**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

| x                                                        | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|
| **For the  quarterly period ended October 1, 2005** |
| o                                                        | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition periodfrom               to**

**Commissionfile number: 1-14330**

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**POLYMER GROUP, INC.**

(Exact name of registrant asspecified in its charter)

| **Delaware**                                                                  | **57-1003983**                        |
|-------------------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)              | (I.R.S. Employer  Identification No.) |
| **4055  Faber Place Drive, Suite 201  North Charleston, South Carolina** | **29405**                             |
| (Address of principal  executive offices)                                     | (Zip Code)                            |

 

Registrant’s telephone number,including area code: **(843) 329-5151**

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

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act)Yes o  No x

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

Indicate by check mark whether the registrant hasfiled all documents and reports required to be filed by Section 12, 13 or 15(d) ofthe Securities Exchange Act of 1934 subsequent to the distribution ofsecurities under a plan confirmed by a court. Yes x  No o

On November 4, 2005 there were 18,867,190 sharesof Class A common stock, 154,966 shares of Class B common stockand 31,131 shares of Class C common stock outstanding. No shares of Class Dor Class E common stock were outstanding as of such date. The par valuefor each class of common shares is $.01 per share.

 

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**POLYMERGROUP, INC.**

**INDEX TO FORM 10-Q**

|                                                     | ** ** | ** **                                                                                  | **Page** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------------------------------|----------|------------|
| IMPORTANT INFORMATION REGARDING THIS FORM 10-Q |       | 2                                                                                           |     |
| **PART I. FINANCIAL  INFORMATION**             |       |                                                                                        |     |
| Item 1.                                             |       | Financial Statements                                                                        |     | 3          |   |
| Item 2.                                             |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |     | 24         |   |
| Item 3.                                             |       | Quantitative  and Qualitative Disclosures About Market Risk                                 |     | 40         |   |
| Item 4.                                             |       | Controls and  Procedures                                                                    |     | 41         |   |
| **PART II. OTHER  INFORMATION**                |       |                                                                                        |     |
| Item 1.                                             |       | Legal Proceedings                                                                           |     | 42         |   |
| Item 2.                                             |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |     | 42         |   |
| Item 3.                                             |       | Defaults Upon  Senior Securities                                                            |     | 42         |   |
| Item 4.                                             |       | Submission of  Matters To a Vote of Security Holders                                        |     | 42         |   |
| Item 5.                                             |       | Other Information                                                                           |     | 42         |   |
| Item  6.                                            |       | Exhibits                                                                                    |     | 42         |   |
| Signatures                                          |       | 43                                                                                          |     |
|                                                     |            |                                                                                             |          |            |  |  |  |

 

1

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**IMPORTANT INFORMATION REGARDING THIS FORM 10-Q**

Readers should consider thefollowing information as they review this Form 10-Q:

**SafeHarbor-Forward-Looking Statements**

From time to time, the Company may publish forward-lookingstatements relative to matters such as, including without limitation,anticipated financial performance, business prospects, technologicaldevelopments, new products, research and development activities and similarmatters. The Private Securities Litigation Reform Act of 1995 provides a safeharbor for forward-looking statements. Forward-looking statementsare generally accompanied by words such as “estimate,” “project,” “predict,” “believe,”“expect,” “anticipate” or other words that convey the uncertainty of futureevents or outcomes.

Various statements contained in this report, includingthose that express a belief, expectation or intention, as well as those thatare not statements of historical fact are, or may be deemed to be, forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These forward-looking statements speak only as of the date ofthis report. Unless required by law, the Company does not undertake any obligationto update these statements and cautions against any undue reliance on them.These forward-looking statements are based on current expectations andassumptions about future events. While management considers these expectationsand assumptions to be reasonable, they are inherently subject to significantbusiness, economic, competitive, regulatory and other risks, contingencies anduncertainties, most of which are difficult to predict and many of which arebeyond the Company’s control. There can be no assurances that these events willoccur or that the Company’s results will be as estimated.

Important factors thatcould cause actual results to differ materially from those discussed in suchforward-looking statements include:

·  uncertainty regarding the effect or outcome ofthe Company’s decision to explore strategic alternatives;

·  general economic factors including, but notlimited to, changes in interest rates, foreign currency translation rates,consumer confidence, trends in disposable income, changes in consumer demandfor goods produced, and cyclical or other downturns;

·  substantial debt levels and potentialinability to maintain sufficient liquidity to finance the Company’s operationsand make necessary capital expenditures;

·  inability to meet existing debt covenants;

·  information and technological advances;

·       changesin environmental laws and regulations;

·       costand availability of raw materials, labor and natural and other resources andthe inability to pass raw material cost increases along to customers;

·       domesticand foreign competition;

·       relianceon major customers and suppliers; and

·       risksrelating to operations in foreign jurisdictions.

2

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**ITEM 1.**                 FINANCIALSTATEMENTS

**POLYMERGROUP, INC.**

**CONSOLIDATEDBALANCE SHEETS (Unaudited)**

**(InThousands, Except Share Data)**

| ** **                                                                                                                                                     | ** ** | **October 1,** | ** ** | **January 1,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                                                                                     | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| **ASSETS**                                                                                                                                                     |       |                |       |                |       |
| Current assets:                                                                                                                                                |       |                |       |                |       |
| Cash and cash equivalents                                                                                                                                      |       | $                   | 27,525     |                | $          | 41,296 |   |
| Accounts receivable, net                                                                                                                                       |       | 123,646             |       | 113,491             |       |
| Inventories                                                                                                                                                    |       | 111,266             |       | 106,349             |       |
| Deferred income taxes                                                                                                                                          |       | 235                 |       | 226                 |       |
| Other current assets                                                                                                                                           |       | 32,872              |       | 37,140              |       |
| Total current assets                                                                                                                                           |       | 295,544             |       | 298,502             |       |
| Property, plant and  equipment, net                                                                                                                            |       | 412,809             |       | 402,603             |       |
| Intangibles and loan  acquisition costs, net                                                                                                                   |       | 44,406              |       | 48,819              |       |
| Deferred income taxes                                                                                                                                          |       | —              |       | 1,489               |       |
| Other assets                                                                                                                                                   |       | 6,922               |       | 3,145               |       |
| Total assets                                                                                                                                                   |       | $                   | 759,681    |                | $          | 754,558 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                 |       |                |       |                |       |
| Current liabilities:                                                                                                                                           |       |                |       |                |       |
| Short-term borrowings                                                                                                                                          |       | $                   | 6,013      |                | $          | 6,981 |   |
| Accounts payable                                                                                                                                               |       | 67,138              |       | 63,773              |       |
| Accrued liabilities                                                                                                                                            |       | 37,471              |       | 34,570              |       |
| Income taxes payable                                                                                                                                           |       | 1,644               |       | 2,427               |       |
| Current portion of long-term  debt                                                                                                                             |       | 3,031               |       | 3,413               |       |
| Total current liabilities                                                                                                                                      |       | 115,297             |       | 111,164             |       |
| Long-term debt                                                                                                                                                 |       | 401,329             |       | 403,560             |       |
| Deferred income taxes                                                                                                                                          |       | 66,795              |       | 65,468              |       |
| Other noncurrent liabilities                                                                                                                                   |       | 21,944              |       | 27,319              |       |
| Total liabilities                                                                                                                                              |       | 605,365             |       | 607,511             |       |
| Minority interests                                                                                                                                             |       | 16,048              |       | 14,912              |       |
| 16% Series A convertible  pay-in-kind preferred shares—0 and 52,716 shares issued and outstanding at  October 1, 2005 and January 1, 2005       |       | —              |       | 58,286              |       |
| Shareholders’ equity:                                                                                                                                     |       |                |       |                |       |
| Class A common  stock—18,867,190 and 10,130,477 shares issued and outstanding at October 1,  2005 and January 1, 2005, respectively             |       | 188                 |       | 101                 |       |
| Class B convertible common  stock—154,966 and 193,390 shares issued and outstanding at October 1, 2005  and January 1, 2005, respectively  |       | 2                   |       | 2                   |       |
| Class C convertible  common stock—31,131 and 54,194 shares issued and outstanding at October 1,  2005 and January 1, 2005, respectively    |       | —              |       | 1                   |       |
| Class D convertible  common stock—0 shares issued and outstanding                                                                                    |       | —              |       | —              |       |
| Class E convertible  common stock—0 shares issued and outstanding                                                                                    |       | —              |       | —              |       |
| Additional paid-in capital                                                                                                                                     |       | 165,389             |       | 77,219              |       |
| Retained earnings (deficit)                                                                                                                                    |       | (52,389             | )          | (33,820             | )          |
| Accumulated other  comprehensive income                                                                                                                        |       | 25,078              |       | 30,346              |       |
| Total shareholders’ equity                                                                                                                                |       | 138,268             |       | 73,849              |       |
| Total liabilities and  shareholders’ equity                                                                                                               |       | $                   | 759,681    |                | $          | 754,558 |   |

 

See Accompanying Notes.

3

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**POLYMER GROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)Three Months Ended October 1, 2005 and October 2, 2004(In Thousands, Except Per Share Data)**

| ** **                                                  | ** ** | **Three Months** | ** ** | **Three Months** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **Ended**             | ** ** | **Ended**             | ** ** |
| ** **                                                  | ** ** | **October 1,**   | ** ** | **October 2,**   | ** ** |
| ** **                                                  | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Net sales                                                   |       |                  | $          | 228,220               |       |   |   | $ | 204,554 |   |   |
| Cost of goods sold                                          |       |                  | 189,315    |                  |       |   | 169,020 |   |   |
| Gross profit                                                |       |                  | 38,905     |                  |       |   | 35,534 |   |   |
| Selling, general and  administrative expenses               |       |                  | 25,431     |                  |       |   | 22,561 |   |   |
| Plant realignment  costs                                    |       |                  | —     |                  |       |   | 222 |   |   |
| Asset impairment  charges                                   |       |                  | —     |                  |       |   | 1,710 |   |   |
| Foreign currency  loss, net                                 |       |                  | 652        |                  |       |   | 429 |   |   |
| Arbitration  settlement, net                                |       |                  | —     |                  |       |   | 282 |   |   |
| Operating income                                            |       |                  | 12,822     |                  |       |   | 10,330 |   |   |
| Other expense:                                              |       |                  |       |                  |       |   |   |   |   |
| Interest expense, net                                       |       |                  | 8,161      |                  |       |   | 7,783 |   |   |
| Minority interests                                          |       |                  | 1,025      |                  |       |   | 415 |   |   |
| Other, net                                                  |       |                  | 80         |                  |       |   | 676 |   |   |
| Income before income  tax expense                           |       |                  | 3,556      |                  |       |   | 1,456 |   |   |
| Income tax expense                                          |       |                  | 3,362      |                  |       |   | 2,052 |   |   |
| Net income (loss)                                           |       |                  | 194        |                  |       |   | (596 | ) |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                  | 14,791     |                  |       |   | 1,953 |   |   |
| Loss applicable to  common shareholders                     |       |                  | $          | (14,597               | )          |   |   | $ | (2,549 | ) |   |
| Loss per common share:                                      |       |                  |       |                  |       |   |   |   |   |
| Basic                                                       |       |                  | $          | (1.17                 | )          |   |   | $ | (0.25 | ) |   |
| Diluted                                                     |       |                  | $          | (1.17                 | )          |   |   | $ | (0.25 | ) |   |

** **

See Accompanying Notes.

4

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**POLYMER GROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)Nine Months Ended October 1, 2005 and October 2, 2004(In Thousands, Except Per Share Data)**

| ** **                                                  | ** ** | **Nine Months** | ** ** | **Nine Months** | ** ** |
|-------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                  | ** ** | **Ended**            | ** ** | **Ended**            | ** ** |
| ** **                                                  | ** ** | **October 1,**  | ** ** | **October 2,**  | ** ** |
| ** **                                                  | ** ** | **2005**             | ** ** | **2004**             | ** ** |
| Net sales                                                   |       |                 | $          | 708,434              |       |   |   | $ | 621,199 |   |   |
| Cost of goods sold                                          |       |                 | 583,669    |                 |       |   | 510,910 |   |   |
| Gross profit                                                |       |                 | 124,765    |                 |       |   | 110,289 |   |   |
| Selling, general and  administrative expenses               |       |                 | 78,760     |                 |       |   | 73,633 |   |   |
| Plant realignment  costs                                    |       |                 | 9          |                 |       |   | 1,463 |   |   |
| Asset impairment  charges                                   |       |                 | —     |                 |       |   | 1,710 |   |   |
| Foreign currency  loss, net                                 |       |                 | 746        |                 |       |   | 1,417 |   |   |
| Arbitration  settlement, net                                |       |                 | —     |                 |       |   | (13,112 | ) |   |
| Operating income                                            |       |                 | 45,250     |                 |       |   | 45,178 |   |   |
| Other expense (income):                                     |       |                 |       |                 |       |   |   |   |   |
| Interest expense, net                                       |       |                 | 24,195     |                 |       |   | 32,317 |   |   |
| Minority interests                                          |       |                 | 3,013      |                 |       |   | 1,522 |   |   |
| Write-off of loan acquisition costs                         |       |                 | —     |                 |       |   | 5,022 |   |   |
| Other, net                                                  |       |                 | (685       | )                    |       |   | 1,781 |   |   |
| Income before income  tax expense                           |       |                 | 18,727     |                 |       |   | 4,536 |   |   |
| Income tax expense                                          |       |                 | 9,297      |                 |       |   | 8,177 |   |   |
| Net income (loss)                                           |       |                 | 9,430      |                 |       |   | (3,641 | ) |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                 | 27,999     |                 |       |   | 3,224 |   |   |
| Loss applicable to  common shareholders                     |       |                 | $          | (18,569              | )          |   |   | $ | (6,865 | ) |   |
| Loss per common share:                                      |       |                 |       |                 |       |   |   |   |   |
| Basic                                                       |       |                 | $          | (1.67                | )          |   |   | $ | (0.71 | ) |   |
| Diluted                                                     |       |                 | $          | (1.67                | )          |   |   | $ | (0.71 | ) |   |

 

See Accompanying Notes.

5

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**POLYMER GROUP, INC.CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’EQUITY AND COMPREHENSIVE INCOME (LOSS) (Unaudited)For the Nine Months Ended October 1, 2005(In Thousands)**

| ** **                                                                            | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **Accumulated**   | ** ** | ** ** |    |   | ** **        | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|---------------|------------|-------------------|------------|------------|---------|--------|-------------------|------------|
| ** **                                                                            | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **Other**         | ** ** | ** ** |    |   |              | ** ** |
| ** **                                                                            | ** ** | ** ** | ** ** | **Additional** | ** ** | **Retained/** | ** ** | **Comprehensive** | ** ** | ** ** |    |   |              | ** ** |
| ** **                                                                            | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Earnings**  | ** ** | **Income/**       | ** ** | ** ** |    |   | **Comprehensive** | ** ** |
| ** **                                                                            | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **(Deficit)** | ** ** | **(Loss)**        | ** ** | **Total**  |    |   | **Income/(Loss)** | ** ** |
| Balance, January 1, 2005, audited                                                |       |       | $          | 104            |       |          |       | $                 | 77,219     |       |    |   | $                 | (33,820    | ) |   |   | $ | 30,346 |   |   | $ | 73,849 |   |   |   |   |   |   |
| Net income                                                                            |       |       | —     |           |       |          | —     |              |       |       | 9,430   |   |              |       | — |   |   | 9,430 |   |   |   | $ | 9,430 |   |   |
| Accrued and paid-in-kind dividends on PIK preferred  shares                           |       |       | —     |           |       |          | 23,349     |              |       |       | (27,999 | )      |              |       | — |   |   | (4,650 | ) |   |   | — |   |   |
| Currency translation adjustment, net of taxes                                         |       |       | —     |           |       |          | —     |              |       |       | —  |   |              |       | (7,296 | ) |   | (7,296 | ) |   |   | (7,296 | ) |   |
| Cash flow hedge adjustment, net of reclassification  adjustment                       |       |       | —     |           |       |          | —     |              |       |       | —  |   |              |       | 2,028 |   |   | 2,028 |   |   |   | 2,028 |   |   |
| Compensation recognized on stock options and  restricted stock grants                 |       |       | —     |           |       |          | 1,980      |              |       |       | —  |   |              |       | — |   |   | 1,980 |   |   |   | — |   |   |
| Conversions and redemptions of PIK preferred shares to/for  Class A common stock |       |       | 86         |           |       |          | 62,841     |              |       |       | —  |   |              |       | — |   |   | 62,927 |   |   |   | — |   |   |
| Balance, October 1, 2005                                                         |       |       | $          | 190            |       |          |       | $                 | 165,389    |       |    |   | $                 | (52,389    | ) |   |   | $ | 25,078 |   |   | $ | 138,268 |   |   | $ | 4,162 |   |   |

 

See Accompanying Notes.

6

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**POLYMER GROUP, INC.CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)(In Thousands)**

| ** **                                                                                | ** ** | **Nine Months  Ended    October 1, 2005** | ** ** | **Nine Months  Ended    October 2, 2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| Operating activities:                                                                     |       |                                                               |       |                                                               |       |   |   |   |   |
| Net income (loss)                                                                         |       |                                                               | $          | 9,430                                                              |       |   |   | $ | (3,641 | ) |   |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |       |                                                               |       |                                                               |       |   |   |   |   |
| Deferred income taxes                                                                     |       |                                                               | 5,957      |                                                               |       |   | 1,074 |   |   |
| Write-off of loan acquisition costs                                                       |       |                                                               | —     |                                                               |       |   | 5,022 |   |   |
| Depreciation and amortization                                                             |       |                                                               | 42,697     |                                                               |       |   | 39,547 |   |   |
| Asset impairment charges                                                                  |       |                                                               | —     |                                                               |       |   | 1,710 |   |   |
| Noncash interest and compensation                                                         |       |                                                               | 1,980      |                                                               |       |   | 2,190 |   |   |
| Changes in operating  assets and liabilities:                                             |       |                                                               |       |                                                               |       |   |   |   |   |
| Accounts receivable, net                                                                  |       |                                                               | (13,170    | )                                                                  |       |   | (7,454 | ) |   |
| Inventories                                                                               |       |                                                               | (7,507     | )                                                                  |       |   | (3,484 | ) |   |
| Other current assets                                                                      |       |                                                               | 3,914      |                                                               |       |   | 367 |   |   |
| Accounts payable and accrued liabilities                                                  |       |                                                               | 8,811      |                                                               |       |   | (3,525 | ) |   |
| Other, net                                                                                |       |                                                               | (5,027     | )                                                                  |       |   | 4,480 |   |   |
| Net cash provided by operating activities                                                 |       |                                                               | 47,085     |                                                               |       |   | 36,286 |   |   |
| Investing activities:                                                                     |       |                                                               |       |                                                               |       |   |   |   |   |
| Purchases of property, plant and equipment                                                |       |                                                               | (56,861    | )                                                                  |       |   | (13,206 | ) |   |
| Proceeds from sale of assets                                                              |       |                                                               | 354        |                                                               |       |   | 783 |   |   |
| Net cash used in investing activities                                                     |       |                                                               | (56,507    | )                                                                  |       |   | (12,423 | ) |   |
| Financing activities:                                                                     |       |                                                               |       |                                                               |       |   |   |   |   |
| Proceeds from issuance of debt                                                            |       |                                                               | 38,536     |                                                               |       |   | 485,217 |   |   |
| Repayment of debt                                                                         |       |                                                               | (42,110    | )                                                                  |       |   | (488,770 | ) |   |
| Loan acquisition costs and other financing costs                                          |       |                                                               | (50        | )                                                                  |       |   | (12,051 | ) |   |
| Net cash used in financing activities                                                     |       |                                                               | (3,624     | )                                                                  |       |   | (15,604 | ) |   |
| Effect of exchange  rate changes on cash                                                  |       |                                                               | (725       | )                                                                  |       |   | (42 | ) |   |
| Net (decrease)  increase in cash and cash equivalents                                     |       |                                                               | (13,771    | )                                                                  |       |   | 8,217 |   |   |
| Cash and cash  equivalents at beginning of period                                         |       |                                                               | 41,296     |                                                               |       |   | 21,336 |   |   |
| Cash and cash  equivalents at end of period                                               |       |                                                               | $          | 27,525                                                             |       |   |   | $ | 29,553 |   |   |

 

See Accompanying Notes.

7

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**POLYMER GROUP, INC.**

**Notes to Consolidated Financial Statements**

**Note 1.**   Principlesof Consolidation and Financial Statement Information

*Principles ofConsolidation*

Polymer Group, Inc. (the “Company”) is a publicly-traded,multinational manufacturer, marketer and seller of nonwoven and orientedpolyolefin products. The Company’s main sources of revenue are the sales ofprimary and intermediate products to the medical, hygiene, wipes and industrialand specialty markets.

The accompanying Consolidated Financial Statementsinclude the accounts of Polymer Group, Inc. and all majority-ownedsubsidiaries after elimination of all significant intercompany accounts andtransactions. The accounts of all foreign subsidiaries have been included onthe basis of fiscal periods ended three months or less prior to the dates ofthe consolidated balance sheets. All amounts are presented in U.S. dollars,unless otherwise noted.

The accompanying unauditedinterim Consolidated Financial Statements and related notes should be read inconjunction with the Consolidated Financial Statements of the Company andrelated notes as contained in the Annual Report on Form 10-K for theperiod ended January 1, 2005. In the judgment of management, theseunaudited interim Consolidated Financial Statements include all adjustments ofa normal recurring nature and accruals necessary for a fair presentation ofsuch statements. The Consolidated Balance Sheet data included herein as of January 1,2005 has been derived from the audited financial statements included in theCompany’s Annual Report on Form 10-K.

*Reclassification*

Certain amounts previouslypresented in the Consolidated Financial Statements for prior periods have beenreclassified to conform with current period classification.

*Changes in Estimates*

During fiscal 2005, theestimated useful lives of certain machinery and equipment utilized in theCompany’s operations were reduced to reflect the technological status andmarket conditions of certain aspects of the Company’s business. The effect ofthese changes was increased depreciation charges of $1.6 million and$2.7 million for the three and nine months ended October 1, 2005,respectively.

*Revenue Recognition*

Revenue from product sales isrecognized when title and risks of ownership pass to the customer. This isgenerally on the date of shipment to the customer, or upon delivery to a placenamed by the customer, dependent upon contract terms and when collectibility isreasonably assured and pricing is fixed or determinable. Revenue includesamounts billed to customers for shipping and handling. Provision for rebates,promotions, product returns and discounts to customers is recorded as areduction in determining revenue in the same period that the revenue isrecognized.

*Accumulated OtherComprehensive Income*

Accumulated othercomprehensive income of $25.1 million at October 1, 2005 consisted of$22.7 million of currency translation gains and $2.4 million of cashflow hedge gains, all net of applicable income tax. Accumulated othercomprehensive income of $30.3 million at January 1, 2005 

8

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

consisted of$30.0 million of currency translation gains and $0.3 million of cashflow hedge gains, all net of applicable income tax.

*New AccountingPronouncements*

In May 2004, the FASB issued FASB Staff Position No. 106-2,“Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003” (“FSP 106-2”). FSP 106-2permits a sponsor of a postretirement health care plan that provides aprescription drug benefit to make a one-time election to defer accounting forthe effects of the Medicare Prescription Drug, Improvement and ModernizationAct of 2003 (the “Act”), which was signed into law on December 8, 2003.The Act introduced a prescription drug benefit under Medicare and federalsubsidies to sponsors of retiree health care benefit plans that provide abenefit that is at least actuarially equivalent to that of Medicare. Aspermitted under FSP 106-2, the Company made a one-time election todefer accounting for the effect of the Act and as more fully explained in Note9 to the Consolidated Financial Statements, in December 2004 the Companyapproved plan amendments curtailing or eliminating various postretirementbenefits in the U.S. As a result, the amounts included in the ConsolidatedFinancial Statements related to the Company’s postretirement benefit plans donot reflect the effects of the Act.

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs” (“SFAS No. 151”). This statement amends earlier guidanceto require that abnormal freight, handling and spoilage costs be recognized ascurrent-period charges rather than capitalized as an inventory cost. Inaddition, SFAS No. 151 requires that the allocation of fixedproduction overhead costs be based on the normal capacity of the productionfacilities. SFAS No. 151 is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. The Company is currentlyanalyzing the new guidance and does not expect it to have a material impact onits financial position or results of operations.

In December 2004, the FASB issued a revision toSFAS No. 123, “Accounting for Stock-Based Compensation.” The revision,entitled SFAS No. 123R, “Share-Based Payment,” is effective for all awardsgranted, modified, repurchased or canceled after June 15, 2005 andrequires a public entity to initially measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award and to remeasure the fair value of that awardsubsequently at each reporting date. Changes in the fair value during therequisite service period will be recognized as compensation cost over theperiod. The grant date fair value is to be estimated using option-pricingmodels adjusted for the unique characteristics of those instruments. In April 2005,the Securities and Exchange Commission issued a final rule thatregistrants must adopt SFAS No. 123R’s fair value method ofaccounting no later than the beginning of the fiscal year beginning after June 15,2005. The Company is currently analyzing the new guidance and does not expectit to have a material impact on its financial position or results ofoperations.

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections.” Thisstatement amends earlier guidance and requires retrospective application toprior periods’ financial statements of a voluntary change in accountingprinciple unless it is impracticable. In addition, SFAS No. 154requires that a change in the method of depreciation or amortization for along-lived, non-financial asset be accounted for as a change in accountingestimate that is affected by a change in accounting principle. SFAS No. 154is effective for accounting changes and corrections of errors made in fiscalyears beginning after December 15, 2005. The Company is currentlyanalyzing the new 

9

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

guidance anddoes not expect it to have a material impact on its financial position orresults of operations.

**Note 2.**   Concentrationof Credit Risks and Accounts Receivable Securitization Agreements

Accountsreceivable potentially expose the Company to concentration of credit risk, asdefined by SFAS No. 105, “Disclosure of Information about FinancialInstruments with Off-Balance Sheet Risk and Financial Instruments withConcentration of Credit Risk.” Sales to the Procter & Gamble Company (“P&G”)accounted for approximately 14% and 12% of the Company’s sales in the firstnine months of 2005 and 2004, respectively. The Company provides credit in thenormal course of business and performs ongoing credit evaluations on itscustomers’ financial condition as deemed necessary, but generally does notrequire collateral to support such receivables. Customer balances areconsidered past due based on contractual terms and the Company does not accrueinterest on the past due balances. The allowance for doubtful accounts wasapproximately $10.3 million and $9.7 million at October 1, 2005 and January 1,2005, respectively, which management believes is adequate to provide for creditloss in the normal course of business, as well as losses for customers who havefiled for protection under bankruptcy laws. Once management determines that thereceivables are not recoverable, the amounts are removed from the financialrecords along with the corresponding reserve balance.

On November 15, 2004, the Company entered into afactoring agreement to sell without recourse, certain receivables to anunrelated third-party financial institution. Under the terms of the factoringagreement, the maximum amount of outstanding advances for the purchase ofdomestic receivables at any one time is $15.0 million, which limitation issubject to change based on the level of eligible receivables, restrictions onconcentrations of receivables and the historical performance of the receivablessold. During the first nine months of 2005, approximately $92.4 million ofreceivables had been sold under the terms of the factoring agreement. The saleof these receivables accelerated the collection of the Company’s cash, reducedcredit exposure and lowered the Company’s net borrowing costs. Sales ofaccounts receivable are reflected as a reduction of *Accounts receivable, net* in the Consolidated Balance Sheetsand a gain or loss is reflected in the Consolidated Statements of Operations onsuch sale, as they meet the applicable criteria of SFAS No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishment ofLiabilities” (“SFAS No. 140”). The amount due from the factoring company,net of advances received from the factoring company, was $4.2 million and$7.4 million at October 1, 2005 and January 1, 2005,respectively, and is shown in *Other currentassets* in the Consolidated Balance Sheets. The Company paysfactoring fees associated with the sale of receivables based on the dollarvalue of the receivables sold. Costs related to this program for the three andnine months ended October 1, 2005 were $0.1 million and$0.3 million, respectively, and are included in *Other expense, net* in the Consolidated Statement ofOperations.

10

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

**Note 3.**   BusinessRestructuring

The Company continuedits restructuring initiatives in 2004 by curtailing production of certain ofits European assets and eliminating several production lines in the Canadianoperations of its Oriented Polymers Division. The European and Canadianrestructuring efforts in 2004 included the reduction of approximately 160positions.

Accrued costs for restructuring efforts are included in *Accrued liabilities* in the Consolidated Balance Sheets. Asummary of the business restructuring activity during the first nine months offiscal 2005 is presented in the following table (in thousands):

| Balance accrued at beginning of year |   | $    | 561    |   |
|--------------------------------------|--------|------|--------|--------|
| 2005 plant realignment costs         |   | 9    |   |
| Cash payments                        |   | (359 | )      |
| Adjustments                          |   | (29  | )      |
| Balance accrued at end of period     |   | $    | 182    |   |

 

**Note 4.**   Inventories

Inventories are stated at the lower of cost or marketprimarily using the first-in, first-out method of accounting and consist of thefollowing (in thousands):

| ** **      | ** ** | **October 1,  2005** | ** ** | **January 1,  2005** | ** ** |
|-----------------|------------|---------------------------|------------|---------------------------|------------|
| Finished goods  |       | $                         | 55,522     |                      | $          | 50,482 |   |
| Work in process |       | 19,055                    |       | 15,612                    |       |
| Raw materials   |       | 36,689                    |       | 40,255                    |       |
|            |       | $                         | 111,266    |                      | $          | 106,349 |   |

 

Inventories are net of reserves of approximately$10.1 million and $8.2 million at October 1, 2005 and January 1,2005, respectively. Such reserves are primarily for obsolete and slow-movinginventories and other valuation allowances. Management believes that thereserves are adequate to provide for losses in the normal course of business.

**Note 5.**   Intangibles andLoan Acquisition Costs

Intangibles and loanacquisition costs consist of the following (in thousands):

| ** **                       | ** ** | **October 1,** | ** ** | **January 1,** | ** ** |
|----------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                       | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| Cost:                            |       |                |       |                |       |   |   |   |   |
| Proprietary technology           |       |                | $          | 30,094              |       |   |   | $ | 29,852 |   |   |
| Goodwill                         |       |                | 15,632     |                |       |   | 15,632 |   |   |
| Loan acquisition costs and other |       |                | 15,561     |                |       |   | 15,511 |   |   |
|                             |       |                | 61,287     |                |       |   | 60,995 |   |   |
| Less accumulated  amortization   |       |                | (16,881    | )                   |       |   | (12,176 | ) |   |
|                             |       |                | $          | 44,406              |       |   |   | $ | 48,819 |   |   |

 

11

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

Componentsof amortization expense are shown in the table below (in thousands):

| ** **                                                                                    | ** ** | **Three**           | ** ** | **Three**           | ** ** | **Nine**            | ** ** | **Nine**            | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                    | ** ** | **Months**          | ** ** | **Months**          | ** ** | **Months**          | ** ** | **Months**          | ** ** |
| ** **                                                                                    | ** ** | **Ended**           | ** ** | **Ended**           | ** ** | **Ended**           | ** ** | **Ended**           | ** ** |
| ** **                                                                                    | ** ** | **October 1,** | ** ** | **October 2,** | ** ** | **October 1,** | ** ** | **October 2,** | ** ** |
| ** **                                                                                    | ** ** | **2005**            | ** ** | **2004**            | ** ** | **2005**            | ** ** | **2004**            | ** ** |
| Amortization of:                                                                              |       |                |       |                |       |                |       |                |       |   |   |   |   |   |   |   |   |
| Intangibles with finite lives, included in selling, general  and administrative expenses |       |                | $          | 1,068               |       |                |       | $                   | 1,428      |   |   |   | $ | 3,186 |   |   |   | $ | 4,314 |   |   |
| Loan acquisition costs included in interest expense, net                                      |       |                | 512        |                |       |                | 486        |                |       |   | 1,519 |   |   |   | 1,456 |   |   |
| Total amortization  expense                                                                   |       |                | $          | 1,580               |       |                |       | $                   | 1,914      |   |   |   | $ | 4,705 |   |   |   | $ | 5,770 |   |   |

 

Intangibles are amortized overperiods ranging from 5 to 17 years. Loan acquisition costs are amortizedover the life of the related debt.

**Note 6.**   AccruedLiabilities

Accrued liabilities in theConsolidated Balance Sheets included salaries, wages and other fringe benefitsof $18.9 million and $20.4 million as of October 1, 2005 and January 1,2005, respectively.

**Note 7.**   Debt

Long-termdebt consists of the following (in thousands):

| ** **                                                                                                                                                                             | ** ** | **October 1,** | ** ** | **January 1,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| Senior Secured Bank  Facility, interest rates for U.S. dollar borrowings are based on a  specified base plus a specified margin and are subject to certain terms and  conditions: |       |                |       |                |       |
| First Lien Term Loan—interest at 7.25% as of October 1, 2005;  due in quarterly payments of $750.0 thousand, with the balance  due April 27, 2010        |       | $                   | 279,250    |                | $          | 281,500 |   |
| Second Lien Term Loan—interest at 10.25% as of October 1, 2005;  due April 27, 2011                                                                                |       | 125,000             |       | 125,000             |       |
| Other                                                                                                                                                                                  |       | 110                 |       | 473                 |       |
|                                                                                                                                                                                   |       | 404,360             |       | 406,973             |       |
| Less: Current  maturities                                                                                                                                                              |       | (3,031              | )          | (3,413              | )          |
|                                                                                                                                                                                   |       | $                   | 401,329    |                | $          | 403,560 |   |

 

*Senior Secured BankFacility*

TheCompany’s Senior Secured Bank Facility (the “Bank Facility”), which was enteredinto on April 27, 2004, consists of a $50.0 million secured revolvingcredit facility, a $300.0 million senior secured first lien term loan anda $125.0 million senior secured second lien term loan. The proceedstherefrom were used to fully repay indebtedness under the Company’s previousRestructured Credit Facility and pay related fees and expenses.

12

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

Allborrowings under the Bank Facility are U.S. dollar denominated and areguaranteed, on a joint and several basis, by each and all of the direct andindirect domestic subsidiaries of the Company and supported by the pledge ofstock of certain non-domestic subsidiaries of the Company. The Bank Facilityand the related guarantees are secured by: (i) a lien on substantially allof the assets of the Company, its domestic subsidiaries and certain of itsnon-domestic subsidiaries; (ii) a pledge of all or a portion of the stockof the domestic subsidiaries of the Company and of certain non-domesticsubsidiaries of the Company; and (iii) a pledge of certain securedintercompany notes. Commitment fees under the Bank Facility are equal to 0.50%of the daily unused amount of the revolving credit commitment. The BankFacility limits restricted payments to $5.0 million, including cashdividends on all securities, in the aggregate since the effective date of theBank Facility. The Bank Facility contains covenants and events of defaultcustomary for financings of this type, including leverage and interest expensecoverage covenants. At October 1, 2005, the Company was in compliance withall such covenants and expects to remain in compliance through the remainder offiscal 2005.

The loanrequires the Company to apply a percentage of proceeds from excess cash flows,as defined by the Bank Facility and determined based on year-end results, to reduceits then outstanding balances under the Bank Facility. Excess cash flowsrequired to be applied to the repayment of the Bank Facility are generallycalculated as 50.0% of the net amount of the Company’s available cash generatedfrom operations adjusted for the cash effects of interest, taxes, capitalexpenditures, changes in working capital and certain other items. Since theamounts of excess cash flows for future periods are based on year-end data andnot determinable, only the mandatory payments of $750.0 thousand perquarter have been classified as a current liability. Additionally, no excesscash flow payment was required to be made with respect to fiscal 2004 and, dueto the planned magnitude of the major capital expenditures for fiscal 2005, anyexcess cash flow requirement with respect to fiscal 2005 is not expected to besignificant.

Theinterest rate applicable to borrowings under the Bank Facility is based onthree-month LIBOR plus a specified margin. The applicable margin forborrowings under the revolving credit facility is 300 basis points, themargin for the first lien term loan is 325 basis points and the margin for thesecond-lien term loan is 625 basis points. The Company may elect to use analternate base rate for its borrowings under the revolving credit facilitybased on the bank’s base rate plus 200 basis points. The Company had nooutstanding borrowings under the revolving credit facility at either October 1,2005 or January 1, 2005. The Company’s average borrowings under therevolving credit facility, which had an effective interest rate ofapproximately 8.21%, were $5.4 million for the period from January 2,2005 to October 1, 2005. The revolving portion of the Bank Facilitymatures on April 27, 2009.

Asrequired by the terms of the Bank Facility, the Company entered into a cashflow hedge agreement, effectively converting $212.5 million of notionalprincipal amount of debt from a variable LIBOR rate to a fixed LIBOR rate of3.383%. The cash flow hedge agreement terminates on May 8, 2007 and isdescribed more fully in Note 12 to the Consolidated Financial Statements.

Subject to certain terms and conditions, a maximum of$20.0 million of the Bank Facility may be used for revolving letters ofcredit. As of October 1, 2005, the Company had $10.2 million ofstandby and documentary letters of credit outstanding under this facility.Approximately $3.0 million was related to the requirements of theshort-term borrowing arrangements of the Company’s China-based majorityowned subsidiary (“Nanhai”). Other letters of credit are in place to provideadded assurance for certain raw material vendors and administrative serviceproviders. None of these letters of credit had been drawn on at October 1,2005.

13

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

*Subsidiary Indebtedness*

Nanhaihas a short-term credit facility (denominated in U.S. dollars and Chineserenminbi) with a financial institution in China which matured in June 2005and was renegotiated, with similar terms and conditions, for an additional twelve-monthperiod expiring in June 2006. The amount of outstanding indebtedness underthe facility was $5.9 million and $5.8 million at October 1,2005 and January 1, 2005, respectively. The annual average interest rateon the new facility is approximately 4.49%. The Nanhai indebtedness issupported by a $3.0 million letter of credit issued by the Company’s agentbank and additional collateral was granted through the pledge of the Nanhaiassets. In addition, Nanhai had outstanding bankers’ acceptances totaling$0.1 million and $1.2 million at October 1, 2005 andJanuary 1, 2005, respectively. These notes, which are denominated inChinese renminbi, mature within three months and are subject to a 0.5%transaction fee. These borrowings are shown as *Short-term borrowings*in the Consolidated Balance Sheets.

At January 1, 2005, theCompany’s Argentina-based majority owned subsidiary had a credit facilitydenominated in U.S. dollars totaling approximately $0.4 million (all withcurrent maturities). These borrowings were fully repaid in the first quarter of2005.

**Note 8.**   Income Taxes

The Company recognized income tax expense of $3.4million and $9.3 million for the three and nine months ended October 1,2005, respectively, on consolidated income before income taxes of$3.6 million and $18.7 million for the three and nine months ended October 1,2005, respectively. This income tax expense is significantly higher than theU.S. federal statutory rate primarily due to losses in the U.S. and certainforeign jurisdictions for which no income tax benefits were recognized. Additionally,the income tax expense is impacted by foreign withholding taxes, for which taxcredits are not anticipated, U.S. state income taxes and foreign taxescalculated at statutory rates less than the U.S. federal statutory rate.

During the three and nine months ended October 2,2004, the Company recognized an income tax expense of $2.1 million and $8.2million, respectively, on consolidated income before income taxes of $1.5million and $4.5 million, respectively. The income tax expense wasprimarily due to foreign withholding taxes, for which tax credits are notanticipated, U.S. state income taxes, and no significant income tax benefitrecognized for losses incurred in the U.S. and certain foreign jurisdictions.

Income tax refunds receivablewere $11.7 million and $15.4 million at October 1, 2005 and January 1,2005, respectively, and are largely comprised of amounts due from European taxjurisdictions. These amounts are included in *Othercurrent assets* on the Consolidated Balance Sheets.

**Note 9.**   PensionBenefits and Postretirement Plans

The Company and its subsidiaries sponsor multipledefined benefit plans and other postretirement benefits that cover certainemployees. Benefits are primarily based on years of service and the employee’scompensation. It is the Company’s policy to fund such plans in accordance withapplicable laws and regulations.

14

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

Componentsof net periodic benefit costs for the three and nine months ended October 1,2005 and October 2, 2004 are as follows (in thousands):

| ** **                                                | ** ** | **Pension Benefit Plans** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended** | ** ** |
| ** **                                                | ** ** | **October 1,  2005**           | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** |
| Current service costs                                     |       |                                | $          | 626 |   |   |   | $ | 583 |   |   |   | $ | 1,917 |   |   |   | $ | 1,743 |   |   |
| Interest costs on  projected benefit obligation and other |       |                                | 1,359      |   |   |   | 1,242 |   |   |   | 4,138 |   |   |   | 3,713 |   |   |
| Return on plan assets                                     |       |                                | (1,486     | ) |   |   | (1,321 | ) |   |   | (4,529 | ) |   |   | (3,950 | ) |   |
| Amortization of  transition obligation and other          |       |                                | 7          |   |   |   | (3 | ) |   |   | 20 |   |   |   | (9 | ) |   |
| Periodic benefit cost, net                                |       |                                | $          | 506 |   |   |   | $ | 501 |   |   |   | $ | 1,546 |   |   |   | $ | 1,497 |   |   |

 

| ** **                                       | ** ** | **Postretirement Benefit Plans** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended**           | ** ** | **Nine Months Ended** | ** ** |
| ** **                                       | ** ** | **October 1,  2005**                  | ** ** | **October 2,  2004** | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** |
| Current service costs                            |       |                                       | $          | 46 |   |   |   | $ | 101 |   |   |   | $ | 136 |   |   |   | $ | 303 |   |   |
| Interest costs on  projected benefit obligation  |       |                                       | 123        |   |   |   | 216 |   |   |   | 366 |   |   |   | 644 |   |   |
| Amortization of  transition obligation and other |       |                                       | (29        | ) |   |   | — |   |   |   | (85 | ) |   |   | — |   |   |
| Periodic benefit cost, net                       |       |                                       | $          | 140 |   |   |   | $ | 317 |   |   |   | $ | 417 |   |   |   | $ | 947 |   |   |

 

As of October 1, 2005, the Company contributed$5.3 million to its pension plans for the 2005 benefit year. The Companypresently anticipates contributing an additional $0.6 million to fund itspension plans in 2005, for a total of $5.9 million.

On December 8, 2003, theMedicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”)was enacted and introduced a prescription drug benefit under Medicare as wellas a subsidy to sponsors of retiree health care benefit plans. As permittedunder FSP 106-1, the Company made a one-time election to defer accountingfor the effect of the Act until the authoritative guidance on the accountingfor the federal subsidy under the Act is issued. Given that the Companycurtailed most of its U.S. postretirement benefit plans in 2004, it will likelynot be eligible to receive the federal subsidy under the Act. Accordingly, anymeasures of the periodic benefit cost, benefit obligation and relateddisclosures for the U.S. and other postretirement benefit plans do not reflectthe effect of the Act.

**Note 10.**   StockOption and Restricted Stock Plans

*Stock Option Plan*

The 2003 Stock Option Plan (the “2003 Plan”) wasapproved by the Company’s Board of Directors and shareholders and isadministered by the Compensation Committee of the Board of Directors. The stockoptions have a 4-5 year life and vest, based on the achievement ofvarious service and financial performance criteria, over a four-year periodbeginning January 4, 2004. As of October 1, 2005, the Company hadawarded grants of non-qualified stock options to purchase 400,000 shares of theCompany’s Class A Common Stock. As of October 1, 2005, 400,000 sharesof the Company’s Class A Common Stock were reserved for issuance under the2003 Plan and no additional stock options are available for future grants underthe 2003 Plan.

15

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

The Company has elected to account for the 2003 Planin accordance with the intrinsic value method as prescribed by APB No. 25,which measures compensation cost as the excess, if any, of the quoted marketprice of the stock at the date of grant over the amount an employee must pay toacquire the stock. Additionally, as a percentage of the options vest based onachievement of financial performance criteria, compensation costs arerecognized over the performance period when it becomes probable that suchperformance criteria will be achieved.

The compensation costs related to the 2003 Plan forthe three and nine months ended October 1, 2005 were $0.5 million and$2.0 million, respectively, and were included in *Selling, general and administrative expenses*in the Consolidated Statements of Operations. For the three and nine monthsended October 2, 2004, these costs were $3,600 and $183,600, respectively.

The 2005 Stock Option Plan(the “2005 Plan”) was approved by the Company’s Board of Directors andshareholders and is administered by the Compensation Committee of the Board ofDirectors. The stock options will only vest and become exercisable on theoccurrence of a change in control, and only after certain target thresholdstied to the cash received by MatlinPatterson Global Opportunities Fund, L.P.and its affiliates are reached in the change in control transaction, or fromthe conversion of securities received in the change in control transaction intocash within one year following the change in control. The term of each stockoption shall end on June 30, 2008, unless the stock option has beenexercised, with a provision to extend the date of exercise by up to one yearfollowing a change in control in which securities are issued as part of the considerationof the transaction. The Company may award grants of non-qualified stock optionsto purchase up to 200,000 shares of the Company’s Class A Common Stock. Asof October 1, 2005, no awards have been granted under the 2005 Plan.

*Restricted Stock Plan*

In May 2004, the Company’sshareholders approved the 2004 Restricted Stock Plan for Directors (the “RestrictedPlan”), which expires in 2014, for issuance of restricted shares to Directorsof the Company, as defined in the Restricted Plan. The Restricted Plan approvedfor issuance 200,000 restricted shares and is administered by a committee ofthe Company’s Board of Directors not eligible to receive restricted sharesunder the Restricted Plan. In the first nine months of 2005, the Companyawarded 1,316 restricted shares to members of the Company’s Board of Directorsfor their Board service to the Company. The cost associated with the restrictedstock grants totaled $30,000 for the first nine months of both 2005 and 2004and was included in *Selling, general andadministrative expenses* in the Consolidated Statements ofOperations. As of October 1, 2005, 154,964 shares of the Company’s Class ACommon Stock are available for future grants.

**Note 11.**   16%Series A Convertible Pay-in-kind Preferred Shares

In conjunction with the Company’s refinancing in April 2004of the Restructured Credit Facility, the Company’s majority shareholderexchanged approximately $42.6 million in aggregate principal amount of10.0% Convertible Subordinated Notes due 2007 (the “Junior Notes”) itcontrolled for 42,633 shares of the Company’s PIK Preferred Shares. Also,during the third quarter of fiscal 2004, $10.1 million in aggregateprincipal amount of the Company’s Junior Notes were exchanged for10,083 shares of the Company’s PIK Preferred Shares and 6,719 sharesof the Company’s Class A Common Stock. Such Junior Notes were subordinatedindebtedness of the Company and provided for interest at an annual rate of10.0%, which interest, at the option of the holder, could be received in 

16

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

additional principal amountsof the Junior Notes or in cash. The Junior Notes could be converted, at theoption of the holder, into shares of Class A Common Stock on the sameterms as included in the PIK Preferred Shares (a conversion rate based on aninitial conversion price of approximately $7.29 per share). As theaforementioned exchanges were a component of the recapitalization of theCompany, involving the majority shareholder and other common shareholders ofthe Company and the exchange by the majority shareholder was a requirement ofthe new Bank Facility, the exchanges have been accounted for as a capitaltransaction and, accordingly, no gain or loss was recognized.

Dividends on the PIK Preferred Shares accrued at anannual rate of 16.0% and were payable semi-annually in arrears on each January 1and July 1, commencing with July 1, 2004. Such dividends were payableat the option of the Company; (i) through the issuance of additionalshares of PIK Preferred Stock; (ii) in cash; or (iii) in acombination thereof. Accordingly, the Company accrued dividends at the statedrate of 16.0% until such time as the form of the dividend was declared by theCompany’s Board of Directors. If the dividend was paid-in-kind through theissuance of additional shares, the Company recognized the dividend at theestimated fair value of the shares issued in excess of the amounts previouslyaccrued.

At any time prior to June 30, 2012, the holdersof the PIK Preferred Shares could have elected to convert any or all of theirPIK Preferred Shares into shares of the Company’s Class A Common Stock atan initial conversion rate of 137.14286 shares of Class A CommonStock per share of PIK Preferred Shares which approximates an initialconversion price equal to $7.29 per share. On June 30, 2012, the Companymust redeem all of the PIK Preferred Shares then outstanding at a price equalto $1,000 per share plus any other accrued and unpaid dividends thereon whetheror not declared, which amount will be payable by the Company (“mandatoryredemption price”), at the option of the Company, (i) in cash; (ii) throughthe issuance of shares of Class A Common Stock; or (iii) through acombination thereof. If paid in stock, the number of shares to be delivered bythe Company will be the mandatory redemption price (as defined earlier) dividedby the then current market price of a share of Class A Common Stock.

On January 14, 2005, the Company’s Board ofDirectors declared that dividends accrued on the PIK Preferred Shares from thedate of issuance through December 31, 2004, in the amount of$5.6 million, would be paid in the form of PIK Preferred Shares. TheCompany recorded the value of the additional PIK Preferred Shares declared as adividend on January 14, 2005, the date the Board of Directors declaredthat the accrued dividends were to be paid in the form of additional PIKPreferred Shares, rather than cash, reduced by the amount of dividendspreviously recorded at the stated 16.0% rate. Using the estimated market valueof the Company’s Class A Common Stock of $18.50 per share, the fair value ofthe 5,540 additional PIK Preferred Shares issued in lieu of cash payment wasapproximately $14.1 million, which exceeded the amount previously accruedby the Company of $5.6 million, based on the stated rate of 16.0%, byapproximately $8.5 million.

On August 3, 2005, theCompany’s Board of Directors declared that dividends accrued on the PIKPreferred Shares from January 1, 2005 through June 30, 2005, in theamount of $4.7 million, would be paid in the form of PIK Preferred Shares.The Company recorded the value of the additional PIK Preferred Shares declaredas a dividend on August 3, 2005, the date the Board of Directors declaredthat the accrued dividends were to be paid in the form of additional PIKPreferred Shares, rather than cash, reduced by the amount of dividendspreviously recorded at the stated 16.0% rate. Using the estimated market valueof the Company’s Class A Common Stock of $27.70 per share, the fair valueof the 4,660 additional PIK Preferred Shares issued in lieu of cash payment wasapproximately 

17

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

$17.7 million,which exceeded the amount previously accrued by the Company of $4.7 million,based on the stated rate of 16.0%, by approximately $13.0 million. Inaddition, the Company accrued a charge for dividends of $1.8 million forthe period from July 2, 2005 through the date that the PIK PreferredShares were redeemed for, or converted to, shares of the Company’s Class ACommon Stock, as described below.

Also, on July 28, 2005,the Company’s Board of Directors authorized the redemption of all of theCompany’s PIK Preferred Shares on or before September 30, 2005. On August 16,2005, the Board of Directors set September 15, 2005 as the redemption date(the “Redemption Date”). In accordance with the terms of the PIK PreferredShares, the Company would redeem all PIK Preferred Shares outstanding at theRedemption Date at a redemption rate of 37.26397 shares of Class A CommonStock per PIK Preferred Share. At any time prior to the Redemption Date,holders of PIK Preferred Shares could exercise their right to convert their PIKPreferred Shares into shares of Class A Common Stock at a conversion raterate of 137.14286 shares of Class A Common Stock per PIK Preferred Share.

As of the close of business onthe Redemption Date, five PIK Preferred Shares had been redeemed by the Companywith the redemption price being paid by the issuance of 187 shares of Class ACommon Stock. Additionally, 62,916 PIK Preferred Shares had been converted byholders into 8,628,473 shares of Class A Common Stock. As a result ofthese transactions, approximately 8,628,660 additional shares of Class ACommon Stock are now outstanding and no PIK Preferred Shares are currentlyoutstanding.

**Note 12.**   Derivativeand Other Financial Instruments and Hedging Activities

The Company uses derivativefinancial instruments to manage market risks and reduce its exposure to fluctuationsin interest rates. All hedging transactions are authorized and executed underclearly defined policies and procedures, which prohibit the use of financialinstruments for trading purposes. SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” as amended by SFAS No. 138, “Accountingfor Certain Derivative Instruments and Certain Hedging Activities (an Amendmentof SFAS No. 133)” requires the Company to recognize all derivatives on thebalance sheet at fair value and establish criteria for designation andeffectiveness of hedging relationships.

The Company uses interest-ratederivative instruments to manage its exposure on its debt instruments. Asindicated in Note 7 to the Consolidated Financial Statements, to mitigate itsinterest rate exposure as required by the Bank Facility, the Company enteredinto a pay-fixed, receive-variable interest rate swap, thus effectivelyconverting the interest payments associated with approximately 50% of the debtto fixed amounts at a LIBOR rate of 3.383%. As of October 1, 2005, thenotional amount of this contract, which expire on May 8, 2007, was$212.5 million. Cash settlements are made quarterly and the floating rateis reset quarterly, coinciding with the reset dates of the Bank Facility debt.

In accordance with SFAS No. 133,the Company designated the swap as a cash flow hedge of the variability ofinterest payments under the senior secured term loans and applied the shortcutmethod of assessing effectiveness. The agreement’s terms ensure completeeffectiveness in offsetting the interest component associated with the BankFacility. As such, there is no ineffectiveness and changes in the fair value ofthe swap are recorded to accumulated other comprehensive income (loss). Thefair value of the interest rate swap of $3.6 million as of October 1,2005 and $0.3 million as of January 1, 2005 was based on currentsettlement values and was included in *Other noncurrent assets*in the Consolidated Balance Sheets.

18

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

The impact of these swaps on *Interest expense, net*for the three and nine months ended October 1,2005 was a decrease of $0.1 million and an increase of $0.5 million,respectively. For the three and nine months ended October 2, 2004, theimpact was an increase of $1.0 million and $1.6 million, respectively.

The Company has entered intocertain foreign currency forward contracts to manage its U.S. dollar exposureon Euro-based obligations for firm commitments related to significant capitalprojects. As of October 1, 2005, forward contracts were executed forspunmelt line purchases related to the Suzhou, China plant and Mooresville,North Carolina expansion. In accordance with SFAS No. 133, the Companydesignated the option as a fair value hedge of the variability of the fairmarket value of a firm purchase commitment. The agreement’s terms ensurecomplete effectiveness in offsetting the foreign currency variabilityassociated with the firm commitment.

**Note 13.**   EarningsPer Share and Shareholders’ Equity

No calculations have beenpresented to reconcile basic income per common share to diluted income percommon share for the three and nine months ended October 1, 2005 and thethree and nine months ended October 2, 2004, as the impact of suchcalculations are anti-dilutive. Average shares outstanding for the three andnine months ended October 1, 2005 were 12,497,354 and 11,113,479,respectively. Average shares outstanding for the three and nine months ended October 2,2004 were 10,372,228 and 9,661,025, respectively.

As of October 1, 2005,the Company’s authorized capital stock consisted of the following classes ofstock:

| **Type**                               | ** ** | ** ** | ** ** | **Par Value** | ** ** | **Authorized Shares** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------|------------|----------------------------|------------|
| PIK preferred stock                    |       |       | $          | .01                |       |                       |       | 173,000 |   |   |
| Class A common stock              |       |       | $          | .01                |       |                       |       | 39,200,000 |   |   |
| Class B convertible  common stock |       |       | $          | .01                |       |                       |       | 800,000 |   |   |
| Class C convertible  common stock |       |       | $          | .01                |       |                       |       | 118,453 |   |   |
| Class D convertible  common stock |       |       | $          | .01                |       |                       |       | 498,688 |   |   |
| Class E convertible  common stock |       |       | $          | .01                |       |                       |       | 523,557 |   |   |

 

All classes of the commonstock have similar voting rights. In accordance with the Amended and RestatedCertificate of Incorporation, all shares of Class B, C, D and E CommonStock may be converted into an equal number of shares of Class A CommonStock. See Note 11 to the Consolidated Financial Statements, for additionalinformation related to the Company’s PIK Preferred Shares.

In April 2004, the UnitedStates Bankruptcy Court for the District of South Carolina resolved certainpending claims filed against the Company in connection with the Modified Planand, as a result, approved the issuance of 1,327,177 shares of the Company’s Class ACommon Stock and 19,359 shares of the Company’s Class C Common Stock whichwere issued on a pro rata basis to holders of common stock of the old PolymerGroup Inc.’s Class 4 General Unsecured Claims per the old Polymer GroupInc.’s Chapter 11 Plan of Reorganization. If these shares had been outstandingfor all periods of fiscal 2004 presented, the pro forma net loss available percommon share (basic and diluted) would have been $0.67 for the nine monthsended October 2, 2004.

19

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

As ofOctober 1, 2005, all of the PIK Preferred Shares had been redeemed or convertedinto shares of the Company’s Class A Common Stock.

**Note 14.**   SegmentInformation

TheCompany’s reportable segments consist of its primary operating divisions—Nonwovensand Oriented Polymers—reflecting how the overall business is managed by theCompany’s senior management and reviewed by the Board of Directors. Each ofthese businesses sells to different end-use markets, such as hygiene, medical,wipes and industrial and specialty markets. Sales to P&G accounted for morethan 10% of the Company’s sales in each of the periods presented. Sales to thiscustomer are reported in the Nonwovens segment and the loss of these saleswould have a material adverse effect on this segment. The Company recordedcharges and/or income in the Consolidated Statements of Operations during thethree and nine months ended October 1, 2005 and the three and nine monthsended October 2, 2004 relating to plant realignment costs, asset impairmentcharges, foreign currency losses, net and arbitration settlement, net whichhave not been allocated to the segment data.

Financialdata by segment is as follows (in thousands):

| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | **October 1,  2005**        | ** ** | **October 1,  2004**       | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** |
| **Net sales**                                                      |       |                             |       |                            |       |   |   |   |   |
| Nonwovens                                                          |       | $                                | 185,699    |                            | $          | 165,166 |   | $ | 572,405 |   | $ | 493,019 |   |
| Oriented Polymers                                                  |       | 42,521                           |       | 39,388                          |       | 136,029 |   | 128,180 |   |
|                                                               |       | $                                | 228,220    |                            | $          | 204,554 |   | $ | 708,434 |   | $ | 621,199 |   |
| **Operating income (loss)**                                        |       |                             |       |                            |       |   |   |   |   |
| Nonwovens                                                          |       | $                                | 18,596     |                            | $          | 14,627 |   | $ | 53,257 |   | $ | 38,401 |   |
| Oriented Polymers                                                  |       | 790                              |       | 2,583                           |       | 9,636 |   | 10,809 |   |
| Unallocated Corporate                                              |       | (5,912                           | )          | (4,237                          | )          | (16,888 | ) | (12,554 | ) |
|                                                               |       | 13,474                           |       | 12,973                          |       | 46,005 |   | 36,656 |   |
| Plant realignment costs                                            |       | —                           |       | (222                            | )          | (9 | ) | (1,463 | ) |
| Asset impairment charges                                           |       | —                           |       | (1,710                          | )          | — |   | (1,710 | ) |
| Foreign currency loss, net                                         |       | (652                             | )          | (429                            | )          | (746 | ) | (1,417 | ) |
| Arbitration settlement, net                                        |       | —                           |       | (282                            | )          | — |   | 13,112 |   |
|                                                               |       | $                                | 12,822     |                            | $          | 10,330 |   | $ | 45,250 |   | $ | 45,178 |   |
| **Depreciation and amortization  expense**                         |       |                             |       |                            |       |   |   |   |   |
| Nonwovens                                                          |       | $                                | 10,919     |                            | $          | 10,133 |   | $ | 33,370 |   | $ | 31,206 |   |
| Oriented Polymers                                                  |       | 3,467                            |       | 2,042                           |       | 7,924 |   | 6,114 |   |
| Unallocated Corporate                                              |       | (37                              | )          | 416                             |       | (116 | ) | 771 |   |
| Depreciation and amortization expense included in operating income |       | 14,349                           |       | 12,591                          |       | 41,178 |   | 38,091 |   |
| Amortization of loan acquisition costs                             |       | 512                              |       | 486                             |       | 1,519 |   | 1,456 |   |
|                                                               |       | $                                | 14,861     |                            | $          | 13,077 |   | $ | 42,697 |   | $ | 39,547 |   |
| **Capital spending**                                               |       |                             |       |                            |       |   |   |   |   |
| Nonwovens                                                          |       | $                                | 21,319     |                            | $          | 4,194 |   | $ | 55,933 |   | $ | 12,647 |   |
| Oriented Polymers                                                  |       | 713                              |       | 158                             |       | 928 |   | 559 |   |
| Corporate                                                          |       | —                           |       | —                          |       | — |   | — |   |
|                                                               |       | $                                | 22,032     |                            | $          | 4,352 |   | $ | 56,861 |   | $ | 13,206 |   |

 

20

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

 

| ** **          | ** ** | **October 1,   2005** | ** ** | **January 1,  2005** | ** ** |
|---------------------|------------|---------------------------------|------------|---------------------------|------------|
| **Division assets** |       |                            |       |                      |       |
| Nonwovens           |       | $                               | 703,847    |                      | $          | 716,532 |   |
| Oriented Polymers   |       | 144,396                         |       | 149,393                   |       |
| Corporate           |       | 19,664                          |       | 16,191                    |       |
| Eliminations        |       | (108,226                        | )          | (127,558                  | )          |
|                |       | $                               | 759,681    |                      | $          | 754,558 |   |

 

Geographic Data:

Geographicdata for the Company’s operations, based on the geographic region from whichthe sale is made is presented in the following table (in thousands):

| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | **October 1,  2005**        | ** ** | **October 2,  2004**       | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** |
| **Net sales**                                                      |       |                             |       |                            |       |   |   |   |   |
| United States                                                      |       | $                                | 110,721    |                            | $          | 92,555 |   | $ | 331,741 |   | $ | 280,501 |   |
| Canada                                                             |       | 27,724                           |       | 26,224                          |       | 86,159 |   | 82,539 |   |
| Europe                                                             |       | 42,799                           |       | 43,739                          |       | 142,106 |   | 142,897 |   |
| Asia                                                               |       | 9,794                            |       | 8,289                           |       | 31,835 |   | 23,177 |   |
| Latin America                                                      |       | 37,182                           |       | 33,747                          |       | 116,593 |   | 92,085 |   |
|                                                               |       | $                                | 228,220    |                            | $          | 204,554 |   | $ | 708,434 |   | $ | 621,199 |   |
| **Operating income (loss)**                                        |       |                             |       |                            |       |   |   |   |   |
| United States                                                      |       | $                                | 254        |                            | $          | 102 |   | $ | 2,103 |   | $ | (547 | ) |
| Canada                                                             |       | (851                             | )          | 1,033                           |       | 3,897 |   | 5,062 |   |
| Europe                                                             |       | 4,055                            |       | 4,162                           |       | 12,859 |   | 12,572 |   |
| Asia                                                               |       | 2,012                            |       | 1,041                           |       | 4,221 |   | 2,641 |   |
| Latin America                                                      |       | 8,004                            |       | 6,635                           |       | 22,925 |   | 16,928 |   |
|                                                               |       | 13,474                           |       | 12,973                          |       | 46,005 |   | 36,656 |   |
| Plant realignment costs                                            |       | —                           |       | (222                            | )          | (9 | ) | (1,463 | ) |
| Asset impairment charges                                           |       | —                           |       | (1,710                          | )          | — |   | (1,710 | ) |
| Foreign currency loss, net                                         |       | (652                             | )          | (429                            | )          | (746 | ) | (1,417 | ) |
| Arbitration settlement, net                                        |       | —                           |       | (282                            | )          | — |   | 13,112 |   |
|                                                               |       | $                                | 12,822     |                            | $          | 10,330 |   | $ | 45,250 |   | $ | 45,178 |   |
| **Depreciation and amortization  expense**                         |       |                             |       |                            |       |   |   |   |   |
| United States                                                      |       | $                                | 6,213      |                            | $          | 6,114 |   | $ | 18,673 |   | $ | 18,032 |   |
| Canada                                                             |       | 2,911                            |       | 1,498                           |       | 6,268 |   | 4,455 |   |
| Europe                                                             |       | 2,086                            |       | 1,990                           |       | 6,971 |   | 6,585 |   |
| Asia                                                               |       | 1,028                            |       | 1,007                           |       | 3,011 |   | 2,999 |   |
| Latin America                                                      |       | 2,111                            |       | 1,982                           |       | 6,255 |   | 6,020 |   |
| Depreciation and amortization expense included in operating income |       | 14,349                           |       | 12,591                          |       | 41,178 |   | 38,091 |   |
| Amortization of loan acquisition costs                             |       | 512                              |       | 486                             |       | 1,519 |   | 1,456 |   |
|                                                               |       | $                                | 14,861     |                            | $          | 13,077 |   | $ | 42,697 |   | $ | 39,547 |   |

 

21

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

 

| ** **        | ** ** | **October 1,  2005** | ** ** | **January 1,  2005** | ** ** |
|-------------------|------------|---------------------------|------------|---------------------------|------------|
| **Region assets** |       |                      |       |                      |       |
| United States     |       | $                         | 222,246    |                      | $          | 166,469 |   |
| Canada            |       | 94,345                    |       | 99,382                    |       |
| Europe            |       | 221,740                   |       | 294,811                   |       |
| Asia              |       | 48,850                    |       | 35,996                    |       |
| Latin America     |       | 172,500                   |       | 157,900                   |       |
|              |       | $                         | 759,681    |                      | $          | 754,558 |   |

 

**Note 15.**   ForeignCurrency Loss, Net

Componentsof foreign currency (gain) loss are shown in the table below (in thousands):

| ** **                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **October 1,  2005**        | ** ** | **October 2,  2004**       | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** |
| Included in operating  income |       |                             | $          | 652                             |       |   |   | $ | 429 |   |   |   | $ | 746 |   |   |   | $ | 1,417 |   |   |
| Included in other,  net       |       |                             | 22         |                            |       |   | 567 |   |   |   | (730 | ) |   |   | 1,595 |   |   |
|                          |       |                             | $          | 674                             |       |   |   | $ | 996 |   |   |   | $ | 16 |   |   |   | $ | 3,012 |   |   |

 

For international subsidiaries which have the U.S.dollar as their functional currency, local currency transactions are remeasuredinto U.S. dollars, using current rates of exchange for monetary assets andliabilities. Gains and losses from the remeasurement of such monetary assetsand liabilities are reported in *Foreign currency gain/loss* in the Consolidated Statements of Operations. Likewise, forinternational subsidiaries which have the local currency as their functionalcurrency, gains and losses from the remeasurement of monetary assets andliabilities not denominated in the local currency are reported in *Foreign currency gain/ loss* in the Consolidated Statementsof Operations. Additionally, currency gains and losses have been incurred onintercompany loans between subsidiaries, and to the extent that such loans arenot deemed to be permanently invested, such currency gains and losses are alsoreflected in *Foreign currency gain/ loss* inthe Consolidated Statement of Operations.

The Company includes gains andlosses on receivables, payables and other operating transactions as a componentof operating income in *foreign currency gain/loss*.Other foreign currency gains and losses, primarily related to intercompanyloans and debt, are included in *Other, net*.

**Note 16.**   LegalProceedings and Commitments

On August 18, 2003, TheIntertech Group, Inc. (“TIG”), an affiliate of Jerry Zucker, the formerChief Executive Officer of the Company, filed a claim seeking damagesassociated with a lease agreement and an alleged services agreement, betweenthe Company and TIG, associated with the lease by the Company of its formercorporate headquarters and the provision of shared administrative services. On April 29,2005, the Company entered into a Settlement Agreement, Receipt and Release (the“Settlement Agreement”) with Jerry Zucker, TIG and ZS Associates LLC (anaffiliate of Mr. Zucker). Pursuant to the Settlement Agreement, theCompany paid TIG $3.1 million as full and 

22

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements (Continued)**

finalsettlement. In addition, the Settlement Agreement contains mutual generalreleases of any and all claims by and among the parties thereto, and arequirement that the Company and TIG file a joint stipulation dismissing, withprejudice, TIG’s lawsuit against the Company, which was appropriately filed on May 2,2005. The settlement amount was approximately equal to amounts previouslyaccrued and, accordingly, there was no gain or loss recognized in fiscal 2005.

During the second quarter of2005, the Company received approximately $0.8 million as its portion ofclass-action settlement agreements with various suppliers of raw materials.These recoveries were included in *Selling, general andadministrative expenses* for the nine months ended October 1,2005.

As part of its efforts toenhance the business, the Company has made commitments to expand its worldwidecapacity. Currently, the Company has several major committed capital projects,including the construction of a new spunmelt manufacturing plant in Suzhou,China and the installation of new spunmelt lines in the facilities in Cali,Colombia and Mooresville, North Carolina, as well as the installation ofadditional capacity in Nanhai, China. Remaining payments due related to theseplanned expansions as of October 1, 2005 totaled approximately$61.6 million and are expected to be expended over the remainder of fiscal2005 and fiscal 2006.

**Note 17.**   SupplementalCash Flow Information

Noncash transactions in thefirst nine months of 2005 included: (i) the conversion or redemption of62,926 shares of the Company’s PIK Preferred Shares into approximately8,629,346 shares of the Company’s Class A Common Stock, (ii) theissuance of 10,200 PIK Preferred Shares as payment-in-kind, in lieu of cashpayment, of approximately $10.3 million of dividends on the Company’s PIKPreferred Shares, which resulted in an additional non-cash dividend charge ofapproximately $21.5 million in excess of the amounts accrued at the stateddividend rate on the PIK Preferred Shares and (iii) the accrual of $1.8million of dividends on the PIK Preferred Shares for the date of the lastdividend declaration date to the date the PIK Preferred Stock were converted toClass A Common Stock.

Noncash transactions in thefirst nine months of 2004 included: (i) the payment-in-kind in lieu ofcash payment of $1.5 million of interest expense on the Junior Notes; (ii) theconversion of $2.7 million of the Company’s Junior Notes intoapproximately 371,382 shares of the Company’s Class A Common Stock; (iii) theexchange of $42.6 million of the Company’s Junior Notes into approximately42,633 shares of the Company’s PIK Preferred Shares; (iv) the exchange of$10.1 million of the Company’s Junior Notes into approximately 10,083 shares ofthe Company’s PIK Preferred Shares and 6,719 shares of the Company’s Class ACommon Stock; (v) the accrual of $3.2 million of dividends on the PIKPreferred Shares; and (vi) the issuance of 1,327,177 shares of the Company’sClass A Common Stock and 19,359 shares of the Company’s Class CCommon Stock in accordance with the ruling of the United States BankruptcyCourt for the District of South Carolina.

**Note 18.**   SubsequentEvents

On October 31, 2005, theCompany announced that it is pursuing the refinancing of its Bank Facility andexpects to close on the transaction before the end of fiscal 2005. The Companyexpects to lower its overall cost of debt and simplify its capital structure.Assuming the transaction closes during the fourth quarter, the Company expectsto incur a non-cash charge of approximately $8.9 million related to thewriteoff of the unamortized loan acquisition costs of the current Bank Facilityin the fourth quarter of fiscal 2005.

23

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**ITEM 2.**                 MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion andanalysis provides information which management believes is relevant to anassessment and understanding of the Company’s consolidated results ofoperations and financial condition. The discussion should be read inconjunction with the consolidated financial statements and notes theretocontained in this Quarterly Report on Form 10-Q and the AnnualReport on Form 10-K for the period ended January 1, 2005. Inaddition, it should be noted that the Company’s gross profit margins may not becomparable to other companies since some entities classify shipping andhandling costs in cost of goods sold and others, including the Company, includesuch costs in selling, general and administrative expenses. Similarly, someentities, including the Company, include foreign currency gains and lossesresulting from operating activities as a component of operating income, andsome entities classify all foreign currency gains and losses outside ofoperating income.

**Results of Operations**

Thefollowing table sets forth the percentage relationships to net sales of certainconsolidated statement of operations items.

| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                  | ** ** | **October 1,  2005**        | ** ** | **October 2,  2004**       | ** ** | **October 1,  2005** | ** ** | **October 2,  2004** | ** ** |
| Net sales                                                   |       |                             | 100.0      | %                               |       |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
| Cost of goods sold                                          |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Materials                                                   |       |                             | 50.8       |                            |       |   | 49.7 |   |   |   | 50.8 |   |   |   | 48.2 |   |   |
| Labor                                                       |       |                             | 8.6        |                            |       |   | 9.3 |   |   |   | 8.5 |   |   |   | 9.7 |   |   |
| Overhead                                                    |       |                             | 23.6       |                            |       |   | 23.6 |   |   |   | 23.1 |   |   |   | 24.3 |   |   |
|                                                        |       |                             | 83.0       |                            |       |   | 82.6 |   |   |   | 82.4 |   |   |   | 82.2 |   |   |
| Gross profit                                                |       |                             | 17.0       |                            |       |   | 17.4 |   |   |   | 17.6 |   |   |   | 17.8 |   |   |
| Selling, general and  administrative expenses               |       |                             | 11.1       |                            |       |   | 11.1 |   |   |   | 11.1 |   |   |   | 11.9 |   |   |
| Plant realignment  costs                                    |       |                             | —     |                            |       |   | 0.1 |   |   |   | 0.0 |   |   |   | 0.2 |   |   |
| Asset impairment  charges                                   |       |                             | —     |                            |       |   | 0.9 |   |   |   | — |   |   |   | 0.3 |   |   |
| Foreign currency  loss, net                                 |       |                             | 0.3        |                            |       |   | 0.2 |   |   |   | 0.1 |   |   |   | 0.2 |   |   |
| Arbitration  settlement, net                                |       |                             | —     |                            |       |   | 0.1 |   |   |   | — |   |   |   | (2.1 | ) |   |
| Operating income                                            |       |                             | 5.6        |                            |       |   | 5.0 |   |   |   | 6.4 |   |   |   | 7.3 |   |   |
| Other expense (income):                                     |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense, net                                       |       |                             | 3.6        |                            |       |   | 3.8 |   |   |   | 3.4 |   |   |   | 5.2 |   |   |
| Minority interests                                          |       |                             | 0.4        |                            |       |   | 0.2 |   |   |   | 0.4 |   |   |   | 0.3 |   |   |
| Other, net                                                  |       |                             | 0.0        |                            |       |   | 0.3 |   |   |   | 0.0 |   |   |   | 1.1 |   |   |
| Income before income  tax expense                           |       |                             | 1.6        |                            |       |   | 0.7 |   |   |   | 2.6 |   |   |   | 0.7 |   |   |
| Income tax expense                                          |       |                             | 1.5        |                            |       |   | 1.0 |   |   |   | 1.3 |   |   |   | 1.3 |   |   |
| Net income (loss)                                           |       |                             | 0.1        |                            |       |   | (0.3 | ) |   |   | 1.3 |   |   |   | (0.6 | ) |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                             | 6.5        |                            |       |   | 1.0 |   |   |   | 4.0 |   |   |   | 0.5 |   |   |
| (Loss) applicable to common  shareholders                   |       |                             | (6.4       | )%                              |       |   | (1.3 | )% |   |   | (2.7 | )% |   |   | (1.1 | )% |   |

 

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**Comparisonof Three Months Ended October 1, 2005 and October 2, 2004**

The Company’s reportablesegments consist of its two operating divisions, Nonwovens and OrientedPolymers. For additional information regarding segment data, see Note 14 “SegmentInformation” to the Consolidated Financial Statements included in thisQuarterly Report on Form 10-Q. The following table sets forth componentsof the Company’s net sales and operating income (loss) by operating divisionfor the three months ended October 1, 2005, the three months ended October 2,2004 and the corresponding change (in millions):

| ** **                                 | ** ** | **Three Months  Ended  October 1,  2005** | ** ** | **Three Months  Ended  October 2,  2004** | ** ** | **Change** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| Net sales                                  |       |                                                |       |                                                |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                | $          | 185.7                                               |       |       |       | $ | 165.2 |   |   |   | $ | 20.5 |   |   |
| Oriented Polymers                          |       |                                                | 42.5       |                                                |       |       | 39.4       |   |   |   | 3.1 |   |   |
|                                       |       |                                                | $          | 228.2                                               |       |       |       | $ | 204.6 |   |   |   | $ | 23.6 |   |   |
| Operating income (loss)                    |       |                                                |       |                                                |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                | $          | 18.6                                                |       |       |       | $ | 14.6 |   |   |   | $ | 4.0 |   |   |
| Oriented Polymers                          |       |                                                | 0.8        |                                                |       |       | 2.6        |   |   |   | (1.8 | ) |   |
| Unallocated Corporate, net of eliminations |       |                                                | (5.9       | )                                                   |       |       | (4.2       | ) |   |   | (1.7 | ) |   |
|                                       |       |                                                | 13.5       |                                                |       |       | 13.0       |   |   |   | 0.5 |   |   |
| Plant realignment  costs                   |       |                                                | —     |                                                |       |       | (0.2       | ) |   |   | 0.2 |   |   |
| Asset impairment  charges                  |       |                                                | —     |                                                |       |       | (1.7       | ) |   |   | 1.7 |   |   |
| Foreign currency  loss, net                |       |                                                | (0.7       | )                                                   |       |       | (0.5       | ) |   |   | (0.2 | ) |   |
| Arbitration  settlement, net               |       |                                                | —     |                                                |       |       | (0.3       | ) |   |   | 0.3 |   |   |
|                                       |       |                                                | $          | 12.8                                                |       |       |       | $ | 10.3 |   |   |   | $ | 2.5 |   |   |

 

The amounts for plant realignmentcosts, asset impairment charges, foreign currency loss, net and arbitrationsettlement, net have not been allocated to the Company’s reportable businessdivisions because the Company’s management does not evaluate such charges on adivision-by-division basis. Division operating performance is measured andevaluated before such items.

**Net Sales**

Consolidatednet sales were $228.2 million in the three months ended October 1, 2005,an increase of $23.6 million or 11.6% over the comparable period of 2004consolidated net sales of $204.6 million. Net sales for the three monthsended October 1, 2005 in the Nonwovens segment improved over comparable2004 fiscal year results by 12.4%, and net sales in the Oriented Polymerssegment improved 8.0%. A reconciliation of the change in net sales between thethree months ended October 2, 2004 and the three months ended October 1,2005 is presented in the following table (in millions):

| Net sales—three  months ended October 2, 2004 |   | $      | 204.6  |   |
|----------------------------------------------------|--------|--------|--------|--------|
| Change in sales due  to:                           |   |   |   |
| Price/mix                                          |   | 15.9   |   |
| Volume                                             |   | 5.3    |   |
| Foreign currency translation                       |   | 2.4    |   |
| Net sales—three months ended  October 1, 2005 |   | $      | 228.2  |   |

 

The increase in net sales during the third quarter of2005 was due primarily to price/mix improvements. The price/mix increase reflectscontinued success in the Company’s ability to improve 

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pricing and the profitcomposition of its sales. The improvement over the prior year period was drivenprimarily by higher prices implemented to mitigate raw material costs in alldivisions, increased value-added business in Latin America and product shiftsin Asia from commodity to specialty applications. Net volume gains of $5.3 millioninclude gains of $6.7 million in the Nonwovens segment, offset bydecreases of $1.4 million in the Oriented Polymers segment. Volumeincreases in the Nonwovens segment were in the United States, and were partiallyoffset by declines in the European, Latin American and Asian markets.

A significant component of the U.S. Nonwovens volumeincrease in the third quarter of fiscal 2005 was generated in the consumerproducts markets as new customer relationships generated substantial salesincreases in the third quarter of fiscal 2005 compared to the same period offiscal 2004. The decreases in the foreign regions were predominately in thehygiene and industrial markets. Oriented Polymers’ decrease in sales volume wasprimarily due to declines in product sales in certain of its businesses, with asignificant portion comprised of lower-margin, commodity items.

Nearly all of the increase insales from foreign currency translation was attributable to the Canadian dollarcontinuing to strengthen against the U.S. dollar during the third quarter.Further discussion of foreign currency exchange rate risk is contained in“Quantitative and Qualitative Disclosures About Market Risk” included inItem 3 of Part I to this Quarterly Report on Form 10-Q.

**Operating Income**

Areconciliation of the change in operating income between the three months endedOctober 2, 2004 and the three months ended October 1, 2005 ispresented in the following table (in millions):

| Operating  income—three months ended October 2, 2004 |   | $      | 10.3   |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Change in operating income due to:                        |   |   |   |
| Price/mix                                                 |   | 15.9   |   |
| Higher raw material costs                                 |   | (9.8   | )      |
| Higher manufacturing costs                                |   | (2.1   | )      |
| Higher depreciation and amortization expense              |   | (1.8   | )      |
| Lower asset impairment charges                            |   | 1.7    |   |
| Volume                                                    |   | 1.4    |   |
| Arbitration settlement, net                               |   | 0.3    |   |
| Lower plant realignment costs, net                        |   | 0.2    |   |
| Foreign currency translation                              |   | 0.1    |   |
| All other, primarily higher SG&A costs                |   | (3.4   | )      |
| Operating income—three  months ended October 1, 2005 |   | $      | 12.8   |   |

 

Consolidated operating income was $12.8 millionin the three months ended October 1, 2005 as compared to $10.3 million in thecomparable period of 2004. The financial effect of price/mix improvements morethan offset the higher raw material costs, reflecting the benefits of theCompany’s new product introductions and ongoing efforts to manage the impact ofhigher raw material costs. Also contributing to the improvement of operatingincome were the absence of asset impairment charges, arbitration settlement,net and plant realignment costs, net in the third quarter of 2005. Offsettingthese favorable impacts were higher depreciation and amortization charges,increased manufacturing costs and higher selling, general and administrativeexpenses. Manufacturing costs increased primarily due to the start-up of newlines and the initiation of new product offerings. Selling, general andadministrative expenses were higher primarily as a result of increased salesvolume, increased non-cash compensation costs related to the Company’s stockoption plans and costs related to the new Sarbanes-Oxley compliancerequirements. The increase in depreciation and amortizationcharges was primarily related to the reduction in the estimated useful lives ofcertain 

26

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machinery and equipment utilized in the Company’soperations to reflect the technological status and market conditions of certainaspects of the Company’s business.

In August and September of 2005, Hurricanes Katrinaand Rita hit the Gulf Coast area, temporarily shutting down a number ofrefineries and chemical processing sites of certain raw material suppliers forthe Company’s North and South American operations. As a result, while suppliesare tight, raw materials continue to be available to the Company, but atsignificantly higher prices. The Company, where allowable based on contractterms, has attempted to raise its selling prices to mitigate the spike in rawmaterials. The effect on the Company’s future results of operations isdependent upon, among other things, the ability to successfully mitigate rawmaterial price increases, the duration of time it takes for the supply chain toreturn to normal production, and the magnitude of the raw material priceincreases. The Company is managing this situation closely in an effort tominimize any adverse effects.

**Interest Expense and Other**

Net interest expense increased $0.4 million, from$7.8 million during the three months ended October 2, 2004 to $8.2 millionduring the three months ended October 1, 2005. The increase in net interestexpense was primarily due to the increase in the Bank Facility’s variableinterest rates, which are based on LIBOR. The effects of increases in LIBORrates were partially mitigated through a pay-fixed, receive-variable interestrate swap contract.

Other, net improved by$0.6 million, from an expense of $0.7 million in the third quarter offiscal 2004 to expense of $0.1 million in the third quarter of fiscal2005. The improvement in other, net was primarily due to the foreign currencygains recognized by foreign subsidiaries on intercompany loan balancesdenominated in currencies other than their functional currency, generally theU.S. dollar.

**Income Tax Expense**

The Company recognized incometax expense of $3.4 million for the three months ended October 1, 2005 onconsolidated income before income taxes of $3.6 million. This income taxexpense is in excess of the U.S. federal statutory rate primarily due to lossesin the U.S. and certain foreign jurisdictions for which no tax income benefitswere recognized. Additionally, the income tax expense is impacted by foreignwithholding taxes, for which tax credits are not anticipated, U.S. state incometaxes and foreign taxes calculated at statutory rates less than the U.S.federal statutory rate. The Company recorded a net income tax expense of $2.1 millionfor the three months ended October 2, 2004 on a consolidated income beforeincome taxes of $1.5 million for such period. The income tax expense wasprimarily due to withholding taxes, for which tax credits are not anticipated,U.S. state income taxes, and no significant income tax benefit recognized forthe losses incurred in the U.S. and certain foreign jurisdictions.

**Net Income**

As a result of the above, theCompany recognized net income of $0.2 million during the three monthsended October 1, 2005 compared to a net loss of $0.6 million during thethree months ended October 2, 2004.

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**Accrued andPaid-in-kind Dividends on PIK Preferred Shares**

On August 3, 2005, the Company’s Board ofDirectors declared a dividend, payable in the form of additional PIK PreferredShares, in the amount of approximately $4.7 million for the period fromJanaury 1, 2005 through June 30, 2005, which amount was accrued as ofJuly 2, 2005 and included as a component of the Company’s PIK PreferredShares in the Consolidated Balance Sheet. As a result of such declaration bythe Company’s Board of Directors to pay the dividend in the form of additionalPIK Preferred Shares, the Company recorded additional dividends, and acorresponding increase in additional paid-in capital, associated with theissuance of the additional PIK Preferred Shares in the amount of approximately$13.0 million, representing the estimated fair value of the additional PIKPreferred Shares issued as of the dividend declaration date, reduced by thedividends previously accrued at the stated dividend rate of 16.0%. In addition,the Company accrued a charge for dividends of $1.8 million for the period fromJuly 2, 2005 through the date that the PIK Preferred Shares were redeemed for,or converted to, shares of Class A Common Stock. The Company accrued a dividendof $2.0 million during the quarter ended October 2, 2004, based on the PIKPreferred Shares’ stated rate of 16.0%.

**Income(Loss) Applicable to Common Shareholders**

As a result of the above, the Company recognized aloss applicable to common shareholders of $14.6 million, or $(1.17) per shareon a basic and diluted basis, for the three months ended October 1, 2005compared to a loss applicable to common shareholders of $2.5 million, or $(0.25)per share on a basic and diluted basis, for the three months ended October 2,2004.

**Comparisonof Nine Months Ended October 1, 2005 and October 2, 2004**

TheCompany’s reportable segments consist of its two operating divisions, Nonwovensand Oriented Polymers. For additional information regarding segment data, seeNote 14 “Segment Information” to the Consolidated Financial Statementsincluded in this Quarterly Report on Form 10-Q. The following tablesets forth components of the Company’s net sales and operating income (loss) byoperating division for the nine months ended October 1, 2005, the ninemonths ended October 2, 2004 and the corresponding change (in millions):

| ** **                                 | ** ** | **Nine Months  Ended  October 1, 2005** | ** ** | **Nine Months   Ended  October 2, 2004** | ** ** | **Change** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------|------------|
| Net sales                                  |       |                                                   |       |                                                         |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                   | $          | 572.4                                                        |       |       |       | $ | 493.0 |   |   |   | $ | 79.4 |   |   |
| Oriented Polymers                          |       |                                                   | 136.0      |                                                         |       |       | 128.2      |   |   |   | 7.8 |   |   |
|                                       |       |                                                   | $          | 708.4                                                        |       |       |       | $ | 621.2 |   |   |   | $ | 87.2 |   |   |
| Operating income (loss)                    |       |                                                   |       |                                                         |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                   | $          | 53.3                                                         |       |       |       | $ | 38.4 |   |   |   | $ | 14.9 |   |   |
| Oriented Polymers                          |       |                                                   | 9.6        |                                                         |       |       | 10.8       |   |   |   | (1.2 | ) |   |
| Unallocated Corporate, net of eliminations |       |                                                   | (16.9      | )                                                            |       |       | (12.5      | ) |   |   | (4.4 | ) |   |
|                                       |       |                                                   | 46.0       |                                                         |       |       | 36.7       |   |   |   | 9.3 |   |   |
| Plant realignment  costs                   |       |                                                   | —     |                                                         |       |       | (1.5       | ) |   |   | 1.5 |   |   |
| Asset impairment  charges                  |       |                                                   | —     |                                                         |       |       | (1.7       | ) |   |   | 1.7 |   |   |
| Foreign currency  loss, net                |       |                                                   | (0.7       | )                                                            |       |       | (1.4       | ) |   |   | 0.7 |   |   |
| Arbitration  settlement, net               |       |                                                   | —     |                                                         |       |       | 13.1       |   |   |   | (13.1 | ) |   |
|                                       |       |                                                   | $          | 45.3                                                         |       |       |       | $ | 45.2 |   |   |   | $ | 0.1 |   |   |

 

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The amounts for plantrealignment costs, asset impairment charges, foreign currency loss, net andarbitration settlement, net have not been allocated to the Company’s reportablebusiness divisions because the Company’s management does not evaluate such chargeson a division-by-division basis. Division operating performance is measured andevaluated before such items.

**Net Sales**

Consolidatednet sales were $708.4 million in the nine months ended October 1,2005, an increase of $87.2 million or 14.0% over the comparable 2004period’s consolidated net sales of $621.2 million. Net sales for the ninemonths ended October 1, 2005 in the Nonwovens and Oriented Polymerssegments improved over comparable 2004 fiscal year results by 16.1% and 6.1%,respectively. A reconciliation of the change in net sales between the ninemonths ended October 2, 2004 and the nine months ended October 1,2005 is presented in the following table (in millions):

| Net sales—nine months  ended October 2, 2004 |   | $      | 621.2  |   |
|--------------------------------------------------------|--------|--------|--------|--------|
| Change in sales due  to:                               |   |   |   |
| Price/mix                                              |   | 58.3   |   |
| Volume                                                 |   | 19.0   |   |
| Foreign currency translation                           |   | 9.9    |   |
| Net sales—nine months ended  October 1, 2005 |   | $      | 708.4  |   |

 

The increase in net sales during the first nine monthsof 2005 was due primarily to price/mix improvements and volume gains. Theprice/mix increase reflects continued success in the Company’s ability toimprove pricing and profit composition of its sales. The improvement over theprior year period was driven primarily by higher prices implemented to mitigateraw material costs in all divisions, increased value-added business in LatinAmerica and product shifts in Asia from commodity to specialty applications.

The primary contributors to the $19.0 million increasein sales volume during the first nine months of 2005 were the U.S. and LatinAmerican regions. In the Company’s U.S. nonwovens business, the consumer andhygiene markets contributed double-digit increases over 2004 as newproducts were introduced into the markets and new customer relationshipsgenerated substantial sales increases. Although the San Luis Potosi, Mexicocapacity expansion was completed in late 2003, it didn’t reach full productivecapacity until the second quarter of 2004. The Latin America region’s sales improvementwas paced by significant year-over-year increases in hygiene and industrialsales. Nonwoven sales volumes decreased slightly in Europe. Oriented Polymers’increase in sales was due primarily to a price/mix improvement, partiallyoffset by lower sales volumes of certain commodity-based products.

Foreign currencies,predominantly the Euro and the Canadian dollar, were stronger against theU.S. dollar during the first nine months of 2005 compared to 2004,resulting in an increase in net sales of $9.9 million due to the favorableforeign currency translation. Further discussion of foreign currency exchangerate risk is contained in “Quantitative and Qualitative Disclosures AboutMarket Risk” included in Item 3 of Part I to this Quarterly Report on Form 10-Q.

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**Operating Income**

Areconciliation of the change in operating income between the nine months ended October 2,2004 and the nine months ended October 1, 2005 is presented in thefollowing table (in millions):

| Operating income—nine  months ended October 2, 2004 |   | $      | 45.2   |   |
|---------------------------------------------------------------|--------|--------|--------|--------|
| Change in operating  income due to:                           |   |   |   |
| Arbitration settlement, net                                   |   | (13.1  | )      |
| Price/mix                                                     |   | 58.3   |   |
| Higher raw material costs                                     |   | (46.3  | )      |
| Volume                                                        |   | 5.6    |   |
| Higher depreciation and amortization expense                  |   | (3.1   | )      |
| Lower asset impairment charges                                |   | 1.7    |   |
| Lower plant realignment costs, net                            |   | 1.5    |   |
| Higher manufacturing costs                                    |   | (0.7   | )      |
| Foreign currency translation                                  |   | 0.7    |   |
| All other, primarily higher SG&A costs                    |   | (4.5   | )      |
| Operating income—nine months  ended October 1, 2005 |   | $      | 45.3   |   |

 

Consolidated operating income was $45.3 millionin the first nine months of 2005 as compared to $45.2 million in thecomparable period of 2004. Operating income in the first nine months of 2004 benefitedfrom the $13.1 million arbitration settlement, net of expenses. Thefinancial effect of price/mix improvements more than offset the higher rawmaterial costs, reflecting the benefits of the Company’s new productintroductions and ongoing efforts to manage the impact of higher raw materialcosts. The net improvement in operating income was positively impacted by thevolume gains noted in the net sales discussion above and the absence of assetimpairment charges and lower plant realignment costs, net in the first ninemonths of 2005. Offsetting these favorable impacts were higher depreciation andamortization charges, higher manufacturing costs and higher selling, generaland administrative expenses. The increase in depreciation and amortizationcharges was primarily related to the reduction in the estimated useful lives ofcertain machinery and equipment utilized in the Company’s operations to reflectthe technological status and market conditions of certain aspects of theCompany’s business. Selling, general and administrative expenses were higherprimarily due to increased sales volume, increased non-cash compensation costsrelated to the Company’s stock option plan and costs related to the newSarbanes-Oxley compliance requirements.

In August and September of2005, Hurricanes Katrina and Rita hit the Gulf Coast area, temporarily shuttingdown a number of refineries and chemical processing sites of certain rawmaterial suppliers for the Company’s North and South American operations. As aresult, while supplies are tight, raw materials continue to be available to theCompany, but at significantly higher prices. The Company, where allowable basedon contract terms, has attempted to raise its selling prices to mitigate thespike in raw materials. The effect on the Company’s future results of operationsis dependent upon, among other things, the ability to successfully mitigate rawmaterial price increases, the duration of time it takes for the supply chain toreturn to normal production, and the magnitude of the raw material priceincreases. The Company is managing this situation closely in an effort tominimize any adverse effects.

**Interest Expense and Other**

Net interest expense decreased $8.1 million, from$32.3 million during the nine months ended October 2, 2004 to$24.2 million during the nine months ended October 1, 2005. Thedecrease in net interest expense was primarily due to the lower interest ratesobtained by refinancing the Company’s 

30

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previous Restructured CreditFacility with the new Bank Facility, effective April 27, 2004, and the eliminationof interest expense on the Junior Notes as approximately $52.7 million inaggregate principal amount of the Junior Notes was converted into 52,716 sharesof PIK Preferred Shares and 6,719 shares of Class A Common Stock. The2004 interest expense includes $1.5 million of payment-in-kind in lieu ofcash interest on the Junior Notes.

The Consolidated Statement ofOperations for the first nine months of 2004 included a charge of$5.0 million for the write-off of the remaining unamortized loan acquisitioncosts related to the Restructured Credit Facility. Other, net improved by$2.5 million, from an expense of $1.8 million in the first nine months offiscal 2004 to income of $0.7 million in the first nine months of fiscal2005. The improvement in other, net was primarily due to the foreign currencygains recognized by foreign subsidiaries on intercompany loan balancesdenominated in currencies other than their functional currency, generally theU.S. dollar.

**Income Tax Expense**

The Company recognized incometax expense of $9.3 million for the nine months ended October 1, 2005 onconsolidated income before income taxes of $18.7 million. This income taxexpense is significantly higher than the U.S. federal statutory rateprimarily due to losses in the U.S. and certain foreign jurisdictions for whichno tax benefits were recognized. Additionally, the income tax expense isimpacted by foreign withholding taxes, for which tax credits are notanticipated, U.S. state income taxes and foreign taxes calculated at statutoryrates less than the U.S. federal statutory rate. The Company recorded a netincome tax expense of $8.2 million for the nine months ended October 2,2004 on consolidated income before income taxes of $4.5 million for suchperiod. The income tax expense was primarily due to withholding taxes, forwhich tax credits are not anticipated, U.S. state income taxes, and nosignificant income tax benefit recognized for the losses incurred in the U.S.and certain foreign jurisdictions.

**Net Income**

As a result of the above, theCompany recognized net income of $9.4 million during the nine months endedOctober 1, 2005 compared to a net loss of $3.6 million during thenine months ended October 2, 2004.

**Accruedand Paid-in-kind Dividends on PIK Preferred Shares**

On January 14, 2005, the Company’s Board ofDirectors declared that dividends accrued on the PIK Preferred Shares from thedate of issuance through December 31, 2004, in the amount of$5.6 million, would be paid in the form of PIK Preferred Shares. Using theestimated market value of the Company’s Class A Common Stock of $18.50 pershare, the estimated fair value of the 5,540 additional PIK Preferred Sharesissued in lieu of cash payment was approximately $14.1 million, whichexceeded the amount accrued of $5.6 million, based upon the stated rate byapproximately $8.5 million. Recording the additional $8.5 milliondividend at the date of declaration has resulted in a reduction in the amountof income applicable to common shareholders and retained earnings, with a correspondingincrease in additional paid-in capital.

On August 3, 2005, the Company’s Board ofDirectors declared a dividend, payable in the form of additional PIK PreferredShares, in the amount of approximately $4.7 million for the period from January1, 2005 through June 30, 2005, which amount was accrued as of July 2,2005 and included as a component of the Company’s PIK Preferred Shares in theConsolidated Balance Sheet. As a result of such declaration by the Company’sBoard of Directors to pay the dividend in the form of additional PIK PreferredShares, the Company recorded additional dividends, and a corresponding increasein additional paid-in capital, associated with the issuance of the additional PIKPreferred 

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Shares in the amount ofapproximately $13.0 million, representing the estimated fair value of theadditional PIK Preferred Shares issued as of the dividend declaration date,reduced by the dividends previously accrued at the stated dividend rate of16.0%. In addition, the Company accrued a charge for dividends of $1.8 millionfor the period from July 2, 2005 through the date that the PIK PreferredShares were redeemed for, or converted to, shares of Class A Common Stock.The Company accrued a dividend of $2.0 million during the quarter ended October 2,2004, based on the PIK Preferred Shares’ stated rate of 16.0%.

In total, for the nine monthsended October 1, 2005, the Company recorded accrued and paid-in-kinddividends of $28.0 million. As a result of the PIK Preferred Shares beinginitially issued on April 27, 2004, the Company accrued dividends at thestated rate of 16.0% during the first nine months of 2004 in the amount of $3.2million.

**LossApplicable to Common Shareholders**

As a result of the above, theCompany recognized a loss applicable to common shareholders of$18.6 million, or $(1.67) per share on a basic and diluted basis, for thenine months ended October 1, 2005 compared to a loss applicable to commonshareholders of $6.9 million, or ($0.71) per share on a basic and dilutedbasis, for the nine months ended October 2, 2004.

**LIQUIDITY AND CAPITAL RESOURCES**

TheCompany’s principal sources of liquidity for operations and expansions arefunds generated from operations and borrowing availabilities under the BankFacility, consisting of a revolving credit facility with aggregate commitmentsof up to $50.0 million and a senior secured first lien term loan of$300.0 million and a senior secured second lien term loan of $125.0 million.The revolving portion of the Bank Facility terminates on April 27, 2009,the first lien term loan is due April 27, 2010 and the second lien termloan is due April 27, 2011. The Bank Facility contains covenants andevents of default customary for financings of this type, including leverage andinterest expense coverage covenants. At October 1, 2005, the Company wasin compliance with all such covenants. Additionally, as of October 1,2005, the Company had no outstanding borrowings under the revolving creditfacility.

| ** **                       | ** ** | **October 1,  2005** | ** ** | **January 1,  2005** | ** ** |
|----------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                       | ** ** | **(In Millions)**    | ** ** |
| **Balance  sheet data:**         |       |                      |       |                      |       |   |   |   |   |
| Cash and cash equivalents        |       |                      | $          | 27.5                      |       |   |   | $ | 41.3 |   |   |
| Working capital                  |       |                      | 180.2      |                      |       |   | 187.3 |   |   |
| Total assets                     |       |                      | 759.7      |                      |       |   | 754.6 |   |   |
| Total debt                       |       |                      | 410.4      |                      |       |   | 414.0 |   |   |
| PIK Preferred Shares             |       |                      | —     |                      |       |   | 58.3 |   |   |
| Total shareholders’  equity |       |                      | 138.3      |                      |       |   | 73.8 |   |   |
|                                  |            |                           |            |                           |            |  |  |  |  |  |  |

 

| ** **                                | ** ** | **Nine Months Ended**     | ** ** |
|-------------------------------------------|------------|---------------------------|------------|
| ** **                                | ** ** | **October 1,  2005** | ** ** | **January 1,  2005** | ** ** |
| ** **                                | ** ** | **(In Millions)**    | ** ** |
| **Cash  flow data:**                      |       |                      |       |   |   |   |   |   |   |
| Net cash provided by operating activities |       |                      | $          | 47.1 |   |   |   | $ | 36.3 |   |   |
| Net cash used in investing activities     |       |                      | (56.5      | ) |   |   | (12.4 | ) |   |
| Net cash used in  financing activities    |       |                      | (3.6       | ) |   |   | (15.6 | ) |   |
|                                           |            |                           |            |  |  |  |  |  |  |  |  |

 

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**Operating Activities**

Net cash provided by operating activities was$47.1 million during the first nine months of 2005, a $10.8 millionincrease from the $36.3 million provided by operating activities duringthe first nine months of 2004, which included a $13.1 million non-recurring netcash inflow from an arbitration settlement. Cash provided by operationsincreased from the comparable period of the prior year primarily due toimproved operating results.

Working capital at October 1,2005 did not change significantly from that at January 1, 2005 asincreases in trade receivables and inventory were generally offset by anincrease in trade payables and a decrease in cash. Accounts receivable at October 1,2005 was $123.6 million as compared to $113.5 million on January 1, 2005,an increase of $10.1 million. Accounts receivable representedapproximately 49 days of sales outstanding at October 1, 2005,compared to 46 days of sales outstanding at January 1, 2005. Theincrease was partially attributable to the growth in net sales in foreignlocations, which often have extended payment terms as compared to domesticterms of sale. Inventories at October 1, 2005 were $111.3 million, anincrease of $5.0 million from inventories at January 1, 2005 of$106.3 million. The Company had inventory representing approximately54 days of cost of sales on hand at October 1, 2005 as compared to54 days of cost of sales on hand at January 1, 2005. Accounts payableat October 1, 2005 was $67.1 million as compared to $63.8 million at January 1,2005, an increase of $3.3 million. Accounts payable representedapproximately 32 days of cost of sales outstanding at October 1, 2005as compared to 32 days of cost of sales outstanding at January 1,2005.

**Investing and Financing Activities**

Cash used in investing activities amounted to $56.5million and $12.4 million for the first nine months of 2005 and 2004,respectively. Capital expenditures during the nine months ended October 1,2005 totaled $56.9 million, an increase of $43.7 million over capitalspending of $13.2 million in the first nine months ended October 2,2004. A significant portion of the capital expenditures in 2005 related to theinstallation of new nonwovens production lines at the Cali, Colombia andMooresville, North Carolina manufacturing sites and at the new site in Suzhou,China. The Cali, Colombia line is expected to become operational during thefourth quarter of fiscal 2005. Investing activities during the first ninemonths of 2005 and 2004 included proceeds from the sale of assets of$0.4 million and $0.8 million, respectively.

Cash used in financingactivities amounted to $3.6 million for the first nine months of 2005, as comparedto $15.6 million being used in financing activities for the first nine monthsof 2004. In each of the first nine months of 2005 and 2004, the Company repaid,on a net basis, $3.6 million of its debt. The Company also paid $12.0 millionof loan acquisition costs in conjunction with the Bank Facility refinancingduring the first nine months of 2004.

**Dividends**

*Common Stock*

The Board of Directors has notdeclared a dividend on the Company’s common stock since the first quarter of2001. The Bank Facility limits restricted payments, which include cashdividends on all securities, to $5.0 million in the aggregate since theeffective date of the Bank Facility. The Company does not anticipate payingdividends on its common stock in future periods.

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*PIK Preferred Stock*

On January 14, 2005, the Company’s Board ofDirectors declared that dividends accrued on the PIK Preferred Shares from thedate of issuance through December 31, 2004, in the amount of$5.6 million, would be paid in the form of PIK Preferred Shares. TheCompany recorded the value of the additional PIK Preferred Shares declared as adividend on January 14, 2005, the date the Board of Directors declaredthat the accrued dividends were to be paid in the form of additional PIKPreferred Shares, rather than cash, reduced by the amount of dividendspreviously recorded at the stated 16.0% rate. Using the estimated market valueof the Company’s Class A Common Stock of $18.50 per share, the fair valueof the 5,540 additional PIK Preferred Shares issued in lieu of cash payment wasapproximately $14.1 million, which exceeded the amount previously accruedby the Company of $5.6 million, based on the stated rate of 16.0%, byapproximately $8.5 million.

On August 3, 2005, the Company’s Board ofDirectors declared that dividends accrued on the PIK Preferred Shares fromJanuary 1, 2005 through June 30, 2005, in the amount of$4.7 million, would be paid in the form of PIK Preferred Shares. TheCompany recorded the value of the additional PIK Preferred Shares declared as adividend on August 3, 2005, the date the Board of Directors declared thatthe accrued dividends were to be paid in the form of additional PIK PreferredShares, rather than cash, reduced by the amount of dividends previouslyrecorded at the stated 16.0% rate. Using the estimated market value of theCompany’s Class A Common Stock of $27.70 per share, the fair value of the4,660 additional PIK Preferred Shares issued in lieu of cash payment wasapproximately $17.7 million, which exceeded the amount previously accruedby the Company of $4.7 million, based on the stated rate of 16.0%, byapproximately $13.0 million. In addition, the Company accrued a charge fordividends of $1.8 million for the period from July 2, 2005 through thedate that the PIK Preferred Shares were redeemed for, or converted to, sharesof the Company’s Class A Common Stock

**Liquidity Summary**

As discussed more fully in Note 7 to theConsolidated Financial Statements included in Item 1 to this Quarterly Reporton Form 10-Q, on April 27, 2004, the Company refinanced itsexisting bank credit facility and entered into a new Bank Facility consistingof a $50.0 million revolving credit facility maturing in 2009, a$300.0 million senior secured first lien term loan that matures in 2010and a $125.0 million senior secured second-lien term loan maturing in2011. The proceeds therefrom were used to fully repay indebtedness outstandingunder the Company’s previous Restructured Credit Facility and pay related feesand expenses. The senior secured first lien term loan requires quarterlypayments of $750.0 thousand and accrues interest at LIBOR plus 325 basispoints. The senior secured second lien term loan accrues interest at LIBOR plus625 basis points. The revolving credit facility initially bears interest atLIBOR plus 300 basis points. The Bank Facility provides the Company withincreased flexibility in terms of cash availability, less stringentrequirements for covenant compliance, extended maturity dates and substantiallyreduced net cash interest costs as compared to the prior bank credit facility.

The Bank Facility contains covenants and events ofdefault customary in financings of this type, including leverage and interestexpense coverage covenants. The Bank Facility requires the Company to apply apercentage of proceeds from excess cash flows, as defined by the Bank Facilityand determined based on year-end results, to reduce its then outstandingbalances under the Bank Facility. Excess cash flow required to be applied tothe repayment of the Bank Facility is generally calculated as 50.0% of theCompany’s available cash generated from operations adjusted for the casheffects of interest, taxes, capital expenditures, changes in working capitaland certain other items. Since the amounts of excess cash flows for futureperiods are based on year-end data and not determinable, only the mandatorypayments of $750.0 thousand per quarter have been classified as a currentliability. Additionally, no excess cash flow payment was made with respect tofiscal 2004 and, 

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due to the magnitude of theplanned major capital expenditures for fiscal 2005, any excess cash flowrequirement is not expected to be significant. Additionally, as required by theterms of the Bank Facility, the Company entered into a cash flow hedgeagreement, effectively converting $212.5 million of notional principalamount of debt from a variable LIBOR rate to a fixed LIBOR rate of 3.383%. Thecash flow hedge agreement terminates on May 8, 2007.

In conjunction with the Company’s refinancing of theRestructured Credit Facility, the Company’s majority shareholder exchangedapproximately $42.6 million in aggregate principal amount of the JuniorNotes it controlled for 42,633 shares of the Company’s PIK Preferred Shares. Inthe third quarter of 2004, $10.1 million of aggregate principal amount ofthe Company’s Junior Notes were exchanged for 10,083 shares of the Company’sPIK Preferred Shares and 6,719 shares of the Company’s Class A CommonStock. On July 28, 2005, the Company’s Board of Directors authorized theredemption of all of the Company’s PIK Preferred Shares on or before September 30,2005. As a result of this redemption offer, all of the Company’s PIK PreferredShares were redeemed or converted to shares of the Company’s Class ACommon Stock during the third quarter of 2005.

On July 28, 2005, the Company’s Board ofDirectors authorized the redemption of all of the Company’s PIK PreferredShares on or before September 30, 2005. On August 16, 2005, the Boardof Directors set September 15, 2005 as the redemption date (the “RedemptionDate”). The Company agreed to redeem all PIK Preferred Shares outstanding atthe Redemption Date at a redemption rate of 37.26397 shares of Class ACommon Stock per PIK Preferred Share. At any time prior to the Redemption Date,holders of PIK Preferred Shares could exercise their right to convert their PIKPreferred Shares into shares of Class A Common Stock at a conversion raterate of 137.14286 shares of Class A Common Stock per PIK Preferred Share.

As of the close of business on the Redemption Date,five PIK Preferred Shares had been redeemed by the Company with the redemptionprice being paid by the issuance of 187 shares of Class A Common Stock.Additionally, 62,916 PIK Preferred Shares had been converted by holders into8,628,473 shares of Class A Common Stock. As a result of thesetransactions, approximately 8,628,660 additional shares of Class A CommonStock are now outstanding and no PIK Preferred Shares are currentlyoutstanding.

On November 15, 2004, the Company entered into afactoring agreement to sell without recourse, certain receivables to anunrelated third-party financial institution. Under the terms of thefactoring agreement, the maximum amount available for the purchase of domesticreceivables at any one time is $15.0 million, which limitation is subjectto change based on the level of eligible receivables, restrictions onconcentrations of receivables and the historical performance of the receivablessold. The sale of receivables under the ongoing factoring agreement acceleratesthe collection of the Company’s cash, reduces credit exposure and lowers theCompany’s borrowing costs.

As discussed inNote 16 to the Consolidated Financial Statements included in Item 1 ofPart I to this Quarterly Report on Form 10-Q, the Company hascommitted to several major capital projects to expand its worldwide capacity,including the construction of a new spunmelt manufacturing plant in Suzhou, Chinaand the installation of new spunmelt lines in its current facilities in Cali,Colombia and Mooresville, North Carolina, as well as the installation ofadditional capacity in Nanhai, China. Remaining payments due related to theseplanned expansions as of October 1, 2005 totaled approximately$61.6 million and are expected to be expended over the remainder of fiscal2005 and fiscal 2006. The financial flexibility needed for these and other capitalprojects was provided in an amendment, dated March 16, 2005, to the BankFacility.

Based on the ability to generate positive cash flowsfrom its operations and the financial flexibility provided by the BankFacility, as amended, the Company believes that it has the financial resourcesnecessary to meet its operating needs, fund its capital expenditures and makeall necessary contributions to its retirement plans.

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On October 31, 2005, the Company announced that it is pursuing therefinancing of its Bank Facility and expects to close on the transaction beforethe end of fiscal 2005. The Company expects to lower its overall cost of debtand simplify its capital structure.

**Off-Balance Sheet Arrangements**

The Company does not have anyoff-balance sheet arrangements.

**Effect of Inflation**

Inflation generally affectsthe Company by increasing the costs of labor, overhead, and equipment. Theimpact of inflation on the Company’s financial position and results ofoperations was minimal during the first nine months of both 2005 and 2004.However, the Company continues to be impacted by rising raw material costs. See“Quantitative and Qualitative Disclosures About Market Risk’’ included inItem 3 of Part I of this Quarterly Report on Form 10-Q.

**New Accounting Standards**

In May 2004, the FASB issued FASB Staff Position No. 106-2,“Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003” (“FSP 106-2”). FSP106-2 permits a sponsor of a postretirement health care plan thatprovides a prescription drug benefit to make a one-time election to deferaccounting for the effects of the Medicare Prescription Drug, Improvement andModernization Act of 2003 (the “Act”), which was signed into law on December 8,2003. The Act introduced a prescription drug benefit under Medicare and federalsubsidies to sponsors of retiree health care benefit plans that provide abenefit that is at least actuarially equivalent to that of Medicare. Aspermitted under FSP 106-2, the Company made a one-time election todefer accounting for the effect of the Act and as more fully explained inNote 9 to the consolidated financial statements, in December 2004 theCompany approved plan amendments curtailing or eliminating variouspostretirement benefits in the U.S. As a result, the amounts included in theConsolidated Financial Statements related to the Company’s postretirementbenefit plans do not reflect the effects of the Act.

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs” (“SFAS No. 151”). This statement amends earlier guidanceto require that abnormal freight, handling and spoilage costs be recognized ascurrent-period charges rather than capitalized as an inventory cost. Inaddition, SFAS No. 151 requires that the allocation of fixedproduction overhead costs be based on the normal capacity of the productionfacilities. SFAS No. 151 is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. The Company is currentlyanalyzing the new guidance and does not expect it to have a material impact onits financial position or results of operations.

In December 2004, the FASB issued a revision toSFAS No. 123, “Accounting for Stock-Based Compensation.” The revision,entitled SFAS No. 123R, “Share-Based Payment,” is effective for all awardsgranted, modified, repurchased or canceled after June 15, 2005 andrequires a public entity to initially measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award and to remeasure the fair value of that awardsubsequently at each reporting date. Changes in the fair value during therequisite service period will be recognized as compensation cost over thatperiod. The grant date fair value is to be estimated using option-pricingmodels adjusted for the unique characteristics of those instruments. In April 2005,the Securities and Exchange Commission issued a final rule thatregistrants must adopt SFAS No. 123R’s fair value method of accounting nolater than the beginning of the fiscal year beginning after June 15, 2005.

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections.” Thisstatement amends earlier guidance and requires retrospective application toprior periods’ financial 

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statementsof a voluntary change in accounting principle unless it is impracticable. Inaddition, SFAS No. 154 requires that a change in the method ofdepreciation or amortization for a long-lived, non-financial asset be accountedfor as a change in accounting estimate that is affected by a change inaccounting principle. SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005. The Company is currently analyzing the new guidance and does not expectit to have a material impact on its financial position or results ofoperations.

**CriticalAccounting Policies And Other Matters**

The Company’s analysis and discussion of its financialposition and results of operations are based upon its consolidated financialstatements that have been prepared in accordance with accounting principlesgenerally accepted in the United States (“U.S. GAAP”). The preparation offinancial statements in conformity with U.S. GAAP requires the appropriateapplication of certain accounting policies, many of which require management tomake estimates and assumptions about future events that may affect the reportedamounts of assets, liabilities, revenues and expenses, and the disclosure ofcontingent assets and liabilities. Since future events and their impact cannotbe determined with certainty, the actual results will inevitably differ fromthe estimates. The Company evaluates these estimates and assumptions on anongoing basis, including but not limited to those related to fresh startaccounting, revenue recognition, sales returns and allowances and credit risks,inventories, income taxes, convertible securities and impairment of long-livedassets. Estimates and assumptions are based on historical and other factorsbelieved to be reasonable under the circumstances. The impact and anyassociated risks related to estimates, assumptions, and accounting policies arediscussed within “Management’s Discussion and Analysis of Financial Conditionand Results of Operations,” as well as in the Notes to the ConsolidatedFinancial Statements, if applicable, where such estimates, assumptions, andaccounting policies affect the Company’s reported and expected results.

The Company believes the following accounting policiesare critical to its business operations and the understanding of results ofoperations and affect the more significant judgments and estimates used in thepreparation of its consolidated financial statements:

*FreshStart Accounting:**  *Inconnection with the Company’s Chapter 11 reorganization, the Company hasapplied Fresh Start Accounting to its Consolidated Balance Sheet as of March 1,2003 in accordance with Statement of Position No. 90-7, “FinancialReporting by Entities in Reorganization Under the Bankruptcy Code” aspromulgated by the AICPA. Under Fresh Start Accounting, a new reporting entityis considered to be created and the recorded amounts of assets and liabilitiesare adjusted to reflect their estimated fair values at the date Fresh StartAccounting is applied. On March 5, 2003, the Company emerged frombankruptcy. For financial reporting purposes, March 1, 2003 is consideredthe emergence date and the effects of the reorganization have been reflected inthe accompanying financial statements as if the emergence occurred on thatdate.

Fresh-start accounting requires that thereorganization value of the Company be allocated to its assets and liabilitiesin conformity with SFAS No. 141, “Business Combinations.” Such allocationshave been reflected in the Company’s Consolidated Financial Statements. Basedon the consideration of many factors and various valuation methods, the Companyand its financial advisors estimated the reorganization value of the Company’snew common equity at approximately $73.4 million as of March 1, 2003.The factors and valuation methodologies included the review of comparablecompany market valuations and the recent acquisition values of comparablecompany transactions as well as discounted cash flow models. The discountedcash flow models utilized projected free cash flows for four future years, withsuch projected free cash flows discounted at rates approximating the expectedweighted average cost of capital (11.0% - 13.0%) plus thepresent value of the Company’s terminal value computed using comparable companyexit multiples. Projected free cash flows were estimated 

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based on projected cash flowsfrom operations, adjusted for the effects of income taxes at an effective taxrate of 39.0%, estimated capital expenditures and estimated changes in workingcapital. The calculation of the reorganization value of the Company was basedon a variety of estimates and assumptions about future circumstances andevents. Such estimates and assumptions are inherently subject to significanteconomic uncertainties. While the Company believes its judgments, estimates andvaluation methodologies were reasonable, different assumptions could havematerially changed the estimated reorganization value of the Company as of March 1,2003.

*RevenueRecognition:**  *Revenuefrom product sales is recognized when title and risks of ownership pass to thecustomer. This is generally on the date of shipment to the customer, or upondelivery to a place named by the customer, dependent upon contract terms andwhen collectibility is reasonably assured and pricing is fixed or determinable.Revenue includes amounts billed to customers for shipping and handling.Provision for rebates, promotions, product returns and discounts to customersis recorded as a reduction in determining revenue in the same period that therevenue is recognized. Management bases its estimate of the expense to berecorded each period on historical returns and allowance levels. Managementdoes not believe the likelihood is significant that materially higher deductionlevels will result based on prior experience.

*ConvertibleSecurities:**  *TheCompany records the accretion of dividends on the convertible securities basedon the stated rate in the securities. If the Company’s Board of Directors, atthe date of any dividend declaration, elects to satisfy the dividend obligationby payment-in-kind, the Company will recognize an additional dividend chargefor the excess, if any, of the fair value of the securities issued, at thedividend declaration date, over the amounts previously accrued at the statedrate. As the Company’s convertible securities are not traded on an activemarket, determination of the fair value of the securities, at the date ofdividend declaration, requires estimates and judgments, which may impact thevaluation of the dividend paid-in-kind. Based on the fact that theconvertible securities are deep-in-the money, the Company has estimated thefair value of the convertible security using the number of shares of theCompany’s Common Stock into which the security is convertible at thethen-current share price. While the Company believes its estimates of the fairvalue of the convertible security are reasonable, the utilization of differentassumptions could produce materially different fair value estimates.

*AccountsReceivable and Concentration of Credit Risks:**  *Accounts receivable potentiallyexpose the Company to a concentration of credit risk, as defined by Statementof Financial Accounting Standards No. 105, “Disclosure of Informationabout Financial Instruments with Off-Balance Sheet Risk and FinancialInstruments with Concentration of Credit Risk.” The Company provides credit inthe normal course of business and performs ongoing credit evaluations on itscustomers’ financial condition as deemed necessary, but generally does notrequire collateral to support such receivables. The Company also establishes anallowance for doubtful accounts based upon factors surrounding the credit riskof specific customers, historical trends and other information. Also, in aneffort to reduce its credit exposure to certain customers, as well asaccelerate its cash flows, in 2004 the Company sold, on a non-recoursebasis, certain of its receivables pursuant to a factoring agreement. At October 1,2005, a reserve of $10.3 million has been recorded as an allowance againsttrade accounts receivable. Management believes that the allowance is adequateto cover potential losses resulting from uncollectible accounts receivable anddeductions resulting from sales returns and allowances. While the Company’scredit losses have historically been within its calculated estimates, it ispossible that future credit losses could differ significantly from theseestimates.

*Inventory Reserves:**  *The Company maintains reserves forinventories valued primarily using the first in, first out (FIFO) method. Suchreserves for inventories can be specific to certain inventory or general basedon judgments about the overall condition of the inventory. General reserves areestablished primarily based on percentage write-downs applied toinventories aged for certain time periods. Specific reserves are establishedbased on a determination of the obsolescence of the 

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inventory and whetherthe inventory value exceeds amounts to be recovered through expected salesprice, less selling costs. Estimating sales prices, establishing markdownpercentages and evaluating the condition of the inventories require judgmentsand estimates, which may impact the inventory valuation and gross margins. Theactual amount of obsolete or unmarketable inventory has been materiallyconsistent with previously established reserves. Management believes based onits prior experience of managing and evaluating the recoverability of itsslow-moving or obsolete inventory that such established reserves are materiallyadequate. If actual market conditions and product sales were less favorablethan we have projected, additional inventory writedowns may be necessary.

*Impairment of Long-LivedAssets:**  *Long-livedassets are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amounts may not be recoverable. For assets held andused, an impairment may occur if projected undiscounted cash flows are notadequate to cover the carrying value of the assets. In such cases, additionalanalysis is conducted to determine the amount of the loss to be recognized. Theimpairment loss is determined by the difference between the carrying amount ofthe asset and the fair value measured by future discounted cash flows. Theanalysis, when conducted, requires estimates of the amount and timing ofprojected future cash flows and, where applicable, judgments associated with,among other factors, the appropriate discount rate. Such estimates are criticalin determining whether any impairment charge should be recorded and the amountof such charge if an impairment loss is deemed to be necessary. In addition,future events impacting cash flows for existing assets could render a writedownnecessary that previously required no writedown.

For assets held for disposal,an impairment charge is recognized if the carrying value of the assets exceedsthe fair value less costs to sell. Estimates are required of fair value,disposal costs and the time period to dispose of the assets. Such estimates arecritical in determining whether any impairment charge should be recorded andthe amount of such charge if an impairment loss is deemed to be necessary.Actual cash flows received or paid could differ from those used in estimatingthe impairment loss, which would impact the impairment charge ultimatelyrecognized and the Company’s cash flows. As of October 1, 2005, based onthe Company’s current operating performance, as well as future expectations forthe business, the Company does not anticipate any material writedowns for assetimpairments in the foreseeable future. However, should current businessconditions or expectations of future performance deteriorate, this may impactour future cash flow estimates, resulting in an impairment charge that couldhave a material effect on the Company’s Consolidated Financial Statements.

*Income Taxes:**  *The Company records an income taxvaluation allowance when, based on the weight of the evidence, it is morelikely than not that some portion, or all, of the deferred tax asset will notbe realized. The ultimate realization of the deferred tax asset depends on theability of the Company to generate sufficient taxable income of the appropriatecharacter in the future and in the appropriate taxing jurisdictions. Inassessing the realization of the deferred tax assets, consideration is givento, among other factors, the trend of historical and projected future taxableincome, the scheduled reversal of deferred tax liabilities, the carryforwardperiod for net operating losses and tax credits, as well as tax planningstrategies available to the Company. Additionally, the Company has not providedU.S. income taxes for undistributed earnings of foreign subsidiaries that areconsidered to be retained indefinitely for reinvestment. Certain judgments,assumptions and estimates are required in assessing such factors andsignificant changes in such judgments and estimates may materially affect thecarrying value of the valuation allowance and deferred income tax expense or benefitrecognized in the Company’s Consolidated Financial Statements.

**RecentSEC Review of Periodic Reports**

Section 408 of theSarbanes-Oxley Act of 2002 requires that the staff of the Securities andExchange Commission (the “SEC Staff”) review the filings of all reportingcompanies not less 

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frequentlythan once every three years. In accordance with that requirement, the SEC Staffrecently completed a review of the Company’s periodic reports and issued aletter (the “Comment Letter”) commenting on certain aspects of the Company’sAnnual Report on Form 10-K for the year ended January 1, 2005and Quarterly Report on Form 10-Q for the quarter ended April 2,2005. As of October 1, 2005, all issues raised in the Comment Letter havebeen resolved to the mutual satisfaction of the SEC Staff and the Company.

**Environmental**

The Company is subject to abroad range of federal, foreign, state and local laws and regulations relatingto the pollution and protection of the environment. The Company believes thatit is currently in substantial compliance with applicable environmentalrequirements and does not currently anticipate any material adverse effect onits operations, financial or competitive position as a result of its efforts tocomply with environmental requirements. Some risk of environmental liability isinherent, however, in the nature of the Company’s business and, accordingly,there can be no assurance that material environmental liabilities will notarise.

**ITEM 3.**                 QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed tomarket risks for changes in foreign currency rates and interest rates and hasexposure to commodity price risks, including prices of its primary rawmaterials. The overall objective of the Company’s financial risk managementprogram is to seek a reduction in the potential negative earnings impact ofchanges in interest rates, foreign exchange and raw material pricing arising inour business activities. The Company manages these financial exposures throughoperational means and by using various financial instruments. These practicesmay change as economic conditions change.

**Long-TermDebt and Interest Rate Market Risk**

The Company’s long-termborrowings are variable interest rate debt. As such, the Company’s interestexpense will increase as interest rates rise and decrease as interest ratesfall. It is the Company’s policy to enter into interest rate derivativetransactions only to meet its stated overall objective. The Company does notenter into these transactions for speculative purposes. To that end, theCompany, as required by the terms of its Bank Facility, entered into aninterest rate swap contract to convert $212.5 million of its variable-rate debtto fixed-rate debt. In addition, the Company includes short-term borrowings inits debt portfolio, especially in foreign countries, in an effort to minimizeinterest rate risk. Hypothetically, a 1% change in the interest rate affectingall of the Company’s financial instruments not protected by the interest rateswap contract would change interest expense by approximately $2.0 millionper year.

**Foreign Currency Exchange Rate Risk**

The Company manufactures,markets and distributes certain of its products in Europe, Canada, LatinAmerica and the Far East. In the Far East specifically, the Company has apresence in China, which revalued its currency in July 2005. As a result, theCompany’s financial statements could be significantly affected by factors suchas changes in foreign currency rates in the foreign markets in which the Companymaintains a manufacturing or distribution presence. However, such currencyfluctuations have much less effect on local operating results because theCompany, to a significant extent, sells its products within the countries inwhich they are manufactured. During the first nine months of 2005, compared tothe same period of the prior fiscal year, certain currencies of countries inwhich the Company conducts foreign currency denominated business strengthenedagainst the U.S. dollar and impacted sales and operating income, although notto as significant an extent as in 

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recentyears. See “Management’s Discussion and Analysis of Financial Condition andResults of Operations” included in Item 2 of Part I of this QuarterlyReport on Form 10-Q.

The Company has nothistorically hedged its exposure to foreign currency risk, although it hasmitigated its risk of currency losses on foreign monetary assets by sometimesborrowing in foreign currencies as a natural hedge. In addition, the Companyrecently entered into foreign currency forward contracts to manage itsU.S. dollar exposure on certain Euro-based obligations for firmcommitments related to significant capital projects. The Company is alsosubject to political risk in certain of its foreign operations.

**Raw Materialand Commodity Risks**

The primary raw materials usedin the manufacture of most of the Company’s products are polypropylene resin,polyester fiber, polyethylene resin, and, to a lesser extent, rayon, tissuepaper and cotton. The prices of polypropylene, polyethylene and polyester are afunction of, among other things, manufacturing capacity, demand and the priceof crude oil and natural gas liquids. The Company has not historically hedgedits exposure to raw material increases, but has attempted to move more customerprograms to cost-plus type contracts, which would allow the Company to pass-throughany cost increases in raw materials. Raw material prices as a percentage ofsales have increased from 48.2% in the first nine months of 2004 to 50.8% for thecomparable period of 2005.

In August and September of2005, Hurricanes Katrina and Rita hit the Gulf Coast area, temporarily shuttingdown a number of refineries and chemical processing sites of certain rawmaterial suppliers for the Company’s North and South American operations. As aresult, while supplies are tight, raw materials continue to be available to theCompany, but at significantly higher prices. The Company, where allowable basedon contract terms, has attempted to raise its selling prices to mitigate thespike in raw materials. The effect on the Company’s future results ofoperations is dependent upon, among other things, the ability to successfullymitigate raw material price increases, the duration of time it takes for thesupply chain to return to normal production, and the magnitude of the rawmaterial price increases. The Company is managing this situation closely in aneffort to minimize any adverse effects.

To the extent the Company isnot able to pass along price increases of raw materials, or to the extent anysuch price increases are delayed, the Company’s cost of goods sold wouldincrease and its operating profit would correspondingly decrease. By way of example,if the price of polypropylene were to rise $.01 per pound, and the Companywas not able to pass along any of such increase to its customers, the Companywould realize a decrease of approximately $2.9 million, on an annualizedbasis, in its reported operating income. Material increases in raw materialprices that cannot be passed on to customers could have a material adverseeffect on the Company’s results of operations and financial condition. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in Item 2 of Part I of this Quarterly Report on Form 10-Q.

**ITEM 4.**                 CONTROLSAND PROCEDURES

Under the direction of ourChief Executive Officer and Chief Financial Officer, the Company evaluated itsdisclosure controls and procedures as of the end of the period covered by thisreport. Based on that evaluation, the Chief Executive Officer and ChiefFinancial Officer have concluded that these disclosure controls and procedureswere effective, as of October 1, 2005.

There were no changes in theCompany’s internal control over financial reporting during the quarter ended October 1,2005 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

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**PART II. OTHER INFORMATION**

**ITEM 1.**                 LEGALPROCEEDINGS

Other than as reported in theCompany’s Form 10-K for the period ended January 1, 2005 underthe caption “Item 3. Legal Proceedings,” the Company is not currently a partyto any material pending legal proceedings other than routine litigationincidental to the business of the Company. See Note 16 to the ConsolidatedFinancial Statements included in Item 1 of Part I to this Quarterly Reportof Form 10-Q for additional details.

**ITEM 2.**                 UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the three months ended October 1,2005, five shares of the Company’s PIK Preferred Shares were redeemed and62,916 shares of the Company’s PIK Preferred Shares and 5,038 shares ofthe Company’s Class B Common Stock were converted into a total of8,633,698 shares of the Company’s Class A Common Stock. Theseredemptions and conversions were exempt from registration based on sections 3(a)(9) ofthe Securities Exchange Act of 1933.

**ITEM 3.**                 DEFAULTSUPON SENIOR SECURITIES

Not applicable.

**ITEM 4.**                 SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

**ITEM 5.**                 OTHERINFORMATION

Not applicable.

**ITEM 6.**                 EXHIBITS

Exhibitsrequired to be filed with this Form 10-Q are listed below:

| Exhibit  Number |                                                                                                           | **Document Description** | ** ** |
|-----------------|-----------------------------------------------------------------------------------------------------------|--------------------------|------------|
|            |                                                                                                      |
| 31.1            | Certification of  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |
| 31.2            | Certification of  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |
| 32.1            | Certification by the  Chief Executive Officer pursuant to 18 U.S.C. Section 1350                     |
| 32.2            | Certification by the Chief  Financial Officer pursuant to 18 U.S.C. Section 1350                     |

 

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

|                              |     | POLYMER GROUP, INC. |
|------------------------------|----------|--------------------------|
| Date: November 14, 2005 |     | By:                      |   | /s/ JAMES L. SCHAEFFER |
|                         | * * | * *                 | * * | James L.  Schaeffer |
|                         | * * | * *                 | * * | *Chief  Executive Officer* |
| Date: November 14, 2005 |     | By:                      |   | /s/ WILLIS C. MOORE, III |
|                         |     |                     |   | Willis C.  Moore, III |
|                         | * * | * *                 | * * | *Chief  Financial Officer* |

 

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