms. Massman served as the Group Vice President, Finance and Corporate Planning for SUPERVALU Inc., a grocery retail company. Prior to that, Ms. Massman served from 1999 to 2001 as Vice President, Business Planning and Operations for Viquity Corporation, an enterprise software company.

Thomas H. Carter (age 60) has served as Vice President of Human Resources since December 2008. From August 2008 to December 2008, Mr. Carter served as a Vice President of Potlatch Corporation, pending completion of the spin-off of Clearwater Paper Corporation. From February 2005 to August 2008, Mr. Carter was retired. From February 2003 to February 2005, Mr. Carter served as Vice President, Human Resources of Sara Lee Coffee & Tea, North America, a division of Sara Lee Corporation. Prior to that, Mr. Carter served from 2002 to 2003 as Senior Director, Employee Relations for Sara Lee Bakery Group, a division of Sara Lee Corporation. From 1999 to 2001, Mr. Carter served as Vice President, Human Resources and Corporate Secretary for Blue Ridge Paper Products, Inc.

Robert P. DeVleming (age 56) has served as Vice President of Consumer Products since December 2008. Prior to December 2008, he was employed by Potlatch Corporation for 30 years. Mr. DeVleming served as Vice President, Consumer Products for Potlatch from October 2004 to December 2008. From May 2003 through October 2004, he was Vice President, Sales, Consumer Products for Potlatch Corporation.

Michael S. Gadd (age 44) has served as Vice President, General Counsel and Corporate Secretary since December 2008. From March 2006 to December 2008, Mr. Gadd served as Associate General Counsel of Potlatch Corporation, and served as Corporate Secretary of Potlatch from July 2007 to December 2008. From 2001 to January 2006, Mr. Gadd was an attorney with Perkins Coie, LLP in Portland, Oregon.

Harry D. Seamans (age 55) has served as Vice President of Pulp and Paperboard since December 2008. Prior to December 2008, he was employed by Potlatch Corporation for 31 years. Mr. Seamans served as Vice President, Pulp and Paperboard of Potlatch from January 2003 to December 2008.

NOTE: The term of office of the officers of the company expires at the annual meeting of our board, and each officer holds office until the officer’s successor is duly elected and qualified or until the earlier of the officer’s death, resignation, retirement, removal by the board or as otherwise provided in our bylaws.

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PART II

Our common stock is traded on the New York Stock Exchange. The record date for our spin-off was the close of business on December 9, 2008, and our spin-off was completed on December 16, 2008. A limited market, commonly known as a “when-issued” trading market, began shortly before the record date for the spin-off, and “regular way” trading of our common stock began on the first trading day after the spin-off. The high and low sales prices for our common stock for the period from December 5, 2008 to December 31, 2008, as reported in the New York Stock Exchange Composite Transactions, were as follows:

There were approximately 1,275 stockholders of record at March 5, 2009.

We have not paid any dividends since the spin-off, although we may pay cash dividends on our common stock in the future. The declaration and amount of any dividends, however, will be determined by our board of directors and will depend on our earnings, our compliance with the terms of our revolving credit facility that limit our ability to pay dividends, and any other factors that our board of directors believes are relevant. Reference is made to the discussion in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II of this report, under the heading “Liquidity and Capital Resources” of the covenants in our secured bank credit facility with which we must remain in compliance in order to pay dividends.

There are currently no authorized repurchase programs in effect under which we may repurchase shares of our outstanding stock.

The table containing equity compensation plan information set forth in Item  12 of Part III of this report is incorporated herein by reference.

Items 6, 7, 7A and 8

The information called for by Items 6, 7, 7A and 8, inclusive, of Part II of this form is contained in the following sections of this report at the pages indicated below:

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None.

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, or the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Subject to the limitations noted above, our management, with the participation of our CEO and CFO, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal year covered by this annual report on Form 10-K. Based on that evaluation, the CEO and CFO have concluded that, as of such date, our disclosure controls and procedures are effective to meet the objective for which they were designed and operate at the reasonable assurance level.

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

This annual report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting due to a transition period established by rules of the Securities and Exchange Commission for newly public companies.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There were no changes in our internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Historically, we have relied on certain financial, administrative and other resources of Potlatch Corporation to operate our business, including portions of human resources, information systems, accounting, tax and corporate services. In conjunction with the spin-off of our businesses from Potlatch, in 2009 we are enhancing our own financial, administrative and other support systems or contracting with third parties to replace Potlatch’s systems. We are also establishing our own accounting and auditing policies and systems on a stand-alone basis. We have entered into a transition services agreement with Potlatch under which Potlatch will provide some of these services to us on a transitional basis.

None.

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PART III

Information regarding our directors is set forth under the heading “Board of Directors” in our definitive proxy statement, to be filed on or about April 7, 2009, for the 2009 annual meeting of stockholders, referred to in this report as the 2009 Proxy Statement, which information is incorporated herein by reference. Information concerning Executive Officers is included in Part I of this report following Item 4. Information regarding reporting compliance with Section 16(a) for directors, officers or other parties is set forth under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2009 Proxy Statement and is incorporated herein by reference.

We have adopted a Code of Business Conduct and Ethics that applies to all directors and employees. You can find it on our website by going to the following address: www.clearwaterpaper.com, selecting “Investor Relations” and “Corporate Governance,” then selecting the link for “Code of Business Conduct and Ethics.” We will post any amendments, as well as any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange, on our website. To date, no waivers of the Code of Business Conduct and Ethics have been considered or granted.

Our board of directors has adopted corporate governance guidelines and charters for the board of directors’ Audit Committee, Compensation Committee, and Nominating and Governance Committee. You can find these documents on our website by going to the following address: www.clearwaterpaper.com, selecting “Investor Relations” and “Corporate Governance,” then selecting the appropriate link.

You can also obtain a printed copy of any of the materials referred to above by contacting us at the following address:

Clearwater Paper Corporation

Attention: Corporate Secretary

601 W. Riverside Avenue, Suite 1100

Spokane, Washington 99201

Telephone: (509) 344-5921

The Audit Committee of our board of directors is an “audit committee” for purposes of Section 3(a)(58) of the Exchange Act. As of December 31, 2008, the members of that committee were Boh A. Dickey (Chair), William D. Larsson and William T. Weyerhaeuser. The board of directors has determined that Mr. Dickey is an “audit committee financial expert” and that he and all of our Audit Committee members are “independent” as defined under the applicable rules and regulations of the SEC and the listing standards of the New York Stock Exchange.

Information set forth under the heading “Compensation Discussion and Analysis” in the 2009 Proxy Statement is incorporated herein by reference.

Information regarding any person or group known by us to be the beneficial owner of more than five percent of our common stock as well as the security ownership of management set forth under the heading “Stock Ownership” in the 2009 Proxy Statement is incorporated herein by reference.

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The following table provides certain information as of December 31, 2008, with respect to our equity compensation plans:

Information set forth under the heading “Transactions with Related Persons” in the 2009 Proxy Statement is incorporated herein by reference. The information required by this item regarding director independence is included under the heading, “Board of Directors,” in the 2009 Proxy Statement and is incorporated herein by reference.

Information set forth under the heading “Fees Paid to Independent Registered Public Accounting Firm” in the 2009 Proxy Statement is incorporated herein by reference.

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PART IV

FINANCIAL STATEMENTS

Our financial statements are listed in the Index to Financial Statements and Schedules on page 27 of this report.

FINANCIAL STATEMENT SCHEDULES

Our financial statement schedules are listed in the Index to Financial Statements and Schedules on page 27 of this report.

EXHIBITS

Exhibits are listed in the Exhibit Index on pages 74-75 of this report.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 17, 2009

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 17, 2009, by the following persons on behalf of the registrant in the capacities indicated.

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Index to Financial Statements and Schedules

The following documents are filed as part of this report:

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Selected Financial Data

Prior to our spin-off from Potlatch Corporation on December 16, 2008, we were a wholly owned subsidiary of Potlatch Corporation. On December 16, 2008, Potlatch distributed 100% of the issued and outstanding shares of our common stock to the holders of record of Potlatch common stock as of the close of business on December 9, 2008. Each Potlatch stockholder received one share of our common stock for every 3.5 shares of Potlatch common stock held on the record date.

Except for the period from December 16, 2008, through December 31, 2008, when we operated as and were accounted for as a separate public company, our results of operations and financial condition reflected in the table below cover periods prior to the spin-off and related transactions. The historical financial and other data were prepared on a combined basis from Potlatch’s consolidated financial statements using the historical results of operations and bases of the assets and liabilities of Potlatch’s Consumer Products and Pulp and Paperboard business and its Wood Products operations at Lewiston, Idaho, and give effect to allocations of expenses from Potlatch. Our historical financial and other data is not necessarily indicative of our future performance nor do they necessarily reflect what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the periods shown. The statement of operations data for each of the years ended December 31, 2005 and 2004, and the statement of financial position data as of December 31, 2006, 2005 and 2004 are unaudited.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Clearwater Paper Corporation is principally engaged in the manufacturing and selling of pulp-based products. We are a leading producer of private label tissue products sold in grocery stores in the United States and we manufacture and market bleached paperboard for the high-end segment of the packaging industry. We also manufacture and market bleached pulp and wood products, including appearance grade cedar products and dimensional framing lumber.

As of December 31, 2008, our business was organized into three reporting segments:

FACTORS INFLUENCING OUR RESULTS OF OPERATIONS AND CASH FLOWS

Our operating results have been and will continue to be influenced by a variety of factors, including the cyclical nature of the pulp and paperboard industry, competition, the efficiency and level of capacity utilization of our manufacturing operations, changes in our principal expenses such as for wood fiber and energy, and other factors.

Net Sales

Our businesses, and in particular our Pulp and Paperboard business, experience cyclical market conditions and, as a result, historical prices for our products and sales volumes have been volatile. Product pricing is significantly affected by the relationship between supply and demand for our products. Product supply in the industries in which we operate is influenced primarily by fluctuations in available manufacturing capacity. Capacity in these industries tends to increase during periods when prices remain strong. In addition, currency exchange rates affect U.S. supplies of paperboard, as non-U.S. manufacturers are attracted to the U.S. market when the dollar is relatively strong. Our paperboard business, through exports, has benefited significantly from weakness in the U.S. dollar over the past few years.

Demand for our products is related to the state of the North American economy in general, as well as, in the case of our paperboard products, the economies of East Asia. The demand for our wood products is affected by the level of new residential construction activity and, to a lesser extent, home repair and remodeling activity, which are subject to fluctuations due to changes in economic conditions, interest rates, population growth and other factors.

The markets for our products are highly competitive and companies that have substantially greater financial resources than we do compete with us in each of our markets. In addition, our industry is capital intensive, which leads to high fixed costs and generally results in continued production as long as prices are sufficient

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to cover variable costs. These conditions have contributed to substantial price competition, particularly during periods of reduced demand. Some of our competitors are lower-cost producers in some of the businesses in which we operate, and, as a result, these competitors may be less adversely affected than we are by price decreases.

Operating Expenses

Other than labor, our principal operating expense items are wood fiber, energy, chemicals and transportation. Prices for these items are volatile and directly affect our results of operations. Competitive market conditions can limit our ability to pass cost increases through to our customers.

Wood fiber. Our most significant operating expense is the cost of wood fiber needed to supply our manufacturing facilities. Both wood chips and sawdust are used in the process of making pulp. We rely on residual wood fibers, such as wood chips and sawdust generated by lumber mill operations and wood chips specifically produced for us by contract wood chipping operations. Prices for this wood fiber can fluctuate greatly. Our average cost per ton of wood chips and sawdust was approximately $203 per ton in 2008, an increase of 25% over the approximately $163 per ton in 2007, which was an increase of 20% over the approximately $136 per ton in 2006. The current high price of wood fiber is largely the result of limited supplies due to the slowdown or shutdown of operations of many lumber mills as a result of the U.S. economic and home construction market downturn. In 2008, we acquired a significant portion of our wood fiber requirements from Potlatch, with the remainder purchased from third parties pursuant to short-term contracts and in the spot market. In connection with the spin-off, we entered into fiber supply agreements with Potlatch for our Idaho pulp facility, which will likely cover volumes of wood fiber similar to what we acquired from Potlatch in 2008. These agreements will employ a substantially similar market pricing methodology as reflected in our historical financial statements.

Energy. Energy is another significant manufacturing expense. We use energy in the form of electricity, steam and natural gas. Our expenses for energy used in our manufacturing processes were $113.7 million in 2008, an increase of 27% over the $89.8 million in 2007, which in turn was 5% higher than the $85.8 million we spent in 2006. Energy prices have fluctuated widely over the past decade and during 2008 we have experienced a period of high energy prices. We have taken steps to reduce our exposure to volatile energy prices through conservation and by increasing our internal electrical production at our cogeneration facility that produces steam and electricity in Idaho. In addition, to help mitigate our exposure to changes in natural gas prices, we use firm-price contracts to supply a portion of our natural gas requirements. As of December 31, 2008, these contracts covered approximately 39% of our expected average monthly natural gas requirements for the Pulp and Paperboard and Consumer Products segments for 2009, plus lesser amounts for 2010. Our energy costs in future periods will depend principally on our ability to produce a substantial portion of our electricity needs internally, on changes in market prices for natural gas and on reducing energy usage.

Petroleum. Petroleum prices also impact our operating results. High fuel prices result in increased freight costs related to delivery of raw materials to our manufacturing facilities and for the delivery of our finished products to customers. Increasing fuel prices particularly affect our Consumer Products margins because we supply customers throughout the United States from our tissue mills in Idaho and Nevada, and we transport bulk, unconverted jumbo tissue rolls, or parent rolls, from our tissue mills to our Illinois tissue converting facility. Freight costs for our Consumer Products segment were $73.3 million in 2008, compared to $63.0 million in 2007. Our total freight costs were $142.0 million and $124.7 million for 2008 and 2007, respectively. In addition, many of the chemicals used in our manufacturing processes, particularly in the pulp-making process, are petroleum-based or are indirectly impacted by petroleum prices.

Maintenance and repairs. We regularly incur significant expenses to maintain our manufacturing equipment. The machines and equipment that we use to produce our products are complex, have many parts and some are run on a continuous basis. We perform routine maintenance on our machines and periodically replace a variety of parts such as motors, pumps, pipes and electrical parts. In 2008, equipment maintenance and repair expenses, including labor, were $62.0 million in our Pulp and Paperboard segment, $21.3 million in our Consumer Products segment and $4.8 million in our Wood Products segment. Major equipment maintenance and repair in our Pulp and Paperboard segment also requires maintenance shutdowns generally lasting up to one week per year at our Idaho facility and up to one week every

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approximately 18 months at our Arkansas facility, which reduce net sales and increase costs in the quarters in which the maintenance shutdowns occur. Periodically, major equipment shutdowns extend beyond one week in duration for large scale maintenance, such as extensive boiler repairs. In addition, we make capital expenditures to increase our operating efficiency and to comply with environmental laws. Our estimated capital expenditures for 2009 are expected to be between $15 million and $20 million.

Corporate Allocations

Historically, we shared corporate functions with Potlatch for a variety of services, including treasury, accounting, tax, legal, internal audit, human resources, information systems and public and investor relations. Upon completion of the spin-off, we became a stand-alone company and our expenses include payment for services to be provided by Potlatch under a transition services agreement. These services include employee benefits administration, information systems, accounting and other services for a period of up to eighteen months following the spin-off. Charges for these services have been set based on actual cost and will be partially offset by charges for certain accounts payable, purchasing, human resources, transportation, treasury, accounting, payroll and information systems related services we provide to Potlatch under the transition services agreement. During the period of the transition services agreement, we will be in the process of setting up stand-alone functions and may incur some duplicative expenses in this process.

Our historical financial statements, prior to December 16, 2008, contain allocations of direct and indirect corporate overhead expenses, including costs for services of the type covered by the transition services agreement, as well as allocations for administrative and selling expenses based on the relative revenues of our wood products operations in relation to Potlatch’s Wood Products segment. We were allocated corporate overhead and wood products administrative and selling expenses of $9.8 million in 2008 (through December 15), $9.7 million in 2007 and $10.0 million in 2006. We believe that the methodology applied to the allocation of these expenses was reasonable. However, we expect to incur approximately $10 million in additional costs in 2009 associated with being an independent, publicly traded company.

CRITICAL ACCOUNTING POLICIES

Our accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which require management to make estimates that affect the amounts of net sales, expenses, assets and liabilities reported. The following are critical accounting matters which are both very important to the portrayal of our financial condition and results of operations and require some of management’s most difficult, subjective and complex judgments. The accounting for these matters involves forming estimates based on current facts, circumstances and assumptions which, in management’s judgment, could change in a manner that would materially affect management’s future estimates with respect to such matters and, accordingly, could cause our future reported financial condition and results of operations to differ materially from financial results reported based on management’s current estimates. Changes in these estimates are recorded periodically based on updated information. Our principal accounting policies are discussed on pages 50-55 of this report.

Long-lived assets. A significant portion of our total assets are invested in our manufacturing facilities. Also, the cyclical patterns of our businesses cause cash flows to fluctuate by varying degrees from period to period. As a result, long-lived assets are a material component of our financial position with the potential for material change in valuation if assets are determined to be impaired. We account for impairment of long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, as measured by its undiscounted estimated future cash flows. Also, in connection with the spin-off, we reviewed our assets for impairment at the asset group and disposal group levels. We concluded that there was no impairment at either level, and that the fair market value of the disposal group exceeded its carrying value at the date of the spin-off.

We use our operational budgets to estimate future cash flows. Budgets are inherently uncertain estimates of future performance due to the fact that all inputs, including net sales, costs and capital spending, are subject to frequent change for many different reasons, including the reasons previously described above under “Factors Influencing our Results of Operations and Cash Flows.” Because of the number of variables

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involved, the interrelationship between the variables and the long-term nature of the impairment measurement, sensitivity analysis of individual variables is not practical. Budget estimates are adjusted periodically to reflect changing business conditions, and operations are reviewed, as appropriate, for impairment using the most current data available. To date, this process has not resulted in an impairment charge for any of our assets associated with our operations.

Environmental liabilities. We record accruals for estimated environmental liabilities that are not within the scope of SFAS No. 143, Accounting for Asset Retirement Obligations, and FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, in accordance with SFAS No. 5, Accounting for Commitments and Contingencies. These estimates reflect assumptions and judgments as to the probable nature, magnitude and timing of required investigation, remediation and monitoring activities. In making these estimates, we consider, among other things, the activities we have conducted at any particular site, information obtained through consultation with applicable regulatory authorities and third parties, and our historical experience at other sites that are judged to be comparable. We must also consider the likelihood of changes in governmental regulations, advancements in environmental technologies and changing legal standards regarding liability. Due to the numerous uncertainties and variables associated with these assumptions and judgments, and changes in governmental regulations and environmental technologies, our accruals are subject to substantial uncertainties, and our actual costs could be materially more or less than the estimated amounts.

Pension and postretirement employee benefits. The determination of pension plan expense and the requirements for funding our pension plans are based on a number of actuarial assumptions. Two critical assumptions are the discount rate applied to pension plan obligations and the rate of return on plan assets. For other postretirement employee benefit, or OPEB, plans, which provide certain health care and life insurance benefits to qualified retired employees, critical assumptions in determining OPEB expense are the discount rate applied to benefit obligations and the assumed health care cost trend rates used in the calculation of benefit obligations.

Note 10 to our financial statements on pages 62-67 includes information for the three years ended December 31, 2008, on the components of pension and OPEB expense and the underlying actuarial assumptions used to calculate periodic expense, as well as the funded status for our pension and OPEB plans as of December 31, 2008 and 2007.

The discount rate used in the determination of pension benefit obligations and pension expense is a weighted average benchmark rate based on high-quality fixed income investment interest rates. At December 31, 2008, we calculated obligations using a 6.15% discount rate. The discount rates used at December 31, 2007 and 2006 were 6.40% and 5.85%, respectively. To determine the expected long-term rate of return on pension assets, we employ a process that analyzes historical long-term returns for various investment categories, as measured by appropriate indices. These indices are weighted based upon the extent to which plan assets are invested in the particular categories in arriving at our determination of a composite expected return. The assumed long-term rates of return on pension plan assets used for the years ended December 31, 2008, 2007 and 2006 were 8.5%, 9.0% and 9.5%, respectively. Over the past 31 years, the period the pension assets have been actively managed, the actual average annual return on pension plan assets has been approximately 10%, as of December 31, 2008.

Total periodic pension plan income in 2008 was $0.7 million. An increase in the discount rate or the rate of expected return on plan assets, all other assumptions remaining the same, would increase pension plan income, and conversely, a decrease in either of these measures would decrease plan income. As an indication of the sensitivity that pension income has to the discount rate assumption, a 25 basis point change in the discount rate would affect annual plan income by approximately $0.7 million. A 25 basis point change in the assumption for expected return on plan assets would affect annual plan income by approximately $0.6 million. The actual rates of return on plan assets may vary significantly from the assumptions used because of unanticipated changes in financial markets, such as occurred in 2008 with the precipitous decline of the stock market in the fourth quarter.

Due to the significant drop in the stock market in the fourth quarter of 2008, our company-sponsored pension plans were underfunded at December 31, 2008. As a result, we will be required to make contributions of approximately $8.7 million (plus interest) to our qualified pension plans for the 2009 tax year.

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Although related to the 2009 tax year, payment of these contributions is not required until September 2010, which is when we expect to make these payments. In addition, we estimate contributions will total approximately $0.2 million in 2009 to our non-qualified pension plan. We do not anticipate funding our OPEB plans in 2009 except to pay benefit costs as incurred during the year by plan participants.

For our OPEB plans, expense for 2008 was $8.6 million. The discount rate used to calculate OPEB obligations, which was determined using the same methodology we used for our pension plans, was 6.15%, 6.40% and 5.85% at December 31, 2008, 2007 and 2006, respectively. The assumed health care cost trend rate used to calculate OPEB obligations and expense for 2008 was a 9% increase over the previous year, with the rate of increase scheduled to decline one percent annually to a long-term ultimate rate increase assumption of 6% for 2011 and thereafter.

As an indication of the sensitivity that OPEB expense has to the discount rate assumption, a 25 basis point change in the discount rate would affect plan expense by approximately $0.3 million. A 1% change in the assumption for health care cost trend rates would have affected 2008 plan expense by approximately $0.9 to $1.1 million and the total postretirement employee obligation by approximately $12.3 to $14.4 million, as reported in Note 10 to the financial statements on page 65. The actual rates of health care cost increases may vary significantly from the assumption used because of unanticipated changes in health care costs.

Periodic pension and OPEB expense are included in “Cost of sales” and “Selling, general and administrative expenses” in the Statements of Operations and Comprehensive Income (Loss). The expense is allocated to all business segments. In accordance with SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R), at December 31, 2008 and 2007, long-term assets are recorded for overfunded plans and liabilities are recorded for underfunded plans. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For underfunded plans, the estimated liability to be payable in the next twelve months is recorded as a current liability, with the remaining portion recorded as long-term. See Note 10 to the financial statements on pages 62-67 for further discussion.

Corporate allocations. Our accompanying statements of operations include allocations, prior to the spin-off, of certain costs from Potlatch directly related to our operations including: medical costs for hourly and salaried active and retired employees, hourly employees’ pension, worker’s compensation, general liability and property insurance, salaried payroll costs (payroll taxes, pension, and other payroll-related costs), equity-based compensation, management performance award or annual incentive plan, interest expense pursuant to our retained obligation agreement and a pro rata share of direct corporate administration expense for accounting, information systems, accounts payable and accounts receivable. The direct costs were charged to us based on the weighted average of the underlying employee base performing the function and payroll or invoices processed, depending on the nature of the cost. In addition to the direct costs discussed above, indirect corporate overhead costs were allocated to us based on an apportionment factor using relative revenues and assets. Selling and administration costs for Potlatch’s Wood Products segment were allocated to us based on the relative revenues of our wood products operations in relation to Potlatch’s Wood Products segment. Management believes the methodologies applied for the allocation of costs were reasonable in relation to the historical reporting of Potlatch, but may not be indicative of costs had we been a stand-alone entity, nor what they may be in the future. In association with being an independent, publicly traded company, in 2009 we expect to incur approximately $10 million in additional administrative costs compared to what was allocated and recorded for 2008.

Except for interest expense associated with our note payable to Potlatch (in connection with the retained obligation agreement further described in Note 6 to our financial statements), no interest expense or interest income was allocated from Potlatch to us prior to the spin-off.

Significant changes could have occurred in our funding and operations if we had operated as an independent stand-alone entity, including a possible change in our capital structure including other debt, which could have had a significant impact on our financial position and results of operations.

Income taxes. The conclusion that deferred tax assets are realizable is subject to certain assessments, projections and judgments made by management. In assessing whether deferred tax assets are realizable, the standard we use is whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income

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during the periods in which those temporary differences are deductible. We consider the scheduled reversal of deferred tax liabilities (including the impact of available carryforward periods), projected taxable income, and amounts of taxable income we would have generated historically if we had been a stand-alone company in making this assessment. In order to fully realize the deferred tax asset, we will need to generate future taxable income before the expiration of the deferred tax assets governed by the tax code.

Based on projected taxable income over the periods for which the deferred tax assets are deductible, we believe that it is more likely than not that we will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2008. The amount of the deferred tax asset considered realizable; however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.

Spin-off matters. Management classified the note payable to Potlatch as current at December 31, 2008, due to the maturity of the related Potlatch credit sensitive debentures on December 1, 2009. Also, management concluded that the company was not impaired at the asset group or disposal group level at the date of the spin-off.

Components of Net Sales and Expenses

Net sales. Net sales consist of sales of consumer tissue, pulp and paperboard and wood products, net of discounts, returns and allowances and any sales taxes collected. Sales taxes, when collected, are recorded as a current liability until remitted to the appropriate governmental entities.

Cost of sales. Cost of sales expenses consist primarily of personnel costs and the cost of raw materials, including wood fiber, energy and chemicals, depreciation and repair and maintenance expenses related to our facilities and freight associated with customer shipments.

Selling, general and administrative expenses. Selling, general and administrative expenses primarily consist of compensation and associated costs for sales and administrative personnel, as well as commission expenses related to sales of our products.

Interest expense. Interest expense is the interest allocated on the $100 million note payable to Potlatch in connection with our retained obligation agreement, as well as interest accrued in relation to the balance outstanding on our credit facility subsequent to our spin-off.

Income taxes. Income taxes are based on reported earnings and tax rates in the jurisdictions in which our operations occur and associated offices are located, adjusted for available credits and temporary differences between reported earnings and taxable income using current tax laws and rates.

Other comprehensive loss, net of tax. Beginning in 2007, due to our adoption of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132(R), we are required to record comprehensive income or loss related to our defined benefit pension and other postretirement employee benefit plans for each reporting period when net gains or losses, or prior service costs or credits existing at the date of initial application of the Statement, are amortized as components of net periodic pension cost. In addition, we are required to record increases or decreases in other comprehensive income (loss) that result from the recognition of additional net gains or losses, or prior service costs or credits that arise during the year.

RESULTS OF OPERATIONS

Except for the period from December 16, 2008, through December 31, 2008, when we operated as and were accounted for as a separate public company, our results of operations and financial condition discussed below cover periods prior to the spin-off and related transactions. The historical financial and other data were prepared on a combined basis from Potlatch’s consolidated financial statements using the historical results of operations and bases of the assets and liabilities of Potlatch’s Consumer Products and Pulp and Paperboard business and its Wood Products operations at Lewiston, Idaho, and give effect to allocations of expenses from Potlatch. Our historical financial and other data is not necessarily indicative of our future performance, nor do they necessarily reflect what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the periods shown.

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At December 31, 2008, our business was organized into three reporting segments: Consumer Products, Pulp and Paperboard, and Wood Products. Sales or transfers between segments are recorded as intersegment net sales based on prevailing market prices.

In the period-to-period discussion of our results of operations below, when we discuss our net sales, contributions by each of the segments to our net sales are reported after elimination of intersegment net sales. In the “Discussion of Business Segments” sections below, each segment’s net sales are presented before elimination of intersegment net sales.

YEAR ENDED DECEMBER 31, 2008 COMPARED TO YEAR ENDED DECEMBER 31, 2007

The following table sets forth year-to-year changes in items included in our Statements of Operations and Comprehensive Income (Loss) for the years ended December 31, 2008 and 2007.

Certain 2007 amounts have been reclassified to conform to the 2008 presentation. Also, see Note 15 to the financial statements.

Net sales—Total net sales increased $72.3 million, or 6%, in 2008 compared to 2007, primarily due to a 12% increase in Consumer Products net sales and a 9% increase in Pulp and Paperboard net sales, partially offset by a 31% decrease in Wood Products net sales. As discussed in detail below under “Discussion of Business Segments,” the increase in net sales was driven by higher selling prices and shipment volumes for both our consumer tissue and paperboard products. Lower lumber selling prices and decreased lumber and pulp shipments to external customers partially offset the favorable comparisons.

Cost of sales—Cost of sales were 94% and 92% of net sales, respectively, for the years ended December 31, 2008 and 2007. The increase of $95.6 million, or 9%, in 2008 over 2007 was primarily due to increased Pulp and Paperboard and Consumer Products segment expenses of 14% and 8%, respectively. As discussed below, the increase in Consumer Products expenses was largely due to increased costs for freight, energy, pulp and packaging supplies, as well as costs associated with increased shipment volumes, and the higher Pulp and Paperboard expenses were primarily driven by increased costs for wood fiber, chemical and energy and costs associated with increased shipment volumes.

Selling, general and administrative expenses—Selling, general and administrative expenses increased $0.6 million in 2008 compared to 2007.

Interest expense—Interest expense on the note payable to Potlatch was $13.0 million in both 2008 and 2007. In addition, we incurred approximately $0.1 million of interest in the last two weeks of 2008 related to the outstanding balance on our credit facility.

Income tax provision—Our income tax provision decreased $8.5 million in 2008 compared to 2007, primarily due to decreased earnings. The effective tax rate was 36.5% for 2008 and 35.7% for 2007.

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Other comprehensive loss, net of tax—We recorded other comprehensive loss, net of tax, of $76.9 million for 2008, compared to a loss of $1.3 million for 2007. The substantial other comprehensive loss for 2008 was due to significant losses in the market value of our pension asset portfolio during 2008.

DISCUSSION OF BUSINESS SEGMENTS

Certain 2007 amounts have been reclassified to conform to the 2008 presentation. Also, see Note 15 to the financial statements.

Operating income for our Consumer Products segment increased $19.7 million, or 112%, in 2008 from 2007. Net sales for the segment increased $52.6 million, or 12%, in 2008 compared to 2007, primarily due to approximately $38.8 million in higher net selling prices and $13.8 million related to increased shipments. The higher net sales for 2008 were due to increases in selling prices and increased sales of premium and ultra quality tissue products. Segment expenses increased $32.9 million, or 8%, in 2008 over 2007. The increase was primarily the result of increases in freight costs of approximately $10.3 million, energy costs of approximately $5.7 million, pulp costs of approximately $5.1 million and packaging costs of approximately $5.1 million.

Operating income for our Pulp and Paperboard segment was $18.9 million in 2008, or 58% lower than 2007 operating income of $45.1 million. Net sales for the segment increased $64.5 million, or 10%, in 2008 over 2007. Paperboard net sales increased $75.1 million, or 13%, in 2008 over 2007. Higher paperboard selling prices accounted for approximately $52.5 million of the net sales increase, while higher shipment volumes accounted for approximately $22.6 million of the increase. Pulp net sales were $92.3 million in 2008, compared to $102.6 million in 2007. Decreased shipments of pulp to external customers accounted for virtually all of the decrease, as average pulp selling prices for 2008 were essentially unchanged from 2007. Expenses for the segment increased $90.7 million, or 14%, in 2008 over 2007. This increase was primarily due to higher costs of approximately $40.0 million for wood fiber, approximately $21.5 million for chemicals and approximately $17.3 million for energy. The increased wood fiber costs were largely attributable to higher chip and sawdust prices for our Idaho pulp and paperboard operation in 2008 compared to 2007. The high chip and sawdust prices were primarily the result of continued reduced supplies throughout 2008 due to the closure of a number of sawmills located in the Western United States.

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The Wood Products segment reported an operating loss of $14.5 million, a significantly higher loss than the $0.1 million loss for 2007. Net sales for the segment decreased $32.3 million, or 27%, in 2008 over 2007, primarily due to an 18% decrease in shipments and a 16% decrease in selling prices for our lumber products in 2008. In 2008, we took seven weeks of downtime at our Lewiston, Idaho lumber mill. Expenses for the segment were $103.5 million, a 15% decrease compared to 2007 expenses due primarily to lower costs associated with decreased sales volumes and lower log costs.

Corporate expenses and eliminations were $13.3 million in 2008, compared to $10.2 million in 2007. The unfavorable comparison was due primarily to increased intersegment profit eliminations in 2008.

YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006

The following table sets forth year-to-year changes in items included in our Statements of Operations and Comprehensive Income for the years ended December 31, 2007 and 2006.

Certain amounts have been reclassified to conform to the 2008 presentation. Also, see Note 15 to the financial statements.

Net sales—Total net sales increased $66.1 million, or 6%, in 2007 over 2006, primarily due to a 9% increase in Pulp and Paperboard net sales, a 6% increase in Wood Products net sales and a 2% increase in Consumer Products net sales. As discussed in detail below under “Discussion of Business Segments,” the increase in net sales was driven by higher selling prices of our pulp and paperboard and consumer products, increased Pulp and Paperboard shipment volumes and stronger sales of cedar lumber products.

Cost of sales—Cost of sales were 92% and 93% of net sales, respectively, for the years ended December 31, 2007 and 2006. The increase of $50.2 million, or 5%, in 2007 over 2006 was primarily due to increased Pulp and Paperboard and Consumer Products segment expenses of 6% and 4%, respectively. As discussed below, the increase in Pulp and Paperboard expenses was primarily driven by increased wood fiber costs and the increased Consumer Products expenses were largely due to increased pulp costs.

Selling, general and administrative expenses—Selling, general and administrative expenses increased $1.3 million in 2007 from 2006.

Income from Canadian lumber settlement—We received $8.5 million in the fourth quarter of 2006 in connection with the negotiated settlement of the softwood lumber trade dispute between the United States and Canada. The $8.5 million represented our portion of the $39.3 million settlement Potlatch received, which represented Potlatch’s total pro rata share of $500 million that was distributed to members of the Coalition for Fair Lumber Imports, of which Potlatch is a member.

Interest expense—Interest expense on the note payable to Potlatch was $13.0 million in both 2007 and 2006.

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Income tax provision—Our income tax provision increased $1.7 million, or 13%, in 2007 over 2006, due to increased earnings. The effective tax rate was 35.7% for 2007 and 37.3% for 2006.

Other comprehensive loss, net of tax—We recorded other comprehensive loss, net of tax, of $1.3 million for 2007.

DISCUSSION OF BUSINESS SEGMENTS

Certain amounts have been reclassified to conform to the 2008 presentation. Also, see Note 15 to the financial statements.

Operating income for our Consumer Products segment decreased $8.1 million, or 31%, in 2007 from 2006. Net sales for the segment increased $7.0 million, or 2%, in 2007 over 2006, primarily due to approximately $22.1 million in higher selling prices, partially offset by a decrease of approximately $15.1 million related to decreased shipments. The higher net sales for 2007 were due to increased sales of premium and ultra quality tissue products, partially offset by significantly reduced sales of parent rolls. Segment expenses increased $15.1 million, or 4%, in 2007 over 2006. The increase was primarily the result of increases in pulp costs of approximately $20.2 million, employee wages and benefits of approximately $3.2 million, packaging costs of approximately $2.3 million, energy costs of approximately $2.1 million and operating supply costs of approximately $2.1 million. The increase was partially offset by lower shipment volumes that decreased expenses by approximately $16.0 million.

Operating income for our Pulp and Paperboard segment increased $19.0 million, or 73%, in 2007 over 2006. Net sales for the segment increased $56.0 million, or 9%, in 2007 over 2006. Paperboard net sales increased $31.1 million, or 6%, in 2007 over 2006. Higher paperboard selling prices accounted for approximately $30.0 million of the net sales increase, while higher shipment volumes accounted for approximately $1.1 million of the increase. Pulp net sales increased $24.9 million, or 32%, in 2007 over 2006. Higher selling prices accounted for approximately $19.9 million of the net sales increase, while higher shipment volumes accounted for approximately $5.0 million of the increase. Expenses for the segment increased $37.0 million, or 6%, in 2007 over 2006. This increase was primarily due to approximately $38.0 million in higher wood fiber costs largely attributable to higher chip and sawdust prices for our Idaho

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pulp and paperboard operation in 2007 as compared to 2006. The high chip and sawdust prices were primarily the result of reduced supply due to the closure of a number of sawmills located in the Western United States.

The Wood Products segment reported an operating loss of $0.1 million for 2007, compared to operating income of $6.1 million for 2006, which included $8.5 million of income associated with the negotiated settlement of the Canadian softwood lumber agreement. Net sales for the segment increased $8.0 million, or 7%, in 2007 over 2006, primarily due to stronger sales of our cedar lumber products in 2007. Expenses for the segment increased $14.2 million, or 13%, in 2007 over 2006, largely due to higher log costs and costs associated with increased sales volumes.

Corporate expenses and eliminations were $10.2 million in 2007, compared to $11.6 million in 2006. The favorable comparison was due primarily to lower intersegment profit eliminations in 2007.

LIQUIDITY AND CAPITAL RESOURCES

Historically, our financial resources were provided by Potlatch, which managed cash and debt on a centralized basis. Our cash receipts were transferred to Potlatch on a daily basis and Potlatch funded our cash disbursements.

At December 31, 2008, our financial position included debt of $150.0 million, including $50.0 million in borrowings under our revolving credit facility, compared to the balance at December 31, 2007 of $100.0 million. Stockholders’ equity at December 31, 2008, was $181.0 million, compared to the December 31, 2007, balance of $268.0 million. The ratio of debt to stockholders’ equity was 0.83 to 1 at December 31, 2008, compared to 0.37 to 1 at December 31, 2007.

The following table presents information regarding our cash flows for the years ended December 31, 2008, 2007 and 2006.

Cash Flows Summary

Working capital totaled $14.0 million at December 31, 2008, compared to $128.5 million at December 31, 2007. The significant changes in the components of working capital were as follows:

Net cash provided by operating activities in 2008 totaled $42.1 million, compared with $108.5 million in 2007 and $96.0 million in 2006. The unfavorable 2008 comparison to 2007 was due to cash used for working capital requirements in 2008, compared to cash provided from working capital changes in 2007, and lower net earnings in 2008 versus 2007. The favorable 2007 to 2006 comparison was primarily due to a larger amount of cash provided from working capital changes in 2007.

Net cash used for investing activities was $31.5 million in 2008, $20.5 million in 2007 and $27.4 million in 2006. The unfavorable comparison of 2008 to 2007 was due to an increase in short-term investments. The smaller amount of cash used for investing in 2007 compared to 2006 was due to capital expenditures of $20.5 million in 2007 compared to $27.5 million 2006.

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Net cash used for financing activities was $7.3 million in 2008, compared to $88.2 million in 2007 and $68.6 million in 2006. Cash used for financing activities in 2008, 2007 and 2006 primarily consisted of net payments to Potlatch in accordance with Potlatch’s centralized approach to cash management prior to the spin-off. Partially offsetting the net payments to Potlatch in 2008 were increases in notes and other short-term payables totaling $66.5 million, which included $50 million in borrowings under our revolving credit facility outstanding at December 31, 2008.

Our estimated capital expenditures for 2009 are expected to be between $15 million and $20 million. We expect the majority of our capital budget to be spent on various discretionary, high-return projects for the Consumer Products and Pulp and Paperboard segments, as well as various routine general replacement projects for each of our segments.

DIVIDEND POLICY

We have not paid any dividends since the spin-off, although we may pay cash dividends on our common stock in the future. The declaration and amount of any dividends, however, will be determined by our board of directors and will depend on our earnings, our compliance with the terms of our revolving credit facility that limit our ability to pay dividends, and any other factors that our board of directors believes are relevant.

DEBT ARRANGEMENTS

Our retained obligation agreement with Potlatch reflects our agreement to pay the principal and interest due on the $100.0 million principal amount of credit sensitive debentures previously issued by an affiliate of Potlatch. We are obligated to make an interest payment on June 1, 2009 and to pay $100.0 million of principal plus accrued interest on December 1, 2009.

The amount of interest due on the debentures is based upon the lower of Potlatch’s credit ratings applicable to the debentures as established by S&P or Moody’s. The following table denotes the interest rate applicable based on various credit ratings:

Potlatch’s current credit ratings are BB+ from S&P and Ba1 from Moody’s, and accordingly the interest rate currently applicable to the debentures is 12.5% per year. In the event Potlatch’s credit rating declines and the interest rate applicable to the debentures increases, we are required to pay interest on the debentures at the then applicable rate, which could be as high as 14.0% per year. Conversely, if Potlatch’s credit rating improves, the applicable interest rate we would pay would be lower.

Under the retained obligation agreement, we are obligated to use commercially reasonable efforts to issue, as soon as reasonably practical, debt or equity securities, or to borrow money from one or more financial institutions or other lenders, on terms reasonably acceptable to us, in an aggregate amount sufficient to pay all amounts owing under the debentures. Concurrently with our receipt of cash proceeds from any disposition of assets equal to or in excess of $50 million, or any equity issuance or debt incurrence other than cash proceeds from our expected $125 million revolving credit facility, we are obligated to apply the proceeds to the remaining payment obligations on the debentures. If the cash proceeds from any equity issuance, debt incurrence or disposition are insufficient to satisfy all of the payment obligations on the debentures, we are obligated to transfer the cash proceeds into an escrow account in which Potlatch will have a first priority security interest. However, we are not required to draw from our revolving credit facility to satisfy our obligations under the retained obligation agreement.

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In the event we are unable to timely pay, and Potlatch thereafter pays any principal or interest due under the debentures, we will be deemed to have received a loan from Potlatch in the amount of the shortfall and we will be obligated to issue a promissory note to Potlatch equal to that amount. All amounts owing under any promissory note issued by us to Potlatch will be due and payable on December 1, 2011. Any promissory note, to the extent issued in connection with our failure to timely make an interest payment on the debentures, will initially accrue interest at a rate per annum equal to the rate of interest applicable to the debentures at the time the note is issued or at maturity of the debentures, plus one percent and after December 1, 2010 until December 1, 2011, the rate of interest applicable to the debentures immediately prior to their maturity plus two percent. In the event we issue a promissory note to Potlatch, we will be obligated to use commercially reasonable efforts prior to the maturity date to issue, as soon as reasonably practical, debt or equity securities or to borrow money, on terms reasonably acceptable to us, in an aggregate amount sufficient to prepay all amounts owing under the promissory note. As security for any promissory note issued by us to Potlatch, we will grant Potlatch a security interest in our real property, fixtures and equipment at our Arkansas pulp and paperboard facility.

The retained obligation agreement contains covenants that limit or restrict our ability to:

CREDIT ARRANGEMENTS

On November 26, 2008, we entered into a four-year $125 million revolving credit facility with certain financial institutions. One day prior to the spin-off, we drew $50 million from the revolving credit facility and transferred that amount to a Potlatch affiliate. The amount available to us under the revolving credit facility is based on the lesser of 85% of our eligible accounts receivable plus 65% of our eligible inventory, or $125 million, in each case less a $10 million borrowing capacity reserve. Additional reserve requirements may be established by the agent bank, as deemed necessary. Subject to certain conditions and agreements by the lenders, the $10 million borrowing capacity reserve may be made available for borrowing. We also entered into deposit account control agreements with our lenders pursuant to our revolving credit facility.

As of December 31, 2008, there were $50 million in borrowings outstanding under the credit facility, and approximately $1.7 million of the credit facility was being used to support outstanding standby letters of credit. Loans under the credit facility bear interest at LIBOR plus between 2.75% and 3.50% for LIBOR loans, and a base rate effectively equal to the agent bank’s prime rate plus between 1.00% and 1.75% for other loans. The percentage margin on all loans is based on our last twelve month’s fixed charge coverage ratio, which is recalculated on a quarterly basis. As of December 31, 2008, the weighted average interest rate on the $50 million of borrowings outstanding under the credit facility was approximately 6.75%, and we would have been permitted to draw an additional $63.4 million under the credit facility. As of the date of this report, we are eligible to borrow under the credit facility at LIBOR plus 3.00%.

A minimum fixed charge coverage ratio is the only financial covenant requirement under our credit facility and is triggered when an event of default exists or when availability falls below 20%, at which time the minimum fixed charge coverage ratio must be at least 1.0 to 1.0. As of December 31, 2008, the fixed charge coverage ratio for the last twelve months was 2.2 to 1.0.

We expect that our primary liquidity requirements will be for debt service under the retained obligation agreement and the credit facility, capital expenditures, payments of dividends, if any, and working capital requirements.

Our obligations under the revolving credit facility are secured by all of our accounts receivable and inventory. The credit facility agreement contains various provisions that limit our discretion in the operation of our business by restricting our ability to, among other things:

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With the borrowing transactions described above, we are significantly leveraged and will be required to apply a significant amount of cash to service our debt obligations. As of December 31, 2008, we had $150.0 million of aggregate indebtedness and up to $63.4 million of additional borrowing capacity depending on the amount of our eligible accounts receivable and inventory. We expect to periodically draw upon our revolving credit facility to meet cash requirements depending on cash flows from operations.

We are currently rated at BB- with a stable outlook by Standard & Poor’s Ratings Services, a division of The McGraw-Hill Companies.

Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures depends on our ability to generate cash in the future, which will be subject to the successful operation of our business, as well as general economic, competitive and other factors outside of our control. Based on our current level of operations, we believe that our cash flow from operations and available borrowings under the revolving credit facility will be sufficient to meet our future cash needs for the next 12 months. However, we expect that outside financing will be necessary in order to satisfy our obligations under the retained obligation agreement discussed above. Pursuant to certain conditions of our revolving credit facility, the maturity of our facility will be accelerated to September 1, 2011, if we are unable to refinance the $100 million credit sensitive debentures by that date.

We cannot be certain, however, that our business will generate sufficient cash flow from operations or that future borrowing will be available to us under the revolving credit facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. If we make substantial capital expenditures or consummate an acquisition, our debt service requirements could increase. We may be required to refinance all or a portion of our indebtedness on or before maturity. We cannot be certain that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all.

CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual obligations as of December 31, 2008. Portions of the amounts shown are reflected in our financial statements and accompanying notes, as required by generally accepted accounting principles. See the footnotes following the table for information regarding the amounts presented and for references to relevant financial statement notes that include a detailed discussion of the item.