Clearwater Paper Corp - Quarter Report: 2009 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the quarterly period ended September 30, 2009

Or

For the transition period from                     to                     

Commission File Number: 001-34146

CLEARWATER PAPER CORPORATION

(Exact name of registrant as specified in its charter)

(509) 344-5900

Registrant’s telephone number, including area code

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ¨    No  ¨

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

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

The number of shares of common stock of the registrant outstanding as of October 28, 2009 was 11,366,129.

Table of Contents

CLEARWATER PAPER CORPORATION

Index to Form 10-Q

1

Table of Contents

Part I

Clearwater Paper Corporation

Condensed Statements of Operations

Unaudited (Dollars in thousands - except per-share amounts)

The accompanying notes are an integral part of these condensed financial statements.

2

Table of Contents

Clearwater Paper Corporation

Condensed Balance Sheets

Unaudited (Dollars in thousands – except per-share amounts)

The accompanying notes are an integral part of these condensed financial statements.

3

Table of Contents

Clearwater Paper Corporation

Condensed Statements of Cash Flows

Unaudited (Dollars in thousands)

Net interest payments for the nine months ended September 30, 2009 were $6.9 million. Net income tax payments for the nine months ended September 30, 2009 were $42.8 million. We paid no interest or income taxes, nor did we receive any income tax refunds, for the nine months ended September 30, 2008, due to Potlatch’s centralized approach to cash management prior to the spin-off.

See Note 9 for discussion of non-cash financing activities associated with the issuance of our senior unsecured notes and the repayment of our obligation to Potlatch.

The accompanying notes are an integral part of these condensed financial statements.

4

Table of Contents

Clearwater Paper Corporation

Notes to Condensed Financial Statements

Unaudited

NOTE 1.

Spin-off from Potlatch Corporation

On December 1, 2008, the board of directors of Potlatch Corporation, which we refer to in this report as Potlatch, 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 indicates, references in this report to “Clearwater Paper,” “we,” “our company” and “us” refer:

NOTE 2.

General

Clearwater Paper 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 businesses were owned by, and we were a subsidiary of, Potlatch until our spin-off on December 16, 2008.

The accompanying Condensed Balance Sheets at September 30, 2009 and December 31, 2008, the Condensed Statements of Operations for the quarters and nine months ended September 30, 2009 and 2008, and the Condensed Statements of Cash Flows for the nine months ended September 30, 2009 and 2008 have been prepared in conformity with accounting principles generally accepted in the United States of America. We believe that all adjustments necessary for a fair statement of the results of the interim periods presented have been included. The results of operations for any interim period are not necessarily indicative of the results of operations to be expected for the full year.

This Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission, or SEC, on March 18, 2009.

We have evaluated subsequent events through the time we filed this Quarterly report on Form 10-Q on November 2, 2009.

NOTE 3.

Recently Adopted and New Accounting Standards

Recently Adopted Accounting Standards

Subsequent Events. In May 2009, the Financial Accounting Standards Board, of FASB, issued guidance that establishes the accounting and disclosure of events occurring after the balance sheet date but before financial statements are issued or are available to be issued. This guidance requires disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. This guidance was effective for interim or annual financial periods ending after June 15, 2009. The adoption of this guidance did not have an effect on our financial condition and results of operations.

Codification. In June 2009, the FASB issued guidance which has become the source of authoritative Generally Accepted Accounting Principles, or GAAP, recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this guidance, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification became nonauthoritative. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this Statement did not have material effect on our financial condition and results of operations.

5

Table of Contents

New Accounting Pronouncements (Not Yet Adopted)

Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. In December 2008, the FASB issued guidance on an employers’ disclosures about assets of a defined pension or other postretirement plan. The additional disclosures include investment policies and strategies, categories of plan assets, and information about the fair value measurements of plan assets. The disclosures required are effective for fiscal years ending after December 15, 2009. Adoption of this guidance is not expected to have a material effect on our financial condition and results of operations. However, we are currently reviewing what effect this guidance will have on our financial statement disclosures.

NOTE 4.

Taxes

The income tax provisions presented in the Condensed Statements of Operations for the 2009 periods have been computed by applying an estimated annual effective tax rate of 36.9%. The actual effective tax rate was 36.9% for the quarter and 30.0% for the nine months ended September 30, 2009, 26.4% for the quarter ended September 30, 2008, and 33.8% for the nine months ended September 30, 2008.

The effective tax rate for the nine months ended September 30, 2009, was favorably affected by $9.8 million of federal production tax credits claimed during the second quarter of 2009 and the reduction of a valuation allowance for state investment tax credits of $3.6 million.

The tax provision for the third quarter and nine months ended September 30, 2008 was calculated on a “carve-out” basis since our businesses were part of Potlatch during those periods, whereas the 2009 tax provisions are reflective of the company’s operations and tax attributes as a stand-alone entity.

We reflect accrued interest related to tax obligations, as well as penalties, in our provision for income taxes. During the three month and nine month periods ended September 30, 2009 and 2008, no such amounts were reflected in our provision for income taxes.

We are registered with the Internal Revenue Service, or IRS, as an alternative fuel mixer and have received refundable tax credit payments in connection with our use of “black liquor,” a by-product of the pulp manufacturing process, in an alternative fuel mixture to produce energy at our pulp mills. The amount of the refundable tax credit is equal to $0.50 per gallon of alternative fuel mixture used. The alternative fuel mixture tax credit is currently set to expire on December 31, 2009.

For the three and nine month periods ended September 30, 2009, we recorded income of $47.1 million and $123.5 million, respectively, in our financial statements related to the alternative fuel mixture tax credit. Through September 30, 2009 we had received payments of $87.4 million related to alternative fuel mixture tax credits.

Beginning in the third quarter of 2009, we elected not to continue our prior practice of making periodic requests for payments related to the alternative fuel mixture tax credit and instead elected to claim the credit on our 2009 income tax return. The amount of credits we have recorded related to the third quarter of 2009 that we expect to claim on our 2009 income tax return is $36.1 million, which are included in “Taxes receivable” on our Condensed Balance Sheet.

We believe there is a reasonable basis to exclude the $123.5 million of alternative fuel mixture tax credits recorded in the nine months ended September 30, 2009 from taxable income. However, in accordance with guidance relating to accounting for uncertainty in income taxes, we have established a liability of $52.3 million which is classified as non-current “Accrued taxes” on our Condensed Balance Sheet.

6

Table of Contents

NOTE 5.

Earnings per Common Share

Earnings per common share are computed by dividing net earnings by the weighted average number of common shares outstanding in accordance with accounting guidance related to earnings per share. The following table reconciles the number of common shares used in calculating the basic and diluted net earnings per share:

Common share amounts shown as outstanding for 2008 periods use the basic average common shares outstanding as of the spin-off date.

NOTE 6.

Equity-Based Compensation

In connection with the spin-off, our board of directors approved and adopted, and Potlatch, in its capacity as our sole stockholder, approved, the Clearwater Paper Corporation 2008 Stock Incentive Plan, or Stock Plan. The Stock Plan provides for equity-based awards in the form of restricted shares, restricted stock units, or RSUs, performance shares, stock options or stock appreciation rights to selected employees, outside directors and consultants of the company. The Stock Plan became effective on December 16, 2008. Under the Stock Plan, we are authorized to issue up to approximately 1.7 million shares. At September 30, 2009, approximately 713,000 shares were available for future issuance under the Stock Plan.

As of the spin-off date, the performance share and RSU awards previously granted to our employees by Potlatch were automatically cancelled, per the terms of the awards, as a result of the spin-off. Under the employee matters agreement we entered into with Potlatch in connection with the spin-off, we agreed to issue new equity awards of equivalent value to replace the equity awards previously received from Potlatch. Replacement awards were granted in the form of RSU grants. The awards will accrue dividend equivalents, if any are paid, based on dividends paid during the RSU vesting period. The dividend equivalents will be converted into additional RSUs that will vest in the same manner as the underlying RSUs to which they relate. The terms of the awards state that the awards will vest after a set period of time has passed, which approximates the remaining vesting or settlement period associated with the cancelled Potlatch equity awards.

As required by accounting guidance on stock compensation, we prepared a calculation as of the date of the spin-off to determine whether any additional compensation cost existed for any excess of the fair value of the modified replacement awards granted by us over the fair value of the original Potlatch performance share and RSU awards. The resulting additional expense of $0.4 million is being recognized over the remaining vesting period for the outstanding replacement grants.

We recorded equity-based compensation expense of $2.2 million for the nine months ended September 30, 2009, of which $1.7 million related to RSUs and $0.5 million related to performance shares. The equity-based compensation expense we recorded for the nine months ended September 30, 2008, which was allocated to us by Potlatch, was $1.6 million. The net income tax benefits associated with equity-based compensation totaled $0.7 million and $0.6 million for the nine months ended September 30, 2009 and 2008, respectively.

7

Table of Contents

In connection with joining our board of directors, in January 2009 our outside directors were granted an award of phantom common stock units, which were credited to an account established on behalf of each director and will vest ratably over a three-year period. In May 2009, our outside directors were granted equity awards in the form of common stock units as part of their annual compensation, which were credited to their accounts. Certain of the awards granted will vest ratably over one year. These accounts will be credited with additional common stock units equal in value to dividends paid, if any, on the same amount of common stock. Upon separation from service as a director, the vested portion of the common stock units held by the director in his stock unit account will be converted to cash based upon the then market price of the common stock and paid to the director. Due to the cash-settlement feature of the awards, we recognize equity-based compensation expense or income at the end of each reporting period based on the portion of the award that is vested and the increase or decrease in the value of our common stock.

Directors of the company also can each elect to defer compensation in the form of stock units. We record compensation expense or income during each reporting period based on the amount of compensation deferred during the period and the increase or decrease in the value of the company’s common stock. We recorded director equity-based compensation and deferred expense totaling $0.8 million for the quarter ended September 30, 2009, and $1.5 million for the nine months ended September 30, 2009. We were a wholly owned subsidiary of Potlatch prior to our spin-off, and thus there was no director equity-based compensation or deferred expense or income for the quarter and nine months ended September 30, 2008.

RESTRICTED STOCK UNITS

RSUs granted under our Stock Plan are generally subject to a vesting period. Certain officers and other employees of the company have been granted RSU awards that will accrue dividend equivalents based on dividends paid, if any, during the RSU vesting period. The dividend equivalents will be converted into additional RSUs that will vest in the same manner as the underlying RSUs to which they relate. The terms of certain outstanding RSU awards state that 20% of the RSUs vest on each of the first and second anniversaries of the grant date of the awards, with the remaining 60% vesting on the third anniversary. The terms of certain other outstanding RSU awards provide for ratable vesting over a three-year period and vesting upon the expiration of a set period of approximately three years.

A summary of the status of outstanding RSU awards as of September 30, 2009, and changes during the first nine months of 2009, is presented below:

For RSU awards granted during 2009, the fair value of each share was estimated on the date of grant using the grant date market price of our common stock. The total fair value of share awards that vested during the first nine months of 2009 was $0.2 million.

As of September 30, 2009, there was $2.4 million of total unrecognized compensation cost related to outstanding RSU awards. The cost is expected to be recognized over a weighted average period of 1.3 years.

PERFORMANCE SHARES

Performance share awards granted under our Stock Plan have a three-year performance period, and shares are issued after the end of the period if the performance measure is met. The performance measure is a comparison of the percentile ranking of our total shareholder return compared to the total shareholder return performance of a selected peer group. The number of shares actually issued, as a percentage of the amount subject to the performance share award, could range from 0% - 200%. Performance share awards granted under our Stock Plan do not represent common stock, and therefore the holders do not have voting rights unless and until shares are

8

Table of Contents

issued upon settlement. During the performance period, dividend equivalents accrue based on dividends paid, if any, and are converted into additional performance shares, which vest or are forfeited in the same manner as the underlying performance shares to which they relate.

The fair value of performance share awards is estimated using a Monte Carlo simulation model. A summary of the status of outstanding performance share awards as of September 30, 2009, and changes during the first nine months of 2009, is presented below:

As of September 30, 2009, there was $2.2 million of unrecognized compensation cost related to outstanding performance share awards. The cost is expected to be recognized over a weighted average period of 2.3 years.

NOTE 7.

Inventories

Inventories at the balance sheet dates consist of:

9

Table of Contents

NOTE 8.

Pension and Other Postretirement Employee Benefit Plans

The following table details the components of net periodic cost (benefit) of our pension and other postretirement employee benefit, or OPEB, plans for the periods presented:

Quarters ended September 30:

As discussed in the notes to our financial statements as of and for the year ended December 31, 2008, our company-sponsored pension plans were underfunded by $91.2 million at December 31, 2008. As a result, at that time we expected to be required to make contributions of approximately $8.7 million (plus interest) to our qualified pension plans for the 2009 tax year. However, as a result of recent guidance from the IRS we now expect our required contributions to be approximately $3.9 million (plus interest). Although related to the 2009 tax year, payment of these contributions is not required until 2010. During the nine months ended September 30, 2009, we made $0.1 million of contributions to our non-qualified pension plan and we estimate contributions will total approximately $0.2 million in 2009. We do not anticipate funding our OPEB plans in 2009 except to pay benefit costs as incurred during the year by plan participants.

NOTE 9.

Debt

On June 11, 2009, we sold $150.0 million aggregate principal amount of senior unsecured notes. The notes are due on June 15, 2016, have an interest rate of 10.625% and were issued at a price equal to 98.792% of their face value. The issuance of these notes generated net proceeds of approximately $144.0 million after deducting discounts and offering expenses. We transferred approximately $107.0 million of these proceeds to a trustee in satisfaction of our obligation related to the indenture under which $100.0 million principal amount of credit sensitive debentures due December 1, 2009 were originally issued by an affiliate of Potlatch. The obligation to repay the credit sensitive debentures was retained by us prior to the spin-off. The $107.0 million consisted of the $100.0 million principal amount underlying the credit sensitive debentures, plus approximately $6.3 million recorded as “Debt retirement costs” on our Condensed Statement of Operations representing our current estimate of the remaining interest obligation due to holders of the debentures on December 1, 2009, and plus approximately $0.7 million included as “Restricted cash” on our Condensed Balance Sheet. The $0.7 million of restricted cash represents the difference between our current estimate of the interest payment due to holders of the debentures on December 1, 2009, and the interest payment that would be owing on December 1, 2009, if the maximum interest rate applicable to the credit sensitive debentures were to apply. Any amounts held by the trustee after payment of the $100.0 million principal amount and accrued interest on December 1, 2009, will be returned to us.

On our Condensed Statement of Cash Flows for the nine months ended September 30, 2009, $38.2 million is reported as “Net proceeds from long-term debt.” This represents the net proceeds received upon completion of the issuance of the senior notes, and consisted of the $150.0 million note proceeds less discounts, net of the direct transfer of approximately $107.0 million to a trustee to satisfy our obligation related to

10

Table of Contents

the $100.0 million principal amount of credit sensitive debentures, as discussed above, and $3.0 million of expenses associated with the offering. An additional $1.2 million of expenses associated with the issuance of the notes is included in “Deferred loan fees” on our Condensed Statement of Cash Flows for the nine months ended September 30, 2009.

The 10.625% senior notes due 2016 are general unsecured obligations and are therefore not secured by our assets. They are equal in right of payment with all existing and future unsecured senior indebtedness and are senior in right of payment to any future subordinated indebtedness. The notes are effectively subordinated to all of our existing and future secured indebtedness, including borrowings under our secured revolving credit facility, which is secured by all accounts receivable, inventory and cash. The notes will be unconditionally guaranteed by any future restricted subsidiary guarantors.

Prior to June 15, 2012, we may redeem, at any time at our option, up to 35% of the aggregate principal amount of the notes with the net proceeds of qualified equity offerings at a redemption price equal to 110.625% of the principal amount thereof plus accrued and unpaid interest. We have the option to redeem all or a portion of the notes at any time prior to June 15, 2013 at a redemption price equal to 100% of the principal amount thereof plus a premium and accrued and unpaid interest.

In connection with the issuance of the senior notes, we entered into a registration rights agreement with the initial purchasers of the senior notes. Under this agreement, we agreed, to the extent the senior notes do not become freely tradable under the Securities Act on or before the 380th day after the date of their issuance, to file a registration statement with the SEC pursuant to which we will offer to exchange the senior notes for notes with substantially similar terms that are registered under the Securities Act. In addition, if applicable interpretations of the staff of the SEC do not permit us to exchange the senior notes, we will be required to make available an effective shelf registration statement registering the resale of the senior notes. If the senior notes do not become freely tradable on or before the 380th day after the date of their issuance, the interest rate applicable to the senior notes will be increased by 0.25% per annum for the first 90-day period and thereafter will be increased by an additional 0.25% per annum for each 90-day period that elapses, subject to a maximum of 1% per annum. The additional interest will accrue on the senior notes until they become freely tradable, until an exchange offer has been completed or a shelf registration statement has been declared effective, as applicable. No amounts associated with the registration rights agreement have been recorded within the accompanying condensed financial statements, as the likelihood that we would have to make any payments under the arrangement is considered remote.

The terms of the notes limit our ability and the ability of any restricted subsidiaries to borrow money; pay dividends; redeem or repurchase capital stock; make investments; sell assets; create restrictions on the payment of dividends or other amounts to us from any restricted subsidiaries; enter into transactions with affiliates; enter into sale and lease back transactions; create liens; and consolidate, merge or sell all or substantially all of our assets.

11

Table of Contents

NOTE 10.

Fair Value Measurements

The estimated fair values of our financial instruments at the dates presented below are as follows:

Fair value accounting guidance establishes a framework for measuring fair value, which provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities, or “Level 1” measurements, and the lowest priority to unobservable inputs, or “Level 3” measurements.

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

Assets measured at fair value on a recurring basis at September 30, 2009 are summarized below:

The carrying amount of our short-term investments approximates fair value due to their very short maturity periods.

NOTE 11.

Derivatives

We do not enter into derivative contracts for speculative purposes. During 2008 and 2009, we had no activity that required hedge or derivative accounting treatment. However, to partially mitigate our exposure to market risk for changes in utility commodity pricing, we use firm price contracts to supply a portion of the natural gas requirements for our manufacturing facilities. As of September 30, 2009, these contracts covered approximately 41% of our expected average monthly natural gas requirements for the Pulp and Paperboard and Consumer Products segments for the remainder of 2009, plus lesser amounts for 2010. These contracts qualify for treatment as “normal purchases or normal sales” under derivative accounting guidance and require no mark-to-market adjustment.

12

Table of Contents

NOTE 12.

Comprehensive Income

The components of comprehensive income for the quarters and nine months ended September 30, 2009 and 2008 were as follows:

Of the $1.7 million reported as other comprehensive income, net of tax, for the quarter ended September 30, 2009, $1.5 million related to our defined benefit pension plans and $0.2 million related to our OPEB plans. Of the $4.5 million reported as other comprehensive income, net of tax, for the nine months ended September 30, 2009, $3.8 million related to our defined benefit pension plans and $0.7 million related to our OPEB plans. Of the $0.3 million reported in other comprehensive income, net of tax, for the quarter ended September 30, 2008, $0.4 million of income and $0.1 million of expense related to our defined benefit pension and OPEB plans, respectively. Of the $0.8 million reported in other comprehensive income, net of tax, for the first nine months of 2008, $1.1 million of income and $0.3 million of expense related to our defined benefit pension and OPEB plans, respectively.

13

Table of Contents

NOTE 13.

Segment Information

14

Table of Contents

FORWARD-LOOKING STATEMENTS

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 liquidity and future growth opportunities, future revenues, cash flows, energy costs, wood fiber costs, manufacturing output, additional corporate overhead and administrative expenses associated with being a stand-alone company, benefit plan funding levels, the effect of recent accounting standards on our financial condition and results of operations, our expectation that we will receive substantial alternative fuel mixture tax credits and the tax treatment of the credits, our expectation regarding the need to periodically draw upon our credit facility to meet cash requirements 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 the risk factors described in Item 1A of Part II of this Report on Form 10-Q and in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2008, 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.

OVERVIEW

Background

Clearwater Paper 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 businesses were owned by, and we were a subsidiary of, Potlatch Corporation until our spin-off on December 16, 2008.

15

Table of Contents

Recent Developments

Alternative Fuel Mixture Tax Credits

We are registered with the Internal Revenue Service, or IRS, as an alternative fuel mixer and have received refundable tax credit payments in connection with our use of “black liquor,” a by-product of the pulp manufacturing process, in an alternative fuel mixture to produce energy at our pulp mills. The amount of the refundable tax credit is equal to $0.50 per gallon of alternative fuel mixture used. The alternative fuel mixture tax credit is currently set to expire on December 31, 2009.

For the three months and nine months ended September 30, 2009, we recorded income of $47.1 million and $123.5 million, respectively, in our financial statements related to the alternative fuel mixture tax credit. Through September 30, 2009 we had received payments of $87.4 million related to the alternative fuel mixture tax credit.

Beginning in the third quarter of 2009, we elected not to continue our prior practice of making periodic requests for payments related to the alternative fuel mixture tax credit and instead elected to claim the credit on our 2009 income tax return. The amount of credits we have recorded related to the third quarter of 2009 that we expect to claim on our 2009 income tax return is $36.1 million, which are included in “Taxes receivable” on our Condensed Balance Sheet.

We believe there is a reasonable basis to exclude the $123.5 million of alternative fuel mixture tax credits recorded in the nine months ended September 30, 2009 from taxable income. However, in accordance with guidance relating to accounting for uncertainty in income taxes, we have established a liability of $52.3 million, which is classified as non-current “Accrued taxes” on our Condensed Balance Sheet.

The future amount of credits for which we ultimately file for, receive, and recognize as income is dependent on, among other things, our future production levels, tax legislation and regulation, and income recognition criteria under generally accepted accounting principles, or GAAP. We do not know whether the U.S. government will amend the tax credit to eliminate or reduce its benefits for pulp and paper companies, but there is the possibility that such action may be taken. Any such amendment of the tax credit could have a material effect on our financial position, results of operations, and cash flows.

Liquidity

As a result of funds from operations and funds from the receipt of alternative fuel mixture tax credits, our balance sheet and liquidity are currently in a strong position. At September 30, 2009, we had $149.4 million of cash, restricted cash and short-term investments. This puts us at a virtually net debt-free position, which we believe will enhance our ability to pursue growth opportunities.

Shelf Registration

On October 29, 2009, we filed a registration statement on Form S-3 to register up to an aggregate of $250 million of debt and equity securities, which is designed to allow us to issue such securities in the future should we elect to do so. This shelf was put in place as part of our overall capital structure planning strategy and could be used, among other things, to allow us to pursue growth opportunities should they arise.

Components and Trends in our Business

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. We set our prices based on the best interests of our company and our customers. However, prices for our consumer tissue products primarily tend to follow the prices of branded tissue products. Demand and pricing for our pulp and paperboard products is largely determined by general global market conditions. Markets have been relatively stable for paperboard in 2009, while market conditions for pulp, although still weak, have improved slightly from early 2009. Demand for our wood products is largely related to the U.S. housing market, which continues to be in a prolonged downturn.

Cost of sales. Cost of sales expenses consist primarily of personnel costs; 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. Input costs for several of our larger cost elements, mainly wood fiber, freight, energy and chemicals, have decreased significantly in 2009 compared to 2008 largely in relation to the overall state of the U.S. and global economies. As economic conditions improve, we would expect to see at least some upward pressure on these costs.

16

Table of Contents

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. We expect our selling, general and administrative costs to fluctuate as we continue to properly staff our administrative functions and implement additional cost controls and procedures.

Interest expense. Interest expense is the interest related to the $100.0 million note payable to Potlatch in connection with our retained obligation agreement, prior to the satisfaction of that obligation in June 2009, as well as interest associated with $150.0 million of senior notes issued by us in June 2009 and with our revolving credit facility. We expect future interest expense to remain relatively consistent with the amounts recorded for the quarter ended September 30, 2009.

Income taxes. Income taxes are based on reported earnings and tax rates in the jurisdictions in which our operations occur and offices are located, adjusted for available credits, changes in valuation allowances and differences between reported earnings and taxable income using current tax laws and rates. We expect our effective income tax rate to remain fairly constant, but it could fluctuate due to changes to the Internal Revenue Code.

RESULTS OF OPERATIONS

Our results of operations and financial condition discussed below for the quarter and nine months ended September 30, 2008, were prepared on a combined basis from Potlatch’s financial statements. The historical results of operations and book value of the assets and liabilities of Potlatch’s Consumer Products and Pulp and Paperboard business and its Wood Products operations at Lewiston, Idaho, were used and give effect to allocations of expenses from Potlatch. This information is not necessarily indicative of what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the quarter and nine months ended September 30, 2008.

At September 30, 2009, 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.

Quarter Ended September 30, 2009 Compared to Quarter Ended September 30, 2008

The following table sets forth period-to-period changes in items included in our Condensed Statements of Operations for the quarters ended September 30, 2009 and 2008.

Net sales—We experienced increased shipments of our consumer tissue, pulp and lumber products and higher net selling prices for our consumer tissue products in the third quarter of 2009, compared to the same period in 2008. These improvements were largely offset by lower net selling prices for paperboard, pulp and lumber. These items are discussed further below under “Business Segment Discussion.”

Cost of sales—Cost of sales was 85.2% of net sales for the quarter ended September 30, 2009, and 95.6% of net sales for the same period in 2008. The decrease of $31.7 million, or 10.1%, in the 2009 period compared to 2008 was primarily due to lower input costs for wood fiber, freight, chemicals and energy.

Selling, general and administrative expenses—Selling, general and administrative expenses increased 85.2% for the quarter ended September 30, 2009 compared to the same period in 2008. The increase was primarily due to additional corporate administration expenses associated with being an independent, publicly traded company, as well as higher incentive compensation related expenses recorded in the third quarter of 2009. Selling, general and administrative expenses for the third quarter of 2008 were favorably affected by approximately $2.0 million of income from legal settlements.

17

Table of Contents

Alternative fuel mixture tax credits—For the quarter ended September 30, 2009, we recorded $47.1 million of income related to alternative fuel mixture tax credits. We began receiving the alternative fuel mixture tax credits in early 2009, therefore no amounts are recorded for the 2008 period.

Interest expense—Interest expense increased 31.6% in the third quarter of 2009 compared to the third quarter of 2008. Interest expense for the third quarter of 2009 was associated with the $150.0 million of senior notes we issued in June 2009. Interest expense for the third quarter of 2008 was associated with our $100.0 million note payable obligation to Potlatch, which was satisfied in June 2009 with proceeds from the issuance of $150.0 million senior notes.

Income tax provision—Our income tax provision increased $26.7 million for the quarter ended September 30, 2009, compared to the same period in 2008, due to increased earnings from operations and additional tax expense resulting from the establishment of a liability for uncertain tax positions related to the alternative fuel mixture tax credit. The effective tax rate was 36.9% for the third quarter of 2009, compared to an effective tax rate of 26.4% for the third quarter of 2008. The tax provision for the third quarter of 2008 was calculated on a “carve-out” accounting basis since our businesses were part of Potlatch during those periods, whereas the 2009 tax provision is reflective of the company’s operations and tax attributes as a stand-alone entity.

BUSINESS SEGMENT DISCUSSION

Consumer Products

The Consumer Products segment reported a $9.6 million, or 7.3%, increase in net sales (before intersegment net sales eliminations) and a $21.0 million increase in operating income for the third quarter of 2009 compared to the third quarter of 2008. The significant increase in operating income was due to the combination of increased net sales and decreased costs. The increased net sales were attributable to increased shipments and higher net selling prices. Average net selling prices for the third quarter of 2009 were 2.4% higher than the average for the third quarter of 2008 due to higher overall pricing. Shipment volumes were 4.8% higher in the third quarter of 2009 compared to the same period in 2008 due largely to increased production at our tissue converting facilities.

Operating costs for the segment were $11.5 million lower in the third quarter of 2009 versus the same period in 2008, or a 9.6% decrease. The decrease was due primarily to lower freight, pulp, packaging supply and energy costs.

Pulp and Paperboard

Net sales for the Pulp and Paperboard segment, before intersegment net sales eliminations, were $10.8 million or 5.5% lower in the third quarter of 2009 compared to the third quarter of 2008. The decrease in net sales was due to significantly lower net selling prices for pulp, slightly lower paperboard net selling prices and a slight decrease in paperboard shipments, partially offset by increased shipments of pulp to external customers and our Consumer Products segment. The lower pulp net selling prices were largely due to the weakening of pulp markets beginning in the third quarter of 2008 and continuing through the middle of 2009.

Operating income increased $57.4 million in the third quarter of 2009 compared to the third quarter of 2008. The significant increase in income for the segment was due to the recording of $47.1 million of pre-tax income in the third quarter of 2009 associated with the alternative fuel mixture tax credit, as previously discussed. Excluding the alternative fuel mixture tax credit income, operating income for the segment was $10.6 million, or 5.7% of net sales before intersegment net sales eliminations, in the third quarter of 2009, which was $10.2 million higher than the operating income for the third quarter of 2008. Results for the third quarter of 2008 included approximately $2.0 million of income from legal settlements.

18

Table of Contents

Excluding the income from the alternative fuel mixture tax credit, the increase in operating income was due to a $21.0 million decrease in operating expenses for the segment in the third quarter of 2009 resulting from lower input costs for wood fiber, chemicals, maintenance, freight and energy. Cost levels for wood chips to supply our Lewiston, Idaho, pulp and paperboard mill have moderated some in 2009 but remain at historically high levels, due largely to the limited supplies resulting from the slowdown or shutdown of operations of many lumber mills in response to the continued U.S. economic and home construction market downturn.

Wood Products

The Wood Products segment reported an operating loss of $4.2 million for the third quarter of 2009, compared to an operating loss of $1.6 million recorded in the same period of 2008. The continued and prolonged downturn in the housing market had a significant negative effect on the results in both quarters. The larger loss for the segment in the 2009 period was due to a decrease in net sales, before intersegment net sales eliminations, which was attributable to 30.6% lower average net selling prices, partially offset by a 31.9% increase in shipments. The lower average net selling prices were due to unfavorable pricing and a lower percentage of higher-value cedar product sales.

Wood Products segment expenses in the third quarter of 2009 were $0.7 million higher than the third quarter of 2008, due primarily to higher overall costs associated with the increased lumber shipments, which were partially offset by lower log costs.

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

The following table sets forth period-to-period changes in items included in our Condensed Statements of Operations for the nine months ended September 30, 2009 and 2008.